Sponsor:  IMF

Panelists: Gustavo Yamada (Dean of Economics and Finance Faculty, Universidad del Pacífico, Peru); Luis Cubeddu (Deputy Division Chief, Strategy Policy and Review Department, IMF); and Ceyda Oner (Deputy Division Chief, Finance Department, IMF)

Chair: Cathy Macauliffe

Presenters – Annette Kyobe, Alex Culiuc, of Strategy, Policy, Review Department

After a decade of strong economic performance, emerging market economies are entering a period of slower growth. During this session, the panelists will delve into the factors behind this change in fate and its implications. They will also shed some light on the growth prospects for emerging economies going forward.

Annette Kyobe

• EM growth is slowing and continues to surprise negatively
• Forecasts have continuously had to be downgraded, and had to revise growth down by 2% in aggregate since 2010
• External risks are increasing in EMs (emerging markets), especially risk of capital flight with unwinding of quantitative easing in developed economies

Questions

1. Why did EMs grow so fast in 2000s, especially role of tailwinds and the domestic fundamentals
2. What has caused the slowdown in EMs since 2010, and how much is cyclical versus structural

• EMs resumed a process of convergence in 2000s, subsequent to 1990s crises, but this is recent
• Drivers of growth: external favourable conditions, and growing export volume from increased trade integration, low interest rates fuelling capital inflows, very high commodity prices primarily benefitting commodity exporters, while trade and financial openness has also increased
• Emerging markets have done well in and of themselves, with institutional quality improvements and macro fundamentals – reflected in lower emerging market bond spreads across EMs
• Large role due to productivity growth
• Why have EMs slowed since 2010?
• Fundamentals have necessarily deteriorated since crisis – 80% of EMs have decelerated in a synchronized slowdown which is a relatively novel factor, only seen before during acute phases of crisis, which has ostensibly passed now
• Weak external demand and external factors
• Fiscal stimulus did contribute to growth
• There are large idiosyncratic country factors, either political instability or other country specific issues
• IS the slowdown cyclical or structural?
• By comparing ‘potential’ growth rates the projection suggests a structural slowdown will occur, though differentiating these issues is very difficult
•  EM Asia has suffered a cyclical slowdown, while Europe and S America has more likely suffered more of a structural slowdown

Alex Culiuc on prospects and policies needed

• Given the beneficial external conditions in the last decade, its important to consider these factors in future, including external demand, commodity price growth, and financial conditions (or the cost of external funding)
• Projections suggest a rebound in export volume growth from EMs, from 5 to 6/7%, but this is below the prior decade, suggesting export-led growth will provide less benefit than before
• Key commodity prices are likely to cheapen slightly, though not to dramatically low levels of early 90s.
• Projecting US rates forward as a proxy suggests an increase of roughly 2% for long-term interest rates to 2018
• How do these changes impact EMs future prospects?
• Most EMs have about 40% exports/GDP ratio, and findings suggest growth in trading partners will have a 1:1 relation to growth in EMs
• Findings show the clear role needed for counter-cyclical fiscal policy, especially significant for shifting terms of trade for commodity exporters
• The determinant of sensitivity to tightening external financing conditions depends on financial openness/integration
• Impact also determined by extent of exchange rate flexibility, whereby fixed rate states are more affected,

What policies needed to improve prospects given headwinds (rather than tailwinds previously)

• Put your macro house in order, and ensure that market volatility affects you as little as possible.
• The projected tightening in financial conditions is not likely to be gradual or smooth, given markets’ response to the US announcement of intention to “eventually” tighten its monetary policy led to EM volatility.
• The most affected were those with worst prevailing current account, the so-called ‘fragile 5’, India, Brazil, Indonesia, Turkey and South Africa.
• Also those with high and increasing inflation (the same 5) were most affected.
• Markets were thus differentiating within EMs
• Of the fragile 5, India did best, by reducing its current account deficit and inflation dramatically, while other 4 moved in opposite direction
• EMs should improve policy communication that could avoid exacerbating
• How to rebalance the growth model?
  • Some should reduce reliance on investment
  • Others need to increase domestic savings
  • How can states re-orient sources of growth?
  • Structural reforms to address impediments to factor accumulation and boost productivity
  • Reform priorities should be country-specific, and are stage/phase dependent, i.e. different reforms at different times will give different ‘bang for your buck’
  • First – address gaps in human and physical capital
  • Second – address labor market rigidities (by examining labour participation)
    • Not much correlation between labour participation and GDP per capita, though poorer states have lower participation rights, especially in MENA region
    • Female labour force participation is a very big explanatory factor in this.
    • Reform priorities evolve as countries develop
    • Which reforms affect productivity t which stage of growth?
      • Banking system reform has highest payoff for EMs in 2^nd and 3^rd quartile of states development
      • Trade liberalization will produce biggest benefit to lower income countries
      • Key takeaways
        • 2000s EMs benefitted from strong external tailwinds
        • Slowdown since 2010 reflects softening of tailwinds allied to structural factors internally
        • Growth will be more difficult as conditions change overall for the worse
        • Policies can ameliorate this, by putting their macroeconomic house in order, and through further structural reforms

Commentary

Gustavo Yamada

Peru’s case likely to be relevant, and had an almost growth miracle, yet now growth has fallen to below 3%.

• This presentation shows many relevant factors, including the external and internal factors
• Internal reform without benign external factors becomes  a much tougher task, and the effect has been magnified now
• How will Peru overcome the so-called ‘Middle Income Trap’, by which states grow to a point but, especially with problematic external environment