Economic performances of many emerging markets and developing economies (EMDEs) have improved markedly over the past 25 years. The past decade was exceptional – for the first time, EMDEs spent more time than advanced economies (AEs) in expansion and experienced minor downturns compared to the 1970s and 1980s, when full-blown recessions or stagnations were quite common.
Although the EMDEs felt the impact of the 2009 global financial crisis, they recovered quickly, and during 2010-12 many of them (aside from Central Eastern European countries) grew at or above pre-crisis rates. Concurrently, the developing regions, led by China, the world’s second-largest economy, now account for virtually all of the global growth. The ‘above-trend’ growth in major Asian, South American and African economies suggest they are beginning to ‘decouple’ from the European Union (EU) countries, the US and Japan. This augurs well for international trade and a more ‘balanced’ world output in the coming decades.
A 2012 International Monetary Fund (IMF) working paper titled ‘The Rising Resilience of Emerging Markets and Developing Economies,’ found that good governance and less recurring exogenous shocks accounted for 60 and 40 per cent respectively of their brisk performance in recent years. The low-income countries (LICs) in Africa are also growing rapidly thanks to the Heavily Indebted Poor Country (HIPC) Initiative, which encourages good policies as a precondition for enhanced debt relief. The IMF estimated real GDP growth in 2012 for Sierra Leone, Niger, Liberia and Cote d’Ivoire at 21.3; 14.5; 9.0; and 8.1 per cent respectively while Chad, Burkina Faso, Ethiopia, Mozambique, Rwanda, Eritrea and mineral-rich Congo (DRC), all recorded growth of over 7 per cent.
Prudent macro policies
So what are the contributing factors to the increasing resilience of these countries?
Homegrown or external shocks that afflicted EMDEs in past decades – namely credit boom-bust cycles and systemic banking crises, as well as deteriorating ‘terms-of-trade’ and sudden stops in capital inflows – have become less frequent and less severe. These economies boast improved policy frameworks and enhanced fiscal space or more diversified production and trade patterns, which mitigate shocks. Moreover, minimum integration with Western capital markets and higher financial openness, as well as rising foreign direct investment (FDI), have helped most countries to achieve robust sustainable growth.
Many EMDEs have, over time, benefited from sound macroeconomic policies – with 80 per cent reporting low inflation thanks to inflation targeting by central banks, as well as operating flexible exchange rate regimes – unlike the hard-pegs of the 1970s and 1980s. The number of countries implementing ‘counter-cyclical’ fiscal policies to support domestic demand in times of downturn has also risen. The average public debt has fallen to 35 per cent of GDP in 2010-11, compared to 45 per cent during 2000–07, according to the IMF.
More flexible exchange rates act as a shock absorber and reduce vulnerability of financial sectors to unexpected devaluations, according to Chang and Velasco, 2004, in ‘Monetary Policy and the Currency Denomination of Debt: A Tale of Two Equilibrium.’ As written in their 2010 book, Emerging Markets: Resilience and Growth Amid Global Turmoil, Kose and Prasad’s explanation for continuous stability in developing regions is their competent policies (as measured by inflation targeting, and floating exchange rates) and adequate policy space (subdued inflation and healthier public finances).
The external positions are now much healthier – with more economies running current account surpluses and capping their external debt to below 35 per cent of GDP, a threshold that analysts view as a level beyond which ‘debt intolerance’ increases. Higher foreign exchange reserve holdings are not only confined to Asia and China, but EMDEs as a group saw its FX reserves rising from 8 per cent of GDP on average in the 1990s to 18 per cent of GDP during 2010–11. Empirical evidence also shows a stronger external position (characterised by balance of payments surpluses, low/manageable external debt, and higher international reserves) provides a cushion and helps prolong expansions and hastens recoveries.
Private flows to the ‘BRICS’ (Brazil, Russia, India, China and South Africa) remained strong in 2011-12 thanks to paltry interest rates in AEs, which fuelled portfolio investment into mainly emerging bond markets in search of higher yields. According to the Institute of International Finance (IIF), a Washington based association of private banks, private capital flows (including direct and portfolio investment) and bank and non-bank financing (ie bonds) to key emerging markets, are projected at US$1,118 billion in 2013 and rising further in 2014 to US$1,150 billion, compared to US$1,080 billion in 2012.
Besides macro-prudential policies, an economy’s structural characteristics dictate its optimal growth and response to exogenous shocks. Structural factors like trade openness, the deregulation of key sub-sectors (notably telecoms and financials) and much-improved business environment are moving in the right direction. Also, there has been a noticeable trend towards increased intra-EMDE trade and financial integration within respective regions, reflected in a greater share of non- (OECD) FDI, mainly from the BRICS into sub-Saharan Africa.
The liberalisation of foreign trade has reduced reliance on domestic markets, but it increases vulnerability to external shocks. This largely explains South Africa’s low growth, because manufactured exports were hit by the eurozone’s recession. Intra-regional trade and lower costs of transportation and communication can help reduce EMDEs’ vulnerability to downturns in AEs. However, it may also increase their exposure to a slowdown in major markets like China or India.
As with the diversification of trading patterns in many regions, greater capital account openness (ie freer open economy) has attracted higher inward FDI. The volatility of capital flows has been mitigated by a change in their composition – with a clear trend towards FDI, which is more stable compared to portfolio investment, which includes stocks, emerging-market government bonds, prime corporate paper and derivatives. Such investments, or ‘hot money,’ are more vulnerable to financial shocks or sudden reversals of capital inflows.
Homegrown shocks are now less widespread – even with substantial financial spillovers and subdued conditions caused by global credit crunches, only four economies (Latvia, Mongolia, Nigeria, Ukraine) had a systemic banking crisis during 2008-09, and none had one in the past three years. Similarly, the incidence of credit booms fell steeply between the 1990s and 2000s.
More recent empirical research by Berg and Ostry (2011), ‘Inequality and Unsustainable Growth: Two Sides of the Same Coin?’ finds that fairer distribution of wealth underpins sustainable robust growth – notable examples are Botswana, Malaysia, Qatar and the United Arab Emirates. Conversely, Dani Rodrik (1999), in ‘Where Did All the Growth Go?’ argued that in places where ‘latent social conflict’ is high – as measured by proxies such as income inequality, ethnic and linguistic fractionalisations, and social mistrust – adjustments to shocks are slow, prolonging spillovers of the initial shock.
The question is whether robust expansion of EMDEs will prove sustainable? Beyond de facto evidence of their resilience through the largest global shock since the 1930s, optimists can point to their prudent frameworks and increased fiscal space – room to manoeuvre without affecting sustainability. These economies are now more diversified, reflected in their output structure, trading patterns and the composition of their capital flows. On the other hand, recent growth in some EMDEs was fuelled by capital inflows, rapid credit growth, and, for commodity exporters, by robust energy and metal prices. These factors are prone to reversal, which suggests that EMDEs may not sustain continuous rapid growth.
There are risks of ‘triple-dip’ recession in the eurozone – thus impacting Central Eastern Europe – and further spikes in geopolitical instability in the Middle East or greater risk aversion leading to sudden withdrawals of funding from the EMDEs. Terms-of-trade may also weaken if commodity prices drop. Meanwhile, continuing sovereign and banking tensions in Western Europe, coupled with the so-called ‘fiscal cliff’ in the US could lead to a protracted stagnation across AEs.
The steady expansion of EMDEs throughout the global slowdown is unprecedented – growth is projected at 5.5 per cent this year, before reaching almost 6 per cent next year, but still falling below the robust rates recorded in 2010-11. Weakness in AEs will undermine external demand, as well as on the terms of trade of commodity exporters, given the assumption of lower prices in 2013.
The scope for further fiscal stimulus has diminished, while supply-side bottlenecks and policy uncertainties have lowered growth in Brazil, India and South Africa. Activity in sub-Saharan Africa is expected to remain robust, however sustainable growth in LICs depends on more investments in basic infrastructure, health and education. In the Arab World, most countries face the challenge of preserving economic stability in a changing political climate.
In China, ensuring sustained rapid growth demands continued progress with market-oriented reforms, whilst rebalancing its economy from heavy reliance on exports towards private consumption.
In summary, the past decade has witnessed a new world order, where the BRICS, not the First World, are driving global recovery. According to the economic historian Angus Maddison, history may repeat itself because the developing economies constituted four-fifths of world output until 1820.