Emerging markets crisis: Everyone is looking at 1997

Share

We are starting to see a consensus over the severity of the emerging markets downturn: Bad, but no 1997. But is that a sign of complacency?

The date 1997 refers to the last Asian crisis, when foreign capital fled, currencies wilted, stocks plummeted and economic growth rates of economic superstars took a dramatic turn for the worse.

In other words, not a good time for investors – and it unfolded at a surprisingly brisk pace. The International Monetary Fund put it this way: "No one could have foreseen that these countries could suddenly become embroiled in one of the worst financial crises of the postwar period."

Needless to say, a repeat is a concern as money again flows out of the region, currencies weaken and stock markets wobble. The Indian rupee has fallen about 19 per cent this year, even after Thursday's bounce. And the iShares MSCI emerging markets exchange-traded fund – a good proxy for emerging market stocks – has fallen 16 per cent from its high point early this year.

Now, observers are busily comparing the two periods to see just how bad things could get this time around, but they are staying calm.

One big difference between then and now is the relative size of external debt. Paul Krugman, writing on his New York Times blog, looked at Indonesia's external debt as a share of gross national income (which is close to gross domestic product): It was elevated in the runup to the 1997 crisis, then surged during the crisis as the currency plunged. Today, Indonesia's debt level is about half what it was in the mid-1990s. In other words, solvency isn't a big fear today, as it was in the 1997 crisis.

As for India, its external debt is lower than Indonesia's today and below what it was in 1990s, suggesting little concern with the country that is bearing most scrutiny during the current emerging market jitters.

"Now, it's possible that I and everyone else who tried to understand what happened in the '90s has the wrong model. But given what we know, I'm relatively – though not totally – calm," Mr. Krugman said.

Then there is the issue of foreign currency reserves: Developing economies have far more of them now than they did in the 1990s. Ryan Avent at The Economist noted that from the start of 2000 to the start of 2008, reserve holdings rose nearly five-fold, to $4.7-trillion.

Governments can use reserves to help private firms, which is what India is now doing. Large reserves also improves a country's exposure to foreign currencies and puts less pressure on their own.

"Only war-torn Syria and embargoed Iran are seeing the 40-50 per cent plunges that currencies like the baht and the ringgit suffered back then," said Avery Shenfeld, chief economist at CIBC World Markets, in a note last week. "Bond yields in these countries, while higher than they were a few weeks ago, aren't that high in absolute, real yield terms, relative to historical norms."

Count Mr. Shenfeld among observers who believe a repeat of the 1997 crisis is unlikely.

Still, things are far from groovy. As Mr. Avent pointed out, one of the key risks comes from a policy mistake – say, aggressively raising interest rates in an attempt to defend a tumbling currency but with the effect of skewering the domestic economy.

The other risk is complacency. While dismissing comparisons to the 1997 crisis are no doubt comforting to investors, they suggest that the worst-case scenario is not built in to share prices – leaving a whole lot of downside should things deteriorate beyond expectations.