The head of the US Federal Reserve, Janet Yellen, delivered the latest statement on behalf of a body which can shake up global financial markets like a cocktail waiter. Analysts and traders have been watching like hawks for signs that the Fed will move to raise interest rates in an effort to see off any emerging inflationary pressures. As usual, her words were parsed carefully.
Ms Yellen appeared to confirm that there would be no hike in rates before the spring. This is no great surprise, given the deflationary impact of the recent drop in oil prices and those of other commodities.
In the back of her mind, the world’s most powerful central banker will no doubt be aware of the impact of any move she makes on the global economy. Already, the dollar has surged and investors have pulled back from emerging market countries into which they were attracted, in large part because of a search for yield in a low to zero interest rate environment.
Yellen must tread carefully. She moves steadily, like a cautious butler carrying a piece of valuable Meissen pottery across a slippery, polished floor. With oil prices and the rouble in freefall in recent weeks, the word ‘contagion’ and the date ‘1998’ have been on the minds of many.
The question people have been asking themselves is: Are we about to witness a re-run of the financial crisis that engulfed East Asia in 1997 before spreading to topple Russia’s banking system the following year, paving the way for the eventual accession of Vladimir Putin to power in the Kremlin?
Over the past 18 months, there has been much talk of ‘tapering’, the gradual pullback from the strategy of quantitative easing pioneered by Yellen’s predecessor, Ben Bernanke. Emerging countries, such as Turkey and Indonesia, where investment bubbles have been financed by capital inflows from the West, have fallen out of favour. Their currencies have been tumbling.
The Turkish lira has fallen to a record low, along with Indonesia’s rupiah. Venezuela is now a basket case, due to a combination of spectacular economic mismanagement and the plummeting price of oil.
Its troubles played no small part in the conclusion of this week’s deal between US president Barack Obama and Cuban president Raoul Castro. The Cuban leadership must now that the largesse available on tap from the Venezuelans is on the point of drying up.
Russia’s travails are there for all to see. This week, Putin warned of two years of austerity during a lengthy end-of-year press conference. The oil price plunge has also impacted on many groups in the West.
Aberdeen, Scotland’s gilded oil capital, has been witnessing lay-offs, salary freezes, and cuts in pay to contractors. Average borrowing costs for energy companies in the US high yield debt market have doubled from an all-time low of 5.68% to 10.43%.
The Bank of International Settlements has been warning about the high levels of foreign borrowing by emerging market companies through the bond markets. Since September 2008, officially, almost $700bn in bonds have been issued by these countries — this figure rises to $1.2tn (€980bn) when issues through offshore subsidiaries in low-tax jurisdictions such as the Cayman Islands are included. Russian firms have issued $115bn and Brazilian firms, $175bn worth of the bonds.
As The Economist has pointed out, many issuers are multinationals with decent revenues, much of it earned overseas. However, property firms dependent on local revenues account for the lion’s share of Chinese bond issues.
The average term is around 10 years, meaning that, in many cases, refinancing of these loans is not yet an issue.
However, yields fluctuate in the case of long-dated bonds. There is also a concern that, as local currencies depreciate against the US dollar, the cost of financing the bonds rises, leaving some issues in a very vulnerable situation.
They, in turn, must rein in their spending, potentially exacerbating the impact of the downturn in economies, often dependent on commodities and contract manufacturing, both of which have been hit hard, in particular, by China’s economic reorientation and thinly disguised slowdown.
Analysts have been watching for parallels with the 1998 financial crisis: They have found both similarities, and important differences. In 1998, oil prices were tanking and emerging market currencies in freefall.
Down they went, dominoes including Thailand, Korea, Malaysia, and Indonesia. Wall Street funds crashed, leaving investors badly burned. This time round, the oil price had halved since the summer and a Venezuelan default on bonds is predicted.
However, one of the countries then in the eye of the storm, South Korea, soon rebounded from collapse and is today far more powerful economically than many Western economies. The IMF has calculated that, as a group, emerging markets now hold just over $8tn in reserves compared to just over $650bn in 1999. Back then, emerging countries were, economically speaking, 10-stone weaklings.
Today, they are far bigger, if more than a bit bloated, in some cases. It will not be so easy to kick sand in their faces — and they are less likely to fall down, damaging shareholders, all in the process.
It is also worth noting that, these days, they are a disparate group. Some, like South Korea, have ascended to the ranks of the high achievers. Others have ‘property and financial bubble’ written all over them, or have just blown the commodity price boom. Some, like Turkey, are in the category of ‘high risk, high potential.’
Others, like Russia, are one-trick ponies with an alarming propensity to either topple or kick out.
One key emerging economy, India, has withstood well the pressure of the markets, standing to benefit from falling commodity prices and being much less exposed to the Chinese economy.
Some investors believes that shares in many emerging economies are now oversold, though many expect that these countries will have to undergo what painful economic restructuring, with possible implications for political stability.
One thing seems clear: 2015 will not be a dull year for those who follow the fortunes of BRICS, like Brazil and Russia, never mind the long list of other challenged, but challenging New World players.
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