According to well-known economists, emerging countries’ growth is expected to continue a downward trend. For many of them, external vulnerability has increased (see box). In the short term (end-2013 and 2014), tougher external financing conditions for governments and major companies as well as tighter monetary policies in several large countries (Brazil, India and Indonesia) in order to defend their currencies or fight against inflationary pressures will necessarily scale back growth prospects in the emerging countries. Excluding China, emerging markets’ growth should hold below 4% for the third consecutive year. Yet several supporting factors exist. Global trade has slowed very sharply since end-2010, dropping to historically low levels. The upturn in the Chinese economy (see below) and the consolidation of the US recovery should revitalise commercial trade and private investment, notably in Latin America and Europe.
In the medium term, there is hardly any doubt that “the party is over” to use R. Hausmann’s expression, if we take as reference point the emerging countries’ booming period (i.e. late 2010 and early 2011). Since then, metal and agricultural commodity prices have lost 15% and 25% respectively, in real terms. To reduce surplus capacity, large mining companies have announced cutbacks in investment spending through 2015. Yet metal prices are currently at the same levels as in early-2006, when the “party” was already well underway (prices were two times higher than the 1995-2005 average). As to oil prices, they have held at persistently high levels, both in nominal and real terms.
Although investors have proved to be increasingly selective, the emerging countries will continue to attract portfolio investments. Equity funds have already returned since September. There is also no doubt that the financial vulnerability of the emerging countries has increased as well. Yet this will result in higher volatility of exchange rates and interest rates and not a balance of payment or sovereign debt crisis. As K. Rogoff points out, flexible currency regimes, the high level of central bank reserves and less foreign currency debt are all factors that protect against crises. By intervening in foreign exchange markets and by announcing measures to strengthen their intervention capacity, central banks whose currencies were hit hardest by the financial turmoil in May-August have managed to preserve their foreign reserves.
Alarming
diagnoses Several articles with eye-catching on the emerging countries’ economic slowdown and financial vulnerability were published by renowned economists recently.
Ricardo Hausmann and Andres Velasco1 examine the causes of the slowdown in growth in the emerging markets. R. 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. And, those two factors explained most of the increase nominal GDP expressed in USD. For sure, this analysis is mainly relevant for commodity exporting countries. But, even for non-commodity exporting countries, the analysis is partially relevant due to the appreciation of real exchange rates. Beyond the so called Balassa-Samuelson effect2, the appreciation of real exchange rates has been fuelled by the manna of record commodity prices. According to R. Hausmann, commodity prices are cyclical by nature: consequently, periods of improving terms of trade and strong capital inflows are also temporary.
Kenneth Rogoff’s analysis3 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.
If there is another round of financial stress, central banks are well positioned to face a new wave of capital flight by non-resident investors. The increased vulnerability of the emerging countries is mainly due to the vulnerability of major non-financial companies that have issued massive amounts of international bonds in recent years. These companies could face refinancing problems and/or greater fragility due to their high exposure to currency risk.
BY François FAURE
In the medium term, there is hardly any doubt that “the party is over” to use R. Hausmann’s expression, if we take as reference point the emerging countries’ booming period (i.e. late 2010 and early 2011). Since then, metal and agricultural commodity prices have lost 15% and 25% respectively, in real terms. To reduce surplus capacity, large mining companies have announced cutbacks in investment spending through 2015. Yet metal prices are currently at the same levels as in early-2006, when the “party” was already well underway (prices were two times higher than the 1995-2005 average). As to oil prices, they have held at persistently high levels, both in nominal and real terms.
Although investors have proved to be increasingly selective, the emerging countries will continue to attract portfolio investments. Equity funds have already returned since September. There is also no doubt that the financial vulnerability of the emerging countries has increased as well. Yet this will result in higher volatility of exchange rates and interest rates and not a balance of payment or sovereign debt crisis. As K. Rogoff points out, flexible currency regimes, the high level of central bank reserves and less foreign currency debt are all factors that protect against crises. By intervening in foreign exchange markets and by announcing measures to strengthen their intervention capacity, central banks whose currencies were hit hardest by the financial turmoil in May-August have managed to preserve their foreign reserves.
Alarming
diagnoses Several articles with eye-catching on the emerging countries’ economic slowdown and financial vulnerability were published by renowned economists recently.
Ricardo Hausmann and Andres Velasco1 examine the causes of the slowdown in growth in the emerging markets. R. 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. And, those two factors explained most of the increase nominal GDP expressed in USD. For sure, this analysis is mainly relevant for commodity exporting countries. But, even for non-commodity exporting countries, the analysis is partially relevant due to the appreciation of real exchange rates. Beyond the so called Balassa-Samuelson effect2, the appreciation of real exchange rates has been fuelled by the manna of record commodity prices. According to R. Hausmann, commodity prices are cyclical by nature: consequently, periods of improving terms of trade and strong capital inflows are also temporary.
Kenneth Rogoff’s analysis3 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.
If there is another round of financial stress, central banks are well positioned to face a new wave of capital flight by non-resident investors. The increased vulnerability of the emerging countries is mainly due to the vulnerability of major non-financial companies that have issued massive amounts of international bonds in recent years. These companies could face refinancing problems and/or greater fragility due to their high exposure to currency risk.
BY François FAURE