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Home > Blogs > Ian Fraser > Looking on the bright side of the emerging market slowdown

Looking on the bright side of the emerging market slowdown

Emerging Market Economic Slowdown Ian Fraser

The slowing of economic growth in emerging economies, especially China, and the increased vulnerability in Latin America, are a mixed blessing for the global economy, according to Stephen Cecchetti, economic adviser to the Bank for International Settlements (BIS). Speaking as the latest BIS Quarterly Review was published earlier this month, Cecchetti said:

“This could be a welcome moderation that helps put growth in these economies on a more sustained footing but even so it means that the emerging market economies won’t support global growth as much as they have in recent years.” (quoted in Central Bank News)

Mario Draghi, president of the European Central Bank, gave global financial markets a shot in the arm in late July when he asserted that the Frankfurt-based ECB would do “whatever it takes” to protect the euro. Then on September 6, the Italian-born central bank governor was true to his word when he declared the ECB would buy an unlimited amount of government bonds of eurozone member states if needed. As the BIS Quarterly review of international banking and financial market developments noted:

Details of the ECB’s new programme of outright monetary transactions (OMTs) were finally unveiled on 6 September. The programme involves discretionary sterilised purchases of short-term sovereign bonds under certain conditions and is subject to a prior request by the respective country’s government for international assistance via the European Financial Stability Facility / European Stability Mechanism (EFSF/ESM).

However the resultant rally, which drove down corporate bond spreads to their lowest levels in a year, should not prompt assumptions that the euro crisis is over. Southern European countries continue to be dogged by fiscal and competitiveness problems that will only be resolved if they maintain their commitment to structural reforms, said Cecchetti.

Emerging markets slowdown: agricultural worker waters crops

Even though some progress has been made with reforming the global financial system, Cecchetti said the process is by no means complete. For example, he pointed out that many banks remain dependent on central bank support and that activity in the unsecured interbank markets remains relatively feeble.

In this context, Cecchetti welcomed the fact that many of the world's largest international banks, sometimes known as G-Sifis (globally systemically important financial institutions) are derisking and diminishing their balance sheets, retrenching to domestic markets and reducing leverage. They are also becoming less inter-connected. Cecchetti welcomed the fact banking is becoming more local, and less driven by aggressive international expansion. However he warned that if the pendulum swings too far the other way, a localised and overly fragmented financial market might also pose risks.

“It reduces the scope for contagion but also increases the risk of domestic crises and reduces the ability to share risks across borders."

The BIS Quarterly report, which covers the period mid-June to mid-September, said that financial markets had been remarkably calm in the period, considering the continued fears about the long-term viability of the euro and the poor growth outlook.

"the volatility of risky assets remained extraordinarily subdued ... Volatility was low compared to recent history in credit, foreign exchange and equity markets. On 13 August, the implied volatility index (VIX) computed from the prices of US equity market options fell to its lowest value since June 2007. With real government bond yields in negative territory in many countries, this means that equity valuations have become more attractive relative to bonds, which in turn may have pushed some investors to increase the equity share of their portfolios.

However the Basel-based BIS is far from oblivious to the potential risks of an emerging market slowdown, for example warning that certain Latin America economies have become more vulnerable to exongenous financial shocks in recent months (the Latin American nations in its sample included Brazil, Chile, Colombia and Peru).

This matters, said the BIS, because of the signs of increased stress in international capital markets. The report said:

"Current data indicate that macroeconomic fundamentals in Latin America, although still strong, have weakened since 2007. Particularly worrisome is the deterioration in the fiscal stance and the current account balance."

Further reading on the outlook for emerging markets:

Tags: Bank for International Settlements , banking , Brazil , central banks , Chile , China , Colombia , corporate bonds , EFSF , emerging markets , equities , ESM , European Central Bank , European Financial Stability Mechanism , european sovereign debt , european sovereign debt crisis , G-SIFI , government bonds , Latin America , major banks , Mario Draghi , OMTs , outright monetary transactions , Peru , Stephen Cecchetti , VIX
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