Cast your mind back to the autumn of 1998, not that long ago, and
one word dominated the financial headlines - Contagion”. Granted, some may not want to conduct this exercise, painful as that time was for many, yet in a period of relative euphoria where such considerations are all but forgotten it is well worth a reminder of how truly awful the year 1998 was for global emerging markets.
While U.S. retail investors watched the valuations of their U.S.- invested mutual funds climb ever skyward, investors elsewhere were left to sweep over the ashes of what was left of the Asian asset markets, burning and smouldering as they were in the first half of 1998 in the wake of the regional economic collapse. Like a brush fire which suddenly catches once more, devastating all in its wake, or a virus which re-emerges to disable the host, the woes of Asia spread to other markets, most notably to Russia. For much of the year, the Russian financial system had seemed on the brink of collapse in any case, but two factors held back many from predicting one - Russia, either in its modern or Soviet form had never defaulted on its debt and the IMF in July 1998 provided it with a USD4.8 billion loan tranche which was aimed at shoring up the financial market and economic confidence. Hindsight is of course 20/20, but both these factors represented the hopes of those who expected Russia to seek to pursue logical economic and financial policies (whatever the policies of the past), hopes that were to be proved bitterly disappointed by the subsequent - and seemingly suicidal move - by the Russian authorities, both to devalue their currency and default on their debts. By then, however, Russian local dynamics were not the only or even the prevailing force driving events which had taken on a much more global nature, overwhelming all before them.
Much as had been the case with the Thai ba/it on July 2, 1997, the devaluation of the Russian rouble on August 17, 1998 stunned global financial markets; not so much a butterfly flapping its wings, as a bear brought low with an earth-shaking thud. Ironically, yet with little apparent sense of irony - or memory - the IMF quickly moved to welcome the devaluation of the rouble, just as it had done initially with that of the Thai ba/it. The subsequent default by Russia on its domestic debt market was greeted however by a deafening silence. The reverberations of those events in Russia were felt instantly all around the world, and not just in the emerging markets but also in those of the emerged or developed world which had up until then seen this process as merely the latest developmental stage in such markets. In the financial markets, pressures quickly moved to Latin America, more specifically to Argentina and Brazil. Increasingly risk averse, investors began to hedge or reduce their emerging market investments and many banks began to take a more conservative view about lending exposure. Across Wall Street, credit line exposure to emerging markets or those to leverage were severely reduced, thus to a certain extent fuelling both the subsequent decline in assets as liquidity dried up and the ensuing credit crunch conditions. However, some brave souls took a completely contrarian view, seeing in the Russian devaluation a golden opportunity to buy into the plunge on the view that the rouble’s un-competitiveness would be eliminated and interest rates would come down, thus causing a significant recovery in Russian asset markets. In those chaotic August days, buying into such a market was like trying to catch a falling machete. They were cut to pieces.
In London, New York, Singapore and Tokyo, trading rooms were in uproar as markets convulsed in the wake of the Russian turmoil. While the initial reaction to the Thai devaluation had run the gamut from disbelief to relief, elation and despair, that to the Russian devaluation and default was unanimous: unequivocal horror. Investors felt utterly betrayed and just as importantly the credibility of the IMF was seriously damaged. The Central Bank of Russia had tripled interest rates and spent billions of dollars in defence of the rouble and once again it had all been for nothing; bitter memories of the Thai baht devaluation. This time investors and corporates would not be caught out again. The selling pressure spread instantly, reaching epidemic levels, hammering with hurricane-like force the ramparts of such far away shores of Argentina and Hong Kong. In the latter, the HKMA was forced for a variety of reasons to intervene in the stock market, spending over HKD100 billion to burn speculators and discourage market manipulation. Hong Kong’s Financial Secretary Donald Tsang, in a speech in London in the wake of these events, vigorously defended these actions, adding pointedly with regard to the interconnectedness of global financial markets that Brazil was the “line in the sand”, that multilateral organisations and the major economies of the world could not allow Brazil to fail as Russia had failed - or face the consequences. For such an eloquent speaker, it was a surprisingly blunt message, but such were the times. International authorities responded with more vigorous leadership. The Federal Reserve Board cut interest rates three times - on September 29, October 15 and November 17 - and the IMF expressed support for Brazil’s economic policies, putting forward a financial support programme of some USD41.5 billion for the country towards the end of that year. As with the Russian rouble however, it was all for nothing. Late on Wednesday, January 13, 1999, Brazil widened the trading band of its currency, the real. On Friday, January, 15, it gave up and scrapped the band altogether. In a single day, the real plummeted by some 1 2 reminiscent indeed of the 1 5 swan dive by the Thai baht a year and a half earlier.
What had started out as an Asian crisis, an Asian flu”, had become a truly global phenomenon, indeed a global financial crisis. The fear of contagion, of contracting the emerging market virus was both cause and effect. It took the emergency actions of the Federal Reserve late in 1998 to calm the situation somewhat and the resolute defence of the Argentinean and Hong Kong dollar pegs to stop the virus from spreading still further. In order to gain a full understanding of the Asian recovery which is currently alleged, we have to first understand the full extent of the damage caused by the initial crisis, how that crisis spread to other regions and what fundamental forces stopped the Asian currencies and asset markets from falling. Just as with the initial Asian crisis itself, the transition period has seen a number of major stages, the first being of course the initial fallout. Indeed, at the macroeconomic level, the Asian crisis became a model, what I have termed the “Classic Emerging Market Currency Crisis” model for the asset class as a whole, one possessing four key phases. Throughout it, I refer liberally to the example of Thailand since it is widely seen as the catalyst for the Asian regional crisis, yet readers should note that this model applies to global emerging markets as a whole - it works vell with regards to the Brazilian and Russian crisis, and indeed fits neatly with the ERM and sterling rises in the more emerged markets:
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