The case for emerging markets hasn’t changed

With larger foreign exchange reserves and lower debt, emerging markets still promise three times the growth in developed markets



Over the past few weeks, we’ve seen significant volatility in the markets, which has spooked some investors, but is also something we have become accustomed to.

Such sell-offs are potential opportunities to pick up bargains if prices move low enough to draw our interest. We have found, however, that these kinds of fluctuations have, in the past, been generally short lived.

For short-term investors, sell-offs like this one can be very worrying. That’s why, to some degree, we will see money quickly jumping out of what are deemed to be “risk assets”, which include emerging market equities. But I think most long-term investors realise that they need to think before they leap, since recoveries can come very fast and it can be difficult to get back in when the recovery comes.

The bottom-line for emerging markets is that the long-term investment case hasn’t dramatically changed. And I don’t see it changing as long as three themes remain in place: emerging markets’ economic growth rates continue to be at least three times faster than those of developed markets; they have much greater foreign reserves than developed markets; and the debt-to-GDP ratios remain much lower than those of developed markets.

These periods of volatility are certainly not new to us and don’t change our conviction about emerging markets. We feel recent declines have been overdone and based largely on irrational investor panic. The recent pullback has been an opportune time to search for bargains for our portfolios.

China fears

Two markets that triggered some of the panic that has spread to emerging markets in recent times are China and Argentina.

Worries are again surfacing about the pace of growth in China after disappointing recent economic data. As I see it, critics of the Chinese government seem desperate to find something wrong in China and have latched on to the idea that China’s growth is slowing. The reality is that China is growing at a very rapid pace. If China can achieve growth in the range of 6-8 per cent this year, it would be incredible for any economy of that size.

As the Chinese economy grows and transforms, we can’t expect double-digit growth; there will be deceleration — but that’s okay.

Run on the Peso

Regarding Argentina, at this stage of the game, the government has acknowledged that there is a problem with the competitiveness of the peso at the official foreign exchange rate.

After having lost some $20 billion in reserves, the government decided to take its medicine, devaluing the currency and easing restrictions on the purchase of dollars for the first time since currency controls were put in place in 2011.

We think Argentina’s currency depreciation is necessary, but it is questionable how the government is accomplishing it. One of the objectives of the policymakers must be to abolish the capital restrictions so that US investment dollars are encouraged to enter the country. If the government does not allow interest rates to rise, in my view, the devaluation will not stop the outflow of reserves; it will only buy time.

The ease in the restrictions to purchase dollars for retail investors appears to be an attempt to reduce demand in the parallel market that provides the basis for the gap between the official and the parallel rate for the "blue dollar". This brings us to fiscal adjustment. The government has been issuing 35 per cent of the monetary base to finance the government. Some forecasters estimate that the 2014 fiscal deficit could reach 5 per cent of GDP. The government must freeze public spending and apply a brave utility rate adjustment.

(The writer is Executive Chairman of Templeton Emerging Markets Group.)

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