Plunging emerging market currencies on the prospect of US stimulus tapering have stirred memories of the 1997 Asian financial crisis, but analysts doubt a similar catastrophe is in the making.
“There are negative linkages (now) but I don’t think that we are in a repetition of the 1990s crisis,” said Jean Medecin, a member of the investment committee at the Carmignac Gestion asset manager.
While the Indian rupee has so far taken the worst beating, falling nearly 15 percent against the US dollar over the past three months, Indonesia’s rupiah and the Brazilian real are down 10 percent, and the Turkish lira over 5 percent in a trend that is frightfully reminiscent of the crisis that began in Thailand in mid-1997.
Back then, investors reacted by panicking, withdrawing funds en masse, resulting in the Thai bath eventually collapsing. The phenomenon then spread like a wildfire throughout Asia, and even to Russia, with foreign capital vanishing almost with the blink of an eye.
Short of capital, emerging countries suffered acute shortages of credit, plunging them even deeper into the crisis.
Fifteen years on, India’s Prime Minister Manmohan Singh last week said emerging countries are now much better equipped.
In 1991, India had only 15 days worth of foreign exchange reserves, he said.
“Now we have reserves of six to seven months. So there is no comparison. And no question of going back to the 1991 crisis,” he said.
This week, Nobel prize winning economist Paul Krugman wrote on his New York Times blog that in retrospect, the flood of money into emerging markets looks like a bubble.
But Krugman said “for the moment, I don’t see a good reason to believe that the bursting of this particular bubble will be catastrophic”.
Standard & Poor’s rating agency agreed.
In a report it called the capital outflows “disruptive not destructive”, and said most Asian developing nations will “weather the disruption without a sharp slowdown in economic growth or prolonged financial volatility”.
Krugman said “what made the Asian crisis of 1997-8 so bad was the high level of foreign-currency denominated debt, and that seems less of an issue now”.
The Economist’s Ryan Avent wrote on his blog that a bigger concern are potential policy errors on behalf of governments and central banks as they try to stem the slide of their currencies.
“Recklessly imposed capital controls could fuel panic and impair long-run growth,” he said.
India’s central bank has tried to stabilise the rupee for months with measures like hiking short-term interest rates and imposing capital controls.
“Worse still, central banks may strangle their economies with high rates in an attempt to protect their currencies’ values,” Avent said.
Thus the end of US monetary stimulus “risks squeezing demand around the world” when its purpose was to prop it up in rich countries.
Ratings agency Fitch said that “policy management will be the key factor in determining whether economic and financial stability is maintained in India and Indonesia following the intensified pressure on currencies and asset prices”.
Recent developments have not prompted it to revise ratings, it added.
So far, however, central banks seem to prefer hiking short-term rates rather than their main rates, which would slow investment, consumption and growth.
Turkey took that tack this week, hiking its overnight rate and shutting off other short-term rates to deter speculation against the lira, while keeping its main rate on hold.
However, the current situation is “a painful adjustment phenomenon” for emerging nations, said strategist Maarten-Jan Bakkum at Dutch bank ING IM.
“After years of rising currencies, emerging economies are now faced with structural problems. In the absence of remedies to cure the problem, they have corrected this through exchange rates,” he said.
Simon Derrick, chief currency strategist at BNY Mellon said that “letting the currency take the strain might be the smartest move for some emerging market nations”.
He noted that in 2008, when emerging markets last tried to stop the outflow of funds, they failed despite spending up to 20 percent of their foreign currency reserves.
Derrick suggested that central bank forex intervention during a time when easy money poured in only gave investors an artificially cheap exchange rate to enter the markets.
“It also provides an artificially advantageous price at which to leave now.”
Still, several countries have moved to defend their currencies.
Brazil, which had led emerging market complaints that Western stimulus measures had resulted in the appreciation of their currencies and eroded its competitiveness, turned around, saying it would make $55 billion available to prop up the real.
Turkey pledged to inject a minimum of $100 million per day, while India announced it would put $1.26 billion into the banking system by buying back long-term government bonds, although it said the move was aimed at making more credit available to boost economic growth rather than defending the rupee.
The investment outflow poses immediate risks for Turkey and India as they rely heavily on short-term foreign funds to cover their large current account deficits (6.5 percent of GDP for Turkey and 4.8 percent for India).
However tapering concerns is only half the story according to analyst Michael Hewson at CMC Markets.
“…the growth slowdowns being experienced in those markets have forced investors to look more carefully at the structural problems that are facing those particular economies, with India and Brazil in particular in the firing line, as growth slows and inflation rises,” he said.
India’s growth slumped to a decade low of five percent in the year to March with inflation now running at 5.8 percent, while Brazil is expecting 2.5 percent growth this year with inflation currently at 6.3 percent.