“Once you start thinking about growth… …it is hard to think about anything else.” So declared economics Nobel laureate Robert Lucas, and his point is at the heart of the most recent report from BofA Merrill Lynch Global Research, titled “BofA ML Emerging Markets: GEMs Paper # 5 – EEMEA growth havens: a primer” dated 1 September 2011.
Emerging markets always had more growth than developed markets. But only now is it becoming more widely accepted that growth in the developed world is likely to be so low for so long that its status as the safer part of the world will be eroded. Indeed, in 5y CDS terms, the Czech Republic and Saudi Arabia are already safer than Austria, South Africa is safer than France, Poland and Turkey safer than Belgium, and Hungary safer than Ireland. Risk premia in equities and local currency yields are lagging CDS, but will follow. Growth is a necessary condition for safety: thus, where are the growth havens?
MENA, South Africa and Turkey are the best placed to witness remarkable economy growth, according to BofA Merrill Lynch Global Research team.
How do EEMEA economies rank in terms of the well-accepted drivers of growth?
According to the academic literature, the most important determinant of trend growth tends to be the initial income level (the concept of “convergence”), but savings and investment, demographics, education, political stability and competitiveness are also crucial. According to summarized data, MENA, South Africa, and Turkey are better placed for the next 10 years than CEE or Russia. However, the dilemma persists: the richest countries tend to have the best preconditions for growth, but the poorer countries the biggest scope for growth.
Income convergence favors the poorest countries, including Egypt, S. Africa and Turkey. Overall, EEMEA is richer than EM Asia and LatAm, suggesting that the region will continue to underperform GEM measured by GDP growth.
During this decade, leverage will play an exceptional role: as discussed earlier, most of the GCC and Russia are best-placed, while Hungary and Poland are worst off and South Africa and Turkey fall in the middle.
Investment tends to be highest in CEE and in the GCC, funded by FDI inflows in the former, and oil and gas in the latter. Savings are high in Russia, but it invests relatively little, and thus exports capital abroad. S. Africa and Turkey face a chronic savings deficit as a crucial constraint on growth.
Demographics are most favorable in S. Africa, Turkey and MENA, which all enjoy a “demographic dividend” of falling dependency ratios through 2020. However, high working age population growth also creates social risks.
In education, CEE and Russia score well. In contrast, S. Africa ranks last in tertiary education, while Turkey does relatively badly on both counts.
As to competitiveness, which includes regulation, law and order, infrastructure etc, the GCC score highest, followed by CEE, while S. Africa, Turkey, Russia and Egypt all rank near the bottom of the distribution.
GCC: safeguarding the social contract
While the Great Arab Revolt has shown the limits of the current MENA social contract, GCC monarchies have proved more resilient, with the exception of Bahrain, and will likely remain so for now. Economic diversification efforts facilitated by the oil boom will continue, though overall regional growth will remain tied to oil price vagaries. At 4.2%, growth in the coming decade is set to remain broadly below pre-2008 levels due to a more streamlined investment pipeline, a recovering real estate sector and a likely less supportive global environment. The current pace of increase in discretionary spending in response to social tensions may have to be reined in to avoid turning it into a binding constraint on growth.
Spending your way out of potential turmoil
The initial response of GCC policymakers has been to sharply increase current spending to accommodate social pressures and to pledge intra-regional fiscal transfers to less endowed members. BofA Merrill Lynch Global Research estimates that these extra GCC spending pledges total US$150bn (12.8% of GDP) while 2011 appropriations could reach 4.9% of GDP, supporting growth. This has averted potential disquiet over governance in most countries, though, over a longer-term horizon, economic reforms will be needed to buoy private sector growth and job creation. We expect the oil boom-led economic diversification program set up after the lost decade of the 1990s to continue over the next decade, unless oil settles in a marked or sustained manner below the regional break even price (US$80/bbl). The Arab unrest will likely encourage GCC policymakers to deliver on their diversification plans though we are still wary of legacy projects and the potential for overcapacity in specific sectors.
A more streamlined investment pipeline
The investment bubble and euphoria of 2004-08, driven in part by abundant external financing, have deflated, though they also reflect the GCC’s limited, yet improving, absorption capacity in the light of geography. On the demand side, investment has mainly driven growth acceleration, though in Kuwait the former is lower than the EEMEA median due to political feuds. Consumption is most conspicuous in Saudi (50% of real GDP), while investment and government consumption generally account for c.30% of GDP each in the region. A large, price-taking, pool of imported labor has meant very low non-oil productivity growth across the GCC.