Over the past two decades emerging markets have seen a number of sovereign crises. In the 1990s and early 2000s crises often originated from a mix of poor governance, fixed currency regimes and unsustainable debt loads with crisis in one country having a negative effect on the general risk assessment towards the whole asset class. Much has changed since then. Improved governance including financial liberalisation where privatisations and FDIs are welcome has gone hand in hand with far more credible monetary policies. Thanks to greater transparency, in depth analytic coverage and a broader investor base, a crisis in one country now stands a far better chance of being contained to that specific country.
Mexico in 1994
A deteriorating external balance, a managed currency regime, lack of competitiveness and worries over Mexico’s ability to service its existing debt made foreign investors dump Mexican assets thereby putting the Mexican peso under extreme pressure. On 21 December 1994 the government abandoned the seven year old managed currency regime resulting in a depreciation of approx 35% against the dollar over the following two months. The floating of the Mexican peso was the start of a Latin American beggar thy neighbour chain reaction.
Asia in 1997
Likewise, when the Thai government in July 1997 decided to abandon a managed currency regime the Thai baht depreciated from around USD/THB 25 to almost USD/THB 55 in the following six months. The de-peg became the start of a regional financial crisis with Indonesia and South Korea being particularly hard hit by the economic downturn. A build-up in foreign debt-to-GDP ratios in the preceding years in several Asian economies to levels as high as 160% made countries even more vulnerable to contagion. In Indonesia sharp price increases caused by a devaluation of the Indonesian rupiah triggered widespread riot which eventually forced President Suharto to step down after 30 years in power.
Russia in 1998
The Asian crisis can be seen as a precursor to the Russian crisis in 1998. With the Russian economy heavily dependent on commodity exports, the decline in commodity prices that followed the Asian crisis of 1997 hit the otherwise inefficient and non-competitive Russian economy hard. Nevertheless the market was taken by surprise when Russia in the summer 1998 abandoned the managed currency regime and defaulted on parts of the domestic debt. By doing so Russia triggered a global liquidity crisis.
Brazil devaluation in 1999
With widespread currency de-pegging and devaluations on more continents investors got increasingly worried that the Brazilian real was overvalued. Consequently, capital outflows accelerated, the fiscal deficit widened to around 8% of GDP and by mid January the government scrapped its effort to prop up the currency causing the real to slide from USD/BRL 1.21 to peak at USD/BRL 2.15 on 3 March. Short term interest rates responded immediately by dropping to 40% from 52% while the Brazil stock index rallied.
Argentina in 2001
As a result of the tragic 9/11 terror attack in New York risk aversion was a dominant driver in the autumn 2001. In this environment the Argentine economy also faced severe headwinds from loss of competiveness due to the Brazilian devaluation and the Argentine peso 1-to-1 parity with a at the time strong US dollar. Risk averse international investors lost what was left of confidence as locals lined up to withdraw money from their bank account and by end December 2001 the government decided to default on its international debt.
Brazil in 2002
The run-up to the Brazil 2002 presidential election won by Luiz Inacio Lula da Silva – by then seen as a populist leftwing catastrophe for the economy – made the currency tumble and triggered devastating spread widening to more than 1,000bps for sovereign hard currency debt. Since then President Lula has proved that investors’ worries were groundless and today Lula is seen as an ambassador for all of Latin America and Brazil is generally seen as a model enjoying investor’s confidence.
Liquidity Crisis in 2008-09
The most recent major spread widening took place in the autumn 2008/spring 2009, when uncertainty surrounding the US originated sub-prime distress was followed by a financial crisis including widespread risk aversion and dollar shortage. Unlike past global financial crisis this time emerging markets was not the epicentre. Thanks to fiscal consolidation and debt management in previous years, emerging markets economies were the last ones to be hit by the global slowdown and the first ones to pull out.
Emerging Markets economies have become important drivers behind global growth
Emerging markets share of global GDP is increasing steadily. At the same time political and structural reforms are taking place in more countries. The unfolding sovereign debt crisis in Western Europe has led to a wide recognition of the strong fundamentals and better debt metrics seen in many emerging markets economies.