Emerging Markets Update

It isn't the financial crisis of 1997 by any means, but the economies in Asia are struggling—again. The Japanese yen, Indian rupee, and the Indonesian rupiah have depreciated 30 percent on average in the last 24 months. Growth rates for India and Indonesia that were around 9 percent and 7 percent respectively two years ago have dropped off significantly, with India now at half that rate. Two of the once mighty BRIC economies (Brazil, Russia, India, and China) are now included as part of a group of countries (namely Brazil, India, Indonesia, South Africa, and Turkey) that have been dubbed by Morgan Stanley as the "Fragile Five." This Commentary considers the implications of slowing growth, currency depreciation, debt exposure, and capital egress for emerging markets, in particular India, together with the connected legal issues.

Taper Tantrums

In late May this year, the U.S. Federal Reserve (the "Fed") foreshadowed plans to taper its US$85 billion per month asset purchases, possibly from as early as October. While there have been fluctuations, the general market reaction was increased long-term interest rates in the U.S. and an egress of capital from developing countries, such as Brazil, India, and Indonesia. However, on September 18, Fed Chairman Ben Bernanke surprised commentators and markets by announcing that tapering of the Fed stimulus would not start yet because the economy was seen as too fragile to withdraw its support. The Brazilian real, the Indian rupee, and the Indonesian rupiah have all fallen significantly against the U.S. dollar in recent months, and yields on bonds in emerging countries have jumped significantly. However, emerging markets did receive a boost from the news that tapering by the Fed will not commence in the near future. Nevertheless, the Fed's tighter monetary controls and a rising U.S. dollar predicated Latin America's crisis in the early 1980s and Asia's crisis in the 1990s, and there are suggestions that similar difficulties may still develop again. The machinations over Fed tapering have revealed some fundamental concerns regarding the status of certain emerging market economies, and these will not necessarily be resolved by the recent fillip provided by its postponement (especially as the delay was due to concerns regarding economic fragility). The Asian currency crisis of the 1990s truly began when Thailand's central bank floated the baht after a run on the currency in July 1997. The decision triggered a financial and economic collapse that spread to other countries in the region, causing growth to plummet and companies to go bankrupt with the only solution being IMF-led bailouts. The crisis of the late 1990s was exacerbated by a number of factors, including fixed or semi-fixed exchange rates, high domestic interest rates, heavy offshore borrowing, and large deficits. The present circumstances are different, not least because of the way in which Asian countries reacted after the previous crisis. Most Asian economies now have sizeable current account surpluses (including China, South Korea, Taiwan, Thailand, Malaysia, and the Philippines, although both Thailand's and Malaysia's balances have deteriorated recently) and foreign exchange reserves, and the proportion of non-performing loans on banks' balance sheets has...