Overheating in Emerging Markets: The Next Crisis? Uri Dadush Carnegie Endowment for International Peace February 16, 2011.

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Presentation transcript:

Overheating in Emerging Markets: The Next Crisis? Uri Dadush Carnegie Endowment for International Peace February 16, 2011

Key Points Conditions for overheating are in place. Overheating remains a largely incipient concern at present. But these are still early days and policy makers must take preemptive measures soon.

Growth Differential Between Advanced and Developing Countries Source: IMF. Average Annual GDP Growth Above Average Advanced Country Growth Percentage Points

International Interest Rates are Much Lower than in 1996… Central Bank Principal Rate Percent * 1996 rate reflects Bundesbank rate; current rate reflects that of the European Central Bank. Sources: Federal Reserve, Bank of Japan, Bank of England, Bundesbank, European Central Bank.

Sovereign bond spreads are down EMBI Global Spread to U.S. Treasuries Basis Points …And Confidence in Developing Countries is Even Higher Source: Emerging Market Debt: Coming of Age, J.P. Morgan, 2011.

Credit ratings are up Average Emerging Market Credit Rating Source: Emerging Market Debt: Coming of Age, J.P. Morgan, …And Confidence in Developing Countries is Even Higher

However, External Debt is Much Lower… Average External Debt Percentage of GDP * Excludes Hong Kong, Korea. Excludes Korea, Saudi Arabia. Source: World Bank.

…Reserves are Much Higher… Average Reserves Months of Imports * Excludes Hong Kong. Source: World Bank

…And Exchange Rates are More Flexible PeggedFloating Hong KongIndonesia MalaysiaKorea ThailandPhilippines Exchange Rate Regimes Prior to Asian Financial Crisis

…And Exchange Rates are More Flexible PeggedFloating Hong KongChinaIndonesiaArgentina MalaysiaRussiaKoreaBrazil ThailandSaudi ArabiaPhilippinesIndia Indonesia Korea Mexico South Africa Turkey Exchange Rate Regimes Today Note that countries with fixed exchange rate regimes have ample reserves.

Framework Where are the Trouble Spots? Domestic Imbalances –Growth –Inflation Financial Exuberance –Stock Market External Imbalances –Real Exchange Rate –Current Accounts OVERHEATING

Domestic Balances Several countries are well above trend growth GDP Relative to Trend Percent difference Source: IMF.

Domestic Balances Inflation is exceeding targets in many countries Current inflation rate above midpoint of official target band Percentage points * Official target unavailable. Represents current inflation rate above 10-year average rate. Source: World Bank.

Equity markets fell sharply during the crisis… Change in Stock Index Since January 2008 Percent difference Financial Exuberance Source: World Bank.

Financial Exuberance …But some have rebounded well above 2008 levels Change in Stock Index Since January 2008 Percent difference Source: World Bank.

Exchange rate appreciation has been large in some countries Change in Real Effective Exchange Rate Relative to Average Percent change External Balances * Change from average. Source: World Bank.

Current accounts are expected to be persistently weaker Current Account Balance Percent of GDP External Balances Source: IMF.

Current accounts are expected to be persistently weaker Current Account Balance Percent of GDP External Balances Source: IMF.

Overall Assessment Clearly Overheating Brazil Indonesia Possibly Overheating India China Argentina Not Overheating Turkey Korea South Africa Mexico

But Capital Flows are Much Lower and Have Yet to Truly Recover Private Capital Flows Percent of GDP * Excludes Hong Kong. G20 emerging markets account for 81 percent of major emerging market GDP. Source: World Bank, Institute of International Finance

Rapid Growth Is Just Returning Source: IMF. Average GDP Growth Percent

Emerging Market Domestic Policy Fiscal consolidation is preferred to monetary tightening. Earlier adjustment can allow for a soft landing. Foreign reserve buildup is costly. Relax capital outflow controls. Capital controls can be used as a last resort, but are not a long-term solution.

Advanced Country Policy The starting point is bad: Massive liquidity overhang. Advanced countries in a fiscal mess. Banks are still fragile. More Global Rebalancing unlikely Worst outcome for developing countries? Inflation builds and sudden monetary tightening in major economies leads to rapid capital reversal, higher global interest rates, and slower global growth. As recovery consolidates: Accelerate fiscal consolidation. Gradually tighten monetary policy.