Financial Analyst

2003 may be the first year for a long time not so see an emerging market economy

(EME) crisis. The Asian crisis of 1997 was followed by Russia (1998), Brazil (1999),

Turkey (2000), Argentina (2001) and Brazil again (2002). Measures taken since 1997

seem to have reduced the severity and degree of financial contagion of subsequent

crises; most emerging market economies moved away from fixed exchange rate

regimes; short-term capital flows were much reduced and less volatile, with the

continued use of capital controls by some and their slower removal by others;

leverage was lower; significant changes took place in the investor base, with a sharp

fall in the participation of hedge funds and portfolio flows and a rise in local securities

markets (even in local derivatives markets for the management of financial risks in

periods of high volatility); investors, till recently, seemed to have become more

discriminatory and less herd-like, helped in part by greater transparency in data

policies and strengthened domestic financial institutions including prudential

supervision. Emerging markets are now more stable on account of the lessons learned

since 1997.

But we have also learned the primary role of financial linkages in contagion (trade

linkages play a role but it is secondary), and the central importance of balance sheet

mismatches in generating the conditions for triggering crisis. Apparently-solvent

balance sheets can hide potentially serious liquidity problems. Since 1997 there have

been great changes in the levels and flows of capital to emerging economies. It