Authors: Uri Dadush, Shimelse Ali, Vera Eidelman
Originally published by the Carnegie Endowment for International Peace
Strong economic performance in developing countries will not only benefit the 5.6 billion people who reside there, but will also impact the likelihood of a double-dip recession in advanced countries.
As GDP growth in advanced countries slows sharply, emerging economies are set to help sustain the global recovery. Though growth in emerging markets has moderated from torrid post-crisis rates, it remains high. In addition, it has grown more reliant on domestic demand, and is broadening across sectors. This high rate of growth can help mitigate a sharp slowdown of domestic demand in advanced countries, but cannot compensate fully for it.
Net exports to developing countries are unlikely to provide a big growth boost to industrial countries in coming years. On the flipside, the slowdown in advanced countries poses obvious risks for developing countries. As policy makers in developing countries withdraw stimulus support, they face a particularly tough dilemma: balancing the risk of inflation with that of a sharp slowdown in GDP growth.
Emerging economies slowing, though from a rapid pace
The ability of developing economies—which have accounted for nearly 70 percent of world growth over the past five years—to continue supporting the global recovery depends largely on the five biggest emerging economies—China, Brazil, India, Russia, and Mexico. Together, these countries account for more than half of developing country GDP and nearly 15 percent of advanced country exports.
Following their extraordinary rebound from the global crisis, GDP growth in China and Brazil has slowed in the past few months, reflecting a slowdown in inventory restocking and a deliberate effort by policy makers to prevent overheating. On the other hand, India’s growth has been sustained and GDP growth in Russia and Mexico has accelerated, driven mainly by consumer demand and manufacturing activity.
Even where it is slowing, growth remains rapid. The HSBC EMI, an index based on 19 Purchasing Manager Index (PMI) surveys across 14 emerging markets, dropped from 57.4 in the first quarter to 55.8 in the second quarter, but that number still indicates economic expansion. By way of comparison, the index hit a trough of 43.4 in the fourth quarter of 2008.
Similarly, exports from emerging economies rose by 14.5 percent (3m/3m annualized) in the second quarter—the slowest pace since the third quarter of 2009 and less than half that of the preceding two quarters, but rapid nonetheless. Industrial production in emerging markets also lost momentum compared to the first quarter, though it still rose by nearly 10 percent (3m/3m, annualized).
Growth has become more self-sustained
Despite the moderation in growth, output in emerging economies is now not only well above pre-crisis levels but is also running above its pre-crisis trend path. GDP in advanced economies, on the other hand, is projected to remain 5–10 percent below pre-crisis trend levels in 2010.
Growth in developing countries has also become more self-sustained as private consumption and investment replace fiscal stimulus as a driver of growth. In China, private consumption grew by more than 10 percent (y/y) in the first half of 2010, and spending on fixed investment increased by more than 12 percent. Strong domestic demand is also helping to drive India’s growth, where services, which account for 55 percent of the economy, grew by 9.7 percent (y/y) and manufacturing output expanded by 12.4 percent (y/y) in the second quarter.
Economic growth in emerging markets is broadening as well. In the second quarter, service sector activity expanded at a faster rate than manufacturing for the first time since the onset of the financial crisis, and employment continues to grow.
Limited benefit for advanced countries
Such strong growth in developing countries can help mitigate the demand slowdown in advanced countries by providing an external source of demand, as happened in 2009. However, advanced countries’ exports to emerging markets are not likely to outpace their imports from those markets unless domestic demand in advanced countries slows very sharply. For example, in the OECD’s baseline forecast, net exports are not expected to contribute to total OECD country growth in 2010 or 2011. In other words, global rebalancing of demand between developing and industrial countries is not expected.
In recent years, advanced countries have consistently imported more from emerging markets than they have exported there and net export growth has contributed little to advanced country growth, except in 2009, when advanced country exports fell, but imports fell by more. The emerging market current account surplus with advanced economies averaged close to 2 percent of advanced country GDP over the last ten years. About 63 percent of the large reserve buildup in developing countries over the last ten years is the result of current account surpluses, with the rest accounted for by net inflows of capital and errors and omissions.
Advanced countries have lost share in the export demand of emerging economies, further limiting the benefit they can derive from growth in developing countries. While more than half of developing country imports come from advanced countries, that share has fallen substantially over the last decade, from 72 percent in 1999 to 56 percent in 2009.
In addition, emerging countries have seen their export share in advanced countries grow over the last ten years. Developing economies have become increasingly involved in trade in parts and components—which is growing rapidly in importance—and have diversified their exports to include a wide range of manufactures.
Still, the slowdown in advanced countries will dampen the growth of exports in developing countries. While emerging nations are now exporting more than they did before the crisis began and managed to increase exports to advanced countries even as GDP growth there slowed in the second quarter, new export orders declined in China, Brazil, and Russia in both July and August. In India, export orders decelerated in August. Mexico—which saw GDP grow impressively in the second quarter due to a strong recovery in manufacturing exports—is particularly vulnerable to a slowdown in the United States, which attracts 80 percent of its exports.
The slowdown in advanced countries will also impact financial markets in emerging economies in ways that are difficult to predict. Though stock prices were largely stable in the second quarter—the MSCI emerging markets index fell by less than 5 percent from March to June, and has risen by 7 percent since then—decreasing global risk appetite could lead to lower prices in emerging markets seen to be especially risky or vulnerable. At the same time, if emerging economies continue to grow while advanced countries slow further and continue to maintain low policy rates, capital flows to the strongest emerging markets could surge, raising the threat of asset bubbles and inflation.
Phasing out stimulus
Inflation is already becoming a concern across many emerging economies. In India, inflation has been at or above 10 percent since January. Indonesia’s inflation jumped to its highest level in 15 months in July, and, in China, inflation also reached a new high in July.
These high rates put pressure on policy makers in emerging markets to withdraw their substantial stimulus packages, which helped them maintain impressive growth through the Great Recession. In 2009, the largest emerging countries cut benchmark policy rates and passed significant tax cuts. Several countries also increased government spending. China’s stimulus package was equivalent to 12 percent of GDP; Russia’s stimulus was a comparable 10 percent of GDP.
The Reserve Bank of India has already increased its policy rates four times since March, and reducing inflation remains a priority. Other countries appear less concerned about inflation for now, though they may have to turn to more aggressive tightening if capital inflows lead to overheating. On the other hand, the souring external growth environment will force policy makers to carefully balance inflationary concerns with those of a global slowdown.
Meanwhile, policy makers in advanced countries must recognize that their economies will have to rely primarily on their own momentum to avoid a double-dip recession. They are not likely to see significant new net external demand from developing countries, as developing countries continue to serve each other’s needs and occupy an increasing share of global markets.
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