Emerging markets don’t face 1997-style crisis

Emerging markets don’t face 1997-style crisis – but caution is still warranted

While emerging market nations are likely to avoid a full-blown financial crisis, caution on their currencies is merited, according to John Peta, manager, Old Mutual Local Currency Emerging Market Debt Fund and Old Mutual Global Strategic Bond Fund

Some investors are wondering if emerging markets today are facing a crisis akin to that which struck Asian economies in 1997. While there are certainly similarities, we believe most emerging-market nations are better insulated from the risk of a financial emergency than they were in the late 1990s.

The crucial difference is that in the late 1990s, many of these countries’ currencies were pegged to the US dollar. They were forced to waste precious currency reserves on defending those pegs – an ultimately failed effort – while domestic companies ran into trouble after having borrowed in dollars. Today, most emerging market countries, with notable exception of China, have floating exchanges rates. This makes them much more resilient because of the flexibility this allows. A weaker currency will lower imports and should be positive for exports.

Local interest rates, meanwhile, do not suggest that any generalised crisis is gripping these nations. While they are rising in Indonesia, they have remained broadly stable in Thailand, which is seen as a less risky market. And though the spreads on US dollar-denominated debt have widened, they have done so in line with the High Yield and High Grade market – which tells us that credit risk is not an issue at present.

That said, while emerging market exchange rates have already seen a lot of weakness, we do not expect much strength in the near term. The currencies most vulnerable are those with strong links to China, and those dependent on commodity exports. As such, key to gauging their future direction will be the introduction of any new Chinese policy initiatives. The path of US monetary policy will also be significant, as the Federal Reserve may raise interest rates as soon as this month.

To position amid these risks, we hedged out much of our Asian and commodity currency exposure over July and August within the Old Mutual Local Currency Emerging Market Debt Fund. We also pared positions in most countries buffeted by commodity-price weakness and concerns over China; Malaysia, which suffers from both, was one of our biggest underweights.

We have added a little of this exposure back of late, yet our outlook remains cautious: while emerging market nations are unlikely to require bailouts from the International Monetary Fund, as some did at the end of the last century, their situations are still perilous.