The last few months of 2008 made it clear that emerging markets in general are not decoupled. It is excessive coupling that got us here in the first place.
To the extent that any economies are insulated from global developments, Brazil and India stand out—neither is at the epicenter of the ongoing global adjustment process. With domestic demand—not trade or foreign investment—as the mainstay of growth, and with low external financing needs, these economies are at the opposite end of the spectrum from most of emerging Asia or Europe. Both economies are in fair structural condition.
For India, cyclical (mis)management risks are mounting; with grossly loose monetary and fiscal policies, and with high and rising inflation, the risk of a repeat of the United Kingdom’s experience in the 1970s is mounting.
Brazil’s chief weakness is sharply reduced commodity prices, which feed into the real economy in a number of ways. But proactive and astute policy-making, with both monetary and fiscal policy now relatively tight, leaves ample scope for policy to lead a recovery in 2010.
Introduction: Emerging Market “Decoupling” Debunked
“Decoupling”—the buzz word for emerging market analysts just 12 months ago—has been successfully debunked. The reason we are where we are in the first place is in fact the precise opposite—extreme coupling. This is the symbiotic relationship, built over the last decade or so, between countries that rely on excess debt for consumption-led growth and countries that funnel excess savings, mainly to the United States, to keep their currencies under control for export-led growth—and coupling is the root cause of the current problem. The subprime debacle and ensuing credit crunch are the consequences.
These massive imbalances were, and still are, most visible in various economies’ current account positions—i.e. huge deficits in the “spending spree” countries, matched by large surpluses in the “savings binge” economies. These savings surpluses are shown in Figure 1. And as many emerging markets, notably in Asia (except India), are by far the biggest savers and lenders and are largely reliant on exports for growth, they lie at the core of the ongoing (and needed) adjustment process. Others, for example emerging Europe, stand at the opposite end of the spectrum, with most economies in the region heavily reliant on external financing and external demand to fuel growth. Many are also directly impacted by the banking crisis, with big chunks of private sector borrowing in foreign currencies from international banks that are now rapidly shrinking their balance sheets. So, broadly speaking, the workout of these imbalances was always going to be harsh, and “decoupling” an impossibility, at least for the bulk of the countries that fit in the emerging market universe.
But two countries stand out in this context—the “B” and the “I” in the notorious BRIC terminology, Brazil and India. This article begins by outlining why, to the extent that they are, Brazil and India are different from the countries mentioned above. Neither economy faces the “W”-shaped outcome that Lombard Street Research envisages for most economies, emerging and advanced, over the next two to three years. The medium-term economic outlook for both countries is positive, modestly more so for Brazil. But in each case this will depend on appropriate policy management, and this is considered in the individual country sections that follow.
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