According to well-known economists, growth in emerging countries is expected to continue a downward trend. For many of them, external vulnerability would have increased given the portfolio investment outflows recorded between May and August. Indeed, tougher external financing conditions for sovereigns and corporates as well as monetary policy tightening in several large countries will necessarily scale back growth prospects in the short term. In the medium term, the rationale behind the growth slowdown is based on a lasting reversal in commodity prices and a weakening in real exchange rates, but both factors need to be put into perspective. External vulnerability has not deteriorated such an extent that it could trigger balance of payment or sovereign debt crises.
Several articles with eye-catching, almost alarmist headlines on the emerging countries’ economic slowdown and financial vulnerability were published by renowned economists in recent weeks1. Their arguments look beyond the short-term consequences of the outflow of portfolio investments reported between May and August.
Alarming diagnoses
Ricardo Hausmann and Andres Velasco examine the causes of the growth slowdown in the emerging markets2. Ricardo Hausmann insists that the emerging countries will no longer benefit from the exceptional conjunction of high commodity prices (resulting in better terms of trade for commodity exporting countries) and rising real exchange rates. He bases his demonstration on the breakdown of GDP growth in dollars according to three factors: real growth (i.e. GDP growth in local currency at constant prices), changes in the terms of trade and changes in the real exchange rates. R. Hausmann provides numerous examples of countries where the latter two factors explain most of the spectacular GDP growth in dollars between 2003 and 2011. The contribution of real GDP growth is marginal except for non-commodity exporting countries. Yet even in this case, the analysis is partially relevant due to the appreciation of real exchange rates. Most importantly, these three factors interact together, either directly (real exchange rates normally tend to appreciate during catch-up phases of productivity and growth3) or indirectly (nominal exchange rates appreciate due to capital inflows attracted by favourable growth prospects, which in turn are justified by high commodity prices). According to R. Hausmann, commodity prices are cyclical by nature (upturns are followed by periods of stability and downturns): consequently, periods of improving terms of trade and strong capital inflows are also temporary.
The same can obviously be said for joint movements in the appreciation of real exchange rates (beyond what is justified by the Balassa-Samuelson effect) and capital inflows.
Kenneth Rogoff’s analysis looks more specifically at the financial vulnerability of the emerging countries, starting with the assumption that the slowdown is here to stay: regime change for the Chinese economy, halting of ultra-accommodating monetary policies in the so-called advanced countries and deterioration in the main macroeconomic balances in the emerging countries. In his eyes, the economic slowdown is more alarming than the assets’ price volatility in financial markets that are still relatively illiquid. He also points out that the reduction in growth spreads between the emerging and advanced countries should eventually lead investors to invest less “blindly” in countries where until now, the development of middle class populations was a sufficient gage for strong growth and political stability. A change in investor behaviour resulting in the normalisation of risk premiums comprises the main vector of fragility. According to K. Rogoff, it is wrong to believe that more local currency debt eliminates the possibility of a financial crisis. Recourse to monetisation to avoid defaulting and “financial repression” (capital controls and financial market regulations) are strategies that reduce short and medium-term growth.
BY François FAURE
To Read the Entire Report Please Click on the pdf File Below.
Several articles with eye-catching, almost alarmist headlines on the emerging countries’ economic slowdown and financial vulnerability were published by renowned economists in recent weeks1. Their arguments look beyond the short-term consequences of the outflow of portfolio investments reported between May and August.
Alarming diagnoses
Ricardo Hausmann and Andres Velasco examine the causes of the growth slowdown in the emerging markets2. Ricardo Hausmann insists that the emerging countries will no longer benefit from the exceptional conjunction of high commodity prices (resulting in better terms of trade for commodity exporting countries) and rising real exchange rates. He bases his demonstration on the breakdown of GDP growth in dollars according to three factors: real growth (i.e. GDP growth in local currency at constant prices), changes in the terms of trade and changes in the real exchange rates. R. Hausmann provides numerous examples of countries where the latter two factors explain most of the spectacular GDP growth in dollars between 2003 and 2011. The contribution of real GDP growth is marginal except for non-commodity exporting countries. Yet even in this case, the analysis is partially relevant due to the appreciation of real exchange rates. Most importantly, these three factors interact together, either directly (real exchange rates normally tend to appreciate during catch-up phases of productivity and growth3) or indirectly (nominal exchange rates appreciate due to capital inflows attracted by favourable growth prospects, which in turn are justified by high commodity prices). According to R. Hausmann, commodity prices are cyclical by nature (upturns are followed by periods of stability and downturns): consequently, periods of improving terms of trade and strong capital inflows are also temporary.
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The same can obviously be said for joint movements in the appreciation of real exchange rates (beyond what is justified by the Balassa-Samuelson effect) and capital inflows.
Kenneth Rogoff’s analysis looks more specifically at the financial vulnerability of the emerging countries, starting with the assumption that the slowdown is here to stay: regime change for the Chinese economy, halting of ultra-accommodating monetary policies in the so-called advanced countries and deterioration in the main macroeconomic balances in the emerging countries. In his eyes, the economic slowdown is more alarming than the assets’ price volatility in financial markets that are still relatively illiquid. He also points out that the reduction in growth spreads between the emerging and advanced countries should eventually lead investors to invest less “blindly” in countries where until now, the development of middle class populations was a sufficient gage for strong growth and political stability. A change in investor behaviour resulting in the normalisation of risk premiums comprises the main vector of fragility. According to K. Rogoff, it is wrong to believe that more local currency debt eliminates the possibility of a financial crisis. Recourse to monetisation to avoid defaulting and “financial repression” (capital controls and financial market regulations) are strategies that reduce short and medium-term growth.
BY François FAURE
To Read the Entire Report Please Click on the pdf File Below.
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