Emerging market challenges unlikely to be overcome quickly, ECB says

The weakness of emerging economies could prove lasting as deep-seated structural problems rather than fleeting troubles are the root cause, posing a risk to growth even in advanced economies, the European Central Bank said on Tuesday.

ECB President Mario Draghi has repeatedly cited subdued growth in emerging market as a drag on the euro area recovery and one of the reasons underpinning its ultra-easy policies.

Elaborating on this point in a regular economic bulletin, the ECB said potential growth among some key emerging economies has weakened, raising the risk of a "sizable" negative impact on global growth.

It cited waning productivity growth, weak investments, rising external debt, tighter financing conditions and deteriorating demographics as some of the reason behind the fading momentum.

 

Key emerging economies have been under strain this year with China's slowdown and rebalancing setting off waves of turbulence on financial markets earlier this year.

Although emerging markets still generate 70% of global growth, their growth rate declined for the fifth straight year last year with many key economies likely weighing on growth both in 2016 and 2017, the IMF said earlier.

"Some of these challenges are unlikely to be overcome quickly," the ECB said. "The impact of weak investment, infrastructure bottlenecks and capacity constraints could be stronger than expected."

"The rebalancing process that is under way is necessary to ensure sustainable growth over the medium term, but the transition path is likely to be bumpy and risks will tend to be on the downside," the ECB added.

Potential growth has been declining for years and some indicators suggest that emerging markets were already overheating during their boom years, as suggested by surging private debt ratios.

Risings external debt is a particular concern as countries increasingly rely on foreign currency, especially dollar-based financing, raising stability risks and blunting the positive impact of currency depreciation, a natural defence against economic turbulence, the paper concluded.

Financing conditions for emerging markets have also tightened with capital outflows picking up toward the end of last year, pushing up bond yields, widening credit spreads and weighing down on equities.

Investment growth is also falling and several major emerging economies are running up against demographic problems, facing a dwindling or stagnating workforce, putting downward pressure on growth.