3 Major Head Winds For Emerging Markets

LONDON – After an exceptional decade of growth in emerging markets (EM), a significant slowdown that started in 2010 has more room to run due to major and long-lasting headwinds, according to analysts at Legal & General Investment Management (LGIM).

Growth in the area has gone down as inflation has gone up and the current account has deteriorated, and weak commodity prices are playing a key role, according to LGIM emerging market economist, Erik Lueth.

Speaking at a press event on Wednesday 3 June, Lueth said China will not reverse any time soon from a consumption to an investment-led economy, and therefore commodity prices will not see relief.

Despite widespread concerns about an interest rate hike in the U.S., Lueth said that monetary policy has had a limited effect on EM growth rates between 1991 and 2000, therefore he expects any move from the Fed to have only a modest impact on the region. This view was echoed by Vanguard economist Biola Babawale in her recent blog for ETF.com.

No Rate Hikes Foreseen

“The thing that worries us a little bit is we look at the public debt level in emerging markets – you can clearly see this level is much higher today than during the 1980s. On the other hand, we are not expecting any [U.S.] interest rate hikes like we saw in the 1980s,” said Lueth.

These concerns have not deterred ETF investors, as broad EM equity funds saw inflows of $2.5 billion in April, the best amount since last summer, as shown by BlackRock data. Performance has pleased so far with the performance of the MSCI Emerging Markets Index of over 11 percent since the start of 2015.

EM has outperformed developed markets since 1963, according to data from the World Bank. But can we expect the same going forward?

Lueth said it is unlikely, with ageing demographics in countries like China. Taking capital accumulation, labour force and productivity growth into account, EM growth will be more than 3 percent until about 2050. After that, it slips to less than 2 percent.

Other non-cyclical headwinds to the region are the amount of leverage, lack of reforms and countries like the UK and the U.S. having less need for imports, meaning we should not expect export growth in EM as we saw in past decades.

“Apart from the G3 slowing, which is a non-structural, [all the other issues are structural and more long-lasting and] the growth story in emerging markets doesn’t look too bright,” he said.