The Financial Crisis Impacts Emerging Local Capital Markets
“S
urprise, surprise, surprise: it hasn’t gone like anyone expected,” announced Neil Allen, Principal Senior Fellow of the Center for Emerging Market Enterprises (CEME) at The Fletcher School, describing the ongoing financial crisis. On October 31, a group of students, faculty, and guest experts gathered for a half-day seminar on the financial crisis and its unexpected spread to capital markets outside the US and Europe. The speakers included Neil Allen, Eliot Kalter, Lawrence Krohn, and Pat Schena of Fletcher, along with Allison Holland of the International Monetary Fund (IMF), Anne Milne of Deutsche Bank, and Anderson Silva of The World Bank Group.
Especially in recent months, with bank collapses straining US and European economies, government and financial officials in emerging markets (EMs) from South America to South Asia are facing their first big test.
Some argue that EMs in Latin America are relatively well-poised to weather the current crisis thanks to the rapid growth of local capital markets. Beginning in the 1990s, a string of countries—first Chile, then Mexico, Brazil, Columbia and Peru—took steps to restructure their financial systems such as privatizing pension funds and strengthening domestic credit markets. The number of domestic investors in EMs has continued to increase since then. Today, over 80% of total government debt in Latin American EMs is local, according to Silva, a Senior Debt Specialist and a Fletcher alumnus. Similarly, across the world, China’s insular financial policies have also helped produce robust domestic debt markets.
Krohn, Holland, Silva and Milne further dissected the financial situation in Latin America. They noted that local capital markets in EMs may be more secure today than twenty years ago, but falling commodity prices and reduced US consumption continue to pose a threat to these economies. Bank loans and direct investment are still the main source of cross-border capital flows, but they are decreasing. New debt issuances in Latin America have dried up; although guarantees from the IMF and advanced economies may restore confidence, they also have the potential to “crowd out” EM debt. Meanwhile, foreign capital is also being sucked from Latin American EMs. Given poor fundamentals in the US, however, it is unclear whether these transfers are truly a “flight to quality,” as has sometimes been suggested. Liquidity, it seems, remains the key issue.
Schena added to the discussion with observations about EMs in the Asian Pacific. Here, the absence of alternate sources of long-term credit, and a vulnerability to heavy use of short-term, foreign currency loans pose a serious threat. Potential solutions might be to increase the tenor of debt, reduce mismatches, and focus on governance, responsibility and transparency. This call for transparency was echoed by Holland, who added that adaptability and creativity would be essential for policymakers in various EMs in the coming months.
If the short-term hinges on smart policy, the long-term question concerns growth. With countries like China posting double-digit growth figures each year, and with some analysts questioning whether the political system can withstand more moderate rates, central bankers and policymakers are naturally concerned. Meanwhile, economists and investors are eager to discover how—and more importantly why—growth varies across countries.
CEME will publish a full report on the “Global Financial Crisis: Implications for Emerging Local Capital Markets” in the near future. CEME was founded by The Fletcher School in 2007 as a leading global hub for research, study, and networking devoted to enterprises in the emerging markets and to promote understanding and engagement that contributes to global prosperity and stability. There are several other events on the topic planned for the current academic year.
Kirby Reiling, F'09