A volatile year awaits emerging economies
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.