This year’s emerging market sell-off has raised the long-standing issue of contagion—the tendency for credit problems in a small set of emerging markets to spill over into a broader credit crunch, often with dire implications for economic fundamentals. Given the nature of credit markets—the fact that they rely on investor confidence—one cannot rule out the possibility of vicious feedback cycles in which investor apprehension restricts credit access, which thereby impedes growth prospects and further erodes confidence.
With this caveat in mind, we believe that there are good reasons to think that recent market turbulence has not put us on the brink of a full-blown emerging market credit crisis. One reason for confidence is that, as a group, emerging markets are less reliant on short-term external financing than they have been in the past.
The chart below tracks the number of Morgan Stanley Capital International (MSCI) emerging markets with “large” current account imbalances—which we define as deficits in excess of 4% of GDP. There were eight MSCI emerging markets with large current account imbalances in January 1997—just before the Asia debt crisis of 1997-98. There were also eight MSCI emerging markets with large current account imbalances in January 2008—at the onset of the global financial crisis.
In contrast, at the beginning of this year, there were only two MSCI emerging markets with large current account deficits: Turkey and Pakistan. The financial difficulties of these markets have been well publicized. The good news is that they stand alone among emerging markets in terms of their current account deficits.
The potential for credit troubles is probably more pronounced in MSCI “frontier” markets—those markets that are considered by MSCI to be even less developed than emerging markets. At present, several MSCI frontier markets have large current account deficits. The most prominent among these is Argentina, whose continuing debt problems are well known.