Argentina and Turkey are not the best examples of emerging markets
Since Turkey and Argentina have both been in the grip of serious crises over recent months, it is natural to wonder whether the emerging markets could be the source of the next downturn.
Although matters appear to have calmed down a bit over the last week or two, Turkey and Argentina really are in serious difficulties. Both have yawning current-account deficits, running at 6pc of GDP for Turkey and 5pc for Argentina.
And since the start of the year, the Argentine peso is down by 50pcagainst the dollar while over the last five months the Turkish lira is down by 35pc. In Argentina, inflation is currently 34pc but it will probably rise above 50pc; in Turkey, inflation is currently 18pc but it will probably rise to about 25pc.
Against this background, it is not surprising that interest rates are sky high, at 24pc for Turkey and 60pc for Argentina. Both countries will fall into recession.
Of course, domestic politicians put the blame for all this on those supposedly evil operators in the financial markets. But the root of the problem in both countries is that the economy has been run at too high a level of demand. Since 2005, in both countries the average annual growth of private consumption has been 4.5pc.
As is normal in such cases, the exchange rate has been too strong so competitiveness has deteriorated, thereby hobbling net exports. Recent currency weakness has been necessary to correct this problem, but of course it carries a heavy short-term cost in the form of higher inflation.
The only real difference between the countries is the root cause of the overheating. In Argentina it is a classic case of fiscal policy being too loose. The budget deficit is currently 6pc of GDP. This is not the trouble in Turkey, where the budget deficit is only 2pc of GDP. There the source of excessive demand has been the rampant growth of bank credit. Typically, emerging markets have suffered from contagion as financial panics in one or more countries spreads to the others. In 1997, devaluation of the Thai baht proved to be the trigger for the 1997-8 Asian financial crisis which engulfed most of south-east Asia, even though Thailand accounted for only about 0.5pc of world GDP.
“Although matters appear to have calmed down a bit, Turkey and Argentina really are in serious difficulties”
And there has been some contagion recently from Argentina and Turkey, but not much. There really shouldn’t be, because Turkey and Argentina are special cases. In most of the rest of the emerging world things are relatively OK.
Economic policymaking in most emerging markets has improved dramatically. On the whole, fiscal deficits have been brought under control and most EMs don’t run large current-account deficits. Some even run surpluses.
Perhaps most importantly, EMs have sharply reduced their reliance on foreign-currency borrowing (mainly in dollars).
Dollar borrowing is especially dangerous for them because when US interest rates have risen their interest bill has increased, and if their currencies have fallen against the dollar then both the interest bill and the capital amount of the debt have risen when expressed in local-currency terms.
The emerging markets crises of the Eighties and Nineties all had their roots in a large build-up of external liabilities. In the Latin
American crises of the Eighties (and again in the 1994 Mexico crisis), these external liabilities were mainly in the public sector.
In the Asian crisis of 1997-8 they were mainly in the private sector. But in all cases these external liabilities reflected large current-account deficits.
Argentina and Turkey have large external financing requirements, reflecting both their current-account deficit and the need to refinance maturing debt. But most other emerging markets have much lower requirements and are nowhere near as vulnerable to a sudden loss of confidence. Since 1980, there have been 154 bank and sovereign debt crises in the EMs.
They have ended up causing little economic impact in the west. (The demise of Long-Term Capital Management in 1998, associated with troubles in Russia, is an exception.) The EMs in crisis simply weren’t big enough. This remains the case today with Turkey and Argentina. EMs have been more dependent upon developed economies for export demand than the other way round. Financial ties are smaller still.
The elephant in the room is China. In 1980 it accounted for less than 2pc of global GDP.
Today the figure is over 15pc. So a crisis in China would be a completely different kettle of fish from any other EM crisis that we have experienced.
The reasons to be worried about China are both economic and financial. The economic issue concerns the inevitable sharp slowdown in China’s growth rate –unless she embarks on a programme of radical reform.
The financial issue concerns the huge rise in credit. Excluding the financial sector, credit extended to Chinese borrowers has gone from about 130pc of GDP in 2007 to 240pc today. Whenever countries have experienced such a credit boom before it has ended in a financial crisis.
The good news is that the Chinese authorities are on top of this risk and they have considerable power over both the economy and the financial system. Nor is any crunch point in China likely to be reached as a result of mishaps in Turkey or Argentina –or any other emerging market. For China, as well as other EMs, the economy that it is most dependent on is the United States.
Although Mr Trump’s protectionist trade policy, on its own, won’t bring the Chinese economy to its knees, it doesn’t help.
For all that, particularly after last week’s shenanigans in Salzburg, the greatest risks to stability remain closer to home.