Lead Securities Market Specialist, Securities Markets Group, The World Bank.1 .... However, these are based on assumptions that EMEs will .... Source: Blackrock ETF Landscape, Emerging Market ETFs Industry Review, November 2010. 300.
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Foreword Otaviano Canuto
Catiana García-Kilroy
Anderson Caputo Silva
by Otaviano Canuto, Vice President and Head of the Poverty Reduction and Economic Management (PREM), Catiana García-Kilroy, Senior Securities Markets Specialist, and Anderson Caputo Silva, Lead Securities Market Specialist, Securities Markets Group, The World Bank.1
Almost three years after the crisis, the new reality reflects the consolidation of a progressive tectonic plate shift initiated a decade ago. Emerging economies (EMEs) are now, with no doubt, at the centre stage of growth and stability in the world economy. This is already having a radical impact on the investment landscape and can be expected to continue. However, EMEs have no room for complacency, as there are two critical factors that can be expected to threaten their new position. Growth without structural reforms is concealing problems that can be seriously destabilising in the future. Globalisation has created interdependencies between EMEs and advanced economies (AEs) that are here to stay, and will continue to count heavily on the economic outcomes of both groups. Understanding and taking action on those two factors as they develop will be essential for policy makers and investors. Differentiation among EMEs in their potential for continuous growth and stability will depend on those actions.
The consolidation of the tectonic plate shift
support a larger margin of manoeuvre for EMEs while limiting growth potential and policy options for AEs. Gross debt over GDP in AEs is expected to be over three times larger than that
EMEs have acted as engines of global economic growth
of EMEs as of end-2011: 103% versus 33% (see Exhibit 2).
and are expected to continue increasing their share over
Fiscal deficit may improve in AEs with recovering GDP growth
total GDP.2 In 2010 their share of global GDP growth was
and austerity packages but it is still expected to be more than
almost 70%. On purchasing power parity (PPP) terms EMEs
double the size of fiscal deficits in EMEs: 6.8% versus 2.7% in
will account for more than half of world GDP (see Exhibit
2011 and 5.3% versus 2.2% in 2012.3
1). This is largely linked to continued EMEs support for The successful and sustained growth story in EMEs is fiscal and monetary discipline, but is also dependent on a counterbalanced by higher and growing inflation new wave of structural reforms to increase output pressures: 6.61% in 2010 and expected 6.51% in 2011 potential and reduce dependency on exports. versus 1.88% and 2.11% for the same years in AEs. This is a Debt and fiscal balances differentials between the two groups
symptom of risks confronted by EMEs as their successful
are a core feature of the ongoing balance shift and will
growth story unfolds, as will be explained below.
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EMEs’ growing share of world GDP
Exhibit 1
GDP based on PPP share of world total 70 60 50
%
40 30 20 10 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 n Emerging and developing economies
Source: IMF, World Economic Outlook Database, April 2011
EMEs’ versus AEs’ gross debt over GDP
Exhibit 2
General government gross debt 120 100 80 % of GDP
2
n AEs
60 40 20 0 2000
2001
2002 n AEs
2003
2004
2005
2006
2007
2008
2009
n Emerging and developing economies
Source: IMF, World Economic Outlook Database, April 2011
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2011
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Narrowing credit default swaps (CDS) spreads
Exhibit 3
5Y CDS Rates, regional averages 600 500
bps
400 300 200 100 0 Jun 09
Sep 09
Dec 09
Asia
Mar 10
Jun 10
ECA/SSA
Sep 10
Dec 10
LAC
Mar 1
Jun 11
Mature markets
* Countries included in regional index: Asia: China, Indonesia, Malaysia, Philippines and Thailand; ECA/SSA: Croatia, Hungary, Kazakhstan, Poland, Romania, Russian Federation, Slovak Republic, Turkey, Ukraine and South Africa; LAC: Argentina, Brazil, Chile, Colombia, Mexico and Peru; Mature markets: UK, Japan and Germany.
Source: Bloomberg
In all, comparisons above weigh highly in favour of EMEs.
narrow impressive gaps with AEs regarding their level of
This is reflected in the large number of credit rating
financial market development. In spite of a much faster
upgrades among EMEs since 2000 and continuous portfolio
growth over the past decade, the stock of equity and debt
investment inflows now above pre-crisis levels.
in EMEs accounted for only 18% of the world’s total
All EMEs’ indices are now investment grade and their local
financial stock at the end of 2010. 4 These figures are set
market segment for bonds has outperformed all asset
for a remarkable transformation. Emerging equity market
classes since the financial crisis, except for gold (following
could reach 55% of global equity market cap by 2030 (from
the GBI-EM index). The last credit rating in AEs took place
31% in 2010).5 Similarly, the share of EMEs in global debt
in 2007 whereas, since that date to May 2011, EMEs have
markets is expected to grow from 11% in 2007 to just over
received 102 credit rating upgrades.
30% by 2030 and to nearly 40% by 2050. 6
EMEs’ outperformance is reflecting higher yields and
These prospects for the development of capital markets in
currency appreciation when compared to AEs. However,
EMEs illustrate their potential in the global financial arena.
EMEs have also become safer destinations as illustrated by
However, these are based on assumptions that EMEs will
improvements in credit ratings and in narrower CDS spreads when comparing AEs and EMEs (see Exhibit 3). The favourable landscape for EMEs is paving the way to
be able to efficiently tackle the significant challenges they face, such as the need for further consolidation of growth and macroeconomic balances through structural reforms
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and accessibility of markets. These challenges are
competitiveness. Several EMEs are already facing important
discussed in the next section.
imbalances for enduring long-term growth as illustrated by higher inflation, strong credit growth and, in several notable
A warning against complacency
cases, worsening current account balances (e.g., Brazil,
EMEs should not take the current situation and positive
policy dilemmas caused by large capital inflows that are
prospects as given. The ongoing rebalancing can come to a
beyond the absorption capacity of most EMEs and therefore
halt as pre-conditions in the macroeconomic front that
accentuate macroeconomic imbalances (e.g., excess liquidity,
have boosted investors’ confidence in EMEs can
credit growth, asset price pressures), but are also highly
Turkey, India, South Africa). This is aggravated by short-term
dependent on domestic policy decisions alien to capital
deteriorate very fast, as recent experience in AEs shows.
inflows. In this context, structural reforms would be critical to EMEs are facing two great challenges to consolidate their
increase output potential and expand the available range of
position. The first one is avoiding overheating and
investable assets, so as to elude the build-up of asset
conducting structural reforms to ensure sustainable growth.
bubbles. Depending on the country, reforms should include
Current growth rates can conceal problems that could
infrastructure, taxes, further liberalisation of the economy
compromise long-term fiscal policy, price stability and
and address pressing social needs in education and health.
The risk of overheating in EMEs
4
Exhibit 4 Current account balance 0 -10
2009
-30 -40 -60
2010
-70
2011
Current account balance
% of GDP
Real credit growth
yoy % change
2011
-50
2009
40 35 30 25 20 15 10 5 0 -5 -10 2009m1
2010
-20 US$bn
% change
Inflation, end of period consumer prices 16 14 12 10 8 6 4 2 0
2009m7
2010m1
2010m7 Brazil
2011m1 Turkey
0 -1 -2 -3 -4 -5 -6 -7 -8 -9
2009
India
Source: IMF, World Economic Outlook Database, April 2011
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South Africa
2011
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The second challenge is related to the broadly acknowledged interdependencies between EMEs and AEs,
What’s next for EMEs as investment destination?
in spite of the greater autonomy of the former. The debate is no longer about the extent of decoupling but how
GDP growth, particularly higher GDP per capita and a
interdependency operates as it can now be expected to be
lower income gap, is generally associated with
a constantly unfolding reality. This is a permanent legacy
availability and quality of infrastructure as well as with
of globalisation and relates to both the financial sector and
stronger institutional frameworks (governance and
the real economy. Whereas south-to-south linkages in
enforceable rule of law). These are essential pre-conditions
trading and capital flows are growing, north-south flows
for increased availability of marketable assets contributing
will still play a very relevant part in EMEs’ capacity to grow.
to sustainable rates of growth. How EMEs will deal with
EMEs’ future is also dependent on successful deleveraging
maintaining sound macroeconomic balances while
in AEs and their resumption of growth. On the investment
conducting structural reforms and improving access, under
landscape side, the risk-on risk-off trading paradigm 7
the current period of bonanza, will determine three
based on the assumption that AEs, and the dollar in
types of trends:
particular, are safe havens, even if the bad news is –
generated in AEs (e.g., eurozone or debt ceiling
A clearer differentiation by international institutional
discussions in the US), shows that increased credibility
investors between the large, most advanced EMEs as
in EMEs is not bullet-proof.
investment destinations.
5
Corporate bond in EMEs
Exhibit 5 Debt issuance in EMEs
1200
1000
US$bn
800
600
400
200
0 2000
2001
2002
2003
2004
n EM Corp debt issuance
2005
2006
2007
2008
n US Corp debt issuance
Source: Thomson IB deals and SIFMA
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Exchange traded funds (ETFs) in EMEs
Exhibit 6
ETF providing exposure to emerging markets 500
250
450
430 ETFs
350
150
# ETFs
300 250
100
200 150
ETF assets (US$bn)
200 $192.5bn
400
50
100 50
0
# ETFs
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
6
1997
1996
0
ETF assets (US$bn)
Source: Blackrock ETF Landscape, Emerging Market ETFs Industry Review, November 2010
–
The expansion into new types of assets beyond
The tectonic plate shift in favour of EMEs is unavoidable but
equities and government bonds. For example,
its outcome can be very different depending on how
corporate bonds at 50% above their pre-crisis issuance
accompanying domestic policies are designed. Local currency
volumes and ETFs with exponential growth since 2003 capital markets would be an essential pillar to manage the are already growth products (see Exhibits 5 and 6).
–
However, their growth potential can only be reached if
multiple short and long-term challenges faced by EMEs:
structural changes as mentioned above are tackled.
funding infrastructure, private sector growth and supporting
The inclusion of frontier markets in the radar screen of
financial stability. For good or bad, consequences will affect
international investors. This is already a post-crisis
both EMEs and AEs. The recent inclusion of local currency
ongoing trend focusing on several low-income bond market development in EMEs as a central topic in the countries in Sub-Saharan Africa and Asia. Some of the middle-income economies in the Middle East and North
G-20 agenda on the International Monetary System is an
Africa can also be expected to join this group if the
acknowledgment of how the future of both EMEs and AEs is
new regimes address the challenges mentioned.
tightly woven together.
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Notes
4 As a share of GDP, the gap is equally wide – total financial stock
1 The authors would like to thank Olga Akcadag for her excellent research support. The views expressed in this article are those of the authors and do not necessarily represent those of the World Bank or World Bank policy, nor do they commit the World Bank in
3
mature economies (source: ‘Mapping Global Capital Markets 2011’, McKinsey Global Institute. August 2011). 5 Goldman Sachs, 2010. EM Equity in Two Decades: A Changing Landscape. Global Economics Paper No: 204.
any way. 2
represents 197% of GDP in EMEs, compared to 427% of GDP in
Canuto, O. and Giungiale, M. (eds.) 2010. The day after tomorrow: a
6 Goldman Sachs, 2010. Emerging Market Debt: From “Niche” to “Core”.
handbook for the future of economic policies in the developing world.
7 Term coined by David Bloom of HSBC referring to correlated
Washington: World Bank. Available at
assets when investors increase or reduce their risk preference
IMF: Fiscal Monitor update, June 2011.
(risk-on versus risk-off).
7
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