Download Government reform — the new driver of emerging markets growth?

Daniel J. Graña
Portfolio Manager
June 2016
Government reform — the new
driver of emerging markets growth?
While investors are by now quite familiar with the struggles in the emerging markets and the reform agendas
of China and India, we think these issues overshadow a
more interesting topic: reform initiatives elsewhere in the
emerging markets that aim to develop domestic engines
of growth. While not always successful, the benefits
of reform are significant. Not only can they provide a
powerful driver of growth, but in doing so they can also
provide insulation from:
T
• ightening U.S. Fed policy
C
• hina’s painful economic transition
F• alling trade and weak commodity prices
In other words, if done correctly, structural reform can
act as an important buffer against the issues that have
hampered EM performance over the past several years.
The government reform “sweet spot”
While investors frequently think of China and India
as exponents of EM structural reform — though not
always as shining examples of reform-led success —
we believe investors should focus on assessing the
potential effectiveness of reform agendas in those
emerging markets where policymakers are bent on
creating institutional change.
The economies of many of the larger EM markets remain
hamstrung due to their exposure to commodities, U.S.
Fed policy, and/or a lack of policies that support domestic
growth. In contrast, markets such as Mexico, Indonesia,
Argentina, and the Philippines are all in the process of
implementing reform-led initiatives that should allow
them to benefit from growth within their own borders
in the near term (i.e., over the next 1–5 years), while
also being somewhat protected from volatility sources
elsewhere in the world. At this intersection of policy
reform, policy independence, and insulation from falling
commodity prices, we believe there is both near- and
longer-term opportunity.
For use with institutional investors and investment professionals only. Not for public distribution.
June 2016 | Government reform — the new driver of emerging markets growth?
A framework for evaluating future EM growth
Economic growth potential
Headwinds to economic growth
reform agenda
Active
Beneficiary of low
commodity prices
Relative policy
independence from
the developed markets
and China
India
Yes
Yes
Yes
China
Yes
Yes
Neutral
Philippines
Yes
Yes
No
Indonesia
Yes
Neutral
No
Mexico
Yes
No
Neutral
Korea
No
Yes
No
Turkey
No
Yes
No
Brazil
No
No
No
South Africa
No
No
No
Identified economic growth
Breaking down walls with Mexico’s reforms
Mexico’s attractive top-down fundamentals are rare in
an EM context. Unlike Brazil and South Africa, Mexico’s
fortunes are not tied to a transitioning China; Mexico
does not contend with excessive leverage like China,
Korea, and Brazil; and it doesn’t have irresponsible
macroeconomic policymaking like Turkey, South Africa,
and Brazil.
Overall, Mexico’s energy-related reform breaks with
a 75-year state monopoly, opening up the sector to
private capital. It has been estimated that more than
US$200 million has been spent on seismic work and that
higher capital expenditures on drilling could commence
in 2017. Assuming the Mexican government shrewdly
negotiates its contracts with private players, the country’s
largely unexplored offshore reserves could prove to be
a paradigm-shifting economic development. As these
locations have a similar geology to the rest of the Gulf of
Mexico, they could be a more attractive energy resource
relative to arctic Russia or other regions beset by political
instability or difficult geologies.
Mexico’s strong ties to the United States are a source of
strength, and the country has become more resilient
through reforms that reduce its exposure to oil price
swings and promote more domestic-oriented growth. For
example, by increasing taxes on non-energy sectors, such
as beverages, and reducing taxes on the state-owned oil
company, Petróleos Mexicanos (better known as Pemex),
policymakers have reduced reliance on energy-related
government revenues from nearly 40% at the peak to less
than 20% today. Concurrently, the government has raised
fiscal revenues from 8.4% of GDP in 2012 to 13.4% in 2015,
which is being directed toward infrastructure spending —
a key generator of domestic growth.
In addition, Mexico’s reform of its telecommunications,
media, and banking sectors has stimulated competition
and may help ensure lower inflation. As the monopolies
and oligopolies in these areas fall, we see strong potential
for investment opportunity across a number of sectors.
2
Putnam Investments | putnam.com
Resetting expectations in Indonesia
A second example of how powerful reforms can alter
the economic and investing climate is in Indonesia,
where President Jokowi’s administration is beginning to
execute on much needed changes after many miscues
and resetting of expectations.
Coupled with pump price decreases and lower interest
rates, the monthly economic data releases since
November 2015 have shown continued improvements in
consumer confidence, business confidence, retail sales,
cement volumes, and car sales. Also, in our conversations with global companies who care about the region,
a sense of guarded optimism about the 2016 outlook
generally prevails. With much needed fiscal policies finally
being implemented, Indonesia is beginning to deliver,
burnishing its reputation as an attractive destination for
global investors.
Navigating difficult political waters, the Indonesian
government has pushed through fiscal stimulus, and
infrastructure spending has begun. A slow patch in the
economy, a weaker rupiah, and lower crude oil prices
have reduced the current account deficit and inflation to
more manageable levels, permitting Bank Indonesia to cut
interest rates. Monitoring the rebound in economic growth
will be a key determinant of Jokowi’s popularity and the
resulting pace of reform momentum. The story is not
without risks as higher crude oil prices and capital imports
related to infrastructure spending will pressure the balance
of payments, just as the central bank — known for its
dovishness — embarks on a potentially excessive interestrate-cutting cycle.
Opportunity at the intersection of policy reform,
policy independence, and commodity price
insulation
While investors remain concerned regarding the structural
challenges facing many EM economies — particularly
China — there remain a number of countries offering
compelling top-down opportunities.
We believe those countries that can successfully
implement economic and market reforms, can benefit
from or are less affected by falling commodity prices,
and are less exposed to the risks posed by a tightening
Fed will likely produce positive growth in the near term.
And, because these smaller markets, such as Mexico and
Indonesia, are often less closely followed than countries
that make up a more significant part of the index, such
as China and South Korea, they represent an important
future opportunity for investors.
The key to Indonesia’s reform efforts is that they are
focused on making the country globally competitive.
Jokowi’s raft of stimulus measures includes tax holidays
for key growth industries; plans to liberalize foreign investment for certain sectors, including telecom, power, and
toll roads; and government guarantees for high-priority
infrastructure projects, of which 30 projects representing
US$63 billion — or 7% of GDP — have been earmarked for
the road, rail, power, and oil and gas sectors.
3
This material is prepared for use by institutional investors and
investment professionals, and is provided for limited purposes.
It is not intended as an offer or solicitation for the purchase or sale
of any financial instrument, or any Putnam product or strategy.
References to specific asset classes and financial markets are for
illustrative purposes only and are not intended to be, and should
not be interpreted as, recommendations or investment advice.
The opinions expressed in this article represent the current,
good-faith views of the author(s) at the time of publication. The
views are provided for informational purposes only and are
subject to change. This material does not take into account any
investor’s particular investment objectives, strategies, tax status,
or investment horizon. The views and strategies described herein
may not be suitable for all investors. Investors should consult
a financial advisor for advice suited to their individual financial
needs. Putnam Investments cannot guarantee the accuracy or
completeness of any statements or data contained in the article.
Predictions, opinions, and other information contained in this
article are subject to change. Any forward-looking statements
speak only as of the date they are made, and Putnam assumes no
duty to update them. Forward-looking statements are subject to
numerous assumptions, risks, and uncertainties. Actual results
could differ materially from those anticipated. Past performance
is not a guarantee of future results.
This material is not directed at, or intended for distribution to or use
by, any person or entity that is a citizen or resident of or located in
any jurisdiction where such distribution, publication, availability,
or use would be contrary to applicable law or regulation or would
subject any Putnam company to any registration or licensing
requirement within such jurisdiction. The information is descriptive
of Putnam Investments as a whole and certain services, securities,
and financial instruments described may not be suitable for you or
available in the jurisdiction in which you are located. This material
or any portion hereof may not be reprinted, sold, or redistributed
in whole or in part without the express written consent of Putnam
Investments. The information provided relates to Putnam
Investments and its affiliates, which include The Putnam Advisory
Company, LLC and Putnam Investments Limited®.
Limited is also subject to the limited regulatory supervision of the
German Federal Financial Supervisory Authority (Bundesanstalt
für Finanzdienstleistungsaufsicht - BaFin). Putnam Investments
Limited is also permitted to provide cross-border investment
services to certain EEA member states. In Europe, this material
is directed exclusively at professional clients and eligible
counterparties (as defined under the FCA Rules, or the German
Securities Trading Act (Wertpapierhandelsgesetz) or other
applicable law) who are knowledgeable and experienced in
investment matters. Any investments to which this material relates
are available only to or will be engaged in only with such persons,
and any other persons (including retail clients) should not act or
rely on this material.
This material is prepared by Putnam Investments for use in Japan
by Putnam Investments Securities Co., Ltd. (“PISCO”). PISCO is
registered with Kanto Local Finance Bureau in Japan as a financial
instruments business operator conducting the type 1 financial
instruments business, and is a member of Japan Securities
Dealers Association. This material is prepared for informational
purposes only, and is not meant as investment advice and does
not constitute any offer or solicitation in Japan for the execution
of an investment advisory contract or a discretionary investment
management contract.
Prepared for use with wholesale investors in Australia by Putnam
Investments Australia Pty Limited, ABN,50 105 178 916, AFSL
No. 247032. This material has been prepared without taking
account of an investor’s objectives, financial situation, and needs.
Before deciding to invest, investors should consider whether the
investment is appropriate for them.
Prepared for use in Canada by Putnam Investments Canada ULC
(o/a Putnam Management in Manitoba). Where permitted, advisory
services are provided in Canada by Putnam Investments Canada
ULC (o/a Putnam Management in Manitoba) and its affiliate, The
Putnam Advisory Company, LLC.
Issued in the United Kingdom by Putnam Investments Limited®.
Putnam Investments Limited is authorized and regulated by
the Financial Conduct Authority (FCA). For the activities carried
out in Germany, the German branch of Putnam Investments
For use with institutional investors and investment professionals only. Not for public distribution.
Putnam Investments | One Post Office Square | Boston, MA 02109 | putnam.com
300817 6/16