Originally Published 2014-02-17 07:24:23 Published on Feb 17, 2014
As the EMEs grow and mature, they can no longer rely on export-driven, credit-fuelled growth and must look inward to initiate deep seated structural reforms and modify their path to economic prosperity. There is a need for effective governance and strong leadership to restore the lost pride of emerging markets.
The emerging markets conundrum
"Emerging Market Economies (EMEs) had long been touted as the stalwarts of global growth by economic pundits in the recent years. Goldman Sachs analysts coined the catchy acronym "BRICS" (Brazil, Russia, India; China, and South Africa) to herald the new drivers of world economy and reports like the World Economic Outlook by the IMF reinforced this exuberance by predicting a ’three-speed’ global recovery led by the EMEs. However, much of this confidence has dissipated in the past few months.

The Chinese economy slowed to 7.8 per cent last year as it focuses its economy more on domestic consumption than exports. India’s growth slowed to 4.5 per cent in 2012-13 (after growing at 8.9 per cent in 2010-11 and 6.7 per cent in 2011-12). In 2012-13, Brazil’s GDP grew by 0.9 per cent and South Africa’s by 2.5 per cent. Even Russia managed growth of only 1.3 per cent despite high oil prices. Many other previously fast-growing emerging-market economies - Turkey, Argentina, Poland, Hungary, and many in Central and Eastern Europe - are experiencing a similar slowdown.

Given the stark contrast between the glorious economic outlook and the glaring economic reality, it is worth reflecting on the main reasons behind the slowdown.

First, the idea that the EMEs could decouple from the global economy and charter their own economic growth turned out to be fallacious. Some of the main factors fuelling the EME engine of yesteryear were external. Asset price bubbles and high commodity prices were combined with a global credit glut. This credit glut, in turn,was facilitated by Quantitative Easing (QE) programmes in the US (and later Japan) - a $4 trillion expansion of the US Federal Reserve’s balance sheet through asset repurchases. Investors, with access to abundant cheap credit, turned away from the US economy’s zero interest rate environment and looked for greater yielding arbitrage opportunities in EMEs with higher interest rates. Cheap credit ultimately led to a surge in capital inflows into EMEs. This exaggerated EME growth, veiling the inherent fragilities in the structural economy. The music stopped when in mid-2013, Ben Bernanke, chairman of the US Federal Reserve announced a gradual tapering of QE, implying that the Fed would eventually scale back QE by $10 billion a month.

Second, dependence on an export led growth with a significant reliance on capital inflows has made the EMEs unstable and volatile. Many of the EMEs have been running large current account deficits, which have increasingly been financed by riskier debt. According to the IMF, Net Private Financial Flows into emerging markets peaked at almost $700b in 2007 before falling to $200b in 2008 following the financial crisis; more recently these inflows reached a high of $500b in 2010, but are projected to fall down to $366b in 2014. This volatility in capital flows is reflected in fluctuating exchange rates and part of it stems from global developments. For example, the currencies of the ’fragile five’ - Turkey, India, South Africa, Brazil and Indonesia - suffered dramatic declines after Mr Bernanke’s taper announcement. More recently, a devaluation of the Argentinean peso again triggered a selloff of emerging market assets leading to wide fluctuations in the currencies. This volatility, stemming from global markets, is deterring investors, who are suddenly being extra cautious when it comes to the EMEs. Moreover, the pickup in growth in advanced economies led by the US and the UK, along with a relative stability in the Eurozone is restoring market confidence in the developed world and contributing to some of the reversal in the global capital movement.

Third, China’s slowdown and restructuring of its economy is leading to a decline in exports in many emerging markets. The latest Chinese manufacturing index reading was 49.6, signalling a contraction in manufacturing output (a number above 50 indicates expansion). For more than a decade, China’s rapid growth had fuelled a remarkable price boom that flattered policymakers in commodity-exporting emerging markets from Russia to Argentina.However, following the third plenary session of the eighteenth committee, China has decided to embark on deep structural reforms to liberalise its economy as well as to make it less dependent on the external sector. As it matures towards a consumption driven growth,China’s slowdown is inevitable.

Finally, the EMEs individually suffer from structural weaknesses (high inflation and fiscal deficits among others) and murky policymaking that is exacerbated by uncertain political conditions. India and Indonesia face elections this year which could be an inflection point in public policy. The Turkish administration is reeling from corruption scandals. Protests are veering dangerously close to full blown political conflicts in Ukraine and Thailand.In Brazil, the government’s efforts to weaken the central bank’s independence and interfere in energy and lending markets are impeding growth. Russia’s reliance on state capitalism continues to be a constraint on economic diversification.

However, the slowdown in the EMEs is a far cry from turning into the next big crisis. Over time, the EMEs have accumulated vast amounts of foreign exchange reserves. According to some estimates, the reserve holdings of the EMEs have increased from $1 trillion to $4.7 trillion from the year 2000 to 2008. Most of these countries also have a free floating currency regime, which will fend off speculative attacks on their currency. Both these factors will make a repeat of an event like the 1997 Asian Financial Crisis extremely unlikely. Moreover, countries such as India and Indonesia have been quick to address the problem of twin deficits i.e.current account deficit and fiscal deficit, and are gradually clearing hurdles for infrastructure projects to boost investment.

In sum, the correction in EMEs reflects a rebalancing of the global economy. The era of astronomical growth in EMEs has come to a close as the global economy aligns itself more towards core economic fundamentals. As the EMEs grow and mature, they can no longer rely on export-driven, credit-fuelled growth and must look inward to initiate deep seated structural reforms and modify their path to economic prosperity. Most importantly, there is a heightened need for effective governance and strong leadership to pacify volatility and restore the lost pride of emerging markets.

(The writer is a Research Assistant at Observer Research Foundation, Delhi)

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