Transcript Overheating in Emerging Markets: The Next Crisis? Uri Dadush Carnegie Endowment for International Peace February 16, 2011

Overheating in Emerging
Markets: The Next Crisis?
Uri Dadush
Carnegie Endowment for International Peace
February 16, 2011
Key Points
• Conditions for overheating are in place.
• Overheating remains a largely incipient
concern at present.
• But these are still early days and policy
makers must take preemptive measures
soon.
Growth Differential Between Advanced and
Developing Countries
Average Annual GDP Growth Above Average Advanced Country Growth
Percentage Points
5
4
3
2
1
0
Asian Crisis Countries
1992-1997
Source: IMF.
G20 Emerging Countries
2005-2010
International Interest Rates are Much Lower
than in 1996…
Central Bank Principal Rate
Percent
7
1996
6
Current
5
4
3
2
1
0
United States
Japan
UK
* 1996 rate reflects Bundesbank rate; current rate reflects that of the European Central Bank.
Sources: Federal Reserve, Bank of Japan, Bank of England, Bundesbank, European Central Bank.
Germany*
…And Confidence in Developing Countries is
Even Higher
Sovereign bond spreads are down
EMBI Global Spread to U.S. Treasuries
Basis Points
Source: “Emerging Market Debt: Coming of Age”, J.P. Morgan, 2011.
…And Confidence in Developing Countries is
Even Higher
Credit ratings are up
Average Emerging Market Credit Rating
Source: “Emerging Market Debt: Coming of Age”, J.P. Morgan, 2011.
However, External Debt is Much Lower…
Average External Debt
Percentage of GDP
70%
1996
60%
50%
40%
2009
30%
20%
10%
0%
Asian Crisis Countries*
* Excludes Hong Kong, Korea.
† Excludes Korea, Saudi Arabia.
Source: World Bank.
G20 Emerging Countries†
…Reserves are Much Higher…
Average Reserves
Months of Imports
14
2009
12
10
8
6
4
1996
2
0
Asian Crisis Countries*
* Excludes Hong Kong.
Source: World Bank.
G20 Emerging Countries
…And Exchange Rates are More Flexible
Exchange Rate Regimes Prior to Asian Financial Crisis
Pegged
Hong Kong
Malaysia
Thailand
Floating
Indonesia
Korea
Philippines
…And Exchange Rates are More Flexible
Exchange Rate Regimes Today
Pegged
Hong Kong
China
Malaysia
Russia
Thailand
Saudi Arabia
Floating
Indonesia
Argentina
Korea
Brazil
Philippines
India
Indonesia
Korea
Mexico
South Africa
Turkey
Note that countries with fixed exchange rate regimes have
ample reserves.
Where are the Trouble Spots?
• Domestic Imbalances
Framework
– Growth
– Inflation
• Financial Exuberance
– Stock Market
• External Imbalances
– Real Exchange Rate
– Current Accounts
OVERHEATING
Domestic Balances
Several countries are well above trend growth
GDP Relative to 1997-2007 Trend
30
Percent difference
25
20
15
10
5
0
-5
-10
-15
-20
Russia
Source: IMF.
Mexico
All
Advanced
Countries
Korea
All
Emerging
Countries
China
Brazil
India
Indonesia
Argentina
Domestic Balances
Inflation is exceeding targets in many countries
Current inflation rate above midpoint of official target band
Percentage points
4
3.5
3
2.5
2
1.5
1
0.5
0
India
Saudi Arabia*
Russia
Indonesia
Brazil
* Official target unavailable. Represents current inflation rate above 10-year average rate.
Source: World Bank.
Argentina
Korea
Financial Exuberance
Equity markets fell sharply during the crisis…
Change in Stock Index Since January 2008
80
Percent difference
60
In March 2009
40
20
0
-20
-40
-60
-80
Russia
World
Source: World Bank.
China Emerging
Markets
India
Brazil Indonesia South
Africa
Turkey
Korea
Mexico Argentina
Financial Exuberance
…But some have rebounded well above 2008 levels
Change in Stock Index Since January 2008
80
Percent difference
Current
60
In March 2009
40
20
0
-20
-40
-60
-80
Russia
World
Source: World Bank.
China Emerging
Markets
India
Brazil Indonesia South
Africa
Turkey
Korea
Mexico Argentina
External Balances
Exchange rate appreciation has been large in some countries
Change in Real Effective Exchange Rate Relative to 1999-2008 Average
60
Percent change
50
40
30
20
10
0
-10
-20
Brazil
Russia
Indonesia
* Change from 2002-2008 average.
Source: World Bank.
Turkey
South
Africa
China
India
Saudi
Arabia
Mexico
Korea
Argentina*
External Balances
Current accounts are expected to be persistently weaker
Current Account Balance
12
Percent of GDP
10
8
1999-2008 Average
6
4
2
0
-2
-4
-6
-8
Russia
Source: IMF.
Indonesia
India
Brazil
South Africa
Turkey
External Balances
Current accounts are expected to be persistently weaker
Current Account Balance
12
Percent of GDP
10
2010-2015 Forecast
8
1999-2008 Average
6
4
2
0
-2
-4
-6
-8
Russia
Source: IMF.
Indonesia
India
Brazil
South Africa
Turkey
Overall Assessment
Clearly Overheating
• Brazil
• Indonesia
Possibly Overheating
• India
• Argentina
•
China
•
•
Korea
Mexico
Not Overheating
• Turkey
• South Africa
But Capital Flows are Much Lower and Have Yet
to Truly Recover
Private Capital Flows
Percent of GDP
10
9
1996
2007
8
7
6
2010
5
4
3
2
1
0
Asian Crisis Countries*
All Major Emerging Markets†
* Excludes Hong Kong.
† G20 emerging markets account for 81 percent of major emerging market GDP.
Source: World Bank, Institute of International Finance.
All Major Emerging Markets†
Rapid Growth Is Just Returning
Average GDP Growth
Percent
G20 Emerging Countries
Asian Crisis Countries
8
7
6
5
4
3
2
1
0
Source: IMF.
1991
1992
1993
1994
1995
1996
2005
2006
2007
2008
2009
2010
Emerging Market Domestic Policy
• Fiscal consolidation is preferred to monetary tightening.
• Earlier adjustment can allow for a soft landing.
• Foreign reserve buildup is costly.
• Relax capital outflow controls.
• Capital controls can be used as a last resort, but are not a long-term
solution.
Advanced Country Policy
The starting point is bad:
•
•
•
•
Massive liquidity overhang.
Advanced countries in a fiscal mess.
Banks are still fragile.
More “Global Rebalancing” unlikely
Worst outcome for developing countries?
• Inflation builds and sudden monetary tightening in major economies
leads to rapid capital reversal, higher global interest rates, and
slower global growth.
As recovery consolidates:
• Accelerate fiscal consolidation.
• Gradually tighten monetary policy.