by Lupin Rahman, PIMCO
- We forecast emerging economies will expand at a faster pace than advanced economies over the secular horizon.
- The challenge for emerging market central bankers is to remain ahead of inflation expectations and retain credibility on inflation targeting. We feel they are well positioned for this.
- We believe global investors remain significantly underweight emerging market assets. We expect this underallocation to decrease, providing multiyear support for the asset class.
Emerging markets are increasingly important drivers of growth for the global economy, though they face challenges to reaching parity with, or even surpassing, today’s developed nations.
In the final of a series of Q&A articles accompanying the recent release of PIMCO’s Secular Outlook, portfolio manager Lupin Rahman discusses growth dynamics, inflation and structural change in emerging markets (EM) as well as what all of this means for the global economy.
Q. Could you discuss growth dynamics in emerging markets and their share of the global economy?
Rahman: We forecast emerging markets to outperform advanced economies over the secular horizon (next three to five years) with growth averaging 6% vs. 2% in advanced economies. Significant transitions already underway in the global economy underpin this trend. Essentially we are seeing a shift from a unipolar world anchored by advanced economies toward a multipolar world with large emerging economies playing an increasingly larger role in the global economy.
Within EM we expect to see differentiation across economies. In Latin America and emerging Asia we forecast growth in the 6% to 7% range to be anchored by low leverage, strong structural demand for commodities and a soft landing in China. Meanwhile, countries in emerging Europe, and in particular those economies with high levels of leverage, are likely to experience a period of modest growth in the 4% range.
The relevance of this increasing importance of EM for investors lies in the remarkable divergence between current investor positioning and the economic realities of the postcrisis world. Specifically, we believe global investors remain significantly underweight emerging market assets in relation to both their current and future share of the world economy, as well as in relation to the trends in their relative credit fundamentals. We believe that as markets reorient to our New Normal view of the world this underallocation to EM will decrease, providing multiyear support for the asset class.
Q. How does the middle class in emerging markets compare to the developed world? And what are
current and anticipated domestic consumption patterns in EM?
Rahman: The growth of the emerging middle class is an important aspect of the EM growth story, particularly in the context of a deleveraging consumer base in advanced economies. If we take the World Bank’s definition, the global middle class is forecast to triple from 400 million in 2000 to 1.2 billion in 2030, with China and India accounting for most of this expansion, according to a December 2006 report. To put this into perspective, this means that by 2030 a significant majority of the global middle class will be from EM.
In addition to important strides in po verty reduction, this shift represents tremendous opportunities in new global consumer markets as EM consumption expands beyond food and shelter and towards consumer durables and services. In fact we are already seeing this trend with spending on automobiles, refrigerators and entertainment showing robust growth. We expect this to continue in the next decade and be underpinned by gains in real EM consumption growth which we estimate will increase by 50% in real terms.
Q. Shifting gears, could inflation cloud the outlook for emerging markets?
Rahman: There have been two important shifts in EM inflation dynamics over the past decade underpinned by more independent central banks, a reduction of fiscal dominance and a reduction in wage indexation. First, the levels of inflation in emerging markets have dropped from double-digit increases being the norm to headline inflation decreasing to the mid-single digits. Second, inflation volatility has decreased as a result of more anchored inflation expectations.
Looking ahead, the current 2 to 3 percentage point differential between emerging market and advanced
economy inflation will likely persist given our forecast of robust EM growth and debt deleveraging in advanced
economies. But importantly, we do not see a sharp secular increase in this differential. Of course there are risks to this baseline view from potential spikes in commodity prices and asset-market bubbles, but the fundamental shifts in inflation expectations mentioned before provide EM policymakers room to maneuver in tackling these shocks.
Q. What are central bankers in those countries doing to contain inflation, and what are the implications of
their policies?
