Guest Post: How do emerging markets get into trouble? Let me count the ways

Karthik Sankaran explains how to get to the promised land, and why so few countries make it there.

This is a guest piece from Karthik Sankaran. Karthik has been involved with EM, FX, and global macro since the late 1990s in a variety of roles on the buy and sell sides. For those on Twitter, Karthik is a wonderful account to follow, mixing erudition, napkin sketches, and groan-inducing dad jokes.

As a reminder, I will be returning from parental leave next week. Thank you all so much for continuing to renew your subscriptions during this time.

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Behind every Argy problem, there is an (r,g) problem. 

In other words, behind every EM problem reminiscent of Argentina, there is a problem in the relationship between a country’s nominal growth rate (g) and the interest rate (r) at which it services its debt stock.  

There is obviously a large academic literature on the subject, but this will not make that cut. What follows here is a set of observations from someone who has been active in, or at least watching, EM foreign exchange (primarily) and fixed income (to a lesser extent) since the 1997 Baht crisis. Something like the below has also been what I’ve been tweeting or writing about for close to 10 years, and talking about with younger colleagues at different jobs. Of course, it also builds on many conversations I’ve had in real life and online with people who have considerably more expertise than I.

I will try below to set out the different kinds of balance of payments problems that EMs run into; the feedback loops among real activity, financial conditions, and investor perceptions; and some broad generalizations about “things that have worked, at least for the EM in question.” This last point will also hint at the global collective actions problems that lurk beneath the issue.

Original Sin

The most recent iteration of Argentina’s problems is yet another reminder of one of the oldest versions of the EM crisis—too much debt denominated in a foreign currency. This is “Original Sin” as Barry Eichengreen and Ricardo Haussman dubbed it, but the problem itself goes back at least a century before then (and yes, Argentina was featured then too). 

Why would a government borrow in a foreign currency?