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The Hypnotic Allure Of Emerging Markets

China, Company Strategy, Economics, Europe, India, Indonesia, Malaysia, Philippines, Thailand, US
By John Richardson on 15-Sep-2015


By John Richardson

A GLEAMING new skyscraper in downturn Beijing, Bangkok, Mumbai, Jakarta or Kuala Lumpur made for fantastic TV viewing, especially if a photogenic reporter was standing in front of such a building.

The reporter would then talk about “Asia’s rising middle classes” as the camera panned-out to people queueing outside Louis Viton and Cartier stores.

He or she would then add that even if this tremendous wealth creation had yet to reach some of the poorest villages in a particular country, if this carried on then everyone would eventually benefit from the “trickle-down effect”.

And anyway, hundreds of millions of average-income people had already become rich thanks to surging real-estate prices, the reporter would argue This in itself was leading economists to predict GDP growth way in excess of the long-term historical trends over the next few years, he or she would add.

The overall visual and audio impact of such news pieces was almost hypnotic.

Then some of us would get on planes and fly to places like Jakarta or Mumbai and see for ourselves the gleaming new skyscrapers and the queues outside the high-end designer shops.

Sitting in the business class airport lounge on the way home, we then might have picked up a newspaper quoting a management consultancy or an investment bank report. The newspaper article could have talked about hundreds of millions more people across the emerging world becoming middle class by Western standards, virtually overnight.

To what extent did these surface impressions influence the decision of your chemicals company to expand capacity? Sure, nobody would have even considered spending any money on a project based just on surface impressions. But what if most of the crunching of data also always seemed to confirm these surface impressions?

Given this almost overwhelming consensus that nothing could realistically go wrong, if you did harbour doubts you would have to be very brave to stand up in a board meeting and say, “No, let’s not do this project”. Let’s hope there were enough brave people around five years ago to prevent too many expensive mistakes.

The good news is that one set of data crunchers – those at the Bank for International Settlements (BIS) – have long warned about the faultiness in the emerging markets growth story.

So those who listened to the Swiss-based BIS, which acts as the bank for the world’s central bankers, will be in a better position to cope with today’s global economic crisis.

What the latest BIS study tells us is this:

  • Global debt ratios are now significantly higher than they were at the peak of the last credit cycle in 2007, just before the onset of the global financial crisis.
  • In emerging markets, debt has spiked 50 points to an average 167% of GDP, and even higher to 235% in China, a pace of credit growth that has almost always preceded major financial crises.
  • Dollar loans to emerging markets have doubled since the Lehman crisis to $3 trillion, and much of it has been borrowed at abnormally low real interest rates of 1%. Roughly 80% of the dollar debt in China is on short-term maturities.
  • The global financial system remains anchored to US borrowing rates, whether or not countries have fixed exchange rates or floating currencies, and regardless of normal theory on trade links and business cycles.
  • On average, a 100 point move in US rates leads to a 43 point move for emerging markets and open developed economies, with powerful knock-on effects on longer-term bond rates.
  • So this latter point means that regardless of whether emerging markets have borrowed in US dollars or in local currencies, they are very vulnerable to the likely eventual rise in US interest rates. One of the arguments about why emerging markets will be better off today than in 1997-1998, during the Asian Financial Crisis, is that is they have less dollar-denominated debt.

The release of this latest BIS study is of course very timely, as it has occurred during the same week when the Fed will announce whether or not it will raise interest rates in September. This would be the first US rate rise since 2006.

But whether or not the Fed raises rates this month or waits until October, December or 2016 is irrelevant to long-term planning, although short term disruptions will be very big indeed.

Equally irrelevant for any chemicals company with the right long-term planning in place would also even be the unlikely decision by the Fed to delay a rate rise indefinitely – and/or if it eventually launched a fourth round of quantitative easing.

This is because China’s decision to permanently end its credit boom is a far bigger deal for the global economy. The global economic impact of this decision is, in fact, so great that there is nothing that the Fed, the European Central Bank or the Bank of Japan can do that will make that much of a difference.

All that Western central banks can instead do is make the eventual reckoning with bad debts and deflation even worse by carrying on with their misguided stimulus.

Chemicals companies with the right long-term strategies will therefore already be sufficiently well-placed to ignore all this distracting background noise. This will enable them to maintain their focus on taking advantage of what will drive sustainable chemicals demand growth in the future: Satisfying basic needs.