WASHINGTON (Reuters) - Emerging-market economies face their biggest challenge in a decade as G7 finance ministers gather this weekend to discuss ways to prevent the financial crisis from snowballing into developing countries.
Leaders from Brazil, Russia, India and China, among others will pressure the world’s richest nations during the International Monetary Fund and World Bank’s Fall meeting in Washington to act vigorously in order to maintain liquidity in global credit markets. A parallel summit of the G20 emerging market and industrialized nations will also take place on Saturday.
At stake for the emerging market economies is a decade worth of fiscal discipline, tame inflation, and sustainable economic growth. Many of those economies, helped by a boom in commodity prices and a decline in the U.S. dollar, accumulated unprecedented levels of foreign exchange reserves that are now being used to help prevent their own currencies and markets from melting down amid a global slump in asset values.
“Decoupling is dead. The talk in emerging markets until recently was that many of those economies would survive the liquidity meltdown in the U.S. and Europe reasonably well,” said Win Thin, a senior currency strategist at Brown Brothers Harriman in New York. “But that’s gone. No country is isolated.”
The Russian central bank has spent about $25.6 billion in foreign reserves in September to support the ruble as their stocks plunged to multiyear lows. In Brazil, stock trading has been halted almost daily in the past week as equity prices sank to their lowest in two years and its currency touched its weakest level since 1999.
While government agencies and banks in most developing countries are not exposed to the same sort of mortgage-related assets that have been poisoning U.S. and European markets, the rapid appreciation of the U.S. dollar, combined with a drop in commodity prices, along with capital outflows, are all forming a “perfect storm,” economists said.
Current account surpluses are quickly turning into deficit and now the World Bank and the IMF see overall economic growth slowing in 2009 in Latin America, Eastern Europe and part of Asia.
“We obviously see a very significant deterioration of the external environment,” said Augusto de la Torre, chief economist for Latin America at the World Bank in Washington. “The shocks have become global, they have become integrated.”
Still, De la Torre and other analysts said the implementation of tight fiscal policies in the past decade may help many of those developing nations to at least buy some time before their economies plunge into recession.
“It makes you wonder what might have happened in some emerging economies if they were not facing this meltdown in such a good position,” said Aviral Rai, senior managing director and head of the developing economies business at Pali Capital, in New York.
While it was relatively easy for developing countries to improve their macroeconomic fundamentals during the global bonanza of the past five years, governments will now need to make unpopular choices, such as further reducing spending, to keep their balance sheets healthy.
“Now many administrations in the region will have to show their true policy convictions,” Goldman Sachs’ senior economist Alberto Ramos told Reuters in New York.
To provide liquidity, many government will also have to ease monetary policy, at a time when inflation is only beginning ease.
But countries that have reduced debt, curbed inflation, and been fiscally responsible will ultimately be favored by investors once the turmoil abates, said Gunter Heiland, asset manager with J.P. Morgan Asset Management in New York.
“Countries that have been fighting inflation like they’re supposed to, now have higher interest rates, and as the shocks come into their areas, they can lower them and keep growth steady,” Heiland said.
Another tough decision for many governments, especially in Latin America, will be whether to seek financial protection from multilateral organizations such as the IMF, which is stigmatized in the region as a reminder of past crisis and a sign of subservience to Washington.
Demand for IMF financing drastically decreased in the past few years, allowing many developing countries to sever ties with the fund.
But the Fund may now edge back to center stage as capital markets dry up, Standard & Poor’s analyst David T. Beers recently forecast.
The IMF “has substantial unused lending capacity, and we expect that capacity to be deployed in support of financial stabilization programs in many more countries that we’ve seen in a long while,” he said.