Impact on Emerging Markets

One of the biggest stories to emerge from the G-20 Summit was the seating arrangement: Lula da Silva of Brazil was on George Bush's right and Hu Jintao of China was on his left. This has repeatedly been said to signal the new international economic order. Immanuel Wallerstein, for example, argues that American political and economic power peaked between 1945 and 1970 and has been declining since. He contends that George Bush's eight years in office hastened that decline, and Brazil's insistence over the weekend on being partners with the US, not mere junior parters, evidences a new multipolar world system.

Yet, assertions of the new multipolarity does not mean emerging economies will be resistant to financial or economic contagion. How will countries be affected? First, stock market spillovers are quite clear. We've seen the MSCI emerging market index (which includes stock markets in Brazil, South Africa, India and China) drop precipitously by 23%. Just as important now it seems is the growing global economic downturn. RGE monitor reports that growth in nine of the largest emerging Asian economies was revised downward. According to the Asian Development Bank, India's growth will fall sharply.

Developing countries are impacted in a number of different ways. Trade, especially in natural resources will slow following drops in demand. Remittances, the second largest financial inflow to many developing countries (exceeding foreign aid) will decline as both economic migration to developed countries declines with job losses and the quantity per remittance drops. Foreign aid, which is pro-cyclical, will suffer along with bad economic news, though development aid has been in secular decline already for two decades. While falling capital flows into developing countries may adversely affect some, for others it may ease pressure on climbing exchange rates and allow for greater internal capital mobilization.

Countries strongly affected will be those with substantial exports to the US and EU, especially those countries selling commodities that are highly income elastic--that is commodities particularly sensitive to changes in income--including, for example, Caribbean and African countries with big tourism sectors. Countries with substantial current account deficits (a macroeconomic account which includes a country's balance of trade, or their exports minus imports, plus their net on interest, dividends and foreign aid) may be in trouble. RGE monitor notes that South Africa's current account deficit (at 7.3% of GDP) has been widening and the country will be less able to finance it with foreign investment, making possible sudden and large capital outflows.

However, despite these turbulent times for the developing world, this crisis is unusual in that it is a crisis in the core. Merrill Lynch's Emerging Markets Macro Weekly from November 10th did an old school country by country risk analysis, which seems to strongly support this view. They crunched about 5000 economic indicators and built a risk ranking for the world (based on current account financing gaps, foreign exchange reserves, exports to GDP ratios, private credit to GDP ratios, private credit growth, loans to deposits ratios, and bank capital to assets ratios). Their results are pretty interesting, and if anything may support Wallerstein's faith in the new multipolarity. They conclude:

The world’s ten most vulnerable economies are: Australia, Switzerland, Korea, Romania, Hungary, Sweden, Bulgaria, Euro area, UK and US. The world’s ten least vulnerable economies are Nigeria, Mexico, Philipinnes, Colombia, Egypt, Oman, Indonesia, Peru, China and Russia.