Seeking A New Paradigm

Author: Laurence Neville


(thousands of employed persons)
** Wages are calculated per day, on a purchasing power parity basis; p = projected;
Source: International Labour Organization

Although emerging markets have avoided a global crisis since 1998, their current prospects are underwhelming, compared with their prospects as of 10 or 15 years ago. This slowdown can be simply explained, according to Capital Economics’ Shearing: Many of the changes that drove growth from the 1980s onwards were one-off shifts. “Economies can never be opened up to foreign capital again, and communism can only come to an end once,” he notes.

Furthermore, the financial crisis and the slowing of growth globally, and particularly in China, have taken an inevitable toll. “Since 2010, Chinese growth has been slowing, putting pressure on commodity prices,” says ING Investment Management’s Bakkum. “And since 2013, markets have started to price the gradual normalization of US monetary policy, and thus capital flows into the emerging world [have slowed].”

The financial crisis and the fall in global growth also help to explain why emerging markets have started to diverge. According to the IMF’s World Economic Outlook, published in October, Brazil is expected to grow 1.4% in 2015, Russia just 0.5%, India 6.4% and China 7.1%. While the rising tide of global growth led by China lifted all boats, an ebbing tide has highlighted countries’ weaknesses, with a consequent impact on their growth rates.

Shearing says the financial crisis and its aftermath have revealed the BRICs’ different structural strains and constraints. For example, China needs to reverse its reliance on investment and switch to a consumption-based model of growth; Brazil must do the opposite; Russia should reduce direct control of its economy and increase industrial diversification; and India needs to free up its economy by improving infrastructure and reducing unnecessary controls.

In short, the shocks of recent years have exposed what some observers have always known—that emerging markets are not identical, although they share some characteristics and approaches to development. “Emerging markets have never been a homogenous group,” says Dehn. “They have been perceived as being one because of an investor mentality that divides countries into risk-free or risky categories.”

The slowdown in emerging markets growth and the BRICs’ economic divergence must be seen in perspective. First, growth in these markets still remains vastly superior to that in developed markets: The IMF predicts advanced economies will grow 1.8% in 2014 and 2.3% in 2015, while emerging markets will expand by 4.4% and 5%, respectively.

Second, the changes that took place in emerging markets from the 1980s onward had a profound effect that continues to be felt today. Those changes lifted hundreds of millions out of poverty and changed global economic and political dynamics. “Even when I worked at the IMF, from 2000 to 2005, [maintaining] the stability of emerging markets remained its major priority,” says Anne at SG. “Now that is no longer the case. Instead, the IMF’s priorities are often problems in developed countries.”

Political stability and policymaking within emerging markets countries has vastly improved. FX reserves were built up during the good times rather than squandered, for example. Dehn at Ashmore estimates that 80% of the world’s FX reserves are now held by emerging markets. Meanwhile, debt-to-GDP ratios in these markets are now around 30%, compared to 80% in the mid-1980s, and few countries have inflation problems.

“Emerging markets used to be a dirty word,” says Anne. “But the subprime and eurozone crises revealed such markets to be relatively solid. In the past, emerging markets experienced significant market volatility and concerns about political credibility. Now, the Australian dollar has greater volatility than many emerging markets’ currencies, while the eurozone crisis [has questioned that region’s] political credibility.”


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