Last updated: 15:27 / Monday, 29 July 2013
By Manuel García Ospina

Are Emerging Markets Vulnerable?

Are Emerging Markets Vulnerable?

It sounds harsh to say that emerging markets can be highly vulnerable. Especially since they have experienced a big boom in recent years, which has led to the suggestion that we are in a world in which emerging markets are of a different kind to those we knew years ago. Such terms such as BRIC, CIVETS, etc., allowed the "developed world" to look at them with different eyes. But today, at the prospect of a reduction of monetary stimulus, some weaknesses have been laid bare.

During the past 10 years, the total government debt in local currency of all the emerging markets combined, went from about 1.5 trillion dollars to almost $ 6 trillion, representing an average growth of 30% per annum which, compared with the economic growth over the same period which averaged 5% annually, shows a marked imbalance between how emerging markets got into debt, and the positive impact such indebtedness may have generated.

We might think that this increase in local government debt went hand in hand with an effective reduction of other forms of indebtedness, which, unfortunately, did not. Both public and private debt, boomed during the last 10 years, fueled by low global interest rates and excess liquidity. Proof of this is that between the period 2008-2013, the emerging markets have received about USD 300 billion, while the debt issued, has been of USD $ 292 billion.

The above sounds like finding oil in Arabia, which means, that wherever funding was seeked, there it was. However, the last few years may show a blurred picture of what happened in real emerging market crises. Let's put it bluntly: after the Asian crisis, emerging markets have not had any deep crises. They may have had strong distortions, as in the period 2001-2003, which included Argentina’s default, but acute, never. So, that is why it becomes so important for financial sector analysts to start looking into a science that very few people like: economic history.

History will tell us that before July 2, 1997(the day in which the Asian crisis officially began),Thailand’s picture was very similar to the following: higher cash flows from Japan and Europe, which financed anything, including local financing institutions, real estate speculation as a whole, a stock market which had been highly dynamic in previous years, a highly overvalued currency, and the 'allegations' of its authorities that the capital flows which were entering were the result of direct investment , which reduced their vulnerability, because they were not portfolio flows.

At the same time, Thailand began to increase its imports, and due to external factors, its industry, especially its technology industry which was the bastion of its economic prosperity, experienced a fall in the price of the products it sold, almost overnight. Clearly, that led to a situation in which the dollars that entered Thailand ended up paying for its imports, and widening the current account deficit.

Would it sound similar if we said, that instead of a fall in the price of technology there was a fall in the price of basic goods? Actually, although market analysts prefer to talk about VIX, CDS and Ebitda multiples, they should watch the level of certain variables such as the current account deficit, which is extremely boring. And they should establish whether Thailand’s indicators in many variables, such as in the level of savings, among other things, are similar to those of some emerging countries today. They may be surprised at what they find. Hedge funds are familiar with this, as they were in 1997, but with one big difference: the leverage which may be achieved today may be much larger than that of 15 years ago.