Economist: New Nail in the Decoupling Theory Coffin
GDP and industrial production data proves that emerging markets grow in tandem with the developed world – and a lot faster.
Jonathan Anderson 26 May 2009
(Caijing Magazine) Since 2001, emerging market GDP and industrial production have outpaced the developed world by growth margins of some four to five percentage points. The latest available data – Q4 2008 for GDP and Q1 2009 for industrial production – shows no signs of change in those relative margins. Although growth fell off sharply virtually everywhere in the global economy, countries in the EM world are still expanding faster, or at least contracting more slowly, than their developed counterparts.
This brings us to the much-debated topic of decoupling. Many assume that, because emerging growth has been pulled down with the G3 countries, the whole concept of decoupling has been discredited. And if you define the term to mean that somehow the EM world could simple grow at whatever pace it wants, without concerns about activity in the United States or Europe, then it has been discredited indeed.
But that was never a very useful definition. In our view, there’s a much better one that investors should pay very strong attention to: Whatever growth rate you see coming out of the developed economies, emerging countries on the whole will grow 4 to 5 percentage points faster. Full stop.
So in 2006, when the United States and Europe were each growing at a real pace of more than 3 percent, the emerging world was growing at nearly 8 percent. And in 2010, if we look at a “weak recovery” scenario in which developed markets grow only at 0.5 percent to 1 percent in real terms, the EM world can still grow at 5 percent or more – five times faster. And for anyone investing in global markets, that is a significant margin.
How do we know this can happen? Here are three reasons.
First, it’s happening already. Despite all the global turmoil of the past few quarters, the EM world is still keeping up a steady, positive growth differential.
But this doesn’t explain “why,” which brings us to the second reason: Fundamentally speaking, the crisis we face today is not an emerging crisis but, rather, a developed crisis. From the very beginning of the global downturn, we have been stressing again and again that, on an aggregate basis, both EM public and private balance sheets are far healthier than those in the United States or the European Union. This makes the current round very different from so many of the emerging crises of the 1980s and ‘90s. Asia and Latin America in particular had high GDP growth rates but also had balanced or surplus trade positions, relatively subdued credit cycles, and very low debt creation. Simply put, these were the least levered parts of the global economy coming into the current downturn.
As a result, the economic situation today for most countries is little different than that, say, of the global IT bust in 2001-’02. Growth has fallen sharply, particularly in smaller, export-led economies. And, with the exception of some periphery cases, neither currencies nor domestic financial systems have come under severe pressure by emerging standards. Thus, in our view, the word “crisis” doesn’t really apply here.
This doesn’t mean there aren’t objective risks; of course there are. And if we turn to Eastern Europe, we find many countries that do face much more serious imbalances at home. But the worst cases are relatively small. By our estimates, the most serious problem economies are no more than 7 to 8 percent of total emerging GDP, which is not a large enough percentage to derail our decoupling view.
The final and crucially important issue is that, when we turn to the BRIC economies – Brazil, Russia, India and China -- we see signs that each is beginning to pull off an early recovery relatively independent of global trends.
Certainly, the most widely followed example is China, where the main driver of the 2008 downturn was not exports but rather the domestic property and construction recession. And, as expected, housing sales, construction activity, steel and electricity demand have already rebounded significantly in the first quarter 2009 and are now rising at a positive year-on-year pace. Combined with the rapid increase in bank lending on the back of government monetary easing and a fiscal stimulus program, there’s been little doubt that China can re-accelerate demand this year even against a weakening export backdrop. In fact, the debate in the market is now about whether the economy “overshoots” the mark through excessive stimulus and credit expansion.
For Russia, the case is more tentative but, at the same time, the turnaround could be even stronger. From a fundamental point of view, Russia was supposed to go through some rough patches in the global downturn but was not supposed to face an outright crisis. Its leverage ratios were high but still far below those in Eastern Europe. And despite falling oil prices, the economy continued to record healthy surpluses on the external account.
Nonetheless, during the second half 2008, Russia faced a looming threat of economic crisis. Over the summer, we saw a surprisingly harsh domestic liquidity crunch, with overextended small- and medium-sized banks teetering on the edge of bankruptcy. The combination of banking system trouble, a visibly overvalued ruble, and some of the most significantly negative real interest rates in the EM world basically led to a rush out the door, as foreign capital, domestic financial institutions and plain vanilla local depositors all moved to convert rubles to dollars. With no real liquidity at home, asset markets collapsed. And as long as this currency-interest rate mismatch continued, there was no way for the government to take measures to stabilize the domestic economy, as any new injection of funds simply joined the outflow flood.
Since January, however, things have looked very different. After a nearly 50 percent decline against the dollar, the Central Bank of Russia (CBR) re-pegged the ruble within new euro-dollar band limits -- limits which have held up very well in the past four months. Even more important, after falling by nearly US$ 200 billion in headline terms, official FX reserves have stabilized over the past quarter as well.
The CBR was forced to bring interest rates up in a hurry to stem currency outflows, but market rates are now falling consistently. And in contrast to many of its beleaguered neighbors, Russia still has a working credit cycle, with new domestic currency lending rebounding visibly (albeit from a very low base) in the first two months of 2009, and with a number of new large corporate loans and rollovers taking place in February and March.
In short, the authorities seem to have resolved a knotty set of macro problems and still emerged with a decent balance sheet, which means they now have a much better chance to fix the domestic banking system and provide new funds to the market without worrying about external instability. So while production and growth data showed a very sharp contraction in domestic activity in the first part of the year, as payments and credit systems come back on line again, we expect much better real indicators by the second half 2009.
Very similar arguments hold for Brazil. On paper, the Brazilian economy should have been one of the least impacted by the global market panic and real downturn. Brazil has the lowest export-GDP ratio of any major emerging market, a relatively closed capital account compared to smaller EM counterparts, and a healthy domestic banking system. So while we were looking for a domestic-led slowdown following the strong credit cycle and high domestic spending of the past few years, and while the sudden currency depreciation last fall came as a shock to the markets, we certainly didn’t expect a “hard landing” for the real economy.
But in practice, Brazil saw a very hard landing indeed. Industrial production fell by around 14 percent year-on-year in the first quarter 2009 – on par with Russia and Eastern European economies such as Poland, Romania and Bulgaria; worse than in Mexico; and far worse than in China and India (which should have been the more natural comparators). That forced most analysts to scramble to downgrade GDP forecasts, and incited a good deal of local soul-searching as observers struggled to reassess long-held views on the health of the economy.
What happened? As we see it, there was a large element of industrial destocking, and destocking that was much more virulent, at least on the domestic heavy-industry side, than in other emerging markets. Looking at the automobile sector, for example, global EM market sales fell by an average 10 percent year-on-year in the first quarter 2009, with an average production decline of 18 percent. For Brazil, by contrast, the figures were a plus 3 percent year-on-year for sales and a decline of more than 20 percent in production. No other major emerging country we follow saw a gap of that magnitude.
Moreover, when we look at electricity consumption data for the industrialized regions of Brazil -- usually a good coincident indicator of manufacturing activity -- the figures were already back in positive growth territory by the end of March. We are comfortable to say that, despite relative disappointment in April auto sales data, the second quarter should already show a significant overall improvement in momentum following a production collapse in the first quarter.
For most of the past 12 months, India has been the least exciting of the four BRIC economies, in the following senses: First, the slowing path of the Indian economy has been the most gradual and most consistent with our ex-ante forecasts; as of the end of 2008, GDP was still expanding at a 5 percent pace, year-on-year, and the latest industrial production figures are far above the EM average.
Second, compared to the other BRICs, India has much less potential for a dramatic, domestic-led rebound, since the banks’ liquidity position is relatively tight, and the extremely high fiscal debt and deficit positions make it difficult to undertake meaningful stimulus on a sustained basis.
Nonetheless, this doesn’t preclude stabilization or a mild turnaround in macro momentum. Our proprietary India Leading Economic Indicator has turned consistently positive over the past three months, pointing to a trough in the domestic cycle by mid-year and a relative recovery in the second half. The main elements of the pickup are a widening government bond yield spread, an acceleration of real liquid money balances given a fall in inflation rates, and the disappearance of foreign institutional investor portfolio capital outflows.
Jonathan Anderson is Head of Asia-Pacific Economics for UBS
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Economist: New Nail in the Decoupling Theory Coffin
GDP and industrial production data proves that emerging markets grow in tandem with the developed world – and a lot faster.
Jonathan Anderson
26 May 2009
(Caijing Magazine) Since 2001, emerging market GDP and industrial production have outpaced the developed world by growth margins of some four to five percentage points. The latest available data – Q4 2008 for GDP and Q1 2009 for industrial production – shows no signs of change in those relative margins. Although growth fell off sharply virtually everywhere in the global economy, countries in the EM world are still expanding faster, or at least contracting more slowly, than their developed counterparts.
This brings us to the much-debated topic of decoupling. Many assume that, because emerging growth has been pulled down with the G3 countries, the whole concept of decoupling has been discredited. And if you define the term to mean that somehow the EM world could simple grow at whatever pace it wants, without concerns about activity in the United States or Europe, then it has been discredited indeed.
But that was never a very useful definition. In our view, there’s a much better one that investors should pay very strong attention to: Whatever growth rate you see coming out of the developed economies, emerging countries on the whole will grow 4 to 5 percentage points faster. Full stop.
So in 2006, when the United States and Europe were each growing at a real pace of more than 3 percent, the emerging world was growing at nearly 8 percent. And in 2010, if we look at a “weak recovery” scenario in which developed markets grow only at 0.5 percent to 1 percent in real terms, the EM world can still grow at 5 percent or more – five times faster. And for anyone investing in global markets, that is a significant margin.
How do we know this can happen? Here are three reasons.
First, it’s happening already. Despite all the global turmoil of the past few quarters, the EM world is still keeping up a steady, positive growth differential.
But this doesn’t explain “why,” which brings us to the second reason: Fundamentally speaking, the crisis we face today is not an emerging crisis but, rather, a developed crisis. From the very beginning of the global downturn, we have been stressing again and again that, on an aggregate basis, both EM public and private balance sheets are far healthier than those in the United States or the European Union. This makes the current round very different from so many of the emerging crises of the 1980s and ‘90s. Asia and Latin America in particular had high GDP growth rates but also had balanced or surplus trade positions, relatively subdued credit cycles, and very low debt creation. Simply put, these were the least levered parts of the global economy coming into the current downturn.
As a result, the economic situation today for most countries is little different than that, say, of the global IT bust in 2001-’02. Growth has fallen sharply, particularly in smaller, export-led economies. And, with the exception of some periphery cases, neither currencies nor domestic financial systems have come under severe pressure by emerging standards. Thus, in our view, the word “crisis” doesn’t really apply here.
This doesn’t mean there aren’t objective risks; of course there are. And if we turn to Eastern Europe, we find many countries that do face much more serious imbalances at home. But the worst cases are relatively small. By our estimates, the most serious problem economies are no more than 7 to 8 percent of total emerging GDP, which is not a large enough percentage to derail our decoupling view.
The final and crucially important issue is that, when we turn to the BRIC economies – Brazil, Russia, India and China -- we see signs that each is beginning to pull off an early recovery relatively independent of global trends.
Certainly, the most widely followed example is China, where the main driver of the 2008 downturn was not exports but rather the domestic property and construction recession. And, as expected, housing sales, construction activity, steel and electricity demand have already rebounded significantly in the first quarter 2009 and are now rising at a positive year-on-year pace. Combined with the rapid increase in bank lending on the back of government monetary easing and a fiscal stimulus program, there’s been little doubt that China can re-accelerate demand this year even against a weakening export backdrop. In fact, the debate in the market is now about whether the economy “overshoots” the mark through excessive stimulus and credit expansion.
For Russia, the case is more tentative but, at the same time, the turnaround could be even stronger. From a fundamental point of view, Russia was supposed to go through some rough patches in the global downturn but was not supposed to face an outright crisis. Its leverage ratios were high but still far below those in Eastern Europe. And despite falling oil prices, the economy continued to record healthy surpluses on the external account.
Nonetheless, during the second half 2008, Russia faced a looming threat of economic crisis. Over the summer, we saw a surprisingly harsh domestic liquidity crunch, with overextended small- and medium-sized banks teetering on the edge of bankruptcy. The combination of banking system trouble, a visibly overvalued ruble, and some of the most significantly negative real interest rates in the EM world basically led to a rush out the door, as foreign capital, domestic financial institutions and plain vanilla local depositors all moved to convert rubles to dollars. With no real liquidity at home, asset markets collapsed. And as long as this currency-interest rate mismatch continued, there was no way for the government to take measures to stabilize the domestic economy, as any new injection of funds simply joined the outflow flood.
Since January, however, things have looked very different. After a nearly 50 percent decline against the dollar, the Central Bank of Russia (CBR) re-pegged the ruble within new euro-dollar band limits -- limits which have held up very well in the past four months. Even more important, after falling by nearly US$ 200 billion in headline terms, official FX reserves have stabilized over the past quarter as well.
The CBR was forced to bring interest rates up in a hurry to stem currency outflows, but market rates are now falling consistently. And in contrast to many of its beleaguered neighbors, Russia still has a working credit cycle, with new domestic currency lending rebounding visibly (albeit from a very low base) in the first two months of 2009, and with a number of new large corporate loans and rollovers taking place in February and March.
In short, the authorities seem to have resolved a knotty set of macro problems and still emerged with a decent balance sheet, which means they now have a much better chance to fix the domestic banking system and provide new funds to the market without worrying about external instability. So while production and growth data showed a very sharp contraction in domestic activity in the first part of the year, as payments and credit systems come back on line again, we expect much better real indicators by the second half 2009.
Very similar arguments hold for Brazil. On paper, the Brazilian economy should have been one of the least impacted by the global market panic and real downturn. Brazil has the lowest export-GDP ratio of any major emerging market, a relatively closed capital account compared to smaller EM counterparts, and a healthy domestic banking system. So while we were looking for a domestic-led slowdown following the strong credit cycle and high domestic spending of the past few years, and while the sudden currency depreciation last fall came as a shock to the markets, we certainly didn’t expect a “hard landing” for the real economy.
But in practice, Brazil saw a very hard landing indeed. Industrial production fell by around 14 percent year-on-year in the first quarter 2009 – on par with Russia and Eastern European economies such as Poland, Romania and Bulgaria; worse than in Mexico; and far worse than in China and India (which should have been the more natural comparators). That forced most analysts to scramble to downgrade GDP forecasts, and incited a good deal of local soul-searching as observers struggled to reassess long-held views on the health of the economy.
What happened? As we see it, there was a large element of industrial destocking, and destocking that was much more virulent, at least on the domestic heavy-industry side, than in other emerging markets. Looking at the automobile sector, for example, global EM market sales fell by an average 10 percent year-on-year in the first quarter 2009, with an average production decline of 18 percent. For Brazil, by contrast, the figures were a plus 3 percent year-on-year for sales and a decline of more than 20 percent in production. No other major emerging country we follow saw a gap of that magnitude.
Moreover, when we look at electricity consumption data for the industrialized regions of Brazil -- usually a good coincident indicator of manufacturing activity -- the figures were already back in positive growth territory by the end of March. We are comfortable to say that, despite relative disappointment in April auto sales data, the second quarter should already show a significant overall improvement in momentum following a production collapse in the first quarter.
For most of the past 12 months, India has been the least exciting of the four BRIC economies, in the following senses: First, the slowing path of the Indian economy has been the most gradual and most consistent with our ex-ante forecasts; as of the end of 2008, GDP was still expanding at a 5 percent pace, year-on-year, and the latest industrial production figures are far above the EM average.
Second, compared to the other BRICs, India has much less potential for a dramatic, domestic-led rebound, since the banks’ liquidity position is relatively tight, and the extremely high fiscal debt and deficit positions make it difficult to undertake meaningful stimulus on a sustained basis.
Nonetheless, this doesn’t preclude stabilization or a mild turnaround in macro momentum. Our proprietary India Leading Economic Indicator has turned consistently positive over the past three months, pointing to a trough in the domestic cycle by mid-year and a relative recovery in the second half. The main elements of the pickup are a widening government bond yield spread, an acceleration of real liquid money balances given a fall in inflation rates, and the disappearance of foreign institutional investor portfolio capital outflows.
Jonathan Anderson is Head of Asia-Pacific Economics for UBS
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