Multi-Asset
Emerging Markets
The decade of weak economic progress in many EMs before the
COVID-19 crisis …
… could make recoveries from the pandemic all the more
protracted …
… without significant reforms to boost productivity as well as the
appeal of EM assets
2 June 2020
The good, the bad and the ugly
If emerging markets had been doing well economically before the COVID-19
outbreak hit, we would be more optimistic about their capacity to recover from the pandemic.
But our analysis shows that the years following the Global Financial Crisis were actually a
lost decade for EMs and that the factors that held their economies back then could now weigh
on future economic and market performance in the absence of significant productivity gains
and structural reforms.
EMs’ growth differential with developed markets fell from an average of a year for
2002-07 to after the GFC. We think the blame lies with the sharp decline in the growth
rate of total factor productivity (TFP) – a proxy for economic progress.
After averaging a remarkable growth rate of % for 2002-07, TFP growth came almost to a
halt in 2011-19. In other words, EMs’ efficiency and productivity gains had started to dry up
long before the COVID-19 crisis hit in 2020.
Why? The reasons we identify include the partial reversal of structural reforms, premature
deindustrialisation, weak investments, misallocation of capital as well as a slowdown in
capital flows. We also look at regional trends: Asia stacks up better than LatAm and
CEEMEA with the performances of countries such as Vietnam and India suggesting
promising outlooks going forward.
Our conclusion: EMs need structural as well as fiscal reforms focused on infrastructure,
education, human capital, the labour market and healthcare to rekindle their growth potential
and bring a shine back to the asset class. The growth slowdown induced by COVID-19 has
seen EM assets underperform relative to their developed peers despite the current global
liquidity backdrop and the impact of cyclical monetary and fiscal support on near-term
economic activity. This points to longer term structural issues. Until these are addressed, not
only could many EMs face a more protracted recovery but also EMs are likely to remain a
tactical asset class for many investors – particularly for local currency assets – rather than a
strategic one.
We also include graphs on TFP for individual countries in the Appendix.
Ali Cakiroglu
Emerging Markets Strategist
HSBC Bank plc
alicakiroglu@
+44 20 7991 0547
Dr. Murat Ulgen
Global Head of Emerging Markets Research
HSBC Bank plc
muratulgen@
+44 20 7991 6782
Nicholas Smithie
Senior GEMs Multi-Asset Strategist
HSBC Securities (USA) Inc.
@
+1 212 525 5350
Edward Parker
Analyst
HSBC Bank plc
@
+44 20 3359 7563
Where next after a lost decade?
Global Emerging Markets
mailto:alicakiroglu@
mailto:muratulgen@
mailto:muratulgen@
mailto:@
mailto:@
Disclosures & Disclaimer
This report must be read with the disclosures and the analyst certifications in the
Disclosure appendix, and with the Disclaimer, which forms part of it.
Issuer of report: HSBC Bank plc
View HSBC Global Research at:
The good, the bad and the ugly
The past decade has seen a decline in EM inflation and interest rates
although this came at the expense of a growth slowdown …
… as total factor productivity – the proxy measure for economic
progress – declined, hampered by lack of reforms and investment
Monetary and fiscal expansion may give a short-term boost, but EMs need
structural reforms to rekindle growth and investment appeal
No growth, no reward
Economic activity in most EMs
is likely to contract for the first
time in more than 40 years
Turbulent times. Headlines are changing fast. That said, one thing that is unlikely to change in the near
term is the severe slowdown in global economic activity. The world economy in 2020 is heading to a
much deeper recession than that seen in the Global Financial Crisis (GFC), and this time, emerging
markets as a whole are likely to join the club as economic activity is contracting swiftly (except for a few
markets such as mainland China, South Korea and Vietnam). This would be the first collective EM
recession in more than 40 years, according to IMF data (Chart 1).
The bleak growth outlook does not bode well for EMs as an asset class. At the end of the day, it is the
growth and EMs’ growth increment over that of developed markets (DMs) that drives returns and
(out)performance vis-à-vis DMs in the long run. We have previously done a detailed analysis on EM
growth and capital flow drivers, which showed that there was a strong relationship between growth,
financial asset returns and flows into EMs1.
1. Most emerging market economies are likely to face their first collective recession in more than
40 years, according to the IMF data
9
6
3
0
-3
-6
-9
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20
DM GDP (y-o-y %) EM GDP (y-o-y %)
Source: IMF, HSBC
1 Global Emerging Markets: No growth, no return, 13 March 2020
The EM growth shine had
been fading for the past
decade
EM local currency assets
underperformed significantly
during that period …
… despite the marked
improvement in the inflation
outlook
As a matter of fact, the EM growth shine had been fading for the past decade. Despite a very supportive
global liquidity backdrop following the GFC, the growth rate for EMs declined from an average of %
for 2002-07, the last time when there was synchronised global recovery, to only % for 2011-19.
Moreover, EMs’ growth differential with DMs came down from an average of to for the
same periods.
This has led to a significant underperformance of EM local currency assets, particularly EM equities. EM
equities underperformed their developed peers significantly in the aftermath of the GFC on the back of the
growth slowdown. Indeed, in the past decade, the only consecutive period in which EM equities did better
than DM equities was 2016-17 when EM economic activity was accelerating and the EM-DM growth
differential was widening in EMs’ favour. There was also an outperformance in the last quarter of 2019,
thanks to some preliminary signs of a stabilisation in EM economic activity amid rising worries on DM
growth, particularly for the US due to Fed’s monetary policy stance back then2.
Moreover, despite the marked improvement in the inflation outlook, which we have discussed in detail
previously,3 EM local currency debt (LCD) has also underperformed in USD terms as the gains from yield
compression (of more than 200bps) were offset by the FX that weakened nearly 50% in nominal terms
(c15% in real terms once pegged currencies are excluded) since 2010.
Meanwhile, EM hard currency debt (EXD) performed remarkably well over the past decade and
significantly outperformed EM LCD returns. This was compounded by a strong appetite for this sub-asset
class particularly after the second half 2018 when the USD bounce accelerated on the back of Fed rate
hikes4. This was something we have been highlighting in our efficient frontier studies5 (Charts 2 -5).
The rest of this report looks at the drivers of the EM slowdown over the past decade with a particular
focus on the total factor productivity, a proxy for economic progress. The report also discusses the
consequences of this slowdown, which include a decline in inflation, EM underperformance as well as a
stall in the income convergence with DMs.
2. EM equities have underperformed their
developed peers significantly …
3. … so has EM local currency government
debt
110
100
90
80
70
60
50
10 11 12 13 14 15 16 17 18 19
20
120
110
100
90
80
70
10 11 12 13 14 15 16 17 18 19 20
FTSE EM (relative to FTSE World, 2010=100) EM LCD in USD (relative to DM bonds, 2010=100)
Source: Bloomberg, HSBC Source: Bloomberg, Refinitiv Datastream, HSBC
2 GEMs Investor: 2020 vision partly cloudy, 10 October 2019
3 GEMs Investor: Emerging Markets in 2020: Sweet and sour, 15 January 2020 4
Currency Outlook: The greenback is back, 10 May 2018
5 Global Emerging Markets: Contagion fears, efficient frontiers, 18 September 2018
4. EM local currency assets significantly
underperformed due to weaker EM FX …
140
130
120
110
100
90
80
70
5. … while EM hard currency debt was
strong and broadly outperformed both
LCD and DM bond returns
200
180
160
140
120
100
80
10 11 12 13 14 15 16 17 18 19 20
60
10 11 12 13 14 15 16 17 18 19 20 EM EXD (2010=100)EM LCD (in USD, 2010=100) FTSE EM (2010=100)
EM LCD (in USD, 2010=100)
Source: Bloomberg, Refinitiv Datastream, HSBC Source: Bloomberg, Refinitiv Datastream, HSBC
The golden years
During the 2000s, EMs were at
full throttle, thanks to very
strong TFP contributions
EM TFP growth for 2002-07
was five times faster than for
DMs
During the 2000s, up until the GFC, EMs were at full throttle; economic activity was expanding rapidly
and EMs’ growth differential with DMs was widening in EMs; favour. The strong growth
(out)performance was largely led by a remarkable improvement in total factor productivity (TFP)
– the ‘crucial’ residual (or the ‘X-factor’) that helps boost living standards, which we will discuss in
detail in the succeeding sections of this report.
Indeed, TFP growth for EMs averaged % for 2002-07, the last period when there was synchronised growth in
the global economy (Chart 6). This was five times higher than that of DMs and was led by the structural reforms
(trade liberalisation, financial services, etc.) of the late 1990s as well as the early 2000s in addition to the
globalisation wave that paved the way for strong capital inflows (foreign direct investments, or FDI) and a pickup
in gross fixed capital formation.
6. EM total factor productivity grew rapidly in 2002-07 thanks to structural reforms as well as the
globalisation wave
4
3
2
1
0
-1
-2
-3
1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019
DM TFP (%) EM TFP (%)
Source: Penn World Tables , HSBC calculations, Conference Board
DM bonds
(2010=100)
7. EMs’ share in global trade surged from
25% in 2000 to about 36% as of 2008
8. Strong foreign trade also led to a pickup in
investments during that period
45
40
35
30
25
20
15
90 92 94 96 98 00 02 04 06 08 10 12 14
16 18
16
14
12
10
8
6
4
2
0
01 03 05
07
09 11 13 15 17
19
25
20
15
10
5
0
-5
-10
-15
EM GFCF (y/y, %)
EM share in global trade (% of total) EM real exports (y/y %, RHS)
Source: Refinitiv Datastream, HSBC Source: Refinitiv Datastream, CPB, HSBC
Mainland China’s participation to
the WTO from end-2001 had a
boosting effect on EM economic
activity
However, EM outlook started to
deteriorate in the aftermath of
the GFC
Moreover, expanding global trade, following mainland China’s participation to the World Trade
Organisation (WTO) from end-2001, also had a boosting effect on EM economic activity through rising
exports and improvements in global supply chains as well as a remarkable pickup in gross fixed capital
formation. Indeed, EMs’ share in global trade surged from 25% at the turn of the millennium to about 36%
of the total in 2008 (Chart 7). This led to a sharp pickup in investments with the pace of growth in gross
fixed capital formation averaging % over 2001-08 (Chart 8).
However, the vibrant outlook for EMs started to deteriorate in the aftermath of the GFC with growth
coming down from an average of % over 2002-07 to % in the past decade of 2011-
19. Moreover, the slowdown was across the board for all regions although the pace was relatively more
pronounced for the commodity producing LatAm and CEEMEA regions (Chart 9).
In LatAm, for instance, the average growth rate for 2011-19 was only % compared with % for 2002-
07. Part of the severe slowdown in the region was due to Brazil, which was in a deep recession for the two
consecutive years of 2015 and 2016 given the deterioration in the political landscape that also had a
negative impact on business confidence and investments.
In CEEMEA, growth declined from % in 2002-07 to % in the post-GFC period, with a significant
slowdown in the likes of Russia and South Africa. In the former, it was the rise in geopolitical risks along
with less supportive commodity prices that led to the slowdown while in the latter, it was the structural
headwinds as well as the political difficulties.
9. EM slowdown was across the board for all regions
Asia (%) CEEMEA (%) LatAm (%) EM (%)
02-07 11-19
Source: Refinitiv Datastream, IMF, HSBC
Growth slowed down in Asia, too
but remained remarkable in
comparison
Meanwhile, growth also slowed in Asia although from an average of % for 2002-07 to a still
remarkable % for 2011-19 thanks to countries like the Philippines and Indonesia where growth
accelerated or remained broadly stable at a respectable level. That said, in two major Asian economies,
namely mainland China and Korea, the average growth rates declined from % and % for 2002-07
to % and % for 2011-19, respectively6.
Drivers of the growth slowdown
Part of the slowdown is the
legacy of the GFC, followed by
European debt crisis
It is true that part of the slowdown in EMs was related to the legacy of the GFC, which was followed by
the European sovereign debt crisis. Despite the unprecedented monetary stimulus by core central banks,
aggregate global demand remained relatively poor compared with the pre-GFC period. As a result of the
subdued global demand, growth in global trade has more than halved in real terms while commodity prices have
remained broadly weak (Charts 10 and 11).
Moreover, the unconventional monetary policies in the form of low if not negative rates and asset
purchase programmes by core central banks (US Federal Reserve, European Central Bank, Bank of
England and Bank of Japan) also triggered a sharp rise in EM leverage, particularly in the non-
financial corporate (NFC) sector (Chart 12).
10. Global trade has slowed considerably 11. Commodity prices were also not
supportive for EMs
140
130
120
110
100
90
80
70
60
01 03 05 07 09 11 13 15 17
19
Global trade
(2010=100) y-o-y %
(RHS)
20
15
10
5
0
-5
-
10
-
15
-
20
62
0
56
0
50
0
44
0
38
0
32
0
26
0
20
0
01 03 05 07 09 11 13 15 17 19
CRB commodity index y/y %
(RHS)
48
36
24
12
0
-12
-24
-36
Source: Bloomberg, CPB, HSBC Source: Bloomberg, HSBC
EM growth came down from an average of % for 2002-07 to
% in the past decade (2011-19)
6 For a comparison of country specific and regional growth rates please, see Appendix at the end of the report.
12. Change in debt (as % of GDP) since 2008 has been most pronounced for mainland China,
UAE and Chile
120
100
80
60
40
20
0
-20
-40
Source: IIF, HSBC
Household NFC Gov't
Total EM debt surged to
185% of GDP in 2019
The core reason for the EM
slowdown has been falling
TFP, in our view
Indeed, total debt (excluding the financial system) rose from c130% of EM GDP at the end of 2008 to
185% of GDP in 2019, reaching a hefty USD60trn. The increase was most pronounced in the NFC
sector, which saw its debt surging more than 20ppt to 92% of GDP () in 2019 and which led
to a rise in debt servicing costs (Charts 13 and 14). Household debt also rose significantly from % of
GDP at end-2008 to 40% () at end-2019.
However, blaming only the external backdrop would be misleading as there was also deterioration in the
domestic backdrops on increasing geopolitical risks (CEEMEA) and unsustainable fiscal policies
(LatAm). But most importantly, there was a sharp slowdown in total factor productivity, which we believe
was the core reason behind the anaemic EM growth performance for the past decade.
13. NFC debt rose significantly, led by the
supportive global liquidity backdrop …
14. … leading to a rise in debt servicing
costs despite falling policy rates
EM debt servicing cost (%)
Source: IIF, HSBC Source: BIS, Refinitiv Datastream, HSBC
C
N Y
A
E D
C
L
P
K
R W
B
R
L
M
Y R
A
R
S
TH
B
ZA
R
C
O
P
TR Y
M
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SA
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U B
PH
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PL
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F
100 35 9
90
28
8
80
21
7
14 6
70
7
5
60
0
6
08 10 12 14 16 18
Non-financial corporate debt (% of
GDP)
Non-financial corporate debt (USDtrn,
RHS)
0
06 0
8
10 12 14 16 18
EM policy rate (%, RHS)
2
0
4
Total factor productivity: once a ‘hero’ turned to ‘zero’
TFP is the ‘crucial residual’
that helps economies boost
living standards
TFP slowdown was most
pronounced in CEEMEA, but it
was LatAm where it turned
negative
Total factor productivity (TFP) can be defined as the residual in a growth equation that is based on the
factors of production, namely capital and labour7. It is considered to be the ‘X-factor’ or the ‘crucial
residual’ that helps economies boost their living standards as well as increase income levels. Moreover,
given the diminishing returns of capital and labour, academic literature suggests that TFP is the most
important driver of potential growth in the long term.
Using the data from Penn World Tables (PWT) 8, we have calculated total factor productivity growth
for the countries in our coverage.
Our calculations show that after averaging a remarkable % for 2002-07, TFP declined
significantly following the GFC, posting only % growth for 2011-19.
only %
Average EM TFP growth for 2011-19
Regional data, moreover, suggest that the slowdown in TFP was across the board although it was the
most pronounced in CEEMEA, down from % to only %. That said, it was in LatAm where TFP
growth turned negative, averaging % for 2011-19 (down from % for 2002-07). Meanwhile in Asia,
average TFP growth came down to a still sizeable % for 2011- 19 from % for 2002-07, according
to our calculations (Chart 15)9.
15. TFP growth has declined significantly over the past decade
4
3
2
1
0
-1
-2
LatAm Asia CEEMEA EM
91-00 (average, %) 02-07 (average, %) 11-19 (average, %)
Note: Based on PPP weighted averages for the countries in our
coverage Source: Penn World Tables , HSBC calculations
7 This growth equation is generally known as the Cobb-Douglas production function, widely used to represent the
technological relationship between the amounts of two or more inputs (particularly physical capital and labour) and the amount of
output that can be produced by those inputs.
8 The Penn World Table is a set of national accounts data developed and maintained by scholars at the University of California
and the Groningen Growth Development Centre of the University of Groningen to measure real GDP across countries and over
time
9 For country-specific TFP data, please see Appendix 1
-
Vietnam is the only country
that actually saw improvement
in TFP growth
TFP growth in India remained
relatively stable at about %
for 2011-19
Russia saw the steepest
slowdown in TFP growth in
CEEMEA region
In LatAm, the Mexican TFP
rate was rather stable but
remained negative
Outperformers and underperformers
Although the slowdown in TFP growth was across the board for all regions, country-specific data
reveal some interesting trends10 (Chart 16).
On the brighter side, TFP growth remained positive for all Asian economies for 2011-19 although the
pace declined from 2002-07, according to our calculations. That said, one Asian country actually saw
improvement compared with 2002-07 – Vietnam11.
Indeed, in Vietnam, the TFP growth rate rose from an average of % for 2002-07 to % for 2011-19,
according to our calculations. This was led by the sharp increase in flows for foreign direct investment
(FDI) as the country increased its share in global supply chains as well as saw a rise in the share of
employment in the manufacturing sector at the expense of the agriculture sector. Moreover, declining
credit to state-owned enterprises along with a pickup in private investment also helped the recovery in
There has been an improvement in human capital, too, which is part of the TFP calculations in our
exercise, thanks to the government’s increasing efforts towards a better education system.
TFP growth in India remained relatively stable at a rate of about % for the 2011-19. In our view, this to a
large extent can be explained by the lagged impacts of the structural reforms in the public and financial
sectors, the government’s digitisation efforts and improvement in capital .
In CEEMEA, Russia saw the steepest slowdown in TFP growth followed by South Africa. These were
also the two economies that experienced the sharpest growth slowdowns. TFP growth remained positive
for CE-3 economies (Hungary, Poland and Czech). In CE-3, the positive TFP growth might be
attributable to increasing FDI flows from the European economies as well as from infrastructure
investments that were largely financed by structural EU funds.
In LatAm, the Mexican TFP growth rate was rather stable but remained in negative territory for 2011-19,
based on our calculations. This can be partly explained by the misallocation or less productive use of
capital. On a separate note, the sharpest declines in TFP growth were seen in Peru and Colombia, two
economies highly exposed to commodity price cycles.
16. Country-specific data reveal that TFP growth rates accelerated in Vietnam, remained stable in
Mexico and India and fell in Russia
8
6
4
2
0
-2
TFP growth (2002-2007 average, %) TFP growth (2011-2019 average, %)
Source: Penn World Tables , HSBC calculations
10 We have applied the same methodology in the Appendix for all EMs; TFP estimates may differ from regional or country-
specific estimates
11 For country-specific TFP charts, see Appendix 12
IMF Country Report: Vietnam,
13 India: Reform and grow, 15 May 2019
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What led to the fall in TFP growth?
Despite short-term costs,
structural reforms have a
significant positive impact on
growth and TFP
The slowdown in TFP growth can be traced back to the following, in our view, although we note that this
list is not exclusive:
Stall in structural reforms: The economic literature suggests that despite the short-term costs on
economic activity, structural reforms have a significant positive impact on growth and total factor
productivity in the medium to long A World Bank study shows that structural reform spurts can
lead up to a cumulative increase in potential TFP growth in four years. The same study reveals that
the impact of reform setbacks materialises faster with a cumulative impact of about in two
There was a significant reform push in many large EM economies during late 1990s and early 2000s.
These reforms helped EMs to upgrade their modus operandi by reducing barriers to efficient investment,
employment, product and services trade, and innovations as well as reducing the obstacles to doing
business, which led to the productivity gains seen until the GFC.
However, the positive reform trend in EMs stalled (likely on increasing political uncertainty and a switch
towards populist policies in many large EM economies) following the GFC (Chart 17),
which also had an impact on growth and economic activity. A World Bank paper from 2015, for
Positive reform trends in EMs
stalled following the GFC
instance, suggests that domestic structural impediments contributed to the slowdown in productivity in
many EMs, particularly in Brazil, Russia and mainland China in Moreover, the authors argue
that about one-third of the growth slowdown since 2010 was due to the fall in potential growth, half of
which was attributed to declining TFP growth.
Premature deindustrialisation: Deindustrialisation is the decline in the relative size of the industrial
sector in an economy. As countries mature and incomes rise, the shares of industry in gross value added
as well as employment get smaller while the shares of services pick up. This is a natural result of the
development process; hence, maturing economies naturally slow as productivity in manufacturing is
generally higher than in
17. Structural reforms stalled in many large EM economies following the GFC
2
1
0
-1
-2
-3
2006 2007 2008 2009 2010 2011 2012 2013 2014
Fiscal reforms Financial reforms Trade reforms
Real sector reforms Aggregate reform index
Note: The index is based on normalised values (Z-scores) using the total number of successful structural reforms in the country from the IMF
MONA database Source: Kouame W., Tapsoba S. (March 2018), “Structural Reforms and Firms’ Productivity: Evidence from Developing
Countries”, Ferdi Working Paper 216
14 Salgado R. (January 2002), "Impact of Structural Reforms on Productivity Growth in Industrial Countries", IMF Working Paper,
WP/02/10
15 World Bank Global Economic Prospects, Box , January 2018
16 Didier, T., M. A. Kose, F. Ohnsorge and L. S. Ye. 2015. “Slowdown in Emerging Markets: Rough Patch or Prolonged
Weakness?", World Bank Policy Research Note 15/4
17 Rowthorn R. and Ramaswamy R. (September 1997), "Deindustrialization - Its Causes and Implications", IMF, Economic Issues 10
The share of manufacturing in
gross value added has been
coming down to the benefit of
services
Premature deindustrialisation, however, can be defined as the falling share of manufacturing activity even
before the maturation of these sectors. This means that the countries are running out of industrialisation
(towards services) sooner and at much lower levels of income compared with the experiences of early
industrialisers18. This can lead to stagnation and even a fall in total factor productivity given that
productivity growth in the manufacturing sector is higher than that of services. Moreover, it can also cause
a deterioration in living standards.
There have been a lot of studies in recent years that suggest premature deindustrialisation has taken place
in many large EM economies. A recent study focusing on deindustrialisation trends in LatAm economies,
for instance, argues that Argentina, Brazil and Chile face premature deindustrialisation, swiftly increasing
their specialisation in commodities, resource-based manufacturers and low productivity
This is not only the case in LatAm economies. The share of manufacturing in gross value added has been
coming down in almost all countries since the early 2000s to the benefit of services (Chart 18). Moreover,
manufacturing employment has also been declining for some time, causing a drag in TFP given the strong
correlation between the two (Chart 19).
18. The share of manufacturing sector in
gross value added has declined to the benefit
of services in EM
19. Declining share of manufacturing
employment in EM seems to be one of the
reasons for lower TFP growth
5
6
5
5
5
4
5
3
5
2
5
1
5
0
04 06 08 10 12 14 16 18
0
92 94 96 98 00 02 04 06 08 10 12 14
16 18
0
Manufacturing (% of total)
Services (% of total, RHS)
Share of manufacturing in employment (y-o-y chg.)
TFP growth (%, RHS)
Source: World Bank, Refinitiv Datastream, HSBC Source: ILO, HSBC calculations
Fixed investments saw a sharp
decline in 2011-19 but
remained strong in Asia
Bleak investment growth: Weak global trade along with the deceleration in capital flows and the legacy
of past excess capacity led to a sharp slowdown in EM investments after the GFC. Indeed, gross fixed
capital formation (GFCF) growth in EMs has been on a declining trend pretty much since 2010, coming
off a post-GFC peak of % in 2010 to % only in 2019.
All regions have seen a deceleration in gross fixed capital formation although the slowdowns have been
relatively more pronounced for LatAm and CEEMEA – the two regions that are also exposed to the
fluctuations in commodity prices. In LatAm, the pace of gross fixed capital formation has declined from
an average of % for 2002-07 to only % for 2011-19. In CEEMEA, moreover, investment growth
averaged % for 2011-19, down from a remarkable % for 2002-07. There was also a decline in
Asia’s gross fixed capital formation (GFCF) although growth still remained relatively strong, averaging
% for 2011-19.
Gross fixed capital formation is generally associated with technical improvements that also lead to
advances in efficiency and productivity. This implies that there is a positive feedback loop between gross
fixed capital formation and TFP (Chart 20).
18 Rodrik D. (February 2015), "Premature Industrialization", NBER Working Paper
19 Castillo M., and Neto ., 2016, "Premature deindustrialization in Latin America", United Nations WP series
Credit growth
FCI
*
20. Gross fixed capital formation (GFCF) has declined noticeably compared with pre-GFC period
20
15
10
5
0
-5
-10
-15
-20
01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19
LatAm (y/y, %) Asia (y/y, %) CEEMEA (y/y, %) EM GFCF (y/y, %)
Source: Refinitiv Datastream, HSBC
The increase in leverage has
failed to transform into
productive investments
Misallocation or less productive use of capital: The side effect of the unconventional monetary policies
was the sharp increase in EM borrowing. The increase in leverage, however, failed to transform into
productive investments in most cases that would help to improve growth given that overall financial
conditions were not as supportive as they were before the GFC (Charts 21 and 22).
Instead, there are many cases in which debt was used either 1) to finance consumption or (2) in less
productive sectors, such as construction, real estate, mining, or 3) to cover short-term working capital
requirements.
21. Financial conditions were not always
supportive over the last decade…
22. …which had an impact on the appetite to
invest
08 09 10 11 12 13 14 15 16 17 18
19
12
10
8
6
4
2
0
10 11 12 13 14 15 16 17 18 19 20
REER EMBI FCI (3Q forward)
Equity LCY returns EM gross fixed capital formation (y/y %, RHS)
Note: *Financial conditions index
(normalised) Source: HSBC calculations
Source: HSBC, Refinitiv Datastream
Mainland China and Turkey have seen a surge in non-financial corporate sector debt (Chart 23). The rise
in mainland China was mostly related with the state-owned enterprises although the higher borrowing of
these companies has led to some extent to a crowding-out effect of more productive private sector
borrowing. In Turkey, there was an increase in borrowing from energy, construction and services sectors,
which are considered to be relatively less productive compared with the manufacturing sector. Indeed, the
services sector’s long-term external borrowing rose significantly over the past decade, reaching USD66bn
or 64% of the total NFC borrowing as of Q1 2020 from USD40bn or 52% of the total NFC borrowing at
end-2010.
The rise in borrowing
led to deterioration in the net
international investment
positions in some EMs
FDI allows the recipient
countries to benefit from
technology spillovers
Meanwhile, the sharp increase in borrowing also led to a deterioration in the net international
investment positions (NIIP) in some EMs. In Chile, Mexico and Turkey, the NIIP deteriorated
considerably between 2008 and 2017-18 followed by some improvement over the past few years. In
Chile and Mexico, the deterioration is largely related to the increasing foreign direct investments into
the resource-based sectors, such as mining, which have been impacted negatively from the deterioration
in commodity prices. In Turkey, however, the worsening of NIIP was led by a rise in external liabilities
due to increasing corporate sector debt (Chart 24).
Slowdown in foreign direct investments: The economic literature suggest that foreign direct
investments are one of the catalysts for economic activity in EM as these not only help to cover the
savings-investment gaps, but also they allow the recipient countries to benefit from the technology
spillovers that lead to improvements in total factor productivity.
A recent study focusing on OECD countries reveals that there is a statistically significant positive
relationship between FDI and TFP with the impact ranging from % to % once other factors are
controlled Meanwhile, our analysis also implies a statistically significant relationship between FDI
and TFP with a lag of up to two years. Based on our calculations every 1ppt change in the FDI flows to
the GDP ratio leads to improvements in TFP growth in the range once country-specific factors
are controlled for.
23. Increases in non-financial corporate debt
(% of GDP) have not led to pickups in
investments
24. Less productive use of capital is also part
of the reason for deterioration in NIIP (% of
GDP) in some EM economies
170 80
160 70
150
140 60
130 50
120 40
110
100 30
90 20
06 07 08 09 10 11 12 13 14 15 16 17 18 19
-
20
-
25
-
30
-
35
-
40
-
45
-
50
-
55
-
60
03 05 07 09 11 13 15 17
19
5
0
-5
-10
-15
-20
-25
-30
-35
China (NFC debt, % of GDP)
Turkey (NFC debt, % of GDP,
RHS)
Turkey Mexico Chile (RHS)
Source: CBRT, HSBC Source: IMF, Bloomberg, HSBC
FDI flows have been on a
structural downtrend pretty
much since the GFC
FDI flows into EMs have been on a structural downtrend pretty much since the GFC21, and at % of
EM GDP, 2019 had the slowest FDI flows since 1995 (Chart 25). Moreover, according to the UNCTAD
World Investment Report for 2018, there has been a consistent decline in the inward FDI ‘rates of
return’ for EMs, suggesting that not only cyclical factors but also structural factors might be at work
(Chart 26).
Apart from these, demographic trends might also be responsible for the TFP growth slowdown,
particularly when looked from the production side of the growth equation. The growth rate of the working
age population has been on the decline pretty much since the GFC, and the share of the working age
population has already peaked in some of the large economies like mainland China, Korea, Russia and
20 Pietrucha J. and Zelazny R. (July 2019), "TFP spillover effects via trade and FDI channels", Economic Research-
Ekonomska Istraživanja
21 GEMs capital flows: Already bleak and still weak, 5 June 2019
22 The demographic divide: Which emerging markets will grow old before they get rich?, 4 May 2016
25. Non-resident capital flows into EM
have been declining, led by FDI…
91 93 95 97 99 01 03 05 07 09 11 13 15
17 19
Non-resident capital flows (% of GDP)
FDI (% of GDP, RHS)
4.
2
3.
5
2.
8
2.
1
1.
4
0.
7
0.
0
26. …as the FDI rates of return have been
falling
12 13 14 15 16 17 18
Inward FDI rates of return in EM (%)
Source: IIF, HSBC Source: UNCTAD, HSBC
Demographic developments
could have mixed impact on
TFP
Slower growth has led to
lower inflation and interest
rates
The slowing growth of the working age population should theoretically mean reduced growth in labour
inputs as well as lower innovation, productivity growth and savings. A study from 2015, for instance,
argued that demographic factors were predicted to depress average annual long- term GDP growth for
2010-19 by % in the sample of OECD countries. Moreover, the study found a positive correlation
between patent applications and age structures in
The impact of 1ppt change in FDI on TFP growth
On the flip side, one could also argue that better demographics might also attract capital and push out the
supply frontier eventually, which could increase potential growth rates. Our colleagues from the Global
Economics team have written extensively on the potential impact of the demographic trends on
Consequences of the growth slowdown
The good…
There was one major positive consequence from the EM growth slowdown in the aftermath of GFC: the
decline in EM inflation and falling interest rates. EM inflation has fallen almost precipitously over the
past decade with core CPI coming down from about % at the beginning of 2011 to the lowest level
ever of % most recently (Charts 27 and 28). This also led the way for aggressive monetary policy
easing with policy rates in EM falling to their lowest levels ever in most of the countries in our
coverage25 (Chart 29).
23 Aksoy, Y., H. S. Basso, T. Grasl, and R. P. Smith. 2015. “Demographic Structure and Macroeconomic Trends”, Banco
de Espana Working Paper No: 1528
24 The rise of the digital natives: What demographic shifts mean for consumption, September 2016 25 GEMs
Investor: Emerging Markets in 2020: Sweet and sour, 15 January 2020
E
G P
TR Y
U
A H
M
X N
R
U B
V
N D
ID
R
IN
R
C
N Y
ZA
R
C
O
P
B
R
L
PH
P
M
Y R
R
O N
TW
D
H
U F
C
L
P
K
R W
TH
B
SA
R
PE
N
C
Z K
IL
S
PL
N
L
at
A
m
A
si
a C
E
E
M
E
A
E M
27. Both headline… 28. …and core inflation has declined over the
past decade
8 10
7 9
6 8
7
5
6
4 5
3 4
2 3
09 10 11 12 13 14 15 16 17 18 19 20
EM CPI (y/y %)*
EM ex-mainland China CPI (y/y %, RHS)
6.
0
5.
5
5.
0
4.
5
4.
0
3.
5
3.
0
2.
5
2.
0
9
8
7
6
5
4
3
09 10 11 12 13 14 15 16 17 18 19 20
EM core CPI (y/y %)*
EM ex-mainland China core CPI (y/y %, RHS)
Note: *PPP weighted average of Brazil, mainland China, India, Indonesia,
Mexico, Poland, Russia, South Africa and Turkey.
Source: Refinitiv Datastream, Bloomberg, HSBC
Note: *PPP-weighted average of Brazil, mainland China, India, Indonesia,
Mexico, Poland, Russia, South Africa and Turkey.
Source: Refinitiv Datastream, Bloomberg, HSBC
29. Policy rates in EM broadly at their lowest levels ever
32
28
24
20
16
12
8
4
0
-4
Nominal policy rate range since 2008 (%) Latest (%)
Source: Refinitiv Datastream, HSBC
EM local currency assets
have underperformed
significantly
… the bad …
The lack of growth in EMs along with the narrowing growth differential with DMs led to a significant
underperformance of EM local currency assets despite the broadly supportive global liquidity backdrop.
EM equities have underperformed their developed peers by nearly 50% since 2011 (Chart 30).
Meanwhile, although local currency debt performed significantly well in local currency terms, thanks to
declining inflation and lower interest rates, their returns in USD terms have underperformed the World
Government Bond Index (WGBI). EM hard currency debt, on the other hand, has been resilient given that
this asset class does not have the FX component. This was something we have been highlighting in our
efficient frontier studies26 (Chart 31).
Our analysis also suggests that there is a relatively strong lagged correlation (of (x)) between TFP
growth and EM FX with EM FX being a leading indicator of up to 1-year.
26 Global Emerging Markets: Contagion fears, efficient frontiers, 18 September 2018
30. EM equities have underperformed their
developed peers…
31. …so have local currency bonds on the
back of weaker EM FX
200
175
150
125
100
75
50
10 11 12 13 14 15 16 17 18 19
20
FTSE EM (2010=100)
FTSE World (2010=100)
220
200
180
160
140
120
100
80
10 11 12 13 14 15 16 17 18 19
20
EM EXD (2010=100)
EM LCD (in USD, 2010=100)
DM bonds (2010=100)
EM LCD (2010=100)
Source: Bloomberg, HSBC Source: Refinitiv Datastream, Bloomberg, HSBC
The same is also true for EM equities relative to the world with a similarly correlation coefficient of
(x) (Charts 32 and 33). There also seems to be a lagged correlation between the EM-DM growth
differential and EM FX as well as the relative performance of EM equities. However, these are not as
strong as TFP growth.
There is a strong lagged
correlation between TFP
growth and EM FX
Correlation coefficient between EM FX and EM TFP growth
32. EM FX is strongly correlated with
lagged TFP growth…
18
12
6
0
-6
-12
00 02 04 06 08 10 12 14 16
18
-
-
33. …and so is EM equities relative to
world
40 4
30 3
20 2
10
1
0
-10
0
-20 -1
-30 -2
-40 -3
94 96 98 00 02 04 06 08 10 12 14 16 18
EM equities (relative to World, %)
EM FX (y/y %) TFP (1-y lagged %,
RHS)
TFP (1-y lagged %, RHS)
Source: Refinitiv Datastream, Bloomberg, HSBC calculations Source: Bloomberg, HSBC calculations
Income convergence of EM
has stalled
…and the ugly
The growth slowdown along with the sharp decline in the total factor productivity have led to a
significant weakening of FX. EM currencies have depreciated nearly 50% since end-2010 (c15% in real
terms once pegged currencies are excluded), which has resulted in a drop in USD-denominated GDP
growth rates. Indeed, annual growth in nominal USD GDP declined from an average of % for
2002-07 to only % for 2011-19. This also led to a halt in the income per capita convergence of EM
with developed countries (Charts 34 and 35).
34. Weakness in EM FX have led to a decline in
USD denominated GDP growth…
35. …also leading to a stall in income
convergence of EM
25
20
15
10
5
0
-5
-10
00 02 04 06 08 10 12 14 16
18
35,00
0
30,00
0
25,00
0
20,00
0
15,00
0
10,00
0
5,000
0
2
1
0
9
8
7
6
98 00 02 04 06 08 10 12 14 16 18
EM GDP (y/y %) EM GDP (USD trn, RHS) EM GDP per capita relaitve to US (%, 2011 prices)
Source: IMF, HSBC Source: IMF, HSBC
Conclusion: EMs need growth and productivity to shine again
The aftermath of GFC was
not particularly bright for
EMs in terms of growth
EMs need structural reforms to
rekindle growth potential and
bring the shine back as an asset
class
The aftermath of the GFC was not particularly bright for EM. There was a sharp slowdown in
economic activity with growth averaging % for 2011-19, down from % for 2002-07, the last
period of synchronised growth in global activity. Moreover, EMs’ growth differential with DMs came
down from an average of to for the same periods.
It is true that part of the growth slowdown was due to the legacy of the GFC, which was followed by the
European sovereign debt crisis. However, it was the sharp decline in total factor productivity (TFP) – the
crucial residual in the growth function – that was responsible for the weakness in economic activity. After
averaging a remarkable % growth rate for 2002-07, TFP growth slowed down significantly to only
% for 2011-19.
There are a few reasons for the deterioration in TFP. These include the partial reversal of structural
reforms, premature deindustrialisation, weak investments, misallocation or less productive use of
capital, and a slowdown in capital flows.
Despite the current global liquidity backdrop, the COVID-19-induced growth slowdown has already led
to an underperformance of EM assets relative to developed world peers, which in our view also reflects
the structural weaknesses as captured by the disappearance of TFP. It is likely that the current cyclical
monetary and fiscal policy support will help economic activity in the near term. However, these likely
will not lead to an improvement in EMs’ growth potential, which is being largely driven by TFP.
Indeed, we believe EMs need structural as well as fiscal reforms, focusing on infrastructure, education,
human capital, the labour market and healthcare, to rekindle their growth potential and bring the shine
back as an asset class. But in the absence of these reforms, not only could many EMs face a more
protracted recovery but they are also likely to remain a tactical asset class for many investors – particularly
for local currency assets – rather than a strategic one.
Appendix
Total factor productivity
We followed a similar methodology to IMF estimations for supply-side decomposition of growth and
estimation of potential growth (Emerging Markets in Transition: Growth prospects and Challenges,
IMF, June 2014). We used the Penn World tables from 1950 to 2018 for historical data.
We derived potential growth from the standard Cobb-Douglas production function: Yt = At
Kt (Lt) (1-) (1)
where Yt : GDP for year t; At : total factor productivity (TPF) for year t; Kt : capital stock for year t; Lt :
employed labour force for year t.
We assumed the capital share of output () to be , in line with the existing literature on
potential growth calculations
Then, we derive the TFP growth rate from (1) -denoted by lower cases- as follows: a = y -
k - (1-)l (2)
The table below compares the drivers of growth based on the above equation.
Drivers of EM growth
2002-2007 (period average, y-o-y %) 2011-2019 (period averages, y-o-y %)
GDP TFP Capital
stock
Employment GDP TFP Capital stock Employmen
t
Argentina
Brazil
Chile
Mainland China
Colombia
Czech Republic
Egypt
Greece
Hungary
India
Indonesia
Israel
Korea
Malaysia
Mexico
Peru
Philippines
Poland
Romania
Russia
Saudi Arabia
South Africa
Taiwan
Thailand
Turkey
UAE
Ukraine
Vietnam
LatAm
Asia
CEEMEA
EM
Source: IMF, World Bank, Penn World Tables , HSBC calculations
Historical TFP growth rates for select EM economies
Brazil (%) Mexico (%)
6
4
2
0
-2
-4
-6
-8
90 92 94 96 98 00 02 04 06 08 10 12 14
16 18
Brazil
6
4
2
0
-2
-4
-6
-8
90 92 94 96 98 00 02 04 06 08 10 12 14 16 18
Mexico
Source: Penn World Tables , HSBC calculations Source: Penn World Tables , HSBC calculations
Mainland China (%) India (%)
10
8
6
4
2
0
-2
90 92 94 96 98 00 02 04 06 08 10 12 14
16 18
Mainland China
6
4
2
0
-2
-4
90 92 94 96 98 00 02 04 06 08 10 12 14 16 18
India
Source: Penn World Tables , HSBC calculations Source: Penn World Tables , HSBC calculations
Indonesia (%) Korea (%)
4
0
-4
-8
-12
-16
90 92 94 96 98 00 02 04 06 08 10 12 14
16 18
Indonesia
8
6
4
2
0
-2
-4
-6
-8
90 92 94 96 98 00 02 04 06 08 10 12 14 16 18
Korea
Source: Penn World Tables , HSBC calculations Source: Penn World Tables , HSBC calculations
Malaysia (%) Vietnam (%)
8
6
4
2
0
-2
-4
-6
-8
-10
90 92 94 96 98 00 02 04 06 08 10 12 14
16 18
Malaysia
6
4
2
0
-2
-4
-6
90 92 94 96 98 00 02 04 06 08 10 12 14 16 18
Vietnam
Source: Penn World Tables , HSBC calculations Source: Penn World Tables , HSBC calculations
Czech Republic (%) Hungary (%)
6
3
0
-3
-6
-9
-12
90 92 94 96 98 00 02 04 06 08 10 12 14
16 18
Czech Republic
6
3
0
-3
-6
-9
-12
90 92 94 96 98 00 02 04 06 08 10 12 14 16
18
Hungary
Source: Penn World Tables , HSBC calculations Source: Penn World Tables , HSBC calculations
Poland (%) Romania (%)
6
3
0
-3
-6
-9
-12
-15
90 92 94 96 98 00 02 04 06 08 10 12 14
16 18
Poland
12
9
6
3
0
-3
-6
-9
-12
90 92 94 96 98 00 02 04 06 08 10 12 14 16
18
Romania
Source: Penn World Tables , HSBC calculations Source: Penn World Tables , HSBC calculations
Russia (%) Saudi Arabia (%)
15
10
5
0
-5
-10
-15
-20
90 92 94 96 98 00 02 04 06 08 10 12 14
16 18
Russia
12
8
4
0
-4
-8
-12
90 92 94 96 98 00 02 04 06 08 10 12 14 16
18
Saudi Arabia
Source: Penn World Tables , HSBC calculations Source: Penn World Tables , HSBC calculations
South Africa (%) Turkey (%)
4
3
2
1
0
-1
-2
-3
-4
90 92 94 96 98 00 02 04 06 08 10 12 14
16 18
South Africa
6
4
2
0
-2
-4
-6
-8
-10
-12
90 92 94 96 98 00 02 04 06 08 10 12 14 16
18
Turkey
Source: Penn World Tables , HSBC calculations Source: Penn World Tables , HSBC calculations
EM regional TFP growth (%)
8
6
4
2
0
-2
-4
-6
-8
81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17 19
LatAm Asia CEEMEA EM
Source: Penn World Tables , HSBC calculations
Disclosure appendix
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including any views expressed on the back page of the research report, accurately reflect their personal view(s) and that no part of their
compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report:
Ali Cakiroglu, Dr. Murat Ulgen, Nicholas Smithie and Edward Parker
Brazilian Securities Exchange Commission (CVM) Regulation No. 598
Pursuant to CVM Ruling No. 598 (May 2018), HSBC has obtained from the analyst(s) listed above under "Analyst Certification" and
disclosed (where applicable), the statements set forth in Article 21 and have rendered (where applicable) the statements set forth in Article 22,
under the sections titled "Analyst Certification" and "HSBC & Analyst Disclosures". The analyst(s) furthermore certifies(y) that the
recommendations contained in this report have been prepared independently, even in relation to HSBC.
Additionally, for purposes of Article 20, the principal analyst responsible for compliance of the mentioned regulation is the first name in
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All Covered issuers Issuers to whom HSBC has provided Investment Banking in the past 12 months
Count Percentage Count Percentage
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1 This report is dated as at 02 June 2020.
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