The downward revision of growth projections for emerging economies by the International Monetary Fund and the World Bank is yet another reminder of how quickly the narrative has changed for these countries. This reversal has led to selloffs in emerging-market assets, be they equities, currencies or fixed-income. Countries that not so long ago were deemed an influential locomotive for global growth (as well as a contributor to global financial stability) are now viewed more as a source of actual and potential disruptions.
Yet things may not be as bad as all that; they certainly don’t have to be if emerging economies adjust their growth models appropriately.
For most of the last decade, emerging economies tended to surprise on the upside. Having been encouraged to pursue more responsible financial management by the various crises of the 1990s, they registered strong growth and accumulated huge financial buffers. As such, they were better positioned than the advanced economies to navigate the fallout from the 2008 global financial crisis. Their rapid recovery surprised even their most ardent advocates. Not only did they provide the world economy with steady growth and new impetus for trade, with their deep cash reserves, they also readily bought securities issued by advanced-country governments running large deficits.
The story of the last couple of years is different, however. Most emerging economies have found it hard to navigate the spillover effects of the unconventional monetary policies pursued by central banks in the U.S. and Europe — be it when the advanced countries contributed to very large capital flows to the emerging world that overwhelmed their markets or in the subsequent phases of volatility and sudden reversals. And with financial markets amplifying these effects considerably, even the best-managed emerging economies have struggled to come up with proper responses to particular events, let alone a consistent set of responses over time.
At the same time, the emerging world received little support for coordinating global policy, be it through the Group of Seven, Group of Eight or the Group of 20. Even modest reforms to the IMF have been stymied by the failure of the U.S. Congress to pass measures that have already been approved by the vast majority of the IMF’s member countries and that would give countries such as China and Brazil more of a voice in the fund. The loss of confidence in the international monetary system has encouraged several emerging economies to opt for alternative approaches, including a new development bank, a new infrastructure bank, enhanced foreign-exchange swap facilities and a series of bilateral payment agreements.
These external adversities would not have been so disruptive had emerging economies pressed forward with pro-growth reforms. Instead, with domestic pressures building on both social and political fronts, the inclination has been to go back to bad old habits rather than forge ahead with the required changes. Just look at Brazil’s reactions to its economic slowdown and inflationary pressures as an example. The temptation has been to revert to relying on the inefficient development bank to spur investments and growth rather than undertake the changes needed to unleash more productive private investments.
In fact, Brazil’s path is similar to the approach that India got stuck in before Narendra Modi’s election, which has led to hopes that India will change, though these aspirations are yet to be fully met. Arguably, in the case of Russia, the attraction of trying to reclaim what is perceived as a more glorious past can also help explain part its involvement in Ukraine. Even in China, where the government is committed to a new growth model, there is still a tendency to fall back on an increasingly exhausted approach that relies excessively on public credit and inefficient investments.
These conditions may get worse before they improve, particularly given the number of emerging economies that will now suffer from the recent sharp fall in commodity prices. Yet it would be a mistake to underestimate the resilience of these countries.
Most emerging economies still possess sufficient flexibility over their financial conditions, structural reforms and macroeconomic policies. Their populations are more aware of their countries’ potential and won’t stand idle forever if their governments continually fail to respond. And technological advances continue to ease the leapfrogging in productivity and the empowerment of individuals.
So, yes, the emerging world is no longer the bright spot it once was. Yet that doesn’t mean it is regressing to the old crisis-prone world of old.
Mohamed El-Erian is the chief economic adviser at Allianz SE. He’s chairman of Barack Obama’s Global Development Council, the author of best-seller When Markets Collide» and the former chief executive officer and co-chief investment officer of Pimco.