Emerging markets: Growth rates vary widely from country to country

Market analysis - 4/18/2016

- The emerging regions used to expand at about the same rate, but not any more. And the divergences will last - Manufacturing PMIs are a good gauge of this macroeconomic reality

Throughout their 2000-2008 boom the emerging economies expanded at a fairly uniform rate. Since then, however, their trajectories have diverged (see left-hand chart below). GDP growth in mainland China and India now exceeds the pace of the more "mature" economies of South Korea, Mexico and Taiwan while commodity exporters like Russia and Brazil bring up the rear.

The most frequently heard explanations for this disparity are the reversal in the raw materials supercycle and the strength of the US dollar. But while these factors have indeed affected the emerging countries' momentum to varying degrees, they are not the only forces at work.

From a structural standpoint, wage growth began to exceed productivity gains from 2010 onwards, undermining competitiveness. This can be seen in emerging companies' annual financial statements, including as narrowing profit margins (see right-hand chart below).

In the long run such declines in profitability can undermine a country's overall economy by dragging down its potential growth rate. In other words, even by using its capital and labour as efficiently as possible, the country will see its maximum level of production drop below the average registered in the past (provided inflation remains stable). In the case of commodity-producing countries, GDP growth is generally reduced even further because they fail to counterbalance their dependence on raw-materials exports by diversifying their economies.


Although manufacturing PMIs are designed as gauges of business confidence, their readings are often quite close to those of GDP growth. Thus they can also be used as a proxy for the latter (see left-hand chart below). 

Mexico and India rank among the most dynamic emerging economies. It is worth noting that these two countries have both demonstrated unusually strong willpower by introducing the structural reforms needed to revitalise domestic productivity. The case of India is nothing short of remarkable, as illustrated by its leap in general competitiveness.  


China's GDP growth slowed to +6.7% in the first quarter of 2016. But while the continuing downturn in manufacturing was foreseeable in view of operational inefficiencies, the country locked in the first tangible benefits of the authorities' monetary and fiscal stimulus designed to boost domestic activity. The challenge they face is to apply this support in proper doses. The real estate market needs to be shored up in average-sized cities, which are burdened by oversupply; but, at the same time, overheating has to be avoided in the biggest urban centres. The industrial sector needs to be streamlined by shifting surplus labour to the services sector. The special nature of these adjustments requires targeted fiscal and budget measures rather than cuts in interest rates. In China opting for this latter policy has often resulted in property speculation and a credit binge. 

The current disconnect between the growth rates in China's manufacturing and service sectors (+5.8% and +7.6% respectively) is natural for an economy in transition (see right-hand chart above). While the pace has slackened a bit in services lately, the downturn should be temporary and reflects a return to normal in financial trading, a segment that was artificially pumped up by the stockmarket boom in early 2015. Yet the support mechanisms that Beijing is resorting to mainly include infrastructure spending—just the kind of gambit that China is supposed to be getting away from. And the use of credit to finance this expenditure will add to the country's debt overhang, already equivalent to 249% of GDP.

Meanwhile Russia and Brazil are the most flagrant examples of economies that live off energy and mineral royalties and are unable to develop new engines of growth. Brazil's creaking, uncompetitive manufacturing sector is a perfect illustration of so-called "Dutch disease". Moreover, the current political crisis is not helping matters. A motion to impeach the president, Dilma Rousseff, received 71.5% support in the lower house of Parliament and will now go before the Senate, where a simple majority is needed for it to pass. A special committee will be formed to recommend impeachment to the senators, who will vote in mid-May. If Rousseff is ousted, she will be replaced for 180 days by the vice-president, Michel Temer. Removing Rousseff from office is no guarantee that the economy will turn up any time soon, but a return to political peace would make it possible to adopt remedial measures and thus mark a step in the right direction.       

The divergence in growth rates between emerging economies is bound to continue. Ironically, the countries that already have the strongest economic potential are often the ones that are also introducing the structural reforms needed to spur competitiveness.

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