Old movie is playing in emerging markets

If it walks and quacks like an emerging markets balance of payments crisis, is it an emerging markets balance of payments crisis? We are not yet there, and hopefully it will not come to one. But the patterns displayed by global financial markets are sufficiently redolent of capital flight from poorer countries in the past that caution is in order.

Start with foreign exchange. In the second quarter emerging market currencies had their worst fall in seven years. July started better, but the downward pressure is back on a steady course of interest rate tightening in the US. This attracts capital to the dollar. Equity investors have been pulling money out of emerging markets for 10 weeks straight. So have bond investors, though that outflow appears to have been staunched — for now.

Seasoned market watchers have seen this movie many times before. In times of low global interest rates, emerging markets are flooded with cheap lending from the rich economies, reflected in large current account deficits. The debt that accumulates as a result, especially when denominated in hard currency, lands them in a zone of instability where a reversal of capital flows can violently disrupt creditworthiness and economic activity. Fears of exactly this phenomenon can be enough to trigger the reversal.

With so much painful history to recall — the Latin American debt crisis in the 1980s, the “Tequila” and Asian financial crises in the 1990s — emerging countries should have learnt not to fall into the same trap again. Some have done that. Macroeconomic performance is better — for emerging markets as a whole, inflation rates are at historical lows. Governments are nowhere near as indebted as in advanced economies. Markets have become more discriminate, differentiating between countries and rewarding those that seem to be managing their economies well.

Where there is danger, it resides in the private sector: emerging market companies now carry more debt as a share of their countries’ economic output than their counterparts in rich countries.