In terms of growth potential, Western economies have been outpaced easily in recent years by countries such as Brazil, Russia, India and China. In these emerging markets, low wages and the ample supply of labour have attracted production and service activities from abroad. Strong global demand for often essential commodities from these emerging markets has fuelled their economies even more.
The benefits of this globalisation are often twofold. In emerging markets, jobs are created and domestic demand gets a lift, boosting trade and economic growth. It also helps those US and European companies which are exporting jobs to keep their margins stable.
China is a prime example. Greater trade liberalisation has enabled its economy to shift into a higher gear. Since 1995, 15 to 20 million jobs have been created every year. The almost insatiable Chinese demand for raw materials also benefits many emerging economies. The Chinese economy is expected to continue to grow by 10 per cent a year.
Since September 1998, emerging equity markets have outperformed developed markets by 12 percentage points on average. Major contributory factors are the ample money supply, falling or low interest rates, strong demand from China and attractive valuations.
Financially, the emerging economies of Asia, Latin America, Central and Eastern Europe are in better shape these days. Many countries boast healthier public finances and high trade surpluses and, through a strong demand for their exports and cheap labour, have been able to accumulate big foreign currency reserves. But strong demand for their exports is also their Achilles’ heel. If investors start to worry about weakening economic growth in the Western world, this may affect emerging markets’ exports, which would hit them hard. If these worries cause steep interest rate hikes, which choke off economic growth, emerging markets will also take a beating. This is what happened in May and June last year.
Since then, shares in emerging markets have rebounded to some extent. It is important to stay alert as long as there are doubts about how far the US economy will fall. The OECD leading indicators, having peaked early last year, have been falling in the last five months – a sign of moderating economic growth. How much further will this downswing go?
A sharp deceleration in US growth remains a risk to our otherwise positive outlook for emerging markets but the Federal Reserve is unlikely to let this happen and we expect it to start cutting interest rates in reaction to weak data. We have increased our neutral stance on emerging markets to an overweight position.
Astrid Smit heads ABN Amro Asset Management’s investment strategy team in Amsterdam.