Transcript THE GLOBAL ECONOMIC ENVIRONMENT FOR EMERGING MARKETS JEFFREY FRANKEL HARPEL PROFESSOR OF CAPITAL FORMATION AND GROWTH HARVARD UNIVERSITY ANNUAL SYMPOSIUM ON CAPITAL MARKETS MEDELLIN, COLOMBIA, MAY 3,

THE GLOBAL ECONOMIC
ENVIRONMENT
FOR EMERGING MARKETS
JEFFREY FRANKEL
HARPEL PROFESSOR OF CAPITAL FORMATION AND GROWTH
HARVARD UNIVERSITY
ANNUAL SYMPOSIUM ON CAPITAL MARKETS
MEDELLIN, COLOMBIA, MAY 3, 2012
TWO- SPEED RECOVERY:
EMS BOUNCED BACK FROM THE 2008-09 GLOBAL RECESSION
MORE STRONGLY THAN ADVANCED ECONOMIES
World Economic Outlook, IMF, April 2012
EM RECOVERY FROM THE GLOBAL RECESSION
CONTINUES STRONGER THAN USUAL,
BUT NOT SO FOR ADVANCED ECONOMIES.
SINCE LAST YEAR, THE IMF HAS REVISED 2012 GROWTH
ESTIMATES DOWN SLIGHTLY, ESP. FOR EUROZONE.
World Economic Outlook, IMF, April 2012
Rate of growth of real GDP (%),
Projections for 2012 & 2013
World Economic Outlook, IMF, April 2012
Euro-recession is pulling down growth.
The US is doing better.
Emerging Market growth is slowing too, but solidly >0.
FOUR BIG RISKS THREATEN
THE GLOBAL OUTLOOK
• “Big” means, not “high probability” per year,
• but probability > 20% per year,
• with big consequences if it were to happen.
• 1) New € crisis =>
• more defaults on periphery, higher spreads
even in northern Europe & possible break-up of €-zone.
• 2) New partisan US budget stand-off.
• 3) Return of “risk off”; EMs hit?
• 4) Commodity price volatility
• E.g., world oil prices double again.
(1) THE CRISIS OF SOVEREIGN DEBT
IN THE EURO PERIPHERY WILL RETURN
• The flash point right now is Spain.
• The trigger in a year could be Greece, again:
• Greece cannot get back to a sustainable debt path
by austerity, as has been clear for awhile.
• When it eliminates its primary budget deficit,
no more incentive to keep servicing debt. => default.
• By then Euro banks may no longer have life-threatening exposure
• having passed debt to ECB, EFSF…+ provisioned.
• With default, Greek exit from euro begins to make sense.
• Or Portugal or Italy. Regardless, contagion to others.
• This time it will probably hit France as well.
• Could contagion reach other high-debt countries?
• UK? Japan?
US?
ACROSS ADVANCED COUNTRIES,
DEBT/GDP IS ALMOST THE HIGHEST IN A
CENTURY, SECOND ONLY TO WWII SPIKE
(2) US DEFICIT WOES
WILL RETURN
• The US has mismanaged its finances
as badly as Europe.
• The US doesn’t have the excuse of 17 legislatures,
• just two deadlocked political parties.
• It is a long-term problem:
• i) Future deficits in “entitlement spending”
• social security & Medicare.
• ii) Current budget deficits since 1981
• Steps in 1990s to restore surplus worked,
• but were reversed in 2001.
THE US NATIONAL DEBT AS A SHARE OF GDP
SOURCE: CBO, MARCH
ONE OBSTACLE,
ABOVE ALL OTHERS
• One of the two political parties has been
hi-jacked by a minority who say fiscal balance
is urgent, but also say it can be done entirely
by cutting domestic spending:
• They want to cut taxes & raise military spending at
the same time as eliminating the deficit,
• which is mathematically impossible.
• Prevents any sort of deal like 1990
• which slowed spending growth
& raised taxes during the 1990s.
THE GAME OF “CHICKEN”
In the 1955 movie
Rebel Without a
Cause, whoever
jumps out of his car
first supposedly
“loses” the game.
James Dean does;
but the other guy
miscalculates and
goes over the cliff.
THE DEBT-CEILING GAME OF “CHICKEN”
• In the summer of 2011, “fiscal conservatives”
recklessly threatened government default,
if their demands were not met.
• The resulting political dysfunction led S&P
to downgrade US bonds from AAA to AA.
• A last-minute solution postponed
the deadline to the end of 2012:
• If no action is taken then, (i) all tax cuts expire,
(ii) all discretionary spending is cut drastically, &
(iii) the debt ceiling law is probably violated anyway.
• I.e., a return of the stand-off:
• => Danger of recession and default !
3) RETURN OF “RISK OFF”
ENVIRONMENT?
• Financial markets have swung
back and forth between
periods of risk-denying “reach for yield” &
periods of risk-obsessed “flight to safety.”
• Risk perceptions were far too low in 2003-07.
• Shot up in 2008-09;
• Down in 2010-11.
• Up again?
SOVEREIGN SPREADS DEPEND ON RISK PERCEPTIONS,
AS REFLECTED IN THE VIX
(OPTION-IMPLIED VOLATILITY OF US STOCK MARKET)
Risk
off
Risk on
Laura Jaramillo & Catalina Michelle Tejada, IMF Working Paper, 2011
Risk
on
ARE EMS VULNERABLE?
• Historically, international financial shocks
(a rise in risk-aversion and/or interest rates)
hit Emerging Markets harder than anyone:
• 1982: International debt crisis (esp. Latin America)
• 1997: East Asia crisis (spreading to Russia, Brazil…).
• Worryingly, EMs seem subject to15-year cycle:
• 7 years of capital inflow drought;
• 7 year of capital inflow flood;
• Crisis hits in 15th year.
THE BIBLICAL CYCLE
• Joseph prophesied 7 years of plenty,
with abundant harvests from a full Nile
-- followed by 7 lean years of drought & famine.
• The Pharaoh empowered his technocratic official
(Joseph) to save grain in the 7 years of plenty,
• building up sufficient stockpiles to save the Egyptian people
from starvation during the bad years.
• -- a valuable lesson for today’s government officials in industrialized &
developing countries alike.
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BIBLICAL CYCLE, CONT.
• For emerging markets, the first phase of 7 years
of plentiful capital flows occurred in 1975-1981,
• recycling petrodollars as loans to developing countries.
• The international debt crisis that began in Mexico
in 1982 was the catalyst for the 7 lean years,
• known in Latin America as the “lost decade.”
• The turnaround year, 1989, saw the first issue of Brady bonds, which helped
write down the debt overhang
• and put a line under the crisis.
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BIBLICAL CYCLE, CONT.
• The second cycle of 7 fat years was the period of
record capital flows to emerging markets in 1990-96.
• The 1997 “sudden stop” in East Asia
was then followed by 7 years of capital drought.
• The third cycle of inflows, often identified with
“carry trade” and “BRICs” came in 2004-2011
• and persisted even through the Global Financial Crisis.
• If history repeats itself, it is now time for a 3rd
sudden stop of capital flows to emerging markets!
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ARE EMERGING MARKETS DUE FOR A
CORRECTION, TRIGGERED BY A NEW WAVE
OF “RISK OFF” BEHAVIOR?
• Most worrisome: Turkey.
• Turkey can probably not sustain the rapid economic growth
and very high trade deficits of recent years.
• Vulnerable to world oil price.
• China could land hard as its real-estate bubble deflates
and the country’s banks are forced to work off bad loans.
• High GDP growth rates in Latin America
over the same period could reverse,
• particularly if global commodity prices fall –
• Esp. if the cause is that the Chinese economy begins to falter.
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BUT: A REMARKABLE ROLE-REVERSAL
SUGGESTS EMERGING MARKETS
ARE NO LONGER SO VULNERABLE:
• Debt/GDP of rich countries (> 80%) is now
more than twice that of emerging markets;
• and rising rapidly.
+
• Even EM “debt intolerance” may be diminishing.
• ≡ creditworthiness for given debt/GDP -- Reinhart & Rogoff
=>
Some EMs Economies are now more creditworthy
than some Advanced Economies
•
• as reflected in credit ratings or sovereign spreads.
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Public finances since 2001
have become much stronger in EMs
BUT WEAKER IN ADVANCED ECONOMIES.
World Economic Outlook, IMF, April 2012
COUNTRY CREDITWORTHINESS
IS NOW INTER-SHUFFLED
“Advanced” Countries
(Formerly) “Developing” Countries
AAA Germany, UK
AA+ US, France
AA- Japan
A+
ABBB+Ireland, Italy, Spain
BBB
BBB- Iceland
BB Portugal
B
CC Greece
Hong Kong, Singapore
China
Chile, Korea
Malaysia, Botswana
South Africa, Thailand
Brazil
Colombia, India, Indonesia
Costa Rica, Jordan, Philippines
Burkina Faso
S&P ratings, Apr.26, 2012
ONE INDICATION OF IMPROVED EM CREDITWORTHINESS:
EM SOVEREIGNS USED TO HAVE TO PAY HIGHER INTEREST RATES
THAN US HIGH-YIELD CORPORATES (BB), BUT NOW PAY LESS.
World Economic Outlook, IMF, April 2012
HISTORIC ROLE REVERSAL IN THE CYCLICALITY
OF FISCAL POLICY IN INDUSTRIALIZED VS.
DEVELOPING COUNTRIES
• In the textbooks, benevolent governments are
supposed use discretionary fiscal (& monetary)
policy to dampen cyclical fluctuations.
• expanding at times of excess supply, and
• contracting at times of excess demand.
• But in practice, …
Copyright Jeffrey Frankel,
PRO-CYCLICAL FISCAL POLICY
THESE 3 PAGES WERE IN L3 APP. IN 2010
In practice, policy has often been
procyclical, i.e., destabilizing,
in developing countries:
• Governments would raise spending in booms;
• and then be forced to cut back in downturns.
• Kaminsky, Reinhart & Vegh (2004), Talvi & Végh (2005),
Alesina, Campante & Tabellini (2008), Mendoza & Oviedo (2006),
Ilzetski & Vegh (2008) and Medas & Zakharova (2009).
• Especially Latin American commodity-producers.
• Gavin & Perotti (1997), Calderón & Schmidt-Hebbel (2003),
Perry (2003), and Villafuerte, Lopez-Murphy & Ossowski (2010).
Copyright 2007 Jeffrey Frankel, unless otherwise noted
Correlations between Gov.t Spending & GDP
1960-1999
Adapted from Kaminsky, Reinhart & Vegh, 2004,
“When It Rains It Pours”
procyclical
Pro-cyclical spending
countercyclicall
Countercyclical
spending
G always used to be pro-cyclical
for most developing countries.
AN IMPORTANT DEVELOPMENT -IN THE LAST DECADE, SOME DEVELOPING COUNTRIES
WERE ABLE TO BREAK THE HISTORIC PATTERN:
• They took advantage of the 2003-08 boom
• to run budget primary surpluses.
• and build reserves.
• By 2007, Latin America had reduced its debt
• to 33% of GDP,
• as compared to 63 % in the United States.
• And so had fiscal space
to respond to the 2008-09 recession.
• I.e., some emerging market countries finally
achieved countercyclical fiscal policies.
CORRELATIONS BETWEEN GOV.T SPENDING & GDP
2000-2009
procyclical
Frankel, Vegh & Vuletin (2011)
countercyclical
In the last decade,
about 1/3 developing countries
switched to countercyclical fiscal policy:
Negative correlation of G & GDP.
TO SUMMARIZE
THE FISCAL ROLE REVERSAL,
• Many important emerging markets have, so
far this century, achieved:
• Lower debt levels than advanced
economies;
• improved credit ratings;
• lower sovereign spreads; and
• less procyclical fiscal policies.
LESS VULNERABLE TO CRISES
IN OTHER RESPECTS AS WELL:
• More flexible exchange rates than before 1997.
• Higher fx reserve holdings
• E.g. relative to short-term debt.
• Less prone to current account deficits.
• Capital inflows less concentrated in $ bank debt
• And local-currency debt.
• More FDI.
• Exception: the one region that apparently didn’t learn
the lessons of the 1990s was Eastern Europe.
(4) COMMODITY
PRICE VOLATILITY
• Prices of oil, minerals & agricultural
commodities have become increasingly
volatile in recent years.
• Especially sharp spikes in 2008 & 2011
• With a crash in between.
• Commodity price volatility likely to continue.
• Whether a commodity price rise is good or bad
depends on
• (i) whether you are a buyer or seller
• (ii) the cause of the increase.
COMMODITY PRICES HAVE BEEN ESPECIALLY
VOLATILE OVER THE LAST DECADE
Commodity prices: all commodities
A.Saiki, Dutch Nat.Bk.
Indices
180
160
140
120
100
80
60
40
20
0
60 61 63 64 66 67 69 71 72 74 75 77 79 80 82 83 85 86 88 90 91 93 94 96 98 99 01 02 04 05 07 09 10
Nominal prices
in prices of 2010
2010=100
*) Deflated by US consumer price index.
Source: HWWA, Datastream.
prices
InReal
prices of
2000*
= nominal in 2000
*
COMMODITY PRICES SPIKED IN
2008, AND AGAIN IN SPRING 2011
Oil
World Economic Outlook, IMF, April 2012
WHAT DETERMINES
COMMODITY PRICES?
• Various idiosyncratic factors in each sector.
• When wheat prices go up, it could be Australian
drought, Russian fires, Canadian floods, US
ethanol subsidies or Argentine export controls.
• But when virtually all commodity prices
move together, it must be macroeconomic:
• 70s↑, 80s↓, 2002-08 ↑ , 2008-09↓, 2009-11↑.
• Leading explanation: global business cycle, e.g., China-
led growth 2002-08 & 2010-11.
• Secondary explanation: monetary policy,
• as reflected in real interest rates.
GROWTH IN CHINA’S IMPORTS OF MINING
PRODUCTS IS A BIG REASON FOR THE UPWARD
TREND IN THEIR PRICES.
World Economic Outlook, IMF, April 2012
OIL PRICES HAVE CONTINUED TO RISE IN 2012.
THEY COULD GO MUCH HIGHER, OR MUCH LOWER.
• This has been idiosyncratic,
not a continuation of the general commodity boom.
• E.g., natural gas prices are strongly down,
• at least in the U.S.
• It is attributable to geopolitical risk:
• Tensions with Iran.
• Sanctions on Iranian oil exports.
• The danger of military conflict
• which might impede access to oil from the Persian Gulf.
COLOMBIA, LIKE MOST LATIN
AMERICAN COUNTRIES, IS VULNERABLE TO
FURTHER SWINGS IN PRICES OF COMMODITIES
ESP. OIL & COFFEE
• Dangers of commodity volatility include:
•
•
•
•
Highly cyclical revenues;
Real currency appreciation crowding out manufacturing
Procyclical fiscal policy;
Procyclical monetary policy.
Risk-manangement recommendations
for commodity-exporting countries
CONTRACT DEVICES TO SHARE RISKS
1. Index contracts with foreign companies
to the world commodity price.
2. Hedge commodity revenues
in options markets
3. Denominate debt in terms of commodity price:
Issue oil bonds & coffee bonds, instead of $ or peso bonds.
Recommendations for commodity producers
continued
COUNTER-CYCLICAL MACROECONOMIC POLICY
4. Allow some currency appreciation in response
to a rise in world prices of export commodities,
but not free floating. Accumulate some forex reserves.
5. If the monetary regime is to be Inflation Targeting,
consider using as the target, in place of the CPI,
a price measure that puts weight
PPT
on the export commodity (Product Price Targeting).
6. Emulate Chile: to avoid over-spending in boom
times, allow deviations from a target surplus only
in response to permanent commodity price rises.
Recommendations for commodity producers,
concluded
GOOD GOVERNANCE INSTITUTIONS
7. Manage Commodity Funds
transparently & professionally,
like Botswana’s Pula Fund
-- not subject to politics like Norway’s Pension Fund.
8. Invest in education, health, & roads.
9. Buyers: Publish What You Pay.
ELABORATION ON TWO PROPOSALS
TO REDUCE THE PROCYCLICALITY
OF MACROECONOMIC POLICY
FOR COMMODITY EXPORTERS
• I) To make monetary/exchange
rate policy less procyclical:
PPT
Product Price Targeting
• II) To make fiscal policy less
procyclical: emulate Chile.
I) THE CHALLENGE OF DESIGNING A CURRENCY
REGIME FOR COUNTRIES WHERE
TERMS OF TRADE SHOCKS DOMINATE THE CYCLE
• Floating accommodates terms of trade shocks,
• thus giving countercyclical monetary policy;
• but can entail excessive
exchange rate movement
• and does not provide a nominal anchor.
• Inflation targeting, in terms of the CPI,
• provides a nominal anchor;
• but can dictate a procyclical monetary policy.
Product Price Targeting
PPT
Target an index of domestic production prices. [1]
• Include export commodities in the index
and exclude import commodities,
• so money tightens & the currency appreciates
when world prices of export commodities rise,
• not when world priced of import commodities rise.
• Automatically countercyclical.
• The CPI does it backwards:
• It calls for appreciation when import prices rise,
• and not when export prices rise.
[1] Frankel (2011).
Professor Jeffrey Frankel
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