A tougher year for emerging markets; 2014 could be when the richer world strikes back

December 30, 2013 6:20 pm

A tougher year for emerging markets

2014 could be when the richer world strikes back

Since the financial crisis, the global economy has travelled at two speeds. Developing countries have steamed ahead, powered by China’s voracious appetite for raw materials. Meanwhile, the west has limped along, as households and states cut back spending to address towering debts.In the past 12 months, however, this picture has shifted. Just as confidence has returned to parts of the rich world, plummeting commodity prices have exposed the frailties of emerging markets. In October, the International Monetary Fund slashed its forecasts for the likes of Indonesia and Brazil. The fund now believes that the bulk of positive news for 2014 will come from high-income countries.

The US economy, in particular, offers grounds for optimism. The housing market has strengthened, after the massive injection of liquidity by the US Federal Reserve helped to lower mortgage rates. The labour market is becoming more buoyant and cheerier consumers have resumed spending. For now, investment is still lagging behind. But were corporations to use the large cash piles upon which they are sitting to finance new projects, the US economy could easily edge closer to its pre-crisis trend. Britain is also motoring, thanks to a sudden jump in consumption. However, banks are still lending too little to business, in spite of ultra-low interest rates.

In east Asia, Japan is emerging from 15 years of deflation, aided by the mammoth monetary stimulus unleashed by its central bank. But for “Abenomics” to succeed, it is essential that the government follows up swiftly with its programme of structural reforms, aimed at lifting long-run growth.

The eurozone is still the worst performer in the rich world. Unemployment remains dangerously high and activity continues to disappoint, particularly in France and Italy. But Spain and Ireland, two of the countries worst hit by the crisis, are picking up. They have a mountain of debt to repay, but at least they have stopped shrinking. The challenge for the currency bloc is to put its banking system on a safe footing. The forthcoming asset quality review by the European Central Bank will be a make-or-break moment. Governments must accept that the exercise needs to be rigorous if Europe is to accelerate again.

The single biggest risk for high-income countries comes from the Fed. Two weeks ago, during his valedictory press conference, chairman Ben Bernanke announced that the central bank would reduce its asset purchases from $85bn to $75bn a month. Markets were not too bothered, as the Fed also promised it would keep rates low for longer than previously thought. But this message may become less credible if “tapering” gathers speed in 2014. This will put upward pressure on market rates on both sides of the Atlantic.

The US should be strong enough to withstand the shock. In the eurozone, the European Central Bank may have to deploy more unconventional weapons, for example launching a new round of cheap funding for banks. Conversely, tapering raises risks for emerging markets. As domestic bonds become attractive again, western investors will repatriate the funds parked in more exotic locations. Countries with large current account deficits could run into trouble. Note Turkey, where the political crisis this month has already sent stocks plunging.

The outlook for the developing world largely hinges on what happens in China. The authorities are adamant that they can keep output growth above 7 per cent. But Beijing also wants to rein in credit creation. Striking this balance will be hard and could lead to a sudden deceleration. That would add to the misery of commodity producers – and transform an uncertain year into a difficult one.