ECONOMIST INTELLIGENCE UNIT
As the global economy slows, many emerging markets are feeling the pinch as demand for their exports weakens. In some cases—notably in China—domestic policy is also contributing to the economic slowdown. The broader question is whether these are mainly cyclical developments or the prelude to a structural adjustment in which emerging markets will no longer sustain the spectacular growth rates of recent years. The answer is probably a bit of both.
Growth in many—though not all—emerging markets still depends heavily on the export of goods to the US and EU. When these markets slow or contract, there is a corresponding impact on the developing world. This is what is now happening in much of the global economy. US growth has slowed from an annualised rate of 4.1% in the fourth quarter of last year to just 1.5% in the second quarter of 2012. Meanwhile, most of Western Europe is in recession or depression. Imports by the US and EU accounted for roughly 38% of emerging and developing countries’ exports last year (according to IMF data), down from 45% pre-crisis in 2007. China’s domestic slowdown is also likely to affect other emerging-market exporters, from Latin American commodity producers to South-east Asian manufacturers. The recent weakness in China’s import data (see chart) has worried economists and businesspeople in its trading partners.
Recent data from a number of emerging markets confirm the deteriorating picture. Taiwan, a major exporter of high-tech goods, saw a contraction in GDP in the second quarter of 2012, and the island’s export earnings have fallen year on year for four months in a row to June. In Brazil, export earnings tumbled by about 18% year on year in June and 6% in July in US-dollar terms, having averaged very strong growth throughout 2010 and most of 2011. Although trade data for many emerging markets continue to hold up fairly well, albeit patchily, external headwinds are strengthening. Data such as those for export-oriented Malaysia (see chart) show a typical trajectory: exporters do not yet face the collapse in demand that occurred during the post-Lehman global recession in 2009, but the sharp rebound that followed that downturn is clearly over.
Nor are external trading conditions the only short-term headache for the emerging world, as domestic factors have also had an effect on growth in many cases. This is certainly true in China, where the slowdown now under way is partly the delayed effect of policy tightening in 2010-11, when the government sought to deflate a property-driven investment bubble and adjust to the effects of its earlier massive stimulus programme. India’s slowdown is largely a domestic story, reflecting problems such as high inflation and interest rates, dysfunctional politics and policymaking, weak investment and poor weather.
The short- and longer-term outlooks
These factors and more underline the deteriorating short-term outlook for emerging markets. The IMF’s latest update, published in mid-July, of its World Economic Outlookdowngrades slightly the outlook for growth in emerging and developing economies in 2012 and 2013. This is also broadly reflected in the Economist Intelligence Unit’s forecasts for the world economy. We expect growth in non-OECD countries collectively to slow to 5.4% this year at purchasing-power parity (PPP) exchange rates, from 6.2% in 2011 and a buoyant 7.7% the previous year. At the beginning of 2012, in contrast, we were forecasting slightly higher non-OECD growth of 5.9% in 2012 and 6.4% in 2013.
Emerging-market growth will accelerate in 2013-16, although average growth of 6.2% during that period won’t match the spectacular highs recorded in the pre-crisis years of 2003-07. The broader questions on many minds, particularly following the recent signs of slowdown in China and India, are whether this recovery will reflect more than just the cyclical effects of recent policy easing and a muted upturn in rich-world growth, and thus whether rapid growth in developing economies is sustainable over the longer term. The IMF’s WEO Update remains sanguine about short-term growth prospects, but it expresses concerns about weaker underlying growth “potential” in future. The Fund observes that emerging-market growth has been “above historical trends over the past decade or so”, and that rapid credit growth may have inflated both economic performances and expectations of the normal rates of growth that should be achievable in emerging markets.
We concur that the supercharged rates of growth recorded in 2003-07 do not look sustainable. However, that boom occurred over a relatively brief period; in the context of the past two decades, in which non-OECD growth averaged 5.2% on a PPP basis, the prospect of sustained growth of over 6% in the next few years would still represent a very respectable performance. This is not to deny that a number of emerging economies face significant structural shifts and challenges in the next decade. China is seeking to rebalance its economy to give greater prominence to private consumption and thus to reduce its reliance on exports and, in particular, fixed investment. Russia needs to make its economy less dependent on high energy prices. More broadly, the perennial challenge for many emerging markets is to put growth on a more sustainable footing by reducing red tape and corruption, liberalising investment and labour markets, and improving basic infrastructure. The recent massive power blackouts in India are a reminder of the risks of inaction on these issues.
Separating cyclical effects from those of structural changes will remain tricky, and our forecasts suggest that the outlook for self-sustaining emerging-market growth is mixed. Chronically slow economic activity in the rich world would certainly present a serious obstacle to growth. Yet this is not to deny the likelihood of an incremental rebalancing towards more domestically driven growth in parts of the developing world—and hence towards growth that is more independent of rich countries’ performance. A number of emerging markets are witnessing rapid growth of a middle class, which will support higher private consumption. Our forecasts for China, for instance, indicate that private consumption will rise from about 35% of GDP in 2011 to well over 40% by the end of this decade. We also forecast that non-OECD economies as a group will make ever bigger contributions to global GDP growth in the next few years. By 2016, these countries will be responsible for around three-quarters of the global economy’s growth on a PPP basis, up from an average of 52% in 1992-2008.
Whether or not this ultimately amounts to decoupling may simply be a question of nomenclature: a judgement as to what degree of separation between advanced and developing economies should be considered meaningful. But it could at least strengthen the argument for a change in focus of analysis. Instead of looking at rich-world growth and estimating the impact on emerging-market prospects, economists may find that the tables are turned and that the advanced economies’ prospects are increasingly measured in terms of emerging-market performances. The cliché about the world catching cold when America sneezes may need turning on its head, and we may find that economy-watchers pay ever closer attention to proverbial sniffles in China, Brazil and elsewhere.
Maritime disputes are getting more serious
China’s maritime-border disputes with neighbouring states, long simmering, have intensified in recent months. The country has clashed diplomatically with the Philippines and Vietnam over the South China Sea, and with Japan over the status of the Senkaku islands (known as the Diaoyu islands in China) in the East China Sea. One reason behind the up-tick in tensions has been poor bureaucratic co-ordination and the conflicting goals of a number of government agencies in China. Outright militarisation of the various disputes appears to be some way off. Yet the failure to make diplomatic progress has become a worrying trend, and armed clashes cannot be ruled out.
Maritime border disputes between China and its neighbours, which have increased notably in frequency since 2010, are showing few signs of abating. On July 12th an ASEAN summit ended in acrimony after Cambodia, which was chairing the meeting, apparently yielded to Chinese pressure to veto any mention of the Scarborough Shoal (called Huangyan Island in Chinese), a reef in the South China Sea over which China and the Philippines have been locked in dispute since April. On July 17th it was reported that a recently established prefecture-level city in China’s Hainan province, Sansha, was to appoint a 60-member legislature to administer territories in the Paracel Islands, which are also claimed by Vietnam. In addition, China and Japan have recently revived their argument over the status of the Senkaku Islands, after Japan protested about the presence of Chinese state fishery patrols in the area. This followed the announcement by the Japanese government that it would “nationalise” some of the islands, which are currently owned by a Japanese private citizen.
Policy co-ordination remains poor
The persistence of such frictions is in part owing to a failure of Chinese foreign policy. When concerns about China’s growing “assertiveness” in relation to its maritime periphery spiked in late 2010, this prompted widespread debate in China about whether the country’s more forceful stance was undoing much of the progress that it had made in improving its image in the surrounding region through its “good neighbour” policy in the early 2000s. For many observers, the most worrying thing was that the ambiguity surrounding China’s ambitions was encouraging a number of states in the region to look to the US for greater political and military support, in a trend that was considered detrimental to China’s overall strategic environment. As a result, China looked to soften aspects of its approach, increasing its bilateral and multilateral engagement in the region. In mid-2011 it agreed to ASEAN-backed implementation guidelines for a “code of conduct” for interested parties in the South China Sea. Some of China’s more hardline domestic voices were quieted, and the foreign policy apparatus re-emphasised the rhetoric of “peaceful development”.
Events in 2012 indicate that this modified approach has not yielded benefits in improving China’s relations with its neighbours. The maritime disputes are driven at a basic level by competition over the oil and gas reserves, as well as fisheries, to which the various islands groups are linked. But China’s failure to allay concerns in the region also stems from problems relating to ineffective policy co-ordination. A report published in May by the International Crisis Group highlighted the number of Chinese institutional actors, ranging from the fisheries administration to local governments, the navy and energy companies, that now have a stake in the South China Sea. These bureaucracies often have competing interests, and are typically content to pursue them narrowly without reference to national foreign-policy goals. This makes diplomacy difficult, particularly as China’s foreign ministry—the body that might be expected to manage such efforts—lacks clout within the country’s policymaking structures. Efforts to set up a more centralised decision-making authority have so far stumbled.
Domestic politics matters
Clearly, the ineffectiveness of Chinese policy is not the only factor stoking tensions. The domestic politics of the countries involved has also played an important role. In China’s case, the change of leadership in the Chinese Communist Party that is expected later this year renders any perception of concessions to neighbours politically difficult at a time when factions within the ruling party are jostling for influence. In Japan, the government’s suggestion that it would buy some of the Senkaku Islands was made in response to pressure applied by the nationalist mayor of Tokyo, Shintaro Ishihara, who has garnered popular support for a campaign to develop the islands. The governments of the Philippines and Vietnam have also both looked to use their disagreements with China for domestic political gain, and anti-China rallies have been staged in the countries’ respective capitals. Although imbuing such territorial disputes with nationalist sentiment may enable governments to make short-term political capital, it means that they have less room to adopt accommodative positions when the situation requires it.
The US role
In the likely absence of a more conciliatory Chinese approach and the complications of domestic political environments across the region, the prospects for resolving maritime disputes in East Asia currently look bleak. The “pivot” in US diplomatic and defence policy towards Asia under Barack Obama’s presidency adds a further level of complexity. This change in emphasis is viewed with suspicion in China, where it seen as an attempt by the US to encircle China and to try to set the agenda on politics in the region. This does little for hopes of a permanent solution to territorial rivalries, as it means that China is also likely to become more entrenched in its position and averse to engaging with multilateral forums that the US also attends. Renewed US interest in Asia also risks emboldening local actors to take a more confrontational approach towards China in the expectation that they can rely on American support. Although the US has defence agreements with a number of Asian states, its commitments under such treaties are often ambiguous. It is unlikely to look kindly on requests to intervene in Asian waters at a time when it continues to maintain a considerable security presence in the Middle East and is in the process of implementing significant cuts in its military budget.
Bottoming out
Fighting against headwinds from a weak external environment and an ongoing adjustment in the property sector, China posted its lowest real GDP increase in three years on July 13th. According to National Bureau of Statistics (NBS) data, year-on-year economic growth tapered off to 7.6% in the second quarter of 2012, from 8.1% in the first quarter. Nevertheless, the latest data (which are still comfortably above the government’s announced target of 7.5% growth for 2012 as a whole) suggest that the economic slowdown is stabilising, and there is ample room for a rebound in the second half of the year as investment recovers and domestic consumption continues to grow.
Although the Chinese economy continues to expand at a rate that would be considered impressive anywhere else, the slowdown in the first half of the year has generated concern both at home and abroad. Local politicians fret over the economy’s ability to create enough jobs to maintain social stability. Those overseas, particularly in the resource-exporting economies that have benefited most from China’s insatiable demand, fear a slowdown in Chinese import growth. Although lower than some would like, the second-quarter GDP figures were greeted by many with sighs of relief, as it was no worse than the market consensus had expected.
Bearish observers have argued that China’s GDP data are tweaked to manage expectations, and that the slowdown has been sharper than headline statistics suggest. They note that electricity generation—historically seen as a more reliable proxy for overall economic expansion than some other data series—essentially stalled in the second quarter, with no rise in output between June 2011 and June 2012. There is some validity to this argument, and it is possible that GDP growth may be lower than the headline figures suggest (although, given the absence of more complete data sets than those from the NBS, rival estimates must be regarded as stabs in the dark at best). Nevertheless, even the power data suggest that the downturn is beginning to stabilise.
Moreover, as the Chinese economy undergoes a shift in terms of its growth drivers, power production is likely to become less useful as a guide for overall economic expansion. The current slowdown has been concentrated in sectors that are tied closely to the flagging property market. These include particularly electricity-hungry industries, such as cement production, and so it is no surprise that demand for electricity has flatlined. However, the main driver of growth this year has been consumption, which accounted for 57.7% of GDP growth in January-June 2012, according to the Wall Street Journal, rather than investment, which contributed 49.4% of growth. (The contribution from net exports was negative.) This contrasts with the year-earlier period, when investment was still the leading driver of growth, contributing 53.2% of the expansion in economic output, compared with 47.5% from consumption.
Credit growth is set to boost investment
Although acknowledging that the economy is coming under significant pressure, Chinese officials are optimistic that a rebound is forthcoming. In a cautiously upbeat statement on July 12th, a development think-tank linked to the State Council (China’s cabinet) said that the economy was likely to “stabilise and even recover modestly” in the second half of 2012 as recent stimulus measures gain traction. The most important factor supporting this view is that recent efforts to stimulate credit growth appear to be having some effect. Bank lending in June was stronger than some had feared, with just under Rmb920bn (US$145bn) in new lending in the month. Much of this lending was short-term in nature, raising questions about whether or not it has been channelled towards investment, but it seems likely that strong credit growth will now serve to support an acceleration in GDP growth in the latter half of the year—particularly as loan demand in the coming months will be bolstered by recent cuts in policy interest rates.
The government is trying to ensure that its efforts to stimulate the economy this time are better designed than the 2008-10 stimulus package was. In one example, a new US$11bn steel plant, set to be built in rural Guangdong, was only approved by the authorities after the province agreed to cut steel production elsewhere by an amount greater than the output of the new mill, so as not to aggravate existing excess supply conditions in the steel sector. In addition, officials have repeatedly emphasised that they will not be lifting any time soon the restrictions on the property sector that were designed to squeeze excesses from that market.
Despite this, there is a growing sense that the sharp downturn in the real estate market may be bottoming out. An index of new house prices compiled by a property agency, Soufun, showed a month-on-month increase (albeit of a marginal 0.1%) in June, representing the first rise in ten months. Meanwhile, some of China’s biggest developers have been making significant land purchases in June-July, suggesting that they may be restocking their land inventories on the expectation of a pick-up in the market.
The jobs picture remains rosy
One final reason why the outlook for China’s economy remains fundamentally positive is that, even as the property sector has slowed, the employment situation has remained healthy. The ratio of job openings to job-seekers fell from 108 to 105 between the first and second quarters, according to China’s Ministry of Human Resources and Social Security, but this still suggests that there were more jobs than people willing to fill them. Against this background, the fact that incomes are still rising rapidly is unsurprising. Urban incomes increased by 13.3% year on year in January-June while those in rural areas were up by 16.1%. This, coupled with a deceleration in the rate of consumer price inflation, which has boosted real purchasing power, has fuelled consumption.
Rebalancing the economy back towards consumption after the investment-fuelled boom of 2009-11 was never going to be painless. However, the fact that the employment market has held up in the first half of 2012 has helped to support consumption and prevent what would otherwise have been a much sharper downturn. As the outlook for investment is now beginning to improve, we believe that the second quarter will mark the low-point for growth and that the economy will gather momentum in the second half of the year. In the light of the second-quarter GDP figures, which were slightly below our forecast of 7.7% expansion, we will be reducing our full-year GDP growth forecast—but the reduction will be marginal.
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