Emerging markets are less reliant on America – most have become healthy enough to generate their own growth – so the slowdown has failed to have a significant impact on the region.
The past few weeks have seen growing fears of global contagion from the American housing market collapse. Does this present a threat to emerging markets? So far, repackaged American mortgage debt has appeared outside the US – in Germany, Australia and in Britain. There is no evidence emerging market financial institutions have any meaningful exposure. The world of proprietary trading desks, and house hedge funds, is largely alien to emerging banking.
Direct economic contagion is also limited: emerging markets do not have a subprime debt market, and personal finance is underdeveloped. Average leverage levels are low. Many countries are now only developing mortgage markets, and have only begun lending at the higher-quality end of the market. There is no equivalent to the subprime market. It is important to keep this correction in perspective. The move in yields for emerging debt is considerably smaller than previous setbacks. Obviously, emerging specific crises – such as Russia in 1998 – generated much bigger moves. However most general risk-aversion moves, such as the 2004 US Treasury scare, also had a bigger impact.
Emerging markets also continue to improve their resilience to external shocks. On almost all measures – external and internal balances, external debt levels, local interest rates, and so on – the strength of emerging markets has improved over the past five years. They now have considerable firepower to stabilise their economies in the face of exogenous shocks.
Last year was another good year – and the first time ever that emerging markets have had four consecutive years of positive returns. In our view, it is high time investors realised they should not take their cue on emerging markets from America. Those who still see the region as the riskiest place to be in times of an American slowdown need to re-examine where economic growth in the region is comingfrom.
America has long been seen as the engine of global growth, but emerging markets are running off their own steam, no longer primarily dependent on exports to developed economies to achieve growth – particularly not now China and India have arrived on the global economic scene.
It is estimated that growth in emerging markets as a whole accounts for about two-thirds of global growth. The Bric (Brazil, Russia, India, China) economies alone account for about a third of global growth. So, instead of being dependent on the global economy for their own growth, emerging markets are key drivers of the global economy. Several economies in Asia are strong enough on their own to generate their growth, as well as to drive it elsewhere. In China, India and Malaysia, the contribution to GDP growth in the past year has been almost entirely from increasing domestic demand, rather than exports – whether to the rest of the Asian region or to the likes of America and Europe.
Other countries, like the Philippines, Taiwan and Thailand, are still dependent on exports. However, they are significantly less dependent on America as they benefit from strong trade with nearer neighbours. Emerging Asian countries’ exports to China now exceed those to America.
Importantly, China’s self-sustained growth story is one driven primarily by investment spending, and not yet by the China consumer. There has been concern about whether China is over-spending on its own growth. We disagree. China’s capital investment spending as a percentage of GDP is running at just over 40% – in line with Japan in the late 1950s and 1960s, and with South Korea and Taiwan in periods of strong growth. The level of investment spending in China is only commensurate with this stage in its economic cycle.
The ability of emerging markets to sustain their own growth is down to massive structural improvement in these economies. In the past, you knew you were investing in more volatile, weaker economies, characterised by hyper-inflation, debt crises and currency crises. That is no longer the case. Inflation is down at single digits across emerging markets, and Latin America’s days of hyperinflation are over. Most countries have seen a massive reduction in debt. The total level of government debt as a percentage of GDP (at 38%) is at less than half the level of developed economies (at 89%).
Overall, there are no direct financial or economic linkages from American credit problems to emerging markets. What we are left with are sentiment effects and a global increase in risk aversion – that is, some increases to the cost of capital. No doubt there will be further reports of funds realising large losses, and increased volatility in global equity markets over the next few months. Emerging markets will no doubt be buffeted by this, but strong growth should continue and, with their relatively limited exposure to global credit, they should be able to avoid dramatic effects.