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A quiet comeback is starting in emerging markets

The writer, Morgan Stanley Investment Management’s chief global strategist, is author of ‘The Ten Rules of Successful Nations’

After their worst decade since the 1930s, emerging stock markets continued to underperform as a group in 2021, deepening the isolation that surrounds this sprawling asset class. So it will come as a surprise to many that eight of the top 10, and 13 of the top 20, best-performing markets of 2021 were in the developing world.

How can that add up? Given its size, China dragged down the emerging market index. With Beijing cracking down on its big technology companies, and self-isolating in the name of economic self-reliance, the country’s stocks were hammered. China was the world’s second worst-performing market last year, ranking 58th out of 59, just ahead of Pakistan.

Every region lagged behind the US, as investors poured money into American tech giants. But, excluding China, emerging markets were up 10 per cent, in line with returns for the rest of the world outside the US. This may foreshadow a quiet comeback.

Money tends to flow into the fastest-growing economies, notably those pulling away from the pack. Emerging economies grew more than five percentage points faster than developed ones at the peak of their boom in 2009. That lead had narrowed to one point by 2020, which goes a long way to explaining a dismal decade for emerging stock markets.

Last year, however, signs of a revival outside China started to show, driven by rising prices for commodities, manufacturing strength in a few countries, rapid growth in the digital economy and the relative financial conservatism of emerging world leaders. In 2021, commodity prices saw their biggest annual gain in nearly a half century, boosting exporters. Among the top 20 hottest markets were major oil powers, including Saudi Arabia in ninth place and Russia in 19th, up 20 per cent for the year.

Though manufacturing is in global decline, it is still an important source of growth in a few emerging countries, which are gaining as factories leave China in search of lower business costs. Also among the hot markets of 2021 were manufacturing powers led by the Czech Republic in 2nd place, Vietnam in 15th and Mexico in 18th.

In the 2010s, an era of deglobalisation saw slowing flows of people, money and trade, alongside a continued explosion in data flows, which are growing fastest in emerging nations. Among the top-20 stock markets that had a boost from the ongoing digital revolution were Taiwan in 13th place, and India in 14th. 

Despite these signs of revival, many commentators fear that central bank plans to slow the pace of monetary stimulus will trigger a retreat from risk, including emerging markets, as happened during the taper tantrum of 2013. But there are big differences today.

Global investors have pulled money out of emerging markets in most years since 2013, reducing the threat of capital flight now. Over the same period, most big emerging markets have grown more financially stable, not less. Currencies are more competitively priced. Foreign exchange reserves are larger. Most big emerging countries have avoided the cardinal risk — borrowing heavily from foreigners. Current account balances, which reflect how much nations need to borrow abroad to finance their purchases, have shifted into surplus.

Talk of emerging market vulnerability now focuses on rising average debt levels, but these averages again skew the reality, distorted by China. After the 2008 financial crisis, China sucked in 70 per cent of all debt flowing to the emerging world; that share has risen to over 80 per cent during the pandemic.

In most other big emerging countries, households and corporations have barely run up debt at all and governments have accrued it less dramatically than their peers in China. Since 2019, total debt, which includes that of governments, corporations and households, is up more than 24 per cent as a share of GDP in China — well above the EM median and two to four times the increase in India, Indonesia, Mexico, Egypt or South Africa.

The global media tend to dwell on troubled cases like Turkey, but markets appear to be sensing the broader move to relative financial stability in many major emerging countries. Though economists are often a step behind, they too expect emerging nations to start re-establishing their growth lead over developed countries in coming years, according to consensus forecasts.

If the fundamentals driving commodities, manufacturing, data flows and economic reform hold up, 2021 could be remembered as the year an emerging market comeback began, even if it was not widely recognised at the time.

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