The rise in economic challenges faced by emerging markets such as China, Brazil, Turkey, Russia and South Africa has dulled the lustre once associated with these countries.
For years, emerging markets propped up global growth as their developed counterparts stalled. Now a deepening slowdown in China and other developing markets has put an end to that fairytale. Economists are suggesting that the emerging world is a risk rather than a cushion.
However, there are pockets of growth, notably India, but also from Indonesia and the Philippines, that will provide investors with interesting investment opportunities, despite the emerging market slowdown.
This does not suggest that countries such as China will not present investment opportunities over the next decade, says Sukumar Rajah, the MD and CIO Asian equity at Templeton Asset Management, but that they are entering a new phase of growth.
A country has four drivers of growth he says: the average age and size of its working population, productivity, capital invested as a percentage of GDP and capital productivity.
If one adds good companies to invest in, accommodating government regulations and a benign interest and inflation environment, then the conditions are ripe for accelerated growth. This is the environment in which China flourished over the past fifteen years.
However, only two of the four levers now apply: China’s working-age population has peaked and will decline in the coming years, and capital invested, which once reached 50% of GDP is declining while debt levels increase. As a result investment is slowing.
The remaining two levers – productivity and capital productivity – are facing some headwinds, but reforms could address this, Rajah says.
China’s economy is likely to continue slowing over the next ten to 15 years, he says. This does not mean that China is a poor investment destination – it is a $10 trillion economy after all – but investors need to re-orient their expectations and understand the factors that are constraining growth.
Other countries in the region are also slowing, perhaps as a result of China’s slower growth. For instance Korea and Taiwan, which have grown at 5% or more over the last decade are finding it difficult to maintain growth levels.
India, however, is in a different position. It is where China was 20 years ago, Rajah says.
Roughly half of the 1.25 billion population is under 25; the domestic savings rate is 30% of GDP and can grow to 40%, fuelling investment in the economy. Capital invested into productive infrastructure is increasing.
Growth is only one factor in an investment story, says Rajah. The other is business, consumer and investor confidence. In this regard Narendra Modi’s Bharatiya Janata Party is working to convince investors and others that the economy is being better run and that growth will be sustainable.
Certainly the economy seems to be on an increasingly stable footing. Inflation has fallen to 4% after floating above 10% for years. The budget deficit and current account deficit have been shrunk to almost zero, the rupee is firm, the stock-market has boomed, and the slump in energy prices is a blessing for a country that imports four-fifths of its oil. “We believe the structural story is in place for the next two decades,” says Rajah.
The government is making good on promises to cut corruption, slash red tape, reform tax and overhaul land acquisition laws to try to attract foreign investment and create jobs for millions of young people.
In addition, it is stimulating the economy by increasing investment in infrastructure and focusing on reforms to make it easier to do business in the agriculture and manufacturing environments.
As a result of the more positive political and economic fundamentals, business and consumer confidence has increased. India is in recovery mode and the economy growing at 7.5%, after slowing to 5%. It is expected that this pace will quicken to 8%.
The Indian market is huge with 5 300 listed companies. Within this number there are of course the good, bad and ugly, says Rajah. “But there are enough companies generating better than average returns for an investor to do well.”
China’s rise was built on export-led manufacturing, and the Modi government is pushing for the same with its “Make in India” campaign. Locally produced products can be exported, but the country also has growing domestic consumption. Fifteen years ago 10% of the population was middle class. Today 25% to 30%, or roughly 400 million people are middle class and this is growing by 10% or 40 million people a year.
However, India’s vast services sector provides it with a unique opportunity to climb the value chain. “Tata Steel was once 20% of the benchmark, now it’s half a percent of it. The IT sector was a blip, now it’s the biggest sector on the Indian stock exchange. Of the top ten IT service companies in the world, five are Indian,” says Rajah.
IT company Infosys has gone from a $100 million company in 1994 to a $40 billion company today. Where it once employed 500 new engineers a year, now it recruits 200 000 engineers a year. “What country do you know that can sustain that level of academic output?” he says. HDFC Bank has shown similar growth increasing to a $50 billion company over 20 years. Indian pharmaceutical companies are growing ahead of the local pharmaceutical market as they take an increasing share of the global market.
India’s competitive advantage – a highly educated but relatively lowly paid workforce – is unlikely to change anytime soon: over the last decade US-based software programmers have seen their salaries increase from $30 000/year to $60 000/year; in the same time the equivalent Indian programmers have seen their salaries increase from $400/year to $2 000/year. “Not in my lifetime is that gap going to narrow.”