29/08/2023, 14:34 Emerging markets look unusually resilient

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Finance & economics | Defying gravity

Emerging markets look unusually resilient

A welcome departure from previous rounds of tightening

Oct 13th 2022 | WASHINGTON, DC Share

T he script is familiar. A Federal Reserve bent on taming inflation mercilessly raises rates. The dollar
soars, global financial conditions tighten and the world economy falls into a broad slowdown. But this
time, there is a twist. Where writers would normally pencil in an emerging-markets crisis, there is instead
an eerie calm.

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29/08/2023, 14:34 Emerging markets look unusually resilient

For decades, fast-growing middle-income countries have been a source of financial trouble. In the early
1980s, the Fed’s crusade against double-digit inflation sparked a Latin American debt crisis; in the 2010s,
the normalisation of policy after the global financial crisis rattled the “fragile five” (Brazil, India, Indonesia,
South Africa and Turkey). Much the same might have been expected during present tightening, which is
the most intense since the early 1980s. In forecasts published on October 11th, the imf again marked down
its projections for global growth, and warned that economies accounting for a third of global gdp are
heading for downturns. The world’s very poorest countries are on the ropes. More than a billion people live
in economies now facing severe distress.

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And yet most big, middle-income countries are weathering the

storm. The imf reckons that emerging economies will
substantially outgrow rich ones this year and next, despite a
slowdown in China and a contraction in Russia. While the euro,
pound and yen are tumbling against the dollar, the Indian rupee
and Indonesian rupiah have managed a more graceful decline,
and the currencies of Brazil and Mexico have risen (see chart 1).
Emergency central-bank intervention is unfolding in London
rather than Brasília.

The resilience of the emerging world is in part a story of

maturation. Since the crises of the 1980s and 1990s, local
financial markets have grown deeper and banks better managed.
Policymaking has improved. Officials have learned the hazards of
careless budgeting and large current-account deficits. Central
banks are more independent, and have adopted the inflation-
targeting approaches used in the rich world.

This sophistication and care has demonstrated its value over the past two years. Many middle-income
central banks began raising rates well in advance of rich countries. This prevented rising inflation from
slipping out of control, and also stopped destabilising currency declines. Take Brazil, which experienced
hyperinflation as recently as the early 1990s, but has worked in recent decades to establish the credibility
and independence of its central bank. When inflation leapt and the real wobbled early last year, the central
bank responded with aggressive rate rises, amounting to a cumulative increase of almost 12 percentage
points. Inflation has fallen from a peak of 12% in April to below 8%; the currency has been among the
world’s best performing. Meanwhile, in the rich world, central banks that have fallen behind the Fed’s
tightening schedule, like the European Central Bank and the Bank of Japan, have experienced vertiginous
currency depreciations and have yet to see inflation peak
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29/08/2023, 14:34 Emerging markets look unusually resilient
currency depreciations, and have yet to see inflation peak.

Emerging-market foreign-exchange regimes have also improved. These economies once relied on
exchange-rate pegs to contain inflation and secure cheaper credit. But the years of crisis encouraged a

move in the direction of floating-rate regimes, in which markets get more of a say over a currency’s value.
Now most governments only occasionally intervene to lean against undesirably fast or big moves.

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Many have paired this with deeper foreign-exchange reserves.

During good times they purchased assets denominated in
reserve currencies, like dollars. This slows the pace of their
currencies’ appreciation and builds a pile of safe assets. In 1998
global foreign-exchange reserves amounted to 5% of world gdp.
By 2020, that figure had risen to 15%, representing a staggering
$13trn. Although Chinese reserves of more than $3trn account for
a large chunk, other emerging-market governments have built up
formidable piles. India’s totals over $500bn, for instance, and
Brazil’s is worth more than $300bn (see chart 2).

These reserves can be deployed to slow a currency’s depreciation

when investor risk appetite drops. This year India has sold
$40bn-worth to keep the rupee’s decline modest and orderly. Yet
reserves are most valuable in the thick of a crisis, when they can
be used to pay for critical imports and meet hard-currency debt repayments. Crucially, they help to
reassure foreign investors that obligations will be honoured.

And emerging economies have addressed their greatest weakness: an inability to borrow in their own
currency. Governments once had no choice but to accept loans denominated in other currencies. This
vulnerability—referred to as “original sin”—could turn a drop in investor sentiment into a financial
catastrophe. Because a fall in the local currency increased the burden of foreign-currency debt, economic
weakness or nervy markets could set in motion a cycle of capital flight, increased pressure to devalue and
lost confidence in the creditworthiness of the government, which often ended in chaotic default.

But after the global financial crisis, bond yields in the rich world tumbled, pushing investors to look for
returns elsewhere. This hunt, combined with improved economic management in emerging markets,
allowed officials to shift borrowing to local-currency bonds (see chart 3). In the mid-2000s, some 46% of
Indonesian public debt and 83% of Chilean debt was owed in a foreign currency. By 2021 those figures had
fallen to 23% and 32%.

The safety purchased by these innovations is impressive. But in a forbidding economic climate, emerging
markets cannot afford a victory lap Although governments have borrowed more in their own currencies
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29/08/2023, 14:34 Emerging markets look unusually resilient
markets cannot afford a victory lap. Although governments have borrowed more in their own currencies,
many companies have not—and if global woes force large firms to seek bail-outs their foreign obligations
could become their governments’ foreign obligations. If worsening financial conditions prompt a flight to

safety, a Fed focused squarely on high American inflation may

not ride to the world’s rescue with a torrent of emergency
lending, as in March 2020.

Stability can also lead to greater risk-taking. The healthier

financial position of emerging markets has allowed some to take
on debt that would once have seemed too high even for rich
countries. India’s debt has risen to 84% of gdp; Brazil’s stands at
88%. In the early 2000s, American and European eminences
convinced themselves—to their subsequent sorrow—that
financial crises were something that only afflicted poorer
countries. Looking back at recent history, the right conclusion to
draw is not that emerging markets are safe. It is that nowhere is.
7

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This article appeared in the Finance & economics section of the print edition under the headline "Defying gravity"

Finance & economics

October 15th 2022

→ Emerging markets look unusually resilient

→ After China’s party congress, is there hope of better policymaking?

→ As Europe falls into recession, Russia climbs out

→ Rates are rising at unprecedented speed. When will they bite?

→ Three economists win the Nobel for their work on bank runs

→ Who will survive the fintech bloodbath?

→ Credit-default swaps are an unfairly maligned derivative

→ Energy shocks can have perverse consequences

From the October 15th

2022 edition
Discover stories from this section
and more in the list of contents

Explore the edition

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