Trade and financial ties between low-income countries (LICs) and emerging market economies (EMEs) have expanded rapidly in recent years. This leads to the potential for economic developments in EMEs to exert spillovers on LICs growth. The most likely and important source countries of such spillovers are the so-called BRICs—Brazil, Russia, India, and China. This article summarizes recent IMF research on these spillovers.
Research on business cycle transmission has regained attention in the wake of the recent global financial crisis. The IMF has recently carried out several studies that examine spillovers from systemically important countries (notably, the United States, European Union, Japan, and China) to the rest of the world (IMF, 2011a–2011e). Similar to earlier IMF work in this field, Bayoumi and Swiston (2007), Helbling and others (2007), and Kose and others (2003) almost exclusively focus on spillovers among advanced and major emerging market economies, with limited attention to transmission to LICs, including spillovers from major EMEs such as BRICs.
Several recent Fund studies, however, have examined the impact on LICs of the global financial crisis and the prospects for recovery. IMF research (2009; 2010) found that the shocks that reverberated around the globe in 2008–09 affected LICs mainly through real economy channels, primarily trade, foreign direct investment (FDI), and remittances; financial channels played a minor role because of the limited exposure of these countries to the financial sector in advanced economies. It was noted that the pace of recovery in LICs would vary across regions mirroring growth in their key trading partners.
Berg and others (2011) examined the short-run effects of the 2008–09 global financial crisis on growth in (mainly non-fuel exporting) LICs. They found that for many individual LICs, 2009 was not extraordinarily calamitous; however, aggregate LIC output declined sharply because LIC economies were unusually synchronized. They also found that the growth declines were on average well explained by the decline in export demand, and as the global economy recovered, their growth should rebound sharply. Compared to previous episodes of global crises, the terms-of-trade decline had a relatively small impact on LIC growth.
Neither the IMF (2009 and 2010) nor Berg and others (2011) differentiated the role of EMEs from that of advanced countries in determining the impact of the crisis and the pace of recovery. In these studies, the external shocks to LICs were mostly treated as global. However, the IMF studies did look at the impact of a global downturn on LICs in different regions based on these countries’ regional trade shares. More recent IMF studies (2011f; 2011g) also differentiated commodity importers from commodity exporters in examining their vulnerabilities to exogenous shocks. The relative resilience of the BRIC economies during the 2008–09 crisis suggests that LICs’ trade and financial ties with EMEs may have helped them cushion the severe contraction of import demand in advanced countries. Moreover, the mild terms-of-trade effect in 2009 compared with previous global crises owe to a large extent to the continued, albeit slower, growth of EMEs during the crisis.
In light of the ever-increasing importance of EMEs—BRICs in particular—for LIC economies, an IMF team undertook a major project to examine the growing linkages between LICs and BRICs—trade, FDI, and development financing. Key results of this project were summarized in an IMF paper (2011h), and reported in detail in several background papers (Mlachila and Takebe, 2011; Mwase, 2011; Mwase and Yang, 2011; Samake and Yang, 2011; Yang, 2011). Although the main focus of that project was to analyze the benefits as well as the challenges posed by the growing LIC-BRIC linkages, its detailed analysis of each of these linkages made it clear that the relationship is sufficiently strong to have a material impact on LICs’ growth performance. In what follows, we summarize the key findings on growth spillovers based on Samake and Yang (2011).
“Several recent Fund studies, however, have examined the impact on LICs of the global financial crisis and the prospects for recovery.”
The study by Samake and Yang employs several techniques to investigate the extent of business cycle transmission from BRICs to LICs through both direct and indirect channels. A global vector autoregression (GVAR) model is estimated to quantify the direct impact on LIC growth cycles of bilateral trade, FDI, productivity, and exchange rates, while a structural VAR model is used to estimate the effects of BRIC demand and technological change on global commodity prices, demand, and interest rates, which in turn affect growth in LICs. The indirect effect on LICs, obtained by feeding VAR results into the GVAR model, forms part of the overall spillover. Finally, an existing model (Berg 2011) is used to simulate the short-run impact of BRICs on growth in LICs during the global financial crisis.
The estimation results show that there are significant direct spillovers from BRICs to LICs. The most important direct channel of transmission is trade, although productivity improvements in BRICs and FDI flows from BRICs to LICs also matter. Trade accounts for around 60 percent of the impact on growth in LICs and is the most significant and persistent channel of transmission of shocks for all regions. The response in African LICs is particularly strong, reflecting the growing trade ties that these countries have forged with BRICs in recent years. The direct impact of BRICs’ productivity changes, in turn, represents around 13 percent of the total impact. Asian LICs seem subject to the strongest impact of BRIC productivity change, probably reflecting the closer integration of Asian LICs into global manufacturing supply chains, in which BRICs (particularly China and India) play a critical role. The FDI channel also matters but, compared with other spillover channels, its impact on LIC growth is more modest.
Spillovers from BRICs to LICs through global demand and price channels are also significant, though generally smaller than the direct spillovers. BRICs’ demand and productivity growth exert considerable influence over changes in some global variables. Spillovers through world commodity prices are the largest in the short run, and those through global demand and interest rates are generally small or negligible. In particular, roughly one third of changes in world oil prices can be attributed to shocks originating in BRICs. Such indirect impact of BRIC demand and productivity through global markets accounts for around 30 percent of the total impact of BRICs on LIC growth.
The overall (direct and indirect) impact of BRICs on low-income-country growth appears to be both substantial and becoming larger. A 1 percentage point increase in BRICs’ demand and productivity leads to 0.7 percentage point increase in LICs’ output over 3 years and 1.2 percentage points over 5 years. These magnitudes are broadly similar to the direct impact of demand and productivity increases in advanced economies in the literature. (A forthcoming study by Dabla-Norris and others (2012) also reports similar estimates of the spillovers from a selected group of emerging market economies to LICs.) The impact has increased from the pre-2007 period; simulations show that LIC growth would have been 0.3 percentage point to 1.1 percentage points lower during the crisis had BRIC GDP declined at the pace at which advanced economies did.
These results have significant policy implications. They point to the potential that increasing linkages with BRIC economies could change the volatility of LIC growth in the short run and contribute to their sustainable growth rates in the long run. Particularly, increasing LIC-BRIC trade and financial ties will only strengthen their business cycle synchronization over time. As long as BRIC business cycles are not fully synchronized with those of advanced countries, these growing ties should help dampen growth volatility in LICs. Thus, in assessing the macroeconomic policy prospects and growth potential in LICs, greater attention should be paid to developments in BRICs and other EMEs as well as their linkages with LICs both via direct and indirect channels.
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MwaseNkunde and YongzhengYang2011 “BRICs’ Philosophies for Development Financing and Their Implications for LICs” IMF Working Paperforthcoming (Washington: International Monetary Fund).
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