1. Regional Economic Prospects: October 2011
European Bank for Reconstruction and Development (EBRD)
Economic fundamentals in emerging Europe are generally better than before the onset of the crisis and the EBRD does not expect another region-wide recession. But it also believes the region now faces greater downside risks.
“[E]xternal shocks may be more severe than in 2008/09 on account of higher stress in the euro zone, including the banking systems, particularly under the downside scenario. There is a risk that the ability of bank groups to pass on support to their subsidiaries in the transition region may be constrained by their national governments. This could result in a substantial reversal of bank debt flows and a large contraction of credit in the region, with potentially severe consequences for output.”
EM Muser: Similar to my recent post (Is the CEE Better Prepared This Time Around?), the EBRD questions whether CEE countries will prove more resilient this time around and hones in on the potential for a severe disruption in cross-border banking flows.
The EBRD advises increased policy coordination along the lines of the Vienna Initiative in 2009, when Western European parent banks collectively pledged to maintain their exposure to the region’s hardest hit countries. The Vienna Initiative was a novel idea that pulled the region back from the brink of a full-fledged crisis. However, such an initiative could prove more difficult to implement this time around given the heightened stress on Western European banks stemming from the eurozone debt crisis.
2. The Past, the People and the Policies
Spyros Andreopoulos, Morgan Stanley
The author examines the forces that have shaped the thinking of today’s central bankers. He notes that the most prominent – Ben Bernanke (US), Adam Posen (UK), Athanasios Orphanides (ECB) – have spent a large amount of time studying ‘depression economics’ – eg. the Great Depression and Japan’s more recent slump. As a result, they believe in avoiding deflation at all costs and in avoiding premature tightening that could tip the economy back into recession.
Andreopoulos notes that this line of thinking comes with certain risks: “In particular, erring on the side of caution likely implies exiting too late, which in turn means elevated medium-term inflation risks. Yet, it is rational for a risk-averse central bank to prefer the lesser of two evils…”
EM Muser: Andreopoulos focuses on advanced economies, but his points are also useful in understanding recent actions of emerging market central banks. Like advanced economies, they face a delicate balancing act.
As the global backdrop darkens, EM central bankers understandably want to cushion the blow on their economies. And since monetary policy works with a lag, several (eg. Brazil, Indonesia, Israel and Turkey) decided to preemptively cut their policy rates, surprising many analysts. (See my post: Giving Turkey’s Central Bank the Benefit of the Doubt). Notably, Turkey has since backtracked and raised its lending rate on Oct 20 due to a sharp depreciation in the lira.
As with advanced economies, cutting rates is a gamble as it raises inflation risks down the line, especially for EM central banks that have fought hard to gain credibility. However, for many, this is the lesser of two evils given the threat of a new global recession.
3. China labour costs soar as wages rise 22%
Simon Rabinovitch, FT
Official data showed minimum wages in the world’s most populous country rose by an average of 22% this year. Labour costs are starting to rival those in other emerging markets, and Vietnam and Bangladesh are among the beneficiaries that are luring low-cost manufacturers and winning market share.
EM Muser: The jump in minimum wages relates to government efforts to calm social tensions and stimulate domestic consumption. However, the rise may backfire as the Economist magazine reports that some businesses, short of cash, are simply not paying their workers. (See: Unpaid wages in China: Can’t pay, won’t pay).
China will continue to offer relatively cheap labour for now, but questions are growing about how long it will last given the country’s demographics. According to UN data, China will add roughly 18 million people to its working-age population in 2011-20, which is paltry compared to the 114 million people added over the past decade.
4. Brics split on euro zone rescue
Carolyn Cohn, Reuters
Emerging markets aren’t going to be the white knights for the eurozone that many had hoped. India and Russia, in particular, are wary of investing in the European Financial Stability Facility (EFSF), although they may still extend financial support through the IMF.
EM Muser: This should not come as a surprise. First, it would be very hard for BRIC leaders to sell their populations on the need for a European bailout when their per-capita incomes are so far below the euro area average.
Second, the big emerging markets have not coordinated well on the international stage, which makes it unlikely the BRICs could successfully reach a joint agreement on a bailout plan. For example, Brazil’s finance minister Guido Mantega let slip in September that a BRIC rescue of the eurozone was a possibility. However, he had failed to consult with the other BRICs before his pronouncement.
The BRICs could exert more influence if they presented a more united front. For example, this spring, many EMs would have loved to place one of their own as head of the IMF. However, they disagreed on who. Europe and the US were better coordinated and managed to stick Christine Lagarde in the top spot. (See my related post: Why Emerging Markets Are Not in the Running for Top IMF Job)