A taxonomy of trouble

Oct 23rd 2008 DELHI From The Economist print edition How are emerging markets suffering? Let us count the ways Illustration by S. Kambayashi EVEN now, not every central banker is terribly impressed by the gravity of the financial crisis that has spread from Western banks to the emerging world’s shares, currencies and credit markets. In India the United Forum of Reserve Bank Officers and Employees—the central bank’s staff union—decided that October 21st was a good moment for its 25,000 members to abandon their posts in a dispute over pensions. The Reserve Bank of India (RBI) denounced it as an illegal strike. The union called it mass casual leave. A few months ago, many emerging economies hoped they could take mass casual leave from the credit crisis. Their banks operated far from where the blood was being shed. The economic slowdown evident in America and Europe was regrettable, but central bankers in many emerging economies, such as India and Brazil, were busy engineering slowdowns of their own to reverse high inflation. They were more interested in the price of oil than the price of interbank borrowing. This detachment has proved illusory. The nonchalance of the RBI’s staff, for example, is not shared by the central bank’s top brass, who, a day before the strike, cut the bank’s key interest rate from 9% to 8%, having already slashed reserve requirements earlier this month. Their staff’s complaint about pensions looked quaint on the day that Argentina’s government said it would nationalise the country’s private-pension accounts in what looked to some like a raid to help it meet upcoming debt payments. The IMF, which has shed staff this year because of the lack of custom, is now working overtime (see article). The governments of South Korea and Russia have shored up their banking systems. Their foreign-exchange reserves, $240 billion and $542 billion respectively, no longer look excessive. Even China’s economy is slowing more sharply than expected, growing by 9% in the year to the third quarter, its slowest rate in five years. The emerging markets, which as the table shows enter the crisis from very different positions, are vulnerable to the financial crisis in at least three ways. Their exports of goods and services will suffer as the world economy slows. Their net imports of capital will also falter, forcing countries that live beyond their means to cut spending. And even some countries that live roughly within their means have gross liabilities to the rest of the world that are difficult to roll over. In this third group, the banks are short of dollars even if the country as a whole is not. Long before Lehman Brothers went bankrupt in mid-September, prompting the world’s money markets to seize up, the currencies of commodity exporters had already started to tumble. South Africa, a huge exporter of platinum and gold, has seen its currency fall further than any other this year except the Icelandic krona. Russia’s rouble peaked on July 16th as oil prices fell, and the Brazilian real began to slip a couple of weeks later. Brazil’s commodity exports amount to 9% of its GDP, according to Lombard Street Research, a firm of analysts. But its commodity firms, such as the oil giant Petrobras, account for over 40% of the stockmarket. Thus the fall in commodity prices has hit the bourses hard. A similar fate befell Russia, where the main indexes were already in decline after the country’s military misadventures in Georgia. India and China benefit from cheaper oil. India, for example, spent almost two trillion rupees ($48 billion) on crude imports in the five months from April to August. But even as their import bills fall, their export earnings are slowing. On October 22nd Tata Consultancy Services, India’s biggest information-technology company, announced that its net dollar profit in the latest quarter was almost 7% below the quarter before. India’s IT bosses are worried about getting paid by banks for work they have done for them. Goldman Sachs says that India’s trade deficit will subtract 1.5 percentage points from its GDP growth this fiscal year and next. India’s exports will be helped by a declining rupee. China’s yuan, on the other hand, has held its own against the dollar, even as the greenback has strengthened recently. It may find itself reprising its stabilising role during the Asian financial crisis, when it held fast to its dollar peg, even as its neighbours and competitors suffered currency collapses. Stephen Green of Standard Chartered calculates that China’s trade-weighted exchange rate, adjusted for inflation abroad and at home, is now at its strongest since 1989. Morgan Stanley reckons the shares of emerging economies have never been as oversold. But foreign investors have punished some economies more harshly than others. The market for credit-default swaps, which insure against default on sovereign bonds has, for example, distinguished between countries running big current-account deficits (over 5% of GDP) and other more abstemious places. Of the four biggest emerging markets, Brazil, Russia, India and China, India has the largest current-account deficit, which widened to 3.6% of GDP in the second quarter. It bridged most of this gap with foreign-direct investment. But its globe-trotting companies also rely on raising money abroad, borrowing $1.56 billion externally from April to June. This borrowing has since become far more expensive. Russia has a hefty surplus on its current account, not a deficit. It earned $166 billion from oil and gas exports in 2007. Its economy should be flush with hard currency. In fact, Russia’s companies and banks are now scrambling to find dollars. The overseas liabilities of Russian banks now exceed their foreign assets by $103.5 billion (excluding net foreign direct investment in the industry), according to the country’s central bank. The country is not awash with petrodollars because the state taxes its energy earnings heavily, and sequesters its dollar takings in its central-bank reserves and its Stabilisation Fund. As Rory MacFarquhar of Goldman Sachs has pointed out, Russia accumulated $560 billion in foreign-exchange reserves from 2000 to mid-2008, even as its banks and companies have added $460 billion to their external debt. Russia, in effect, lends dollars to Western governments, then borrows them back again from Western banks. Now those Western banks are suddenly reluctant to lend, which means Russia’s government will have to close the dollar-circuit itself. The central bank will deposit $50 billion of its foreign-exchange reserves in the state-owned Vnesheconombank, which will, in turn, lend that money to companies and banks faced with imminent foreign-debt payments. There is an irony here. The West’s financial institutions have long been hoping for sovereign-wealth funds, flush with petrodollars, to arrive as saviours. But Russia, at least, now needs all its sovereign wealth to save itself. http://www.economist.com/finance/displayStory.cfm?source=hptextfeature&story_id=12481004