By Patrick Barta and Marcus Walker | February 2008
| The global credit and economic crunch was made in America. But despite hopes to the contrary, the pain will be shared by developing nations from Turkey to Thailand. |
Developing economies— where 85% of the world's population lives— are maturing and are far less fragile than they were a decade ago. But they aren't yet strong enough to escape the pain of a slowdown in the industrialized world and hardly sufficiently large or self-sufficient enough to hold up global growth on their own.
Those realities were underscored last month, as stocks in China, India and other parts of developing Asia swooned along with their Western counterparts, amid fears of a global recession. Hong Kong's Hang Seng Index suffered its biggest one-day point decline ever, and Indonesian shares also dropped substantially. While many Asian markets also rebounded strongly, worries persist that developing-world markets remain at risk of the gathering economic storm.
Many emerging markets are reliant on exports to rich countries. And while local sources of economic growth, including consumer spending, have taken root in China and elsewhere, they aren't enough to keep developing countries from seriously slowing if their export engines sputter.
Economists have been debating for years whether the developing world is robust enough to motor ahead should the mammoth U.S. economy soften. That theory of "decoupling" now faces a real-world test, and was a major topic at the gathering of the world's business and political elite recently at Davos, Switzerland.
"No country can decouple from the U.S.," said Kamal Nath, India's trade minister, at Davos. "The question is only the degree of impact."
American consumers hold far greater sway over the world economy's fate than do their counterparts in the big emerging markets: They spent about $9.5 trillion last year— nearly six times as much as Chinese and Indian consumers between them, said Stephen Roach, chairman of Morgan Stanley in Asia.
In Thailand, shoe exports are already cooling and some apparel factories have already closed. In China, furniture makers are facing weaker sales. Hua Chao Art & Furniture in Zhongshan says exports to the U.S. fell about 17% in 2007 compared with the previous year, in part because of the U.S. housing bust. "Production may shrink and jobs may be cut accordingly," said a sales manager at the company.
International brewing giant SABMiller PLC, based in London, says beer sales have slowed in some emerging markets, including Asia and Africa, where growth in those two markets slid to 8% in the fourth quarter of 2007 from 30% a year earlier. Remittances— money sent home by emigrants working in the U.S.— have started to slow in Mexico as construction jobs north of the border disappear.
In Latvia, Kazakhstan and South Africa, the price of insuring debt has skyrocketed— a simple reflection of the international credit markets and an indication that investors see more risk. It now costs $155,000 to insure $10 million of Latvian debt from default, up from $15,000 in August, according to Markit Group, a London credit-information firm.
"One has to remember that the U.S. remains the dominant economy globally,". says Ifzal Ali, chief economist of the Asian Development Bank in Manila. To argue that emerging-market economic growth can be sustained without the U.S. is "quite a stretch and can be quite misleading," he says. The U.S, after all, accounts for 22.5% of the world economy, according to the latest World Bank estimates. Japan, along with Germany, France, Italy, Spain and the United Kingdom, account for an additional 23.6% [[and note that, since Europe and Japan are still far more export oriented than the US, they are also likely to slow, if the US slows, though perhaps not nearly as much: normxxx]].
That isn't to say emerging markets are headed for disaster. China, by far the largest emerging economy, is still on track to grow strongly in 2008 [[but that is somewhat deceptive, as China needs a minimum growth of 6% - 7% just to breakeven (it needs at least 10% in order to keep its masses moving in an orderly way to the big city centers, and to provide them with jobs when they get there); anything less is moving towards depression: normxxx]]. That could keep commodity prices from collapsing— despite the latest fears of a correction. Chinese demand, in turn, could help sustain resource-rich countries in Latin America, Africa and Southeast Asia. Economists at Anglo-Australian mining giant Rio Tinto predict that commodity prices will remain at historically high levels for a long time to come because of China, which accounted for between 60% and 90% of the increase in world demand for steel, aluminum and copper between 2000 and 2006.
Emerging-market spending on infrastructure also is likely to continue [[and may even increase in reserve-rich countries: normxxx]]. China's latest five-year plan calls for more than $100 billion in railway construction, including a $22 billion Beijing-to-Shanghai high-speed railway. Russia, India and oil-rich Middle Eastern countries are nearly as ambitious. The trend benefits multinational companies such as Caterpillar Inc. and General Electric Co. Emerging markets "never totally decoupled" from the economies of richer countries, GE Chairman Jeff Immelt said in a conference call with analysts last week, but are "becoming increasingly decoupled." GE is betting on continued strong demand for its aircraft engines from Latin American airlines, and for its generation equipment in India, South Africa and other places with "power shortages everywhere," he said.
War Chests
In the late 1990s, several emerging markets ran out of foreign reserves and defaulted on debts. In the decade since, some have built huge war chests. Brazil sits on a cushion of $185 billion. Russia has stored some of the country's oil revenues in a fund valued at $160 billion. In all, emerging markets have an estimated $4.1 trillion in central-bank reserves. "This time we have something of a vaccine when the U.S. sneezes," says Claudio X. Gonzalez, chairman of Kimberly-Clark de Mexico SA, referring to Mexico's estimated $7 billion on hand from oil-export revenues, a recent sale of toll roads, and other sources. "This extra money won't entirely free us from the effects of a U.S. slowdown, but it should help."
In the unlikely event that growth in industrialized countries as a group fell to zero— which last occurred in the early 1980s— growth in Asia outside Japan would be halved from last year's 8.7%, economists at Lehman Brothers calculate. Their current forecast calls for a more modest slowdown, to about 7.6%, but they warn that a "serious downturn" is now "plausible."
Emerging markets— the term applies to what once were known as developing countries or the Third World— historically have been the weak links of the global economy. Many suffered from poverty, economic mismanagement, corruption and the fickleness of international investors. But a lot has changed. Living standards in a handful of Asian economies— South Korea, Singapore, Hong Kong— have risen to the level of some European countries. Even excluding those success stories, emerging markets have been growing at better than a 7% pace over the past few years, double the rate of big industrialized countries, according to the International Monetary Fund.
But emerging markets aren't immune if demand for imports falters in the U.S. and Europe and fails to revive in Japan. Many emerging markets depend more than ever on exports. In Asia excluding Japan, exports were the equivalent of about 55% of gross domestic product in 2007, compared with slightly less than 40% in the recessionary year of 2001, according to Lehman Brothers. "The set of countries that is trying to grow on exports is still quite large, and they're not all going to be able to," says Simon Johnson, chief economist at the International Monetary Fund.
Taiwan, Singapore and South Korea are particularly exposed to U.S. consumers, because they are major suppliers of semiconductors and other high-tech goods that Americans snap up [[except in recessionary times: normxxx]]. Singapore's economy contracted for the first time in four years during the fourth quarter of 2007, largely because of slowing exports. In Thailand, several apparel-related businesses have closed. Shoe exporters say demand growth, running at double-digit-percentage increases in early 2007, has been cut in half, in part because of a strengthening baht.
'Still Buying Shoes'
"It's been a bit slow" lately, says Thamrong Tritiprasert, chairman of the footwear committee of the Federation of Thai Industries, a manufacturing association. But 2008 should be strong, he says, in part because Thailand is expanding to other markets, including Europe. "Even when there's a recession, people are still buying shoes," he says [[but not as often or as many or as expensive: normxxx]]. The most-successful economies in Europe's former communist bloc have likewise staked their futures on trade with rich countries.
Slovakia has become the Detroit of Europe, thanks to massive factory building in recent years by foreign car makers, including Volkswagen AG of Germany and South Korea's Kia Motor Corp. Slovakia's exports, dominated by cars, are equivalent to 70% of GDP, and surging car production has pushed economic growth above 8% in the past two years. But most customers are in Western Europe, where consumer spending was already in retreat late last year.
Turkish makers of refrigerators, washing machines and televisions also are looking to Western Europe. Vestel Group, based in Istanbul, gets three-quarters of its $3.6 billion in annual revenue from exports, and more than 90% of those exports go to the European Union. The company is benefiting from Europeans' shift from old-fashioned TVs to flat-screen models. But, as Vestel's corporate-finance director, Figen Cevik, says: "If consumer confidence deteriorates, people might postpone their purchases" of flat-screen TVs.
Mexico is particularly vulnerable to a U.S. slowdown, because some 23% of its annual economic output comes from exports to the U.S. Shipments of finished cars to the U.S. last year fell 60,000 units to 1.2 million, though to date Mexico has offset those declines with increased sales to other parts of the world. Mexico's exports of manpower are also under threat. The U.S. housing slump has led to the loss of some 100,000 construction jobs, many filled by illegal immigrants. That has dramatically slowed the growth of money sent back home by migrants. After nearly quadrupling to $24 billion in 2006 from $6.6 billion in 2000, remittances sent back to Mexico grew perhaps 3% last year, according to the Inter-American Development Bank. That is the slowest rate of growth in more than 20 years.
Many emerging markets had hoped to reduce reliance on U.S. and European consumers by boosting domestic spending. Yet while consumer expenditures have increased in many places, they haven't kept pace with other sources of growth. Consumer spending now makes up a smaller percentage of economic activity in China, Brazil and India than in the early 1990s, according to data from forecasting firm Global Insight. In China, consumer spending now accounts for about 35% of the economy, compared with 46% in 1990— and more than 70% currently in the U.S.
Thailand's Ferrari Showroom
In Thailand, hopeful developers have built or renovated ultra-high-end malls throughout the central business district. One, called "Siam Paragon," includes a Ferrari showroom and luxury fashion boutiques. Yet staff say most big-ticket items are purchased by foreign tourists or expatriates. At an Adidas boutique in one of the malls, sales agent Jiraporn Duangchisin says sales are down some 70% over the past few months. "I don't know where all the people have gone," she says. Financial problems in the U.S. and Europe also pose a risk to emerging economies, thanks to the unifying force of globalization. In the year to October 2007, Brazilian stocks moved in the same direction as the S&P 500 more than 90% of the time, according to data from Citigroup. For India, the figure was 70%. [[And, in all EMs, most divergences from the developed world stock markets are to the downside because of some local 'happening'. : normxxx]]
In China and India, analysts warned that share prices had by early 2008 reached bubble-like levels and could be vulnerable to severe corrections. Investors have already dumped some emerging market company stocks because they've become wary of companies that could get whacked if the U.S. slowdown worsens. Shares of Warsaw-based GTC, one of Eastern Europe's largest property developers, have fallen around 30% in the past two months, even though the company is doing well and has a large cash reserve.
"The market has taken a pessimistic view of the company because it thinks times are going to be harder" for the international property sector as a whole, says Mariusz Grendowicz, a Polish banker who sits on GTC's board. Marian Owerko, president of Polish dried-fruit company Bakalland, is confident about his exports, but says raising finances for operations is getting harder due to global investors' increasing skittishness about risk. The banks he uses— mostly local subsidiaries of international lenders that incurred losses on U.S. mortgages— are demanding as much as 0.4 percentage point extra interest for loans. "We are looking for new banks," he says.
Some fast-growing economies at Europe's periphery run the risk of turmoil thanks to their own imbalances. Romania, Bulgaria and Hungary have large trade deficits that could trigger currency slides and defaults on foreign-currency debts. In Hungary, taking out mortgages in euros or Swiss francs is all the rage— and could bring trouble if the forint, the Hungarian currency, weakens, economists say.
Current-Account Deficit
Hungary's current-account deficit— a measure of the difference between what a nation invests and what it saves— is large by international standards, at more than 7% of GDP. Romania's is above 13%, and Latvia's and Bulgaria's are at more than 20% of GDP. That means these economies must attract a huge amount of foreign capital each year, relative to the size of their economies— something many analysts doubt they can sustain. Africa's key financial center, South Africa, is also running a current-account deficit that's expected to swell to 7.5% in 2008 [[and has recently been worsened by severe electric power shortages that have shut down or seriously curtailed output at many of its gold mines, a substantial export product: normxxx]], according to Credit Suisse.
Among ex-Soviet bloc countries, Russia appears to be in a relatively strong position because of its large currency reserves, and because high commodity prices have helped boost incomes and spending. Retail groups such as Germany's Metro AG are building giant stores in Russia and see the Russian consumer market as one of their brightest prospects. But even in Russia, there are signs of possible financial-market trouble. Interest rates at which Russian banks lend money to each other for between a week and a month have doubled since last July. If oil and other commodity prices head lower, Russia could come under greater pressure.
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