Emerging-Market Rebound Depends on China and India
(Bloomberg Opinion) -- This year’s sell-off in emerging-markets assets has abated in recent weeks and valuations are tempting, but it’s too soon to say things have bottomed. The key to any rebound is China and India, two economies where the outlook has deteriorated in recent weeks.
The relative size of their economies — together they accounted for more than 25 percent of global output in 2017 — and stock markets — they are the only two developing economies to figure in the top 10 in world market capitalization rankings — make them bellwethers for the entire asset class. China, the world’s largest exporter, has seen its foreign sales threatened by the escalation of tariffs by the U.S., contributing to about a 20 percent drop this year in the CSI 300 Index of equities. India, the world’s third-largest economy measured by gross domestic product based on purchasing power parity, has seen its currency depreciate in the face of mounting costs to import oil.
President Donald Trump has singled China out as the main problem as he tries to reduce the U.S. trade deficit. America’s shortfall in trade with China expanded from an already sizable $347 billion in 2016 to $375 billion in 2017. With the monthly deficit increasing further during the current year to a record $36.8 billion in August, the gap for the year is expected to surpass $400 billion.
The Trump administration on Sept. 17 imposed a 10 percent tariff on $200 billion of imports from China effective yesterday. The rate will increase to 25 percent in January if the situation is not resolved, which looks likely after China dashed prospects for a near-term resolution by warning Trump his threats of further tariffs are blocking any potential negotiations. The tariff comes on top of levies already placed on $50 billion of Chinese products. Trump holds open the option to impose a tariff on all imports from China totaling $505 billion last year.
With exports of goods and services accounting for about 20 percent of Chinese gross domestic product, the latest tariffs will have a significant impact on the economy. The tariff threat has already sparked capital outflows and weakened the currency. On the domestic front, retail sales, an indicator of economic well-being, have grown more slowly in the past six months. Another measure, the purchasing managers’ index for manufacturing, is at lower levels than a year ago. Slower growth in the Chinese economy will have a negative impact on other emerging markets such as Brazil that are highly dependent on sales to Chinese buyers.
At about $12.2 trillion, the China’s gross domestic product is larger than India’s at $2.60 trillion, but the latter has been the fastest-growing major economy in the world over the past several quarters. India’s real growth of 8.2 percent in the second quarter exceeded the 6.7 percent increase in China. India’s non-oil imports increased to $33.4 billion in August from $22.5 billion two years earlier.
The Indian economy’s Achilles’ heel is its dependence on imported oil, its largest single import. With the price of Brent crude at around $80 per barrel, twice the level of a couple of years ago, India’s deficit in the trade balance has surged, and the rupee has plunged in value. The sharp depreciation in the rupee is likely to extend the emerging market correction in two ways. First, Finance Minister Arun Jaitley suggested this month that the government would take steps to limit “non-essential” imports. India has been an attractive market for exporters in other Asian countries, the U.S. and the U.K., and import restrictions are likely to be quickly transmitted. Second, with the rupee’s 13 percent drop this year, Indian exports are more competitive in foreign markets. Expect other emerging economies to attempt to weaken currencies in reaction to the move.
India’s equity market has bucked the broad retreat in emerging markets until late August. Since then, though, the S&P BSE Sensex has plunged 6.66 percent on rising concern about non-performing loans held by Indian banks and a large infrastructure leasing firm defaulting on its debt.
In common with other developing economies, China and India have felt the impact of a stronger dollar and rising U.S. interest rates that have prompted capital outflows. How the two economies react to U.S. tariffs and higher energy prices may determine the turning point for emerging markets as a whole.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Komal Sri-Kumar is the president and founder of Sri-Kumar Global Strategies, and the former chief global strategist of Trust Company of the West.
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