Last year proved a challenging period for emerging markets.
Economic growth was subpar, geopolitical crises dominated headlines, weaker oil prices and ongoing rebalancing in China heightened pressure on commodity producers, and developed markets monetary policies continued to cause market volatility.
However, emerging market sovereigns and corporates still posted strong returns relative to developed markets, while local currency government bond spreads tightened even as they were hurt by weak currency performance.
Going into 2015, these challenges will remain.
In general, with the assumption of continued recovery in developed markets, emerging market countries that are sensitive to the global cycle are likely to benefit most.
Commodity exporters are less well positioned than commodity importers. This is due to structural (supply-side) increases in energy sources and more subdued demand globally, which to some degree is down to a shift in growth toward service-oriented activities and therefore less energy-intensive uses, as in the case of China.
Geopolitical events are typically never far away, but 2014 had more than its fair share. The Ukraine-Russia conflict was the most noticeable, given the importance of central and eastern Europe as part of the emerging market debt (EMD) universe. It looks like the conflict, in whatever shape or form, will remain a drag for some time. That said, EMD as a whole has been relatively resilient in the face of frequent headline-producing developments.
During the course of the year, election uncertainties have largely proven to be opportunities for structural improvements. The outcomes in Indonesia, India and Ukraine ushered in reform-minded governments, although political opposition to reforms remain in these countries. With reforms already set in motion in Mexico and continuing in China, the productivity catch-up theme in emerging markets could have further legs after years of subdued progress.
Next year’s election schedule is less heavy, with Argentina and Venezuela in Latin America, Poland and Turkey in central and eastern Europe, and Nigeria and Ivory Coast in Africa providing the key races.
In the case of Argentina, regime change and the promise of less unorthodox policies are likely. In Venezuela, the picture is less clear as the midterm elections could turn into a powerful catalyst for change if the opposition is successful, but the removal of the current administration is still distant.
For the broader emerging universe, China remains a bellwether. Its restructuring towards a more consumption-driven economy appears underway, as shown by the rise in its services trade deficit. But investors will likely need to navigate the short-term pain of economic rebalancing.
Overall, subdued growth and lower inflation in emerging markets – the latter due to low commodity prices in areas such as agriculture – should enable relatively easy monetary policies and support consumer demand in emerging markets. Weak oil prices should help countries with structural or cyclical funding gaps, such as India, Indonesia and Turkey, to tackle their vulnerabilities to funding pressures emanating from the probable upcoming tightening cycle in the US.
