How will the major emerging economies of Brazil, China and India be affected by the current wave of financial instability? Lower stock prices in the United States and Europe have lowered growth expectations in all three of these countries, along with their stock prices. Higher interest rates due to the higher default risk in OECD countries also affect them. The volatility that has affected stock markets in these three economies is, therefore, the same as it is elsewhere. But will the instability spread more widely within their financial sectors and economies more broadly, impairing their growth performance?

In the 2008 financial crisis, the short-term impact on these economies was, in some cases, major; however, their economic bounce back was equally strong. China, for instance, saw its pre-crisis export growth of 30 percent per year plunge to negative 20 percent in early 2009, only to see a surprisingly quick rebound to pre-crisis rates. India saw its stock market index halve, and the country experienced repatriation of significant amounts of inward foreign investment, only to see inward investment quickly resume Brazil witnessed a sharp currency depreciation, but growth rates of GDP accelerated both through and beyond the crisis.

This time, the same issues of potential contagion and the degree of decoupling of the major emerging economies from the United States and Europe are the key issues. The situation in each of these countries differs, with Brazil perhaps in better shape than India and China. For China, the current wave of global financial instability centred on European debt woes and the US rating downgrade — the aftermath of the Congressional debt limit debate could hardly have come at a worse time. The 2009 crisis-related injections of infrastructure spending have largely run their course. Local governments are now experiencing problems with land sale financing, due in part to new rules on compensation for occupants and tighter regulation, as well as slowing growth.

Potential contagion effects for China centre on worries over US and European solvency. These have elevated concerns over whether China will eventually have to take a large real capital loss on its reserve holdings (now $3 trillion). Another dimension of the contagion could be a further rise in house prices in Beijing and Shanghai, bringing an even greater risk of a bubble in real estate markets. Overall, the prospect of negative growth in Europe and anemic performance in the United States and Japan gives less confidence in China’s ability to maintain the 30 percent export growth it saw before the 2008 crisis.

The bright spots for China are the deep social underpinnings of growth and reform, which are evident in the rapid upgrading of the workforce in educational attainment and growth elsewhere outside the OECD bloc, which will help maintain growth in China. China–India trade has grown 33 fold since the mid-1990s; however, Southern trade still accounts for only 20 percent of China’s trade. China has two difficult decades to navigate while it waits for the South to fill what could become a Northern void. In the next couple of years, China’s growth could dip to seven percent, and its engagement with OECD countries will gradually be reduced proportionally. China’s growth seems resilient in the medium and longer term, and China will continue to grow — although perhaps not at 11 percent every year, but enough to close the gap with the OECD bloc in three to four decades.  

For Brazil, growth this year has reached 7.5 percent, and has continued to accelerate after the 2008 crisis. Two things differentiate Brazil from China.  One is the smaller injection of liquidity and major stimulus in response to the 2008 crisis. Accelerating inflation is thus less of a problem, and the end of stimulus does not threaten to truncate Brazil’s growth to the same degree. Second, Brazil, much more so than China, has managed to diversify its trade away from Europe and the United States. In 2000, 25 percent of Brazilian exports went to the United States; today, it is 10 percent. And the three percent of exports going to China from Brazil in 2000 have now grown to 15 percent. A downturn in Chinese growth could turn out to be more of a potential problem for Brazil, rather than financial volatility that may lead to reduced growth in the United States and the European Union.

India’s situation lies somewhere between the Brazilian and Chinese cases. India’s growth rates before the 2008 crisis were not quite as high as those for China. Proportionally, growth fell less during the crisis in India than it did in China, and it returned more quickly for India.  Inflationary pressures do not seem as severe as they do for China, and proportionally less stimulus was applied in India as a crisis response. India’s trade performance lagged behind that of China, and pre-crisis trade growth rates were lower than those of China, but post-crisis trade has risen to approach the Chinese rate of 30 percent. For India, the threat of contagion mainly takes the form of truncating the acceleration of trade growth, a more serious problem for India than either China or Brazil.

The global economy today is highly interdependent. China, in particular, is integrated deeply into the global economy and its financial system, India and Brazil less deeply. Financial volatility and impaired growth performance in Europe and the United States will inevitably impact these three economies. The questions are how much and for how long?  The long-term trend, however, is now much more rapid South–South trade and trade and investment growth than either North–North or North–South. The share of world trade that is North–North has fallen from around 54 percent in 2000 to around 42 percent today. As Southern countries grow, they will also collectively become increasingly less prone to contagion from Northern financial woes. Getting to this “Southern Nirvana” is the challenge for the South. At the same time, the North has an equally high stake in the continued growth of India, China and Brazil as the drivers of growth for Northern recovery.

China has two difficult decades to navigate while it waits for the South to fill what could become a Northern void.
  • John Whalley

    John Whalley is a CIGI Distinguished Fellow. His research interests include G20 issues, globalization, Chinese policy issues and climate change negotiations. In addition to his work at CIGI, John is a fellow of the Royal Society of Canada and the Econometric Society, and co-director of the Centre for International Economic Relations at the University of Western Ontario. He is also a foreign fellow of the Russian Academy of Natural Sciences.

The return of market volatility has shaken the confidence of a fragile recovery. How are leading economies responding? Is the current turmoil giving way to another free-fall in global markets? Are the international governance mechanisms, established after the last crisis, up to the task of averting another crises? What can the major powers do? In this timely commentary series, CIGI experts examine these key issues, and offer recommendations for policy makers looking to restabilize the world economy.