Emerging markets: looking for new momentum

An analysis by Ariel Emirian, Economist at Societe Generale
12 February 2014

At a time when the economic and financial situation in developed countries appears to be gradually improving in the US, the eurozone, the UK and Japan, new questions have arisen, this time from the emerging world.

This is all the more remarkable given that since 2008 emerging markets were considered the strongest area for global growth compared with Europe and America, which were mired in various crises. Their situation was in stark contrast to that of the '80s, which were characterised by a series of sovereign debt defaults and has been called "the lost decade," or that of the '90s, when emerging markets experienced various financial and/or sovereign debt crises such as those of Mexico in 1994, Asia in 1997, Russia in 1998 and Argentina in 2002, to mention only the most prominent.

At the turn of the century emerging markets entered a period of strong growth, driven by a combination of several factors: the international integration of China, the rise in the price of commodities (which many of these countries export), improved terms of trade and ample global liquidity. But all of these factors, which brought about what might be called "the winning decade," are now tapering off or undergoing a reversal. This has given rise to two major concerns that have spooked the markets for several months now:

  • How much will China slow down? This question is at the heart of discussions surrounding the structural slowdown in major emerging markets.
  • What will be the impact of a less accommodating US monetary policy? This concern partly explains the waning interest in riskier assets, including those of emerging markets.

In addition to these major concerns there is a perceived increase in political risk in countries such as Turkey, the Ukraine, Thailand and Argentina.

Since the beginning of the year, this environment has led to an outflow of capital from emerging markets, resulting in market downturns and currency depreciation against the dollar and the euro. As in May 2013 (following the Fed’s statements regarding the gradual taper of its quantitative easing policy), this episode is chiefly affecting countries whose trade deficits have deteriorated in recent years. The increase in their external deficits has made these countries dependent on international funding, and therefore more sensitive to capital flows. However, it should be noted that emerging markets are now generally in better financial shape than during the major crises of the '90s. They have already gone through a long period of deleveraging, they have more flexible currency systems that provide a cushion against shocks and they have succeeded in establishing foreign exchange reserves that, in the current situation, provide a reliable safety net. We are therefore not dealing with a widespread emerging market crisis.

Obviously, not all of the countries are in the same situation. As already mentioned, the countries most affected by the current movements are those with external deficits and whose currencies have been depreciating since May 2013, such as Turkey, India, Indonesia, South Africa and Brazil. These markets have entered a phase of adjustment that should result in less growth. Russia and China face more structural issues. Russia needs to reduce its dependence on oil revenues while China should rebalance its growth model toward more consumption and less investment. For their part, the countries of central and eastern Europe are benefiting from the slight improvement in the eurozone and are generally in a phase of very gradual resumption of growth after years of adjustment. Other countries have high or accelerating growth rates. Some countries are seeing accelerating exports (Korea, Malaysia, Philippines), while others are benefiting from a favourable FDI (Foreign Direct Investment) cycle (Mexico, Peru, Colombia, Chile and various countries in sub-Saharan Africa), and others are rentier states like the Gulf countries.

In the medium term, the question is how growth patterns will change in emerging markets. These markets are at risk of falling into what is known as the trap of middle-income countries, i.e. after a measure of success, they remain "stuck" in their current level of development. Faced with these challenges, they will need to review their development model and cope with more moderate growth beginning in 2014-15. Nevertheless, this more moderate growth rate should remain higher overall than in developed countries due to still-untapped catch-up potential as well as current investments, particularly in infrastructure, and in some emerging markets to demographics that remain favourable.