Emerging market equities are more domestic than you think

The analysis of sales exposure by regions for emerging market (EM) companies reveals interesting insights. Companies included in the MSCI EM index, a benchmark for emerging market equities, derive 77% of their revenues from EM economies as defined by MSCI and 23% from developed markets. This suggests that the average EM stock universe has more than 60% of sales from domestic sources, quite close to the S&P 500 where 70% of sales are exposed to the US, and significantly higher than the Stoxx 600, where only 40% of companies’ revenues are exposed to Europe (Chart 1).

This high level of domestic revenue contrasts sharply with the widely held perception that EM companies are very sensitive to global trade and cyclicality. This percentage of 63% underscores the importance of domestic markets in driving revenues for EM corporates. A detailed examination of the geographic sales exposure of the MSCI EM index reveals a heavy leaning towards four main markets: China, India, the US, and Europe. No other market accounts for more than 4% of revenues. This is partly because China is a heavyweight in the MSCI EM Index and most Chinese companies are domestically oriented. 

In terms of regional exposure within the EM index, China emerges as the most domestic-centred market, followed by ASEAN (Association of Southeast Asian Nations), MENA (Middle East and North Africa), and India. In contrast, North Asia, which includes Korea and Taiwan, has the highest international exposure. This is driven by tech names, which have the highest revenue share from Japan. At a sector level, real estate (93%), utilities (91%), and financials (90%) are unsurprisingly the most domestic sectors, while IT (41%) and materials (50%) are the least exposed to domestic markets. This very different sector distribution, which also depends on the country, therefore, also strongly determines the internationality of the companies' earnings in the individual countries.

Why China is simultaneously the world's leading exporter and yet a domestic oriented economy

China's status as a leading exporter is largely due to its massive manufacturing sector, which produces a wide range of goods for international markets. The paradox of China’s economy is that it can rely on a massive domestic base for consumption, due to its large population with high middle income purchasing power, while it has remained highly dependent on export markets to support its marginal GDP growth, especially over the last few years despite an adverse environment. Or explained the other way around, private consumption was under so much pressure that it could contribute even less to economic growth than usual.

The current structure of China’s economy is the result of the following phases:

1. An initial strategy (from Deng Xiaoping’s reforms to 2008) following the traditional neo-classical growth model through which emerging economies, with cheaper and more abundant labour, attract foreign direct investment (FDI), develop manufacturing capacities and export to the rest of the world. This strategy obviously culminated in the years following China’s accession to the World Trade Organization (WTO);
2. The great financial crisis marked an initial turning point with China being forced to reflate massively its domestic demand as US demand was crumbling. It should have been the starting point of a new growth strategy, relying on the increasing purchasing power of a large base of 1.4 bn consumers aspiring to similar consumption access as in developed economies. This should have translated into a significant cut in already extremely high savings levels.
3. However, this strategy rapidly conflicted with the priority given to the reinforcement and modernization of production capacities, supported by massive investments into sectors such as clean energy and electrification, cloud computing and AI. While production capacities increased, domestic consumption did not grow as much as it could/should have done, which only served to reinforce the importance of export markets for local producers.
4. This “dual circulation” economy, while already significantly dependent on local consumers from a “static level” point of view, became even more imbalanced in terms of growth contribution from net exports with the crackdown on corruption, the COVID pandemic and ultimately the property crisis, which has sustained deflationary pressures through negative wealth effects.
5. While China’s authorities have been quite slow to acknowledge the deflationary threat, they seem to be much more supportive and have recently explicitly identified private consumption reflation as the top priority of their economic policy. This priority is likely also prompted by the growing trade tensions and tariffs threats that highlight even more the necessity to rebalance China’s economy more in favour of domestic demand.

In other words, while its domestic market represents 87% of the sales of its companies, this very high level could increase even further if measures supportive to consumption start to lift the level of confidence among Chinese households. The same dynamic also explains why, despite multiple global economic and geopolitical shocks, such as the US-China trade war, the Covid pandemic, the Russia-Ukraine war, and global supply chain rearrangements, China's export dominance has not only persisted but even strengthened. Its share of global exports has risen, and its trade surplus has more than doubled from 2017 to 2024.

China's economic reforms, initiated at the end of the 1970s, have significantly increased its share of global goods exports. This growth, however, has been to the detriment of Europe, the United States, and Japan, which have experienced severe industrial decline. Despite this, the structure of China's trade remained virtually unchanged from 1990 - 2010. However, high-income countries represent today only about 50% of Chinese trade, while the Global South (the term refers to countries that are less economically developed or are in the process of developing, often located in the Southern Hemisphere) already accounts for more than 40% (Chart 2). This group of countries is enabling China to diversify its imports, secure new markets, and reduce its vulnerabilities amidst strategic competition with the West.

Trade between emerging markets booms

Trade within EM countries has seen significant growth over the past few years. This growth has been driven by several factors, including economic liberalization, improved infrastructure, and increased integration into global supply chains. Many EM countries have also pursued regional trade agreements, which have helped to reduce trade barriers and boost intra-EM trade. One of the key trends in intra-EM trade has been the growing importance of South-South trade (trade between EM countries in the Global South). This has been fuelled by the rapid economic growth of countries like China, India, and Brazil, which have become important trading partners for many other EM countries.

In terms of sectors, intra-EM trade has been particularly strong in areas such as manufacturing and commodities. Many EM countries have been able to leverage their comparative advantages in these areas to boost exports to other EM markets. However, despite the growth in intra-EM trade, trade between EM and developed countries (North-South trade) still accounts for a significant portion of global trade. This is due to several factors, including the size and wealth of developed country markets, as well as the historical trade relationships that many EM countries have with developed countries.

This development also becomes visible when looking at the distribution of the earnings of companies in the MSCI EM Index by regions (Chart 3). The MSCI EM companies generate almost half of all earnings in Asia, which not only covers the local consumption mentioned at the beginning, but also increasingly the trade flows between emerging markets.

Conclusion

Trade dynamics have been evolving in recent years, with a significant shift in the balance of power. While trade between emerging markets and developed markets, particularly the US and EU, remains strong, there has been a noticeable increase in intra-EM trade. This shift has gradually reduced the past over-dependency of key emerging markets on the demand from the most advanced economies.

Trade tensions, notably between the US and China, have significantly influenced North-South trade movements. Despite this, there has been a noticeable increase in export capacities directed towards other emerging economies. This trend could intensify if leading emerging economies like China, India, Brazil, and possibly Indonesia, manage to boost their domestic demand. This shift may also be a reaction to the US's increasing economic isolation under Trump's protectionist trade policies, which pose a threat to the volume of exports from emerging markets to the US.