Investec Asset Management

How Emerging Markets Need to Structure Economic Reforms

December 19, 2013

Aniket Shah

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Much of the unbridled enthusiasm around emerging-markets countries has dissipated in recent years. Economic growth rates have fallen by nearly half from their pre-2008 highs. Although emerging-markets equities outperformed those in developed markets by 293 percent from 1999 to 2009, they have significantly underperformed — by 36 percent — since 2010 (see chart 1). The volatility in key debt markets this summer, prompted by the hint that the U.S. Federal Reserve Board would taper its bond purchases, has caused additional concern about the sustainability of these markets and economies.

Source: MSCI Emerging Markets US$ Total Return and MSCI World US$ Total Return used as benchmarks for this calculation.

During the past 25 years, major crises — India in 1991, Mexico in 1994 and Russia and Southeast Asia in 1998 — have kick-started economic reform. Improvements in fiscal management, the introduction of productivity-enhancing policies and smarter financial regulation have bolstered long-term, broad-based growth and driven emerging markets forward. Although arguably no emerging market is currently going through a comparable crisis, the significant slowdown in growth is cause enough to push forward much needed reforms. But what are they? To answer that question, we need first to examine factors in emerging-market growth.

Emerging markets have benefited from three major tailwinds that will likely not continue to the same extent going forward.

The first is high, across-the-board commodity prices. The China-driven commodity boom helped drive growth in Latin America, Russia and other commodity exporters after years of stagnation. From 2003 to 2011, energy and metals prices tripled and agricultural prices surged by 50 percent. Major impacts of this development included allowing emerging-markets countries to increase public expenditures, with Russia raising public spending to upwards of $9,000 per person; and leading commodity exporters such as Brazil and Chile to build reserves that dampened volatility and reduced the risk of a future crisis.

The second major tailwind is growth in trade and economic openness. The ascension of China to the World Trade Organization in 2001 was a watershed moment for global trade. Low- and middle-income countries saw their share of global exports more than double, from 21 percent to 43 percent, between 1994 and 2008. During this time China and India had annual growth in exports of 18 percent and 14 percent, respectively. The next important phase of global trade, so-called South-South trade between emerging economies, is set to grow at a rate of more than 18 percent a year, further enhancing the importance of financial openness for these countries.