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Emerging Markets Briefer

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Global rebalancing underway

Mon, Jun 15 2009, 14:56 GMT
by Danske Research Team

Danske Bank A/S

Global imbalances had grown large

Two years ago more or less held the world record for current account deficits when the Latvian deficit reached more than 25% of GDP in Q3 2007. Since then we have seen a remarkable turnaround, and in January the Latvian current account actually turned positive! This is a very good illustration of the rebalancing of the global economy that has been going on since the second half of 2007.

From 2003-4 to the second half 2007, global imbalances grew dramatically. This was of course visible in asset market bubbles around the world and in macroeconomic imbalances. In the Emerging Markets universe this was especially visible in the significant increase the current account surpluses in most Emerging Asia countries, while at the same time there was a clearly unsustainable rise in current account deficits – mainly in CEE, Turkey and South Africa.

But that picture is changing now

In parallel with the global financial crisis, these imbalances have diminished. However, even though this rebalancing process arguably has already gone a long way, we think the process has much further to go.

Fundamentally, this adjustment can happen through three channels: i) relative domestic demand can move between the surplus countries versus the deficit countries; ii) exchange rates can adjust – with the currencies in surplus countries strengthening and the currencies in deficit countries weakening; or iii) via similar higher/lower wage and prices between surplus/deficit countries.

The present adjustment is happening through all three channels, but so far most of the adjustment has been through domestic demand. A very notable example is again Latvia where domestic demand has collapsed – while the authorities have refused to use the exchange rates as an adjustment mechanism. The opposite is taking place in China, where the Chinese authorities have eased fiscal and monetary policy to boost domestic demand.

There are limits to how much of the adjustment to global imbalances can (and should) be made through developments in relative domestic demand, and one should therefore expect currency adjustments to play a bigger role in the continued rebalancing process going forward. We therefore would expect the Emerging Asian currencies to strengthen vis-à-vis the CEE currencies.

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Published on  Mon, Jun 15 2009, 14:59 GMT