Global Financial Power: The wealth of nations

04/10/2009 | Taimur Ahmad

In the years preceding the financial crisis of 2008/9, the shift in the centre of gravity of global financial power from developed to developing economies was already being widely touted

In the years preceding the financial crisis of 2008/9, the shift in the centre of gravity of global financial power from developed to developing economies was already being widely touted.

When the crisis struck, emerging markets were seen – for the first time – to be a safe haven in the wake of a global storm, although in the end, nowhere escaped unscathed from the fury unleashed by the collapse of Lehman Brothers.

But today most major emerging market economies are bouncing back, resuming their ascent through ever growing stockpiles of currency reserves and sovereign wealth, a bigger share of global output and rapidly developing domestic markets. It’s precisely the apparent resilience of these economies which their proponents – in financial markets and the policy sphere alike – are now taking as vindication of their long-running argument: that the centre of gravity of financial power is moving eastward.

Our special report takes a closer look at this supposed shift in the balance of global financial power that has accompanied the rise of emerging markets. We look at the forces underlying the economic and financial empowerment of the emerging regions – including, governance and reform, trade and investment, capital and regulation, and growth and develpment – and we ask: who are the key figures shaping the rise of the emerging markets – from within?

After extensive research, we have narrowed the field to 40 emerging world political, financial and business leaders who, arguably, best represent today’s transformation. The list does not pretend to be exhaustive nor final; this is simply a window into power and influence in the emerging world.

Through a series of interviews and profiles, we provide a unique picture of the people, ideas and actions that are shaping the 21st century as the emerging markets come of age.

If ever a more potent symbol of the rising power of the emerging economies was needed, it came with September’s announcement that the Group of 7 – the once elite economic club of rich-countries including the United States, Britain, Canada, France, Germany, Italy and Japan – would be replaced as the world’s preeminent economic policy forum, by a much broader Group of 20, that includes China, India and Brazil.

After more than three decades of dominance, the G7 has finally been neutralized as a distinct entity in a move that symbolizes the growing economic heft of emerging regions such as Asia and Latin America.

In 2000 developing countries accounted for 37% of world output (at purchasing power parities). Last year their share rose to 45%.

But the G20’s empowerment also represents a degree of capitulation by rich countries, humbled by an economic crisis that has crippled western banking systems and strained government budgets on a scale unprecedented in the post-war west.

The IMF estimates that western banks still have to announce a further $1.5 trillion in write-downs, while government debt as a proportion of GDP is likely to approach 120% in advanced economies by next year. As a result of the financial crisis, the US – long seat of global financial power – has fallen prey to a high and rising debt trajectory which could see US debt reach almost 110% of gross domestic product by 2014, according to the IMF.

The balance of world economic activity is rapidly shifting from the advanced economies of North America, western Europe and Japan towards the emerging economies—a transfer of power that has been amplified by the global crisis of the past two years and, more recently, by the beginnings of the economic recovery, of which China is the forefront. The facts speak for themselves: today, on a purchasing power parity basis, China’s GDP is larger than Japan’s; India’s is larger than Germany and Russia’s larger than the UK

The advanced economies are expected to grow by a modest 1.3% next year, following a 3.4% decline this year, according to the IMF’s latest forecast. China and India, by contrast, are projected to expand strongly – by 9% and 6.4% respectively.

Outward signs

Collapsing growth in advanced economies during the global crisis had severe global knock-on effects: economic activity contracted sharply across emerging markets in the fourth quarter of 2008, with double digit declines in exports and industrial production and market slowdowns in retail sales. But the rebound has in many ways been more remarkable than the crash, not least because it has defied historical precedents for emerging markets.

Financial markets in emerging economies have proved astonishingly resilient, having benefited from the growing risk appetite since the markets began to rally in March. In particular, this helped open credit markets that had put severe pressure on some governments, especially in eastern Europe, as they struggled to refinance debt.

The MSCI Barra index of emerging equity markets has outperformed the Dow Jones Industrials by about 20% since before Lehman’s collapse, and by almost 40% since early March. EMBI+ spreads are at around 320 basis points, less than just before Lehman failed.

By and large, the newfound resilience of emerging economies is a result of lower fiscal deficits, larger foreign exchange reserves and less corporate dependence on foreign borrowings.

As Mexico’s central bank governor puts it: “As a whole, emerging market countries have strengthened their economic policy frameworks, their levels of international reserves, their fiscal positions, etc to an extent that they’ve been in a much better position to deal with this crisis.”

But the bounce back of emerging market assets is also a relative phenomenon, in large part down to the fact that their simpler financial systems were not saddled with the toxic waste that sank developed world peers. For the latter, the crisis is one of excessive debt, and of a deleveraging process which is still playing itself out.

Large emerging economies have been cautious in liberalising their financial systems, so have been less affected by the West’s financial heart attack. And their recoveries have been boosted by governments which have dramatically loosened monetary policy and increased government spending.

China, for instance, is using its state-owned banks to pump out loans at astonishing rates - $800 billion in the first quarter of 2009. Brazil and India too are opening the floodgates to credit.

In reserve

One of the most obvious outward manifestations of financial power has been the massive accumulation of current account surpluses and foreign exchange reserves by emerging markets, especially Asia and most notably in China, but also by the oil producing countries. Emerging markets foreign reserves have grown at an inordinate clip in recent years, and today they amount to roughly $4.2 trillion, representing over 60% of world international reserves.

This makes the situation of the dollar – and more generally the stability of the international monetary system – very much dependent on the behaviour of surplus emerging economies, especially their appetite for investing in US Treasury bonds.

Surplus and fast growing emerging economies have also reduced their external indebtedness, repaid most of the official multilateral debt and are, by and large, in a better position to conduct their policies and withstand international shocks.

Global say

In recognition of their increased global might, the newly emboldened G20 has vowed to grant emerging economies more say in the institutions of global governance: China and other underrepresented emerging markets will get a large share – at least 5% — of quotas in the IMF, while developing nations’ sway over the World Bank will increase by at least 3%.

Developing country participation and representation, especially in the World Bank and the IMF, has long been a source of discord; and reform of the institutions has been seen as key in building a new architecture for global markets.

The latest impetus for reform represents a bold counter-offensive by emerging markets that mark some important shifts in global economic governance.

But it’s early days yet – and the extent of any likely reform should not be overstated. After all, the rich countries have hardly given up their power in international bodies, only softened it.

Boom and bust

Although the emerging market financial crises of the 1980s and 1990s may seem a thing of the past, this does not mean that developing economies as a whole have decoupled from the global growth cycle.

For now the newfound resilience of countries like China, India and Brazil is unlikely to offset the disastrous state of the rest of the world economy. While the three big nations recover, developing countries as a whole are still mired in recession.

And in the medium term, the ascent of the emerging markets will continue to be turbulent one; as the current economic crisis shows, there is no certainty to the economic outlook. More specifically the collapse in western demand means that Asia in particular will have to rethink its growth model as its grapples with the demise of export-led development. And as Asia readjusts – perhaps to a more modest growth trajectory – so too the rest of the world.

There are other immense challenges. Emerging markets still have relatively low per capita incomes, not to mention vast demographic challenges – particularly in emerging Asia – in the decades ahead: more than 20% of Asians will be elderly by 2050, and China’s elderly population will soar within a decade.

Moreover, rising inequality, rampant corruption and the potential for political instability all dent an otherwise compelling narrative. So does the lack of proper functioning democracy in some of the key emerging economies, including China. As Beijing gains in wealth and influence, rest assured that its neighbours, if not beholden to Chinese largesse, will resist explicit moves towards Chinese hegemony.

Yet for now, increasingly many western firms are taking the bet that closer engagement with the emerging world will pay off. Last month HSBC announced the relocation of its chief executive’s office from London to Hong Kong. As Stephen Green, the bank’s chairman remarked at the time: “Asia and China are the centre of gravity of the world and of our business.”

If ever a more potent symbol of the rising power of the emerging economies was needed, it came with September’s announcement that the Group of 7 – the once elite economic club of rich-countries including the United States, Britain, Canada, France, Germany, Italy and Japan – would be replaced as the world’s preeminent economic policy forum, by a much broader Group of 20, that includes China, India and Brazil.

After more than three decades of dominance, the G7 has finally been neutralized as a distinct entity in a move that symbolizes the growing economic heft of emerging regions such as Asia and Latin America.

In 2000 developing countries accounted for 37% of world output (at purchasing power parities). Last year their share rose to 45%.

But the G20’s empowerment also represents a degree of capitulation by rich countries, humbled by an economic crisis that has crippled western banking systems and strained government budgets on a scale unprecedented in the post-war west.

The IMF estimates that western banks still have to announce a further $1.5 trillion in write-downs, while government debt as a proportion of GDP is likely to approach 120% in advanced economies by next year. As a result of the financial crisis, the US – long seat of global financial power – has fallen prey to a high and rising debt trajectory which could see US debt reach almost 110% of gross domestic product by 2014, according to the IMF.

The balance of world economic activity is rapidly shifting from the advanced economies of North America, western Europe and Japan towards the emerging economies—a transfer of power that has been amplified by the global crisis of the past two years and, more recently, by the beginnings of the economic recovery, of which China is the forefront. The facts speak for themselves: today, on a purchasing power parity basis, China’s GDP is larger than Japan’s; India’s is larger than Germany and Russia’s larger than the UK

The advanced economies are expected to grow by a modest 1.3% next year, following a 3.4% decline this year, according to the IMF’s latest forecast. China and India, by contrast, are projected to expand strongly – by 9% and 6.4% respectively.

Outward signs

Collapsing growth in advanced economies during the global crisis had severe global knock-on effects: economic activity contracted sharply across emerging markets in the fourth quarter of 2008, with double digit declines in exports and industrial production and market slowdowns in retail sales. But the rebound has in many ways been more remarkable than the crash, not least because it has defied historical precedents for emerging markets.

Financial markets in emerging economies have proved astonishingly resilient, having benefited from the growing risk appetite since the markets began to rally in March. In particular, this helped open credit markets that had put severe pressure on some governments, especially in eastern Europe, as they struggled to refinance debt.

The MSCI Barra index of emerging equity markets has outperformed the Dow Jones Industrials by about 20% since before Lehman’s collapse, and by almost 40% since early March. EMBI+ spreads are at around 320 basis points, less than just before Lehman failed.

By and large, the newfound resilience of emerging economies is a result of lower fiscal deficits, larger foreign exchange reserves and less corporate dependence on foreign borrowings.

As Mexico’s central bank governor puts it: “As a whole, emerging market countries have strengthened their economic policy frameworks, their levels of international reserves, their fiscal positions, etc to an extent that they’ve been in a much better position to deal with this crisis.”

But the bounce back of emerging market assets is also a relative phenomenon, in large part down to the fact that their simpler financial systems were not saddled with the toxic waste that sank developed world peers. For the latter, the crisis is one of excessive debt, and of a deleveraging process which is still playing itself out.

Large emerging economies have been cautious in liberalising their financial systems, so have been less affected by the West’s financial heart attack. And their recoveries have been boosted by governments which have dramatically loosened monetary policy and increased government spending.

China, for instance, is using its state-owned banks to pump out loans at astonishing rates - $800 billion in the first quarter of 2009. Brazil and India too are opening the floodgates to credit.

In reserve

One of the most obvious outward manifestations of financial power has been the massive accumulation of current account surpluses and foreign exchange reserves by emerging markets, especially Asia and most notably in China, but also by the oil producing countries. Emerging markets foreign reserves have grown at an inordinate clip in recent years, and today they amount to roughly $4.2 trillion, representing over 60% of world international reserves.

This makes the situation of the dollar – and more generally the stability of the international monetary system – very much dependent on the behaviour of surplus emerging economies, especially their appetite for investing in US Treasury bonds.

Surplus and fast growing emerging economies have also reduced their external indebtedness, repaid most of the official multilateral debt and are, by and large, in a better position to conduct their policies and withstand international shocks.

Global say

In recognition of their increased global might, the newly emboldened G20 has vowed to grant emerging economies more say in the institutions of global governance: China and other underrepresented emerging markets will get a large share – at least 5% — of quotas in the IMF, while developing nations’ sway over the World Bank will increase by at least 3%.

Developing country participation and representation, especially in the World Bank and the IMF, has long been a source of discord; and reform of the institutions has been seen as key in building a new architecture for global markets.

The latest impetus for reform represents a bold counter-offensive by emerging markets that mark some important shifts in global economic governance.

But it’s early days yet – and the extent of any likely reform should not be overstated. After all, the rich countries have hardly given up their power in international bodies, only softened it.

Boom and bust

Although the emerging market financial crises of the 1980s and 1990s may seem a thing of the past, this does not mean that developing economies as a whole have decoupled from the global growth cycle.

For now the newfound resilience of countries like China, India and Brazil is unlikely to offset the disastrous state of the rest of the world economy. While the three big nations recover, developing countries as a whole are still mired in recession.

And in the medium term, the ascent of the emerging markets will continue to be turbulent one; as the current economic crisis shows, there is no certainty to the economic outlook. More specifically the collapse in western demand means that Asia in particular will have to rethink its growth model as its grapples with the demise of export-led development. And as Asia readjusts – perhaps to a more modest growth trajectory – so too the rest of the world.

There are other immense challenges. Emerging markets still have relatively low per capita incomes, not to mention vast demographic challenges – particularly in emerging Asia – in the decades ahead: more than 20% of Asians will be elderly by 2050, and China’s elderly population will soar within a decade.

Moreover, rising inequality, rampant corruption and the potential for political instability all dent an otherwise compelling narrative. So does the lack of proper functioning democracy in some of the key emerging economies, including China. As Beijing gains in wealth and influence, rest assured that its neighbours, if not beholden to Chinese largesse, will resist explicit moves towards Chinese hegemony.

Yet for now, increasingly many western firms are taking the bet that closer engagement with the emerging world will pay off. Last month HSBC announced the relocation of its chief executive’s office from London to Hong Kong. As Stephen Green, the bank’s chairman remarked at the time: “Asia and China are the centre of gravity of the world and of our business.”

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