Are emerging markets submerging?
By Kenneth Rogoff
Former chief economist of the IMF, Professor of Economics and
Public Policy at Harvard University
With economic growth slowing significantly in many major
middle-income countries and asset prices falling sharply across the
board, is the inevitable "echo crisis" in emerging markets already
upon us? After years of solid - and sometimes strong - output gains
since the 2008 financial crisis, the combined effect of
decelerating long-term growth in China and a potential end to
ultra-easy monetary policies in advanced countries is exposing
significant fragilities.
The fact that relatively moderate shocks have caused such profound
trauma in emerging markets makes one wonder what problems a more
dramatic shift would trigger. Do emerging countries have the
capacity to react, and what kind of policies would a new round of
lending by the International Monetary Fund bring? Has the eurozone
crisis finally taught the IMF that public and private debt
overhangs are significant impediments to growth, and that it should
place much greater emphasis on debt write-downs and restructuring
than it has in the past?
The market has been particularly brutal to countries that need to
finance significant ongoing current-account deficits, such as
Brazil, India, South Africa, and Indonesia. Fortunately, a
combination of flexible exchange rates, strong international
reserves, better monetary regimes, and a shift away from
foreign-currency debt provides some measure of protection.
Nonetheless, years of political paralysis and postponed structural
reforms have created vulnerabilities. Of course, countries like
Argentina and Venezuela were extreme in their dependence on
favorable commodity prices and easy international financial
conditions to generate growth. But the good times obscured
weaknesses in many other countries as well.
The growth slowdown is a much greater concern than the recent
asset-price volatility, even if the latter grabs more headlines.
Equity and bond markets in the developing world remain relatively
illiquid, even after the long boom. Thus, even modest portfolio
shifts can still lead to big price swings, perhaps even more so
when traders are off on their August vacations.
Until recently, international investors believed that expanding
their portfolios in emerging markets was a no-brainer. The
developing world was growing nicely, while the advanced countries
were virtually stagnant. Businesses began to see a growing middle
class that could potentially underpin not only economic growth but
also political stability. Even countries ranked toward the bottom
of global corruption indices - for example, Russia and Nigeria -
boasted soaring middle-class populations and rising consumer
demand.
This basic storyline has not changed. But a narrowing of growth
differentials has made emerging markets a bit less of a no-brainer
for investors, and this is naturally producing sizable effects on
these countries' asset prices.
A step toward normalization of interest-rate spreads - which
quantitative easing has made exaggeratedly low - should not be
cause for panic. The fallback in bond prices does not yet portend a
repeat of the Latin American debt crisis of the 1980's or the Asian
financial crisis of the late 1990's. Indeed, some emerging markets
- for example, Colombia - had been issuing public debt at
record-low interest-rate spreads over US treasuries. Their finance
ministers, while euphoric at their countries' record-low borrowing
costs, must have understood that it might not last.
Yes, there is ample reason for concern. For one thing, it is folly
to think that more local-currency debt eliminates the possibility
of a financial crisis. The fact that countries can resort to
double-digit inflation rates and print their way out of a debt
crisis is hardly reassuring. Decades of financial-market deepening
would be undone, banks would fail, the poor would suffer
disproportionately, and growth would falter.
Alternatively, countries could impose stricter capital controls and
financial-market regulations to lock in savers, as the advanced
countries did after World War II. But financial repression is
hardly painless and almost certainly reduces the allocative
efficiency of credit markets, thereby impacting long-term
growth.
If the emerging-market slowdown were to turn into something worse,
now or in a few years, is the world prepared? Here, too, there is
serious cause for concern.
The global banking system is still weak in general, and
particularly so in Europe. There is considerable uncertainty about
how the IMF would approach an emerging-market crisis after its
experience in Europe, where it has had to balance policies aimed at
promoting badly needed structural change in the eurozone and those
aimed at short-run economic preservation. That is a topic for
another day, but the European experience has raised tough questions
about whether the IMF has a double standard for European countries
(even those, like Greece, that are really emerging markets).
It is to be hoped, of course, that things will not come to that. It
seems unlikely that international investors will give up on
emerging markets just yet, not when their long-term prospects still
look much better than those of the advanced economies.
Besides, the current sentiment that the eurozone has gotten past
the worst seems exceedingly optimistic. There has been only very
modest structural reform in countries like Italy and France.
Fundamental questions, including how to operate a banking union in
Europe, remain contentious. Spain's huge risk premium has almost
disappeared, but its debt problems have not.
Meanwhile, across the Atlantic, the political polarization in
Washington is distressing, with another debt ceiling debacle
looming. Today's retreat to advanced-country asset markets could
quickly revert to retreat from them.
The emerging-market slowdown ought to be a warning shot that
something much worse could happen. One can only hope that if that
day should ever arrive, the world will be better prepared than it
is right now.