We had a big debate on emerging markets' growth prospects at our Annual Meetings in October 2013. We lowered our 2013 growth forecast for emerging markets and developing economies by a whopping 0.5 percentage points compared to our earlier forecast. Some argued that we were too pessimistic. Others said that we should have stuck with the lower-growth scenario we had devised at the onset of the global financial crisis.
Fast forward to today. Indeed, most recent figures indicate that the engines of global growth --emerging markets and developing economies -- have slowed significantly. Their growth rate dropped about three percentage points in 2013 from 2010 levels, with more than two thirds of countries seeing a decline -- Brazil, China, and India lead the pack. This is important for the global economy, since these economies generate half of today's global economic activity.
In my more recent travels around the world -- five regions on three continents -- I received the same questions everywhere: what is happening with the emerging markets? Is the slowdown permanent? Can emerging markets boost their growth? What are the downside risks?
No major pickup in emerging markets and developing economies' growth.
Emerging markets and developing economies are now stabilizing, but don't expect their growth rate to bounce back anytime soon to the high levels we observed in the past decade. In fact, we forecast a moderate pickup in emerging and developing economy growth to 5.1 percent this year, and to 5.4 percent in 2015.
One key reason is that several tailwinds that supported growth in the past are fading:
- We estimate China's decades-long double-digit growth rate, which supported its trading partners' growth, to have slowed to an average of 7.7 percent in the last two years.
- Commodity price surges, which have helped resource-rich countries, have ended.
- Historically easy financing conditions of the past have begun to give way to higher global interest rates.
- The share of international trade in total output has shrunk in the past two years, with no sign of a significant reversal to catch up with the upward trend observed in the past decade.
Structural changes in the global economy are fundamentally affecting the emerging markets and developing economies.
China's rebalancing away from investment will have a significant long-term impact on many countries. We welcome a moderate slowdown in China because current investment levels are unsustainably high. Government policies are rightly geared toward reducing the share of investment in GDP by several percentage points over the next three to five years.
Our analysis suggests that a one percentage point cut in China's investment growth would subtract between one-half and nine-tenths of a percentage point from GDP growth in the regional supply chain. This would create a significant impact across a range of economic, trade, and financial variables among China's major trading partners and commodity exporters.
Financial markets will likely be volatile for the foreseeable future. The main reason is that an orderly transition to a world without unconventional central bank policies will likely face multiple challenges:
- smooth adjustment of short-term interest rate expectations
- gradual return to normal of the difference in yields on long-term and short-term bonds
- smooth portfolio adjustments
- gradual unwinding of excessive leveraging
- continuously liquid markets
- economic growth gaining strength.
The turmoil in financial markets in May 2013 after the U.S. Federal Reserve began to discuss its plans to slow the pace of buying government bonds is a case in point. At that time, interest rates increased even in Europe, even though there was no change in the health of their economies.
To keep up with this changing global environment, emerging market and developing economies have to continuously adjust their economic structures and economic policies.
A stark example of how elusive persistent strong growth can be is the lack of convergence of Latin American economies toward advanced economies. This chart shows that this group's GDP made a full reverse circle between 1962 and 2011. Their per capita income has remained stagnant compared to the United States. In contrast, emerging market economies in Asia saw their relative per capita income improve continuously, with the notable exception of the period of the Asian crisis in the late 1990s.
Current domestic policies are not sufficient for financial stability in many economies that depend on capital flows. Corporate balance sheets are overstretched in a number of others. Uncertainty about the shape and direction of policies and supply-side constraints, including inadequate infrastructure and regulations, inhibit much-needed investment. Demographic pressures including aging populations, and tense industrial relations do not help either.
How they can do it.
Building a strong economy rather than simply injecting more monetary or fiscal stimulus remains crucial. For example, Brazil should commit to the long-standing primary surplus target. India needs to restart the process of reducing government debt and deficits and supply-side reform to bring down inflation and achieve strong growth. Indonesia should reassert monetary policy's key role to provide a nominal anchor. Turkey should increase its saving rate.
Better demand management is necessary but not sufficient for strong and sustainable growth. Governments also need to ensure strong productivity growth, including by promoting an environment for innovation.
While there is no one recipe for enhancing productivity, our work suggests countries should calibrate their reforms to their stage of development. For example, in upper-middle income countries, this would require further enhancing skills in the labor force and investing in research and development. Priorities in lower-middle income countries would include alleviating infrastructure bottlenecks and lowering barriers to foreign direct investment. In low-income countries the focus could be on strengthening economic institutions needed for market-based economic activity, getting more from agriculture, and improving basic education and infrastructure.
Policymakers need to understand how policies in one part of the world affect everyone else since this will impact their decisions and actions, no matter which country they live in.
To facilitate this, we have been highlighting key spillovers in our reports.
This also means policy coordination in today's hyper-connected world is critical. The global fiscal stimulus at the onset of the global financial crisis is an important example. The need for coordination in the area of cross-border resolution of failing or troubled banks is another example. We encourage this kind of coordination every chance we get.
The moderate pickup in global growth should not lead to complacency. We may not go back to the good old days. In all fairness, several emerging market and developing economies have implemented good policies in the aftermath of last May's turmoil. However, given the long and difficult list of policies required to achieve strong and sustained growth, any hesitancy in implementing them will complicate life for emerging economies in the future.
From iMFDirect Blog
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