Emerging markets balance sheet

The decoupling arguement appears to be surely settled, as the butterfly flapping its wings in New York is shaking up the airwaves in Shanghai and Mumbai! The contagion effect on the emerging economy financial markets, exchange rates and the monetary policy, has been significant. Now the real economy too in these countries are feeling the effects of the recessionary conditions in US and Europe.



Here is an attempt to tally the pluses and minuses facing emerginge conomies. The negative side first.

1. Many of the emerging economies, especially in the East Asia, are export driven and will feel the pinch from reduced consumption and imports by the developed economies. Both the manufacturing exporters, like China and ASEAN, and the services sellers, like India and Phillipines, will be adversely affected.
2. The commodity exporters, like oil producers and many Latin American and African countries, will find their windfall profits from the commodities price boom, suddenly disappear. Brazil’s commodity exports amount to 9% of its GDP and its commodity firms, such as the oil giant Petrobras, account for over 40% of the stockmarket.
3. The falling asset prices and resultant unwinding of positions from emerging economies, and the decline in corporate investment resources of multi-national firms, will squeeze the availability of external funds through both Portfolio (FPI) and Direct Investment (FDI) inflows.
4. The unwinding of positions by US and European financial institutions to shore up the reserves of the distressed parent firms, has put downward pressure on the domestic currencies. The falling currencies could substantially offset the advantage gained from declines in commodity prices.
5. The low US interest rates and the absence of adequate depth in domestic financial markets, will mean that the massive foreign exchange surpluses invested in US Treaury Bonds will continue to yield only nominal returns. These investments will remain as one of the largest foreign aid programs in world history.
6. The exports of many of the East Asian economies contain significant import content. The depreciating local currencies make import more expensive, and thereby forcing some amount of pass through into the export prices.
7. The depreciating local currency will make the dollar-denominated loans taken by private firms and governments more expensive. Besides increasing the interest burden and cost of capital, it also opens up the possibility of defaults.

On the positive side
1. The cheaper commodity prices will ease inflationary expectations and give the Central Banks more room to manouvre with monetary policy, besides easing the price pressure on the poor population.
2. By making exports more competitive, the cheaper currencies, could help ease current account deficits in countries like India, and boost exports everywhere.
3. The crisis provides an ideal opportunity to spur domestic consumption growth in many of these economies, which is vital to ensuring the sustenance of the high economic growth rates of recent years. A strong domestic demand can help insulate economies to some extent from such global turmoils.
4. The substantial domestic savings, in the range of 30-50%, will, once the apprehensions (arising mostly from the Wall Street and its linkages with the domestic markets) about credit quality eases, help keep open the tap for investment capital.
5. Unlike the Wall Street and increasingly, the European financial markets, which are facing a solvency crisis, the emerging economy financial markets are only experiencing a liquidity crisis. The crucial difference is that a solvency crisis has to ultimately climax in massive losses, a liquidity crisis can ease if confidence is restored back into the market.