If you are surprised by prospects of stronger growth in EM then you are not alone; perceptions about EM have been too negative for some time. EM economies have in fact grown almost exactly in line with their long-term trend throughout the disruptive 2012-2015 period, approximately 5.0% per year, which is exactly the same as EM’s average growth rate from 1990 to 2007. It may also surprise you that the only region of the world to truly have lost momentum is developed economies. The average rate of growth in developed economies has virtually collapsed following the financial crisis of 2008/2009. The growth rate for developed economies is down by a jaw-dropping 42% to just 1.6% compared to the pre-crisis trend growth rate of 2.7%.
Now prepare for more surprises. Newly issued growth forecasts from the IMF suggest that these trends will continue; developed economies are not seen to recover their former dynamism in the next five years, while EM countries will accelerate. EM economies are seen to accelerate to 4.1% growth in 2016, up from 3.9% in 2015, and rising to 5.1% per year by 2021. By contrast, developed economies will slow to 1.9% in 2016 and to further decelerate to just 1.8% average growth by 2021.
Forecasts are obviously designed to be missed. Still, there seems to be some method in this madness. EM economies have been through the mill in recent years, facing down a “taper tantrum”, the surging dollar, crashing commodity prices and the start of the Fed’s hiking cycle. These events spooked investors, but the resulting financial stresses failed to spark widespread defaults in EM. Indeed, default rates for EM corporates are lower than for US corporates. EM’s strong fundamentals, it seems, did their job.
More importantly, that which does not kill you, makes you stronger. The financial tightening and currency adjustments inflicted on EM during the last few years have made them lean and competitive. EM current account balances are improving dramatically, pushing up net exports as well as currency reserves. Yields in EM bonds markets look far more attractive than the yields on offer in the developed world. Critically, the US dollar has become a victim of its own success, its strength now undermining the very growth and rate hike expectations that led to its rally in the first place.
All this suggests that global capital flows could become far more balanced going forward, perhaps even to start to wash back into EM. There are already signs of this happening; if it continues, then consumption and investment will also rise and EM will be on to a benign path that further reinforces the nascent growth momentum emanating from the external sector.
What could mess up this picture? The main challenge comes from developed countries. Disappointment with growth is already pushing ever more populist politicians into positions of power and the lack of conventional easing tools after years of zero interest rates, multiple doses of QE and financial repression is a major concern. It seems clear that the next round of easing measures will be distinctly third rate, including “helicopter money”, directed credit, currency manipulation and so on. At best, such policies will impart nervousness, at worst they will create severe losses for the bulk of global investors who are limit long developed markets after years of chasing QE bids.
Do not for one second be naïve enough to believe volatility can be positive for sentiment towards EM. Even so, there is a silver lining. Market inefficiencies — such as excess volatility — can be turned into profits. It is precisely when EM asset prices overreact to global events, especially when the volatility originates from events outside asset class, that investors can find the best opportunities to add to the asset class. And especially when the growth outlook provides balmy tailwinds.
Jan Dehn is Head of Research at Ashmore Investment Management Ltd