A U.S. Recession Could be Good for Developing Countries

Emerging economies would benefit from a U.S. recession, according to David Lubin, Head of Emerging Markets Economics at Citibank.

Interest rates would decline and the dollar would weaken, he says in the Financial Times, reversing the economic tightening that has been bad for emerging economies.

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“It has eroded access to international capital markets, increased the risk of debt default—especially for low-income countries—and destabilized their currencies, pushing price stability even further from the grasp of even the most adept central bank.”

The recessions in the 1990s and 2007-8 allowed for a loosening of U.S. monetary conditions that helped spur capital inflows to emerging economies, Lubin writes, and could be a model for the current situation. He says the period of risk aversion at those moments in history were similar to what we are experiencing today.

He also notes that those recessions didn’t end well. “The rise in capital flows in the early 1990s came to an abrupt halt with Mexico’s Tequila Crisis in late 1994. And the post-financial crisis boom in capital inflows ended in a series of bumps: a hefty sell-off in asset prices towards the end of 2011, and the “taper tantrum” starting in spring 2013 when the Federal Reserve triggered market turmoil by tightening monetary policy.”

Other factors affecting capital inflows to developing countries were also present, he says. And the “pull” factors were strong. “You can think of these as the growth potential of emerging economies, the effort that their policymakers put into encouraging inflows of long-term investment capital and the overall confidence that market participants have that ‘things are looking OK’ for the developing world,” Lubin writes.

These days, he says the “pull” factors are hard to find, citing weak global trade, increased protectionism, and geopolitical tensions. Economic reforms that increase growth are also absent, except in cases such as Vietnam or Indonesia. So, Lubin concludes that “push” factors will be significant in determining capital flows, as long as a post-recession boom, if there is one, “doesn’t, as in the past, turn to bust.”