CAMBRIDGE – Emerging-market equities and exchange rates are again under severe downward pressure, but are the underlying economies really as fragile as global traders seem to fear? The short answer, for a few, is probably “yes,” but for most, “not just yet.”
For most countries, what we are seeing is a recalibration as investors incorporate the risk that China’s GDP might rise more slowly, the US Federal Reserve might start tightening monetary conditions more quickly, and policy backsliding in many countries might undermine potential growth. At the same time, Europe’s massive shift to a trade surplus (a key factor underpinning the region’s new-found stability) and the Japanese yen’s sharp depreciation are among myriad factors squeezing countries seeking to rein in current-account deficits.
It seems like only yesterday that Goldman Sachs analysts were celebrating the growth miracle of the “BRICS” (Brazil, Russia, India, China, and South Africa) and the International Monetary Fund, in its April 2013 World Economic Outlook, was forecasting a three-speed global recovery led by emerging markets.
What happened? The most popular culprit is the Fed, which has begun to taper its highly experimental policy of “quantitative easing,” or purchases of long-term assets aimed at supporting growth beyond what could be achieved with zero nominal interest rates. But the Fed’s role is almost certainly overblown.
For one thing, the Fed’s retreat partly reflects growing confidence in the US economy, which should mean a stronger export market for most emerging economies. Moreover, the Fed’s modest tightening is being matched by a trend toward looser monetary policy in the eurozone and Japan; so, overall, advanced-country monetary policy remains highly accommodative.
Uncertainty over China’s growth path is more fundamental. For more than a decade, China’s stunning growth has fueled a remarkable price boom that has flattered policymakers in commodity-exporting emerging markets from Russia to Argentina. Remember how the Argentines were able to thumb their noses at the pro-market “Washington Consensus” in favor of an interventionist “Buenos Aires consensus”?
Now, not so much. China’s near-term growth is an open question, as its new leadership attempts to curb the unsustainable credit-fueled boom. Until recently, global markets had not seemed to recognize that a growth recession was even a possibility. Certainly, if there ever is a pause in China’s heady growth, today’s emerging-market turmoil will seem like a mere hiccup compared to the earthquake that will ensue.
There are other notable, if less consequential, fundamentals in the mix. The shale-gas revolution in the US is changing the global energy equation. Energy exporters such as Russia are feeling the downward pressure on export prices. At the same time, hyper-low-cost energy in the US is affecting Asian manufacturers’ competitiveness, at least for some products. And, as Mexico reforms its energy sector, the range of pressures on Asian manufacturing will expand; Mexico is already benefitting from cost pressures in China.
Japan’s Abenomics is also important for some countries, as the sharp depreciation in the value of the yen puts pressure on Korea in particular and on Japan’s Asian competitors in general. In the long run, a Japanese resurgence would, of course, be beneficial to the region’s economies.
Stability in the eurozone has been perhaps the single most important positive factor underpinning market confidence in the last year. But, as periphery countries move into current-account balance and northern countries such as Germany run massive surpluses, the flip side has been deterioration in emerging-market surpluses, heightening their vulnerabilities.
At the core of emerging-market problems, however, is policy and political backsliding. Here, there are significant differences among countries. In Brazil, the government’s efforts to weaken the central bank’s independence and meddle in energy and lending markets have harmed growth.
Turkey is suffering acute challenges to its democratic institutions, as well as government pressure on the central bank. Russia’s failure to develop strong independent institutions has made it difficult for an entrepreneurial class to emerge and help diversify the economy.
In India, central-bank independence remains reasonably strong, with the Reserve Bank of India now mulling a move to an inflation-targeting regime. But a sustained period of populist policies has weakened trend growth and exacerbated inflation.
Nevertheless, some emerging markets are moving forward and stand to benefit from the turmoil if they are able to stay the course. Aside from Mexico, countries such as Chile, Colombia, and Peru are well positioned to gain from investments in institution-building. But, of course, new institutions can take decades, and sometimes longer, to consolidate.
So, overall, how fragile are emerging markets? Unlike in the 1990’s, when fixed exchange rates were widespread, most countries now have shock-absorbing flexible rates. Indeed, today’s drama can be interpreted, in part, as a reflection of these shock absorbers at work.
Emerging-market equities may have plummeted, but this, too, is a shock absorber. The real question is what will happen when the turmoil moves to debt markets. Many countries have built up substantial reserves, and are now issuing far more debt in domestic currency. Of course, the option of inflating away debt is hardly a panacea. Unfortunately, there is surely more drama to come over the next few years.
Kenneth Rogoff, Professor of Economics and Public Policy at Harvard University
Copyright: Project Syndicate