Turmoil in emerging economies

The recent G20 summit discussed a new phenomenon – economic turmoil beginning in some major developing countries. Coordination to prevent future crises is still elusive.

by Martin Khor

What a difference half a year makes. At the G20 summit of the world’s major economies held in the first week of September, attention turned to the weakening of the emerging economies.

This was a contrast to previous summits.  Then, the major developing countries were seen as the drivers of global growth, as the developed countries’ economies were faltering.

For two years or so, the European crisis was the focus of anxiety. The American economy was also plagued with domestic problems. The economies of the developing world, including China, India, Brazil and Indonesia, were the safety net keeping the global economy afloat. 

But in its report for the G20 summit in St. Petersburg, the International Monetary Fund (IMF) had to do an embarrassing about-turn.  It reversed its previous theory that the emerging economies were on the fast track and keeping global growth going. It now warned that the stagnation in these countries is now a drag on the global economy.

Victims

Developing countries’ leaders correctly point out that their economies have been victims to the developed countries’ monetary policies, especially the United States’ “quantitative easing” (QE), under which the US Federal Reserve has been pumping $85 billion a month into its banking system.

A lot of this ended up in developing countries’ equity and bond markets, as US investors searched for higher yields there, since the US interest rates have been kept near zero.

However, when the Fed chairman indicated the QE would be “tapering off” and long-term interest rates started rising in response, the capital invested in developing countries has been flowing back to the US.

Vulnerable emerging economies have been hard hit, and worse may yet come. Especially vulnerable are those which have a current account deficit, since they depend on capital inflows to fund these deficits.

The outflow of needed capital and the increased risk have caused their currencies and their stock markets to plunge. This in turn leads to more capital outflow, due to anticipation of further falls in equity prices and in the domestic currency itself. The currency depreciation also fuels inflation.

Thus, former stalwarts India, Indonesia, Brazil, South Africa and Turkey are now the victims of a vicious circle.

In Indonesia, the currency fell in the first week of September across the 11,000-rupiah-to-the-dollar mark (it was 9,500 a year ago), as the July monthly trade deficit rose to $2.3 billion and the annual inflation rate hit 8.8% in August.

In India, the currency fell to 68 rupee to the dollar (from 56 a year ago) before recovering to 65 rupee after a well-received inaugural media conference by the new central bank governor on 5 September.

India’s current account deficit is running at around $90 billion a year, making it very dependent on capital inflows. In mid-August, the government introduced limited capital control measures including restricting citizens’ money outflows to $75,000 a person (from $200,000 previously) and restraining local companies’ investments abroad.    

The current account deficits are also significant in South Africa ($25 billion in the latest 12 months), Brazil ($78 billion) and Turkey ($$54 billion), making them vulnerable to the vagaries of capital flows.

The South African rand has fallen in value by 18%. President Jacob Zuma blamed the currency slide on the potential tapering of the US quantitative easing. “Decisions taken by countries based solely on their own national interest can have serious implications for other countries,” he justifiably complained.

Countries affected have a few policy tools to deal with the situation.  One is to try to stabilize the currency through the central bank purchasing the local currency by selling the US dollar. But this is expensive, and the country may draw down its reserves, especially if speculators keep betting that its currency will fall by more. This is the bitter lesson that Thailand and others learnt in the 1997 Asian financial crisis. 

Another policy measure is capital controls. Ideally this should be imposed to prevent inflows. But most countries allow the inflows in the good times, and then when these suddenly turn into outflows, the boom-bust problem is laid bare.

Malaysia in 1998-99 imposed controls on outflows of both residents and foreigners, which was effective in stopping the crisis. It was heavily criticized at that time, but now even the IMF is recommending capital controls if the situation is bad enough.

Ultimately there have to be international reforms to prevent excessive capital flows from the source countries, and developed countries have to be disciplined so that their economic policies do not have negative fallout effects on developing countries.

But we will have to wait for such useful international coordination on capital flows and economic policies to take place.                                            

Martin Khor is Executive Director of the South Centre, an intergovernmental policy think-tank of developing countries, and former Director of the Third World Network.

Third World Economics, Issue No. 553, 16-30 Sept 2013, pp6, 11