Lecture 18: Crises in Emerging Markets
Continuing from Lecture 12
• Boom-bust cycle of inflows & outflows
• Sudden stops
•
•
Managing capital outflows
Speculative attacks
• Contagion
• IMF Programs
•
• Appendices:
•
•
Car crash analogy
The most recent cycle
•
•
•
The 2003-08 boom
Who got hit by the Global Financial Crisis of 2008-09?
Who got hit by the “taper tantrum” of 2013?
ITF220 - Prof.J.Frankel
Cycle in capital flows to emerging markets
Cycle
prophesied by
Joseph
in Egypt:
7 fat years
followed by
7 lean years.
ITF220 - Prof.J.Frankel
Cycle in capital flows to emerging markets
• 1st developing country lending boom
(“recycling petro dollars”): 1975-1981
– Ended in international debt crisis 1982
– Lean years (“Lost Decade”): 1982-1989
• 2nd lending boom (“emerging markets”): 1990-96
– Ended in East Asia crisis 1997
– Lean years: 1997-2003
• 3rd boom (incl. China & India this time): 2003-2008
– Ended in 2008 GFC – at least for the moment.
– Crisis of the Euro periphery: 2010-12
• 4th boom: 2010-11
– Hit by end of Fed’s QE? 2013-16
ITF220 - Prof.J.Frankel
The role of US monetary policy in the cycle
• Low US real interest rates contributed to EM flows
in late 1970s, early 1990s & early 2000s. (BP=0 shifts down.)
• The Volcker tightening of 1980-82 precipitated
the international debt crisis of 1982. (BP=0 shifts up.)
• The Fed tightening of 1994 helped precipitate
the Mexican peso crisis of that year.
– as predicted by Calvo, Leiderman & Reinhart (1993).
• Perhaps it is happening again, as i*↑?
After Fed “taper talk” in May 2013,
capital flows to Emerging Markets reversed again.
Jay Powell, 2013, “Advanced Economy Monetary Policy and Emerging Market Economies.”
Speech at the Federal Reserve Bank of San Francisco Asia Economic Policy Conference, Nov.
http://www.frbsf.org/economic-research/publications/economic-letter/2014/march/federal-reserve-tapering-emerging-markets/
Sudden stop
Example: the 3rd wave of flows to EMs
was interrupted by the Global Financial Crisis in late 2008.
Global
Financial
Crisis
start
Alternative Ways to Manage Capital Outflows
Say a country finds itself with a deficit, e.g., because i* ↑shifts BP line
i
A. Allow money to flow out
(can cause recession,
& banking failures)
B. Sterilized intervention
(can be difficult, and only
prolongs the problem)
•
C. Allow currency to
depreciate (inflationary)
D. Reimpose capital controls
(probably not very effective)
Y
ITF220 - Prof.J.Frankel
Speculative attack:
The capital outflow accelerates so rapidly that the central
bank is forced to devalue by its rapid loss of all reserves.
3 generations of models of speculative attacks,
with 3 kinds of causes:
* Overly expansionary macro policy
-- Krugman (1979)…
* Excessive speculation: “Multiple equilibria”-- Obstfeld (1994)…
* Domestic financial structure: moral hazard (“crony capitalism”)
-- Dooley (2000)…
ITF220 - Prof.J.Frankel
What is the difference between a speculative
attack and a regular balance of payments crisis?
• In Hemingway’s The Sun Also Rises,
a character is asked, "How did you go bankrupt?”
His response: "Gradually ... then suddenly."
ITF220 - Prof.J.Frankel
Traditional balance of payments problem:
Reserves gradually run down to zero,
at which point CB is forced to devalue.
ITF220 - Prof.J.Frankel
Sudden exhaustion of Mexico’s reserves in 1994 Peso Crisis
35000.00
30000.00
25000.00
IMF PROGRAM
20000.00
15000.00
CRISIS
10000.00
5000.00
Level
3m Moving Avg
ITF220 - Prof.J.Frankel
1995M4
1995M3
1995M2
1995M1
1994M12
1994M11
1994M10
1994M9
1994M8
1994M7
1994M6
1994M5
1994M4
1994M3
1994M2
1994M1
1993M12
1993M11
1993M10
1993M9
1993M8
1993M7
1993M6
1993M5
1993M4
1993M3
1993M2
1993M1
1992M12
0.00
Data source: IMF International Financial Statistics.
Modern currencycrises: reserves almost falloff a cliff.
Speculative attack
(See graph for Mexico, 1994.)
An irrational stampede?
Not necessarily.
Rational expectations theory says S can’t jump unless there is news;
at the date of the attack the remaining Res is (just barely) enough
to satisfy the increase in FX demand without a jump in the price S.
ITF220 - Prof.J.Frankel
Contagion
In August 1998, contagion from
the Russian devaluation/default jumped oceans.
Source: Mathew McBrady (2002)
ITF220 - Prof.J.Frankel
Categories/Causes of Contagion
• “Monsoonal effects” (Masson, 1999): Common external shocks
• E.g., US interest rates ↑ or “Risk off”;
• World recession;
• $ commodity prices ↓.
• “Spillover effects”
• Trade linkages;
• Competitive devaluations (“currency war”);
• Investment linkages.
• Pure contagion
• Stampede;
• Wake-up call: Investor perceptions of,
e.g., Asian model or odds of bailouts;
• Illiquidity in financial markets.
ITF220 - Prof.J.Frankel
Major IMF Country-Programs
3 components
•
Country reforms
(macro policy & perhaps structural)
•
Financing from IMF
(& sometimes G-7, now G-20)
•
Private Sector Involvement
(so public money doesn’t go to bail out investors).
ITF220 - Prof.J.Frankel
Appendix 1: The Car Crash Analogy
Sudden stops:
“It’s not the speed that kills, it’s the sudden stops”
– Dornbusch
Superhighways:
Modern financial markets get you where you want to go fast,
but accidents are bigger, and so more care is required.
– Merton
ITF220 - Prof.J.Frankel
Is it the road or the driver? Even when many countries
have accidents in the same stretch of road (Stiglitz), their own
policies are also important determinants; it’s not determined
just by the system.
– Summers
Contagion is also a contributor to multi-car pile-ups.
ITF220 - Prof.J.Frankel
THE CAR CRASH ANALOGY, continued
Moral hazard -- G7/IMF bailouts that reduce the impact of a given
crisis, in the LR undermine the incentive for investors and
borrowers to be careful. Like air bags and ambulances.
But to claim that moral hazard means we should abolish the IMF
would be like saying drivers would be safer with a spike
in the center of the steering wheel column. – Mussa
Correlation does not imply causation:
That the IMF (doctors) are often found
at the scene of fatal accidents (crises)
does not mean that they cause them.
ITF220 - Prof.J.Frankel
Reaction time: How the driver reacts in the short interval
between appearance of the hazard and the moment of
impact (speculative attack) influences the outcome.
Adjust, rather than procrastinating (by using up reserves
and switching to short-term $ debt) – J Frankel
Optimal sequence: A highway off-ramp should not dump
high-speed traffic into the center of a village before streets
are paved, intersections regulated, and pedestrians taught
not to walk in the streets. So a country with a primitive
domestic financial system should not necessarily be
opened to the full force of international capital flows
before domestic reforms & prudential regulation.
=> There may be a role for controls on capital inflow
(speed bumps & posted limits).
-- Masood Ahmed
ITF220 - Prof.J.Frankel
Appendix 2:
More on crises in emerging markets
• Cycles of capital flows to developing countries
• Are big current account deficits dangerous?
• How did the 2003-08 boom differ from past cycles?
• Who got hit by the Global Financial Crisis of 2008-09?
• Who got hit by the “taper tantrum” of 2013?
ITF220 - Prof.J.Frankel
Cycles of capital flows to developing countries:
1975-81 -- Recycling of petrodollars, via bank loans, to LDCs
1982 -- Mexico unable to service its debt on schedule =>
Start of international debt crisis worldwide.
1982-89 -- The “lost decade” in Latin America
1990-96 -- New record capital flows to emerging markets globally
1994, Dec. -- Mexican peso crisis
1997-2002 – EM currency crises:
1997 July -- Thailand forced to devalue =>
starting East Asia crisis (Indonesia, Malaysia, Korea...)
1998, August -- Russia devalues & defaults on much of its debt.
=> Contagion to Brazil; LTCM crisis in US.
2001, Feb. -- Turkey abandons exchange rate target
2002, Jan. -- Argentina ends “convertibility plan” (currency board)
2003- - New capital flows into developing countries, incl. China, India..
- interrupted by GFC 2008-09
& “taper tantrum” 2013.
ITF220 - Prof.J.Frankel
Are big current account deficits dangerous?
Neoclassical theory: if a country has low capital/labor ratio
or transitory negative shock, large CAD can be optimal.
In practice: Developing countries with big CADs often get into trouble.
Traditional rule of thumb: “CAD > approx. 4% GDP” is a danger signal.
“Lawson Fallacy” -- CAD not dangerous if government budget is
balanced, so borrowing goes to finance private sector, rather than BD.
Amendment after Mexico crisis of 1994 –
CAD not dangerous if BD=0 and S is high,
so the borrowing goes to finance private I, rather than BD or C.
Amendment after East Asia crisis of 1997 –
CAD not dangerous if BD=0, S is high, and I is well-allocated, so the
borrowing goes to finance high-return I, rather than BD or C or empty
beach-front condos (Thailand) & unneeded steel companies (Korea).
In taper tantrum of 2013 – CA deficit countries vulnerable (“Fragile Five”).
ITF220 - Prof.J.Frankel
How did the 2003-08 boom differ from past cycles?
• BRICs China & India were big recipients of private capital inflows.
• Most EM countries did not use inflows to finance CA deficits,
– but rather to pile up international reserves.
• Most middle-income countries no longer fix their exchange rate.
• Perhaps as a consequence, many borrowed less in $,
– more in their own currency.
– And more FDI.
•
• => less vulnerability to a sudden stop.
• In global crisis of 2008, some developing countries
were relatively “decoupled” from the shock
• The big exception was much of Central & Eastern Europe:
– Ex ante: Lots of borrowing denominated in € (& even Swiss Francs)
– Ex post: The worst-hit, in 2008-09.
ITF220 - Prof.J.Frankel
The Global Financial Crisis was quickly transmitted
to emerging market currencies in September 2008.
Source: Benn Steil, Lessons of the Financial Crisis, CFR, March 2009
24
Spreads had been low, but rose again in Sept.2008,
esp. in Central/Eastern Europe.
World Bank
ITF220 - Prof.J.Frankel
Best and Worst Performing Countries
in Global Financial Crisis -- F&S (2012),
Appendix 4
GDP Change, Q2 2008 to Q2 2009
Lithuania
Latvia
Ukraine
Estonia
Macao, China
Russian Federation
Bo tto m 10
Georgia
Mexico
Finland
Turkey
Australia
Poland
Argentina
Sri Lanka
Jordan
Indonesia
To p 10
Egypt, Arab Rep.
Morocco
64 countries in sample
India
China
-25%
-20%
-15%
-10%
-5%
0%
5%
10%
The variables that show up
as the strongest predictors of country crises are:
(i) reserves and (ii) currency overvaluation
0%
10%
20%
30%
40%
50%
60%
Reserves
Real Exchange Rate
GDP
Credit
Current Account
Money Supply
Budget Balance
Exports or Imports
Inflation
Equity Returns
Real Interest Rate
Debt Profile
Terms of Trade
Political/Legal
Contagion
Capital Account
% of studies where leading indicator was found to be
statistically signficant
(total studies = 83, covering 1950s-2009)
External Debt
Source: Frankel & Saravelos (2012)
70%
Global investor interest in government debt resumed
for some Emerging Markets in 2010
Serkan Arslanalp & Takahiro Tsuda, The Trillion Dollar Question: Who Owns Emerging Market Government Debt, March 5, 2014, iMFdirect
Countries with worse current accounts were hit
by greater currency depreciation after “taper tantrum” of May 2013.
Mishra, Moriyama, N’Diaye & Nguyen,
“Impact of Fed Tapering Announcements on Emerging Markets,”
IMF WP 14/109 June 2014
Countries with higher inflation rates, also, were hit
by greater currency depreciation after May 2013.
Mishra, Moriyama, N’Diaye & Nguyen,
“Impact of Fed Tapering Announcements on Emerging Markets,”
IMF WP 14/109 June 2014