International Economic Update

Two Recoveries: Advanced, Emerging Economies on Different Tracks
November 4, 2010

Real gross domestic product (GDP) growth is expected to linger below 3 percent through 2011 for the advanced economies. In contrast, GDP growth is expected to remain strong for the emerging economies, creating a two-speed global recovery (Chart 1).

The advanced economies are experiencing low growth rates, with no sign of increases as the temporary factors supporting 2010 growth fade. Private demand is driving the recovery; however, a shift from fiscal stimulus to fiscal consolidation threatens the persistence of this economic boost. High unemployment rates continue to drag on the economy as the restructuring of major industries—auto, finance and construction—limits job creation. An improved labor market will be required for private-sector demand to remain strong (Chart 2).

GDP growth has improved in the emerging economies with a surge of capital inflows from the advanced economies. Real GDP growth is expected to average over 7 percent for the main emerging economies—China, India, Brazil and Russia. Growth is expected to slow in 2011 due to a withdrawal of fiscal stimulus and tightening of monetary policy, but it is still expected to outpace growth in the advanced economies.

Capital Inflows to Emerging Economies
Excess liquidity in the advanced economies coupled with favorable economic prospects in the emerging economies produced a rush of capital inflows to the emerging economies. Chart 3 illustrates the direct relationship between relative GDP growth and net capital inflows: When the GDP growth rate is higher in the emerging economies than in the advanced economies, net capital flows pick up in the emerging economies.

Because of a strong link between capital inflows and rising asset prices, the uptick of the emerging economies' stock markets is a good indicator of these inflows (Chart 4).

Although asset prices have not yet reached precrisis levels, the rate of price increases raises concern over the stability of the capital inflows. Since July, stocks have risen 43.4 percent in China, 23.1 percent in Russia, 14.8 percent in Brazil and 14.4 percent in India. Driving this concern is the composition of the capital investments. As seen in Chart 3, portfolio investments represented the biggest increase in net capital investments in 2009, rising by over $200 million. Portfolio investments are highly volatile, putting pressure on asset prices, which can lead to inflation and a subsequent retreat of investment. A more stable component of private capital flows is foreign direct investment (FDI). Significantly, FDI remains the largest component of private capital flows to the emerging economies. The Institute of International Finance projects FDI to total 45 percent of net private inflows in 2010.

Declining Dollar Fuels U.S. Trade
The excess liquidity in the U.S. that is fueling capital inflows to the emerging markets is also contributing to a weak U.S. dollar. As of Oct. 29, the dollar had declined 2.7 percent since September's Federal Open Market Committee meeting (Chart 5).

A weak currency stimulates exports, rebalances trade and promotes growth. The purchasing managers indexes (PMIs) for both manufacturing and nonmanufacturing export orders show that the weaker U.S. dollar has already contributed to increases in export orders (Chart 6).

Total manufacturing orders increased from 51.1 in September to 58.9 in October. Manufacturing export orders increased 11 percent over the same period. The nonmanufacturing export orders index rebounded nearly 12 points from August to September to reach 58, representing the largest monthly increase since the series' debut in July 1997.

Recovery Continues
Though the pace of GDP growth is expected to slow, private demand continues to boost the global economy. Excess liquidity in the advanced economies is driving increased investment in the emerging economies. Advanced economies such as the U.S. are seeing an increase in exports as excess liquidity drives down currency values.

—Adrienne Mack and Anthony Landry

About the Authors

Mack is a research analyst and Landry is a senior research economist in the Research Department of the Federal Reserve Bank of Dallas.


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