Emerging Markets Equity Commentary: June 2014

Emerging Market Equities Advance amid Improved Outlook for Exports

Emerging market equity prices outperformed the developed markets for a second month in June, helped by strong gains in Thailand, Russia, and Brazil. India, China, and Taiwan also outperformed during the month on optimism that growth in the emerging economies is unlikely to slip further. The global economy appears to be recovering from the soft trends that prevailed for several months at the beginning of this year. As a result, the outlook for exports of manufactured goods has improved and commodity prices have stabilized. At the same time, the domestic policy environment has improved in select countries such as India and Turkey. The crisis over Russia’s annexation of parts of Ukraine appears to have faded. The economic sanctions against Russia so far have been modest in scale while select western governments have shown willingness to maintain their current relations with Russia.

Select emerging countries have seen improvement in export volumes in recent months, brightening their export outlook for the rest of this year. Shipments from China gained in May and June, helped by more robust demand from the U.S. Korea and Taiwan also reported gains in export volumes during the month of June, despite relatively subdued European demand. Manufacturing activity recovered in China in June while other countries such as Indonesia and India saw further gains. However, Korea and Taiwan saw softer factory activity trends during the month of June. Outside Asia, factory output continued to be weak in Brazil and South Africa. Most emerging market central banks maintained their interest rates during the month, except in Malaysia where the benchmark rate was increased.

Near-Term Outlook

Emerging market asset prices reacted very negatively last year to concerns that the U.S. Federal Reserve could possibly wind down its asset purchases earlier than expected. However, markets reacted calmly when the Fed started the bond purchase tapering during the fourth quarter of last year. More recently, the Fed’s guidance that the bond purchases would be wound down completely by this October has also not caused much anxiety. It is now widely accepted that liquidity flows to emerging markets are unlikely to see a meaningful decline, unless a sudden and unexpected rise in inflation risks force higher interest rates in the developed world. Even as the Fed has curtailed its purchases, the Bank of Japan and the European Central Bank could expand their similar programs later this year if economic growth and inflation fall short of targets. In addition, optimism about improved economic performance could help sustain capital inflows into the emerging markets.

China, Russia, Brazil, South Africa, and India, members of the BRICS geo-economic grouping, are pushing ahead with efforts to create a reserve fund to help them survive future financial crises. The fund is expected to have a corpus of $100 billion and will be in addition to the existing arrangements each of these countries have with the IMF. The BRICS group is also planning to establish a development lending institution, with initial funding of $50 billion, which will play a role similar to the World Bank. The emerging countries currently have less influence, relative to the size of their economies, at the World Bank and the IMF and these efforts are an attempt to overcome that. While these measures are unlikely to bring short-term benefits, increased cooperation between the large emerging countries could result in improved trade cooperation and other gains in the future.

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