The growth problem in emerging markets has long been underestimated. It has now become clear that the problems are structural, that only reforms can ensure a sustainable recovery. Both the lower growth in world trade (especially the much lower Chinese growth rate) and the declining capital inflows (because of the gradual normalization of US monetary policy) are negative factors that will not disappear in the coming years. Meanwhile, there are also clear EM-specific reasons why growth should continue to fall: an increasing dependence on credit, a weakened competitiveness and a deteriorating investment climate.
In 2010, the average growth rate in emerging markets amounted to 8%. In 2015, only half of this growth will be left. And without changes in economic policy, the slowdown is likely to persist. It is important that governments start to decrease expensive subsidies, which often do not benefit those for whom they were intended and limit the possibility of productive investments in infrastructure. India has made progress in recent months, Indonesia has yet to start. Fiscal and labor reforms are also needed to encourage companies to invest again. In many emerging markets, investment growth has been negative in recent years. Brazil makes a good example.
Deregulation and improvements in infrastructure are badly needed to restore competitive positions after years of increasing regulatory pressure and soaring wages. And in order to reduce imbalances in the economy and the financial system, something needs to be done about the excessive credit growth. In a large part of the emerging world, debt as a percentage of GDP has gone up too fast. Not only does this create vulnerabilities in the banking system, it also limits the possibility of future growth. Thailand, Malaysia and Turkey are among the countries that have experienced the most pronounced credit growth.
Over the past three years, emerging currencies have depreciated by an average of about 20%. This decline has been even more spectacular in the countries with the largest imbalances, the weakest growth and the least willingness to reform. In the countries that have put their houses in order, currencies declined less sharply. As in most countries growth continues to fall and reforms do not get off the ground, currencies are likely to depreciate even more. In the end, this will increase the pressure and enforce change. Countries that prefer to take matters into their own hands and want to avoid a crisis, have little time to waste. The sharp depreciation of EM currencies in recent weeks shows yet again that the urgency is great.
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