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  1. Analysis
May 6, 2008

EMERGING MARKETS ANALYSIS: Will the credit crunch trigger an EMs crisis?

A decade ago, overheating Asian economies led to a worldwide collapse in emerging market economies. As the credit crunch bites in the West, could the knock-on effect hit the developing world again? Mark Bursa thinks not.

A decade ago, overheating Asian economies led to a worldwide collapse in emerging market economies. As the credit crunch bites in the West, could the knock-on effect hit the developing world again? Mark Bursa thinks not.

Will the downturn in the US and European economies but the brakes on growth in the Emerging Markets?

Economists would be right to be cautious – after all, it was only a decade ago when overheated markets in a few politically volatile Asian nations – the so-called “Tiger economies” – sparked a global emerging markets collapse. As a result, three Korean automakers went bust, almost all investment in Russia was brought to an abrupt standstill, and Latin American demand was decimated. Could this happen again?

Probably not. A lot has changed in the global economy. Regardless of America’s problems – and the current crisis is very much caused by America’s problems – the emerging markets are a very different proposition to 1998. In particular, China and India have become major global economic forces since the turn of the century.

The strength of these emerging markets means that a crisis in America does not have the same level of impact as it once did. The International Monetary Fund expects global growth to fall from 4.9% in 2007 to 3.7% this year, a decline, but not a disastrous one. Effectively, the global economy is much more “joined up” than it was a decade ago – when the “Asian flu” affected the emerging markets but had almost no impact on Europe or North America.

The automotive sector is an excellent barometer of change. Whereas in the 1990s, there was no domestic market for cars to speak of in China, now it is rivalling that of Japan. The number of university-educated professional people in China – all potential future car owners – numbers around 300 million, greater than the entire population of the US.

Change in other EMs has been equally noticeable. Indian businesses have reached a level of sophistication that has made them world players – Tata being a prime example. Brazil, meanwhile, has exploited its vast reserves of natural resources, making its economy a much sturdier proposition than in 1998. Russia is to all intents a Western Capitalist economy.

Significantly, the growth in these markets is not based on money lent over-enthusiastically to less affluent consumers by the likes of failed banks Northern Rock in the UK and Bear Stearns in the US. Consumer credit is playing a role in China, India and Brazil, but economic strength in those countries is underpinned by strong GDP growth.

Not that the Asian economies are bomb-proof. China and other Asian markets still depend on the US and Europe as a destination for the products they produce. The Chinese may not have cracked the car market in the West, but they dominate the markets for computers, mobile phones, white goods and home entertainment. If the credit crunch causes demand for these goods to dry up, there will be an impact on Asian economies.

Figures from Euromonitor show in 2007 that 34.6% of goods imported to the US came from the Asia Pacific region. About 22.7% of Japan’s total exports of manufactured goods went to the US and 21% of China’s. So there is a substantial degree of exposure to the US economy.

Economists suggest that the US recession will be long and shallow rather than short and sharp like previous blips in 1990 and 2001. The 1990 crisis was similar to the current one, with homeowners bearing the brunt of the crisis through vastly reduced property values. The 2001 crisis was an altogether different animal – caused by the Millennial madness that was the Dot-com boom.

Indeed, there’s an argument that today’s credit crunch is “son of dot-com boom”, when cash-rich, overheating markets meant US banks needed to find something to do with their money. The less sensible took the enormous risk of turning trailer trash into property magnates, thus creating the sub-prime mortgage market. Not for nothing were these deals on offer referred to as “Ninja” mortgages – No Income, No Job, No Assets.

Sub-prime is not the only issue. Further pressure on US and European economies come from rising oil, commodities and food prices. America’s actions in the Gulf have not helped with regard to oil prices, and these are also being forced up by strong demand from emerging markets, especially China. And while the emerging markets may be insulated from sub-prime, they are not insulated from rising oil prices – and this might be the factor that puts the brakes on growth.

This is no bad thing, many economists believe. Since 2002, the year the Chinese car market came alive, growth in emerging markets has been rapid. Slower growth might be no bad thing in the circumstances – rampant growth could lead to rampant inflation in emerging markets, a situation that crippled Brazilian growth, for example, a decade ago. Slower, steadier growth is preferable to a cycle of boom-slump-boom.

However, economists believe Chinese growth is solid. “Domestic Chinese consumer demand and also domestic private company investment still remain very robust,” said Robin Bew, EIU Chief Economist. “We think it’s going to remain so. But interestingly, so do all those foreign invested companies. So I think the story remains pretty strong.”

Bew forecasts “9-10% growth in China, certainly for the next couple of years”, less than the stellar growth of earlier this decade, but still impressive. There will be a small dip this year, but a negligible one, according to the major financial institutions. The Asian Development Bank has lowered its 2008 forecast for China’s economic growth from 10.8% to 10%, while the World Bank is more cautious, cutting its 2008 forecast for China from 9.6% to 9.4%.

If translated to the car market, this level of growth would still be sufficient to fuel the ongoing investment programmes in manufacturing capacity – though a note of caution is needed here too; overcapacity would become a serious problem if the market were to stop growing.

This seems unlikely. The global centre of economic gravity is already shifting to China, India and other large emerging economies, according to a PricewaterhouseCoopers study, “The World in 2050”. The report suggests that China could overtake the US in around 2025 to become the world’s largest economy and will continue to grow to around 130% of the size of the US by 2050. India could grow to almost 90% of the size of the US in the same period. Other emerging markets such as Brazil, Russia and Mexico will overtake Japan, Germany and the United Kingdom, it added.

In the short-term, the economic situation also has a bearing on automakers’ global plans. Will a collapse in demand for cars in the US and Europe affect the export plans of Asian automakers? Or will rising oil prices force US consumers into the type of smaller, cheaper cars that could be sourced from China, India or the Pacific Rim? Again, a cautious approach would be sensible here – indeed, Chinese car firms may use the state of the US and European economies to delay their export plans, allowing them to sort out their emissions and safety issues.

Strangely, some of the winners could be US automakers. The weakness of the dollar makes exporting from the US appealing, and repatriating profits made overseas. GM’s strong performance in China, where it sold more than 1 million cars in 2007, may act as profitable insulation against a domestic decline in demand for gas-guzzling SUVs. And the availability of less gas-guzzling vehicles developed in Korea through GM-Daewoo may help retain customers looking to downsize.

At most risk are European luxury automakers dependent on the US – step forward BMW, Audi, Porsche and Mercedes. The effects of BMW’s balance sheet are already obvious – BMW blames “exceptional expenses” stemming from the credit crunch for a 17% fall in first quarter net profit to EUR487m.

If this causes a fall in share prices, could it attract speculative investors from cash-rich nations such as India or Russia, or even Gulf states such as Dubai? Is Tata’s acquisition of Jaguar and Land-Rover the tip of the iceberg? America’s notorious “corporate raider” Kirk Kerkorian has taken the opportunity to take a punt on a 5% stake in Ford. What might Dubai Investment Capital do? Might Ratan Tata want to add to his portfolio sooner rather than later? Or Russia’s GAZ group, with Martin Leach at the helm?

Economic turmoil inevitably leads to a shakeout in the business world. This one will run and run.

Mark ‘Coolbear’ Bursa

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