The crashes in Chinese stocks have shaken global confidence. Yet China has already experienced a sharp economic slowdown in the first quarter of 2015. Just as they are experiencing a hard landing, two other major emerging economies, Russia and Brazil.
This is why for some analysts, the current phase gives hope that by now we have reached the last phase of the adjustment structural for emerging economies. From which to be able to restart with more "constructive" investment positions. This is at least the opinion of the Morgan Stanley experts expressed in the recent report of 15 July “EM Fundamentals Inflecting Lower – a Third, Painful but Final Stretch?”
“Three of the five most exposed emerging economies have experienced a growth shock and have likely fallen onto a weaker growth path – write the Morgan Stanley analysts – Fundamentals have deteriorated in seven of the nine economies considered most externally exposed (Brazil, South Africa, Turkey, Indonesia, Colombia, Russia, Malaysia, Peru and Mexico). For analysts, the reason lies in an important dynamic of disinvestment, in English unwind, which is sweeping the emerging markets, and which is linked to three fronts: the US Qe, the Chinese lever and the domestic credit of the emerging countries.
However, it was precisely the sharper fall in fundamentals that increased conviction of Morgan Stanley analysts that emerging markets "may well be in the third and final phase of their macroeconomic adjustment, on the road to a painful catharsis that will ultimately support growth and equity prices".
So instead of looking at a growth rebound, Morgan Stanley says it monitors the occurrence of at least one of the following conditions:
1) An evident change compared to the past in the growth model
2) A positive trend of the second derivative of growth
3) Lower growth but better quality
In particular, there are three dimensions on which the fall in the fundamentals of emerging countries can be analysed: 1 The structural fracture (divide) and the dividend of the "reform club"; 2) The fracture related to exposure; 3) The commodities rift.
THE STRUCTURAL FRACTURE
Emerging countries are divided between those who are making the reforms and those who are not. The former include China, Russia, Brazil, South Africa and Turkey. For the latter, the "Reform Club", India and Mexico. In particular, the reform process in China has slowed down to balance the headwinds due to its leverage and demographics, which has translated into a shock to growth in the last 3-4 months. For their part, Russia and Brazil are seeing virtually no reforms but are both on the path of macroeconomic adjustment. Finally, South Africa has shown little interest in reform or adjustment – some improvements are happening but the pace has been too slow from an investor perspective. The same is true for Turkey, which has seen some macroeconomic improvements but not enough to significantly reduce its external exposure. "The worrying aspect - say the Morgan Stanley analysts - is that the interest in avoiding a painful macroeconomic adjustment is such that we do not give hope for an improvement unless it is driven by the market". Conversely, the countries in the reform club, India and Mexico, are likely to see the benefits of the reforms they are implementing.
THE EXPOSURE FRACTURE
Morgan Stanley analysts have divided the emerging world into two parts: Em-likes and Dm-likes. The latter, such as China, Korea and Malaysia, enjoy current account surpluses, have low inflation and deflationary risks. Em-likes, such as Brazil, Turkey, South Africa, Russia, India, Indonesia and Mexico, depend on external financing, worry about upside risks to inflation, and policy makers therefore have little monetary or fiscal space. Among these, the most exposed externally, Brazil, Turkey and South Africa, which saw their fundamentals weaken more in the face of high inflation which restricted the room for maneuver of policy makers to support growth, were especially affected. Morgan Stanley recalls that the Brazilian central bank was surprised by the stubborn determination in carrying out its message: rate hikes will continue until inflation falls to 4,5%, estimated by the central bank in 2016. The Sarb, the bank central South Africa is likely to embark on a cycle of rate hikes in 2015. “The result – Morgan Staley's analysts explain – is that rates will remain higher for longer, putting more pressure on the growth of all these economies”.
Economies such as Colombia, Peru and Russia have seen investment and growth fall almost everywhere while the devaluation of the currency has increased the risks of inflation. A special case is Mexico which, despite being one of the most exposed economies, due to a domestic bond market largely in the hands of foreigners, "is not however vulnerable".
THE COMMODITY FRACTURE
Commodity exporters will benefit the most. It is a thesis that the analysts themselves define as "counter-intuitive". “Commodity-oriented economies – analysts point out – they will be forced to change their growth pattern due to violent changes in commodity prices. They will have to abandon commodity-related investments and spending as the macroeconomic deterioration will make them much more competitive. On the other hand, commodity importers will enjoy a boost from the tailwinds, but that won't change the way they invest or consume. “That's why – conclude the experts – the increase in productivity is likely to be much greater among commodity exporters. After the adjustment, growth will be lower but of better quality, one of the signs of a new growth model that we see as an important support to asset prices”.
When will it be possible to be positive on commodity-producing countries? For Morgan Stanley analysts it is necessary to wait for "the second derivative of growth after the macro adjustment to become positive and a new growth model begins to emerge", i.e. when the source of growth will no longer be commodities and consumption but when it will shift to manufacturing with the devaluation of the exchange making the economy more competitive. A change that is already taking place in Indonesia where commodity-oriented investments are already decreasing and imports show more investment goods. Russia is likely to be the next country to show such a transformation, experts assure, and Brazil shouldn't be too far behind either.
