Much of the stress in the global economy right now is concentrated in emerging markets. There are many reasons why this matters to investors. Measured at purchasing power parity, the advanced economies now only account for 43% of global GDP, down from 54% in 2004.
The share of emerging markets is lower when calculated using market exchange rates, but they undoubtedly exert a significant pull on the global economy. Exports from the advanced economies destined for emerging markets have increased significantly over the past two decades. In 1995 exports to final demand in emerging markets accounted for 22% of total exports in the average OECD country; in 2011 that had reached just over 33%, with exports now accounting for a larger share of GDP than they did in most countries versus 1995 as well.
Financial institutions and asset managers in the advanced economies have also lent a considerable amount to governments and, in particular, banks and non-financial corporations in recent years. Emerging market bonds outstanding to foreigners stand at more than USD3 trillion, much of it in foreign currency and especially US dollar-denominated debt. Additionally, financial shocks emanating from emerging markets can destabilise financial markets in the developed economies, whether that be due to fears of economic and financial contagion or large swings in currencies. While lower commodity prices are a boon for importers, they weigh on inflation.
Of course, exposures to emerging markets vary considerably. The three advanced economies that stand out for having the largest direct exposure to emerging market growth are Australia, Japan and Korea, where exports to final demand account for more than 50% of total exports.
Countries with a more modest exposure (30% of exports or less) include the Benelux and Iberian countries. While the proportion of Canadian and Norwegian exports heading directly for emerging markets is low, their practical exposure is much higher because weak emerging market demand has contributed to the large drop in oil prices since mid-2014. This is not a reason to panic, as long as emerging markets are slowing but not collapsing. However, it does help explain why advanced economy central banks are so sensitive to foreign developments.
Source: Standard Life Investments
