Recent strength in emerging markets economies has been driven by two key issues - weakness in the US...
Recent strength in emerging markets economies has been driven by two key issues - weakness in the US dollar and job creation stemming from economic growth. It is also creating attractive opportunities for investors.
A recurring feature of countries in the emerging markets arena is their high level of international borrowing, largely denominated in dollars. This means that any movement in the dollar's value will have an impact on the country's economic strength. If their own currency loses value, economies can become stretched. However, the current weakness of the US dollar is good news for heavily indebted countries such as Brazil and Turkey.
In Brazil, the Lula government is fully exploiting the situation by using the low cost of servicing its dollar-denominated debt to free up funds for social projects that are helping to drive job creation. The effectiveness of the policies is underlined by employment statistics, which show that more than two million jobs have been created since Lula was elected around two years ago.
That is also having a positive impact on the broader economy, with a marked increase in borrowing by individuals. The normal pattern is for a person who is unemployed or is working in an unofficial capacity to move into an official position. The employer will introduce that individual to a bank. With a salary being credited to his account, the new employee will be able to establish a financial record and will become eligible for credit facilities or bank loans, which can be used to finance consumer spending.
Clearly, this is positive for banks, which are seeing extremely high demand for loans. Although rising interest rates have dampened demand slightly, the increases have not deterred many new borrowers whose main concern is the availability of credit and their ability to repay it.
Banks are now building up expertise through lending to individuals, whereas in the past their only business was helping to finance government deficits. Retail lending was considered too risky, particularly when government business generated easy, guaranteed revenues. We expect the number of small, profitable loans to pick up.
The situation in Brazil is similar to the one that exists in Turkey, which also has a large amount of US dollar-denominated debt. The weakening dollar has removed the stress in the system, reducing inflation and enabling the government to lower interest rates and engineer an upturn in domestic demand. This has manifested itself most markedly in the demand for cars and car loans.
In South Africa, a new black middle class is starting to emerge and this group is now a key contributor to consumer spending and, significantly, to the growth in new savings products. This is proving beneficial for life companies, which supply those products and are seeing substantial inflows of new business. This is having an impact on the retail and financials sectors, with some banks now providing products aimed solely at this new market. As a result of the growing demand for loans and credit throughout emerging markets, banking is the industry to which we have the highest exposure.
However, South Africa differs slightly from other emerging markets because a large amount of the jobs growth has occurred in commodity industries. Companies are paid in dollars although their cost base is in rand. One of the biggest job creators in South Africa is derived from the capital expenditure of mining companies, so the current position is a concern for the government, which is trying to force down the value of the currency.
Nevertheless, the effects of economic growth are similar to those in Brazil. The ability to borrow money has created a housing boom. Driven by the increased employment levels and government policies designed to increase home ownership and participation in the economy, many are now running their own companies or progressing up the management ladder in others.
Meanwhile, in Mexico, the number of mortgages issued by banks is in the tens of thousands and those granted by government agencies are in the hundreds of thousands. As a result, there is a tremendous pent-up demand and we believe this makes house builders an attractive investment opportunity.
There are some clouds on the horizon, however. If interest rates in the US rise sharply, the high levels of indebtedness could prove troublesome. Likewise, if the recent rally by the dollar developed into a longer-term trend, this could cause some difficulties.
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