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Emerging Markets Aren’t Out of the Woods Yet

How They Can Manage the Risks

The floor of the Buenos Aires Stock Exchange in Buenos Aires, Argentina, September 2018 Marcos Brindicci / REUTERS

Emerging markets had a bumpy 2018. Over the summer, Argentina and Turkey saw their currencies fall sharply as their economies ran into trouble. Argentina had to turn to the International Monetary Fund for a $57 billion loan. Commentators sharpened their pencils, ready to draw parallels with the wave of financial crises that swept over emerging markets in the late 1990s.

Yet most emerging-market economies came through the summer’s turbulence more or less unscathed. That is largely thanks to big improvements in economic and financial management since the last major wave of crises in the 1990s. Most countries that succumbed to crises then have moved from pegged exchange rates to largely floating exchange rates and have adopted sounder monetary policies. Most also now have more resilient banking systems, the result of a general shift away from risky short-term bank funding in favor of long-term funding from bond markets.

Perhaps the most remarkable change since the crises of the 1990s has come in the way emerging-market countries finance their debt. Governments now borrow much more in their own currencies than in foreign ones, making them less vulnerable to runs and currency crises. But risks remain. Developing countries still have work to do if they are to shield themselves from the vicissitudes of global financial conditions.

ORIGINAL SIN

Economists once thought that emerging-market countries that borrow from abroad were confined to doing so only in foreign currencies. Barry Eichengreen and Ricardo Hausmann called the phenomenon “original sin” because it seemed to doom developing countries to perpetual dependence on foreign financial conditions. When a country’s currency fell, its government found its debts harder to pay. Debt crises turned into currency crises.

But since the 1990s, the share of emerging-market government debt issued in foreign currencies has fallen significantly. Foreign investors have grown more comfortable owning government debt denominated in the local currency. In some countries, such as Peru, South Africa, and Indonesia, foreign investors now hold around 40 percent of government debt in the local currency. Many other

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