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.