Over the past year, China has generated a lot of news globally, including a trade war with the U.S., technology espionage and its current foreign policy (the “Belt and Road Initiative”). These events are generally viewed as negative for frontier markets (especially the last item, which I will discuss in more detail in another blog post). In this post, I am keen to discuss China’s impact on frontier countries, and effectively to follow up on my recent post, “The three leapfrogs in Frontier", by delving further into the sources of frontier markets’ ability to “leapfrog” – in this case, an ability supported by China.
In my view, beyond the rise of China as a superpower, what is less discussed are China’s gifts to the world that could have a transformational impact on frontier countries. These gifts are in the areas of communication and power and will likely extend to electric vehicles. Essentially, through government- and corporate-led capital investment, China has lowered the cost for smartphones, solar power panels and, soon, electric vehicle batteries, enabling these products to be affordable for lower-income frontier countries. In the same way as discussed in my previous blog post, these items enable the “leapfrog” phenomenon. I view China’s investments as “gifts,” because frontier markets didn’t contribute to the investment program, yet are reaping the rewards.
Let’s start with China’s initial gift: smartphones. No device has had more impact on the emerging and frontier world than this basic device. As explored in my previous post, penetration of mobile phones in frontier countries is generally in line with developed and broader emerging markets. The key driver of this growth has been the collapse of smartphone prices. This incredible affordability was driven by heavy Chinese investments in production capacity; as a result, as seen in Chart 1, China is now the largest producer of mobile smartphones, with a 32% global share. This manufacturing infrastructure and scale have lowered the prices of smartphones to near $250 (USD) – down more than 40% since 2010.
Source: IDC, Statista, Bloomberg Intelligence
Over the same decade, China applied the same investment strategy to energy and power. Historically, China imports oil for its power needs, which raises both pollution and security concerns. Hence Chinese policy makers focused on green power, including solar panels, to improve air quality and become self-sufficient in power generation. As seen in Chart 2 (which compares annual solar capacity additions measured in megawatts versus cost of solar power generation), starting in 2008, China invested heavily in solar power capacity, which led to a complete collapse in panel prices and made solar power installation costs cheaper than coal (see the June 2017 blog post “Solar power: Transformative to EM and FM countries?”). These investments were indeed gifts to frontier markets, because most frontier economies suffer both from power shortages and heavy reliance on fossil fuel commodity imports (which puts negative pressure on their trade balances). With cheaper solar power, countries like the Philippines have benefited tremendously; that country has moved from chronic power shortages to a power oversupply in the past ten years. In the longer term, inflation should be less volatile as well, because energy tends to be a large part of the inflation calculation basket.
Source: Bloomberg New Energy Finance (BNEF)
The current capital wave is in electric vehicles. Car penetration in China continues to rise, but, as with power generation, China is keen to reduce its reliance on oil imports and to improve air quality. Yet most Chinese citizens cannot afford an expensive Tesla, nor does the government want to rely on foreign-built technology. Therefore, as seen in Chart 3, China is ramping up spending in the electric vehicle (EV) sector – in this case, lithium-ion battery (which power electric cars) production – in the hopes of becoming global leaders in EV. This growth in capacity, as in the case of phones and solar power, is helping to lower the cost of EV production costs.
Source: Bloomberg New Energy Finance (BNEF)
In all three scenarios above, lower prices for new technologies have had a positive knock-on effect for frontier countries. Given their lower incomes, abundance of sun and lack of fixed-line telephone networks, frontier markets are ready to embrace China’s gifts of better, greener communication, power generation and transport, which will likely transform their economies in dramatic ways.
The negative knock-on effect, however, is on global competitors in these three sectors, whose costs are likely higher than Chinese levels: this is likely part of the reason for the current U.S.-China trade war. Rather than take a side in these battles, I am concerned to understand the implications of this global dynamic, and to find the best investment opportunities for shareholders of Fidelity Frontier Emerging Markets Fund. The key winners in frontier markets should be large consumers of power (platinum miners, heavy oil-importing countries), while gasoline retailers and coal miners are the likely losers.
Thanks for reading,
Adam Kutas, CFA