Five years ago, as the financial crisis swept through the developed world, emerging economies led by the so-called “Brics”– Brazil, Russia, India and China – were tipped to inherit the earth. While rich-world governments wrestled with unsustainable debts and unavailable credit, growth in the emerging world roared ahead, sucking in swathes of foreign capital. There was even talk of a new economic order.
Not any more. Although officials are divided about when to begin “tapering” the $85bn-a-month bond purchases with which the Federal Reserve is supporting the US economy, they are agreed that it will be this year. The prospective end to quantitative easing is enough to push up bond yields and, with them, long-term interest rates. And that is enough to send emerging-market investors scurrying for the exit. If the US economy is strengthening, higher-risk alternatives are less attractive and the “carry trade” – where investors borrow cheaply in the US and earn a higher return elsewhere – makes less sense.
Thus, the mooted return to more normal monetary conditions in the US has wrought havoc in emerging markets. Currencies have plummeted across Asia, dragging the Indian rupee down to an all-time low against the dollar. The Brazilian real and the South African rand have also been hit hard. Meanwhile, stocks have tumbled from Mumbai to São Paulo and there is much talk of another Asian bubble burst.
The irony is that emerging markets have been demanding that the developed world tighten monetary policy throughout the five years of unconventional measures. Brazil has even talked of a “currency war”. But the current travails cannot be blamed solely on Western self-interest. Hardly less of a factor is the slowing growth in China, as Beijing tries to unwind its own post-2008 stimulus measures. Furthermore, as the flood of QE-cheapened credit starts to recede, it is those with the poorest economic stewardship, and the highest current-account deficits, that are most exposed.
India is a case in point. Once the darling of Asia, predicted to overtake China as the world’s economic powerhouse, New Delhi failed to use the good times to push through much-needed reforms. Restrictive markets and high levels of graft, combined with soaring corporate debt, rickety banks and political tinkering, have spooked investors – hence the rupee’s near-15 per cent drop in the past three months alone.
So far at least, few are predicting a repeat of the catastrophic financial crisis that rocked Asia in the mid-1990s. But most expect further instability to come, particularly once the Fed’s tapering actually begins. At last weekend’s annual economic symposium at Jackson Hole, Christine Lagarde, the managing director of the International Monetary Fund, even went so far as to call for “further lines of defence” against an emerging market crisis.
The concern is not an idle one. There is a real danger that a significant slowdown in the developing world checks the nascent recovery elsewhere. It is here that the over-hyped new economic order is evident. While the rich world rode out the last Asian crisis largely unscathed, this time such invulnerability is by no means certain – particularly if China’s “soft landing” proves not so soft after all.