The short and long of emerging markets
Fickle investors have spurned emerging markets in recent weeks, but this rout has obscured a more alluring vista out on the horizon.
Developing economies now account for 50 percent of global output and 80 percent of economic expansion and are projected to continue growing far faster than developed nations. They are expected to possess an even larger share of global growth, wealth and investment opportunities in years to come. So much so that the labels investors use to classify some of these nations will change as the developing develop and the emerging emerge into more potent economic powers
But this long-term view has been lost on many of those who look to emerging market assets for a higher yield in the short term. Their ardor cooled when the Federal Reserve signaled it may soon ease the stimulus that has kept credit cheap, signaling higher interest rates ahead. That was coupled with signs of slower growth in key emerging markets like China and Brazil.
Still, the developing world’s gross domestic product growth of 5 percent this year and 5.4 percent next, as projected by the International Monetary Fund, will far outpace the advanced economies’ 1.2 percent and 2.1 percent. Developing countries are now also better armed to keep panic at bay, with more foreign exchange reserves than before and less aggregate debt than developed nations. Many have put their economies on firmer foundations.
Fear of a mass exodus of investors, however, has still sent emerging market shares down about 10 percent in the past two months, as measured by the MSCI Emerging Markets Index, compared with a marginal rise in the Standard & Poor’s index of U.S. shares.
Consider some other data that the World Bank has crunched, suggesting developing nations will attract increased capital flows because their growth implies big investment opportunities, improved creditworthiness and the ability to better diversify portfolios and manage risk.
According to one bank report, by 2030 developing countries will represent two-thirds of all global investment, up from about half today and from one-fifth in 2000. At that time, half the global stock of capital is expected to reside in the developing world, compared to less than one-third today. That means a shift in the distribution of wealth and in the creation of opportunity.
This shift in investment activity coincides with the catch-up growth that began during the 1990s, as developing nations integrated into global markets, transformed their economies and improved their institutions, Hans Timmer, director of the World Bank team that produced the report, told me.
“Productivity catch-up, increasing integration into global markets, sound macroeconomic policies and improved education and health are helping speed growth and create massive investment opportunities, which, in turn are spurring a shift in global economic weight to developing countries,” the report said. And to be clear, this is investment in buildings and machinery, not the more flighty financial flows.
The BRIC nations are expected to loom large. China will make up 30 percent of all investment activity, while Brazil, India and Russia together will account for more than 13 percent of global investment in 2030 — edging the 11 percent projected in the United States.
But their growing importance as sources and destinations of capital flows will not be a BRICs story alone, the report says. It calls out Sub-Saharan Africa, for example, which can be expected to not only receive a growing volume of capital flows but also to attract an increasing share of the total capital flows to developing countries.
The bank’s researchers forecast that developing countries will likely have the resources needed to finance massive future investments for infrastructure and services. That’s predicated on strong saving rates, expected to top out at 34 percent of national income in 2014 and averaging 32 percent annually until 2030. Meanwhile, the saving rate for high-income countries will fall from 20 percent to 16 percent.
In aggregate terms, the developing world will account for 62-64 percent of global saving of $25-27 trillion by 2030, up from 45 percent in 2010.
This points to greater wealth in the developing world as a percentage of the global total: the average per capital income of the developing world is expected to rise from about 8 percent of that in high-income countries in 2010, to about 16 percent by 2030. The average citizen of what is now a developing country, according to one bank scenario, will earn 19 percent of the income of an average high-income country citizen by 2030.
Indeed, one McKinsey study projects more than half the world’s population will have joined the consuming classes by 2025, boosting consumption in emerging markets to $30 trillion a year. It will, the report says, be nothing short of the “defining growth opportunity of our times.”
Seizing on this theme, Bhaskar Chakravorti and Gita Rao, writing in Foreign Affairs recently, pointed to the hand-wringing over the decline of American power and urged U.S. businesses to compete in emerging markets to help themselves grow, hire again and create wealth.
Another fan with a long lens is Mark Mobius, chairman of the Templeton Emerging Markets Group, who wrote last month that commodities, exports and infrastructure development could continue to be leading growth drivers in many emerging economies, but overall growth is likely to arise increasingly from healthier domestic demand.
“Expanding consumer wealth is creating an increasingly large and discriminating body of middle-class consumers across emerging markets, and their demand is, in turn, creating increasingly significant domestic economic activity,” Mobius said. “…. With a relatively high proportion of the population in emerging markets moving into the workforce and a relatively low proportion of dependents, demographics are acting to reinforce consumer demand.”
These forecasts are not unconditional. Some risks will reduce over time. Others will increase.
The countries must continue to drive increases in productivity and attract investors to finance the investments, the bank’s report says.
There is also an assumption that some of markets will have addressed some of the hurdles to invest now — which variously include poor governance, lax enforcement of contracts and property rights, corruption, lack of adequate infrastructure and distribution networks and uneven pipeline of talent.
In addition, as emerging economies develop, their financial markets integrate more into global ones, and they ease restrictions on capital that flows across their borders, then it becomes more difficult to shield them from international shocks, the World Bank’s Timmer said. They can mitigate those shocks as alternatives to the dollar rise and they build reserves in other currencies like the euro and the yuan.
There are other challenges that concern Neil Shearing, chief emerging markets economist at Capital Economics in London. The first, already well-known in China, is the need to reposition economies to be more consumer driven and less dependent on exports. The second is avoiding the kind of investment bubble created in the eastern European property market — which burst a few years ago.
“If the investment is in glitzy shopping malls,” Shearing told me, “it can create bubbles and be dangerous. Whereas investment in China is excessive but in roads, railways and ports that you do want to look for.”
Growth may slow, and challenges will abound, but the prospects loom large. And therein lies opportunity.
PHOTO (Top): Laborer walks past piles of steel coils at a steel wholesale market in Shenyang, Liaoning province, July 15, 2013. REUTERS/Stringer
PHOTO (INSERT): Workers stand inside the Mane Garrincha National Stadium in Brasilia June 6, 2013.