Rocks, hard places and everything in between
China’s leader Xi Jinping hailed his country’s advanced military capabilities last week as he presided over a massive military parade in Beijing.
The occasion was the commemoration of the 80th anniversary of Japan’s surrender and the end of World War II. No leaders from the West were in attendance of the event, which one commentator described as aimed at showing that China was “a great power rooted in the developing world”.
This is a difficult moment for developing countries, squeezed between the world’s two superpowers, America and China, but also facing disruption from artificial intelligence and climate change. They’re witnessing China becoming more assertive on the global stage, while the US becomes more unpredictable and less friendly, as seen in the devastating cuts in foreign aid that hit the poorest countries hardest and the sharp increase in import tariffs.
Before going further, it should be remembered that we are talking about a very diverse group. Some will happily align with one of the superpowers, while others will try to steer a middle ground. They also have different economic dynamics and usually only have one thing in common: they are not rich. However, even that oversimplifies things slightly. South Korea, for instance, counts as an emerging market according to index providers like MSCI even though its economic sophistication and high living standards put it on par with many developed countries. This is because MSCI considers how easy it is for global investors to enter and exit a market, and Korea scores poorly on that count. The other thing to note is that not all developing countries are on investors’ radar screens. MSCI classifies developed economies as part of the World Index (23 countries), while developing economies fall into the Emerging Markets Index (24 countries) or the second tier Frontier Markets Index (28). This still leaves out more than 100 countries whose capital markets are too small or restricted to warrant index inclusion.
The diversity between emerging countries therefore means that grouping them together should only be done with a pinch of salt, while any thorough discussion of the topic will necessarily be long. There is only space here to make five quick points.
Weak dollar benefit
The first is that there is another commonality between emerging markets: they tend to benefit from a weaker US dollar since so many of them trade and borrow in dollars. As their currencies appreciate, there is also room to cut interest rates, stimulating domestic economies and financial markets. A weaker dollar also encourages capital inflows, since investors have greater certainty of earning a return in dollars. One of the biggest challenges in these countries is that the returns on offer might be compelling, but not so much when translated back into hard currency. . Simply put, periods of superior emerging market return in bonds and equities have usually coincided with a weaker US dollar as chart 1 shows.
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