By Michael Schuman
(Bloomberg View) — The world’s investors are still quaking about a feared emerging markets meltdown. In a recent survey by Dutch fund manager NN Investment Partners, a third of the institutional investors queried said a financial crisis in the emerging world was the biggest risk they face today, topping a renewed Eurozone crisis and rising interest rates. The fear seems justified. China’s topsy-turvy stock market and deteriorating currency are roiling global markets. Brazil and Russia have entered deep recessions. International Monetary Fund Managing Director Christine Lagarde warned in a Jan. 12 speech that developing countries “are now confronted with a new reality” of slower growth.
However, a financial crisis in emerging economies is less likely than the scary headlines and global market turmoil suggest. The fact is that most developing countries are in much sounder shape than they at first appear.
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Pundits warn of a dangerous explosion of debt in the emerging world. Yet by historical standards, the buildup in most countries hasn’t been dramatic. In a 2015 study, Neil Shearing, chief emerging markets economist at research outfit Capital Economics, analyzed previous crises and discovered that “problems tend to emerge after a rapid expansion of debt, rather than when debt passes a specific threshold.” His advice is to watch the pace at which debt is accumulated, rather than its absolute size, when trying to spot the next meltdown.
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And in recent years, most emerging economies haven’t added enough debt, relative to the size of their economies, to justify the most bearish warnings. Over the past decade, Malaysia’s private debt-to-GDP ratio has risen by 18.5 percentage points, India’s by 17, Indonesia’s by 12.5 and South Africa’s by 11, according to data provided by Capital Economics. By comparison, before the 1997 financial crisis, that ratio had surged by nearly 100 percentage points in Thailand and well over 50 in Malaysia.
Many developing economies are much better prepared for external shocks as well. In many key emerging markets, most of the new debt is denominated in local, not foreign currency; that makes them less vulnerable to weakening currencies and capital outflows. Foreign exchange reserves have also been beefed up substantially. According to World Bank data, Indonesia had accumulated $112 billion in reserves by the end of 2014 — nearly six times higher than in 1996, before the Asian financial crisis. Thailand’s pile, at $157 billion, was four times bigger. In India, reserves stood at only $5.6 billion in 1990, ahead of its near-debt crisis; by 2014 they’d grown to $325 billion.
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Of course, predicting that crises will or won’t happen is a risky business, too. A handful of important countries have become much shakier in recent years, most notably China, which has witnessed by far the most spectacular explosion of debt among major emerging economies. Its private sector debt has jumped 80 percentage points to over 200 percent of GDP in the past decade. Turkey, Brazil and Russia are possible flash points as well. There’s always a chance that a blowup in one country could spread throughout emerging markets, as happened in the late 1990s. In such panicked circumstances, the differentiated conditions of individual economies cease to matter very much.
Still, emerging economies have proven remarkably resilient amid the traumas of the past three years. Concerns over the impact of Federal Reserve tightening have led to a stampede of capital out of emerging markets at different periods since mid-2013. In the last quarter, outflows hit an all-time record of $270 billion — larger than the amount that fled during the depths of the 2008 financial crisis. Currencies across emerging markets have tanked as a result. India’s rupee has lost about a fifth of its value against the dollar since mid-2013, and Indonesia’s rupiah a third. The Russian ruble is worth less than half what it was only 18 months ago. Yet despite these stresses, no major emerging economy has tumbled into a full-blown crisis.
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What’s going on in the developing world is not a financial crisis, but a growth crisis. The IMF forecasts emerging economies will expand only 4.3 percent in 2016, well below the 8.2 percent of 2006. That’s a problem in itself for a global economy desperately searching for new sources of growth — and most of all for the 900 million people still trapped in poverty. Lagarde, in her recent speech, noted that income levels in the emerging world are converging to those of advanced economies at less than two-thirds the pace predicted a decade ago, a trend she lamented was “cause for concern.” The struggles of emerging markets may not provide the world’s next big crisis, but they are one of the world’s biggest problems.
