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The euro crisis

The gap is narrowing

by Ellen Thalman

In brief

The Greek debt crisis has sent shock waves around the world. Emerging market nations are gaining ever more clout internationally, and the distinctions between them and advanced nations are blurring.

According to Robert Zoellick, the president of the World Bank, the economic turmoil emananting from Europe in May was not just “financial crisis, part two”, but rather “sustainable growth challenge, part one”. Writing in London’s Financial Times he pointed out that focussing on debts and fiscal retrenchment would not be enough because “the world and Europe also need to return to solid growth”. Otherwise, Zoellick’s argument went, fiscal adjustment will be more painful and politics harder to manage.

The World Bank expects that developing countries’ economies will grow by about six percent this year and next – more than twice the growth rate expected for rich nations. According to Zoellick, the difference is due to several factors. For instance, emerging markets and developing countries have been investing in infrastructure and reforming economic policies for various sectors, especially services.

Indeed, the fundamentals for many emerging countries look better today then they did 10 years ago, and the so-called BRICS (Brazil, Russia, India and China) seem ready to become engines of global growth as the rich world struggles out of recession. After crises in the 1990s and after the turn of the century, many emerging markets did a lot to get their fiscal houses in order. They have imposed tighter budgets, improved debt-to-GDP ratios and boosted growth.

According to the World Economic Outlook the International Monetary Fund (IMF) published in April, “global activity is recovering at varying speeds, tepidly in many of the advanced economies, but solidly in most emerging and developing economies”. The IMF also noted, however, that investors were flocking to emerging markets in the wake of Greece’s debt crisis and related worries in other euro zone countries.

The IMF is contributing € 30 billion to the € 110 billion package the EU designed in support of Greece as well as € 250 billion to the EU’s € 750 billion scheme put in place for emergency measures in the future. IMF involvement, however, implies using funds of all IMF shareholders, including emerging market nations.

Arvind Subramanian, an Indian economist at the Washington-based think tank Peterson Institute, admits that, in view of their growing clout, it is correct for China, India, Brazil and other emerging market nations to make such contributions. He also notes, however, that it seems “unfair and perverse” that “taxpayers in much poorer countries should contribute so that rich financial institutions can get away with reckless lending”. In his view, the private-sector banks that lent Greece funds should be forced to carry at least some of the burden.

The IMF’s recent Regional Economic Outlook for Asia warns that sovereign liquidity and solvency in the euro zone may turn into a potentially contagious sovereign debt crisis around the globe. Even though the crisis has been contained so far, growing international risk aversion could put Asian private-sector institutions under stress, the IMF argues, because they have prominent refinancing needs.

Former communist countries in Europe and the former Soviet republics in central Asia are also at a high risk of contagion, the European Bank for Reconstruction and Development warned in May. It added that goods exports from the region to the EU and capital flows in the other direction might slow down.

Since the collapse of Lehman Brothers in 2008, many sub-Saharan African countries weathered the global crisis fairly well, the IMF noted in a recent regional outlook. The downside, however, is that poor people are less able to cope with economic stress than those who are better off.

The more a country is integrated into the world economy, moreover, the more it feels the global crisis. John Lipsky, a high-ranking IMF officer, First Deputy Managing Director of the IMF, says that “falling global demand reduced prices for many commodity exporters and resulted in slumping sales for many nontraditional exports”. He added that, in 2008, there was a “sudden stop” in capital flows to emerging markets and developing countries.

At the moment, the euro crisis seems to be reinforcing the dollar’s role as the world’s reserve currency. European policymakers had been working on establishing the euro as an alternative. Growing uncertainty about the euro, and even the EU as a whole, has led investors to consider assets in other denominations. As D+C was going to print in late May, China’s State Administration of Foreign Exchange, for instance, was expressing doubts about holding euro bonds. This government agency owns about € 630 billion of euro zone debt.

China’s leadership, however, is also worried about the dollar. Their country alone holds nearly $ 2 trillion in reserves. Last year, the Chinese government floated the idea of a new global reserve currency, showing just how concerned it is about eventually ending up with stockpiles of depreciated US currency.

Though doubts are growing about the USA and the EU, most investors still tend to have more faith in the institutions and markets of the advanced regions. Political insecurity is still considered greater in emerging markets and even more so in developing nations. Moreover, the purchasing power of consumers is much lower there too. In the past, growth in the emerging markets has largely depended on exports driven by demand in rich nations.

The gap is narrowing, however, and as the balance of international wealth shifts many wonder not so much whether the US and Europe will remain the dominant global economic powers, but when their power will be challenged and by whom. Some see the emergence of the BRICs as a sign that wealth is already shifting from West to East. This could eventually bring about a multi-polar political power structure, especially if the USA is forced to cut its heavy defence spending. At some point, Washington will have to start repaying its massive debts – budget deficit forecasts of $1 trillion are ominous.
(Ellen Thalman)