Given sharp slowdown in the US and European economies, the question of whether major emerging markets can sustain global growth has become increasingly critical. A key issue is whether, if faced with a serious economic slowdown, they would be willing and able to deploy aggressive expansionary fiscal and monetary policies to stimulate their economies and sustain global growth.
Impact
- China is the only emerging market that can have significant global impact through an expansionary policy pursued in isolation.
- Neither the G20 nor BRICS as a group are likely to be able to deliver an effective coordinated response to the slowdown.
- Yet demand from emerging markets is the key driver for OECD growth.
What next
Whether import demand from emerging markets rises by 10-15% or 20-30% probably will dictate the direction of the developed world over the coming year -- into recession or back to recovery. However, in most emerging markets policymakers have less firepower to encourage a favourable outcome than they had in 2008-09. This is because several factors have been combining to force them into policy tightening, creating less buoyant domestic demand conditions and exacerbating the slowdown in world trade.
Analysis
Weak second quarter GDP results and short-term indicators -- from US jobs data to export orders in China -- coupled with a fall in world trade and the debt crisis in Europe all point to near stagnation in advanced economies and a less buoyant picture for the developing world. The slowdown in emerging markets reflects the negative impacts of rising commodity and consumer prices, which have been followed by monetary tightening in some countries. There has been growing concern over how much scope emerging markets have to stimulate their economies should the recent 'soft patch' worsen in the final months of 2011.
China
As a leading exporter, China inevitably is vulnerable to weakening world trade. In late 2008 and and early 2009, the steep export fall hit the economy hard, but the government's two-year, 4 trillion-renminbi (626 billion dollars) stimulus package and a substantial easing in credit conditions quickly offset these losses. Domestic demand and imports rose. This was possible because China previously had low government deficits and debt, and an ample savings surplus.
Yet a number of concerns have surfaced regarding overheating, the potential repercussions of local authorities' credit risks and possible future loan losses. For example, investment in infrastructure has been largely funded through local government borrowing:
- Loans to local government financing platforms rose from 1 trillion renminbi in early 2009 to almost 11 trillion renminbi at the end of 2010, equivalent to 25-30% of GDP and over 100% of local-government revenues.
- Adding these loans to central government debt would raise the gross public debt-to-GDP ratio from 19% to approximately 44%.
- Standard and Poor's reckons that 30% of such loans could be non-performing in future.
- Most of this borrowing has been from local banks, further concentrating regional risks.
Moreover, the recent stimulus has meant that China's gross capital formation has continued to climb from around 40-45% to nearly 50% of GDP in three years. Further investment would increase the chances of a 'hard landing' down the line as China could find itself with an overcapacity problem.
Nevertheless, if faced with the prospect of a severe slump, the likelihood is that Beijing would embrace stimulus, albeit more cautiously than in 2009. China could afford another stimulus package. If necessary, the central government's prudent debt and fiscal position still allows considerable scope for expansionary spending, worth perhaps an extra 5% of GDP (around 300 billion dollars) over the year ahead.
India
India's economy has been suffering from the inflationary impact on local prices and wages of high commodity prices, as well as the effects of the related rise in interest rates. World growth and goods trade are lesser concerns as India's relatively closed economy insulates it from cycles in goods exports -- services trade is more important.
Nevertheless, despite existing public-sector debt of almost 80% of GDP, India introduced a small stimulus package in 2008-09, involving a variety of tax cuts, a 900 billion-rupee (15.5 billion-dollar) infrastructure programme and various other measures. Thanks to recent high growth in nominal GDP (in part inflation), the debt ratio has now eased back slightly, but there would still be considerable reluctance to introduce another expansionary package:
- Not only is there concern about the need to improve public sector finances, but the still high inflation rate and worries about the sustainability of very rapid economic growth will argue in favour of maintaining a fairly prudent budget stance.
- More importantly for the rest of the world, even if India were to adopt an aggressive fiscal stimulus for the year ahead, the impact on world trade and growth would be tiny.
Other economies
It is doubtful whether emerging economies except China would have enough fiscal room for manoeuvre to implement a meaningful stimulus. Several have particular leeway:
- Brazil and Mexico. Although more typically encouraged to improve public sector finances, they may have some scope for easing fiscal policy.
- Russia. Finances have benefited from high energy prices. However, private consumption and capital outflows probably offer automated stimuli (more effective than fiscal spending), impacting through key trade and investment partners, such as Turkey.
- Indonesia. Despite now low public sector debt, Jakarta has been reluctant to step up government spending after the long recovery from the 1997-98 Asian crisis.
- Gulf oil economies. These are likely to be pursuing easier fiscal policy anyway, even if it means limiting growth in sovereign wealth funds.
Outlook
Major emerging market economies are able to withstand the impact of a slowdown in growth in the developed world. The easier growth profile that has emerged in the developing world in 2011 has been largely due to the negative effects of inflation and policy tightening -- yet many emerging markets are still seeing robust economic expansion.
However, whether they will be able to grow strongly enough to pull the world economy along over the next 6-12 months probably depends on inflationary trends. If commodity prices weaken and reduce price pressures, this may offer more potential for emerging markets to ease monetary policy, and may even encourage a softer fiscal stance in a few key countries.
If developing countries as a whole support growth in the 5-6% range, there is a good chance that developed economies can record 1.0-1.5% growth. World growth would drop, but an outcome of 3.0-3.5% and prospects of a firmer 2013 would be far better than the dire performance of 2009.
