In the recent past, leading brokers like Morgan Stanley have increasingly raised concerns over the building blocks of emerging markets. Through the 1990s and the early 2000s, emerging markets increasingly captured a larger share of global GDP and growth. Since 2011, this impact has waned. Why is this so and what does it mean for the future of emerging markets?
Low US rates may not continue…
This is by now well known. The impact on emerging markets was all too visible when the US hiked rates by 25 bps in December this year. With the talk of rate hike in June back in circulation, the concerns are up once again. Typically, emerging markets have prospered when US rates have been dovish. This is largely because a dovish US rate policy means that global fund managers hold on to their risk-on strategy. When Fed rates are hiked, risk-off is back. That is the big fear. Over the last 25 years, except in 1994 and in 2006, the Fed policy has generally been dovish. If the Fed shows a distinct shift towards hard rates, EM interest could wane further.
Cheap oil is bad news…
Generally oil and industrial commodities tend to move in tandem. If you look across emerging markets, most of them are dependent on higher prices of oil and industrial commodities. EM nations like Brazil, Venezuela, Middle East, Indonesia, South Africa, Turkey and Malaysia as well as developed nations like Canada, Australia and Norway are largely dependent on buoyant commodity prices. Generally, emerging markets have given their best performance at a time when oil and commodities have been on a secular uptrend. With oversupply and weak demand, this cycle looks hard to break.
What about Chinese demand?
Rising Chinese demand was the story of emerging markets over the last 20 years and more so after the Lehman crisis of 2008. That seems to be changing. China itself is facing a slowdown in growth with its average GDP growth rate falling by 300 bps below its long term average. The Chinese economy is also undertaking a subtle shift from a producer driven economy to a consumption driven economy. That means demand for commodities may never come back to the scale seen in the last 20 years. That is surely bad news for emerging markets.
Morgan Stanley is right in saying that the basic building blocks of EMs are in question. Cheap commodities and weak Chinese demand may be here to stay for a long time. Emerging markets need to look beyond commodity exports and interest rate arbitrage to sustain interest in EMs. The time may have come to look to elevate their nations to a higher plane of economic sophistication! ©