REMARKS BY JAVIER GUZMÁN CALAFELL, DEPUTY GOVERNOR AT THE
BANCO DE MÉXICO, AT THE SESSION "THE TASK FOR EMERGING MARKETS".
REINVENTING BRETTON WOODS COMMITTEE-UBS INTERNATIONAL GLOBAL
MACRO SEMINAR "MANAGING THE SOFT LANDING OF THE GLOBAL
ECONOMY". Washington, DC, April 12, 2019.1
I thank the organizers for the kind invitation to participate in this panel.
The deceleration of world economic activity that we have seen during the last
years has encompassed both advanced and emerging market economies.
However, when we look at projections by the main international institutions
both for the short and the long terms, hopes for a recovery from the current
weakness fall disproportionately on the shoulders of the emerging market
economies (EMEs). For instance, according to the most recent projections by
the IMF, the upturn of global growth in 2020 depends entirely on higher
growth rates in these countries, and projections for the long term do not show
a much different picture. In fact, according to the Fund, emerging markets and
developing economies' share in global growth will increase from around 76
percent this year to 85 percent in 2024.2
With this as a background, it is obviously important to identify possible
roadblocks ahead, not only for the benefit of EMEs themselves, but in the
interest of world economic activity. In general, the external environment faced
by EMEs at present is quite challenging, and the situation is unlikely to change
much in coming years. However, I would like to focus on two issues which, in
my view, are of special importance at this stage. The first is related to the
implications, from a medium- to long-term perspective, of the potential for a
more gradual normalization of monetary policy in the advanced economies
(AEs). The second focuses on the consequences of the recent protectionist
trends for global value chains, and the resulting repercussions on EMEs.
Following a period of turbulence and volatility in late 2018, international
financial markets have displayed a more orderly behavior since the turn of this
year. This has been particularly beneficial for EMEs. Per some estimates,
portfolio capital flows to these countries increased more than three-fold
between the last quarter of 2018 and the first quarter of 2019, a development
that has been accompanied by an appreciation of these countries' currencies,
declines in domestic interest rates and, in general, easier financial conditions.
To a significant extent, shifting market expectations regarding the future path
for monetary policy in the main AEs, particularly in the United States, explains
this result. Following recent communications signaling patience in determining
potential adjustments to its monetary policy stance while maintaining the
target range for the federal funds rate, the Federal Reserve has, in its latest
monetary policy meeting, substantially revised downwards its projections for
this variable over this and the next couple of years. In addition, the pace of
reduction of its balance sheet will be slower starting next month, a process
that is intended to conclude in September this year.
The expected slower pace of normalization of monetary policy in AEs seems to
be well justified in view of the evolution of the main macroeconomic
aggregates in these countries. However, is the associated improvement in the
financial environment facing EMEs giving us reasons to celebrate? I believe this
is far from clear. In fact, this pause in the monetary policy tightening cycle in
AEs may result in a more complex and uncertain external setting for EMEs. It
is true that the risk of an additional tightening of financial conditions in these
economies in the near future appears to have receded. Nonetheless, it should
be noted that the sense of relief perceived at present may well be just
temporary, and even perilous:
 The flip side of more monetary gradualism in AEs is a downgraded
perspective for economic activity in these countries and, consequently,
at the global level. As already pointed out, the prospect of lower interest
rates abroad should help alleviate some short-term pressures on EMEs,
especially in the monetary and financial fronts. However, the fact that
this new, more subdued outlook for rates derives from a less favorable
real sector evolution in AEs suggests that, from a medium-to-long term
perspective, the net effect on EMEs is likely to be detrimental.3
 The possibility that risks for financial stability continue to build up in a
context of persistently low interest rates and existing vulnerabilities,
both in AEs and EMEs, is particularly concerning. The progress achieved
in alleviating some of these risks during the years after the Global
Financial Crisis is remarkable. However, the task in this respect is far
from complete, and ongoing global shifts at the current juncture clearly
accentuate the challenges. Among these, it is worth to highlight the still-
high debt levels, both public and private, in a number of economies, a
situation that is aggravated by potential mismatches between assets
and liabilities in terms of currencies, liquidity and maturities. In addition,
an environment of low interest rates for longer may affect the
profitability and risk-taking decisions of banks and other financial
institutions, while the valuations of some assets (especially on the risky
side of the spectrum) may continue to stretch further.4

The potential of a more pronounced global economic downturn and,
paradoxically, of a disorderly tightening of global financial conditions,
persists. Even though the global economy and financial system have
shown relative resilience to adverse shocks in recent times, scenarios of
this type can still be triggered by developments in a number of fronts.
These include, beyond the materialization of the above-noted financial
stability risks, events that have been in the limelight for some time
already, such as the tensions between the US and trade partners,
notably China; the Brexit process; weaknesses in the euro area;
idiosyncratic challenges in a number of EMEs and, in general, a sharper
than expected deceleration of world economic activity as a result of a
combination of factors.
 An additional concern relates to the lack of space that monetary policy
in the US and other AEs may have to counter an economic downturn. In
contrast to the situation of a decade ago (i.e. at the outbreak of the
GFC), those economies' central banks at present run the risk of "not
having the ammunition" required to face a mild deceleration, let alone
a major economic or financial shock. This, as a result of a normalization
that has proceeded more slowly than originally thought, and which
appears to have come to a halt in part due to neutral interest rates that
are estimated at levels substantially lower than in the past.

While concern is reasonably concentrated now on the possibility of a
significant weakening of global economic activity, we must not lose sight
of the other side of the coin, i.e. the potential for a surprise that forces
the resumption of monetary policy normalization at a faster pace than
currently anticipated. In particular, while a lot of attention is paid to the
increased probability of a recession in the United States, the baseline
scenario for growth above potential this year and not far from this level
for 2020 is usually not attached the same importance. Clearly, the
disruptive impact of a surprise along these lines could be far greater
under current expectations.
A second aspect of today's global economic landscape that is worth
highlighting relates to the turn towards protectionism of recent. The costs,
both in the short and the long terms, impinged on the world economy from
increased tariffs and other barriers to trade have been extensively discussed,
and the impact is already evident in international trade figures. In fact, the
WTO recently reduced projections for global trade growth for 2019 to the
lowest level in three years, to a significant extent as a result of rising
commercial tensions and tariffs.5 The implications for trade in intermediate
goods within the framework of global value chains (GVCs) is particularly
worrisome for a number of reasons:
 The proliferation of GVCs lost momentum since 2011, and this trend has
probably been accentuated by the aforementioned protectionist
actions. However, their importance at present remains significant:
around 70 percent of international trade is for production under these
arrangements, a figure that can be roughly translated as trade in
intermediate goods and services being about twice as large as that
serving final demand.6

Notwithstanding their prominence, GVCs are particularly at risk due to
ongoing trade conflicts. This is mainly due to the cumulative effect that
tariff increases have on the total production cost of final goods, given
their multiple border crossings within these frameworks, a principle that
applies to other trade barriers as well.7 Additionally, a deeper sense of
caution may hinder further country integration (both at the intensive
and extensive margins) into GVCs, in view of the magnification of
spillovers from bilateral tariff increases that they bring about.8 Thus, it
would be reasonable to expect a further, albeit probably protracted,
retrenchment in GVCs as regional and global production arrangements
adjust to environments characterized by higher barriers to international
trade.
 GVCs are an important driver of productivity gains in the partaking
economies through a number of channels. In addition to the innovation,
technology adoption and knowledge spillovers arising from the close
interaction between firms in less developed economies and foreign
counterparts that may be at, or close to, the technological frontier,
productivity is enhanced internally by the specialization, external
competition and the increased access to higher-quality and more cost-
effective inputs inherent to GVCs, while the scope to leverage scale
economies may as well play an important role.9

Closely related to the above, GVCs are to a significant extent responsible
for some beneficial macroeconomic outcomes of recent times, including
subdued price pressures resulting from lessened bargaining power in a
number of industries and input markets.
 Uncertainty related to trade frictions and the ensuing decline of cross-
border flows of goods and services, is most probably behind the recent
moderation of industrial activity, particularly in sectors that are heavily
reliant on GVCs, such as manufacturing.10 The downshift that has been
observed in global industrial production since last year is partly the
result of transitory shocks such as the ones experienced by the
European auto industry a few months back. However, manufacturing
and other industrial activities are clearly facing significant headwinds
from protectionism and dislocations to GVCs, that may intensify in
coming years should risks to international trade continue to materialize.
I would like to conclude by noting that although, as I said at the beginning,
expectations of an improvement in the world economic situation in the short
and long terms depend crucially on the performance of EMEs, their realization
is far from assured. Potential growth in these countries has fallen during the
last decade and the possibility of further declines down the road is high.11
While part of the explanation lies in the evolution of demographic dynamics,
low investment rates and dismal productivity growth are at the heart of these
trends. In view of the complex nature of the factors behind long-term
developments such as these, major efforts must be made to sustainably
enhance these economies' productive capacity. Domestic policy efforts have a
central role in facing these challenges. However, it is unclear whether
achieving this objective will be feasible in an external environment that, partly
as a result of the factors explained above, is creating an atmosphere of
uncertainty and adversely affecting productivity, thus pushing just in the
opposite direction.