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P. Jegadish Gandhi

Financial crises in Emerging Markets An essay on Financial Globalisation and Fragility By Alexandre Lamfalussy Publishers: University Press, Hyderabad Price RS 260

Financial globalisation is not a steady state but a process. Financial fragility — periods of financial exuberance followed by episodes of financial distress have been integral to the working of market economies since time immemorial. The messianic economic salvation of globalisation has been challenged with the onset of financial crises in 1980s, especially in the emerging markets in developing countries. An overt supportive view that the IMF should as crisis manager, be held responsible for severity of emerging market crises both in developed and developing countries.

As an experienced General Manager of the Bank for International Settlement (BIS) and President of the European Monetary Institute and Professor of the Institute of European Studies, Catholic University of Louvain, Belgium, Alexandre Lamfalussy has analysed four major crises in emerging markets: Latin America in 1982-83, Mexico in 1994-95, East Asia in 1997-98, and Russia since 1998.

The treatise is categorised into to five compartments with caption-conveying titles: Four crises in Emerging Markets - An overview; Four crises in Emerging Markets specificities and common features; Does Financial Globalisation Aggravate on Alleviate market problems; Crisis Prevention and Crisis Management.

The four crises display a bewildering variety, with striking similarities. In the following section, the author presents a synoptic table that compares the key features of these crises under five headings: balance-of-payments and exchange market developments before the crisis, domestic developments before the crisis, the development of the crisis, contagion, and crisis management. The main derivative is that the large-scale accumulation of short-term external debt, which eventually became unsustainable, was at the heart of the four crises. The process leading to the build up of these debt levels varied from case to case. What mattered most was the end result: the size and the maturity profile of the external debt.

There can be no doubt that financial globalisaion enhances the risk of contagion. The corollaries of globalisation resulted in an enhanced three-fold financial interdependence — geographical (between countries of the gloablised world), market (for instance, between debt and equity markets), and between segments of the financial industry. They have led to the creation of a highly competitive environment across borders, between individual financial intermediaries, and between groups of intermediaries.

Four macro conclusions are inevitable. First, that the build up of excessive short-term indebtedness and the accompanying asset price bubbles were at the heart of the four crises. Second, that the exuberant behaviour of lenders and investors from the developed world played a major role in raising leverage and asset prices to levels that eventually became unsustainable, often under the influence of specific factors. Third, that the process of financial globalisation aggravated all four crises and, if left unattended, could contribute to the eruption of new crises in emerging markets. Fourth, that the jury is still out on the question of whether the process of globalisaion has made the financial systems of the developed world more or less prone to manifestations of fragility.

Lamfalussy tenders no simplistic prescriptions in this book; instead he offers carefully considered policy recommendations that are both pragmatic and wise. The process of financial globalisation throws up problems of worldwide dimension, which cannot be handled on an ad hoc basis. Even if all preventive measures taken by national authorities work, their sum total may turn out to be dismally inadequate for reducing the risk of a systemic crisis. And there is a genuine risk that in the case of a major crisis, national policy reactions will tend to diverge rather than converge. Establishing a cooperative framework should therefore be the major assignment for all those who are given the task of designing a `new financial architecture'.

The contents of the book are comprehensive and cohesive in its analytical insights and in its prescriptive policy initiatives. It is a refreshing referral to the global financial thinkers and policy-makers.

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