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Emerging markets won’t be able to trade out of the current slowdown

First published: The Times, 3/10/2015

The curtain-raiser to next week’s probably sombre economic mood at the annual October IMF meetings in Lima, Peru was the announcement a few days ago by the World Trade Organisation of yet another downward revision to world trade growth. The change, from 3.3 to 2.8 per cent, was not unexpected and may not be the last downgrade. The relationship between world trade and world GDP growth has broken down, and the principal losers from this phenomenon are emerging and developing countries.

From about 1990 until the financial crisis in 2007-08, world trade grew at a little more than twice the rate of world GDP. These years witnessed the last broadly successful attempts at trade liberalisation, and a surge in the intensity of globalisation of both finance and direct investment. China arrived at the centre of the global trading and economic system in spectacular fashion, and a swathe of emerging countries, including those in the former Soviet bloc, China, India, Brazil, Turkey, and several in Sub-Sahara Africa opened up and introduced wide ranging economic reforms.

We look back at those gung-ho years and wonder about the aberration that is today, because since 2008, world trade has grown more slowly than world GDP. More realistically, though, those years were the aberration, and it seems very unlikely that they will return. Too much has changed.

Globalisation may not have stalled but there’s no question that its intensity has faltered. The capacity in many major emerging countries to implement economic reforms and boost local demand has withered as the need has increased. In advanced Western economies, consumers have become more sober, and deleveraging remains a work in progress. And the impact of China on the world could not be more different. The economic slowdown will last for some years, and China’s own deleveraging has barely begun; the structure of growth is already significantly less commodity-intensive, especially for the mining and metal sectors; and as Chinese companies have evolved, the share of imports of parts and components in Chinese exports has roughly halved over the last decade to about 35%.

With world trade in a funk, the effects on growth will be felt far and wide. Japanese and German companies exporting vehicles and capital goods, for example, to debt-laden emerging countries, or those in recession, such as Brazil and Russia, will suffer. By and large, though, the US and EU are not likely to be nearly as badly affected as a broad swathe of emerging and developing countries that are more bound up in and dependent on trade. Emerging and developing country imports amount to about $8 trillion, the equivalent of just over 10 per cent of world GDP, and over 40 per cent of world imports. These orders of magnitude are about  three times larger than for imports into the US and from outside to inside the EU.

Moreover, the economic effects of stagnant trade on emerging counties has been aggravated by the sharp rise in the US dollar, now in the third year of a bull market that shows no sign of ending yet. It has risen by between 10-25 per cent this year against major emerging currencies, other than the Yuan, and by between 10-50 per cent over the last 3 years. On yet closer examination, three further themes emerge.

First, although external debt and fiscal risk indicators for most countries are elevated, they are still some way off the dangerous levels reached before the Asia crisis in 1995. Yet all is not well. Collapsing trade is only one of several conditions to have triggered a growth crisis. Aside from over-reliance on exports, other factors include the neglect of domestic demand, a failure to implement timely reforms, weak institutions, political volatility and the consequences of over-indebtedness. The last of these in particular has been singled out by the IMF as a key financial stability risk, specifically arising from the 4-fold rise in non-financial corporate debt over the last decade to $18 trillion – much of it in bonds and in US dollars – and the doubling of the ratio of debt to equity.

Second, although the slump in trade is universal, the effects on economic growth and currency depreciation have differed markedly comparing mainly manufacturing- with predominantly commodity exporting emerging countries. The latter have come off substantially worse, suggesting that the accentuated commodity cycle may be having an especially negative impact on world trade and growth patterns.

Third, China’s central role in the emerging market predicament isn’t going fade any time soon. Slower and less investment-intensive growth means weaker commodity imports and prices. Over-capacity in real estate and in heavy industry, and the reluctance to accept defaults means that construction and investment will remain on the rack for the foreseeable future, along with exports, profits and GDP.

Fortunately, Chinese households haven’t buckled, the broader economy is certainly not in a state of collapse, and it is most unlikely to trigger a global recession. Few would have anticipated that the global economy’s well-being would depend on the steady, if unspectacular, growth in the US and the EU. Long may it continue, because the new ‘crisis’ in emerging markets is one they have to solve at home. They can’t trade their way out.