When China sneezes… 2014
The spectre of the volatility that struck emerging markets in 2013 hangs over many of the investment pages of this month’s IPE. And no wonder – it feels like last year provided confirmation, at last, that these markets are entering a new paradigm.
The pre-crisis model of low wages, low interest rates and artificially weak exchange rates was always going to struggle when the developed-world consumers of all those exported goods fell on hard times. Moving to the more sustainable, post-crisis model of allowing a consuming middle class to develop via rising wages, meaningfully positive real rates and free-floating currencies was always going to be a long and painful process.
Equity investors cottoned on to this early: emerging market stocks underperformed developed markets for some time before 2013. Bond and currency markets, by contrast, seemed to sail on regardless, barring some choppy waves in late summer 2011. It took the catalyst of the threat of the withdrawal of US dollar liquidity – QE ‘tapering’ – to bring the markets into line.
Moreover, the fallout has revealed how much further there is to go to create the consumption-led economies that emerging market and luxury goods investors, with their PowerPoint presentations laden with exciting demography data, like to imagine. The currencies of economies running current account deficits, in particular, have been routed, threatening a growth-killing combination of runaway inflation and high interest rates. Two of our three Strategy Review interviewees suggest that the emerging consumer, everyone’s favourite long-term investment theme, might be due for a re-think: essentially the trade is undervalued, they say, but they also cite the prospects of falling real wages and rising unemployment.
But there is another side to this story, which looks to another big emerging markets event from 2013 – the Third Plenary Session of the 18th Communist Party of China Central Committee. Market reaction to this, once the extent of the reform agenda became known, was positive. That may not have been a given just a few years ago, when Chinese equity investors preferred to see monetary loosening or renminbi weakness.
So what are these investors rewarding? The prospect of a greater role for free markets in setting the value of money and investments is important, for sure, but they may also like what a rising renminbi and monetary tightening in a world of loose policy implies – China weaning itself off US dollar liquidity. Of course, this contrasts starkly with its hapless neighbours, now struggling to fund their deficits (which explains the impressive recent outperformance). But if China’s move to free itself from the greenback is accompanied by further moves to internationalise its own currency, that may provide its neighbours with an alternative to dollar funding with which to smooth the economic transition that has recently become so volatile.
The increase in renminbi trade financing might be an early indication of how this trend could develop. If so, the emerging consumer story starts to look much more compelling again – and we may see the Third Plenum as the real reason to look back on 2013 as the paradigm shift for emerging markets.