Jerome Booth, Head of Research at Ashmore Investment Management comments on the global backdrop for emerging markets over the past year and forecasts an encouraging future for EM asset classes.
Reviewing some of the key themes in 2009:
· Whilst there was global disruption to cross-border finance, the main negative impact on selected emerging countries has been a fall in export demand from the US and Europe. This is much more straightforward to deal with than the credit crunch and banking sector problems of the developed world.
· Emerging markets cut interest rates during the downturn, just as in the developed world – an indication of lack of perceived (or actual) increase in emerging sovereign credit risk.
· The nascent recovery in the US is highly fragile, and, in the absence of further fiscal resources, has depended on the Fed’s ability to convince markets that everything is recovering. Such sentiment has pushed up asset prices which in turn has helped banks recapitalise. Keeping yield curves steep has also helped the banks.
· Towards the end of 2009 monetary policy in the US has probably reached the limit of what it can achieve to help the economy rebound. There is a dissonance between further deflationary pressures and market concerns over inflation. There is also a stress between the desire for more quantitative easing and dollar credibility.
· 2009 was the year the G20 rose to prominence, reflecting a new reality of global economic power.
Outlook for 2010:
· Global rebalancing requires the dollar, euro and sterling to fall relative to the currencies of large surplus countries in the emerging markets. This will allow a US/European export-led recovery, but needs a consumer boom in Asia and other emerging markets to fuel it”.
· US consumer confidence is very shaky and the risk of further hoarding by consumers, which could cause a major double dip and much higher unemployment than currently anticipated, is not expected by any of the main investment banks, all of which predict above par growth in the US next year.
· A US funding crisis, though unlikely, could occur – $1.7 trillion of Treasury issuance is planned next year. Central banks are the dominant external buyers and already hold around 50% of Treasuries.
Outlook for emerging markets:
· Given the risk of a double dip and further sharp deleveraging, emerging market (multi-country) asset classes are arguably now safer than their equivalents in developed countries.
· Emerging countries have a wide range of policy tools to cope with further external shocks or other economic problems
· A number of East Asian economies in particular will have to move to a more domestic demand driven model of growth in future. The main prompt for Asian currency appreciation is likely to be inflationary pressure associated with their strong V-shaped recovery.
Further still, the credit crunch should be highly positive for emerging market asset classes insofar as it speeds changes in:
· Global perception (away from the core-periphery model which largely leads investors to ignore emerging markets);
· Risk perception and measurement: risk is everywhere, not just in far flung emerging markets – also closer to home;
· Asset allocation – moving from cap weight to GDP weight, from home bias, from equity bias, and from agency problems causing herding;
· The investment destination of existing emerging market savings pools, including central bank reserves – more to domestic investment and other emerging markets.
Looking ahead Jerome states that there are a number of scenarios, many of them involving further problems in the economies of the developed world, that may unfold:
“The main scenario is still one of gradual recovery in the US, no calamitous double dips, and gradual rebalancing of global exchange rates. But one should think in terms of different scenarios not just a single forecast. One should insure against the worst case scenarios, even if they are not the most likely. The best insurance is more exposure to emerging local currency debt”.
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