The emerging markets are expected to be “well-insulated” from the tightening of liquidity in the global marketplace, according to analysis from EFIC, the Australian export credit agency.

EFIC’s chief economist Roger Donnelly believes that the emerging markets will not, as yet, suffer from the same problems they saw in 1997/98, due to having developed a stronger economic foundation. However, much of this relative stability is dependent on the US and Japan avoiding a fall into recession. “In contrast with a decade ago, most emerging markets now have floating exchange rates that if anything are under-valued rather than over-valued, larger foreign exchange reserves, lower short-term foreign debt, and external current account surpluses rather than deficits,” he explains in the latest risk analysis bulletin released by EFIC.
“As net capital exporters with big foreign exchange buffers, they have little need to tap international markets for liquidity at an unfavourable time like the present,” he adds.
As an example of the emerging markets resistance to the credit crunch, he points to the September report from the Bank for International Settlements. He notes that the rise in emerging market sovereign credit spreads has not been as sharp as for similarly-rated industrial country corporate credit.

He cites reasons including the continuing stream of rating upgrades outnumbering downgrades, and positive technical factors including large coupon and amortisation payments, expected debt buybacks and a low level of sovereign issuance.
In light of emerging market shares and currencies outperforming their industrial country counterparts, he suggests that this economic resilience is a sign that the emerging market asset class has “come of age”.

However, emerging markets are not completely immune from the credit turmoil. He predicts that asset prices could significantly deflate as carry trades are unwound.

A lack of strict regulatory and accounting regimes in place in emerging markets could delay recognition of losses suffered on financial instruments linked to the US sub-prime problems. Falling construction rates and weakening consumption in the US is hinting at the increasing chances the US economy will fall into recession.  Similar economic signals are being seen in Japan, suggesting it could follow the US into a downward spiral.

Donnelly suggests those markets most susceptible to the decreasing level of credit are those in Central and Eastern Europe who have large external financing needs. Other potential victims include those with richly-priced asset markets, such as China and some Gulf Arab states.