Emerging Markets Are Still the Future
Remember when emerging economies were supposed to save us all? After the 2008 financial crisis, the traditional engines of global growth—the U.S., Western Europe, and Japan—stumbled into recession. To the rescue came the once-poor developing world. China, India, Brazil, and other up-and-comers powered the global economy through the historic downturn. The meek were inheriting the earth.
Not completely, as it turns out.
Today, as the U.S. recovery gains steam and even debt-burdened Europe stirs to life, the emerging world has tumbled into trouble. Growth is slowing, currencies are plunging, and investors are fleeing. Fears of a protracted slowdown in China sparked a worldwide stock selloff in August. The turmoil has even resurrected terrifying memories of previous emerging-markets crises, like East Asia’s rout in 1997, igniting jitters that the fragile global economy faces yet another financial debacle.
But international investors are making a big mistake. The emerging world will be just fine, thank you. The global business community is allowing short-term uncertainty to cloud the long-term reality of the changing global economy: Emerging markets are still our future.
There are certainly a host of reasons to be down about the developing world at the moment. Hypercharged growth rates have cooled just about everywhere. The International Monetary Fund forecasts that the output of emerging economies will rise only 4.2 percent in 2015, a sharp drop from 7.4 percent five years ago. Brazil and Russia, both proud members of the BRIC group of large developing nations, are in recession. China, the supposed juggernaut of the emerging world, has seen growth drop to its lowest rate in a quarter century.
Terrible policy is to blame. Politicians have been complacent about implementing the reforms necessary to keep growth going. China is example No. 1: Its top leaders have done little to overhaul an outdated, investment-heavy growth model. They’re still procrastinating about changes that would unleash the private sector, open markets, and improve productivity—all crucial for prosperity.
In India, perhaps the only major emerging economy with sound prospects right now, Prime Minister Narendra Modi has yet to prove he can walk his bold talk of deregulating the economy to encourage investment. On Aug. 30, Modi announced he wouldn’t renew a controversial executive order that loosened restrictions on the purchase of land for industrial projects—a major setback to his efforts.
Then there’s Vladimir Putin, who has strangled his oil-dependent economy by favoring an aggressive foreign policy and isolating Russia from the West, forgoing the investment and technology his country needs to advance.
All this is happening while the international environment remains uncertain. Although growth in the U.S. and Europe is improving, the developed world may not be strong enough to buy more of the exports of developing nations, sparking a recovery among them. Investors have also been spooked by the expectation that the U.S. Federal Reserve will begin raising interest rates for the first time since the 2008 financial crisis. That could suck cash from developing economies (as U.S. assets become more attractive) and raise their borrowing costs—a potential double whammy for their already subdued growth prospects.
As a consequence, a torrent of cash has fled the developing world. Investors yanked more than $900 billion from the world’s 19 largest emerging economies over a 13-month period ended in July, according to NN Investment Partners, a Netherlands-based asset-management firm. That’s almost double the amount pulled at the depths of the 2008 financial crisis. Currencies have taken a beating. The Indonesian rupiah and Malaysian ringgit recently touched lows against the U.S. dollar last seen during the late-1990s Asian financial crisis.
What’s significant is that the developing world has endured such drastic capital outflows without tumbling into a full-fledged economic meltdown, proof of its new resilience. Neil Shearing, chief emerging-markets economist at research firm Capital Economics, deemed predictions of an impending crisis “overblown.” “It is striking,” he wrote in an August report, “that many [emerging-markets] currencies have lost up to half their value over the past couple of years, without triggering widespread financial stress.” Shearing noted that the level of foreign-currency debt of most developing economies is lower than it has been in the past, making them less vulnerable to weakening currencies. Other economists point to external surpluses and larger currency reserves in many Asian emerging economies as indicators of their financial strength. Of course, these circumstances don’t ensure a crisis won’t happen, but they make one much less likely.
Nor should higher U.S. interest rates be as damaging as many investors fear. In a June study, HSBC economist Frederic Neumann and strategist Jessica Wu analyzed previous Fed tightening cycles and discovered they’d left emerging Asia “relatively unscathed,” at least in initial stages.
Going further, Michele Mazzoleni, vice president at California-based investment manager Research Affiliates, calls the whole notion that rising U.S. rates are automatically bad for emerging economies a “myth.” Historical evidence shows that when interest rates rise on the good news of a strong U.S. economy—the reason behind any Fed tightening now—capital flows into emerging markets. Not only does a healthy U.S. bolster overall global growth, Mazzoleni reasons, it also enhances investors’ appetite for risk. “What is good for the United States and other developed economies is also good for the emerging world,” he believes.
While high-profile developing countries may be struggling, others continue to excel. Many of today’s better performers sat on the sidelines during the developing world’s big growth surge of the late 20th century and are just joining the party—a sign that the emerging-markets story is becoming broader. The Philippines, long a laggard in supercharged Asia, is expanding at about 6 percent annually. Myanmar, coming out of self-imposed seclusion, is growing at more than 8 percent. Once-dormant African economies are showing promise. Ethiopia, for decades a symbol of poverty, is expected to expand by 8 percent or more through 2017. The IMF forecasts that a large group of low-income countries will grow 5.1 percent in 2015 and 6.2 percent next year.
None of this is to say that challenges don’t remain. Growth cannot be sustained without painful reforms requiring political will—a critical ingredient that’s been in short supply. In Brazil, for instance, corruption scandals are paralyzing the government of President Dilma Rousseff as growth tanks; in Indonesia, newly installed President Joko Widodo hasn’t yet lived up to his reputation as a reformer; Shearing at Capital Economics says Turkey is a potential trouble spot as well.
Nonetheless, the long-term story hasn’t changed. The middle class in the U.S. and Europe will continue to be a pillar of the global economy, but the world’s new consumers—and new growth engines—will still be found in developing, not developed, countries. Even if the Chinese leadership fails to shift from investment-dependent to consumption-led growth, consumer spending in China will grow 60 percent over the next decade, according to the Demand Institute, a think tank. In a 2012 study, HSBC researchers prognosticated that almost 3 billion people will enter the ranks of the middle classes by 2050—nearly all in emerging economies. That would create a seismic shift in the world economy: Consumption in emerging countries could account for almost two-thirds of the global total in 2050, a significant increase from only about one-third today.
Where stock markets, currencies, and growth rates will head in coming months may be unclear. That the meek will eventually inherit the earth is not.
Schuman is a journalist based in Beijing.