Xavier Institute of Management

Decoupling of Emerging Markets: Is it Reality or Myth?

Decoupling of Emerging Markets: Is it Reality or Myth?

Author: Faheem Akram (+91-7873501214) Date written (MM/DD/YY): 28/06/12

2012 Faheem Akram

Xavier Institute of Management

Decoupling of Emerging Markets: Is it Reality or Myth?

For the past few years, the term Decoupling has been quite popular on the web along with globalization. Now we all are familiar with the term globalization, but lets understand what the term Decoupling is, and then we shall discuss the hype that surrounds Decoupling of the Emerging Economies. Decoupling, as has been defined in the traditional sense, means the ability of emerging countries to grow without any stimulus from developed countries, primarily the US. It focuses upon whether or not emerging markets are tough enough to protect themselves from effects of recessions in the developed countries in an era of globalization where we talk about The World is flat. But whats the reason that has made Decoupling the buzzword? The most important reason is shaky recovery of developed nations with V shaped likely to change into U or even worse W shaped recovery and robust recovery of the emerging markets like India & China. Decoupling theory indicates the growing strength of the emerging markets along with weaning strength of the developed countries. It also indicates that emerging markets are achieving selfsustainability. With the present economic condition where the large developed economies have taken a downturn on their path of growth, the concept of decoupling becomes quite relevant. Those in favour of the decoupling theory believe that the Asian economies (that form the major chunk of Emerging Markets) can survive the hits of recession and slowdown in the US economy, considering this as a problem local to US and European economies. In order to understand decoupling, we need to explore how emerging markets have grown in the previous decade with respect to the U.S. economy. Lets analyse Financial and Business decoupling separately. In the last three decades the U.S. has grown slowly (2-3%) and the emerging markets have seen a high growth rate (7-9%). Emerging markets share in the worlds growth has increased significantly; BRICs accounted for two-third of worlds GDP growth. If we talk about exports between the U.S. and emerging nations, exports to the U.S. have stumbled but those to other emerging nations have surged. For example Chinas growth in exports to the U.S. slowed to only 5% in 2008, but exports to India, Brazil and Russia were up by 60% and those to oil exporters by 45%. This indicates 1/2 of chinas exports now go to other emerging markets. Second sign of decoupling can be seen in the commodities prices. Earlier commodities prices were linked to the demand in the U.S. In spite of decreasing demand in the U.S., commodities prices are still high because of strong demand and consumption in emerging markets that also shows a sign of self-sufficiency. Here one may ask, Wont Decoupling be a foolish idea to think about, in this era of Globalization? Economies today are more convergent towards each other, and are not only
2012 Faheem Akram

Xavier Institute of Management

Decoupling of Emerging Markets: Is it Reality or Myth?

dependent on each other but one can easily say they are more entangled into each other through growing trade and finance between them. The facts speak otherwise. Some signs that make Decoupling Theory a reality: Other than Japan, Asian countries had sent 62% of their exports to countries other than U.S.A., Europe and Japan in 2010 so far, up from 54% in 2003. Imports also convey the same story. During the same period, Asian imports from countries other than the above mentioned countries rose to 68% of the regions total, from 60%. 10 years back developed economies contributed around 2/3rd of global GDP after allowing for differences in purchasing power, now they contribute over half of the global GDP. During the period 2002-08 almost 85% of emerging economies grew faster than U.S. According to an IMF study the rate of growth of emerging economies was 6.6% whereas developed ones limped along at 2.2%. The major reason of recovery in the developed markets has been due to the cost cutting measures rather than focusing on top line growth. This also indicates that level of investment has come down progressively. The emerging markets now not only trade with richer markets but they have extensively grown their trades among themselves. For example rest of the emerging markets have increases their exports to each other which surmounts to 50% of their total exports.

All the above facts are also in alignment with a study done by IMF. According to this study 1% point increase in the growth of developed nations corresponds to 0.76% points increase during 1960-1985 while only 0.34% points increase during 1986-2007 in the growth rate of the emerging economies. This indicates emerging nations have decoupled from developed nations and are self-sufficient. It also indicates that the developed economies have now lesser impact on the growth of the emerging economies. Another fact supporting the idea of Decoupling and Globalization co-existing together is that the spending power of the consumers in the developing economies has increased dramatically. The domestic demand in emerging economies has grown by almost four times, making these economies more self-sufficient. Now lets talk about financial decoupling. Few years back we saw how the sub-prime crisis caused immense trouble in the stock markets right from the U.S. to emerging markets But with the slowdown in the US and European markets damaging the emerging markets, the decoupling theory seemed to be on a losing ground, proving it to be a myth. During the crisis Dollar-denominated assets were purchased by investors in Flight to safety. Money started flowing into the U.S. from overseas. Dollar was seen as a safe currency to invest. The U.S. dollar

2012 Faheem Akram

Xavier Institute of Management

Decoupling of Emerging Markets: Is it Reality or Myth?

index, an estimate of the dollars worth relative to a collection of other world currencies, rallied from low 70s in mid-2008 to a high of 89 in mid-2009. While the S&P 500 index crashed 38.5% in 2008, 30 odd countries witnessed drops of 50% or more. Even the strongest emerging markets like: Brazil (41.2% decline), Russia (72.4% decline), India (52.45% decline) and China (65.39% decline) didnt escape the punishment. FIIs take interest in emerging markets as long as the U.S. economy is also doing good but capital inflows tended to reduce during global slowdown as investors shunned risky assets and invest in Safe Haven. This Indicates the Financial decoupling is not as strong as the Business decoupling between emerging markets and the developed nations. The emerging markets are still challenged with problems of poverty, corruption, political instability. With 37% population still below poverty line in India, it is far from being ready to decouple itself from developed nations. Also, alarming increase in population in these developing nations is also a major concern for rise in commodities prices and self-dependency. Chinese economy is largely export-driven and, therefore, depends on steady demand from developed countries. Also, there have been doubts over Chinas real estate bubble. There are issues like inflation and infrastructure affecting Indian economy although its growth is not entirely export-dependent. India recently recorded an inflation rate of 7.55% (as of May 2012) which was above its growth rate of 5.3%. Since the beginning of 2011, the growth in emerging markets has been slow compared to the recent past when the growth was robust. Thus, the old saying When the U.S. sneezes, the rest of the world catches a cold still remains relevant but limited in magnitude. We cant say decoupling is complete but may term it as an on-going process. It might sound a bit clichd but in an ever growing globalised economy, decoupling seems unlikely if not improbable. We are living in a Partially decoupled World.

2012 Faheem Akram

Xavier Institute of Management

Decoupling of Emerging Markets: Is it Reality or Myth?

References: Emerging Markets Decoupling Theory - A Myth: By Dr. Saima Rizvi MBA, PhD. Lecturer (Finance) Amity Business School Emerging markets - The decoupling debate: From The Economist (Hong Kong print edition) Decoupling - Maybe it is not dead after all: By Chip Krakoff (Emerging Markets Outlook) Facts are taken from this blog : http://iimc-finclub.com/finblog/the-decoupling-theory/

2012 Faheem Akram