Mark Mobius*
08 February 2007 00:00
Overview
Emerging markets recorded strong performances in the final quarter of 2006, leading the asset class to end 2006 at a historical high. Lower risk premiums, a robust macroeconomic environment, significant fund inflows and new equities issuances continued to attract domestic and foreign investors to emerging markets. Latin American markets were the top performers during the period as key countries such as Brazil, Mexico and Argentina continued to report good economic growth, improve their fiscal positions and benefit from healthy export demand. Stronger local currencies led Eastern European markets such as the Czech Republic, Hungary, Poland and Turkey to record higher gains in US$ terms. Similarly, South African returns also benefited from a weaker US dollar. In Asia, investors remained drawn to China’s growth story with the MSCI China jumping 35,9% in US$ terms. Elsewhere in the region, the imposition of capital controls and almost immediate reversal of policies to exclude the equity market coupled with the military coup earlier in September led to the Thai market to under perform its regional peers.

Regional Update
Despite a slight deceleration, GDP growth in China remained robust at 10,7% y-o-y for the first nine months of 2006. While key economic indicators such as fixed asset investment and industrial output accelerated m-o-m in November, growth levels were still lower than those seen prior to the implementation of the government’s tightening measures. In November, China registered a trade surplus of US$22,9bn, slightly lower than the record US$23,8bn in October. The US and China held talks in December where an agreement to narrow trade imbalances were reached. Both countries also announced plans to increase cooperation on issues such as energy, investment and the environment. President Hu Jintao also visited Africa, India and Pakistan during the period where trade and business agreements were signed.

South Korea’s economy grew a revised 4,8% y-o-y in the third quarter, slightly higher than the preliminary 4,6%. While the central bank forecasts GDP to grow 5% in 2006, it lowered its growth expectation for 2007 to 4,4% in line with slower global growth. The central bank also left interest rates unchanged during the quarter as inflationary pressures remained benign. Conversely, the bank raised the reserve requirement ratio to 7% from 5%, in an effort to weaken the Won, which is at a nine-year high, and tighten lending in the booming property market. In the area of trade, South Korea ended its fifth round of talks with the US with little progress and signed a number of trade and investment agreements with Indonesia during the period. Regionally, six-party talks aimed at reaching an agreement for North Korea to abandon its nuclear weapons program resumed in December.

In South Africa, GDP grew 4,4% in the first nine months of 2006, compared to a revised 5,1% for the year 2005. Key drivers included strong household consumption and investment expenditure as well as the finance, real estate, and manufacturing sectors. Moreover, interest rates were raised by a total of 100 basis points during the quarter in an effort to curb inflationary pressures and credit growth. Recognizing the competitive global corporate environment, the government exempted foreign companies from complying with the black empowerment regulation of selling a 25% stake in their local venture black businesses.

Economic growth in Brazil accelerated in the third quarter with GDP growing 3,2% y-o-y, compared to the 1,2% y-o-y growth in the preceding three-month period. The finance ministry expects GDP growth to accelerate in the future as the economy reaps the benefits of the interest rate cuts over the year. The bank lowered interest rates by another 100 basis points during the quarter. The government is expected to release additional measures aimed at boosting growth and investment which should further support the country’s economic recovery. In politics, President Lula won a landslide re-election in the second round presidential elections on October 29. No major policy changes are expected.

The Mexican economy grew 4,9% y-o-y in the first nine months of the year, raising expectations for 2006 to record the fastest GDP growth since 2000. Mexico, along with Brazil, continues to be one of the prime investment destinations in the region. Foreign direct investment totalled US$14,1bn in the first three quarters of the year, up 9,5% y-o-y. Politically, President-elect Calderon was inaugurated on December 1 and appointed his cabinet. Political friction continued with the Democratic Revolution Party (PRD) refusing to accept Calderon as the country’s legitimate president. However, focused on implementing government policies, Calderon initiated an austerity package which should save about 0,3% of GDP in 2007. Key measures include a 10% reduction in salaries of the president and key cabinet members as well as stringent cost cutting efforts in government offices.

Growth in the construction, financial and manufacturing industries propelled GDP growth in Russia to 4,6% y-o-y in the first nine months of the year. This led the government to upgrade its full year growth forecast to 6,8%. Despite the robust growth, inflation remained benign with CPI increasing 0,6% m-o-m in November. In the area of trade, Russia and the US signed a bilateral agreement for the country’s accession into the World Trade Organization (WTO), overcoming the last major obstacle in Russia’s bid to join the trade bloc. Improving regional relations, Russia signed more than US$1bn worth of economic and military agreements with Indonesia in December. Election dates for the elections were announced with the presidential elections scheduled for March 8 2008 and the parliamentary elections for December 2 2007.

Turkey’s GDP growth slowed to 3,5% y-o-y in the third quarter as the substantial interest rate hikes in the second quarter had a negative impact on private consumption. However, growth in the first year-to-September period was 5,7% y-o-y with the industry, trade and construction acting as key drivers of the economy. Interest rates remained unchanged during the quarter as the central bank expects inflation to remain within targets. Investor confidence in Turkey has improved significantly since the May-June correction with FDI and portfolio inflows totalling US$24bn in the 12-month period ending October 2006. However, slowing European Union accession talks may raise investor concerns. Positively, support from the International Monetary Fund continued with the release of a US$1,1bn tranche in December.

Outlook
Expectations of a soft landing in the US economy, a pause in US interest rate hikes and an improved global environment should support emerging markets. The correction in oil prices in the last few months has impacted oil-exporting markets such as Russia and Mexico. However, we expect oil prices to remain firm because of geopolitical and bottleneck problems. The role of emerging markets in the global economy has grown significantly in recent years and we expect this trend to continue in the future. While companies have recorded significant price appreciation, corporate earnings have also increased allowing valuations to remain attractive. The opportunities are plentiful with strong fundamentals supporting the long-term uptrend of these markets. Moreover, many companies are experiencing strong growth and there are many upcoming IPOs in markets such as China and Russia which warrant attention.

* Mark Mobius is the MD of Franklin Templeton