Still no homogeneity in emerging markets

Graham Smith
Graham Smith
Market Commentator5 September 2018

There may be nothing to fear but fear itself, but that’s been more than enough for investors in emerging markets to fret about this week. Indonesia is the latest country to have been swept up in a whirlwind of debt and currency concerns.

What a difference a year makes. Last summer, Argentina raised almost US$3 billion selling a 100-year bond yielding 7.9%1. Today it is in the arms of the International Monetary Fund, fending off repeated attacks on its currency with the world’s highest interest rates of 60%2.

Argentina’s difficulties stem from concerns President’s Macri’s reformist government has been too slow to implement electorally unpopular measures to rein in the country’s burgeoning budget deficit.

As the world awaits perhaps two more rises in US interest rates this year, doubts about Argentina’s ability to repay the interest it owes on increasingly expensive US dollar borrowings mount.

President Macri will be hoping his announcement this week of a new tax on exports and a reduction in the number of government departments will be enough to convince markets he is serious about improving Argentina’s solvency3.

The stakes are high though. Argentina still labours under the legacy of the country’s 2001-02 crisis, which culminated in a debt default. Confidence in Argentina as a destination for international investment became lost for a generation and the crisis inflicted poverty on the nation.

This week, Indonesia – another country left exposed by a weak current account position – experienced more of the fallout from Argentina as a government minister reported seeing speculative pressure being applied to Indonesia’s currency.

The Indonesian government has imposed higher tariffs on imported goods to quell the country’s demand for dollars, while the central bank has felt compelled to use up more of its foreign exchange reserves by intervening in currency and bond markets4.

Such events evoke memories of the so-called Tequila crisis of the mid 1990s, during which rising US interest rates sparked a devaluation of the Mexican peso and resulted in a sell-off that permeated into Asia.

This time though Asia looks better prepared to resist contagion, with currencies that are no longer pegged against the dollar and finances in considerably better shape – predominantly current account surpluses and substantial war chests of foreign exchange5.

Both factors make Asian countries much more able to continue making payments to their external bond holders. Indonesia’s economic profile – with a relatively large current account deficit though not one to rival those of Argentina or Turkey – is much closer to being the exception than the rule.

Meanwhile, many other emerging markets are making hay as the world economy continues to expand and as markets at home benefit from past liberalisation measures and a combination of rising wealth and consumer demand.

Asia appears to be coming out on top, with a heady mix of strong economic growth and low inflation backed by modest current account deficits and substantial foreign currency reserves.

Like Indonesia, India also runs a deficit, but there the similarity largely ends. India saw its economic growth rate accelerate to 8.2% last quarter – comfortably outpacing its big rival China6.

Indian manufacturing and consumer spending are both on a roll, having recovered comprehensively from the introduction of a national goods and services tax in July 2017.

That’s not to say India is exempt from global pressures. The latest survey of India’s manufacturers found sentiment moderating in August with oil prices, higher US interest rates and capital outflows from emerging markets among the predictable concerns7.

The rupee has also fallen back of late amid the wider bout of pressure on emerging market currencies.

Even so, corporate India has a lot to be pleased about. A competitive rupee is helping exports and domestic consumer spending has been growing well. Reports of strong sales last month by the Indian carmakers Ashok Leyland, Bajaj and Tata are consistent with a positive overall picture8.

Unlike India, Taiwan runs a sizeable current account surplus – about US$18 billion in the three months to June9. Its economy is a bellwether of global demand as so much of it is devoted to the export of goods.

So it is with a wider significance that Taiwanese economic growth accelerated to its highest level in more than three years in the second quarter – to 3.3% on an annual basis10.

As with any country so geared into global trade there are mounting risks. US-China trade tensions represent a particular threat to a country so dependent on Chinese supply chains.

What these country examples show though is that emerging markets have a tendency to behave differently from one another for good reason. Their economies may be only distantly related in terms of their makeup and sensitivities to the global environment.

An old adage along the lines “the only thing that goes up in a true bear market is correlation” is undoubtedly true. However, broad diversification still offers the best defence under these circumstances.

Fidelity’s Select 50 list of favourite funds contains three that invest in a diverse range of emerging markets with a strong focus on stock selection.

The Fidelity Global Emerging Markets Fund currently has more than 60% of its portfolio invested in Asia, with large holdings in the Hong Kong insurer AIA Group, India’s HDFC Bank, Taiwan Semiconductor, Samsung Electronics and the Chinese online retail giant Alibaba.

Consumer defensives are in strong evidence in the Janus Henderson Emerging Market Opportunities Fund, which currently has large positions in Uni-President (Taiwan) Tiger Brands (South Africa) United Breweries (Chile) as well as Heineken and Unilever.

Source:

1 Reuters, 19.06.17
2 Banco Central de la Republica Argentina, 30.08.18
3 New York Times, 04.09.18
4 Channel News Asia, 04.09.18
5 Bloomberg, 22.02.18
6 Government of India, 31.08.18
7 Markit Economics, 03.09.18
8 Reuters India, 03.09.18
9 Central Bank of the Republic of China (Taiwan) 20.08.18
10 Reuters, 31.07.18


Important Information

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