The pace of vaccine rollouts has accelerated in core emerging markets (EMs) in the past few months. However, EMs continue to lag advanced economies--most EMs are well short of the so-called herd immunity level of 70%-80%--and vaccination rates vary widely remain across subregions. Specifically, countries we cover in EM-EMEA (Europe, the Middle East, and Africa) and Latin America are generally ahead of countries in EM-Asia (see chart 1).

Because of their faster progress on the vaccination front, just as virus-related restrictions eased, recoveries across EM-EMEA and Latin America--as measured by inflation-adjusted GDP (or real GDP)--were stronger in the second quarter than we had expected. Exports, especially commodity-related, expanded rapidly, and the services sectors that are usually vulnerable to the pandemic performed better than expected under the circumstances. The early signs for the third quarter are encouraging as mobility measures continue to move up (see chart 2) with low tolerance for renewed restrictions on economic activity.

On the other hand, in EM-Asia, even as economic growth was better than expected in the second quarter, the delta variant's rise in the third quarter tempered recovery more than we had anticipated. The slow progress of vaccine rollouts in the region combined with low tolerance for virus spread led to renewed restrictions on activity. Only recently has the spread of virus come somewhat under control, and mobility measures have started to normalize.

Chart 1

Chart 2

All this means is that recovery is delayed in EM-Asia, not derailed. In the near term, gains from the reopenings will be stronger in EM-Asia than in other regions, which should help the lagging EM-Asia economies get back to their pre-pandemic real GDP levels by the beginning of next year. Most EM-EMEA economies have returned to their pre-pandemic level of activity as they avoided renewed restrictions in the past three months. The median pre-pandemic real GDP gap for Latin America as of the second quarter is about 2% (see chart 3).

Chart 3

Merchandise trade will continue to support growth in the EMs in the coming quarters (inventory restocking continues in advanced economies after registering a very low inventory-to-sales ratio in the first half of 2021), but it's set to moderate. The pandemic-induced relative increase in goods spending is expected to shift back to services as activity in people-sensitive sectors normalize, thus boosting trade in services.

EM foreign exchange valuations are currently cheap, and current account positions are generally positive, by historical standards. EM currencies that typically appreciate when commodity prices and terms of trade improve have not strengthened in the same way as they have in past episodes of rising commodity prices.

Chart 4

Inflation continues to rise in many EMs because of higher fuel and food prices, and supply chain disruptions interacting with a stronger economic rebound. Unlike in advanced economies, the food weight in the consumer price basket is higher in the EMs. The U.N. FAO Food Price Index was up 33% in August from the same period last year, with little sign of softening in the near term. At the same time, exporters and factories are struggling with the impact of supply chain disruptions, shortages, shipping delays, and chronic port congestion.

Central banks in Brazil, Russia, Mexico, and Chile have already raised policy rates to tighten financial conditions to rein in inflationary pressures, while more countries in Latin America and EM-EMEA are likely to do so as well, sooner than previously anticipated, to keep inflation expectations anchored. (Turkey is an exception, with a surprise 100-basis-points cut just recently.) In contrast, inflation pressures in EM-Asia remain muted, outside of the Philippines. Inflation in India has eased somewhat since our last publication (on lower food price inflation) but remains near the upper end of the tolerance range at 6%. Except for a few countries (China, Saudi Arabia, and Indonesia), the majority of the countries in EMs are running real interest rates looser than their 10-year averages, by less than 100 basis points at the low end (Thailand and Turkey) to almost 600 basis points (Brazil) (see chart 6). To be sure, monetary stance is tighter than it seems, once adjusted for one-off effects and base-effects influencing current inflation.

Chart 5

Chart 6

Growth Forecasts: Revised Up For Latin America And EM-EMEA And Down For EM-Asia

We have raised our EM-14 (excluding China and India) real GDP growth forecast for 2021 as a downward revision for EM-Asia was more than offset by upward revisions for Latin America and EM-EMEA (see tables 1 and 2). Specifically, we lowered our growth forecast for EM-Asia by 0.4 percentage points (ppt) to 7.6%, while we revised Latin America and EM-EMEA up by 0.5 ppt and 0.7 ppt, respectively, to 6.2% and 4.8%. Our forecasts for 2022 are unchanged at 3.6%. Forecasts for 2023 and 2024 also remain broadly unchanged, averaging 3.1%. As of second-quarter 2021, 10 out of 16 EMs (EM-16, which includes China and India) were short of pre-pandemic levels. We forecast that all 16 will pass their pre-pandemic peaks by the end of second-quarter 2022.

Table 1

Table 2

Table 3

The detailed macro forecast tables--inflation, unemployment, exchange rates, and policy rates--appear in the Appendix.

Latin America (Argentina, Brazil, Chile, Colombia, and Mexico)

Growth in Latin America was a touch better than expected over the last quarter. The main reason was robust activity in the services sector, which has been more resilient to the impact of the pandemic. Lockdowns are having less of an impact on GDP in the region, with sectors that still have social distancing restrictions in place accounting for a small share of GDP. We therefore expect the region's GDP growth to start to stabilize around its trend growth, which is 2.5% on average. We see growth slowing to about 2.4% in 2022. The region will return to its pre-pandemic GDP level at the beginning of 2022, on average.

Chart 7

As economic growth picks up, inflation expectations have increased, which, for most of the region, remain above the central bank targets, both for year-end 2021 and next year. Latin American central banks have already started to increase interest rates, and will continue to do so in the coming months. Net monetary tightening, combined with net fiscal tightening (removal of stimulus), are the main reasons we expect growth to slow in 2022 compared with this year. Elections in several countries between the end of 2021 and 2022, amid high unemployment and social unrest, will likely limit investment until there is more policy predictability--also a key reason we expect slower growth next year.

By country, the biggest revision to our 2021 GDP growth forecast is for Chile--up just over 2 ppt to 9%. Consumption has been very strong, mainly as a result of several rounds of pension withdrawal allowances. However, this will also lead to a sharp slowdown in consumption next year, which is why we expect GDP growth to slow to 2.5% in 2022. For the rest of the region, we made only small upward adjustments to 2021 GDP growth--and in some cases marginal downward revisions for 2022--mostly reflecting better-than-expected second-quarter GDP results this year and higher inflation and interest rates next year than previously projected.

To read our full report on Latin America, see "Economic Outlook Latin America Q4 2021: Settling Into The New Post-Pandemic Normal Of Slow Growth."

EM-EMEA (Poland, Russia, Saudi Arabia, South Africa, and Turkey)

EM-EMEA economies posted solid growth in the second quarter--surprising again on the upside--benefiting from stronger-than-expected consumption and exports in most economies. As a result, we have revised up our 2021 growth forecasts for Poland, Russia, South Africa, and Turkey. EM-EMEA economies are ahead in the recovery, with output in Poland and Russia back to its pre-pandemic level in the second quarter and Turkey's real GDP exceeding its pre-pandemic level by 9%. South Africa's gap with its pre-pandemic activity has narrowed faster than expected, though there is still significant slack in the economy.

Growth in the third quarter varied by country, in part because of differences in pandemic developments. Growth momentum has remained strong in Poland but slowed in Russia. In South Africa, a third COVID-19 wave and riots in July weighed on growth, but the impact on activity appears to be temporary. A somewhat better-than-expected summer tourism season boosted Turkey's economy and foreign currency revenues.

Nevertheless, EM-EMEA economies are finishing the quarter with mobility levels that are close to, or above, pre-pandemic levels (see chart 8). This bodes well for consumption in the fourth quarter, but it also suggests that in the coming quarters, economic gains from further reopenings will be smaller than before. The path for domestic activity will be determined by how fast confidence returns, which is linked to progress on vaccinations, as well as policy settings.

Exports expanded rapidly, both in volume and value, thanks to robust global demand and high commodity prices. Trade will continue to support growth in the region in the coming quarters, but it's set to moderate as global spending shifts away from goods toward services and commodity prices ease. Among key EM-EMEA economies, Poland is the most exposed to supply chain disruptions, which will continue to weigh on the country's industrial production and exports for some time. That said, we expect the impact to be relatively limited thanks to Poland's diversified exports.

Chart 8

Inflation continues to rise in EM-EMEA economies, drifting further away from the central banks' targets, as supply-side pressures are interacting with a stronger economic rebound. Elevated core inflation, higher inflation expectations, and, in some cases, tightening labor markets are weighing on central banks to act.

The Russian central bank continued tightening in the third quarter, and even though the key rate is now in the restrictive territory, the bank will likely hike again to further anchor inflation expectations. Poland's central bank has remained on hold so far, but we now see its first hike earlier than previously anticipated, at the beginning of next year. Following a hike in March, Turkey's central bank kept the key rate on hold at 19% until recently, but delivered a surprising 100-basis-points cut in September, despite a continuing rise in headline inflation, to 19.25% in August. The recently announced shift in monetary policy focus to core inflation, which eased to 16.8% in August, suggests that more rate cuts are likely this year. In South Africa, core inflation remains subdued, reflecting larger economic slack, and headline inflation is likely to stay well within the target range of 3%-6%. We expect the South African Reserve Bank to keep rates on hold until the beginning of 2022.

To read our full report on EM-EMEA, see "Economic Outlook EMEA Emerging Markets Q4 2021: Higher Inflation Persists Amid Stronger Rebound."

EM-Asia (India, Indonesia, Malaysia, the Philippines, and Thailand)

Growth outlooks in EM-Asia are now stabilizing following severe and prolonged COVID-19 waves. Indonesia has been responding with light, rather than strict, lockdowns since early in the pandemic, while Malaysia and Thailand have recently eased restrictions, even though COVID-19 is not fully contained. The Indian economy is now recovering following a downturn due to a severe escalation in COVID-19 cases in April and May.

Severe COVID-19 waves hit economic activity hard in emerging southeast Asia, which led us to lower our 2021 growth forecasts for these economies. In August, we revised up our 2021 growth forecast for the group--Indonesia, Malaysia, the Philippines, and Thailand--to 3.1% from 4.3% and revised up 2022 marginally to 5.7% from 5.6% (see "Pandemic is Disrupting 2021 Growth Outlooks in Southeast Asia," Aug. 17, 2021).

Gradual reopening of the economy will support growth in EM-Asia. However, balance sheet costs have risen as households drew down on savings and the informal, micro, and small enterprise sectors faced closures. These costs will take time to unwind, and we expect economic activity for the region to be 11% below the pre-COVID-19 path by the end of 2022 (see chart 9).

Chart 9

While domestic demand recovers gradually, international trade has been preventing growth from slowing more sharply. Trade volumes and values are noticeably higher than pre-pandemic levels. However, a slowdown in trade is now underway, which means domestic demand will have to do more of the lifting to support growth.

Inflation in Asia-Pacific remains broadly muted as core price pressures are subdued. Weak domestic demand and lockdowns have kept a lid on core prices, which have, in turn, held back overall inflation. Energy price inflation is increasing at double-digit rates. Food prices, which have a higher weight in the overall inflation basket, have been more steady, though they've ticked up recently in Indonesia and the Philippines. Overall, this means we expect monetary policy to remain accommodative in the region until mid-2022.

To read our full report on Asia-Pacific, see "Economic Outlook Asia-Pacific Q4 2021: Growth Slows On COVID-19 And Rising China Uncertainty."

Risks To Growth

Even as economic activity in the EMs ramps up, downside risks to our growth forecasts from COVID-19 can't be brushed off just yet--in particular, worsening fatalities could reverse some reopening trends. At the same time, across the EMs (and globally, for that matter), manufacturers and exporters are facing headwinds from supply chain disruptions and surging freight and maritime costs. The risk is rising that ironing out supply-side wrinkles may take longer than the first half of next year.

Additionally, there are risks related to domestic fiscal and monetary policy focus transitioning to the post-COVID-19 expansion. First, in many EMs, fiscal positions have weakened significantly during the pandemic. In some cases, fiscal weakness predated the pandemic. It will be key for those EM governments to put their fiscal accounts on credible, sustainable paths, including stabilizing or reducing key debt ratios--albeit for most economies, a moderate fiscal adjustment may be sufficient to stabilize current ratios. Removing stimulus measures is a challenging task when the recovery is still fragile, with elevated levels of unemployment, and growth deceleration could prove sharper than expected.

Second, monetary authorities will have to walk a fine line in anchoring inflation expectations while supporting short-term growth. Core inflation in countries in Latin America and EM-EMEA (except South Africa) is running above central bank targets (target bands in some), and inflation expectations are rising in some, putting pressure on central banks to raise rates more aggressively than expected. Even in EM-Asia, where inflation remains fairly muted (except the Philippines, where it is above central bank target), central banks in the region are wary of easing in fear of capital outflows, considering the Fed is getting closer to tapering quantitative easing, which is the first step in normalizing monetary policy.

While not our baseline forecast, it is worth emphasizing that there is an outsize risk from U.S. policy normalization that may happen earlier than what is currently priced in the market (December 2022) (see more in "Economic Outlook U.S. Q4 2021: The Rocket Is Leveling Off," Sept. 23, 2021). The resulting repricing could cause market volatility, including widening spreads and diminished market access for higher-risk borrowers, as well as asset price volatility and downward adjustments, with knock-on effects on spending and, ultimately, employment and growth.

Even though most EM currencies are weak by historical standards, a renewed steepening in U.S. yields could still push those currencies lower and result in a less favorable backdrop for EM credit. (We emphasized in our third-quarter outlook that higher U.S. risk-free rates can have a number of negative effects on EMs. For more, see "Economic Outlook Emerging Markets Q3 2021: Despite Rising Resilience, Vaccinations Are The Key To Recovery," published June 28, 2021.)

In China, the government's policy stance of "dual circulation" (reduced dependence on foreign technology and economies) and "common prosperity" (reducing income disparity and aligning social values) implies an increased tolerance for lower GDP and private-sector income growth. If new Chinese policy direction results in materially slower trend growth, given China's established position in propelling global growth, the impact will be felt by a wide swathe of EM trading partners as well, especially commodity exporting ones. In addition, at the time of this writing, further uncertainty stems from property developer Evergrande, which is on the brink of defaulting. The recent downfall of Evergrande and China Huarong Asset Management Co. Ltd., resulting from regulatory changes and policy implementation, could cause temporary market dislocations, leading to heightened volatility and restricting market access for lower-rated EM issuers.

Together, these point to a possibly bumpy transition from ultralow rates and easy financing conditions to the post-COVID-19 steady state.

Related Research

S&P Global Ratings' research

• Economic Outlook Asia-Pacific Q4 2021: Growth Slows On COVID-19 And Rising China Uncertainty, Sept. 27, 2021
• Economic Outlook EMEA Emerging Markets Q4 2021: Higher Inflation Persists Amid Stronger Rebound, Sept. 27, 2021
• Economic Outlook Latin America Q4 2021: Settling Into The New Post-Pandemic Normal Of Slow Growth, Sept. 27, 2021
• Economic Outlook U.S. Q4 2021: The Rocket Is Leveling Off, Sept. 23, 2021
• Emerging Markets Monthly Highlights: Growth Is Resilient To The Pandemic, Inflationary Pressure Could Linger, Sept. 15, 2021
• Pandemic Is Disrupting 2021 Growth Outlooks In Southeast Asia, Aug. 18, 2021
• Economic Outlook Emerging Markets Q3 2021: Despite Rising Resilience, Vaccinations Are The Key To Recovery, June 28, 2021

Other research

• The EM Terms of Trade Puzzle, International Institute of Finance, Sept. 16, 2021
• Trade And Development Report 2021, U.N. Conference On Trade and Development, Sept. 15, 2021

Appendix

Table 4

Table 5

Table 6

Table 7

Table 8