Emerging Markets: An Interview with Dr. Alexander Mirtchev

Diplomatic Courier: What should rapidly developing economies and emerging markets do in the economic crisis?

Dr. Mirtchev: The recovery of emerging markets and rapidly developing economies itself is likely to be prolonged and patchy, with some industry sectors outpacing others. The commodity-rich economies, for example, ended up owning a lot of overpriced assets through their banks, sovereign wealth funds, and other vehicles. The degree of leverage associated with the funding of a boom and the degree of involvement of their banks and other financial intermediaries has determined the magnitude of balance sheet effects in these countries and their respective actions….

Emerging Markets: An Interview with Dr. Alexander Mirtchev

Diplomatic Courier: What should rapidly developing economies and emerging markets do in the economic crisis?

Dr. Mirtchev: The recovery of emerging markets and rapidly developing economies itself is likely to be prolonged and patchy, with some industry sectors outpacing others. The commodity-rich economies, for example, ended up owning a lot of overpriced assets through their banks, sovereign

wealth funds, and other vehicles. The degree of leverage associated with the funding of a boom and the degree of involvement of their banks and other financial intermediaries has determined the magnitude of balance sheet effects in these countries and their respective actions. If the supply of credit collapses during the bust, companies will simply go bankrupt and a generation of entrepreneurs will return to not very rewarding unreformed civil services. The key here is, therefore, to adopt policies that would preserve the fledgling entrepreneurial spirit of these nations, the can-do attitude that has been driving them to take risk and at least try to build solid companies. Stop-gap finance is essential but each nation will have to take a close look at their financial intermediaries: were they irresponsible or plain incompetent in their conduct in the credit market? It seems that governments have to approach their financial sectors with a much stricter yardstick than the “real economy” actors who hold the promise of restoring economic growth in these markets. In short, the rapidly developing economies and emerging markets should look for their own way out of the recession, some in the context of global cooperation, such as the framework of the G20, others separately, in directions they perceive as strategic for their own survival and future development.

Diplomatic Courier: What industries do you think economies will turn to, if they will, and why?

Dr. Mirtchev: Rapidly developing economies and emerging market governments would follow different exit strategies. Their plans would focus on those industries that they consider to be in line with their post-crisis core economic development. In addition, we would see some “experiments”,sometimes even “turning a new leaf” in new directions that are considered but not yet proven to be of long-term potential for the respective economies. In reality, they will concentrate their practical efforts on their core industries and in directions where they anticipate surging growth, and where their cash-making competitive advantages, real or perceived, lie. These economies are likely to engineer economic growth initially in selected industry sectors, such as mining, power generation, consumer goods, and agribusiness, with the potential for exponential recoveries the more the fallout of the financial crisis in the developed economies begins to subside. In some cases, I hope the winner will be agriculture and food processing. In some emerging economies, the crisis is bringing the meager safety nets to the point of rupture, which in many places could mean famine and tragedy. Food production is possible at a local micro-scale and with proper know-how, some external financing, and agricultural market liberalization, it can lead to the emergence of sustainable businesses that will create employment and feed millions. Of course, modern agriculture, services, and industry depend on infrastructure. Experts recognize that failing to fill the infrastructure financing gap will entrench Africa’s position as a competitive laggard when global economic activity recovers.

Diplomatic Courier: If economies will not change their international focus, how do you see that focus evolving?

Dr. Mirtchev: The international focus will come back as countries begin to re-assert their relative competitive advantages and the growth strategies derived from them. The main question is whether they will do it within the existing rules-based system largely governed by the WTO. The impetus behind continuing the Doha Round negotiations comes from the apprehension about the possible erosion of the global market through the “thousands cuts” of small protectionist measures, as well as the symptoms of the fragmentation of the global market. It is important to keep in mind that the rapidly developing economies like China, India, Russia, or Brazil would maintain their focus on policies that would solve their own economic problems first throughout the recovery and the immediate post-crisis global economy, and that would, by and large, shape the specificities of their international focus. It should also be expected that rapidly developing economies would try to establish new synergies between themselves, looking for new opportunities and sources of income beyond the not yet recovered developed economies, and taking a “front seat” in the not so fortunate smaller emerging markets.

Diplomatic Courier: What are some developing economies that have managed to be successful during this recession and what has been their key to success?

Dr. Mirtchev: Any discussion of success would appear premature until we are certain about the signs of global recovery which in fact means U.S. economic recovery. Falling a little less fast into the precipice is not a measure of success until one hits bottom and is able to bounce back. However, it is not too soon to speak about the factors needed for a rebound. For now, the relative success lies with the rapidly developing economies such as China, India, Russia, Brazil, etc. that have made use of their core lines of success, such as natural resources or extra production capacities. These economies not only enjoy some natural advantages but have also been able to build a lot of “positive credit” on the basis of their contribution to the global economy.

Diplomatic Courier: During a down turn there are often opportunities for investments that can provide significant returns once a recovery is entered into. Do you feel that the emerging markets of the world today will be able to access these opportunities, or have they been hit too deeply by the recession to act?

Dr. Mirtchev: The appetite for risk is quickly returning to both the capital markets and institutional investors. Even though the end of the crisis has not yet been reached by any measure, ‘bottom fishing’ by multinationals, sovereign wealth and private equity funds has already started. Institutional investors have already started to proactively look for deals among the distressed assets left in the wake of the crisis, even though the crisis has not ended yet. It can be said that we are seeing positive signs, strengthened by the perception that the ‘bad news’ from the financial sector has come to light and the market is ‘tired’ from the continued ‘doom and gloom’. At the same time, regulatory authorities will at least attempt to avert new bank-financed booms that can lead to more painful busts. Therefore the opportunities for private investment may look much less attractive to investors if governments aggressively limit leverage, introduce countercyclical loan-to-value limits, enforce stricter loan requirements, impose limits on foreign exchange exposure, eliminate implicit foreign exchange guarantees, or fiscal incentives for particular types of loans.

Diplomatic Courier: Protectionism vs. free trade has been a hotly debated subject. What impact could a pro-protectionist stance in the U.S. have upon these economies?

Dr. Mirtchev: This so-called debate was fuelled not least by the U.S. presidential campaign that coincided with the rapidly unfolding global credit crunch. As the need for political posturing recedes, so does the rhetoric for outright protectionism. Political campaigns come and go, but one way or the other, the law of unintended consequences applies in bad times with a vengeance. Having said so, the threat of protectionism is quite real. Despite current statements to the contrary by the G8 and the G20, government intervention measures taken by developed economies, rapidly developing economies and emerging markets to tackle the problems caused by the economic crisis, may still result in persistent waves of protectionism and ultimately, market fragmentation. This threat should be considered seriously, whatever rhetoric may be used as an excuse for self-inflicted isolation by some. The danger of protectionism and the signs of market fragmentation could set back economic growth for a period that could be longer than even the worst-case scenarios. The reality is that the U.S. has no other viable choices but to work together with other key economies to preserve the policy framework for global trade and stop the debilitating trade contractions. Global trade volumes are expected to decline by approximately 10 percent in 2009, the worst decline since the 1930s. Global foreign direct investment inflows are projected to fall by nearly 30 percent in 2009 compared to 2008. Emerging and developing economies (especially Eastern Europe and Central Asia) are particularly hard hit as the capability of firms to invest has been reduced by decreasing access to financial resources and their propensity to invest is diminished by negative economic prospects. However, emerging and developing economies are still important markets for both Foreign Direct Investment and U.S. exports, and these economies can be a key driving force in the global recovery assuming investments and trade rebound with international support.

Diplomatic Courier: What does the crisis mean for the development institutions that purport to guide developing markets?

Dr. Mirtchev: The London G20 meeting in April promised an extra $500 billion to the IMF plus $100 billion in lending to developing and emerging markets from the multilateral development banks, led by the World Bank. In addition, $250 billion has been promised for the next two years to support trade finance, $50 billion of which would come via the World Bank. The World Bank has committed $54.8 billion in FY 2009 to assist struggling countries–a 54 percent increase over FY 2008. With increasing resources comes an increasingly complicated political landscape on who controls the money, what strings are attached to the money, as well as where and what projects get financed. Several rapidly developing economies–namely China, Russia and Brazil–have made substantial financial commitments to the IFIs within the G20 context and are already demanding a greater say in how the money is spent. They would need to be engaged in the process of assisting global economic recovery, and their role should be mutually acceptable and beneficial for all the players. The U.S. has committed $108 billion in additional support for the IMF – and this support is coupled with a call for governance reform and in the case of U.S. contributions, certain conditions, e.g., higher labor and environmental standards. The G20 and G8 summits achieved what they had set out to do–firm statement on introducing expanded and strengthened regulation in the financial sector, a boost to the IMF and an agreement that global growth should be supported. Nonetheless, there is still significant ground to be covered as far as jump-starting economic activity is concerned, and coordination is difficult to achieve on how to provide the necessary impetus and confidence to the global economy. Moreover, at the July G8 Summit leaders indicated that the IMF would be the place where policy recommendations on stimulus exit strategies should be developed. What that means is that the developing countries have–again–a choice: to revert to the old paradigm of waiting for hand-outs while pretending to heed the policy advice or develop their own thinking about how assistance should be structured in the wake of the crisis. The choice is theirs since post-Cold War, no one is likely to want to impose a solution on them. In the long run, the new financial architecture could very well align itself with the evolving nature of the global market and in particular the global financial sector, acknowledging and even facilitating its emerging new realities, instead of essentially strengthening and retrenching the previous status quo. This means to gradually build up the elements of a ‘global financial mega-market’ of mass participation, based on the new technologies and infrastructure that are already in place, that empowers the market players and individual consumers to conduct business activity, incentivizing rather than restricting, establishing clear, consistent, and transparent rules of the game, and, respectively, educating about the new realities. This, however, is yet to be seen. [DC]

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