Thursday, October 23, 2014
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The Emerging Economies’ Eurozone Crisis

WASHINGTON, DC – Most of today’s economic institutions, from money to banking, evolved over many years – the unintended consequences of decisions by millions of individuals. By contrast, the eurozone stands out for being a deliberate creation. It is arguably the world’s second-largest, deliberately-planned economic structure, after Communism.

The eurozone is a remarkable experiment, a genuine vanguard of global progress. As 2012 comes to a close, it is in trouble, and every effort must be made to nurture and strengthen it.

By the second half of 2011, it was evident that emerging economies, which had weathered the financial crisis that began in 2008 moderately well, were taking on water as the eurozone crisis deepened. Growth slowed sharply in Brazil, India, China, and other countries.

Central banks acted as lenders of last resort, thereby averting a major crisis. In December 2011 and February 2012, the European Central Bank announced the long-term refinancing operation (LTRO), whereby European banks were lent around €1 trillion ($1.3 trillion) in two tranches. Then, in July, came ECB President Mario Draghi’s famous assurance to do “whatever it takes” to save the euro. The United States Federal Reserve injected liquidity, as did other advanced countries’ central banks.

There was a collective sigh of relief, financial markets stabilized, and industrial-production rebounded. The question on everyone’s mind now is whether this post-storm calm will last, allowing the global economy to pick up.

Nowhere does this question loom larger than in developing and emerging economies, which are outside the main theater of the crisis, but are more precariously positioned than the advanced countries. Many had only recently begun to grow rapidly, and, with vast reservoirs of poor people, economic growth has a moral urgency that it does not have in rich countries.

So, will the global economy stage a sustained recovery? Examining the past as carefully as I can, and aware of the risks of augury, my answer has to be no. Until 2015, the outlook is gloomy for Europe and, by extension, for the emerging and developing economies. The injection of liquidity that occurred over the last year was the right policy. But it only bought time; it did not solve the problem. And time is running out.

Unfortunately, most people have an instinctive propensity to look away from approaching problems until they are very close. America’s “fiscal cliff,” for example, was long in coming, but we are scrambling to avoid it only now. So we should take early stock of the fact that there is another problem coming our way, which may be called (to give it the resonance of a coming storm) Edward – the “European Debt Wall and Repayment Deadline.”

The LTRO money that banks received on such easy terms, we must recall, took the form of three-year loans, which implies a wall of debt repayment in December 2014 and February 2015. If Europe succeeds in making major fiscal and banking reforms and gets its economy in order, Edward will lose steam. If not, the crisis will persist, and Europe will be rocked as Edward makes landfall by the end of 2014.

Where does that leave developing countries? The US and Europe are the world’s two largest economic powerhouses. Their slowdown will have an adverse impact on all emerging economies. Moreover, the US and Europe have already used large doses of fiscal stimulus, which shares an uncanny similarity to antibiotics. Administered over a short duration, it can be a powerful antidote; but, used repeatedly over too long a period, the side effects can outstrip the benefits.

Consider the case of India. Since 2009, India has been expanding its deficit as a deliberate measure to counter its economic slowdown. Because fiscal expansion followed several years of restraint, it was very effective in spurring demand and output growth. But now the scope for further expansion is limited. Unlike advanced countries, most emerging economies are exhibiting inflationary pressures, which could be exacerbated by another round of stimulus spending. So the short-run situation remains precarious.

Nevertheless, for emerging economies, the medium- to long-term prospects are bright. Countries that are saving a substantial amount, investing in human capital, and providing a modicum of good governance should resume their previous rapid growth.

India, for example, is saving and investing well over 30% of its GDP, devoting a significant share of these resources to infrastructure. Its entrepreneurial capacity is expanding. In several recent years, India’s outward direct investment in Britain has exceeded inward direct investment from Britain. So, once the crisis is over, annual growth should rebound to its earlier rate of more than 8%.

Investors seem to be taking this view to heart. They have been tightfisted when it comes to short-term equity investments. But, when it comes to long-term direct investment, they committed a record-high $43.8 billion to India in 2011-2012. Beyond the current crisis, the prospect appears to be similar in other major emerging economies, including Brazil, China, and Indonesia.

Easing short-term jitters and paving the way for further developing-country growth will require a clear and credible program for returning high-income economies, especially those in Europe, to a sustainable fiscal path. It will be a bumpy road ahead, requiring careful navigation and bold policy implementation.

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  1. CommentedJonathan Lam

    Gamesmith94134: the emerging economies’ eurozone crisis

    As kaushik basu mentioned on the fiscal cliff and Edward – the “European debt wall and repayment deadline”, The European Central Bank announced the long-term refinancing operation (LTRO), whereby European banks were lent around €1 trillion ($1.3 trillion) in two tranches with the liquidity the Fed can provide. It sounds as the best deal in heaven; but it also invokes the inflation through credit that has no collateral or valued-added goods from imports and its deficit is not improving.
    How does the inflation rate take another hike or its exchange as 1.22 euro to 1.31 to a dollar if its economy only worked in a short-term stimulation with no growth? Eventually, it is either inflationary or devaluation of Euro. ECB President Mario Draghi’s famous assurance to do “whatever it takes” to save the euro; however, many lost confidence on the disintegration on its political union or financial sustainability.

    “The injection of liquidity that occurred over the last year was the right policy. But it only bought time; it did not solve the problem. And time is running out.” How does Emerging Market Nations feel if they realize it was the data that the FED and ECB attempt to cook with fiat money and there is no escapade for draining their reserves or shrinking their currencies for sake of Euro? There must be other alternatives for the fundamentals and valuation in saving themselves from inflation or invasion. Otherwise, trade war is inevitable.

    In term of a balance act to a long term loan or investment, first, it is to stop these emerging market nations using its reserves and reinvest in stocks or real estate in the developed nations and bounce off when fiscal cliff or Edward howls during its contraction. Secondly, we must establish a system that will stop my ten years bond at 3.75% yield clash on the 1.5 or 1.6 slides. Thirdly, the scheme should not be swan song for the long term investors when the holding houses are benefitted in reverse trading and laugh at their good will investors if inflation or devaluation hits.

    In order to sustain harmony among the developed nations and emerging market nations, the system must realize we must give the sovereignty a status in a long-term investment that World Bank can serve as guarantor to those bonds that it could hold on to till the debtor nations can buy them back. Perhaps, WTO can be the mediator in advising the parties wisely in recapitalize their asset class capitals to trade under good will, after all, it is the comptroller by IMF to service the transaction in currencies at a rate that would void manipulation.

    In the recent reports, billions would have rolled into the Emerging Market nations; it elevated the local asset type capitals and real estate at an unsustainable level for their local and flooded credit markets and stock markets by cutting its profit margin. In contrast, many emerging market nations would be precarious on how liquidity is exhausting its reserves in its counter measures to stop inflation locally in the emerging market nations. Fiscal cliff and Edward do sound like to give it the resonance of a coming storm if Euro keeps on sliding against dollar; unless World Bank, WTO and IMF can focus issues on the fundamentals and valuation of all currencies not just Eurodollar, or yen.

    I am saying these offering of long term loans must be treated with respect; and some offer good will to help those needed a long term loan to revive. It is not an act of a smart investment if they were suckered into it; everyone understands it is not for profitable return but to sustain the stability of the global financial world. There are not many choices if we all know it is going to crack.
    Tectonic forces sew us together and separate us apart at the will of the earth, and it is a single entity.

    May the Buddha bless you?

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