Friday, April 18, 2014
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Are Emerging Markets Submerging?

CAMBRIDGE – With economic growth slowing significantly in many major middle-income countries and asset prices falling sharply across the board, is the inevitable “echo crisis” in emerging markets already upon us? After years of solid – and sometimes strong – output gains since the 2008 financial crisis, the combined effect of decelerating long-term growth in China and a potential end to ultra-easy monetary policies in advanced countries is exposing significant fragilities.

The fact that relatively moderate shocks have caused such profound trauma in emerging markets makes one wonder what problems a more dramatic shift would trigger. Do emerging countries have the capacity to react, and what kind of policies would a new round of lending by the International Monetary Fund bring? Has the eurozone crisis finally taught the IMF that public and private debt overhangs are significant impediments to growth, and that it should place much greater emphasis on debt write-downs and restructuring than it has in the past?

The market has been particularly brutal to countries that need to finance significant ongoing current-account deficits, such as Brazil, India, South Africa, and Indonesia. Fortunately, a combination of flexible exchange rates, strong international reserves, better monetary regimes, and a shift away from foreign-currency debt provides some measure of protection.

Nonetheless, years of political paralysis and postponed structural reforms have created vulnerabilities. Of course, countries like Argentina and Venezuela were extreme in their dependence on favorable commodity prices and easy international financial conditions to generate growth. But the good times obscured weaknesses in many other countries as well.

The growth slowdown is a much greater concern than the recent asset-price volatility, even if the latter grabs more headlines. Equity and bond markets in the developing world remain relatively illiquid, even after the long boom. Thus, even modest portfolio shifts can still lead to big price swings, perhaps even more so when traders are off on their August vacations.

Until recently, international investors believed that expanding their portfolios in emerging markets was a no-brainer. The developing world was growing nicely, while the advanced countries were virtually stagnant. Businesses began to see a growing middle class that could potentially underpin not only economic growth but also political stability. Even countries ranked toward the bottom of global corruption indices – for example, Russia and Nigeria – boasted soaring middle-class populations and rising consumer demand.

This basic storyline has not changed. But a narrowing of growth differentials has made emerging markets a bit less of a no-brainer for investors, and this is naturally producing sizable effects on these countries’ asset prices.

A step toward normalization of interest-rate spreads – which quantitative easing has made exaggeratedly low – should not be cause for panic. The fallback in bond prices does not yet portend a repeat of the Latin American debt crisis of the 1980’s or the Asian financial crisis of the late 1990’s. Indeed, some emerging markets – for example, Colombia – had been issuing public debt at record-low interest-rate spreads over US treasuries. Their finance ministers, while euphoric at their countries’ record-low borrowing costs, must have understood that it might not last.

Yes, there is ample reason for concern. For one thing, it is folly to think that more local-currency debt eliminates the possibility of a financial crisis. The fact that countries can resort to double-digit inflation rates and print their way out of a debt crisis is hardly reassuring. Decades of financial-market deepening would be undone, banks would fail, the poor would suffer disproportionately, and growth would falter.

Alternatively, countries could impose stricter capital controls and financial-market regulations to lock in savers, as the advanced countries did after World War II. But financial repression is hardly painless and almost certainly reduces the allocative efficiency of credit markets, thereby impacting long-term growth.

If the emerging-market slowdown were to turn into something worse, now or in a few years, is the world prepared? Here, too, there is serious cause for concern.

The global banking system is still weak in general, and particularly so in Europe. There is considerable uncertainty about how the IMF would approach an emerging-market crisis after its experience in Europe, where it has had to balance policies aimed at promoting badly needed structural change in the eurozone and those aimed at short-run economic preservation. That is a topic for another day, but the European experience has raised tough questions about whether the IMF has a double standard for European countries (even those, like Greece, that are really emerging markets).

It is to be hoped, of course, that things will not come to that. It seems unlikely that international investors will give up on emerging markets just yet, not when their long-term prospects still look much better than those of the advanced economies.

Besides, the current sentiment that the eurozone has gotten past the worst seems exceedingly optimistic. There has been only very modest structural reform in countries like Italy and France. Fundamental questions, including how to operate a banking union in Europe, remain contentious. Spain’s huge risk premium has almost disappeared, but its debt problems have not.

Meanwhile, across the Atlantic, the political polarization in Washington is distressing, with another debt ceiling debacle looming. Today’s retreat to advanced-country asset markets could quickly revert to retreat from them.

The emerging-market slowdown ought to be a warning shot that something much worse could happen. One can only hope that if that day should ever arrive, the world will be better prepared than it is right now.

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  1. CommentedJose araujo

    Again some lessons to be learned from the recent emerging markets growth, but probably not what Rogoff is concluding.

    First, resource base growth is extremelly unequal leveraged by the export base growth policy,which concentrates wealth on very few and a apathic internal demand.

    Second, the demonstration that low wages and labour flexibility isn't a determinant for growth of productivity increases. It is is turned into higher profits for a class that is already much richer then the rest of the population.

    Supply side economics with resource export based economics proved again to be disasterous, no matter if you are trying to pin this on QE, Brics are the living a proof classic think is wrong.

  2. CommentedJeff Burd

    I totally agree with Zsolt Hermann. There are no emerging, developed or down the bottom markets. All we have today is one global economy, where all countries are totally interdependent on each other. To give you an idea: if for any reason African countries will stop supplying copper (for example) the market prices for all electrical / electronic products will be flying skyhigh within a few months.

    Unfortunately the "big" economy experts still do not understand that our civilisation has reached a major milestone in it's development, where old (GREED IS GOOD) competitive behaviour concepts no longer work. The GFC was the first manifestation of it, but not last. The next crisis will be much stronger and longer, so that may be we wake up to the fact that our disbalanced system of wealth distribution betwen individuals, communities and countries is crying for a total change.

    We need a new system of wealth distribution, based on cooperation between the countries, communities and individuals. If we as the whole humanity will not understand this in the next few years, the natural events will take care of these disbalances through economic, political, social upheavals.

    But dear "big" economists, may be if you put your thinking caps on, just may be, we can avoid a lot of pain and suffering the natural process of our civilisation development has prepared for us. All we need is the desire to develop a new economic system, based on equality of people,communities and countries. Than we may be able to build a new world, based on connection of people - not hatred, cooperation of people instead of competition for more than WE really need.

  3. Commenteddonna jorgo

    nothing is simple in economy ..(compication ) but every time when the economy come down so (i mean is very down ) the atenttion have to go some were (SYRIA ) RIGHT NOW next ?

    i like your column .always correct (but we needed academic) solution ..mathemantice ..numbers are important to write and to keep too
    Emerging market's well CHINA is good ..India too .Europe not trust
    America too
    so the best if some one have to see emerging market is AFRICA ..they needed to much investim AND there is the futuro ..
    thank you

  4. CommentedEnrique Woll Battistini

    It seems evident that world-scale, or global, monetary issues should not be managed, by advanced countries, emerging countries, or the IMF, solely with a view typical of technical investment criteria, that is, with a short term outlook. It seems evident, rather, that they should be managed with heavy fundamentals' investment criteria, quite literally. In other words, monetary policy seems to have too much "20th century monetary policy" about it, and not enough "21st century economic development policy," or long-term criteria, underpinning it. They must be concurrent to exist at all, and be sustainable. Perhaps the most important element to this concept is Social Inclusion, or sharing of the benefits of work, everybody's work, by everyone, all consumers -productive or not, able-bodied or not. It is a matter of degree, which must be fair, and as such must be flexible and vary over time and place, gradually eliminating poverty in real and relative terms. When this is attained, real inclusion will be too, and not before. This is not communism, or even 20th century socialism: It is common sense to those who are conscious of the world as it is today and will be tomorrow if it does not adapt creatively and effectively to its own needs. More common sense: Poverty is the natural enemy of peace, and extreme poverty is the irreconcilable enemy of peace. If everyone able-bodied is to be productive, in principle, and everyone is to be included in consumption, then the way the world as a whole views development, and the investments that make it possible, must be approached in Partnership, on a global scale. If this were accomplished, and it will, we would all be able to preserve and enjoy the natural and man-made wonders about us.

  5. CommentedProcyon Mukherjee

    Sir, Your book "This time is different" had a chapter dedicated on the subject of where capital would flow. I did not quite agree to the inference that capital would not move where capital to labor ratios are high, but where the institutions, governance standards are conducive for investments to fructify to match the productivity gains. Today the data would point that capital did flow to the emerging markets where the ratios are indeed high, and today in the slightest hint of withdrawal the markets have dumped these destinations.

    Whether Institutions and governance standards are a result or means to an end, is a matter of debate; for India in particular, these may have been the weakest link, but capital flight is the fundamental source of market gyrations. While matters would settle on new normals, the shift in many parameters would take much more time to heal. But whether or not developed nations live in an insulated world needs no conjecture.

  6. CommentedZsolt Hermann

    There is no such thing as "emerging market".
    There is only one market.
    If we look at the picture illustrating the article, that house sinking in the water is the whole, global world.
    We are all sitting on that sinking house/boat.
    And regarding throwing the safety equipment, there is nobody "on the outside" who can throw a rope to us.
    Unless we all change the whole collapsing system we are stubbornly trying to resuscitate, changing from artificial demand driven "constant quantitative growth" illusion to an available human and natural resource driven, realistic socio-economic system, we will all drown very soon.
    And the most important thing we have to understand is that we all depend on each other, thus we have to make the changes in a mutually responsible and complementing way.

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