Practical analysis for investment professionals
27 August 2013

Turmoil in Emerging Markets: Is It 1997 All Over Again?

Posted In: Economics

From the moment US Federal Reserve Chairman Ben Bernanke mentioned the word “taper” in May, markets the world over have begun to embrace a new reality. With expectations that the US Federal Reserve will soon begin to tighten monetary conditions, the Treasury Yield Curve has shifted upward by more than 100 basis points, the US dollar is appreciating after years of decline, and emerging markets — particularly those in Asia — are grappling with renewed volatility. Growth has begun slowing, interest rates have been rising, capital is fleeing, and in countries such as India and Indonesia, currencies are dropping sharply. All of which raises the question: Is a second Asian Contagion, like the one in 1997, in the offing?

History may not repeat itself, but it sure does rhyme. Once again, as in the mid-1990s, easy money has inflated Asian economies, particularly over the past five years. And once again, an imminent shift in US monetary policy is the pin bursting the bubble.

To really understand where emerging markets are today, and what might be in store, it is instructive to look at the root causes of the 1997 Asian financial crisis. The seeds of that crisis were planted in the late 1980s and early 1990s, when many Southeast Asian nations, including Thailand, Indonesia, Malaysia, and the Philippines, experienced a long period of prosperity dubbed the “Asian Miracle.” Many of these countries achieved sustained, strong growth by employing some variant of the infrastructure growth model, a term used to describe growth fueled by investments in manufacturing, exports, technology, and infrastructure, coupled with abundant cheap labor. This combination enabled Asia’s emerging economies to produce goods for export at competitive prices. It was a formula further supported by exchange rates that were fixed to the US dollar, the currency of their largest export market. But the boom was fueled by credit, much of it denominated in US dollars, as foreign capital sought out higher interest rates coupled with limited currency risk. In short, the Asian Tigers had hitched their wagon to the US economy.

Unfortunately, things began to sour in 1995, when the United States adopted the Reverse Plaza Accord, whereby the US Federal Reserve reversed its previous efforts to reduce the value of the US dollar and coordinated monetary policy with Japan and Germany to increase the value of the dollar relative to those countries’ currencies. The rising dollar was a pivotal moment for the Asian Contagion: Over the 1995–1997 time frame, the Japanese yen fell approximately 60% against the US dollar, making Japanese exports much cheaper on the international export market — and naturally, much more competitive against exports from Asian Tiger countries that were still pegged to the now rapidly appreciating US dollar. As the dollar appreciated, currency markets smelled a problem and began selling Asian currencies, homing in first on the Thai baht, which authorities were forced to devalue in July 1997. Once Thailand broke its peg, currency traders swooped in on the remaining Asian Tigers, forcing each of them to break their own pegs. Ultimately, the International Monetary Fund was called in to provide financial support and help arrest the capital flight.

Once again, emerging market economies are suffering from capital flight. Yet some things have changed. As a recent article in the Wall Street Journal points out, Asian economies, for the most part, no longer maintain currency pegs to the US dollar; instead, their currencies float freely. In addition, Asian central banks’ foreign reserves are substantially larger. Even so, dependence on foreign capital still runs high: In India, where the rupee has dropped 13% in three months to an all-time low against the US dollar, external debt clocks in at more than $400 billion, of which roughly 80% is denominated in foreign currencies. India’s current account deficit is equal to about 5% of GDP.

Similarly, the Economist reports that in Indonesia, where the national currency, the rupiah, has hit a four-year low against the US dollar, the current-account balance swung to a deficit of 2.7% of GDP last year — and has since widened to 4.4% of GDP.

For these countries to correct their deficits, their currencies must fall materially. Markets have already responded to the Bernanke taper meme, so even though the choice has been made for them by global investors, they now find themselves stuck between a rock and a hard place: Do nothing and watch their external debt skyrocket if their currencies continue to fall in value — or defend their currencies and keep rates low to spur their economies.

This dilemma points out a key lesson from the 1997 Asian financial crisis that is just as valid today: Government economic policies — whether it is setting non-market interest rates, pegging currencies, or whatever the case may be — inherently force markets to depart from the equilibrium that would be achieved by citizens freely choosing the supply and demand of anything, including currencies and credit. The resulting imbalances ultimately and inherently destabilize markets. The only unknown is where the imbalance will manifest itself. Well, now we know.

What about the free flow of capital? A common and often-repeated explanation for the 1997 crisis is that the Asian Tigers had too strongly embraced free trade and money flows, which led to serious gyrations that destabilized their economies. Nobel Prize–winning Columbia University economist Joseph Stiglitz has famously contended that “too much liberalization” was a root cause of the Asian crisis and had subjected these countries to “the will of speculators.” Perhaps, as Stiglitz and others argue, there should be a more measured approach governing capital inflows — a subject that is already receiving renewed focus from scholars and policymakers alike. But to highlight a country’s openness to foreign capital as a problem without also highlighting the abrogation of free market interest rates and exchange rates strikes me as shortsighted.

Yet here we are. Unfortunately for emerging markets like India and Indonesia (not to mention Turkey and Brazil), easy money in the developed world has likely created yet another credit-induced bubble that appears ready to pop. Or to switch up analogies: Money is like water. It always flows somewhere, and it’s never quite clear exactly where it will go. The resulting, inevitable malinvestment that follows in its wake is revealed only after calamity strikes.

Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

About the Author(s)
Ron Rimkus, CFA

Ron Rimkus, CFA, is a content director at CFA Institute, where he focuses on economics and alternative investments. Previously, he served as CEO at the online technology company he founded, Chaos Management, Inc. Prior to founding Chaos Management, Rimkus served as director of large-cap equity products for BB&T Asset Management, where he led a team of research analysts, regional portfolio managers, client service specialists, and marketing staff. He also served as a senior vice president and lead portfolio manager of large-cap equity products at Mesirow Financial. Rimkus earned a bachelor of arts holds a BA in economics from Brown University and an MBA from the UCLA Anderson School of Management. Topical Expertise: Alternative Investments · Economics

44 thoughts on “Turmoil in Emerging Markets: Is It 1997 All Over Again?”

    1. Biharilal, thank you for the comment!!

  1. Ron,

    Excellently crafted and well explained stuff. I too experienced !997 Asian Financial Crisis when I was growing up. It was as same experience as I had facing the great recession of the US during late 2000’s.

    I really like the last 3 lines:
    “Money is like water. It always flows somewhere, and it’s never quite clear exactly where it will go. The resulting, inevitable malinvestment that follows in its wake is revealed only after calamity strikes.”

    Keep it up.


    1. Nroop, thanks for your comments. Much obliged!

  2. Harshal Shah says:

    Great in

  3. Harshal Shah says:

    Great Post.

    1. Hershal, many thanks!

  4. Nitin says:

    Decent piece

    1. Thank you for your restrained enthusiasm! 🙂

  5. Akash Bachhawat says:

    Nice piece.
    Wonder why we aren’t able to write things pre rather than post!!!..but indeed an insightful piece.

    1. Akash, I intended this piece to light the path a bit. You may recall that the “Asian Contagion” of 1997 spread to Russia and Brazil. In total, it took more than 18 months to play out. The markets began to create turmoil in Thailand in maybe May of 1997, causing the devaluation on 2 July 1997. It wasn’t until August of 1998 that Russia defaulted. Look for the usual suspects. The monetary system is global. The massive excess liquidity of the past 5 years went somewhere. Much of it went on an Emerging Market carry trade where investors borrowed short term in US dollars and Japenese yen and invested (or lent) capital in emerging market debt and equity among other places. Look for it in terms of current account deficits, central bank interventions into currency markets, dubious public works projects, rapid credit expansion (in excess of real growth), etc. This thing is far from over. To use a baseball analogy, this thing is in the first or second inning.

  6. Ashok says:

    Nice article- crisply articulating the real issue.

  7. Rajesh Mehta says:

    Excellent write up worth reading.

    1. Rajesh, at your service. 🙂

  8. Abhishek Lingras says:

    Awesome article. The way you put those things to read is Killer man..Nice work.

  9. Kaushik Saraf says:

    Probably almost every time an Emerging Market will have a Current Account Deficit, may be that’s why they are called as Emerging. I am happy if the GDP rate is positive.

    Ron, please tell me from an Indian perspective, How much of the depreciation in INR can be attributed to Psychological Effect ?


    1. Hi Kaushik, Thanks for your comments. Currencies are set by a complex quasi-market process. Because market participants are human, there is always a psychological and emotional component embedded in prices. However, because central banks are also heavily involved in buying and selling their own currencies and setting monetary policy, both policy and political considerations are embedded in the INR values as well. To my knowledge, nobody has built a framework to estimate how much psychology/emotion is embedded in prices by specific issues. That said, my view is that most of the movement of the INR is based on policy and macroeconomic differentials that have evolved recently and therefore the depreciation of the INR is a rational response and very little is psychological.

  10. uday says:

    Excellent, very true ,what are the lower levels did Syria effect will impact

    1. Hi Uday, I believe your question is how much are events in Syria affecting the rupee. Right? If so, I would venture to say very little. Macroeconomic and policy considerations do hold a great deal of explanatory power here. (Though if there were somehow major asset holdings in INR that Syria was liquidating, maybe…)

  11. Jinto says:

    Good article. So if I put it in Indian perspective (I am from India), India has more to lose from currency depreciation than to gain from it (unlike in the case of Japan).

    1. Hi Jinto,

      I would encourage you to think about it in terms of trade-offs. If India wants to keep its external debt from becoming a greater problem, it must stabilize the rupee and increase interest rates. However, if it increases interest rates [substantially], it will likely throw the economy into recession. Theoretically, if it lowered rates to stimulate the economy (very unlikely of course), then it would stimulate the economy (through incremental credit creation), but accelerate the outflow of capital (and accelerate inflation). Doing nothing is also a choice because the US is shifting monetary policy in a global monetary system, so doing nothing means India is easing (relative to the US which is – likely – tightening.

  12. Abhishek says:

    Well Ron, its high time for emerging markets to step up and take concrete decsions, but ideally when currency depreciates, exports could be encouraged and that might make up for the CAD. China, in the past has depreciated its own currency to hike its exports and its has worked you see, doesn’t this help…why aren’t these situations made such impossible tasks…

    1. Adnan Qureshi says:

      Abhishek the problem that India is facing as of now is the implementation of those fiscal and monetary policies on top of that the political instability with the elections coming up have also led the Rupee to depreciate much more further.
      The situation that you explained is good but only when the Demand for Indian Exports is high. China on the other hand is like the worlds Industrial Capital so you see where we are lying as of now

  13. Sandeep Purohit says:

    Hello Ron,

    Thanks again for yet another very knowledgable blog. I agree with you and Indian Rupee breached 68 mark against dollar today. I have two questions-
    1. can you elaborate little more when you said ” For these countries to correct their deficits, their currencies must fall materially.”
    2. can you also explain little more the how fed’s tapering of monetary policy would impact the emerging market’s currency depreciation.

    I did not know the earlier currency crisis but now I can understand what happened and why. I would also like to mention some other factors which are prevalent today not sure about of earlier scenario.

    Do you feel that inflation is also playing big role now ? After the financial crisis of 2007-08, US has not seen any inflation compare to what Indian economy has been seeing. So its currency should depreciate in same ratio, I would say. Also, some government policies like Indian lower house just passed food security bill and this bill would increase the fiscal deficit by another 0.25% of GDP.

    1. Hi Sandeep,

      Under the current global fiat currency regime, currencies should float freely according to supply and demand. Free floating currencies would adjust in value until trade imbalances are minimized thereby preventing significant buildups of deficits or surpluses. Various departures from free markets create imbalances in the economy as the natural supply and demand for goods is altered. Central banks are constantly tinkering with money supply and interest rates (and bank loans through regulatory oversight) to override the natural equilibrium of free markets. In India’s case, they are sending more money abroad than they are bringing in (current account deficit). Therefore, pressures have been building to reduce the value of the rupee to correct the imbalance. (A lower rupee will make Indian goods more attractive on the international market and stimulate foreign demand and improve capital flow into India).

      The second issue you raise is about the Fed taper. The Fed taper means a tightening of US monetary policy and consequent strengthening of the US dollar. For the past five years it has been extremely easy to borrow cheaply in the US (as well as Japan and Europe) and invest that capital in Emerging Markets and earn a substantial spread. (known as carry trade). The unwinding of Fed policy threatens the carry trade and forces investors to unwind the position. Naturally, they must sell Emerging Market assets (bonds, stocks) and sell the currency, then find a new investment alternatives. Hope this helps!

      1. Sandeep Purohit says:

        Thanks so much for your explanation, I really appreciated.

  14. Jonathan says:

    Excellent write up Ron!
    What do you think is making the currencies of the emerging markets depreciate is it the ineffective mamagement of the economies or is it due to the Fed tapering?

  15. M Ashok, CFA says:

    Fair enough to say Nobel winning Joseph Stiglitz was short sighted (in not considering currency peg and other frictions). But other commentators on India currency matters now also seem far more short sighted and are not blameless. In that, comparing India’s currency fall with Asian crisis of ’97 faced by its counterparts.

    Today a country like Thailand has a GDP of $365 Billion with 66 million population. India is nearly 5 times bigger (in output) with GDP of $1.8 Trillion and a population of 1.2 billion. Trade-wise, exports is still a small component of the economy. We are still, for practical purposes, a closed economy. Our currency regime is still controlled, though commentators fashionably call we (India) are almost fully convertible.

    On an average India saves about 30% of its income. That’s roughly internal savings of over $400-$500 billion every year!. If you see the Foreign Inst. Flows into the country since ’91 (as per SEBI- the capital market regulator) the net inflow till date, that is about two decades, is only $140 bn. The problem with India’s savings is that they are not fully channelized into financial assets, rather it goes into gold and real estate assets. Leaving household holding of equity and marketable instruments very low. Roughly 8% of India’s saving goes into financial assets. As a result, foreign money holds significant stake in India’s equity markets and even small shifts in this flow cause wide gyrations in equity prices.

    Sure our currency depreciation was waiting to happen because our inflation differential with DM got wider and our growth differential got narrower. Happy to see currency depreciate rather than being pegged like other countries. This depreciation is a natural cure to avoid a disaster. The adjustment required, is happening and will be done.

    Other than that, India and its govt knows what it takes to put it back on the growth path. We all know what those issues are. (environmental clearances, fuel price adjustment….). I mean we not walking in the dark.

    Therefore comparing India with much, much, much smaller counterparts which are single industry driven, homogeneous economy, homogeneous skill sets, centrally planned economies is just wrong and short sighted.

    Just one more quick datapoint. India’s USD reserves at $275 billion places it on the 10th highest dollar reserves country in the world. At no. 2 is Eurozone (bunch of countries) and 2 other oil producing nations. Remove these two entities (India has barely any oil and it imports all its needs) India is well within top ten dollar reserves countries in the world.

    M Ashok, CFA

    1. M Ashok, thank you for your thoughts and perspective. External debt denominated in USD is approximately $220 billion. Reserves being greater than this external debt figure is a positive, but it does not guarantee that the falling rupee won’t cause a problem for debtors. The Russian default in 1998 was similar (in this regard). To be clear, I am not suggesting that India will experience exactly what Thailand did in 1997. However, I am suggesting that the massively easy monetary policy of the past five years has created bubbles in Emerging Markets and we are only now beginning to find out where the problems are. Thanks again – great input!

      1. M Ashok says:

        Thanks Mr. Ron.

        Total external debt per Reserve Bank data on 31, Mar was $390 Bn. The rupee debt is quite small. Of this short term debt constitute 25% or $96 Bn. If you dig into the overall external debt figure you will see corporate borrowing is over $120 Bn. I agree that debt is debt, but it’s unlike other countries where sovereign debt (raised to fund public welfare and govt excesses) was high in relation to capacity to repay. This corporate $ debt is not all pervasive. It’s among a few companies which have loaded significant amount of debt to fund their overseas acquisitions in pre-GFC era.

        India’s Current Account Deficit of +4% is worrying. CAD, as acknowledged by the govt themselves, should be in the 2.5% zone for long term stability. Now, studies show that it is not necessary that currency depreciation follows expansion in CAD deficit. In fact it’s in India experience that it saw currency appreciate even when CAD deficit widened. Neither do I agree with experts who attribute recent currency fall to inflation differential. Look at the inflation numbers (CPI) from 2011. It’s mostly in double digit or high single digit every month. The differential with DM always existed. So why didn’t currency correct then? Why did it take so long?

        I think the answer to that is that one is global growth has slowed and India’s growth differential with DM has narrowed substantially. Two, there is always role that speculators play. They amplify bad news to their advantage.

        Another point is unlike other EMs (including Latam) $ inflows into India didn’t create asset bubbles – in equity, debt or currency or real estate. You may argue on real estate that Mumbai is a bubble, but I would say Mumbai real estate has always been precious asset, with or without easy liquidity. It’s because the city is India’s only financial centre and simply keeps attracting best talent from all over the country.

        Also look at Indian consumer spending. Do you know only 2% of Indians hold credit cards? Do you know less that 25% Indians are connected to formal banking system? Credit card and education credit as on FY13 is $1.5 Bn. Housing credit is $7.4 Bn. If there is easy liquidity as commentators say where is all that money going? It has to flow into normal banking channels only right?

        You know, as Ruchir Sharma says in his recent book Breakout Nations – I am not quoting, but to that effect – it’s become cliched to speak in terms of country buckets – BRICS, EMs etc. Each of these countries in that bucket are unique and no worthy trade idea is ever going to emerge by just lumping together everything in your analysis. These acronyms mislead investors and new acronyms replace old ones simply because old ones didn’t work.

        Thanks again for responding.
        M Ashok

        1. Anirudh Sarda, CFA says:

          Excellent article Ron. Also liked the comments posted by Ashok.

      2. M Ashok says:

        I am quite surprised that you again made a comparison, this time between Russian default and ongoing Indian crisis. Let me quickly make a few brief points.

        1. Russia had a fixed currency peg going into the crisis. At some point during the crisis the experimented with a ‘floating peg’. It didn’t work and then the eventually had to devalue the ruble

        2. Russian economy then was very weak. Their internal fiscal position was bad. They had started defaulting on internal debt repayments already, a sign of impending external defaults.

        3. Russia was running a high inflation of close to 80% before the crisis. Russia was a welfare state (continues to be) and welfare costs ballooned through the roof.

        4. Russian relied on crude and metal exports as primary drivers of the economy. This resulted in rising tide of $ inflows. But when crude and metal prices fell for a while in ’98, Russia ran out of $ inflows precipitating the crisis.

        5. Russia was funding a war in Chechnya before the crisis! This weakened the govt reserves meant for a rainy day.

        These are not the circumstances prevailing in India. Currency is free float, though central bank intervenes only to restrain volatility, not levels. Not relying on single industry for livelihood. No war thankfully. Inflation, yes in high single digit but not out of control.

        Thanks for your inputs.
        M Ashok, CFA

  16. Hamad says:

    Excellent article. Worth reading. Mr. Ron i like all your write ups, always add value to my knowledge and understanding. Keep it up.

    1. At your service, Hamad!

  17. Sankruti Mehta says:

    Very good write-up. Being from India..I can relate!!

    1. Thank you, Sankruti.

  18. Niko says:

    Great article Ron.

  19. Nadeem aftab says:

    After a long period of time, today i could get understand what led to Asian Crisis….Excellent article

  20. Muralidhar says:

    Excellent post ! Well articulated by Mr. Ashok too. Look forward to such insightful posts.

  21. Ankit Jain says:

    Thanks Ron. I have gone through your article and found it very knowledgeable. very good job.

    Here, I would also like to appreciate Ashok for his facts and facts and insights.

    I concur with Ashok that Indian external debt in Dollar is very less, compare with other countries. I think its economy cycle which tend to flows from up to down. Indians are good savers, even in us Indians have good fico scores. India is a consumption driven economy because of huge population unlike china which is export driven. Our CAD will always be in negative beacuse. we majorily depend on Gold, pulses and oil for imports and export services and textiles. So with the depreciation of Rupee the export sector have picked up and import has fallen. Indian reserves has increased close to$290 billion including gold reserves. MNC and various other companies wants to enter Indian market for business, however there many restrictions. India should open doors to MNCs as India need more funds for development and they need more ROE. the potential growth of India is close to 7%. Howver inflation is increasing with food inflation around 15-20% because of huge population, wastage of food, bad storage systems. Inflation will remain sticky for coming years also. India is best performer in BRICS in equity. ROE of India is better than other EM countries.

    thanks everyone.

    Ankit Jain.

  22. M Ashok, CFA says:

    Thanks Ankit for your contribution. I noticed the fact that you mentioned that India is the best performer among emerging markets in cal 2013 (or BRICS as you say..I need to check this one.). But yes, India’s diversity, growth potential, macro policy environment is not wholly appreciated many times.

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