Risk of ‘lost decade’ for emerging economies

As the status quo of economies gradually emerges after the pandemic, the risk of a “lost decade” – the term for a period of slow growth, in the face of financial crises and social unrest – with emerging countries is increasingly evident.

Emerging economies, which had hoped to rise into the ranks of the rich, have faced successive setbacks in recent years. Over the past three years, for the first time since the 1980s, more than half of the population of emerging economies has grown in income – measured in purchasing power parity – below that of the US.

The IMF forecasts economic output in emerging markets will grow 3.8% this year and 4.4% in 2023. These are numbers that were heavily revised down last year and below averages. 5% annually in the decade before Covid-19 emerged.

In fact, emerging economies have been through such tough times before. During the 1960s and 1970s, they enjoyed a period of relative prosperity, bringing with them optimism and prospects. But after that good period came what New York University economics professor William Easterly describes as “lost decades,” in the 1980s and 1990s.

In the 10 years to 1990, the average of annual GDP per capita growth in emerging economies fell below zero. And it was not until the late 1990s and on that the boom re-emerged, lighting up again. new hope.

Recently, however, the crisis pendulum has returned. Emerging markets face structural obstacles, such as financial challenges and changing trade patterns, reminiscent of the obstacles they faced in the 1980s and 1990s.

Financial pressure is the most serious threat. In the early 1980s, the US Federal Reserve (Fed) raised interest rates significantly to curb inflation. For the poorer economies, which had been usury in previous years, the fiscal tightening in the US and the subsequent strengthening of the dollar was overwhelming. So the waves of debt and banking crises hit them.

Some of those scenarios are similar today. Emerging countries’ share of both public and private debt to GDP rose steadily in the 2010s, and spiked during the pandemic. Public debt ratios in middle-income economies are now at record highs, and indebtedness in the poorest countries has risen to levels similar to those seen in the 1990s.

Of the world’s 70 low-income countries, more than 10%, including Chad and Somalia, are already facing unsustainable debt. While another 50%, including Ethiopia and Laos, are at high risk of entering that state, according to the World Bank. A decade ago, only about a third of poor countries were or were at high risk of falling into such poverty.

The Ukraine crisis has increased the cost of food and energy. Wheat and oil are both about 50% more expensive than they were a year ago. For importing countries, this increases the cost of food and energy subsidies, depletes foreign currency reserves and weighs on economic growth.

Rising prices also added pressure on central banks in rich countries around the world to tighten monetary policy. Investors expect the Fed to raise its key rate by nearly 3 percentage points in 2022. That would be the biggest one-year rate hike since the early 1990s. Along with the move to shrink the balance sheet. In terms of accounting, this year’s Fed tightening could be the strongest since the 1980s.

These moves are putting enormous pressure on vulnerable emerging economies. Capital flows back to the US to take advantage of the higher exchange rate. The dollar is also strengthening – having gained more than 10% in the past year. Costs in the emerging world therefore rise. Yields on local currency debt in emerging economies on average have risen by more than a third since last summer.

According to the IMF, the share of bond issuers experiencing payment problems has more than doubled. They include such as Ukraine, Egypt and Ghana. Many countries are likely to follow in the footsteps of Sri Lanka, which defaulted on April 12.

However, systemic crises can still be avoided, which have characterized the previous lost decades. For example, many middle-income economies have increased their financial hedging by increasing their foreign exchange reserves. Investors have also become more discerning.

Instead, the bigger worry is that the debt burden will hurt growth. Because, it will be harder for governments to cut taxes and limit resources to invest in education and infrastructure. Local banks, which already lend money to the government, may be reluctant to finance private borrowers if the bonds they hold depreciate. Domestic government debt now accounts for about 17% of bank assets in emerging economies, up from 13% in the early 2010s, and much higher than the 7.5% average in rich countries.

Another challenge comes from global trade. The business of emerging economies has also sunk in the past. Between 1960 and 1980, the share of goods trade in GDP in these countries doubled, from 9% to 18%. But when the lost decades came, share growth stalled.

Trade then spiked again as global supply chains expanded across East and Southeast Asia in particular. But that association is once again at risk. Geopolitical tensions, the tendency of countries to become self-sufficient and concerns about the reliability of supply chains can affect trade. All of this reduces the opportunity for poor countries to borrow technology and know-how from foreign companies, and to sell to the rich world.

The global economy will also be influenced by the largest emerging market and also the world’s main growth engine: China. Between 1970 and 2000, the Americas and Europe accounted for nearly half of global GDP growth. Growth in rich countries began to decline sharply in the 1970s, thus weighing heavily on the global economy as well as in emerging economies.

However, in the 2000s, the world economy had a chance to boom again as China contributed more to global growth than the US and Europe combined. China’s GDP now decelerating, with growth of about 5% this year, will not cause the global economy to stagnate. However, the blockade, the real estate market cooled can still cause great damage.

Several emerging markets could benefit. Companies wary of reliance on China may be able to shift production elsewhere at low costs. Rich countries hope to prevent poorer countries from drawing closer to Russia, and China can lower trade barriers and increase investment abroad. Persistently high commodity prices will boost revenue for food, energy and metals exporters.

However, on the whole, the higher debts, combined with the ineffective investment in human and physical capital over the years, will take a heavy toll. The IMF forecasts that the GDP of all emerging economies by the end of 2024 will still be about 6% below pre-pandemic levels. Meanwhile, the GDP of most rich countries is expected to be less than 1% lower.

Session An (According to The Economist)