EMERGING MARKETS
The role of political risk is also rising in India. With
only a few weeks to go before the next general election, opinion polls suggest that the Indian National Congress party – the party of Sonia Gandhi and Rahul Gandhi – may suffer a major defeat at the hands of the Bharatiya Janata Party. This may still leave the choice of new Prime Minister up in the air, since it is extremely difficult to amass an outright parliamentary majority. That has not happened since 1989.
... countries that seek to limit exchange rate volatility will tend to see that volatility re- channelled into variations in foreign reserves
China The previous economic growth model in China
was dominated by large-scale infrastructure building with the state playing a key role in many aspects of the economy. As the Chinese economy has grown and modernized, there has been a natural evolution towards diminishing economic benefits from additional large scale, state-directed infrastructure projects. Moving forward, China will likely aim to modernize its services sector and liberalize factor prices including the currency, interest rates and energy prices. For now though, China still has relatively restrictive currency controls and typically limits currency moves in a tight range.
Capital controls and currency policies, however,
may result in a misleading picture of the impact of global asset allocation shifts on Chinese markets. With economic growth in China on a slowly decelerating path from the 10% real GDP of past decades to around 7.7% for 2013, and perhaps only 6.5% to 7.0% in 2014, Chinese equities were not shielded from the general sell-off in EM equities. The Shanghai composite index lost 6.7% for all of 2013 and fell a further 4% in January 2014. Also, we note that countries that seek to limit
exchange rate volatility will tend to see that volatility rechannelled into variations in foreign reserves – the basic tool for containing currency movements. Indeed, China was actually a net seller of US
Treasuries in December 2013, suggesting there was implicit downward pressure on the RMB.
Scenarios Going Forward We see Emerging Markets as becoming more
positive on economic grounds while remaining risky on political grounds. We draw several conclusions from our overall EM analysis as well as our three case studies. First, the EM currency sell-off in 2013 and early 2014 was driven by the combination of relative out- performance in US equities, decelerating economic growth in many EM countries, and rising EM political risks, and was exacerbated by the relative lack of
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