Why and how the paths of developing economies are set to diverge markedly
WISE investors know that winning bets shine more brightly if they are not overshadowed by big loss-making trades. The way in which capital flowed to and from emerging markets in recent years meant that such discrimination went out of the window. Now, however, change is coming.
Two influences in particular are behind this. The first is the retreat by America’s Federal Reserve from ultra-loose monetary policy. Cheap credit gave good and bad economies alike a boost; as its effect fades, capital allocation will become more disciplined. The peculiar traits of each emerging market, from macroeconomic management to productivity growth, will have a greater say in how its economy performs as well as how investors view it. The second shift is in America’s trade policy, which is taking a worrying turn towards economic nationalism—a course whose effects on emerging economies will differ depending on their location and trade patterns. As a result, the reasons for success or failure among emerging markets may be quite different from the recent past.
Begin with macroeconomic management, in which there is already a growing divergence. Turkey is at one end of the spectrum. Despite its fiscal prudence, it has other ills that have long made the cautious wary of emerging markets, including a big trade deficit financed by hot money and lots of foreign-currency debt. It also suffers high inflation. The central bank has been slow to tackle this and seems cowed by Recep Tayyip Erdogan, the president, who insists that high interest rates cause inflation (see article).
Contrast this with progress elsewhere. Little more than a year ago, South Africa was bracketed with Turkey as an emerging market to avoid. Its president, Jacob Zuma, attempted to subvert the Treasury, a bastion of orthodoxy. He failed. South Africa’s central bank has also stuck to its inflation mandate in the face of a slowing economy and weaker rand. Despite a brutal recession, Brazil’s central bank has also concentrated on pulling inflation back towards its goal of 4.5%; the country is getting to grips with the fiscal laxity which is the source of much of its economic misery. With interest rates at 13%, there is ample room to ease monetary policy. Central banks in Russia and India have also run fairly tight monetary policies. As inflation falls further, they will have scope to cut interest rates.
Ultimately, sustained success depends on productivity growth. The sharp slowdown in rich countries has been mirrored in emerging markets. It is marked in commodity-led economies, where resource booms have deterred productive investments in other industries. Export-led growth has proved a reliable spur to efficiency. It is harder to achieve consistent gains in output per person in any economy that looks inwards. Letting domestic spending rip often leads to wasteful building booms. Still, there are biggish emerging markets that have managed fairly steady productivity growth through the swings of the global credit cycle. India is one; Indonesia another. Of smaller countries, the recent records of Peru, the Philippines and Uruguay stand out.
With American economic nationalism, strengths will be tested against a new criterion: exposure to established trade routes. Supplying the American consumer was once a ticket to riches for emerging markets. It may now be a source of frailty: Mexico is now a target of American protectionism (see Free exchange). Other places may also suffer. Singapore, South Korea and Taiwan have enjoyed strong manufacturing output and exports on the back of a reviving world economy. But it is hard to feel upbeat about the prospects of such export-leaning economies if trade wars break out.
India, in contrast, missed out when a new breed of global supply chains in manufacturing was forged between rich and developing countries. But with anti-trade sentiment a growing threat, there is a lot to like about an economy of 1.25bn people that is powered by domestic demand. Brazil, too, has a biggish domestic economy with fairly weak trade ties to America and the potential to strengthen its regional links.
To the discerning, the spoils
Even in this new era, the influence of rich-world monetary policy will not disappear. The value of the dollar will continue to matter, especially to those emerging markets that took on lots of foreign-currency debts in the go-go years. Equally, the impact of economic policy and trade vulnerability will rarely be neatly aligned. Turkey, for instance, counters its macroeconomic weakness with underlying strengths in its patterns of commerce. It trades far more with Europe than America, an advantage it shares with economies in eastern Europe. This means the identities of those emerging-market economies that will thrive and those that will falter are not preordained. But the factors sorting blockbusters from turkeys will be new.
This article appeared in the Leaders section of the print edition under the headline "Turkeys and blockbusters"
