EKIP– Expert Club for Economics and Politics A Different Opinion
This year is shaping up to be a very interesting one for global financial markets, but unlike the previous five, which focused on developed economies and their debt problems, attention is now shifting to the East. It is not that the West has managed to overcome its problems and is already confidently on the path to recovery; on the contrary, debt levels in developed countries are higher than they were at the beginning of the crisis, and structural problems in most countries have hardly been addressed. The focus has shifted to emerging markets due to the capital outflows observed in the past few months, as a result of which the currencies of many of these countries have collapsed to record lows. There has been talk of currency crises in many countries due to the inability of the authorities to resist market forces using the tools at their disposal.
With the onset of the Great Recession, emerging economies became the main engine of the global economy, after developed countries were faced with one of the most serious debt crises in their history. Unfortunately, however, the interest in the countries of the East was not driven by structural advantages, but almost entirely by the availability of easy money, created by the central banks of large developed countries and redirected to these economies for the purpose of arbitrage profit. The fact is that there are also structural differences in these countries that make them an attractive investment destination. The levels of debt in these countries (both private and public) were (and still are) much lower than the levels in the developed world, the demographic picture is much more favorable, there are a number of unexplored opportunities and undeveloped businesses that have existed in the West for years. But we must not forget that these countries also carry many risks for any potential investor. High levels of corruption, weak protection of private property, and dysfunctional institutions are just some of the problems that would repel a large portion of business. And given these shortcomings, the question arises: would the roughly $4 trillion in new money have been poured into developing economies over the past five years if this money had not entered the financial system in the form of loans at near-zero interest rates? Most likely not in that volume.
Capital outflows from emerging markets began in the summer, when the US Federal Reserve (FED) announced its intention to reduce its monthly asset purchase program. Initial skepticism about this program is understandable, given the unsatisfactory recovery in the US and the deteriorating labor market in the country. But now we have already witnessed two reductions of $ 10 billion per month and the program for buying government and mortgage bonds is now $ 65 billion per month. And while many analysts attribute what is happening in the financial markets in emerging countries entirely to the actions of the Fed, it should not be forgotten that these countries still have relatively serious problems.
Although economic growth in recent years has managed to lift many people out of poverty, in most countries corruption still exists at all levels of government, private property is still poorly protected, and the rule of law is far from assured. In other words, the outflow of capital from developing economies is a consequence not only of the Fed's policy, but also of specific local problems faced by many developing countries, the "recovery" in the Eurozone, which is redirecting a lot of capital to this part of the world, the enviable performance of the stock markets in Europe and the US in 2013, which is also arousing investor interest. It is also relevant to mention here that, contrary to common opinions, a reduction in the monthly asset purchase program by the Fed is not the same as a tightening of monetary policy in the world's largest economy. The key interest rate in the US is expected to remain close to zero for a long time, and even if the central bank reduces its monthly asset purchases to 0, banks will still be able to take out "free" loans and redirect the money to assets of their choice.
The consequences of capital outflows from developing countries can be very serious both for them and for the global economy as a whole. And while some countries rely more on domestic savings for investment, those that borrowed funds in foreign currency have faced much more serious risks in recent years. This is the case in Turkey, where at an aggregate level a significant amount of the loans in the economy are short-term and denominated in dollars. It is anyone's guess what happens to the nominal amount of these loans in conditions of a declining value of the local currency. As I wrote in a comment of mine from late August, capital outflows will lead to a tightening of monetary policy in developing countries, and we have already witnessed several such actions by central banks.
The market reaction, however, does not speak well of investor confidence in the authorities’ ability to deal with the currency crisis. Raising key interest rates, however, is a double-edged sword, as many developing countries have seen bubbles inflate over the past few years due to increased lending. Since a large part of the loans granted are tied in one way or another to the key interest rate, the rising costs of servicing them will lead to many bankruptcies and the potential bursting of these bubbles, which have largely driven the economic upswing in emerging markets in recent years. In my commentary from August, I had said that after tightening monetary policy, IMF assistance or bankruptcy would follow, but I would also add that the imposition of capital restrictions is also a possible scenario. Many developing countries have a number of capital restrictions in various forms, but the moment there is talk of imposing measures similar to those in Cyprus (which, I should note, were initially supposed to be in place for no more than a few weeks), a currency crisis will become inevitable.
