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Emerging Market Crisis May Derail Global Economic Recovery

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Emerging Market Crisis May Derail Global Economic Recovery

  1. 1.   Weekly  Commentary   QNB  Economics   economics@qnb.com.qa   8  September  2013     Emerging   Market   Crisis   May   Derail   Global   Economic   Recovery,  According  to  QNB  Group   The   emerging   market   (EM)   crisis   currently   underway   in   Asia   and   Latin   America   may   derail   the  incipient  global  economic  recovery,  according   to  QNB  Group.  The  financial  turmoil  unleashed  by   the   Federal   Reserve   (Fed)   announcement   that   it   will   start   tapering   its   asset-­‐purchasing   program   soon—the   so-­‐called   Quantitative   Easing   (QE)—   has  led  to  large  capital  flight  from  most  EM,  a  large   weakening   of   their   currencies,   and   higher   long-­‐ term   interest   rates   globally.   If   the   Fed   starts   QE   tapering  in  its  forthcoming  meeting  on  September   17-­‐18   as   announced,   this   is   likely   to   unleash   further   EM   capital   flight,   thus   undermining   their   economic   growth   and   reducing   global   export   demand.   This   will   inevitably   have   a   knock-­‐on   effect  on  the  relatively  weak  growth  in  the  US  and   the   incipient   recovery   in   Europe.   Ultimately,   QE   tapering  may  well  be  self-­‐defeating  as  it  could  in   fact  lead  to  lower  growth  both  in  the  US  and  the   rest   of   the   world,   thus   derailing   the   global   economic  recovery  according  to  QNB  Group.   On   June   19,   Fed   Chairman   Ben   Bernanke   announced  a  tapering  of  its  QE  policies  contingent   upon   continued   positive   US   economic   data.   This   announcement   marked   an   end   to   three   waves   of   QE   that   have   flooded   US   financial   markets   since   2009   with   an   estimated   USD2.9trn   (19.3%   of   US   GDP),   according   to   the   economic   research   of   the   Federal   Reserve   Bank   of   St.   Louis.   The   opportunities,  however,  to  invest  these  resources   have   been   limited   in   advanced   economies   given   near-­‐zero  interest  rates  in  Europe,  Japan,  and  the   US.   Global   financial   institutions   therefore   used   a   significant  portion  of  this  liquidity  to  invest  in  EM,   which   offered   higher   returns.   This   led   to   higher   EM   exchange   rates,   lower   interest   rates,   and   to   some  extent  higher  growth  momentum.   Unfortunately,  the  QE  party  for  EM  came  to  an  end   on  June  19.  As  has  been  the  case  in  previous  EM   crises,  it  pays  to  be  the  first  one  out  of  the  door,   because   exchange   rates   are   still   high   and   it   is   easier   to   liquidate   large   financial   investments   when   foreign   exchange   liquidity   is   still   plentiful.   Accordingly,   global   financial   institutions   have   rushed  to  liquidate  their  EM  investments  since  the   Fed  announcement  in  order  to  cash  in  their  capital   gains  and  avoid  being  faced  with  policy  measures   that   could   restrict   their   capital   movement.   The   result   has   been   a   panic   selling   of   EM   exchange   rates  (Figure  1).  The  Fed  announcement  has  also   lowered   demand   for   government   bonds   globally,   thus  leading  to  higher  long-­‐term  interest  rates  in   EM  and,  to  a  lesser  extent,  in  advanced  economies.   This   has   shaken   EM   consumer   and   investor   confidence,   which   will   inevitably   lead   to   lower   economic  growth  going  forward.     EM  Central  banks  have  added  to  the  capital  flight   by  trying  to  lean  against  the  wind.  They  have  used   their  international  reserves  and  raised  policy  rates   to  defend  their  currencies.  Most  prominent  in  this   defense  has  been  the  Reserve  Bank  of  India  (RBI),   which  has  witnessed  a  decline  in  the  Rupee  of  14%   since   June   19.   In   response,   the   RBI   has   used   its   international   reserves   to   defend   the   Rupee   and   tightened   liquidity.   Restrictions   on   gold   imports   and    
  2. 2.   Weekly  Commentary   QNB  Economics   economics@qnb.com.qa   8  September  2013       Figure  1.  Emerging  Markets  Exchange   Rates   (%  change  against  USD)   M alaysia 95 100 105 110 115 120 18-­‐Jun 03-­‐Jul 18-­‐Jul 02-­‐Aug 17-­‐Aug 01-­‐Sep - 9% - 4% - 14 % - 11 % - 9% - 4% - 14 % - 11 % - 9% - 4% - 14 % - 11 % - 9% - 4% - 14 % - 11 % - 9% - 4% - 14 % - 11 % -­‐9% -­‐4% -­‐14% -­‐4% -­‐11% C hange   from  Jun  18 India Brazil Indonesia Thailand   Source:  Bloomberg   capital   account   outflows   have   also   been     tightened   in   order   to   stem   the   outflow   without   success.   At   the   same   time,   there   are   early   signs   that  the  Indian  economy  is  slowing  down  rapidly,   with   the   HSBC   Purchasing   Managers’   Index   indicating  the  manufacturing  sector  contracted  in   August  for  the  first  time  since  the  global  economic   crisis  of  2009.  There  is  even  talk  of  a  possible  IMF   credit  line  to  help  India  weather  the  storm.  Similar   narratives   are   occurring   in   other   EM,   like   Brazil,   Indonesia   and,   to   a   lesser   extent,   Malaysia   and   Thailand.  Overall,  the  EM  crisis  resembles  in  many   aspects  the  Asia  crisis  of  the  late  1990s.     Today’s  EM  crisis  has  serious  implications  also  for   advanced   economies.   Unlike   in   the   1990s,   advanced   economies   are   today   more   than   ever   dependent  on  EM  for  their  own  growth.  China,  the   US,   Germany   and   Japan   were   the   world’s   largest   exporters  in  2012  and  an  increasing  share  of  their   exports  have  flown  to  emerging  markets  in  recent   years.   A   significant   decline   in   EM   growth   would   inevitably   have   a   knock-­‐on   effect   on   their   own   exports  and  therefore  on  their  growth  momentum.   This  comes  at  a  critical  time  in  the  global  recovery,   where  the  United  States  is  still  showing  relatively   weak   economic   growth   and   Europe   is   slowly   coming   out   of   a   two-­‐year   long   recession.   A   significant   slowdown   in   EM   economic   growth   could   therefore   put   in   jeopardy   the   recovery   in   advanced  economies  as  well.     Overall,  all  indicators  show  that  QE  tapering  may,   at   this   stage,   have   negative   implications   for   both   EM  and  advanced  economies.  During  the  Jackson-­‐ Hole   meeting   in   late   August,   Fed   officials   have   ruled  out  taking  a  global  perspective  into  account   in  formulating  their  QE  tapering.  According  to  the   QNB   Group,   if   the   Fed   does   taper   now,   this   will   worsen   the   EM   crisis   and   may   derail   the   global   economic  recovery,  including  in  the  US.