By Mohamed El-Erian, Project Syndicate
Imagine for a moment that you are the chief policymaker in a successful emerging-market country. You are watching with legitimate concern (and a mixture of astonishment and anger) as Europe’s crippling debt crisis spreads and America’s dysfunctional politics leave it unable to revive its moribund economy. Would you draw comfort from your country’s impressive internal resilience and offset the deflationary winds blowing from the West; or would you play it safe and increase your country’s precautionary reserves?
That is the question facing several emerging-market economies, and its impact extends well beyond their borders. Indeed, it is a question that also speaks to the increasingly worrisome outlook for the global economy.
The very fact that we are posing this question is novel and notable it its own right. You can add this to the list of previously unthinkable things that we have witnessed lately. That list includes, just in the last few weeks, America’s loss of its sacred AAA rating; its political flirtation with a debt default; mounting concern about debt restructurings in peripheral European economies and talk about a possible eurozone breakup; and Switzerland’s dramatic steps to reduce (yes, reduce) its safe-haven status.
The answer to the emerging markets’ question would have been straightforward a few years ago. It is not today.
In the world of old, the West’s economic malaise already would have pulled the rug from beneath most emerging-market countries. Indeed, the conventional wisdom – supported by many painful experiences – was that when the industrial countries sneezed, the emerging world caught a cold.
Today, however, several (though not all) emerging-market countries are benefiting from years of considerable efforts to reduce their financial vulnerability by accumulating huge amounts of international reserves. They have also paid back a significant share of external debt and converted much of what remains into more manageable local-currency liabilities.
This sharp balance-sheet improvement has been instrumental in enabling emerging countries to bounce back strongly from the 2008-2009 global financial crisis, whereas the West continues to hobble along. Indeed, until the recent renewed downturn in America and Europe, the emerging world’s major policy concern was too much growth, mounting inflationary pressure, and economic overheating.
Today’s emerging countries have considerable policy flexibility and much greater latitude to act than they had in the past. Accordingly, faced with a weakening global economy, they confront two basic policy choices.
On the one hand, they can compensate for the global weakness by turbo-charging their own internal demand through aggressive fiscal stimulus. This would shield their populations from the West’s problems and, at the global level, provide a counter-impetus to the deteriorating global outlook.
In the process, they would shift some of the policy emphasis from production to consumption. They would run down their trade surpluses and, in some cases, allow their currencies to appreciate. Their international reserves would decline and/or their debt would rise.
On the other hand, these economies can opt for greater self-insurance. In this scenario, rather than stimulating domestic demand, they would fortify their defenses, positioning themselves for a long and stormy winter for the global economy. Thus, they would minimize the deterioration in their trade surpluses, maintain competitive exchange rates, and safeguard their foreign reserves and net-creditor positions. In the process, they would accentuate the pressure on the global economy from the West’s seemingly endless downturn.
I suspect that emerging-market policymakers’ hearts are advocating the former. After all, a domestic stimulus would help maintain economic growth. Moreover, a counter-cyclical policy would signal to the world these countries’ willingness to take on global responsibilities.
But I also suspect that their heads are cautioning against spending a lot of money in an attempt to accomplish a difficult, if not impossible, task. After all, there is little to suggest that emerging economies could counter, effectively and sustainably, a large synchronized slowdown in the West, especially when it comes with the risk of another banking crisis.
My inclination is to believe that the head will prevail – but not completely. Emerging-market economies will take some steps, including interest-rate cuts, to safeguard domestic growth. They will also signal willingness to help the West financially. But such steps, while notable, would prove insufficient to counter fully the slowdown emanating from the West; and it certainly would not materially change the outlook for the United States and Europe.
Despite their strong fundamentals, emerging countries still feel vulnerable in the face of the West’s economic weakness, policy shortfalls, and political paralysis. Moreover, they know from experience that there are no easy and immediate solutions to the West’s debt overhang and structural impediments to growth. And they have no illusions about the potential for effective global policy coordination.
In such circumstances, policymakers in emerging markets will eschew boldness for prudence. They will hope for a short winter for the global economy, but they will plan and position for a long one. Accordingly, they will show very limited appetite for risking the hard-earned policy gains of the last 10-15 years, and the resilience and self-assurance that has come with those gains.
Having put yourself in their position for a moment, can you blame them?