- There were no clear trends across global emerging markets in January. Markets in Central and Eastern Europe generally performed well. This was because the risks of ‘contagion’ from the financial problems of peripheral Euro area countries were perceived to have reduced
- Investors in the Middle East and North Africa (MENA) region were unsettled by the political unrest in Tunisia and Egypt
- Concerns over mounting inflationary pressures weighed heavily on particular emerging markets. India, where there are fears that manufacturing companies will not be able to pass on high input costs to their clients, was a notable laggard
- Where emerging markets central banks changed monetary policies during the month, it was almost inevitably to lift interest rates. In some countries, including China, the reserve requirement ratio was
- Particular embryonic markets – such as Sri Lanka – have performed well in response to local factors
Global emerging markets in JanuaryThe fortunes of emerging markets were mixed during January. In Central and Eastern Europe, many markets performed well. This was because of events in the peripheral (but developed) countries of the Euro area. The governments of Spain, Portugal and Italy all successfully undertook sizeable bond issues. There were also landmark issues by the European Financial Stabilisation Mechanism (EFSM) and the European Financial Stability Facility (EFSF) – two European Union (EU) institutions which were established last year. Collectively, these bond issues were seen by financial market participants as indicating that the risks associated with the fiscal problems of the peripheral countries had reduced. In particular, the potential for contagion – the process whereby problems in one country lead to a reassessment of risks in another, with the result that the second country suffers a financial crisis – was seen to have dropped. In essence, a new financial crisis in Europe – which would have been bad news for the Central and Eastern European countries, was seen as being less likely.
As is the case in much of the emerging markets universe, particular central banks in Central and Eastern Europe are increasing official interest rates towards ‘normal’ levels. During January, the National Bank of Poland (NBP), for instance, lifted its key rate by 25 basis points to 3.75%. This marked the first rise since 2008 and followed hawkish rhetoric from NBP Governor Marek Belka.
The markets of the Middle East and North Africa (MENA) region retreated during January. This was largely the result of investors’ reaction to the political unrest in Egypt and Tunisia. As of early February, it is not possible to predict what the political landscape of either country will ultimately look like. However, we make two observations. The first is that in neither Egypt nor Tunisia are there obvious financial imbalances that can easily result in a financial crisis. The second is that actual regime change in Tunisia (and potential regime change in Egypt) does nothing to alter the long-term strengths of the MENA region, which include opportunities from infrastructure development and – in all likelihood – growth in consumer spending.
Elsewhere, the Central Bank of the Republic of Turkey (CBRT) cut its key 1-week repo rate by another 25 basis points to a new low of 6.25%. The central bank also indicated that the reserve requirement ratios that apply to Turkey’s commercial banks would be lifted further.
As we explain below, inflationary pressures were seen by investors to be a problem in India, if not across the Asia-Pacific as a whole: in Latin America, concerns over inflation also came to the fore in Brazil. During the month, the monetary policy committee of the Brazilian central bank lifted the key Selic interest rate by 50 basis points to 11.25%. The central bank had earlier increased the commercial banks’ reserve requirement ratios. Consumer price inflation in Brazil was 5.91% in calendar year 2010, well above the official target of 4.5%.
The new administration of President Dilma Rousseff announced that Brazil’s Sovereign Wealth Fund (SWF) will be permitted to trade in currency derivatives. This was seen as an indication that the authorities would like to limit (or reverse) the appreciation of the Real. Elsewhere in Latin America, Chile’s central bank surprised observers by keeping the key policy interest rate unchanged at 3.25%. Over the last few months, that central bank has clearly been tightening policy. It is possible that policy-makers would like to contain any further rises in the Chilean Peso.
Region in focus: Asia-Pacific
In general, the short- and medium- term prospects for the emerging markets of the Asia-Pacific region will depend on two issues. One is the impact of rising inflation on corporate earnings. The other is the strength of domestic demand in the various countries.
The latest weakness of the Indian stock market, for instance, suggests that many investors are concerned that higher prices for food and raw materials will cause manufacturers’ profit margins to be squeezed. In January, the Reserve Bank of India (RBI) increased its key repo rate by 25 basis points to 6.50%, which is the highest level since early 2008. The RBI has had to deal with an acceleration in wholesale price inflation from 7.5% per annum in November to 8.4% in December. To a certain extent, inflationary pressures are the result of a drought that has pushed up food prices: however, fuel and raw materials have also become more expensive.
By contrast, the major Chinese stock market indices moved sideways during January. As is the case in India, poor harvests have caused food prices to rise. Like its Indian counterpart, the People’s Bank of China has been tightening monetary policy. (In the last month that central bank has, for example, lifted the commercial banks’ reserve requirement ratios – the percentage of their deposits that must be held as cash or deposited with the central bank – for the seventh time since early 2010). However, non-food inflation in China has been fairly benign.
More importantly, we think that the economic prospects for China are better than are generally envisaged by stock market participants. China’s economy grew by 10.3% last year. Looking forward, we expect both industrial output and domestic consumption to continue to expand quite rapidly. In our view, Chinese companies are attractively valued. We are positive about the prospects for telecommunications equipment vendors. Stocks that can benefit from the growth of China’s – already large – middle classes should, we believe, also perform well.
South Korea is another major market in the region that should, we believe, perform well over the coming year. Thanks to the recovery in the global economy – but especially in the emerging markets – the country’s multi-national corporate giants are enjoying very strong sales. Hyundai Motor, for instance, is running its car plants in China and the USA – as well as at home in South Korea – at above 100% capacity utilisation levels.
One implication of this is that the multi-nationals will have to invest in new plants over the next year or so – and a number of leading South Korean companies will be able to benefit. Hyundai Heavy Industries, for instance, which is the world’s largest shipbuilder, is benefiting from the normalisation of demand for new vessels after the implosion of 2008/09. However, it also derives a large part of its revenue and earnings from non-shipbuilding businesses such as power plants, diesel engines and construction equipment. Hyundai Heavy Industry supplies industrial customers in China and the Middle East – as well as companies in Europe and the USA that are investing once more.
Furthermore, we are confident that domestic demand in South Korea itself can grow in a sustainable way. Consumer spending is picking up as South Korean households recover from the challenges of the global financial crisis. One company that should benefit from this is Lotte Shopping. Lotte is the largest retailer in South Korea and one of the largest in Asia. It is enjoying strong increases in its department stores, discount superstores and supermarkets.
In Southeast Asia, Indonesia’s stock market was falling for much of January. Investors were anxious about mounting inflation, the headline rate of which is just under 7%. For the time being, Bank Indonesia, the central bank, has not seen fit to lift official interest rates. However, we think that investors’ fears are unjustified. Indonesia is a country where businesses, households and policy-makers are accustomed to high inflation. Indonesia’s economy has grown rapidly even when the rate of inflation has been well above the current level. Indonesia’s improving macro-economic fundamentals are reflected in the decision of Moody’s Investor Services to lift Indonesia’s credit rating to Ba1, which is one notch below investment grade. In short, we think that Indonesia is very near the point where interest rates will come down substantially because investors’ perceptions of risk are improving.
We also note that commodity/food price- driven inflation is actually good news for Southeast Asian countries such as Thailand, Malaysia (and, to a degree, Indonesia). This is because these countries are major net exporters of food. The main impact of higher commodity/food prices is enlarged household incomes in rural areas, and not a compression in manufacturers’ profit margins. For particular commodities, the Southeast Asian countries are leading producers in global terms: Malaysia and Indonesia together, for instance, account for about 90% of the production of the world’s palm oil.
There is no reason why the Southeast Asian countries cannot be among the fastest growing economies in the world over the medium-term. Generally, their demographic profiles are ‘young’: workforces and household incomes are rising. Banking systems are, for the most part, under-developed: this means that many households have significant capacity to borrow in order to pay for the goods and services that they consume. Unlike in much of the developed world, government finances are in good shape. This means that infrastructure spending should be a key driver of economic expansion.
Two of the best performing stock markets in the region since the beginning of 2011 have been Vietnam and – in spite of massive floods – Sri Lanka. Sri Lanka’s economy continues to regroup and to rebuild after three decades of civil war. An unexpected cut in official interest rates was the catalyst for the latest improvement in investors’ sentiment. The announcement of around US$1bn in new inwards investment, half of which is coming from the Shangri-La Group (which is planning to build a 500 room hotel in Colombo) has also been well received. A key development in Vietnam has been the conclusion of the Communist Party Congress, where a new political leadership was elected, with the Prime Minister serving a second term. Now that the issue of succession has been resolved, Vietnam’s government can focus on the further development of an economy that has benefited from growth in tourism and services.