Discuss the effects of the global financial crisis of 2008 on different emerging markets.

Question

What will be an ideal response?

Answer 1

The financial crisis affected emerging economies less than the developed nations and their recovery was more rapid, while the industrialized nations still struggle with higher taxes and persistent unemployment. Most of the emerging market countries have faced severe economic crisis in the 1990s and upon such crises have implemented new policies ensuring better conditions and a sound financial system. Such policies assisted in their recovery from the financial crisis of 2008 as many emerging market countries have come out of the crisis with relatively fewer issues as opposed to their counterparts in industrialized nations. The rapid diffusion of the financial crisis of 2008 highlighted the interdependence of the economies around the globe (WorldBank, 2011).

Mainly due to export-led growth policies, many emerging markets generated current account surpluses which in turn helped reduce risk ratings and perceptions of such countries globally and propelled further foreign investment (Griffith-Jones et al., 2010). Globally, emerging markets have been increasing contributions to foreign direct investment both as sources and destinations and this contribution is expected to increase. The trend towards further internationalization of production continues. The focus of foreign investment activity has been shifting from manufacturing to services and primary sectors (WIR, 2010). Global liberalization of financial markets and increased usage of financial intermediaries and instruments have increased interconnectedness among countries globally. Reliance on international funding has enabled the growth of many EMs but also exposes such countries to shocks in advanced economies as experienced in the global financial crisis of 2008 (Claessens et al., 2010). Among emerging markets, the largest Asian countries such as China and India have intense trade relations with the developed countries however the business cycles among the countries are not strongly correlated. However, with increased trade and integration in the world economy, interdependence among emerging markets and developed countries has been increasing (Fidrmuc and Korhonen, 2010).

EM economies were affected by the global crisis of 2008 in various ways. Decline in demand in advanced economies affected trade performance of EMs as demand exports contracted. Rapid decline in foreign capital inflows from advanced economies also affected many EMs adversely (Llaudes et al., 2010). A major impact of the global financial crisis is the decline in lending which also means the decline in cross-border lending. After the financial crisis of 2008 financial institutions in advanced economies were faced with reduced liquidity and ‘credit crunch’, hence credit available for cross-border trade, as well as investment, is restricted. In parallel, credit available for investing into emerging markets or credit available for emerging markets from institutions in developed markets is also restricted (Griffith-Jones et al., 2010). Financial institutions as well as corporations in EMs which rely on lending from institutions in advanced economies are facing major challenges. Meanwhile, countries whose financial systems relied more on domestic deposits were able to better shield against the crisis (Llaudes et al., 2010).

Among the EMs, countries which relied on domestic demand for growth fared better during the crisis. For instance, domestic demand in Indonesia which amounted to 90 per cent of the GDP as of 2007 enabled the country to rebound from the crisis rapidly despite the contraction of demand in its major trading partners (Llaudes et al., 2010). Especially after the global crisis of 2008 the necessity to reduce dependence on advanced economies is highlighted. Many EM’s economies are faced with the challenge of boosting consumption in their economies and reducing their dependence on foreign capital inflows (Rajan, 2010).

The crisis also highlights the dangers of stemming from volatility in capital flows in emerging economies. A significant factor which contributed to the growth of many emerging markets is increased foreign investment. The volatility of such investment has created problems for some EMs in the past. For instance, one of the reasons for the financial crisis in Turkey in 2001 was the immediate withdrawal of foreign investment. More recently, the global financial crisis has highlighted potential risks due to the volatility of foreign capital flows (Griffith-Jones et al., 2010).