The world should fear an emerging market rout
Developing countries need a stimulus to offset capital outflows
Capital is cascading out of emerging markets as investors, companies and financial institutions lose confidence in developing countries. The outflows, which have risen towards $1tn over the past 13 months, hold a significance that extends well beyond the frailties of the countries themselves. The dynamism of developing nations helped restore the world to growth in the aftermath of the 2008-09 financial crisis. It is now dissipating fast.
Their vitality is being sapped by a vicious circle of cause and effect. Capital outflows add to pressures on emerging market currencies to weaken against the US dollar, thus inhibiting import demand, damping economic growth and spurring further outflows. If the cycle cannot be arrested, the risk is that a growth slump in developing countries — which account for 52 per cent of global gross domestic product in purchasing power parity terms — could pull the wider world into recession.
The resilience of emerging markets may be critical. But the prognosis is poor. To an extent, the growth model that generated rapid economic expansion over the past three decades appears to be broken. David Lubin, head of emerging market economics at Citi, says three key engines of GDP growth — exports, public domestic spending and private domestic spending — are all sputtering.
Exports are hobbled by a collapse in the growth of global trade. Public spending is weak because many countries are too nervous to loosen fiscal policy, fearing a loss of sovereign creditworthiness at a time when capital inflows are scarce. And private domestic spending is hampered by the fact that credit markets in many countries are in “post-boom” mode: neither domestic lenders nor borrowers have much appetite for risk, Mr Lubin adds.
The upshot has been a sustained slide in GDP growth. Bhanu Baweja, strategist at UBS, estimates that emerging market GDP expansion eased to an average 3.5 per cent in the first quarter, its lowest level since the 2008-09 crisis. He adds that if China’s huge economy is stripped out, the remaining emerging market GDP growth may have been “close to zero” in the first quarter. Few analysts are predicting an upturn in fortunes later this year.
So what can be done to reverse the downward spiral? One answer is urgent structural reform. Only Mexico and India have elected leaders who are committed to a definable programme. Other emerging markets largely squandered the opportunity for reform that more than a decade of rapid growth afforded them.
A more immediate boost, however, could be had from the selective loosening of fiscal policies in some developing countries. It is easy to understand why many governments are loath to consider this; with the US Federal Reserve expected to raise interest rates sometime this autumn, many developing countries will be reinforcing fiscal discipline so as to keep borrowing costs as low as possible. But at a certain point, the imperative to generate growth needs to take precedence, at least in those countries that have some room for fiscal pump-priming.
The need for new infrastructure, especially in India, China, most of sub-Saharan Africa and much of Latin America, is keen. Multilateral organisations such as the World Bank, the African Development Bank, the Inter-American Development Bank and the new Chinese-led Asia Infrastructure Investment Bank should move quickly to step up their lending. Emerging market countries, too, should invest where they can. The alternative is to risk the current emerging market run developing into a rout.