Since the turn of the year, emerging markets have enjoyed strong performance. This rebound has been spurred by a de-pricing of the tail risk in China.
The market realised that, despite the challenging situation in China, the authorities are in control and have the ability to deal with their vast stock of debt and spare industrial capacity.
Alongside this, emerging markets have benefited from a number of other exogenous influences. The significant rebound in commodity prices has coincided with all big commodities exporters slashing their forecasts. This will enable emerging markets to be more flexible with their budget for 2016. This also coincides with an improvement in competitiveness for emerging markets as most exchange rates depreciated significantly over the past three years.
Additionally, over the past two years productivity gains have been strong and unit labour costs have risen less compared to the developed world. The present conditions are now favourable for an export-led recovery in emerging markets. This should help policymakers to manoeuvre more easily.
Instead of relying on developed economies, it’s time for emerging market economies to focus on achieving the structural reforms needed to adapt to a growing middle class; building economies that are more focused on services; and trying to diversify away from an excessive dependence on commodities.
| KEY FIGURES |
14.3%: China’s percentage share of the MSCI Asia Pacific index 553: Number of constituent stocks in the MSCI Emerging Markets Asia index 6.7%: Chinese Q2 year-on-year GDP growth |
In the past, reforms in the emerging markets have been aimed at reducing external vulnerabilities by introducing flexible exchange rates, reducing the dependence of financing through external debt and fiscal consolidation. A more recent trend is reforms driven by pressure from the middle classes.
Recent elections held in a number of prime countries are a manifestation of that pressure.
In India, a cross-section of the population elected Narendra Modi on his promise to boost investment and reduce corruption. Cutting red tape and setting growth and profit targets for state-controlled enterprises should stimulate the economy and restore profitability and investments.
In Indonesia, the election of Joko Widodo as president also corresponds to an aspiration for more transparency and business-friendly reforms.
Finally, in China the rapidly growing middle class, associated with the current transition towards a consumer- and service-led economy, also wants a more transparent and efficient economy.
These messages were heard loud and clear by the new leadership, who embarked on rationalisation of the vast state-owned enterprises sector. This will reallocate unproductive capital, reduce overcapacity and allow the private and public sector to compete on an equal footing. It should prove highly beneficial for the Chinese market and economy in the medium term, although could be distressing in the short term.
The recent rebound in emerging markets will allow policymakers to breathe more easily, but is not a reason to be complacent. Indeed, recent examples have shown that reforms are not being exclusively driven by market forces anymore, but by pressure from the middle classes. This pressure is showing no sign of diminishing.
