For Emerging Markets, 2015 Isn’t 1997 – by Greg Ip (Wall Street Journal – August 26, 2015)

Echoes of 1997 exist, but financial crisis is less of a risk today than economic stagnation

The Federal Reserve was planning to raise interest rates, oil prices were sinking, and an emerging Asian country devalued its currency.

For emerging markets, there are unsettling similarities between 1997, when Thailand’s devaluation touched off a crisis that engulfed Asia and eventually Russia and Latin America, and the present, when China’s devaluation has triggered selloffs in currencies, stocks and bonds.

The good news is that a lot has changed since then. Today, falling currencies aren’t a sign of a brewing crisis, but a welcome shock absorber. The bad news is that China’s slowdown and the accompanying slump in commodity prices are exposing structural weaknesses that emerging economies have neglected for too long.

For emerging markets, the Fed’s apparent determination to tighten monetary policy stirs unpleasant memories. In 1981-82, 1994, and 1997-98, the fact or fear of higher U.S. interest rates squeezed countries and companies that borrowed in dollars, precipitating crises.

Entering 1997, many emerging market currencies were pegged to the dollar. Those pegs had stabilized inflation and provided certainty to investors and exporters. But they also encouraged governments, banks and companies to borrow heavily in dollars, which was cheaper than borrowing in the local currency, and foreigners to lend in local currency.

Growing trade deficits, though, made those pegs unsustainable. To counter selling pressure, central banks spent scarce foreign currency reserves buying up their currencies. Eventually, they were forced to devalue, starting with Thailand, and later, the Philippines, Malaysia, South Korea, Indonesia, Russia and Brazil.

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