In the aftermath of the financial crisis, it was widely believed that emerging markets would take over the global stage, with developed countries taking a secondary position. This appeared logical, as these were the growing economies largely insulated from both the financial turmoil in the US or the sovereign debt crisis of Europe. In addition, with a low base level and surplus capacity—especially in infrastructure—there appeared to be tremendous scope to maintain high growth for a decade, if not more. The famous decoupling hypothesis was mooted, which argued that these economies were separated from the mainland countries and could push the world economy along on their own. Seven years on, however, the business cycles have changed and the tune being hummed is quite different.
First, the main growth impulses are coming from the developed countries, with the US now poised to witness higher interest rates as the unemployment rate has come down and the threat of inflation, though distant, is being talked about. The European Central Bank (ECB) has also been fairly gung-ho about growth by 2017, and most of the countries are on a growth path albeit at different paces. The Greek crisis has ebbed, and while the refugee problem remains, there is definitely no concern about the recession, with the ECB pledging to ease the monetary reins. In fact, the latest statement reaffirms its belief that the quantitative easing (QE) programme was responsible for this turnaround.
On the other hand, China has slowed down, as have Brazil and South Africa, which are all members of the BRICS group, and Russia remains in disarray. India appears to be the only engine running at a stable pace, which, however, does not matter much for the global economy, given the domestic orientation. Interestingly, most emerging market central banks are moving towards lowering interest rates to propel investment at a time when the US is going to increase them.
Curiously, the slowdown in global trade due to pressure on developed economies has impacted emerging economies, which did well on the back of exports. They have not been able to create their own trading circles and are still dependent on the US to keep their economies ticking.
Second, inflation has remained low in developed countries while the picture is disparate for emerging markets. While lower oil prices have helped across the globe, their impact has been greater for developed countries. Domestic factors have impacted inflation, especially on the supply side. Although some countries continue to have high inflation—such as Russia, Brazil and, to an extent, India—the rates are moderate in others, but still higher than those in developed countries.
Third, emerging markets had a flurry of foreign investment flowing in the last 5-6 years as interest rates remained low in these economies, while developed economies confronted low growth situations. Besides, with their prospects appearing to be better, valuations of equity markets tended to be overstated, with portfolio investors coming in relatively large numbers. But since July, there has been a tendency for these flows to get reversed and move back to the US. We have a potential situation where the US increases interest rates while central banks in emerging markets lower theirs. Add to this currency depreciation, and foreign investors would be in a withdrawal mode. The prospect of a US Federal Reserve rate hike has prompted these funds to turn around as well as present a greater business opportunity, given that the US economy has started its upward trajectory. This has caused distortions in the market as negative flows have upset the balance of payments of several emerging markets. Further, it appears the stock markets of developing economies are inexorably linked to the US stock indices.
Fourth, related to the foreign institutional investor (FII) flows, the currencies have become more volatile, with emerging markets bearing the brunt. The strengthening of the dollar due to stronger economy as well as lower outflows had collateral impact on their currencies. While all currencies have depreciated, volatility has increased. Brazil, Malaysia, Turkey and South Africa have witnessed significantly higher rates of depreciation. In addition, with most currencies depreciating by between 15% and 25%, the competitive advantage has diminished substantially and has only added imported inflation.
Fifth, the debt scene has changed dramatically. The leverage of companies has increased for emerging markets, thus pushing up the debt-to-GDP ratios, while the same has been coming down for advanced economies that have gone in for consolidation. Even though there is no imminent threat of a crisis, the possibility of non-performing assets (NPAs) increasing has gone up as they tend to increase when economies slow down. Anecdotally, it has been observed that when economies grow, they tend to get leveraged and the chasms do not show as long as this chain is kept in motion. However, when economies start to slow down, the problems emerge as companies are not able to service debt. A challenge today for these countries will be that, with their external debt increasing mainly due to companies’ borrowing from the euro markets where rates are very low, debt service would become expensive on account of currency depreciation that has taken place. Low GDP growth with higher interest rates and extended debt levels is a perfect recipe for a debt crisis.
Last, developed countries, especially in the eurozone, have been able to moderate their fiscal balances as part of the austerity measures that came along with the package (the UK and Japan remain exceptions). Emerging markets have not shown the same kind of discipline and hence may have to scale back in the coming years.
Hence, overall, it does appear that the scales have turned in favour of western economies as growth models of emerging markets were still centred on the US and European countries. A conclusion is that the so-called South-South dialogue that was in vogue for quite some time now has not resulted in these nations creating a decoupled environment in which they could grow on sustained and symbiotic basis.
Given the differing stages of development and core competencies, creating an alternative ecosystem is difficult. African nations, for instance, are rich in natural resources but are otherwise low growth centres. Latin America has distance issues as well as vulnerable economic indicators, while East Asia is export-driven, with the main consumer being developed countries. China, although very strong on its own, faced the barrier of limitations erected by a growth model driven by investment more than consumption.
Quite clearly, the invisible hand has not led to this decoupling and we continue to be in a flat world where all countries are interlinked.
The author is chief economist, CARE Ratings. Views are personal