Emerging Markets Have The Really Decoupled From The Rest Of The World
rest of the
How it became omnipresent? 4
What’s up next? 5
What’s happening in Developing Economies? 6
Where are Developing Economies headed to? 8
Are they (Developing Economies) really “decoupling” or
lagging in parallel? 9
Vivek Sharma Page 2
Things could scarcely have looked rosier for the world economy at the start of 2007.
The Emerging Markets, led by the giants of China, India, Russia and Brazil (the BRIC
countries) had been posting 7%-10% growth rates for years. Property and stock market
booms had brought consistent growth in North America and Europe. Investment was
bringing economic development to much of the South East Asia, Middle East and Africa,
and even Japan was recovering from its deflationary times.
What difference a year makes?
The global economy was then punched back by a series of economic events that may
be setting the stage for stagflation to make a come-back. It started with the sub-prime
crisis in the US, caused by loans to risky or sub-prime mortgagees who did not have
strong credit histories. While house prices were rising there wasn’t a problem, but as
house prices slowed and then crashed to earth, default rates started to rise.
To add fuel to the fire, sub-prime loans had been packaged and re-packaged in a range
of derivative financial instruments such as Collateralized Debt Obligations (CDOs). It
was not always clear what the contents CDOs consisted of, as they were combined,
sliced and re-sold between financial institutions and funds, and which in some cases
allowed risky debt such as sub-prime loans to be packaged as part of low-risk
Vast swathes of CDO investments had to be written off, and banks became suspicious
of investment, borrowing and lending, since it was not always clear what the underlying
security was. Once banks stopped lending, the Credit Crunch hit.
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How it became omnipresent?
World then witnessed extraordinary scenes of government regulators in US and UK
having to help save collapsing banks in order to avert a meltdown of the financial
system, and to Sovereign Wealth Funds (SWFs) from the developing world taking large
stakes in venerable western banks like Citibank and UBS in return for keeping them
With house prices having fallen more than 20% in many areas of the United States,
even prime mortgage holders now find themselves with negative equity. The federal
government has been forced to step in and assume responsibility for both Fannie Mae
and Freddie Mac, who between them back over half of all American mortgages.
The part II of the blow involved the rise of commodity prices. Just before the dawn of the
21st century, oil average $16 a barrel. By 2008, less than 10 years later, oil hit a high of
$146 a barrel; a stunning rise of more than 800%. From early 2007 to mid 2008 alone
the price has risen more than threefold from the mid $40s (McKinsey Quarterly).
The price of food has also started spiralling. Rice and other grain prices have doubled
from 2007 - 2008, leading to food riots in a score of developing markets. Most
agricultural and farm produce prices have been going through the roof. In fact almost all
commodities, including those used for energy, construction and consumption, have
been rising rapidly.
Price rises have been fuelled by the demands of the emerging markets, particularly the
BRIC nations, who together account for nearly 3 billion people. In order to maintain their
high rates of growth and help lift more of their populace out of poverty, they require
more and more commodities.
A similar crisis was faced in the 1970s. After a period of strong global economic growth,
when the world economy was averaging 5% a year GDP increases, the world hit supply
constraints in oil and food. For the next fifteen years, global GDP growth slowed to an
average of 3.2% per year. This became known as the stagflation era. Growth
opportunities were limited, but prices continued to rise with a continued lack of supply.
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What’s up next?
Reports by IMF presume that a sustained recession, frozen banks, and rising
unemployment are likely to keep the US and many other countries in recession but
projected that the global economy would experience a gradual recovery in 2010, with
growth picking up to 3 percent. However, the outlook is highly uncertain, and the timing
and pace of the recovery depend critically on strong policy actions.
Recently, World Bank in one of its quarterly economic updates (March 2009) iterated
that advanced economies (especially G8s) are suffering the deepest recession since
World War II. They are expected to contract 2.0 percent in 2009, a sharp downward
revision from the negative 0.3 percent estimate two months ago. The Bank also expects
the U.S. economy, at the center of an intensifying global financial storm, to contract 1.6
percent in 2009, sharply down from its estimate of a 0.7 percent growth issued just two
months ago (January 2009).
Although the Obama Administration is trying hard to handle things optimally but there
are numbers to tussle them stiffly. The recent US Treasury report quoted that monthly
budget deficit soared to $192.3 billion in March and is near $1 trillion just halfway
through the budget year, as costs of the financial and auto industry bailouts and the
recession mount. It also said that through the end of March, $293.4 billion had been
provided to support companies through the $700 billion bailout fund Congress passed
last October. That support has been provided primarily to banks, although insurance
giant American International Group Inc. and auto companies General Motors and
Chrysler also have received assistance.
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What’s happening in Developing Economies?
While all of the major advanced economies are projected to shrink in 2009 and recover
only gradually thereafter, the large emerging economies (particularly China and India)
are expected to experience only a slowdown not a contraction in 2009 and generally
retain much better medium term prospects than the advanced economies. PwC
(Pricewaterhouse Coopers; global giant in audit and advisory) projects that by 2014 the
share of emerging economies rise to just over half (50.5%) of world GDP in purchasing
power parity (PPP) terms, up from 43.7% in 2007. The PwC figures are based on
analysis of IMF data on current world GDP shares combined with the firm’s latest
medium-term growth projections.
Other notable findings from this analysis by PwC include that, by 2014:
while the US would remain the largest economy in the world, its share of global GDP at
PPPs is projected to be down from 21.3% in 2007 to 19%;
China could overtake the euro area and move into second place;
India could nudge ahead of Japan; and
The UK share of world GDP in PPP terms could fall from 3.3% in 2007 to 2.9% in 2014.
The study states some sharp slowdowns in emerging market growth in 2009, notably in
Russia and Brazil. Growth in China and India could slow to only around 5-6% in 2009,
but this is still a pretty respectable performance when contrasted with expected declines
in GDP of around 1% or more in the US, Japan and the euro area. The UK economy
could shrink by close to 2% in 2009, putting us at the bottom of the G7 league table. Of
course there are many uncertainties around any such projections, with short-term risks
still weighted to the downside for all the major economies. But the conclusion that the
emerging economies are likely to increase their weight in world GDP significantly over
the next five to six years seems relatively robust, even though they are clearly not
immune to the global downturn.
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World economic output shares: GDP at PPPs
Real GDP growth (main scenario)
Shares Shares Average
Major economies 2007 2014 2008 2009 2010 2011-14
US 21.30% 19.00% 1.30% -1.30% 1.30% 2.80%
Euro area 16.10% 13.90% 1.10% -0.90% 1.30% 1.90%
China 10.80% 14.70% 9.40% 6.00% 7.00% 8.50%
Japan 6.60% 5.60% 0.20% -1.10% 1.00% 1.60%
India 4.60% 5.90% 7.20% 5.50% 6.50% 7.90%
UK 3.30% 2.90% 0.90% -1.80% 0.80% 2.40%
Russia 3.20% 3.60% 6.80% 3.10% 4.50% 5.50%
Brazil 2.80% 2.90% 4.80% 2.70% 3.30% 4.20%
Mexico 2.10% 2.00% 1.90% -0.20% 1.70% 3.40%
Canada 2.00% 1.80% 0.60% -0.50% 1.50% 2.50%
Other advanced economies 7.00% 6.40% 2.20% -0.20% 1.50% 3.00%
CEE and other CIS 5.30% 5.30% 4.50% 1.00% 2.00% 4.00%
Other developing Asia 4.70% 5.30% 6.00% 3.50% 4.50% 5.50%
Middle East 3.80% 4.20% 6.00% 3.00% 4.00% 5.30%
Other Western hemisphere 3.40% 3.40% 4.50% 2.50% 3.20% 3.80%
Africa 3.00% 3.30% 5.20% 3.00% 4.00% 5.30%
Advanced economies 56.30% 49.50%
Emerging economies 43.70% 50.50%
World 100% 100%
Source: PwC & IMF
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Where are Developing Economies headed to?
According to the ADB’s (Asian Development Bank) report on Macroeconomics of
Sustainability; growth in emerging and developing economies is expected to slow
sharply from 6.25 percent in 2008 to 3.75 percent in 2009, under quot;the drag of falling
export demand and financing, lower commodity prices, and much tighter external
financing constraints.quot; China's growth rate is expected to ease from near 9.0 percent in
2008 to around 6.7 percent in 2009.
It also mentioned that stronger economic frameworks in many emerging economies
have provided more room for policy support to growth than in the past, helping to
cushion the impact of this unprecedented external shock. Although these economies will
experience serious slowdowns, their growth is projected to remain at or above rates
seen during previous global downturns, it added.
Meanwhile, in emerging economies, despite some recent moderation, sovereign and
corporate spreads are still elevated. As economic prospects have deteriorated, equity
markets in both advanced and emerging economies have made little or no gains, and
currency markets have been volatile
All told, rapidly developing economies could spend as much as $6. 6 trillion on
infrastructure in coming years, according to Merrill Lynch estimates. Some of the
projects could be delayed or canceled as a result of the global slowdown. Regardless,
the opportunities are substantial. With more than 1.3 billion people in China, 1.1 billion
people in India, 190 million in Brazil, 140 million in Russia, 85 million in Vietnam, 71
million in Turkey—and hundreds of millions more in other rapidly developing countries—
the potential is huge, even in these tough times (World Bank Database).
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Are they (Developing Economies) really “decoupling” on lagging in parallel?
First, while worldwide economic growth is expected to drop from 5% in 2007 to 3% in
2009, according to International Monetary Fund projections, there is a significant
difference between projected gross domestic product quot;growthquot; in the developed
economies of the U.S., Western Europe, and Japan—all of which have already tipped
into recession—and those in the rapidly developing economies (RDEs). Economic
growth in the developed economies is expected to decline by half of a percent, while the
RDEs are expected to post an average growth rate of 6.1%. Both projections may prove
overly optimistic, but the key point is that the RDEs are expected to grow next year,
while the developed economies are not Boston Consulting Group).
Second, the global economic downturn is taking place in the new era of quot;globality,quot; with
companies everywhere competing with everyone for energy, raw materials, skilled and
unskilled workers, management talent, scientists and engineers, knowledge, financing,
customers, markets, and virtually everything else along with complex interdependent
business models. The West no longer calls all the shots.
The first major opportunity relates to cost. During these times of economic uncertainty,
businesses and consumers in the U.S. and Europe are quot;trading down,quot; choosing lower-
priced goods. A recent BCG (Boston Consulting Group) survey, for instance, found that
consumers are trading down in almost every category, from mobile phones to snack
Because of the trading-down phenomenon, companies will rely even more on RDEs,
where production costs are 20% to 30% lower than in the developed economies.
Although labor rates have increased in recent years, they are still a fraction of what they
are in Western Europe and the U.S. rising productivity, declining bulk shipping costs,
and falling currency exchange rates, particularly against the dollar, increase the RDE
cost advantage (Franklin Temple: Global Investment Scenario 2009).
The second opportunity is for global engineering and capital-goods companies to
capture business in the RDEs by focusing on their massive investments in
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infrastructure. China, for instance, is building upwards of 100 new airports, 186,000
miles of new roads, 75,000 miles of new railroad tracks, and may add additional
projects, according to news reports, to make up for the slowdown in consumer goods
exports. China also plans to expand port capacity by 85% between 2010 and 2020. This
creates a huge opportunity for U.S., European, and Japanese companies (Xinhua).
Similarly, India's government has plans to invest up to $460 billion on infrastructure in
the next five years. Overall, infrastructure spending in India could increase from 5% to
9% of GDP by 2012. Although not as substantial, the other two BRIC countries—Brazil
and Russia—are also planning to make hundreds of billions of dollars in infrastructure
investments over the next several years (The Economy Watch).
In addition to emerging markets, frontier markets also present attractive investment
opportunities. Frontier markets include economies at the lower end of the development
spectrum. They are generally smaller and less developed than other emerging markets
but have the potential to grow at a fast pace and could become tomorrow’s emerging
By offering foreign direct and/ or foreign institutional investors with the opportunity to
invest in a “younger generation of emerging markets”, frontier markets provide an
attractive investment opportunity. Many of the characteristics that have made emerging
markets fascinating to investors are now becoming increasingly evident in frontier
markets. These characteristics include: positive economic trends such as high growth,
high potential for capital market development as well as the presence of attractively
Given the steep market decline, investors have begun to shift their focus to the
increasingly attractive valuations in emerging markets. Many markets are trading at
single-digit price-to-earnings ratios, with many companies trading at below their net
asset value. Stock prices rebounded in December as investors sought to benefit from
the attractive investment opportunities in the asset class. As of mid-December,
emerging markets looked set to end 2008 above their year-lows.
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Emerging markets today are better regulated and have improved transparency. The
legal, financial and technological infrastructure in most markets is also much more
advanced. Moreover, emerging market companies have higher quality accounting
standards than in the past. Many of the emerging countries, Asian countries in
particular, have built up sizeable foreign exchange reserves and thus are better able to
withstand turbulence brought about by external forces.
The perception of risk in emerging markets is now beginning to shift as investors realise
(1) Emerging markets have become net creditors with vast holdings of foreign exchange
(2) Emerging markets continue to record much higher economic growth compared to
the developed countries and
(3) the debt levels of many emerging market countries is lower than that of developed
China now has US$1,900 billion in foreign reserves, Russia has US$437 billion, South
Korea’s total is US$200 billion, Taiwan has US$281 billion, and India has US$246
billion. Average economic growth in 2009 for emerging markets is expected to be 3.8%
compared to a 0.8% decline for developed countries. For example, while China is
expected to grow by 8.1%, the US economy is expected to contract by 0.6%. The total
debt to GDP ratio of emerging countries averages 94%, while the ratio for developed
countries is 233%. Japan’s ratio is 365%, the US is 240%, while the ratio for China is
130%, and Brazil is 90% (IMF Data).
While there has been much talk about emerging markets “decoupling” from the US
market, the reality is that, in this day and age, decoupling is not possible given the
tremendous improvements in communications, money transfers and world trade. There
has been a move in recent decades towards more intense globalization and
interdependence between world economies. But whereas in the past, the US was the
centre as the largest economy in the world, the US economy’s dominance is waning, as
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other economies continue to grow at much faster rates. This has especially been the
case in the emerging market countries where we are seeing new centers of economic
wealth and growth. China, Russia, Brazil and India are clear examples. Moreover, there
is a great deal of new growth taking place in the world today. Overall it cannot be ruled
out that the emerging economies are vulnerable to the global economic turmoil but
alongside their immunity; although limited; lies more in their own infrastructure
development and public consumption and spending patterns for which there needs to
be a recurring capital flow from the developed economies as well.
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Newsletters, reports, periodicals, journals, factsheets, research papers and databases
The World Bank
International Monetary Fund
Asian Development Bank
Boston Consulting Group
The Economy Watch
Securities and Exchange Board of India
Center for Development Policy Research (School of Oriental and African Studies)
The Business Week
The United States Treasury Department
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