Monetary Easing Prevalent in Emerging Markets in the Third Quarter

The US-China trade conflict has remained at the forefront of investor concerns in recent months, with both governments imposing tariffs on each other’s goods. While continued tensions are likely to result in continued market volatility, Franklin Templeton Emerging Markets Equity nonetheless finds reasons to be positive about emerging markets, with a more dovish global central bank backdrop offering support.

Three Things We’re Thinking About Today

  1. Finance Minister Nirmala Sitharaman announced a meaningful reduction in India’s corporate tax rates to help spur investment and boost growth in the country’s slowing economy. These changes came as a positive surprise and send a strong signal that the government has recognized the stress that corporates face from weak sentiment and subdued economic activity. While there has been some concern that the measure will result in a decrease in revenues, we believe there are mitigating factors that could reduce the loss in revenues. It is also important to note that the level of impact differs from sector to sector, particularly in sectors subjected to the highest effective tax rates. For instance, banking would be a key beneficiary as it is a full-tax paying industry. Most consumer companies also benefit from the corporate tax cuts. However, companies that currently receive tax relief or incentives from the local state government will not benefit as much. Overall, we think India’s corporate tax cuts should help spur investment over the longer term. We continue to favor companies that can benefit from secular growth drivers such as favorable demographics, infrastructure investment, urban and rural consumption growth and increasing income levels.
  2. China recently announced the removal of the investment quotas under its Qualified Foreign Institutional Investor (QFII) and RMB Qualified Foreign Institutional Investor (RQFII) programs. Increasing market access for foreign investors has been an ongoing process, as China undertakes structural reforms to its capital markets and allows foreign firms greater control over their assets. The move also follows a recent decision to allow foreign financial firms an option to take majority stakes in joint ventures. Certainly, the lifting of these restrictions on foreign investment in China was a welcome surprise. However, we think it is unlikely to have a dramatic impact in the short term because the existing quota system was underutilized. If we see further measures to liberalize and enhance market access that will encourage index providers such as MSCI and FTSE to increase the inclusion factor, we think China’s weighting in global benchmark indexes will invariably rise, and passive funds may have no choice but to step up their purchases of Chinese securities. While the overall immediate impact of China’s move to lift restrictions on foreign investment may not be drastic, we think the initiative signifies China’s commitment and long-term strategic decision to further increase access to its financial markets.
  3. Optimism surrounding the government’s economic agenda, including the key social security reform, has resulted in a more favorable climate in Brazil. While the country’s economic recovery has been slower than expected, with the government forecasting gross domestic product (GDP) to grow by 0.85% in 2019, government and central bank efforts could improve the country’s longer-term GDP growth potential.1 Inflation has also remained under control, allowing the central bank to lower interest rates to record-low levels to stimulate the economy. We believe the approval of pension system reform is key to stimulating investment and credit, which should help improve economic activity, as well as help significantly reduce Brazil’s fiscal deficit. A major privatization plan has also been announced, and we expect tax and other reforms that could improve the ease of doing business to follow. We maintain a positive outlook on the equity market and continue to have a favorable view on domestic-oriented themes, including financials and consumer-related sectors.