G20 to Emerging Markets: We Feel Your Pain

The G20 communique and action plan, along with loads of background documents on the G20 economic program, have been released, though it may have been easy to miss amid the avalanche of Syria news.  The economic agenda was laid out in my colleague Stewart Patrick’s scene setter earlier this week, and leaders appear to have stuck to the script.  There was appropriately strong emphasis on growth and concern about high levels of unemployment.  There was encouragement for further financial reform.  In terms of substantive deliverables, the focus was on agreement to move forward with the June G8 plan to reduce tax avoidance and evasion, modest measures to boost investment, and an extension of the commitment to avoid protectionism.  All positive news, even if not substantial enough to distract markets from today’s U.S. job numbers.

But the central economic theme at the summit, beyond Syria, was one of concern about the global recovery.  First the good news–leaders welcomed signs of recovery in the industrial world, and pledged to growth-oriented policies going forward.  Advanced G20 countries agreed to keep fiscal policy flexible and agreed monetary policy should be “carefully calibrated and clearly communicated”.  This all makes sense, but sidesteps the ongoing debate over austerity and central bank exit from easy money policies.  That said, it is nice to see that for the first time in years the G20 was not in crisis mode regarding the eurozone.  Hints of green shoots in Europe, however fragile, were welcomed.

In contrast, the leaders recognized downside risks from sharp capital outflows and deteriorating growth prospects in the emerging world.  G20 emerging markets–notably India and Brazil–reportedly sought commitments from the Federal Reserve regarding tapering, but the Fed wasn’t at the meeting, and commentary at Jackson Hole last month already made clear that EM concerns are unlikely to have much of an influence on Fed policy.

The action plan states that “facing increased financial volatility, emerging markets agree to take the necessary actions to support growth and maintain stability, including efforts to improve fundamentals, increase resilience to external shocks and strengthen financial systems.” So, it’s up to them to fix their own problems. Beyond that, the action plan appears to list previous policy commitments and generally endorses urgent action.  My concern regarding emerging markets going forward is that, rather than strengthening macro policies and letting exchange rates adjust, these countries would turn increasingly to capital controls and macro-prudential measures contributing to protectionism and further deleveraging.  The communique restates leader’s commitment to open markets and resisting protectionism, and the commitment to improving global tax governance is an important step  toward improving the long-term incentives for capital flows.  However, it will be interesting to see if the above commitments hold in practice if market turmoil intensifies.

This piece is cross-posted from Macro and Markets with permission.