A year after the Lehman Brothers went bankrupt, the jury is still out on whether the world economy has actually ?decoupled? or not. The decoupling paradigm had gained considerable strength before the manifestation of the financial crisis. The paradigm proposes that business cycles in major emerging markets such as those in India and China had become independent of those in the developed country markets and the US economy in particular.
The months following the Lehman collapse highlighted two features. First, the rapid erosion in the credibility of the decoupling notion. Second, the inability of global institutions to gauge the depth of the financial crisis. In retrospect, it appears that faith in the decoupling theory had initially encouraged institutions to accept the financial crisis as essentially a Trans-Atlantic phenomenon with limited impact on emerging markets. The IMF?s periodic assessments of the world economic outlook are the best examples.
The initial response of the IMF to the crisis was relatively muted. In its first assessment of the post-Lehman world economy released in October 2008, the Fund mentioned that the world economy was experiencing a major downturn due to ?…the most dangerous shock in mature financial markets since the 1930s?. However, the shock was clearly expected to be confined to mature markets. The IMF projected world GDP growth at 3.9 per cent and 3.0 per cent respectively for 2008 and 2009.
The next assessment in November 2008 reduced global growth to 3.7 per cent and 2.2 per cent for 2008 and 2009. But the decoupling notion was yet to give way. The IMF still pinned hopes on emerging economies by expecting them to grow by 5.1 per cent in 2009.
In another couple of months, however, the IMF lost hope of the Trans-Atlantic virus not becoming a global pandemic. Its assessment of January 2009 conveyed a distinctly alarmist impression. Global growth for 2009 was projected at only 0.5 per cent making it the worst year for the world economy since the 2nd World War. It is interesting to note that it took the IMF only four months (October 2008-January 2009) to lose faith in a decoupled world. It now expected China and India to grow at much lower rates of 6.7 per cent and 5.1 per cent in 2009.
The April 2009 forecast dashed the remaining slender hopes of the decoupling hypothesis. The IMF admitted that despite limited exposure to toxic assets of failed financial institutions in the West, emerging markets were hit hard by developments in Western markets. As the revised estimates pulled down global growth to -1.3 per cent in 2009, growth in emerging markets was projected at only 1.6 per cent. The revisions left little doubt that the spread of the crisis has been unquestionably global though its impact could have varied across regions.
The latest assessment of the IMF in July 2009 is a shade brighter than the one in April 2009. The IMF?s periodic assessments and changing forecasts indicate that it took almost three months after the Lehman default to gauge the global dimension of the crisis. Till then, there was hope that decoupled emerging markets led by China and India will maintain global growth albeit at a reduced level. But rapid contractions in external trades in both countries forced the realisation that business cycles in these countries were not entirely desynchronised from those in advanced markets.
But has the crisis entirely debunked the notion of decoupling? The first nine months after the fall of the Lehman suggest so. The recent months, however, convey a somewhat different impression. Had business cycles across the world been coupled, then the shape and pattern of global recovery would have been uniform. But the growth projections suggest that recovery in China, India and the emerging markets is expected to occur at a much faster pace than in the developed markets. This implies that the business cycles in China and India and some other emerging markets are actually capable of maturing autonomously without relying on stimulus from advanced markets.
The independent growth of business cycles in these countries may be due to specific factors such as size of the economy providing room for greater multiplier effect of stimulus packages. It may also be on account of the larger scope of technological advancements and learning resulting in higher productivity gains.
But whatever be the reasons, the supposed ?trend decoupling? of emerging markets and particularly those of China and India will occupy attentions of economists as the world economy embarks on the painful process of slow recovery.
?The author is a visiting research fellow at the Institute of South Asian Studies at the National University of Singapore. These are his personal views