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The retreat of the emerging nations

The retreat of the emerging nations

Jitters on the world economy hamper Fed’s task

by David Marsh

Mon 9 Sep 2013

The sharp deterioration in emerging market economies over the summer, weakening one of the main economic props for export-oriented nations like Germany, lowered international growth prospects just at the time when confidence was starting to ripple back around the world.

Only five months ago, Christine Lagarde, managing director of the International Monetary Fund (IMF), spoke of a three-speed global recovery. The emerging world was in the vanguard. The US was picking up steam. And the euro area remained becalmed.

In the meantime, belief in emerging markets' resilience has proven flawed, confirming some senior central bankers' belief in the early summer that budgetary and current account imbalances in these countries were storing up problems for the future.

Strong hints of reductions in the Federal Reserve’s liquidity injections, coupled with greater attention given to hitherto-neglected imbalances in many emerging market nations, have generated an abrupt change in sentiment. The combination has been sufficient to spark sharp falls in currencies and steep rises in capital market interest rates.  Talk of US 'tapering' seems to have severely tapered growth perspectives in nations ranging from Brazil to Turkey.

As leading officials from the developing world concur, unconventional monetary policies in most of the developed economies in the last few years lulled the emerging markets into the illusion that deficits could be financed without pain. Now they know better. There are undeniable parallels with the deterioration of peripheral euro countries' investment credibility that sparked the European sovereign debt crisis.

The IMF has now carried out its own U-turn, admitting in a report ahead of last week’s G20 summit in St Petersburg that world economic momentum was now coming mainly from advanced economies. However, in the euro area at least, the position doesn’t appear that rosy. Mario Draghi, European Central Bank president, expressed extreme caution about the recovery last week.

The Paris-based Organisation for Economic Cooperation and Development (OECD) has joined in the sobriety. Last week it stated that worse prospects in many emerging economies — where it highlighted 'significant market instability, rising financing costs, capital outflows and currency depreciations' — offset a better outlook in the US, Europe and Japan.

In its overall world view, the OECD now sees Britain heading growth among the advanced countries. Britain’s growth in the third quarter of 2013 is put at 3.7% at an annualised rate, against 2.6% in the US, 2.5% in Japan, 2.3% in Germany, 1.4% in France and a contraction of 0.4% in Italy.

The euro area crisis is far from over. The OECD says it 'remains vulnerable to renewed financial, banking and sovereign debt tensions.' A prolonged growth downturn in emerging market countries would lower these prospects further. In the on-off debate on winding down quantitative easing, the new round of jitters on  the world economy makes the Fed’s task still more complicated as it prepares a decision in coming weeks.

David Marsh is chairman of OMFIF.

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