Three stages of Emerging Markets in a financial crisis - Essay Example

Stages of Financial Crisis Insert Introduction The Economies in an early stage of economic development recently opened up to the flow of services, goods and capital from the rest of the world. This would resemble countries like the United States which are considered advanced, but with some important differences. There are three stages of emerging markets in a financial crisis that this paper analyses.The first stage: Initiation of financial crisisUnlike in advanced countries economies where crises are triggered by a number of factors, financial crisis develops along two reasons in emerging markets: it can either be mismanagement of financial liberalization and globalization or severe fiscal imbalances.

Mismanagement of financial liberalization and globalization becomes the major culprit as was evident in Mexico in 1994 as well as many East Asian countries in 1997 (Myeconlab, 2011). In the United States, we sow the seeds of a financial crisis in the emerging market countries as those countries liberalize their financial system. This is done by doing away with restrictions on the financial institutions and markets domestically and opening up the economies to flow of capital and financial firms from other nations.

Stage two: currency crisisA currency which is fixed against the US dollar becomes subject to a speculative attack, where the speculators engage in the massive sales of the currency. Currency crisis sets in as currency sales floods the market and supply outstrips demand which leads to the value of currency collapsing. Interest rates get high, uncertainty increase and asset prices fall.Stage three: Full-pledged financial crisisThe emerging market economies denominate several debt contracts in foreign currencies leading to a currency mismatch.

The domestic currency depreciation increases the value of debts relative to assets which leads to the decline of the net worth of a firm. This decline then increases adverse selection as well as moral hazard problems. Investment also declines as well as economic activity. Therefore to prevent financial crisis in emerging market certain policies are considered including improving prudential regulation and supervision, limiting currency mismatch as well as seq1uencing financial liberalization.ReferenceMyeconlab. (2011). Web Chapter.

A Journal of Financial Crisis in Emerging Market Economies, 1-22.