The Impact of the Global Financial Crisis on Emerging Financial Markets: Volume 93

Emerging financial markets have largely proven resilient to the consequences of the Global Financial Crisis. While this owes much to the bitter experience and economic strategies developed and implemented following the Asian Financial Crisis of 1997–1998, providence also played a hand in that relatively few of its financial institutions were exposed to the complex structured products that underpinned the demise of many financial intermediaries in the United States and Europe. The objective of this volume is to investigate and assess the impact and response to the crisis in emerging markets from a number of perspectives. These include asset pricing, contagion, financial intermediation, market structure and regulation. Our hope is that the assembled chapters offer clear insights into the complex financial arrangements that now link emerging and developed financial markets in the current economic environment. The volume spans four dimensions: first, a series of background studies offer explanations of the causes and impacts of the crisis on emerging markets more generally; then, implications are considered. The third and final sections provide insights from regional and country-specific perspectives.

This chapter analyses the causes and effects of the financial crisis that commenced in 2008, and it examines the dramatic government rescues and reforms. The outcomes of this, the most severe collapse to befall the United States and the global economy for three-quarters of a century, are still unfolding. Banks, homeowners and industries stood to benefit from government intervention, particularly the huge infusion of taxpayer funds, but their future is uncertain. Instead of extending vital credit, banks simply kept the capital to cover other firm needs (including bonuses for executives). Industry in the prevailing slack economy was not actively seeking investment opportunities and credit expansion. The property and job markets languished behind securities market recovery. It all has been disheartening and scary – rage against those in charge fuelled gloom and cynicism. Immense private debt was a precursor, but public debt is the legacy we must resolve in the future.

The world has been gripped by the severest global financial (and economic) crisis since the Great Depression of the 1930s. How did it come about, what is being done to alleviate its consequences and, vitally, what measures should be undertaken to ensure against its recurrence are therefore questions that must be satisfactorily addressed. Preventing ‘financial crises’ from ever happening again is of course completely out of the question, they being inherent to the economic system as we understand it; rather that of those of the ‘severest’ kind. Fortunately, a vast literature has been accumulating on these issues, so the intention here is not to add to it and reinforce the perception that economists will offer more opinions on a single issue than the total membership of any assembled group thereof for the purpose. Hence, this is confined to a consideration of the most convincing explanations. Owing to space limitations, I shall not examine the recommendations for future action in all the mentioned areas but will do so for what is being offered to cater for the capital adequacy and pro-cyclicality since they are of the essence and involve many players.

The paper analyzes the impact of the global financial crisis on capital flows, financial markets and economic activity in Asia and attempts to explain why Asian markets were hit hard despite relatively strong fundamentals, and why the subsequent recovery was relatively quick. The openness of a country to trade and finance and the degree of integration into international financial markets are shown to be important determinants of the swings in economic activity and capital flows during both the reversal and recovery phases. It also discusses the role played by macroeconomic and financial policies in the recovery and concludes with some lessons from Asia's experience.

Emerging markets are said to have sustained relatively well in the recent global crisis. There are several factors that help explain this popular view, such as, for example, perceived separation from key international financial centres. Still a lot is to be digested in the crisis aftermath with immediate implications for financial markets and real economy. This chapter offers a unique insight into dynamics within transition economies via an extended blended fiscal–monetary policy rules model with possibility of foreign reserves targeting and foreign currency-denominated debt dynamics. Calibration is based on actual data and is done under various targets and financial risk conditions. Prudent monetary policy and fiscal policy initiatives within current context drive the choice of targets. That may help dampen negative impacts of the crisis and thwart potential currency run. This chapter advances three possible post-crisis scenarios, each with unique solution for reserves, exchange rate, sustainable debt and output levels. Categorizing between net exporters and net importers based on countries' external positions, group-specific results are derived. While both groups are susceptible to exchange-rate risk affected by a multitude of shocks due to their fragile financial system, net importers risk high inflation, but net exporters over-borrowing. This chapter contributes to the literature on global financial crisis, macroeconomic policy, and role of nominal targets and foreign reserves in emerging markets.

When faced with a financial crisis, debtor countries rarely choose to default on their international financial obligations. Instead, they typically choose to renegotiate their debt service obligations. According to a number of economists, the main motivating factor behind borrowers' and creditors' willingness to restructure is the benefit associated with preserving international trade ties. This raises an interesting question: is the benefit associated with maintaining international trade ties shared equally between the borrower and creditor banks? Or is the outcome dependent on a so-called ‘bargaining game’ between the borrower and creditor banks, and if so, can we identify these variables? According to our analysis, as a borrower's trade ties with developed countries strengthen, the borrower's (and/or creditor's) bargaining power diminishes (strengthens) and it thereafter agrees to restructure at less favourable terms. However, even after controlling for trade ties, we found that major borrowers were able to extract more concessions from the lenders.

Emerging-market (EM) assets have historically been regarded as inherently risky and particularly vulnerable to international shocks that result in a general increase in investor risk perceptions. In this chapter, we assess the ongoing relevance of this view by examining the linkages between EM and non-EM stock and bond markets in the past two decades, with a focus on how these relationships played out during the global financial crisis of 2007–2009. We evaluate how these linkages have evolved over the period 1992–2009, through statistical tests of whether the volatility of EM financial markets changed – either in their response to international shocks originating in advanced-economy markets or in their independent fluctuations.

We find that over a longer period EM, bond and stock prices have on average moved in the same direction as the prices of non-EM risky assets, and this co-movement has persisted. However, these relationships have evolved somewhat over time. Both EM sensitivity to international shocks and EM-specific volatility in EM sovereign-bond spreads appear to have decreased over time, consistent with the greater fundamental stability of EM economies and perhaps a reduced inclination by investors to sell off EM assets in response to a rise in risk perceptions. Somewhat in contrast, while an upward trend in co-variation between EM and non-EM stock prices suggests an increasing degree of global market integration, idiosyncratic volatility has declined, consistent with a diminished level of locally driven risk in these markets.

In addition, the response of EM asset prices to the latest financial crisis appears to be moderate in comparison to historical experience. This evidence may reflect reduced EM vulnerability to external shocks in general, which is consistent with some encouraging improvements in the underlying fundamentals of EM economies over the decade preceding the onset of the crisis.

The global financial crisis has magnified the role of Financial Sector Surveillance (FSS) in the International Monetary Fund's activities. This chapter surveys the various steps and initiatives through which the Fund has increasingly deepened its involvement in FSS. Overall, this process can be characterised by a preliminary stage and two main phases. The preliminary stage dates back to the 1980s and early 1990s, and was mainly related to the Fund's research and technical assistance activities within the process of monetary and financial deregulation embraced by several member countries. The first ‘official’ phase of the Fund's involvement in FSS started in the aftermath of the Mexican crisis, and relates to the international call to include financial sector issues among the core areas of Fund surveillance. The second phase focuses on the objectives of bringing the coverage of financial sector issues ‘up-to-par’ with the coverage of other traditional core areas of surveillance, and of integrating financial analysis into the Fund's analytical macroeconomic framework. By urging the Fund to give greater attention to its member countries' financial systems, the international community's response to the global crisis may mark the beginning of a new phase of FSS. The Fund's financial sector surveillance, particularly on advanced economies, is of paramount importance for emerging market and developing countries, as they are vulnerable to spillover effects from crises originated in advanced economies. Emerging market and developing economies, which constitute the majority of the Fund's 187 members, are currently the recipients of over 50 programmes of financial support from the Fund (including those of a precautionary nature), totalling over $250 billion.

Former Japanese Prime Minister Yukio Hatoyama continues to actively promote his party's East Asian Community (EAC), which he had as a centrepiece of his coalition government. This chapter supplements an earlier one where I compare the EAC with that of the late South Korean President Roh Moo-hyun's Northeast Asian Community (NEAC) and examine the impediments that have been the cause of friction in the region, the removal of which is fundamental to the creation of these communities, and show that that they will be around for a very long time. This chapter concentrates on what the EAC can learn from the European Union experience since both Hatoyama and Roh have stated that it is the EU that has been the source of their inspiration. It argues that the basic requirements for a ‘customs union’, let alone a ‘common market’ or ‘economic community’, will not be realised by the EAC in the foreseeable future. This suggests that the best that can be hoped for is a ‘preferential trade and investment arrangement’, between China, together with Hong Kong and Taiwan, Japan, both the Koreas and the United States, otherwise one must wonder why the EAC or NEAC is needed, rather than the ASEAN+3 and ASEAN+6 that are presently in the making. The problem is that both Hatoyama and Roh have ruled out the United States as a full member while at the same time they want it to continue to provide security for the region when full membership would enhance that. Nevertheless, the vision is admirable and should be desired by the whole world, not just the parties directly involved, so should receive our full support.

We examine how the international financial crisis of 2007–2010 has impacted on the performance of emerging market MNCs relative to their developed market counterparts. We present our multinational classification system and categorise the world's largest firms, the Global Fortune 500 (GF500), according to their degree of multinationality. We show that the number of GF500 firms from emerging markets has increased significantly over the past decade, and that the international financial crisis of 2007–2010 has further enhanced this trend. We compare the relative risk-adjusted performance of emerging and developed markets before and since the international financial crisis. We show that although the GF500 firms from developed markets tend to be more multinational than the GF500 firms from emerging markets, the latter have outperformed the former over the past decade – both before and after the recent international financial crisis.

There is ample empirical evidence in the literature for the positive effect of central bank transparency on the economy. The main channel is that transparency reduces the uncertainty regarding future monetary policy and thereby it helps agents to make better investment and saving decisions. In this chapter, we document how the degree of transparency of central banks in Central and Eastern Europe has changed during periods of financial stress, and we argue that during the recent financial crisis central banks became less transparent. We investigate also how these changes affected the uncertainty in these economies, measured by the degree of disagreement across professional forecasters over the future short- and long-term interest rates and also by their forecast accuracy.

This chapter simultaneously investigates the most important calendar anomalies in stock returns: day of the week, turn of the month, turn of the year and holiday periods, in four of the most important Latin American stock markets: Argentina, Brazil, Mexico and Chile. Previous evidence available for these countries is very limited. Our results indicate that the three markets show a rather similar pattern regarding return seasonality. A day of the week effect, consisting in negative returns on Mondays, is reported for all the stock markets but the Mexican. The turn of the year effect is observed only in Argentina, and moderate holiday and turn of the month effects are reported in the Brazilian and the Mexican markets, respectively. In addition, significant levels of first-order return autocorrelation are reported for the four stock markets. The contemporary financial crisis has dramatically affected the behaviour of stock prices worldwide, causing, among other effects, a huge increase in price volatility and probably changing the behaviour of participants in financial markets. We have also investigated to what extent our results have been affected by the current abnormal situation.

In this chapter, we investigate the effect of long memory in volatility on the accuracy of emerging stock markets risk estimation during the period of the recent global financial crisis. For this purpose, we use a short (GJR-GARCH) and long (FIAPARCH) memory volatility models to compute in-sample and out-of-sample one-day-ahead VaR. Using six emerging stock markets index, we show that taking into account the long memory property in volatility modelling generally provides a more accurate VaR estimation and prediction. Therefore, conservative risk managers may adopt long memory models using GARCH-type models to assess the emerging market risks, especially when incorporating crisis periods.

That asset returns are typically neither independent nor normally distributed is a stylised fact of many financial markets. We examine market returns for a number of emerging Asian nations before and during the Asian crisis and global financial crisis periods and consider how well these are described by the assumptions of normality and independence. Specifically we seek to ask how – if at all – these crises impacted upon the time-series properties of stock market returns in the emerging Asian economies. The first part of the chapter examines the comparative fit of the normal distribution to daily stock market returns for each of the economies under observation. The second part of the chapter follows with an examination of dependence relations in emerging Asian market returns around the crises periods.

While differences in stock price behaviours among developed countries have been extensively researched and documented, investigations of this nature for emerging economies are, however, much less comprehensive. We undertake a quantitative analysis that investigates six different types of panel data models to define the best one that explains the stock price behaviour of publicly traded companies in emerging countries. The research is based on a sample from Compustat Global, including 5,167 stocks of companies from 38 emerging countries, covering 119 months (1998–2007), totalling 235,621 observations. This analysis of the elasticities of regressors corresponding to stock transactions in stock markets, through a considerable sample, contributes to a deeper discussion about stock price behaviour in countries with less developed stock markets. The findings demonstrate that stock quantity and total volume traded per month significantly influence closing price behaviour over time, with more efficient estimators for the fixed effect model. Moreover, different elasticities are verified among countries. This chapter does not take into account the macroeconomic reasons why the differences among countries occur. Further, the consideration of developed countries, such as United States, United Kingdom, France or Australia, could bring the possibility of comparison of stock prices among countries in a broader perspective. Overall this analysis can help governments and private initiative for the formulation and implementation of strategic actions, in order to constantly improve the quality of their stock markets and, consequently, to increase the entry of resources destined to the development of nations.

This chapter examines crisis propagation mechanisms to the Southeast European exchange-rate markets during the 1998 Russian crisis and the Turkish crisis of 2001. It focuses on whether and how the crises spread to these markets after interdependencies and common external shocks are accounted for. Results for Albania, Bulgaria and Croatia are presented and compared. Understanding the propagation mechanisms of crises to these countries and the reaction of these markets to such shocks in comparison to trading partners and other countries within Europe is an important issue in the context of their potential accession to the European Monetary Union and the adoption of inflation targeting frameworks. It is found that Albania has relatively isolated financial markets in comparison with the other countries in the sample and is not affected by contagion, while Croatia is mostly affected by the crises directly and indirectly.

The phenomenon of positive autocorrelation in daily stock index returns is often viewed as a consequence of stable behavioural patterns of certain investor groups (see, e.g., Sentana & Wadhwani, 1992; Koutmos, 1997). However, such patterns may change due to extreme events, that is, financial crises, and thus affect the autocorrelation in returns. Emerging markets and especially BRIC countries have experienced severe crises in the last 20 years and are therefore a suitable object for studying this effect.

The focus of this chapter is on identifying substantial changes in the autocorrelation of BRIC markets' index returns after experiencing upheavals of the financial system. For this purpose, we look for structural breaks in the parameters of an ARMA–GARCH model with the standard endogenous search procedure.

Our approach yields no statistically significant evidence of the autocorrelation changes due to the crises. Only in India the decline in autocorrelation in 1998 seems to be economically relevant, but is not significant statistically. Significant shifts that we could identify were rather related to microstructural changes, such as abolishment of price change limits by China and the removal of a leading player in India's market in 1992. All in all our results suggest that even though extreme negative events on financial markets may induce changes in feedback trading strategies, their influence on autocorrelation is not pronounced enough. The impact of other factors, in the first place of regulatory changes, seems to be of larger relevance.

In this chapter I characterize the relationship between macroeconomic variables and the terms structure of interest rates using the recent macro-finance approach adapted to the case of an emerging economy and applying it to Brazil. I find that macro variables help to explain the dynamics of the yield curve in emerging markets, specially in periods of high volatility. Moreover, the notion of great external vulnerability of emerging economies is confirmed by the strong role of the nominal exchange rate change, which explains up to 37% of the variation in yields in Brazil. However, the model does a poor job in forecasting yields during the financial crisis of 2008. This fact seems to be related to the strong fall in international commodity and industrial goods prices (in dollar terms), which limited the passthrough from the strong depreciation of the exchange rate to inflation.

This chapter describes the evolution of the Brazilian investment fund industry and the impact of domestic and international crises on investors, managers and the main types of funds offered in Brazil. In particular, it explores the effect of the subprime crisis and shows that the first wave of this crisis had very little impact, but the second wave with the collapse of Lehman Brothers did have a major impact on risk, returns and flows of the mutual fund industry in Brazil.

Although China has claimed since 2005 that it will move towards a more market-oriented system of managing its foreign exchange, it has remained, in part, a managed economic system. This chapter examines the relative importance of fundamentalist, chartist and currency arrangements in determining the RMB exchange regime using both traditional linear and non-linear artificial intelligence models. We find that the emphasis on the US dollar as a reference currency has declined. Fundamentalist forces are becoming strong determinants of the currency exchange. The genetic programming approach is among the best performing in minimizing forecasting error.

This chapter measures stock market liquidity with three low-frequency liquidity estimators, and investigates the long-term behaviour of commonality in liquidity on the Shanghai Stock Exchange (SSE) through principal component analyses and panel regressions. The findings provide strong evidence of liquidity co-movement on the SSE from its inception to the present. The extent of commonality in liquidity varies significantly over time. Remarkably, it surged in 2007, which corresponds to the onset of the subprime mortgage-triggered financial crisis; however, the subsequent behaviour is divergent among our different liquidity proxies.

In this chapter, I examine the properties of four realized correlation estimators and model their jumps. The correlations are between the three main FTSE indices of the Athens Stock Exchange. Using intraday data I first construct four state-of-the-art realized correlation estimators which I then use in testing for normality, long memory, asymmetries and jumps and also in modelling for jumps. Jumps are detected when the realized correlation is higher than 0.99 and lower than 0.01 in absolute values. Then the realized correlation is modelled with the simple heterogeneous autoregressive (HAR) model and the HAR model with jumps (HAR-J). This is the first time, to the best of my knowledge, that the realized correlation between the three indices for the Greek equity market is examined.

The currency premium is one of the three components of the differential between local and foreign interest rates. Emerging economies such as South Africa typically face positive interest rate differentials, that is, a higher cost of capital than developed economies. In this chapter we aim at identifying the determinants of the South African rand–U.S. dollar currency premium using monthly data over the period 1997–2008. We carry out an empirical analysis using dynamic time series econometric techniques to estimate the determinants of the one-month and one-year currency premia. Our findings show that the currency premia at both horizons are driven by long-run movements in the expected inflation differential between South Africa and the United States, risk aversion as a proxy for the price of rand exchange risk, and the volatility of the rand exchange rate as an indicator of the quantity of that risk. Misalignments in the real effective or rand–U.S. dollar bilateral exchange rates display mixed results in terms of their impact and statistical significance on both currency premium. Our parameter estimators overall are stable and robust to sample variations. Monetary policy is an important determinant of currency premia at both one-month and one-year horizons, but risk aversion is equally important to determine its time fluctuations.

Before the 1997 Asian Financial Crisis, Thailand had the fastest growing level of foreign direct investment (FDI) inflows amongst Asian economies. The general objective of this research is to evaluate the determinants of FDI investment in Thailand post the 1997 crisis; our empirical investigation of the determinants of Thailand's FDI relates to the period 1998–2008. The end of this period also covers the global financial crisis of 2007–2008; the effects of this crisis on FDI generally may be premature to judge given that most FDI projects have lead times ranging from 12 to 18 months. The chapter also provides an update covering the latest available FDI data by comparing 2008–2009 quarter 1 FDI flows both regionally and for Thailand.

This study aims to explain that more conservative and supervised but supported banking system can be an advantage during the crises periods. We use the US banking system as the origin of the recent collapse, and the Turkish banking as the more profitable one during the recent crisis years. We have found evidence that, in the context of the specific type of externally initiated yet spreading crisis of confidence and funding that affected world institutions, the structure of the Turkish banks actually turned out to protect the Turkish financial system.