“Growth Slowdown, Precarious Recovery” — the subtitle of the IMF’s latest World Economic Outlook, published this week — is as good an attempt as any to capture the spirit of the age. The question is, what, if anything, can policymakers do to speed up growth and make any recovery sustainable?
In the US, where the IMF expects the economy to slow from 2.9 per cent growth last year to 1.6 per cent in 2024, the Federal Reserve has already called an end to its two-year cycle of interest rate rises. In the eurozone, where growth will slow from 1.8 per cent last year to 1.4 per cent in 2024, according to the IMF, nominal policy rates have been at or below zero for the past three years.
The scope for fiscal stimulus looks just as tight. The US faces a $1tn budget deficit this year, equal to 4.5 per cent of GDP. European governments, which have more wriggle room, appear almost congenitally reluctant to loosen budget constraints.
This has left many investors looking to emerging markets for hopes of government action. Here, the IMF’s prognosis is less pessimistic. While it expects growth across EMs to slow from 4.5 per cent last year to 4.4 per cent in 2019, it also expects a recovery to 4.9 per cent by 2024.
Yet the outlook is highly diverse, as are the options for policy response. In China, the biggest single growth engine for many other emerging markets, the IMF sees growth slowing from 6.6 per cent last year to 5.5 per cent in 2024.
Policymakers in Beijing have already stepped up to the plate and loosened restraints on credit. Their action this time is necessarily on a smaller scale than previous interventions — before growth began to slow last year, the government’s priority was to rein in runaway debt — but it has been met with enthusiasm by many investors.
“People are very focused on this,” says Nachu Chockalingam, senior EM debt portfolio manager at Hermes Investment Management. “It’s one of the things they have factored in, that the government will be supportive of stabilising the economy.”
Another focus of attention is India, soon to overtake China in population terms and already the fastest-growing large emerging economy. The IMF expects growth there to accelerate from 7.1 per cent last year to 7.7 per cent in 2024. Nevertheless, a change of governor at the central bank has turned previously hawkish monetary policy more dovish. To the surprise of many, the bank has cut interest rates twice this year, raising concerns of political capture before this month’s elections.
Few others have similar freedom to act. For Turkey, says Magdalena Polan, senior economist at Legal & General Investment Management, the optimal policy response to the economy’s steep dive into recession would be to flood it with money, preferably funded by the IMF.
But, for now at least, that option is not available. “Foreign investors would be spooked and you’d get another run on the currency,” she says. “We are used to V-shaped recessions in Turkey but with the policy options as they are, we don’t see any chance of a swift recovery.”
In a less dramatic way, similar constraints are at work in Mexico, where the recently elected Andrés Manuel López Obrador has launched ambitious public projects even though the country’s investment-grade credit ratings have been put at risk by overspending. The president appears to have backtracked somewhat under pressure from ministers and markets, though many investors are waiting to see which direction he will take.
John Paul Smith of EcStrat, an investment consultancy, is scornful of the notion of emerging markets being able to turn on the fiscal or monetary taps.
“The idea that we can all go on a fiscal binge, or that interest rates are so low that we can all do whatever we like — it just breaks down when you look at the countries,” he says.
The one country where stimulus could be carried out successfully, he says, is Russia — but there, the government is moving in the opposite direction.
“They have a huge pension problem and Putin is nothing if not strategic,” he says. “He’s looking at the demographics.”
Indeed, he sees pension liabilities as a common theme constraining EM policymakers. He also worries about the role of parastatals and state-owned enterprises, and the fact that many governments are using their state banking sectors to conduct off-budget financing. In China, he says, an “unquantifiable” amount of money is being used to bail out companies and local governments through the back door to avoid systemic defaults.
If policymakers are indeed constrained, an alternative view is that this is a good thing. Randolph Wrighton, managing director at Barrow, Hanley, Mewhinney & Strauss, says that out of 20 emerging markets he covers, 19 have central banks operating under rules-based frameworks, up from three 20 years ago, and the same number have limits on government debt and spending, up from five 20 years ago.
“I don’t think it’s in anybody’s interests for them to stretch themselves to help their economies,” he says. “What they can do is to keep moving towards first-world policies, with transparency, accountability and rules-based systems.”
Yet while the trend over the past 20 years is clear, if at times uneven, it is far less clear that today’s EM policymakers are on the path to further reform. The IMF may have called it right, after all.