World News /29 Aug 2019
08.29.19

Unstable Global Economy Makes Investors Flee Emerging Markets

The World Bank reports that the pace of global economic growth reached its lowest level in three years. Large emerging markets failed to attain expected levels of international trade and investment, despite forecasted growth in these markets for 2020.

Additionally, the UN Conference on Trade and Development reported a fall in overall global flows of foreign direct investment (FDI). The funds amounted to $1.3 trillion, which is the worst level since the last global financial crisis in 2008.

In response, The Guardian reports that world leaders expressed concerns for the global economy during the G20 Summit in Osaka that took place in June. These leaders pressed Xi Jinping, President of the People’s Republic of China, and United States President Donald Trump to finalize a trade deal, given that trade tensions between these two countries have a significant impact on the global economy.

With a weaker global economy, the outlook for large emerging markets, including China, Brazil, Russia, and India has worsened.

For example, Chinese economic data from June reinforced the evidence of a domestic slowdown, according to the Wall Street Journal. The statistics on industrial output and investment almost violate the government’s 6 percent bottom line for growth. Larry Hu, an economist at Macquarie Group in Hong Kong, said: “It seems like all of China’s economic drivers are losing steam, from exports to property.” Mr. Hu also noted that previous stimulus measures did not increase infrastructure investment.

Consequently, China’s economic growth will most likely decrease in coming years, according to the South China Morning Post. Fitch Ratings, a global rating agency, forecasted a slowdown in China’s growth from 6.2 percent this year to 5.8 percent in 2021. The agency also suggested that the Chinese banking system lacks the ability to provide lending at a scale that would boost economic growth.

This 6.2 percent figure, reported by China in mid-July as its second-quarter growth, represents the slowest year-to-year quarterly growth rate in the past 27 years, according to CNBC. With already concerning debt levels, if China continues to use debt to provide economic stimulus as it did in the past, its debt will become even worse.

Foreign Affairs reports that other factors also serve as indicators of a slowdown. An aging population, lower birth rate, slowing global economy, and rising wages also challenge the Chinese economy. Together, these factors hinder Beijing’s ability to maintain steady growth rates.

Ultimately, this Chinese slowdown weakens the global economy, according to the New York Times. Countries like Germany and Australia now show signs of weakness due to increasing supply chain costs, decreasing exports, and geopolitical risk. Many multinational companies are postponing capital spending due to U.S. tariffs on Chinese goods.

Brazil, another large emerging market, serves as another example of lower growth expectations, according to the BBC. Even though a Bloomberg poll from last year classified Brazil as one of the top bets for foreign exchange, stocks, and bonds, the country’s fiscal deficit hampers economic growth and increases pressure for liberal reforms.

Nonetheless, the vote from the lower house of Congress in favor of pension reform recently raised investors’ confidence according to the Financial Times. This bill would give the Brazilian government a total savings of roughly $250 billion in the next ten years through the increase in the minimum retirement age and other rules that are more demanding for retirement. If Congress approves this legislation, the next step for investors would be tax reform.

Bloomberg reports that Brazil’s pension funds are one of the major factors responsible for the country’s unsustainable public debt levels. Without change, Brazil will not be able to grow to the levels that the market would expect. Thus, the reform would likely open the door for new changes, including a possible interest rate cut.

Reuters reports that despite optimism surrounding pension reform, many economists attest that this reform alone cannot generate growth. Issues like a high unemployment rate and low consumer confidence remain. William Jackson, a chief emerging markets economist at Capital Economics, stated that while pension reform is important, “Many of the other factors that are holding back growth in Brazil are unlikely to fade any time soon.”

Yet, the recent free trade agreement between Mercosur and the European Union may provide Brazil some relief. According to the Rio Times, the agreement will increase Brazil’s gross domestic product by $87.5 billion and expand foreign investment in Brazil by $113 billion over the next 15 years.

In addition, Brazilian industrial products will become more competitive in Europe as these products will no longer face EU tariffs. However, agricultural products like ethanol, sugar, and meat will face import quotas.

Meanwhile, Russians have begun to express dissatisfaction with their economy according to The Moscow Times. Alexei Kudrin, head of the Russian Chamber, admitted that Russia suffers from falling living standards and widespread poverty. “We are in a state of economic stagnation that doesn’t lend itself to optimism,” he stated.

Nevertheless, real GDP growth exceeded expectations in 2018, according to the Russia Economic Report from the World Bank. The report forecasted growth of 1.2 percent in 2019 but cited risks for medium-term growth such as the possibility of harsher economic sanctions, lower oil prices, and the financial instability in other emerging markets.

To counter these risks, Russian President Vladimir Putin signed a decree in May 2018 to modernize the economy, according to the Global Times. The decree hopes to transform Russia into one of the top five economies in the world by 2024 through structural changes and investment in technology. In a live call-in session, Mr. Putin suggested that Russia needs to strengthen its economy to ensure its status as a global power.

However, if Russia decides to increase its expenditure on foreign policy goals so that it can claim global power status, there will be less funding for domestic changes and investments that can create growth. TASS, a Russian news agency, reports that Russian Prime Minister Dmitry Medvedev recently endorsed efforts to boost economic growth. During a national development goals meeting, the prime minister stated that while external factors slowed the economy, the government must take actions to reduce these risks so that Russia’s growth can exceed the global average.

However, the country may lack FDI that can sponsor growth. Russia Matters, a research project conducted by Harvard Kennedy School’s Belfer Center for Science and International Affairs, reported that after Russia’s annexation of Crimea in 2014, FDI dropped to $8.8 billion in 2018 due primarily to fewer investments from Western countries.

The research also mentions that despite strong trade ties with Russia, China is not investing enough to balance the lack of western funds. Consequently, unless there are major policy changes and more protections for investors, Russia will likely see even less FDI.

In the meantime, India may have the brightest outlook of all emerging markets. Although the International Monetary Fund (IMF) reduced India’s growth expectations for the next three years due to “softer underlying momentum,” the institution presumes that India will remain the fastest-growing economy in the world with a 7.3 percent real GDP growth, reports the Economic Times.

Nevertheless, India failed to reach its expected real GDP growth for the first quarter of 2019. According to Trading Economics, India’s real GDP growth grew only 5.8 percent until last March. For this first quarter, the market expected growth of 6.3 percent.

Additionally, there are other important concerns for the Indian economy. While the United Nations forecasted India’s population will outgrow China’s by 2024, the country struggles with jobless growth, a macroeconomic circumstance in which a high unemployment rate accompanies growth. In fact, the unemployment rate in India recently reached a 45-year record high.

Consequently, an IMF article recommended labor market reforms to keep the economy growing. India has a growing working-age population that represents two-thirds of the total population but its per capita income is far lower than other large emerging markets, including China, Brazil, and Russia. As such, the government should eliminate outdated and restrictive labor laws so it can increase the female labor force participation and stimulate formal employment.

In response to these pressures, India outlined plans to meet its goal to become a $5 trillion economy, reports the Voice of America. Indian Finance Minister Nirmala Sitharaman emphasized the need to invest in infrastructure, technology, and job creation. As the economy loses momentum, the government seeks to create growth with a model similar to China’s: more investment, savings, and exports.

Ultimately, emerging markets’ common challenges can slow the global economy, according to a report from the Global Economic Prospects. The report makes a warning against significant increases in government debt in these markets.

Last year, the debt-to-GDP ratio for these economies was 51 percent of GDP on average. While low global interest rates soften the risk of debt, the World Bank recommended a balance between using these lower rates and avoiding too much debt.

Moreover, the report predicts that investment in emerging markets for the next three years will continue to reach the lowest levels ever recorded. Under these circumstances, the World Bank expects limited growth and more difficulties in the path to reach the UN’s Sustainable Development Goals.

How can emerging markets respond to these challenges? The IMF’s World Economic Outlook suggested that fiscal policy should reduce debt levels and that government spending should prioritize infrastructure and social purposes. Additionally, macroeconomic policies should provide capital and liquidity in order to offset possible changes in global portfolios.

Meanwhile, in the larger picture, the IMF recommended that countries lessen trade and technology tensions in addition to uncertainties concerning existing trade agreements. Through adaptation, reforms, and rules regarding new fields like digital trade, multilateral institutions like the World Trade Organization can provide relief to the world economy by stabilizing expectations and regulations regarding international trade.

If you're interested in writing for International Policy Digest - please send us an email via submissions@intpolicydigest.org