A Perfect Storm in Emerging Economies
1.1 THE LIQUIDITY MIRAGE
End of an Era
By playwright Arthur Miller’s yardstick: “An era can be said to end when its basic illusion areexhausted”. With much of the blockbuster economic growth of the past few years now appearing like aliquidity mirage, the curtains have indeed come down on an era.This is particularly painful realisation for the developing world. While the problems with the US economyhave been well-telegraphed for long, the widely held view till as recently as mid-September was that theemerging market growth story was largely intact and that most these countries had to fear was somecontagion from a housing-led US recession. But now it’s becoming increasingly apparent that theliquidity mirage (read: global credit bubble) has also fuelled the exceptional growth rates in emergingmarkets for much of this decade.Since 2003, there was a marked increase in the trend growth of developing economies, with the averagerate jumping to 7% from 4% between 1980 and 2002. India’s growth trajectory too shifted higher bysimilar magnitude during the same period from 6% to 9%.Much of the increase was attributed to structural factors such as benefits of globalisation, the demographicdividend and better macroeconomic policy management. While there is more than an element of truth insuch arguments, it’s hard to escape the conclusion that much of the growth leap was due to easy access to
.Whenever money is cheap and easily available in the global system, it spills over into emerging markets.But in a tighter liquidity environment – as is the case now – such funding dries up.It was no coincidence that the rise of emerging markets began in earnest from mid-2003, once the USeconomy started to recover strongly on the back of a booming housing sector.Following the tech bust in the preceding year, the US Federal Reserve cut interest rates aggressively toengineer a new growth cycle. This resulted in US households accumulating more debt, largely in the property sector. But the Fed was not just setting US interest rates – it was also determining the global price of money. Capital gushed into many developing countries that did not want to run an interest rate policy too different from the US given the currency linkages.The fundamental flaw with the emerging market growth model is that foreign capital typically nearly half the finances needed for expansion in any year.Given the easy availability of credit over the past few years, corporates in the developing world raisedhuge amounts of debt/equity to fund ambitious growth plans, largely from western financial institutions.Last year was a bumper year, with $ 435 billion in new overseas syndicate loans, $ 150 billion in externalcorporate bonds issuances and $ 210 billion of foreign IPO money heading to emerging markets. Such aglobal
suddenly turned off, leaving many emerging market companies high and dry.Ironically, some of the economies most affected by the credit crisis are those that were perceived to haverelatively strong macroeconomic fundamentals and viewed as reasonably safe bets with their large forex,robust fiscal accounts and healthy current account balances. Lenders/investors took comfort in the strong balance sheets of various countries.