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Overheating in Emerging Markets: The Next Crisis?

Overheating in Emerging Markets: The Next Crisis?. Uri Dadush Carnegie Endowment for International Peace February 16, 2011. Key Points. Conditions for overheating are in place. Overheating remains a largely incipient concern at present.

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Overheating in Emerging Markets: The Next Crisis?

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  1. Overheating in Emerging Markets: The Next Crisis? Uri Dadush Carnegie Endowment for International Peace February 16, 2011

  2. Key Points • Conditions for overheating are in place. • Overheating remains a largely incipient concern at present. • But these are still early days and policy makers must take preemptive measures soon.

  3. Growth Differential Between Advanced and Developing Countries Average Annual GDP Growth Above Average Advanced Country Growth Percentage Points Source: IMF.

  4. International Interest Rates are Much Lower than in 1996… Central Bank Principal Rate Percent * 1996 rate reflects Bundesbank rate; current rate reflects that of the European Central Bank. Sources: Federal Reserve, Bank of Japan, Bank of England, Bundesbank, European Central Bank.

  5. …And Confidence in Developing Countries is Even Higher Sovereign bond spreads are down EMBI Global Spread to U.S. Treasuries Basis Points Source: “Emerging Market Debt: Coming of Age”, J.P. Morgan, 2011.

  6. …And Confidence in Developing Countries is Even Higher Credit ratings are up Average Emerging Market Credit Rating Source: “Emerging Market Debt: Coming of Age”, J.P. Morgan, 2011.

  7. However, External Debt is Much Lower… Average External Debt Percentage of GDP 1996 2009 * Excludes Hong Kong, Korea. † Excludes Korea, Saudi Arabia. Source: World Bank.

  8. …Reserves are Much Higher… Average Reserves Months of Imports 2009 1996 * Excludes Hong Kong. Source: World Bank.

  9. …And Exchange Rates are More Flexible Exchange Rate Regimes Prior to Asian Financial Crisis

  10. …And Exchange Rates are More Flexible Exchange Rate Regimes Today Note that countries with fixed exchange rate regimes have ample reserves.

  11. Where are the Trouble Spots? Framework • Domestic Imbalances • Growth • Inflation • Financial Exuberance • Stock Market • External Imbalances • Real Exchange Rate • Current Accounts OVERHEATING

  12. Domestic Balances Several countries are well above trend growth GDP Relative to 1997-2007 Trend Percent difference Source: IMF.

  13. Domestic Balances Inflation is exceeding targets in many countries Current inflation rate above midpoint of official target band Percentage points * Official target unavailable. Represents current inflation rate above 10-year average rate. Source: World Bank.

  14. Financial Exuberance Equity markets fell sharply during the crisis… Change in Stock Index Since January 2008 Percent difference Source: World Bank.

  15. Financial Exuberance …But some have rebounded well above 2008 levels Change in Stock Index Since January 2008 Percent difference Source: World Bank.

  16. External Balances Exchange rate appreciation has been large in some countries Change in Real Effective Exchange Rate Relative to 1999-2008 Average Percent change * Change from 2002-2008 average. Source: World Bank.

  17. External Balances Current accounts are expected to be persistently weaker Current Account Balance Percent of GDP Source: IMF.

  18. External Balances Current accounts are expected to be persistently weaker Current Account Balance Percent of GDP Source: IMF.

  19. Overall Assessment Clearly Overheating • Brazil • Indonesia Possibly Overheating • India • China • Argentina Not Overheating • Turkey • Korea • South Africa • Mexico

  20. But Capital Flows are Much Lower and Have Yet to Truly Recover Private Capital Flows Percent of GDP 1996 2010 * Excludes Hong Kong. † G20 emerging markets account for 81 percent of major emerging market GDP. Source: World Bank, Institute of International Finance.

  21. Rapid Growth Is Just Returning Average GDP Growth Percent Source: IMF.

  22. Emerging Market Domestic Policy • Fiscal consolidation is preferred to monetary tightening. • Earlier adjustment can allow for a soft landing. • Foreign reserve buildup is costly. • Relax capital outflow controls. • Capital controls can be used as a last resort, but are not a long-term solution.

  23. Advanced Country Policy The starting point is bad: • Massive liquidity overhang. • Advanced countries in a fiscal mess. • Banks are still fragile. • More “Global Rebalancing” unlikely Worst outcome for developing countries? • Inflation builds and sudden monetary tightening in major economies leads to rapid capital reversal, higher global interest rates, and slower global growth. As recovery consolidates: • Accelerate fiscal consolidation. • Gradually tighten monetary policy.

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