Emerging markets 2019 outlook
Emerging markets’ economic resilience: It’s a kind of magic
- The roots of emerging markets’ recent slowdown go back to early 2018, when global financing conditions started to tighten. Growth should nevertheless remain relatively resilient into 2019 albeit showing diverging regional and intra-regional trends
- Pent-up demand in Brazil and India should help growth to gain traction, while the global economic slowdown is likely going to affect most Asian and European developing markets. Recession in Turkey and Argentina, where elections will take place in 2019, should alleviate some of the imbalances but further policy action is needed to tackle structural issues and credibly anchor market expectations
- The economic outlook remains fragile, due to numerous ‘unknowns’ that could significantly affect emerging markets’ trajectory, such as a stronger US dollar, higher US Treasuries rates, overshooting oil prices and the possibility of a full-blown trade war
2018: The root of the slowdown
At the beginning of 2018, rhetoric of “synchronous economic growth” supported market enthusiasm. Almost a year on, and this optimism has vanished; instead, a sturdy US economy carried on with its overextended cycle, supported by corporate tax cuts. This situation contributed to a tightening of global financing conditions (dollar appreciation and an increase in US Treasury yields), which was exacerbated in EMs by capital outflows (Exhibit 1). Meanwhile, the US administration engaged in trade disputes going well beyond what most observers initially estimated. Frictions have emerged between the US and major EM economies such as China, Mexico and Russia, as a result of trade tariffs, which have been imposed, or due to targeted sanctions.
Still, economic growth proved rather resilient through the first half of this year. Early estimates of GDP performances for Q3 look surprisingly strong in some countries and EMs are set to deliver GDP growth to the tune of 4.6% in 2018, just a touch below the 4.7% registered in 2017. Yet, the roots of the economic slowdown go back to mid-2018. Turkey and Argentina started to face major headwinds, which we expect will lead them into recession. But these are not big enough economies to drive a sharp broad-based adjustment of the wider EM segment.
Source: Datastream and AXA IM R&IS calculations
2019: From trade engine to domestic demand buffers
A set of external factors including US trade war rhetoric, currency shocks, tighter global financing conditions (albeit still loose in a historical perspective) should all limit EM expansion, keeping it below its trend growth in 2019. Our expectations of an upcoming escalation of the tariffs Chinese exporters have to pay to the US, from the current 10% to 25% on goods worth $200bn, will impact global trade next year. The effect of these tariffs could go beyond China and the US, as a significant portion of Chinese products is not manufactured entirely in China. Processed and assembled products make up 30% of Chinese total exports. This supply-chain connection means that the shock from the Sino-US trade war could be contagious for many countries that co-produce with China. As its exports to the US decline, China’s imports of components and inputs from supply-chain partners will decrease too, spreading the negative shock across the global production process. Mexico and Canada may end up as net beneficiaries of China’s loss of market share in the US, but most Asian countries will likely be casualties of the trade war. Temporary trade disruptions and diversions from one country to another will bear transition costs worldwide and we see EM as a whole no longer benefitting from the strong export growth engine in 2019.
Instead, we expect domestic demand to remain relatively resilient overall, alleviating some of the pressures coming from weaker trade volumes. Healthy household balance sheets, generally robust labour markets and pent up demand in some big EMs, such as Brazil and India, are likely to support household consumption into 2019. Additionally, fiscal stimulus is expected to support some Asian economies including India, Indonesia, the Philippines and Thailand (all these countries have elections likely taking place in the first half of 2019), as well as Korea and Malaysia (which have relatively expansionary budgets pencilled in for 2019). Conversely, a more restrictive fiscal stance is expected in Argentina and Turkey, as well as in Brazil.
2019: Diverging regional and intra-regional trends
EM growth is likely to stay at 4.6% in 2019; it’s a kind of magic hiding strong regional divergences between EM geographical blocks as well as diverging economic trends intra-regionally (Exhibit 2).
Source: AXA IM R&IS calculations – As of 23 November 2018
Economic slowdown is likely to continue in Asia, driven by trade headwinds, which might affect China, Korea, Taiwan, Thailand and Singapore. Meanwhile, India and Indonesia are expected to continue to deliver relatively robust growth after having pushed through significant reforms in recent years. India’s domestic demand rebounded in 2018 after a weak 2017 and this trend should continue into 2019, as it reaps the benefits of structural reforms and benefits from its favourable demographic dividend. Indonesia has been able to deliver a very resilient and consistent 5% growth per annum since 2014 and will likely continue to do so, benefitting from investment. It is also one of the least impacted countries by the trade war. Nevertheless both India and Indonesia remain highly vulnerable to oil price spikes, which could depress their respective trade balances, given their large dependence on oil imports. In addition, higher oil prices would weigh on public finances, given their large subsidies on oil-related products. In addition, currency weakness could add to these woes. As a result, central banks are inevitably under pressure to remain vigilant on the monetary policy front. Should the recent oil price weakness remain persistent in 2019, India and Indonesia may see these pressures waning, offering room for some positive surprises.
The less buoyant global economic backdrop and in particular the weakness in the Eurozone should put some pressure on growth in EM Europe. Central European countries have so far shown little deterioration, as depicted by some strong GDP estimates for Q3. Strong domestic dynamics and European Union funds may still provide support into 2019 but GDP growth is expected to moderate going forward, reflecting weakness in the Eurozone economy.
The overheated Turkish economy, buoyed by a large pre-election fiscal boost in 2017, came to a brutal standstill this year. Growing structural imbalances and political tensions with the US translated into a substantial depreciation of the currency, widening spreads and asset price losses. The Turkish central bank hiked interest rates by 1,600bps to 24% to restore some confidence, to anchor inflation expectations and stabilise the currency. Still, Turkey will inevitably head into recession in the coming quarters (Exhibit 3) and adjustments can be brutal. Any forecasting exercise bears a wide margin of error, given that monetary and fiscal policy reactions to any further financial markets pressure can be significant. We have pencilled in GDP growth at 0.5% for next year after 3.5% in 2018. Turkey is walking a tightrope and policy decisions will need to provide the right balance between credibly anchoring market expectations, while striving to limit the downward pressure on the economy. In this context, its upcoming municipal elections are likely to prove more difficult for President Recep Tayyip Erdogan than initially thought.
Source: Datastream and AXA IM R&IS calculations
In Russia, GDP growth is expected to reach 1.9% in 2018, supported by higher oil prices and recovering domestic demand. The economy has felt the pressure of the ongoing US sanctions, as well as a poor harvest. Still, Russia’s macroeconomic framework remains strong given a credible fiscal rule. The 2019 implementation of VAT hikes is expected to keep a lid on the economic performance, as this will likely lead to a drop in consumption in Q1 of 2019, while the negative effect on real income will subside beyond that. Altogether, we forecast Russian GDP growth at 1.8% in 2019 and 2020, with consumption accelerating slightly but external trade slowing. Additional sanctions from the US remain a significant threat to our outlook.
In Latin America, the Andean economies - Chile, Colombia and Peru - remain on a strong foothold. The newly elected administrations are seeking to push through important reform agendas, which focus on fostering economic growth while tackling structural imbalances. This should boost growth in the long run. Mexico’s economy should grow at 2.2% in 2019 – the same pace as in 2018. This relatively weak level is at least in part due to a slowdown in US demand. The newly elected President Andrés Manuel Lopez Obrador (commonly referred to as AMLO) will take office in December and his agenda aims to increase fiscal spending. This could deteriorate Mexico’s sovereign credit worthiness, put pressure on the currency and reinforce the tightening of financial conditions. Nevertheless, we remain confident in Mexico’s institutional strength and the enactment of the fiscal responsibility law, which should limit the deterioration of public finances. Argentina is already in recession, and growth should remain in negative territory in 2019 (but probably to a lesser degree than in 2018), given the tight financing conditions and fiscal consolidation, which was agreed upon in the IMF’s Stand-By Arrangement. General elections will be held in the second half of 2019, in a difficult economic environment.
Source: Datastream and AXA IM R&IS calculations
Brazil is expected to emerge from its lethargy following the strongest recession in its history, and we expect growth to rise to about 2.5% in 2019 from 1.5% in 2018, supported by a recovery in domestic demand from depressed levels (Exhibit 4). However, important hurdles remain; the newly elected President Jair Bolsonaro will need to convince a very fragmented Brazilian Congress to adopt the much needed structural reforms in order to navigate the country’s debt trajectory onto a sustainable path. The success of these policy actions is of significant importance to the economic outlook.
Economies in the Middle East (with the exception of Iran, which is highly likely to endure negative economic growth, given the US’s sanctions should enjoy a favourable expansionary environment on the back of strong oil price dynamics, in Saudi Arabia, and reform momentum in Egypt.
Another political year with policy implications
2019 marks a big election year for many countries including India, Indonesia, Thailand and the Philippines (mid-term). In general, we do not envisage surprise outcomes and expect policy continuity. In India, the political outcome is particularly important for the policy direction going forward. Here, the ultimate battle will likely be held between Narendra Modi’s Bharatiya Janata Party and the main opposition the Indian National Congress. But even with a change of prime minister, policy continuity is anticipated. For Indonesia, with the current polls suggesting a 20pp lead for incumbent President Joko Widodo, the prospect of him winning is strong. Thailand’s military junta has finally promised to hold the much-delayed election in February, which should allow the return to a civilian-ran government from a military-ran one, though further postponement cannot be ruled out. Finally, midterm elections in the Philippines will gauge the extent of the population’s support for President Rodrigo Duterte’s policies.
Testing EM policy makers’ astuteness
The extent of the current economic slowdown, which has been ignited by the tighter global financing conditions, will depend on the quality of policy responses, particularly in vulnerable economies. We see inflation pressures receding into 2019 as the effects of the past FX weakness and oil price strength fade. Growth moderation should require less monetary tightening in 2019, although some central banks may still need to act in order to stabilise their currencies or to keep inflation expectations credibly anchored – most notably in Turkey, Argentina, India, Indonesia and the Philippines. So far, exchange rate flexibility has helped to absorb recent external shocks but it will affect private and public balance sheets. Central banks’ interventions in the currency markets remained rather limited in 2018, albeit focused on addressing market dysfunction in moments of stress, while still keeping adequate reserve buffers. This should continue to be the case next year. As mentioned previously, EM fiscal policies appear rather counter-cyclical with the exceptions being Argentina and Brazil.
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