First the good news. Financial "crises" are not what they used to be. Indeed, they never were. Despite the literal meaning of the word, it is a misnomer since there have been no catastrophic collapses of national, regional or global financial markets. For this reason, a less alarming word should be chosen to replace "crisis." Its inappropriateness also arises from its link to Marxian economics whereby it was used to describe inherent and fatal contradictions of capitalist markets, a presumption that is contradicted by historical facts.
Capital markets have become increasingly less fragile because of structural adjustments in emerging market economies and reforms in more advanced economies that offset the possibility of systemic failures. Similarly, new financial instruments like derivatives have helped spread risks and costs. This has led to improvements in the quantity and quality of financial data from domestic capital markets whereby the global capital market can operate more efficiently.
Now the bad news. These sorts of adjustments (which will continue to be erroneously described as "crises") are likely to be more frequent. This is because the widespread availability and rapid access to better data to more global investors will lead to similar conclusions about risks associated with investments in far-flung reaches of the world.
Actually, these adjustments are part of the growing pangs of the movement towards a more efficient capital market. Although there may be some short-run costs, they will yield long-run benefits. Increased efficiency means that capital costs will become lower.
Despite their greater frequency, the severity and the duration of the adjustments from shocks to the global and local financial systems will be less. This is because of the reforms and restructuring that they induce as in the case in much of East Asia that have introduced policies so that their economies can operate more effectively in a global setting.
Despite efforts towards reform and restructuring, many problems remain unresolved in many of the emerging market economies. In the case of East Asia, there is a substantial overhang of bad debt and enfeebled financial systems in the aftermath of the 1997 "crisis."
Judging from current evidence, it is likely that a new cycle of adjustments will occur affecting many of the emerging market economies. Part of this is based upon an expected slowdown in world economic growth. Consensus forecasts suggest that global economic growth will be less than 3.5 percent in 2001, down from 4.2 percent in 2000. US growth is forecast to be about 3.1 percent, considerably less than the 5.2 percent growth expected for 2000.
Emerging market economies are vulnerable to unfavorable shifts in the terms-of-trade caused by declines in demand for their exports accompanied by falling commodity prices and weakened exchange rates that raise their import bills. At the same time, there may be net capital outflows from investor's reassessments of risks of placing funds in emerging market economies.
Another worrying sign is found in the softness of the emerging market composite index complied by the International Finance Corporation. This index is down by more than 30 percent of its dollar value from its peak reached in February of this year. Stock markets in Latin America, East Asia and Eastern Europe are the biggest losers. This reflects a trend where global capital is steering clear of high-risk countries and moving away from high-risk stocks. For example, dollar-denominated bonds issued by governments of emerging market economies are up 2-percentage points over US Treasuries since October. This growing spread indicates that creditors see rising risk and growing uncertainty in lending to these governments.
These tendencies are not limited to emerging market economies as evident in the retreat of the NASDAQ and other high-tech stock market indexes that have pushed US technology stocks off their March peak by nearly 40 percent. Corporate bonds have risen sharply over US Treasuries with those in the highest risk category are 10 percentage points higher and bonds of higher quality blue chip companies are about 2 percentage points than they were in mid-1999.
One country that faces daunting problems is Argentina. Its domestic inflation is low and government debt is about 50 percent of GDP (about US$123 billion) and the public sector budget deficit is only 1.9 percent of GDP.
However, it is experiencing a slowdown aggravated by the rising international value of the US dollar. (Argentina permanently fixed the exchange rate of the peso against the dollar.) After negative GDP growth of 3.2 percent in 1999, the economy is expected to record very anemic positive growth in 2000. Riots and discontent have induced opposition politicians to demand increases in social expenditures.
Consequently, there has been a loss of confidence in Argentina's fiscal position causing the spread for the interest paid on Argentine debt over US treasuries to rise by almost 50 percent during the past year to over 8 percent.
These conditions have made Argentina's public finances unsustainable. The problem is that it has a considerable amount of short-term debt that must be refinanced during the first quarter of 2001. If the risk premium does not narrow, there is a rising probability that Argentina might default on its debts. It has turned to the International Monetary Fund to help resolve an impending liquidity crisis.
Argentina's attempts to reschedule its debt will impact on other Latin American countries that tend to have low domestic saving rates and so are dependent upon outside capital. Brazil is watching closely since in the coming year it will be facing repayment of US$27 billion of its public and private debt.
In sum, it appears that emerging market economies will be likely to experience a financial shock in the coming months. Considered opinion has it that Taiwan's financial system is on the brink of a serious calamity. And this is a country that has enormous foreign reserves and a strong economy. The lesson of the past is that these favorable conditions are insufficient to avert the painful adjustment costs brought on by financial "crises."
Christopher Lingle is Global Strategist for eConoLytics.com.
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