Q&A: Aberdeen Asset Management’s Devan Kaloo’s outlook for emerging markets

Devan Kaloo, head of global emerging markets at Aberdeen Asset Management, offers his current views on the outlook for emerging markets.

How exposed are the emerging markets to the UK and Europe?

In an historic referendum in June, the British electorate voted for a future outside the European Union. Global markets have recovered since the initial shock, but the vote adds to an increasing sense of political and economic uncertainty. As a general rule, the emerging markets are less exposed to the UK and Europe than other asset classes. For example, less than 20 per cent of emerging market exports go to the UK and Europe. That said, this number is closer to 40 per cent for the economies of Eastern Europe. Latin American economies are least affected. The concern with regards to Brexit is whether subsequent events associated with the vote will spark a flight to safety and a further rally in the dollar. A stronger dollar and weaker emerging market currencies may lead to further capital flows out of the emerging markets and affect the performance of dollar-denominated funds.

How will Fed policy affect EM equities?

This is really a question about the direction of US interest rates. For now at least, we think it’s unlikely the Federal Reserve will raise rates this year. The currency market seems to have disregarded recent comments from policymakers that have taken on a more ‘hawkish’ tone. This, of course, could change at any time. The Fed is conflicted over further signs of improvement in the domestic economy and growing uncertainties overseas. US policymakers will be wary of adding to any concerns in financial markets caused by Brexit. With the possibility of a shock result in the US presidential elections this November, the risk of further market volatility damaging the US economic recovery cannot be ruled out. Barring any shocks, ‘lower-for-longer’ US rates should help support EM equities.

Has China finally turned a corner?

Growth seems to be stabilising as some of the measures that the government has taken to support growth are beginning to bear fruit. Domestic consumption remains pretty positive and one area where we’ve seen a pickup is in the property market. Inventory levels are starting to clear and construction activity is up, which is helping with overall economic growth. Investors have taken recent currency weakness in their stride. They are beginning to understand that there are reasons for renminbi weakness, other than devaluation and a race to the bottom. With the renminbi now linked to a trade-weighted basket of 11 currencies, some weakness against the dollar should be expected. Furthermore, the pace of capital outflows is decelerating (because of capital controls). That said, debt levels are still a concern while corporate profitability is declining.

Is Rajan leaving the RBI a blow for reforms in India?

Reserve Bank of India governor Raghuram Rajan announced he will leave in September when his current term ends, dashing any hopes for an extension. There are concerns the departure of the respected but outspoken central banker, a key architect of reforms, may help trigger a new period of uncertainty. There’s no doubt he is a foreign investor favourite who represents stability and competence – a steady pair of hands who stood up against political interference and fought for central bank independence. But reforms have been a team effort and the government has been as important as the central bank in attracting record foreign direct investment, the transition to a positive basic balance of payments and keeping food inflation under control. Meanwhile, a credible Monetary Policy Committee, inflation targeting and the overhaul of bankruptcy rules are principles the government is committed to, thus helping to ensure policy continuity. Individual states are making progress securing land for infrastructure development, even if the politicians cannot agree on new legislation to achieve this at a national level. A separate drive to slash red-tape and boost transparency has led to the creation of one-stop-shop online and mobile portals, as well as simplified registration procedures for starting businesses.

What’s the outlook for EM corporate earnings?

Analysts have been dialling back expectations for corporate earnings in many regions. For example, people are now forecasting negative earnings in Europe, Japan and the UK. However, the outlook continues to be positive for earnings in the emerging markets and the US. From an emerging market perspective, we remain pretty positive about what we’re seeing on the ground with regards to our companies. They are reporting decent results, particularly those companies outside the commodity sector, where we still see some decent margin expansion and growth in earnings denominated in local currencies. So if there isn’t a strong dollar, or the dollar remains flat, there is scope for significant earnings in dollar terms to come through for the year.