Emerging markets have made considerable progress in recent years developing their economies and financial market institutions. However, they are increasingly under strain from destabilized conditions in developed economies. The lack of buffers available to mature economies, such as strongly credible central banks, is exacerbating problems, making more emerging market crises highly likely in the near term.
Mature economies have several key advantages compared with emerging markets:
• Buffers. Typically emerging markets are going through a rapid structural change process. Mature markets, by contrast, have a slowly changing economic set-up. Likewise, emerging markets typically have little or no reserves (either in the structural or monetary sense) to help them face a crisis. On the other hand, mature economies can usually rely on a host of buffers that cushion the shock, and thus crises often are softened and shortened.
• Flight to quality. Mature economies also benefit from 'flight to quality' activity. In practice this means that the currencies of countries seen as lacking buffers (institutional, structural, or in the form of monetary reserves) depreciates compared to the currencies of countries seen as more robust. In emerging markets the pressure on currencies can magnify an already existing problem. In mature economies, the opposite effect can ameliorate a difficult situation, which acts as a further crisis buffer.
• Mature institutions. Mature policy institutions within developed economies serve as another buffer. An independent central bank, with transparent and sophisticated policies, able to rely on an effective monetary transmission mechanism, is a crucial tool for a mature economy. The absence of such an institution has been a major drawback in emerging markets. The Turkish central bank's response to the crisis in 2001 as opposed to the near-crisis of 2006 is an example of this; both the monetary policy setup and its delivery were more credible in the latter case, and hence played a significant role in averting crisis. The situation has since deteriorated.
Current crisis. During the current crisis expectations at the outset were that both mature and emerging markets would act more like developed economies in the past. This appears not to have been the case. Mature economies seemingly are behaving more like emerging markets did in the past, making it increasingly difficult to forecast future trends, and -- more importantly -- limit the level of uncertainty in the market. Buffers are exhausted too fast, currency markets are highly volatile, and tried-and-tested policy institutions haven been relatively ineffective.
Furthermore, the presumption that some emerging markets would play important roles in halting the global slide into recession (China was mentioned most often, but also Russia and Brazil) proved entirely unfounded, especially as commodity prices collapsed and global trade ceased. Emerging markets have proven neither resilient during, nor the panacea for, the current global recession. As market conditions continue to deteriorate, the risk of more emerging market crises will continue to rise.