Asia - China, India face challenge of home-made errors

As 2012 begins, the world's eyes will be watching emerging economies for signs of whether they are losing momentum or finding stability after small setbacks at the end of last year.

Beyond purely asking whether these countries are likely to go into recession, what happens this year will test yet one more confidently held truism about the most recent incarnation of globalization: are emerging economies decoupled from developed countries?

Already, the signs are not encouraging. 2011 ended with the stock indices of various emerging economies in troubling condition. Exchanges in the BRIC countries had a terrible 2011 - Brazil and Russia were down 18%, India 23%, and China 21%.

For emerging economies with political turmoil over the past year, the returns were even more bad: Egypt's EGX30 was down almost 50%, Greece's Athex Composite was down even more than that. Emerging economy currencies had a similarly disastrous 2011.

In most cases, these returns reflected significant softening in the countries' respective gross domestic product (GDP) growth rates. The best example of this relationship was Brazil, which saw its GDP growth shrink to a range of 0.7-0.8% over the course of 2011. GDP growth turned negative for several countries troubled by the eurozone crisis, including Greece, Ireland and Portugal. The twin specters of economic and political turmoil spelled trouble for emerging economies around the world in the last quarter of 2011.

For developed countries, 2011 ended on a mixed note: GDP growth in the United States started off the year at a paltry 0.4% and worked its way to a Q3 GDP of 1.8%, certainly an improvement, but noticeably weaker than 2010's GDP growth rate range of 1.7-3.7%. The United Kingdom, largely due to the impact of its much lauded austerity program, saw its GDP growth slow to 0.50% in Q3, while Belgium, France, the Netherlands, Luxembourg, Spain and Italy all saw their GDP growth dip to less than 2% as the year drew to a close.

The financial crisis of 2008 has leveled one supposed truth after another about how the new globalized economy was supposed to work. Now, the established wisdom that emerging and developed economies are decoupled from one another appears to be the next such assertion to be tested.

Decoupling argues that the pent-up demand in emerging economies like China and India is so great that they can, if forced, continue to grow significantly as they build additional infrastructure and modernize their economies.

Advocates of de-coupling, such as Jim O'Neill, the chairman of Goldman Sachs Asset Management, who first coined the BRIC term, have been able to point towards the amazing growth of these countries since 2001 as well as the continued strength of the Chinese economy since the 2008 financial crisis as evidence that this theory is accurate, at least in so far as it characterizes China's economy.

In his new book, The Growth Map: Economic Opportunity in the BRICs and Beyond, O'Neill writes that "The aggregate GDP of the BRIC countries has close to quadrupled since 2001 ... The world economy has doubled in size since 2001, and a third of that growth has come from the BRICs ... Their combined GDP increase was more than twice that of the United States and it was equivalent to the creation of another new Japan plus one Germany, or five United Kingdoms, in the space of a single decade."

Critics of de-coupling believe that China's GDP growth in the period after 2008 owes much to a massive stimulus program Beijing put through which was large and timely enough to make up for softening export demand, but that this was a one-time success which is not repeatable.

To this group, the weak Consumer Price Index and Producer Price Index numbers in November are beginning to suggest that China's economy is heading for a slowdown. Equally troubling to these critics are signs that the Chinese real estate market, a critical factor in terms of economic growth and job creation for the country, has begun to implode.

If the events of 2008 to 2011 offer any insight into de-coupling it may be this: while the BRIC nations had enough financial horsepower to push through the 2008 financial crisis, which began in developed economies with minimal negative effect, other countries, what O'Neill calls the "Next 11" (Bangladesh, Egypt, Indonesia, Iran, South Korea, Mexico, Nigeria, Pakistan, the Philippines, Turkey and Vietnam) as well as precariously positioned European emerging economies, do not quite yet have the same ability.

In fact, what the last several years appear to show us is that the world has a whole new set of economic interdependencies: yes, the relationship between China's ability to export to North America is critical to the former country's ongoing growth, but the relationship between China or India to the much smaller and more fragile economies around is more important than has been previously understood.

While advocates of de-coupling might be able to argue that the American and Chinese economies are growing increasingly independent of one another, the same healthy distance and de-coupling does not yet exist between smaller regional economies and a growing Chinese and Indian economy.

In fact, recent studies show that emerging economies export more to China than to the United States, a finding echoed by research done by M Ayhan Kose, an International Monetary Fund researcher who found that emerging markets' trade with other emerging markets increased by some fourfold from 1960 to 2005.

For the most part, the trade between emerging economies falls into the categories of commodities, raw materials, and basic manufacturing. What this means, of course, is that instead of the traditional argument that if the United States "sneezed, the rest of the world would catch a cold", it is China or India's sneeze that might induce a cold for developing nations.

This makes the recent signs of distress in China and India's respective economies that much more troubling. In many ways, the performance of these two countries remains one of the only positive points that American and European multinationals can point towards when looking at where they can generate revenue growth and profitability from over the next 12-18 months.

After all, it was the ongoing strength and relative stability of China's economy in particular that allowed many multinationals in the fast-moving consumer goods, luxury products, and pharmaceutical industries to rise above a major economic contraction in the United States and Europe after the disaster of 2008.

Facing an American economy still struggling with what is likely to be a decade-long debt-deleveraging process that will soon find new teeth as the United States government pursues additional austerity programs at the same time the eurozone's future remains very much in question, the role of emerging economies in securing and stabilizing the future of multinationals is critical.

For companies selling into these markets, a major setback in China or India could severely damage their financial performance, leading to further job cuts not only in their overseas businesses but in their domestic operations as well.

Such a setback would also quell much of the euphoria surrounding emerging markets and their ability to act as an offset to instability and recessions in the developed world. De-coupling hinted at the great promise that could come from emerging economies bringing their nations forward into the modern-age; but like many ideas, de-coupling might be right in one way (a coherent de-coupling from China and the United States), but terribly wrong in another (the coupling between China and other regional developing economies).

As 2012 moves forward, business leaders, policy makers and politicians are all watching for signs of whether the emerging economies of China and India in particular will continue to grow or begin to show signs of slowdown and perhaps even recession.

Writing in a recent Morgan Stanley note titled, "Why India is Riskier than China", Stephen Roach says "Seduced by the political economy of false prosperity, the West has squandered its strength. Driven by strategy and stability, Asia has built on its newfound strength. But now it must reinvent itself ... Downside pressures currently squeezing China and India underscore that challenge. Asia's defining moment could be [at] hand."

Both countries have been able to prove they can stand on their own two feet against economic contractions in the developed West; now, however, they must equally prove that they can navigate a period of instability caused by policy decisions of their own making, not those economic realities imposed on them by their largest export markets.

If they cannot, 2012 is likely to mark a year where the American and European recessions align with similar setbacks in China and India, the results of which would have profound economic and - perhaps most importantly - political repercussions for years to come in developed and emerging economies alike.

Benjamin A Shobert

Asia Times

Benjamin A Shobert is the managing director of Teleos Inc, a consulting firm dedicated to helping Asian businesses bring innovative technologies into the North American market.

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