By Maarten-Jan Bakkum, Senior Emerging Markets Strategist at ING Investment Management
Emerging markets have had a rough time recently. Over the past two and a half years, their economic performance has stayed behind that of developed markets. The debt crisis has led to meaningful change in the US and Europe. In the US, the banking system has been cleaned up and the economy appears to be moving again.
Lower energy prices and years of cost cuts are pushing the American industry forward again. As to Europe, much has changed in Greece, Spain, Portugal and Ireland, where the crisis forced a sharp drop in wages, which is clearly leading to more competitive power. The first cautious signs of recovery are slowly becoming visible. In the Eurozone as a whole, clear steps have been taken towards more policy coordination and overarching regulation of banks.
Overall, we see major changes in the US and Europe, while Japan has also clearly set itself apart with its great monetary decisiveness. The emerging world looks a bit pale by comparison. The source of the debt crisis obviously lay in the developed markets, and the urgency of reform was simply greater in the US and Europe. Still, it is disappointing to see how little economic reform has taken place in the emerging world in these past years.
This is one of the main reasons why economic growth has dropped in the emerging markets. Their competitive strength has weakened, and their economic instability has grown. While growth prospects for the US, Europe and Japan are still not great, their chance of improvement has clearly improved. The emerging markets seem to have little room for recovery. Substantial job market reform, less government intervention in the economy, a better investment climate and more room for infrastructural investments in government budgets would have a positive impact on potential growth in emerging markets. But except for Mexico and India, we see little initiative in this direction.
Reform fatigue and lagging growth will continue to frustrate emerging markets in the coming years. The chance that the US, Europe and Japan will continue to perform better is large. In the past months, we have seen flows to emerging debt starting to reverse. Currencies have come under pressure. If market nervousness about Fed quantitative easing continues, emerging markets will face more capital outflows. This risk comes on top of the structural negatives for EM growth. The underperformance of emerging markets assets is likely to continue.