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From Emerging to Diverging Markets
Sharp swings in exchange rates. Swooning equity markets. Slowing growth. Investors in emerging markets over the past three decades have seen all these warning signs before. And when they flash in a number of economies simultaneously, the outcome often is not good.
So what should we make of the volatility that seems to be suddenly sweeping some of the world's most dynamic developing economies, including China, India, Brazil, Turkey, South Africa, Indonesia, and Mexico? For more than a decade, the economic success of these emerging markets has driven global growth and lifted millions of people out of poverty. Companies that built international businesses around such markets have found important new sources of growth and lowered their costs.
For executives who have come to view the global economy as essentially a two-speed world—composed of sluggish, mature developed economies and rapidly growing developing economies—the change in fortunes has been jarring. For the next few years at least, companies will have to learn to shift gears, perhaps frequently, as they navigate the global economy. Instead of treating all the big developing economies as emerging markets, they must learn to approach them as diverging markets—economies that are growing at different speeds, experiencing different degrees of financial health, and facing different structural challenges.
For the first in an ongoing series of snapshots of the changing global economy, leaders of The Boston Consulting Group's operations in Brazil, Turkey, and China discuss what they are seeing in these examples of diverging markets.
Our collective view is that important structural changes clearly are under way in all the RDEs. It is important, however, for executives to look beyond today's headlines and keep their sights focused on the longer term. Even though some economies will fall far behind, collectively, the emerging markets will remain the biggest sources of growth for decades. To scale back now would be to cede these pivotal battlegrounds for global leadership to more far-sighted competitors, particularly hard-charging domestic companies that are well accustomed to risk and volatility. But to continue with a one-size-fits-all approach to emerging markets without recognizing the differences among them would be just as costly.
First, let's look at the rather disappointing developments that lie behind the headlines. Although some economies in Asia and Africa still continue to grow rapidly, there is no question that growth in most major RDEs is slowing. China recently announced that its economy grew at an annualized rate of 7.7 percent in the second quarter of 2013, but only after its expansion had weakened in nine of the previous ten quarters. The latest 2013 growth projections for India have been revised downward, to 5 percent, while growth in economies such as Brazil, Russia, Turkey, South Africa, and Mexico is expected to track even slower, at around 2 to 3 percent—close to projections for the U.S. economy.
The declining appeal of emerging markets is also evident in capital flows. Emerging-market stocks, as measured by the MSCI World Index, are down about 12 percent so far this year, while the U.S. benchmark Standard & Poor's 500 index is up about 15 percent. Foreign direct investment in greenfield and expansion projects, meanwhile, decreased 28 percent in 2012 in China, 38 percent in Brazil, and 54 percent in India.
Much of the volatility in capital flows has no doubt been triggered by rising interest rates in the U.S. resulting from expected changes in Federal Reserve policy, which have prompted investors to pull funds out of bonds and higher-risk assets in emerging markets. Experience has shown that sharp pullbacks in some emerging markets can trigger a wider contagion that wreaks havoc across the developing world for many months—as was the case following the 1982 Mexican financial crisis and the crash of the Thai baht in 1997.
But the volatility also reflects weakening public finances in some countries and expectations of less growth in corporate profits. Surveys find that international executives believe risks are growing in emerging markets. Even in China, a significant number of companies say that profits and growth have stalled.
The degree of exposure to volatility varies dramatically by country, however, depending on factors such as level of foreign debt, dependence on commodity exports, and fiscal position. Current-account deficits and inflation have risen in Indonesia and South Africa, for example, but remain relatively healthy and stable in other emerging markets. Brazil’s economy is slowing as a domestic-consumption boom winds down, but its banks and public finances remain sound. The financial systems of Turkey and Mexico also appear to be in relatively good shape.
All the short-term anxiety does not diminish the reality that emerging markets still present companies with some of the greatest opportunities for growth over the medium and long term. Last year, RDEs accounted for 59 percent of global growth. China’s economy is still booming by world standards, most African economies are growing at a 5 to 6 percent clip, and the Philippines are expanding at an annualized rate of around 7 percent. For the next several years, the GDPs of RDEs are projected to grow several percentage points on average faster than those of developed economies.
What’s more, the drivers of growth in many emerging markets remain powerful. In Turkey, 6 million households are projected to enter the middle and affluent classes in the next five years. In Indonesia, we project that 68 million people will enter the middle and affluent classes by 2020—a number equivalent to the entire population of the U.K. Thirty-six percent of Brazil’s 60 million households will have joined the ranks of the middle class and affluent by 2020, compared with 29 percent in 2010. By that time, Brazilian households will represent a $1.6 trillion market. In China and India, such households will represent $10 trillion in buying power.
Most emerging markets have much more favorable demographics than developed economies. Although the working-age population is starting to decline in countries such as China, where the median age is now 36, it is still growing in other RDEs. The median age in Turkey is just 29. In Indonesia, half the population is under the age of 30. In India, the median age is 27. As a result, a much larger proportion of the populations of these countries will be productive and attain higher incomes in the coming decades.
It would also be a mistake to underestimate the ability of many emerging markets to adapt to adversity. Indian governments since the 1980s have repeatedly used financial crises to ram through important reforms that set the stage for future growth. Many bullish reports about East Asia in the early 1990s may have seemed mistaken when the Asia financial crisis hit in 1997 and 1998. But multinationals that viewed that period as a window of opportunity to buy strategic assets in East Asia reaped the dividends when the region quickly recovered.
Multinational companies that pull back now may miss out on important opportunities and fall behind competitors. Chief among the latter are a group that we call global challengers—fast-growing, globally minded companies such as Huawei, Vale, and Bharti Airtel that have roots in emerging markets and are establishing international leadership positions in their industries.
Such companies have been able to catch up with many multinationals in performance, and they are incorporating best practices into their business models, becoming more agile on the ground and developing an intimate understanding of local consumers. In a BCG survey of more than 150 executives of multinational companies, more than three-quarters said they expect their companies to gain share in emerging markets—but only 13 percent think their companies have the capabilities to successfully take on local competitors. In fact, 102 of the global Fortune 500 companies had their headquarters in an emerging market in 2012, which is double the number of such companies on the 2008 list.
If multinationals choose to retreat from emerging markets, they could face a double whammy: not only a much tougher competitive environment when they try to return in two or three years' time, but also a set of domestic challengers that have strengthened, grown, and attained a better position to compete head-to-head in the rest of the world. The emerging-market boom may be cooling for now. But the battle for the future is only heating up.
Now more than ever, distinguishing carefully among emerging markets and making fact-based, reasoned decisions about which direction to take in each of them can be the difference between tremendous success and weak performance.