Friday, June 12, 2015

The Great Reversal: developing countries no longer the growth engine

After the financial crisis, there was much talk of "decoupling". This meant that growth in the developing world would  be de-linked from that in the developed world which was weighed down by the financial sector. The developed world might suffer slow growth but, for a variety of reasons, the developing world would grow rapidly so that "convergence" - the catching up of the developing with the developed world- would happen sooner than thought. So it was for about three or four years after the crisis.

Alas, like most economic forecasts, this one has met a sorry fate. The World Bank now says that it is the developed world that will be the growth engine of the world. Developing countries will see growth slowing down- with India and China being notable exceptions. What explains the slowdown in the developing world? One can point to a range of factors, some of which are specific to a few economies:
  • China's economy is slowing down, in part inevitable following the high growth rates of several years
  • A slump in commodity prices (to which China's slowdown has contributed) is affecting several leading developing economies, notably Brazil and Rusia
  • Much of the boom in production and trade in the Asian countries was China-centred and these economies are feeling the effects of the Chinese slowdown
  • The impending reversal of interest rates in the US is a big factor. Already, emerging markets have seen huge outflows and this is likely to intensify once the Fed decides to hike interest rates. 
In short, the two great themes of the past decade- China's rapid growth and cheap credit- are now diminishing in importance.

India looks good in relation to a range of developing countries- a growth rate of around 7.5%  and a current account deficit of around 1-1.5% this year makes it a bright spot. But the global slowdown is bound to have its effect- export growth will be muted. A return to 9% growth looks very unlikely in the medium-term- we will be lucky to touch 8%.

India's big problem is that low employment elasticity of income in recent years means that 8% growth just cannot generate the jobs it needs. The signs in recent weeks of Modi emphasising equity rather than pushing for growth suggest that the PM has seen the straws in the wind.

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