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New Emerging Stars: The Monks in the Marketplace

While some of the more celebrated nations of the past decade are languishing, a bunch of new economic stars are quietly breaking out on the upside and turning growth leaders
RUCHIR SHARMA

t is not such a bad year, after all. Even as China experiences a hard landing of sorts and the large commodity economies of Brazil and Russia seem stuck in the mud, some less-celebrated emerging markets are charting their own course and breaking out on the upside. This is the Third Coming of growth in emerging markets. The first was a dizzying period of discovery from the late 1980s to early 1990s and the second came in the great boom of the mid-2000s, when it seemed all the emerging economies were taking off together, fuelling extraordinary returns. But that era ended in 2010. Since then, as the global economy slowed, the easy money dried up and the blue-sky optimism faded, the Third Coming has looked likely to be an era marked by moderate and uneven growth in emerging economies, with new stars rising to the top, and a break-up of herd behaviour in the markets. Because many large developing economies are moving to a lower growth trajectory , and because their stocks and currencies are no longer cheap, it seemed probable that gains for emerging market stocks would slow to an average annual pace of 10% in the coming decade. The first nine months of 2012 have played out exactly along these lines. Emerging-market stocks are up around 10% so far this year and, after narrowing for years, the gap in performance between the winners and losers is widening sharply . Compared to the big splashy stars of the last decade, many of the new economic stars are like monks in the marketplace, quiet figures cloaked under drab robes, concealing an enlightened spirit inside. Here is a quick and selective review of some of the winners so far this year: Turkey: The best-performing major emerging market is up nearly 40%. After overheating in 2011, the economy is landing softly on a more sustainable growth path this year. The government of Prime Minister Recip Tayyip Erdogan has become an inspiration for reformers across the Muslim world. Erdogan brought to Turkey both economic orthodoxy , taming the hyperinflation that raged when he took office, and normalcy , by opening up opportunities for Muslims who had been shut out of plum jobs by the previous secular regimes. In a predominantly Muslim country , this was tantamount to welcoming the majority into the commercial and administrative mainstream, and Turkey has prospered ever since. This is counter-exhibit A for westerners who think Muslim modernity is an oxymoron. The Philippines: The second-best performing emerging market is up almost 30%. Since his election in 2010, President Noynoy Aquino has been pushing positive reform, and may finally deliver his legendary political dynastys promise to re-

ARINDAM

store the lustre of the Philippines of half a century ago, when it was billed as the next east Asian tiger. The nations huge wealth in natural resources is still largely untapped, and its long-stagnant per-capita income is under $2,500 meaning it still has a lot of room to grow from a low base. Recently , some analysts have begun touting it as a manufacturing revival story as well. Thailand: The Thai market is up around 25%. Like the rest of its neighbours, Thailand could benefit from a reversal of one of the critical factors that triggered the east Asian financial crisis the devaluation of the Chinese currency , which suddenly made south-east Asia uncompetitive. Now, the movement of currency values and labour costs is making Asean in general, and Thai manufacturing in particular, competitive again. The wild card is the political tension between capital and countryside: if the new prime minister can contain it, Thailand is in a strong position to grow. India: The only Bric nation that is beating the emerging-market averages this year, India is largely making up for some of last years underperformance and benefiting from wellbehaved commodity prices. Even though growth expectations have been revised sharply downward over the past year, the Indian market has been steadily outperforming since the start of the year. Foreign investors have hung on to belief that there is an inertial rate of growth of at least 5% for the Indian economy , given its low per-capita income of $1,500. Reforms announced in the past month have reaffirmed the faith of foreign investors and so far worked to arrest the downward momentum in growth expectations. Mexico: The fifth-best performing major emerging market is up almost 20%. In theory , stock market performance should track the underlying growth of an economy , but thats not how it works in Mexico, where the market consistently outperfor-

ms the economy . The reason is monopolies. Big Mexican companies enjoy abnormally-high profit margins at home, which they use to expand abroad, making them attractive as investments. But monopoly control also jacks up prices Mexicans pay more for mobile phone service and food than Americans do and lowers productivity , slowing long-term growth. Mexico remains a low-growth economy with a hot market, particularly hot this year because of the prospect of muchneeded economic reforms under a newly-elected president. Poland: This market, too, has appreciated by nearly 20% in dollar terms, but for good economic reason. It remains a case study of the sweet spot in Europe, which is the period after a country enters the EU and before it adopts Despite the the euro. At this slowdown in stage, the country China, Russia has reformed its fiand Brazil, nancial institutioemerging ns to meet EU remarkets, quirements, contaiincluding ned its budget and India, are trade deficits to growing at meet eurozone tara smart clip gets. So, it is stable, attracting investment and benefiting from EU subsidies. And, it suffers none of the instability that comes with adopting the euro, which recently undid other small European nations like Portugal and Ireland. Poland recently confirmed its status as a model European reformer with a tough pension overhaul that raised the retirement age to 67, at a time when many Europeans still retire in their late 50s. Colombia: Once again, the bestperforming market in Latin America, Colombia has appreciated by another 20% through September. It is an amazing rebound. Colombia has a long democratic tradition, but was overrun by drug traffickers and leftwing guerrillas in the 1990s. Under tough new leaders, it has beaten

back criminals and rebels, and begun to emulate the reforms that made Chile the richest nation in the region. With a diverse economy , Colombia is starting to gain traction. South Korea: The South Korean market has been surprisingly resilient, up around 15%, even though it is a manufacturing exporter exposed to a slowing global economy , particularly China. One of only two nations along with Taiwan that managed to sustain growth at a pace above 5% for five decades, it is now poised to graduate from emerging to a developed nation, leaving Taiwan behind. South Koreas strength is its manufacturing sector, which continues to grow as a share of the economy , long past the point when manufacturing growth normally tapers off. South Korean manufacturing has not only produced the first global brands from the emerging markets, like Samsung one of the best performing large-cap stocks in the world this year but it is now diversifying away from those giants, with smaller companies up and coming. Nigeria: The best-performing frontier market has appreciated by around 40% in 2012. Plagued for years by corrupt presidents, Goodluck Jonathan brought integrity to the office. He also gets the basics of reform, mobilising investment in agriculture, oil and gas, and, most importantly , the power grid. The whole country generates as much electricity as some small towns in England, and the lack of a reliable power supply has made Nigeria one of the most expensive markets in which to operate a business. But in an underdeveloped country that has recently seen a landmark change from bad to good leadership, this can be a platform for rapid growth. Nigeria has lots of room to grow from a low base, with a per-capita income below $1,500, and many easy targets for investment and reform.
(The author is head of emerging markets and global macro at Morgan Stanley Investment Management)