Wed, Feb 01, 2012 - Page 9 News List

Are emerging markets due for correction soon?

By Jeffrey Frankel

Emerging markets have performed amazingly well over the past seven years. In many cases, they have far outperformed advanced industrialized countries in terms of economic growth, debt-to-GDP ratios, countercyclical fiscal policy and assessments by ratings agencies and financial markets.

As this year begins, however, investors are wondering if emerging markets may be due for a correction, triggered by a new wave of “risk off” behavior. Will China experience a hard landing? Will a decline in commodity prices hit Latin America? Will the EU’s sovereign-debt woes spread to neighbors such as Turkey?

Indeed, few believe that the rapid economic growth and high trade deficits that Turkey has experienced in recent years can be sustained. Likewise, high GDP growth rates in Brazil and Argentina over the same period could soon reverse, particularly if global commodity prices fall — not a remote prospect if the Chinese economy begins to falter or global real interest rates rise this year. China, in turn, could land hard as its real-estate bubble deflates and the country’s banks are forced to work off the bad loans.

This is not wild doom-and-gloom speculation. The World Bank has just downgraded economic forecasts for developing countries in its 2012 Global Economic Prospects, released this month. For example, Brazil’s annual GDP growth, which came to a halt in the third quarter of last year, is forecast to reach 3.4 percent this year, less than half the 7.5 percent rate recorded in 2010. Reflecting a sharp slowdown in the second half of the year in India, South Asia is slowing from a torrid six years, which included 9.1 percent growth in 2010. Regional growth is projected to decelerate further, to 5.8 percent, this year.

Three possible lines of argument — empirical, literary and causal, each admittedly tentative and tenuous — support the worry that emerging markets’ economic performance could suffer dramatically this year.

The empirical argument is simply historically based numerology: Emerging-market crises seem to come in a 15-year cycle. The international debt crisis that erupted in mid-1982 began in Mexico and then spread to the rest of Latin America and beyond. The East Asian crisis came 15 years later, hitting Thailand in mid-1997 and spreading from there to the rest of the region and beyond. We are now another 15 years down the road. So is this year the year for another emerging-markets crisis?

The hypothesis of regular boom-bust cycles is supported by longstanding academic literature, such as the writings of US economist Carmen Reinhart. However, I would appeal to an even older source: the Old Testament — in particular, the story of Joseph, who was called upon by the Pharaoh to interpret a dream about seven fat cows followed by seven skinny cows.

Joseph prophesied that there would come seven years of plenty, with abundant harvests from an overflowing Nile, followed by seven lean years, with famine resulting from drought. His forecast turned out to be accurate. Fortunately, the Pharaoh had empowered his technocratic official (Joseph) to save grain in the seven years of plenty, building up sufficient stockpiles to save the Egyptian people from starvation during the bad years. That is a valuable lesson for today’s government officials in industrialized and developing countries alike.

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