The bucharest university of economic studies Faculty of international business and economics

Emerging markets financial crisis and recovery

Curelea Elena-Alexandra , group 933

5/6/2014

Introduction

The aim of this paper is to present and formulate an opinion on the performance of emerging market economies during the 1998 crisis as well as to outline the main forces that stood behind their recovery and economic growth using empirical evidence.

Main findings

The academic literature uses a series of factors to explain the large declines in the emerging market index. Among these, as Seth J.Masters (1999) points out, crises tend to be more frequent in developing countries and their effects are up to fifteen times worse than in developed ones. Also, the changing nature of capital flows during the 1990’s ,which came in the form of equity flows, foreign direct investment and portfolio debt, and the domination of portfolio investors and corporations rather than governments over the inflows of money made it more likely for the crisis to become global.

During the years it was proved that althought the crashes were notable, developing countries managed to record very rapid economic growth , moving from large deficits to even larger surpluses, as in the case of Asian economies. According to the same research, there are several forces that caused the performance of the asset class to look very differently over time :1) the extreme volatility of emerging markets ; 2) the diversification of assets which reduce a portfolio’s risk.

It is in my opinion that the former has made emerging markets attractive for developed-market investors when it comes to long term asset allocation as recent history shows (for example, the investment boom to India).

In the same view, research conducted by Christopher B. Barry (1998) or Geert Bekaer (1997) show that emerging markets offer high returns, high volatility and diversification benefits when combined with developed market portfolios and also point out that liquidity, measured by the market turnover ratio is in direct relation with the investments in emerging markets.

Furthermore, Graciela L. Kaminsky (2001) is among the fewest that offer a good ilustration of the relationship between mutual funds , through which equity flows are channeled, and the rapid expansion of emerging economies after the 1998 Asian crisis , making available the example of the Asian and Russian crises that had a large impact on Asian and Latin American funds .

Moreover, I would like to point out as an interesting result of the research among the assessed articles the fact that there are several gaps in the literature when it comes to future investments from developed economies. The need for an asset pricing model that could suggest appropriate hurdle rates for each potential investment is acute as corporations expand their operations to emerging markets nowadays.

Conclusion:

The empirical evidence and information exposed previously confirm the validity of the impact that the 1998 financial crisis had over emerging markets. In my opinion, the boom and bust periods of any economy are inevitable and emerging markets have proven that recovery can be achieved and sustained overtime. Therefore, it can be concluded that despite the very real problems in the financial sector of the crisis countries in Asia, the current literature on the effects of capital flows on emerging markets reveal little reason for rich developed countries should reconsider holding their assets in emerging markets.

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References:

1) Seth J Masters (1999) - “After the fall” , Journal of Portfolio Management; vol. 26, no.1; ABI/INFORM Global pp. 18-26;

2) Christopher B. Barry, John W. Peavy III and Mauricio Rodriguez (1998) - “Performance Characteristics of Emerging Capital Markets” , Vol. 54, No. 1, pp. 72-80;

3) Geert Bekaer, Campbell R. Harvey (1997) -“Emerging equity market volatility” , Journal of Financial Economics no.43, pp. 29-77;

4) Graciela L. Kaminsky, Richard K. Lyons and Sergio L. Schmukler (2001) - “Mutual Fund Investment in Emerging Markets: An Overview”, The World Bank Economic Review, Vol. 15, No. 2 , pp. 315-340;

5) Geert Bekaert - “Emerging Equity Markets and Market Integration” , The Worl Bank Review , vol. 9 , no.1 ,pp. 75-107;

6) C. R. Harvey (1998) - “The Future of Investment in Emerging Markets”, NBER Reporter .

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