A: Emerging markets have gotten a lot of things right, but they’re still political and corporate governance risks to consider. So where are some of the risks?
The Chinese shadow banking system is one. The reason it’s a concern is just that it’s an unknown — we don’t know what we don’t know. And it’s not even clear the Chinese officials understand the full scope of the problem.
But while I’m concerned about it, some of the recent steps from the Chinese authorities to more aggressively deregulate the financial sector are encouraging. They loosened the bounds on which the currency can trade, and they’re moving to further deregulate what banks can both charge and pay for loans and deposits. This deregulation is a good thing because if it continues, and I expect it will, it will hopefully shrink the size of the shadow banking sector. It will also bring more transactions into the official sector so we’ll have more clarity about how bad China’s debt problem is.
And while India has a lot of promise and it’s easy to construct a great long-term bullish case about the market, there also are significant risks associated with India. Normally, I mention all the things that emerging markets have done right. They’ve lowered their deficits and they’ve brought their current account deficits into line. But India’s an exception. The country is still running a very large fiscal deficit and a relatively large current account deficit. It has massive structural inefficiencies and unlike other emerging markets, it also still has a very big inflation problem.
iShares MSCI Emerging Markets (NYSEArca: EEM)
Russ Koesterich, CFA, is the iShares Global Chief Investment Strategist.