Emerging markets, by definition, are meant to emerge. Strip out China, however, and the economies of the developing world are now growing more slowly than the developed world for the first time since 1999.
Emerging markets ex-China eked out output growth of just 1.92 per cent last year, according to IMF data, below even the spluttering growth of the developed world, where output rose 1.98 per cent.
Moreover, this plays down the travails of those living in developing countries: when their faster population growth is taken into account, the underperformance of EMs vis-à-vis developed countries in per capita terms is starker still.
In other words, China aside, the universe of emerging countries is no longer on course to converge with the richer world. Instead, it is falling further behind.
“The disappearance of the EM-DM growth differential should be a particular cause of concern,” said Guillermo Mondino, head of emerging markets research at Citi.
“It’s called lack of convergence. The theory suggests that emerging markets ought to be growing faster than developed markets and catching up [but] I think [the emerging world] is probably going into a little bit of a recession now,” added Mr Mondino, who defined an EM recession as growth significantly below the potential rate.
The futures of billions of people will depend on whether this reversal of the trend towards convergence proves to be a blip, or whether it is instead the strong showing of emerging countries during the 2000-2014 period that ultimately turns out to have been anomalous.
If the rapid industrialisation of China during this period, which spurred the commodity “supercycle” — spreading the benefits across much of the emerging world — proves to be a one-off step change, the danger is that there could be a return to the norms of the 1980s and 1990s. Then growth in EMs ex-China typically lagged behind that of the developed world, as the first chart shows.
One argument against this is that many EM countries, such as India, Turkey and South Korea, are, in fact, net commodity importers. As such, it might be sensible to think they should be able to grow more strongly in the current environment than when commodity prices were at unprecedented highs.
In other words, low commodity prices should be redistributive (transferring wealth from Brazil to India, for example) rather than reducing growth across the EM world.
Analysis by Citi casts doubt on this, however. Its data suggest that, since the late 1970s, there has been a reasonably strong correlation between capital flows into emerging markets and the oil price, as the second chart shows.
Mr Mondino said this reflects the recycling of petrodollars from oil exporters to emerging markets in general, which Citi describes as a “robust, albeit mysterious, phenomenon”.
“High oil prices supported EM GDP growth in the 1970s by increasing the availability of external financing. We think lower oil prices in the second half of the 1980s helped to make that decade a growth disaster by helping to prevent any recovery in the flow of capital to EM.
“And in the 2000s, high oil prices helped to support capital flows and robust growth,” said Mr Mondino. “Now, in the midst of a very sharp fall in oil prices, capital flows to EM are in a state of collapse.”
If this analysis is correct, it suggests that emerging markets will struggle to attract significant capital inflows unless and until the oil price recovers.
Moreover, with the differential between EM ex-China and DM growth now negative, Mr Mondino feared that “one of the main pillars of the investment case for EM is being eroded”.
He added: “There used to be a virtuous circle that connected capital flows, EM GDP growth and the oil price: strong growth supported the oil price, which supported capital flows through petrodollar recycling and, in turn, plentiful capital inflows supported growth.”
Given that the aggregate current account balance of 15 large oil exporters will turn negative this year for the first time since 1998, according to forecasts from the IMF, “it seems as though this has now turned into a vicious circle,” Mr Mondino concluded.
Despite this, Citi’s central forecast is that growth in EM ex-China will gradually rise back above that of the developed world in the next year or so, with EM ex-China growth recovering to a little over 3 per cent in 2017, although David Lubin, head of emerging markets economics at Citi, suggests the risks are to the downside.
Others are also reasonably optimistic. Tom Becket, chief investment officer at PSigma Investment Management, believed the bulk of the EM slowdown happened last year, and growth is now flattening out.
“What we are probably seeing now is a stabilisation at a low level in emerging market economies. These levels are probably more sustainable,” he said.
Nicolas Schlotthauer, head of emerging markets fixed income at Deutsche Asset Management, said he did not see a trend towards even weaker growth in emerging markets, despite the headwinds, arguing that energy importers would benefit from lower oil prices.
As for Citi’s fear that low oil prices will deprive all EMs of capital, Mr Schlotthauer was confident of replacement inflows, such as public-private partnerships in the infrastructure field. He also argued domestic sources of finance, such as pension funds and insurance companies, could take up some of the slack in a number of EMs.
Mr Mondino, though, feared that sluggish economic growth in EMs could lead to damaging policy responses, such as a sharp rise in protectionist measures witnessed in recent years.
“We are seeing a gradual move away from globalisation, more frequent use of barriers to capital mobility and a gradual weakening of the inflation targeting framework that many EMs had adopted,” he said, citing Turkey, Brazil and Mexico of examples of the latter.
“We clearly see a weakening of the policy framework that was a critical backbone of the positive EM story of the past decade. It’s being eroded on the margin.”
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