7 of a series of Macro & Market themes in which a team of lead economists discuss cyclical and structural dynamics that will drive markets next year.
Emerging-Market Growth Challenges Continue
Our forecasts for key emerging and frontier markets suggest growth has fallen from a pace of 4% (ex-China) to around 2.5-3.0%, with most of the outperformers in Asia. Although some of the drivers of lower growth are cyclical, and reflect the challenge from the terms-of-trade shock (due to the low commodity prices), others seem to be structural.
Cyclical vs. Structural Growth Trends
We see the following drivers challenging growth in emerging markets and driving divergence between them:
- The pace and pattern of growth in developed markets, especially Europe and Japan, will limit their demand for emerging market goods. Southern European countries that used to import from emerging markets and frontier markets are reliant on monetary stimulus and still undergoing imports contraction, while core countries’ external surpluses are increasing. Thus, emerging markets that were looking to boost exports in the face of weaker domestic demand, such as Turkey, South Africa and some ASEAN countries will struggle to increase volumes. Any currency weakness will therefore mostly help with import rather export adjustment.
- Some of China’s slower import growth is structural as it lowers demand for investment goods and base metals, while also deepening China’s own supply chain for exports and domestic consumer goods. This will reinforce the sluggishness of global trade, particularly for commodity exporters and ASEAN countries.
- Global trade growth has downshifted and, in our forecast, will keep pace with global GDP, not exceed it. Countries that are in the middle or high end of global value chains, such Israel, Mexico and South Korea, may be better positioned than countries such as Malaysia and Thailand.
- The 2014-15 political cycle ushered in many new governments (such as in India and Indonesia), but also saw incumbent regimes retain power. Many of these (such as South Africa and Turkey) have lacked the capability or willingness to implement many structural reforms to boost growth or alleviate supply-side constraints. While the removal of some political uncertainties in Turkey will boost growth in 2016, this development will come with a wider current account deficit and higher inflation as populist policies become more likely, increasing Turkey’s vulnerability to Fed hikes and any spillovers from regional geopolitical issues (Russian retaliation).
- Infrastructure buildout plans in Brazil, India, Indonesia and South Africa, among others, have hit political snags and fallen victim to weakened fiscal circumstances. Delays in addressing these issues are set to lower short- and medium-term growth trends, while also risking higher inflation by reducing the level of non-inflationary growth.
- Corruption scandals and political deadlock across much of Southeast Asia will weigh on investment. This weaker growth will expose administrations that are struggling to hit fiscal targets, increasing the need for sovereign issuance in Malaysia and Indonesia. Central banks will likely choose the path of least resistance and allow some greater FX depreciation.
Monetary Policy Implications: Divergence Persists
With developed-market policy diverging and global trade growth stagnating, emerging- and frontier-market central banks will continue to diverge in terms of policy, based on their exposure to the different poles of global growth (China, the eurozone and the U.S.). The degree to which countries opt to pursue protectionist policies rather than increasing greater productivity from national or international resources through structural reforms will be a key differentiator between countries and markets in 2016 and beyond.
Although most emerging-market policy rates will begin or continue trending up after the Fed begins hiking rates, there is significant scope for policy divergence based on domestic fundamentals, which will allow some “lowflation” countries (such as those in Central and Eastern Europe) to cut rates as they are more linked to EUR, while others in Asia will able to keep rates low (Korea, China).
Domestically focused countries, such as Brazil, India and Russia, will see cuts contingent on the degree that inflation falls and their commitment to (in many cases new) inflation-targeting regimes. Countries like Russia and Colombia that have allowed currency depreciation should adjust more quickly to the energy terms-of-trade shock and could benefit from some import substitution.
We see shifts in monetary policy leadership as a key risk to watch, and the upcoming turnover in several emerging market central banks in spring 2016 (Malaysia, Poland and Turkey) raises the risk of more political interference. We think this risk is negligible in Malaysia due to the central bank’s strong institutional capacity and the independence of the candidates for governor. However, more expansive policy stances seem likely in both Poland and Turkey, with Turkish rates looking particularly vulnerable as a result of increased political interference and pressure to ease. These policies will leave them more vulnerable to currency adjustment