Since March, emerging stock markets have risen by 10%. This rally might indicate an improved growth outlook, and is strong enough for us to re-examine our cautious growth scenario for emerging markets. The average growth level is currently some 5%, slightly more than half the growth in 2010. In our scenario, economic growth in the emerging world will decline further to 4% by the beginning of 2015. The growth slowdown is primarily caused by three factors: the deterioration of the investment climate and competitive position of most emerging economies, the gradual normalisation of monetary policy in the developed world, and the ongoing growth slowdown in China.
The strength of the emerging stock markets over the past few months can be explained by an improvement – or at least the perception of an improvement – in the first two factors, despite the deterioration of the Chinese growth outlook.
The growth potential for most emerging markets has fallen considerably over the past few years, due to a sharp rise in wages and real exchange rates, a greater government role in the economy and an increase in the tax and regulation pressure. Hence the clear deterioration in the competitive position and the investment climate. This negative development has been most clearly visible in Brazil and India. It is the success of the Chinese growth model that has put policymakers on the wrong track. A recovery of growth potential now requires an extensive policy correction, far removed from the interventionist model.
In recent months, there has been growing hope amongst investors that this year’s elections in India, Indonesia and Brazil will be won by pro-reform parties. That would break the negative policy trend in the emerging world and boost the growth outlook. So far, this optimism has only been confirmed by a positive election result in India. For the other two countries, investors are still hoping. It is therefore too soon to assume a new, positive policy trend in the emerging world.
The US has started normalising its monetary policy. Given the reasonable US growth figures, we can assume that the tapering will continue and interest rate increases will start sometime next year. This should exert continuing pressure on capital flows to the emerging world. Nevertheless, there has been a clear revival in the EM carry trade over the past few months. This is primarily due to growing expectations that the European central bank will further relax monetary policy. At this stage, expectations of further steps by the ECB would appear somewhat exaggerated. Capital flows to the emerging world remain vulnerable.
And then there is China. The growth slowdown is continuing. The most recent figures for the Chinese housing market indicate a strong correction. This is exerting further pressure on economic growth and increases the risk of a system crisis. All in all, the prospects for the Chinese economy are starting to look increasingly gloomy. In view of the great importance of Chinese demand for the entire emerging world, this remains the most important reason for not being too enthusiastic about the recent rally in emerging stock markets.
Maarten-Jan Bakkum, ING IM