Boom Time for Emerging Markets

These are heady days for emerging markets. It's called global synchronous growth, which means that GDP is growing at a brisk rate in most nations. It has produced an economic bonanza for countries as diverse as Chile and Slovakia, and their stock markets reflect this: Morgan Stanley's main emerging-markets index is up 40 percent this year. It's a tide that lifts all boats—even the African continent is growing faster than 5 percent. While the success of China and India are familiar to many, Ruchir Sharma, the head of Morgan Stanley's $35 billion emerging-markets portfolio, has long called attention to the truly global breadth of the phenomenon. He spoke with NEWSWEEK's Barrett Sheridan about the boom. Excerpts:

NEWSWEEK: Emerging markets have grown extraordinarily well in the last four or five years. Why is this happening now?
Ruchir Sharma: In the 1970s, we hit a very broad inflection point. Never before in the history of development had so many people lived in such poverty. The most populous countries in the world—China, India, etc.—were following economic models that were yielding very poor economic results. Since then, we've had a turning point, especially with China. More and more countries have jumped on the bandwagon and are following similarly responsible monetary, fiscal and trade policies. That's why we've seen this all come together this decade.

It sounds like you're saying this boom is a result of policy changes more than anything else—that people in power have gotten their act together.
Other economic models, whether it was mixed socialism or whatever, were discredited, given the poor results they yielded. Everyone now has been following the same economic orthodoxy: targeting low inflation, trying to access global capital and integrating with the global economy.

The emerging-market boom has lasted four or five years already, and many would argue that it can't go up forever.
I think that's true. All these people who are making projections about where BRIC [Brazil, Russia, India and China] economies will be in 2030 or 2050—I don't believe any of that. The history of economic development shows that very few countries become First World nations. However, cycles can last longer than people think. It's true that emerging markets have gone up for four to five years, but this cycle could easily be much longer than that.

Aside from China, India and the other prominent emerging markets, which countries are you optimistic about?
This boom has been extremely broad. We've been very optimistic about the Eastern European countries. They have built very good institutions, the quality of human capital is very good and they've been very successful at attracting a lot of FDI [foreign direct investment]. Another place where things have started to improve is the Middle East, which was a complete hellhole for many years. But the growth story has been very impressive and synchronous across the world.

Some places are starting from a very low base. Is, say, 5 percent growth enough for them to see meaningful improvements in living standards, or does it need to be higher?
This is the best economic period the global economy has enjoyed since the 1960s. But they're all starting from a low base and have so much bureaucracy and regulation that I can't think of what can practically be done—it's just human nature not to carry out reforms when things are going well but to carry out reforms when you have your back to the wall.

What are the major trends we should watch in 2008?
I think the single biggest risk to the emerging-market boom would be a generalized pickup in inflation. There are some signs of that happening, particularly in China.

But central banks have become a lot more professional in recent decades. Will they be able to address this threat properly?
I don't mean hyperinflation, or that these central banks would let loose completely and let inflation soar to even double digits. But to see a cyclical pickup in inflation? That's possible.

With the credit crunch roiling Western markets, is there a bit of schadenfreude in developing countries these days?
Yes. What's happening in the U.S. brings about both some fear, just because the U.S. is still the largest economy, and also some amount of schadenfreude. All these emerging markets, particularly in Asia, remember the lectures that they used to get from U.S. policymakers during the Asian deflation of 1997-1998, and now they think it's basically the pot calling the kettle black, so to speak.

Do you think that sentiment is misdirected?
The real disappointments in the global economy are Japan and Europe. When the U.S. grows well, like it did between 2003 and 2006, they underperform the U.S., and when the U.S. declines, those economies merely follow. If you look at world shares of GDP, emerging markets have gone up substantially over the last 10 to 15 years, but the U.S. has remained steady around the 25 percent level. The real big declines have taken place in Japan and Europe. Japan's share has gone from 15 percent 10 to 12 years ago to 8 percent currently. In purchasing-power parity terms, the European economies, too, have declined considerably.

It almost sounds like you're describing a world in which Europe and Japan are more coupled to the U.S. than the emerging markets now.
Absolutely. That is a central point.