As a significant portion of the developed world recovers, attention turns to inflation and economic overheating. In emerging markets, the situation is more uneven. Rising commodity prices, improving trade flows and consumer spending are all favorable factors. However, in many poor countries, the recovery is far from being in good shape and remains dependent on improving the health situation. The significant differences between these economies call for a very differentiated approach to investment.
The slow post-pandemic recovery continues to weigh on countries’ fiscal health, and although current account balances hold and the weakness of the US dollar may ultimately help to improve the situation, many emerging markets remain lagging behind. the global recovery.
The International Monetary Fund (IMF) anticipates this lag in the recovery of emerging countries, visible at the macroeconomic level. Historically, the difference in growth rates between emerging and developed economies has been over 2% per year on average. However, according to the IMF, this gap will narrow to 1.5% this year, due to a faster recovery in the economies of developed countries. Emerging economies “have been hit harder and are expected to suffer larger losses in the medium term” than their developed counterparts, says the IMF. In particular, the world could see worsening economic inequalities, as the pandemic has pushed some 95 million people below the “extreme poverty” line.
The main threat to the global economy is that rising infections and slow vaccination programs erode confidence and delay a full recovery. As a result, we now estimate that emerging economies will return to their pre-pandemic growth path three to six months later than initially expected, in the first half of 2022.
Estimates of “excess mortality” – or the difference in death rates compared to previous years – based on official data and modeling, show that Asia in general and India in particular have been hit the hardest. More than a year after the start of the pandemic, the poorest countries are the least vaccinated and the most affected by contamination.
In India, the pandemic is particularly worrying. Based on official reports, the number of deaths attributed to Covid-19 reported to the population has practically doubled over the past month. The scale of the disaster is difficult to measure, as the country’s limited testing centers and failing health system are contributing to an underreporting of the true number of cases.
Brazil, where health measures were imposed late, the government of President Jair Bolsonaro having shown resistance to scientific advice, has recorded more than 444,000 deaths linked to Covid-19, the second highest figure in the world after the United States. Mortality, expressed as a percentage of the population, has doubled since the start of the year.
The multiplication of cases in emerging economies has wider consequences for the rest of the world. Whether it is Latin America, Asia or Africa, any region that continues to suffer from widespread contamination increases the risk of new variants appearing, which in turn threatens to jeopardize the global recovery. . In March, the World Health Organization warned that “If Brazil does not show seriousness, it will continue to affect its entire neighborhood and even well beyond”.
The outbreak of contaminations in India has an even more direct impact. Following the crisis, the country restricted exports from its Serum Institute, the world’s leading vaccine manufacturer. This will particularly affect countries in South Asia and Africa, which depend on India for vaccine production.
In addition, we may see variations in the degree of effectiveness of vaccines. Chile has implemented the fastest vaccination program in the world, after Israel. To date, 89% of its population has received a first dose of Sinovac vaccine. But since the reopening of its economy, Chile has faced a rapid increase in cases, undermining confidence in the Chinese serum which accounts for more than 90% of the vaccines administered in the country.
The intervention of emerging governments throughout the pandemic has avoided its worst consequences. However, the debt resulting from this spending now requires reform, as public debt-to-GDP ratios have all risen there since 2019 due to the pandemic.
While this spending did not cause a debt crisis in Latin America, it did not prevent sovereign ratings from suffering. Last week, the S&P rating agency downgraded Colombia’s sovereign rating from investment grade to speculative grade (from BBB- to BB +). The move follows President Iván Duque’s failure to gain acceptance for his plan to reshuffle government revenues, including tax increases, amid protests against these measures.
Current account surpluses – that is, the fact that a country exports more goods and services than it imports – helps dampen bad news. As the current account balances of emerging countries are almost all positive, we do not believe that there is a risk of short-term crisis in most of them. This reflects the slowdown in the private sector and in consumer spending, offset by governments’ support for their economies.
Nevertheless, sovereign debt will be essential in determining where investors should place their capital. Even though some countries like Brazil, Colombia and South Africa need to be watched closely for any sign of government deficit and current account deficit.
Any tightening of monetary policy by the US Federal Reserve, by raising its key rates or reducing its asset purchases, constitutes a major risk for emerging economies.
Inflation and rates
The monetary policy to support the economies is also proving to be more robust. Currently, emerging central banks enjoy much greater credibility in the markets than they did ten years ago. While interest rates rise in some countries, they are starting from historically low levels. Policymakers are aware of the dangers of too rapid a rise in the cost of capital, and they do not need to be restrictive in the short term.
While inflation remains under control, just like in North America and Europe, we are starting to see some transient spikes in energy and consumer goods prices.
For example, in a context of increasing inflationary pressure between March and April, Russia’s central bank raised its key rate by 75 basis points to 5%, thereby living up to its reputation for orthodoxy and credibility. Given the easing of its forward guidance, we expect two further increases of 25 basis points by the end of the year. As a result, real rates should turn positive soon, somewhat cushioning geopolitical and US sanctions risks for sovereign bond holders.
In March, Banco Central do Brasil started raising interest rates to 3.5%. It plans to continue this increase to around 5.5% and is considering reducing its monetary support. Indeed, in Brazil, consumer prices increased by almost 7% in April 2021 compared to April 2020, more than double the target of 3.25% set by the central bank. In addition, Brazil is currently experiencing one of its worst droughts in decades, further increasing the risk of inflation. The central bank’s response should help control inflation.
Overall, we don’t expect emerging economies to embark on a continuous cycle of rate tightening until the end of 2021.or even early 2022. In addition, many economies are expected to benefit from improved trade flows and commodity prices, which remain tied to the development of inflation.
As we have written many times, investors must treat each emerging economy on its merits, and the fiscal impact of the pandemic has only reinforced this need. An important distinction concerns the weight of each emerging asset class in global indices. If Asia weighs more heavily in equity indices, for example, Latin America is more important in sovereign debt.
For bond investors, given China’s economic recovery, we continue to favor renminbi-denominated bonds, that offer yield, potential currency gains and diversification from the main asset classes. We also have an overweight position in emerging market debt denominated in hard currency, as it trades at reasonable valuations and allows for additional returns; corporate bonds are particularly attractive in this segment, as they should benefit more quickly from the global recovery while avoiding part of the budgetary constraints linked to sovereign debt.
On the equities side, we favor emerging Asia, which has been less impacted by the Covid crisis so far and which should continue to benefit from strong demand from Chinese markets.
Emerging currencies should hold up well for the next few months thanks to positive macroeconomic data and reduced political risks. In line with our preference for sovereign bonds, we favor the renminbi as our currency, and we recently revised our opinion on the Russian ruble and the Brazilian real upwards, while downgrading our opinion on the Indian rupee.