RGE Monitor's Newsletterhttp://www.rgemonitor.com/econo-monitor/253402/one_year_later_still_crunch_timeWe recently surveyed the economies at risk of recession and concluded that a full-fledged G7 recession is in the making, quenching hopes of economic and financial decoupling and bringing back those risks of global recession that we overviewed at the beginning of the year. Moreover, one year later the credit crunch, inside and outside the U.S., is still alive and well.
How is all this playing out for emerging markets?
Central Eastern Europe and the Baltics, South East Europe, RussiaGrowth in Eastern Europe looks set to slow in 2008 in line with core Europe. As some 65% of the EU10's exports are destined for the Eurozone, EU newcomers� fate is largely tied to that of its western neighbors.
Although inflation remains above target in most CEE countries, central banks in the Czech Republic, Hungary, and Poland have ended or are near the end of their rate hike cycles, as they turn their attention to slowing growth. A gradual and orderly deceleration appears to be ongoing in Central Europe, with the Czech Republic and Poland expected to post robust growth of around 4-5% in 2008 and Slovakia expected to post 7% growth. Hungary continues to be the growth laggard. After a trough of 1.3% real GDP growth in 2007 (the slowest of any CEE country), Hungary�s 2008 growth could surpass last year�s, but there are downside risks. Public finances and a shaky government remain key issues.
Meanwhile, the Baltic states have said bye-bye to double-digit growth. Different from the softening in Central Europe, the Baltics are experiencing a sharp slowdown after booming over the last seven years. Especially worrisome is the fast double-digit inflation accompanying the slowdown. Having contracted in both Q1 and Q2, Estonia�s economy has now officially entered recession. Latvia looks to be in a similar boat. While some analysts expect a more moderate slowdown in Lithuania, other analysts points to the fact that its business cycle is 12-to-18 months behind its Baltic brethren.
Will Romania and Bulgaria follow in the Baltics� footsteps? Like the Baltics, these Balkan countries boomed after EU accession and show similar alarming imbalances. Different from the Baltics, however, Romania and Bulgaria have not hit major slowdown mode yet. Romania seems especially vulnerable due to its twin deficits and low FDI coverage. Bulgaria is also vulnerable due to its ultra-high current account deficit (projected to reach 20% of GDP in 2008), but its responsible fiscal policy and higher FDI coverage separate it from Romania.
Although Q1 growth exceeded expectations, Turkey is expected to slow to around 4% this year after 5% growth in 2007. Meanwhile, the downward trend in inflation is over, with consumer prices rises in July coming in at over 12% yoy. Political tensions remain a risk. While Turkey's Constitutional Court rejected a ban on the governing AK party, temporarily relieving tensions, analysts see political risk remaining high in Turkey over the long-term due to deep-rooted divisions within society over the role of religion.
In Russia real GDP slowed to 7.6% in Q2 2008 � down from 8.5% in Q1 � amid falling industrial production and declining resource exports growth (despite high commodity prices). Trade (especially oil/gas) and construction continue to be the main drivers of growth, which is expected to stay north of 7% in 2008 and could be a welcome slowdown from the previous overheating situation. On the inflation front, total CPI grew 14.7% year-over-year in July, slightly lower than in May and June (15.1%). Even if these numbers are close to the government target of 10-12%, inflation remains a concern. A weaker Rouble exchange rate might have negative effects on inflation. However, better harvests may lower food prices, improving the inflationary outlook in coming months. Heightened political risk for equities and lower commodity prices have contributed to outflows as many Rouble long bets have been closed.
Middle East and North Africa, South AfricaIn North Africa, high international food prices have incited inflation. Yet, countries are witnessing record growth rates; Egypt�s growth rate is forecast at 7% in 2008, despite inflation being at a 16-year high. Morocco�s growth rate is expected to triple in 2008, yet increased inflation and fears of monetary tightening cast doubts on the sustainability of maintaining such fast growth beyond 2008. Tunisia's economy slowed to an annual 5.8% growth rate in Q1 08, compared to 6.5% in Q1 07, with the slowdown based on soaring commodity prices and weaker European markets. The main challenge lies in Tunisia's ability to limit the impact of rising world food and fuel prices, as well as the impact of global financial turbulence, on inflation and growth.
GCC countries will continue to lead the region in GDP growth (IMF predicts 6.1% real GDP growth in 2008), with continued high oil prices supporting the large foreign reserves accumulation and fiscal expansion. These oil and gas exporters are rushing to diversify their economies to sustain future growth and relieve high unemployment for a young and growing native population. UAE and Qatar are expected to post the highest real GDP growth rates - 8% and 14.3%, respectively. Smaller resource endowments there give a stronger impetus to diversify. The GCC's rapid growth comes at the cost of high inflation. Despite various subsidies and price controls, annual CPI inflation is in the double digits even for Saudi Arabia, where inflation has historically ranged from 1-2%. Behind inflation are negative real interest rates, which have led to soaring money supply growth. In favor of supporting growth, policymakers have been reluctant to cut fiscal spending or break free from accommodative U.S. monetary policy.
Lebanon�s growth outlook has been recently revised upwards by international agencies (growth rate forecasted at 4.4% for 08) despite the rising risks of inflation. The country�s growth remains well below its potential because of political uncertainty and institutional deficiencies. Jordan�s real GDP growth is projected to be 6.1% in 2008 despite the current inflationary pressures that are expected to moderate by the end of the year. Israel�s robust economic growth (5.4% in 07), on the other hand, is expected to slow in 2008, likely reaching only 3% in 2009. Increased inflation alone is not enough to explain the country�s slowdown. Rather, global conditions that are less supportive of export growth, the real appreciation of the shekel, and an unchanged level of investment in 08/09 are also contributing to slowing growth.
South Africa's economy rebounded in Q2 2008 to 4.9% as strong recovery in manufacturing and mining sectors more than offset slump in retail sales caused by rising interest rates. Despite double digit inflation of 10.6%, the central bank held its key rate steady at 12%, partly heeding growing concerns about slowing spending and growth. The widening of the current account deficit (at 9% of GDP in Q1 2008 from 7.5% of GDP in Q4 2007, the widest in 26 years) and high reliance on portfolio equity inflows relative to other emerging market economies have raised South Africa�s vulnerability to external shocks. The Rand continues to weaken amid concern over attracting foreign capital inflows as global growth slows.
AsiaThe growth forecast for ASEAN emerging markets has also been revised down as inflation and the global slowdown form a perfect storm. Double-digit inflation and negative real interest rates in most countries, due to global food and fuel prices, have only been exacerbated by domestic factors like strong credit growth, loose and delayed monetary tightening, fiscal spending, and asset bubbles. The second-round price effects via higher wages, transportation, and production costs are affecting foreign investor sentiment, posing risks to asset markets, capital flows, and the currency in spite of large forex reserves. Exports have taken a hit since mid-2008 as the economic slowdown is spreading from U.S. to other G-7 export markets, Europe, Japan, and several EMs (China, Latam, Middle-East). However, any bias towards loose monetary policy and undervalued currency to aid exports will only raise the risk of a stagflation-like environment.
While exports and manufacturing activity in Thailand, Philippines, and Singapore will be severely hit, India and Vietnam�s trade and current account deficits will make them worse-off amid global credit crunch and capital outflows. Correction in oil and commodity prices will also impact Indonesia and Malaysia�s current account surpluses. Singapore will take a hit from the contraction in electronic exports and the impact of the global turmoil on the financial and real estate sectors, while political risks will take a toll on investor sentiment in Malaysia and Thailand and exacerbate the slowdown. High interest rates will also hit private consumption and investment even in countries with strong domestic demand like India, Indonesia, Malaysia and Vietnam, preventing any cushion from the global slowdown. Ballooning food and fuel subsidies will reduce the room for counter-cyclical fiscal spending, though countries like Singapore and Philippines are relatively better-off.
After the stellar 9%-plus growth in 2006-07, India�s 2008 growth forecast has been lowered to below 8%. In spite of being labeled a domestic-demand driven economy resilient to global slowdown, the recent investment boom and above-potential growth were buoyed by benign global liquidity conditions. The oil price shock has exposed India�s vulnerability with the trade deficit, expected to exceed 10% of GDP while global financial turmoil and weakening growth prospects have led to capital outflows and downward pressure on the currency. Corporate earnings and capex plans are also at risk amid rising production costs and lending rates, accentuated by the global credit crunch and stock market volatility. Inflation, at a 16-year high, is partly driven by food, commodities, and fuel price hikes, but it has been exacerbated by strong domestic demand, pre-election fiscal spending, and credit growth. The subsidy burden may raise the fiscal deficit to over 10% of GDP. Furthermore, interest rate hikes will severely impact consumer spending and private investment so any easing of global commodity prices would be a major boon.
South Korea, often noted as the bellwether of the global economy, is slowing - don't let those strong export growth figures fool you. Though export growth accelerated to 37.1% y.y in July, the strength comes from price not volume growth. Moreover, import prices again outpaced export prices, worsening the terms of trade. Business and consumer confidence are at multi-year lows and materializing as a slowdown in both domestic demand and manufacturing and non-manufacturing output. What's to blame? Tighter credit conditions and lackluster global demand. Both the public and private sectors have lowered forecasts for Korea's annual nominal GDP growth to 4.7%.
Chinese growth has decelerated for the last four quarters, reaching 10.1% in Q2. While its size may allow it to avoid an Olympics bust, global weakness, and persistent inflation, the time of double-digit growth may be over for now. Private consumption is now contributing more to growth and retail sales are rising in real terms, but inventory pileups could indicate overcapacity in some sectors. Exports to the EU, which marked double-digit growth in 2007 and offset a decline in trade with the U.S., are now slowing. With a focus on growth, and with headline inflation declining, the Chinese government is selectively stepping away from its tight monetary policy, loosening loan curbs and limiting RMB appreciation � and might instead rely on a stimulus package. Slowing growth, contagion from global markets, a shortage of credit, and waning corporate profits have contributed to declines in Chinese equity and property markets. And check out RGE Analyst Rachel Ziemba�s analysis of the post-Olympics Chinese economy: Is China Suffering an Olympic Shock?
Latin AmericaWhile some believe Latin Ameririca�s commodity windfall is over due to the decrease in commodity prices and the US slowdown, these economies should remain resilient in 2008-2009. The leading economies of the region - Brazil, Mexico, Argentina, Chile, Venezuela, Peru and Colombia - are performing well (to varying degrees) with solid macro fundamentals and good perspectives for the future. Indeed, domestic demand has been the main driver of growth in the region, according to the IMF, at the same time that current account surpluses are being challenged and capacity utilization has remained quite high. The region should grow 4.3% in 2008, well below the 5.6% growth in 2007.
In Brazil, it is no surprise that real GDP growth was strong in Q1, with the economy advancing about 6% around the turn of the year. However, we do not expect this strength to last long. In fact, growth has probably already peaked, and the central bank is not done with hiking interest rates.
In Mexico, Q2 2008 GDP growth came in on the downside: 2.8%, below the consensus of 3.2%. The Mexican economy continues to show unexpected resilience to the U.S. slowdown, though some easing has been evident.
Chile�s economy grew 4.3% y/y in 2Q08, above expectations of 3.9% and above 1Q08 growth of 3.3%. Domestic demand was the big driver, expanding by a whopping 11.0%. The increase in investment took the ratio of investment to GDP to a high 26.4%. While investment was the big driver behind the increase in domestic demand, consumption is also growing above GDP and above its potential.
Peru�s economy continues to live in a golden age. The latest national account data show that the economy continues to expand strongly. Led by investment expenditure, GDP grew 9.3% y/y in the first quarter. This contrasts with Colombia�s economy, which will maintain its positive growth trajectory, though at a much slower pace than in recent years due to the U.S. slowdown. The economy will expand at a solid, sustainable pace of about 4.0-5.0% in 2008-09.
In Argentina, the effects of the farmer�s strike will probably have a larger impact on the second quarter numbers. According to these numbers, the Argentine economy grew 8.4% in Q1 2008 compared to the same period a year earlier, while it grew 0.6% compared to the last quarter of 2007 on a seasonally-adjusted basis.
In Venezuela, the government reported the economy expanded 7.1% in Q2 2008 due to a major fiscal impulse and strong private consumption activity. Looking ahead, the macroeconomic outlook is not as promising since crude oil prices seem to be in retreat, hyperinflation has resurfaced (consumer prices increased by 33.7% y/y in July), and economic deceleration is materializing. Meanwhile, the government�s unilateral seizure of Cemex assets will further damage bilateral relations between Mexico and Venezuela.
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