Emerging Economies Hit Hard by the Financial Crisis

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Shakil Adil / AP

A Pakistani money changer counts rupees in Karachi on Oct. 24

Earlier this year, one of the great hopes for the world economy dodging the bullet of America's subprime mortgage meltdown was the robust growth in developing economies — and the hope that the consumer markets they generated at home would take up the slack as Western consumers were forced to tighten their belts. But the financial crisis that started with homeowners walking away from mortgages on Main Street, U.S.A., has begun to roil the teeming bazaars of Islamabad, the old-world neighborhoods of Budapest and the gleaming office towers of São Paulo. Countries are now lining up, tin cups in hand, seeking bailouts from the International Monetary Fund (IMF). And the line is lengthening. Iceland got $2 billion; Ukraine, $16.5 billion. Hungary needs $12.5 billion, and then there's nuclear-armed Pakistan, perhaps the world's most combustible country, which needs up to $15 billion to stave off potential financial collapse. So dangerous is the situation in Pakistan that the government has to hold negotiations with IMF officials in Dubai — the IMF declared Pakistan off-limits for its personnel after a bomb ripped through the Marriott Hotel in Islamabad last month. Pakistan has just six days before its dwindling foreign-exchange reserves run out, the Foreign Minister told his German counterpart, Frank-Walter Steinmeier, on Tuesday. Steinmeier helpfully suggested that because the situation in Pakistan was so difficult, the IMF ought to expedite negotiations over the bailout that are set to conclude next month.

The massive global flight from anything but the safest investment — if, in this market, such a thing exists — started late in the summer, and has now crippled emerging markets. The speed with which this has happened has been extraordinary, and it took the IMF very much by surprise, fund insiders say. "A year ago, it was the emerging markets that were carrying the world," says an IMF official. "Boy is that over." In fact, countries like Russia and Kazakhstan that just six months ago were fat and happy on a diet of petro dollars are now burning through national "rainy day" funds and bailing out banks that had only peripheral exposure to subprime mortgages. Their problem now is foreign-equity investors — hedge funds in particular — stampeding for the exits.

But it's not only sophisticated investors driving the crisis as they unwind their positions all over the world in order to repatriate dollars and meet margin calls. Consider the so-called yen carry trade, in which anyone could borrow money in the Japanese currency at extremely low interest rates (the key policy rate at the Bank of Japan is still just 0.5%) and invest in higher-yielding currencies like the New Zealand dollar, where interest rates were 6% or higher, and then pocket the difference. Unfortunately, the allure of the low-yielding yen also appealed to prospective home buyers in Hungary, where in the first quarter of this year, according to Budapest's central bank, 5% to 10% of all new mortgages were yen-based loans. (You read that correctly: 5% to 10% of all mortgages written in Hungary earlier this year were yen-based loans.) Since then, the yen has soared in value against the dollar — reaching a 13-year high on Monday — as well as against most other currencies. That's because investors all over the world are repaying yen loans or, in Wall Street's jargon, "unwinding the yen carry trade," as the flight to cash continues. That in turn has made the cost of a yen-based mortgage much higher for Hungarians, whose salaries are paid in forints, the local currency that has plunged more than 15% against the yen in the past six months, to produce a classic example of financial-sector turmoil trickling down to the real economy.

The financial crisis is now beginning to slow real economic activity — in some cases quite dramatically — all over the world. Consumer sentiment in Seoul, the capital of South Korea, has plunged to its lowest level in eight years, as the won, the local currency, has weakened sharply and stocks have plunged. Park Yung Tae is an office worker who was laid off earlier this year and invested his severance pay in the KOPSI, the Korean stock market. Big mistake. His life savings of $50,000 has been trimmed to just $10,000. Ship owners in Hong Kong say the rates for hiring the large container vessels that ship consumer electronics, toys and clothes to the West have fallen 40% in the past two months, amid a drastic slowdown in international trade. And across what had been the booming economies of Eastern Europe, growth has slowed sharply, economists say.

The real economic pain in emerging markets matters immensely to the economic prospects of the U.S. and other developed countries. Indeed, to the extent that that there was growth in the U.S. earlier this year, it was buttressed by strong exports. Now that prop underneath the world's economy has buckled. Jonathan Lipsky, first deputy managing director at the IMF, says 100% of the global growth forecast by the fund for 2009 was to have occurred in emerging markets. "Now," he says, "we have to make sure that potential is protected." That's plainly going to be an expensive proposition. The IMF is now ladling out cash as fast as suddenly bankrupt economies line up for it. The fund has $200 billion on hand and access to about another $50 billion to manage the intensifying global emergency. Chances are it will need all of those funds, and a lot more besides, before this is over.

With reporting by Stephen Kim / Seoul and Andrew Downie / São Paulo

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