- Exports by emerging market economies are the most important factor in explaining long-term growth.
- EM exports have remained sluggish for the past three years due in part to the subpar nature of global growth.
- As emerging markets struggle to overcome the challenges to their growth story, the EM landscape will likely face significant challenges ahead.
Equity markets in the developed world did very well in 2013 while the picture was far more mixed in the developing world. So far this year emerging market (EM) stocks have not just trailed developed market equities but have also had us wondering whether the difficulties in the EM world could infect the developed economies. Data released in the early part of the year (factory orders, PMIs) continues to show further slowdown in the Chinese economy which has the markets worrying about a “hard landing” scenario. China is reaching the limits of a debt-fuelled and investment-led growth model and could be headed for not just a slowdown but significant stress in the financial sector of the economy. Most economists believe that growth will be slow but that it will not be a de-stabilizing factor globally. Geopolitical tensions in Ukraine have added to the equity market woes. However, over the past two weeks EM equities have started to outperform the U.S. markets, particularly since Janet Yellen’s press conference following the FOMC meetings in March.
In January, we identified faster export growth as one of the early signs of improvement in the prospects for emerging economies. For most EM countries, exports remain the most important factor in explaining long-term growth. With a potentially better global growth outlook this year, we expected a pick-up in EM exports. But exports remain weak. As seen in Exhibit 1, this has been the third year of near zero growth in EM exports, translating into weaker EM gross domestic product, corporate earnings and stock prices.
Source: Jon Anderson, Emerging Advisors Group
Part of the reason for the sluggishness of EM exports is the subpar nature of global growth. True, the developed world is recovering, but it has been a weak recovery. U.S. growth has not broken out of the 2%-3% range, the eurozone is no longer contracting but expectations are for growth of only about 1%, and there are questions regarding Japan’s ability to sustain any growth rebound with the advent of the new consumption tax. Global growth has simply not been strong enough to support high demand for EM exports. The question is whether a continuing gradual recovery will eventually translate into EM export acceleration or whether other forces are at work.
The ongoing weakness in EM exports has led some to question whether EM economies have lost relative competitive advantage and market share. In late 2012, Robert McConnaughey, Director of Global Research, argued that one should not dismiss the relative strengths of U.S. competitiveness. Low cost production from emerging Asia was a threat to U.S. businesses, but American businesses adapted to the environment, using outsourced labor and overseas capital deployment as an asset to improve corporate productivity and margins. This evolution has continued with the discovery of cheaper sources of U.S. domestic energy adding to the competitive advantage of U.S. manufacturing. Despite its numerous challenges, the U.S. continues to maintain some significant and durable advantages over the rest of the world.
The EM economies are not alone in facing concerns about sluggish exports. Signs of weak global demand are also evident in the Japanese trade data. Despite over 20% devaluation of the yen in 2013, export growth in Japan has been at best modest while their trade balance has deteriorated due to increased cost of imports. A strategy of devaluation-led export growth works only in an environment of strong global demand, one that has yet to materialize in this cycle. For both EM economies and Japan, growing evidence of a loss of competitive advantage and share of global trade would be extremely damaging to prospects. End market weakness is challenging enough for the crucial export engine, but compounding that with more structural problems would be bad news indeed.
Whether it is a case of weakness in demand for EM exports, increased competitiveness from the developed world or an inability of EM countries to reform their own growth models, the EM landscape will likely face significant challenges ahead. This by no means rules out pockets of country and sector specific EM strength. However, a solid global growth outlook and sustained rise in global trade is critical to consistent broader EM outperformance. We will continue to closely scrutinize the health of export growth as an important gauge of EM economic health.