Slowdown in emerging economies

Salman Sakir There has been a slowdown in emerging economies like India and Indonesia while there is a revival of the old ones, specially the United States. The slowdown in the emerging economies is mostly observed for economic growth, exchange rate and level of debt. On the other hand, the old economies are improving the economic scenario of their respective countries through sound macroeconomic policies. This has led to improvements in growth and employment in those countries. According to the World Economic Outlook Update, July 2013 of the IMF, the advanced economies are forecast to contribute 2.23 per cent to the global GDP growth of 3.93 per cent. The emerging market and developing economies are expected to contribute 1.69 per cent to the global GDP growth in the fourth quarter of 2013. Therefore, the contribution of the advanced economies to the global GDP growth will outpace that of emerging market and developing economies. Figure 1 shows the GDP growth for the world, advanced economies and the emerging market and developing economies. Contribution of the emerging market and developing economies to the global GDP growth has a downward trend, as shown in Figure 2. SLOWDOWN IN EMERGING ECONOMIES: The expansionary monetary policy, implemented by the US, has led to a significant inflow of credit in the emerging economies. Since 2005, international investors looking for a high yield pushed $200 billion into emerging economies. This led to high growth rates and an increase in real estate prices there. As the US Federal Reserve is considering a reversal of quantitative easing, this could lead to a series of currency and credit crises in the emerging economies. International investors try to get out of countries that they consider risky; when the Federal Reserve tapers off its quantitative easing, the credit availability will decrease which will increase the interest rates. When the cost of capital increases, returns in emerging economies may look less attractive; this may result in capital flight out of these countries. Since May 2013, $16 billion have been pulled out from emerging market debt funds and $24 billion from equity funds. With lower credit availability, countries which are dependent on foreign capital to finance their current account deficits start having difficulties. India and Indonesia are the two countries in Asia with the biggest current account deficit for which they depend on foreign capital. Both the countries have recently experienced falls in values of their currencies and equity markets. In response to the 2008 financial crisis, the second-largest economy in the world started the largest stimulus package in its history. Currently, China has a total debt (government, corporate and household) in terms of gross domestic product ratio crossing 200 per cent. This ratio increased from 130 per cent in 2008 and, currently, stands at more than US $16.3 trillion. The high level of financial leverage has put the Chinese economy's financial risk similar to those of Thailand, Japan, Spain and the United States during their respective financial crises. The stimulus package financed infrastructure projects and development of real estate while the manufacturing units also expanded. However, there is a slowdown in the real estate market which paralleled the slowdown in the economy. The country which grew at double-digit rates is finding it challenging to maintain a growth rate of 7.5 per cent. The slowdown in the economy would not affect only the Chinese economy but Australian mines and German manufacturers as well. China's decreased demand for commodities has adversely impacted the growth of commodity-exporting countries like Brazil, Russia, South Africa and Indonesia. Chinese exports, even though they have decreased, are performing quite well. However, there has been a slowdown in domestic demand. India's economy depends on the limited supply of skilled labour for its growth rather than the vast supply of cheap and unskilled labour. The increase in wages of the skilled workers has eroded its competitive advantage in some industries like call centres for which the Philippines has become an alternative destination. On the other hand, manufacturing's share of the economy decreased from 17 per cent in 1995 to the current level of 14 per cent. The Indian rupee has lost 20 per cent of its value this year, making it one of the worst performing currencies in the world. The government has raised the interest rate by 2 per cent to 10.25 per cent, mainly to stem the decline of the currency. The economy is expected to grow by only 5.6 per cent. On the other hand, the government has approved infrastructure projects worth US $27.4 billion. Tight credit is having a negative impact on business investment and consumer spending. It had a current account deficit of 6.7 per cent of GDP last year. This year it has a fiscal deficit of 9 per cent of GDP. Again, foreign investors have been withdrawing money from the Indian economy and have pulled out nearly US $12 billion since the beginning of June. This had a negative effect on the currency as well as the economy. The slowdown in the Indian economy is one of the reasons for international investors pulling out while the recovery of the US economy is making other investment destinations more attractive. Russia and Brazil are expected to grow by only 2.5 per cent in 2013. The largest Latin American economy experienced a commodities boom as well as a domestic credit doom. The commodities boom can be attributed to the voracious appetite of China while the quantitative easing policy of the US Federal Reserve was behind the boom in domestic credit. The cheap money has flowed into emerging economies for better investment returns and may have created a domestic credit bubble in Brazil. It has increased wages and made manufacturing exports more expensive. Therefore, the Brazilian economy is showing signs of stress because of reduced demand for commodities by China as well as the domestic credit bubble. Bangladesh till now has had a healthy macroeconomic situation, including a considerable foreign exchange reserve. However, the drop in the Indian rupee may make Indian exports more competitive relative to Bangladesh's exports. This may have an adverse impact on Bangladesh's exports and the current account balance. Also, the slowdown in the Indian economy may lead to reduced exports to India. Even though the Bangladesh macroeconomic situation is stable, it is certainly not immune to the risks and weaknesses of the global economic environment. Turkey is a country that is vulnerable to a freeze in capital inflows. It has a current account deficit of over 6 per cent of GDP, and its short-term debt and debt-payments are over 150 per cent of available reserve assets. On the other hand, its currency lira has depreciated by 13 per cent against the dollar since early 2013. According to Morgan Stanley, foreign exchange reserves of emerging economies, excluding China, decreased by US$81 billion (which is two per cent of the total reserves held by them) between May to July of this year. This is due to outflows and central bank interventions in currency markets. RECOVERY OF THE OLD ECONOMIES: There has been a significant improvement in the housing market in the US. House purchases as well as its prices have consistently increased, which has improved the wealth of its citizens. Even though there is still substantial unemployment, the US economy has consistently added jobs. The improvement in the employment scenario has benefited the ongoing recovery of the real estate market. The stock market in the US has recovered and some even predict that there is a new long-term bull market ahead. Even though it is notoriously difficult to forecast stock market trends, the US stock market has significantly recovered from the lows during the financial crisis. This has increased the wealth of the world's largest economy. Again, shale oil production has benefited the US recovery as it has also increased the demand for US-made tools. Rising wages in China could increase manufacturing activities in the US. Again, a consumption-focused Chinese economy may lead to higher demand for US products; this may result in increased exports by the United States to China. Since 2009, the overall trade deficit of the US dropped to its lowest level. Overall, the US economy is expected to grow from the projected 1.7 per cent in 2013 to 2.7 per cent in 2014, as shown in Table 1. 'Abenomics' is benefiting the Japanese economy. After stagnating for more than two decades, the economy is showing signs of revival and growth. It is showing its strongest growth since the 1980s boom. Also, the weaker yen has made imports expensive so that the Japanese may buy more domestically manufactured products. This increased demand may lead to an expansion in Japanese manufacturing. Overall, the Japanese economy is making a comeback and is expected to grow by 2 per cent in 2013. However, it is forecast to grow by only 1.2 per cent in 2014 because of potential weakness in the global economic environment. The Euro area will continue having recession in 2013; it will contract by 0.6 per cent in 2013 and experience a slight growth of almost one per cent in 2014. However, Canada, Germany and the United Kingdom are all predicted to register improvements in growth rates in 2014. FINAL WORD: China has to make its economic growth more sustainable and transform export-led and debt-financed growth to consumption-based growth. This may lead to increased appetite of households for German cars and American manufactured goods. The richer Chinese consumers will consume more food leading to a boom for meat and grain producers. Also, a consumption-based economy will fuel the purchase of luxury items by the Chinese consumers. China can use its foreign exchange reserve of US $3.5 trillion to make the transition from an export-focused economy to a consumption-based one. Otherwise, it runs a risk of being trapped in middle-income and being debt heavy. This may have spillover effects on other emerging economies including the resource-exporting countries that have depended on China for their growth. Increased investment in power, improvement in infrastructure including roads and highways, and updating regulations may help to improve the Indian economy. Also, increased emphasis on manufacturing may help to take advantage of the vast supply of labour and revamp the economy.