21 October 2018
Rrising consumption and disposable incomes as well as the recovery of the real estate market will help China avoid a hard landing. Photo: Xinhua
Rrising consumption and disposable incomes as well as the recovery of the real estate market will help China avoid a hard landing. Photo: Xinhua

Think out of the box when investing in emerging markets

Debt levels in emerging markets (EMs) have been increasing since the global financial crisis, leading to a debt to gross domestic product (GDP) ratio of about 150 percent or above.

I will review the present situation in the EMs and offer a few investment strategies.

Most of the debt growth in EMs is contributed by the private sector. In Asia, credit expanded by over 30 percent, accounting for 104 percent of the GDP, if not higher.

But if we just consider sovereign debt, the GDP ratio only increased 13 percent.

Many investors worry the EMs will face another international payment crisis similar to what happened in the 1990s.

Currently, most of the debts are denominated in local currencies, unlike in the ’90s when most were denominated in certain strong currencies.

Meanwhile. EMs have strong foreign reserves that will help them in repaying their debts. Data shows their foreign reserve pool has grown to US$8.4 trillion by the end of 2014 from only US$0.9 trillion in 1990.

Still, their heavy debt burden will impact local GDP growth in the mid-term.

Economic growth is slowing in EMs but accelerating in development economies. As a result, the gap in their GDP growth rates has been narrowing for many years.

The trend may start to turn around in 2016, partly because of a moderate economic recovery in the EMs. The International Monetary Fund forecasts a 3.6 percent growth in global real GDP this year, compared with an expected 4.5 percent expansion for the EMs.

The strong recovery, however, may just be reflective of economic data from Brazil, Russia and some Latin American countries, but not an overall strong rebound for the EMs.

Prices of commodities, especially crude oil, are a key factor affecting sentiment in the financial markets.

We believe the oil price will not rebound significantly, but will show a steady increase. So the negative impact of low oil prices will be relieved up to a certain extent.

Demand for oil is expected to remain stable. Capital investment by US energy producers has decreased. Since October 2014, the number of active drilling wells in the United States has dropped by 66 percent.

This will ease oversupply. However, members of the Organization of the Petroleum Exporting Countries are still debating about the proper output level. This means the issue of oversupply will not be resolved abruptly.

Concerns over China’s economy and policy stability were another negative factor for the EMs in 2015. We expect the country’s economic growth to slow further as it transforms into a service-led economy.

But rising consumption and disposable incomes as well as the recovery of the real estate market will help the country avoid a hard landing.

In the past two years, the EMs have resorted to currency devaluation to boost economic growth. Many of the EM currencies are at levels below their 10-year average in terms of effective exchange rate.

On the other hand, a decrease in productivity and a shortage in the labor market may slow the pace of economic growth in the US, and lead to a weaker dollar.

What are the implications? Although EMs have notably adjusted their currencies, interest rates, credit levels and stock market valuations, investor sentiment remains low and holdings in the EMs are at a low level.

To relieve the pressure on EM assets, it is necessary to have a brighter economic outlook in China and other EMs, less impact from commodity prices and a moderate pace of dollar appreciation.

Investors should focus on EMs that have less dependence on the US dollar exchange rate, big foreign reserves, better economic and corporate earnings growth and a strong current account.

This article appeared in the Hong Kong Economic Journal on Feb. 1.

Translation by Myssie You

[Chinese version 中文版]

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Managing Director, Chief Market Strategist, Asia, J.P. Morgan Asset Management

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