9 July 2009

Emerging Markets Economic Outlook

Serdar Küçükakιn, Senior Economist

Differentiation across the regions

• Asia: V-shaped recovery
• Emerging Europe: crisis averted, but huge problems remain
• Latin America: not the 1980s

Global outlook World economy: output gap

A point that in our view needs clarification is the strength of the %
expected global rebound. Many market participants remain
4
sceptical about the idea that the developed economies in
2
particular will achieve anything more than stabilisation in the
rest of 2009. We think that at the heart of this discussion 0
between sceptics and the more optimistic (or less sceptical) -2
lies a confusion between cyclical and medium-term drivers of
-4
growth. It is undeniably true that the ongoing credit crisis has
changed the global economic and financial landscape, and that -6
growth, especially in the developed economies, will therefore 1980 85 90 95 2000 5 10
be lower in 2010 and beyond than pre-2007. Over the coming
World Advanced economies Emerging economies
quarters, however, growth is most likely to be driven primarily
by cyclical factors. Source: IMF

These dynamics can potentially produce significant rebounds
in activity, fuelled by very low inventories in an environment in
which the output gap is extremely large, while consumption
and especially sentiment are stabilising. Although the fall in the
pace of activity has not been as dramatic in the US as in other
regions, businesses have been destocking rapidly. Policy
support has been massive, and this is likely to boost US output
growth in the second half of the year.
Incoming European data suggest that the eurozone remains a
laggard in terms of positive data, which is consistent with the
weaker cyclical and policy supports. The output collapse has
nevertheless been so large in Europe that cyclical factors will
most probably help to generate some rebound in the months
ahead.
The second support for this view can be found in the
continuing disfunctioning of the credit market. The following
diagram shows that while the monetary base in the US has
skyrocketed, the US money multiplier has collapsed. If the
central bank increases the monetary base in a normally
functioning banking system, there will be a multiplier effect on
loans. Banks lend out the excess cash they have, and these
loans are then spent and redeposited at banks. This in turn
creates new bank lending power, new deposits and so on.
However, there is nothing normal about today’s market: bank
lending growth is decelerating and the surge in the monetary
base is consequently piling up in excess reserves.
US: monetary base and money multiplier

120 10
Given the unprecedented policy action by central banks such
100 9
as the Fed, the Bank of England and also the ECB, the
80 8
markets have become noticeably more concerned with inflation
60 7
in the last couple of months. We think there is little danger of
40 6
inflation becoming a real problem in the years ahead. This view 20 5
is supported firstly by the global output gap, which turned 0 4
negative in 2008 and has so far only increased. In other words, -20 3
the difference between the potential and real output is growing. 00 01 02 03 04 05 06 07 08 09
In fact the IMF’s calculations suggest deflation rather than
Monetary base (%yoy, lhs) M2 money (multliplier, rhs)
inflation, especially in 2010.
Source: Thomson Financial, calculations ABN AMRO Econ. Department.

SERDAR KÜÇÜKAKΙN +31 (0)20 629 5086

ECONOMICS DEPARTMENT

Zooming in on the emerging economies, a central theme in the
global economy last year was the possibility of decoupling of
emerging economies, especially those of emerging Asia, from
that of the US. Then, however, in September 2008 came the
collapse of Lehman Brothers, and the resultant paralysis in the
global economy put this idea to rest. Looking back at the
events after the collapse of Lehman Brothers, we can see that
indeed no economy was spared.
Nevertheless, we believe that when it comes to the possibility
of some kind of decoupling of emerging economies from the
US economy, you have to look through the business cycle to
make a balanced judgement. In other words, we have seen the
downswing, but you also have to take into account the upswing
and look who is leading whom. Furthermore when talking
about the possibility of decoupling, the market focused almost
solely on the possibility of a decoupling of trade. It is important,
however, to distinguish between the three channels that
dominate the relationship between an emerging economy and
the developed world: (1) the real channel, (2) the financial
channel and (3) the financial/real channel.
The real channel relates to the trade links and, as is now clear,
no country was spared from the economic fall-out triggered by
the collapse of Lehman Brothers.
The financial channel is a natural consequence of financial
integration: investors arbitraging (and unwinding) positions,
driven by yield search and market sentiment. This is the
infamous financial contagion. Indeed, the collapse of Lehman
Brothers led to all the emerging economies experiencing
enormous capital flight, which left huge problems for those
countries with already stretched balance sheets.
The last channel refers to the painful effect that a tightening of
external finance has on a country that is highly dependent on
this source of finance. Not only does it magnify the downward
trend during the initial negative shock, but it will also inhibit the
countries from implementing counter-cyclical polices and put
downward pressure on the medium-term growth prospects.
We believe this last channel to be very important in explaining
the different growth paths projected for the three emerging
regions. The Asian countries were hit hard because of their
dependence on foreign trade, while past experience meant
foreign investors in particular got the jitters with regard to Latin
American countries. However the independence of both
regions from the need for external financing generally enabled
Asia and Latin America to stand firm during the downswing and
is now enabling them to rebound significantly. Emerging
Europe is in a totally different ball game and is not only
suffering from its close trade linkages with its EU-partners but
is also suffering from its dependence on external financing
because of years of enormous current account deficits.
SERDAR KUCUKAKIN +31 (0)20 629 5086
9 July 2009
Summing up and judging the incoming data, Asia will lead the
way with regard to recovery, with China obviously in the driving
seat. The Latin American economies will follow. In the
eurozone and especially the US the recovery will grow more
visible in the second half of 2009. The recovery in emerging
Europe will be tentative, with several emerging European
countries possibly not even seeing any tentative sings of
recovery this year at all.
Asia
In the final quarter of 2008 emerging Asia experienced its
sharpest slowdown since the Asian crisis more than ten years
ago, with the lion’s share of the collapse being concentrated in
the manufacturing sector. The drying-up of new orders,
especially from the West, meant that shipments plunged; this
in turn led to sharp rises in inventory levels, which caused
manufacturers to slash production sharply and had very
adverse effects on GDP. The countries hit hardest were
generally those with the highest export/GDP ratios.
Export of goods and services % GDP (2008)
China 35.8
Hong Kong 212.5
India 24
Korea 52.9
Malaysia 103.5
Singapore 234.3
Taiwan 74.2
Source: EIU
This, however, is now in the past as there are currently very
clear signs that emerging Asia is on its way to sharp recovery.
We believe there are five factors that are currently working
simultaneously to create a virtuous circle
The first factor is obviously the growing and encouraging signs
that the economies of the eurozone and especially the US are
stabilising, with a positive impact on Asian exports. Admittedly,
the recovery in Asian exports has so far been somewhat
disappointing, with Chinese exports, for example, falling by an
average of 21.8% in the first five months of the year. However
the rebound in Western forward-looking confidence indicators,
such as the US ISM index, which rose to 44.6 in June from the
low of 32.9 recorded in December last year, can be interpreted
as a positive sign for inter-regional export prospects in the
months ahead.
Another factor that is currently having a positive effect on the
Asian economies is the favourable inventory dynamics. As
stated above, the lion’s share of the collapse in Asia was
concentrated in manufacturing. Given that the correlation
between industrial production and economic growth is very
high in the region (China 0.80, Korea 0.81, Taiwan 0.78), a
collapse in industrial output leads to a sharp decline in
ECONOMICS DEPARTMENT

economic growth. However the flip side of the coin also holds.
In the past couple of months manufacturers have slashed
inventories so rigorously that they now have to rebuild their
stock levels. This, in combination with stabilising global growth,
will in our view boost industrial production and have positive
knock-on effects on economic growth.
The third factor working for the Asian economies is the fiscal
authorities’ swift response to the global economic downturn in
the form of enormous discretionary fiscal stimulus packages
focusing on transfers, subsidies and infrastructure. The largest
in absolute size and as a percentage of GDP has of course
been that of China (USD 586 billion, 14% GDP). The market
was quick to focus on the positive effects of this stimulus
package on the economy, but then also turned its focus rather
quickly to the delays that some infrastructural projects were
experiencing and suggested that the effects of this package
could be less than initially envisaged. We do not agree with
this view and indeed believe that past delays in infrastructural
projects mean that the start of these projects will put extra
upward pressure on growth in the months ahead. The Chinese
authorities have admitted these delays and have reassured the
markets that they will not lead to these projects being
cancelled, even explicitly stating that new infrastructural
projects will, if necessary, be launched to support growth.
China: newly started projects
% yoy
100
80
60
40
20
0 Correlation of GDP growth (period 2001-2008)
-20
-40
05 06 07 08 09
Eastern area Western area Central area
Source: CEIC
Another channel that is underpinning the current positive
developments is the monetary stimulus created through lower
policy rates and easier credit conditions. Unlike the US or the
eurozone, the money multiplier in the Asian region has not
collapsed. The money multiplier in Korea, for example, has
been hovering between 3.5 and 4.5 since the start of the
millennium, while easier credit conditions resulted in new
lending skyrocketing (up 201%) in China in the first six months
of the year compared to the same period last year. This huge
increase in liquidity has been used to fund the government’s
infrastructural projects, which are mainly targeting the areas
with the highest need for such investments. In other words, the
western and central areas of China.
SERDAR KUCUKAKIN +31 (0)20 629 5086
9 July 2009
Judging by statements from several central bank officials
across the region, their focus, despite the positive
developments identified in the region, is still very much on the
fragile state of economic activity across the globe and headline
deflation. Therefore we do not think that the region’s central
banks are in a hurry to reverse the easy credit conditions, at
least not sharply. Regarding inflation in May CPI fell by 1.4% in
China and 0.3% in Singapore, while consumer prices in
Thailand declined by 4% in June. For several reasons,
however, we think this bout of deflation will be short-lived. First
of all, many countries such as China responded to the global
slump by administratively lowering the prices of many services
in early 2009. Next year, however, the influence of this
adjustment will fade away. Secondly the prices of many
commodities, ranging from oil (+35% in the year to date) to
soya and sugar (+28% and +29% respectively), have risen
across the board. This will also put upward pressure on
consumer prices. We should also not forget the projected V-
shaped recovery path, which is not compatible with a long
period of deflation.
Last but certainly not least, the growing intra-regional
dependence, with of course China at its heart, is in our view
amplifying the positive trends discussed above. As the
following table shows, the correlation of business cycles is
quite high. In other words, a positive development in one
country leads to a positive development in the other. Given the
countries in the region’s growing dependence on Chinese
demand, developments in this country are especially important.
With our projected growth of 7.5% this year and 8.5% next
year, the effects of developments in China on the region as a
whole can only be described as promising.
China HK Korea Singapore Taiwan
China 0.73 0.41 0.77 0.65
Hong Kong 0.37 0.87 0.76
Korea 0.65 0.69
Singapore 0.84
Taiwan
Source: Bloomberg
Emerging Europe
In Asia we identified five factors that are specific to that region
and are currently combining to create a virtuous circle. There
are also some very specific factors currently affecting the
economies of emerging European countries. However, despite
some forward-looking surveys in several countries signalling
that the trough of economic activity should by now have been
reached, the factors identified tell us only that the problems
these countries are experiencing are here to stay, at least for a
while.
ECONOMICS DEPARTMENT
 9 July 2009

The first factor indicating the magnitude of the problems faced correlation in the period 2001 - 2008 between industrial
by many countries in the region is of course the financial production in countries such as Hungary, the Czech Republic
support from the IMF and EU (Hungary: USD 25 billion; and Poland on the one hand and imports by the eurozone on
Romania: USD 13 billion; Latvia USD 9.5 billion). However, this the other hand (0.58, 0.47 and 0.42 respectively), there will not
support comes at a price. The EU has already reminded the be much oxygen coming to the rescue of these countries’
EU-member emerging countries on several occasions of their industrial sectors in the near future.
fiscal obligations under the Maastricht Treaty. Ambitions to
adopt the euro have been one of the main reasons prompting Industrial production
several countries in the region to raise VAT rates in order to % yoy
bring down their public deficits. We are not against the EU’s
call to keep the Maastricht criteria in mind as, in the long run, 30
healthy public finances are undeniably supportive of growth. In 20
the short term, however, especially under the current economic 10
conditions, raising taxes will also undeniably have adverse 0
effects on consumer spending and thus on economic growth, -10
while the region’s consumers are already suffering the effects -20
of sharply rising unemployment and the drying-up of credit -30
from banks (see below). 00 01 02 03 04 05 06 07 08 09

Hungary Czech Republic

In sharp contrast, for example, to the action taken during the
Asian crisis, the IMF has so far avoided requesting harsh fiscal
adjustments. Instead it has allowed funding to be used for
fiscal financing. Now, however, the IMF looks to be changing
its stance. One of the biggest disputes between the IMF and
the Turkish government that has prevented the two from
reaching agreement is the intention of the central government
in Ankara to increase the local government budget by
TRL 3.5 billion (USD 2.26 billion). Countries such as Hungary,
which will have to augment the current program with the IMF,
will most probably face a similar situation to that of Turkey.
Another factor negatively affecting the region is the ongoing
problems with private balance sheets. Global credit strains
have depressed domestic spending and slowed activity and
are constraining the local banks’ ability to sustain the strong
domestic credit expansion of recent years. In the pre-crisis
period the funding for this credit expansion came from the
large Western banks. But now, with virtually all the major
Western banks in great financial distress themselves; this
source of funding has dried up. With almost no access to
foreign liquidity, banks have consequently begun to conserve
liquidity and capital by reining in new lending. This tight credit
is reinforcing the economic difficulties
In the past, the emerging European countries have benefited
greatly from their growing trade links with their EU partners.
The Czech Republic, Poland and Hungary, for example, export
84%, 77% and 74% respectively of their goods to the EU.
However, these links are now working in the opposite direction.
With the eurozone (as a good substitute for the EU) now
experiencing its most severe economic difficulties in modern
times, its demand for imports has dropped sharply. In other
words, an export-led recovery for emerging European
countries is currently out of the question. Given the visible
Source: Bloomberg
The emerging European countries have seen some
improvements in their trade balances in recent months
because of the collapse in internal demand. However the very
close trade links with their eurozone partners mean the
potential for further improvements in their trade balances looks
limited.
Another factor that is limiting further improvements in trade
balances is the rebound of oil prices by almost 34% so far this
year. This increase in oil prices, and more generally in
commodity prices, may also affect the policy stance of the
inflation-targeting central banks in the region. The central
banks could become more reluctant to continue lowering their
policy rates. At the same time we wonder whether the rate cuts
so far have had any significant positive effect on the
economies since the banks do not seem to be passing lower
policy rates on into lower lending rates and, as explained
above, remain very reluctant to lend.
Besides their growing ties with their EU partners, the emerging
European countries also have increasing economic ties with
each other. Car parts, for example, are being produced in
Poland and Hungary and then sent to the Czech Republic for
assembly. Therefore the correlation of these countries’
industrial production is very high at around 0.80. The growing
industrial integration previously fostered economic expansion
because it meant that resources were allocated relatively
efficiently. However, the flip side of the coin for these countries
in the current setting is that the integration is having only
negative spill-over effects.

SERDAR KUCUKAKIN +31 (0)20 629 5086 ECONOMICS DEPARTMENT

 9 July 2009

If we focus on individual countries, the biggest pain is being felt final quarter of 2008 are by no means comparable with the
by countries with a currency peg, such as the Baltic States, as debt crisis of the 1980s. To us, the latest contraction looks little
these pegs are precluding nominal exchange rate adjustments. more than a business cycle contraction. Generally the
Other parts of the economy are therefore bearing the brunt of countries in the region cleaned up their act after the debt crisis
the (amplified) adjustments. and invested heavily in their macro institutions by, for example,
establishing floating exchange rates, inflation targeting, large
A note on Russia: like other emerging European countries, stocks of reserves and more sound fiscal/debt policies.
Russia has averted financial meltdown, but it had to use
around USD 200 billion of its foreign reserves to do so. And, as Policy rates
is also the case elsewhere in the region, Russia’s problems are %
by no means over. After shrinking by a staggering 9.8% yoy in
18 9
the first quarter, the economy is now declining at an even
faster rate. According to the Minister of Economics the 16 8
economy contracted by 10.5% in April and by 11% in May. 14 7
This decline can for a large part be attributed to the decrease
12 6
in investment, but the downward trend in investment seems so
far only to be getting worse. 10 5

8 4
Russia: fixed investment
2006 2007 2008 2009
%yoy
Brazil (lhs) Mexico (rhs)

30 Source: Bloomberg
20
10 One of the biggest differences compared with the ‘lost decade’

0
is, in our view, the current availability of monetary policy as a
stabilisation device that can be used to counter the downturn.
-10
This is in contrast to past downturns, when many countries in
-20 the region had to pursue austerity measures that simply
-30 aggravated the downturn. Good examples of this change are
00 01 02 03 04 05 06 07 08 09 Brazil and Mexico. In both countries the policy rates have been
cut quite aggressively to fight the downturn.
Source: Bloomberg

In Mexico there were already in February-March high

The increase in oil prices will provide some oxygen to the frequency data providing tentative indications that the sharp
Russian economy, but the authorities have also come up with deceleration in growth was coming to an end. However, the
an ambitious plan to broaden the country’s industrial base and near paralysis of activity in late April-early May caused by the
so make it less dependent on oil and gas. We applaud this outbreak of AH1N1 influenza deepened the output contraction.
initiative, but at the same time realise that drawing up an
ambitious plan is one thing, while executing it is another, Brazil is already showing clear sings of recovery. After an
especially in the wake of rising oil prices that could once again annualised contraction of 13.8% in the final quarter of 2008,
cloud over the need for structural adjustments in the economy. the rate of contraction almost totally lost momentum in the first
quarter of 2009 (-3.3 annualised), while high-frequency data
Latin America also suggest that economic growth probably returned to
The very sharp collapse in economic activity in Latin America positive territory in the second quarter.
has made some observers wonder whether the region is once
again entering a ‘lost decade’, such as in the 1980s. This, in
combination with the general increased risk aversion, led to
considerable capital flight from the region. As a result in the
period September 2008-October 2008 the currencies of Brazil,
Mexico and Chilli lost 23%, 9.9% and 10.2% respectively of
their value against the USD.
Indeed you have to go back to 1980s to find examples of
similar declines in GDP. In our view, however, the sharp
declines that the Latin American countries experienced in the

SERDAR KUCUKAKIN +31 (0)20 629 5086 ECONOMICS DEPARTMENT

 9 July 2009

Brazil: vehicle production Argentina: central government primary surplus*

Thousands of vehicles % GDP

350 4
300
250 3

200
2
150
100 1
50
0 0
00 01 02 03 04 05 06 07 08 09 2004 2005 2006 2007 2008 2009

Source: Bloomberg Source: IIF (2009: IIF forecast)

Going forward, the combination of improved fundamentals, the
swift monetary policy response and the improvement in world
economic conditions, illustrated by higher commodity prices,
mean the region is likely to show more consistent signs of
stability over the next few months and, in some cases, a
recovery resembling a V-shape.
President Chavez of Venezuela has most probably welcomed
the latest increase in oil prices. However we are only afraid
that renewed increases in petrodollars will simply lead to
further costly nationalisations that in the long run make the
country’s financial position even less sustainable.

Despite our relatively upbeat outlook for the region, the build-
up of slack in the region’s economies means that inflation will
not be an issue. Despite currency pass-through effects,
inflation has started to come down and we expect it to ease
further in the coming months.

Having said this, we must make a clear exception for two ‘bad
boys’, Argentina and Venezuela. Because of their
unsustainable, populist policies both countries’ fiscal accounts
have deteriorated significantly. This, in combination with the
fact that they still have virtually no access to international
capital markets, makes the financial outlook for both countries
very challenging. The Argentinean government in particular,
with its short-term external debt of USD 20.4 billion, will have
to find ways to resolve this funding challenge.

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SERDAR KUCUKAKIN +31 (0)20 629 5086 ECONOMICS DEPARTMENT