Emerging Economies – Overheating Index

The Economist last week introduced a new index for measuring emerging economies according to their risk of overheating. These economies make up more than 50% of the world’s GDP and over the last five years have produced more than 4/5ths of global real GDP growth.

The chart below tracks 27 countries according to their risk of overheating. The Economist take 6 different indicators and the scores for these are then added to form an index – 100 means that the economy is red-hot on all 6 measures.

The 6 indicators

1. Inflation – This has an average rate of 6.7% in the developed world. In the emerging markets inflation to vary – 1.7% Taiwan, 20% or more in Argentina, Vietnam and Venezuela. In China core inflatin is at 2.4% whilst Brazil has 5.5% and India is over 8%. When growth is bumping up against capacity constraints and labour markets are tight, food inflation may impact into wages and prices.

2. GDP – a country’s average GDP growth rate since 2007 compared with its growth rate between 1996 and 2006. Growth in Argentina, Brazil, India, and Indonesia has exceeded its long-term trend which assumes little spare capacity. However there appears to be plenty of spare capacity for other countrys – Hungary, Czech Republic and Russia.

3. Unemployment – a lot of emerging markets have been experiencing tight labour markets which are indicative of low unemployment levels – most have levels below their 10 year average. Brazil’s unemployment rate is at record low levels and this has led to wage pressure.

4. Credit Expansion – the best measure is to measure the different between the growth rate in bank credit and nominal GDP. In an emerging economy as the financial sector develops it is normal for the levels of GDP to be less than that of bank lending. However in countries like Argentina, Brazil and Turkey lending to the private sector has increased 20% more than nominal GDP. Though in China bank lending has halved over the past year and is in line with GDP growth.

5. Real Rate of Interest
– (Interest rate – inflation rate) this is negative in over half the emerging economies. In rapidly growing economies, as many emerging are, negative real interest fuel faster credit growth and inflation. China’s rate is positive but this understates the level of its recent contractionary monetary policy.

6. Change in Current-Account Balance – economies that run increasing current-account deficits generally means that they are overheating as domestic demand outstrip domestic supply. Turkey, Brazil, and India seem to be experiencing huge demand relative to supply.

When the scores from the six variables we can see that there are 7 countries where the index is over 80. Argentina is the only country where all six are red and Brazil and China are close by.

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