10 years of financial crisis: Ghost of Lehman haunts emerging markets again

Lehman Brothers (Photo: Reuters)
The   flood of liquidity that supported the global financial system after the fall of Lehman Brothers has turned into a pain-point for emerging markets (EMs) 10 years later.

Tightening liquidity conditions in developed markets (DMs) has raised the spectre of EM outflows, contributing to a rout which has seen the Turkish lira and the Argentine peso fall over 40 per cent and the Indian rupee hit a record low by going past the 72-mark against the dollar.

“We believe that the collapse in EM asset prices is driven by uncertainty regarding US monetary policy (a hawkish Fed), trade policy (tariffs against its trading partners) and foreign policy (sanctions against Russia and Turkey). With the challenging external environment, investors focus on EM’s vulnerability rather than its valuation proposition,” said a September 9 Morgan Stanley report. 

“Taken together, DM monetary policy normalisation is gaining traction, and after years of being blind-sided by the hunt for yield, 2018 is the year that investors are becoming more attentive to EM risks, exacerbated by increasing trade protectionism and China’s economic slowdown,” said Nomura Group’s Emerging Markets Special Report in September 2018.

Global central banks had begun to pump in liquidity a decade ago as the crisis spread across asset classes.

Global stock markets saw the erosion of $37 trillion of market value or 18 times India’s current market capitalisation, and emerging markets in particular were badly hit. In India, the benchmark Sensex crashed as much as 60 per cent due to the crisis. The index had touched a high of 20,873 on January 8, 2008 tumbled to 8160 on March 9, 2009.

Emerging market currencies began to depreciate as capital outflows took hold. Fixed income markets were frozen because of lack of liquidity. The Bloomberg Commodity index, which was around the 160-mark at the beginning of 2007, hit a high of 237.95 on July 2, 2008 as investors sought safety in hard assets. Subsequent volatility caused it to crash to a low of 106.09 by December 5, less than six months later.

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Central banks responded with a large dose of liquidity.

In the US, the epicentre of the quake, quantitative easing meant trillions of dollars of bond purchases. The upper bound of the Federal Reserve (Fed) fund rate, a key measure of interest rates was reduced from 5.25 per cent in August 2007 to 0.25 per cent and remained there till December 2015, and even today it is at just 2 per cent. 

The European Central Bank and Japan had their own versions of quantitative easing, helping markets finally unfreeze.  

Shankar Sharma, joint managing director of First Global describes 2008 Global Financial Crisis as once-in-a-lifetime event, noting in a recent interaction that many asset classes and securities have not yet crossed their 2008 highs in dollar terms.

Meanwhile, developed markets have now started to reverse course, and emerging markets have again felt the brunt.  

The MSCI Emerging Market Currency index hit a 52-week low in September. The rupee edged past a record low of 72 against the dollar this month. This has also had an impact on dollar returns in markets like India.

In rupee terms, the stock market took out January 2008-highs in November 2010 thanks to the money pumping undertaken by the global central banks. However in dollar terms, the Indian markets managed to climb back to 2008 levels only in January this year. The subsequent fall in the rupee because of emerging market woes has once again pushed markets below their 2008 level in dollar terms.

Ten years now does not seem so long ago, as the Lehman crises seem set to play out another leg.  

/> Next: How the government and the economy weathered the storm.