As leaders chill in Davos, emerging economies going downhill fast

DAVOS, Switzerland — More than a trillion dollars of investment flows has fled emerging markets over the past 18 months but the exodus may not even be halfway done, as once-booming economies appear trapped in a slow-bleeding cycle of weak growth and investment.

While developing economies are no stranger to financial crises, with several currency and debt cataclysms infecting all emerging markets in waves over recent decades, leaders gathering for this year's World Economic Forum (WEF) in Davos in the Swiss Alps are fearful that this episode is much harder to shake off.

Seeded by fears of tighter US credit and a rising US dollar, and coming alongside a secular slowdown of China's economy and an implosion of the related commodity “supercycle”, there's growing anxiety that there will be no sharp rebound at the end of this downturn to reward investors who braved out the worst moments.

"The global backdrop and the drivers for emerging markets are very different from 2001," David Spegel, head of emerging markets at ICBC Standard Bank said, referring to the time Asia, Russia and Brazil were recovering from the crisis waves of the late-1990s.

"Back then all the stars were aligned for globalisation and emerging markets benefited the most. This time around, we just don't have those multiple catalysts," he added.

The chief catalyst in 2001 was of course China. Its entry to the World Trade Organisation (WTO) unleashed a decade-long export and investment miracle that propelled its economy from sixth place globally, to the world's second biggest.

Its ascent hauled up much of the developing world, from Latin American exporters of soy and steel to the Asian workshops which became part of its gigantic factory supply chain. But its slowdown is whacking these countries equally hard.

Exports from emerging markets, from Korean cars to Chilean copper, are declining year-on-year at the sharpest rate since the 2008-09 crisis, according to UBS.

Global trade in fact likely grew slower than the world economy for the fourth straight year in 2015, according to the WTO, a United Nations body. That contrasts with previous decades when commerce expanded at least twice as fast as world growth.

The gloomy conclusion some are reaching is that the China effect was possibly a once-in-a-lifetime shift, whose effects are now dissipating forever.

"Rather than expecting emerging markets to mean-revert towards the golden years of 2002-2007, there is a risk that in terms of trade, what we are reverting to is the environment of 1980s," UBS strategist Manik Narain said.

Flight

One feature of the "golden years" was the extraordinary amount of capital that poured into the developing world; according to the Washington DC-based Institute of International Finance (IIF) net inflows in 2001-2011 totalled nearly $3 trillion.

Some of this is starting to reverse as last year saw the first net capital outflow since 1988, a $540 billion loss, says the IIF which predicts more flight in 2016.

Other forecasters such as JPMorgan reckon nearly a trillion dollars have fled China alone since mid-2014; its central bank reserves alone declined more than $500 billion last year.

Redemptions from emerging stock and bond funds hit a record $60 billion last year, according to fund tracker EPFR Global.

IIF Executive Director Hung Tran says emerging markets' problems are not just external. They must overcome a key homegrown issue — falling productivity.

Tran estimates productivity, which provides clues on future economic growth, is growing at just 0.9 per cent a year across much of the developing world, a quarter the rate seen before 2007 and not far from richer countries' 0.4 per cent.

"Productivity advantage of emerging markets countries, which is key for attracting capital flows and investment, has collapsed," Tran said. "There is a cycle of diminishing returns on investment."

Slow-burn crisis

There are some bright spots such as India and Mexico. But with China fears on the rise and Brazil and Russia in recession for the second straight year, investment returns across the sector are unlikely to recover soon, many fear.

Emerging stock market performance has lagged developed peers for five years now, and corporate earnings have shrunk for more than four years, Morgan Stanley (MS) has calculated.

This is the longest decline in the MSCI equity index's history, MS says, noting the longest prior earnings recession in the asset class was after the 1997 crisis and lasted two years.

Richard House, head of emerging market debt at Standard Life Investments, notes the strengthening dollar is spooking investors in emerging currency bonds too.

"Fund performance hasn't been good across the industry... Local market funds have been an outflow asset class for a while and that experience is going to impact people's mindset going forward," House said.

The fear of large-scale outflows is clearly on policymakers' minds. To combat such an exodus, emerging economies may have to resort to radical measures such as coordinated securities market interventions, of the kind done in the West after 2008, Mexican central bank head, Agustin Carstens, as suggested

Ultimately though he said that to boost long-term growth, there was only one solution — tough economic reform.

Separately, , the WEF's founder is in somber mood.

Klaus Schwab, the 77-year-old chief of the world's most recognised annual economic meeting, said he's worried about Europe's future, the fallout from plunging oil prices and gaping inequalities worldwide.

In an interview with The Associated Press, Schwab said he wanted a "forward-looking" theme to dominate discussions this year, which officially runs from Wednesday through to Saturday: and has built this edition around the idea of the Fourth Industrial Revolution.

He said vast, speedy technological advances in the digital age in areas like nanotechnology and automation threaten to leave many unskilled workers without jobs or at an economic disadvantage.

In Davos, about two-thirds of the 2,500-plus attendees are decision makers from the business world: The boardroom, not the shop room floor, has an outsize representation in this snow-capped, ultra-chic Alpine resort. 

World leaders, including US Vice President Joe Biden, prime ministers David Cameron of Britain and Nawaz Sharif of Pakistan, and German President Joachim Gauck are set to attend.

Iranian Foreign Minister Mohammad Javad Zarif is likely to be a headline-act after international sanctions against his country were lifted over the weekend under a deal on Tehran's nuclear programme. Some business leaders will be contemplating a resumption of economic ties with the long-isolated, oil-rich Islamic republic.

Iran's oil ministry announced plans Monday to boost oil production by 500,000 barrels per day after the sanctions were lifted, and Schwab noted the possible harmful impact of even more supply on developing countries that depend on oil revenues at a time when crude prices have already slumped to their lowest level in more than 12 years.

"Of course, we will have to absorb now a larger supply dimension. What concerns me is the impact, the social impact, it has on certain countries," said Schwab. "Just think of Nigeria, which so much depends on oil, and other African countries... not to speak about what's the impact on Russia and so on."

As for Europe's struggle to manage an influx of more than 1 million refugees and migrants last year, he said the continent was at a "crossing point". Europe needs to find the right balance between its values and its capabilities of taking them in, and assuage tensions that have put the Schengen zone, which eases cross-border travel, to the test, he said.

"My concern is that Europe, at the moment, is in a phase of disintegration," Schwab said. "Europe would be completely marginalised if we break up into different nation-states again."

He said solidarity with refugees was a core European value.

"It's not a question whether we should have solidarity or not, it's how much can we afford? And here I think we haven't found the right answer yet," he added.