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The great emerging markets deceleration

20 November 2015 Momentum Investments

• “Is Brics anything more than an acronym?” • “The wind has gone out of the Brics’ sails”. • “If you are not growing then you are regressing”. • “SA needs a “Modi moment”.

Dr. Martyn Davies, managing director of Emerging Markets and Africa at Frontier Advisory Deloitte, spoke about the decline of emerging markets at the Momentum Investment Summit held in Cape Town on 12 November.

Davies said investors believed the economic gravity of the world was shifting from developed countries to emerging markets. Politicians believed it too, buying into the idea of a new power block, the Brics (Brazil, Russia, India, China and South Africa), to rival the G8.

Belief in the Brics saw unprecedented investment into emerging markets. Davies questioned whether Brics is anything more than an acronym. He described Brics as a loose geopolitical formation with no common purpose or binding principles beyond knowing they are “not Western”.

Davies believes the wind has gone out of the Brics’ sails. He referred to the collapse of the Goldman Sachs Brics Fund after it lost almost 90% of its assets. The biggest emerging economies are faltering with Russia and Brazil in recession, China’s growth slower, India’s sluggish economic reform and SA in a stationary state.

Davies said if you are not growing then you are regressing. Historically, it takes about 4.9 years to recover from an economic crisis. Yet seven years after 2008, growth is still mediocre.

Davies asked: “Is mediocre the new normal? With no indication that the global economy will improve, what will drive SA’s economic growth to 6% or even 3%?”

Davies asked whether SA’s economic decline is structural or cyclical. He defined structural issues as changes that are politically difficult to achieve, whereas a country can generally ride out cyclical issues. SA is burdened by structural issues in a time when the developed economy is struggling with cyclical issues.

For fifteen years the world experienced artificial economic times. This period was enabling but abnormal. Only three countries did not grow in 2007 – Zimbabwe, Congo and Fiji. In contrast, 114 countries grew at more than 5%, which is staggering, given that previously 30 to 40 countries would fail to grow every year. This led to massive global liquidity and high growth levels on the back of low inflation. Investor confidence in the emerging markets was at an all-time high.

Davies described the past decade as one of convergence. Emerging markets were grouped into a single investment category, as their growth was synchronised on the way up. The future is divergence, as each country finds its own speed of growth during the global deceleration. Africa is already integrating in new and unexpected ways. A new emerging market focus block is evolving, as East Africa increases trade with India, Arabia and Asia.

According to Davies, China must be removed from the emerging markets basket as its sheer size, scale of development and employment growth is disruptive. Despite slower economic growth, China is poised to do well, as it undergoes structural changes to move away from investment-led to consumption-driven growth.

Davies said India is unlikely to become another China. However, under Prime Minister Narendra Modi, its experiencing a bullish phase as Modi makes incremental improvements to break the cycle of structural decline.

With China out of the equation, Davies said it will take 115 years for emerging markets to catch up with the developed world. He advised that if SA wants to grow, it needs to become a market-led economy, free from state control and intervention, over-taxing of the wealthy and over-regulation of industries. He said social-welfare economies lack the incentive to create wealth, while left-wing economics destroy wealth and ultimately societies.

Davies believes SA needs a “Modi moment” – a political shift that will result in structural changes to reignite the economy. It took India 66 years to remove its post-independence leftist and bankrupt political regime. SA could expect a similar timeframe to change its post-independence political regime.

Can Africa grow if commodity prices remain subdued? Davies said there is no evidence that resources drive development. However, no country has succeeded without industrialisation. Success is ultimately driven by diversification, with a country’s exports as a measure of this success. For instance, Nigeria’s economic success was distorted by its oil reserves. After oil prices collapsed, Nigeria’s economy weakened as it has little real industrialisation to fall back on.

Davies’ message to SA is that its economic success needs to be driven by diversification, not commodities, not beneficiation, but industrialisation.

 

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