Emerging World Poses More Danger Than in 1990s: Cutting Research

Developed economies are less resilient to an emerging-market shock than they were in the 1990s, when crises from Thailand to Russia rattled investors without triggering a global recession.

That’s according to an 81-page study released March 5 by Morgan Stanley economists and strategists. They estimate a 1990s-style slump in emerging-market demand would create an average drag of 1.4 percent for four quarters on the growth of the U.S., while the euro area and Japan probably would be tipped into recession.

Reasons for the greater vulnerability include the fact that developing markets, and especially China, now have a stronger impact on the world’s economy, supply chains and trade. Emerging economies account for about half of global gross domestic product, up from 37 percent in 1997-1998.

Developed economies are also more exposed to their smaller counterparts via exports, corporate revenue and banking, and the financial crisis of 2008 means they are weaker now than two decades ago, said the authors, including London-based Manoj Pradhan.

The Federal Reserve and the Bank of Japan probably would respond by easing monetary policy, lowering commodity prices and bond yields as a result. That would help revive growth, although the recovery would be weak, they said.

“If an emerging-market shock materializes, we believe the impact on developed markets could be stronger than it was in the late 1990s and would most likely last longer,” the Morgan Stanley team wrote.

The study is based on a scenario in which emerging-market imports fall 15 percent for two quarters, financial conditions deteriorate as they did in the 1990s and commodity prices decline, with the cost of oil dropping to about $80 a barrel.

Europe’s equity markets would be the most adversely affected among global stocks given its companies have derived 65 percent to 80 percent of their revenue growth from emerging markets in recent years.

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Debt travails will continue to plague the euro region’s biggest economies through 2030, according to Deutsche Bank AG.

A model created by co-chief European economist Gilles Moec aims to assess the extent to which European nations have addressed their macroeconomic and financial shortcomings.

Based on estimates of economies’ non-inflationary growth rates and historical trends, plus data for debt, current accounts and investment, Moec’s calculations show France, Italy and Spain are set to encounter difficulties in “meaningfully” reducing their debt ratios.

Italy, for example, won’t cut its public debt below 120 percent of GDP before 2023, while Spain’s will settle at around 90 percent starting in 2020. France’s may fall to 85 percent from a peak of 96 percent, only to set new highs by 2030.

Only Germany will “continue to display a quite healthy trajectory for deficits and public debt,” London-based Moec said in the Feb. 28 report.

“We suggest that the persistent macro-financial imbalances in Spain and Italy by the middle of the next decade would still generate some significant spread-widening, should another episode of ‘sovereign stress’ occur,” Moec wrote. “France would be less affected, but would not be as immune as it was in 2011/12.”

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Emerging-market companies may be sitting on “hidden debt” that leaves them more vulnerable than official statistics suggest.

That’s because such companies often issue bonds through overseas affiliates, according to Jens Nordvig and David Fritz of Nomura Holdings Inc.

Inspired by a study from the Bank for International Settlements, New York-based Nordvig and Fritz estimated in a March 4 report that $400 billion, or almost 40 percent of private net developing-nation debt issued, has been done offshore since 2010.

Such exposure is generally not included in external debt statistics because it is issued by overseas subsidiaries rather than by entities in the countries where the firms are headquartered, the BIS said in a September study.

Looking to gauge the “external vulnerability” of countries, Nordvig and Fritz said that Brazil, China and Russia are the main contributors to offshore issuance. Brazil, for example, has $154 billion of offshore corporate bonds, equivalent to 7 percent of GDP. China has $200 billion, or 2 percent of GDP.

“In an environment of rising global interest rates and emerging-market currency depreciation, this hard-currency debt could become increasingly difficult for borrowers to repay, and as such it is important not to overlook the ‘hidden debt,’” said Nomura.

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Breakthroughs in information and technology have increased demand and pay for highly skilled and university-educated workers, outpacing the need for employees with middle-range skills, according to the London School of Economics.

Technical change accounted for 15 percent to 25 percent of the growth in the aggregate wage bill of highly skilled workers, the study by Guy Michaels, Ashwini Natraj and John Van Reenen found.

The results were based on employment and wages in 11 countries during the past 25 years. The pay of low-skilled workers was less influenced by developments in technology, it said.

To contact the reporter on this story: Simon Kennedy in Paris at skennedy4@bloomberg.net

To contact the editor responsible for this story: Melinda Grenier at mgrenier1@bloomberg.net

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