Emerging market bounce may disappoint long-term investors

Apr 07 2014, 14:36 IST
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SummaryEmerging stocks are on track for a third consecutive week of gains.

A tentative recovery in emerging markets may paradoxically disappoint some investors who had hoped a sell-off earlier this year would push governments into making reforms to stimulate longer-term economic growth.

Higher asset prices and a return of portfolio investment flowing into countries such as India may mask the urgency for emerging economies to reduce their reliance on foreign capital and improve productivity at home.

Following an exodus of investors during most of the first quarter, emerging stocks are on track for a third consecutive week of gains. Emerging dollar debt has outperformed U.S. Treasuries and global corporate bonds so far this year as cheap valuations attract investors looking for a bargain.

While investors would normally welcome such gains, they believe reforms are vital for achieving lasting economic growth that can buoy markets in the longer term. Governments, however, tend to take action that might be unpopular with voters only during a crisis - and then ease off once it is over, they say.

"(Politicians) generally do the right thing after they've exhausted all the other measures. People reform under pressure, and they get lazy again," said Austin Forey, investment manager at JP Morgan Emerging Markets Trust.

There is evidence that some of the riskiest economies, such as Ecuador, Pakistan and even Ukraine, aim to borrow again as market conditions improve despite the absence of significant economic reforms.

But governments cannot afford to slow down on measures such as diversifying economies that rely too heavily on commodity production, encouraging citizens to save more, loosening labour laws and scrapping costly price subsidies.

In the last few years, investors poured into emerging markets in search of better returns after the Federal Reserve drove down U.S. debt yields to stimulate the domestic economy.

However, the Fed is expected to scrap its main tool in this policy, buying bonds, this year and raise official interest rates in 2015, attracting investors back to U.S. markets.

Current gains on emerging markets appear fragile and remain modest compared with the earlier losses.

"The recovery we've seen is just a fraction of the sell-off and it's more tactical. No one is thinking beyond three months on their horizon," said Salman Ahmed, global fixed income strategist at Lombard Odier Investment Managers.

"For the next phase of foreign inflows ... you have to see an uptick in growth and it will not come from abroad. How do you generate domestic growth? Either you consume more by borrowing or increase productivity with reforms.

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