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Monthly Emerging Markets Review
August 2014
Mark Mobius, Ph.D.
Executive Chairman, Templeton Emerging Markets Group
OVERVIEW
Emerging markets remained on an upward trend in August, with returns largely driven by substantial politically driven strength
in Latin America. Asian markets were marginally higher, while Eastern European markets were slightly lower. The MSCI
Emerging Markets returned 2.3% in US Dollar terms for the month. Brazil was the top performer with the MSCI Brazil Index
returning 11.1% in US Dollar terms. The death in a plane crash of presidential candidate Eduardo Campos transformed the
election race. Mr. Campos’s running mate, environmentalist Marina Silva was adopted as the new candidate of the Socialist
Party, and polls suggested that her popularity was close to incumbent President Dilma Rousseff in the polls, and ahead on a
head-to-head basis. The prospect of defeat for President Rousseff sent Brazilian equities sharply higher. Also in Latin
America, solid economic data and the start to implementation of energy reforms buoyed Mexican equities, while stock specific
issues pushed Peru ahead. Elsewhere, solid economic data and corporate results boosted Thailand and Taiwan, while plans
to increase the capacity of the Suez Canal and hopes for continued financial support from Gulf State allies produced some
excitement in Egypt. European markets saw some softer performances with Turkish stocks consolidating after recent gains,
while the ongoing crisis in Ukraine and fears of additional sanctions pressured sentiment on Russia. Indonesia and South
Korea also slipped marginally, while political unrest sent Pakistan sharply lower.
REGIONAL UPDATE
Asia
Foreign direct investment flows into China declined 0.4% y-o-y to US$71.1 billion in the first seven months of 2014.
Investment in the manufacturing sector, which declined 14.7% y-o-y to US$25.2 billion in the same period, was the main
reason for the slowdown. Urban fixed-asset investment increased 17.0% y-o-y in the January to July period, slightly slower
than the 17.3% y-o-y increase in the first half of 2014. Retail sales rose 12.2% y-o-y in July, bringing the year-to-July growth to
12.1% y-o-y. Consumer prices rose 2.3% y-o-y in July, unchanged from June. Strengthening external demand led export
growth to accelerate to 14.5% y-o-y, bringing the total for July to US$212.9 billion. Imports, however, declined 1.6% y-o-y to
US$165.6 billion, resulting in a US$47.3 billion trade surplus in July. This compared to a surplus of US$17.6 billion a year
earlier and US$31.6 billion in June.
The Bank of Korea reduced its benchmark interest rate by 25 basis points (0.25%) to 2.25% in August to stimulate the
domestic economy. This was the Bank’s first adjustment in 15 months. The consumer price index eased to 1.6% y-o-y in July,
from 1.7% y-o-y in June, and remained well below the Bank of Korea’s 2.5% to 3.5% target inflation rate for the year. Growth
in exports accelerated to its fastest pace since December 2013. Exports rose 5.7% y-o-y to US$48.4 billion in July, compared
to an increase of 2.5% y-o-y in June. Exports to the US and European Union continued to record double-digit growth, while
exports to China declined, compared to a year earlier. Imports rose 5.8% y-o-y to US$45.9 billion, resulting in a trade surplus
of US$2.5 billion in July. The government announced details of its tax reforms bill, which included measures to encourage
wage increases, reduce dividend taxes and lower excessive retained earnings for corporations. The reform is expected to be
submitted for approval to the National Assembly in September.
Franklin Templeton Investments
Emerging Markets Newsletter
| August 2014
The Indian economy expanded at its fastest pace in more than two years. GDP growth accelerated to 5.7% y-o-y in the
second quarter, from 4.6% y-o-y in the first quarter. Improvements in the mining, manufacturing and financial services sectors
supported growth. The Reserve Bank of India maintained its benchmark interest rate at 8.0% for the third consecutive month
in August. While the Bank left the cash reserve ratio unchanged, the statutory liquidity ratio for commercial banks was
reduced by 50 basis points (0.50%) to 22.0% to encourage credit growth to support the domestic economy. Inflationary
pressures rose in July mainly due to higher food prices. The consumer price index increased to 8.0% y-o-y in July, from 7.3%
y-o-y in June. Growth in industrial production eased to 3.4% y-o-y in June, from 5.0% y-o-y in May. Prime Minister Narendra
Modi emphasized the need for better governance and the importance of job creation and attracting foreign investment in his
first Independence Day speech. Aimed at expanding defense and economic ties, Mr. Modi made a trip to Japan at the end of
the month. The prime minster also visited Nepal in August where he offered a US$1 billion loan for investment in hydropower
and infrastructure projects.
Latin America
Brazil’s GDP contracted 0.9% y-o-y in the second quarter, compared to a revised 1.9% y-o-y growth in the first quarter.
Declines in the manufacturing and construction sectors, as activity slowed during the FIFA football World Cup, were the main
reasons for the contraction. On a q-o-q basis, GDP declined for the second consecutive quarter, putting the country into a
technical recession. GDP contracted 0.6% q-o-q in the second quarter, compared to a revised 0.2% y-o-y decline in the first
quarter. The Central Bank cut reserve requirements for banks to support the domestic economy. Banks will be allowed to use
up to 60% of reserve requirements on term deposits they have with the Central Bank to make new loans or acquire loans from
other banks. Inflation remained at the Central Bank’s upper target limit of 6.5% in July, unchanged from June. The current
account deficit widened to US$6.0 billion in July, from US$3.3 billion in June. The accumulated current account deficit for the
12 months ended July 2014 totaled US$78.4 billion, or 3.5% of GDP. Foreign direct investment inflows increased to US$5.0
billion in July, from US$3.9 billion in June, bringing the 12-month total to US$64.0 billion, or 2.8% of GDP. Foreign exchange
reserves totaled US$379.0 billion in July.
Africa
The South African economy grew an annualized 0.6% q-o-q in the second quarter, avoiding a recession after declining 0.6%
q-o-q in the first quarter. The agriculture, financial and transport sectors supported growth, while the five-month strike in the
platinum mines, which ended in late-June, led the mining sector to contract by an annualized 9.4% q-o-q. This was, however,
better than the annualized 24.7% q-o-q decline in the first quarter. On a y-o-y basis, GDP grew 1.0% in the second quarter
compared to an increase of 1.6% in the first quarter. Growth in retail sales slowed to 1.5% y-o-y in the second quarter, from
3.1% y-o-y in the first quarter due to lost wages resulting from the platinum strike, higher inflation and interest rates, and
weakness in the job market. The consumer price index eased to 6.3% y-o-y in July, from 6.6% y-o-y in June, remaining above
the upper limit of the Central Bank’s inflation target range of 3% to 6% for the fourth consecutive month.
Eastern Europe
Russia’s GDP grew 0.8% y-o-y in the second quarter, slightly lower than the 0.9% y-o-y increase in the first quarter,
according to preliminary data released in August by the Federal State Statistics Service. The Ministry of Economic
Development lowered its 2015 GDP growth estimate to 1.0%, from 2.0%. The consumer price index eased to 7.5% y-o-y in
July, from 7.8% y-o-y in June. Foreign direct investment into the country declined to US$12.2 billion in the first quarter, from
US$40.2 billion a year earlier. The decline was partly due to an exceptional inflow in the first quarter of 2013 as well as the
increased uncertainty resulting from the conflict in Ukraine. Russia’s sovereign wealth fund announced plans to invest US$6.6
billion in the domestic banking sector. Russia banned imports of food and agricultural products from countries that imposed
sanctions against the country. Agriculture official Sergei Dankvert met representatives from Argentina, Brazil, Chile, Ecuador
and Uruguay to discuss increasing agricultural exports to Russia. Restrictions on importing meat, fish and produce from Latin
American countries were also relaxed.
The Central Bank of Turkey maintained its key benchmark interest rate at 8.25% in August. The Bank had previously reduced
rates by a cumulative 175 basis points (1.75%) in the previous three months. The overnight lending interest rate was reduced
by 75 basis points (0.75%) to 11.25%, while the overnight borrowing interest rate remained unchanged at 7.5%. The
consumer price index edged up to 9.3% y-o-y in July, from 9.2% y-o-y in June. The current account deficit narrowed to
US$24.2 billion in the first half of 2014, from US$37.1 billion a year earlier, mainly due to a lower trade deficit. Growth in
industrial production moderated to 1.4% y-o-y in June, from 3.5% y-o- y in May, mainly due to sluggish growth in domestic
demand. Prime Minister Recep Tayyip Erdogan became the country’s first directly elected head of state after winning the
presidential election in August.
Franklin Templeton Investments
Emerging Markets Newsletter
| August 2014
FEATURE OF THE MONTH: REFORMS IN CHINA
Reform efforts in China seem to be gaining momentum. The big question is whether these reforms will buoy investor
confidence, and jumpstart China’s local A-share market. In November 2013, the Chinese Communist Party convened its Third
Plenary Session, resulting in a general blueprint for the country going forward officially called “A Decision on Major Issues
Concerning Comprehensive and Far-Reaching Reforms.” There were a variety of areas targeted, including fiscal reform, anticorruption efforts, and integrated rural-urban development. Since then, the Chinese government has released more detailed
reform plans, and of particular interest to us as investors are those related to the capital markets.
The reform plan is comprehensive and we believe most of the specific reforms initiated are significant for investors. Some of
them could have an immediate impact, while some are more structural in nature, rendering potential market impact over a
longer-term basis.
It is clear that the Chinese government’s intention is to ensure that markets will play a more important role in the economy in
order to maintain strong growth. The government’s ongoing efforts to rebalance the economy away from exports and
investment toward domestic consumption coupled with wage growth of up to 20% experienced in recent years are positive.
Such reform has the potential to be very positive for the long-term performance of both the economy and Chinese equity
markets.
Plans to address overcapacity and promote a more open and transparent market seem to point to a policies that will
emphasize state-owned company reforms and higher profitability. Reform of regulated fuel, water and utility prices could
potentially further increase the profitability of some State Owned Enterprises (SOEs). At the same time, a commitment to use
market forces to regulate prices along with moves against regional monopolies and unfair trading practices could expose the
SOEs to additional competition. We believe a more commercial attitude among SOE managements could have positive
implications for the quoted subsidiaries of such bodies, while various mixed ownership enterprises and finance companies
could also offer opportunities to investors.
Notably, reforms to the financial markets have generally been positive, such as the announcement to allow for two-way
investment between the Shanghai and Hong Kong stock exchanges and the widening of the trading band of the Chinese
Yuan. Further policy announcements could be a catalyst for strong equity market performance.
Over the medium to longer term, we believe the greater participation of foreign investors may change market dynamics in the
direction of better governance at the company level. We also believe all these new reform initiatives could help gradually
regain interest in China’s A-share market among domestic investors. The goal of these efforts is to make China’s capital
markets much more diverse, structured and transparent. This is very important, in our view, as there is a large amount of
private savings in China that could be invested. Such capital market development will enable companies to raise finance
through share issues rather than depending on the state-owned dominated banking system.
Overall, China’s domestic equity market was quite weak in the first half of 2014 for a host of reasons. The market has been
negatively impacted by poor macroeconomic data, worries on news of bond defaults and rising new share supply in the equity
market. Although reform excitement had lifted the longer-term structural outlook of the economy and the market late last year,
the China A-share market started to correct after the Third Plenum ended. Attention subsequently turned to the reality of
implementing reforms.
In terms of sector themes, we are beginning to look more carefully at the banking sector and particularly the larger banks with
stronger deposit franchises as well as some other financial companies that have the potential to benefit from the development
of capital markets. We also see good long-term value in the building materials sector, which has undergone massive market
consolidation and capacity rationalization. Underpinned by structural demand growth we also positively view pharmaceutical
and selected companies in the consumer sector in China.
We have seen growing consumer demand as a key theme not only in China but in emerging market economies globally,
including the lesser-developed frontier markets. Within this theme, we regard the expansion of demand for not just products
but also consumer services as particularly interesting. Our research metrics have been uncovering a growing class of
emerging market-based service businesses and we believe the growth potential for emerging and frontier market services
could be substantial. According to the World Bank, more than 70% of the economic activity of “high income” countries was
generated through services in 2012. For “low and middle income” countries, equivalent to emerging and frontier markets, the
figure was 53%. Emerging-market service businesses could thus potentially benefit not only from underlying economic growth
but also from convergence with the share of services within developed-market economies.
Perhaps the most exciting services field, in our view, is that connected to the development of the Internet. With legacy brickand-mortar assets relatively scarce in many emerging markets, adoption of Internet-based trading has been rapid in many
service industries. Chinese online travel and ticketing businesses are examples of traditional service businesses adapting
themselves to the online age.
Franklin Templeton Investments
Emerging Markets Newsletter
| August 2014
While China represents one of the largest economies in the world, it is a typical emerging market in that it still has a relatively
low participation rate in capital markets. This provides good potential opportunities for value-oriented investors like us, as
valuations were generally depressed by the lack of market confidence. However, news of capital market reform initiatives by
the government led investor confidence to recover; leading Chinese equity prices to rebound in recent months.
We believe that the economic recovery in the developed markets is a positive factor for China’s market. Greater growth in
these countries should help sustain China’s exports and support its overall economy. On the fiscal side, we anticipate that the
Chinese government is likely to maintain a slightly loose policy, moderately increasing government spending in social
infrastructure to stimulate the economy. Risks include possible investor outflows from emerging markets generally as the US
Federal Reserve continues to taper its asset purchase program, the need to wind down activities of polluting industries, and
possibly even default of trust products that have made unprofitable investments. The overall picture is bright but we must be
prepared for corrections along the way.
IMPORTANT LEGAL INFORMATION
This document is intended to be of general interest only and does not constitute legal or tax advice nor is it an offer for shares
or invitation to apply for shares of any of the Franklin Templeton Luxembourg-domiciled SICAVs. Nothing in this document
should be construed as investment advice.
Franklin Templeton Investments have exercised professional care and diligence in the collection of information in this
document. However, data from third party sources may have been used in its preparation and Franklin Templeton has not
independently verified, validated or audited such data. Opinions expressed are the author’s at publication date and they are
subject to change without prior notice. Given the rapidly changing market environment, we disclaim responsibility for updating
this material.
Any research and analysis contained in this document has been procured by Franklin Templeton Investments for its own
purposes and is provided to you only incidentally. Franklin Templeton Investments shall not be liable to any user of this
document or to any other person or entity for the inaccuracy of information or any errors or omissions in its contents,
regardless of the cause of such inaccuracy, error or omission. In emerging markets, the risks can be greater than in
developed markets.
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