IMF head Christine Lagarde probably wasn’t smiling this much when she had to apologize for her agency’s botched UK economic forecast. Photo by Pool/Getty Images.
Six months after the Fed announced the first “taper” of quantitative easing (QE), it’s clear widespread fears Emerging Markets (EM) would collapse as the Fed winds down didn’t come true. Money is still rolling into the developing world, EM stocks are up, and on balance, developing nations are growing just fine. Yet the taper terror stalwarts aren’t conceding: They’re warning the fallout was merely delayed—and worsened—by the fact US interest rates stayed relatively low. Apparently, that’s why investment flows stayed positive, which is causing EM governments to delay economic reforms, which will both condemn them to slower long-term economic growth and make them even more vulnerable once the music stops—which will then put a strain on the rest of the world. Convoluted? Yes. Valid? Probably not. In our view, taper terror 2.0 isn’t any likelier to come true than the original—it’s just another brick in the wall of worry.
The supporting evidence for the latest doom and gloom, predictably, is the IMF’s and World Bank’s updated growth forecasts. Both lowered their outlook for EM, citing lackluster economic reform progress. And both claim easy money in the developed world and fiscal stimulus in developing nations are the only things keeping the party going. When they end, EM nations’ enviable growth ends, unless structural reforms accelerate.
Now, as we’ve shown here, here and here, the whole “easy money” notion is misplaced. There is no evidence QE is propping up the developing world. According to data from the Institute of International Finance (IIF), private capital inflows into the developing world, though high, are still a bit below 2007’s level. As a percentage of GDP, they’re down to levels seen a decade ago.i Seems to us continued growth just created more opportunities for investment. As for fiscal stimulus, most of that argument rests on China’s stimublitz of 2008/2009—not exactly a material growth driver in 2011, 2012 or 2013. Overall and on average, there is nothing artificial about recent EM growth, and there is no reason for EM growth to stop when QE stops or interest rates rise. (And no reason the world would even need to rely on EM for growth once developed-world monetary policy gets “tighter,” but that’s an entirely different article.)
Those factoids alone should put a stake in taper terror 2.0. But the reform aspect transcends the taper. Setting aside the issue of QE entirely, structural reforms have been a key driver of the developing world’s progress in recent years. If these were to slow significantly or reverse, it would be a negative.
That said, we don’t see much evidence of a slowdown or U-turn. There are anecdotes—Indonesia waffling on ending fuel subsidies, India enacting new restrictions on onion exports, Turkey’s Prime Minister once again pushing the central bank to cut rates—but there is plenty of positive progress. Just this week, Thailand ended its controversial and economically destructive rice subsidy program. Mexico is pushing ahead with the second round of legislation to open its Energy sector to private and foreign investment. Brazil is reportedly about to ease regulations in its industrial sector. China’s latest mini-stimulus plan was built around private investment in infrastructure and small business. Korean President Park Geun-hye marked her first year in office by announcing a host of deregulatory measures in February. And Korea’s private sector seems to be voluntarily reforming itself: Some of the biggest family-run mega conglomerates (aka chaebol) appear to be taking steps toward restructuring as holding companies, potentially pre-empting official efforts to crack down on them (one of Park’s as-yet unfilled campaign pledges) and perhaps sparing markets the angst of dealing with intervention.
We could go on, but you get the drift. Broad-based reform continues. It probably won’t boost growth overnight—structural changes tend to have a delayed but longer-lasting impact than quick stimulus—but it should provide more incentives and opportunities for private firms to invest in the developing world. That’s true whether we’re talking portfolio investment, joint ventures with local firms or full-fledged expansion—all are beneficial and very long-term positives. Yet, based on the limited coverage we’ve seen, most folks don’t fully appreciate this. Instead, attention gets heaped on two supranational organizations with long track records of using their economic forecasts to exert political influence (and then having to eat crow when reality proves them wrong).
Even if EM growth slows some and reform moves in fits and starts, this isn’t necessarily a negative for stocks in EM or globally—it’s more or less normal. As we’ve seen in China, growth can slow some without bringing big disruptions globally. It’s also natural for growth rates to slow as countries get bigger—when the growth base is larger, a comparable dollar-based GDP increase gets smaller in percentage terms. That’s math, not weakness. As for reform, fitful progress has been the norm for about two decades. It’s abundantly clear stocks don’t need to see an avalanche of market-oriented changes to do overall fine. They simply need the reality of reform to beat expectations. To us, expectations seem awfully low, and a fair amount of progress seems to be sliding under the radar—a rather bullish disconnect.
This isn’t to say EM stocks outperform wildly—or even at all. But it does strongly suggest fears of developing world weakness and policy malaise wreaking havoc globally are pretty wide of reality. For stocks, this is likely just another false fear keeping sentiment down and the wall of worry alive—bullish whether you own EM stocks or stick with the developed world.
i The IIF’s definition of Emerging Markets differs from MSCI’s. It excludes Greece and Qatar and includes several frontier markets, like Argentina, Ukraine and Venezuela.