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COLUMN - The short and long of emerging markets

Source: Reuters - Thu, 25 Jul 2013 21:16 GMT
Author: Reuters
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By Gary Regenstreif

NEW YORK, July 25 (Reuters) - Fickle investors have spurnedemerging markets in recent weeks, but this route has obscured amore alluring vista out on the horizon.

Developing economies now account for 50 percent of globaloutput and 80 percent of economic expansion and are projected tocontinue growing far faster than developed nations. They areexpected to possess an even larger share of global growth,wealth and investment opportunities in years to come. So much sothat the labels investors use to classify some of these nationswill change as the developing develop and the emerging emergeinto more potent economic powers.

But this long-term view has been lost on many of those wholook to emerging market assets for a higher yield in the shortterm. Their ardor cooled when the Federal Reserve signaled itmay soon ease the stimulus that has kept credit cheap, signalinghigher interest rates ahead. That was coupled with signs ofslower growth in key emerging markets like China and Brazil.

Still, the developing world's gross domestic product growthof 5.0 percent this year and 5.4 percent next, as projected bythe International Monetary Fund, will far outpace the advancedeconomies' 1.2 percent and 2.1 percent. Developing countries arenow also better armed to keep panic at bay, with more foreignexchange reserves than before and less aggregate debt thandeveloped nations. Many have put their economies on firmerfoundations.

Fear of a mass exodus of investors, however, has still sentemerging market shares down about 10 percent in the past twomonths, as measured by the MSCI Emerging Markets Index, comparedwith 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 capitalflows because their growth implies big investment opportunities,improved creditworthiness and the ability to better diversifyportfolios and manage risk.

According to one bank report, by 2030 developing countrieswill represent two-thirds of all global investment, up fromabout half today and from one-fifth in 2000. At that time, halfthe global stock of capital is expected to reside in thedeveloping world, compared to less than one-third today. Thatmeans a shift in the distribution of wealth and in the creationof opportunity.

This shift in investment activity coincides with thecatch-up growth that began during the 1990s, as developingnations integrated into global markets, transformed theireconomies and improved their institutions, Hans Timmer, directorof the World Bank team that produced the report, said.

"Productivity catch-up, increasing integration into globalmarkets, sound macroeconomic policies and improved education andhealth are helping speed growth and create massive investmentopportunities, which, in turn are spurring a shift in globaleconomic weight to developing countries," the report said. Andto be clear, this is investment in buildings and machinery, notthe more flighty financial flows.

The BRIC nations are expected to loom large. China will makeup 30 percent of all investment activity, while Brazil, Indiaand Russia together will account for more than 13 percent ofglobal investment in 2030, edging the 11 percent projected inthe United States.

But their growing importance as sources and destinations ofcapital flows will not be a BRICs story alone, the report says.It calls out Sub-Saharan Africa, for example, which can beexpected to not only receive a growing volume of capital flowsbut also to attract an increasing share of the total capitalflows to developing countries.

The bank's researchers forecast that developing countrieswill likely have the resources needed to finance massive futureinvestments for infrastructure and services. That's predicatedon strong saving rates, expected to top out at 34 percent ofnational income in 2014 and averaging 32 percent annually until2030. Meanwhile, the saving rate for high-income countries willfall from 20 percent to 16 percent.

In aggregate terms, the developing world will account for62-64 percent of global saving of $25-27 trillion by 2030, upfrom 45 percent in 2010.

This points to greater wealth in the developing world as apercentage of the global total: the average per capital incomeof the developing world is expected to rise from about 8.0percent of that in high-income countries in 2010, to about 16percent by 2030. The average citizen of what is now a developingcountry, according to one bank scenario, will earn 19 percent ofthe income of an average high-income country citizen by 2030.

Indeed, one McKinsey study projects more than half theworld's population will have joined the consuming classes by2025, boosting consumption in emerging markets to $30 trillion ayear. 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 thehand-wringing over the decline of American power and urged U.S.businesses to compete in emerging markets to help themselvesgrow, hire again and create wealth.

Another fan with a long lens is Mark Mobius, chairman of theTempleton Emerging Markets Group, who wrote last month thatcommodities, exports and infrastructure development couldcontinue to be leading growth drivers in many emergingeconomies, but overall growth is likely to arise increasinglyfrom healthier domestic demand.

"Expanding consumer wealth is creating an increasingly largeand discriminating body of middle-class consumers acrossemerging markets, and their demand is, in turn, creatingincreasingly significant domestic economic activity," Mobiussaid. ". With a relatively high proportion of the population inemerging markets moving into the workforce and a relatively lowproportion of dependents, demographics are acting to reinforceconsumer demand."

These forecasts are not unconditional. Some risks willreduce over time. Others will increase.

The countries must continue to drive increases inproductivity and attract investors to finance the investments,the bank's report says.

There is also an assumption that some of markets will haveaddressed some of the hurdles to invest now which variouslyinclude poor governance, lax enforcement of contracts andproperty rights, corruption, lack of adequate infrastructure anddistribution networks and uneven pipeline of talent.

In addition, as emerging economies develop, their financialmarkets integrate more into global ones, and they easerestrictions on capital that flows across their borders, then itbecomes more difficult to shield them from international shocks,the World Bank's Timmer said. They can mitigate those shocks asalternatives to the dollar rise and they build reserves in othercurrencies like the euro and the yuan.

There are other challenges that concern Neil Shearing, chiefemerging markets economist at Capital Economics in London. Thefirst, already well-known in China, is the need to repositioneconomies to be more consumer driven and less dependent onexports. The second is avoiding the kind of investment bubblecreated in the eastern European property market - which burst afew years ago.

"If the investment is in glitzy shopping malls," Shearingtold me, "it can create bubbles and be dangerous. Whereasinvestment in China is excessive but in roads, railways andports that you do want to look for."Growth may slow, and challenges will abound, but the prospectsloom large. And therein lies opportunity.

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