For the past decade or so, pundits have been debating, analyzing and discussing the rise of the so-called emerging market economies (EM). Certainly, China’s rise to international prominence has been nothing if not meteoric and was predicted by surprisingly few observers in the beginning. Whether economists doubted the sustainability of real growth rates of 10% or whether the power of compounding confounded them is a moot point by now.
Recently greater pessimism has begun to spread about the EM growth outlook, and this pessimism focuses at least as much on structural as on cyclical issues. The slowdown in China is widely seen as the result of as necessary to ensure the longer-term sustainability of, admittedly, remains very high growth, north of 7%. The economic reform agenda put forward by the Third Plenum last year was nothing short of impressive, even if it remains to be seen to what extent the Xi-Li leadership will prevail over vested interests that stand to lose from the reforms.
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| Source: IMF |
By contrast, Brazil and Russia are not only experiencing disappointing growth, but both countries have failed to lay out, let alone pursue a coherent medium-term structural reform strategy. With the election of Modi in India and a very capable central bank leadership under Rajan, the outlook has improved, even if, again, it remains to be seen how aggressively the new government will be pursuing necessary, supply-side reforms. In short, the outlook for the major EM is mixed, but it seems very unlikely that, absent broader reform, the EM will return to the level of growth seen in 2003-11, even if the US sustains solid growth and the euro area returns to a recession-free growth path.
Economic size is one thing, financial size is another. Impressively, four of the ten largest economies are so-called EM. But it is perhaps also noteworthy that the Dutch economy is about the same size as Turkey’s, a country with a population of more than 70 m. Similarly, Norway’s economy with its 5 m people is roughly the same size as Poland, a country of 40 m. What is more noteworthy is the role advanced economies, and especially the large advanced economies, play in global finance. As the EM are typically both smaller and less financially integrated, EM foreign claims do not even begin to compare to those of the advanced economies.
China, as usual, stands out in terms of the sheer size of its foreign claims of around USD 6 tr, not too far behind France or even Germany and Japan, the latter being the world’s largest net creditor. In fact, China has the world’s second-largest net international investment position in dollar terms after Japan. But size is not everything. Nearly USD 4 tr of foreign claims consist of reserve assets in the form of highly-rated sovereign or quasi-sovereign debt securities. This arguably enhances China’s importance even further given that the public sector (mostly the PBoC) controls such a large pot of money, even if it yields China little in terms of influence vis-à-vis its largest debtor, the US treasury.
The speed with which Chinese assets have increased over the past few years is also pretty impressive. Foreign assets have increased six-fold in dollar terms (even though they have actually declined as a share of GDP!). Chinese foreign assets are twice the size of the combined holdings of Brazil, India and Russia. Excluding Taiwan, China’s foreign assets are larger than those of the ten largest EM combined. Last but not least, the net international investment position (IIP) of Brazil, India and Russia has in dollar terms tended to stagnate or even deteriorate in recent years, while China’s net IIP has improved markedly, rising from USD 1.5 tr in 2008 to almost USD 2 tr today. China is a major net international creditor, while Brazil and India are debtors and Russia’s creditor position is very small.
China will not only remain the most important EM in financial terms, but will also soon be overtaking France and Japan in terms of foreign assets. After all, China’s international financial integration, measured as foreign assets as a share of GDP, is rather limited at the moment. Ongoing reforms aimed at loosening capital account restrictions may lead to greater private-sector cross-border holdings of foreign assets. Private-sector capital outflows would also lead to a greater diversification of Chinese assets holdings, which remain heavily concentrated in public-sector-controlled reserve assets.
Generally speaking, this is a trend that we can expect to see across the EM. Historically, large reserve holdings were due to the need of the EM to buy “insurance” against a potential sudden stop in capital inflows, the existence of a managed or pegged exchange in the context of balance-of-payments surpluses and/ or extensive restrictions on resident capital outflows. This is what skews EM foreign asset holdings towards low-risk, low-return reserve assets. The move towards greater currency flexibility, generally solid fundamentals and looser capital flow restrictions will lead the EM, and above all China, to become more significant international financial actors. It will nonetheless take time for the even the larger EM (aka BRIC), China as usual excepted, to rival the major advanced economies in terms of their international financial importance.