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16 July 2013

EM’s long-term prospects are still strong

It has been a difficult year for emerging market economies, policy makers and investors. A slowdown in the global economy has dented activity across many emerging economies. But despite the recent headwinds, there is an impressive long-term growth story that shouldn’t be ignored, especially when set against the challenges other regions have faced in recent years.

Many commentators have been quick to point to the overall slowing of emerging market growth as evidence of fragility. Even China, the world’s largest commodity importer, appears to be in the doldrums with rampant credit creation and the activities of the shadow banking sector creating significant structural challenges.

Like other emerging markets, China is also transitioning fr om an investment-led economy to one driven by domestic consumption. This has proved a bumpy road at a time when the middle income trap and loss of the demographic dividend looms large. And the authorities seem wary of implementing large-scale fiscal stimulus for fear of stoking inflation in an economy wh ere the credit to GDP ratio stands at a dangerous 200 per cent.

However, despite these challenges, the IMF predicts China’s economy will grow by 7.75 per cent this year. Although a slight downgrade on earlier growth forecasts, this is still a rate that even the best performing economies in Europe can only dream of.

There is no doubt that uncertainty still abounds, with Ben Bernanke’s recent attempts to explain the Fed’s monetary policy intentions creating unusual market volatility.

The question we must ask is whether this uncertainty and knock-on market volatility is a function of short-term pressure or something more fundamental? In my view it is the former. In the case of the Fed, the real reason for wanting to consider winding down its QE programme is a worry that the policy is overheating the credit market. It is also recognition that the US economy may no longer require such extraordinary stimulus measures and that its housing and labour markets are on the road to recovery, which is good news for all economies around the world, including emerging markets.

The immediate impact of the Fed’s QE tapering will be a capital outflow as higher US bond yields push up the value of the US dollar. Traditionally, a higher US dollar, in the event of any gradual tightening of US monetary policy, pushes down the prices of commodities over time, reversing the gains in the terms of trade that many commodity producers have enjoyed in recent years. This points to a need for structural change in emerging markets but not to fundamental, long-term challenges for these economies.

Many still point to the perceived under-performance of the Brics in global equity markets this year. But the story of their out-performance growth is frayed at the edges. Growth and performance across emerging economies have never been uniform and the downbeat view currently propagated overlooks a highly convincing longer-term investment story.

The long-term shift in the centre of economic of gravity has moved from west to east. As Raghuram Rajan noted in the Andrew Crockett Memorial Lecture recently, the “advanced economies” have seen a long-term decline in their industrial structures which has been masked by previous debt-fuelled increases in consumption.

Emerging economies are the growth economies of the world. They are seeing rising incomes per head and infrastructure investment accompanied by urbanisation and modernisation. All of which are the life-blood of economic development. This is accompanied by very favourable demographics which point to a strong professional and middle class to bolster domestic demand in the long-run. The story is just as compelling as it ever was.

Some commentators would have us believe that we could turn the clock back to a time when developed economies made all the running. But the reality of globalisation is that the fortunes of countries across the world are now interwoven.

We are all used to emerging market investment stories that on closer inspection seem to over-state prospects. In the last decade or so they have been the stock in trade of the industry. But the trend among commentators to use current short-term challenges as an opportunity to somehow get their own back, is short-sighted. The reality for emerging markets is usually more prosaic and it certainly does not invalidate a longer term story of economic advancement. 

Corporate Communications VTB Capital