In 2023, it has become clear that the economic prosperity sustained by globalisation over the last two decades is no longer viable. The world has become more unstable, while the scientific community agrees that the health, climate and economic challenges of the last three years were merely a prelude to the world of tomorrow. This observation leads us to believe that it is essential to broaden our investment universe while continuing to closely scrutinise the quality of macroeconomic fundamentals.
Developed countries face an unprecedented situation
In our article "Shift in Context for the Bond Markets", we highlighted a significant paradigm shift, we highlighted a significant paradigm change: after years of rock-bottom interest rates, during which governments financed themselves cheaply, inflationary pressures and the rapid rise in interest rates that followed are placing Western economies, whose debt has traditionally been perceived as a safe haven, in a unique economic situation. Indeed, the question of their capacity to bear the higher costs of refinancing their debt has clearly arisen.
While the situation in the United States is vulnerable, but less questionable thanks to a certain dynamism in economic activity, the situation in Europe is more worrying, since the massive fiscal spending made possible by the accumulation of zero-cost debt issues has not succeeded in creating sufficient production value within the economies over the medium term. In concrete terms, the European economy is hoping for growth of around 2% a year over the next few years, while the cost of maintaining this growth is, as at November 2023, set at a reference value of 4.5% a year.
Emerging countries: 77 countries spread over 60% of the earth's habitable surface and a favourable dynamic
The habitable land surface includes the surface of the 194 countries recognized by the UN, with the exception of Antarctica and Greenland.
Source: International Monetary Fund, BLI
Over the last two decades, the international trade landscape has undergone profound changes that have redefined the drivers of international economic prosperity. Against this backdrop, emerging countries have managed to come out on top. First and foremost is China, which, with its affordable, skilled workforce, has benefited from these structural changes and attracted the bulk of the world's production. The Chinese governing party, led by Xi Jinping, now holds the keys to global economic growth. Similarly, countries such as South Korea, driven by conglomerates like Samsung, LG and Kia, have succeeded in penetrating most of the old continent's markets. In the tertiary sector, Oman, a small country in the south of the Arabian Peninsula, has become a luxury tourist destination. Chile, historically known for its landscapes, is now at the heart of the supply of resources needed to manufacture batteries. These idiosyncratic economic stories reflect a geographical, cultural and economic diversification that seasoned investors can no longer ignore.
Indeed, the growing importance of emerging economies is reflected in the financial markets. The investment universe for debt issued in hard currency is no longer limited to the Western countries whose economies are directly dependent on the euro or the dollar. Between 2000 and 2022, as euro and dollar rates fell, the secondary market for emerging country debt issued in hard currency consolidated. With an increasingly liquid market, the emerging market debt segment represents an attractive universe, if only for its size and diversity.
Why extend your investment universe to emerging countries?
In addition to the attractiveness linked to the above-mentioned characteristics of the universe, we have identified two main factors of long-term support: demographics and technological progress. Against these two favourable trends, however, the factor of the quality of governance in emerging countries must always be taken into account.
1) Demographics: a young population that rewards work
The world's population increases every year, but the trends are different depending on whether we analyse what is happening in developed or emerging countries.
The age pyramid in advanced economies is in fact inverting, a phenomenon that is particularly marked in Europe. What's more, while social benefits have been strengthened in the economic structure of developed countries, it seems that the value of work has been eroded, giving way to a fall in productivity. The structural effects of an ageing and less productive population are numerous. On the income side, the tax revenues received by governments will shrink, resulting in less flexible budget spending.
While migration policies could be a solution to Europe's demographic problem, history shows us that European cultures are not very inclusive, making such policies ineffective.
In contrast, emerging countries benefit from a younger, larger population that is beginning to accumulate capital. This is evidenced by the increase in purchasing power that countries such as Mexico, Indonesia and India have experienced over the last two decades.
The emergence of this middle class, which values work, is one of the structural factors underpinning the sovereign debt of emerging countries. However, at present, a number of factors are limiting the production and consumption capacity of this growing middle class, notably the lack of financial inclusion and a level of corruption that is still too high. Improving these two factors is essential to the long-term development of these societies.
Medium- and low-income nations succeeding in including the majority of economic agents in their formal economy will increase their taxpayer base, resulting in greater flexibility and financial stability.
These inclusion efforts must be accompanied by greater transparency of the economic system. Although some emerging economies have seen improvements in corruption and inclusion, notably in Eastern Europe, the road to full transparency remains arduous, with many challenges to overcome to avoid falling back into the mistakes of the past.
2) Technological breakthroughs: will the future be different from the past?
At the last World Bank and International Monetary Fund congress, economists, tax experts and governments from developing countries expressed two points of consensus:
- The democratisation of access to new technologies will be a key factor in stimulating the development of reforms;
- For these reforms to be implemented effectively, financing must follow.
The first point is the main argument for our conviction that the future will not mimic the past. The emergence of technologies such as cloud computing, which allows access to computing resources via the internet rather than a physical computer, and blockchain, which allows full transparency in government tax spending, represent major advances on a global scale. Although progress is timid due to the capital costs and time required, the implementation of these technologies is progressing, particularly in countries where corruption is the main obstacle to economic development .
All new projects require capital for their development. Accompanied by global experts, aware of past failures, the governments of emerging countries need capital above all to guide their middle classes towards sustainable social prosperity. The second point of the annual conference mentioned above highlights this issue. At present, while professional investors and the public sector are supporting these reforms by investing in emerging market sovereign debt, it is a fact that private investors are still lagging behind.
So could emerging countries become the developed countries of tomorrow? Could the developed countries become the emerging countries of tomorrow? While, from a purely financial point of view, emerging market debt offers an attractive return compared to developed countries, fiscal reforms still need to take place to ensure the durable development of their economies.
In a world prone to fragmentation, it nevertheless seems clear that a well-informed investor needs to broaden his or her investment universe. The economic and geographical heterogeneity offered by developing countries, and the favourable factors for their development, offer a diversification that seems obvious, while requiring active monitoring of the macroeconomic balances of each economy.
Finally, given that the emerging middle class will make up a major part of tomorrow's consumption, actively supporting the reforms that will shape this consumption is part of a move towards shared objectives. This is where we have a role to play as long-term investors.
Source cover image: IMF
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