BRIC: Is the fastest period of emerging-market growth behind us? Emerging Markets: A Contrarian Special?

BRIC: Is the fastest period of emerging-market growth behind us?

Defending the motion

Ruchir Sharma, Head of emerging markets and global macro at Morgan Stanley Investment Management

It is rare for emerging nations to sustain growth faster than 5% for even one decade, much less two or three, and only six countries have grown that fast for as long as four decades in a row.

Against the motion

Kishore Mahbubani, Dean and Professor, Lee Kuan Yew School of Public Policy, National University of Singapore

In 2013, China’s economy will grow by 7.8%, India’s by 5.6% and Brazil’s by 2.5%. In response, Western media headlines have begun screaming that the emerging-market story is over. Oh dear, here comes Western wishful thinking again.

The moderator’s opening remarks

Aug 20th 2013 | Ryan Avent

Since the early 2000s emerging markets have powered global economic growth. Emerging economies grew faster than the rich world, and from 2003 to 2011 they raised their share of global output by a percentage point each year. As a result, emerging markets now account for more of the world’s GDP than advanced economies. Yet as The Economist recently noted, a “great deceleration” seems to be under way. The Chinese and Indian economies have slowed dramatically from double-digit growth rates prior to the financial crisis; the IMF expects China to grow by just 7.8% this year and India by 5.6%. Most other large emerging economies are also slowing sharply.This economic hiccup is prompting intense debate. Some worry it may be a permanent change: the end to a remarkable era of rapid growth that won’t be repeated. The tailwinds that pushed forward the recent boom are dying down, they reckon. Growth owed much to rapid expansion in China, but a richer China in need of economic rebalancing can no longer tow the emerging world along in its wake. The reforming spirit in places like India and Brazil seems to have petered out prematurely, leaving such economies with less room for growth than many once imagined. Soaring commodity prices are plateauing as supply grows and rich-world demand drops, turning a source of strength for commodity producers in Africa and Latin America into a drag. And rich economies are no longer interested in borrowing to gobble up imports from upstart economies, preferring instead to work on raising the competitiveness of their own labour forces. Though many emerging markets may still grow faster than rich-world ones, their performance is likely to disappoint relative to the recent past.

Others are less sure that the best days are behind the emerging world. Rapid growth in places like China and India was possible thanks to a century of poor economic performance, in which less-developed economies failed to take advantage of new technologies. In 1890 an average American was about six times better off than an average Chinese or Indian. By the early 1990s the American was doing 25 times better. Relatively minor policy improvements allowed big but poor economies to close the gap quickly.

Yet plenty of room for catch-up remains. Real output per person in India, for example, is still only 8% of that in America. Other big economies, like Nigeria, are even farther behind. Meanwhile, large emerging markets have taken advantage of some of the gains of the recent boom to lay the groundwork for future growth. China has made enormous infrastructure investments, and educational attainment around the emerging world is rising rapidly.

The future of the global economy rests in the balance. An emerging-market slowdown could mean less economic disruption across advanced economies, from high commodity prices or competition from low-wage workers, but it could also mean a dimmer outlook for sales and investments into the booming emerging world. Across emerging markets slower growth would mean more people in severe poverty for longer, and a major downgrade in residents’ aspirations. And the world economy as a whole would lose out if big emerging economies contribute less to the world’s stock of innovation and ideas. But such pessimism may be premature.

To thrash these matters out we are pleased to welcome Ruchir Sharma, head of emerging markets and global macro at Morgan Stanley Investment Management, and Kishore Mahbubani, dean and professor at the National University of Singapore’s Lee Kuan Yew School of Public Policy. We hope you will join the debate as well and add your comments.

The proposer’s opening remarks

Aug 20th 2013 | Ruchir Sharma

During the boom of the last decade, many economic pundits embraced the long view, arguing that because China and India dominated the world economy in the 17th century, they could do so again in the 21st century. Ignoring the messy centuries in between, these forecasters seemed to be saying that 17th-century performance guarantees future results. That is, of course, not how economic cycles work. Normally, what is hot one decade cools in the next, and this is what we are seeing in the emerging world today. After a torrid decade, the emerging world is cooling off, relative to the developed world, and the largest emerging markets—Brazil, Russia, India and China, hyped as the BRICs—are cooling off relative to unsung new stars, like the Philippines, Nigeria and lately Mexico.

This cooling phase will be particularly dramatic, because of the unprecedented scope and pace of the boom in the last decade. Starting with the highly accommodative American monetary policy stance in 2003, in response to the tech bust, a tide of easy money fuelled a new investor enthusiasm for emerging nations that in turn had cleaned up their act following the serial crises that had afflicted many of them in the 1990s. Over the next four years, the average annual GDP growth rate in emerging nations doubled to 7.5%. By 2007, with three small exceptions, every economy in the emerging world was growing, and more than 100 were growing faster than 5%. This kind of synchronised global boom had never happened before, so far as the records show, and it is not likely to happen again.

The onset of the global financial crisis in 2008 signalled the end. For a while, the emerging world appeared to defy the global economic slowdown as it relied on massive stimulus measures to lift domestic demand and counter the slump in export growth. By mid-2009, the emerging economies were growing 10 percentage points faster than the G7 economies, but since that peak, the gap has fallen to just 2 percentage points this year, as the stimulus effects wear out, the structural growth problems in many of the emerging markets become apparent, and a revitalised America and Japan reduces the supply of easy money in emerging markets.

That does not mean that the emerging-market story is completely over, just that it is returning to its normal state of churn. The average growth rate in emerging economies has fallen by 4% this year to just 2.5% outside China. The hottest economies of the last decade, the BRICs, are now among the coolest. China is in transition from the double-digit growth rate of a poor, young economy to the more sedate pace of a middle-class economy. It has already seen its growth rate fall below 8% over the past year. And due in good measure to the alarmingly rapid rise in its debt burden, to over 200% of GDP, China could see growth slow to 5-6% in the coming years.

These cycles have endured at least since the second world war. Today, only 35 of the 185 economies tracked by the IMF are developed; the rest have been “emerging” forever. It is rare for emerging nations to sustain growth faster than 5% for even one decade, much less two or three, and only six countries have grown that fast for as long as four decades in a row. Most nations that do grow rapidly for a decade soon become complacent. They quit reforming, and fall back to where they started. That is why the average income in a country like Brazil is no higher, as a share of the average American income, than it was in 1960. Indeed, even after the boom of the last decade, the gap between the average incomes in the developed and emerging worlds was as wide in 2011 as it was in the 1950s. Right now, Brazil, Russia and South Africa are growing no faster than America. So much for last decade’s popular theory of “convergence” of the rich and the poor.

Sustained economic success is rare. So pundits need to analyse economies as individual stories, not grouped in a faceless “emerging” class or a catchy marketing acronym. As China slows, the foggy talk of a coming Asian century should give way to a more pointed focus on which nations can flourish in the next five to ten years. The rise of the rest will yield to the rise of the select, what I call the “breakout nations”, capable of growing faster than rivals in the same income class.

What is increasingly apparent is that last decade’s era of easy growth is over and not all emerging markets will be breakout nations. Their paths will vary significantly and it will take new reformist-minded leadership to create winners, as we have seen with the Philippines and Mexico of late, while countries with stale leadership such as Russia and Brazil turn into the laggards. No nation can hope to grow as a free rider on the tailwinds of fortuitous global circumstances, as so many did in the last decade. They will have to propel their own weight, and remember that not all trees grow to the sky.

 

The opposition’s opening remarks

Aug 20th 2013 | Kishore Mahbubani

In 2013, China’s economy will grow by 7.8%, India’s by 5.6% and Brazil’s by 2.5%. In response, Western media headlines have begun screaming that the emerging-market story is over. Oh dear, here comes Western wishful thinking again.

Yes, there is a strategic pause in this growth story. But it is far from over. The emerging markets, especially China and India, will return to high growth, driven forward by some fundamental forces which remain unchanged. Let me mention three.

First, up to 1820, the two largest economies were always those of China and India. Europe and America have dominated the global economy for the past 200 years. But the past 200 years have been a major historical aberration. All historical aberrations must come to a natural end. One point is worth emphasising here: it took a massive amount of underperformance to shrink the Chinese and Indian economies. All that the Chinese and Indians need to do is perform normally, on a par with the rest of the world. Does anyone still doubt their ability to do this?

Second, to understand the potential performance of Chinese and Indians, just look at the performance of Chinese and Indian students at North American universities. The numbers studying there have exploded. Chinese students have grown from nearly 60,000 in 2002 to 194,000 in 2012 and Indian students from nearly 67,000 in 2002 to over 100,000 in 2012. Similarly, the percentage of American science and technology PhD graduates who have Asian origins have exploded. This talent will eventually flood the Chinese and Indian economies. Yes, many will not return. But even if they do not, they will contribute to their home country’s growth. The ethnic group with the highest per-head income in America is Indian. Directly or indirectly, they are contributing to the Indian growth story.

Third, in a point that the Western mind cannot literally see or experience, there has been a sea change in Asian psychology. When I grew up in Singapore as a child, and when Singapore’s per-head income was the same as Ghana’s, we could not even conceive of the possibility that we could ever become as developed as the Western countries. In my lifetime, Singapore’s per-head income has exceeded that of its former colonial master, Britain. Singapore’s gross national income per head was $61,100 in 2012 while Britain’s was $36,880. Yes, there was a time when the success of the Asian tigers, like South Korea and Singapore, were seen as aberrations. Today, most Asians, including Chinese and Indians, Indonesians and Filipinos, see no reason why they too cannot succeed.

In short, the long-term trajectory remains unchanged. Yes, there will be many short-term stumbles or strategic pauses. Some pauses may even be healthy. China’s leaders seem to realise that the old cheap-labour, export-driven model may no longer work. Also, many in China believe that the last decade was a wasted decade of no reform. Now China’s leaders want to change direction. In going around a corner, it is wiser to slow down to avoid making the mistake that the Spanish train driver made in turning a corner at full speed. There is a lot of wisdom in China’s slowdown.

The Indian story is different. Here politics is holding back growth. With the general election looming in 2014, few expect any serious reform initiatives soon. Yet, as Ruchir Sharma points out, “As India’s most dynamic states post rapid and substantive growth, the country is rediscovering its natural fabric as a nation of strong regions.” Many Indian states are growing at or near double-digit rates. One other little-known fact should provide greater hope for a strong Indian rebound. The Indian private sector performs much better than the Chinese private sector, with the comparative average return on investment being 16.7% for India and 12.8% for China in 2006.

Does this mean that all “emerging markets” will bounce back from their current travails? Absolutely not. The term “emerging markets” was easy shorthand to describe rapid growth by developing states in many different regions. But they do not belong to a natural category where all their destinies are inextricably bound to each other. A few may even fail. That too is perfectly natural. Local politics does make a huge difference.

Take Turkey as an example. It was a strong performer for over a decade. Then it stumbled. Why? Bad politics. It was unwise of Recep Erdogan to alienate a strong and powerful political constituency. Can he backtrack and recover? Yes, he can. Will he? Time will tell. The same is true of Brazil. Here, over-confidence was the big problem. When governing elites begin to assume that rapid economic growth is as inevitable as the morning sunrise, they run into problems. Economic growth is inherently difficult, especially in the move from middle income to high income. Brazilian leaders will have to think hard about the major strategic adjustments they have to make.

Finally, it is wise to remember that there have been bouts of pessimism before. It was only 15 years ago, at the height of the Asian financial crisis, that economies like South Korea and Indonesia, Thailand and Malaysia seemed to be total wrecks. Many Western voices touted that the Asian “miracle” was over. These four economies are now three times, nine times, three times and four times their size in 1998. Will such economies stumble again? Of course they will. Will they be able to pick themselves up and start running again? Of course they will.

Emerging Markets: A Contrarian Special?

By Roben Farzad on August 20, 2013

When the U.S. financial system crashed in 2008, market watchers were increasingly romancing the idea of a “decoupling” that would separate emerging-market fortunes from those of the subprime-hobbled U.S. Such economies as Brazil’s and China’s, the thinking went, had the demographics and national balance sheets to keep growing and wowing as America foundered.

Never happened. In fact, five years later, as China grows at its slowest clip in 13 years and India’s currency and stock market plunge, investors are favoring U.S. shares over emerging markets by the most ever. The divergence of metrics is getting contrarians excited.

According to Bloomberg data, cash is fleeing emerging-market exchange-traded funds and flowing into U.S. stock funds at the fastest rate on record. $95 billion has gone into American share ETFs this year, while developing-nation ETFs logged withdrawals of $8.4 billion. Indeed, emerging market ETFs are working on their biggest annual outflow since Bloomberg began tracking the data in 2000.

BofA Merrill Lynch’s monthly survey of investment managers discovered that emerging market equity exposure is at its lowest in 12 years, and the category is the most under-owned of all the asset classes and sectors it tracks. That flashes a buy signal to chief investment strategist Michael Hartnett.

The Standard & Poor’s 500-stock index is trading at 16 times profit, 70 percent more than the MSCI Emerging Markets Index; the latter’s multiple of 9.4 is close to its lowest since 2009.

“In many ways, investors in emerging markets have priced in a crisis event, even though no actual event has actually occurred, as in 1997 and 1998,” says Michael Gayed, co-portfolio manager of the ATAC Inflation Rotation Fund, who thinks the sector is coiled for a big rebound. “If the markets of developed economies are indeed correct about future growth, it would be illogical to assume that their emerging-market suppliers do not participate and their stocks do not get pulled higher. With fund-manager allocations as low as its been in a decade, a lot of negativity has been priced in, especially relative to the U.S.”

Bloomberg’s polling of economists sees the U.S. economy expanding 3 percent in 2015, almost double this year’s pace, while the combined gross domestic product of the BRIC countries (Brazil, Russia, India, and China) will grow at a rate of nearly 5.9 percent.

“The outflows occurring in emerging markets have more to do with the nervousness over less liquidity than the actual economic cycle,” U.S. Trust’s Chris Hyzy told Bloomberg’s Lu Wang. “The bull market is alive and well.”

Meanwhile, the chief executive officer of A.P. Moeller-Maersk (AMKBF), owner of the world’s biggest shipping line, said concern that emerging markets are losing their growth momentum is overdone.

Contrarians can take further comfort from emerging markets’ outsized volatility, relative to the U.S.: The S&P 500 is the calmest in more than six years, compared with China, Brazil, India, and Russia. The S&P 500’s 30-day historic movement plunged 29 percent to 8.75 this year, while the measure for the MSCI measure of 21 developing nations spiked 83 percent to 13.3.

The last time U.S. shares showed such valuation-premium and volatility relative to emerging-markets was in the summer of 2004, when emerging markets went on to beat the U.S. by 29 percentage in the next 12 months, according to Bloomberg data.

“There are times when the market acts with certainty that all is awful,” says Gayed. “Those tend to be good entry points over time. “