Investors have given up on emerging market equities. Volatility, currency weakness and economic uncertainty have led to investors taking money out of emerging markets for 22 consecutive weeks. The announcement last May that the US Federal Reserve would be tapering its quantitative easing policy, and the volatility which followed, was the final straw for many investors, but it has really been three years of bad news for emerging markets.
“Global money easing from Europe and the US flowed very easily into emerging markets when it began in 2008,” said Kathryn Langridge, manager of the Jupiter Global Emerging Markets fund.
“Stimulus created a number of distortions in the region; exchange rates went up, interest rates were kept unsustainably low and the veneer of success meant emerging market governments took their eye off the ball.”
Instead of implementing structural reforms necessary to weather the global recession that was being felt hard in developed markets at the time, emerging market governments rode the Fed-driven monetary phenomenon. So the shock of QE tapering mean interest rates had to rise and governments who had not addressed their problems had to face the challenge of reforming – of building economies which would be better positioned to weather the global recession storms of the future.
“China has had distorted growth,” continued Langridge. “The big challenge of the new government is to rebalance from an investment and credit lead economy to one fuelled by domestic factors.”
Chinese Premier Li Keqeiang was elected in March last year, and has promised considerable reforms to the country. But managing the slowdown in growth alongside deleveraging the public purse will be a difficult balancing act. The first victim of this duel task was solar power company Shanghai Chaori Solar which became the first default in Chinese bond market history. While several reports heralded this default as an indicator that the end was nigh for China, Catherine Yeung, investment director for Fidelity said that the default was actually a positive indicator – and should be welcomed by investors.
“China could wipe its own debt tomorrow – but then no lessons would be learned,” she said. “These managed defaults are a sign that the corporate sector is being held accountable for its mistakes, which will help promote the kind of transparency we are used to in the West.”
Evidence of reform is visible. Old cement factories and polluting industrial firms are being closed down as they fail to comply with China’s new environmental policies.
“The government is being hard on state owned enterprises and encouraging small and medium sized business,” said Yeung. “China has the cash to reform and shut down sectors it does not consider support the nation’s long term growth strategy – while still achieving growth.”
China is reforming its social policy too. The Chinese have not had social security in the past, and distrusted the stock market – which is why property became such a popular store of wealth. But the government has plans for a new pension system, outsourcing investment mandates to private companies, bringing it more in line with those in developed economies.
Not that these changes will bring about overnight results. The negativity surrounding China is intense, and the nation has a considerable mountain to climb before it can say the problems of the past five years are behind it – even further to go it is stable enough to weather another macro disaster.
“China has a very clear roadmap to reform,” said Langridge. “China has borrowed too much, and financed itself in a way that is inefficient at best, corrupt at worst. But the problems are being tackled, and for stock pickers there are some great opportunities in the region.”
