Emerging Economies and Their Race to Net Zero

Climate change poses a dual challenge for emerging economies. Not only are they at risk of suffering disproportionately from extreme weather events, rising sea levels and droughts, but they must also find a way to hike up their GDP while keeping greenhouse gas emissions at bay. They are, it appears, bearing the brunt of the transition to net-zero.

Michael Ganske, fixed income portfolio specialist at T. Rowe Price, however, begs to differ. He believes increasing decarbonisation efforts actually create opportunities for emerging markets.

After all, going green requires one thing above all: industrial metals. The demand for metals like lithium, cobalt and rare earths are crucial components for renewable energy generation and electric cars, is expected to shoot up over the next few years.

‘A lot of emerging economies are benefitting from that,’ Ganske says. ‘China, South Africa, Zambia, Chile, Peru – they all stand to profit from the growing appetite for key metals .’

Somewhat counterintuitively, it’s also their early-stage infrastructure that gives emerging countries another edge in the race towards carbon neutrality. ‘When you build a city from scratch,’ Ganske says, ‘you can be more conscious about energy efficiency and the use of resources.’

But, as he also points out, the shift to cleaner energy sources costs money – and plenty of it.  Getting access to that money is easier said than done. Unlike their developed counterparts, emerging markets struggle with financing, be it for political or structural reasons.

‘They pay a premium above risk-free rates,’ Ganske explains. ‘If you want to finance something in, for example, Germany, currently you pay under 1 percent  interest. In an emerging economy with a low credit quality, you pay treasury plus a spread of on average  400 basis points. It’s just much more expensive.’

Another aspect that makes transitioning to net-zero emissions that much harder for emerging countries is their reliance on heavy industry. ‘Many EM economies tend to be less service-oriented and more manufacturing and energy intensive than advanced nations. That’s why switching to oil and gas alternatives can be even more of a challenge than in developed markets,’ he adds.

Wake-up call

As gradual as transitioning to sustainable energy sources may be, external shocks such as the war in Ukraine can speed things up. Ganske believes a combination of political animosities and prudent foresight could turn out to be a real game-changer for decarbonisation efforts across the world.

‘Governments – especially in Europe – don’t like the idea of being dependent on a pariah state. They want to have alternatives, and that’s where emerging economies come in.

‘What we’re witnessing now is a structural change that sees Russia cut off from the global energy market for good. There’s no way Europe will say “let’s forget about the war and go back to normal”. That’s not going to happen.’

Instead, developed countries are calling on nations like Venezuela and Iran to cover their energy needs. ‘The political stance towards those two nations will change. It’ll be a lengthy process and the outcome is far from clear, but you can already see the US reconsidering their stance towards  Venezuela. And suddenly, Iran doesn’t look that bad either.’

Shunning Russian oil and gas will likely lead to a short-term uptick in carbon emissions as it disrupts the phase-out of coal which can act as a short term alternative. Yet, according to Ganske, the necessity to find new energy sources is going to sharpen the focus on renewables also from emerging markets in the long run.

‘Many investors believe that the decarbonisation movement is invalidating the investment case for emerging economies, but that’s not right,’ he says. ‘You just have to be much more granular in your approach to find the countries that are really benefitting from it.’

 

General Emerging Market risks

Capital risk – the value of your investment will vary and is not guaranteed. It will be affected by changes in the exchange rate between the base currency of the fund and the currency in which you subscribed, if different. Equity risk – in general, equities involve higher risks than bonds or money market instruments (Equity funds only). Counterparty risk – an entity with which the fund transacts may not meet its obligations to the fund (Fixed income funds only). ESG and Sustainability risk – may result in a material negative impact on the value of an investment and performance of the fund. Geographic concentration risk – to the extent that a fund invests a large portion of its assets in a particular geographic area, its performance will be more strongly affected by events within that area. Hedging risk – a Fund’s attempts to reduce or eliminate certain risks through hedging may not work as intended. Investment fund risk – investing in funds involves certain risks an investor would not face if investing in markets directly. Management risk – the investment manager or its designees may at times find their obligations to a fund to be in conflict with their obligations to other investment portfolios they manage (although in such cases, all portfolios will be dealt with equitably). Operational risk – operational failures could lead to disruptions of fund operations or financial losses.