InvestmentsMar 2 2023

Does China matter more than the US for emerging markets?

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Does China matter more than the US for emerging markets?
Shanghai has powered much of China's economic growth. (FT Montage)

And in such a world, the US is always going to play a substantial role, the largest economy in the world with a vast consumerist market, but also, via the dollar, the controller of the world’s reserve currency, and vast quantities of capital. 

But the growth of China, as both a consumer of commodities and of consumer goods, may be changing the drivers of emerging market returns.

And China’s equity market itself is around a third of the global emerging market index, so an investor who buys an emerging markets equity tracker fund is also invested in China.

Chinese economic growth may be the more important emerging market economic growth this year.Tom Kynge, Sarasin and Partners

Jonathan Toub, fund manager at Aviva Investors, has had an overweight position to Chinese equities for quite some time, which he describes as a “painful investment”, but has seen it bounce back this year. 

He says much of the negativity around Chinese equities, and around wider emerging markets, relates to the statements of policymakers in the country in 2022, which implied a new, less pro-business approach is coming.

Reality check

But Toub says the rhetoric has not been matched by action, so as investors became aware of this reality, he expects Chinese equities to perform better, and have a beneficial impact on the rest of the asset class. 

He adds that it is “hard to get away from the fact” that the economic performance of commodity exporting emerging economies such as Indonesia and Brazil are reliant on Chinese commodity demand. 

China is particularly important as a source of commodity demand because its economic growth has, for many years, come through fixed asset investment – that is, building property and other infrastructure, which requires commodities. 

Economies such as that of the US generate a much greater proportion of their GDP from consumption than from fixed asset investing, and so are a much less important source of commodity demand. 

Damien Buchet, chief investment officer at Finisterre Capital, says: “The likely rebound in Chinese commodity imports will support oil and metals producers from the Middle East to Africa and Latin America.

"Tourism and investment flows will massively accrue to neighbouring Asia, while Central Europe and Mexico will be more distant beneficiaries of the US-China frictions over the medium term, through the re-shoring of key production.”

He says emerging markets are likely, in aggregate, to grow in 2023 by around 4 per cent more than developed markets, and he feels this provides a “cushion” for investors in the asset class, even if the global economic outlook darkens from here. 

Arun Sai, senior multi-asset strategist at Pictet Asset Management, elaborates on this further, saying that China has now “reached a level of critical mass” in terms of the size of its economy, that “it is not reliant on the global economic cycle”, and this increasingly means that other emerging economies are becoming less beholden to the global cycle, though he notes the strength of the dollar continues to matter to all other emerging economies. 

Half a world away

But for Tom Kynge, portfolio analyst at Sarasin and Partners, the picture is more nuanced, with an increasing divide among emerging market economies between those with prospects strongly linked to China and those whose prospects continue to rely on the US. 

He says: “Emerging market growth drivers have become increasingly disparate in the past few years due to trends such as near-shoring and the rising geopolitical tensions between China and the US. Having said that, all emerging market countries are still significantly reliant on both major powers but to varying degrees.

"Proximity is still a major determinant of economic reliance. Mexico’s manufacturing business is more likely to be reliant on the US market while Vietnamese businesses are more likely to have close ties with their Chinese counterparts.

"As China is likely to provide the majority of the impulse to global growth in the year ahead – while US economic growth is expected to moderate – you could argue that Chinese economic growth may be the more important emerging market economic growth this year.”

Kamil Dimmich, emerging market equity investor at North of South, says that while emerging markets underperformed in 2022, “they fell only in line with developed markets really. But even then it was China that dragged the rest down, the commodity exporting countries within the emerging markets actually performed well.” 

Sai says the strength of the dollar (see article one) and the Chinese investment cycle are the two factors that determine emerging market economic performance, but he is confident about the outlook for the Chinese economy right now, and says one area of potential comfort for investors is that central banks in Asia, including China, are pursuing what he calls “orthodox” economic policies, which should make it easier for investors to understand the direction of travel for those economies. 

Toub says India seems to have its own economic drivers, rather than be reliant on China. India is not a commodity producer or seller of luxury goods, but does have a large population of its own.

He says that increasingly emerging market investors tend to want to own either India or China, and that right now he feels Chinese equities are cheaper, as they performed poorly in 2022, whereas Indian equities did well. 

As both India and China are commodity importers, growth in either is likely to benefit the commodity exporters within the emerging markets universe. 

David Thorpe is investment editor at FTAdviser