The economic forecasters back up the bulls. Southeast Asia is predicted to grow faster than 6 percent, Russia and Poland more than 5 percent, Africa better than 4 percent, and even beleaguered Latin America is expected to rise above 3 percent. According to Global Insight’s research, the growth rebound will be most dramatic in current or former pariah economies: Venezuela will snap back from a 10 percent recession in 2003 to top 5 percent this year, and growth in war-torn Iraq will jump from negative 21.2 percent to a positive 39.7 percent.
Investors are putting their money where the growth is. A report released last week by the fund researcher EmergingPortfolio.com showed that 2003 was a record year for inflows into equity and fixed-income funds focusing on emerging markets. The new year is off to an equally strong start, with $350.4 million of new money going to emerging markets in the first week of 2004 alone. Indeed the new passion for the far-flung inspired a warning last week from the Institute of International Finance (IIF), which represents big banks and investment firms. Officials of the group said emerging- market asset prices appeared to be “moving ahead of fundamentals, as was the case in 1997 before the Asian financial crisis.”
So why are investors running back to Thailand and South Korea when the United States is forecast to grow a healthy 4 percent? “As strong as the U.S. is going to be, a number of key emerging markets will grow even faster,” says Nariman Behravesh, chief economist for Global Insight.
The growth is driven by the global upturn, but also by the mini-locomotive effect of Asia, and in particular China, which accounted for 13 percent of global economic growth last year. While Chinese exports have been growing about 30 percent per year, its imports have grown even faster, about 40 percent last year. China buys between 20 and 25 percent of the globally traded volume of many key commodities, like iron ore. This has boosted exports and raised growth prospects for many emerging nations that rely on commodity exports.
Asia, led by China, is now the major consumer of Nigerian oil, boosting prosperity in West Africa. The Chinese are snapping up soy in Brazil, copper in Chile and timber and metals in Southeast Asia and Africa. “In economic terms, China is coming to occupy the same space in emerging markets that the U.S. occupies in the larger world,” says Sharma. The Indonesians are expected to lose 150,000 jobs to China this year in textiles alone, yet they are also expected to see GNP growth jump from 3.8 percent last year to 5 percent in 2004, in part due to Chinese demand for Indonesian petroleum products, palm oil and rubber.
Of course, China won’t have a net positive effect in every market. Oil-importing countries like South Africa could suffer as Chinese demand pushes up commodity prices, forcing them to pay heftier energy bills. South Africa’s strong European trade links could also be a liability as the euro value remains high. The same is true for other African countries like Chad and Cote d’Ivoire with currencies linked to the euro.
Even the optimists are picking with care. Merrill Lynch released a report earlier this month recommending numerous emerging-market plays, like Indian banking stocks and Thai construction and telecom equities. The thinking is that emerging stocks are still trading at a 35 percent discount to stocks in New York or Tokyo, and they started so low that there’s still plenty of room for improvement.
It’s best to remember that emerging markets are a mixed bag. While the IIF cited markets like Poland, the Philippines and Venezuela as overpriced bets on weak debtors, investors have faith in reform elsewhere. “We had seen some reform fatigue in the late 1990s,” says Merrill Lynch emerging-market strategist Tulio Vera. “But as the economy has picked up, countries are more able and willing to kick-start new efforts.” One source of optimism is India, which last month raised the limit on foreign investment in private banks from 49 percent to 74 percent. Asia’s budget surpluses are impressing investors, as are Brazil’s pension and tax reforms. South Korea has pulled itself back from a credit crisis, and consumer confidence there is rising. In short, says Global Insight’s Behravesh, “It’s too early to say that it will all end in tears.”
He and others believe that if Asians in particular continue to restrain public spending, emerging-market growth should continue well into the new year. The big question, as always, centers on China. If inflation in China were to rise quickly and drive up prices in the United States, too, that could prompt the Fed into raising interest rates too quickly. Higher interest rates means loans would become more expensive, which could result in a crushing debt load for countries like Brazil or Argentina. A similar situation prompted the Mexico crisis back in 1994, and put an end to the last golden era of emerging markets.
That’s why China and its exchange-rate policy will be a hot topic at Davos. If the Chinese can bite the bullet and let their currency rise, rather than maintaining its strict peg to the falling dollar, the stronger renminbi would help defuse the risk of economic overheating and dampen the inflation threat. If, on the other hand, inflation strikes, investors may come to wish they had been content with lower returns in the major markets.
