Morningstar Advisor - October/November 2009 - 51

There’s been a big change in global banking, and emerging-market banks are the big beneficiaries. Emerging-markets banks are demonstrably healthy. They’re almost exactly opposite of what Western banks are. They are in a much better position to support their economy and lend at high margins. Rusty Johnson stretching, if you will. They are in a much better position to support their economy and lend at high margins. It’s very likely that the amount of global capital—particularly the U.S. dollar, which was slopping around at very low interest rates as money chasing lending—has contracted substantially. Global credit will be less available and priced more according to risk. Emerging-market banks that are in strong financial positions are going to be in a much better position to earn decent returns going ahead. Foster: We are paying a lot more attention to the development of the fixed-income markets, especially for corporate issuance in Asia Pacific. The missing link in Asia Pacific has been deep and robust bond markets to efficiently and transparently finance long-term infrastructure projects. The bond market is one of the important developments that people need to pay attention to over the next five and 10 years. For example, the link between demographics and savings rates. Ten years ago, the average saving rates in India was about 8% of GDP. Today, it’s over 30%. It’s the same across all the emerging markets. We’re seeing a much higher proportion of the population moving into their working years, which is very positive for emerging markets and will continue to remain positive for the next 20 to 30 years. In the West, as the baby boomers retire, the demographics are turning sharply worse. The ramifications of this for most emerging markets are huge. Whereas 10 years ago most of them would have had to access foreign capital markets in order to develop, now with the savings rate going up because of this demographic dividend, they have the ability to fund growth domestically. That’s why Andrew’s point about the bond markets becomes quite important. Dutta: Arjun, what about the point Andrew made about currency links breaking down? You do a lot of macroeconomic modeling in deciding your country rates. What kind of evidence have you seen on that front? Divecha: What Andrew said is exactly right. appreciate in real terms relative to the developed currencies as long as the growth rates are higher, and I certainly think you can make the case that growth rates will be higher. That case is strengthened by the fact that emerging markets are now running more independent currency and monetary policies. Foster: The one caveat I put around this discussion is that the dollar casts a huge shadow over the markets, especially in Asia Pacific. Until there’s a surrogate for the dollar to help provide financing for long-term credit in the region, I would expect some shorter-term volatility in the currencies of the region that may not be representative of the unilateral strength in the Asian currencies. There has to be something that helps replace the liquidity that’s currently based in dollar capital markets. Dutta: What are some of the biggest risks in emerging markets that you see looming on the horizon? Johnson: The amount of money China has Alongside that, people should no longer take for granted the currency linkages. Some of the Asian currencies, in particular, have been at least implicitly linked to the dollar. That linkage is no longer going to be a key one going forward. Many of the central banks in the region are acting to create a credit stimulus and manage their own domestic interestrate policies. Over the longer term, that means some of the linkages around currencies will probably break down. Divecha: We’re watching how the role of demographics will play out long term. There has been a gradual process of emerging markets effectively running independent currency and monetary policies, rather than linking themselves to the dollar or to the euro. As a result, we think that the currency of countries that have fast growth will appreciate relative to countries that have slow growth. It’s sort of a Samuelson effect. In the long run, emerging currencies will in fact invested. I go there and find oceans and oceans of empty property and office buildings. They have invested a tremendous amount in fixed assets. I think it could cause a bit of a hiccup. China has the money. Morgan Stanley said in its weekly report that China basically uses its balance-sheet strength to flow its income statement. The amount China has shocked into the system is understandable in a world in crisis, but I’m concerned about how this is going to turn out. If China starts to MorningstarAdvisor.com 51

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Morningstar Advisor - October/November 2009

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