Imagine you’re aboard a flight that’s on its final approach into the Indira Gandhi International Airport in Delhi, India. For most of the flight, the plane, a 787, has been traveling at about 903 km/hour (that’s around 560 miles/hour). As the flight attendants collect that last few plastic cups, the plane starts to slow and banks gently to line up with the runway. The man next to you, oddly distraught over the change in airspeed, yelps as the pitch of the engines audibly lowers. Panicking, he unbuckles his seatbelt, stands up and yells, “It’s slowing down!! Why is it slowing down?!? I’m bailing out!!”
While you’d never expect this sort of thing to actually happen on a real flight to India, something similar is happening with emerging market investors. Look at the fund flow patterns in the last six to twelve months, and you’ll see a distinct shift out of emerging and into developed markets. But is slowing growth a reason to bail out completely? For us, emerging markets remain a structurally positive story and a place to profit from good opportunities when we find them. There will be issues from time to time that will serve as cause for reflection, but it’s important to keep things in perspective and focus on long-term outcomes.
As example, one specific factor that’s currently holding sway over investors is the state of the current accounts in India and Indonesia. Current account deficits are an issue in both countries. However, rather than a harbinger of emerging market doom, I would argue that this is really part of the process of these economies maturing, and the recent market action, if anything, sends a strong signal to their policy makers to refocus attention on very structural reforms that made them successful in the first place.
Many emerging economies (India and Indonesia included) took the rapid pace of growth during the past 10 years for granted, and unfortunately, they used that growth as an excuse to take a step back on structural reforms. In the process, their savings dropped and current account deficits ballooned. That made it hard for them to domestically fund the very high levels of capital expenditure required to support infrastructure growth that’s key to them realizing their huge demographic potential. The result was an excessive dependence on foreign savings, which hurts currencies and sentiments in environments like these when global interest rates (especially those in the United States) go up. Exaggerated currency weakness is no doubt painful, but also has a silver lining – it can act as a catalyst for domestic growth through import substitution, which often bodes well for future growth.
India needs to do a lot more to regain investor confidence, but their issues needn’t be held up as reasons for abandoning emerging markets entirely. Just like slowing or a little turbulence shouldn’t have one running for the exit row to bail out of your next flight, so too should investors keep a long-term perspective and focus on the benefits that emerging market allocations can bring to their portfolios.
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