Are analysts rushing to conclusions or are there serious risks to long-term growth prospects in emerging markets?

A street market in Johannesburg, South Africa. September 18, 2015 Steven dosRemedios/Flickr CC BY-ND 2.0

By Joseph Dana | June 12, 2017

Amid the political chaos in the US and the UK in early June, there was fresh debate about growth prospects in emerging markets. This, of course, is nothing new. In its annual report on global economic prospects, the World Bank found growth increasing in both advanced and emerging markets in 2017. Growth in emerging markets and developing economies is forecast to strengthen from 3.5% in 2016 to 4.1% in 2017.

Moreover, the Institute of International Finance (IIF) found that foreign investment in emerging markets will increase 35% from 2016 to $970bn this year. In a report released this month, the IIF said threats to short-term trade have significantly subsided. Despite rising growth in 2017, the World Bank expressed caution about long-term investment in emerging markets and developing economies, and subsequent effects on productivity growth.

The report’s findings were released amid a flood of negative news from several key emerging markets. South Africa went into a recession for the first time since 2009 after manufacturing, construction, and transport growth contracted as the country continues to be plagued by political leadership questions. A corruption case involving Brazil’s President Michel Temer has eroded confidence in the country’s economy, and its medium-term growth prospects, though he was recently acquitted of the most serious charges of receiving illegal campaign funding for the 2014 election. Meanwhile, in India, recently released GDP figures from Q1 2017 revealed slowing growth. Statistics indicate economic growth is slowing down despite a whole raft of measures designed to spur growth, including a goods and services tax to be introduced on July 1, 2017.

Cracks appearing in emerging markets?

These events, coupled with the World Bank’s warnings on long-term growth, led to a chorus of economists and analysts warning of cracks in the emerging world. Are analysts rushing to conclusions or are there serious risks to long-term growth prospects in emerging markets? Recent data from commodity-exporting emerging markets might provide some answers. The sharp decline in oil prices has placed significant constraints on these economies, and has led to scaled-back forecasts on growth.

Inversely, oil importers should, in theory, experience income gains as the price of energy commodities declines. However, the World Bank notes, “… renewed weakness and financial stress in large oil-exporting EMDEs [emerging markets and developing economies] could have adverse contagion effects on other economies through trade, financial market, and remittance flows”.

This bang-on effect certainly presents challenges to long-term growth with regards to the level of outside investment into emerging markets. Shrinking current investment could depress “aggregate demand in the short term and slow capital accumulation over the longer term”. Such risks could extend to deceleration of capital deepening, the World Bank warns, which has been an engine for growth in emerging markets. The analysis points to possible investor risk, which is nothing new in emerging markets.

Risks Related to Weak Productivity and Investment GrowthRisks Related to Weak Productivity and Investment Growth

Sources: Penn World Table, World Bank, 2017

Trade agreements and policy concerns

The current risks to investment in emerging markets could easily transform into longer-term challenges if the rising tide of protectionism in the West continues to amass political power. The erosion of the “multilateral rules-based system that has been in place since the 1940s” poses risk in the form of downward pressure on economic integration, job creation, and growth. But is this threat overblown?

The threat, highlighted in the World Bank report and in a recent emerge85 article on multilateral trade, is centred on the US and President Donald Trump’s hints at major shifts in fiscal, trade, and immigration policies. But it is not limited to the US, and extends to other advanced economies, such as the UK, and its ability to craft new bilateral trade deals with emerging markets after leaving the EU. The UK’s interest in fresh trade deals with the GCC, for example, has been called into question after the recent deterioration of relations between Qatar and its Gulf neighbours raised questions about the strength of the regional alliance.

By definition, emerging markets are prone to risks. While investment levels are showing signs of improvement in the short-term, and growth is up from last year, emerging markets are still volatile and uncertain. Moreover, these markets are disproportionately impacted by events they don’t control. In its long-term growth forecast, the World Bank underlined that current levels of foreign investment in emerging markets should not be taken for granted. Given the uncertainty and changing political currents in the West, emerging markets could find themselves at the mercy of decisions outside of their control. There are, however, some areas in which emerging markets could overcome uncertainties and chart their own path forward.

Cities as engines of growth

Moving beyond short-term considerations and near-term risk analysis, the role that cities occupy in the long-term health of emerging markets opens up several possibilities for growth. Cities have quietly taken on more responsibility in steering growth. By now, it is an old talking point to discuss how the world is urbanising. We all know that people are moving to cities (and building them up) at a rate faster than at any other point in history.

As emerge85’s co-directors Afshin Molavi and Mishaal Al Gergawi note in the lab’s mission statement: “Over the next 14 years, there will be another billion urban dwellers globally. By the year 2050, two out of three people in the world will live in cities.”

In advanced economies, cities are pushing for greater independence to ensure access to global capital markets – London after Brexit is a prime example. After Trump announced he would pull the US out of the Paris climate accords, cities such as Pittsburgh announced they would still abide by the accord. In an opinion piece for The New York Times, Pittsburgh Mayor Bill Peduto and Paris Mayor Anne Hidalgo said: “In the absence of executive leadership in the US, an unprecedented alliance is emerging among cities like ours to push progress forward.”

As the World Economic Forum highlighted this month, emerging market cities must be empowered with data so mayors, civic leaders, and urbanists can address risks such as forced migration, terrorism, income inequality, and unemployment. While cities in Europe and North America are awash with information, emerging market cities are still left largely in the dark when it comes to the collection and use of data about residents. Short-term slowdown in investment could be overshadowed by long-term growth as cities attract private investment, better understand their residents, and, ultimately, become more productive.

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