Emerging Markets – tomorrow is another day

Key points:

  • Growth has been weak in 2019, hurt by the US/China trade war and a series of idiosyncratic issues for countries such as India, Brazil, Mexico, Argentina and South Africa. We expect some rebound in 2020.
  • Policy has generally turned more proactive. Fiscal policy has eased, and street protests could spur additional public spending even in more fiscally constrained economies. Central banks have also eased policy.
  • The path of the US economy and dollar, developments in the trade war and shifts in Chinese stimulus will dominate developing countries’ growth profiles, currencies and financial markets performance.

2019 growth undershot expectations

Ongoing weakness in global growth has been driven by a sharp deterioration in manufacturing activity, while higher tariffs and prolonged trade policy uncertainty have damaged investment and global trade. In addition, the automobile industry has been under pressure from a variety of factors, including new emissions standards in the euro area and China. The global tech cycle has been going through its own downturn too. We now envisage growth to be 0.5 percentage points (ppt) weaker in emerging markets (EM) in 2019 compared to 2018, slowing from 4.4% to 3.9% (Exhibit 1).

The trade war has made a crucial contribution to this slowdown, but is not the only factor in play. Emerging Asia is expected to be affected by the ongoing trade tensions, but a few countries appear to be net beneficiaries from relocations of lost Chinese tariffed goods - likely Vietnam and to a lesser extent India. Most are, on balance, net losers - hurt by losses related to weaker Chinese demand, more than they gain from displaced US demand, with South Korea and Taiwan the most notable examples. Both economies have also suffered from a downturn in the tech cycle. Furthermore, domestic demand resilience faded throughout the region by mid-2019 and prompted us to revise down our growth expectations for Asia ex. China to 5.2% from 5.8%.

Central Europe (CE4) is also feeling the manufacturing slowdown, particularly given its close alignment with German automotive production. Nevertheless, the region remains strong by virtue of resilient domestic demand, supported by expansionary public spending policies, including strong European Union (EU) structural funds. Growth in CE4 remains solid around 3.9%, albeit weakening from exceptional levels of 4.6% in 2017 and 2018.

Exhibit 1: EM growth forecasts

Most of the disappointment in the growth projections for this year come from countries that we had expected to be more insulated from global trade tensions, but which suffered from idiosyncratic issues. In India, for example, trouble in non-banking financial corporations dampened everything from car to housing sales. Brazil’s economic recovery from one of its worst recessions on record has been underwhelming overall, with policy uncertainty proving a drag on investment.

Meanwhile, mixed policy signals from the Mexican administration undermined business sentiment and depressed investment there. Neighbouring Argentina faced renewed economic pressure as the currency sank in the wake of a political comeback by the Peronists, reviving the spectre of debt restructuring. Russia had to absorb a sales tax hike imposed this year, while the administration kept a tight grip on its policy mix through the first half of 2019. Broad-based weakness took hold in South Africa, which has struggled with a constantly growing cost of debt. The contingent liabilities of state-owned enterprises, in a context of weaker global demand, have dampened public revenues and private investment.

A better 2020: the laggards’ comeback

While the global backdrop is not expected to improve significantly next year, nor is it expected to collapse. In this context, we expect some catch-up from those economies pressured by idiosyncratic issues this year. Meanwhile, monetary policy easing and fiscal packages should be supportive and encourage stabilisation. We forecast broader EM growth to recover to 4.3% in 2020.

South East Asian economies are likely to see growth continue to decelerate in 2020, albeit at a slower pace. Indeed, a partial trade resolution and the recent turnaround in the tech cycle may attenuate the slump in investment. Additionally, central banks have delivered an easing in financing conditions with monetary policy moves this year (Exhibit 2). There is still some scope for further interest rate cuts as inflation remains under control. Moreover, governments have implemented counter-cyclical fiscal policies to alleviate the slowdown. As mentioned earlier, India has been the unexpected laggard of the region in terms of economic performance, decelerating for the third year in a row - likely to sub-6% in 2019 from 8.2% in 2016. Fiscal stimulus via corporate tax cuts, more forceful reforms - such as labour market reform - and monetary easing – the central bank reduced interest rates this year by 135 basis points (bps) - should eventually help domestic demand recover. We expect Indian GDP growth to improve to 6.2% in 2020.

Exhibit 2: Past monetary policy supportive into 2020

Latin America’s activity should begin to normalise from currently depressed levels, but rising social tensions remain a threat. Growth appears to be stabilising, albeit slowly. An investment slump should gradually recover, helped by monetary policy easing – both former and expected - in the region in a context of weak growth, limited inflation pressures, a global easing bias and generally tight fiscal policies. Brazil’s reform agenda will continue beyond the diluted Social Security reform that has recently been approved by the Senate, while Mexico’s 2020 budget continues to signal discipline. A gradual recovery from very depressed levels of domestic demand should be supportive next year. A better communication of economic policies by the administration of President Andrés Manuel López Obrador should bring recovery to construction and mining sectors in Mexico, while remittances and positive real wage growth support consumption. Exports remained relatively strong, indicating that a degree of US import substitution from China has taken place, and underlining the importance of the US-Mexico-Canada Agreement trade deal, which is still awaiting US Congressional approval. Brazilian investment should also recover gradually, reducing the economic slack. Fiscal policy will remain tight post-Social Security reform, allowing more monetary easing. We forecast Latin America growth to reach 1.8% in 2020 from 0.2% this year, but there is a risk of another disappointing year. The region remains dependant on the commodity cycle. Moreover, social tensions are becoming more visible in Latin America, with more populist leaders emerging in Brazil, Mexico, Colombia and Argentina, and street protests erupting more recently in Chile, Bolivia and Ecuador, raising concerns for the political stability of these countries. Argentina and Venezuela remain in very challenging situations.

Central European countries continue to show robust economic growth. While the region cannot remain immune to the Eurozone slowdown, domestic demand cushions the deceleration in manufacturing sector. Consumer confidence remains strong – close to historical highs – on the back of structurally tight labour markets supporting strong wage growth and still-subdued inflation. Public finances are sound, and governments can provide further stimulus in case of an abrupt slowdown. Abundant EU structural funds should continue to translate into robust investment activity in 2020. Turkey is also likely to see growth bottoming out. Investment collapsed following the sharp depreciation of the currency in 2018 which allowed the current account to balance and inflation to recede. The central bank cut rates massively, by 1,000 bps this year, while the government enacted significant fiscal stimulus. Most of the policy levers now appear exhausted - though the risk of over-reach is non-negligible under President Recep Tayyip Erdoğan’s pressure - but the past stimulus is likely to allow Turkish domestic demand to recover in 2020. In Russia, a difficult external environment and US sanctions weighed on the economy this year. A less tight policy mix is likely to support Russian activity in 2020.

As always, at the mercy of shocks

A rebound in EM growth in 2020 depends on a reversal of several factors seen in recent years, including global trade tensions, which brings downside risks. However, key EM regions would also be dependent on policy responses globally, particularly in the US and China. Additionally, the multitude of street protests reported around the globe - particularly in Latin America and the Middle East and North Africa - increases the political risks in these regions.

Looking at 2021, the pace of US economic deceleration should remain a major driver for EM economies and financial markets performance through risk on/risk off periods. Furthermore, the continuing deceleration of the Chinese economy should continue to be a drag on the Asian region and more broadly across emerging markets through trade links and/or the impact on commodity prices. A lot of the fiscal and monetary space will have been used, leaving the region more vulnerable to external factors and events. As such, we envisage emerging markets growth to decelerate in 2021 from 4.3% to 4.2%.

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