Storm clouds over emerging economies

In recent weeks, the currencies and bonds of indebted countries have plunged into crisis and IMF bailouts again loom. Kyran Fitzgerald surveys the risks to the rest of the world.

Twenty years ago, the IMF was called in to organise bailouts of a host of previously high-performing East Asian countries which had developed serious difficulties.

Countries such as Thailand, Indonesia, and even South Korea found themselves on the brink of collapse.

Turkey’s president Recep Tayyip Erdogan addresses members of his ruling party in Istanbul earlier this month. Turkey’s external debt has exploded on the back of cheap money from overseas, and all the indications are that the law of economic gravity is about to finally prevail with perhaps devastating consequences. Pic: AP

It emerged that South Korea’s actual financial reserves were well below the officially stated figures.

The rescue succeeded, and the affected East Asian economies rebounded.

Japan, however, has yet to fully recover from the consequences of the implosion in its property market.

At this time, the course of recent Russian history had been altered as a result of the economic mismanagement that occurred during the years of Boris Yeltsin’s rule.

1998 was also the year when investors lost their shirts in Moscow and, not long after, the long rule of the hardline nationalist, Vladimir Putin began.

So is history about to stage a repeat performance as so-called emerging market countries from Brazil to Turkey face into a new period of financial turbulence?

Last week, IMF chief Christine Lagarde arrived in Buenos Aires to meet with Argentina’s president Mauricio Macri.

This was no routine, ‘getting to know you’ encounter.

The South American nation, which endured its own meltdown a decade and a half ago, with much of its middle class financially wiped out following a debt default, is reliving an old nightmare.

The centre-right president has struggled to deal with the poisonous legacy of his left populist predecessor, Cristina Fernández de Kirchner and with the longer-term consequences of economic mismanagement dating back decades.

President Macri has baulked at carrying out the sort of economic reforms sought by lenders.

Mauricio Macri

The country’s currency, the peso, has tanked, forcing the authorities to raise interest rates to a staggering 40%.

In 2001, Argentina defaulted on around $132bn (€110bn) worth of foreign debt.

The IMF is on hand to prevent a repeat, but the fear is that ordinary citizens will be faced with another devastating bout of austerity as the country moves back into an IMF programme.

The turn in fortunes has been speedy. Last year, Argentina issued a 100-year bond which was heavily oversubscribed.

More recently, investors have been rushing to the exits.

Several time zones away lies Turkey. Here, too, the wolves may be circling.

Its authoritarian-populist leader, President Recep Erdogan, has presided over a popularity-boosting era of heroic overspending.

He has managed to keep the party going up to key elections in which he is expected to cement his authority.

But all the indications are that the law of economic gravity is about to finally prevail with perhaps devastating consequences.

Turkey’s external debt has exploded on the back of cheap money from overseas.

Between 2002 and 2014, the economy almost quadrupled in size, with most of the growth accounted for by a construction and consumption surge rather than by investment in genuinely productive capacity.

In recent years, commentators have been warning about the consequences of this runaway growth.

By 2014, the country’s external debt reached $372bn, or 47% of GDP.

In the fourth quarter of 2017, external debt amounted to over $453bn, or over 53% of GDP.

Several other large emerging economies have enjoyed similar bubble growth trajectories.

In many ways, the story of emerging markets is part of the dark side of quantitative easing as cheap money flooded into these economies in search of higher returns.

The parallels with the Noughties lending boom are not hard to spot.

It would seem that the fox — or foxes — may not be far from the chicken coop.

The Financial Times reported at the weekend that “the investor pullout from emerging markets has accelerated with equity funds suffering their worst outflow in nearly a year” while bond markets have also been hit.

We have been here before, of course. In 2013, we were faced with the so-called taper tantrum when the US Federal Reserve signalled its intention to unwind its ‘easy money’ strategy, causing ructions in financial markets.

In 2015, financial markets in China tanked on the back of reports of dangerous levels of over-lending and over-capacity.

That country’s strong state intervened to staunch the fires.

On this occasion, however, there are real concerns that a major geopolitical event could act to trigger financial market contagion.

Several large economies are indebted and exposed.

The Trump administration’s withdrawal from the nuclear deal with Iran has been accompanied by a spike in oil prices.

A surge in energy prices in 2008 helped trigger the markets’ meltdown.

This time, many more alternatives exist. However, any conflict leading to disruption in oil supply from the

Arabian peninsula would have obvious impacts.

But leaving such speculation to one side, other actions could serve as triggers of crisis, including an extension in international trade conflict and a misjudgement on the part of the Federal Reserve.

Its new chairman, Jerome Powell, the world’s top central banker, is still finding his way.

What is clear is that what happens to emerging market economies in the coming years will impact on us all.

The ECB estimates that these economies account for almost two-thirds of global GDP.

Growth in these economies slowed.

As debt falls due to be tackled, further steeper falls are in prospect.

The concern is that, as these economies adjust, the world financial system could take a hit.

The ECB paints a relatively rosy picture, arguing that many of these countries appear better able to withstand external shocks than in the past.

The central bank argues many have “stronger economic fundamentals”, more flexible exchange-rate regimes and more substantial foreign exchange reserves.

However, I recall similar arguments being used about Irish banks as the property boom drew to a close in 2007. The ECB has got it wrong before.

Between 2010 and 2014, the total external debt of emerging market countries rose from $3 trillion to $5 trillion (€4.18 trillion). This constitutes a rather large iceberg.

Take Turkey. What happens if, or when, that country hits the rocks.

It is not hard to imagine its president seeking a large financial bailout from the EU as a condition for continuing its deal with Europe over housing migrants in his country.

This is but one of the many consequences that could flow as chickens come home to roost following the long era of easy lending into emerging market countries that that has greatly flattered our global growth performance.


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