Wolfgang Sussbauer’s Post

Transcript

>> So Denis, what do you see as the opportunities over the longer term in EM, and how might that have changed from what investors have become accustomed to? >> Kathy, thanks. So there are a number of tailwinds that are either firmly in place or taking hold that'll have a profound impact on EMs going forward. And because of this, I think that diversification from a country perspective is going to become more of a focus for allocators. So first, emerging market growth outperformance is back after a lull post-COVID and that's expected to stay high for the foreseeable future. Second, competition between the U.S. and China is changing global power dynamics. And third, demographics are likely to create differentiation between emerging market and developed market policy and that could very well have an impact on debt. Importantly, all of these are interrelated and should be on everyone's radar today. Going back, the most important aspect for EM outperformance over developed markets has been growth differentials; how much emerging markets are growing over developed markets. And we have some graphics in our paper about this. So when growth differentials have been above two percent, emerging market debt has historically outperformed developed market debt. And then if we go to 2021 and 2022, when that growth differential slipped to below one and a half percent, EM gave back all of its outperformance versus developed market debt. Now, importantly going forward, the consensus forecasts are for EM to regain that growth premium well-above two percent, and with that that EM debt outperformance should come back. So there are a number of factors that are contributing to this increased growth within EM, but from a really high level, it's the story of convergence is taking hold. So, EMs are maturing. In 2007 emerging markets overtook developed markets in terms of share of GDP and then since then they've increased that gap, taking about 60 percent of global GDP today. And then over the last few years, EMs have actually eclipsed developed markets in terms of their share of global exports. So in terms of what's caused EMs to grow more than developed markets, it's been those exports combined with domestic consumption from growing middle classes within EMs and then on the export side, it's been a focus on technology, as well as critical commodities. So copper, lithium, nickel, rare Earth minerals, agribusiness, as well as hydrocarbons. EM is exporting the materials that the world needs and are likely going to need more of given the technology revolution, as well as the green energy transition. So moving to the second point, competition between the U.S. and China. This is creating geopolitical realignment with both countries vying for influence within emerging markets, particularly the global south. This was kicked up into high gear post Russia's invasion of Ukraine, when only a third of the global population went along with the U.S. sanctions on Russia. Alright, that happened because U.S. has lost a lot of its influence within the global south to China, with its Belt and Road Initiative. So now to counter that, the West is using a form of economic real politic to compete with China on both the quantity as well as quality of the financing that they provide to geopolitical swing states. So the first phase of this is the G7's Partnership for Global Infrastructure and Investment. Right, it's over half a trillion dollars that's going to be invested within emerging markets and disbursed until 2027. Right, it's no coincidence that Indonesia was the first recipient of this funding. They were one of the world's most populous states and they're a geopolitical swing state that the West is trying to court. Another really important dynamic of the competition between the West and China is shifting global supply chains. So historically China has been the largest exporter to the United States, that changed last year. Mexico overtook China as the largest exporter to the United States, that was a combination of rising exports from Mexico, but also exports from China being down over five percent during the last five years. And EMs have taken all that market share, this is going to be a really important tailwind to EM ex-China growth going forward. And now going to the third point, demographics and how that dovetails with debt. So, emerging markets have less debt than developed markets and there are good reasons why developed markets have a larger debt capacity than emerging markets, however, demographic is going to be a really important dynamic going forward and in emerging markets, working age populations outside of China and South Korea either continue to grow or flat line, while in developed markets, it's widely expected for that working age population to decline meaningfully over the next decade and that's going to put a lot of pressure on fiscal policy. So in the U.S. it's inevitably going to mean more expenditures on Social Security and Medicare, and this is just not a dynamic that emerging markets will have to deal with for decades.