Domino effect

WASHINGTON — Developing countries including China and India, where red-hot growth has lifted hundreds of millions of people out of poverty in recent years, are showing signs of economic cooling as the effects of the downturn that started in the United States continue to spread around the globe.

Fears that booming emerging markets are becoming caught up in a global slowdown helped send the dollar soaring this week. Investors continue to flee juggernauts such as Russia into safer, dollar-denominated investments. The shift comes as the prices for commodities from developing countries, particularly oil, drop precipitously.

For many of these countries, a modest slowdown may actually be good news. Some had been growing unsustainably fast, raising the specter of inflation and threatening long-term prosperity. Yet the slowdown is also confronting the largest emerging nations with a key test. After years of breakneck growth, they must recalibrate their economic policies to avoid steeper downturns that could stymie job creation, hinder efforts to reduce poverty and lead to political instability.

"Basically, what you've got is the emerging world now slowing at the same time as the developed world," said Michael Hartnett, chief emerging markets strategist for Merrill Lynch. "Though the magnitude of their slowdown is a lot more modest, it is a negative for the global economy. The question now, obviously, is how much will they slow down?"

Europe and Japan — with economies tied closely to the United States through trade routes and financial systems — caught America's cold first and have continued to feel its effects. European stock markets in particular have taken a beating this week, and the European Commission warned Wednesday that some of the region's biggest economies, including Britain, Germany and Spain, are heading into recession.

The developing world had remained relatively resilient against the global turbulence — particularly given the pummeling many countries took during the Asian and Latin American financial crises of the 1990s and the early 2000s. But as the first-world economies now decelerate, demand for the goods and services from emerging markets is being curbed. Many developing countries had only recently been cashing in on the rise in commodities prices.

While they are still growing at rates that would be the envy of developed nations, the signs of a shift in fortunes are sprouting up from Shanghai to New Delhi to Sao Paulo.

In India, the high-tech and outsourcing sectors are softening as they absorb cutbacks from U.S. corporate clients. In China, diminished export expansion is cooling the economy from a growth rate of 12 percent last year to 9 percent to 10 percent this year, while the stock market in Shanghai has fallen more than 60 percent since its peak in October. In Brazil, exports slipped last month after surging for months.

Though still awash in oil money, Russia's economy lagged in August, a slowdown that was exacerbated when foreign investors pulled billions of dollars out of the country in the wake of its invasion of neighboring Georgia. Last week, the Russians intervened in the currency market more heavily than they had since the late 1990s to prop up the ruble, and the cost to protect government bonds from default shot up. The country's benchmark index on Thursday sank to its lowest since January 2006.

For the United States, there are pros and cons to the developing world's decelerating growth. On one hand, it is already contributing to falling commodity prices, driven up for years by the insatiable demand in emerging markets. Reduced oil imports by China — now the world's second-largest consumer, after the United States — is one factor behind the steep drop in gas prices at American pumps in recent weeks. Natural gas, as well as staples such as corn and wheat, have also taken double-digit-percentage falls off their highs.

But on the other hand, emerging-market cooling is adding to the overall drop in global growth, which is set to slide at least to 4.1 percent this year from 5 percent in 2007, according to the International Monetary Fund. That is likely to spell trouble for U.S. exports, which propped up the economy in the last quarter. That was especially true in the case of China, where a hunger for American medical equipment, soybeans and plastics have made it the largest market for U.S. goods outside North America. The strengthening dollar, which has made U.S. products more expensive overseas, is also likely to erase the recent export gains.

Emerging markets most linked to the developed world are suffering most. Mexico, bound to the U.S. market through NAFTA, is slowing down sharply, partly as remittances from immigrants in the United States plummet because of the loss of construction jobs. The Baltic states of Estonia and Latvia are heading into recession as Europe's economy buckles under the weight of the U.S. downturn, drying up the investment flows that buoyed those nations in recent years.

Yet in sub-Saharan Africa, enjoying its most robust growth in decades on the back of the global commodities boom, there is still nary a hint of the global slowdown, partly because of still-healthy demand from China. Foreign investors are still pouring in cash as they bet on the region's huge growth potential. And as long as commodity prices do not slip too sharply, the easing of prices will actually help sub-Sahara Africa to tame inflation — still one of the biggest economic ills facing the developing world.

Nowhere is the economic balancing act being watched more closely than in China, the undisputed powerhouse of developing nations; it is now vitally important as an export market for much of the world. As Chinese growth cools, policymakers in Beijing are changing tactics. Once, the overriding concern there was that consumers and businesses would spend too much, driving up inflation. But the government has apparently decided that slower growth is now the greater threat, moving in recent weeks to loosen lending to regional banks, which could in turn provide more loans to medium and small businesses.

China also has an ace in the hole with almost $2 trillion in cash reserves, leaving it free to spend on massive infrastructure projects that will keep feeding the domestic economy. All indications are that the cash will flow. While China spent about $42 billion on Olympics-related construction, it is now expected to spend in the neighborhood of $180 billion to rebuild the area devastated by the Sichuan earthquake in May, according to Nicholas Lardy, senior fellow at the Peterson Institute for International Economics.

"They have money to spend and places to spend it," Lardy said. "But I also think China will be less of a contributor to global growth as time moves on. Its demand for energy is going to slow down. You can't look for China to keep things going on a global basis."

For years, analysts have argued that China's biggest challenge would come during periods of slow global growth, when it would have to look to its increasingly massive middle class to fuel its economic expansion. Consumer demand now accounts for only about 35 percent of China's economy, about half the proportion in the United States. No one knows how long will it take for Chinese consumers to spend more.

As the economies of the United States and Europe slow, however, Western companies are banking on sooner rather than later. Yum Brands, the Louisville, Ky.-based owner of fast-food chains, is staying on track to open 500 KFCs and Pizza Huts in China this year, bringing the chains' total there to 3,000. Seen as more chic than cheap in China, KFCs and Pizza Huts are attracting big spenders. As a result, they are at least twice as profitable as U.S. locations, allowing for a recoup of the $500,000 set-up cost per store in two years, compared with five or six years in the United States. China now represents 25 percent of Yum's worldwide profit, up from nearly zero 10 years ago. Within three years, the company estimates, its China profit will equal the profit from its current largest market, the United States.

"We are not seeing the slowdown at all in our restaurants," said Tim Jerzyk, a Yum senior vice president. "I think the issue is that Chinese GDP has been growing above 10 percent for several years, but even if it grows at 8 percent over the next five years, it's still triple the U.S. rate, and that's terrific for us."

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