Will Emerging Markets continue their historical outperformance?

Saturday, April 15th, 2017

Emerging markets and developing economies have become increasingly important in the global economy, not just as centers of production but also as final destinations for consumer goods and services. But can they continue to outperform developed markets over the medium term? The IMF in its latest World Economic Outlook seems to think it will be a challenge.

 

Emerging Markets

 

In the last few decades the contribution of emerging markets to global growth has been increasing rapidly. However the external environment has changed drastically over the last few years. Today the global economy is facing risks from increased protectionism in advanced economies, tighter fiscal conditions in the USA, a rebalancing of the Chinese economy and a reversal in the commodity cycle.

How does the external environment affect emerging markets? According to the IMF paper, three factors of the external environment have collectively contributed 2 per cent to per capita income growth on average in the 1975-2014 period. This accounts for more than half the medium term growth of emerging markets on average. It is therefore very important to understand how the changing external environment will affect growth going forward.

There are three main external factors that can affect emerging market growth:

  • External Demand: The amount of exports and the contribution of exports to the growth of the domestic economy. A number of economies that have heavily relied on export growth, like China, are now facing challenges due to slowing global demand
  • External Finance: The financial flows into and out of the economy. With rising US interest rates, external financing conditions for emerging markets are expected to tighten. However global investors continue to search for yield and therefore countries with stronger fundamentals may continue to benefit.
  • Commodity Terms of trade: This is the reliance of the economy on commodity prices. It provides as indication of the income gains or losses associated with changes in commodity prices for both commodity exporters and importers. The commodity terms of trade are expected to improve for emerging markets as prices recover, but the outlook remains subdued and prices are expected to approach a fraction of those prevailing in the boom years.

 

Emerging Markets

 

 

With a less buoyant external environment compared to a few years ago, emerging markets should expect a weaker growth impulse from external conditions. However, domestic policies and structural attributes of these developing economies can still mitigate the impact of these external forces. Certain domestic policies and good structural reforms can help these economies obtain a more favorable growth in the medium term.

 

 


About the author

Rishad is the founder of Kairos Capital. He started his career with Standard Chartered Wealth Management and has extensive experience in markets, particularly in terms of mutual funds and stocks.

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