Has the Emerging-Economy Crisis Cycle Ended?
Judging by the limited contagion from the Turkish crisis, it seems that longstanding patterns in emerging markets may no longer apply. But that does not mean that emerging economies are in the clear; on the contrary, they still have plenty to worry about, not least an escalating trade war.
BOGOTÁ – Crises are nothing new for emerging economies, which have repeated the same patterns again and again, with often-devastating results. But have those patterns finally been broken?
Emerging economies have experienced boom-bust cycles in external financing for decades. The boom phase generates current-account, fiscal, and private-sector deficits – outcomes that are compounded by increases in domestic financing. Eventually, however, high debt levels lead to a loss of confidence and sharp cuts in external financing – a so-called sudden stop – producing balance-of-payments, fiscal, and financial crises.
Then, contagion sets in, as increasingly risk-averse investors, particularly short-term investors from developed-country markets, begin to withdraw funds from other countries to cover losses they incurred in the economies where the crises originated. With that, the crises spill across borders, affecting whole regions or even the entire class of emerging economies.
That is what happened in Latin America in the 1980s, when Mexico’s moratorium on external debt servicing in August 1982 sparked a region-wide debt crisis. The same thing occurred in East Asia in the 1990s: the crisis began in Thailand in July 1997 with the collapse of the baht, and quickly spread to other East Asian countries. It became a broad-based emerging-economy crisis in August 1998, after Russia imposed a moratorium on payments by commercial banks to foreign creditors.
The 2008 crisis played out a bit differently. It began in the developed world, with the fall of the US investment bank Lehman Brothers that September, and initially spread to emerging economies. But, after just over a year, the bust became a boom, as expansionary monetary policies in the developed world drove yield-seeking investors toward emerging markets.
The question that is now being hotly debated is whether this financing boom planted the seeds of a new emerging-economy crisis. We may soon learn the answer. After all, as history shows, all it takes is for one country to break down. Today, that country could be Turkey.
The Year Ahead 2019
Featuring commentaries by Joseph Stiglitz, Sri Mulyani Indrawati, Angus Deaton, Célestin Monga, Jean-Claude Juncker, and other leading thinkers. Now available for pre-order.
Last week, the Turkish lira plummeted, triggering the depreciation of more currencies, especially those of South Africa and Argentina, though all floating Latin American currencies also faced depreciation, as did those of the Czech Republic, Poland, Russia, and several East Asian countries, including China. Risk premia increased, and equity prices fell.
It is impossible to say for sure whether a new broad-based crisis is in the offing. After all, it would have been difficult to predict that the 1982 Mexican moratorium and the 1997 collapse of the baht would generate broad-based, protracted crises, or that the 2008 crisis would only briefly sweep up the emerging economies.
Nonetheless, there are reasons to think that old patterns may no longer apply. At its peak, during the week of August 8-15, the currencies of Argentina, South Africa, and Turkey depreciated by 8-14% against the US dollar. Yet the currencies of other emerging economies depreciated by no more than 4%.
This suggests that contagion is not taking hold as easily as it has in the past, and that broad-based sudden stops may be less likely. Even the most affected economies were able to limit the fallout of their currency collapses, with the Turkish authorities’ swift response to the lira collapse and the Argentinian central bank’s sharp interest-rate hikes having partly calmed markets.
This seems to reflect a new resilience to contagion that has formed over the last ten years or so. Emerging economies’ external financing was barely affected by the eurozone crisis, which peaked in 2011-2012, or the US Federal Reserve’s initial announcement, in 2013, that it would roll back its expansionary monetary policies. Even the commodity-price drop of 2014, which weakened the currencies of several commodity-exporting economies, brought no sudden stop in external financing. And the wave of capital flight from China in 2015 and early 2016 produced no broad-based effects.
This may be because investors are now taking a more nuanced approach to their analyses of country risk. Instead of painting all emerging economies with the same brush, they are accounting for each country’s economic fundamentals, domestic political stability, and relationships with others (for example, Turkey’s current diplomatic tensions with the United States).
So, judging by the limited contagion from the Turkish crisis, and from other recent episodes, it seems that old patterns may no longer obtain. But that does not mean that emerging economies are in the clear. On the contrary, they still have plenty to worry about, not least rising protectionist sentiment and trade tensions among major global powers. Smart policies, together with an improved global financial safety net from the International Monetary Fund, therefore remain of the utmost importance.