By John Manning, International banker
W.he COVID-19, which caused unprecedented volatility in global financial markets last year, has been an extremely uncertain 12 months for investors. Nonetheless, the equity markets recovered strongly in most cases and ended the year in full swing. And perhaps the most commendable has been the performance of emerging markets (EMs). But, given the muted upturn in 2021, can emerging markets shake off pandemic concerns and show the same resilience for the remainder of the year as they did in the final months of 2020?
Last year, the MSCI Emerging Markets (EM) Index – the benchmark index for representing large and medium-sized companies in 27 emerging markets with almost 1,400 components and a free float-adjusted market capitalization coverage of around 85 percent in each country – outperformed the S&P 500 Index for the first time since 2017: +18.5 percent compared to the S&P 500 +18.4 percent. And from the point of view of the International Monetary Fund (IMF), the emerging countries are likely to experience considerable economic growth overall in the future. In part of its World Economic Outlook published in early April, the IMF raised its growth forecast for emerging and developing countries for this year to 6.7 percent, a significant improvement from the 6.3 percent it forecast in its January report would have. However, the fund kept its emerging markets forecast for 2022 at 5.0 percent; nevertheless, it reflects an extremely optimistic assessment of the growth path in the emerging countries.
Asian countries remain at the forefront of the EM complex after already doing so in 2020, with markets in China, Taiwan and Korea increasing around 40 percent over the year. Much of the region – including China – was first out of the blocks for the last two quarters of 2020 and this year’s first quarter in terms of the economic recovery from COVID-19. As lockdown restrictions were relaxed across the region, the level of economic activity has steadily recovered, with China being the first to weather the crisis but also one of the first to get back on track. Much of Asia has also been supported by robust demand for its exports, with social distancing restrictions supporting demand for electronics such as laptops from Vietnam and Taiwan as much of the world continues to be restricted to working and studying from home. this lively demand is likely to continue for some time.
But while China has already managed to reach gross domestic product (GDP) again before COVID-19, many emerging economies will not be able to repeat this feat until 2023 at the earliest, according to IMF chief economist Gita Gopinath. The fund also said that cumulative per capita income in emerging economies (excluding China) will be 20 percent lower than pre-pandemic projections in 2020-2022, much higher than the 11 percent projected for developed countries. “The divergent recovery paths are likely to create significantly greater differences in living standards between developing countries and others compared to pre-pandemic expectations,” Gopinath recently admitted.
S&P Global Ratings has similarly raised its growth forecast for emerging markets in 2021, with GDP growth expected to be 6.4 percent this year (excluding China) – a 50 basis point increase from the rating agency’s previous forecast – after falling by 5.4 percent in 2020 also identified three key explanatory factors for the upgrade:
- The outlook for global growth and external demand has improved, particularly in the United States and China, which should boost emerging markets manufacturing and raw materials.
- Surprisingly positive growth in the fourth quarter of 2020, meaning the carryover from that quarter to 2021 is higher than expected for most emerging markets.
- In some emerging countries, a more supportive fiscal policy stance is being adopted than previously assumed.
However, the near-term outlook for the domestic economy in emerging markets remains subdued, with acceleration expected in the final quarters of the year “as vaccinations accelerate and global demand increases”. BNP Paribas, meanwhile, estimated that emerging economies’ real GDP should grow 6 percent in 2021, despite very unequal performance between countries being predicted. “Economic activity benefited from stronger than expected momentum in late 2020 / early 2021, and favorable external factors continue to support growth recovery (further catching up in world trade, rising commodity prices and lower domestic borrowing costs than before the Covid19 crisis”), “said the French bank End of March. “However, many downside risks cloud the near-term outlook.”
Indeed, one of the downside risks that has emerged since Paribas’ outlook was released has been the emergence of more waves of COVID-19, which are subject to further damage to emerging economies – as has been acutely observed in India over the past few weeks. The South Asian nation – home to nearly 1.4 billion people, or 18 percent of the total population of the world – saw the world’s largest increase in new coronavirus cases in one day for two consecutive days in late April as a mutated variant of the virus continues to do so causing alarming numbers of cases and deaths, which in turn force the renewal of high-level restrictions on the world’s fifth largest economy. Sonal Varma, India’s chief economist at Nomura Holdings, said in late April that the country would “clearly experience a sequential growth slump” in the first fiscal quarter from April to June, with GDP expected to decline 1.5 percent over the three months. Month period.
The US economy, which is picking up again, must also be taken into account, in particular its potential effects of slowing growth in the emerging markets. Compared to last year, emerging market returns were not as pronounced in the first quarter of 2021; Some have attributed this to the perceived recovery in the U.S. economy, which has accelerated since new President Joe Biden announced a nationwide vaccine campaign that is ahead of schedule. The rebound has also raised long-term US Treasury bond yields, which has helped the dollar regain some of the strength it lost last year. This should prove challenging for some emerging markets, particularly Turkey, which continues to have an excessive dollar-denominated debt burden.
In addition, with Turkey, Brazil and Russia all raising their key interest rates recently, some emerging economies are facing aggravated economic conditions that could stifle growth for much of the year. However, Turkey’s growth has proven remarkably resilient in the face of more restrictive sentiment so far, and a heavy carryover has prompted S&P to revise its forecast for this year to 6.1 percent GDP growth for the Eurasian nation. The rating agency also expects Latin America to be one of the last regions in the world to return to pre-pandemic levels, as structural weaknesses, particularly in investments, will continue to dampen economic recovery.
Ultimately, as in virtually any country in the world, the outlook for emerging economies still depends heavily on how long the pandemic has lasted and how effective the response in those countries is. If vaccination programs are quick and effective and have the opportunity to reach the majority of the population, the blocking measures can safely be lifted at an earlier point in time. The IMF noted that it believes vaccination programs will provide adequate protection for most developed and some emerging economies by the third quarter of 2021 and most other countries by the second half of next year. But, as India proves again, that may be easier said than done. India is a large global vaccine manufacturer, but the ongoing domestic crisis means exports of vaccines have been stopped to address the evolving situation domestically. Other well-known emerging economies such as Brazil and Russia are also lagging significantly behind when it comes to vaccinations, even though both are major vaccine manufacturers.
The likelihood of cases spilling over also means other countries could suffer from the surge in cases in India. There is already evidence that neighboring countries Nepal and Sri Lanka are seeing more infections, while other economies in Asia such as Hong Kong and Singapore have recorded cases from India. However, it should also be emphasized that many emerging economies – especially in Asia – will continue to enjoy favorable conditions in the future and will not suffer from sluggish vaccination efforts or impending fines. “China, South Korea and Taiwan have weathered the pandemic best so far, have little external debt, and therefore few external vulnerabilities, and can broadly maintain an accommodating domestic stance,” the City of London Investment Management Company recently stated in its quarterly outlook from April. “Given their leadership in the asset class, EM[s] can therefore continue to perform well. “
Hence, with the emerging markets outlook increasingly diverging in the coming year, it appears that certain markets within the broader complex will continue to outperform while other emerging markets continue to grapple with the challenges of the pandemic. While exposure to emerging markets remains an attractive option for investors overall, recent projections suggest that drilling down to identify specific emerging market winners may ultimately be the more prudent approach.