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Marcus Wright RBS Economics November 2015
Emerging Markets: Gimme Shelter
What’s this about?
- Growth in emerging markets is slowing. This is concerning. We consider two key questions:
1. What are the problems in emerging market economies?
2. Why does that matter to us?
Emerging markets matter more than ever
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10
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60
70
1994 1996 1998 2000 2002 2004 2006 2008 2011 2013 2015
Share of the Global Economy (%)
Developed EconomiesEmerging EconomiesEmerging Asia
Source: IMF
0%10%20%30%40%50%60%70%80%
1994 1996 1998 2000 2002 2004 2006 2008 2011 2013 2015
Contribution to Global GDP Growth
Developed EconomiesEmerging EconomiesEmerging Asia
Source: IMF
• Emerging markets have accounted for 50%-60% of global output & 70% of global economic growth each year since the crisis.
• They are much more important to the global economy compared with the late 1990s when the last EM crisis struck.
• In other words, an EM slowdown can do a lot of damage to the outlook for global growth.
Pass the credit parcel
• While credit growth stagnated in developed economies following the crisis, it rebounded quickly in emerging markets.
• But now slower EM credit growth and Eurozone deleveraging has left global credit growth in the doldrums.
-5%
0%
5%
10%
15%
20%
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Outstanding Private Sector Credit to Developed and Major Emerging Economies
(% Y/Y Change)
Source: BIS
-10%
0%
10%
20%
30%
40%
2000 2002 2004 2006 2008 2010 2012 2014
Outstanding Private Sector Credit(% Y/Y Change)
Developed Economies Emerging EconomiesSource: BIS
Quelle surprise – China is the main culprit
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5
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15
20
25
China - Credit to Private Non-Financial Sector(Oustanding, $ Trillion)
Source: BIS
0%
20%
40%
60%
80%
100%
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
Outstanding Credit to China's private sector...
As % of the USAs % of global
Source: BIS
• Credit to China’s non-financial private sector has risen a staggering $15trn since the crisis – close to the size of the US economy.
• China’s credit pile has risen from a mere 20% of the level of the US to 80% in just six years.
• When credit rises that much so quickly, much of it inevitably gets wasted.
A reckoning awaits China’s banking sector
-
5
10
15
20
25
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Liabilities of Chinese Corporates(Trillions of RMB)
TransportationManufacturingMining, utilitiesNonfin servicesConstruction and real estate
Source: IMF
• It’s the corporate sector that has driven China’s debt increase.
• Hong Kong’s build-up has been even greater, relative to the size of its economy.
• China’s banking sector is likely to be sitting on non-performing loans in excess of official figures.
• China can afford the clean-up but the debt overhang and banking sector repair will drag on growth.
-40
-20
0
20
40
60
80
100
Corporate Sector Debt(% of GDP Change since Crisis)
Source: BISNon-financial Corp Sector
That debt is becoming more of a burden
• Emerging economies have gorged on debt. Consequently, since the crisis, they are devoting more of their incomes to repaying it.
• Developed countries by contrast are devoting less.
0% 10% 20% 30% 40%
UK Rest of World
USJapan
France AustraliaGermany
NetherlandsCanada
SpainItaly
Sweden
Banking Exposure to China and HK by Country
(% of $1.5 trn global exposure)
Source: BIS
• Despite China’s relatively closed financial system, global banking exposure to China is $1.5trn.
-10
-5
0
5
10
Den
Spa
UK Hun
Por
SA US
Aus
Fin
Jap
Ger
Ita Kor
Cze
Pol
Mex
Swe
Bel
Indi
aFr
aIn
don
Bra
Neth
Thai
Mal Tur
Rus
HK SA
RCh
ina
Debt Service Ratios- Change since 2008, Private Non-Fin Sector
Source: BIS
Mainly Developed Economies
Mainly Emerging
Economies
A big score…off-shore
500
1,500
2,500
3,500
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Emerging and Developing Economies -Debt Securities Outstanding($ Bn)
At Home
Including Offshore Borrowing
Source: BIS
China - Offshore Bonds by IndustryReal Estate
Finance
Oil and Gas
Utility and Energy
Computers and ElectronicsMetal and Steel
TransportationSource: IMF
• Offshore bond issuance results in the classic emerging market problem – currency mismatch on the balance sheet of EM firms.
• A move toward tighter US monetary policy could expose these vulnerabilities.
• Unsurprisingly, China is
again the major player with real estate, finance and oil & gas the main sectors.
The problems are more than debt alone• Having previously grown
much faster than the pace of global GDP growth, world trade growth is now slower.
• Emerging markets hoped for a strong rebound in export growth following the crisis but it never materialised. It’s not just due to the Eurozone.
• China’s slowdown is transmitting across other emerging markets as reduced demand for their exports.
-20%
-10%
0%
10%
20%
30%
40%
2003 2005 2007 2009 2011 2013 2015
Export Volume (% Y/Y Change)
Emerging Economies
Emerging Asia Source: CPB
Pre-crisis average: 10%
Post-crisis average: 4%
-15%
-5%
5%
15%
1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015
Global GDP Growth v Global Trade Growth(% Y/Y Change)
Global Trade Growth
Global GDP Growth
Here comes the deflationary wind
• Emerging markets pushed investment in productive capacity, housing & infrastructure in response to the global slowdown.
• The global economy benefitted because developed economies pulled back.
70
80
90
100
110
120
2007 2008 2009 2010 2011 2012 2013 2014 2015
Investment as Share of GDP(2007 = 100)
Developed Economies Euro AreaEmerging Economies
Source: IMF
-4 6 16 26 36
ChinaS. Korea
PhilippinesTaiwan
SingaporeMalaysia
Months in Producer Price Deflation(Over past 36 months)
Source: Macrobond
• Too much investment. Too much capacity. Lots of price deflation.
• That deflation gets exported to the developed world.
Falling productivity, but room for reform
0.0
1.0
2.0
3.0
4.0
1970s 1980s 1990s Pre-Crisis 2011-2012 2013-2014
EM Labour Productivity per Person Employed (% Y/Y Change)
Source: Conference Board
• Emerging market productivity growth has slowed substantially.
• It’s another sign that investment in many emerging markets, particularly China, has been targeted at the wrong areas. Capital has been misallocated.
• And emerging markets, generally speaking, are relatively difficult places to do business.
• They remain a long way behind the great emerging market success story – S.Korea.
40
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90Ease of Doing Business(Distance to Frontier of Best Practice, 100=best)
Source: World Bank
Less favourable demographics have arrived
30
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80
90
1950 1960 1970 1980 1990 2000 2010 2020 2030
Population Dependency Ratio
China IndiaS.Korea
Source: UNRatio of population aged 0-14 and 65+ per 100 aged 15-64
Forecast
40
50
60
70
80
90
1950 1960 1970 1980 1990 2000 2010 2020 2030
Population Dependency Ratio
Selected Emerging Economies
Developed Economies
Ratio of population aged 0-14 and 65+ per 100 aged 15-64 Source: UN
Forecast
• China’s dependency ratio has started to rise (more dependents per working-age person). The change to the one-child policy may have come too late in the day.
• South Korea’s is also beginning to rise. But South Korea is a much richer country.
• A falling dependency ratio has thus far boosted growth. Those days are over for many emerging markets.
• India remains in the midst of its ‘demographic dividend’.
Consequences…
• The issues facing emerging markets, are deep-rooted & unlikely to disappear soon. Consequently their drag on global growth, trade & inflation will likely persist.
• In response, the US Fed & the Bank of England may have to keep interest rates lower for longer. The ECB and the Bank of Japan will likely expand their Quantitative Easing (Buying for longer).
…and yet more consequences
• All the while emerging markets will likely remain a source of financial vulnerability. Periodic bouts of financial stress like those seen in recent months should be considered the norm.
• China’s policy response to its debt problems will be a crucial influence on the fortunes of the global economy in the coming years. Either it cleans up its banks and rebalances growth toward services and consumption (of which there is so far little or no evidence) or it doesn’t & risks heading into financial stress.
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This material is published by The Royal Bank of Scotland plc (“RBS”), for information purposes only and should not be regarded as providing any specific advice. Recipients should make their own independent evaluation of this information and no action should be taken, solely relying on it. This material should not be reproduced or disclosed without our consent. It is not intended for distribution in any jurisdiction in which this would be prohibited. Whilst this information is believed to be reliable, it has not been independently verified by RBS and RBS makes no representation or warranty (express or implied) of any kind, as regards the accuracy or completeness of this information, nor does it accept any responsibility or liability for any loss or damage arising in any way from any use made of or reliance placed on, this information. Unless otherwise stated, any views, forecasts, or estimates are solely those of RBS’s RBS Economics Department, as of this date and are subject to change without notice. The classification of this document is PUBLIC. The Royal Bank of Scotland plc. Registered in Scotland No. 90312. Registered Office: 36 St Andrew Square, Edinburgh EH2 2YB. The Royal Bank of Scotland plc is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. © Copyright 2015 The Royal Bank of Scotland Group plc. All rights reserved
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