Global growth in emerging markets continues to slow down for a number of reasons which include the collapse in demand for commodities and a rising level of debt that is becoming unmanageable. It is the third financial crisis that began with the collapse of the housing market in the United States, followed by the European debt crisis, which has now moved on to the emerging world.
Growth in the developed countries is being constrained by what is now occurring elsewhere. Events and conditions in emerging markets matter enormously, now that 58% of the world economy can be situated there, if one considers Purchasing Power Parity (PPP).
World map showing real GDP growth rates for 2009. (Countries in brown were in recession.)
There will be no sustainable economic recovery in Europe, North America and East Asia unless there is a resolution to the overhang of debt, that now exists in emerging markets. Many of these economies have stopped growing, as world demand for commodities dropped substantially.
The dramatic diminution of economic growth in China and the relatively slow growth throughout the West, has brought an era to an end in the developing world.
Unlike the sovereign debt crisis in Europe which is largely the result of government driven indebtedness, the situation in Latin America and elsewhere in the emerging world, is the result of both governmental and private debt that has grown to enormous proportions.
Private sector debt in the developing world has grown from 73% of GDP (Gross Domestic Product) in 2007 to 107% at the end of 2014. It is still rising as consumers and businesses struggle to maintain solvency, in the new economic reality.
Chinese President Xi Jinping holds hands with fellow BRICS leaders at the 2014 G20 Brisbane summit in Australia
If one considers a myriad of loans issued by non banking institutions, total debt levels in the private sector exceed 125% of GDP. It is estimated that 75% of the total amount is the result of credit extended to businesses. Corporate debt has risen from 50% of GDP in 2008, to nearly 75% by 2014 in the emerging world.
This explosion in debt has been seen not only in China, but in Brazil, Chile, Turkey and in other previously rapidly growing economies. The biggest borrowers were in construction, energy, mining, and resource development.
If this rapid accumulation of debt was leading to higher income, it would not be necessarily a bad thing, but the opposite is happening. Many of these firms are now saddled with leverages of debt, that have become crushing with lower revenues. Profits are quickly disappearing as a result.
Part of the bonanza in credit for the emerging world, was the consequence of the significant decline in loans in the developed world. In order to maintain market share, many countries extended credit to customers overseas. This often went way beyond levels that would be prudent in normal circumstances. China by itself, began a massive expansion of credit in 2009, in order to keep the factories at home humming. They were more willing to lend money than many of the richer countries of the world, in order to keep the business orders forthcoming.
Chinese factory near Yangtze River
Another phenomena was the near zero or even below zero in some cases, in interest rates in the developed part of the world. The race to the bottom by the central banks of many Western countries, was an attempt to stimulate more growth, but it also had the side effect on domestic investment. Since returns would often be paltry at home, investors began earnestly looking elsewhere for better results.
This search for better returns brought huge amounts of foreign investment to the developing world. Far more, than could be prudently spent. It allowed a run up in assets and more resource development than was really needed. Witness the empty shopping malls and housing developments exemplified in China and in a number of other countries. Supply had simply outstripped demand, with the abundance of easy credit.
Annual percentage growth rate of GDP of Russia, 2008–2014
As the near collapse in commodities lead by oil, natural gas, and minerals intensifies on a global level, a reverse in investment is now occurring. Not only are western investors abandoning emerging markets in droves, but domestic investors are leaving as well. Far more capital is leaving these regions than is now coming in, as entrepreneurs begin looking for safety.
As money begins to flow out rather than in, there is a corresponding impact on the domestic currency. The slow down in the internal capital and investment markets soon leads to recession. This is what has happened first in Russia and then in Brazil. They are looking for declines in GDP of 4% and 3% respectively.
The contagion is now spreading to countries like Malaysia, South Africa and Turkey to name just a few. These countries have seen their national currencies plunge in the last two years. The situation will get far worse, if the United States ever gets around to raising interest rates. The strength of the American dollar is causing a number of countries in the developed world to begin to hoard USD (United States dollar) as a hedge against further financial instability.
Shortages in Venezuela leave empty store shelves in a store.
The lack of foreign investment in many emerging markets, is leading to mounting current account deficits. This in turn is causing domestic prices to rise precipitously. A number of governments will then attempt to manipulate the currency, by keeping official exchange rates higher.
It has the corresponding effect of damaging exports in the effected country. Also if the conversion rate is too out of balance, it begins an illicit trade in currency. This can be seen readily in countries like Argentina, Egypt, Venezuela and other like minded nations.
Other emerging nations may have a healthy current account surplus and large foreign exchange reserves. This is the case with China, despite rapidly rising levels of corporate and public debt. The country has amassed reserves that equal $3.5 trillion USD. It will allow the country a great deal of flexibility, in dealing with its current debt situation. The debt to GDP ratio in China has surpassed 250%. As a comparison it was only 147% at the end of 2008.
A Hyundai automobile. The automotive line is a key sector in South Korea’s industry.
Still other developing countries have a firm current account surplus, rather big foreign exchange reserves, and respectable public finances. However, they are dealing with enormous private debt and excess production. The problem here will be deflation.
A good example for this is South Korea, which is Asia’s 4th largest economy. The citizens of Korea, have one of the highest household debt ratios in comparison to incomes in the world. At 81% of GDP, it may well prove to be unsustainable. By comparison, the rate in Germany is 54% and even tops the United States at 77%.
Singapore is also somewhat, in this category. It has soaring household debt which saw the largest increase from 2007 to 2013 worldwide. Government debt to GDP ratio now exceeds 99%. The city state also has enormous corporate liability. Total debt to GDP has now breached 380%, making the country the 3rd largest debtor nation in the world.
Skyline of Singapore’s CBD
Collectively the nations of China, Singapore, South Korea and perhaps Thailand will not experience a balance of payments crisis, even if there is a major flight of capital in a souring market. They will be able to weather the financial storm, as long as they can keep interest rates low. It will make servicing their huge debt burden possible, at least in the short term.
The problem will be in the long run. Growth will begin to stagnate, as rising debt overtakes businesses and corporations. Since these governments will not wish to foreclose on non-performing loans, more of their domestic industry will no longer be profitable.
Banks in these countries are heavily influenced by government policy, which is to roll over bad corporate loans to prevent factory closures and job losses. What results are known as zombie companies, that are fast becoming a feature of those capitalist economies that have major government direction and control.
To have these unproductive companies continue, often leads to over production which forces down prices, as these distortions in the market are magnified. It hurts investment at large and keeps valuable assets under performing. Profits continue to decline in corresponding sectors. This eventually leads to lower growth in GDP.
Countries like Brazil and Turkey are in far more dire straits. The large run up in private debt led by corporations has been made far worse, now that foreign investors are leaving these markets in large numbers. Their sizable current account deficits, makes them dependent on foreign lending to stay afloat. Without outside investment, their economies will simply be unable to grow. That will make their domestic political and social structures unstable.
These recent developments in the emerging world will have an huge impact on nations like Australia, Canada, Japan, New Zealand and the United States, as well as the continent of Europe. The lack of growth in developing markets, will hamper exports from these richer areas of the world. Lower growth in the developed world in turn, will reduce the demand for imports from the emerging areas. It is a vicious economic cycle, that will ultimately lead to lower overall global growth in GDP.