The transformative economic reforms initiated by China in 1979 brought average growth to around 10 per cent per annum. Through trade and investment, China has become profoundly influential in other countries’ economies and its breakneck growth has been characterized by high levels of fixed investment, much of it funded by debt. Now the country must undertake a difficult transition towards a more balanced growth model, in which domestic consumption plays a more important role. This change is expected to result in significantly lower growth.
Some contend that China’s slowdown is a general warning that emerging markets are no longer attractive targets for investment. However, China’s model is not the only route to economic prosperity and other nations, such as Vietnam, have become lower cost alternatives to China for inward investment.
Growth beyond China
Emerging nations can catch up with other economic leaders who have followed differing paths to prosperity—like Japan, for example, which led the way in manufacturing; Germany, which is a global leader in engineering; or Australia, which is a dominant exporter of commodities. Or some could follow the balanced approach exemplified by the U.S. Whichever path emerging nations take, they will be helped by the more stable basis for growth that has developed in recent years in the form of greater fiscal responsibility, improved central bank independence, and less reliance on borrowing in foreign currencies. Nevertheless, such reforms have not been uniform across countries, and problems, such as corruption, persist.
All emerging markets have high potential rates of growth because they are at a lower level of productivity than richer nations, but the actual rate of growth depends partly on their natural attributes (i.e., resources and demographics), and also on the policies and politics they pursue. Sustainability of growth also varies. Some countries, such as Turkey, have strong growth but suffer from imbalances such as current account deficits, which make them vulnerable to future volatility. The credibility of political and economic institutions also has a bearing. For example, owing to its political failings, Argentina has had serial debt defaults despite economic advantages. Others, such as Colombia, have made more progress than is appreciated.
Finding the winners among emerging markets can be worthwhile for both bond and equity investors. Higher growth is naturally beneficial to equity returns and, if sustainably based, should also lead to falling risk premiums in emerging markets bonds. Finally, growing productivity should help currencies appreciate if economic governance also controls inflation. Regardless of China’s slowdown, emerging markets remain an exciting investment opportunity.
Kenneth Barker is director, clients department, Baillie Gifford