Emerging market crisis – will there be contagion to East Asia?

Chief Economist John Greenwood analyzes whether East Asia is at risk from the ills of the current crises in Argentina, Turkey and Venezuela.

Sep 10, 2018 | John Greenwood

In 1997-98, most of the smaller East Asian economies faced a crisis. It started in Thailand and rippled through Korea, Indonesia, Malaysia, Taiwan, the Philippines, Singapore and Hong Kong. Stock markets and housing markets crashed, and currencies were devalued. 

Even the Singapore dollar fell from 1.43 to 1.78 against the US dollar between June 1997 and August 1998. Across the region interest rates were raised abruptly.

In Korea and Indonesia, the International Monetary Fund (IMF) was called in to provide emergency loans. Hong Kong was the only economy in the region that did not devalue its currency.

In the past few weeks, Argentina and Turkey have been hit by crises similar to the Asian Financial Crisis of 1997-98. Their stock markets have plunged, their currencies have tumbled, and the central banks have been forced to raise interest rates very steeply – to 60% in the case of Argentina and 17.75% (so far) in the case of Turkey. 

In Venezuela, the crisis is of an entirely different magnitude. The inflation is like Zimbabwe during the worst years of President Mugabe. Inflation in Venezuela has recently surged to over 60,000% p.a. (according to Prof Steve Hanke of Johns Hopkins University). Goods have disappeared from the stores – as they did briefly in Hong Kong during the Hong Kong-dollar crisis of September 1983. And people are fleeing to neighboring Colombia and Brazil in search of jobs and security – just like how people fled from Zimbabwe to South Africa when the inflation reached extreme levels.

Three questions arise: What caused these crises? Why do the crises seem to occur simultaneously in different economies at the same time? What is the risk of contagion to Asia?

Let’s answer each in turn.

First, the crises were all caused by excessive spending relative to the capacity of the economy.  The excess spending can be government-led, as in Argentina and Venezuela, or led by the private sector, as in Turkey. Either way, this shows up in rapid money growth.

In the case of government-led spending, instead of raising money through taxes or borrowing on the open market, the government funds its excessive spending and budget deficits through the central bank. In short, it prints money to pay for public sector salaries, subsidies for food, fuel, or utilities, or over-generous state pensions. This is what has happened in Venezuela and to a lesser extent in Argentina.  

In the case of excess private-sector spending, the central bank typically keeps interest rates too low, causing credit growth to sky-rocket. This is what has happened in Turkey. 

Whether the spending is government-led or private sector-led, there is one guaranteed symptom: excess money growth. In Venezuela, M2 has grown astronomically – by over 6,700% in the year to June 2018. In Argentina local currency M3 grew at 34% in the year to June, and has averaged 33% p.a. since 2014. In Turkey, M3 was 22% over the year to July, and has averaged 16% p.a. since 2014. 

Needless to say, excess money growth produces other symptoms: current-account deficits, rising inflation, and a weakening currency. Argentina, Turkey and Venezuela have all experienced these problems in recent years. 

Second, emerging-market crises tend to build up during a period of calm or easy credit conditions in the developed economies. In East Asia in 1997-98, all the economies shared the same framework of fixed exchange rates and rapid growth with domestic interest rates higher than US rates. They all took advantage of low rates in the US (especially between 1992 and 1995) to borrow in US dollars, financing their current-account deficits with big capital inflows. And they all had excess money growth.

In Argentina and Turkey, the backdrop is similar, except that they have had floating or managed exchange rates. The build-up of the current crisis was masked by rising stock markets in the US, East Asia and other emerging markets in 2017. Low interest rates in the US, Europe and Japan encouraged Argentina and Turkey to borrow foreign currencies – like the Asian economies had done in 1992-97. As long as the inflows continued, investors remained calm.  But sooner or later, the symptoms of excess money growth will show up. When somebody rings the alarm bell, there is a rush for the doors – leading to falling share prices, currency depreciation and a surge of inflation. 

Third, the key question for East Asia is: will the contagion spread from Argentina and Turkey to engulf every Asian economy from Korea down to Indonesia? To a degree, flexible exchange rates across most of Asia have provided a shock absorber that did not exist in 1997-98. However, the answer depends not on whether the economies have oil (like Indonesia), or raw materials (like Malaysia), or a fixed exchange rate (like Hong Kong). The avoidance of contagion will depend on how they have been managing their monetary systems.  

Initially all emerging-market stock markets and the floating currencies will fall a bit – as we are seeing – because global investors will sell their most liquid emerging-market holdings. But, provided that the monetary systems have been well managed, the mark-down of prices will only be temporary. The table below shows that money growth across the region has been very restrained over the past year. Single-digit money growth means that, on an economy-wide basis, there cannot be excess spending in Asia.                                          

Money Growth in Asia
Economy Measure of Money Year-to-Year % Change Latest Data
Korea M3 7.2% June
Taiwan M2 3.8% July
Hong Kong HK$M3 6.2% July
Malaysia M3 5.9% July
Thailand M3 5.1% July
Singapore M3 2.7% July
Indonesia M2 6.1% July
India M4 9.2% August

Asian economic managers have learned the lessons of 1997-98. Argentina, Turkey and Venezuela have yet to learn those lessons. 


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The opinions referenced above are those of John Greenwood as of September 7, 2018. 

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