No consensus has emerged with regard to the final consequences of the capital flight from emerging market economies. This is hardly surprising given that the west’s central bankers have yet to disentangle from history’s biggest monetary experiment; of which the outcome is also far from certain. Regardless of incipient growth in the US and Europe - and even the latest positive PMI data from China - we’re still in uncharted waters as Uncle Sam’s quantitative easing programme starts to wind down.
The search for yield in a world of zero interest-rates ensured that a fair portion of the flood of new capital released in recent years found its way into emerging markets, many of which subsequently cut domestic interest rates to counter destabilising inflows of ‘hot money’. Now, with the $80bn (£51.3bn) released monthly under QE3 likely to be reduced, emerging market currencies that appreciated in the build-up of the stimulus measures are beginning to lose ground against the greenback. Rapid depreciation of regional currencies, particularly India’s rupee and the Indonesian rupiah, has raised the spectre of the 1997-98 Asian financial crisis, when widespread devaluation prompted a surge in interest rates that caused bad debts to pile up in the banking sector, eventually resulting in an economic slump across the region.
It is argued that the catalysts that allowed the crisis to unfold in Asia during the late 1990s no longer apply, particularly given the lower degree of leverage across regional economies and a shift towards floating exchange rates. More important, the size of Asia’s domestic bond markets has expanded substantially over the past decade, with a consequent reduction in the foreign currency component of external debt for emerging Asian economies. Asia’s economies are probably more resilient but the recent market reaction suggests otherwise. The sell-off in emerging market assets began in earnest midway through May, but intensified towards the end of August when the US Federal Reserve indicated that it would commence trimming its bond purchases.
