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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MENA Economy, Investments and the Specter of the Arab Spring

MENA Economy, Investments and the Specter of the Arab Spring

  • The obstinate political instability has weakened the macroeconomic fundamentals of the MENA region.
  • Investor confidence has been severely impacted resulting in a decline in the FDI received by the MENA region.
  • There is an urgent need for structural business and regulatory reforms, infrastructure development, and improvement of the education system, for the region to recover from the Arab Spring and regain its position as an attractive investment destination.

In this article we try and assess the repercussions of the Arab Spring on the MENA region’s macroeconomic and investment climate. In the first half, we discuss the trend of declining GDP growth (5.6% in 2012 to 2.8% in 2013) – a trend which is more pronounced in developing oil exporting countries – and the challenges faced by the region to recover to its historic average growth rate of 4%. We then focus on the falling FDI received by the region in wake of dented investor confidence, and how non-oil manufacturing and services sectors have been impacted more than their resource-rich counterparts, thereby creating a case for structural reforms if the region has to regain its position an attractive investment destination.

  • The unrest created by the Arab Spring is not limited to the political and social spheres only; rather, the persistent political instability has weakened the macroeconomic fundamentals of the MENA region.  An October 2013 report by the World Bank – “MENA: Investing in Turbulent Times” – tracks the on-going political turmoil, and its effect on the economy and the attractiveness of the region as an investment destination.  As per the report, despite the recovery in global macroeconomic conditions, MENA region’s GDP growth is expected to come down from 5.6 percent in 2012 to 2.8 percent in 2013.  The effect of unfavorable political and social conditions is starker in case of the developing oil exporting countries (like Libya, Iran, Syria) experience greater turbulence; as a result, their GDP growth will decline from 9 percent in 2012 to -0.4 percent in 2013.  GCC oil exporters’ efforts to increase oil production will help them outperform the region’s growth in 2013, but their growth will also be lower on y/y basis, as oil production is currently at capacity in both Kuwait and the United Arab Emirates, and Qatar’s growth continues to decline due to the winding-up of its natural gas program and the fall in crude oil prices.

MENA Economy, Investments 1

                                                                        Source: World Bank 

  • Per the report, MENA may revert to its average growth rate (of the past four decades) of 4 percent in 2014, in the event of greater political stability and improved policy measures.  However, we believe that achieving the 4 percent mark will be challenging, especially in the wake of lower credit ratings, rising inflation, weaker currencies, falling exports, inflated current account deficits, and declining tourism receipts in the region.
  • The spill-over effects of the instability also include dented foreign investor confidence, which has resulted in a decline in the FDI received by the region.  It is well known that political stability and favourable policy are among the key drivers of FDI into emerging markets. Therefore, it is not surprising that the onset of the Arab Spring coincides with a decline in FDI inflows into the MENA region.  A comparison of FDI inflows (see chart below) shows that while other developing countries were able to maintain FDI inflows post the financial crisis, MENA countries – developed as well as developing – experienced a huge drop in FDI inflows starting 2011-2012. This period coincides with the phase of extreme political and social turmoil in the region, where governments were overthrown in Egypt, Tunisia, Libya, and Yemen; civil wars erupted in Libya and Syria; and major protests were staged in Bahrain, Jordan, and Lebanon.

MENA Economy, Investments 2

                                                                        Source: World Bank

  • Finally, while FDI inflow into resource rich sectors remains unaffected by the political situation, FDI into non-oil manufacturing and services sectors declined to the political-instability and unfavourable policies. As per FDI Markets data cited by the report, resources & oil manufacturing and non-tradable sectors were recipients of Greenfield FDI worth USD 540 billion from 2003-12, which is ~50 percent higher than the amount received by non-oil manufacturing and commercial services sectors in the same time frame. One of the key reasons for this difference is the lack of democratic accountability, government instability, unstable business environment, and conflicts in the region, which matter more to foreign investors looking at the non-resource tradable and services sectors. Therefore, it is not surprising that while FDI investments focused on resource-rich sectors remained largely unaffected by the political situation, and the already low FDI to manufacturing and services sectors declined further due to the crisis, thereby depriving the region of efficiency seeking investments, which are necessary for job creation, technology enhancement, and sustainable growth of the region.

We believe that the facts above clearly highlight that finding solutions to the political situation should be a priority for MENA leaders.  However, we also believe that the need for structural business and regulatory reforms, law enforcement, infrastructure development, and improvement of the education system is higher than ever now, for the region to recover from the Arab Spring and regain its position as an attractive investment destination.

The article is written by Faisal Hasan for Arab Business Review

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