Emerging markets and currencies are feeling the heat as the crisis in Iceland has turned the spotlight on other potential blow-ups across the world. So who else is in trouble?
The western financial crisis is going global. Investors have been selling out of “anything remotely risky”, notes Dresdner Kleinwort’s Jon Harrison. Commodity producers such as Brazil and Mexico have been hammered as jitters over global growth have mounted. Their stockmarkets are now down by around 56% and 40% respectively this year. But the spotlight has fallen mainly on countries with high debt levels and banking sectors that are dependent on external funding. There are “quite a few” more potential Icelands out there, says Lars Christensen of Danske Bank.
In Asia, Pakistan, struggling with political turmoil, a huge current-account deficit and dwindling foreign-exchange reserves, has had to turn to the IMF, the World Bank and the Asia Development Bank to secure funding to cover $3bn of debt that it will soon have to pay. The Korean won posted its biggest one-day fall in a decade last week.
The highly indebted private sector and Korean banks’ heavy reliance on short-term foreign borrowings make it far “more fragile than other Asian financial systems”, notes Leo Lewis in The Times; around 12% of the banking sector is funded by the gummed-up wholesale debt sector. And the current-account deficit is in the red. Early this week, the Korean authorities calmed the markets with a $100bn government guarantee of banks’ foreign-currency debts maturing between now and June 2009. It also injected $30bn of highly sought-after dollars into the banking system.
Citigroup has highlighted Indonesia – where the stockmarket “recently seems to have spent more time closed than open”, says the FT – and Korea as the Asian countries most vulnerable to the sudden reversal of external financial flows. Still, Korea looks much healthier than it did in 1997, says Capital Economics. The ratio of short-term external debt to foreign-exchange reserves was then 300%; now it’s 72%. Moreover, Asia as a whole has over $4 trillion in foreign-exchange reserves that can be used to bolster currencies. It also has little consumer debt and is by and large “a continent of current-account surpluses, well-capitalised banks and modestly leveraged balance sheets”, as Louise Lucas says in the FT. So this time round, Asia’s capital-flight problem looks “manageable”. The larger problem is “how to cope when western markets lose their appetite for Asia’s exports”. The Asian Development Bank points out that 60% of Asia ex-Japan’s exports go to America, Europe and Japan. Given the darkening outlook in these economies, and the fact that Asian earnings are still expected to grow by an unrealistic 14% in 2009, the Asian bear market is unlikely to be over.
But the risk of financial crises has been highest in central and eastern Europe. Virtually all the economies in this region (except Russia, which is using its foreign-exchange reserves to bolster banks and businesses hit by the shutdown in global borrowing) have large current-account deficits and hence high external debt to GDP ratios. So they are dependent on foreign financing just as investors flee risk. Current-account deficits have reached 15-20% in the Baltics and Balkans, and 10% in Ukraine. The downturn in western Europe is also denting confidence.
A particular worry is that in central and southeast Europe and the Baltic states, consumers and companies have borrowed in foreign currencies, notably euros and Swiss francs; last year almost 90% of loans were made in these currencies in Hungary. The interest rates on foreign-denominated loans were lower, but now that the local currency is sliding – it has hit a two-year low against the euro – consumers and firms are struggling as they are spending more on repayments. The western banks who supplied these loans via local subsidiaries are now under pressure and local lenders are cutting back on or raising the cost of foreign-denominated loans.
Hungary has received a €5bn credit line from the European Central Bank to cover local banks’ shortage of euros, while the IMF is lending Ukraine and Iceland up to $14bn and $6bn respectively. It may also help Serbia. Such moves may help avoid the “poisonous cocktail of currency devaluations, spiralling inflation, sharp increases in bond yields and steep drops in output” that typify balance of payments crises, according to Capital Economics. But plunging commodity prices and hence export revenues may soon cause currency crises in poorly managed and hence especially vulnerable Ecuador, Venezuela and Argentina, reckons Win Thin of Brown Brothers Harriman. The emerging-market firestorm isn’t over yet.