Despite this summer’s sell-off that drove down many of their currencies, emerging markets (EMs) are strong enough to make any widespread systemic crises unlikely in the future, says Legal & General Investment Management (LGIM).
In its Fundamentals briefing, LGIM’s emerging market strategist, Brian Coulton, says there are challenges ahead for EM policymakers, but he does not anticipate the crises of the past to reoccur
“Discussions of the Federal Reserve tapering its asset purchases sparked currency stress in some major EM economies with several exchange rates falling by 15% or more between May and August this year. This induced flashbacks of the frequent crises of the 1990s and called into question whether we are on the brink of entering a similar era,” says Coulton, noting that South Africa, Indonesia, Turkey, Brazil and India had been singled out by the market as a ‘fragile five’ at particular risk because of external funding requirements.
“But we must keep things in perspective. The majority of the largest EM economies do not face major external funding challenges, and those that do are still mostly in much better shape than in the 1990s. The currency volatility to date is very small in comparison to previous crisis episodes and this resilience is down to three main factors.”
First the imbalances are not particularly widespread. Among the largest EM economies, four have a surplus or balanced current account and it is difficult to identify an entire EM region with the external imbalances that characterised previous crises. Second, foreign direct investment capital inflows remain strong in many of the major EM economies, covering most of the current account deficits in much of Latin America, for example.
“Third, external solvency looks relatively robust and has improved markedly across many of the major EM economies since the 1990s” says Coulton. Among the largest, China, Russia, Korea and Thailand are all net external creditors, while Brazil and Mexico have gross external assets roughly equal to external debt. Even among the more vulnerable ‘fragile five’, external balance sheets have generally improved sharply compared to the picture that preceded earlier crisis episodes.
Weaker exchange rates in deficit countries in combination with better demand prospects from the advanced economies should help reduce imbalances over time. “There are important areas of vulnerability – including Turkey where external finances are weaker – and if China’s hard landing fears were to re-emerge, challenges for EM policymakers would intensify,” Coulton concludes. “But for now, the tapering shock is unlikely to threaten a sharp collapse in EM growth.”
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