Can Investors Bet on a Broad Emerging Markets Recovery?

Can Investors Bet on a Broad Emerging Markets Recovery

  • Following the 2008 financial crisis, emerging economies rebounded. But since 2011 things have changed.
  • Emerging economies are now richer than ever. And while these countries still have an opportunity to grow in the future, their growth rates are likely to be slower than in the past. 
  • As advanced economies recover and their monetary policies return to more conventional policies, further weakness in emerging markets’ equities and bond markets is expected.

During the global financial crisis the world economy stabilized thanks to vibrant emerging markets. Now, emerging economies are weakened by slower growth, rising financial vulnerabilities, and outflow of capital attracted by higher interest rates in the U.S.

What happened after the financial crisis?
Following the 2008 financial crisis, emerging economies rebounded. But since 2011 things have changed. In 2013 growth was 4.5 percent, compared with 6.5 percent two years earlier. Except for Arica, all emerging market regions were marked by some form of economic slowdown. These were the growth rates of the following areas in 2013 : Russia (1.5%), developing Asia (6.5%), Latin America (2.6%), MENA (2.4%), and Central and Eastern Europe (2.5%).
Emerging economies are now richer than ever. And while these countries still have an opportunity to grow in the future, their growth rates are likely to be slower than in the past. This is normal when a country’s catching-up process succeeds in raising its per capita income and its economy approaches a steady state. For example, Chinese GDP per capita tripled in a decade. At 7.5% in 2013 and 7.3% in 2014, China’s growth is lower than during the past decade, but it remains strong for a country where the GDP per capita is about to reach $10,000 this year.
The problem is that Chinese growth is unbalanced. China’s economy continues to rely on high investment and too much credit. In contrast, consumption is weak; it only represents 35% of the GDP. This low level of consumption reflects the macroeconomic challenges faced by the world’s second largest economy—as it redistributes income in a way that enables sustainable growth—and a larger middle class that benefits the economy by enabling more people to be consumers.
In other emerging and developing countries the problem is reversed. Consumption is too dynamic compared to production capacities, and growth is blocked by supply constraints and a lack of investment. Thus, in places like India, Brazil, Turkey, Indonesia, and South Africa current account deficits have widened to alarming levels .
These external imbalances in emerging countries indicate a contradiction between the aspirations of a growing and educated middle class—looking for more consumption—and production whose development is impeded by the lack of investment and inefficiency of the administration. Lately, these contradictions have resulted in growing political tensions (in Brazil, Turkey, and Ukraine) and increased financial fragility.
Countries with high external deficits are usually vulnerable to unexpected monetary shocks, leading to capital outflows. When the U.S. Federal Reserve hinted at its intention to put an end to its accommodative monetary policy last summer, many emerging markets—particularly those with weak fundamentals—experienced strong reversals of capital inflows as investors reacted to the expected “tempering” by reducing their investments in riskier assets (including the assets of emerging markets).
What to expect?
Renewed troubles and retrenchments of capital flows have certainly not led to a new financial crisis, and none of the emerging countries have defaulted on their debt or called for the IMF’s support (which was often the case in the 1990s).
Whereas this is a strong sign that emerging economies have become stronger, the cost of external financing for these countries increased, their currencies depreciated, and their monetary authorities had to raise interest rates (to contain inflationary pressures). All the same, equities and bond markets dropped.
Fighting inflation and preventing a currency from depreciating require tighter monetary policies. But this hampers domestic demand and weakens growth. Moreover, currency depreciations aggravate public deficits and create the sentiment that emerging countries are less able to service their debts denominated in foreign currencies.
As advanced economies recover and their monetary policies return to more conventional policies, further weakness in emerging markets’ equities and bond markets is expected. Emerging markets will face challenging headwinds this year.

The article is written by Dr. Charbel Cordahi for Arab Business Review

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The Dutch Disease that plagues Rentier Iraq

The Dutch Disease that plagues Rentier Iraq

 

  • Some of the symptoms of Dutch disease are that it creates very rich countries but poor citizens, and high financial revenues with few job opportunities.
  • Oil export increase raises the value of the local currency but it makes the national industry less competitive with goods of other countries.
  • To worsen the situation, the government of oil-producing country is not linked to citizens as it does not need them, because it receives its vast resources from oil industry. 
  • Getting rid of the resource curse that has hit the economy of Iraq and infected its political system requires several solutions including the diversification of the country’s exports to be free of the single-source economy, which depends on oil. 

Iraq seems to be hit by many curses. Among those, the most serious is the resource curse, or what is so called (Dutch Disease).

This word was first used as a term in 1977 and can be defined as a set of negative effects that badly influence the establishment of proper economy. Some of the symptoms of Dutch disease are that it creates very rich countries but poor citizens.

It also provides greater financial revenues with few job opportunities. That’s applied in Iraq. This disease has previously struck other countries in addition to Netherlands, such as Spain, Australia and Nigeria.

Oil export increase raises the value of the local currency but it makes the national industry less competitive with goods of other countries. On the other hand, the oil market is unstable with volatile prices. Also this industry is one of those, which doesn’t absorb unemployment, requires intensive and immense capital and labor at professional level of skills.

Perhaps the most serious symptoms of Dutch disease are those related to the side effects of the disease, as the crisis transit from the field of economics to the field of political practice. Rentier states and those countries, whose economy depends entirely on oil, suffer from some governments that give all their efforts to the perpetuation of the existing political regime at the expense of the fundamental goals of the state.

In addition to this, the government of oil-producing country is not linked to citizens as it does not need him, because it receives its vast resources from oil industry. When citizens do not pay taxes, they have that feeling of separation along with their government, especially when the state/ Government turned into a shop that sells oil.

The government, then, is not afraid of citizen accountability, because citizen does not supply the country’s economy. Thereof, it is reflected in the political performance of the governments of such Rentier states. That actually leads to a political climate in which the authoritarian tendencies and dictatorial aspects are vivid in addition to mating between wealth and power.

So Dutch disease contributes to the creation of a more centralized state, through which the government spending is doubled. Moreover, it makes the citizen’s capability of formulation of public policies shrinks and that generates an atmosphere of discontent among those who are marginalized- the people, and helps the government to enhance its repressive means to keep the situation unchanged. This situation has plagued Iraq since several decades when oil was discovered. Current and previous governments of Iraq have abused the oil fortunes to create regimes and to ensure their stay in power as long as possible. These governments are used to distributing donations to those who are close and loyal to them neglecting the vast majority who is getting crumbs in their rich country.

Although the new political system in Iraq, after the fall of the former regime, is based on a democratic basis and a constitution, which guarantees the independence of the three powers (Legislative, Executive and Judiciary) and allow those powers to derive their legitimacy from the people as the source for all authorities, influential political blocs are formed. Those blocs collected fortunes through their political status, and acquired huge privileges concerning oil, as well as the exploitation of public money in the purchase of consciences especially in the election season to get the votes of the electorates, in addition to widespread administrative and financial corruption.

Getting rid of the resource curse that has hit the economy of Iraq and infected its political system requires several solutions including the diversification of the country’s exports to be free of the single-source economy, which depends on oil. It also requires a policy of decentralization in the organization of the oil industry and the applying the principle of transparency in handling this industry, in addition to the establishment of an oil fund that ensures a fair distribution of oil profits to the citizens along with developing a tax system in order to re- link the citizens to their government.

The article is written by Falah Mousa for Arab Business Review

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