An emerging risk
From the bursting of the subprime bubble to the unravelling of the eurozone debt crisis, the developed world is still coming to terms with the aftermath of its credit binge. Emerging markets have looked relatively sober by comparison. But there are worrying signs that they too have begun to overindulge.
In Turkey, Brazil and Russia, private sector credit grew by more than 20 per cent over the 12 months to April. In China it rose by roughly 15 per cent. Between 2007 and 2011, Poland’s ratio of private credit to gross domestic product climbed from 32 per cent to 49 per cent.
Optimists say fast credit growth is normal in booming economies. Provided the money is channelled into useful investment, borrowing can be beneficial for long-term development. And anyway, while growth rates may be high, the stock of both public and private sector debt is much lower than in the US, western Europe or Japan.
However, fast credit growth can often hide problems with the way credit is allocated. In Brazil, for example, much of it has been used for consumption rather than for building roads and bridges. In China, money has too often flowed to wasteful projects by politically well-connected firms, rather than financing the credit-starved small and medium-sized enterprises.
Misdirected credit can produce two damaging consequences. First, when too much money is channelled into the housing sector, for example, this can create dangerous bubbles. China is currently seeking to keep the lid on its own property boom. Second, suboptimal credit allocation can harm economic growth, both in the short and in the long run.
This is why emerging markets need to be careful about how they respond to the current slowdown in the world economy. This week the Bank of China cut both its deposit and its lending rates. Brazil also eased its monetary policy just over a month ago, cutting its benchmark rate to a record low.
While there is a case for monetary stimulus, this needs to be accompanied by a process of reform that ensures credit flows where it is most needed. In Brazil this means cutting the high cost of labour and the red tape that gets in the way of investment. In China it is about reforming the banking sector so that credit flows are driven by economic and not political considerations.
By raising the rate of sustainable economic growth and reducing the risk of credit crises among emerging economies, these reforms would indirectly benefit the developed world. But no one should expect them to have an impact on the crisis. To deal with their own hangovers, the US and the eurozone need to look at home. It will not be emerging markets that provide the cure to the developed world’s ills.