A volatile year awaits emerg­ing economies

China Daily (Canada) - - COMMENT -

In 2015 de­vel­oped coun­tries’ eco­nomic growth could re­cover to the level of their po­ten­tial. The growth rate of the US could even sur­pass its po­ten­tial, sup­ported by a healthy house­hold bal­ance sheet, a tighter la­bor mar­ket, and the rise in ca­pac­ity uti­liza­tion. As for the Eu­ro­zone, although uncer­tain­ties as­so­ci­ated with the Ukraine/Rus­sian cri­sis would linger, the de­pre­ci­a­tion of the euro and the sig­nif­i­cant drop in oil prices will likely prove sup­port­ive of its eco­nomic re­cov­ery next year. In Ja­pan, the post­pone­ment of the sec­ond hike in con­sump­tion tax to April 2017 and the rad­i­cal quan­ti­ta­tive eas­ing mea­sures will prob­a­bly im­prove its growth out­look beyond ex­pec­ta­tions in 2015.

Emerg­ing mar­ket economies will likely face greater uncer­tain­ties in 2015, and their per­for­mances will also likely di­verge. Coun­tries such as Rus­sia and Brazil will face greater dif­fi­cul­ties be­cause of geopo­lit­i­cal fac­tors and the de­cline in com­mod­ity prices. Some coun­tries may ex­pe­ri­ence sig­nif­i­cant cap­i­tal out­flows due on the US rate hikes and spec­u­la­tive at­tacks from global in­vestors. On the other hand, some Asian emerg­ing economies will likely ben­e­fit from the re­cov­ery of the de­vel­oped economies, es­pe­cially the US. Turkey may be­come one of the ben­e­fi­cia­ries from the sharp de­cline in oil prices.

The Chi­nese econ­omy will face up­ward and down­ward pres­sures. A pos­i­tive fac­tor that should support China’s growth in 2015 is the ex­port sec­tor, which will ben­e­fit from the re­cov­ery of the de­vel­oped economies. Our lat­est fore­cast shows that China’s mer­chan­dize ex­port growth may ac­cel­er­ate to around 7 per­cent in 2015, up by about one per­cent­age point from 2014. On the other hand, real in­vest­ment de­cel­er­a­tion may be­come an im­por­tant drag to eco­nomic growth in 2015, as prop­erty sales (mea­sured in floor space sold for com­mod­ity hous­ing) de­clined by 7.8 per­cent be­tween Jan­uary and Oc­to­ber this year. His­tor­i­cal data shows that prop­erty in­vest­ment is largely de­ter­mined by prop­erty sales in the pre­vi­ous quarters. Our base­case fore­cast for China’s real GDP growth is that it may de­cel­er­ate to 7.1 per­cent in 2015 from around 7.4 per­cent in 2014.

An im­por­tant chal­lenge for emerg­ing economies in 2015 will be po­ten­tial cap­i­tal flight in the face of the US rate hike. If the pace of the US rate hike is more ag­gres­sive than ex­pected, sig­nif­i­cant cap­i­tal out­flows from someEM coun­tries may re­sult in high vo­latil­ity in their ex­change rate and fi­nan­cial mar­kets. For some small­erEM­mar­kets, even if the US rate hike is fully ex­pected, cur­rency volatil­i­ty­may not be avoid­able given the small size of their FX and cap­i­tal mar­kets.

To avoid ex­ces­sive short-term cross­bor­der cap­i­tal flows and their im­pact, the In­ter­na­tion­alMone­tary Fund and many EM­coun­tries have sought to de­velop a frame­work for “Cap­i­tal Flow Man­age­ment”. My viewis that this frame­work should take into ac­count at least five el­e­ments: First, Main­tain­ing healthy eco­nomic fun­da­men­tals. Coun­tries with stronger growth, in­fla­tion, fis­cal and bal­ance of pay­ments po­si­tions tend to be much less sus­cep­ti­ble to cap­i­tal flows; Sec­ond, Keep­ing macro pol­icy flex­i­ble. For ex­am­ple, in the face of cap­i­tal flows, per­mit­ting some ex­change rate ap­pre­ci­a­tion may help re­duce ex­pec­ta­tion of fur­ther ap­pre­ci­a­tion and thus con­tain­ing the in­cen­tive for ad­di­tional in­flows; Third, Adopt­ing cer­tain pru­den­tial mea­sures such as Tobin taxes or Tobin fees, un­re­mu­ner­ated re­serve re­quire­ment, caps on loanto-value ra­tios, and cap­i­tal-based lim­its on ex­ter­nal debt, when cap­i­tal in­flows are stronger than what can be han­dled by macro pol­icy re­sponses; Fourth, Strength­en­ing mul­ti­lat­eral and bi­lat­eral liq­uid­ity support mech­a­nisms. In ad­di­tion to the IMF, and re­gional mech­a­nisms such as the EU and Chi­ang­Mai Ini­tia­tives, BRICS mem­bers’ Con­tin­gency Re­serve Ar­range­ment and bi­lat­eral for­eign ex­change swap agree­ments can also in­crease the re­sources, flex­i­bil­ity and ef­fec­tive­ness of liq­uid­ity as­sis­tance; Fifth, Im­prov­ing pol­icy com­mu­ni­ca­tions be­tween is­su­ing coun­tries of in­ter­na­tional cur­ren­cies (mainly theUS) andEM­coun­tries, to help the lat­ter bet­ter pre­pare for the pos­si­ble spill-over ef­fect of pol­icy changes in ma­jor economies. The au­thor is chief economist of the re­search bureau of the Peo­ple’s Bank of China.


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