Tag Archives: Emerging Markets

Made in China? Think Twice.

A quick pop quiz:

Which of the following countries is the lowest cost manufacturer in Western Europe?

  1. Spain
  2. Germany
  3. United Kingdom

If most of you answered Spain and some of you Germany, then its time to take a harder look at the global competiveness landscape. The correct answer is the United Kingdom. Most of us have outdated views of which countries are low cost and which ones are high cost. Often the easiest way to sort this in our head is to classify emerging market countries as cheap and competitive and the developed world as prohibitively expensive for manufacturing. But a new study on global competitiveness challenges these simplistic assumptions.

The big shift

With the world focused on big-ticket issues like the Crimean crisis and impending tapering by the Federal Reserve, valuable nuggets of news tend to slip under the radar. One such nugget was the release of the Boston Consulting Group’s (BCG) Global Manufacturing Cost Competitiveness Index. This new index tracks changes in production cost of 25 exporting countries over the last decade. The index is based on four drivers of manufacturing competiveness that include wages levels, energy costs, productivity growth and currency exchange rates.

The results of the ranking process are fascinating with Mexico emerging as less expensive than China, UK turning up as the least expensive nation for manufacturing in Western Europe and Brazil ranking as one of the most expensive countries for manufacturing activity. The two biggest positive surprises were Mexico and United States, with the latter making big strides thanks to cheap energy costs due to falling natural gas prices, rising productivity and stagnant wages.

Investment perspective

So what does it all mean for the Emerging Market Investor?

Several emerging economies covered in The Emerging Markets Handbook including Brazil, Poland, China and Russia have lost competiveness in terms of manufacturing over the last decade. At the same time many emerging markets are no longer cheaper than the US. Identifying the next export powerhouse could mean the difference between outperformance and below average results for emerging market investors.

As we have explored in our book, almost all emerging countries have used manufacturing and exports as the fuel of rapid GDP growth. It could also mean identifying companies in developed nations that could benefit tremendously from expanding domestic capacity and exporting to emerging markets. An investor could also shift his/her portfolio allocation from export-focused emerging market companies to companies that benefit more from domestic consumption. There could also be tremendous opportunities in frontier markets that would be happy to see a manufacturing shift from their new high-cost neighbours.

In order to develop a long-term view of emerging market trends, it pays to take a closer look at some of the underlying factors/drivers that determine change in rankings like the one put out by BCG. Often insightful research and interesting trends get drowned out by noisy headlines of the day. It is up to the thoughtful investor to ferret out these insights and profit from them.

By Pran Tiku CFP & Vikram Kondur CFA

Our comments, opinions and analysis are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Markets and economic conditions are subject to rapid change, comments, opinions and analysis are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.

India: The Great Election Hope Trick

Election fever

The world’s largest democracy goes to the polls this month. The collective wisdom of 800 million people is likely to produce an outcome that could have huge implications for the global economy. Recent exit polls project a win for the coalition led by the pro-business Bharathiya Janata Party (BJP), headed by Narendra Modi, whose promises include “minimum government and maximum governance”. Financial commentators and pundits seem to have taken to overly simplifying the election outcome in binary terms. A win for Mr. Modi would mean reforms and rapid economic growth while any other outcome would be an absolute disaster for the Indian economy. In a complex country like India the truth lies somewhere in between.

Crumbling BRIC?

To say that the last twelve months have been challenging times for the Indian economy would be an understatement. First came the ignominy of being part of the underperforming BRICS (Brazil, Russia, India, China and South Africa). Then came the dubious honor of joining the Fragile Five, a term coined by Morgan Stanley for countries with high inflation, weak currency, slumping growth and large external deficits. With this in mind, does a new elected government really have a chance of reviving the economy? The Indian stock market definitely seems to think so and it has seen a strong rally since the first exit polls started coming out in February 2014. But investors must realise that this is a hope-based rally. The hard reality of fixing a complex economy like India will set in once the election fever subsides.

Magic wand

Mr. Modi’s pro-business credentials and his reputation for speedy execution have raised expectations among the Indian public and foreign investors that a wave of his magic wand will heal India of its self-inflicted wounds. But historic precedent suggests that the impact of structural reforms is felt many years after the first shot at fixing a country’s problems. Take the case of Brazil, whose cycles of boom, bust and chronic inflation made it a basket case of economic mismanagement in the 1970s and 1980s. It took a visionary in the form of Fernando Henrique Cardoso to break the back of inflation and pass through reforms that succeeded in putting Brazil on the economic map. His time as finance minister and two terms as President from 1995 to 2002 set the foundation for Brazil’s rapid growth trajectory. It took close to ten years of reform before results were visible to the Brazilian public and the investment community at large. Successive governments under Presidents Lula Da Silva and Dilma Rouseff have ridden the wave created by President Cardoso.

Rocky road

The lesson from all this is that deep structural reforms take time to be implemented and it takes years before they show up as solid economic growth. A recent report by Credit Suisse indicated that only a quarter of investment projects in India are stuck under the federal government. This means Mr. Modi will need active cooperation from the State governments to implement reforms and push through investments. In India’s cacophonous democracy, implementation is bound to take time. Also, most of the “easy” reforms have already been implemented leaving the new government with the unenviable task of pushing through tougher unpopular reforms to correct the course of the economy. These include labour reform, reforms in land acquisition, judicial reform, streamlining India’s gargantuan bureaucracy and allowing FDI in retail.

Even with the best-case scenario of having a federal government with a strong mandate, it could take two years to start seeing results on the ground. The challenge of doing all this while keeping a lid on inflation and rising unemployment will be no mean task.

Demographic dividend

So why the urgency to implement the above mentioned reforms? As noted in The Emerging Market Handbook, the simple one-word answer is demographics. There is no precedent in world history where one nation has been gifted with so many young people entering the workforce at the same time. With an average age of 28 years, India’s demographic edge is expected to last another 40 years. The next ten years will be crucial to reap the benefits of this enormous “natural resource”. A resurgent Indian economy has the capacity to carry global economic growth on its back the way China has done for the last two decades.