Nearly two years into the pandemic, COVID-19 cases continue to ebb and flow, playing a central role in global economic activity. Nonsynchronous peaks and troughs of pandemic waves across core EMs have meant that the recovery is proceeding at varying and choppy speeds.

Activity appears to be rebounding strongly across EM Asia to begin the fourth quarter following a weak third quarter. The virus wave in EM Asia has receded sharply since our September publication, while manufacturing activity picked up substantially--as we had expected--in October as several countries emerged from lockdowns. Indonesia and Malaysia stand out among their regional peers, given their strong manufacturing recovery following a sharp contraction earlier (see chart 1). The region is a key part of Asia's trade network and is integrated into global electronic and autos supply chains. Lockdowns here scrambled suppliers' delivery times of components for production and final goods to other parts of the world.

Brazil and Mexico bore such a spillover in the third quarter, given that their recovery stalled partly due to disruptions to supply chains and shortages. Auto production in both countries, the region's major hubs for this industry, took a hit from shortage of microchips during the third quarter--a sharp reversal from what seemed in the first half of the year a promising rebound (see chart 2). EM Asia's pick-up in manufacturing is a welcome sign for the rest of the world, including Brazil and Mexico, as it portends to partial easing of supply-related headwinds to manufacturing in the fourth quarter. However, shortages are likely to persist for some time, curbing auto production capacity.

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Chart 2

On the other hand, new outbreaks--seemingly driven by the Delta variant--have become a challenge in the fourth quarter for emerging economies in Europe (Poland and Russia) (see chart 3). The latter country reimposed containment measures in early November to curb a fourth wave of infections that has led to the highest number of daily cases and deaths since the pandemic began. Poland's retail and recreation mobility has weakened steadily in the past month. Albeit we observe only a diminished impact on economic activity, outbreaks in Russia and Poland have served as a reminder about the risks when a large share of the population remains unvaccinated. South Africa, where the level of vaccination is the lowest among key EMs, moved to a level 1 lockdown on Oct. 1, 2021--the lowest level of restrictions--but the new COVID-19 variant (Omicron) brings a risk of stricter lockdowns.

S&P Global Ratings believes the new Omicron variant is a stark reminder that the COVID-19 pandemic is far from over. Although already declared a variant of concern by the World Health Organization, uncertainty still surrounds its transmissibility, severity, and the effectiveness of existing vaccines against it. Early evidence points toward faster transmissibility, which has led many countries to close their borders with Southern Africa or reimpose international travel restrictions. Over coming weeks, we expect additional evidence and testing will show the extent of the danger it poses to enable us to make a more informed assessment of the risks to credit. Meanwhile, we expect the markets to take a precautionary stance in markets and governments to put into place short-term containment measures. Nevertheless, we believe this shows that, once again, more coordinated, and decisive efforts are needed to vaccinate the world's population to prevent the emergence of new, more dangerous variants.

As the pandemic cycles through EMs, vaccination rates have picked up substantially in the past two months-- Chile, China, and Malaysia already reached the so-called herd immunity threshold of 75%. In the meantime, the pace in the Philippines, Indonesia, and Thailand has accelerated notably in the past three months. Saudi Arabia, which had an early start to vaccination, has slowed down significantly in the past three months since reaching the 50% mark. The vaccination rollout in Poland has also stalled (54% fully vaccinated), while in Russia the share of the population fully vaccinated is 37%, which is less than the global average of 42% and remains a step slower than core EM peers at a similar vaccine progression stage. In South Africa, vaccination accelerated in the last couple of months compared to its regional peers, but overall share of population vaccinated is the lowest among the core EMs, with less than a quarter of the population fully vaccinated. Vaccine hesitancy could be a key obstacle in those countries where vaccination uptake is relatively slow or stalling, but logistical issues also play a role in some cases. We note that EMs excluding China have moved away from a zero-COVID strategy, and the bar for reinstating severe restrictions remains high given the progress in vaccination (notwithstanding severe strains on the healthcare system).

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Meanwhile, inflation continues to rise in many EMs because of higher fuel and food prices, and supply chain disruptions interacting with a stronger economic rebound and tight labor markets in Poland and Russia. Imported inflation is an important factor, as export prices across major trading partners have shot up, and this effect is in some cases compounded by weaker currencies. Unlike in advanced economies, the food's share of the consumer price basket is higher in the EMs. The U.N. FAO Food Price Index was 133.2 in October, having risen for three consecutive months and is currently at its highest level since July 2011 with little signs of receding in the near term. At the same time, exporters and factories are struggling with supply-chain disruptions, shortages, shipping delays, and chronic port congestion. Imported inflation is also an important factor, because export prices in major trading partners have shot up, and this effect is in some cases compounded by weaker currencies.

However, in our view inflation will soon peak (see chart 5). We see signs that inflation is starting to slightly ease as supply bottlenecks unjam, higher prices weaken demand, and base effects start to wear off. Although S&P Global Ratings analysts recently raised our oil price assumptions and now expect Brent oil prices to average $65 per barrel (bbl) in 2022, up from $60/bbl previously, this still marks levels lower than $70-$85/bbl the last three months. We anticipate a more moderate $55/bbl in 2023 and beyond as supply picks up (versus $64/bbl 2019 average). The S&P GSCI Industrial Metal Price Index hovered around 475 last week, which is still higher than 2019 range of 310-335, although more than 11% lower than the near-term peak in mid-October. After surging in August and September, the Baltic Exchange Dry Index (BDI) declined by 55% as of third week of November 2021, from its record high in October, and is now near its lowest level since the start of the pandemic. While the BDI can experience significant volatility, the significant drop does suggest that bottlenecks in the global transportation network are improving. On the manufacturing front, the Taiwan Manufacturing Purchasing Managers' Index of backlog of orders fell to 50.3 as of October from a peak of 71.5 in April, signaling that semiconductor production capacity is improving relative to strong global demand (a good indication for rising car production). Still, production and delivery momentum has slowed with bottlenecks in some sectors, most notably semiconductor chips, which have held back production in sectors including electronics and autos. Despite the noted improving production capacity, S&P Global Ratings analysts see pressure in the chip manufacturing sector lasting another year.

Chart 5

Rising inflation will continue to keep central banks on a tightening bias. The pace of tightening accelerated with more aggressive moves in Latin America and EM-EMEA. Over October-November, six central banks in Brazil, Chile, Colombia, Mexico, Poland, Russia, and South Africa raised rates, in several cases starting earlier than expected and/or delivering above-consensus interest rate hikes. These policy responses reflect in part a weaker anchoring of medium-term inflation expectations. The recent rapid rise in energy prices has increased market-implied expectations for more rate hikes in the coming months across most EMs outside of Asia. The outlier was Turkey, which reduced rates despite high and rising inflation, causing the lira to tumble. We view developments in Turkey as country-specific, and don't expect a broad-based contagion to other EMs. However, global financial conditions are set to tighten, posing challenges to EMEA economies. Our base-case scenario assumes that this tightening will be gradual, but a risk has risen of a faster monetary policy normalization in advanced economies, particularly in the U.S.

Our Updated Forecasts

We have raised our real GDP growth forecast for 14 EMs (excluding China and India) for 2021 by 0.2 ppts to 4.9%, reflecting the upward revision for EM EMEA, with no changes to Latin America and EM Asia (see tables 1 and 2). We trimmed our forecast for 2022 by 0.1 ppt to 3.5%, driven by a 0.5 ppt downward revision to Latin America's growth, largely because of downgraded forecasts for Brazil and Chile. Forecasts for 2023 and 2024 remain broadly unchanged, averaging 3.1%.

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. Despite the likely easing of supply-chain pressures, we expect year-over-year (y-o-y) growth rates to slow further across EMs. The pandemic-induced increase in spending on goods is likely to shift back to services, given that activity in sectors that rely on close physical proximity normalizes, boosting trade in services (e.g., tourism). Gradual withdrawal of fiscal support (sharply in Chile in 2022) means larger burden of growth going forward on the private sector that has seen its purchasing power erode from inflation. Tighter financial conditions (especially in countries such as Brazil) will hinder GDP growth by raising borrowing costs on interest sensitive spending for households and businesses.

Table 1a

Table 1b

Table 2

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

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

We forecast GDP growth in key EMEA emerging economies to average 3.2% in 2022, broadly unchanged from our September forecast. We expect a slower growth than the regional average of 5.2% this year, due to a number of factors:

• Normalization of growth rates after a strong rebound linked to reopenings of the economies;
• Softer global demand for manufactured products and commodities;
• A gradual withdrawal of fiscal support; and
• Tighter and more volatile external and domestic financing conditions.

Still, most economies in this region should see above-average growth in 2022, given that the recovery from the COVID-related downturn hasn't run its course, and some sectors continue to operate below capacity.

The pandemic's recent resurgence in emerging Europe is weighing on near-term growth prospects in the region. South Africa moved to a level 1 lockdown on Oct. 1, 2021--the lowest level of restrictions--but a new COVID-19 variant (Omicron) brings a risk of stricter lockdowns. While we observe a smaller economic damage from new waves, the worsening pandemic situation can still undermine confidence and spending, even in the absence of widespread lockdowns. Insufficient progress in vaccination remains a key risk to the outlook. In some countries in EMEA, vaccination rollout is low or has stalled. While Poland was initially was ahead of other EMs in terms of its vaccination levels, over the past few months progress has slowed. The share of vaccinated population has increased by only by 2 percentage points (ppts) over the past two months, and the total level is relatively modest at 55%--significantly below the 67% level of the EU. In Russia and South Africa, vaccination levels are even lower, but we have seen some progress over the past couple of months.

Among key EMEA emerging economies, we expect the strongest growth in Poland, with growth averaging 5.0% next year, on par with an expected 2021 output of 5.2%. Our 2022 growth forecast is 0.3 ppts lower than our September baseline, mainly because of a somewhat less bullish view on fixed investment growth in the context of the increasing tensions between the Polish government and the EU concerning the Polish judicial system reforms. We expect the Russian economy to grow by 2.7% in 2022, down from a projected 4.2% in 2021, as domestic demand moderates amid policy tightening. Oil exports should rise in line with the OPEC+ agreement, and we also see an upside in gas exports. Meanwhile, geopolitical risks have flared up.

Recovery in Turkey is well ahead of those in other EMs, but risks to macroeconomic stability have risen amid the volatility in financial markets. Our baseline assumes a stabilization in financial markets and a slowdown of GDP growth to 3.7% in 2022 from an expected 9.8% this year. But there's a very high uncertainty around this scenario, given that sharply different outcomes for the exchange rate, inflation, interest rates, and ultimately growth, are possible next year and in 2023.

Inflationary pressures persist across most key EMEA emerging markets, with recent readings at multi-year highs amid strong demand, ongoing supply disruptions, high food and energy prices, and tight labor markets in Poland and Russia.

Several EMEA central banks have brought forward or accelerated policy tightening. Central banks in Poland and South Africa started normalizing rates this quarter, while Russia's central bank raised the key rate by 75 basis points (bps) to 7.5% in October, further into restrictive territory. Turkey's central bank, on the other hand, slashed the policy rate by cumulative 300 bps in October and November, after a 100 bps cut in September. These frontloaded rate cuts, which accelerated after a dismissal of top central bank officials in October, undermined market sentiment and triggered a selloff in Turkey's currency markets, with the lira dropping 20% versus the U.S. dollar since mid-November.

Chart 6

We believe that many of inflation drivers, such as high energy prices and supply bottlenecks, are temporary, and expect them to subside in the coming months. Our baseline is for annual headline inflation to start declining gradually across EMEA emerging markets, which in many cases is already occurring in the fourth quarter. Nevertheless, inflation is likely to remain elevated throughout the first half of 2022, and above the target in most cases. Heightened uncertainty about domestic and global inflation outlook and the speed of U.S. monetary policy normalization will continue to keep central banks on a tightening bias.

The direction of Turkey's monetary policy is unclear at this point. The rapid depreciation of the lira will add to already significant inflationary pressures, raise the risks of deposit dollarization, and strain corporate balance sheets. This can lead to an eventual reversal of the easing cycle, and even a sharp hike in the policy rate. At the same time, recent developments suggest a bigger tolerance for lira depreciation and preference for lower rates.

To read our full report on EM EMEA, see "Economic Outlook EMEA Emerging Markets Q1 2022: High Inflation And COVID-19 Threaten To Slow Recovery," published Nov. 30, 2021.

LatAm (Argentina, Brazil, Colombia, Chile, And Mexico)

We lowered our 2022 GDP growth forecast for the five major Latin American economies by roughly half a percentage point to 1.9%, compared with the expected 6.2% growth in 2021, the forecast for which remains unchanged from our previous publication. This is mainly due to higher and less transitory-than-expected inflation, which will push up interest rates across the region. The combination of higher energy prices (which are driving more than half of the CPI increases), weaker exchange rates, and the impact of ongoing re-openings will keep inflation above central-bank targets throughout 2022. Furthermore, supply-chain bottlenecks have been more disruptive than expected to manufacturing production in the region. This will take a toll on near-term growth in countries with large manufacturing hubs, such as Mexico and Brazil. Several factors will keep downside risks to growth particularly high in 2022. The combination of slow growth, high inflation, and still-weak labor market dynamics, amid a heavy electoral cycle, will increase demands for continued fiscal stimulus measures. This could increase upward pressure on interest rates to compensate for the associated higher fiscal risk premia, and keep investment subdued.

Chart 7

Two countries stand out for having a higher risk of a deeper-than-expected GDP contraction in 2022--Chile and Brazil. In Chile, domestic demand surged in 2021 due in large part to sizeable stimulus measures that are unlikely to be repeated in 2022. Domestic demand in Chile is now running 20% above its pre-pandemic level, compared with the median 6% across the major LatAm economies. Brazil's ongoing aggressive tightening in monetary policy that will continue into 2022, partly due to weaker fiscal dynamics, threatens to subdue domestic demand more than expected. The last time real rates (in a one-year ex ante basis) were at this level was in 2015, during which the Brazilian economy contracted. We currently forecast GDP growth in Brazil to slow to 2% in 2022 from 4.8% this year, and in Chile to 2% in 2022 from 11.4% in 2021.

See our LatAm macroeconomic outlook for further details on our forecasts for the major economies in the region, "Economic Outlook Latin America Q1 2022: High Inflation And Labor Market Weakness Will Keep Risks Elevated In 2022," published Nov. 29, 2021.

EM Asia (India, Indonesia, Malaysia, The Philippines, And Thailand)

Third-quarter growth was weak in EM Asia in line with our expectations as the pandemic's escalation and subsequent lockdowns weighed on economic activity. The pace of new COVID-19 cases has slowed sharply across the region and vaccination rates are improving, although these five economies as a group trail behind the rest of Asia in vaccination coverage. Authorities are gradually opening economies and looking to live with the virus, while future lockdowns are likely to be targeted and less economically costly.

Following a severe pandemic wave during the third quarter, mobility has now recovered to near pre-pandemic levels, and activity has been picking up as well. The average manufacturing purchasing managers' index (PMI) reading for the region was 53.4 in October, indicating that the manufacturing recovery is gaining steam following weakness during lockdowns. The activity momentum means that fourth-quarter activity will show a strong rebound.

Chart 8

Note: Economies included are India, Indonesia, the Philippines, Malaysia, and Thailand. Data aggregated using simple averages. Baseline mobility refers to median mobility over the five-week period between Jan. 3 and Feb. 6, 2020. Sources: IHS Markit and Google Community Mobility Reports.

Our growth forecasts across the region are stabilizing. The two exceptions are Malaysia and the Philippines. We cut our 2021 growth forecast for Malaysia by 60 bps to 2.6% as the economy contracted sharply at 4.5% y-o-y in the third quarter, owing to tight lockdowns and smaller fiscal stimulus than in 2020. In contrast, Philippines' growth surprised on the upside with y-o-y rate of 7.1%, compared with consensus expectation of 4.8%, thanks to strong consumer activity.

In contrast with other EM regions, inflation remains broadly contained in emerging Asia for now. The two factors behind it are the controlled food inflation and low core inflation, as domestic demand is recovering gradually. Core inflation is likely to pick up in 2022 as re-opening progresses, which will heighten inflationary pressure and cause central banks to begin monetary policy normalization.

See our Asia-Pacific outlook for further details on our forecasts for the major economies in the region: "Economic Research: Asia-Pacific: Ghosts Of COVID Past Hover Over 2022," published Nov. 30, 2021.

Downside Risks To Factors Shaping The Growth Outlook

Factors that pose downside risk to our baseline growth forecasts haven't changed much since our last publication. In the near term, growth across EMs could be weaker than we project if the pandemic takes longer than expected to abate. If the new Omicron variant indeed proves more contagious as initial reports suggest, there will be a short-term reversal in the reopening of global travel and tourism--the economic fallout of which would probably be largest in South Africa and EM countries with larger tourism sectors such as Thailand, Indonesia, and Mexico. If global risk appetite falls, this could cause more stress in countries with large external financing needs, namely Turkey in our core set of EM countries. Over coming weeks, we expect additional evidence and testing will show the extent of the danger the variant poses to allow us to make a more informed assessment of the risks to macro-credit.

On policy transition risk, removing fiscal stimulus measures is a challenging task when the recovery is still fragile, with elevated levels of unemployment, and growth deceleration could be sharper than expected. Political risk in LatAm is also rising due to adverse socioeconomic and political dynamics. Moreover, monetary authorities will have to walk a fine line in anchoring inflation expectations while supporting short-term growth. Core inflation in LatAm and EM EMEA is running above central bank targets (target bands in some) and rising, while inflation expectations are increasing in some countries, putting pressure on central banks to raise rates more aggressively than expected. At the same time, developed markets' central banks are poised to become less expansionary, winding down QE and beginning multi-year process of rate normalization. Persistent high inflation requiring an unanticipated monetary policy adjustment in the major global central banks is now a credible macro risk. While an orderly reflation remains our macro-credit base case, the chance of a disorderly transition to a more normal rate structure still exists in EMs, which have a higher risk of sharp moves in capital flows (needed to finance budget and current account deficits), less anchored inflation expectations, and lesser fiscal space, and would feel the effects more acutely. In the event of rising outflows, EM central banks may be forced to raise rates aggressively to protect the balance of payments and support exchange rates.

China's policy to transition toward "common prosperity" and greater financial discipline, in the near term, could mean growth disruption that's more broad-based than the ongoing real estate sector slowdown. China's greater shift toward slower medium-term growth will mean slower demand growth for EMs--and a deeper among some. Trade linkages with China vary across countries; several economies have large trade exposure. Some economies rely on China's demand for metals and raw materials, such as Chile and South Africa, while others are more dependent on energy or machinery (including electronics) demand, such as Malaysia, Thailand, and the Philippines.

Chart 9

Appendix

Table 3

Table 4

Table 5

Table 6

Table 7