Seeking A New Paradigm

Author: Laurence Neville


Bakkum, ING Investment Management: Since 2013, capital flows to emerging markets have slowed as investors started to price in the normalization of US monetary policy.

Although they cannot recreate the impact of one-off changes like market liberalization, emerging markets can find new ways to stimulate growth. “A fresh wave of reform is needed: Emerging markets need to go back to the 1980s,” says Shearing at Capital Economics.

A crucial question is whether the export-oriented model that drove emerging markets’ growth for 30 years is sustainable. For the countries that have advanced most in recent decades, the growth model has inevitably changed. “In many countries, a middle class is emerging and economies are becoming less export-focused and more inward-looking,” says Anne at SG. It remains to be seen if China can manage the switch smoothly.

Some observers question whether export-driven growth is viable for any emerging markets nowadays. “Manufacturing has become much more capital- and skill-intensive, with greatly diminished potential to absorb large amounts of labor from the countryside,” says the IAS’s Rodrik.

However, Shearing believes that “export-focused manufacturing still has a significant role to play in many emerging markets’ growth strategies.” And Anne holds that the experience of emerging markets in previous decades can be repeated in so-called frontier markets in Africa, for example. “They can also learn from the mistakes of the Asian tigers by [noting] that export competitiveness—and therefore exchange rate flexibility—is essential, as is production diversification,” he adds.


If the world accepts that emerging markets are heterogeneous, how then should they be categorized? Ashmore’s Dehn says that forthcoming gradual global financial tightening will separate countries that are forward-looking from those that are less adaptive to new conditions. “By far the most important factor in the success of countries in the medium term is whether their governments are prudent, flexible and smart enough to cope with shocks,” he explains. However, Dehn sees most emerging markets as forward-looking and believes the broad outperformance of emerging markets will continue: His “prudent” categorization doesn’t easily differentiate between emerging markets.

Shearing at Capital Economics suggests a categorization based on the type of reform required. Higher-income countries, such as those in much of Latin America, emerging Europe and richer countries in Asia, need to raise skills, education, research and development spending and productivity. In contrast, lower income countries, such as those in sub-Saharan Africa or parts of southeast Asia, need to get the basics right by opening up trade, simplifying tariffs and running prudent fiscal and monetary policies.

Anne, SG: Emerging markets used to be a dirty word. But the subprime and eurozone crises revealed such markets to be relatively solid.

Alternatively, emerging markets can be grouped according to whether they have a current-account deficit—like Brazil, Turkey, South Africa and Indonesia—or a surplus, like China, the Gulf states or South Korea. “While Turkey is often viewed positively, the risk is that its borrowing is used to finance domestic demand rather than to improve its capital stock,” explains Shearing. “As quantitative easing is withdrawn and rates rise, it could become harder for the country to sustain its deficit.”

Another way of classifying countries is to divide them into commodity producers (or even further, into producers of agricultural commodities, energy or metals) and manufacturers. “Global trends, such as the shale gas revolution, affect different countries in different ways. Shale gas has cut oil exports from Nigeria to the US and led to a fall in oil prices,” says Shearing. “But it has benefited Chile, which is a huge energy importer and metals producer.”

Similarly, the end of China’s export boom has led to a fall in many commodity prices. “For commodity producers, the immediate future may be determined by what they have done with their commodity windfall from recent decades. Generally, Latin American countries have spent it, whereas Gulf states have saved it,” says Shearing.

Anne says that from an investment strategy perspective, emerging markets can also, most obviously, be grouped by region. “Asia remains a growth story and is expected to outperform; Latin America remains sensitive to the US economy; and EMEA has significant geopolitical risk—and CEE, vulnerability to the eurozone,” he notes.

The lack of consensus about how emerging markets should be categorized reflects broader uncertainty about the global economy. It presents investors with a challenge but also an opportunity. Many of the countries that currently fall under the emerging markets banner will continue to generate significant returns in the years to come. But not all will. Investors will have to be much more selective than they were in the past. n


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