Far East & Emerging Markets

24 Jan 2020

As highlighted earlier, emerging markets have borne their fair share of the downward revisions to global economic growth in 2019.  In light of the trade tensions that were prevalent (and escalating) for much of the year, such an outcome was unsurprising given the open nature of many of the economies to global trade. 

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However the year has ended with the likely prospect that the first phase of an agreement between the US and China will be signed very soon, although it is probable that sparring between these parties will remain a feature for many years to come, given the issues yet to be resolved covering intellectual property and technology transfer.  Those risks might intensify as those topics might be even harder to resolve if there were to be a Democrat in the White House next year, hence there is some incentive for the Chinese to keep the momentum going this year.
 
Despite all the headlines about trade, the trajectory of economic growth in China is little changed.  Growth in Q3 was reported as 6%, but manufacturing activity was a depressant with the latest purchasing managers’ data announced at 50.2, only fractionally above the psychologically important 50 level.  The authorities will want to maintain a supportive stance to growth, but are mindful of not recreating the liquidity issues that surfaced in the shadow banking system previously. 
 
Cuts to the Reserve Ratio Requirement (now at 10.5%, down from 16.5% at the start of 2018) should allow the formal (and more secure) banking regime to accommodate a shift in the growth of credit away from the shadow banking sector.   China has also been using its fiscal policy to support growth, with a rise in government deficits to finance both personal taxation cuts and for enhanced infrastructure spending, especially in the area of pollution control.
 
India has continued to disappoint with growth well below prior projections.  Q3 was measured to be a mere 4.5%, the lowest growth rate for more than five years.  A sharp rebound is expected for the fourth quarter, but still leaving the outcome for the full year at around 5.5%, well below the 7.4% achieved in 2018 and original forecasts of 6.8% for 2019. Both fixed investment and domestic consumption lay behind the weakness and prompted the Indian Central Bank to embark on a programme of rate cuts, which began from a level of 6.5% in January and finished the year at 5.15%.
The Indian Government under Mr Modi seems prepared to finance growth through looser fiscal policy, with projections that the public deficit could reach 6% of GDP this year.
In light of inflation being around the Bank’s 4% target, it is expected that interest rates can still fall a little further in forthcoming months.  The authorities also unveiled a cut to corporation tax to help revive the economy, which should facilitate an improvement in business confidence and lead to growth in the year ahead getting back above 6% by the year-end.   The Indian Government under Mr Modi seems prepared to finance growth through looser fiscal policy, with projections that the public deficit could reach 6% of GDP this year.
Some encouragement amongst the gloom is offered by the chart above, which illustrates that money supply in Europe has resumed its uptrend after the dip in Q2 and has now surpassed the peak of spring 2018.  Should international tensions dissipate and domestic demand continue to be solid, then the current bleak path for PMIs could reverse. 
 
In that regard European equities, rather like the UK but for entirely different reasons, have been neglected by global investors and look cheaply rated.  Though analysts have reduced profit forecasts for Continental equities as the months have passed since the spring, their expectation is still for 4% growth in calendar 2019 and 8% next year.  The dividend yield of c3.5% is very appealing compared with the potential returns from bonds.  In the latest quarter, shares recorded very modest gains, with Italy and France in the vanguard.
Debt levels still rising in EM
Debt levels still rising in EM chart

Source: BCA Research

Notwithstanding the undoubted superior long run potential economic growth in the emerging economies, and the relatively low rating on which their equity markets stand (less than 15X for the year just ended), many commentators point to the escalating levels of debt, as can be seen in the chart above.  In contrast to the advanced economies, where a modest rise in the level of Government debt to GDP has been offset by a fall in private sector debt (and all the more intriguing given the ultra-low interest rates available to borrowers), both Government and private sector debt levels have climbed sharply – Government debt from 36% to 51% of GDP since 2011 and private sector debt from 96% to 141% over the same period (and this despite the much higher prevailing interest rates).  Given that total debt levels are still some way below those in the advanced world, this is not yet a red flag to investors, but the trend needs to be watched carefully, especially if a period of faster economic growth does not emerge.

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