Mark Mobius on the outlook for emerging markets

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This post is a guest contribution by Dr Mark Mobius, executive chairman of Templeton Asset Management.

Emerging markets surged in the second quarter of 2009 with the MSCI Emerging Markets Index returning 34.8% in US$ terms. Part of this return was due to weakness in the US dollar. A return of confidence in emerging markets, the desire for higher returns and the search for undervalued companies support the markets’ uptrend.

Latin American and Eastern European markets were among the strongest performers during the quarter, while most Asian markets also recorded strong double-digit returns. A rebound in commodity prices and stronger domestic currencies supported markets in Latin America. Asian markets continued to attract significant portfolio inflows allowing markets such as China, India and Thailand to outperform their regional counterparts. In Eastern Europe, Hungary returned 69.7% in US$ terms in part due to a strong forint. Poland returned 37.0% in US$ terms, while Russia ended the quarter up 37.8%. Turkey was among the top emerging-market performers with a return of 57.2% in US$ terms. A stronger rand led the South African market to end the three-month period with a 31.3% gain in US$ terms.

The growing assertiveness and importance of emerging markets in the global economy were demonstrated when Brazil, Russia, India and China held an inaugural summit in Russia where they called for greater involvement from emerging economies in global financial institutions. Leaders from the four countries also voiced their desire for increased economic reform.

Regional update

China‘s GDP grew 6.1% year on year in the first quarter of 2009, compared to 6.8% year on year in the last quarter of 2008. This was mainly due to a decline in export growth and lower manufacturing and industrial growth. However, investment in fixed assets increased by 28.8% year on year, as government efforts to boost economic recovery showed results. A rebound in industrial production and retail sales growth in May continued to point to the success of the government’s fiscal stimulus measures. Retail sales rose by 15.2% year on year in May, higher than the 14.8% and 11.6% y‑o-y increases in April and February 2009 respectively. Value-added output increased by 8.9% year on year in May, following a 7.3% y-o-y growth in April. Exports, however, contracted by 26.4% year on year in May due to weaker demand.

Consumer prices continued to decline, with a 1.4% y-o-y fall in May due to lower transport, food and housing costs.

Aimed at improving trade and economic relations with its global counterparts, China signed a number of agreements with the European Union, Brazil and Taiwan. China also vowed to improve cooperation with the US on climate change.

Government efforts to stimulate South Korea‘s economy showed some results in the first quarter of 2009. GDP grew 0.1% quarter on quarter, after declining by 5.1% quarter on quarter in the last three months of 2008. Key drivers included a rebound in private consumption and government expenditure. While exports declined by 4.2% quarter on quarter, the contraction was an improvement from the 8.9% q-o-q fall reported in the final quarter of 2008.

After cutting its benchmark interest rate by a total of 325 basis points (3.25%) in the preceding six months to support the domestic economy, the Central Bank left the rate unchanged at a record low of 2.0% in June.

In an effort to support the financial sector, the Financial Services Commission launched a US$15 billion fund to recapitalize the country’s largest banks.

South Korea and the US vowed to strengthen bilateral relations during a three-day US visit by President Lee Myung-bak where he met his counterpart, Barack Obama. South Korean and EU trade ministers agreed to accelerate the completion of the bilateral trade agreement. Moreover, South Korea signed a bilateral agreement with the United Arab Emirates on greater cooperation on developing the latter’s nuclear energy program.

The Mexican economy contracted by 8.2% year on year in the first quarter of 2009 as a result of declines in the manufacturing, construction, retail and tertiary services sectors. The government forecasts 2009 GDP to decline 4.1% year on year. The industrial sector continued to suffer, with production contracting by 13.2% year on year in April – more than double the 6.4% fall in March.

The Central Bank continued to lower interest rates during the quarter as part of efforts to stimulate the domestic economy. The Bank reduced its benchmark interest rate by 200 basis points (2.0%) to 4.75%.

Inflationary pressures maintained a downward trend due to lower domestic demand. Consumer prices rose by 5.98% year on year, a 7-month low and below 6% for the first time this year. This compared to an increase of 6.5% year on year in December 2008.

The International Monetary Fund (IMF) approved a US$47 billion credit line for Mexico under its new Flexible Credit Line facility as a precautionary measure.

In Brazil, the GDP declined by 1.8% year on year in the first three months of 2009, its sharpest contraction in more than 10 years. This was mainly due to weak global demand and investment in machinery and equipment, which resulted in a 15.2% y‑o‑y decline in exports and a 14.0% y-o-y drop in gross fixed capital formation. On the positive side, private consumption rose by 1.3% year on year. Moreover, the government announced additional measures to support the economy.

The Central Bank maintained an expansionary monetary policy during the quarter by cutting its benchmark interest rate by 200 basis points (2.0%) to 9.25%. Inflationary pressures also continued to ease. Consumer prices increased by 5.2% year on year, within the Bank’s target range of 2.5%-6.5%, mainly due to weaker domestic demand and lower global commodity prices.

Aimed at further boosting trade and economic relations, President Luiz Inacio Lula da Silva and Chinese President Hu Jintao signed a number of agreements pertaining to areas such as science, law, finance, energy and agriculture during the former’s recent trip to China. Lula also visited Turkey where both sides vowed to further develop bilateral relations.

South Africa’s GDP declined by 1.6% quarter on quarter and 6.4% year on year in the first quarter of 2009. Double-digit declines in the manufacturing and mining sectors had the largest impact on growth. The construction sector, in contrast, contributed to economic growth with a 9.4% increase in government infrastructure.

After cutting its benchmark interest rate twice in May, the South African Reserve Bank decided to keep the interest rate unchanged in June. The interest rate was cut by 200 basis points (2.0%) to 7.5% on news that the economy was officially in a recession and inflation remained relatively high. This brought the total rate cut to 400 basis points (4.0%) for the first six months of this year.

Inflationary pressures have also eased, with consumer prices increasing by 8.0% in May – its lowest level since December 2007.

Politically, general elections were held in April and the ruling African National Congress (ANC) Party emerged victorious, but narrowly missed achieving a two-thirds majority. Party leader Jacob Zuma was sworn in as president in May and a new cabinet was announced in June.

The Russian economy contracted by 9.8% year on year in the first quarter of 2009, compared to a 1.2% y-o-y growth in the final three months of 2008. Weakness in manufacturing and construction were the key culprits. The manufacturing sector declined by 23.5% year on year, while construction output fell by 20.9% year on year.

After increasing the benchmark interest rate by 300 basis points (3.0%) in 2008, the Central Bank switched to a loosening monetary policy in April by cutting its benchmark interest rate for the first time since June 2007. The interest rate was subsequently reduced again in May and June. In total, the interest rate was reduced by 150 basis points (1.5%) to 11.5% during the quarter.

Consumer prices increased by 12.3% year on year in May – the lowest in more than a year.

Russian officials undertook a number of overseas trips in May to strengthen economic ties with its trading partners. Prime Minister Vladimir Putin paid a visit to Japan to discuss enhancing bilateral relations in the energy and business sectors. Putin also visited Mongolia to boost cooperation in the areas of trade and economy with the signing of agreements pertaining to areas such as agriculture.

In Turkey, GDP declined by 13.3% year on year in the first three months of 2009. While growth in public spending supported GDP, contractions in private consumption, exports and gross fixed capital formation caused GDP to fall. Exports fell by 11.3% year on year while gross fixed capital formation declined by 29.7% year on year.

The Central Bank maintained an expansionary monetary policy to support the domestic economy. The Bank reduced its benchmark interest rate by 175 basis points (1.75%) to 8.75% during the three-month period ended June.

The IMF and Turkey agreed to restart stalled talks on a three-year stand-by loan agreement valued at US$25 billion-US$45 billion. Prime Minister Erdogan visited Brussels in June to accelerate European Union (EU) membership talks.

A new chapter on taxation was also opened for discussion, bringing the total number of subjects under negotiation to 11.

Foreign Minister Ahmet Davutoglu met with US Secretary of State Hillary Clinton in Washington in June, where both parties agreed to expand US-Turkey bilateral relations. Brazilian President Luiz Inacio Lula da Silva also visited Turkey in May where both sides agreed to further develop bilateral ties.

Politically, Prime Minister Recep Tayyip Erdogan reshuffled his cabinet in May. Former Foreign Minister Ali Babacan was appointed as State Minister and Deputy Minister responsible for the Turkish economy.

Outlook

The outlook for emerging markets remains positive thanks to their relatively strong fundamental characteristics and faster growth than their developed counterparts. While some emerging economies contracted in early 2009, most are expected to return to positive growth by end 2009 or 2010.

In the face of the global economic slowdown, the major markets of China and India continue to record exceptionally robust growth rates. China and India are expected to grow by 8% and 6% respectively in 2009.

The accumulation of foreign exchange reserves also puts emerging economies in a much stronger position to weather external shocks with reserves.

Moreover, an important and strong contributor to growth in emerging markets has been the growing middle class. Emerging markets account for more than 80% of the world’s population, providing them with strong purchasing power and the ability to spend their way into growth. At the forefront are markets such as China, India and Brazil.

Another area that is poised to support economic growth in emerging markets is investment, particularly in infrastructure. This is an area in which we have seen governments boost public spending in markets such as China and India. More importantly, the current valuations of emerging markets remain attractive.

Source: Mark Mobius, Templeton Asset Management – Emerging Markets Overview, June 2009.

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