World Markets Need ‘Second Generation’ of Reforms


After years of strong performance, emerging economies are experiencing a slowdown, and a new round of reforms will be necessary if growth is to be sustained in the face of a more challenging external environment.
Because of the reforms pursued after the financial crises of the 1990s, many emerging economies are now more resilient and better able to avert any problems that arise as a result of a reversal of the positive external conditions. In order to boost their growth potential, however, these countries may now need to pursue a second generation of reforms, the panelists said.
“It is important for policymakers to recognize the changing dynamics of the global economy and design economic policies accordingly,” said Naoyuki Shinohara, IMF Deputy Managing Director.
Cyclical or Permanent?
It is difficult to quantify how much of the slowdown in emerging markets is permanent or temporary. Some of the factors affecting the prospects of emerging markets include the slowing of China, the end of the commodity price boom, and the tapering of unconventional monetary policies in some advanced economies. “How much of these factors is structural and how much is cyclical is ambiguous.
The good news is that emerging markets have become more resilient in recent years, with a “war chest” of reserves, more flexible exchange rates, and stronger financial systems. But policy decisions will not be easy: “Whether you tighten monetary policy or ease it, each choice has its tradeoffs.”
Peru was set to grow at rates over 6 percent—double the Latin American average—over the next few years. With the changing global circumstances, the question is how to maintain this momentum in the future, and that entails reforms.
Peru is in a better position than its neighbors. Although richly endowed with gold and copper resources, Peru is not particularly threatened by the prospect of a change in external conditions. Peru’s dependence on tax revenues coming from commodities is 4 percent of GDP, this level is much lower than that of other commodity producers in Latin America. Peru  has been able to diversify its economy, and it is increasingly become dependent on domestic drivers of growth.
Markets will increasingly distinguish between the emerging economies that have sound fundamentals, like Peru, and those with budding vulnerabilities such as large current account deficits, large fiscal deficits, sharply slowing growth, and rising inflation, Roubini noted.
Cause for Concern
While most emerging markets have tools such as flexible exchange rates to help them cope with the slowdown, there is no room for complacency. More worrisome than the changing external factors is emerging economies’ rising level of private and public indebtedness.
The growth has come at the expense of more credit. The question is, what is the marginal efficiency of continuing to extend that credit?” Emerging economies are becoming increasingly leveraged, but they’re getting less and less for it.
Indonesia has taken two important steps. The first was to tighten monetary policy significantly—by 150 basis points—and the second was to begin phasing out its huge energy subsidies.
“In June, seeing the pressure coming from financial markets, they were able to convince their parliament to start phasing out energy subsidies and reduce the budget deficit, therefore making fiscal policy more credible. Sometimes countries need the threat of a crisis to spur action on politically unpopular measures.
Getting to the Next Level
A “second generation” of structural reforms to increase productivity and boost competitiveness is necessary if emerging markets hopes to achieve sustained high growth rates, even in less favorable global conditions. More investment in human capital and in physical capital is crucial, as is more efficient delivery of public services.
Such reforms are necessary to increase emerging economies’ potential growth but countries have to find the fiscal resources to carry out the needed increase in investment—and that is the politically tricky part.
There are economies that suffer from what is known as the “middle-income trap,” when an emerging country’s per capita income stops converging to that of advanced economies. This happens when a country is unable to move into higher value-added production, and at the same time is no longer able to compete with countries with cheaper labor costs. This is not an easy problem to solve, but the change in global dynamics presents the opportunity put more emphasis on structural reforms.
Cautious Optimism
Comparing the current environment with the situation in the 1990s prior to the Asian financial crisis, a panelist was “cautiously optimistic.”
The economic fundamentals are much stronger today, but at the same time, no two crises are identical. We have learned lots of lessons from past crises, but unfortunately booms and busts continue. So we need to be vigilant.
Middle-income Trap
Middle-income trap means that average incomes in the countries, which till now had been growing rapidly, will stop growing beyond a point — a point that is well short of incomes in the developed West. Effectively these countries could become 'middle class', and stay that way.
                                                                                                           (IMF Survey October 10, 2013)

Tuesday, 11th Aug 2015, 04:02:34 PM

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