EMD economies brac­ing for more chal­lenges

New Straits Times - - Business -

WHILE the re­cent surge in ex­ports and strength­en­ing de­mand across most economies have buoyed ex­pec­ta­tions that the global econ­omy is on an up­ward growth tra­jec­tory growth this year, the ex­ter­nal en­vi­ron­ment of emerg­ing mar­ket and de­vel­op­ing (EMD) economies is set to be­come more chal­leng­ing in the medium term. The In­ter­na­tional Mon­e­tary Fund (IMF) in its lat­est out­look pub­li­ca­tion has de­scribed it as a “less trav­elled and com­pli­cated” ex­ter­nal en­vi­ron­ment for the EMD economies.

It said EMD economies over a pe­riod of two decades had dou­bled share to more than three fourths of global growth in out­put and con­sump­tion. A large part of this catch-up can be at­trib­uted to favourable ex­ter­nal con­di­tions, cou­pled with sup­port­ive do­mes­tic poli­cies and in­sti­tu­tions that re­in­forced the ben­e­fits to growth de­rived from abroad.

Ex­ter­nal con­di­tions mat­ter Coun­tries that ex­pe­ri­enced growth spurts, de­fined as achiev­ing a real gross do­mes­tic prod­uct per capita growth of at least 3.5 per cent an­nu­ally over five years and where the trend growth is two per cent higher than the ear­lier pe­riod, have had favourable ex­ter­nal con­di­tions. Their trad­ing part­ners’ growth were strong with larger cap­i­tal in­flows, es­pe­cially com­mod­ity ex­porters, they had bet­ter terms of trade and higher export prices rel­a­tive to im­ports.

The ben­e­fits from a stronger growth of trad­ing part­ners stem from the larger mar­ket size that en­ables the ex­port­ing coun­try to achieve higher pro­duc­tiv­ity gains as­so­ci­ated with economies of scale. A larger vol­ume of cap­i­tal in­flows, mean­while, raises growth by eas­ing credit ra­tioning and re­duc­ing bor­row­ing costs while a favourable terms of trade can be likened to a wind­fall in export earn­ings. These favourable ex­ter­nal con­di­tions helped many EMD economies at var­i­ous stages of de­vel­op­ment to grow at higher rates.

The IMF study iden­ti­fied 95 growth ac­cel­er­a­tion episodes that were as­so­ci­ated with favourable ex­ter­nal con­di­tions. Like­wise, it found 125 re­ver­sal episodes re­lated to a de­cline in ex­ter­nal con­di­tions. Malaysia was iden­ti­fied to have a growth ac­cel­er­a­tion episode in 2002 as it ben­e­fited from the rapid growth of the Chi­nese econ­omy, strong com­mod­ity prices and rise in cap­i­tal in­flows.

Shifts in ex­ter­nal en­vi­ron­ment

The tail­winds from a favourable ex­ter­nal con­di­tions for EMD economies have be­gun to wane in the post-global cri­sis en­vi­ron­ment as ad­vanced economies post lower po­ten­tial growth, the Chi­nese econ­omy grows more slowly while be­ing re­bal­anced and the com­mod­ity cy­cle shifts down­wards. To­gether with the ris­ing risk of pro­tec­tion­ism in ad­vanced economies and tighter fi­nan­cial con­di­tions that will re­sult from the nor­mal­i­sa­tion of United States mon­e­tary pol­icy, the ex­ter­nal con­di­tions for EMD economies are an­tic­i­pated to turn less favourable in the medium term.

Counter to wan­ing tail­winds While the ex­ter­nal con­di­tions turn less favourable, EMD economies can still sus­tain mod­er­ate to high growth if they pur­sue the ap­pro­pri­ate pol­icy mix and create the right do­mes­tic con­di­tions. These do­mes­tic poli­cies and con­di­tions are found to in­ter­act with the ex­ter­nal en­vi­ron­ment in a re­in­forc­ing man­ner when ex­ter­nal de­mand, fi­nan­cial con­di­tions and terms of trade are favourable while damp­en­ing the neg­a­tive ef­fects to growth when the ex­ter­nal en­vi­ron­ment turns neg­a­tive.

One of the keys to coun­ter­ing the fad­ing ex­ter­nal tail­winds is to raise lo­cal fi­nan­cial depth while pur­su­ing re­gional trade and fi­nan­cial in­te­gra­tion. An­other key is to en­sure the ini­tial con­di­tions con­ducive for growth ac­cel­er­a­tions are ful­filled. These in­clude main­tain­ing low lev­els of ex­ter­nal debt and cur­rent ac­count bal­ance and build­ing stronger buf­fers to smoothen the im­pact of wors­en­ing global fi­nan­cial con­di­tions.

How gov­ern­ment can re­spond

The pol­icy frame­work pro­vides sta­bil­ity for ex­change rate and mon­e­tary and im­proves over­all pre­dictabil­ity of the eco­nomic en­vi­ron­ment, which helps to set firms and house­holds’ ex­pec­ta­tions and spend­ing in re­sponse to changes in the ex­ter­nal en­vi­ron­ment. Im­por­tantly, hav­ing larger buf­fers, fis­cal space and a flexible ex­change rate regime are help­ful in ad­just­ing to shift­ing ex­ter­nal con­di­tions and fa­cil­i­tat­ing price sig­nals to en­sure that cap­i­tal, labour and man­age­rial resources are al­lo­cated ef­fi­ciently.

Fi­nally, strong in­sti­tu­tions in­clud­ing high qual­ity of gov­er­nance, le­gal and reg­u­la­tory en­vi­ron­ment, ef­fi­cient public ser­vices and high ed­u­ca­tion level are found to con­trib­ute to bet­ter long-term growth out­comes.

Emerg­ing mar­ket and de­vel­op­ing economies can get the most out of a weaker growth im­pulse from ex­ter­nal con­di­tions by strength­en­ing in­sti­tu­tional frame­works and adopt­ing a pol­icy mix that fos­ters trade in­te­gra­tion, per­mits ex­change rate flex­i­bil­ity and en­sures that vul­ner­a­bil­i­ties stem­ming from high cur­rent ac­count deficits and ex­ter­nal debt, as well as high public debt are con­tained.

Im­pli­ca­tions for busi­nesses The stronger growth of EMD economies, to­gether with ris­ing in­fra­struc­ture needs, sug­gest that con­tin­u­ing cap­i­tal in­flows from the ad­vanced economies fac­ing pop­u­la­tion ag­ing and ex­cess sav­ings. Given that China has ac­counted for a rapidly in­creas­ing share of global de­mand, Malaysia’s ex­po­sure to China has in­creased sub­stan­tially. China’s slow­down there­fore poses chal­lenges for Malaysia and other EMD economies. Nonethe­less, the transition of the Chi­nese econ­omy from an export-driven to a con­sump­tion-based and its mov­ing up the value chain will create op­por­tu­ni­ties for Malaysian firms. They can also lever­age on the in­crease in ser­vices trade as­so­ci­ated with China’s re­bal­anc­ing and its in­creas­ing in­vest­ment abroad.

The writer is the Pro­fes­sor of Eco­nomics at Sun­way Univer­sity Busi­ness School and Di­rec­tor of Eco­nomic Stud­ies Pro­gram at Jef­frey Cheah In­sti­tute on South­east Asia at Sun­way Univer­sity. He is also an ex­ter­nal mem­ber of Bank Ne­gara Malaysia’s Mon­e­tary Pol­icy Com­mit­tee. The views ex­pressed in this ar­ti­cle are his own.

Given that China has ac­counted for a rapidly in­creas­ing share of global de­mand, Malaysia’s ex­po­sure to China has in­creased sub­stan­tially. China’s slow­down there­fore poses chal­lenges for Malaysia and other EMD economies.

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