The evidence of recent days suggests that financial
investors are more inclined to take the risk of investing in emerging markets rather
than the developed world. It is not exactly a new phenomenon: After all, the
hunt for yield has been a recurrent theme of financial investing for much of
the past eight years. But what is different today is that the EM universe is less
stable than it was once perceived to be.
Non-agricultural commodity producers have suffered badly as
the price boom of recent years appears to have come to an end. The election of
President Trump, which threatens a round of US protectionism, will do nothing to
help countries which depend on exporting to the west. Rising US interest rates,
and the upward pressure this will impose on the dollar vis-à-vis EM currencies,
will raise debt servicing costs. Moreover, the impact of rapid growth in
raising wages in many EMs has reduced their competitive advantage at a time when
many companies are looking to shorten their global supply chains.
The travails of the BRICS countries are symbolic of all that
has changed in recent years. Brazil has laboured under the burden of a corruption
scandal that has seen the president replaced and the economy fall into
recession. Russia suffers from sanctions imposed in the wake of the Crimea
incursion – an event which has been exacerbated by the decline in energy
prices. India is the one exception to the general trend, although even here the
strange decision to demonetise large parts of the economy points to a government
capable of following economically harmful policies which will impact on growth
this year. Chinese growth has slowed sharply, although the much-feared boom and
bust is not immediately apparent.
Meanwhile South Africa – which does not
deserve to be mentioned in the same league as the other BRICS countries – is
being hammered by falling commodity prices and exceptional economic mismanagement.
We can also add in Turkey for good measure, another market previously viewed positively
by investors, which has undergone radical political change since last year’s
coup attempt and where the government’s exertion of even more pressure on a
nominally independent central bank has done nothing to support investor
confidence.
Faced with all of these problems, why are investors even contemplating
going back to these markets? First of all, many EMs are cheap following the
sharp collapse in key emerging currencies in the wake of the 2013 taper tantrum,
so it is still possible to find value if investors are prepared to take the
risk. But perhaps what has prompted investors to look further afield is the
fact that the stability which traditionally favoured developed markets is being
eroded by the rise of populist politics. The unity of the EU is threatened by
Brexit, and faced with a lack of returns and mounting political uncertainty in continental
Europe, it may pay to look beyond the safe haven trade for the time being.
Indeed, the Trump rhetoric has not proven to be as damaging to EMs as was
feared in November. It may yet prove to be the case, in which case fund flows
will reverse, but there is simply no point in hanging around waiting for an
event which may take years to materialise – if indeed it does so at all.
But perhaps the crucial point is that there appears to be
evidence that growth in EM economies is beginning to pick up. The Institute
for International Finance last week reported that its EM growth tracker in
January pointed to the fastest rate of monthly activity growth since June 2011. As
emerging markets increasingly become bigger consumers rather than simply exporters
of low cost goods to the west, they will continue to gain in importance.
A report published a couple of years ago by PwC (here)
highlighted that current trends in demographics, capital investment, education
levels and technological progress suggest that by 2050, seven of the world’s
top 10 economies will be what we currently describe as emerging economies. According
to the report, those with the greatest growth potential are those with
demographics on their side. Thus, India is projected to grow by an average of
5% per annum between 2014 and 2050 to propel it to second place in the global standings
on a PPP-adjusted basis whilst Nigeria can grow at a rate of 5.5% per year to
take it into the world top 10. We should always take such projections with a
grain of salt, but they do make the point that there is a huge degree of
untapped potential in many of these countries: population size alone suggests
that Indonesia, Nigeria and even Pakistan have the potential to become significant
economies.
What all economies require to grow rapidly, however, is institutional
stability. If they cannot achieve stable government, many of the big EM
economies will remain stuck in low gear. But whilst in the next few years we may
not see the stellar growth across the EM universe which characterised the period
2002-2012, these economies continue to offer great catch-up potential.
Investors ignore them at their peril.
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