Interview with Yves Zlotowski, Chief Economist at Coface
Yves Zlotowski holds a PhD in Economics from Paris X Nanterre University. He joined COFACE in 2001 and has been Chief Economist since 2007. He also publishes articles in various academic and specialist books and journals. Yves Zlotowski discusses with BSI the challenges facing emerging economies today.
What is your outlook for emerging economies?
YZ – Our current forecasts for the weighted average of emerging economies are 4.3% in 2013 and 4.7% in 2014. We expect a slight acceleration in the short term, thanks to the strong performance of the US economy and the anticipated recovery in the eurozone. Through foreign trade, a slight acceleration in activity in emerging countries is therefore expected. However, these GDP growth rates should be viewed in the context of growth rates during the 2000-2012 period, which were closer to 6%. Emerging economies are losing one to two points on average, which is not insignificant.
The factors explaining this slowdown are the most important issue for emerging countries: external shock or internal problems? The first option seems difficult to sustain, even if it is often the thesis put forward by the authorities in emerging countries. Looking back at growth trends since the crisis, we see a sharp negative shock in 2009, followed by a spectacular rebound in 2010-2011. And since then… a slow deceleration. It seems difficult to believe that this is solely the result of sluggish demand in advanced countries, especially since a refocusing of foreign trade between emerging countries is (somewhat) limiting the impact of growth problems in Europe.
So the slowdown we are seeing in emerging economies is due to internal factors? This ties in with the debate on potential growth in emerging economies.
YZ – Something structural is at work in emerging economies. You only have to analyze the components of domestic demand. Consumption remains dynamic (despite a slight slowdown, it is still growing at around 5%); on the other hand, supply is suffering more, with a more marked slowdown in investment. On the one hand, household demand remains buoyant, with the middle classes continuing to expand and wages continuing to rise, but on the other hand, supply is no longer keeping pace, both in terms of production and, more fundamentally, in terms of supply conditions (infrastructure, business climate). To put it more simply: a very luxurious mall in a major capital city, with luxury boutiques catering to upmarket consumers, will suffer power cuts. India, Brazil, and Russia are good examples of this type of problem.
How can we explain this supply constraint weighing on emerging economies?
YZ – The nature of the slowdown in investment is a complex phenomenon. However, beyond the specific characteristics of each country, two major obstacles are apparent today: governance and infrastructure.
There are measures of governance, some more precise and reliable than others, but it is very difficult to grasp the dynamics. What is happening today in Russia, Indonesia, and Turkey? We may have the impression that things are deteriorating or improving, depending on the case, but honestly, we don’t know how to measure it. On the other hand, what is certain is that the development of the middle class, which is increasingly educated and demanding, makes the persistence of shortcomings in the business climate more problematic than before. The middle class no longer tolerates governance issues as an obstacle to its expansion. A very simple example: if a young, educated person wants to start a business, they will face poorly protected property rights, administrative harassment, unstable and inconsistent regulations, corruption, and so on.
In addition to the governance obstacle, there is also the more basic issue of infrastructure: if the road network is inadequate, urban transport is deficient, and airports and ports are congested, growth will effectively plateau. Finally, other types of constraints can weigh on supply, particularly in the labor market, with shortages of skilled labor.
Are the authorities in emerging countries capable of solving these problems? How might the 2014 elections in many emerging countries impact the decisions that will be made?
YZ – These structural problems cannot be solved with macroeconomic policy instruments. What is at stake is not lowering interest rates or implementing a fiscal stimulus plan. Emerging countries have certainly accumulated real expertise in fiscal and monetary policy. But that will not be enough. What is at stake are structural reforms to improve the business climate, infrastructure, and education. Such reforms take time. The infrastructure problem in Brazil or India cannot be solved in one legislative term, or even two.
Furthermore, the impact of political deadlines on reforms is often overestimated because behind problematic infrastructure lies the ability of institutions to take action and negotiate with stakeholders—issues that ultimately depend on more than just which party is in power. Public institutions are facing their moment of truth. One of the problems facing emerging countries is the existence of economic rents, which make change difficult and reforms complicated. On the other hand, political deadlines could have a significant impact on social protests. The upcoming deadlines in Turkey and Brazil in 2014 are fertile ground for bringing the frustrations of the middle classes to the forefront.
Apart from these internal risks, are emerging economies less vulnerable to external shocks? How do you view the financial turmoil that shook emerging economies this summer?
YZ – I completely disagree with the theory that nothing has changed in emerging markets, that we were wrong, that they are ultimately vulnerable, and that the situation is identical to that which prevailed in the 1990s. On the contrary, the situation is very different.
Admittedly, there is a real issue related to the decline in the aggregate current account surplus of emerging markets, with worrying and rising current account deficits in some cases, such as Turkey, India, South Africa, and Indonesia. Emerging countries have certainly experienced significant capital outflows triggered by the Fed’s announcements starting in May 2013. With hindsight, we can see that these sudden withdrawals were nevertheless carried out with a certain degree of discrimination, with the exchange rates falling most in countries where external deficits had widened the most. This gives the impression of a very classic emerging market story, which is reassuring for old hands at country risk. However, the real question is the nature of the need for foreign currency financing. Yes, there is still a high need for financing in some cases (India, Turkey, Brazil), but it is no longer governments or banks that are driving the need for foreign currency, but companies. We have moved from a situation where the pressure was on systemic players (banks, governments) to a situation where the pressure is on corporate, private players. Despite a major default by a Brazilian company, OGX, the currency crisis in the summer ultimately had no major impact (no sovereign default, no emergency appeal to the IMF).
Is that why central banks did not intervene as much to defend their exchange rates? Does this herald a change in strategy on their part?
YZ – Yes. Perhaps emerging countries are realizing that currency crises are much less serious than they used to be. Central banks also know that they can do nothing about massive capital outflows, as was the case when Lehman Brothers went bankrupt or during the summer of 2013. But there is still a paradox: reserves do not protect against sharp falls in exchange rates, yet emerging countries continue to accumulate them. In my opinion, this is because they have no other choice. Reserves play a particularly important role during periods of massive inflows: when faced with huge inflows, accumulation helps to limit the appreciation of their currency.
Central banks also have other tools at their disposal. Some of them have implemented capital controls, particularly in Brazil. Are they effective? More or less. The amounts involved are so huge that the ability to act through regulation is limited. It does not completely prevent exchange rate fluctuations, but these controls do alter the structure of capital inflows somewhat, favoring FDI over portfolio flows. Ultimately, the question today is what gains emerging countries have derived from financial globalization. While these gains have been high in the past, they are now more debatable.
Given these risks, do you still see emerging markets as areas with high growth potential for French companies?
YZ – Absolutely. For many sectors, emerging countries continue to represent an extraordinary windfall. Even in so-called difficult countries, consumption remains dynamic (which is favorable for construction, distribution, telecoms, financial services, agri-food, luxury goods, and automobiles). The prospects for development in these sectors are considerable, but investors need to revise their plans: household spending is no longer growing at double-digit rates. We are entering a phase in which the middle classes will be more cautious. Given the needs in urban infrastructure, rail and airport transport, there are opportunities to be seized. And these are sectors in which French companies are at the forefront. But this raises the question of public governance. Managing foreign investment in major infrastructure is not entirely straightforward and poses problems of internal political balance, as we have seen in Brazil and India. We have come full circle, back to the question of governance.
Interview by Samuel D.
