Following years of net inflows, portfolio capital began to
look for a way out of emerging markets in 2015. Investors are
concerned about China's difficult economic transition, slowing
growth, low productivity, rising debt, sour political and
geopolitical headlines, weak consumer demand, and the prospect of
global interest rate normalization. Many are questioning the
strategic role that emerging markets play in their portfolios and
even those staying for the long haul recognize that these
economies face an important crossroads.
In this paper we consider data on financial stability and
growth and consumption to describe how the emerging markets got
to this crossroads, which road they need to take to reach the
next stage of development-and what it all means for
Not so long ago, in the teeth of the 2007-09 financial crisis,
emerging markets were the saviours of a stricken world. After
growing at four-times the pace of the highly-indebted developed
world since the mid-1990s, they had the fiscal buffers to forge
their own way, building their cities and realising the promise of
vast populations poised on the threshold of the middle class.
Less than five years later, growth has slowed dramatically. A
rout in emerging market currencies is coinciding with a
tightening of financial conditions, reflected in stock market
sell-offs and widening credit spreads-all against a backdrop of
rising political and geopolitical risk. A decade of declining
government leverage was arrested in 2007 and, according to the
Institute of International Finance (
), net capital flows to emerging markets turned negative in 2015
for the first time in almost 30 years.
Sceptical voices have long argued that the emerging world owed
its "catch-up growth" to a mix of China's expansion and low
global interest rates, which led to an unsustainable run-up in
commodity prices and a flood of capital. As those trends reverse,
the resulting glut of often questionable investments lies
Moreover, while the end of the commodity supercycle is broadly
accepted as a consequence of the transition to more
consumption-led growth, recent analyses of income distribution
suggest that the emerging world's middle class may not be growing
fast enough to smooth that transition.
With this background in mind we have looked at two sets of
data-on financial stability and productivity and consumption-to
describe where emerging markets are today and where they need to
go next. We believe the data suggest three things for investors
to remember amid the gloomy headlines.
The first is to
keep things in perspective
. Yes, measures of financial stability have deteriorated since
2007, but they remain substantially better than in the
late-1990s, and better than the developed world's today.
Similarly, while we may not have seen the middle-class expansion
that we hoped for 10-15 years ago, more than 600 million people
have lifted themselves out of poverty this century, crossing
significant income and consumption thresholds.
The second is that
one metric rarely tells the whole story of a country or
. News headlines like to zero-in-on current accounts one day,
fiscal balances or corporate leverage the next. But what do
current account balances tell us without reference to reserves?
How does the flow of debt relate to the stock? Is it significant
that the places with higher debt levels are often the ones with
higher incomes and consumption?
emerging markets are far from homogeneous
. Globalization has caused convergence between emerging and
global financial markets, and we find substantial regional themes
in our data. But they also reveal extreme differences between
regions and countries. Investors should take note of these
idiosyncrasies not only to maximise return, but also to allocate
capital efficiently to facilitate the next phase of "catch-up"
convergence with the developed world.
Debt Ratios in the Emerging World Remain Low, but Are
Gross Government Debt as a Percentage of GDP
Source: IMF. Estimates start after 2014.
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The Neuberger Berman Emerging Markets Debt team deploys an
internally-generated, proprietary Country Credit Model (
) to rank emerging countries. Illustrations shown herein
reflect the CCM scores for the fiscal balance and public debt,
and for the current account balance and short term
debt-to-reserve ratio, respectively. Green and red arrows
signify a positive or negative progression
(improvement/deterioration) since 2012 based on CCM scores.
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