The developed world debt crisis has shattered the myth about never-ending emerging market growth and exposed the complacency that had set in among developing economies and investors.
That is the view of Ruchir Sharma, head of the global emerging market equity team at Morgan Stanley Investment Management, who argues that the EM boom peaked in late 2010 after a “truly freaky” decade of growth fuelled by easy money from central banks in the West.
He couched his views to underline what he sees as a common misperception about the present economic slowdown across emerging markets (and more specifically to promote his new book, Breakout Nations: In Pursuit of the Next Economic Miracles).
“Growth rates in emerging markets have been slowing down over the past couple of years and a lot of this is attributed to the fact that there is a crisis in Europe and the US is slowing down,” he told an audience at the Foreign Correspondents Club in Hong Kong last week.
“Yes, but it also tells you that this is a changed environment and that the very easy money that was available over the past decade to grow is no longer available. All these countries took that decade [2000-2010] to mean [EM growth] was a permanent levitation act.
“But a lot of Western institutions which lent to these emerging markets are no longer in a position to do so and there is now no substitution for that, so now a lot of them are falling down after making the mistake of believing their own hype.”
He identified 2003 as the touch-paper year when many emerging markets saw their economies take off fuelled by easy money started by the Federal Reserve, with annualised growth rates soaring to a mean of 7.5% between 2003-07.
“This was a unique period in economic history, we have never seen so many countries boom in unison,” he reflects. “By 2005 any man and his dog could raise money in emerging markets, and by 2010 just the dog would do. That led to talk it was inevitable emerging markets would converge with the developed world.”
But now he says Brazil will be lucky to see GDP growth of 2% in 2012, Russia 4% and India 6%. He concedes China is a different case, but no less misunderstood.
China is slowing after regularly hitting double-digit growth over the past three decades, Sharma notes, which when adjusted for exchange rates is the same level as “the gold medalists of growth” – Japan, Korea and Taiwan, which all successfully avoided the middle income trap.
“Japan, Korea and Taiwan at this stage of their development began to slow down, downshifting by about four percentage points. Japan did in the 1970s, and Korea and Taiwan in the 80s and 90s, and I think that is where China is today.”
He notes that China exports as a share of the global economy now stand at about 10%, exactly where Japan was at the peak of its boom.
But it is hard to go beyond that, he suggests, adding that the talked-of stimulus in China would likely only exacerbate an already high debt-to-GDP ratio.
He mocks, too, those who argue China needs to rebalance its economy towards consumption and away from exports. “The only reason consumption as a share of GDP is so low is because exports and investment have been growing at an even faster pace,” he says.
“China will rebalance not because consumption will accelerate but because exports and investments will begin to slow down. The convergence of the rebalancing will happen on the downside, not the upside.”
Sharma’s conclusion is that emerging markets can no longer be considered a homogenous block, and that investors must search for breakout nations that are more likely to exceed expectations rather than fall short of the hype (he warns that Myanmar could become the new Vietnam).
Nations he identifies as having promise include the Philippines, Indonesia, Poland, Turkey, Nigeria and Sri Lanka.
“You have to realise that the last decade was a freaky decade and that not every emerging market is destined to converge with the developed world,” he adds. “Now you need to look at emerging markets on an individual, country-by-country basis.”