History may not be a good guide for the current crisis. Nevertheless, a look at past global slowdowns might give us some clues about what to expect.
The database of the International Monetary Fund is a good place to look. The data on global gross domestic product (GDP) growth is available from 1980 onwards. Drastic slowdowns occurred in 1982, when global GDP fell to 0.9%, in 1991, when it fell to 1.5% and in 2001, when it fell to 2.2%.
Of course, things are much worse this time, and IMF expects world growth to fall to 0.5% in the current year.
What’s interesting from our point of view is what happened to the developing Asian economies during these slowdowns. The lowest rate of growth for developing Asia was 3.5% in 1998 during the Asian crisis. This time, IMF expects developing Asia to grow at 5.5% in 2009.
Also See Global Downturn (Graphic)
But here’s what happened during the Asian crisis. World GDP growth fell from 4% in 1997 to 2.5% in 1998, growth in all emerging markets went down from 4.9% to 2.4% and growth in developed Asia fell from 6.3% in 1997 to 3.5% in 1998.
And look what happened to private sector capital flows to emerging markets—they dropped from $226 billion (about Rs11.2 trillion) in 1996 to $207 billion a year later and then collapsed to $72 billion in 1998 and it wasn’t till 2004 before fund flows went back to the level they had reached in 1996.
The collapse in private capital flows to developing Asia was far more dramatic. They went down from $123 billion in 1996 to $53 billion a year later and then plummeted to a negative $48 billion in 1998. Again, it wasn’t until 2004 that fund flows regained the level they were at in 1996.
In the current crisis, IMF estimates private fund flows to developing Asia will plunge from a record $291 billion in 2008 to $22 billion this year. Worse, portfolio flows, which are estimated at outbound $25 billion for developing Asia, are forecast to be outbound $108 billion this year. That alone should be sufficient to take the markets down further this year.
Unlike during the Asian crisis, this time the heart of the problem is centred on the developed world. One argument is that since countries such as India will be hurt relatively less by the crisis, at some point or another, capital will flow to them. But the link between stock market returns and GDP growth is tenuous at best.
In the mid-1990s, when GDP growth in India was high by the standards of the time, stock market returns didn’t match that growth. For instance, in 1994-95 GDP growth was 6.4%, while returns from the Bombay Stock Exchange’s benchmark index, the Sensex, were a negative 13%. The following year, GDP growth improved to 7.3%, while the Sensex rose by all of 2%. And in 1996-97, when GDP growth was 7.3%, the Sensex was flat.
While it’s certainly correct that the fund flows into India in 2003-07 coincided with an economic boom, that relationship may not hold in an environment of deleveraging. There is little doubt that the market boom in India during 2003-07 was the result of excessive leverage in the global financial system. That leverage is still unwinding, the latest instance being the collapse of the eastern European emerging markets.
Perhaps a closer parallel is the dotcom bust of 2000, which affected the developed world more than developing countries. In 2001, for instance, GDP growth in the advanced economies fell to 1.2% from 3.9% in the previous year, while growth in developing Asia fell from 7% to 5.7%. Despite negative portfolio flows in 2001 and 2002, foreign direct investment flows remained steady.
But there are two problems with that analogy—this time, the banking system in the West has imploded, which means one of the main conduits for fund flows to emerging markets has collapsed. It’s difficult to envisage nationalized Western banks filling that vacuum.
Moreover, IMF is predicting a contraction of 2% in the advanced economies this year. It’s also predicting they will grow at 1.1% next year, which is lower than the growth they had in 2001, during the depths of the dotcom bust.
That seems to make all predictions of a recovery in emerging markets this year appear rather premature.
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Graphics by Ahmed Raza Khan / Mint