The credit crunch is good for emerging markets
What are the strategies for reducing government debt in Europe and why do investors need to think differently about emerging markets? These were two of the questions discussed during a travelling conference in Luxembourg entitled “Investment opportunities and risks in Europe and beyond”. The caravan went on to Paris and Stockholm. The event in Luxembourg was organised by the CFA-Institute and supported by Luxembourg for Finance.
Sovereign debt, the future of the Euro and investments in emerging markets were the topics chosen by the three speakers from the UK. Jerome Booth is Head of Research at Ashmore Investment Management. He says that investors need to think differently about emerging markets.
Booth gives reasons for this shift. “The emerging markets, which is where I manage money, are a part of the world which never had a credit crunch, because they didn’t have a 30 year build-up of leverage. They are the winners, they are the surplus countries and therefore they are relatively safe”.
Representing 53% of global GDP, emerging markets now account for the major part of the worldwide economy. And we are not just talking about the BRIC-countries (Brazil, Russia, India and China), but some 64 countries that are very heterogonous.
“They are the creditors; it is their money. It is very important to understand that pension funds in Western Europe and the US are suddenly waking up to see that they have a completely inadequate exposure to emerging markets. They will be slowly changing that over the next 10 to 15 years.”
His analysis about Western Europe and the United States is less flattering, which he calls the crash zones for investors. There are two main reasons which support his argumentation: “Deleveraging has not yet happened. People were over leveraged, banks were over leveraged. The historic evidence is that this is a very painful wealth destruction process which takes many years.”
Toby Nangle speaks about deleveraging too. He is Director of the multi-asset group & fixed income and currency team at Baring Asset Management. According to Nangle, there are four ways of deleveraging. Growth is one of them, but is not on governments’ agenda right now. The reason for this is lack of productivity.
So we are left with the other three methods which are within government control. There is fiscal austerity, that is, tightening budgets; default, which is non payment of debts and lastly, inflation. “These are the three sovereign sins, and they are all pretty ugly in a different way”, comments Toby Nangle.
In a G20 statement all the governments promised to halve their budget deficit by 2014. “To hit their goals, these countries need to record the very best budget surpluses that they’ve had in any single year for the past 40 years and repeat that every year until 2020, which is possible but implausible.”
So we are left with default and inflation. Until last year, default would have seemed a bit unlikely but now it is probably the consensus. The market is pricing in the high probability of some kind of default in the outskirts of Europe and in some of the weaker US States.
According to Toby Nangle much of the developed world is still living in a bubble. He thinks that the relative standard of living in the global economy will fall which is how the world should work. “We shouldn’t condemn the emerging world to an existence of poverty. Rather, through their hard work they should be rewarded by a higher standard of living.”
Constantine Ponticos, Managing Director of Investment Management-Research at Pareto Investment Management focused on the problems faced by the euro. “European institutions are all very weak with the exception of the European Central Bank”, he said.“ I think that during the Greek crisis the European governments and their leaders failed to get ahead of the crisis. The only institution that I think took the initiative almost beyond its brief was the European Central Bank.
And he points out another failure in leadership. “Early on in the financial turmoil we had a banking crisis in Hungary. The European response was essentially to go to the G8 or the G20 to negotiate a much larger allocation for the International Monetary Fund, get the IMF involved and indirectly bail-out our banks.”
To him, the crises in Greece and Ireland have shown that the Stability and Growth Pact was never enough to hold the euro zone together. It was basically a gentlemen’s agreement. But there are positive things to be said too. The whole point of a currency union is to facilitate trade by taking away currency volatility and to have free movement of capital so that savers are not confined to investing in domestic stocks or borrowers confined to domestic pools of savings.
A round of applause for the euro, which remains still the second or third most important currency in the world. The single currency is useful for countries like China, which run a very large currency account surplus. What are they looking for? “They are looking for open capital accounts, they are looking for the rule of law, property rights and a strong justice system. That narrows the field of available currencies.” CW
(photo: Anouk Antony, Luxemburger Wort)