Ruchir Sharma, head of global macro and emerging-market equities at Morgan Stanley Investment Management in New York, describes the current decade for investors as a ‘post-Brics world’.
“My argument for investors is the reverse of what it would have been 10 years ago,” Sharma says. “Every decade has had a theme that captures everyone’s imagination,” such as tech in the 90s, Japan in the 80s and natural resources in the 70s. For each period, these themes delivered incredible returns to equity investors, in the 500% to 1,000% territory. But then they crashed, sometimes for decades.
Sharma says the Brics story for Brazil, Russia, India, China and South Africa was a “mania” that has had its day. Investors still banking on these big emerging markets will be disappointed, because they are going to experience continued economic deceleration.
Sharma made his comments speaking at the Emerging Markets Private Equity Association’s annual conference in Washington, DC. An exclusive interview with Sharma will appear in FinanceAsia’s June edition, highlighting additional themes.
Sharma says growth rates for the likes of Russia and Brazil will fall to 2% to 3%, not the 4% to 5% of yore. China and India, thanks to lower per-capita income rates, will grow around 5% to 6% during the next three-to-five years. “This is still healthy,” Sharma says, “but nonetheless a sharp comedown from the elevated rates they’ve enjoyed.”
For investors this will mean disappointing stock index performance. Sharma says the Bric equity markets peaked in 2007. In dollar terms they are collectively down by about 40% since then, while the S&P 500 has surged. This signals a change in leadership throughout the global economy, he argues.
And that will matter to investors: “Investors care about expectations,” Sharma says. “India’s per-capita income today is $1,500. To them, 5% GDP growth feels like a recession.”
Joking about the tendency of The Economist magazine cover to misread peaks and troughs, Sharma recalls how it portrayed Africa as the “hopeless continent” in 2000, and represented Brazilian growth in 2009 with a Rio statue of Jesus rocketing across the sky. “Last year, The Economist described Africa as the hopeful continent. I’m a little concerned about that! Is Africa hopeful because of fundamental reforms, or because it’s been lifted by high commodity prices?”
A few countries have broken out of this cycle. China and Poland have been proactive reformers, not just reforming when their back is against the wall. Sharma says the opportunity today is in countries that have done badly, but which are changing their ways: the Philippines, Thailand and Mexico are examples where the elite sensed the world was passing them by and so made hard changes.
“But boom countries such as Brazil and Russia grew complacent, stopped their reforms, resumed meddling in the private sector, and should today be avoided by investors,” he says.
Although China has a chance to break out of the boom-bust cycle and establish itself as an upper-middle class country, it is plagued by debt, and that will keep its GDP growth permanently below 6%.
“The one crucial variable in any financial crisis is excessive credit growth, particularly in relation to underlying GDP growth,” says Sharma. “For the past five years, Chinese credit growth has outpaced the economy. Until 2007, for every dollar of credit expansion, China enjoyed a dollar’s worth of growth. But since then, it takes three or four dollars of lending to stimulate a dollar’s worth of growth — the same as the US or Spain in the past decade.”
The slowdown will affect demand for commodities, where prices are already under strain due to overinvestment during the past few years. Sharma predicts commodity prices are facing a prolonged slump, and that will affect Brazil, Russia and other producers.
“Emerging markets performed a levitating act during the 2000s thanks to cheap money, and from 2003 to 2008, GDP growth averaged 7.5%,” Sharma concludes. “That’s going to fall to 4.5% as trade and capital flows slow, but with much greater dispersion among these markets. The stars of the future include the Philippines, Indonesia, Thailand, parts of Latin America, Turkey, Poland and some frontier markets. Many of these were laggards but they will be among the leaders now.”
