Emerging markets are set to rebound in 2023, according to the Federated Hermes’ Global Emerging Markets Outlook, boosted by the re-opening of China. Rebounds in South Korea, Taiwan and Brazil and the stability of India, Indonesia and Mexico will support emerging markets’ growth

While emerging markets (EM) underperformed developed markets (DM) in 2022, this was distorted by the China lockdown. Stripping out China, emerging markets performed in line with the developed world, the report states. 

“In addition to trough valuation and light investor positioning the differential between emerging and developed markets is set to expand on the back of favourable demographics, manufacturing capabilities and availability of critical resources,” said Kunjal Gala, London-based Head of Global Emerging Markets at Federated Hermes Limited.

China is at a critical juncture and faces three principal challenges: geopolitical rivalry with the US, the ongoing fallout from Covid-19 and issues in its property sector. Chinese equities are approximately 25% cheaper compared to the historical average on the MSCI China index. The report authors expect the Chinese market to perform in 2023 if the economy re-opens and policymakers successfully stabilise the property sector.

While investors are likely to focus excessively on the impact of the re-opening of China’s economy, the prospect of a less hawkish US Federal Reserve, and possibly rate cuts in the latter half of 2023, the Outlook looks beyond the near-term momentum to ten potential medium to long-term challenges and opportunities for emerging markets: 

  1. China: Opportunities beyond re-opening
  2. India: 2020-2030: India’s decade ahead
  3. Brazil: A lost opportunity or time to get constructive
  4. Memory Chip Industry: From cyclical to structural
  5. Supply chains: reallocation to create long-term winners
  6. Commodities and Energy: Long-term case
  7. Electric Vehicles: a multi-year opportunity
  8. Global tourism: Hopeful in 2023 and beyond
  9. Inflation: Will China’s re-opening fuel inflation
  10. ESG: Relevance for EM in a complex world

China’s transformation beyond re-opening

The report argues that the debt-fuelled model that drove growth in the past in China is now irrelevant and, therefore, historical valuations are less meaningful. 

“We are focused on how China is likely to evolve beyond the initial re-opening boost to trade. We believe that China is unlikely to grow annually at more than 6- 6.5% in real GDP terms and a mid to low single-digit outcome is feasible,” said Gala. “Beyond the issues at the surface, the Chinese economy is undergoing a more profound transformation that is exciting and presents unique investment opportunities for long-term investors.”

The themes that the Federated Hermes team examine [link] include digitisation in several industries, renewable technologies, biotechnology, financialisation of savings, the metaverse and localisation.

India: a bright decade ahead

The Federated Hermes Global Emerging Markets team expects India to gain even greater prominence over the next decade. They believe that while the US and China will remain just as important, the rise of India’s economy is a force to watch. 

“India is now the fifth largest economy and will likely be the third largest in the next seven years, with its GDP more than doubling from the current US$3.3 trillion,” Gala stated. “According to our analysis, India is forecast to add more than $400bn to its GDP yearly, a scale that only the US and China surpass.”

India is also one of the countries expected to benefit from the “China +1” push as companies diversify their supply chains. Sectors expected to benefit include electronics, autos, pharmaceuticals, semiconductors, green hydrogen, solar cells, electric batteries and electric vehicles. 

ESG and Emerging Markets

As the world faces growing social and environmental challenges, such as climate change, biodiversity loss, the cost-of-living crisis and social inclusion, environmental, social and corporate governance (SG) concerns have particular relevance in emerging markets, where many of the challenges are most acute. The Outlook report explores renewable energy, financial inclusion and good corporate governance. “We see board independence and diversity as crucial factors in ensuring effective challenge and avoidance of groupthink,” said Gala.

Renewables and other enablers of the carbon transition to further grow in relevance as emerging markets address the need to transition while capitalising on global demand for products, services, and commodities essential for a net-zero world.

In conclusion, over the medium to long-term the Federated Hermes team forecasts a shift in the investment environment that will likely be decisively different from the last ten years. Underpinning this shift will be higher-than-normal inflation and cost of capital, along with sticky supply-side constraints (energy, commodities, and labour). The shift will likely create winners and losers at global and regional levels. While developed economies are learning to adjust to inflation, emerging economies have a golden opportunity to improve their competitiveness, capitalising on leadership in growth, demographics, manufacturing prowess, and resource availability.