World economy: Not "decoupled"
June 14th 2010 FROM THE ECONOMIST INTELLIGENCE UNIT Strong growth in many emerging markets in early 2010 has drawn new supporters to the idea that emerging economies can now power ahead independently of the developed world. Certainly, domestic demand in leading emerging economies is booming, partially underpinning the global recovery. However, this owes much to fiscal stimulus and loose monetary conditions. A sustainable rebalancing of emerging-market growth away from exports to the developed world will only be achieved gradually. In the interim it seems premature to expect emerging markets to drive global economic growth after the impact of temporary factors fades. Many emerging markets are set to perform strongly in 2010, despite continued sluggishness in much of the developed world. Emerging Asia is posting the quickest rebound. China's real GDP grew by a blistering 11.9% year on year in the first quarter of 2010 and India's by 8.6%, while economies in the Association of South-East Asian Nations (ASEAN) are also performing well. It is a similar story for most of Latin America, the Middle East and Africa. Brazil's economy was among the strongest in the world in the first quarter, growing by 9%. The picture of emerging-market strength is not universal. Some laggards, such as Venezuela, are suffering from poor policies. And much of Eastern Europe is still labouring under the fallout from its severe economic crisis. Still, the performance of most emerging-market regions contrasts starkly with the travails of developed economies, and raises the question of how far the emerging world can now sustain its own momentum. New-found resilience A number of developments have strengthened emerging markets' self-reliance. First, trade flows between emerging markets have surged in recent years (although a significant proportion of this still depends on final demand in the developed world). Second, rapid growth in large emerging economies has boosted demand for commodities, supporting growth in other emerging markets. Lastly, and most importantly, policy improvements have boosted many emerging markets' resilience to external shocks. With the exception of Eastern Europe, emerging markets generally avoided large externally funded booms in the years preceding the crisis, limiting their exposure to the debt hangovers being felt elsewhere. Strong fiscal positions and large reserves have also given them levers to respond to the global downturn. Policy is playing a key role in supporting rapid growth in the emerging world. The inventory cycle is also a crucial factor—companies in major export markets are adjusting their stocks to account for improving trading conditions, temporarily boosting demand for exports from emerging markets. (Amplifying the effect is the fact that emerging economies are also restocking, thus boosting domestic demand as well.) But neither policy nor inventory effects can drive growth indefinitely. The support from fiscal stimulus for growth will decrease without a further expansion, and monetary policy will have to tighten as signs of overheating appear in some of the faster-growing economies, including Brazil and China. Some countries, notably China, can afford to maintain an expansionary fiscal stance (albeit not on the scale of 2009), but others, such as Brazil and India, have less room for manoeuvre because of higher public-debt levels. At the same time, the outlook for export demand from the developed world is uncertain. Governments are running out of money and cannot maintain fiscal stimulus, and inventory effects are invariably short-lived. If emerging markets are to sustain their strong performance, therefore, the question is how far they can generate a self-sustaining expansion of domestic demand. Consumption challenge The extent to which this is already occurring is difficult to determine. The Economist Intelligence Unit expects China, India and Brazil each to post growth in private consumption of roughly 6-9% in 2010, contributing 3.2-3.7 percentage points to their overall growth, and growth in fixed investment of about 10-13%, contributing 2.3-5.3 percentage points to growth. The contribution to growth of the external sector, by contrast, is forecast to be flat in China and around -1 percentage point in Brazil and India. However, this is due in part to the impact of domestic stimulus measures boosting consumption and investment, thus pulling in imports. The IMF estimates that domestic stimulus contributed 2.4 percentage points to China's real GDP growth of 8.7% in 2009; adding the impact of other countries' stimulus measures on demand for China's