The options for emerging markets From a recent Citi presentation, a chart stressing the potential risk of negative-feedback loops in the options available to those emerging market countries now trying to stem capital outflows and defend their currencies: The chart makes an important point and is self-explanatory, but it isn't comprehensive. Notably excluded is the imposition of capital controls on outflows, which thus far have been mostly resisted with the exception of some limited measures in India. They too are a bad option. As we noted in the vastly different context of Cyprus, controls on outflows rarely work. Or perhaps it's more correct to say that there is an awful lot of disagreement about the prior instances in which they were tried and might have worked. The Reinhart-Rogoff-Magud meta-analysis from 2011 found only one example - Malaysia in 1998 - in which controls on outflows were mildly but inarguably helpful. Otherwise: There is little evidence of "success" in other countries attempting to control outﬂows, either in terms of altering the volume or regaining monetary policy independence. And the Malaysia example had a distinctive set of circumstances whereby the controls could be complemented by counter-cyclical fiscal policy, bans on short-selling the currency and trading it offshore, and fixing the ringgit to the dollar to ward off the speculators. This doesn't mean that controls can't work in India or elsewhere. But in addition to their historical impotence, such controls also carry the risk of further scaring off investors at precisely the time when they seek reassurance. (The record of capital controls on inflows is better but still not great. That's another conversation.) Also unmentioned is the option to lobby the central banks of developed countries, encouraging them not to tighten policy too quickly. This option appears to have been pursued with some vigour at Jackson Hole last weekend, but probably won't carry much weight at the next FOMC meeting. So the immediate options, at least those of a sweeping nature, are unattractive. And the possibility that emerging market central banks and governments will overreact and excessively tighten policy is a singular concern. That's no reason to be fatalistic, and each country can still try combinations of targeted policies appropriate to its unique circumstances. The Reserve Bank of India has already attempted to weaken the link between climbing interest rates and currency fluctuations by intervening in bond markets, and on Wednesday it announced new swap lines to help its state-owned oil companies meet their dollar requirements. In addition to import duties on gold and flat-screen televisions, the government appears to be awkwardly lumbering towards supply-side reforms to make the country more attractive to foreign investors. For a sense of India's particular and complicated set of conditions, which we don't pretend to grasp, try the recent posts by Ashok Rao, Simon Johnson and Tyler Cowen. But the broader issue is that it remains quite difficult to gauge the severity of the year's EM currency and asset selloff - and to know whether it is more attributable to an acute market crisis versus a more fundamental economic shift. Among the various possible causes normally cited are the Fed's talk of tapering; the unwinding of carry trades; Chinese rebalancing; the pass-through effects of this rebalancing on commodity-exporters (Australia, South Africa, various countries in South America); the end of the commodity super-cycle generally; the limits to growth in countries that procrastinated on necessary structural changes; continued sluggishness by developed-country consumers; and dwindling investor patience with widening current account and budget deficits. The causes aren't mutually exclusive, of course, and some influence the others in various ways. It's also tough to know, at least for the inexpert or non-obsessive follower of international economics, how prepared the affected countries are to handle it. The current situation - has it reached the level of "crisis" yet? - inevitably will have a similar feel to the crises of the 1990s given the reversal of hot money flows, the threat from speculators attacking various currencies, and even the involvement of some of the same countries. But so much is different, and most of the differences are positive. As our colleagues David Pilling and Josh Noble wrote in Wednesday's FT: Back then, many countries had fixed exchange rates and their companies were heavily exposed to foreign debt. As currencies came under pressure, central banks desperately spent reserves to defend them. When the peg finally broke, currencies collapsed and companies" foreign-denominated debts soared. Thailand, Indonesia and South Korea had to seek help from the International Monetary Fund. Partly as a result of now largely discredited IMF austerity packages, they subsequently plunged into deep recession. Indonesia, the worst affected, lost 13.5 per cent of GDP in a single year. Suharto, the dictator, was toppled. Today the picture is very different. Asian economies have flexible exchange rates, much higher reserves and sounder banking systems. India, for example, has reserves to cover seven months of imports compared with only about three weeks when it had its own "come-to-IMF" moment in 1991. Nor, this time around, has India's central bank wasted much firepower on defending the currency. Instead, it has largely allowed the rupee to slide. A weaker currency should boost exports and slow imports, closing the current account deficit automatically. And so it might, hopefully without much lasting damage. We would also note the still-favourable growth differentials between developed and emerging market countries, which didn't exist in the 1990s. Admittedly this doesn't preclude a new crisis or crises of a different flavour, and do read the full FT piece for the thoughts of more-pessimistic commentators, with careful attention to the points of Ruchir Sharma. Still, for the moment the problems seem at least endurable, if not actively manageable. And although these countries" immediate choices are regrettably limited, there is also a more hopeful longer-term story that can be told about this year's events. It's mainly about how (some of) the lessons of the 1990s and the recent developed-world financial crisis have been heeded. In addition to the ability of emerging market currencies to respond to market forces, the relevant Asian countries also better understand the need for multi-lateral coordination and support during crises. Furthermore, as economists from Standard Chartered explained, it's likely that investors have become more discerning about the details of countries" external funding problems. The economists looked at the short-term external debt situations for India, Indonesia, and Thailand - the three countries involved running a current account deficit - and found that "in all three cases the vast majority of the debt due within one year does not come with serious financing risk." More broadly, we've been especially interested in tracking the continued expansion of local-currency debt and capital markets, where tremendous progress has been made in the last decade and a half, especially in sovereign and corporate bond markets. They're important for a few reasons. Companies in emerging markets find it easier to borrow in their own currencies, and are better able to hedge their debt if they rely on imports denominated in foreign currencies. Currency swings therefore become less threatening. Indeed the problem of indebted companies unable to roll over their foreign-denominated debt has much smaller this time round - again with the big exception of India's state-owned oil giants. Emerging market governments with sophisticated capital markets also have less need to build up massive stores of foreign currency reserves, a process that exacerbated the unnatural problem of global imbalances in the decade prior to the crisis of 2008 - when too much capital flowed from developing countries to developed countries rather than the other way round. And of course, robust local-currency debt and equity markets, when accompanied by sound governance practices, reduce the dependence on foreign bank lenders and lead to a more diversified base of stakeholders. The main worry about ratcheting up the development of these markets is that doing so increases the probability of internally driven, consumer- or construction-led bubbles, and the ensuing domestic financial crises. This is undeniably true. It's equally true that dangerous financial innovations are likely to emerge, and that some countries will fail to implement the appropriate macroprudential regulations and policies to constrain overzealous and unqualified borrowers, and to prevent the buildup of current account deficits. Such measures should always complement the opening and development of capital markets. India and Indonesia already have failed in this regard, and the failure is partly responsible for what's happening to them now. It's a messy world. Most countries have accepted these concessions as the cost of participating in a globalised trading system. For justification they can reasonably point to the increased robustness to external crises, the benefits of a more-dynamic economy and, when the time comes, the enhanced ability of sovereigns and central banks to manage their own downturns and recoveries. International trade and capital flows collapsed after the financial crisis of 2008. Within Europe the balkanisation of financial markets has mostly remained in place. But as both Citi's presentation and a helpful McKinsey report explain in detail, by 2012 capital inflows to emerging markets had returned nearly to their pre-crisis levels. These inflows returned, however, mainly in the form of foreign direct investment and investments via capital markets rather than bank lending. Foreign direct investment is already considered to be a more stable kind of inflow. And the progress in developing local-currency capital markets also indicates that the growth in portfolio flows will be less worrying in the future, if certainly not yet. These were favourable trends. Despite the present slowdown, in time they are likely to resume course given the disproportionately shallower financial markets in developing countries. Investors in local-currency emerging market debt have been shellacked this year, and clearly the FX markets are spooked. Maybe the selloff will accelerate and new balance of payments crises really are imminent. We don't know: much depends on policy still being decided, especially given the recent introduction of heightened geopolitical risks. We certainly don't mean to dismiss the possibility of a terrible outcome, especially for an individual country. For now, however, the problems appear both different in nature and smaller in scale, and unlikely to spread uncontrollably. If we're right about that, then a plausible explanation is that the lessons of the 1990s haven't gone entirely ignored. And if a number of emerging market countries are about to enter a grinding period of slower growth and structural adjustments, or to experience new financial strains, at least they do so better prepared. Still, until events play out a bit longer, we're not ready to let the above impressions lodge too deeply. There is too much we've yet to grapple with. It's unavoidable that such an overview will include significant omissions, and with that in mind, we suggest as further reading: A new IMF paper argues that capital flows are always and everywhere a fickle phenomenon. A paper presented by Hélène Rey at Jackson Hole, and covered by Robin Harding, finds that even a floating exchange rate doesn't give an EM country dominion over its monetary policy; effective capital controls are needed. Given their history of mixed results, this inspires little confidence. Even the IMF's volte-face on controls a few years ago came with significant caveats, appropriately. As Robin goes on to explain, global finance would hugely benefit from a credible mechanism to compel current account surplus countries to rebalance. It doesn't exist, and it's unclear whether the momentum of recent years for bigger, globally-coordinated regulatory fixes will come to anything. Ryan Avent writes the tricky compromises involved in a country's decision to use its foreign-currency reserves to defend its currency and support domestic companies. Paul Krugman, who literally wrote the book on the crises of the 1990s, is beginning to look closely into the current iteration, and we look forward to the results. We're also hoping to goad Pawel Morski, who forgets more about emerging markets every five minutes than the rest of us have collectively learned, to return to the blogging arena and slay us all with what we didn't know we didn't know.