The Good, Bad, And Ugly Of Emerging Markets
With Europe now seemingly in exile from even the bravest knife-catcher value-manager, and, despite media protestation, US equities facing weak macro data and a fiscal cliff of epic proportions; it is no surprise that everyone and their mom thinks emerging markets are the place to be. However, as UBS notes today, not all EM balance sheets (whether government, corporate, or private) are the same and they break down the low, medium, and high risk balance sheets across Asia, LatAm, and EMEA.
UBS - Where are EM balance sheets at risk?
Looking at Global Emerging Market (GEM) balance sheets from three angles, government, companies and consumers, we find that in aggregate they look very healthy. Whether we look at public debt, net debt or external debt to GDP, indebtedness of emerging market governments is a lot less than in the developed world. Emerging market government debt has fallen over the past few years, in stark contrast to the rise in public debt we have seen in the West.
A similar pattern is visible at the corporate level. GEM Inc’s balance sheet looks very strong across all the Emerging Markets. A decade of bumper profits has led to a large increase in shareholders’ equity while the financial crisis left GEM CFOs reluctant to assume more debt, despite low yields. The result is a record low net debt to equity ratio of 20%.
It is in private credit where we have seen an increase in indebtedness in the emerging markets. Private credit growth averaged 12% per annum between 2001 and 2011 as private credit as a percentage of GDP increased from 80% to 100%. We believe this credit boom for the most part has supported not undermined growth.
However, aggregate figures hide country-by-country balance sheet strengths and weaknesses. Below we take the emerging market universe and assign a low, medium or high risk rating to each of their government, corporate and private debt characteristics, combining them into an overall balance sheet risk score.
- Low risk. In sum, Indonesia, Malaysia, Philippines, Peru and Russia appear best positioned. Strong balance sheets that support sustainable growth are rewarded by investors by relatively high multiples, in all cases except Russia, where concerns over corporate governance weigh heavily.
- Medium risk. China, South Korea, Taiwan, Thailand, Chile, Colombia, Mexico, Czech Republic, Egypt, Hungary, Poland and South Africa are all medium risk. They display either one area of remarkable weakness, such as consumer credit in Korea and high government indebtedness in EMEA, or are just average in all categories, like Czech Republic.
- High risk. Those countries with have the highest balance sheet risks are Brazil, India, Morocco and Turkey. In the case of Brazil and Turkey, the risk is reflected in cheap valuations.
As is evident in Europe, high debt levels are detrimental to economic growth and equity returns. Solid government accounts generally reward policymakers in such markets with valuable policy flexibility, while healthy consumer balance sheets allow credit growth to be a strong domestic growth driver. In a slow and uncertain global growth environment, pillars to support growth are crucial and are market differentiators - especially if global contagion spreads as we suspect.