Tiago Cavalcanti, senior economics lecturer at the University Of Cambridge, assesses the dynamics currently found in some emerging economies, and their prospects going forward. In addition, Charlie Awdry, China equities portfolio manager, comments on a changing China, while Sat Duhra, Co-Manager of the Henderson Asian Dividend Income Strategy, discuses where his team believes attractive opportunities can be found in India and shares some stock picks.
Although emerging market economies were affected by the 2008 financial crisis and subsequent recession in the developed world, the crisis was somewhat less profound in these economies. Some analysts suggested that emerging markets could decouple from high income nations and deliver self-sustained growth rates. However, many commodities-exporting emerging market economies could not decouple from China. So as China’s growth decreased from double digits to less than the government target of seven per cent, growth has slowed down in other emerging markets.
As China’s rebalancing economy veers away from investment and towards consumption, product prices may remain low for some years. Tight monetary policy in America could also affect liquidity and interest rates in emerging markets. As these dynamics evolve, emerging countries should feel the impact in different ways.
Facing global challenges
Russia is a prime example of a nation feeling the effects of China’s economic rebalancing. Heavy dependency on oil and gas production has left it vulnerable to changes in global commodity markets. This issue, combined with international sanctions and political tensions, has led Russia towards a major recession.
GDP is forecast to shrink by roughly four per cent in 2015 (one of the lowest GDP growth rates among emerging market economies) and to remain negative in 2016. The depreciation of the Russian ruble could boost exports and increase foreign investment in Russia, but this is unlikely given the international sanctions and geopolitical situation. Unless oil and gas prices rise, high growth in Russia in the short term is unlikely.
Challenges from within
After many years of macroeconomic stability with sustained growth, Brazil is now struggling with the collapse in commodity export prices and rising domestic inflation. GDP is expected to shrink by more than three per cent in 2015 and is forecast to be negative in 2016. This represents the worst recession in the country since the 1930s, a recession fed by political and corruption scandals linked to Brazil’s campaign financing system and involving Petrobras, Brazil’s state oil company, and a network of subcontracted companies. The country is now running a fiscal deficit of about 10 per cent of GDP and, given the political environment, it does not seem that the economic problems will be solved in the short term.
A varied dynamic
Mexico has had a somewhat different growth dynamic to that of Brazil and Russia. Although the Mexican economy faced a major slowdown in 2009 when GDP shrank by 4.7 per cent, economic growth has been robust since (above four per cent from 2010 to 2012, and 1.4 per cent in 2014) and is expected to be above two per cent in 2015 and 2016.
Mexico has implemented major reforms in the energy sector and telecom and broadcasting industries which might attract foreign investment and improve productivity. Given Mexico’s membership of the North American Free Trade Agreement, growth is expected to stay relatively high as the American economy recovers. As in Brazil, Mexico has a major problem with drug trafficking and crime, which affect not only the welfare of its population but foreign direct investment.
India is the poorest economy among the BRICS, with a GDP per capita about one-third the size of Brazil’s. But growth has been robust in India, averaging about seven per cent per year since 2009. While Brazil and Russia are facing inflation pressures and they have tightened monetary policy despite their economic recessions, India has controlled inflation since 2013 and has recently cut its policy interest rate to a four-year low.
Given that India is not a commodity-exporting economy, it has benefited from low commodities prices that made imports to the country cheaper. Growth potential is still high, particularly as pro-growth reforms promised by Prime Minister Narendra Modi to deregulate the goods and labour markets are yet to be implemented, along with reforms to the caste system.
Work to be done
Although growth in emerging markets has slowed recently, the dynamics have been quite diverse. The economies that have shown more reliance on their commodity exports may need to better manage the resulting volatility to offset the negative effects of commodity booms and slumps. In general, emerging markets need to diversify their economies, improve public infrastructure and institutions to attract investment, and increase productivity.
Charlie Awdry – China equities portfolio manager
Economic activity in China continues to be squeezed by the competing needs of reform and deleveraging and challenged by a loss of competitiveness in the manufacturing sector. Rebalancing is taking place but declining commodity prices illustrate how significant the ‘old part’ of the economy is. The vibrancy of the ‘new consumer economy’ is probably underrepresented in official growth measures. We should expect more volatility in markets especially as the currency is weakening but as Simon Ward, Henderson's Chief Economist has been highlighting, monetary trends have improved as a result of recent policy easing and so we may see improving activity levels over coming months.
We will continue to see diverging valuations between consumer-driven businesses, such as technology, consumer services and healthcare. These sectors will generally be generating profit growth, while sectors dominated by state-owned enterprises (SOEs), like energy, telecommunications and financials, will struggle to react to the tougher economic environment, and will most likely continue to be ‘inexpensive’. We do not own any banks and continue to strongly favour privately-managed consumer-driven businesses with strong profit margins and cash flows.
Sat Duhra – Co-Manager of the Henderson Asian Dividend Income Strategy
India continues to offer some attractive opportunities, given the recovery of the domestic economy and the focus on structural reform to address sustainable growth.
Bharti Infratel’s telecom tower business model appears compelling for income investors in Asia. The stock is a direct beneficiary of India’s strong data growth but without the inherent operational and regulatory challenges faced by the telco operators. This is an interesting way of playing the upside from the expected network roll-out given the US$10bn splurge on spectrum in Feb 2014 and a strong new market entrant. In addition, the company has a net cash balance sheet.
Infosys, the IT company, is another attractive stock. The new CEO has outlined some ambitious growth targets with a move away from traditional IT services into artificial intelligence and automation. Overseas earnings also provide stability into a potentially weakening currency environment. This is a stock with no debt, defensive qualities and a transformational growth plan which does not appear priced in at current levels.
Note: References made to individual securities should not constitute or form part of any offer or solicitation to issue, sell, subscribe or purchase the security.