In September, a speech to the Chamber of Commerce in Portadown, Andy Haldane, the chief economist of the Bank of England Bank of England warned that we could be moving into the third stage of the financial crisis: the “Emerging Market” crisis of 2015.
The financial crisis that began in the Anglo-Saxon countries in 2008, before moving to the Eurozone, was caused by large slugs of global liquidity that in turn inflated, then deflated capital flows, credit, asset prices and growth in different markets and regions. This pattern, suggested Haldane, has many similar characteristics to what is happening in Emerging Market Economies (EME) now.
Immediately after the crisis, over $600 billion of capital moved out of crisis-affected developed markets, straight into EMEs. As capital moved, growth followed. Since 2010, annual growth in EMEs has averaged 6 per cent, three times the level of developed countries.
In fact, EMEs have accounted for 80 per cent of global economic growth in the last five years, with China alone accounting for half. It could be said that China effectively bailed the rest of the world out of the global financial crisis. However, this came with a cost.
China’s rapid boom was fuelled by trillions of debt. “There has been a credit bubble of epic proportions in China,” observes Neil Shearing, Chief Emerging Markets Economist at Capital Economics. “I’ve never seen credit flood in as fast as it did into China over the last seven years.”
Since March 2014, the cycle has turned, with over $ 300 billion of capital on official estimates flowing out of EMEs. The commodity price cycle has turned down, hitting those EMEs who are heavily dependent on commodity exports, such as Russia and Brazil while benefitting, relatively speaking, those who are net importers.
And, as Haldane observed, where money has led, growth has followed, as it did on the way up. But now that growth is slowing down.
Indeed, the IMF expects EME growth to slow to below 4 per cent in 2015, marking the fifth consecutive year of declining growth. Coming on top of the downturn in the commodity price cycle, high levels of debt, political instability and the likelihood of a rise in the dollar interest rates (the dollar also being the currency in which most EMEs borrow), this could create, Haldane suggested, the perfect EME storm.
So are investors right to be wary of EMEs?
A POSITIVE VIEW
The answer seems to be that much of this is already reflected in the markets. This has been particularly noticeable in China, where shares on the highly speculative Shanghai exchange lost almost half their value between June and September 2015. Fears that Chinese growth figures have been overstated since at least 2013 have also undermined confidence.
Yet at the same time, this is merely the outward manifestation of a painful, but necessary transition to a more sustainable, if slower, kind of economy where growth is much more heavily dependent on domestic consumption.
As Shearing points out, “China’s population is twice as large as Europe and the US combined, so some sectors such as the service sector can still grow.“ He also makes a comparison between China now and California in the 1990s: as the US recession hit the rest of the country’s economy, California continued to prosper. Each region of China is so disparate, argues Shearing, that it is difficult to draw meaningful conclusions about the whole and apply it to the parts.
Indeed, it is this very diversity even within some EMEs, and certainly between many EMEs today that makes it harder than in the past to generalize about them.
Poliana Kudyavko, a fund manager at Bluebay, believes that markets are underestimating the prospects of long-term growth in many EMEs. In addition, she believes that markets are failing to differentiate between good and bad stories in different markets, citing Latin America as a case in point.
“For example,” she says, “Mexico has a robust reform agenda and strong legal framework, which we believe would make the implementation of future infrastructure programmes successful. We also like countries such as Chile, which has a very high level of corporate governance and a supportive policy framework. Even… Colombia we believe is moving in the right direction over the longer term, despite facing shorter-term challenges.
While EMEs who are commodity importers will currently be in a better position than before when the price cycle was higher, Kurdyavko also believes that the influence of the commodity price cycle argues alone does not determine how attractive a market may be.
“As a commodity importer,(India) has seen strong progress on the reform agenda and has therefore been a favourite destination for a lot of investors. However, in the case of Turkey, the country has not benefited to the same extent from weaker commodity prices because of structural and domestic issues and a government framework that is not supportive for the economy.”
Shearing makes a similar point. “Thirty years ago a lot of the economies we would now regard as emerging were in very similar positions. Many of the structural issues were the same”.
Now, after the EME crises of the 1980s and 90s, and reforms in the late 90s, rapid growth and integration of emerging markets into the global economy, EMEs have become much more diverse. The richer countries like Korea, with its successful manufacturing and biotech industries are in a very different place to the poorer countries such as Sub-Saharan Africa, or those like Argentina and Venezuela where financial and political stablity is threatening society and the entire fabric of the country.
Shearing believes believes that while the headwinds against EMEs still exist, we may be past the worst of it. “I think the big falls in commodity prices are behind us,” he continues, “and that a lot of the news about the Fed and interest rate rises are reflected in markets.”
Even Haldane, it turns out is relatively sanguine. “It may be third time lucky”, he said in Northern Ireland. Even today, EMEs remain less integrated into global capital markets than the Anglo-Saxon and European countries of the first and second stages of the financial crisis were.
Moreover, there is another point that markets appear to be overlooking: the fact that the US is even thinking about raising interest rates is a sign that it is on a more secure financial footing. Surely this is a good thing for markets and economies, whether advanced or emerging? The latter have been preparing for this rise for two years now.
Yes, growth may well be slower, but there is still considerable individual potential in so many corners of EMEs around the world. We may just have to become a little better at looking beyond the big picture, and to learn to distinguish between not just economies, but regions and industry in the next stage of global growth.
Photography by Anna Farmbrough