While the main drama of the financial crisis plays itself out in New York and London, the ripple effect on the wider world is palpable. Investors in emerging markets – the second-tier economies – predict an era of faltering growth and currency weakness.
Overall, emerging stock markets are already down 33 percent this year – far worse than Wall Street's performance. Concern over the viability of Washington's $700 billion bailout plan contributed to Tuesday's tumble of the South African rand by more than 2 percent. The Indian, Turkish, and Russian stock markets all skidded more than 3 percent.
But few market analysts foresee a return to the financial tumult that overwhelmed Asian economies in 1997 and Russia, Brazil, Argentina, and Turkey in subsequent years. Emerging market economies today generally boast far more robust finances, with healthy surpluses accumulated for just such a rainy day. Some may even appear attractive to investors wary of Wall Street and London.
"The unfortunate reality is that in one way or another everyone in the world is exposed, but that doesn't mean there won't be winners and losers," says Arnab Das, head of emerging markets research at Dresdner Kleinwort, an investment bank in London.
Mark Williams, an analyst of emerging Asian economies at Capital Economics, a London consulting firm, adds: "Whenever something like this has happened, risk aversion has always won out and emerging markets tend to suffer more than most when the world gets into trouble."
Of immediate concern are those countries running large current account (trade) deficits, which continue to rely on international investment to balance the books. South Africa's deficit, for example, runs at close to 10 percent of gross domestic product. In some countries in the Balkans, and the Baltics, and in Central and Castern Europe, it's even higher; Turkey's trade deficit is also cited as cause for concern.
"The financial stress leads investors to avoid things that are high risk," warns Nigel Rendell, senior emerging markets strategist at Royal Bank of Canada. "Emerging markets can be a high risk and an area to keep out of." He says that if investment flows dry up, then these countries could be left short of cash. The only option then would be to allow currencies to slide.
The currency "is either devalued, or allowed to depreciate, or you have to slow down the domestic economy and slow imports from coming in at such a rate," Mr. Rendell says. That could mean a sharp slowdown in growth rates in Turkey and Eastern Europe.
India leaking capital
India, too, has been leaking capital, resulting in a falling currency that in turn has put upward pressure on inflation, currently more than 12 percent. "Comparatively we would say India is relatively insulated, because its economy is relatively closed, but we have seen capital leaving India and pressure on the currency," says Hugo Navarro, an economist with Capital Economics. "It's to the stage where the government is stepping in and taking steps to strengthen [the rupiah] because of concerns over inflation."
On the brighter side are emerging economies that are flush with cash thanks to peak commodity prices (Russia and Brazil) or their own economic boom (China). But even these countries are not immune. Leading Shanghai stocks are down more than 60 percent from their peak; the Russian market, which has fallen more than 50 percent over the past four months, was suspended for two days last week.
Mr. Williams notes that "emerging Asian stocks have fallen by more than those in the developed world," but he says that the region does not suffer from the same financial imbalances afflicting Western finance. "We've seen nothing like the kind of property bubble that has grown up in the US and UK, so there is good reason to think that Asian growth will hold up pretty well," he says.
The big question is whether the US and European economies will slow enough to affect Asian exports. In this regard, Williams says, India and China are well insulated because much of their demand is generated by domestic consumers. "But some of the smaller economies like Singapore, Malaysia, and Taiwan are very reliant on exports to the US and Europe," he notes.
Another gauge of the health of emerging markets is the premium that must be paid by borrowers. This has been widening steadily in recent months, making loans more expensive and raising questions about whether borrowers will be able to roll over their loans when due dates fall.
Who will refinance these loans?
Dutch bank ING has calculated that $111 billion worth of emerging market bonds must be refinanced during the next year. But credit is tight. That's raising doubts about whether corporate borrowers will be able to refinance their loans.
"I don't think we'll see a sovereign debt default problem," when a country can't repay its loans, says Mr. Das. The focus will instead be on banks and "companies that have been major issuers into the credit bubble."
He says, "Russia, Kazakhstan, and Ukraine had a number of banks issuing debt. They haven't all lost access [to credit], but if even Gazprom is having to pay higher [interest rate] spreads [on loans], you can be sure that the weaker names will continue to have a much harder time getting bond deals done."