The 1997 emerging market crisis and now

In 1998, the markets were largely expecting the US Federal Reserve to raise interest rates with growth pushing 6%.

Federal Reserve
Source: Bloomberg

A year later, what actually eventuated was a 75 basis points cut in the funds rate, taking the rate to 4.75%. Concerns around emerging markets were largely at the centre of the Fed’s thinking.

Fast forward to 2015, and we’re staring at a similar issue, whereby Asian emerging market economies are facing the issue of slowing growth, falling oil prices, and rising USD denominated debt concerns – all amid excessive investment. The result is massive outflows from emerging market equity funds, not to mention rampant and prolonged selling in the domestic currencies.

With the exception of Indonesia, one would be hard pushed to find an Asian country (ex-Japan) that isn’t in a multi-year producer price deflationary spiral. Naturally the deep declines in commodity markets are having a sizeable impact, which have also been magnified by political issues (in Malaysia, Hong Kong and Thailand), as well as Chinese growth concerns in general.

The key issue has to be the contribution that emerging markets provide to global GDP. In 1998, this contribution was 15%, while it’s now closer to 40%. The capital markets, as well as global economics in general, are far more interlinked. This is undoubtedly the concern for many developed markets, especially Australia. Whether we see a protracted crisis in the banking system this time around is yet to be seen, and I am personally sceptical. But I think global markets are right to be concerned, due to the fact that we have seen such ferocity behind the moves in various currency markets and outflows from emerging market equity funds.

It is worth noting, however, the big difference between Asian economics currently and in 1997/98. Firstly, and on a positive note, we know that many Asian countries run sizeable current account surpluses – their reliance on offshore funding is therefore mitigated. Exchange rates are also more flexible and freely floating than in 1997, and the holding of FX reserves are significantly higher. This provides central banks with the opportunity to support their exchange rate if needed. Liquidity is also significantly higher.

It should also be remembered that Asian growth (ex-Japan) is hardly collapsing. Using statistics from Nomura, they estimate that Asia (ex-Japan) has slowed around 2.5 percentage points between 2006 and 2014.

We also know that China has many different policy levers at its disposal still. Looking at the concentration of the equity holdings and the high savings rate, a further collapse in the Chinese stock market should not impact the consumer dramatically. I don’t sit in the camp of developed market equities being heavily influenced by the idea of a link between the stock market and the economy – but what we are seeing is more psychological. The fact is, despite huge interventions from the Chinese central bank and regulator to support the market, the various measures are failing to provide the desired support. To many investors and traders, this shows vulnerabilities and a loss of confidence in officials’ ability to support the market.

If we want to draw parallels, then one could compare the moves in Chinese markets to the NASDAQ in 2000. The price action we are seeing from late 2014 looks remarkably like the Dot-Com crash.

My personal belief is that the concerns around China and emerging markets and the parallels with 1997/98 are overblown. But the uncertainty these aforementioned issues have provided is a clear reason for the Fed to hold-off from moving rates in September. The market is now placing only a 50% probability of a December hike and there is no guarantee this will materialise, especially when there has been increased talk of another round of balance sheet expansion (quantitative easing) to bring real rates (inflation adjusted bond yields) lower, from high profile figures like Larry Summers. The push back in expected policy tightening should help financial conditions as well as keep developed equities supported, although I personally think the fact we are even seeing an increased conversation around QE4 is very bearish indeed.

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