The financial whipsaw that has cut through the emerging markets in recent weeks has evoked bad memories of the 1990s when collapsing currencies, bank runs and IMF missions became commonplace.
Those crises – in Mexico in 1994/95 and in Asia and Russia later in the decade – were self-made. Today, the emerging markets have become caught up in the crossfire that began in the West and has now spread to all corners of the world.
Trying to make sense of what is happening is no easy task. Emerging markets are, for the most part, far better managed and have many more resources available than in previous crises but that seems to matter not a jot as even relatively strong countries are coming under attack. Indiscriminate selling is the order of the day as investors make a mad dash for the safe havens of the US dollar and treasuries. The sense of panic, moreover, shows no signs of going away.
Russia’s five-year CDS, for example, is trading at distressed levels of 1,123bp. Although Russia is still in reasonable shape compared to its peers, investors foresee greater risks ahead.
The sliding oil price potentially puts its current account and fiscal surpluses in danger of turning into deficits. Then there’s the $530 billion of external debt that the country’s corporates and banks have racked up this decade that the state may end up assuming. Last, and most importantly, is the fate of the rouble, which is at a two-year low against the dollar. With more than 85% of bank deposits now in roubles compared to 60% five years ago, further depreciation could lead to massive retail flight, maybe as much as $70 billion, according to Alfa Bank.
Never mind that Russia has built an impressive war chest of $487 billion of foreign exchange reserves and another $190 billion from oil reserves. That is apparently of little comfort to investors as its CDS spread trades on a par with Indonesia’s and wider than Iceland’s before it sought aid from the IMF.
Russia is still unlikely to tread a similar path but nothing can be discounted in this pernicious environment.
Other countries in central and eastern Europe are in trouble too. Hungary, the Baltics, Romania, Bulgaria and Ukraine all have a huge over-reliance on external capital. In Hungary, for example, 60% of all corporate and household borrowing is in foreign currency.
In total, the region has borrowed $1.6 trillion in dollars, euros, Swiss francs and even yen, according to the Bank for International Settlements, leant to a large extent by banks in western Europe. Some countries, such as Hungary, have pegged their currency in the Exchange Rate Mechanism as a precursor to joining the euro. The likelihood is that these currency pegs will be unsustainable.
While emerging Europe is the most vulnerable developing region it is not alone in its suffering. In Asia, Pakistan faces the threat of default. Korea’s government is fighting hard to shore up its banking system and economy by spending $130 billion.
In Latin America, Argentina is entering a financial abyss after its five-year CDS spread ballooned out to an incredible 3,800bp following the government’s announcement that it was to nationalize its private pension fund system. Both Brazil’s and Mexico’s central banks have had to prop up the real and peso to prevent systemic risk spreading from losses generated by corporates and financial institutions making bad bets in the FX derivatives markets. Even the Middle East is not immune to the crisis.
For so long the emerging markets held firm against the credit crunch. Yes certain countries with overleveraged financial systems, such as Kazakhstan, became embroiled. For the most part, though – despite falling stockmarkets, which in itself is less of an issue in most emerging nations because capital is largely provided by banks – financial systems seemed sound. Very few banks in the emerging markets were exposed to US sub-prime mortgages.
The intensifying of the financial crisis sparked by the Lehman Brothers bankruptcy has changed the landscape. The resultant beggar-thy-neighbour policies adopted by the US and some European countries in fully guaranteeing bank deposits have made emerging markets even more vulnerable. Risk aversion has led to a massive outflow of capital.
Supporting banking systems and preventing currencies from further collapse are the crucial tasks facing policymakers.
Some countries will need outside help. Ukraine and Hungary have already agreed emergency loans from the IMF. Belarus, Serbia and Pakistan are all in discussions with the Washington lender too. Others may well follow.
How far emerging markets assets will fall is anyone’s guess, though growing fears of a global recession will mean a continued liquidity squeeze.
Those fears have arisen because of the slowdown in the US and Europe. There is, though, another danger looming. If China’s economic bubble bursts then a global slump not recession will be on the cards. For emerging markets, the 1990s would then almost take on a rose-tinted hue in comparison.
