beyondbrics

This post is the seventh of a series – 12 for 2012 – that beyondbrics is running on key emerging markets topics for the new year.

By Stanislaw Gomulka, chief economist at the Business Centre Club

The sharp declines in emerging currencies have generated bad headlines with fund managers complaining about the losses imposed on their emerging market investments. But currency depreciation will bring benefits next year, as these countries adjust to the coming global slow down, in the form of boosting export competitiveness. In Poland this is already happening.

Worldwide shocks typically result in fluctuations in economic performance that are, as a percentage proportion of GDP, similar in size across countries irrespective of their level of development.

Any such external or internal shock, in demand or technological, takes economy somewhat away from its natural trend growth path. But the trend growth paths vary greatly among countries. The typical path for advanced countries is one with the GDP per capita annual growth rate of some 1 to 2 percent.

Emerging countries, however, enjoy what the US economic historian Alexander Gerschenkron half a century ago called “advantages of backwardness”. These advantages are potent only when they are capable of generating or bringing about international transfer of new products and technologies from more advanced countries – often these come cost-free, as multinationals move technology within their operations from developed to developing countries.

This capability is strongly dependent on the quality of internal institutions and economic policies. Consequently, the growth paths differ widely among those countries. But for the group as a whole the trend growth rate is now about 4 to 5 percent (For China and India this rate is now even higher, some 6 to 9 percent).

A powerful shock, one that costs, say, 3 per cent of GDP, would therefore result in a fall of GDP by 1-2 percentage points in advanced economies, causing a recession, but causing only a slowdown to 1-2 percent growth in emerging markets. The impact of such a common shock on the rate of unemployment would be about the same in both groups of countries, but the psychological perception in financial markets and the political perception in the countries themselves would typically be rather less negative in the emerging countries, by virtue of them still being capable of economic growth.

The financial crisis three years ago in the advanced part of the world economy and the present tensions in the eurozone have increased the macroeconomic risk for international portfolio investors. Their reaction has been to transfer some capital from emerging economies to the countries considered by them as exceptionally safe. The countries enjoying the highest credibility are the USA, Japan, Germany and Switzerland. This transfer has caused considerable depreciation of the exchange rates of the emerging countries’ currencies as well as considerable reductions in the interest rates on public debt of the most credit-worthy countries.

In the emerging markets, these depreciations have improved competitiveness and therefore helped to reduce the negative impact of the initial external shock on economic activity. This particular factor has been more powerful in smaller economies, which are generally more dependent on foreign trade. The emerging economies have also benefited from the fact that their financial sectors, particularly banking, are relatively much smaller, and so less capable of causing harm during a financial crisis.

In the years 2008-09 Poland gained from all three of these factors. From January 31 2008 until February 19 2009 the value of the zloty against the euro dropped 50 per cent from 3,20 zloty to 4.90 Also, in 2008 Poland’s public debt and budget deficit were relatively small, permitting the government to adopt a highly expansionary fiscal policy in the years 2008-10 .

In the years 2011-12 Poland is conducting a mildly contractionary fiscal policy. But the financial sector continues to be in good health and the zloty is weak again, having fallen this year against the euro by 13 per cent. Net exports are increasing, expected to contribute to the GDP at least half a percentage point in 2012. Moreover, the EU economy is not expected to suffer a recession , in any case not one of the kind experienced three years ago.

Poland’s GDP growth in 2011 of about 4.2 per cent has created a great deal of optimism among households and businesses. Domestic demand is therefore expected to grow in 2012, though less rapidly than in 2011. All in all, I expect the GDP growth in 2012 to be in the range of 2 to 3 per cent in Poland, and in the range of -1 to +1 per cent in the EU as well as in the eurozone.

Poland’s experience demonstrates the advantages of a flexible currency in difficult times. However, for normal times the case for adopting the euro (elimination of exchange rate risk, lower interest rates and bigger foreign direct investment) remains about the same now as it did when Poland joined the EU in 2004.

Stanislaw Gomulka is chief economist at the Business Centre Club and a former deputy finance minister

Further reading:
Series: 12 for 2012
Poland: end-of-year zloty shenanigans, beyondbrics
Poles repel fear of Europe’s next recession, FT
Ambitious Warsaw increases its influence, FT