Emerging markets currency crisis is the product of the global liquidity deluge
Anthony Rowley says it is time for an international review of the amount of liquidity flooding the global financial system and the ability of markets, particularly in developing countries, to withstand massive movements of capital
Back in the 1990s, a few years before the Asian financial crisis erupted, I suggested to a senior International Monetary Fund official whom I was interviewing that unrestricted capital flows into emerging markets might not be an altogether good thing. His reply almost took my breath away and I am reminded of it now as we face another possible currency crisis.
It was necessary to expose emerging markets to global capital flows, he suggested, “to test their weak points”. This seemed to me at the time akin to saying that small farms should be connected to massive irrigation pipelines to see whether the ensuing deluge of water would wash them away.
Many countries in Asia duly went ahead and abolished capital controls in line with the neoliberal economic thinking of the “Washington consensus” which also conferred upon emerging markets the mixed blessing of portfolio inflows into and out of their newly established or recently revived stock markets.
Then came the 1997 crisis and among those that suffered most were Indonesia, where the rupiah fell last week to its lowest level in three years, barely above its 1998 crisis level, and South Korea. Malaysia, at that time also under the government of Prime Minister Mahathir Mohamad, wisely imposed capital controls.
Another IMF official cautioned before the 1997 crisis that that idea of “phasing in” capital market liberalisation, in order to test the waters before opening up fully, was not practicable. The denizens of the Washington ivory tower later relented to this view. But, by then, the horse had bolted and many saw little point in closing the stable door.
Today, we are again seeing a number of emerging market currencies in crisis territory – not least the Argentinian peso and the Turkish lira but also the Indonesian rupiah, while the Chinese renminbi is also coming under downward pressure. The Australian dollar, though hardly an emerging market currency, is meanwhile suffering a mini crisis.
This turmoil is partly collateral damage from US President Donald Trump’s absurdly irresponsible trade wars against China and others, and the impact that is having on market sentiment. And it is partly a result of rising interest rates in the United States and the consequent desire of global investors to chase yield not in emerging markets but in dollar investments.
What is scary about this impending new currency crisis is that it could also precipitate a debt crisis, especially in Asian and other emerging markets and particularly in the corporate sector. Dollar or other foreign currency-denominated debt becomes harder to service in terms of local currency earnings once those currencies start to slide.
What is happening now in corporate debt markets, mainly in emerging economies, should be worrying people much more than it is. Why? For one, corporate debt in emerging and developing economies now significantly exceeds levels before the 2008 global financial crisis.
As pointed out in a previous column, the World Bank has noted that the increase in corporate debt ratios over the past decade has been “most pronounced in East Asia and the Pacific”.
What is important now is to consider the possibility that re-imposition of capital flows may be on the cards in countries where signs of distress emerge – and that open capital regimes need to be re-examined.
To go back to the parallel between global capital flows and irrigation systems, the liquidity in the main conduit has grown massively as a result of huge quantitative easing exercises by the world’s leading central banks in response to the global financial crisis in 2008.
Much of this liquidity subsequently flowed to emerging markets to escape derisory yields on financial securities in advanced economies, not least in the US. This process is being reversed now, and with US interest rates rising – and set to rise further – more money will exit emerging markets.
It is surely time for an international review of the size of global liquidity relative to the ability of stock and bond markets around the world – especially those in emerging markets – to absorb massive inflows and outflows without suffering systemic failure at the national or global level.
Asian and other emerging markets have erected some defences against financial crises since 1997, not least by building up foreign exchange reserves and arranging currency swaps at government level. At the corporate level, there is better matching of debt maturity and currency risks. But even these defences could be washed away by the tide of global liquidity.
Whether an administration in the world’s largest economy that is obsessed with “making America great again” by cutting others down to size is capable of leading a global reform initiative is, to say the least, open to question. Maybe only another crisis can precipitate needed reforms.
Anthony Rowley is a veteran journalist specialising in Asian economic and financial affairs