Why richest investors are rushing to emerging markets?

21 Nov, 2007, 1812 hrs IST,Swaminathan S Anklesaria Aiyar, TNN

Oil is close to $100/barrel. Top financial companies (Citigroup, Merill Lynch) have lost tens of billions of dollars in the subprime mortgage crisis in the US. The US housing bust is spreading like a cancer across OECD countries. Half the economists in the US predict a recession next year.

This might seem a portent of a world economic disaster that crushes poor countries like India. But, astonishingly, the health of the world economy looks not merely good but arguably the best in history. No wonder stock markets breaking records across all developing countries.

We suddenly see a seismic shift in the entire structure of the world economy. For centuries, the high-income countries (led by the US) have dominated the world economy. The US has long been the locomotive of the world economy, pulling others along. Whenever the locomotive slowed, so did the wagons behind.

Not any more. The task of pulling along the world economy has passed, with no fanfare or celebrations, to developing countries. Developing countries have emerged as the new global locomotive.

According to the IMF, in 2006 the US contribution to global growth was only 12% in PPP (purchasing power parity) terms. But China accounted for a whopping 30%, and India for 11%. A wide swath of Asian and African countries made significant contributions.

The world still suffers from a thousand problems. Yet the high price of oil, the subprime mortgage crisis, the OECD housing bust and the imminent US recession all appear to be no more than warts on the skin of a rather healthy world economy.

The best evidence for this comes from the World Economic Outlook (WEO) of the IMF, released last month. It says that world GDP growth was 5.4% last year, will remain a healthy 5.2% in 2007, and will slow to maybe 4.7% in 2008.

Average annual GDP growth between 2004 and 2008 will be a fabulous 5.1%. Average annual per capita income in this period will grow at 4 %, the highest in history.

These are all estimates in PPP (purchasing power parity) terms. In nominal dollar terms, the growth is distinctly lower. Yet PPP is the best yardstick for measuring welfare.

Growth has been exceptionally fast in poorer countries. Between 2004 and 2008, GDP growth will average 7.8% in all developing countries, against just 2.7% in high-income countries. So, growth is both faster and better distributed than ever before.

The world is familiar with the story of accelerating economic growth in China and India. Yet fast growth is no longer confined to a few developing countries. It has spread right across Asia and Africa.

Sub-Saharan Africa, the poorest and slowest-growing part of the world, has suddenly taken off. The World Bank estimates that African countries averaged over 5.5% GDP growth in the last four years, against just 2.4% in the 1990s.

Some of the most spectacular stock market booms have occurred in Africa. The currency that has appreciated most against the dollar this year—over 33%—is the Guinean franc. The South African rand is also among the top appreciating currencies this year.


In the past, whenever the US economy swung downwards, Africa crashed. Countries of Africa and Latin America depend overwhelmingly on exports of commodities. And in the downswing of a business cycle, commodity prices typically crash. Indeed, a sharp fall in commodity prices is often an omen of coming recession.

But not this time. World commodity prices remain astonishingly strong despite a slowdown (and possible recession) in the world’s two biggest economies, the US and Japan. The stock market prices of commodity companies continue to soar, and oil is heading for an all-time record.

What is happening? Have both the stock markets and commodity markets been seized by irrational exuberance?

Actually, no. Rich countries are post-industrialisation economies, where per capita consumption of commodities has long plateaued. Hence in these countries, commodity consumption rises very little with GDP. That is why commodity prices fell in the 1980s and 1990s despite substantial growth in high-income countries.

But the new global locomotives, countries like China and India, are taking off from very low per capita levels of commodity consumption. Hence their demand for commodities is rising stridently with GDP growth. Fast growth in Asia has greatly raised the demand for commodities, and hugely benefited commodity exporters in Africa and Latin America. Many commodities have risen two to ten times in price over the last decade (see table).

If the US goes into a mild recession next year, Asian countries will surely suffer a slowdown. Even so, they may average 5%-6% GDP growth. Which means they will keep consuming more commodities, thus maintaining the economic health of Africa and Latin America too.

Let me not exaggerate. Developing countries may be the new locomotives of world growth, but are by no means the dominant economic powers. They remain poor, with incomes far behind that of rich countries.

But the sheer number of people in poor countries — China and India account for one-third of world population — means that, despite their poverty, they now contribute the lion’s share of global economic growth. It will take decades for fast growth to convert them from low-income to high-income countries. Nevertheless the economic balance of the world has been transformed. This is revolutionary.

Don’t take my word for it. Just look at the behaviour of the richest investors in the world. Ten years ago, when the Asian financial crisis created major risks and uncertainties, investors of the world fled from developing countries to the US and Europe in search of safe havens. But today, confronted with new risks such as a possible US recession, the richest investors of the world are rushing to emerging-market bourses in search of safety. Money talks. And big money is screaming from the rooftops.

Is this euphoria premature? Will this prove to be one more false dawn for developing countries? Maybe. The recovery in Africa is fragile. But the new strength of Asia looks like a transformation that is here to stay