However, with the world economy now experiencing a more modest pace of expansion, there are questions regarding the sustainability of the EM growth engine going forward.
With the MSCI Emerging Markets index underperforming developed markets by more than 20 percentage points year-to-date and with volatility among EM currencies spiking in recent months, investors have clearly been adjusting expectations for these economies.
But are EMs capable of adapting to the more moderate external environment or are the wheels about to come off?
Performance of indices in 2013
Source: FE Analytics
One source of optimism is the relative health of sovereign balance sheets within the emerging markets. On a debt-to-GDP basis, these economies average just 35 per cent, compared with a 110 per cent average among their developed market peers.
This would typically imply both a lower default risk but also greater scope for fiscal expansion to support domestic activity in the event of a slowdown. However, there are some clear caveats to consider here.
Firstly, it is not just sovereign borrowers that are capable of racking up debt. Corporates and households also have the potential to run into credit difficulties, with excessive leverage here likely to have equally negative consequences for an economy.
Of course, history would tell us that this is a less likely cause of macroeconomic instability than a sovereign debt crisis. However, one noticeable trend accompanying EM growth in recent years has been the rapid expansion of leverage.
In China, for example, private credit plus "social financing" have risen from less than 130 per cent of GDP in 2009 to more than 170 per cent in 2013. In addition, the corporate sector’s debt burden is currently close to 125 per cent of GDP, which is very high for a developing country.
These levels paint a dramatically different picture of the economy than its rather benign sovereign debt position – China’s government debt-to-GDP ratio is closer to 60 to 70 per cent – and highlight the difficulty of assessing the health of these economies using sovereign balance sheet analysis alone.
Perhaps a more pertinent guide to the durability of the EM economies to a slower pace of global growth is the current account balance. This represents the net foreign investment or lending/borrowing position of a country vis-à-vis the rest of the world.
On face value, EMs again appear to be in a relatively healthy position, with a combined current account surplus of $297bn. However, take out China and the resource-rich Middle East nations from these calculations and the aggregate figure falls to $50bn.
Of course, temporary current account imbalances, either positive or negative, may not in themselves be a source of instability, as currency adjustments can ease these pressures over time. However, persistent imbalances in the current account is a much more complicated situation to address, and may provide investors with just cause for concern.
To help understand the underlying trends in EMs' current account balances, it makes sense to break this rather diverse set of economies down even further. Of the major EMs that currently have a current account surplus as a percentage of GDP, it is noticeable that the majority are in the Pacific-Asia region, including Taiwan, Myanmar, Korea, Philippines, China and Thailand.
These economies are not only largely net exporters but also boast sizeable official foreign reserves, providing an additional buffer in the event of volatile capital flows. Of course, there are exceptions amid the region too, with India and Indonesia noticeable for not only their current account deficits but also their relatively low reserves.
The story is less encouraging in other parts of the EM universe, with economies in Latin America, eastern Europe and Africa more prone to current account deficits as a percentage of GDP.
Perhaps more worryingly, the trajectory of the current account balance in many of these countries appears to be on a deteriorating trend, heightening concerns that these deficits may be more than just a short-term problem.
Not surprisingly, recent currency weakness has focused on countries that share these characteristics, with the South African rand, Turkish lira and Indian rupee all under pressure.
So how should investors position themselves in the current environment? Despite the worries surrounding the performance of emerging economies, it would be wrong to tar them all with the same brush.
Within the EM universe, a number of economies appear well placed to cope with any deceleration in global growth, with robust sovereign balance sheets and plentiful current account surpluses.
On the other hand, there are other nations where external pressures are likely to make life increasingly difficult – with central banks forced into defensive action to support currencies, such as running down foreign reserves or hiking interest rates.
This environment presents opportunities for the investor who is capable of understanding the fundamental drivers of both macro trends and asset prices within these regions.
Indeed, with assets within emerging economies now trading at a considerable discount to where they were 12 months ago, there may be opportunities for investors to add selective exposure at attractive levels if, as we expect, the second half of 2013 brings an improvement in global growth.
Jason Hepner is investment director of global strategy at Standard Life Investments. The views expressed here are his own.
