Thus far, South Korea’s economy has responded well to won strength, and its exporters have been increasing efficiencies and cutting costs. So, South Korea is currently an area of interest for us. More generally, if further pronounced weakness occurs across emerging markets generally, we will be on the hunt for opportunities in other places where we see a proliferation of potential bargains.
China: A Wild Card
China is of course the wild card for emerging markets as well as for the global economy. For two decades, China’s economic growth has been turbocharged. Surging exports and intensive state-driven investment have lifted millions out of poverty and propelled China into the ranks of global economic superpowers. However, we believe the sustainability of China’s old development model is now at the crunch point.
In China, the more vibrant private sectors of the economy in small- and medium-sized enterprises have been typically starved of cash. The larger state-owned enterprises, as well as local governments, have meanwhile enjoyed easy access to loans, which they have often used to fund redundant projects offering low rates of return. We believe structural reforms are needed to sustain sufficient growth. But even then, most of the reform measures that the government has proposed will take time to have an effect. So the key determinant of China’s growth for this year, and the next several years, in our view, will be how aggressive policy makers will be in attempting to wean the economy off its reliance on credit and investment. We believe this transition is unlikely to happen smoothly, and the risk of a sharp slowdown cannot be discounted. But we think not dealing with credit excesses would be a long-duration and potentially even worse scenario.
Hoping For A ‘Long’ Landing In China
The fact that China has started to embrace reform is clearly good news. However, structural reforms are not easy to implement, and it will be very difficult for China to easily reduce investment as a share of economic activity. What we should hope for in China is not a soft landing versus a hard landing, but a long landing. In sum, we think China’s problems are large but not yet crippling. The good news for investors is that China’s leadership seems to recognize that a serious deleveraging is in order, in addition to structural reform and a shift toward a more market-based economy to more efficiently allocate capital. So the question is not really whether China will be transformed—in many ways, that transformation has begun. Our focus is on how that transformation plays out, what is destroyed and what emerges to replace it, and where we will find stock opportunities as China’s deleveraging unfolds.
Cindy Sweeting, CFA, is president of Templeton Investment Counsel, LLC and director of portfolio management for Templeton Global Equity Group.