Can Investors Bet on a Broad Emerging Markets Recovery?

Can Investors Bet on a Broad Emerging Markets Recovery

  • Following the 2008 financial crisis, emerging economies rebounded. But since 2011 things have changed.
  • Emerging economies are now richer than ever. And while these countries still have an opportunity to grow in the future, their growth rates are likely to be slower than in the past. 
  • As advanced economies recover and their monetary policies return to more conventional policies, further weakness in emerging markets’ equities and bond markets is expected.

During the global financial crisis the world economy stabilized thanks to vibrant emerging markets. Now, emerging economies are weakened by slower growth, rising financial vulnerabilities, and outflow of capital attracted by higher interest rates in the U.S.

What happened after the financial crisis?
Following the 2008 financial crisis, emerging economies rebounded. But since 2011 things have changed. In 2013 growth was 4.5 percent, compared with 6.5 percent two years earlier. Except for Arica, all emerging market regions were marked by some form of economic slowdown. These were the growth rates of the following areas in 2013 : Russia (1.5%), developing Asia (6.5%), Latin America (2.6%), MENA (2.4%), and Central and Eastern Europe (2.5%).
Emerging economies are now richer than ever. And while these countries still have an opportunity to grow in the future, their growth rates are likely to be slower than in the past. This is normal when a country’s catching-up process succeeds in raising its per capita income and its economy approaches a steady state. For example, Chinese GDP per capita tripled in a decade. At 7.5% in 2013 and 7.3% in 2014, China’s growth is lower than during the past decade, but it remains strong for a country where the GDP per capita is about to reach $10,000 this year.
The problem is that Chinese growth is unbalanced. China’s economy continues to rely on high investment and too much credit. In contrast, consumption is weak; it only represents 35% of the GDP. This low level of consumption reflects the macroeconomic challenges faced by the world’s second largest economy—as it redistributes income in a way that enables sustainable growth—and a larger middle class that benefits the economy by enabling more people to be consumers.
In other emerging and developing countries the problem is reversed. Consumption is too dynamic compared to production capacities, and growth is blocked by supply constraints and a lack of investment. Thus, in places like India, Brazil, Turkey, Indonesia, and South Africa current account deficits have widened to alarming levels .
These external imbalances in emerging countries indicate a contradiction between the aspirations of a growing and educated middle class—looking for more consumption—and production whose development is impeded by the lack of investment and inefficiency of the administration. Lately, these contradictions have resulted in growing political tensions (in Brazil, Turkey, and Ukraine) and increased financial fragility.
Countries with high external deficits are usually vulnerable to unexpected monetary shocks, leading to capital outflows. When the U.S. Federal Reserve hinted at its intention to put an end to its accommodative monetary policy last summer, many emerging markets—particularly those with weak fundamentals—experienced strong reversals of capital inflows as investors reacted to the expected “tempering” by reducing their investments in riskier assets (including the assets of emerging markets).
What to expect?
Renewed troubles and retrenchments of capital flows have certainly not led to a new financial crisis, and none of the emerging countries have defaulted on their debt or called for the IMF’s support (which was often the case in the 1990s).
Whereas this is a strong sign that emerging economies have become stronger, the cost of external financing for these countries increased, their currencies depreciated, and their monetary authorities had to raise interest rates (to contain inflationary pressures). All the same, equities and bond markets dropped.
Fighting inflation and preventing a currency from depreciating require tighter monetary policies. But this hampers domestic demand and weakens growth. Moreover, currency depreciations aggravate public deficits and create the sentiment that emerging countries are less able to service their debts denominated in foreign currencies.
As advanced economies recover and their monetary policies return to more conventional policies, further weakness in emerging markets’ equities and bond markets is expected. Emerging markets will face challenging headwinds this year.

The article is written by Dr. Charbel Cordahi for Arab Business Review

To read more thought-leadership stuff by leaders from Arab Region, please visit Arab Business Review

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The Dutch Disease that plagues Rentier Iraq

The Dutch Disease that plagues Rentier Iraq

 

  • Some of the symptoms of Dutch disease are that it creates very rich countries but poor citizens, and high financial revenues with few job opportunities.
  • Oil export increase raises the value of the local currency but it makes the national industry less competitive with goods of other countries.
  • To worsen the situation, the government of oil-producing country is not linked to citizens as it does not need them, because it receives its vast resources from oil industry. 
  • Getting rid of the resource curse that has hit the economy of Iraq and infected its political system requires several solutions including the diversification of the country’s exports to be free of the single-source economy, which depends on oil. 

Iraq seems to be hit by many curses. Among those, the most serious is the resource curse, or what is so called (Dutch Disease).

This word was first used as a term in 1977 and can be defined as a set of negative effects that badly influence the establishment of proper economy. Some of the symptoms of Dutch disease are that it creates very rich countries but poor citizens.

It also provides greater financial revenues with few job opportunities. That’s applied in Iraq. This disease has previously struck other countries in addition to Netherlands, such as Spain, Australia and Nigeria.

Oil export increase raises the value of the local currency but it makes the national industry less competitive with goods of other countries. On the other hand, the oil market is unstable with volatile prices. Also this industry is one of those, which doesn’t absorb unemployment, requires intensive and immense capital and labor at professional level of skills.

Perhaps the most serious symptoms of Dutch disease are those related to the side effects of the disease, as the crisis transit from the field of economics to the field of political practice. Rentier states and those countries, whose economy depends entirely on oil, suffer from some governments that give all their efforts to the perpetuation of the existing political regime at the expense of the fundamental goals of the state.

In addition to this, the government of oil-producing country is not linked to citizens as it does not need him, because it receives its vast resources from oil industry. When citizens do not pay taxes, they have that feeling of separation along with their government, especially when the state/ Government turned into a shop that sells oil.

The government, then, is not afraid of citizen accountability, because citizen does not supply the country’s economy. Thereof, it is reflected in the political performance of the governments of such Rentier states. That actually leads to a political climate in which the authoritarian tendencies and dictatorial aspects are vivid in addition to mating between wealth and power.

So Dutch disease contributes to the creation of a more centralized state, through which the government spending is doubled. Moreover, it makes the citizen’s capability of formulation of public policies shrinks and that generates an atmosphere of discontent among those who are marginalized- the people, and helps the government to enhance its repressive means to keep the situation unchanged. This situation has plagued Iraq since several decades when oil was discovered. Current and previous governments of Iraq have abused the oil fortunes to create regimes and to ensure their stay in power as long as possible. These governments are used to distributing donations to those who are close and loyal to them neglecting the vast majority who is getting crumbs in their rich country.

Although the new political system in Iraq, after the fall of the former regime, is based on a democratic basis and a constitution, which guarantees the independence of the three powers (Legislative, Executive and Judiciary) and allow those powers to derive their legitimacy from the people as the source for all authorities, influential political blocs are formed. Those blocs collected fortunes through their political status, and acquired huge privileges concerning oil, as well as the exploitation of public money in the purchase of consciences especially in the election season to get the votes of the electorates, in addition to widespread administrative and financial corruption.

Getting rid of the resource curse that has hit the economy of Iraq and infected its political system requires several solutions including the diversification of the country’s exports to be free of the single-source economy, which depends on oil. It also requires a policy of decentralization in the organization of the oil industry and the applying the principle of transparency in handling this industry, in addition to the establishment of an oil fund that ensures a fair distribution of oil profits to the citizens along with developing a tax system in order to re- link the citizens to their government.

The article is written by Falah Mousa for Arab Business Review

To read more thought-leadership stuff by leaders from Arab Region, please visit Arab Business Review

Caution is the word of the day GCC Economies

Caution-GCC Economies

 

  • We live in an interconnected world and geopolitical developments in Ukraine and Syria are bound to add volatility in global geopolitical environment and influence small and large economies around the world.
  • Further, the economic environment is undergoing an unusual shift, through unorthodox and new policy making in Japan, US and Europe.
  • In such a situation small sized GCC economies, which are also dependent heavily on commodity prices and transit of goods, should exercise caution, and not get swayed by the rosy pictures stock markets around the world are painting.

 

Recent events in Ukraine and the long term unresolved situation in Syria have been the source of many questions about long term effects to the geopolitical and economic environment. Needless to say we live in a very interconnected and globalized world and such events are bound to add to an increasing volatility in the global geopolitical environment that is bound to influence economies around the world. 

Such events come on the back of a very unusual economic environment whereby we are witnessing the unfolding of unorthodox and new policy making: Japan’s monetary policy, Fed’s unwinding or fiscal stimulus, the Euro ever present crisis and a US stock market that seems to no longer relate to the real economy. Therefore, regardless of the personal opinions we may hold on any particular event it is necessary to process these events and reconcile their potential effects with the economic decisions that we make today or that we plan to make tomorrow.

CAUTION is therefore the word that comes to mind when I reconcile geopolitical events in progress with economic indicators coming out of several G7 economies. And therefore CAUTION applies to smaller size economies like the UAE or the GULF that are much dependent on both commodities prices and transit of goods. The recent over-subscription of the Dubai IPO of Marka is a sign that ought to be evaluated carefully.

I would like to motivate my CAUTION advice by aggregating some key facts from around the globe as it is often difficult to cut through the clout of main stream media and especially the halo effect of the new Dow Jones records. Following are some of the warning signs around the globe:

  • Japan: Abenomics shock economic therapy is generating concerning effects: the plunging yen has crushed the Japenese purchasing power in spite of the growth in the stock market may have given the illusion for someone to get richer. The recent 15% correction may make the illusion disappear, especially if the USD/JPY breaks below 102. At the end all that will be left for the Japanese people is a soaring energy bill and ever increasing food prices. Japanese wages have been falling for 22 straight months with a fall of 0.4% in March only. In the latest news, Sony slashes profit outlook by 70% thanks to Abenomics.
  • China: The official Chinese PMI index misses expectations. As a correlated ripple effect: Australian PMI (greatly correlated to China) declined by more than 3 percentage points to its lowest point in nine months (6 consequent months of contraction);
  • USD: While the Dow Jones seems to continue its rally some of the fundamentals of the US economy don’t seem very rosy, signaling once again a strong decoupling between the stock market and the “real” economy. The below data doesn’t give us much confidence in US consumer spending and overall US demand.
    • During the “recovery” period 2010-14 employment gains have taken place only in low-wage industries while during the recession employment losses took place mostly in high to mid wage industries
    • While the US population has kept growing since 2007 there are approximately 1.3 million jobs less
    • 20% of US families don’t have at least a family member employed
    • Consumer spending for durable goods in the USA has dropped 3.23% since last November 2013
      • Lower-wage industries constituted 22 percent of recession losses, but 44 percent of recovery growth.
      • Mid-wage industries constituted 37 percent of recession losses, but only 26 percent of recovery growth.
      • Higher-wage industries constituted 41 percent of recession losses, and 30 percent of recovery growth.
    • As of today 56% of US citizen own subprime credit
    • 90% of the jobs in the USA pay an average of less than 35,000 USD per year
  • Ukraine: the instability is bound to generate a more rigid contraposition between Russia on one side and the USD & Europe on the other. While sanctions so far have been more formal than substantial the rhetoric is increasing on both sides and there may be instability pass onto the economic system increasing its volatility and impacting energy prices.
  • EU parliamentary elections: while the EU periphery keeps on evidencing clear signs of weakness (Italy, Greece, Spain, Portugal) new elections are looming. Word from the street is that parties against the EURO are gaining significant strength and are bound to acquire a sizeable stake in the new European parliament. If that turns into reality there may be some hard questions put on the plate of the European Union leadership and whether fundamental union regulations are to be readdressed.

Therefore, CAUTION must be the word of the day. In the post 2008 world we have accepted as systemic a much higher volatility index which makes it a bit more difficult to evaluate wider base economic and stock market swings. We just need to analyze the speeches of the heads of the Central Banks to realize that they are leaving for themselves wide arrays of options sometimes at odds with each other. Economic indicators are more difficult to read. In such an environment positions should be short, optimism measured and cash an invaluable asset to give investors the ability to ride with profits both the “bull” and perhaps the “bear” coming our way. 

Sources:

http://economyincrisis.org/content/all-sign-point-to-a-servant-economy

http://www.nelp.org/page/content/lowwagerecovery2014/

http://time.com/2742/nearly-half-of-america-lives-paycheck-to-paycheck/

http://www.bls.gov/news.release/ocwage.nr0.htm?_ga=1.73666065.22471688.1396473081

 

The article is written by Luca Gorlero for Arab Business Review

To read more thought-leadership stuff by leaders from Arab Region, please visit Arab Business Review