asian financial crisis

Emerging markets jitters: No, it's not 1997 all over again

January 28, 2014: 12:16 PM ET

It is understandable that some are comparing recent emerging markets troubles to the Asian financial crisis of 1997. But while it isn't the best time for emerging markets, it is hardly the end of days.

By Cyrus Sanati


A real estate agent's window in Shanghai, China

FORTUNE -- The recent financial turmoil pummeling the emerging markets has conjured up memories of the Asian financial crisis of 1997. Talk of contagion, economic meltdowns, and Chinese defaults has managed to spook an already jittery Wall Street, causing many investors to simply dump their emerging markets holdings and run for cover, making a bad situation even worse.

But this isn't 1997 all over again, and whatever crisis that may be brewing today will look very different from what happened back then.

Today, emerging market countries have more sophisticated monetary policies and larger capital reserves, allowing them to better defend their currency from speculative attacks. While some countries will drown, like Argentina, the vast majority will be able to keep their heads above water.

It has been a tough January for the U.S. markets, with the S&P 500 (SPX) down by around 3.6% so far this year. But it has been especially rough for the emerging markets, with the MSCI EM index down 7.1% during the same time. As such, there is growing concern among investors that whatever is going on in the emerging markets could get worse and that if they don't act fast enough, they could see their cash disappear.

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While some investors are bolting for the exits, the vast majority appear to be holding steady. True, the drop-off in the MSCI EM index is concerning, but many had expected that, given the current paradigm shift in the world economy. Europe is now (rightly or wrongly) in full recovery mode, while the U.S. is growing at the fastest clip in years. This has investors shifting their money out of the emerging markets and back into the developed markets. The trend is expected to continue as the U.S. Federal Reserve tapers its open market bond purchases, causing U.S. interest rates to rise over time.

Amid this normal, cyclical rebalancing of capital flows, a few emerging market countries have experienced abnormally sharp drops in the value of their markets, their currencies, or both. Among the worst hit are Argentina, China, Turkey, Ukraine, and South Africa. So what do all these countries have in common? Pretty much nothing, except that they are all considered emerging markets. Given this seemingly random dispersion of economic illness throughout the globe, some investors are concerned that we are in the midst of a full-blown economic contagion set to infect all emerging market countries at random intervals.

It is understandable that some are comparing what is going on today to the Asian financial crisis of 1997. Back then, the forced devaluation of the Thai baht caused a cascade of failures across Asia. The crisis was eventually resolved through major changes in the monetary policies of the affected countries and massive capital injections (bailouts) from the International Monetary Fund (IMF). There is ongoing debate over the best way to resolve that crisis (forced austerity by the IMF as a condition for funds has been widely criticized), the situation stabilized without causing lasting damage to the region or to the developed markets.

But there are a number of key differences between the Asian economic crisis and today's emerging markets rout. Back in 1997, there was little in the way of capital controls designed to limit hot money from rushing in and out of an economy. The Southeast Asian economies thought that they would be the darlings of the economic landscape for years and allowed money to flow in unabated from the West and the Middle East. This led to massive speculation, including a real estate bubble of immense proportions. The massive Petronas towers, which, in 1998 became the first and second tallest buildings in the world, serve as a monument to this speculation.

The crisis today has little to do with hot money rushing out of emerging market countries. Indeed, Argentina -- arguably ground zero for today's crisis -- has suffered from a dearth of foreign investment ever since it defaulted on its international debt back in 2002. The government's expropriation of YPF, the former state-owned energy company, from Spain's Repsol in 2011 year solidified the notion that Argentina isn't the safest place to invest your cash. In Ukraine and South Africa, there is a dearth of foreign investment, and you won't find any mega-skyscrapers being built in Istanbul, Turkey. As for China, while there is certainly a speculative real estate bubble in some regions, the money and financing are largely coming from domestic, not foreign, sources. In addition, strict capital controls have prevented money from being taken out of the country.

During the Asian financial crisis, unsustainable currency pegs collapsed. The Thai baht and the Malaysian ringgit were both pegged to the U.S. dollar at a fixed exchange rate. The superficial stability this peg created in their currencies fueled speculative booms. But when the U.S. started raising interest rates in the late 1990s, the peg started to hurt the Asian export-driven economies. As their exports fell, so did their reserve of dollars, leaving these economies vulnerable to speculators. Thailand was eventually forced to abandon its dollar peg and devalue the baht, which caused a whole host of problems, especially for Thai businesses that had borrowed money in foreign currencies.

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Today, very few emerging market countries maintain pegs to the dollar, so they are better able to respond to changes in the monetary environment. China is the big exception, with its hard 6.8 yuan peg to the U.S. dollar. But China maintains the largest cache of foreign currency reserves in the world, some $3.7 trillion, allowing it to counter any attack on its currency.

Like China, most emerging market countries have learned from the 1997 crisis and have built up sizable reserves to fend off speculative attacks on their currency. A notable exception to this is Argentina, which, because of the dearth of foreign investment in the country, along with artificial price caps on everything from food to energy, has seen its foreign reserve balance cut in half in the past year. With only $30 billion left, the country was forced to devalue the peso by 15% last week. But since there is little foreign investment in Argentina these days, it is unlikely that this will have any major impact on the world economy. Sure, Brazil, Argentina's largest trading partner, could feel a sting as Argentines are forced to curb their consumption of foreign goods, but it won't be too painful to Brazil given the diversity of its economy.

Make no mistake, we still have a major problem. But it seems to be more a crisis of confidence as opposed to a crisis of market fundamentals. Sure, there is probably a real estate bubble in China, and yes, intervention by the state to shore up shaky financial products, such as trust securities, is clearly an issue. But for now, it appears that China has things under control. Its currency is protected, and its waning export numbers should rebound this year as Europe recovers from recession.

Meanwhile, Argentina's economy needs to be rebooted, and political disruption in Ukraine and Turkey are a necessary evil to ensure proper democratic change. But other emerging market countries, like India, aren't suffering from any of these issues and are slated to grow like gangbusters this year. So while it isn't the best time for emerging markets, it is hardly the end of days.

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