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Near-term outlook: Easy monetary policy and fiscal stimulus
The short-term fundamental outlook for emerging markets appears cloudy thanks to subdued growth, stagnant exports and continued global trade tensions. Slowing economic activity, coupled with placid inflation and negative output gaps, has not gone unnoticed by EM policymakers. Central banks — from Mexico to Malaysia, Serbia to Sri Lanka — have been quick to shift towards policy easing to stabilise activity. With the US Federal Reserve unlikely to tighten policy anytime soon, this trend seems set to continue into next year, assuming currencies remain stable.
This has provided a healthy environment for EM local currency bonds, the yields of which have dropped sharply during 2019. While developing countries have more room than developed markets to cut monetary policy further, global fiscal easing is the next obvious gateway to loosen financial conditions further. The recent corporate tax cuts in India and increased budget deficit targets in South Korea may provide a blueprint for developed countries. However, any increase in the sizeable global debt burden, now estimated at more than 320 per cent of GDP will act as a further structural impediment to long-term global growth.
Medium-term outlook: Rising temperatures in politics and climate
Recent developments suggest the early 2020s may herald a new era of heightened political risk in EMs. While the stability of governments has never been far from the minds of investors, the extraordinary pace of populist protests in countries such as Chile, Bolivia, Egypt, Iraq, Lebanon and Ecuador has shocked markets.
Governments are increasingly coming under intense pressure from populations frustrated with economic inequality, disenfranchisement, corruption and fiscal austerity. In the past, political risks in EM tended to peak and trough predictably with the electoral cycle. The new reality, however, is that social media can spark almost instantaneous unrest; as a result, political risk looks set to rise into next year.
In much the same vein, climate change will be a major challenge for EMs over the coming years. This has already disproportionately impacted developing countries and political pressure from the electorate is likely to force governments around the world to accelerate remedial action.
Over the coming decade, those EM countries and companies that fall behind the curve on a progressive decarbonisation agenda are likely to be punished by impatient activist investors, forcing financing costs higher. We may also see the onset of green trade wars, with countries imposing carbon border taxes on each other, creating winners and losers in the EM world. Given the exponential rise of climate change on the political agenda, particularly in northern Europe and Australasia, this no longer seems a radical or far-fetched concept.
Long-term outlook: Opportunities in EMD despite US-China battle
The next decade will be dominated by a battle for global hegemony between the US and China. This extends well beyond tariff escalation and into areas such as artificial intelligence, cyber security, robotics, military prowess and geopolitical influence. We may witness a short-term detente on trade between Presidents Trump and Xi over the coming weeks, but deeper agreement on more pertinent issues will remain elusive. This is likely to weigh on the long-term prospects of the Chinese renminbi and EM currencies more broadly, given their sensitivity to global growth and trade. However, it may not be as severe as expected if EMs continue to reduce their reliance less on manufacturing.
At the same time, favourable demographics, a potentially powerful driver of growth, will continue to provide a significant tailwind for EM debt. The coming decade is likely to see a dramatic rise in investment and capital flows into frontier market regions such as sub-Saharan Africa, which are witnessing rapid acceleration in labour force growth.
The global transition towards the highly disruptive third industrial revolution also presents an opportunity. Emerging markets now have a chance to leapfrog older technologies and catch up with the rest of the world, just as they did with mobile phones. While many of these longer-term themes will be difficult for investors to trade today, they are worth keeping an eye on as the forces that will shape markets over the next decade. And while the asset class can be volatile and risky, the benefits to investors — growth, yield and low correlation to developed market assets — are compelling.
The full version of this article was originally published in the FT and can be viewed here.