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It was only five years ago, but it feels like a different era. Roger Agnelli, the then chief executive of Vale, the Brazilian mining company, had just taken delivery of the first of an order of 35 Valemax ships, the biggest dry bulk carriers ever built. The vessels, bought primarily to ship iron ore to a voracious China, were so large that each one could carry iron ore sufficient for the steel to build the Golden Gate Bridge in San Francisco three times over.
“We are living through our best days . . . I strongly believe that even better days are ahead of us,” said Mr Agnelli in 2010. But Vale’s fortunes would soon begin to fade. Mr Agnelli was ousted a year later, and China temporarily banned the ships from its ports on safety grounds. In the first quarter of this year, the company reported its worst financial performance in six years.
Vale’s problems are symptomatic of a broader malaise, with emerging markets slumping in the first quarter to their weakest performance since the 2008-09 crisis. China’s appetite for metal ores and other resources is on the wane, Brazil’s once-buoyant economy is in recession, Russia is in crisis and several smaller countries are also suffering declining growth and capital outflows.
The worry is that these problems are no longer contained within emerging market economies; they are spreading to the developed world too. The dependable boost that the global economy has derived from the youthful dynamism of its developing countries for well over a decade — with the exception of during the global financial crisis — has recently become an outright drag. The Bric countries (Brazil, Russia, India and China) — long seen as the world’s growth engine — are now a particular burden.
Adam Slater, economist at Oxford Economics, a research company, says this slowdown could create “an EM-induced recession for the global economy”. He notes that the Brics account for a fifth of global gross domestic product. “Two [of them] are already in recession and one is slowing sharply,” he says.
Trade is the mechanism through which robust demand has been transmitted to other economies, including Europe and the US. But, according to an analysis by Oxford Economics, a slump in import demand in the first quarter of this year turned emerging markets from contributors to global trade growth to detractors for the first time since 2009.
The size of the switch is stark. In aggregate, the 17 largest developing economies reduced world trade values by 0.9 percentage points in the first quarter, down sharply from the average 2.5 percentage points they added to trade growth annually between 2000 and 2014, when their share of global trade was 43.3 per cent of the total, according to Oxford Economics.
Early indications are that the slowdown in trade has continued into the second quarter. China’s exports shrank by a further 2.5 per cent year on year in May, their third month of decline, while its imports were down 17.6 per cent in dollar terms.
“Emerging markets have shifted from being a major support to world trade growth to a significant drag,” says Mr Slater. “The slowdown in China and other emerging markets represents a significant negative shock to world growth.
“We would be more confident that the world could ride this out if it were not for the fact that growth in advanced economies is still rather moderate,” Mr Slater adds.
After the crisis, emerging markets bounced back quickly to average annual GDP growth of about 6 per cent, compared with about 2 per cent in developed countries. But this engine of global growth has stuttered.
Bhanu Baweja, global head of emerging markets strategy at UBS, says growth in these markets has already slid to an average of 3.5 per cent during the first quarter of this year, its lowest level since the crisis. Even more emphatic is the fact that if the contribution of China is stripped out, the average gross domestic product growth of emerging markets in US dollar terms “may be close to 0 per cent in 2015”, Mr Baweja says.
At the same time international capital appears to be heading for perceived safety. The floods of money that made their way into emerging markets in the period of low interest rates since the global financial crisis are, in most countries, either slowing to a trickle or reversing course. In the three quarters to the end of March, these markets suffered bigger net capital outflows than they did during the crisis, according to NN Investment Partners. This week, the Institute of International Finance reported the biggest monthly sell-off in emerging bonds since the “taper tantrum” of 2013 when the markets feared the US was going to reduce the scale of its quantitative easing programme.
If emerging market economies continue to falter this year, the impact on the developed world could be profound.
The last time a serious emerging markets-led global slowdown occurred in 1999, in the aftermath of the Asian financial crisis, the developing world was a more marginal presence in the global economy.
Now it accounts for just over 52 per cent of global GDP in purchasing power terms and some 35 per cent in nominal terms. This compares with just 38 per cent and 23 per cent respectively at the time of the Asian crisis. “So weakness in EMs has a bigger global impact now,” says Mr Slater. “If we think about the old refrain from the global financial crisis that ‘it started in America’, then we may note that the US accounted for 24 per cent of world GDP [at that time].”
The contribution of these countries to growth, and particularly to trade growth, outstripped their weight in the global economy. Thus, the Brics accounted for 15 per cent of world trade between 2000 and 2014, but contributed 23 per cent of its growth during the same period. The loss of this outsized contribution is being keenly felt.
There is also a greater financial symbiosis that intertwines the fate of developing economies and the rest of the world in a way that did not really exist at the time of the Asian crisis. According to figures from the Bank for International Settlements, the exposure of its members lending across borders to recipients in emerging markets reached $6tn at the end of 2014, about double the level of 1999, Mr Slater says.
Policy makers are starting to sound the alarm. Choi Kyung-hwan, South Korea’s finance minister, told the Financial Times last week that the slowdown in global growth, at a time of unprecedented monetary laxity, posed a challenge similar in complexity to those faced during the 2008 crisis.
He criticised leading economies for not doing enough to stimulate growth and warned that “the advanced economies will again see spillovers from the negativity in emerging markets” if they do not do more.
His comments came as the Organisation for Economic Co-operation and Development slashed its forecast for global growth to 3.1 per cent for 2015, down from November’s forecast of 3.7 per cent. South Korea has not been spared the broader global slowdown, with exports sliding 10.9 per cent in May from the same month a year earlier and imports falling 15.3 per cent.
The Fed effect
Mr Baweja believes that the collapse in trade is the biggest threat facing the emerging world today — much more significant than the prospect of rising interest rates at the US Federal Reserve.
“Exports are contracting and the only mechanism of correcting countries’ external imbalances is import contraction,” he says. But such a correction is not the solution. “If you increase exports your economy is growing. If you kill demand, growth will be much lower. In obsessing about the Fed, people are missing the fact that we will see much less trade, which will lead to much lower EM growth.”
The effects are already being seen. The premium of emerging market growth over that in the developed world is now at its lowest level in 15 years. In dollar terms — the standard way of measuring trade and economic output — the same is true of real growth in developing economies.
Call for diversification
Those countries that benefited first from the China-led commodities boom and second from cheap global credit are struggling to find a plan C.
“It is hard to see how free trade can help,” says Mr Baweja. For much of the past 20 years, each percentage point of growth in global economic output led to more than two percentage points of growth in global trade volumes — traditionally the source of a boost in output for many emerging markets. He predicts this 2:1 ratio of trade to output will stabilise closer to 1.3:1.
It is not only commodity exporters that are suffering. Figures compiled by UBS show that exporters of manufactured goods are also performing badly. Nor is it all a matter of dollar valuations, as the weakness in trade is also apparent when it is measured in local currencies.
Mr Baweja argues that the “South-South” concept of trade between developing economies as a driver of global growth has always been an exaggeration. “It is a big supply chain with its focal point in China.”
Many commodity exporters have tried to diversify what they produce and who they sell to. But if Mr Baweja is correct, there will be little comfort for countries such as Chile, which has found that fine wines are no match for King copper.
Share of trade for 17 largest developing economies
This may lead some countries to turn to fiscal or monetary stimulus. Mr Choi says South Korea has room to do either or both; his ministry is planning to announce a “comprehensive package” of pro-growth measures in July.
Others will be more constrained. Brazil is battling to restore confidence in its fiscal accounts by cutting spending and raising taxation, even as the country faces deep recession. It is also raising interest rates to fight inflation and attract foreign capital.
At the other extreme, Hungary and Thailand are cutting interest rates in the face of deflation. But they may not be able to do that for much longer if the Fed raises rates later this year as it would expose them to the risk of destabilising outflows and currency devaluations.
Fall in Chinese imports in May, in dollar terms
Conventional wisdom suggests that a Fed rate rise will be traumatic for emerging markets, especially for the enormous number of companies that have issued dollar-denominated debt over the past decade. But some analysts believe it does not have to be too painful.
“There is no question of a balance of payments crisis,” says Mr Baweja, who points to improvements in balance sheets over the past 15 years to support his argument. “Emerging markets don’t have the ingredients for a blow-up, but neither do they have the ingredients for growth.”
He notes that the big themes of this century — low US interest rates, the rise of China and globalisation — have all been beneficial to developing nations. But with those trends all in reverse, it is hard to see the next driver of growth for these countries or the world economy.