If the focus for investors in the UK this year has been rising inflation and low interest rates, in emerging markets one of the key factors has also been inflation but with rising interest rates.

These factors, as well as a stuttering global economic recovery, have made it a volatile first half of 2011 for many markets, with a cooling of the enthusiasm for some markets in the short term but the belief that these economies will continue to lead on long-term growth.

China

As the largest of the four biggest emerging markets – the BRICS (Brazil, Russia, India and China) – China is a global trendsetter in economic terms, with an increasingly powerful role. But like many other markets, it has had a rocky ride so far this year.

Louisa Lo, head of Asia ex Japan equities at Schroders said recently: “China – like most major economies – has been on something of a rollercoaster ride this year. However, after the events of the last two and half years, volatility was always going to be a feature of the recovery and, in our view, the headwinds currently affecting the region do not impact the economy’s long-term outlook.”

Lo said the battle against inflation in China ‘rages on’ with the Chinese authorities using monetary policy to try and suppress rising prices. Other factors also have impacted on inflation, including a drought in the lower reaches of the Yangtze River and regional power shortages, Lo added.

However, Lo’s view is that inflation will peak during 2011, and while monetary policy will impact on company growth, she does not expect a shock slowdown in China.

Company growth

Despite concerns over China’s headline Gross Domestic Product (GDP) growth, Guido Stiel, who co-manages the Allianz RCM BRIC Stars Fund, wrote at the end of June that companies he visited in Hunan province had a ‘crystal clear’ focus on their strategy for the coming years, including further export growth.

The long term growth potential, driven by good companies, is the focus for many fund managers in the region.

The managers of the M&G Global Emerging Markets Fund say they focus on companies that are creating value for shareholders. Co-manager of the fund Matthew Vaight believes a good company should have management that ‘allocates capital efficiently and a strategy to ensure that the business can grow profitably and generate sustainable returns.’

The team say that state-owned businesses in Russia and a lack of capital discipline in some Chinese companies can mean poor shareholder returns, so the approach of the fund is to identify those companies which can create that value.

Imports and exports

One of the challenges to sustained growth for companies is a reliance on exports, because this in turn relies on strong demand from other markets.

Philip Poole, global head of macro and investment strategy at HSBC Global Asset Management recently said that: “Markets want to believe that emerging economies can become the locomotive that replaces the US as the marginal source for demand for the global system. Much store is placed on rising consumption in China.”

Market pressures elsewhere

The economic drivers and circumstances in the BRIC countries are all different, but aspects like positive demographics, a large working population and relatively low debt levels, are seen as long-term factors that drive economic growth.

Shorter term, however, India has continued to suffer from high inflation, which has deterred investors. In May the Financial Times reported that inflation was at 9.1 per cent, and also raised concerns that these price increases were becoming structural as food prices – which were driving up inflation – had fallen, but the wholesale prices index was still going up.

In Brazil, some commentators have raised concerns about the rising level of debt which individuals are taking on, while inflation and the monetary policy response have also weighed on the Brazilian stock market.

In his latest monthly report, Dean Newman, who manages the Invesco Perpetual Latin American Fund said that Brazil and Mexico had been the weakest performers in the region, but saw promise in the fact the Mexican authorities appeared to have a handle on their inflationary pressures.

Ewan Thomas, investment director and head of emerging market equities at Neptune said in a recent update that some emerging markets had underperformed developed markets in recent months.

However, a rising oil price in the first part of 2011 had helped performance in Russia where companies can benefit from rising energy prices.

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