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With the spread of COVID-19 having slowed in recent months, the focus of policymakers and markets has started to shift from the immediate needs of the health crisis towards the economy. Across both developed and emerging markets we are seeing containment, albeit with uneven progress, and economies globally are starting to reopen.
Consensus suggests that a potential vaccine is at least 12 to 18 months away—and in the interim countries will need to start operating effectively again, whether from a health, social or governance perspective. The long-term—and far-reaching—economic consequences of lockdowns will also become clearer and need to be managed.
There is no clear template that any country can follow in dealing with this crisis, but several factors have been shown to successfully drive containment. Decisive policymaking paired with effective execution have been crucial, alongside social cohesion and economic resilience.
As we look to 2021 and beyond, we think these attributes will help countries get through the immediate crisis, while those economies and companies with sustainable comparative advantages will weather what is likely to be an extended period of weaker economic performance.
A Stronger Case for Emerging Markets
The crisis has highlighted the strengths of emerging markets, whether in terms of their social, governance and health care systems, or the fiscal and corporate reforms they have undertaken over the last two decades. Robust balance sheets across emerging markets have proven to be a source of resilience, and we believe that will continue.
Before the full scale of the crisis became clear, the expectation was for China to deliver some of the largest fiscal and monetary stimulus among major economies. However, the developed world has turned out to be the biggest deployer of stimulus—far exceeding what we saw in the global financial crisis—and how this will eventually be repaid has yet to be determined.
Stimulus in emerging markets has been more measured, in part due to lesser means in certain countries, while others have left room for further action. Policy support has been fairly limited in East Asian markets that have deftly handled the pandemic, such as South Korea and Taiwan, while China has ample ammunition for further spending, to be targeted across both old and new economy infrastructure.
The Future Brought Forward
Secular trends driving opportunities in emerging markets have accelerated because of the crisis. In effect, the future has been brought forward. That boosts our optimism in economies and companies that benefit from this evolution of the asset class.
We have been focused on three new realities in emerging markets. One is their increased institutional resilience. Corporates across many emerging markets entered the crisis with stronger balance sheets compared to developed countries—net cash levels once considered inefficient have proven to be prudent. Countries such as Brazil, India, China and South Korea have benefited from institutional reforms in years past, entering this crisis with stronger foundations and greater fiscal flexibility relative to history and Western peers—which also bodes well for recovery.
Second, the nature of emerging markets economies has changed. We have seen a transformation in the last decade away from cyclical sectors and dependence on foreign demand, towards domestic consumption and technology. The contribution of trade to the Chinese economy has halved from its peak, ensuring that China is no longer beholden to a recovery in Western economies.
The third reality centers on innovation, and the notion of emerging markets “leapfrogging” the developed world in terms of infrastructure and business models. We have seen this unfold in areas such as mobile telecoms, broadband, e-commerce, and e-payments—and more recently in new areas such as education and health care amid lockdowns. Such business models are highly suited to the structures of emerging markets, and benefit from the availability of superior data coverage at substantially lower cost in countries including China and India.
New business models have also impacted Western popular culture. For example, TikTok, a video-streaming platform owned by China-based private company ByteDance, has helped galvanize discussion of social issues in the United States and other parts of the world. Run by an American chief executive officer, growth in TikTok’s already strong viewership has drastically accelerated this year. A range of emerging market companies that originally targeted domestic needs are finding acceptance and renewed traction in the developed world.
South Korea embodies much of these new emerging market realities. Its economy has undergone significant restructuring, and its fiscal position and corporate balance sheets are healthier than before. The country is also highly plugged into the “new economy,” with world class companies across hardware (particularly semiconductors and batteries) and the internet space. In a post-pandemic world, big data, remote working, cloud computing and various other areas will drive increased demand for semiconductors.
India’s pharmaceutical industry is another world leader. While India’s primary health care ranks poorly, the pharmaceutical sector nonetheless possesses strong intellectual capital and enormous scale, with the result that Indian companies form the backbone of global vaccine production. Large US and European companies developing COVID-19 vaccines are receiving—and need—manufacturing support from Indian companies in order to produce at the required volumes in the future. While current headlines may focus on India’s management of the pandemic, this risks obscuring the progress in other areas, as is often the case in the emerging world. Emerging markets have underlying strengths that are not always well-known, and therein lies the opportunity for investors.
US-China Relations: Pragmatism Will Prevail
The nature of US-China relations has changed, at both the political and economic levels. Washington’s view of China as a rival superpower has brought about a different policy stance: the current administration is taking a sharper approach than before, which is likely to persist.
The US presidential election also has a huge effect on the country’s rhetoric: the US government has expressed its displeasure with China on various occasions in recent weeks, but limited policy action has followed. Clearly, the United States wants to project a tough stance on China but it also needs to continue a highly mutually beneficial economic relationship; the interconnectedness of companies and consumers globally means that neither country can afford to cut the other off.
Rhetoric will likely remain heated as the election approaches but once passed, and as a US economic recovery becomes clearer, the tone should improve. US companies that target China’s domestic market or manufacture in the country will find it difficult to secure other credible and sustainable sources of demand or supply, which will point to a more pragmatic outcome in US-China relations, albeit with a more hostile overtone.
Geopolitical risks are par for the course for emerging market investors. While we continually factor these considerations into our investment decisions, of far greater importance are company fundamentals and earnings sustainability, as well as the irrefutable combination of demographics and long-term growth potential.
Environmental, Social and Governance (ESG): More Critical than Ever
Company engagement is a crucial part of emerging market investing. Bringing about better corporate behavior and a better understanding of companies’ responsibilities toward all stakeholders are efforts we continue to push in our stewardship of client capital.
The tone of engagement in emerging markets has shifted: companies that formerly took a narrow, hard-nosed approach to returns are adopting more accommodative measures. In countries such as South Korea, South Africa and Brazil, companies are placing more emphasis on ESG issues. We have seen leading companies in South Korea publicly apologize for governance missteps and manage their balance sheets more effectively through returning capital to shareholders. ESG reporting has become mandatory in some countries, a trend we expect to continue elsewhere.
The ESG conversation is changing further amid the pandemic, with a greater focus on the social impact of policies. Many governments are supporting jobs, while companies are more cognizant of the reputational risks of layoffs. ESG has become more important, with companies considering it critical to sustainable business performance. In our view, this “delta” of improving ESG in emerging markets is a further tailwind supporting the secular outlook for the asset class as the world emerges from this crisis.
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