Emerging markets on different paths

The emerging markets’ story is being rewritten as investors become more discerning

Back in the, emerging markets could do no wrong in investors’ eyes, as they piggybacked on the success of stellar growth in China and a credit explosion in the United States. Now, faith in emerging markets is faltering, as their asset values take big hits and economic growth stalls. But investors haven’t written them off; they’re simply asking lots of questions.

The biggest question on everybody’s lips is: What about China? After all, emerging markets’ fortunes have been closely tied to China’s and the country is now undergoing irrevocable change. “For the last 10 years, China has really been the linchpin driving the emerging markets story,” says Amin Rajan, a veteran industry consultant and chief executive of CREATE Research, an independent global forecasting center, which, together with Principal Global Investors, wrote the Not All Emerging Markets Are Created Equal research survey.

Following double-digit growth last decade, China’s growth has halved to around 7%. Other emerging nations, such as Brazil and Russia, have been hit badly as they depend heavily on China, which is hungry for their raw materials and fuel.

RISK AND REFORM

If China is going to move forward, it needs to undertake radical reforms, but so far they have been gradual and piecemeal, explains Rajan. “In the latest round of reforms, China promised to look at various activities of state-owned enterprises, but hasn’t said anything about removing their subsidies, for instance. As much as 30% of revenues of China’s top state-owned companies come in the form of subsidies – both overt and hidden. You can’t become a world-class economic power when you have that degree of government control.”

Governance risk is a further challenge stalling the country’s progress. In China, like Brazil or Russia, companies tend to be government- or family-owned. Many don’t declare dividends, and the board largely comprises family members or friends. But with experience comes knowledge. As it matures, China is recognizing the need to rebalance its economy and realizing that it can’t grow at the breakneck speed of the previous decade and simply rely on the growth driver of low-cost manufacturing alone, Rajan says. “China knows it needs to change its economic base and move up the value chain into services or the self-sustaining consumer-goods industries.”

PLAYING TO THEIR STRENGTHS

It’s a lesson that other emerging nations need to learn – if they want to create new growth engines and avoid being caught in a middle-income trap, caused by a seeming inability to create fresh competitive advantage to rise to the next level of economic maturity. Emerging markets need to differentiate and play to their strengths. India, for example, needs to shake itself free of the controls, subsidies and misallocation of resources that currently weigh it down, and significantly improve its infrastructure, Rajan continues. Russia, meanwhile, needs to loosen its over-reliance on the energy sector, vulnerable as it is to fluctuations in energy prices, and broaden its industrial base, as does Brazil.

Some emerging nations are already taking the necessary steps, such as Malaysia, which is building up a world-class Islamic finance center, rather than just relying on the export of palm oil. Taiwan aims to become the world’s high-tech production location, Brazil is promoting its leisure industry, while Ghana is processing cocoa products, such as chocolate. “All of them are trying to move into high-value-added activities,” says Rajan. “If they are successful, there will be huge growth potential in emerging markets.”

Some countries have even broken free of the middle-income trap, such as Singapore, which is selling financial services to the whole of Asia. Chile is profiting from a focus on consumer goods and tourism, and South Korea by concentrating on electronics.

It is clear that as emerging nations develop differently, they will have as much that divides them as unites them. They will no longer be distinct regional groups that can be described by catchy acronyms, such as BRICS. In the future, investors will assess countries and their stocks on their individual merits instead.

DIVERGE OR CONVERGE?

As they differentiate, most emerging markets will also continue to converge with developed nations, particularly in financial markets. Fund managers in South Korea, for example, are already starting to use investment theories employed by their counterparts in the West. But it will be a while before Asians think about investment in a Western way. Asia has held a long tradition of saving, and the thought of losing all or even some money by investing it remains completely alien, explains Rajan. Economic pressure may, however, help change their way of thinking. Like their Western neighbors, emerging markets are starting to age rapidly as people have fewer babies and live for longer.

“What took 100 years in the West is happening within a single generation in emerging markets,” comments Rajan. “India and Indonesia are the only nations left with a demographic dividend.” China will really start to age rapidly after, as the effects of the government’s one-child policy begin to bite. Then savers are going to demand higher returns than the ones they are currently getting from their saving accounts, which might trigger them to risk investing their money, rather than saving it for a rainy day, Rajan points out.

All in all, emerging markets might never again match the stellar growth of the last decade, but nor are they yesterday’s news. The dominant investor attitude towards them seems to be one of either “wait and see” or opportunistic play. “If you want to make money in emerging markets, many investors now believe you’ve got to be opportunistic, i.e., get in and out as soon as you make money,” says Rajan. The new emerging markets’ story will no doubt gradually unfold.

Emerging markets on different paths

The emerging markets’ story is being rewritten as investors become more discerning

Emerging markets on different paths

The emerging markets’ story is being rewritten as investors become more discerning

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