Escalating risks ahead4 min read . Updated: 01 Oct 2012, 10:13 PM IST
Emerging economies are contributing to their problems with their non-transparent economic decisions
The emerging economies are already in a stagflationary situation. QE3 is pushing them further in that direction. The stock markets in emerging economies have performed poorly relative to the United States’. This divergence will likely continue during QE3. Indeed, the relative underperformance of emerging market stocks may escalate capital outflow in emerging economies, triggering financial crises like in 1998."
Thus wrote Andy Xie in his latest missive in the English language version of the Chinese Caixin magazine. It is true that emerging markets are going to be at the rough end of the stick of monetary debasement policies pursued by the West. The task of reducing the burden of debt will be achieved by debasing their own currencies and paying back the debt in nominally same but value-eroded currencies. The money that these central banks create in the US and in Europe may not lead to higher prices within their borders due to other factors. But as capital flows there, it will create an inflation headache in the developing world if the impact on domestic money supply is not neutralized.
While many governments will vow to do so, talk is cheap. The seduction of capital flows and rising asset prices will be too strong to be resisted. Politicians will lean on central banks to discourage them from sterilizing inflows. Domestic money supply and credit growth will rise uncontrollably, leading to asset bubbles and higher cost of living. Statistics can lie but people’s misery from higher cost of living will be real.
In addition, the inducement to speculation that easy money offers is too tough to resist for the Western financial industry. Investment banking is dead. Companies prefer to sit on cash or buy back shares rather than chase an acquisition target. There is not much demand for commercial credit. Banks are reluctant to lend to individual borrowers. Their profits are coming from proprietary trading, appropriately rechristened to stay outside the legal scanner.
In bizarre judgements, judges in the US Federal Appeals Courts have upheld challenges mounted by the financial industry against regulatory changes proposed by US regulatory agencies. In a recent ruling, a judge of the US District Court for the District of Columbia vacated the rule on position limits (the number of derivative contracts that a trader can hold on certain commodities) imposed by the Commodities Futures Trading Commission (CFTC) and sent it back to the CFTC for “further proceedings". Commodities and currencies are not toys for traders-toddlers to play around with. They are not playing with commodities or currencies but with the lives of millions of poor consumers the world over and small import and export businesses.
Judge Robert Wilkins of the US District Court of the District of Columbia has, unwittingly, cleared the roadblock against potentially higher inflation in the developing world in the months ahead. In the process, Western nations will be able to maintain the relative standing of their countries over their emerging counterparts. That will be crucial for them to hold on to their current positions of dominance and power in international economic and other forums.
As always, there is more than one angle to the story. It is not as though emerging economies are helpless victims of the machinations of the West. They are clearly contributing a lion’s share to their emerging problems with their non-transparent economic decisions. Underdeveloped institutional strength and autonomy prevent the institutional checks and balances from kicking in, to arrest the damage caused by decisions arising from short-term political imperatives.
Just last week, Moody’s downgraded the credit rating of South Africa from A3 to Baa1. Vietnam too saw its sovereign credit rating lowered from B1 to B2 and the ratings of eight Vietnamese banks were downgraded as a result.
According to Moody’s, the main driver for the downgrade of South Africa’s ratings is the lowered assessment of institutional strength to “moderate" from “high", an important factor in the rating agency’s judgement of a sovereign’s economic resiliency. The revision reflects Moody’s view of the South African authorities’ reduced capacity to handle the current political and economic situation and to implement effective strategies that could place the economy on a path to faster and more inclusive growth. They might as well have been speaking of India or the US. Vietnam’s opaque and insular Communist party structure has been unable to handle the fallout of half-baked and incomplete market and economic opening. That has only seen capital inflows turn into unsustainable credit boom, bust, rising banking system bad debts and a political witch-hunt. Vietnam is looking at a lost decade from the time the economy peaked in 2007.
The Indonesian economy is displaying classic signs of overheating. The current account deficit has swelled to over 3% of gross domestic product (GDP). Credit growth has been running at more than 20% of GDP for the last several years. Even if the credit/GDP ratio is coming off a low base, there is the challenge of digesting too much credit in a short span of time. The currency is overvalued.
Investors have to resist the temptation to switch mindlessly from the debased North to the dysfunctional South.
V. Anantha Nageswaran is the co-founder of Aavishkar Venture Fund and Takshahila Institution. Comments are welcome at firstname.lastname@example.org
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