How India, and other emerging markets, missed the bus

US Federal Reserve Board chairman Ben Bernanke’s signal last week that the era of ultra-loose monetary policy in the US was close to its sell-by date may have triggered an indiscriminate bloodbath in global asset classes. But one constituency in particular - emerging markets, including India - bore the brunt of the news, with their currencies, and equity and debt markets being walloped even more sharply than others'.

That’s because no other cluster of markets had benefited so comprehensively from the successive rounds of Quantitative Easing that the Fed unleashed in response to the 2008 global financial crisis, and indeed from the easy money policy in the US since the late 1990s. For almost a decade, emerging markets were quite the flavour of the season, and held out the promise of higher growth and superior returns on investments.

[caption id=“attachment_900945” align=“alignleft” width=“380”]  The failure of emerging markets, including India, to make the most of the conducive external environment of the past decade will extract a price in terms of future growth. Reuters[/caption]

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But although emerging markets profited from the propitious external environment in the early stages of their growth cycle, they appear not to have made the most of the window of opportunity that was afforded them. Where structural reforms where warranted - and, if implemented, would have set these economies on the path to higher growth - they slackened. Instead, they celebrated too soon and went on spending binges on ‘vanity projects’ and unsustainable big-bucks social sector spending, which today threaten to drag down their economies - at a time when the global economic environment is a lot more punishing and the moneybags that funded them are taking their money and running away.

Indeed, in failing to capitalise fully on the favourable environment of the past decade, which - as the events of the past few days have established - are close to being dissipated, India and other emerging markets may have missed their shot at economic glory.

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As Tyler Cowen, professor of economics at George Mason University, points out, BRICS nations aren’t just witnessing a momentary growth slowdown; instead, what they face is a graver problem: the reality that “sustained, meteoric growth in emerging economies may no longer be possible.”

That’s because the growth drivers of the past few decades - the arbitrage of low-cost labour, an optimal population profile, the advantages of supply chain globalisation, among others - are no longer valid. The rise of automation and the 3D-printing revolution, which allows machines to perform more and more functions in manufacturing (and sometimes even in services), renders the erstwhile advantage low wages irrelevant, notes Cowen.

What this means, as Manoj Pradhan of Morgan Stanley notes, is that whereas for the past 50 years, a strong US economy fed strong external demand for Emerging Market economies, a new-found renaissance in US manufacturing, driven by cheaper energy in the form of shale gas, will see the US emerge as a competitor for emerging markets, not as a consumer.

More and more analysts, like bond fund PImco’s senior fund manager Ramin Toloui, reckon that the “golden era of emerging markets growth has definitely passed” and that investors will increasingly seek greater differentiation within the cluster of emerging markets. And although Toloui himself reasons that most emerging market economies have shored up their balance sheets and may not necessarily face a crisis, others are not so sanguine.

Hedge fund investor Stephen Jen, for instance, sees what happened last week in emerging markets as mere “tremors”, which forewarn of an inevitable quake ahead, which will be bigger and more intense. And particularly since the Fed indication of a scaleback of monetary stimulus coincides with real signs of a slowdown in the Chinese economy - and discernible signs of a mammoth cash crunch in China - the prognosis isn’t overly healthy for emerging markets.

Part of these emerging economies’ problem appears to be that they bought too readily into intimations of their economic ascendance - and failed to make the critical investments and reforms that would have propelled them into a higher orbit. And they began to uncork the celebratory champagne bottles rather sooner than warranted.

In 2010, for instance, when New Delhi hosted the Commonwealth Games, which were nothing more than a vanity project to seek momentary me-too glory, the wheels were already coming off the India growth story. There were those, like Mani Shankar Aiyar, who argued then that India could do without such extravaganzas, particularly given the many unmet developmental priorities. But people like him were painted as party-poopers who were incapable of having a bit of sporting fun - and laughed out of court.

Of course, Aiyar had the last laugh when the shoddy Commonwealth infrastructure collapsed in a heap and the whole project was shown to have been mired in corruption. It was the widespread outrage over the Commonwealth Games corruption scandal, along with Radia tape revelations about the 2G scam, that triggered the Anna Hazare-led anti-corruption movement in early 2011. Today, the anti-corruption movement may have been reduced to a mere shadow of its former self, but the sense of outrage over the widespread corruption and the warped developmental priorities of the governments is still widely shared.

Brazil today is going through much the same kind of a political churn, with protestors actively campaigning for a spectator boycott of the World Cup 2014, the stadiums for which are appropriating scarce financial resources away from social spending targeted at large parts of the population - such as subsidies on urban transportation.

The striking thing is that the uprising in Brazil is driven by popular anger directed against the government for its record of corruption, high prices and poor public services. But while much the same conditions for political outrage exist in India too, the popular response has been rather more passive.

None of all this means that the emerging market economies will curl up and die. But failure to capitalise on the conducive external environment will extract a price in terms of future growth. India, and other economies in its cluster, will fall well short of the economic destiny that they had begun to believe was theirs for the taking.