Global Economic Environment Tests EM Resiliency
As most emerging market (EM) economies continue to recover from the COVID-19 pandemic since our March forecast publication, global macroeconomic headwinds, including geopolitical and financial conditions, have deteriorated further. The optimism of early 2022 has given way to worries of a sharply weakened global economy ahead of us on account of a longer-than-expected Russia-Ukraine conflict, higher energy and commodity prices, economic damage from pandemic lockdowns and restrictions in China, and faster monetary policy normalization in the U.S., Eurozone, and many other major central banks. The focus of the global macroeconomic outlook has become the ability of central banks–most notably the U.S. Federal Reserve–to return to its 2% inflation target while avoiding a sharp downturn.
Despite the challenging global economy, GDP growth held up relatively well across most of the EMs in the first quarter. However, momentum stalled (at best) in the second quarter and weakening growth is on the cards for the next few quarters, especially in the EM-EMEA and LatAm economies.
Solid activity growth in both commodity importers and commodity exporters in the first quarter partly reflects resilient domestic demand on the back of ongoing momentum from the pandemic recovery, and in some cases, the lingering effect of government stimulus measures. Domestic demand has kept economies afloat during this recovery in some countries where external demand has yet to recover to pre-pandemic level (Argentina, Thailand, Saudi Arabia, Chile). In some cases, recovery in exports have outshined that of domestic demand (Brazil, Mexico South Africa, Indonesia) (see chart 1). That said, recovery from COVID-19 has broadly continued in the service sector. Export momentum eased generally in line with global trade slowdown after the bounce-back in 2021. The demand for EM manufactured goods is likely to weaken further as softer global growth becomes a headwind. In addition, consumer demand growth was due to naturally shift from tradable goods to non-tradeable services as the service sector normalizes and strengthens with fading impact from the COVID-19 pandemic.
EM EMEA (Poland, Saudi Arabia, South Africa, And Turkey)
Macroeconomic outlook remains challenging, despite upside growth surprises. Quarter one GDP growth in major EM EMEA economies surprised to the upside, both in commodity-importing countries in Emerging Europe (Poland, Turkey), as well as in commodity exporters (Saudi Arabia, South Africa). Domestic demand showed resilience to negative shocks, helped by continuing momentum related to the post-pandemic recovery, and in some cases policy stimulus. Trade performance diverged, with exports falling in Poland and Turkey on the previous quarter, but expanding strongly in South Africa. After a solid first quarter, we expect slower growth in the coming quarters, amid mounting headwinds from a prolonged Russia-Ukraine conflict, accelerated tightening of monetary policy by the U.S. Fed and other major central banks, and weaker global growth prospects. Elevated food and energy prices have fueled inflation, with weaker exchange rates adding to price pressures (outside of Saudi Arabia). The hit to consumer purchasing power, tighter financial conditions, and fading effects of post-pandemic recovery will weigh on domestic demand throughout the year.
The sensitivity to these developments varies across economies. The Russia-Ukraine conflict is taking an increasing toll on emerging Europe, and high frequency and leading indicators point to a slowing growth momentum in Poland and Turkey. With the conflict lasting longer than initially anticipated, the risks of more severe disruptions to trade, supply chains, and energy supply have risen. At the same time, energy exporters in MENA are enjoying windfall revenues (which more than offsets higher food imports bills), but slower global growth and tighter financing conditions will moderate these gains. Meanwhile, several commodity-importing MENA economies are among the most vulnerable to current developments, being net importers of both food and energy, and sourcing a large part of their cereal supplies from Russia and Ukraine (see “Food Price Shock Reverberates Through MENA Economies,” May 26, 2022).
LatAm (Argentina, Brazil, Chile, Colombia, and Mexico)
Resilience so far this year, but weakness expected ahead. Latin American economies have been more resilient than expected to the current mix of external headwinds, so far this year. The major economies in the region expanded on average 0.9% quarter-on-quarter in the first quarter of 2022, following 0.7% growth in the last quarter of 2021. Domestic demand held up relatively well across most of the region, reflecting ongoing momentum from the pandemic recovery downturn, and in some cases, the lingering impact of government stimulus measures. In some countries, exports also picked up, most notably in Brazil, helped by strong commodity exports. The lockdowns in China have not had a major impact on manufacturing production in Latin America, so far, despite fears of potential supply-chain disruptions filtering throughout the region. However, the recent tightening in global financial conditions, coupled with continued upward supply-side pressures on inflation, and an increase in uncertainty over global growth, are likely to weaken growth in the region the remainder of 2022 and into 2023.
Taking all these factors into consideration, our GDP growth forecast for Latin America increased to 1.9% from 1.7% previously, but decreased for 2023, to 1.7% from 2.1% previously. Risks to our GDP growth forecasts are mainly to the downside. In the current environment of high inflation, weak employment dynamics, and high economic uncertainty, policy predictability in the region is low, with potentially negative implications on investment. Another key risk to the region is a potentially weaker-than-expected U.S. economy, which would impact Mexico the most due to the strong trade links between both countries, but the associated deterioration in confidence and financial conditions would also imply lower growth for the rest of the major Latin American economies.
EM Asia (India, Indonesia, Malaysia, The Philippines, And Thailand)
Reopening drives growth momentum in emerging Asia. Emerging Asia’s economy is recovering as the region re-opened gradually following intermittent lockdowns in 2021. Recovering consumer demand is a key growth driver and is likely to remain resilient over the next few months. We expect steady growth for the region of 6.4% in 2022 following a 6.6% growth in 2021, even in the current uncertain global environment. First quarter growth in the region was broadly resilient. It was in line with expectations in Indonesia (5.0% y/y) and Thailand (2.2% y/y). In Indonesia, public consumption growth was significantly weaker relative to last year which offset steady private demand and trade growth. First quarter growth was strong in Malaysia (5.0% y/y) and the Philippines (8.3% y/y) on strong private demand. India’s growth over the calendar first quarter was slightly weaker than expected (4.1% y/y), and in contrast to the rest of the region’s consumer activity growth weighed on overall growth.
Inflation will rise during the second half of 2022 across emerging Asia, but for now it remains moderate relative to the U.S. or Europe. The recovery in consumer demand began in late 2021, and as a result core consumer price pressures have only started picking up now. Food and energy prices will be influential in the inflation trajectory. Energy price inflation remains high except in Malaysia and Indonesia. The two economies are net energy exporters and are not passing some of the energy commodity cost increases to consumers. Food price inflation is moderate but is now rising. A significant proportion of agricultural product trade is intra-regional but will nevertheless be affected by rising global food inflation. Capital outflow pressures remain moderate. There have been significant equity outflows out of India and the Philippines, but other portfolio outflows are limited. Emerging Asia currencies have depreciated less against the U.S. Dollar relative to the major currencies. However, rising U.S. interest rates pose a risk of heightened capital outflow pressures.
Risks To Baseline Growth Forecasts Squarely On The Downside
The risks to our baseline forecasts have picked up since our last forecast and remain firmly on the downside. The Russia-Ukraine conflict is more likely to drag on and escalate than end earlier and deescalate, in our view, pushing the risks to the downside. As S&P Global Ratings noted in a previous global macroeconomic outlook report, a hard downside scenario would involve a broad-based trade rupture between Russia and the German-centered industrial complex, taking down growth, incomes, employment, and confidence, and spreading to the rest of the global economy. A second worry is inflation remaining higher for longer, requiring central banks to raise rates more than is currently priced in, risking a harder landing, including a larger hit to output and employment. In a particularly bad variation of this risk, fuel and food inflation would remain high even if core inflation (which central banks more directly control) declines, leading to stagflation. That’s a surefire recipe for regression in living standards, deterioration in policy credibility, and an environment of social unrest.
China matters for the rest of EMs. The economic impact on China from its latest COVID-19 lockdowns were more severe than we anticipated. S&P Global lowered China’s 2022 real GDP growth forecast to 4.2% in May from 4.9% in March, and now further to 3.3% given only a small rebound tracking in May and June. With restrictions on people’s movements eased only gradually, new restrictions imposed in other areas and overall sentiment remaining poor, the recovery is slower than in 2020.
China’s underlying growth drivers are important to EM growth prospects. Consumer spending was hit harder by the lockdowns than investment and industrial production, which mitigates the impact on other economies, as China’s consumption is less import intensive. Nonetheless, China’s imports have weakened severely, in part because of the impact of the property downturn on commodity imports. It hasn’t gone unnoticed that S&P Global Rating’s GSCI industrial metals prices peaked in March and has since trended down now at levels last seen in August 2021, (which is still elevated co mpared with pre-pandemic highs), hinting at shallower industrial demand for China and its peers. Emerging markets in Asia are the most at risk from weakening Chinese consumption and tourism. Thailand, Malaysia, and the Philippines stand out as having the highest exposure in emerging markets from this angle. They are also among the most at risk from further supply-chain disruptions, albeit manufacturing continues to operate with limited disruptions under pandemic restriction. And it’s not just EM Asia. Mexico, for example, has the highest value-added share coming from China in the computer and electronics sector at nearly a fifth of total output. An important caveat to make is that unless lockdowns take place in key manufacturing hubs, disruptions to those supply chains may be limited. Raw industrial metals and minerals exporters like South Africa, Brazil and Chile are vulnerable to unfavorable downward price shocks in the global industrial sector.