Emerging Markets Crisis; Long-Lasting Damage Is Possible

Article excerpt


As the financial crisis unfolds and deepens, there seems to be an expectation - even a hope - among policy-makers and analysts that, despite globalization, emerging markets have been somehow decoupled from the chaos, and will consequently grow sufficiently to prevent what is now a near-global recession from turning into something worse.

This is wishful thinking. The full impact of the current crisis may be delayed somewhat, but barring close attention and action, the effects on emerging markets threaten to be profound and long-lasting.

It is true that emerging markets began the year in reasonably good financial shape. According to a World Bank report published in June, as of the middle of 2007 the foreign exchange reserves at developing countries amounted to $3.2 trillion, just under 25 percent of their combined gross domestic product. The top five countries accounted for 60 percent of the total.

The good news is that those figures undoubtedly swelled during the 12 months ended June 30, 2008; the bad news is that growth in those foreign exchange reserves was almost certainly skewed in favor of oil and commodity-producing countries. For everybody else, the vertiginous increase in food and energy prices was extremely painful.

Needless to say, the steep decline in oil and commodity prices since mid-summer has been a welcome relief. But, on balance, the collapse in equity and debt prices around the world since September has more than offset the benefit of lower food and oil bills.

For much of this decade, private capital inflows - debt and equity - provided the much-needed fuel for growth in emerging markets. Last year, those inflows totaled a record $1 trillion, according to the same World Bank study cited above. The increase marked the fifth straight year of strong gains. The study notes, too, that net bank lending and bond flows have increased from virtually zero in 2002 to 3 percent of developing countries' GDP in 2007, while net foreign direct and portfolio equity flows have increased from 2.7 percent of GDP to 4.5 percent.

Accompanying the report was a 2008-2009 forecast for private fund flows. At the time, conditions were sufficiently uncertain that the bank's analysts felt constrained to make two projections.

Under a soft-landing scenario, private fund flows were expected to decline by about 15 percent in 2009 from 2007 levels. Under a hard-landing scenario, private fund inflows were forecast to drop by nearly 50 percent in 2009. Subsequent developments have, however, given new meaning to the phrase hard landing. It seems unlikely, for example, that forecasters could have anticipated that by late November stock prices in China, as measured by the Shanghai Composite Index, would have declined by nearly 64 percent as of earlier this month; that equity prices in India would be down by more than 55 percent; or that the Morgan Stanley EAFE world index would be down by nearly 50 percent. …