Sunday Times

Is the next global fi­nan­cial crisis brew­ing in emerg­ing mar­kets?

- By Roger Boo­tle Business · Currencies · Finance · Latin America News · Politics · Financial Crisis · World Finances · Foreign Exchange Market · Financial Markets · Lehman Bros Holdings · Turkey · Argentina · China · Beijing · United States of America · Donald Trump · Capital Economics

With the 10th an­niver­sary of the Lehman col­lapse just passed, com­men­ta­tors and an­a­lysts are cast­ing around for signs of the next crisis brew­ing. Since Turkey and Ar­gentina have both been in the grip of se­ri­ous crises in re­cent months, it is nat­u­ral to won­der whether emerg­ing mar­kets could be the source of the next down­turn. Al­though matters ap­pear to have calmed down a bit, Turkey and Ar­gentina are in se­ri­ous dif­fi­cul­ties. Both have yawn­ing cur­rent-ac­count deficits, run­ning at 6% of GDP for Turkey and 5% for Ar­gentina. And since the start of the year, the Ar­gen­tine peso is down 50% against the dol­lar, while over the past five months the Turk­ish lira is down 35%.

In Ar­gentina, in­fla­tion is 34% but will prob­a­bly rise above 50%; in Turkey, in­fla­tion is 18% but it will prob­a­bly rise to about 25%. It is not sur­pris­ing in­ter­est rates are sky high, at 24% for Turkey and 60% for Ar­gentina. Both will fall into re­ces­sion.

Of course, do­mes­tic politi­cians put the blame 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 4.5%. The ex­change rate has been too strong so com­pet­i­tive­ness has de­te­ri­o­rated, hob­bling net ex­ports. Re­cent cur­rency weak­ness has been nec­es­sary to cor­rect this prob­lem, but 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 6% of GDP. This is not the trou­ble in

Turkey, where the bud­get deficit is only 2% of GDP. There the source of ex­ces­sive de­mand has been the ram­pant growth of bank credit.

Eco­nomic pol­icy-mak­ing in most emerg­ing mar­kets has im­proved.

On the whole, fis­cal deficits have been brought un­der con­trol and most emerg­ing mar­kets don’t run large cur­rent-ac­count deficits.

Ar­gentina and Turkey have large ex­ter­nal fi­nanc­ing re­quire­ments, re­flect­ing their cur­rent-ac­count deficit and the need to re­fi­nance ma­tur­ing debt. Since 1980, there have been 154 bank and sov­er­eign debt crises in the emerg­ing mar­kets. They have ended up caus­ing lit­tle eco­nomic im­pact in the West. The emerg­ing mar­kets in crisis sim­ply weren’t big enough. This re­mains the case to­day with Turkey and Ar­gentina. Emerg­ing mar­kets have been more de­pen­dent on 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 2% of global GDP. To­day, the fig­ure is over 15%. 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 it 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 130% of GDP in 2007 to 240% to­day. When­ever coun­tries have ex­pe­ri­enced such a credit boom, it has ended in a fi­nan­cial crisis.

The good news is the Chi­nese au­thor­i­ties are on top of this risk and have con­sid­er­able power over the econ­omy and 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, the econ­omy it is most de­pen­dent on is the US. Al­though US Pres­i­dent Don­ald Trump’s pro­tec­tion­ist trade pol­icy, on its own, won’t bring the Chi­nese econ­omy to its knees, it doesn’t help.

Rea­sons to be wor­ried about China are both eco­nomic and fi­nan­cial

✼ Boo­tle is chair­man of Cap­i­tal Eco­nom­ics ✼ Ron Derby is away

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