Decoupling theory was thought to have suffered a fatal blow over the past 18 months. Its advocates were dismayed to find that emerging economies did not hold firm while developed countries collapsed in a financial-induced mess. And the subsequent global recession was not even synchronous - export-driven economies such as South Korea were among the first to enter the recession. Global trade suffered the worst slump since the 1930s, according to recent work by Reinhart and Rogoff (2009), and exporting nations were at the sharp end.
But the idea of developing countries outpacing industrialised economies has made something of a comeback in recent months. Only today UK-based advertising agency WPP posited the “LUV-shaped” global economic recovery: an L-shaped recovery in Western Europe; a U-shaped turnaround in North America; and a V-shaped recovery in the BRICs and the next 11 major emerging economies. Jargon aside, this states that Western Europe will experience a protracted period of flat-to-low growth, the US will recover but not immediately and the BRICs and other select developing countries are in the midst of a strong, rapid recovery.
Is there evidence to support this view? The HSBC Emerging Markets Index published earlier this month provides robust support. The index, compiled by Markit, is based on 18 manufacturing and service sector PMI surveys across 13 countries. It shows that output rose in the third-quarter by the largest amount since Q2 2008. Leading indicators point towards further output growth in the coming months as companies rebuild their inventories.
The IMF is also bullish about emerging market prospects. Its Regional Economic Outlook for Asia and the Pacific, published yesterday, forecasts that growth in Asia will accelerate to 5.75% in 2010 from 2.75% in 2009, both higher than previous projections. The agency highlighted the emphatic policy response from the region’s major economies, made possible by prudent fiscal policies in the run up to the global recession. Monetary and fiscal stimuli have helped support domestic demand without placing government finances at risk (see convergence of BRIC CDS spreads to G7 and Western Europe in chart above).
But the real driver of the swift recovery wasn’t internal. Global trade, the very factor that caused the EM recession, has staged a strong recovery. In fact, it started to rise back in February, way before other measures of economic activity were stabilising. This “return to normalcy”, as the IMF puts it, has meant that emerging market countries have rebounded just as quickly as they slumped in 2008. Rather than decoupling, the fortunes of developing countries appear to be as bound to the “old” industrialised world as ever.
That said, investors bullish on EM would have welcomed the stronger than expected US third-quarter GDP figures released yesterday. The initial reaction of global credit markets was as positive as could be expected. But the rally proved ephemeral, and spreads and stocks have sold off today after another US economic release suggested that the recovery is fragile. Personal consumption expenditure in September fell unexpectedly after rising for four consecutive months. The expiration of the “cash for clunkers” car rebate programme appears to have hit spending. Incomes also fell slightly, indicating that consumer spending will remain weak.
The data highlighted the fears of many: the world’s largest economies are on life-support provided by the government. It is the great unknown whether the private sector can replace the stimulating effects of public spending and medium-term sovereign spread direction will be determined by the answer.
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