The writer is head of emerging markets economics at Citi
“American Recession Now!” It really doesn’t seem like the most obvious rallying cry for emerging economies. The fact is, however, that a US recession may well be what is needed to make room for a reliable fall in US real interest rates and a reliable weakening of the dollar.
And that easing of US monetary conditions would certainly do a good thing for emerging economies now. The recent tightening of those conditions has had some pretty dire consequences for them. It has eroded their access to international capital markets; increased the risk of debt default, especially for low-income countries; and destabilized their currencies, pushing price stability further beyond the reach of even the most savvy central bank.
The idea that capital flows will return to emerging markets after a US recession has some history behind it. Two episodes are especially worth considering: the early 1990s and the aftermath of the global financial crisis in 2008.
The United States experienced recessions beginning in 1990 and beginning in 2007 that lasted eight months and 18 months, respectively. Both episodes allowed for a significant easing of US monetary conditions, helping to trigger capital inflows to emerging economies after a period of risk aversion that was not unlike the one we have been through recently.
In 1992, for example, international capital markets provided net loans to emerging economies to the tune of about 1 percent of GDP after almost 10 years of taking money from them. By 2010, that flow had risen to 2 percent of GDP after two barren years as the Lehman crisis and its aftermath unfolded.
It must be said that both episodes ended badly: the surge in capital flows in the early 1990s came to an abrupt halt with the Tequila Crisis in Mexico in late 1994. And the post-crisis boom in capital inflows financial situation ended in a series of potholes. : A sharp sell-off in asset prices towards the end of 2011, and the “tantrum” that began in the spring of 2013 when the Federal Reserve caused market turmoil by tightening monetary policy.
It is also true that these two “boom episodes” in capital flows to developing countries were not entirely the result of an easing of US financial conditions, as other factors were at play.
Such easing is best understood as a “boost” factor for capital flows: investors want to seek higher returns from developing countries when US rates are low and when the value of the dollar is falling.
But “pull” factors are also relevant. You can think of this as the growth potential of emerging economies, the effort their policymakers put into encouraging long-term investment capital inflows, and the general confidence market participants have that “things are looking good.” good” for the developing world.
Looking back at those two historical episodes mentioned above, it is worth noting that on both occasions the “pull” factors were quite strong.
In the early 1990s, emerging markets benefited from investor enthusiasm for the proposed benefits of globalization and the effort that countries: MexicoTurkey, Thailand, and the like, were doing it to lower trade barriers, integrate into the global economy, reduce budget deficits, and reduce inflation.
Furthermore, since the early 1990s, several countries had benefited from debt reduction under the Brady initiative. Thus, emerging market balance sheets were perceived to be cleaner than in the crisis period of the 1980s.
Similarly, the post-financial crisis environment also saw a significant “pull” factor for emerging markets. Emerging economies emerged relatively unscathed from the crisis, while growth expectations were supported by China’s decision in late 2008 to launch a massive stimulus programme, revitalizing global commodity prices and trade growth. world.
The strong “pull” factors of emerging markets are hard to pinpoint these days. global trade growth is weak, disproportionately hurting developing countries. Protectionism is on the rise as geopolitical tensions threaten globalization. And there is little evidence of growth-enhancing domestic economic reforms, with exceptions like Indonesia or Vietnam.
Therefore, “push” factors are likely to be important in determining capital flows to emerging markets. The trick will be to make sure that any post-recession US boom in such flows does not turn, as in the past, into a bust.