In October the International Monetary Fund raised its forecast for global growth in 2010 from 2.6 per cent to 3.2 per cent and revealed that emerging economies, particularly China and India, would lead the world economy out of recession with an overall growth rate of 5.5 per cent. During the third quarter of 2009 China's GDP alone expanded at an annual pace of 8.9 per cent.
In contrast with the difficult conditions prevalent in Western economies, key emerging countries are demonstrating a strong ability to rely on their long-term domestic structural growth drivers and on their capacity to reform in difficult economic times. Emerging market economies in all regions, in fact, are recovering impressively from last year's crisis - we can say that they have truly decoupled.
The MSCI Emerging Markets Index has already risen by 71 per cent YTD in 2009 (as at November 12). The rally has been supported by a recovery in risk appetite thanks to government stimulus and inventory rebuilding. In comparison, the S&P 500 has risen a mere 14.7 per cent from the start of 2009.
On a GDP basis, the emerging world is dominated by the BRIC economies (Brazil, Russia, India and China). Over the last decade, emerging markets (especially China and India) have shown growth rates well in excess of developed countries.
Asian economies have been recovering strongly from the recent violent downturn. A few important factors have contributed to this outcome - relatively strong banking systems, sound policy making (assisted by hard-won recent experience of crisis in 1997-98) and China's extraordinary first-half credit surge. China's economic recovery has been dramatic and the outlook remains good.
Stable growth will continue at a relatively strong (6-8 per cent) rate and will be more balanced, benefitting from both public fixed investment (infrastructure) and continued domestic liberalisation/reform. China's future policy on the Renminbi is uncertain but, sooner or later, they will have to yield to overwhelming pressure for appreciation. Meanwhile, gains are likely for most other regional currencies - especially those with similarly-solid growth prospects and positive policy trends - namely India, Indonesia and Taiwan.
The shift in economic power from West to East is underpinned by forecasts for strong productivity and economic growth, together with some strong economic fundamentals; with many emerging nations holding large foreign exchange reserves and experiencing large trade surpluses.
The anticipated strong future economic growth can be attributed to a number of factors namely the shift in focus from agriculture to industry and services (urbanisation); growth in the labour force, particularly relative to developed markets; globalisation, in particular the integration of China and India into global trade; an increasingly conducive environment for foreign direct investment; deepening capital markets; high rates of investment and the adoption of technology which has improved efficiency; and trade with other emerging economies (as opposed to the US consumer) which is increasingly important.
Developed economies (especially the US) are experiencing a relatively slow growth recovery, due to the need for the private sector to deleverage and for households to save more. In contrast, emerging economies which did not participate in the credit boom and have high surpluses (especially China and China-linked countries) are experiencing a more normal, cyclical recovery in growth.
However, while the emerging economies have the opportunity to grow at higher rates than developed markets, in order to do so there are number of conditions which must be achieved, namely economic factors - stable monetary and fiscal policies; human resources - education is an important factor in supporting rapid GDP growth, by providing a flow of skilled workers; technological capabilities - adoption of new technology is a key driver of improvements in capital efficiency; and political conditions - a robust legal system and a democratic government are most conducive to strong future economic growth.
Consequently, while the underlying growth drivers are powerful, there are a number of ways in which countries could fail to deliver on their growth prospects. As such, it is important that investors monitor developments closely and consider a diversified approach to investing.
Lately, investors have become a little wary of a potential bubble developing in emerging market stocks, as the sustained uptrend has prompted valuation concerns and has made these equities susceptible to bouts of consolidation in the short term. While some short-term market valuations look relatively expensive, there is no doubt the long-term rationale for investing in emerging markets remains very clear. But where should you invest, equities or debt (bonds)?
Emerging market equities might seem like the obvious choice, however, they do not always outperform debt.
Overall in economies experiencing high economic growth equity markets should deliver relative outperformance. However, debt should always be considered as part of a balanced portfolio. The case for investing in emerging market debt rests on the long term improvement in the economic fundamentals of emerging countries which should lead to improved credit quality, lower yields on emerging market bonds, appreciation of emerging market currencies and improved liquidity.
Emerging market economies are expected to continue to grow strongly due to a mix of rising productivity, internal consumption, government investment in infrastructure, economic and financial reforms, and favourable demographics.
There are strong arguments for a positive long term outlook for select emerging economies. However, the extent to which different countries are exposed to the key elements of the emerging market growth 'story' varies and needs to be factored into investment decisions.
The long term outlook for emerging economies should have a positive impact on emerging market related investments and in particular emerging market equities and debt.
The author is general manager of Growth Investments Ltd.
This article should not be considered as advice to invest or otherwise.
Growth Investments Ltd (C-21821) is authorised to conduct Investment Services Business by the Malta Financial Services Authority and is an enrolled Tied Insurance Intermediary of Middlesea Valletta Life Assurance Company Ltd.