With signs of overheating in the developing world, fears of a repeat of the 1990s Asian financial crisis or the 1980s Latin American debt crisis are surfacing. To assess the danger and outline policies that emerging markets and advanced countries should pursue to avoid such an outcome, Carnegie hosted a discussion with Anoop Singh, director of the International Monetary Fund’s Asia and Pacific department, Frederick Jaspersen, director of the Institute of International Finance’s Latin America department, and Carnegie’s Uri Dadush. Carnegie’s Yukon Huang moderated.
All three speakers emphasized that the conditions for overheating—rapid growth and confidence in developing economies paired with historically low interest rates in advanced ones—are clearly in place:
Nonetheless, Dadush argued that large emerging markets appear more robust today than in periods before previous crises. Compared to Asian crisis countries, today’s major emerging economies have much lower levels of external debt (debt owed to foreigners), higher levels of foreign exchange reserves, and more flexible exchange rates. Those countries with pegged exchange rates, such as China and Saudi Arabia, have ample reserves and large current account surpluses.
Jaspersen, Singh, and Dadush outlined the major components of potential overheating. Policy makers must carefully monitor all three components, since problems in one of them could add to those in the other two:
Based on these indicators, participants agreed the risk of overheating is growing, particularly in Asia and Latin America.
Singh noted several areas of concern in Asia, the world’s most rapidly growing region:
Despite these concerns, Singh noted that monetary and fiscal policy in Asia has not been tightened to prevent potential overheating and is still supportive of growth. However, he also highlighted reasons for optimism:
Participants also noted overheating pressures in China, now the world’s second largest economy.
Huang added that general inflationary pressures in China are not all bad. Wages—which are very low relative to productivity by international standards—need to rise. Inflation in the coastal regions helps rebalance China domestically, by shifting resources to the poorer regions inland, and externally, by increasing the REER.
The recovery in Latin America has been rapid by historical standards. Fiscal and quasi-fiscal stimulus helped drive growth, which exceeded 6 percent in 2010. However, Jaspersen highlighted two major issues—rising inflation and currency appreciation—that worry policy makers.
Jaspersen noted that Latin American policy makers have addressed these challenges differently. Brazilian leaders have focused more on containing exchange rate appreciation than on inflation,
choosing to introduce capital controls and add to reserves rather than rapidly tighten monetary policy. Other countries, such as Chile, have concentrated on reducing the fiscal deficit, controlling inflation, and following a more flexible exchange rate policy.
While signs of overheating are in their early stages, leaders should normalize policy in emerging markets soon, participants agreed. Dadush emphasized that the dangers will only increase as interest rates in advanced countries are likely to remain low for an extended period, and the growth cycle in developing countries is just returning after a massive recession. The current imbalances are not unmanageable but, left unaddressed, will require far more drastic policy changes in the future.
As the recovery picks up in advanced countries, leaders should gradually tighten policy rates and accelerate fiscal consolidation. Dadush said policy makers must not rely so heavily on monetary policy. Using it to propel the recovery could accelerate inflation, while rapid tightening could hit emerging markets with a triple whammy: a capital flow reversal, slower global growth, and diminished risk appetites.
Participants expressed concern that the troubling surge in food prices is spilling over to other parts of the economy.