Investors need to wake up to the fact China can no longer be relied upon to drive growth for an array of emerging market economies. As Financial Times writes in an article "China can no longer be counted on for EM growth", the combination of an existing slowdown in China, Beijing’s trade war with Washington and, just as importantly, a shift in the make-up of the economy means its days as the best friend of emerging market investors looks numbered.
China accounts for 70 per cent of all manufacturing in Asian emerging market economies, according to JPMorgan. Yet China’s overall expansion this year is expected to be no more than 6.5 per cent — the slowest pace since 1990 — and just 6 per cent next year.
For every 1 percentage point slowdown in China’s GDP, emerging markets lose an average of 0.7 percentage points in growth, according to Bank of America Merrill Lynch. For those Latin American countries that send everything from copper to oil to China, the hit swells to 1.2 percentage points.
And South Korea — which is treated as an emerging market by investors because of its weighting in major indices — is ground zero for collateral damage when it comes to Washington’s attempt to stifle Chinese exports. No other country is as intertwined with Chinese electronics supply chain, so it’s no surprise that traders consider the Korean won as something of a proxy for the more tightly controlled renminbi. The Kospi, the country’s benchmark equity index, is down 15 per cent this year while the won has fallen almost 6 per cent versus the dollar.
South Korea isn’t the only Asian economy that is exposed: Taiwan, Singapore, Malaysia and the Philippines have all benefited from the rise of China as a manufacturing powerhouse, especially since the global financial crisis.
“China is an integral part of Asian supply chains, making the region vulnerable to weaker Chinese growth and the trade war,” says Ethan Harris, head of global economics for Bank of America Merrill Lynch in New York.
What’s more, the pistons that drive China’s growth are shifting. The services sector is displacing manufacturing as the economy becomes far less resource-hungry. In the first half of this year, the services sector contributed more than 4 percentage points to mainland Chinese GDP, while manufacturing represented only half that amount, according to lender ANZ in Hong Kong.
It’s a set of circumstances that will force those emerging markets most heavily enmeshed in Chinese supply chains to try to reinvent themselves. It comes against a backdrop in which a rising dollar and US interest rates has already seen investors sour on emerging markets.
“Investors wondered whether emerging markets is the canary in the coal mine that could be a precursor for a broader risk off move in 2019,” JPMorgan economist Luis Oganes noted of 400 of the bank’s clients who were in Indonesia for the International Monetary Fund and World Bank last month.
Then there’s the squeeze from a weaker Chinese currency. As China’s current account surplus shrinks and threatens to become a current account deficit on a more permanent basis, the renminbi comes under more pressure. That makes it more attractive to source goods within China than go abroad. “As the deficit becomes more prominent, the positive spillover to emerging markets becomes more limited,” says David Lubin, an emerging market strategist at Citigroup in London. Instead, “China becomes more competitive with emerging markets”.
Some observers are more sanguine about the ability of emerging markets to adapt to China’s changing economy. For example, just as global stock markets plunged last month, Credit Suisse quietly released its annual Global Wealth Review. It concluded that “China is now clearly established in second place in the world wealth hierarchy”.
The report goes on to note that total household wealth in the mainland has increased fourteenfold to almost $52tn since the turn of the millennium. It has more than 3.5m millionaires (or just over 8 per cent of the worldwide total), according to the report, and more residents with more than $50m than any country except the US.
Yet you don’t have to have $1m to experience the joys of consumption.It is catering to the demands of Chinese consumers that offers an opportunity for companies in emerging markets. The challenge for investors is identifying the corporate winners from this trend, while navigating the short-term noise as the trade tensions between Beijing and Washington play outs.