Emerging markets’ resilience tested
By Alan Beattie
08.10.2008 - "The Financial Times"
Financial infernos in the developing world are usually episodes of spontaneous local combustion: the Mexican “tequila crisis” of 1994-5; the Asian and Russian financial crises of 1997-8; and Argentina’s debt default of 2001.
But the firestorms that swept emerging market assets this week leapt across from the crises burning in Europe and the US.
Optimists still argue that many big emerging markets have done much to raise their defences. But Monday’s huge corrections in equity markets have undermined the idea that the developing world has grown immune to shocks to confidence, international capital flows and trade.
In theory, emerging markets are much more secure than during previous episodes of weakness – such as Latin America’s “lost decade” in the 1980s or the Asian and Russian financial crises.
“No one wants to try to catch falling knives but, while the market moves have been dramatic, you could cut off most of the emerging currencies from external capital for a long time and they would still be fine,” says Jerome Booth, head of research at Ashmore, a leading specialist emerging-market investor. “The emerging world has taken out a lot of insurance against potential problems”.
Fewer big emerging market countries are heavily dependent on overseas investors than in previous episodes and their public finances, in particular, are in much better shape. A decade after the Asian and Russian financial crises, emerging Asian countries have maintained current account surpluses – last year averaging 5 per cent of gross domestic product – and built up hefty official foreign exchange reserves.
Michel Camdessus, the former managing director of the International Monetary Fund, forecast in a speech in Manila on Tuesday that, “thanks to the dynamism of Asia, the global economy will avoid recession”.
Many Latin American countries have also shaken off the fiscal and current account profligacy for which the region was once famous, and commodity exporters across the emerging world have benefited from the big rise in food, oil and metals prices.
Only in central and eastern Europe are there the big current account deficits, rapid recent inflows of capital and extensive foreign ownership of banks that make economies particularly vulnerable to a sudden decline in investor sentiment.
Falls in share prices have been dramatic but the equity markets of most emerging market economies are far less developed than their counterparts in the rich world. Consumers and corporate financing are, thus, less susceptible to falling stock prices.
But Arvind Subramanian of the Peterson Institute for International Economics in Washington warns that, at times of fear and uncertainty, logic might be overthrown. “Sometimes the outcomes prove to be completely disproportionate to the triggers,” he says.
There are, broadly speaking, two channels for the credit crunch to be transmitted: through financial market stress and through the effect on the real economy.
Sectors with exposure to foreign finance and more risky and speculative economic activity have taken a hit, and there have been outbreaks of localised panic from spasms of unfocused fear. The markets’ manic Monday saw US Treasury yields fall, but the spread between US Treasury bonds and emerging market bonds, as measured by JPMorgan’s benchmark “EMBI+” metric, blew out to its highest since 2004.
In Peru, for example, a rush of activity from so-called “junior” mining companies – adventurous outfits that rely on capital markets to finance their exploration – has tailed off, as falling metals prices and the credit crunch have deprived them of momentum.
“To me the exploration business is over, in this kind of a market,” says Kerry Smith, of Canadian investment dealer Haywood Securities. “Particularly exploration on greenfields projects, where you have no resources, wildcat drilling . . . you have to be prepared for it to take five years before [the financing] comes back.”
In South Africa, confidence that tough regulation has prevented the banking system being poisoned by the kind of toxic assets that have infected US and European banks is tempered by the need to keep attracting foreign capital.
Pretoria has a current account deficit equivalent to 9 per cent of gross domestic product, the Johannesburg Stock Exchange has lost 30 per cent of its value over the past 12 months and raising fresh banking capital has become extremely expensive.
India recently experienced a mini-run on ICICI Bank, the country’s second-largest lender, despite official reassurances that it was well capitalised.
Further down the line, slowing or shrinking export markets in the US and Europe will test the ability of emerging markets to generate their own domestic demand, and undermine those countries – particularly in Latin America – benefiting from the high prices of commodity exports.
“My original worry was that the main risk [to emerging markets] would come from a slowdown in the industrial economies,” says Geoffrey Bell, a New York-based financial adviser to governments. “Now that’s an established fact.”
In Mexico, for example, although the banking system is strong the economy remains highly dependent on its northern neighbour: 80 per cent of Mexican exports go to the US, equivalent to 25 per cent of GDP, and some economists have revised down growth expectations sharply to 1 per cent or below for next year. “The mood has gone from one of ‘Mexico is strong and has its own motors for growth’ to one of ‘Wow. Mexico is going to get clobbered’,” says Damian Fraser, of UBS Pactual in Mexico City.
Developing economies have varying degrees of room to respond to any slowdown with fiscal and monetary policy. In China, if anything the crisis might be a blessing in disguise, taking pressure off Beijing to raise interest rates to slow the economy. Countries such as India, with a weak fiscal position and rising current account deficit, have less room for manoeuvre.
Additional reporting by Tom Burgis, Stephen Fidler, Matthew Green, Naomi Mapstone, Raphael Minder, Adam Thomson and Stefan Wagstyl
SOUTH KOREA: Falling won takes toll
Taesan LCD was a small but profitable South Korean flat-panel TV parts maker with annual revenues of about Won600bn before it was hit by the global credit crunch.
The company became the first big South Korean victim of the financial turmoil, filing for a debt-workout programme last month after suffering investment losses of Won80.64bn ($70m, €49m, £38.5m) on currency option trading in the first half of the year amidst the currency’s sharp decline against the dollar.
Taesan is not alone. A number of small and mid-sized enterprises in the country are facing heavy losses from currency hedge trades that went the wrong way.
The won has fallen almost 30 per cent this year to become the worst performing important currency and South Korea is expected to suffer its first annual current account deficit since the 1997-98 Asian financial crisis.
The plight of Taesan and other SMEs prompted the government to take measures to protect them, and earlier this month officials announced a plan to inject more than Won4,300bn to help enterprises struggling with the liquidity crunch.
But the crunch that the small companies face is unlikely to ease any time soon as the won is set to remain under pressure. “The volatile [foreign exchange] market and overshooting [exchange] movements are likely to drive some SMEs to default,” Bryan Song, head of research at Merrill Lynch in Seoul, said in a recent report.
By Song Jung-a in Seoul
EASTERN EUROPE: Investors take flight
While much of the world’s attention has been taken by the astonishing economic rise of China and India, it is central and eastern Europe that have been scooping up much of the capital.
But just as the big inflows of money to east Asia in the 1990s ended in crisis, so relying on footloose foreigners to finance investment has also put the region at risk of a severe reversal.
In 2007 central and eastern Europe overtook emerging Asia as the single biggest recipient of the flows of capital into emerging economies. It took in $365bn out of a global total of $780bn, most of which was debt and nearly half of which went to Russian corporates.
Even in the first half of 2008, confidence remained and the region continued to borrow. But with oil prices falling and investors fleeing from risky assets, not to mention Russia’s aggressive foreign policy, financial markets and systems have started hurting badly. Russian equities are 60 per cent off their peak; Ukraine’s are down more than 70 per cent. Banking systems are seizing up, notably in Russia, Ukraine and Kazakhstan.
Further west, the Baltic states, with more stable politics but without huge energy exports, have built up large current account deficits they are struggling to finance. Latvia and Estonia are in recession; Lithuania may follow. Romania and Bulgaria, labelled “gravity-defiers” by the European Bank for Reconstruction and Development, are growing fast but also have imbalances.
By Stefan Wagstyl in Kiev
Additional reporting by Alan Beattie
NIGERIA: Fears for oil exports
Nigeria has been largely immune to the short-term volatility roiling more established emerging markets.
But analysts warn that the turmoil on Wall Street could pose longer-term risks to prospects for a recovery in sub-Saharan Africa’s second biggest stock exchange if it fuels a global slowdown that saps prices for oil exports.
Nigeria enjoyed one of the strongest performances of any emerging market last year on the back of surging demand for banking stocks following a successful consolidation exercise.
Flush with cash, banks such as United Bank for Africa, First Bank and Access Bank used the funds to expand across the continent.
But growing global concerns over bank valuations helped trigger a steep correction in Lagos – where banks make up about two-thirds of the total market capitalisation of $85bn (€62bn, £48bn). The NSE All Share Index has lost 31.44 per cent since March 5, according to Afri-Finance, the advisory firm.
Although foreign investors have played a role in influencing sentiment in Nigeria, last year they accounted for only about 12 per cent of the value of transactions, limiting their potential to cause havoc with a hasty retreat. Nigerian banks are, however, concerned that the credit crunch will make it harder to secure credit lines in the US and Europe for trade finance.
Another worry is how banks will manage their losses in the local market. Much of last year’s gains were driven by banks lending money for share purchases that have soured.
By Matthew Green in Lagos
MEXICO: Dollar flows dry up
For the past seven years Catalina Valdespina has been building a modest single-storey house in Senguio, a small town in the Mexican state of Michoacán, with dollars sent by her two sons who work in the US.
By last November, she had managed to tile the floors of the three bedrooms and she was about to start saving to tile the bathroom and put down a kitchen floor. Then, almost overnight, she had to stop everything. “I thought I’d have it all finished by this year but, well, things changed,” she says.
The change was in the fortunes of the US economy.
Her sons, who had been working informally in the US construction sector, found it ever more difficult to get work and the monthly transfers back home of $200-$300 (€147-€220, £114-£170) dried up. Ms Valdespina has not received a cent from them all year.
The US downturn and the financial crisis have started to hit millions of Mexican families who for years have relied on remittances – the money that mainly undocumented migrant workers send home. Mexico’s central bank last week reported the biggest single yearly fall in remittances – 12.2 per cent in August – since it started keeping records. The bank said it expected further falls in coming months.
Senguio is one of dozens of towns in Michoacán and other Mexican states that have long depended on remittances. “There is no work so migrants are sending less and less money back,” says Rubén Sánchez Sanguino, the parish priest. “People here are desperate.”
By Adam Thomson in Senguio, Mexico
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