Emerging markets to retain growth advantage

The gap initially reflected the much stronger economic performances of the emerging economies, but the differential is being kept wide by the increasing underperformance of the advanced nations.

“The growth gap between emerging and advanced economies is expected to remain wide,” said Warren Jestin, chief economist, Scotiabank, “with most advanced nations already embarked upon a multi-year period of household deleveraging and fiscal consolidation—developments that will keep their output in the slow lane of growth.”

Jestin added that “emerging nations have the fiscal and financial flexibility to underpin solid economic gains in their home markets, a development that remains supportive over the longer term for international trade and commodity markets.”

Heightened political uncertainty in recent months has aggravated the slow pace of reforms critical to reducing the significant deficit and debt problems in the euro zone and the United States, with the broad financial market and confidence shake-out around the world threatening the durability of the tepid recovery underway.

Japan’s massive rebuilding efforts and the rebound in auto and electronics manufacturing will lift the economy to the top of the advanced nations’ growth ladder through the remainder of this year and most of 2012. Australia is also expected to remain a relative outperformer because of its close commodity and trade linkages with the still strong Asia-Pacific region.

China is expected to remain the global growth leader, though the combination of domestic credit restraint and slowing international demand will trim its output growth to around 9% next year. India’s strong domestically generated expansion will continue to keep the country’s growth rate around eight per cent. In Brazil, prior policy tightening and a stronger currency—both have reversed somewhat in recent weeks—will contribute to a slower pace of activity, though the country will remain a strong performer because of significant investments in manufacturing and resources. Peru and Chile will continue to post comparatively stronger regional growth on the back of ongoing capital investments in their expanding resource sectors.

Emerging market flows

A Barclays Capital report shows emerging market assets registered US$5.1 billion of outflows in the week to October 5, driven by equity fund outflows of US$3.3 billion and bond fund outflows of US$1.8 billion (equivalent to 0.9% of EM bond AUM).

Emerging market dedicated bond funds, for which the data provide a split between local and hard currency, suffered another week of outflows (US$0.5 billion and US$0.7 billion local and hard currency, respectively).

The pressure from outflows remains large, albeit less intense than the previous week. This is helpful news for the markets, inasmuch as it suggests a little less haste for funds to rebuild cash levels. Last week, outflows from local bond funds were the equivalent of 3% of local bond fund AUM and this week’s outflows are 1%.

If funds hypothetically did not sell the underlying assets, their cash levels would still be quite high (at around 6%, according to our estimates). Nevertheless, emerging market investors are likely to remain defensive, as euro area challenges remain large and policymakers can still be perceived to be too reactive (ECB failing to cut despite some market expectations of a rate reduction).

Peru, Hungary and South Africa are the three countries with the largest bond fund outflows since beginning of August (measured as a percentage of total market cap). In external debt markets, all three countries have seen a decrease in investor allocations recently but, while South Africa remains a firm overweight, Peru now screens as underweight.