Just came back from the IMF Annual Meetings in Istanbul, where I attended meetings with ministers and central bank presidents of more than 12 countries, as well as officials from the IMF and G7 governments. Here are a few concise conclusions from all those meetings, that will certainly take a bit more time to fully digest and write a proper elaborated summary (which clients will have to suffer through soon). These are some of the issues discussed and their implications.

In summary, the meetings were bullish for emerging markets, less so for G7. Because of continued reserve accumulation by most surplus countries, I am a bit less concerned about USD rates. However, there is and there will continue to be a historic global portfolio reallocation away from core markets. I came out of these meetings with more conviction about currency diversification and regional diversification (especially into Latin America and Asia). Thus, in most portfolios we are reducing exposure to the US and increasing the international diversification, including currencies and commodities.

There is a consensus that economic activity in the foreseeable future will be brisker away from the US and Europe, mostly in China and the rest of Emerging Markets. Whether that growth is enough to substitute the US, or pull G7 out of a mediocre scenario is a key question, and the consensus seems to be that it would not. I have my optimistic doubts, as I think people underestimate the interdependency linkages, as well as the flexibility of the US economy.

Most of the best emerging economies are rebounding nicely, with growth rates in some already pointing to pre-crisis levels. Economies with significant exposure to trade with the US and the EU have and will continue to suffer the obvious effects. Some have seen serious swings in their real exchange rate to accommodate for this shock (MXN, PLN, etc.). Emerging markets debt is an asset class that passed its most serious test ever, converting it in a less risky and volatile alternative. Inflows are bound to continue and change the traditional relative value assessments vis-à-vis high grade and high yield. Local currency debt is going through the same process, faster than its USD relative and the potential for growth of AUM is significant.

The famous global rebalancing that apparently we all want, is unlikely to materialize. Imbalances are bound to persist, which is good news for the US fiscal and financing needs (thus, not all is bad for the dollar). In other words, the desire to have people in emerging economies consume more and save less, and the opposite in the US, in order to reduce the imbalances that produced debt excesses in G7, is not a matter of collective action supported by incentives. The crisis taught most countries in EM that having very large reserves (self-insurance) worked very well, and they are bound to not only replenish those stocks but continue to build on them. There is no international insurance mechanism large/fluid/efficient enough to substitute self-insurance. An efficient insurance market is usually better than self-insurance, but governments do not see an acceptable alternative to self-insurance through large reserves. Thus, countries with surplus are bound to continue to have them and accumulate reserves, which means the demand for dollars and US Treasury bonds is not under threat.

This last point has changed to a large extent my view on rates in the US in the short-term (less concerned). We are now slightly more comfortable with USD rates exposure (which was mostly indirect, through corporate bonds and EM debt denominated in USD). The US could have a smooth bridge supporting its transition to a better fiscal stance. How long and wide that bridge is remains a difficult and unprecedented question for all. I continue to believe that a large part of the recovery in markets we are witnessing (including commodities) is due to a desire to diversify global portfolios away from nominal assets into real international assets.

At the same time, global private portfolios are bound to go through a historic rebalancing away from G7 into the rest of the world, with emphasis in Asia and the best convergent stories in EM (China, Brazil, India, Turkey, Korea, Singapore, Taiwan, Indonesia, Philippines, Colombia, Peru, Chile, Czech, Poland, etc.). This process is happening, and is bound to deepen, across both equities and debt. Our portfolios are a reflection of that, and are now undergoing an increase in that direction.

There seems to be an interesting disparity in the timing of exit strategies (stimulus withdrawal) between G7 and EM countries, with the latter moving faster to correct their fiscal imbalance and leaving the monetary side for when inflation comes back. Thus, we are bound to see better fiscal performance outside of G7, which will be yet another underlying force in favor of EM and non-G7 developing countries. Not to mention how drastic it already is the comparison of debt/GDP ratios across those groups, with roles reversed relative to the ’80s and ’90s.

On monetary policy, inflation targeting has grown in credibility and standing as the policy of choice, as those countries adhering to it the most fared the crisis better. I think there is the potential for spurious correlation here, as they are also the countries with the high reserve stocks and other credible institutions. What can be said is that countries with rule-based macro frameworks (inflation targeting, fiscal rules) had the possibility to produce the largest stimulus programs (especially relative to their history), and did not need to go as far as G7 with better results. Thus, proving the benefits of credible rule-based institutions.

The crisis helped some countries to break through interest rates floors (Brazil, especially). Though fundamentals would have permitted lower rates before, policy changes in such direction and magnitude appeared too daring, as if there was a multiple equilibria problem that was too difficult to crack. There will be a dilemma for many of these countries if inflation starts to creep up, as higher rates would make the capital inflows a larger problem for policy makers.

After hearing so much praise for how well stimuli worked, I hate to report that the crisis appears to have left a horrible legacy in terms of policy making lessons and myths. It seems generally accepted that fiscal stimulus worked and is good, beyond the jump-starting credibility boost initially intended. I always thought that the coordination failures produced by the severe credibility crisis required some strong signal to improve expectations and bring back coordination. That was the role of fiscal policy and monetary policy. But hearing G7 policymakers talk about not withdrawing the stimulus until the economies can “grow for themselves” makes me wonder what have we learnt. I would believe that the sooner the fiscal stimulus is withdrawn the better the prospects for the private sector to allocate those resources to productive use. But, there seems to be a stronger reliance on stimulus and away from the more fundamental macro/micro reforms of de-regulation and openness to trade as a result of this crisis. Thus, in terms of the prospects for productivity growth, the legacy of this crisis is a scorecard for active policies and regulation that is detrimental for the efficiency of economies in the future.

A big picture issue without immediate portfolio implications is the now accepted relevance of G-20. It seems now clear that G7 is no longer a leadership forum, that G-20 is, and that the IMF and the UN are of lesser relevance and usefulness. In that context, the weight of China is clearly significant, and its leadership role alongside the US (as opposed to under or behind) is now accepted.

Asia’s reliance on exports to the US and EU could mean growth is capped in the short-term. However, I think that better balance sheets and exposure to EM growth is what is helping Asia rebound. Here is where the issue of China working on changing its model, from export led to a local economy with productivity growth comes in. A lot was discussed on the different avenues Chinese policymakers are following for that purpose, which for the most part are on the investment front, as well as potentially changing the distribution of wealth along capital and labor. China’s relevance in the coming years cannot be emphasized enough.

Brazil’s exposure to commodities and China, together with the improvements and performance of its macro framework, make it one of the most attractive investment destinations. Thus, I would not be surprised to see the reai (BRL) appreciate further due to significant capital inflows (both real and portfolio). Reserve accumulation will reduce the pace and magnitude of that appreciation, but not the direction.

For Argentina, there are three issues: holdouts, IMF and the Paris Club. I think the re-opening of a bit worse exchange for holdouts is very close and likely, but the idea is to issue debt as a result, without necessarily any other improvement in macro or micro policy. Then, whether the IMF sign-off needed for the Paris Club, and how much reserves Argentina will devote to settle the Paris Club makes me less optimistic about anything after an exchange of a large portion of the holdout paper.

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