My Two Cents

Is the crisis moving to emerging markets?

Chris Farrell Oct 25, 2008

Economist Dani Rodrik, one of the country’s leading international and development economists, thinks so. After a day like today it’s a chilling post:

One can make a decent argument that the financial crisis has bottomed out in the advanced countries (with the real-economy consequences still to come of course). But it is barely starting in the emerging markets, and it could get much, much worse.

Some of these economies are hurt by (now) declining commodity prices; others by large existing current account deficits; and if you do not have a problem on either account, you are (like China) dependent on export markets in the advanced countries that are about to dry up. These fundamentals are greatly magnified by risk assessments in financial markets. Now that advanced countries have bailed out and guaranteed vast portions of their financial systems, there is a much greater demarcation between “safe” and “risky” assets, with emerging markets in the second category. The flight to safety is already taking a huge toll on them. And the worst is likely to come when domestic residents join en masse in the capital flight.

All of this means that governments in these economies will be under pressure to mimic the public guarantees and bailouts that we have seen in the U.S. and the EU. But there is a big difference. Emerging markets for the most part have weak and fragile fiscal systems, and the magnitude of the potential run is huge relative even to the large mountains of reserves that many of them have built up. Socialization of private liabilities may enhance confidence in the rich countries; it will likely magnify the run in emerging markets. So we are talking about economic collapses that could be significantly bigger than what the rich countries will experience. And this time developing countries can legitimately say: it wasn’t our fault!

Rodrik goes on to discuss why the IMF is going to have to take a leading role to contain the crisis.

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