We think there is little prospect of recent country-specific crises spilling overinto other EM or DM markets.
Some have pointed to an institutional or country-wide credit event as sparkingcontagion. Yet it is worth noting that credit markets have been discriminatingcarefully of late. Indeed, the spread between virtuous (like Malaysia, Poland,Mexico) and fragile (like Indonesia, Turkey, Brazil) EM sovereign CDS is at itswidest in nearly a decade. This is in part a reflection of the heterogeneity ofregulatory regimes across the sector. Institutional strength is importantbecause it allows markets to price credit risk more efficiently, reduces capitalmisallocation and provides crucial cushioning in the event of failure. Norshould it be ignored. A simple measure of the World Bank’s Regulatory QualityIndex does a very good job of explaining EM FX market moves over the pastyear. This suggests we might do well to place more emphasis on what creditcycles in EM don’t have in common, rather than what they do.
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DB