Guest Post By Lenoy Dujon of Economics Global – Founder and Global Macro Strategist
As the global economy continues its economic recovery amidst the ongoing COVID-19 pandemic, given the current accommodative economic environment, we believe Emerging Markets will finally have an opportunity to breakout from the pack in 2021.
Over the years, global investors have become skeptical of investing in the Emerging Markets. While various structural factors weighing on potential growth have had a role to play, Emerging Markets have been growing well below their economic potential due to numerous cyclical challenges as well. Just as the group began to emerge from a cyclical downturn in 2017, the advent of US-China trade tensions, and the COVID-19 pandemic, disrupted their recovery. To “add fuel to the fire”, the severe outbreak of COVID-19 and the lack of fiscal policy space among many Emerging Market countries to provide substantial counter-cyclical support, meant that Emerging Markets initially lagged behind their Developed Market peers.
However, as the global economy is currently undergoing an unprecedented economic recovery, we expect the Emerging Markets to see a strong cyclical recovery in 2021, as their outlook has improved dramatically in recent months.
Emerging Markets have already begun to gain momentum, as many emerging economies have started to see a strong uptick in economic activity, as a pickup in global growth continues to provide a strong supportive foundation for this group. This can already be seen in the fact that external demand conditions are improving, as Emerging Market exports are already growing on a year-on-year basis in September 2020, helped by a strong recovery in demand in key markets. In fact, we see external demand conditions continuing to be a strong catalyst for Emerging Markets this year, as improving demand in China and the US continue to improve. Further, we believe this economic strength will continue to improve in the 1H 2021, as the development and distribution of various vaccines continues. While large quantities are limited at the moment, large populations will not have to reach herd immunity to resume full economic activity. By protecting vulnerable groups of the larger population, this will help to lower fatalities and lessen the strain on (fragile) public health systems, especially in countries where re-opening has been less-than-stellar.
Central Bank Policy and Private Consumption
When it comes to monetary policy, central banks across the Emerging Markets have been able to aggressively ease monetary policy in response to the historic pandemic. Across the group, central bank balance sheets have expanded at the fastest pace in recent history, with some even seeing real policy rates declining into negative territory. As the recovery continues, and as confidence improves, we believe the effectiveness of easy monetary policy will increase, as these economies will see a pickup in domestic credit demand.
Moreover, we believe Emerging Market central banks are unlikely to feel any pressure to remove liquidity prematurely any time soon. With the US Federal Reserve on hold until at least 2023, coupled with a weak outlook for the US Dollar, Emerging Market central banks will face little pressure to raise interest rates to protect their respective exchange rates, or prevent the outflow of capital. Admittedly, while structural issues do linger, such as inadequate infrastructure, we do not believe them to be constraints on the cyclical recovery for Emerging Markets. In fact, on the contrary – we believe a cyclical recovery will help to alleviate such structural challenges, alongside a rebound in economic growth.
Further, Emerging Market private consumption is expected to sharply recover this year, as consumer sentiment improves and consumers re-gain confidence to spend. The widespread availability of a COVID-19 vaccine will lead to the full resumption of in-person activities, providing a boost to consumption growth. In addition, favourable external demand conditions will also lead to a bounce back in industrial capital expenditure, indicating that economic activity in the private sector will recover as well. Admittedly, while we do expect some tightening of macro policies later this year, any tightening will come against a backdrop where the economic recovery is in full swing.
Despite our optimistic outlook for Emerging Markets in 2021, there are dark clouds that still linger that market participants should be mindful of. In the interim, the global economic recovery is still dependant upon the path of global COVID-19 infections. As COVID-19 cases pass the 100 million mark, if proper measures are not undertaken to i) control further spread of the virus, and ii) distribute available vaccines fast enough, this could draw out the global recovery much longer than anticipated. If this were to occur, we believe this would weigh on economic sentiment both domestically and externally. On the domestic front, this could reduce household spending and capital expenditure, as well as put additional stress on hard hit areas such as the retail, hospitality, travel, and services industries. On the external front, a less-than-stellar economic recovery would reduce external demand from key markets such as China and the US, and put pressure on Emerging Market exports. Under this scenario, this unfortunately would be a “one-two” hit to Emerging Markets, which could push them back into the investment corner, and off of investors’ radars.
Overall, despite the downside risks that investors should keep in mind, we do believe the tailwinds outweigh the headline risks, setting up the Emerging Markets to break out from the pact this year.
© 2021 Economics Global Inc.
Any views expressed here are those of Economics Global Inc. as of the date of this publication, are based on available information, and are subject to change without notice. This document does not constitute investment advice.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.
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