Should we compare economic situation of emerging economies with respect to 1997-98 or 2007-08?

A brilliant question posed by Prof Andres Velasco of Harvard.

now investors are again asking what will happen in emerging markets if and when the big bad taper wolf shows up.

As always with economists, there are two schools of thought. Optimists claim that most emerging economies are well prepared to withstand the shock, because their dollar debts are lower than in the past, while their fiscal positions are much stronger. Pessimists claim that in the absence of well developed local financial markets and a global lender of last resort, emerging economies remain vulnerable to a sudden stop in capital flows.

There is merit to both views, but one must dig a little deeper to see why. To say that emerging markets’ financial and fiscal positions are stronger raises the economist’s traditional question: Compared to what?

If the base of comparison is the eve of the 1997-1998 Asian financial crisis (which later spread as far as Moscow and Buenos Aires), it is clear that, in most countries, vulnerabilities have lessened.

…But if the base of comparison is 2007, just before the global financial crisis, a somewhat different picture emerges. The much-needed counter-cyclical fiscal packages of 2009 overstayed their welcome in several countries, resulting in larger public-debt burdens. And the substantial capital inflows since 2010 have caused sharp asset-price increases and swift credit expansion in countries ranging from Chile to Malaysia. So what could happen when those flows are reversed?

It depends on which side one is on…if you believe they are stronger you pick 1997-98 otherwise 2007..

The reality is emerging markets which had emerged strong post-2008 crisis are all reeling under serous pressure as crsis has lingered on..before the crisis they were dependent on easy money from abroad and now too..

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