Emerging markets policymakers have come to regard the developed markets regulatory model as effectively broken and will therefore adopt a more cautious stance vis-à-vis financial sector liberalisation and deregulation. This does not mean that they will abandon plans for further financial liberalisation altogether; but they will undoubtedly pursue a more gradualist, selective and “homemade” approach to developing their financial sectors.
The worst economic and financial crisis since the Great Depression has caused remarkably little political instability. Although the full social impact of the economic downturn may not have been felt yet, the economic stabilisation currently underway carries the promise that serious political instability will be avoided altogether.
Neither has there been a shift towards more populist (less sustainable) policies since the beginning of the crisis. If anything, we will be witnessing a shift towards more prudent policies in crisis-hit countries undergoing IMF-supervised adjustment (e.g. CEE). As spelt out in a previous comment, emerging markets (EM) will likely be adopting more aggressive FX intervention policies, but a major change in macroeconomic policies is not on the cards. However, EM policy-makers have come to regard the developed markets (DM) regulatory model as effectively broken and will adopt a more cautious stance vis-à-vis DM-style financial sector liberalisation and deregulation.
Government ownership of banking assets: It will not have escaped EM policymakers that governments with direct control over (parts of) the domestic bank sector were able to alleviate (somewhat) the effects of the credit crunch (e.g. China) by counteracting what would otherwise have been very pro-cyclical lending behavior by the banks. This won’t lead governments to nationalise banks. However, it may lead them to increase the resources of existing public sector banks in order to boost their lending capacity (e.g. Brazil) and it will make them reluctant to relinquish control in the form of “window guidance”, public ownership and control of banking assets etc. Should the recent government-directed lending surge seen in some EMs generate a sharp rise in bad loans and fiscal losses, EM attitudes may change again. For now, greater government control over bank credit will appear attractive to many policymakers.
Foreign ownership of banking assets: Pre-crisis, the transfer of capital and management expertise from DMs to EMs in the form of foreign ownership of domestic banks was considered desirable. Today many EM governments, rightly or wrongly, will regard foreign ownership as more of a mixed blessing. Parent banks have shown a willingness to re-capitalise their local subsidiaries in some instances (e.g. Ukraine), thus contributing to banking sector stability. Anecdotal evidence suggests that foreign banks’ willingness to increase (or maintain) lending does not differ systematically from that of domestically-owned private-sector banks.
However, even where foreign banks’ local operations are sufficiently liquid and capitalized, they often prefer to park their excess funds with the central bank rather than lend to the private sector (e.g. CEE). Nor is there evidence that the problems some parent banks experienced in their home markets has led to an above average cutback in their foreign on-shore lending (e.g. Mexico) – cross-border lending is naturally a different matter! Nonetheless, in the eyes of policymakers, this risk was real enough during the height of the crisis. Concerned about the possibility of “reverse contagion”, EM policymakers will be more selective and more cautious before further opening their doors to foreign banks, unless the need to recapitalize their banking sector combined with fiscal constraints does not leave them any choice (e.g. Iceland).
Domestic financial liberalisation: Not surprisingly, many EM policymakers have come to doubt the benefits derived from DM-style financial (de-)regulation. Most of the larger EMs have in place more restrictive regulations than their DM counterparts, ranging from higher capital requirements (e.g. Brazil) to restrictive regulation of various financial markets segments (e.g. China). Given the apparent failure of the DM regulatory model and the relative resilience of many EM financial systems during the crisis, EMs will be much less inclined to move forward along the lines of the DM model than before the crisis. This does not mean that they will abandon plans for further financial liberalisation altogether; but they will certainly adopt a more gradualist, selective and “homemade” approach.
Policymakers will regard the crisis as a once-in-a-lifetime event that hit EMs as innocent by-standers. In many cases, the DMs suffered more than the EMs and many EMs are emerging from the crisis more quickly than “over-leveraged” DMs. There is therefore little incentive for the EMs to fundamentally change macroeconomic policies. What the global crisis will do is make many EMs more cautious and selective when it comes to privatising, opening up and liberalising their financial systems along the lines of the DM model. Liberalisation will certainly not come to a complete halt, however. At the same time, DM governments will be in a weaker position to demand financial sector deregulation and liberalisation (e.g. US-China SED), while DM banks will be in a financially weaker position to purchase (relatively) more expensive and financially stronger EM banks. It will be interesting to see whether EM banks will take advantage of their improved position vis-à-vis their DM peers and expand in the DMs (or in other crisis-hit EMs).