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Emerging Economies under Observation

In early 2015 the Eurozone still seemed to pose a danger for global economic
growth. But now the emerging markets are the new focus of investors.
The Eurozone dominated the headline until recently. Greece threatened to break the
unity of Eurozone and became emblematic for Europes inability to solve the
problem. The stock market and Euro seemed unaffected by this, and the latter even
recovered in the second quarter. Perhaps this was because the investors were not
hindered by the Greek drama and made note of the progress made by the periphery
economies. By undertaking structural reforms, they significantly reduced their
current account and budget deficits. As China recently decided to moderately
devaluate renminbi, the international stock market saw sharp decline(see macro
outlook). The investors have now shifted their attention to emerging markets.
A glimpse in the real GDPs of the developed and emerging countries gives us the
reasons for this shift. The developed economies are growing since 2012, while the
growth rate for emerging economies is on a decline since 2010.The value of shares
from the developed countries has thus increased in the last four years, in
comparison to the emerging economy shares which were trending sideways until
this August, when the devaluation of reminbi hampered this horizontal trend.
Although the emerging economies are still growing, in aggregate. But many
investors are worried about the quality of this growth. They are looking back at the
outbreak of the financial crisis of 2007, which marked a structural turning point for
the world economy. Both the consumption and capital expenditures collapsed
leading to a severe recession.
At this point, the export driven growth model of many emerging markets was in
danger . Many governments and companies, which are often controlled by state
policy in many developing countries, greatly increased capital expenditures to
stabilize their economies. As a result the investment ratio the capital expenditure
in relation to GDP- rose significantly. This in turn lead to a positive contribution by
the emerging markets to the global economic growth even in the crisis year of 2009
and with China contributing significantly.
Falling trend growth
Since 2010 however the economic growth of developing countries is declining,
inspite of very high investment rate. The International Monetry Fund(IMf) has
concluded hat the trend growth in emerging markets is falling. For the period from
2008 to 2014 the IMF has estimated an annual trend growth rate of 6.5% for
emerging economies. According to IMF, it may drop to 5.2% for 2015 to 2020. 1

1 International Monetary Fund: World Economic Outlook, as of04/2015

One of the reason for this trend is the lack of structural reforms in many emerging
economies during the last decades. The relaxed monetary policy in developed
countries encouraged many investors to invest in developing economies, which
offered a interest rate advantage. Moreover these emerging markets showed
stability during the financial crisis. But this financially conducive environment only
helped them to veil their growing economic weakness. One example is China.
Companies in the steel, cement and solar energy sector received a lot of loans for
investment, creating overcapacity.
A result of this economic development is the increase in the debt owned by the
corporate sector in the developing countries, not just in nominal terms but also in
relation to GDP. If this debt-financed investment does not stimulate much growth,
the interest payment will become a burden. The risk of credit defaults and
bankruptcy is likely to rise. The combination of high investment rate, rising debts
and less growth has made the emerging markets increasingly vulnerable to crisis.
Economic reforms are crucial. Among the developing countries, which have already
adopted reforms , are Mexico and India. In China also things have started to change.
However the state intervention on the capital markets has shown how difficult it is
for the Chinese Communist Party to adopt market driven reforms. Countries
implementing structural reforms should become attractive to investors inspite of the
risks being involved. Valuation discounts is given on shares and bonds from the
countries who are seeking to lessen the troubles in adjusting to market demands.
10
8
6
4
change in %

developed countries
developing countries

0
-2
-4
-6

Past performance is not indicator of future performance. There is no guarantee that


investment objectives or expected returns will be met. Forecasts does not guarantee future
performances. They are based on assumptions, estimates, opinions and hypothetical models
that may prove to be false.

Shrinking of growth difference


The emerging economies stand out with a high growth rates before the financial
crisis. In the crisis year of 2009 they even prevented the world economy from
getting caught into recession. But since 2010 the growth difference between the
developed and the emerging economies is shrinking. At the same time there is
downward growth trend in the emerging economies.

Low investment efficiency(Text accompanying graph 2)


The combination of high investment rate and declining growth dynamics points out
to the inefficient use of capital, in part, that is invested in the developing countries.
To ensure efficient use of the investments, some tough structural reforms are
necessary. This makes it difficult for the government to implement them.
World (GDP growth)
Although the world economy is growing at a moderate rate but the downward trend
is causing concerns.
3,5%* - Forcast for 2016
*Deutsche AWM forcast as of 21/09/2015
We expect global growth to remain moderate and likely weaker. This reflects two
forces: a weaker than expected recovery in advanced economies, and a further
slowdown in emerging economies.
Christina Lagarda, International Monetary Fund, speech given on September 1, 2015
Developing Countries (GDP growth)
The Productive Growth in the developing countries has fallen sharply since
2010.This has caused their slow growth rate.
4.5%* -Forecast for 2016
*Deutsche AWM forecast as of 21/09/2015

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