Are emerging markets the new drivers of the global economy?
At the beginning of the 20th century, the boxer Joe Walcott (aka “The Barbados Demon”) was welterweight champion of the world for three years. Despite his short stature (he stood just 5’ ½ ’’ tall) he was extremely successful against much larger and heavier opponents. He had exceptional stamina and durability as well as a proven punch. Given that throughout his career he had sent many a heavyweight crashing to the floor, it is fitting that he coined the phrase “The bigger they are, the harder they fall”.
This also seems to be true of economies. Developed economies have been hit much harder by the current financial crisis than their less-developed counterparts. According to the most recent estimates by the IMF, emerging market economies are forecasted to grow by 5.1% in 2009, whereas a collective contraction of 3.4% is expected for advanced economies. Overall, the IMF is expecting the global economy to shrink by 1.1% during 2009 – the first annual contraction since World War II.
It seems emerging economies have ridden the wave of the crisis better than their more advanced counterparts. Yet how can it be that the world’s poorer nations fared better than the rich world in the worst recession since the Great Depression and what implications does this have for the future?
Emerging economies have ridden the wave of the crisis better...
Dealing with imported troubles
Emerging markets don’t have a history of dealing competently with economic crises. The Mexican “Tequila-Crisis” of 1994–5, the Asian as well as Russian crises of 1997–98 and the Argentinean debt default of 2001 are all examples of the consequences of bad economic management. However, in dealing with the 2008 meltdown, policymakers in the developing world have proven themselves capable of managing the crisis effectively and pragmatically.
As opposed to US and European banks, financial institutions in emerging markets were not contaminated by toxic assets and subprime mortgages. Whereas banks in developed markets lost more than US$ 1 trillion on toxic assets and bad loans between January 2007 and September 2009, banks in the developing world remained fairly stable. In some cases they even thrived, as for example in Lebanon. Due to the constant crisis situation in the country, there is a tradition of conservative regulation at the Central Bank in Lebanon. Banks are not allowed to take on too much debt and they have to have at least 30% of their assets in cash. In addition, Lebanese banks are not allowed to speculate in risky packages of bundled up debts.
Lebanon is in no way representative of emerging economies. This example, however, does highlight a trend: Debt levels in emerging economies are generally modest. While emerging markets have suffered from the global liquidity squeeze in the short term, they are not exposed to the same risks as developed markets.
Keep on growing in the New World
Apart from having robust banks and low levels of debt, emerging economies will also bounce back because of a shift in trade. Across the emerging markets, revenues from exports to other emerging economies have now overtaken exports to the industrial nations and domestic demand in many countries is growing at a very fast pace. This means that emerging economies are less dependent on the developed world for growth than they were a few years ago. This is particularly the case in China, where demand for domestic products contributed around four times more to GDP growth than total exports did in 2007.
Yet stable banks and changing trade patterns do not suffice to explain the success of emerging markets in mitigating the effects of the crisis. The main catalyst behind the recovery is China. In November 2008, the country announced a US$ 586 billion stimulus package. The speed and relative success so far of this stimulus stands in stark contrast with that of the USA. According to a recent study by the World Bank, Beijing’s government spending will generate more than 80% of the country’s overall economic growth this year. The success of Beijing’s efforts is partially due to the fact that the country was already in the midst of a nationwide infrastructure programme when the recession commenced and could thus hit the ground running.
A vast sea of possibilities
These changing economic realities have been registered on the political level. The emergence of G20 as the primary international policy-making forum, replacing the Group of Seven, exemplifies this shift. But what implications does this have for investors?
According to BNY Mellon Asset Management, the share of emerging markets in world GDP has increased to an estimated 30% in 2008 and is expected to grow to 50% in 15 years. Yet emerging markets currently account for only 13% of stock market capitalization and the average pension fund allocates a mere 5% of its portfolio to emerging markets. There is thus much room for expansion and new investments. Their high growth rates render developing countries highly attractive for investors. It is, however, of the utmost importance to tread cautiously in this vast sea of investment possibilities.
The term “emerging markets” includes a large array of countries with considerable differences concerning economic and investment profiles as well as levels of stability. When contemplating investments it is crucial to keep the heterogeneous character of this group in mind.
The small open economies in Asia, such as Singapore, Taiwan and Malaysia, with their flexible economies and strong links to China, are a good bet. Nonetheless, their reliance on international trade leaves them exposed to future global economic downturns.
In the Middle East, Saudi Arabia, the United Arab Emirates, Kuwait and Qatar offer potential profits for investors, especially if oil prices stay high; although in some instances their legal frameworks are the source of some concern for investors.
Brazil has received much attention since the economic crisis. Being one of the last countries to be affected by the crisis and also one of the first to recover, the country that is otherwise known for Carnival and football has become the darling of investors worldwide.
Sources of stability
In these more established emerging market economies, stock market growth has increased as governments impose tighter regulations, as well as encouraging better protection for shareholders. This has led to increased confidence and demand from both domestic and foreign investors. At the same time, emerging markets can carry a higher risk than established markets. This is because emerging markets can be affected by factors such as political and economic instability, social unrest, or sudden changes to government policies.
The value of investments in emerging markets can also fluctuate more than in more developed markets. However, emerging market investments have strong growth potential and will gain a more prominent role in the years to come.
The future is now
Given strong economic growth in emerging markets, investing solely in US and European stocks no longer makes sense. Emerging market economies are outpacing developed countries in the global economic recovery and may continue to do so for some time. This has brought with it a change in perceptions. Emerging markets are no longer seen as weak and dependant on the rich world. They have proven their ability to stand on their own, without the richer nations supporting them.
Just like the “Barbados Demon”, they possess exceptional stamina and durability. Gone are the days when people talked about the emerging markets as the future. Now they are the present.
Article by Adam Lockstein
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