> Specialist Outlook> Emerging markets: The 'children' are growing up
Ihab L. Salib, a Federated Investors senior vice president and senior portfolio manager who heads the Pittsburgh-based financial services company's International Fixed Income Group, discusses the growing role that emerging markets/developing countries now play in the global economy
As almost any parent knows, the teenage years can be difficult. Obedient children who once seemed to love spending time with Mum and Dad transform almost overnight into antisocial beings who seem to take pleasure in seeing how far they can stretch the rules. Then, mercifully, they grow up, and we remember what is we liked about them (and hopefully, they remember what it is they liked about us). We may even become amazed at how well they've turned out. This is all scientific, you know. The prefrontal cortex, which controls judgment, decision-making, impulse-control and other critical behaviors, is among the last part of the brain to fully developâ€”not until around age 25 does it fully mature.You may be wondering, "What does this have to do with the emerging markets?'' Well, in many ways, today's emerging-market countries are a lot like those petulant teenagers who have now grown up. Until this past decade, these countries were prone to economic tantrums. Whenever the Western economies caught a cold, they would get the flu. Their export markets would dry up. Internal demand, never enough to support their economies, would decline. Production cutbacks and layoffs would ensue, followed by social unrest and political upheaval. Foreign capital would flee, their currencies would plunge in value and inflation would soar. It is a story that has been repeated time and again, from the Latin American crises of the 1980s to the Mexican (1994), Asian (1997) and Russian (1998) crises of the 1990s. The emerging markets just weren't ready to join their more developed brethren at the grown-ups' table.How times have changed. In the aftermath of this most recent global financial crisis, it is the emerging markets/developing countries that have emerged stronger and better positioned for growth. According to professors Carmen M. Reinhart and Kenneth Rogoff, of the University of Maryland and Harvard, respectively, private debt exceeds more than 200% of GDP in advanced European countries and nearly 300% in the United States, its highest since data began in 1916. This is in addition to record public debt that has soared as policymakers adopted massive and coordinated stimulus to stem global decline. By comparison, debts – both public and private – are relatively small in the developing world. The IMF estimates that gross government debt as a percentage of GDP will exceed 122% of GDP by 2015 in advanced G-7 countries, vs. 32% in emerging G-20 countries – a reversal of the situation of only a few decades ago.A big part of this shift has to do with the rapid rise of a massive middle class, and thus internal demand, in the emerging markets of Asia and Latin America. China, Brazil, India and others are undertaking huge investments to support their rapidly growing economies, much as happened in the post-World War II United States more than a half century ago, when veterans returning from World War II settled down, raised families and spawned an economic boom. The United Nations estimates the ranks of the global middle class will swell by 2 billion people by 2030, and that population growth rates in the world's less developed regions will average roughly five times that of the world's developed regions over the next 10 years – a growth differential that is expected to widen in subsequent years. Developing countries also are projected to account for more than three-fourths of global GDP by 2050, up from about half now.This growth, spurred by a booming middle class, largely separates what is happening in emerging countries now versus a few decades ago. Then, much of the money flowing into developing countries was of the short-term variety. Investors and lenders would get in, make a quick profit, then get out at the first sign of economic or political upheaval. Thus, each crisis in a developing country effectively would shrink its middle class, as runaway inflation spawned by currency devaluations and austerity measures undertaken to bring fiscal budgets in balance ate away at savings and undermined hope of professional advancement. Worse, emerging-market countries' reliance on foreign sources of funds made them beholden to the developed countries and what were viewed as their apparatchiks, the International Monetary Fund (IMF) and the World Bank. It was difficult to see this cycle of dependency ever changing.That began to change with the 2001 recession, which saw developing countries emerge more quickly than in the past. Now, in the aftermath of the 2008 crisis, the global dynamic has shifted and the developing and developed worlds are converging, a result of the much more rapid growth that is occurring in emerging markets vs. the major industrialized countries. We saw some of this convergence at Pittsburgh's gathering of the G-20 in September, 2009, where several developing countries were made full partners, assuring their place at the table when it comes to shaping global economic policies. Indeed, as much of the developed world continues to wrestle with the consequences of the financial crisis, they have become increasingly reliant on China, Brazil and other emerging-market economies as sources of growth and global stability. This has strengthened developing countries' ties to and interaction with the rest of the world, fostering a more promising environment for trade and helping beat back attempts at protectionism.To be sure, developing countries' less-regulated, higher-beta markets have always been more volatile and less liquid, in part because of their history of political and economic eruptions. The past few decades are scattered with the remnants of lenders and investors felled by debt crises and market collapses in Latin America and Asia, and these concerns are not easily dismissed or forgotten. For example, even though Brazil is the world's eighth-largest economy, with low debt levels and a credit rating that was raised by Moody's from speculative to investment-grade status in September, 2009, yields on Brazilian government debt still run roughly three to four times above levels of comparable U.S. Treasury securities. This reflects higher inflation, true, but it doesn't fully explain the differential. Simply put, investors continue to demand a risk premium for the sins of the past.Still, it's clear that as the world emerges from the worst global financial crisis since the Great Depression, the roles between emerging-market and developed countries in many ways have reversed. Debt-laden developed countries are now being forced to deleverage, rebuild savings and restore their balance-sheet health, a process that undermines an economy's future growth potential because so much of its resources must be used not to build productive capacity but to restore fiscal health. At the same time, many emerging countries – particularly in Asia and Latin America – are using their comparatively stable fiscal situation and financial wherewithal to work on building their internal economies to meet the needs of their rapidly expanding middle classes. As a result, emerging-market growth that historically was driven by commodity or low value-added export-led models increasingly is being driven by domestic demand variables. In addition, financial reforms have made it easier to deal with inflation, created healthier banking systems and improved access to longer-term credit, all of which are helping support expansion in the consumer and housing sectors. Rapid urbanisation and developmentâ€”and the growing need to reduce bottlenecks in the economy that hamper such activityâ€”have underscored the need for substantial investments in infrastructure, including railroads, telecommunications, roads, ports, airports, power stations, water supply and sanitation systems. India alone is planning $1.7 trillion of such investment over the next 10 years, and office and residential construction is surging in China, where it is expected that 350 million more people will move into its urban centers by 2025. Overall, the U.N. predicts 1 billion new dwellings will need to be built by 2020 to accommodate developing countries' growth.This does not mean we believe emerging-market economies can or will fully decouple from advanced economiesâ€”the financial and global trade interrelationships are strong and likely will remain so between emerging-market and advanced economies. But we do believe that emerging-market economies have become far more resilient to the vagaries of the global commodity markets and external consumption patterns. Moreover, we also think that the emerging markets will continue to benefit from the current global liquidity environmentâ€”as long as the advanced economies continue to experience growth with low inflationary expectations. In short, we believe in the emerging markets' secular and improving structural credit story. It is not a new story or simply a short-term investment opportunity. While we at Federated have always counselled investors to maintain a diversified portfolio that includes international holdings, the case has never been more compelling. In today's global economy, investors who opt to stay close to home may be missing some of the most compelling opportunities since the rise of the U.S. middle class.
For further information about Federated, please contact Richard W. Boyd, Managing Director, Federated International Management Division, at firstname.lastname@example.org or +1 412-288-1594.
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