Jeff Schultz, Senior Economist, BNP Paribas South Africa
- In emerging markets, we see policy ‘flippers’ and ‘floppers’.
- In most of the West (Latam and CEEMEA), robust recovery has come with higher inflation, forcing central banks to flip to rate hikes. In turn, growth in these regions is set to moderate next year.
- In emerging Asia, by contrast, sluggish growth and low inflation allow central banks to keep interest rates floppy, at low levels. Along with loose fiscal policy, low rates should support a bounce back.
- We expect EM fiscal consolidation will be gradual, due to little appetite for austerity. Politics bears watching, especially in countries with elections.
- We believe comfortable current account positions will be sustained across most EM, especially where commodity prices help.
- We think the outlook for EM asset prices remains broadly benign, especially if EM decouples from concerns on China.
- Still, differentiation favours relative value trades and being more selective.
Market concerns on growth downturn look overdone
We have seen two significant developments in recent months: the spread of the Covid-19 Delta variant (and associated supply constraints), and a slowdown in China on the back of new restrictions and a regulatory shift. However, we think market concerns about the growth impact of these developments have been exaggerated (see Global Outlook Q4 2021, dated 7 September).
In our opinion, progress in vaccinations will continue to weaken the link between the pandemic and its economic impact, while upcoming Chinese stimulus is likely to support China’s growth. In addition, commodity prices, a key driver for many emerging markets, are increasingly supported by global growth trends rather than Chinese growth alone.
That said, we worry that lingering supply-chain disruptions, along with continued de-globalisation and nearshoring trends, could work as a negative supply-side shock putting upward pressure on inflation. In fact, we are concerned that EM inflation could peak higher and persist for longer than many assume.
Global outlook supportive for EM, if less than before
Despite a near-term speed bump, our view on underlying global growth remains positive: global liquidity conditions remain abundant, prospects for commodity prices still look encouraging (supporting EM current account balances) and we continue to expect a fairly tantrum-less taper by the US Fed. That said, the prospective rise in real yields in advanced economies suggests less support than before for EM asset prices. We therefore prefer relative value trades in EM, rather than outright bullish positions.
Local conditions indicate different paths among EM regions
Beyond global factors, local conditions suggest differing paths ahead for EM regions. In Latam and most of CEEMEA, growth remains fairly robust, although inflation concerns are forcing more central banks to hike interest rates, from Brazil and Chile to Russia and Central Europe. In turn, with a lag, we expect cumulative monetary tightening to cool growth in these regions next year.
In contrast, especially in countries where Covid-19 has continued to be a concern, growth in emerging Asia remains sluggish compared to its otherwise speedy long-term trend, entailing a more protracted recovery path. Facing smaller macroeconomic imbalances and less inflation pressure than other regions, most central banks in Southeast Asia seem in no rush to hike. As a result, we see room for growth to gain traction in emerging Asia into next year.
Policy flippers and floppers
Virtually every country eased policy in the initial aftermath of the pandemic shock. However, we now see increasing policy differentiation across the globe, including within EM. Fiscal balances in EM are likely to take time to recover their pre- pandemic levels, as fiscal consolidation will probably prove to be gradual. While such a broad description remains true for EM overall, the specifics vary from country to country.
We think the monetary policy response so far falls roughly into two main categories: flippers and floppers. Flippers are the policymakers who are facing increasing inflation pressure and cannot afford to stay in denial for too long, so are embarking on a tightening cycle. They have either been hiking rates already or we think they will start soon. That includes almost every central bank in Latam (Brazil, Mexico, Chile, Colombia), and many in CEEMEA (Russia, Hungary, Czech Republic, Poland, South Africa).
In contrast, floppers are the policymakers who are keen to keep policy in accommodative territory for longer. In some cases, this is because they are not yet facing any major inflationary pressure (most countries in EM Asia) or are even considering some additional easing (Japan). Alternatively, they explicitly prefer to stay behind the curve on purpose, under their recently altered monetary policy regimes (the Fed and the ECB).
All things considered, while global factors remain broadly supportive (if less so than before), varying local conditions look set to bring increased differentiation within EM in the months ahead, in our view.