Downgrades to our developed-market growth projections mean that demand for manufactured goods is likely to soften in 2022. Global trade is an important driver of EM growth and while further post-pandemic restocking by companies may provide near-term support, the stellar rates of export growth seen during 2021 are unlikely to be sustained. This could be negative for small, open EM economies across Asia, in parts of Central and Eastern Europe, and in Mexico.
The weaker China outlook is likely to have implications for certain EM. For example, if subdued real-estate sector activity leads to softer demand for commodities, such as industrial metals, this could impact exports of economies in Latin America and Sub-Saharan Africa.
Within EM, tighter monetary and fiscal policy will increasingly weigh on growth. We believe the sharp increase in EM inflation, which stifled many EM in 2021 and forced central banks into relatively aggressive interest-rate hikes, could subside. However, higher rates typically weigh on activity with a lag of six to nine months. Combined with the possibility of some fiscal retrenchment, as governments attempt to repair the damage to budget positions caused by the pandemic, tighter policy is likely to be a significant drag on activity. That may ultimately mean central banks don’t deliver the tightening that is priced into markets, opening a potential window of opportunity for investors in local markets.
The upshot is that we expect EM GDP growth to slow from an expected 6.5% in 2021, to around 4.5% in 2022. If we are right, then EM growth is unlikely to outpace that in some developed markets. And while that shouldn’t be a complete surprise to investors, such a narrow growth premium has typically set a tricky backdrop for markets.
Tom Wilson, Head of EM Equities
The global stimulus in response to the pandemic is now fading with liquidity growth falling away and the US taper imminent. Anticipation of tighter monetary conditions has put upward pressure on the US dollar, which is a headwind for emerging-world financial conditions. Bottlenecks, labor-market disruption, rising energy prices, and post-COVID economic catch up have also created more persistent inflation than anticipated, which has been driving stagflation fears.
There’s been ongoing normalization globally, underpinned by vaccine distribution, as well as high levels of post-infection immunity. Vaccine penetration in EM has been catching up with developed markets, while studies, including in India, show elevated levels of natural immunity after infection. In general, this could result in fewer future restrictions on activity, enabling bottlenecks to be addressed and reducing disruption to manufacturing and logistics in 2022.
Meanwhile, the withdrawal of stimulus and fading pent-up demand may see inflation pressures ease and should calm stagflation fears. Of course, new variants pose an ongoing risk and could materially change the outlook, especially if they evade existing vaccines and lead to higher mortality rates.
Policy tightening from the Federal Reserve (Fed) may be an ongoing headwind, but EM are more resilient when compared to the last Fed hiking cycle, as FIGURE 2 illustrates. External accounts are typically in good shape, recent capital inflow has been less hot than in 2013, EM currencies are generally looking cheap, and the yields on EM local debt are relatively attractive.