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Global stock crisis, local lessons

The unthinkable happened in October. The miracle economies of South East Asia, once regarded as symbols of stability, were hit by a series of speculative attacks that kicked the legs out from under local equity markets and--Hong Kong and China excepted--caused massive currency devaluations. The currencies of Indonesia and Thailand lost more than 30 percent of their value, while Malaysia and the Philippines suffered slightly smaller declines.

For the first time, a stock market crisis in the developing world had truly global consequences. The Dow Jones index of industrial companies in the United States suffered its greatest single day point loss in history on Oct. 27, and the markets in Latin America quickly followed suit. Paradoxically, the early reports on these events were coming in just as the idb was convening a conference on the pros and cons of the growth of Latin America's stock markets titled "The Development of Securities Markets in Emerging Economies: Obstacles and Preconditions to Success" (see article "Stock Anxiety" on this issue).

While the markets in London and New York registered strong recoveries in the weeks after the October crash, the Latin American bourses, and particularly those of Argentina and Brazil, failed to regain much of the lost ground. But in a significant contrast to the Asian economies, currency devaluations in Latin American have been the exception rather than the rule. Only Mexico, by virtue of its flexible exchange rate regime, experienced a significant devaluation, and that actually had the effect of reassuring markets and stemming the drop in Mexico's bourse. Other countries in the region opted to raise interest rates in order to defend their hard currency reserves and maintain exchange-rate stability.

Although October's stock market drop came at a time when the global economy was in solid shape, it also followed a period of "irrational exuberance" in many countries' equities markets, to quote the premonitory and much-publicized opinion of Alan Greenspan, chairman of the U.S. Federal Reserve.

On its own, this correction in the tendency of equity markets toward overvaluation is healthy. The danger is that governments may react by changing economic policy erratically, especially in economies that are fiscally and financially vulnerable, as is the case in many Latin American countries.

Fortunately, most of the region's economies are strong or, at least, are stable enough to enable leaders to make necessary policy adjustments without risking a major crisis. Economic growth rates at the time of the shock were at their highest levels in two decades, a fact that should give political and social viability to fiscal and monetary adjustments, where required. Inflation is under control in almost all the region's countries; memories of the cost of price instability are still fresh and there is broad consensus about which anti-inflation policies are most likely to succeed. With few exceptions, international hard currency reserves are sufficient to withstand substantial external shocks.

Overall, reaction to the market drop has been encouraging. In Brazil and Mexico, to cite two particularly significant cases in the region, the crisis has opened new political space for discussing crucial reforms that have been postponed up until now. Throughout Latin America and the Caribbean, the events in Asia and their aftershocks appear to have reminded governments, legislatures and economic agents that capital markets are myopic, and that periods of apparent prosperity must be used to shore up fiscal and financial safeguards against inevitable crises.

*The writer is senior research economist in the IDB's Office of the Chief Economist.

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