It was three years ago overnight Thursday that Lehman Brothers collapsed, deepening the GFC, freezing markets, helping international trade to slump sharply in a matter of weeks and triggering recessions across Europe and the US.
But not in economies such as China, Brazil, India, Indonesia: the so-called emerging markets. (Nor Australia, but it was close).
Three years on and with fears Europe and the US are on the brink of a return to recession and the European debt crisis still out of control and threatening to trigger a re-run of the 2008-09 GFC, it’s natural to wonder how the emerging world, particularly Asia, would fare in the event of another recession in advanced countries.
The Asian Development bank this week forecast an easing in growth over the rest of this year and into 2012, as have a multitude of forecasters.
Next week we will probably get similar forecasts from the World Bank and the IMF at their autumn meetings in Washington
AMP Capital Investors Chief Economist, Dr Shane Oliver writes that "this is particularly important because the emerging world is now more than 50% of world economic activity.
"It’s also critically important for Australia given our key export markets in Asia."
Lessons from 2008-09
During first half 2008 there was much talk that the emerging world could decouple from the deteriorating economic environment in advanced countries.
This helped push commodity prices to record highs into mid-2008.
Ultimately the blow to confidence and trade following Lehman’s demise saw the emerging world pulled into recession along with advanced countries, commodity prices fall 60% and emerging market shares fall more than advanced country shares through the associated bear market (with a 59% fall in emerging market shares and a 61% fall for Asian, ex Japan, shares versus 56% for developed market shares).
So those looking for decoupling were disappointed.
Or were they?
While there is no doubt those who thought the emerging world could just sail on through despite the problems in advanced countries were wrong, emerging countries did do much better than advanced countries through the downturn and in the subsequent recovery.
And their share markets rebounded by much more – up 118% from their GFC low to this year’s highs versus a gain of 82% in developed country global shares.
The key lesson seems to be that emerging countries remain coupled to the global economic cycle, but can continue to outperform over time.
Similarities to 2008
There are a number of similarities to the situation in 2007-08 before the GFC for the emerging world.
Now like then emerging countries have been battling an inflation problem, which in large part reflects higher food prices but also a rise in underlying inflation.
This can be seen for Asian inflation in the next chart.
This has resulted in rising interest rates and, as was occurring before the GFC, a slowing in growth, with leading indicators suggesting a further slowdown ahead.
What’s more, budget deficits are worse than was the case in 2007, suggesting less scope to respond with stimulus.
In 2007 emerging countries had a budget surplus equal to 0.1% of GDP on average, whereas now they have a budget deficit equal to around 2% of GDP on average.
This is highlighted by the problems Chinese local governments now face with much higher debt following their participation in the Chinese stimulus programs of 2008-09.
And emerging countries don’t appear to have significantly reduced their export exposure to developed countries since the GFC.
So far, so bad. This all suggests that if advanced countries slide into a recession, the emerging world is vulnerable.
But it’s not that simple – the emerging world is in much better shape however, a number of considerations are different this time around, or at least suggest the emerging world will continue to perform much better than advanced countries.
First, emerging countries are structurally sounder.
Budget deficits of around 2% of GDP in emerging countries compare to average budget deficits of around 8% of GDP in developed countries.
Public debt levels are low at around 35% of GDP on average, compared to around 100% of GDP in developed countries.
Households are not under pressure to reduce debt in the emerging world.
While the scope to provide further fiscal stimulus is reduced compared to 2008-09, it is nevertheless much stronger than is the case in developed countries.
This also applies to China – while its higher level of public debt today (gross public debt is around 50% of GDP) means it is more constrained than in 2008, it still has scope to provide fiscal stimulus if need be as its public debt is low by global standards and in any case it would simply be borrowing from itself.
(China is the world’s biggest creditor nation & its net public debt is zero.)
Second, just as inflation subsided in Asia and other emerging countries in 2008, clearing the way for monetary easing, the same is likely to o
