17th June 2014
Jan Dehn, Head of Research at Ashmore has reviewed several important emerging markets discussing Mexico, Turkey, Columbia’s important election and the failure of China to be included in the MSCI Emerging market index. We include his views below.
Investors may have felt that a recovery in Mexico was to be as elusive as Beckett’s Godot. Mexico has tested their patience since major reforms were undertaken by the government last year, with the expected growth dividend that usually follows reforms sorely absent. We think this impatience is somewhat misplaced.
Reforms reduce the cost structure of the economy, thus raising the trend growth rate. By contrast, Mexico’s recent growth performance has been sluggish mainly for cyclical reasons. The cyclical drags include weakness in the homebuilder sector, tax increases arising from fiscal measures, general uncertainty associated with the reform process, slow infrastructure investment by the new government and, importantly, very weak growth in the United States in Q1. This is why recent data gives grounds for optimism. A few weeks ago we reported on stronger than expected retail sales. Last week we then had signs of acceleration in industrial production, which rose 0.6% mom in April, up from 0.2% the previous month (seasonally adjusted). Construction picked up for the third month running. In addition, we expect tailwinds from US growth to begin supporting Mexico’s growth and last week’s 50bps rate cut will help too. The real benefits of Mexico’s reforms will only truly be felt later. Unlike in the past, Mexico will now be able to grow faster and for longer before running into balance of payments and inflation constraints to growth as a result of the recent reforms.
The Turkish economy expanded much faster than expected in Q1. GDP rose 1.7% qoq, more than four times faster than anticipated. On a yoy basis, real GDP expanded at 4.3%. Exports were an important driver, rising 7.0% qoq, while domestic household spending contracted outright and investment was low. This pattern for GDP is exactly what you would expect given recent changes in Turkish macroeconomic policy, namely devaluation of the currency and the rate hikes earlier in the year. Turkey has seen extremely rapid credit growth, rendering the economy very sensitive to higher rates. The Turkish central bank hiked rates in January and now domestic demand and imports are declining (imports down 2.4% qoq in Q1). Meanwhile, the weaker TRY has made exports more competitive. Turkey’s economy is responding rapidly to adjustment, as indeed do most EM countries, especially if they have the flexibility of low state involvement in the economy (as in the case of Turkey).
Incumbent President, Juan Manuel Santos, won the presidential run-off election against former Finance Minister Oscar Ivan Zuluaga. This is good news. Both candidates advocated sound economic policies. However, Santos’ campaigned on continuing peace talks with the FARC rebels, while Zuluaga favoured resumption of military action against the FARC. We think the peace process has better odds of ending the war with the FARC than a resumption of military action. Also, Santos’ win means continuity. Finally, Santos is an extremely experienced politician and, in our view, one of most gifted of his generation in all of Latin America. By contrast, we believe a Zuluaga administration would be heavily influenced behind the scenes by former president Alvaro Uribe.
The US Supreme Court is likely to decide this week whether to reject, accept or seek further information before making a final decision on Argentina’s appeal of a New York Second District Court ruling in favour of holdout investors. The decision could have far-reaching effects as it may impact the payment stream to holders of performing bonds.
MSCI, the equity index provider, announced last week that the China-A shares inclusion in the main EM index will be delayed until 2015. MSCI needs to weigh up the growing interest and accessibility of the local market with the actual ability of its clients (namely institutional investors, large index funds, etc.) to invest. Access is still restricted to accounts with QFII and RQFII systems in place, although this is likely to continue to evolve over time – MSCI’s decision was therefore not surprising and does not change the status quo.
Tensions continue to slowly ramp higher last week with the outbreak of open three-way fighting in Northern Iraq. Oil prices are now trading at the highest level for a year. Iraq has become vulnerable to destabilisation following the recent withdrawal of US military support, an important source of the government’s ability to hold on to power in a country deeply divided along sectarian lines. Indeed, the Baghdad government’s legitimacy is disputed in large parts of Iraq. Bashar Hafez Al-Assad’s victory in the Syrian civil war earlier this year has caused an influx of fighters into Northern Iraq.
Western powers now face a tough dilemma: to provide military support for the Iraqi government to help preserve Western influence in what is still a strategically important country, but in doing so, incur the ire of Western voters with no appetite for another Middle East intervention. The West’s loss of moral authority to act has already inflicted diplomatic defeats on Western powers in the Syrian conflict and over Crimea and in Georgia, though Western interests were well-served by the coup in Egypt. We see very little chance that the West will be able to significantly ramp up its influence in the region from current levels, which means that the West’s most important allies increasingly have to rely on their own financial and military means to see off the threat to their rule from militants.