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Stephen Grenville: IMF ignores its own data on emerging economies

Christine Lagarde, managing director of the International Monetary Fund, told the Group of 20 summit in St. Petersburg last September: "Just as some advanced economies have begun to gather momentum, many emerging markets are slowing." With this warning in mind, it is instructive to consider the IMF's latest assessment of emerging market economies in its World Economic Outlook, issued just ahead of its annual meeting in Washington on April 11-13.     

     Essentially, the IMF has continued its hand-wringing rhetoric about the risks facing emerging economies. The latest WEO notes that "downside risks to growth in emerging market economies have increased even though earlier risks have partly materialized and have already resulted in downward revisions to the baseline forecasts."

     All this fretting about emerging economies does not fit either recent history or the Fund's own forecasts.     

     Emerging economies were, of course, adversely affected by the 2008 global financial crisis. They participated in the 2009-10 stimulus programs, which saw a sharp recovery in 2010. But this stimulus was not maintained, and by mid-2011, growth had fallen to levels that were substantially lower than before the crisis but more sustainable than the breakneck pace throughout the decade leading up to it. Since mid-2011, emerging economies in aggregate have maintained a stable pace of annual expansion, with minor deviations, at around 5%. The IMF forecasts this pace of growth to continue over the next two years.     

     So why the dramatic rhetoric about emerging economies slowing? Moreover, where is the handover implied by Lagarde, which would see advanced economies doing the heavy lifting in driving global growth? The IMF acknowledges in its WEO that two-thirds of forecast global growth will come from emerging economies.

     It is true that the advanced economies are doing a bit better now than in 2012, when they were growing at less than 1%.  But Europe continues to disappoint, with almost no growth in 2013 and a feeble 1.5% forecast for the next two years. Japan's 2.5%  performance in 2013 was an unsustainable aberration due to the stimulatory effect of "Abenomics", with the IMF forecasting a sub-1%   average over the next two years. The U.S. is certainly doing better than it was, but the next two years are forecast to average less than 3%, about half the rate of a typical recovery period in past decades.*

A flawed story

The IMF's narrative clearly fails to capture the reality of the past five years, while Lagarde's confidence in the advanced economies to drive future growth ignores their feeble recovery.

     Part of the problem is that the Fund was far too optimistic that the stimulus-boosted recovery of 2010 would be sustained. Thus it missed the timing of the slowdown in emerging market growth. Of course the IMF was not alone in misreading the recovery. All the international bodies, such as G-20, Organization for Economic Cooperation and Development, Bank for International Settlements and World Bank, shared this view. The policy debate was side-tracked by a sudden fixation with excessive official debt. The result has been five years of flaccid recovery, with the dynamic of recovery in the advanced economies undermined by harsh budget austerity.

     Getting the right narrative on emerging economies is now central to making sense of the prospective global growth story. As a result of a huge growth spurt in the decade before the 2008 crisis, combined with their much milder downturn during the crisis and their sustained growth since 2008, the emerging economies now account for half of global gross domestic product,  calculated on a purchasing-power basis. 

     Moreover, growing as they are at twice the rate of advanced countries. Emerging economies have accounted for three-quarters of global growth since 2009. Understanding their cyclical behavior and their likely future performance is now critical to understanding how the world economy will perform in coming years.

Capturing the nuances

The challenge for any forecaster is that these countries are disparate and their economic performance will show more year-to-year variation than advanced economies. Aggregation loses the complexity of the story.

     Let us relate this, again, to the IMF's interpretation of the past decade or so. In the current WEO, the Fund devotes a whole chapter to the impact of advanced economies on growth in emerging ones. To do this, however, the IMF averages the growth of the major emerging economies over the period since 1998 and focuses on the deviation around this average, going on to explain this deviation in terms of external or domestic factors. The fundamental difference between the unsustainable pre-2008 period and the sustainable post-2010 period is lost in this averaging process.

     A more accurate narrative goes like this: In the decade or so leading up to the 2008 crisis, there was an amazing "alignment of the planets." China continued its  development rush, channeling vast resources into government-sponsored investments while also clocking up a massive export surplus. India, dogged for decades by limitations that were summarized in the term "Hindu growth rate," turned in a performance not far behind China's. Brazil, which for decades had been the "country of the future," chronically unable to realize its potential, got its act together.

     None of this, however, was sustainable. The world was not going to allow China to continue its disruptive external imbalance, running an export surplus equal to 10% of its GDP. There was too much global saving, and China was seen as the main culprit. India and Brazil flopped back into their traditionally disappointing sub-potential growth mode. To calculate a base-line growth rate by averaging these two fundamentally different periods would lead to faulty extrapolations.

     Any sensible story about the prospects for world growth needs to start from two basic premises. First, that emerging economies now have enough heft in global growth that their future trajectories will be key not only to growth, but to global commodity prices and international trade. Second, that they are now on a sustainable growth rate, lower than the pre-2008 pace, but still twice as fast as that of advanced economies

The next chapter

Getting the China forecast right is central to getting the global forecast right. China is now bigger than Europe and accounts for half of global growth. The Fund's down-beat commentary on emerging economies is still distorted by its failure to see the shape of the China growth story over the past five years. China's days of double-digit growth came to an end in 2008, with the global crisis. Its huge credit stimulus package in 2009 -- nearly 10% of its GDP -- temporarily overrode this underlying reality, with another double-digit growth spurt in 2010. But this kind of stimulus could not be maintained, and growth slid back over the following two years to what is probably a sustainable pace, the current annual rate of 7-8%.

     But throughout this period, when the underlying pace of growth had already fallen to this sustainable rate, financial markets and gloomy commentators -- one even predicting that China would average 3% growth in the current decade -- continued to foresee further slowing. In fact, the slowing had already occurred and global growth had adapted to it.

     Of course there are risks to this "business as usual" view about China's prospective growth. China must rebalance its economy, shifting resources from investment to consumption. It must also fix the excesses of the financial sector. None of this will be easy, but China has successfully made similar transformations and corrections in the past. There is no good reason to worry more about China's ability to fix its problems than about the fragile stability of Europe, laden as it is with official debt and a banking system which is both undercapitalized and saddled with rising non-performing loans.

     What about the other big emerging economies: Do their growth prospects justify the hand-wringing? The IMF's figures, as distinct from its words, are sensible enough.  India, having survived being one of the so-called 'fragile five', is seen as achieving a robust growth rate of around 6%, not a return to double-digit growth, but the sort of performance any converging economy with competent policies should be able to achieve. Brazil has some political problems to sort out, so its below-potential forecast also makes sense.

     In short, the Fund's detailed forecasts reflect the reality that some emerging economies will underperform. Of course it makes sense to enumerate the risks to these individual countries and the general risk that the unwinding of the U.S. Federal Reserve's quantitative easing program might not be perfectly smooth. But on average, emerging economies will grow twice as fast as advanced economies. It is unlikely that advanced countries will ever again contribute more to sustained global growth than the emerging economies will. The IMF's rhetoric should reflect this.

* The figures quoted in the text and in the table are comparisons of annual fourth-quarter (4Q-on-4Q ) growth rates, which usually provide a more accurate reflection of the profile of the cycle than the commonly used year-on-year figures.

Stephen Grenville, a former deputy governor and board member of the Reserve Bank of Australia, is a visiting fellow at the Lowy Institute for International Policy in Sydney and a consultant to the IMF and other institutions on financial issues in East Asia.


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