Transcript
Speaker: Hello, a very warm welcome indeed to this HSBC Global Research LinkedIn Live discussion on emerging markets.
Speaker: My name is Chris Brown-Hulmes, I'm the managing editor here at Global Research and I'm delighted to be joined today by Dr. Murat Ulgan, our global head of emerging market research.
Speaker: Now in the next half hour, Morat will be sharing his key insights on emerging markets.
Speaker: I'm going to set the ball rolling.
Speaker: Morat, I think it'd be great to start with a bit of context here.
Speaker: Can you just tell us how emerging market assets have performed so far this year and relative to developed markets and bring us right up to date, given that there have been quite a few jitters in markets in the last few days?
Speaker: Yes, thank you very much, Chris, and hello everyone.
Speaker: Indeed, it's been quite a volatile summer.
Speaker: Actually, since the beginning of the year, the risk sentiment has seen a
Speaker: rollercoaster ride, we've seen large swings in financial markets.
Speaker: And when you look at the EM asset classes, their performances year to date, they're close to or even below zero.
Speaker: And as it was a big underperformance compared to EM, compared to developed market equities.
Speaker: And it's understandable because, you know, when you look at the external backdrop, there are so many moving parts and so many uncertainties, financial markets in general and emerging markets in particular, they have to content with
Speaker: Continued COVID-19 headwinds, the downside risk to the global economy, uncertainty surrounding inflation, an impending Fed tapering of asset purchases and a resurgent dollar.
Speaker: And as you said recently, the headlines coming out of the Chinese property development sector
Speaker: They haven't been helpful either, even though things are calming down a little bit.
Speaker: So too many moving parts, a lot of uncertainties.
Speaker: And it doesn't look like any of these will go away anytime soon in the remainder of the year or going into 2022.
Speaker: So understandably, it's been quite volatile and not great performance, somewhat disappointing performance, I have to say.
Speaker: Thank you.
Speaker: Well, you're right on the topic here because we did have a poll in the run up to this about the challenges facing emerging markets for the rest of the year.
Speaker: We gave the audience four options.
Speaker: One was Fed tapering, another inflation, another slower global growth, and the final one a stronger dollar.
Speaker: Now, top of the poll by a short margin over inflation was slower global growth.
Speaker: Do you see that as the main challenge for emerging markets?
Speaker: It is a big challenge because when you look at the emerging markets and how they drive flows, capital flows, portfolio flows, and how returns are correlated, emerging markets are known to be higher growth in the economy.
Speaker: So growth is very important, very correlated with those.
Speaker: When growth is under pressure or there are downside risk or loss of momentum, that inevitably impacts flows and returns.
Speaker: As a matter of fact, we posted on LinkedIn previously
Speaker: what we call a global growth factor, when we look at the market's pricing of global growth outlook from financial market parameters almost on a daily basis.
Speaker: It's a volatile series, but it tells us a story there, and it's actually very well correlated with other indices, other global growth trackers that use some monthly macro parameters.
Speaker: I think the story here or the message is somewhere around at the end of the second quarter of this year,
Speaker: Global growth momentum has peaked and ever since then it's been slowing down and this is impacting emerging markets as well.
Speaker: That's obviously because of COVID and obviously because of the Delta variant.
Speaker: It is a bigger issue in Asia, but in other parts of the world as well.
Speaker: And all the associated continued restrictions in certain places, maybe not that much in the West, but the numbers are elevated there too.
Speaker: So that clearly causes downside risk to the global growth outlook or loss of momentum deceleration.
Speaker: And that impacts EM activity, EM performance and EM outlook.
Speaker: So understandably, it is perceived to be a big risk in the remainder of this year.
Speaker: But clearly inflation is also perceived to be a big risk.
Speaker: I mean, how worried are you about that?
Speaker: That's actually very interesting.
Speaker: I mean, if you look at the poll results, you know, people are worried about slower growth and higher inflation.
Speaker: That is not a great combination.
Speaker: I mean, inflation has been on an uptick across emerging markets, you know, just to put things into numbers since the beginning of the year, it's gone up from about 2% to about 4%.
Speaker: If you exclude China, actually, it's more like from 4.5% to 6.5%.
Speaker: And core inflation has been on the rise as well.
Speaker: And no wonder, you know,
Speaker: Some emerging market countries are actually hiking rates and some are quite aggressive, not in Asia, but clearly in Latin America and parts of EMEA.
Speaker: So there is a worry about inflation.
Speaker: Although when we looked at inflation in more detail, with a few exceptions, it does appear to be mostly a cost side issue that is stemming from the earlier rise in commodity prices stemming from
Speaker: Supply chain disruptions and all the prices that are going up for raw materials, for semi-finished goods, finished goods, it's actually a downside growth risk as well because it's supply shock.
Speaker: So the supply chain disruptions are featuring in downside growth risk and also in higher inflation risk.
Speaker: But it's mostly a cost issue.
Speaker: Although different regions are showing different dynamics and trends in terms of passing these cost pressures,
Speaker: into end user inflation.
Speaker: It's quite interesting actually broadly speaking in Yemen, Asia and parts of EMEA, these cost pressures are not passed on to end user inflation that much, whereas in Latin America they are actually passed and spilled over to end user inflation and you know CPI inflation and it's no wonder that Latin American centimax have been the most aggressive in monetary policy tightening.
Speaker: Yeah so one of our audience is asking here do you see stagflationary risks picking up going into 2022?
Speaker: Well, I mean, to me, stock relation is a bit of a definitional issue.
Speaker: I think it depends on how much growth slowdown and inflation rise you're factoring in.
Speaker: But let's put it this way.
Speaker: It is a deterioration of growth inflation tradeoff.
Speaker: You unfortunately get subdued growth outlook and still inflation issues.
Speaker: But again, I go back to my earlier point.
Speaker: Inflation to us, broadly speaking, generally speaking, is a cost side issue and it will subside.
Speaker: So admittedly, this is a little bit more prolonged and protracted than we had originally thought, but we still believe this is mostly a cost side issue and demand side inflation pressures are still broadly absent and the labor markets still have a big slack.
Speaker: How big a concern is Fed tapering going to be for emerging markets?
Speaker: It's a big deal.
Speaker: We've looked at it under the sort of concept of global liquidity, the backdrop of global liquidity.
Speaker: And actually throughout the summer, a few things have happened.
Speaker: one of which was posted for emerging markets, which was the SDR injection by the IMF.
Speaker: It's the special drawing right.
Speaker: It's a unit of international currency.
Speaker: It's the unified account for the IMF.
Speaker: And IMF has actually conducted its biggest SDR injection to member countries, $650 billion, because in history, an EM received $275 billion, a little bit less than 1% of EM GDP.
Speaker: So that is a posted on global liquidity.
Speaker: But what is negative,
Speaker: is clearly where the tapering comes into the equation.
Speaker: But even before tapering, we have looked at the changes in global liquidity.
Speaker: It's annual change, the growth rate, the first derivative.
Speaker: Pretty much since the end of the first quarter of this year, global liquidity growth is actually coming lower.
Speaker: Now, don't get me wrong.
Speaker: Global liquidity is still plentiful, it's still ample, and it's still growing.
Speaker: But it's growing at a much, much slower pace compared to what it was late last year and early this year.
Speaker: And this has implication on IAM fund flows with a lag.
Speaker: we have established correlations and it takes up to three to four quarters of a lag
Speaker: the changes in global liquidity, they spill over and impact E&M fund flows.
Speaker: Now, tapering comes into the equation right here because tapering, when it starts, how it will be conducted, at what clip every month, how much the Fed will reduce treasury purchases or asset-backed security purchases, and when it will end, the intensity magnitude, they will all dictate the future path of global liquidity growth and with a lack E&M fund flows.
Speaker: That's why it's so critical for emerging markets.
Speaker: Yeah, but the last time we had tapering, which was back in 2013, at the end of the global financial crisis, emerging markets were really thrown into a bit of a panic, that so-called taper tantrum.
Speaker: Do you expect anything like that to happen this time around?
Speaker: Chris, it's too early to say this is going to be a tantrum less taper.
Speaker: But there are some areas where you can think that the risks are reduced.
Speaker: For one thing, emerging market countries are already hiking interest rates and increasing their risk premium.
Speaker: As a matter of fact, when you look at what is priced into the markets, the monetary policy out to go across EM, again, it shows regional differences, but broadly speaking, is almost at par the hopelessness.
Speaker: as in 2018.
Speaker: And 2018 was the year when the Fed was actually hiking interest rates.
Speaker: Not only hiking, but hiking more than forecast.
Speaker: At the moment, they're not hiking.
Speaker: They're not even starting tapering yet, whereas emerging markets are increasing interest rates in certain cases pretty aggressively.
Speaker: I take this as kind of a preparation on the EM side, on the risk premium, trying to preempt a repeat of taper tantrum, as you said.
Speaker: So that's one thing.
Speaker: The second thing is
Speaker: The external balances, they're in a much, much better shape.
Speaker: And really, however you slice and dice, whatever you look at, you look at high yield EM, you look at commodity EM, the external balances are much better compared to the taper tantrum.
Speaker: I mean, remember back then, the countries who were singled out with large current account deficits, large emerging market countries on average, 4.5% of
Speaker: of GDP current account tips.
Speaker: Now we're talking about 1% less, you know, for some current account surplus.
Speaker: I think that picture is vastly different, which means the external funding requirements are not that ample.
Speaker: And as I mentioned, there is this extra modest help coming from the IMF in terms of SDR injection, which is also helping with fiscal and external funding needs.
Speaker: So there are differences that mitigate the risks.
Speaker: So is it fair to say that those are the two big positives for emerging markets at the moment, the SDR injection and the stronger external balances?
Speaker: Is there anything else you'd like to point to as supporting factors?
Speaker: I mean, it has been pretty strong inflows into emerging markets before the taper tantrum in 2011, 2012, obviously post-global financial crisis.
Speaker: But also, if you remember, there was Abenomics and quantitative and qualitative easing by Bank of Japan,
Speaker: And this has attracted significant fixed income portfolio flows, carry trade related portfolio flows into emerging markets back then, you know, causing crowded positioning and, you know, currencies have appreciated and they cause current account deficits.
Speaker: And now look, you know, we covered the current account part, but there haven't been those significant carry related flows.
Speaker: Yes, there have been some flows into EM.
Speaker: you know, as sort of, you know, as a lagged impact of increasing global liquidity, but they've been mostly to the equity markets.
Speaker: Year to date, out of $110 billion of inflows into EM, $85 billion plus went into equities.
Speaker: And also on the fixed income side, you know, a big part went to China because it's now, you know, opening up its, you know, bond markets have been included in bond indices, etc.
Speaker: So,
Speaker: In a way, you know, I don't know if this is positive or not, but in comparison to, you know, the sort of, you know, the episode leading up to the taper tantrum in 2013, compared to that, I would say the carry trade related inflows towards emerging markets are a lot less, which, you know, as a corollary, hasn't caused appreciation of the currencies.
Speaker: Now, as I'm sure a lot of our audience will know, research has been doing a sentiment survey, EM sentiment survey since last year.
Speaker: We've now had five editions out.
Speaker: The sixth one will be coming in early November.
Speaker: The last one, Murat, showed that investors were pretty cautious sitting on a lot of cash.
Speaker: What do you think is going to do, what's going to be required for them to start putting that cash to work?
Speaker: Yes, Chris, I'm glad you brought it up.
Speaker: It's actually very interesting.
Speaker: You know, we ask investors their cash positions and nearly half of them have in excess of 5% cash in their portfolios.
Speaker: And that's a lot.
Speaker: You know, in certain cases, it's actually 7, 8, if not 10%.
Speaker: That's really a lot of cash that is underinvested or perhaps waiting for the right opportunity.
Speaker: to invest.
Speaker: And the other interesting thing, actually, you know, that's one question we ask.
Speaker: And the other question we also ask is, how are you intended to change that cash position?
Speaker: Are you intended to put it to work, meaning decreasing it or increasing or keeping broadly the same?
Speaker: And 59% said, we want to keep the cash levels broadly unchanged over the next three months.
Speaker: And that 59 is actually the highest since the survey started.
Speaker: So there is a lot of undecided investors,
Speaker: you know, perhaps hesitating to dip in or dip out, not necessarily being positive or negative about emerging markets, but just, you know, perhaps waiting for the right opportunity.
Speaker: And again, to me, it's totally understandable.
Speaker: The context we have drawn at the beginning of this call, we mentioned about all these challenges.
Speaker: And remember, you know, at the beginning of the summer, the whole sort of global market concept was about
Speaker: FED's Hohkisch tilt and inflation, high inflation numbers in the US and what this would mean about global cost of funding.
Speaker: Very swiftly in the summer, this is changing to COVID-19 delta variant varies and downside risk to global economy.
Speaker: So when, you know, the various changes, concerns change so rapidly from one end of the spectrum to the other, when you gyrate so wildly, it's only natural that people want to sit on cash and expect maybe the global environment to tranquil a little bit, you know, have a better predictability, less fluid, and then put that cash to work.
Speaker: Now, on the back of that, one of our questions is, after several quarters of doing the EM survey, are you seeing some longer term trends emerging?
Speaker: That's an excellent question.
Speaker: We do, and there's probably no surprise that, you know, actually a couple of them, one of which is generally Asia is the most preferred region, although in the latest summer survey, investors have actually reduced their positions a bit.
Speaker: And obviously, we've seen a lot of volatility in Asian Chinese markets over the last few months.
Speaker: But that, you know, that trend is very clear.
Speaker: What is interesting is, you know, the other regions, Latam and EMEA, they keep shifting places.
Speaker: And Middle East as well, we go a little bit more granular.
Speaker: But Asia still remains, by and large, a big area where investors prefer.
Speaker: That is, you know, I have to say, we've only done five surveys.
Speaker: So it's, you know, a bit early to draw some structure, long-term conclusions.
Speaker: But that's one thing.
Speaker: Pretty much in every survey, investors are most sort of, their net position, net sentiment, are mostly positive towards Asia, even though they trimmed a bit in the summer survey.
Speaker: I think more important than this is to me a structural and secular trend, it's the ESG engagement.
Speaker: Pretty much in every quarterly survey, the ESG engagement increases.
Speaker: You know, ESG, environmental, social and governance aspect of investing in EM is becoming a lot more ingrained in investor behavior, in investor outlook.
Speaker: It's not only a developed market issue anymore.
Speaker: It's an emerging market issue.
Speaker: ESG, EM linkages are growing.
Speaker: Every survey, every quarter we ask investors,
Speaker: are you running a portfolio?
Speaker: Do you have any exposure either direct or indirectly?
Speaker: Are you running an ESG portfolio?
Speaker: Do you have any exposure on the ESG side?
Speaker: And every quarter, this is increasing.
Speaker: In the latest survey, nearly half of the investors had an exposure to ESG attributes, running an ESG portfolio, either direct or indirectly.
Speaker: That I can clearly say and see as a long-term secular structure trend.
Speaker: But we have a question here saying, do the growth concerns that we've already just been talking about mean that businesses will actually focus less on ESG?
Speaker: I wouldn't think so.
Speaker: I mean, if anything, you know, we have a fantastic research department looking at all the ESG issues and they're constantly published.
Speaker: I think there is a lot of interconnectedness.
Speaker: There is a lot of interlinkages between the ESG attribute and the growth outlook of countries.
Speaker: I mean, in emerging markets, for instance, energy transition comes to my mind or all the climate challenges.
Speaker: They have implications for the growth outlook, you know, a sustainable growth,
Speaker: growth without generating imbalance of inflation or current account and all the investment and infrastructure needs that will shape growth.
Speaker: I mean, I can give you examples.
Speaker: In Asia, Indonesia is my favorite story and Indonesia has been recipient of massive foreign direct investment over the past few years because it has substantial nickel and cobalt deposits and companies from Asia, from the West, they invest like Greenfield, FDI, foreign direct investment in Indonesia.
Speaker: Why?
Speaker: because of, you know, green revolution, because of electrical vehicles, because in Indonesia they can produce the batteries and that gives boost to the growth outlook.
Speaker: So I wouldn't necessarily say, you know, these are working in opposite direction.
Speaker: And actually, I would say pretty much, you know, focusing on ESG brings you eventually a better predictable and sustainable growth outlook.
Speaker: So they actually reinforce each other rather than impede each other.
Speaker: One question we've got is about potential changes in global supply chains and the sort of trend towards more local production.
Speaker: And the question is, you know, which regions could be the main beneficiary?
Speaker: Yeah, very good question.
Speaker: I would say rejigging of supply chains or the shifts in supply chains, they have been there even before the pandemic.
Speaker: I mean, obviously, we have been dealing with a lot of trade tensions and frictions over the last three, four years.
Speaker: And already this was quite topical, you know, how the supply chains will shift and which countries and which regions would benefit.
Speaker: And the pandemic has brought, you know, another
Speaker: interesting and unexpected dynamic in here where the supply chains have been disrupted, partly broken, especially when it comes to the semiconductors and microchips holding up the automotive production and industry in various parts.
Speaker: Our economists have done very, very good pieces on that, especially out of Asia and also out of London.
Speaker: And at the moment,
Speaker: Their assessment evaluation is this is actually a bigger issue in the West than in emerging markets.
Speaker: And obviously, when I say emerging markets, I should probably specify more Asia as a big manufacturing hub across all emerging markets.
Speaker: So it's a bigger issue in the West, you know, from wherever you look at it.
Speaker: You look at the delivery times being extended, you look at the backlogs.
Speaker: You know, if you look at output, less new orders, it is a much bigger issue in the West compared to Asia.
Speaker: But, you know, clearly it's an issue for global supply chains and production.
Speaker: Are there countries benefit from that?
Speaker: I think there are, you know, those countries who are closer to the demand centers, so to speak, and they are flexible.
Speaker: They can do, you know, in small batches, they can ship pretty quickly.
Speaker: They are benefiting.
Speaker: You know, in Asia, we've been seeing this shift for quite a long time.
Speaker: in favor of Vietnam and Malaysia, for instance.
Speaker: I think in India, Turkey benefits a lot.
Speaker: You know, Turkish export numbers have been pretty strong over the past few months or since the beginning of the year because it's very close to Europe and it can easily ship and flexibly a lot of things where, you know, they are benefiting from some replacements, some shifts out of Asia towards Turkey.
Speaker: And in the U.S., in America, or Latin America, Mexico is a big beneficiary.
Speaker: as you know, US is the big demand center.
Speaker: Clearly, you know, Mexico was already connected a lot to the US with 80% of exports ending up in the US, especially manufactured exports, but with the supply chain disruptions
Speaker: In the aftermath of COVID, they benefited from that, you know, sort of, you know, an extra sort of, you know, additional benefit being drawn out of that.
Speaker: So I think those are the dynamics that are impacting supply chains that could they could be structured, they could be long term.
Speaker: And there are some beneficiaries from each region.
Speaker: We've got a question here on emerging EMFX, which is saying with the global economy losing momentum and the Fed potentially reducing stimulus, what is the longer term outlook for EM currencies?
Speaker: Yeah, I'll talk about longer term, but in the near term, our team is direction looking for a stronger dollar, albeit, you know, modestly stronger dollar going into next year.
Speaker: which obviously has an impact on emerging market effects.
Speaker: I'm actually quite surprised that when we pose this question in the poll, that answer hasn't been picked up that much.
Speaker: I was expecting more people picking that.
Speaker: So maybe there are some divergence of views.
Speaker: I think over the medium to long term, the drivers of EMFX outside of
Speaker: global financial and liquidity conditions, I would say EM's own growth dynamics and EM's productivity dynamics, especially total factor productivity.
Speaker: And that actually is obviously tied into growth dynamics.
Speaker: Higher total factor productivity means sustainable long-term growth without imbalances.
Speaker: So to the extent emerging market countries
Speaker: can actually record sustainable long-term growth and a growth that is actually at premium over developed market growth, they will attract inflows in capital and their currencies tend to appreciate.
Speaker: Unfortunately, over the last three decades, we've only seen
Speaker: total factor productivity coming down, especially the last decade before the pandemic, after the global financial crisis.
Speaker: But there are exceptions.
Speaker: You know, Vietnam is the only country where TFP has gone up.
Speaker: India is the only country where TFP stayed the same, where the rest, they have come down.
Speaker: I think
Speaker: productivity growth and sustainable growth is what is needed for EMFX to perform better, not only in real terms, but also in nominal terms, in an environment of growth challenges, in an environment where the easy parts of globalization change
Speaker: could be behind us for emerging market countries.
Speaker: And if anything, from here onwards, it's up to individual emerging market countries to boost their potential via structural reforms, structural changes to boost their productivity.
Speaker: To me, that would be critical.
Speaker: In the near term, as I said, directionally, we're looking for modestly stronger dollar.
Speaker: So you use the initials TFPs, what's that?
Speaker: Total factor productivity?
Speaker: Total factor productivity, correct.
Speaker: This is, you know, just to give a bit of a context, it's essentially what you get out of your economies beyond what you put in in terms of labor and capital, the factors to production.
Speaker: This is about your policies.
Speaker: This is about your monetary stability.
Speaker: This is about your, you know, investment environment, you know, privatization, liberalization, all the rules and regulations to essentially boost and support and address the business environment.
Speaker: Let's turn to commodities.
Speaker: Where do you see commodities in the next one to three years and what impact do you expect that to have on inflation and real growth?
Speaker: Yes, so our commodities teams, they've been long saying that this is not a super cycle.
Speaker: And in fact, we've seen some big correction commodity prices very recently, perhaps tying to the issues and headlines coming out of China and China property development sector, especially the iron ore.
Speaker: but also still, they still do look for some modest correction in commodity prices, which, you know, perhaps not necessarily too bad for the commodity producing and exporting economies, because these economies, especially in the EM space, especially in Latin America, they haven't benefited from an earlier substantial and significant increase in commodity prices since the middle of last year.
Speaker: So they haven't benefited much in terms of the gains where you see in terms of trade, in external balance, in trade accounts.
Speaker: So in that sense, some modest correction may not have a big impact either.
Speaker: And obviously, when we talk about commodities, we should talk about not only the demand where we mentioned there are some downside risk, global activities losing a bit of momentum, but there are also some supply realities, especially in oil.
Speaker: There is a very disciplined demand.
Speaker: and tight management of supply by OPEC and OPEC plus, which changes the outlook for oil prices.
Speaker: The outlook for the global economy would have argued weaker oil prices, but then the very disciplined supply management kind of holds up prices.
Speaker: And then the final thing is, I circle back to ESG and this sustainability agenda of all large economies where when you put them under each other, the ambitious targets of going to net zero
Speaker: that would mean significant demand for the green commodities, quote unquote, you know, the likes of copper, nickel, cobalt and others.
Speaker: So there are so many factors and vectors influencing commodity price in the near term, perhaps some weakness.
Speaker: But there are some other supply dynamics and long term demand dynamics featuring into that as well.
Speaker: Morat, it's been a fascinating discussion.
Speaker: Thanks very much for your time and your insights today.
Speaker: Thanks very much indeed to everyone who's joined the call and for some excellent questions.
Speaker: Thank you all very much.
Speaker: Thank you.
Speaker: Thank you for listening today.
Speaker: This has been HSBC Global Viewpoint Banking and Markets.
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