## _sdn1406 - Executive Summary

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---

### Overview
- After decades of stalled and regressed convergence, emerging markets (EMs) returned to convergence in the 2000s, helped by supportive external conditions, improved policy frameworks, and growth-enhancing reforms.
- The external tailwinds (buoyant global trade, high commodity prices, easy financing) that supported the 2000s are unlikely to prevail in the coming years; many large EMs have faced market pressure as advanced economies begin to normalize monetary policy and external financial conditions tighten.
- The note analyzes supply-side factors, external conditions, and macroeconomic policies for a large sample of EMs, assessing the roles of:
  - trade and financial openness;
  - advanced markets versus emerging markets as trading partners; and
  - commodity dependence and changes in terms of trade.

### Why EM growth was high in the 2000s
- Broad outcome and magnitudes:
  - EM growth averaged 4¾ percent between 2000 and 2012, about 1 percentage point higher than the average observed during the previous two decades.
  - 60 percent of EMs had higher growth in the 2000s compared to the 1990s.
  - EMs now account for about half of global output in PPP terms.
- Drivers and empirical findings:
  - Higher total factor productivity (TFP) explains 1½ percentage points of the 1¾ percentage point higher average growth rate in EMs in the 2000s compared to the 1990s.
  - Factor accumulation (capital and labor) remained the main driver of output growth in the 2000s; strong terms of trade growth and easy financing facilitated higher investment and capital accumulation.
  - Favorable external conditions (rising global trade, lower global interest rates, and high commodity prices) and continued trade and financial liberalization together accounted for about half of the increase in EM growth in the 2000s relative to the 1990s.
- Specific quantified contributions:
  - For the average commodity-exporting EM, a 5¼ percent annual improvement in terms of trade over the last decade contributed to a ¾ percentage point increase in growth.
  - For the median financially open EM, a 170 basis point decline in global real interest rates raised GDP growth by ¼ percentage point (about 15 percent of the higher growth these countries saw in the 2000s); financially open EMs in the top quartile grew on average by ½ percentage point more due to lower global interest rates.
- Sensitivities to external demand:
  - About 25 percent of the higher growth in the average non-commodity EM in the 2000s was due to external demand (increased trade openness and marginally higher trading partner growth).
  - EM growth is more sensitive to demand from advanced markets (AMs): a one percentage point increase in AM trading partners’ growth raises EM growth by around 1 percentage point.
  - Commodity exporters’ growth is highly sensitive to demand from large EMs (BRICS), reflecting their impact on global commodity prices.
- Policy and fundamentals improvements:
  - Many EMs implemented structural reforms and strengthened policy frameworks, which contributed to lower public and external debt, improved international reserve coverage, and more flexible exchange rate regimes.

### Why EMs are slowing down
- Recent slowdown facts:
  - EM growth has been slowing since the 2010-11 post-crisis peak; by end-2013, EM growth was on average 1½ percentage points lower than in 2010-11.
  - 80 percent of EMs decelerated in 2012.
  - Country examples: China’s output growth slowed by 2¼ percentage points (to around 7¾ in 2013); Brazil’s slowed by 2¾ percentage points (to 2¼ percent).
- Regression-based analysis (24 EMs, 2010-13):
  - Much of the slowdown is explained by weaker external demand (trading partners’ import demand), with external demand playing a large role through 2012 and a smaller but still statistically significant role in 2013.
  - When trading partners are split, AMs and China explain most of the external demand contribution.
  - Other external factors (terms of trade, U.S. 10-year yield, VIX, capital flows) were not statistically significant in explaining the 2011-13 slowdown, likely because annual averages were relatively stable in that period.
  - Domestic factors mattered as well: fiscal policy turned contractionary in 2013 as stimulus was unwound; countries that were overheating in 2010 (positive output gaps, overvalued exchange rates) experienced sharper slowdowns.
- Cyclical versus structural components:
  - Decomposing the slowdown across 70 EMs shows cyclical and structural factors are, on average, equally important in explaining the recent slowdown.
  - The cyclical component implies some recovery as trading partner growth strengthens; the structural component (decline in potential growth) implies more persistent weakness and requires policy action.
  - The relative importance varies across regions: structural factors weigh more in Emerging Europe, while cyclical factors dominate in Emerging Asia.
- Vulnerabilities and balance-sheet effects:
  - EMs that entered the global financial crisis with large current account deficits (e.g., parts of Emerging Europe) have taken longer to recover due to deleveraging and balance-sheet repair.
  - Countries that allowed financial and external imbalances to build saw weaker post-2008 growth.

### Medium-term prospects for EMs
- External environment outlook and implications:
  - Advanced economies are expected to continue recovering (IMF April 2014 WEO baseline), which should support a cyclical bounce in EM growth.
  - AMs are not expected to return to pre-crisis debt-fueled growth rates; monetary policy normalization will tighten global financial conditions and likely produce bouts of volatility similar to those since May 2013.
  - Commodity prices are expected to soften somewhat, reflecting China’s projected gradual slowdown and rebalancing; this will dampen investment in commodity exporters while benefiting commodity importers.
- Implications for factor allocation and productivity:
  - Physical capital accumulation is expected to moderate as global interest rates rise; softer commodity prices will reduce returns to commodity-sector expansion and slow investment in commodity-exporting EMs.
  - Balance sheet repair in euro zone–linked EMs will continue to weigh on investment in Emerging Europe; political tensions may affect investment in MENA.
  - Labor accumulation contributions may be limited by aging populations in some EMs and by limits in reducing natural rates of unemployment.
  - TFP growth may be lower over the medium term absent further growth-enhancing reforms because TFP is partly procyclical.
- Potential growth projections and magnitudes:
  - Using production function methods and assuming capital and TFP grow at their 2000–12 average annual rates (an optimistic assumption), potential GDP growth for EMs is estimated to average roughly 3½ percent during 2013-17 — 1¼ percent lower than for 2003-12.
  - The strong growth momentum of the 2000s may not be repeated in the coming years if recent trends in factor accumulation and TFP continue.
- Impact of trading-partner growth and external conditions:
  - A 1 percent decline in EM trading partner growth would lower average growth over the medium term by 0.6 percent.
  - The impact of trading partner growth increases with the degree of trade openness.
  - For commodity exporters, lower EM growth (particularly by BRICS) would likely offset any gains from improved AM prospects.
- Tighter external financing conditions:
  - For the median EM with external assets and liabilities constituting 114 percent of GDP, the 110 basis point increase in the real U.S. 10-year bond rate for 2014-18 (over 2009-13) projected in the April 2014 WEO would lower GDP growth by less than 0.2 percentage points.
  - EMs in the top quartile of financial openness would see a decline of about 0.4 percentage points over a five-year horizon from such external tightening.
  - The effect is partial because real rates would rise only when AM growth picks up, which would concurrently support EM growth.
- Softer or flat commodity prices:
  - The 3 percent decline in the terms of trade for the median commodity-exporting EM projected in the April 2014 WEO would reduce growth over the medium term on average by about ½ percent.
  - The impact is estimated to be negligible for non-commodity exporters.
  - Large commodity exporters could face larger losses; IMF (2014b) estimates commodity exporters in Latin America could see growth lower by 1¼ percentage points relative to the boom years (2003-11) even with commodity prices remaining at their current levels.

### Policy implications and priorities
- High-level prescription:
  - Reorient growth engines toward sustainable domestic sources and revitalize them through structural policies to improve factor allocation and boost productivity.
  - Macroeconomic policy stance should be tailored to country-specific circumstances, but broadly:
    - Use policy buffers prudently where available; avoid procyclical loosening that could build vulnerabilities.
    - Address balance-sheet vulnerabilities in countries with built-up external and financial imbalances to prevent prolonged slowdowns.
    - Implement structural reforms that raise TFP and labor and capital efficiency (e.g., deregulation, labor market reforms, measures to increase labor force participation).
  - For commodity-exporting EMs, prepare for softer commodity prices by prioritizing policies that broaden the growth base and limit excessive investment in lower-return commodity expansions.
  - Financially open EMs should be mindful that tighter global financial conditions will raise investment costs and debt-service burdens; policies to strengthen balance sheets and build buffers are important.

#### A. Macroeconomic policy priorities
- Immediate challenge: strengthen macroeconomic frameworks.
  - In some cases, tighter monetary policy will be needed to contain inflation and strengthen confidence.
  - Fiscal policies may need tightening where the fiscal stance is procyclical, adds to funding pressures, or current account deficits are too high.
  - Exchange rate flexibility should serve to buffer shocks; foreign exchange intervention could be used to reduce excessive volatility where reserves are adequate.
- Fiscal policy and commodity price shocks:
  - Estimates suggest sensitivity of commodity exporters’ growth to a decline in terms of trade can be reduced by 30 percent for countries able to implement countercyclical policies.
  - Countries that saved a greater share of their commodity windfall over the previous decade will be in a better position to cushion declining terms of trade.
  - Reliance on demand-side policies should be limited given the persistent nature of lower commodity prices.
- Exchange rates and tighter global financial conditions:
  - The impact of an increase in U.S. long-term interest rates can be mitigated by a flexible exchange rate regime.
  - For the median EM with a fixed exchange rate, higher U.S. long-term interest rates have a statistically significant negative impact on growth both over a one-year horizon and over a five-year period.
  - For EMs with floating exchange rates, the impact is not statistically significant.

#### B. Rebalancing growth
- Internal rebalancing is needed to reorient economies to more sustainable growth models.
- Avoiding buildup of excess demand is a priority to prevent external imbalances and boom/bust cycles.
- Country-specific directions:
  - China: reduce investment (and credit growth) to more sustainable levels, factor in permanently lower external demand in the tradable sector, increase domestic consumption, and level the playing field for the domestic private sector.
  - Other EMs (e.g., Brazil, Turkey, South Africa): reduce consumption and boost savings to ensure a larger share of investment is financed domestically, reducing external structural deficits and the risk of boom-bust cycles.

#### C. Improving growth prospects through structural reforms
- Revitalizing growth will require structural reforms; second-generation reforms may be needed in many EMs.
- Reform priorities vary by country and stage of development:
  - Raising productivity:
    - For EMs closer to the technological frontier (e.g., Poland): increase research and development spending and tertiary education to boost absorptive capacity and innovation.
    - For lower-end EMs (e.g., China): move up the value chain by adopting new technologies.
    - Boost productivity in the service sector as resources shift from manufacturing to services; increase labor market flexibility and deepen financial sectors.
  - Investing in human and physical capital:
    - A more educated workforce and better infrastructure increase capacity to absorb and develop new technologies and raise productivity.
    - Example: South Africa faces poor education quality and energy and infrastructure bottlenecks (electricity and railways) that constrain growth; easing these constraints would mobilize excess labor.
    - Increasing investment in human and physical capital is a low-hanging fruit for a number of lower-income EMs.
  - Facilitating better resource allocation:
    - Address structural impediments that constrain labor force participation to add productive capacity and offset unfavorable demographics (e.g., increasing female labor force participation in MENA).
    - Poland: reduce structural unemployment by addressing skill mismatches and better aligning education to job needs.
    - Latin America: reduce informality and support growth by moving firms to the formal, more productive sector.
    - Improve regulatory environment for domestic businesses, particularly small and medium-size enterprises.
    - Further capital market development (equity, bonds, securities) to mobilize domestic financing for private investment.
    - Reduce financial repression to move resources to more productive uses.

### Conclusion
- After substantial progress in the previous decade, EM growth has slowed.
- EMs’ higher growth during the 2000s reflected increased productivity and favorable external conditions; most EMs remain in the middle-income range.
- With waning favorable external conditions, rollback of post-crisis stimulus, and leveling productivity gains, growth has been slowing across EMs.
- Continuing income convergence will be more challenging; markets are differentiating EMs by how well policymakers manage the transition to less-favorable external conditions.
- Policymakers need to strengthen macroeconomic policies and address vulnerabilities.
- Sustaining strong growth requires renewed emphasis on structural reforms tailored to country-specific circumstances:
  - Lower-income countries: reforms to move up the value chain and develop new sectors.
  - Higher-income EMs: reforms toward innovation and technological development.
  - Reforms to reorient growth away from consumption in some cases (Brazil and Turkey) and away from investment in others (China).
- Challenges to reforms include opposition, concentrated short-term costs, political economy constraints, weak capacity, and governance issues.
- Decisive and timely policy action is needed; early commitment to tailored reforms yields significant long-term benefits.

*Source: IMF Staff Discussion Note — Emerging Markets in Transition, Executive Summary.*

### Executive Summary ......................................................................................................

### _sdn1406 - Executive Summary

### Table of contents — Major themes and sections
- Executive Summary ................................................................................................................................................................. 3
- Why Was Emerging Market Growth High in the Last Decade? ............................................................................. 4
- Why Are Emerging Markets Slowing Down? ................................................................................................................ 9
- A. External and Domestic Demand Factors ............................................................................................................ 10
- B. Cyclical and Structural Factors ................................................................................................................................ 11
- Medium-Term Prospects for Emerging Markets ....................................................................................................... 12
- Policy Priorities Going Forward ........................................................................................................................................ 15
- A. Macroeconomic Policy Priorities ........................................................................................................................... 15
- B. Rebalancing Growth ................................................................................................................................................... 16
- C. Improving Growth Prospects through Structural Reforms ......................................................................... 17
- Conclusion ................................................................................................................................................................................ 19

### Annexes and analytical material
- Annex 1. Organizing the Emerging Market Universe: The Role of External Linkages ................................. 21
- Annex 2. Structural Reforms: Lessons from Four Case Studies ............................................................................ 24
- Annex 3. Prospects for the “Next” Emerging Markets? ........................................................................................... 27
- Analytical Appendix .............................................................................................................................................................. 29
  - A. Supply-Side Decomposition of Growth and Estimating Potential Growth.......................................29
  - B. Impact of External Factors on Emerging Market Growth.....................................................................30
  - C. Domestic and External Factors Explaining the Current Slowdown.....................................................32
- References ......................................................................................................................................................................... ....333

*https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/sdn/2014/_sdn1406.pdf*

### EXECUTIVE SUMMARY

### EXECUTIVE SUMMARY

### Overview
- After decades of stalled and regressed convergence, emerging markets (EMs) returned to convergence in the 2000s, helped by supportive external conditions, improved policy frameworks, and growth-enhancing reforms.
- The external tailwinds (buoyant global trade, high commodity prices, easy financing) that supported the 2000s are unlikely to prevail in the coming years; many large EMs have faced market pressure as advanced economies begin to normalize monetary policy and external financial conditions tighten.
- The note analyzes supply-side factors, external conditions, and macroeconomic policies for a large sample of EMs, assessing the roles of (i) trade and financial openness; (ii) advanced markets versus emerging markets as trading partners; and (iii) commodity dependence and changes in terms of trade.

### Why EM growth was high in the 2000s
- Broad outcome and magnitudes:
  - EM growth averaged 4¾ percent between 2000 and 2012, about 1 percentage point higher than the average observed during the previous two decades.
  - 60 percent of EMs had higher growth in the 2000s compared to the 1990s.
  - EMs now account for about half of global output in PPP terms.
- Drivers and empirical findings:
  - Higher total factor productivity (TFP) explains 1½ percentage points of the 1¾ percentage point higher average growth rate in EMs in the 2000s compared to the 1990s.
  - Factor accumulation (capital and labor) remained the main driver of output growth in the 2000s; strong terms of trade growth and easy financing facilitated higher investment and capital accumulation.
  - Favorable external conditions (rising global trade, lower global interest rates, and high commodity prices) and continued trade and financial liberalization together accounted for about half of the increase in EM growth in the 2000s relative to the 1990s.
  - Specific quantified contributions:
    - For the average commodity-exporting EM, a 5¼ percent annual improvement in terms of trade over the last decade contributed to a ¾ percentage point increase in growth.
    - For the median financially open EM, a 170 basis point decline in global real interest rates raised GDP growth by ¼ percentage point (about 15 percent of the higher growth these countries saw in the 2000s); financially open EMs in the top quartile grew on average by ½ percentage point more due to lower global interest rates.
  - Sensitivities to external demand:
    - About 25 percent of the higher growth in the average non-commodity EM in the 2000s was due to external demand (increased trade openness and marginally higher trading partner growth).
    - EM growth is more sensitive to demand from advanced markets (AMs): a one percentage point increase in AM trading partners’ growth raises EM growth by around 1 percentage point.
    - Commodity exporters’ growth is highly sensitive to demand from large EMs (BRICS), reflecting their impact on global commodity prices.
- Policy and fundamentals improvements:
  - Many EMs implemented structural reforms and strengthened policy frameworks, which contributed to lower public and external debt, improved international reserve coverage, and more flexible exchange rate regimes.

### Why EMs are slowing down
- Recent slowdown facts:
  - EM growth has been slowing since the 2010-11 post-crisis peak; by end-2013, EM growth was on average 1½ percentage points lower than in 2010-11.
  - 80 percent of EMs decelerated in 2012.
  - Country examples: China’s output growth slowed by 2¼ percentage points (to around 7¾ in 2013); Brazil’s slowed by 2¾ percentage points (to 2¼ percent).
- Regression-based analysis (24 EMs, 2010-13):
  - Much of the slowdown is explained by weaker external demand (trading partners’ import demand), with external demand playing a large role through 2012 and a smaller but still statistically significant role in 2013.
  - When trading partners are split, AMs and China explain most of the external demand contribution.
  - Other external factors (terms of trade, U.S. 10-year yield, VIX, capital flows) were not statistically significant in explaining the 2011-13 slowdown, likely because annual averages were relatively stable in that period.
  - Domestic factors mattered as well: fiscal policy turned contractionary in 2013 as stimulus was unwound; countries that were overheating in 2010 (positive output gaps, overvalued exchange rates) experienced sharper slowdowns.
- Cyclical versus structural components:
  - Decomposing the slowdown across 70 EMs shows cyclical and structural factors are, on average, equally important in explaining the recent slowdown.
  - The cyclical component implies some recovery as trading partner growth strengthens; the structural component (decline in potential growth) implies more persistent weakness and requires policy action.
  - The relative importance varies across regions: structural factors weigh more in Emerging Europe, while cyclical factors dominate in Emerging Asia.
- Vulnerabilities and balance-sheet effects:
  - EMs that entered the global financial crisis with large current account deficits (e.g., parts of Emerging Europe) have taken longer to recover due to deleveraging and balance-sheet repair.
  - Countries that allowed financial and external imbalances to build saw weaker post-2008 growth.

### Medium-term prospects for EMs
- External environment outlook and implications:
  - Advanced economies are expected to continue recovering (IMF April 2014 WEO baseline), which should support a cyclical bounce in EM growth.
  - However, AMs are not expected to return to pre-crisis debt-fueled growth rates; monetary policy normalization will tighten global financial conditions and likely produce bouts of volatility similar to those since May 2013.
  - Commodity prices are expected to soften somewhat, reflecting China’s projected gradual slowdown and rebalancing; this will dampen investment in commodity exporters while benefiting commodity importers.
- Implications for factor allocation and productivity:
  - Physical capital accumulation is expected to moderate as global interest rates rise; softer commodity prices will reduce returns to commodity-sector expansion and slow investment in commodity-exporting EMs.
  - Balance sheet repair in euro zone–linked EMs will continue to weigh on investment in Emerging Europe; political tensions may affect investment in MENA.
  - Labor accumulation contributions may be limited by aging populations in some EMs and by limits in reducing natural rates of unemployment.
  - TFP growth may be lower over the medium term absent further growth-enhancing reforms because TFP is partly procyclical.
- Potential growth projections and magnitudes:
  - Using production function methods and assuming capital and TFP grow at their 2000–12 average annual rates (an optimistic assumption), potential GDP growth for EMs is estimated to average roughly 3½ percent during 2013-17 — 1¼ percent lower than for 2003-12.
  - The strong growth momentum of the 2000s may not be repeated in the coming years if recent trends in factor accumulation and TFP continue.
  - For the median EM (exports/GDP of 36 percent), a 1 percent increase in AM trading partner growth would boost EM growth by nearly (text truncated in source at this point).

### Policy implications and priorities
- Reorient growth engines toward sustainable domestic sources and revitalize them through structural policies to improve factor allocation and boost productivity.
- Macroeconomic policy stance should be tailored to country-specific circumstances, but broadly:
  - Use policy buffers prudently where available; avoid procyclical loosening that could build vulnerabilities.
  - Address balance-sheet vulnerabilities in countries with built-up external and financial imbalances to prevent prolonged slowdowns.
  - Implement structural reforms that raise TFP and labor and capital efficiency (e.g., deregulation, labor market reforms, measures to increase labor force participation).
- For commodity-exporting EMs, prepare for softer commodity prices by prioritizing policies that broaden the growth base and limit excessive investment in lower-return commodity expansions.
- Financially open EMs should be mindful that tighter global financial conditions will raise investment costs and debt-service burdens; policies to strengthen balance sheets and build buffers are important.

*Source: IMF Staff Discussion Note — Emerging Markets in Transition, Executive Summary.*

### 0.9 percent, while a 1 percent decline in EM

### 0.9 percent, while a 1 percent decline in EM

### Impact of trading-partner growth and external conditions
- A 1 percent decline in EM trading partner growth would lower average growth over the medium term by 0.6 percent.
- The impact of trading partner growth increases with the degree of trade openness (Figure 15).
- For commodity exporters, lower EM growth (particularly by BRICS) would likely offset any gains from improved AM prospects.

- Tighter external financing conditions:
  - For the median EM with external assets and liabilities constituting 114 percent of GDP, the 110 basis point increase in the real U.S. 10-year bond rate for 2014-18 (over 2009-13) projected in the April 2014 WEO would lower GDP growth by less than 0.2 percentage points (Figure 16).
  - EMs in the top quartile of financial openness would see a decline of about 0.4 percentage points over a five-year horizon from such external tightening.
  - The effect is partial because real rates would rise only when AM growth picks up, which would concurrently support EM growth.

- Softer or flat commodity prices:
  - The 3 percent decline in the terms of trade for the median commodity-exporting EM projected in the April 2014 WEO would reduce growth over the medium term on average by about ½ percent.
  - The impact is estimated to be negligible for non-commodity exporters.
  - Large commodity exporters could face larger losses; IMF (2014b) estimates commodity exporters in Latin America could see growth lower by 1¼ percentage points relative to the boom years (2003-11) even with commodity prices remaining at their current levels.

### Policy priorities going forward — overview
- As global conditions turn less supportive, countries need both sound macroeconomic policies to address imbalances and structural reforms to sustain or restore growth potential.
- Reform priorities depend on country circumstances; key policy contours are highlighted below.

### A. Macroeconomic policy priorities
- Immediate challenge: strengthen macroeconomic frameworks.
  - In some cases, tighter monetary policy will be needed to contain inflation and strengthen confidence.
  - Fiscal policies may need tightening where the fiscal stance is procyclical, adds to funding pressures, or current account deficits are too high.
  - Exchange rate flexibility should serve to buffer shocks; foreign exchange intervention could be used to reduce excessive volatility where reserves are adequate.

- Fiscal policy and commodity price shocks:
  - Estimates suggest sensitivity of commodity exporters’ growth to a decline in terms of trade can be reduced by 30 percent for countries able to implement countercyclical policies (Figure 17).
  - Countries that saved a greater share of their commodity windfall over the previous decade will be in a better position to cushion declining terms of trade.
  - Reliance on demand-side policies should be limited given the persistent nature of lower commodity prices.

- Exchange rates and tighter global financial conditions:
  - The impact of an increase in U.S. long-term interest rates can be mitigated by a flexible exchange rate regime.
  - For the median EM with a fixed exchange rate, higher U.S. long-term interest rates have a statistically significant negative impact on growth both over a one-year horizon and over a five-year period.
  - For EMs with floating exchange rates, the impact is not statistically significant (Figure 18).

### B. Rebalancing growth
- Internal rebalancing is needed to reorient economies to more sustainable growth models.
- Avoiding buildup of excess demand is a priority to prevent external imbalances and boom/bust cycles.
- Country-specific policy directions:
  - China: reduce investment (and credit growth) to more sustainable levels, factor in permanently lower external demand in the tradable sector, increase domestic consumption, and level the playing field for the domestic private sector (Figure 19).
  - Other EMs (e.g., Brazil, Turkey, South Africa): reduce consumption and boost savings to ensure a larger share of investment is financed domestically, reducing external structural deficits and the risk of boom-bust cycles.

### C. Improving growth prospects through structural reforms
- Revitalizing growth will require structural reforms; second-generation reforms may be needed in many EMs.
- Reform priorities vary by country and stage of development:
  - Raising productivity:
    - For EMs closer to the technological frontier (e.g., Poland): increase research and development spending and tertiary education to boost absorptive capacity and innovation.
    - For lower-end EMs (e.g., China): move up the value chain by adopting new technologies.
    - Boost productivity in the service sector as resources shift from manufacturing to services; increase labor market flexibility and deepen financial sectors (Figure 20).
  - Investing in human and physical capital:
    - A more educated workforce and better infrastructure increase capacity to absorb and develop new technologies and raise productivity (Easterly and Levine, 2001).
    - Example: South Africa faces poor education quality and energy and infrastructure bottlenecks (electricity and railways) that constrain growth; easing these constraints would mobilize excess labor.
    - Increasing investment in human and physical capital is a low-hanging fruit for a number of lower-income EMs (Figure 21).
  - Facilitating better resource allocation:
    - Address structural impediments that constrain labor force participation to add productive capacity and offset unfavorable demographics (e.g., increasing female labor force participation in MENA).
    - Poland: reduce structural unemployment by addressing skill mismatches and better aligning education to job needs.
    - Latin America: reduce informality and support growth by moving firms to the formal, more productive sector.
    - Improve regulatory environment for domestic businesses, particularly small and medium-size enterprises.
    - Further capital market development (equity, bonds, securities) to mobilize domestic financing for private investment.
    - Reduce financial repression to move resources to more productive uses.

### Conclusion
- After substantial progress in the previous decade, EM growth has slowed.
- EMs’ higher growth during the 2000s reflected increased productivity and favorable external conditions; most EMs remain in the middle-income range.
- With waning favorable external conditions, rollback of post-crisis stimulus, and leveling productivity gains, growth has been slowing across EMs.
- Continuing income convergence will be more challenging; markets are differentiating EMs by how well policymakers manage the transition to less-favorable external conditions.
- Policymakers need to strengthen macroeconomic policies and address vulnerabilities.
- Sustaining strong growth requires renewed emphasis on structural reforms tailored to country-specific circumstances:
  - Lower-income countries: reforms to move up the value chain and develop new sectors.
  - Higher-income EMs: reforms toward innovation and technological development.
  - Reforms to reorient growth away from consumption in some cases (Brazil and Turkey) and away from investment in others (China).
- Challenges to reforms include opposition, concentrated short-term costs, political economy constraints, weak capacity, and governance issues.
- Decisive and timely policy action is needed; early commitment to tailored reforms yields significant long-term benefits.

*Source: IMF staff analysis from the provided content.*

### Annex 1. Organizing the Emerging Market Universe: The Role of External

### Annex 1. Organizing the Emerging Market Universe: The Role of External Linkages

### Country sample and coverage
- Country sample: A total of 53 countries are selected for the analysis, including 43 major EMs, nine newly industrialized economies (NIEs), and two frontier markets.
- The nine NIEs are currently classified as advanced economies by the IMF’s World Economic Outlook (WEO) and are included as high-income references (examples given: Czech Republic, Korea, Singapore).
- Vietnam and Nigeria are low-income countries included because they have relatively deeper financial markets with active foreign participation.
- The complete country list (53 countries) is provided (Table 1), including: Algeria; Angola; Argentina; Armenia; Azerbaijan; Bosnia and Herzegovina; Brazil; Bulgaria; Chile; China, Mainland; Colombia; Costa Rica; Croatia; Czech Republic; Dominican Republic; Egypt; Estonia; Guatemala; Hong Kong SAR; Hungary; India; Indonesia; Iraq; Israel; Jamaica; Jordan; Kazakhstan; Korea, Republic of; Latvia; Lithuania; Malaysia; Mexico; Morocco; Nigeria; Pakistan; Panama; Peru; Philippines; Poland; Romania; Russian Federation; Singapore; Slovak Republic; Slovenia; South Africa; Taiwan (Province of China); Thailand; Tunisia; Turkey; Ukraine; Uruguay; Venezuela; Vietnam.

### Taxonomy indicators and data sources
- The taxonomy covers seven indicators reflecting differences in financial and trade openness, export destination, and commodity dependence (Table 2).
- Indicators, descriptions, data sources, and periods:
  - Financial Openness: External assets plus liabilities, in percent of GDP, excluding reserve assets. Data Source: External Wealth of Nations Database, WEO Database. Period: 2000-10.
  - Trade Openness: Exports plus imports (goods and services), in percent of GDP. Data Source: WEO Database. Period: 2000-12.
  - Growth of Terms of Trade: Annual growth of terms of trade, in percent change. Data Source: WEO Database. Period: 2000-12.
  - Export Share to Euro Zone: Exports to euro zone, in percent of total exports of goods and services. Data Source: Direction of Trade Statistics (DoTS) Database. Period: 2000-12.
  - Export Share to the United States: Exports to United States, in percent of total exports of goods and services. Data Source: DoTS Database. Period: 2000-12.
  - Export Share to China: Exports to China in percent of total exports of goods and services. Data Source: DoTS Database. Period: 2000-12.
  - Commodity Exporters: Net commodity exports, in percent of GDP. Data Source: WEO Database. Period: 2000-10.

### Clustering methodology
- Two-stage clustering approach:
  - Step 1: For each indicator, six clusters are identified using Ward’s linkage clustering method in Stata. Countries are grouped into clusters that minimize the error sum of squares (equivalently, maximize R-square) within each cluster. The number of clusters is determined by the choice of dissimilarity level.
  - Step 2: Cluster numbers are refined through the use of judgment. A robustness test using kernel density estimation is used to ensure consistency of the countries in the different clusters.
- Footnote on robustness: Despite failing the robustness test, Hong Kong SAR and Singapore (economies with exceptionally large values of financial and trade openness) are grouped in a cluster with other economies with “relatively” high values of openness (Panama, Jordan, Hungary, and Taiwan Province of China).

### Final cluster output and key findings
- The final cluster results are given in Table 3. Countries are ranked from highest to lowest value for each indicator.
- Non-colored cells at the bottom of Table 3 represent missing observations.
- Finding: There are 21 countries in the top two clusters of “Net Commodity Exports to GDP.”
- Table 3 presents the ranked lists of countries by cluster for each of the seven indicators (Financial Openness (External A+L/GDP); Trade Openness (TX+TM)/GDP; Growth of Terms of Trade; Export Share to Euro Zone; Export Share to U.S.; Export Share to China, Mainland; Net Commodity Export to GDP). (The Table 3 output shows the country orderings for each indicator and notes missing observations.)

*Source: _sdn1406 - Annex 1. Organizing the Emerging Market Universe: The Role of External Linkages*

### Annex 3. Prospects for the “Next” Emerging Markets?

### Annex 3. Prospects for the “Next” Emerging Markets?

### Outlook for frontier low-income countries (LICs) and key messages
- Rapid growth in a number of low-income countries (LICs) has positioned them for middle-income status. These frontier LICs have:
  - grown rapidly for long periods,
  - overcome periods of growth decline and backtracking,
  - and subsequently made progress on convergence.
- Going forward, these rapidly growing economies must maintain momentum to graduate to middle-income status.
- Lessons from EMs apply to frontier LICs: maintain sound domestic policies, address financial-system vulnerabilities, implement wide-ranging productivity-enhancing reforms, and foster private sector development.

### Structural risk factors for a growth slowdown (summary of Table 4)
- Estimating the probability of a growth slowdown using a sample of frontier LICs and EMs highlights the following potential risk factors:
  - Institutions
    - Need to streamline cumbersome business regulations and strengthen institutions that promote property rights.
    - Prudential regulations could limit the build-up of excessive risk in the financial system.
  - Demography
    - High risk of slowdown from unfavorable demographic trends due to a high dependency ratio and imbalanced gender participation in the work force.
    - Policy priorities: combating gender discrimination and pursuing inclusive education and labor market reforms.
  - Infrastructure (communications and roads)
    - Frontier LICs face higher risk of slowdown arising from lack of infrastructure including communications, transport, and energy generation.
  - Structural transformation (output composition)
    - Transition of labor from agriculture to manufacturing and services exposes economies to risk of slowdown.
    - Managing risk requires reforms that enhance productivity, particularly in the nonagricultural sector.
  - Macroeconomic factors
    - Risks from financial openness and overinvestment. Countries that benefited from strong capital inflows need to be mindful of sudden stops that may lower potential output permanently (Cerra and Saxena, 2008).
    - Overinvestment in certain sectors driven in part by high capital flows and commodity price gains needs scaling back and redirection to increase productivity elsewhere.

### Supply-side decomposition of growth and estimating potential growth (Analytical Appendix A)
- Production function and decomposition
  - Uses a standard Cobb-Douglas production function where output depends on physical capital stock, employed labor force, human capital per worker, and total factor productivity (TFP).
  - Growth decomposition follows equation (2) in the source (growth rates of output decomposed into contributions from capital, labor, human capital, and TFP).
- Data sources and construction
  - Annual data from Penn World Table 7.1 (PWT) for 1980–2010; WEO database used for 2011–12.
  - Capital stock constructed with investment data from PWT using the perpetual inventory method until 2010; WEO investment data for 2011–12.
  - Labor input: employment series obtained using labor force from PWT and employment rate (one minus unemployment rate) from WEO.
  - For 2011–12 labor force assumed to rise in line with the UN Population Projection database (constant fertility scenario) for individuals age 15 and above.
  - Human capital modeled as a function of average years of schooling using Barro and Lee (2010) data (per Bils and Klenow (2000) and Ferreira, Pessoa, and Veloso (2013)).
- Key parameter and robustness
  - Assume capital share of output, α, of 0.40 (in line with Gollin, 2002). Main findings robust to a range of values for α.
- Trend extraction and projection assumptions
  - Trend series for K, L, h, and A for 1980–2017 obtained using Hodrick-Prescott (for both λ = 6.25 and λ = 100), Baxter and King (1999), and Christiano and Fitzgerald (2013) filters.
  - Assumptions for 2013–17:
    - (i) capital and TFP grow by the average annual rate observed in 2000–12;
    - (ii) labor input projected using WEO projected unemployment rates; labor force grows in line with working-age population from UN Population Projection database; labor force participation rates remain constant at their latest observation;
    - human capital increases at the 2005–10 average annual growth rate.
  - Projections include through 2019 to avoid end-of-sample bias.
- Definitions of slowdown components
  - Structural slowdown: change in potential growth rate from a historical average (example: 2000-12 versus 2013-18).
  - Cyclical part: residual from change in actual growth rates and structural change between 2012-13 and 2010-11.

### Impact of external factors on emerging market growth (Analytical Appendix B)
- Empirical approach
  - Fixed effects growth regressions using macroeconomic panel data averaged over consecutive five-year periods; time fixed effects (dummies for each five-year period) control for global conditions not captured by the model.
  - General regression specification: first difference in log of real per capita GDP (per capita GDP growth) regressed on external conditions, standard growth regressors, country fixed effects, and time fixed effects.
- External condition variables emphasized
  - External demand: trading partner growth (computed as weighted average growth using partners’ share in reporting country’s export basket).
  - International financing conditions interacted with degree of financial openness: measured by changes in the real interest rate on the 10-year U.S. T-bond.
  - Change in the log of terms of trade.
- Data coverage and sample
  - Panel covers 1962-2011.
  - Regressions restricted to countries with population of at least 2 million people, yielding 129 countries: 66 EMs, 21 AMs, and 42 LICs.
  - Export weights computed as five-year averages from IMF Direction of Trade Statistics (DoTS) for 1960-2011.
  - For countries that started reporting to DoTS later, partners’ import data used to recover export weights.
  - EM partner growth: computed in two stages; common component with AM partner growth excluded by regressing EM partner growth on AM partner growth and using residuals in subsequent analysis.
- Additional data and definitions
  - GDP growth series and commodity dependence: World Bank’s World Development Indicators. Commodity exporter defined as net commodity exports (fuels and metals) averaged over 10 percent of GDP in years 2002-11.
  - IMF’s International Financial Statistics: select macro variables (current account balance/GDP, investment/GDP, terms of trade) and real interest rate on the 10-year U.S. T-bond.
  - Financial integration: sum of total external assets and total external liabilities net of international reserves (Lane and Milesi-Ferretti dataset).
  - Exchange rate regime classification: IMF AREAER Database.
  - PRIO Armed Conflict Dataset used to identify war episodes.

### Domestic and external factors explaining the recent EM slowdown (Analytical Appendix C)
- Data and sample for the slowdown analysis
  - Staff calculations using October 2013 WEO, GEE and AREAER databases, and vulnerability exercise; public sources (Bloomberg, IFS, HAVER).
  - Annual data for 2011, 2012, and 2013 with initial conditions for 2010.
- Regression setup
  - Pooled panel OLS (country fixed effects excluded to allow country-specific time-invariant initial conditions; year fixed effects excluded due to short sample).
  - Global conditions captured through change in VIX index variable.
- Variables in the specification
  - Dependent variable: yearly real GDP growth rate.
  - Domestic factors: fiscal policy measured by change in the cyclically adjusted primary balance to potential GDP; exchange rate regime (peg dummy equal to one when exchange rate classification is below or equal to 8).
  - Initial conditions (measured in 2010): REER overvaluation, output gap, measure for financial openness; interaction of initial financial openness (FO) with fundamentals (peg).
  - External factors: trading partner real import demand.
  - Global risk aversion: change in the VIX index.
  - Variables tested but not significant: commodity exporter status; monetary policy measured by change in policy rate; additional external measures (terms of trade, current account balance to GDP, interaction of terms of trade with net commodity exports to GDP).
- Robustness checks
  - To address potential circularity from EM-EM trade, import demand from advanced economies (AMs) and EMs were separated; EM import demand measure used is the part not explained by AMs’ import demand. Results robust to this disaggregation.

*Source: Annex 3 and Analytical Appendix of _sdn1406 - Annex 3. Prospects for the “Next” Emerging Markets?_*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/sdn/2014/_sdn1406.pdf_