Jun 30th 2011 | from the print edition
WHEN the term “emerging markets” was coined 30 years ago by Antoine van Agtmael, then at the World Bank, these economies accounted for one-third of global GDP (measured at purchasing-power parity). Now they make up more than half. More dramatic still, emerging markets produced more than four-fifths of global real GDP growth over the past five years.
Important though these countries are, many commentators still tend to lump them together in a way they never would with developed economies. Headlines about rising inflation, rampant bank lending and a flood of capital inflows might appear to suggest that virtually all emerging economies are overheating. In reality, some are red-hot and others are only lukewarm. An analysis by The Economist tries to identify the hottest spots.
The chart shows our ranking of 27 emerging economies according to their risk of overheating. We take each economy’s temperature using six different indicators. The scores from these indicators are then summed to produce an overall index; 100 means that an economy is red-hot on all six measures. (The rankings for all of the individual indicators can be found here)
Start with inflation. This has jumped more sharply in emerging economies than in the developed world, to an estimated average rate of 6.7% in May. But it ranges from a modest 1.7% in Taiwan to 20% or more in Vietnam, Venezuela and Argentina (using private-sector estimates for the latter rather than the government’s lower but dubious figure). Most of the pickup in inflation over the past year was due to higher food prices, which have a bigger share of the consumer-price basket than in rich countries. So if food prices stabilise, headline inflation will fall later this year. In China core inflation (excluding food and energy) is only 2.4%, but it is a more worrying 5.5% in Brazil and over 8% in India. Where growth is bumping up against capacity constraints and labour markets are tight, food inflation may spill over into wages and other prices.
Our second indicator tries to gauge spare capacity by comparing a country’s average GDP growth rate since 2007 with its growth rate in the previous ten years. Growth has exceeded its long-term trend in Argentina, Brazil, India and Indonesia, but is well below trend (suggesting ample spare capacity) in Hungary, the Czech Republic, Russia and South Africa. China’s growth has also been slightly below trend. An economy’s potential growth rate may have increased over time, thanks to reforms. However, tight labour markets (our third indicator) confirm that several economies have been growing unsustainably fast. In Argentina, Brazil, Indonesia and Hong Kong unemployment is well below its ten-year average. Brazil’s jobless rate is at a record low and wages are accelerating.
The fourth symptom of overheating, and one of the most important, is excessive credit expansion, which can lead to asset bubbles as well as inflation. The best measure of excess credit is the difference between the growth rate in bank credit and nominal GDP. It is normal for bank lending to grow a bit faster than GDP in an emerging economy as the financial sector develops, but credit is outpacing GDP by an alarming margin in Argentina, Brazil, Hong Kong and Turkey. Lending to the private sector has increased by around 20% more than nominal GDP over the past year in both Turkey and Hong Kong. But not all emerging economies are awash with liquidity. In ten of the 27 countries, including Russia, South Africa, Egypt and Chile, credit is growing more slowly than GDP. The growth rate in China’s bank lending has halved over the past year or so, and is now broadly in line with GDP growth.
Our fifth indicator is the real rate of interest, which is negative in over half of the economies. That may be appropriate where demand is weak but in rapidly growing economies, such as Argentina, India, Vietnam and Hong Kong, negative real rates are fuelling faster credit growth and inflation. At the other extreme, Brazil’s real interest rate of almost 6% is among the highest in the world. China’s benchmark lending rate is slightly positive but this understates the extent of its recent monetary tightening: the central bank has also sharply raised banks’ reserve requirements and capped credit growth.
Our final temperature gauge is the external balance. A widening current-account deficit can be a classic sign of overheating, as domestic demand outpaces supply. Turkey looks particularly worrying, with its deficit expected to jump to 8% of GDP this year, up from 2% in 2009. Rising current-account deficits in Brazil and India also suggest domestic demand is growing too fast.
Adding up the six scores reveals seven hotspots where most of the indicators are flashing red: Argentina, Brazil, Hong Kong, India, Indonesia, Turkey and Vietnam. Argentina is the only economy where all six indicators are on red, but Brazil and India are not far behind. China, often the focus of concerns about overheating, is well down the rankings in the amber zone, partly thanks to more aggressive monetary tightening. Russia, Mexico and South Africa are in the green zone, suggesting little risk of overheating.
Red-hot economies with negative real interest rates need to raise them. Fiscal policy is also too loose in many places. Budget deficits have been reduced slightly since 2009 but this is largely because strong growth has boosted tax revenues. On a general-government definition, six of the seven are still running quite large deficits (8% of GDP in India, for example); only Hong Kong’s government is in surplus. Given that their economies are booming, all of them should arguably be running a surplus. Drivers who ignore red warning lights on the dashboard risk a serious breakdown.