Judging by the fear and panic that gripped investors in emerging markets during the middle of the year, you might have concluded that prospects for the world's supposed growth spots had turned stone cold. Not so. Even if the world's emerging economies don't emerge quite so smoothly as the most optimistic scenario outlined or its frontier economies don't push out their boundaries so remorselessly, their long-term growth is still likely to put the developed world's to shame. So, assuming that investors are buying in at decent prices - the sort of prices on offer currently - then it will continue to make sense to have a chunk of capital invested in emerging markets equities.
As for that mid-year panic - prompted by the nightmare of a world without the monetary stimulus of the US central bank (the 'Fed') - it proved to be short-lived. True, the MSCI Emerging Markets index - an index of national champions - dropped 9 per cent in July. But it recouped lost ground fairly quickly, and in early December was showing a minor gain over the previous 12 months. Simultaneously, the MSCI Frontier Markets index, which gets closer to the sort of growth that adventurous investors seek, was 22 per cent higher than 12 months earlier.
It is important to grasp that the withdrawal of the Fed's programme of quantitative easing will not be as cataclysmic as some vested interests like to suggest. At least that's the conclusion of the International Monetary Fund (IMF) based on a study of similar situations. "No broad-based deterioration in global economic and financial health occurred at the onset of previous episodes of US monetary policy tightening since 1990," says the IMF in its latest World Economic Outlook.
That said, the IMF is concerned about the similarities between macroeconomic conditions today and those that applied in 1994 when the Fed's benchmark interest rate doubled to 6 per cent within 12 months and emerging markets economies continued to deteriorate. Like today, 1994’s slowdown followed heavy capital spending in emerging economies, which produced a growth spurt. However, the IMF reckons that today emerging economies are better equipped to cope thanks to exchange rate regimes that are more flexible and cushions of foreign exchange reserves that are plumper.
Besides, much of 2013's slowdown was the cyclical dip that followed bumper years in 2010-11. Those good times were prompted by government responses to 2008's global financial crisis. That meant huge fiscal stimulation, which generated both additional spending on infrastructure (especially in China) and boosted consumption-led growth, too. But these things run their course, especially as they tend to cause their own bottlenecks and inflation.
The cyclical factors played "a large, perhaps underappreciated role", says the IMF. But the global monetary marshal also expects that among the so-called 'Brics' - the most powerful of the emerging countries - the slowdown won't translate into long-term lower growth in Brazil, India and South Africa; only China and Russia will see long-run effects - and in China's case, that might even be good.
The stock markets
| The broad indices | Value | Market cap ($bn) | PE ratio | Dividend yield (%) | Percentage change -1 year | Percentage change -3 years | Percentage change -5 years |
|---|---|---|---|---|---|---|---|
| MSCI Emerging Mkts | 1,003 | 3,865 | 12.4 | 2.6 | 1 | -7 | 95 |
| MSCI Emerging Mkts SmallCap | 1,005 | 521 | 11.6* | 2.5 | 4 | -12 | – |
| MSCI Frontier MKts | 581 | 130 | 12.8 | 3.8 | 22 | 0 | – |
| MSCI Bric | 283 | 1,623 | 10.4 | 3.2 | 0 | -20 | 76 |
| The Brics | |||||||
| Brazil (Ibovespa) | 50,252 | 1,250 | 14.4 | – | -11 | -26 | 38 |
| Russia (RTS) | 1,373 | 807 | 6.5 | – | -4 | -14 | 108 |
| India (S&P BSE Sensex) | 20,708 | 561 | 15.7 | – | 12 | 8 | 129 |
| China (SSE Composite) | 2,252 | 2,694 | 10.8 | – | 12 | -21 | 19 |
| South Africa (FTSE/JSE All-Share) | 44,132 | – | – | – | 17 | 42 | 118 |
| Other key markets | |||||||
| Argentina (Merval) | 5,291 | 162 | 10.4 | – | 115 | 53 | 430 |
| Indonesia (Jakarta Composite) | 4,322 | – | – | – | 1 | 16 | 259 |
| Malaysia (KL Composite) | 1,824 | – | – | – | 13 | 21 | 115 |
| Mexico (IPC) | 41,877 | 443 | 21.0 | – | -1 | 11 | 110 |
| Nigeria (All-Share) | 38,995 | 83 | – | – | 48 | 57 | 27 |
| Poland (WIG 20) | 2,482 | 125 | 10.8 | 3.3 | 1 | -10 | 41 |
| South Korea (Kopsi 200) | 261.5 | 840 | 14.0 | – | 3 | 2 | 99 |
| Turkey (ISE All-Shares) | 84,830 | – | – | – | 15 | 22 | 244 |
India
For India and Brazil, that conclusion might seem a bit optimistic. Take India first. With characteristic understatement, the IMF says India still faces "persistent supply-side constraints". That's a polite way of saying that its infrastructure remains lousy and that its businesses are still bound by too much red tape. Proof of this is high inflation. The IMF expects inflation to be 11 per cent this year, falling to 9 per cent in 2014 even though it has hacked back its forecasts for real growth in output - 3.8 per cent this year (the forecast was 5.6 per cent just three months ago) and 5.1 per cent in 2014 (cut back from 6.2 per cent).
Yet the major worry emanating from India's slowdown is whether the country can exploit its biggest bonus, which also happens to pose its greatest threat - its 'demographic dividend'? China provides the model. To exploit its own demographic dividend of young workers, China created about 130m jobs between 2002 and 2012. India faces at least an equal challenge. Its working-age population will rise by 125m between 2010 and 2020, then by another 100m in the following decade.
Meanwhile, India lacks the control economy that did so well for China, its workforce lacks the skills of China's and it spends less on its infrastructure. Not that the differences between the two countries is that wide and India's chaotic semi-functional democracy could be more creative than China's authoritarian model. At least, Sukumar Rajah, the chief investment officer of Templeton Asset Management in Singapore, is optimistic. "There is no meaningful dilution in the long-term fundamentals underpinning the India story," he says, pointing out that India's high savings ratio can fund much capital spending; that wage inflation is already moderating and that manufacturing exports are ticking up, helped by the rupee's depreciation.
All that is to the good. Even so, India is not our choice of emerging market for 2014. Nor is Brazil, which is also in a funk.
Brazil
Brazil's fast growth of the 2000s is now seen for what it was - a combination of a welcome liberalisation of regulations plus a commodities boom. The benefits of the first have worked their way through, while the commodities boom has petered out. That leaves Brazil still with too much anti-business regulation, a developed world’s state pension system attached to a middle-income country and infrastructure that's a disgrace.
The IMF reckons that these constraints will persist and forecasts growth of 2.5 per cent this year and next. Maybe the IMF is forgetting the boost that Brazil should get from hosting football's World Cup next year and the Olympic Games in 2016 because that’s not even the rate that advanced economies such as Australia and New Zealand are forecast to achieve. Apart from these sporting spectacles, in the short term just about the only good news is that Brazil's incredibly overvalued currency is depreciating. That's good for incoming football fans and it will help cut Brazil's current account deficit by curbing imports.
The countries
| GDP† (% ch pa) | Inflation† (% ch pa) | Current acc balance† (% GDP) | Short-term interest rates (%) | Currency strength (v $; % ch pa) | |
|---|---|---|---|---|---|
| Brazil | 2.5 | 5.8 | -3.2 | 9.5 | -12 |
| Russia | 3 | 5.7 | 2.3 | 5.5 | -6.3 |
| India | 5.1 | 8.9 | -3.8 | 8.8 | -13.4 |
| China | 7.3 | 3 | 2.7 | 3.3 | 1.9 |
| South Africa | 2.9 | 5.5 | -6.1 | 5 | -15.8 |
| Argentina | 2.8 | 11.4 | -0.8 | 12.2 | -20.1 |
| Indonesia | 5.5 | 7.5 | -3.1 | 7.3 | -17.3 |
| Malaysia | 4.9 | 2.6 | 3.6 | 3 | -4.6 |
| Mexico | 3 | 3 | -1.5 | 3.5 | nil |
| Nigeria | 7.4 | 8.2 | 3.6 | 12 | -1.6 |
| Poland | 2.4 | 1.9 | -3.2 | 2.6 | 4.9 |
| South Korea | 3.7 | 2.3 | 3.9 | 2.5 | 1.6 |
| Turkey | 3.5 | 5.3 | -7.2 | 3.5 | -11.6 |
| Sources: S&P Capital IQ & national statistics *Forward PE ratio †IMF forecast for 2014 (forecasts for Argentina are unreliable); index values & performance as at 4 Dec 2013 | |||||
Russia
Russia suffers similar dysfunction to Brazil, with the added burden of extra corruption and a more authoritarian regime. The IMF has chopped two percentage points off its estimate for Russia's growth this year - cutting it to just 1.5 per cent - and three-quarters of a point off 2014's, bringing that to 3 per cent. However, it reckons that Russia's ability to withstand external shocks is better than it was thanks to a more flexible exchange rate policy and higher foreign exchange reserves.
Even so, Russia's main challenges persist. It must reduce its dependence on exports of oil and gas (while simultaneously renewing that industry's clapped-out capital equipment) and improve the investment regime by reducing government interference in the economy. The trouble is that this diagnosis is depressingly familiar yet - much like Russia's leaders - it is rarely tackled.
