The emerging market crises of the late ’90s had a number of different causes ranging from cheap credit and excessive foreign investment to straightforward mismanagement, but as Societe Generale analyst Michala Marcussen points out, tightening Fed policy often served as the catalyst to set off a crisis. The next FOMC meeting is just around the corner, and most analysts expect the Fed to continue as planned and taper to purchases to $65 billion, but this time around an emerging market crisis would have a bigger impact on the global economy.

Emerging Markets

“The second half of the 1990s was shaped by a wave of emerging market crises,” Marcussen writes. “Fast forward to 2014 and fundamentals in emerging economies are in aggregate much improved, with overall more flexible currency regimes, stronger external balances, more developed domestic debt markets and larger FX reserves.”

Many emerging market countries still show weakness

But the aggregate numbers hide a lot of specific weaknesses. Marcussen calls out Argentina, Venezuela, Chile, Peru, South Africa, Ukraine, Turkey and Thailand as the ‘weak links’ in the emerging market universe, with large trade imbalances and weak economic policy, and these countries make up around 4% of global GDP. Brazil, Indonesia, and India also have serious imbalances and also need serious structural reforms she argues, and they make up another 6% of global GDP. If you consider Russia to be in trouble after the ruble’s recent drop then throw in another 3% and 13% of global GDP is susceptible to crisis.

“Our expectation is that the Fed will complete tapering by the late summer and we look for the first rate hike in mid-2015. The balance of risks today are tilted to earlier tightening, but with the twist that a full blown emerging market crisis would likely stop the Fed in its tracks. The Fed, however, is unlikely to act pre-emptively to prevent an emerging crisis,” writes Marcussen.

Emerging market share of global GDP has more than doubled

This assumes that China is able to maintain growth around the 7% level, something that many economists don’t think will happen. While emerging markets as a whole have grown from 18% to 40% of global GDP since 1994, China’s share has grown from 4% to 14%. If Fed tightening does trigger an emerging market crisis, the effects would likely be further reaching than they were in the past.

“Our baseline remains that China can avoid a hard landing, but the risk will remain for the foreseeable future,” Marcussen writes. “Other emerging economies are likely to see a further slowing of growth momentum, and in some cases painful recession could prove hard to avoid.”