Emerging Markets and Today’s Global Crisis
Emerging market countries—the better off among the developing nations—have gained clout and heft in the international financial system in the few months since the world’s first global financial crisis hit in September, 2008. It took the most severe economic downturn since the Great Depression to get there.
As the financial crisis worsened in the United States and spread to Europe in October, the emerging markets were invited to take a seat at the table with the big boys—the industrialized nations—that since World War II have pulled the strings in the strings in the international financial institutions (IFIs) and often dictated harsh economic measures to developing nations.
The United States and Brazil convened a special meeting of the G-20 in mid-November 2008 in Washington, D.C. to discuss the fast-moving financial distress. For the first time, all of the G-20 members were included in the debate on reforming the world’s financial system.1
Today’s financial crisis is the first international meltdown in recent history that was not triggered by market failures in the developing world. In the initial phase of the crisis, as U.S. banks began to collapse and recession began to take hold in industrialized nations, the heavy hitters among the developing nations were seen as part of the solution for the weakening global economy. Since the Asian and Russian crises of 1997 and 1998, most large emerging economies made a turnaround that put their public finances in order, reformed rules to attract foreign investment, expanded their export trade and boosted their growth rates to levels that created a growing class of consumers among their citizens.
These policies made the countries solvent, and their economies grew so big that they became players in world markets. Most developing nations were running a budget surplus when the crisis struck in September, and across the developing world leaders could boast of having strong, solvent banking systems. In January 2009, China overtook Germany to become the third largest economy in the world. Together, the BRIC countries held 41 percent of worldwide foreign exchange reserves last November.2
With recession hitting the United States and Europe, World Bank economist Justin Lin predicted in November, 2008, that “in the next year, developing countries could account for all of the world’s GDP growth.” Consumers in the still-growing economies of Brazil, Russia, Indian and China (known as “BRIC” countries) are “going to rescue the world,” Jim O’Neill, the Goldman Sachs Group economist who identified those nations as future dynamos for the world economy, said in December 2008.
By January, the outlook for large emerging economies had worsened. Although the BRICs are expected to grow this year, they will also take the biggest falls. In China, growth is to slip to 6 percent from 9 percent, in Brazil growth will drop to 2 percent or less from 5 percent. In Mexico, which is heavily dependent on trade with the United States, growth this year will be zero or perhaps negative.
The financial crisis soon spawned an economic crisis. Banks reduced lending to corporations and cut back on trade lines that finance international trade valued at $14 trillion annually. Production began to slow worldwide, and prices of commodities that lead exports in many developing nations were slashed.3
As markets shrank, production began to decline, and the new phase of the global slowdown—the social crisis—began. Mining companies, electronics, toy and clothing manufacturers and builders began letting workers go from late 2008. Unemployment is expected to rise this year in industrialized countries and in emerging nations as well. The large youth population in developing economies means that robust growth—above four percent or more—is needed simply to employ new workers that enter the labor force each year.
To prevent slipping into recession and to head off social unrest, governments are launching economic stimulus plans. IFIs promptly made more lending available on more flexible terms and with rapid disbursements.
China’s two-year $586-billion stimulus package, announced Nov. 9, 2008, led the way. The funds (equivalent to about 7 percent of GDP) will finance new transportation infrastructure and reconstruction of towns flattened by the 2008 earthquake. The huge package would create jobs and allow consumer spending and signals markets that investment will flow into the economy.
Public spending, heavily focused on construction of infrastructure, is becoming the favored prescription for emerging and developing countries to maintain employment and consumer purchasing power. Economic stimulus packages have been launched in Brazil, Mexico and South Korea. These countries can afford to increase public spending, thanks to recent budget surpluses and low debt-to-GDP ratios that make it viable for them to run a deficit.
Developing countries that cannot afford deficit spending face the twin maladies of recession and social unrest. World Bank President Robert Zoellick in January encouraged the G-20 to decide at its April, 2009, meeting to back a “Vulnerability Fund” for poorer countries to finance social programs, invest in infrastructure and lend to small and medium businesses.
Ultimately, some countries may see political crises. Where elections and referendums are to be held, a shrinking economy, rising unemployment and closed-off social mobility will most likely weaken incumbent politicians and, where conservatives are in power, could favor populist leaders.
International financial institutions (IFIs) have regained relevance and perhaps credibility that was deeply eroded by the 1997-98 Asia crisis. The International Monetary Fund, World Bank and regional banks like the Inter-American Development Bank (IDB) have been quick to make new commitments of funds.
By January, the IMF had loaned out $47.9 billion to hard-hit countriesand was preparing a precautionary loan for El Salvador and negotiating with Turkey.4
The World Bank is pledged to expand lending for middle-income countries by $100 billion through 2011, and will expedite $42 billion of grants and interest-free loans to the poorest countries.
The IDB joined forces with the Andean Development Corporation and the Fund of Latin American Reserves to open up a $9.3-billion liquidity line offering short-term financing, and the three institutions pledged to boost their program lending in 2009 to a record $30 billion, combined, for government projects, social programs, banking systems and balance-of-payments support. The liquidity lending is innovative because it does not require that a country have an agreement with the IMF and carries no policy conditions.
Might the IFIs offer a cure for the crisis and would the funds be enough? IMF Managing Director Dominique Strauss-Kahn cast gloomy warnings for 2009 in late January. IMF resources could run out as the crisis grinds on, he suggested. The $250 billion available at the onset of the crisis, plus an additional $100 billion offered by Japan, could be exhausted. It may take an additional $150 billion to see the emerging markets and low-income countries through the great recession of 2009, Strauss-Kahn has said.
- The G-20 includes the G-7 industrialized nations plus Russia plus Argentina, Australia, Brazil, China, India, Indonesia, Mexico, Saudi Arabia, South Africa, South Korea and Turkey. (Actually, there are only 19 members, but by convention the group is called G-20).
- International reserve holdings in the BRICs in November 2008 were: China: $1.9 trillion, Russia: $484 billion; India: more than $300 billion; Brazil: $208 billion.
- For example, in 2008, the prices of crude oil, copper, zinc and nickel fell by more than 50 percent, coffee and soy fell by more than 17 percent.
IMF lending by January 2009 went to Belarus, Hungary, Iceland, Latvia, Pakistan, Serbia and Ukraine.