Nobody talks about “decoupling” any more. Instead, emerging economies are sinking alongside developed ones. In 2008 emerging stock markets fell by more than those in the rich world, and financial woes forced countries such as Hungary, Latvia and Pakistan to go cap in hand to the IMF. Taiwan’s exports have plunged by 42% over the past year, and South Korea’s by 17%; even China’s have shrunk. Singapore’s GDP fell by an annualized 12.5% in the fourth quarter of 2008, its biggest drop on record. Is this the end of the emerging-market boom?
Over the five years to 2007, emerging economies grew by an annual average of more than 7%. But in the past three months their total output may have fallen slightly, according to JPMorgan, as the fall in exports was exacerbated by a sudden drying up in trade finance. For 2008 as a whole, average growth in emerging economies was still above 6%, but recent private-sector forecasts suggest that this could slip to less than 4% this year. That is grim compared with the recent past, though still robust set against an expected 2% decline in the GDP of the G7 countries.
Short-term pain is only to be expected. But some economists argue that emerging markets’ longer-term prospects have been badly hurt by the global financial crisis. From Brazil to China, they claim, the boom was driven largely by exports to American consumers, easy access to cheap capital and high commodity prices. All three props have now collapsed. In particular, as America’s housing bust causes households to save more, they will import less over the coming years. This could reduce emerging economies’ future growth rates.
Yet emerging economies’ reliance on America is often exaggerated. The surge in their total exports as a share of GDP since 2000 might, on the face of it, suggest that their boom was powered by just under 20% of GDP (see chart 1). Most of the growth in exports has been within the developing world.
For sure, emerging economies will not return to their exceptional growth rates in 2007 (no bad thing either, since many of them were overheating). But it is equally wrong to assume that they cannot recover until America rebounds. There are good reasons to believe that emerging markets’ share of world growth will continue to climb (see chart 2).
Gerard Lyons, chief economist at Standard Chartered, argues that most emerging economies are not plagued by America’s deep structural problems, such as an overhang of debt, which could cramp growth for several years. Although 2009 will be a painful year for poorer countries, those with high savings and modest debt could recover fairly quickly. On many measures, such as government and external balances, emerging economies look much sounder than the big rich ones.
Unfortunately, aggregate numbers conceal many horrors, most notably in Eastern Europe. Countries such as Hungary, Estonia, Latvia and Turkey have huge current-account deficits and foreign debts. Between 2000 and 2008, the ratio of foreign debt to GDP dropped from 37% to 20% in Latin America and from 28% to 17% in emerging Asia, but jumped from 45% to 51% in central and eastern Europe.
As foreign capital dried up, GDP fell by 4.6% in Latvia and by 3.5% in Estonia in the year to the third quarter of 2008. Capital Economics, a research consultancy, expects another 5% drop this year. Hungary’s economy is expected to contract in 2009. Turkey may also be heading for trouble. Its debt service payments due in 2009 amount to 80% of its foreign reserves, the highest ratio of any big emerging economy.
Russia has run current-account surpluses for many years, yet it has also been badly hit by an outflow of capital and a credit freeze. Banks and companies are finding it hard to roll over their foreign debt. Official reserves have fallen by $160 billion, or 25%, since August. As a result of lower oil prices, Russia is likely to run its first current-account and budget deficits in a decade, and its economy may well contract in 2009.
Asia’s export-led economies have been hurt by the collapse in global demand. Output is already falling in Singapore, Hong Kong and Taiwan. However, current-account surpluses and modest domestic debts mean that most of the region is much less exposed to the credit crunch than eastern Europe is. Asia has two other advantages. First, as a large net importer of raw materials it will benefit from the plunge in commodity prices, unlike Latin America. And second, with the exception of India, Asian countries have low public-debt-to-GDP ratios, giving them more room for fiscal stimulus than other emerging economies. Such policies take time to work, but after a nasty 2009, Asia is well placed to be the first region in the world to recover.
China is crucial to Asia’s fortunes. Many economists expect GDP growth to slow to around 7% in 2009, down from almost 12% in 2007 and its slowest rate for almost two decades. Thousands of factories have closed in southern China, triggering concerns that rising unemployment will cause social unrest. This prompted the government to unveil a large fiscal stimulus in late 2008, which should help to boost growth in the second half of this year. With debts of only 18% of GDP, the government has plenty more room to boost spending. And if China has to rely more on domestic demand, this will help to steer it onto a more sustainable path.
A comparison of China with India in any case shows that exports are not the main thing that determines how vulnerable economies are to the global crisis. India’s exports as a share of GDP are much smaller than China’s, so one might expect it to be holding up better. But a big chunk of Indian investment -- the main driver of recent growth -- has been financed by overseas borrowing or new equity issuance. Both have dried up. The government’s huge budget deficit also limits its room for fiscal easing. On January 2nd India announced its second monetary and fiscal stimulus package within a month, but the extra spending is tiny. Standard Chartered thinks that GDP growth will dip to 5% in 2009, well below its recent 9% pace.
Latin America’s prospects lie somewhere between those of Asia and emerging Europe. Weak commodity prices could push the region into running a large current account deficit, just as private-capital inflows decline sharply. Latin America also has less scope for fiscal stimulus than Asia, because many governments (including Argentina and Brazil) used the windfall from higher commodity prices to boost spending rather than cut debt. Goldman Sachs forecasts that Brazil will grow by only 1.5% in 2009, whereas Mexico’s GDP could fall by 0.5% because of its stronger trade links with America. The bank reckons that both should recover fairly quickly. Argentina is another matter. Credit-default-swap spreads on its government debt have surged to horrifying levels, signaling that investors see a high risk of default.
During the past five years virtually all emerging economies boomed. Now their fortunes will diverge much more. The most important factor determining how they cope with the recession in the rich world will be whether they are high savers, able to stimulate their own economies, or big borrowers. If international investors continue to shun risk and rich-world governments swamp markets with their own borrowing, it will be hard for emerging-market governments to issue bonds and for banks and firms to roll over debts. Some developing countries will therefore remain sluggish for longer than others.
Overall, however, their long-term prospects remain good, thanks to structural reforms and better macroeconomic policies over the past decade. In December the World Bank forecast that GDP per head in poorer countries would rise at an annual pace of 4.6% during 2010-15, similar to that during the past decade, and more than twice as fast as in the 1990s. That word “decoupling” may yet get dusted off again.
