Investment Adventures in Emerging Markets


PODCAST: How COVID-19 Is Testing the Resiliency of Emerging Markets

Manraj Sekhon, chief investment officer, Franklin Templeton Emerging Markets Equity, discusses the emerging markets landscape across North Asia, India and Latin America, and the path forward toward recovery from the COVID-19 pandemic.

Listen to our latest “Talking Markets” podcast.


Alistair MacDonald: Manraj, it has been nearly four months since COVID-19 started making headlines. The near-term economic impact has clearly been massive and far reaching, but stimulus has likewise been unprecedented. So, where do we go from here and what are the key takeaways so far?

Manraj Sekhon: I think it’s worth just separating the health issue from the economy. Clearly the situation continues to evolve and what we can say is that this scare is not going away. The experience of different countries, different governments in dealing with it show that this is not entirely about throwing money at the problem. It’s not entirely about the measures and the care that people take. It is certainly affecting different communities, different countries in different ways.

The consensus right now, which I think is accurate, is that this current phase of the virus will carry on for a few months. There will be more waves of infections, as we’ve seen in Singapore as well as other parts of the world. The acute scare, in terms of the number of cases, is probably something that we’re at the peak of, if not past. But given that we have, still, very little understanding of the virus and how it can evolve, the kind of protection and measures to deal with it will continue for some time. So, we will have to have protection measures at least until we have vaccines that can treat it in a scalable and effective safe way, and that’s probably at least 12 to 18 months away. So, I think we have to be prepared to deal with this for a while.

The second thing about what’s going on that we need to be clear about is that clearly the global economy entered this phase in generally good shape. When you look at the major economies around the world, whether it was in terms of balance sheets, growth, the level of jobs and orders, things were generally good. Emerging markets, similarly, were in generally good health. Clearly there were outliers which were going through individual crises, but the general state of emerging market for a crisis of this scale was good. And interestingly, unlike other crises, it is the case with this one that there is no particular segment of the economy, in terms of companies or participants, that can take the blame for the crisis. This is a health crisis, and as a result, everyone has been affected in the same way.

What’s different about this crisis, over and above the fact that the economy was in reasonably good shape, is that the stimulus we have seen has been unprecedented. Whether it’s fiscal policy in developed markets, as well as emerging markets or monetary policy, it has been at a totally different scale from what we have seen before. And that’s provided a backstop, which we have seen in markets, so the policy has provided a backstop. But at the same time, the shutdown that we are seeing around the world is unprecedented. And we are seeing a level of slowdown in economic activity that a lot of companies, a lot of investors are still trying to get their heads around.

We are seeing clear examples around the world of how those countries, those systems that have managed this best in parts of Northern Europe, in China, how they are dealing with it and how they are coming out of it. And what’s clear is that there are some trends in terms of the market, in terms of the economy, that are developing that we can all learn from and that there are very clear winners and similarly very clear losers. And what’s important is I think that this phase that we are going through will be a temporary phase and it will pass.

Alistair MacDonald: You touched upon policymaking there, and on that front, many emerging markets have been resolute in policymaking to suppress the virus yet a lot more measured in terms of fiscal stimulus. How does the response thus far across emerging markets compare with that seen in the West?

Manraj Sekhon: I think what’s interesting about that is, no single set of policy measures has shown to be the most effective and complete and comprehensive in dealing with this. It has not been just about money. In the West, where certainly in theory health care systems, innovation, the level of skill should have been more effective in dealing with this crisis, we haven’t actually seen that. It’s not just about money, it’s not just about systems, it’s about governance, it’s about decisive government and in some emerging markets we have seen very effectively decisive government in bringing about slow down and lockdowns of the economy to stem the spread. But we have also seen very significant fiscal spend in places like North Asia, certainly China, Taiwan, Hong Kong, other parts of the emerging world have seen really levels of fiscal spending not seen before.

I think when you look at other economies in emerging markets such as India, Brazil, we have not seen the same level of fiscal spend, but there, my view is that the governments are taking a wait-and-see approach. They recognize that a lockdown is a given with significant economic cost and they are waiting to see how long this will take and to what degree they can stem the spread before targeting their fiscal spend. Clearly, their fiscal positions need to be calibrated more differently, so I think across emerging markets, there are more bullets to come, and they will be targeted very carefully, real rates are higher, so that gives a lot more room for relaxation on both monetary and fiscal policy.

Alistair MacDonald: Much recent discussion of emerging markets has focused on the relatively strong performers in North Asia. Those countries that have been relatively successful, both in terms of virus suppression and in terms of market performance, and what about elsewhere? How do things look in the likes of India and Brazil?

Manraj Sekhon: That is an interesting point. You are right, we haven’t heard as much about India and Brazil. We are seeing a curfew in India that’s certainly going to be in place for the next couple of weeks. I don’t think it will be extended beyond that for a couple of reasons. First of all, the monsoons will be due in India soon after that. So, there’s a lot of stuff that needs to happen before the monsoons. And secondly, the harvest in certain parts of India will be due. So, a lot of processes have to be put in place before that can take place. So, we think the lockdown won’t continue beyond that. But when you look at the number of cases in India now, now we know clearly the health care systems in India leave a lot to be desired, generally. But the number of cases with the testing that’s happened, has shown that the confirmation rate is quite a bit lower than what we have seen in the West. Now that could be due to a number of reasons, including just the level of spread as a result of the curfew, that’s also just the general sort of a strength of the immune systems in places like India. There’s a lot of possible reasons for it. So, thus far in terms of the infection rate in India, it looks to be a lot more contained.

In terms of the economy and the markets, the markets have sold off mainly on the fears of what the risk of the community spread will be in India. The government has done some easing in terms of monetary policy, has begun some easing in terms of fiscal policy, but there’s potentially a lot more to go. Oil prices are a good example. We have seen significant reductions in oil prices, but we have seen very little of that being passed onto the consumer mainly because of how oil is regulated in India. So, for now, I think the situation in India is pretty well contained, but we do believe we are going to see more in terms of policy easing in the weeks and months to come.

When you look at the other major economy that a lot of people should be looking at Brazil, we have seen the backdrop in terms of fiscal policy be a lot stronger because of the tightening that happened over the last year. So, the fiscal position is better and the foreign reserves that the Brazilian government has built up is now proving to be a very effective source of ballast whilst all of this is going on. But similarly, we have seen the oil price as well as commodity prices generally correct, that’s proven to be a real source of pain for the currency. So the economy right now is going through a very difficult position, but I would say that having a strong set of reserves and having record low interest rates in Brazil is making the overall capacity for the Brazilian economy to handle this a lot better than we have seen in the past. So, these economies are going through a significant pain like all other economies, but I do believe we are going to see further policy easing and the general state of these economies relative to history is more strong than what we have seen in previous crises.

Alistair MacDonald: So, returning perhaps to North Asia and a market that has been quite a contrast with not only the likes of Brazil and India, but also developed markets such as the United States and the UK, Italy, and China. It is, perhaps ironically, been somewhat of a safe haven during this crisis and not just from a market perspective, and what does this augur for the future?

Manraj Sekhon: I think when people look at China through this crisis, there’s a lot of takeaways both for how we look at China going forward, as well as how China interacts with the rest of the world, certainly the US and perhaps most importantly for us as equity market investors, looking at some of the trends that are taking place in China as an indicator of what to expect around the world and certainly in other emerging markets. Now, clearly China’s been very determined in dealing with this crisis and has come out of it relatively well. It is interesting that the source of the problem has proven to be the most resilient economy in dealing with the problem. And as a result of that, the government has been able to focus not on containment, but on normalization of the economy. So, we do believe what we are seeing in China is a case of first in, first out. So, the economy is coming out of this with a reasonable recovery.

The data points we are looking at in terms of economic activities suggest that the economy’s back to about 80% of its pre-Chinese New Year activity level and the government has also begun relaxing fiscal and monetary policy, but again has chosen to be quite careful in using its bullets. What’s been interesting about the Chinese authorities look at this crisis is that it’s made a very clear statement that it will be focusing on jobs rather than growth. So, they have recognized that this will be a long drawn out… of course, they do recognize that they need to maintain full utilization in the economy. And, this is something that is very different from what we have from Chinese policy in the past.

As a result of all of that, we do think there is pent-up demand in the Chinese economy that we are going to see reflected in growth in the second half of this year and putting it all together, that’s meant that China has been relatively resilient and has outperformed the rest of the world. And interestingly, the proportion of the index represented by China has gone up from about 35% to 41% through this crisis, which is probably not what people would have expected back in January.

Alistair MacDonald: Let’s talk a little bit more about the longer term, so emerging markets historically have been adaptive, resilient to change. Do we think things will be different this time?

Manraj Sekhon: In short, no, Alistair. When you look at the emerging markets over the last 10 years or so, what’s been striking has been the change in some of the underpinnings of the emerging market economies, which has not been really unique to any particular country, it’s been widespread.

So, you have seen a lot of institutional reform across emerging markets, whether it’s in terms of central bank policy, whether it’s in terms of fiscal policy, market reform. What you have also seen is that the breadth and depth of emerging market economies has increased greatly. So rather than being export-oriented or commodity-oriented, you’re seeing a lot more domestic representation in the markets and the economy. And obviously, you are seeing a lot more representation of the new trends in the global economy, whether it’s digitalization, technology, health care and so on. So, some of these long-term trends in emerging markets have been striking and certainly to a much greater degree than we are seeing in some of the developed world.

And when you look at this crisis, I guess it’s accelerated some of these trends. So whether it’s the growth of the consumer, the greater penetration of technology and digitalization that I mentioned, you see these trends accelerate and in some cases to a level that I think is not what a lot of the market participants would have expected as recently as six to 12 months ago. And when you put this together with the fact that balance sheets in emerging markets have been stronger coming out of this, a lot more companies have been relatively low in terms of debt, a lot of companies have been building up cash in their balance sheets. It means that the ability of emerging markets and emerging market companies to deal with this crisis is a lot greater.

When you look at crises historically, what it’s shown is that it’s actually been a spur for greater innovation, more resilience and adapting to a new challenge. Over the last 5-10 years, we have seen emerging markets leapfrog developed markets in terms of technology and new systems, the new economy. I think we are going to see more leapfrogging over the next year or two spurred on by this crisis.

Alistair MacDonald: If we look at one of the often-repeated mantras in recent months and weeks, we are constantly hearing how the world will never be the same post COVID-19. What do you think will change?

Manraj Sekhon: I think, you know, when history is written about it, the effects would have been temporary in the grand scheme of things, but the impact will be long lasting. There’s a whole range of areas where we think things will change and governments is one. So right now, we think that as you look on the horizon for visibility in terms of demand, visibility in terms of customer activity, one key customer that will continue to be a driver of growth in a time when growth is relatively scarce will be the government.

We have seen significant fiscal spend in emerging, as well as developed countries. A lot of governments are very keen to make sure that people remain solvent, remain occupied in their jobs and this will continue to be a key focal point for government in itself. And then, the other area we have been spending a lot of time thinking about has been supply chains.

At the end of this phase of this crisis, I think a lot of consumers and corporates will have to ask themselves to what greater degree will they be willing to pay a premium for security of supply of key goods. And, that means companies will be looking to diversify their supply chains, not just looking at where it’s the cheapest, where they can ensure security of supply. It will also mean that companies that are buying in from other firms in their ecosystem will not just be focusing on the most valuable part of the supply chain, but the tightest part of the supply chain. What are the goods that they really need to ensure they have supply of, to make sure that they can produce?

Localization is another theme where we think a lot of key industries will see localization of supply rather than globalization. So those are a number of themes that we think will evolve and clearly there will be opportunities across emerging markets as a result of that, in places like Southeast Asia, possibly India, possibly Mexico, but it remains to be seen how those countries take advantage of those opportunities.

Alistair MacDonald: And now the obvious follow up question, Manraj, what won’t change?

Manraj Sekhon: I think the world looks slightly different and there are many pronouncements about the trend of working from home and the advent of technology and electronic learning and so on. Now, clearly those are trends that will continue to develop and will be powerful sources of growth, whether it’s electronic commerce, e-learning, e-payments, e-health, with even remote hospitals, those will accelerate. But I think certainly when you look at drivers of growth in emerging markets, what’s been key for these markets for the last 200+ years, which is urbanization, the development of infrastructure, the growth in jobs in urban areas, in skilled areas, in manufacturing, the need to globalize and sell into new market, none of that’s going away. And people in rural India or Indonesia or China or Brazil will not be deterred by this in looking for a better quality of life. So I think we have to be very careful in extrapolating too far some of the trends that we have seen in this period as being enduring because people will adapt and these trends will not necessarily provide the jobs in growth that we need to see in emerging markets. And, I don’t think those trends are necessarily unique to emerging markets, in certain parts of the US which is relatively less affluent, in parts of the UK, similarly not everybody has access to technology and certainly not everyone has the skills to take part in the economy in a remote fashion. So, access to technology, access to skills, is key and the governments have to ensure that. But ultimately, people will need to find jobs and they will need to find new markets still. Localization, in itself, does not mean that companies will look at globalization any differently because ultimately to drive scale, to drive profitability, to drive growth, we need to look for bigger markets. So, I do think that the theme of globalization is not something that’s going to be ending anytime soon.

Alistair MacDonald: Well, thank you again, Manraj, very much for your insights today.

Host: And thank you for listening to this episode of Talking Markets with Franklin Templeton. If you’d like to hear more, visit our archive of previous episodes and subscribe on iTunes, Google Play, Spotify, or just about any other major podcast provider. And we hope you’ll join us next time, when we uncover more insights from our on-the-ground investment professionals.

What Are the Risks?

All investments involve risks, including possible loss of principal. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets.

There is no assurance that any estimate, forecast or projection will be realized.

Important Legal Information

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