As most emerging market (EM) economies continue to recover from the COVID-19 pandemic, the Russia-Ukraine conflict and inflation risks now dominate the outlook. The circumstances surrounding geopolitical tensions continue to evolve quickly in unexpected ways, and the implications for global economies are highly uncertain. In the near term, the conflict is likely to weigh on economic activity for most parts of the emerging world and raise inflationary pressure broadly.

Table 1

Macro Data Came In Stronger Than Expected Since Our November Publication

The Russia-Ukraine conflict escalated midway through first quarter--at a time when macro data since our last Credit Conditions Committee (in November) had come in stronger than expected globally, including in most EM economies. Combined with historical revisions, overall real GDP growth in 2021 now appears to have been 7.3% for our sample of 16 EM countries, which is 0.3 percentage points (ppts) higher than we expected in November. Excluding China and India, EMs likely grew 5.6% during the year, materially above our 5.0% forecast. In the fourth quarter of 2021, Mexico, Philippines, and Thailand were the only economies in our sample with real GDP still below fourth-quarter 2019 levels.

The omicron variant of COVID-19 spread quickly, but its economic impact was limited. S&P Global's (previously IHS-Markit) manufacturing purchasing managers' index (PMI) in the first two months of the year point to decent industrial output growth even as omicron spread during the months. Aside from Russia, only four EMs (out of 12 reported in our sample)--Brazil, Malaysia, Mexico, and Turkey--appear to have been struggling before the conflict began (see chart 1). However, PMI surveys also suggest that supply chains remain stretched. Supplier delivery times are still lengthening (albeit at a slower rate), and backlogs of work building (see chart 2).

Chart 1

Chart 2

The Russia-Ukraine Conflict Is Likely To Exacerbate Negative Supply Shocks

The Russia-Ukraine conflict could exacerbate shortages and lead to higher prices. Russia is an important exporter of hydrocarbons, fertilizers, and metals, while Russia and Ukraine are major producers of grains--particularly wheat and corn (see chart 3). Russia is facing difficulties in exporting some of its products because of sanctions, logistical issues, and unwillingness of some established trade partners to buy Russian products, while Ukraine has been cut off physically in many ways. In addition, Belarus (which is subject to international sanctions) is a major exporter of fertilizers, particularly potash, which accounts for one-fifth of the world's total exports. The conflict has caused a widespread surge in commodity prices. Prices for some commodities have jumped by more than 30% in the past two weeks (see chart 4).

Chart 3

Chart 4

For most EMs outside of Europe and Central Asia, direct trade (see charts 5-6), financial, and other economic ties with Russia are very small as a percent of each country's GDP--and with Ukraine smaller still. That said, Russia and Ukraine's important role as major exporters across many commodity classes risks disruptions to global supply chains, which would affect EM industrial production. Disruptions to the supply of metals (such as palladium and nickel) and gases (such as xenon) could exacerbate capacity underutilization in EM auto production (for example, in Mexico and Brazil), which is already hampered by the ongoing semiconductor shortage. On the other hand, South Africa--which is already a major exporter of platinum group metals, which include palladium as one of the rarest metals on earth used in auto production--is poised to increase its investments and exports to cover some of the sudden void of such metals from issues with Russian supply (either due to sanctions imposed on Russia or self-avoidance from sourcing companies).

Chart 5

Chart 6

An Important Channel Of Impact: Higher Commodity Prices

Commodity prices is the most important indirect channel that could affect EM economies. Energy prices are likely to remain higher over the coming months compared with what we thought just a couple of months ago--reflected in S&P Global Ratings' recent upward revision of energy prices (see "S&P Global Ratings Raises Near-Term Oil And Gas Price Assumptions," published Feb. 28, 2022). Ten out of the 16 EM economies we look at are net importers of energy (see chart 7). Structural vulnerability metrics point to Thailand, Turkey, Chile, the Philippines, India, and Poland as most at risk to the energy price shock (see "What Higher Energy Prices Mean For Emerging Markets," published March 3, 2022). Malaysia, Indonesia, South Africa, and Latin American countries (excluding Chile) are net exporters or close to neutral in energy trade. But composition of energy trade matters. In our view, because Indonesia, South Africa, and Latin American countries rely on refined oil imports, consumers will face a higher price tag either directly or indirectly.

Chart 7

Chart 8

Agricultural commodity prices will potentially rise further in the coming months given Russia, Ukraine, and Belarus's major role in food commodity and fertilizer production. The World Food Program cites inventories are already tight globally, and weather events hampered last year's plantation season, so much so that now the upcoming harvest looks bleak. Compared with advanced economies, food consumption weight in EMs accounts for a higher percentage of their consumption (about 25% for a median EM) (see chart 8). Food price inflation was elevated in EMs in Latin America and Europe, the Middle East, and Africa (EMEA) throughout 2021 but remained low in EMs in Asia. In general, Asian EMs seem to be less vulnerable given their higher reliance on rice (instead of wheat), which should be less affected by spillovers from the conflict in Ukraine.

Rising food prices have long been a catalyst for social and political upheavals in EM economies. In many countries in North Africa and the Middle East that are particularly dependent on food imports, there are already now reported protests by the population against a sharp rise in prices. Governments might be tempted to try to shield households from the impact of higher food and energy costs. Latin American countries are particularly in the crosshairs--because countries rely on refined oil imports, governments must choose between extending fuel subsidies and seeing deficits widen further, or allowing inflation to run away from central banks' targets for a second straight year. In Brazil and Mexico, energy prices (especially gasoline) have a large tax component, and in both cases, governments have started to lessen the tax burden on energy consumption. While mitigating the impact of the price increases on inflation, income, and growth, that would likely result in deteriorating fiscal dynamics. Overall, fiscal policy in many EM economies is more limited after two years of COVID-19-related budgetary support.

Our Updated Forecasts

As such, we have lowered our 2022 real GDP growth forecast for EMs by 0.8 ppts to 4.0%. This lower forecast mainly reflects the downward revision for EMs in EMEA (see tables 2-3), led by the massive downgrade to Russia (severe recession, whereas we expected 2.7% GDP growth previously) and the more than 1 ppt downward revision to Poland and Turkey. We trimmed our forecast for 2023 by 0.1 ppt to 4.3%. Forecasts for 2024 and 2025 remain broadly unchanged, averaging 4.4%.

Inflation will be 1.2 ppts higher for the median EM compared with November forecasts, with the median in Asia 0.7 ppts higher and the median in Latin America and median EMEA more than 2 ppts higher. Inflation will likely exceed central bank targets in more countries (see table 4). Higher inflation will keep EM central banks in tightening mode in 2022. We have raised policy interest rates assumptions broadly for 2022 and beyond. Anchoring inflation expectations amid rising inflation combined with rising U.S. interest rates will dictate central bank policy decisions in the short term. In 2023, however, we anticipate central banks in Latin America to start cutting policy rates as inflation starts heading back to target and the need to support growth trumps the risk of not meeting inflation expectations (see table 5).

Table 2

Table 3

Table 4

Table 5

Concurrent Risks Ahead

A key risk to our baseline growth and inflation forecasts come from energy and food prices staying high for longer than currently assumed in our baseline forecast.

On average, our estimates for oil and gas prices are about 30% higher in 2022 than in our November baseline. The effect is a spike in inflation in the next two quarters as prices rise sharply, followed by a decline in inflation rates as energy prices drift lower. Importantly, we also assume that oil and gas continue to flow from Russia to its energy trading partners. Our assumption could prove to be too optimistic if the current geopolitical conflict evolves in a way that leaves energy prices (and other commodities including food, for that matter) higher for longer than in our baseline assumption. Larger share of household budgets would be spent on energy (and food), since these purchases are necessary for most households and leaves less to spend on other items. The same goes for businesses whose goods must be shipped from place to place or that use fuel as a major input (such as the airline industry). Such combination of more expensive production and consumption would mean a lower growth profile and higher inflation than in our baseline case.

If the pandemic has taught us anything, it is that interdependent and complex supply chains globally mean that small disruptions in one region can be seriously amplified somewhere else, and a significant supply shock can lead to an even greater demand shock.

The virus continues to circulate, and the possibility of new variants remains a concern. New COVID-19 lockdowns in China could also create obstacles in globally integrated demand and supply, at least in the near term. Besides, a persistent slowdown in the world's second-largest economy (beyond just the near term from lockdowns) would also mean a lower global growth to bank on.

Additionally, in the case of a sharper Fed tightening than what S&P Global Ratings currently assumes (or the market is currently pricing for that matter), the feedthrough to tighter monetary conditions would follow broadly in the EMs--those EMs that have dollar pegs (the Gulf--Saudi Arabia), follow the Fed closely (Mexico), or are at an early stage of their hiking cycles (South Africa), would face more upward pressure on their domestic interest rates. Higher interest rates, in the absence of improved growth prospects, would in turn tame domestic demand. Combined with a higher commodity import bill for many net importers, current account and public debt vulnerabilities may turn out to be larger than currently appreciated. (For our discussion on EM vulnerability see "How Prepared Are Emerging Markets For The Upcoming Fed Policy Normalization?," published Jan. 27, 2022.)

Russia: Forecast With A High Degree Of Uncertainty (And Humility)

The Russian economy will experience significant fallout from the impact of international sanctions and decisions by Western businesses to either halt operations in Russia or cut ties with the country altogether. The precise combination of sanctions placed against it has never been imposed on a large, globally integrated economy, so we have little to go on to predict how big the impact will be, other than that it will be large.

Still, with a high degree of forecast uncertainty (and humility), we pencil in the Russian real GDP to decline by 8.5% this year. For comparison, the greatest one-year decline was in 1992 when the economy shrank by 14.5%, part of a much larger multiyear shrinkage of about 40% during the early '90s transition from a centrally planned to market-oriented economy. The Russian economy contracted by 5.3% in 1998, during the Russian financial crisis, and by 7.8% during the global financial crisis. The 2015 recession--triggered by falling oil prices and international sanctions--was milder, with GDP declining by 2%, while the COVID-19-related downturn resulted in a 3% drop in output in 2020.

Even under the assumption that sanctions will spare Russia's commodity exports, we expect overall export volumes to decline this year. Large-scale capital outflows have led to a sharp drop in the ruble, prompting the central bank to hike the policy rate to 20% and introduce capital controls. The pass-through of large currency depreciation to domestic prices is fueling inflation, which we expect to average 16% this year. Investment is set to decline sharply amid a confidence shock, a significant tightening of financing conditions, and uncertainty about future demand. Even though a fiscal response will likely offset some of these trends, the overall decline in domestic demand will be sizable.

Chart 9

Emerging EMEA (Poland, Turkey, South Africa, And Saudi Arabia)

Because of its geographic and economic proximity, EMs in Europe are the most exposed to the Russia-Ukraine conflict via trade, financial, and confidence channels. Another channel of transmission is higher energy prices, as most emerging European economies in our core EM sample are net energy importers, including Poland and Turkey. What's more, they are exposed to elevated and highly volatile European gas prices. Higher energy and food prices are adding to already high inflationary pressures, with weaker exchange rates exacerbating these trends. Meanwhile, spreads have widened and exchange rates depreciate, more sharply than in other regions, tightening financial conditions. For the rest of the key EMs in EMEA, including Saudi Arabia and South Africa in our core EM sample, the picture is mixed. Direct trade links with Russia are small, while rising commodity prices are benefiting some commodity exporters, such as Saudi Arabia (oil) and South Africa (iron ore, platinum, gold). However, the deceleration in global growth and hit to confidence will likely limit these gains. A prolonged conflict, resulting in more severe trade, supply chain, and possibly energy supply disruptions is a key downside risk for EMs in Europe.

Economic fallout from the conflict is interrupting strong growth momentum in Poland. We have revised GDP growth down to 3.6% in 2022, from 5% in the November forecast. While exports to Russia make up only 3% as a share of total Polish exports--down from more than 5% before the 2014 conflict--the Polish manufacturing sector is closely integrated into European supply chains and will therefore suffer from supply chain disruptions due to the conflict, as well as weaker European demand. At the same time, the conflict-related confidence shock will weigh on private investment. We have also significantly raised our inflation forecast, to 8.6% in 2022, reflecting upside inflation surprises, higher oil price assumptions, weaker currency, as well as looser fiscal policy and the increase in the minimum wage. There are notable uncertainties around the inflows of refugees and their integration into Poland's labor market, as well as outflows of workers from the construction sector.

For Turkey, the spillovers from the conflict are amplifying domestic challenges, pushing up already high inflation, worsening external accounts, and further clouding economic outlook. In our baseline scenario, we expect GDP growth to slow sharply to 2.4% in 2022 (a downward revision from 3.7% previously) from 11% in 2021. High-frequency activity data point to a weaker start of the year, with industrial production and retail sales contracting in January. Exports have been one of Turkey's key growth drivers, but trade prospects have dimmed. Exports to Russia and Ukraine account for around 4% of total exports, and Turkey is also facing weaker demand from the eurozone, its major exports destination. Higher exports to the Gulf may partially offset these losses. The prospects for tourism are uncertain, with an upside from stronger European tourism thanks to an improved pandemic situation and a competitive lira, but likely a lower number of visitors from Russia, which accounted for 19% of all foreign arrivals last year. That said, Turkey can potentially benefit from being one of the few destinations with direct flights from Russia and visa-free travel arrangements. In any case, the current account deficit is set to widen due to rising energy imports. In the environment of faster Fed tightening, this will keep the Turkish lira under pressure. Rising food and energy prices and weaker currency will worsen an already dire inflation outlook. We have made further revisions to our expectation for annual average inflation in 2022 this forecasting round, to 55%, above our already raised inflation forecast from early February of 49.5% for the year (see "Turkey Macroeconomic Update: Higher Inflation, Uncertain Growth Path," Feb. 3, 2022).

We have lowered our 2022 GDP growth forecast for South Africa to 1.9% (from 2.4% in November). We expect economic growth to decelerate as most GDP components have reached pre-pandemic levels, while rising inflation will exert pressure on households' real incomes. South Africa's exporters should benefit from ongoing price rallies across iron ore and platinum group metal markets, and we expect exports to perform strongly in 2022. Having said that, problems with energy infrastructure are still present and may constrain production and exports. On the back of rising oil prices, we have raised our inflation forecast to 5.9% on average in 2022. Taking into account rising inflation risks and accelerated Fed tightening, we now expect the South African Reserve Bank to raise the key rate to 5% by the end of the year. Terms of trade have improved thanks to higher metal prices (although rising oil prices offset some of the gains), and we expect this to offer support for South Africa's rand amid the Fed tightening and ongoing market volatility.

Chart 10

(To read our full report on emerging EMEA, see "Economic Outlook EMEA Emerging Markets Q2 2022: Weaker Growth, Higher Inflation, Tighter Financing Conditions," published March 28, 2022.)

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

Economic growth in Latin America toward the end of 2021 was generally better than expected, driven by a continued recovery in demand and, in some cases, fueled by stimulus measures. By the end of last year, GDP in every major Latin American economy was back to its pre-pandemic level, with the exception of Mexico, where supply-chain disruptions and weak investment dynamics drove economic activity to stall in the second half of 2021. We expect a weak first half of 2022 as an uptick in inflation, higher interest rates, less fiscal stimulus, continued supply-chain disruptions, and the initial impact on confidence from the Russia-Ukraine conflict take a toll on economic activity. We lowered our 2022 GDP growth forecast for Latin America by 0.2 ppts to 1.7%.

The impact of the Russia-Ukraine conflict on Latin America's GDP is relatively mild compared with other parts of the world due to low trade and financial linkages with that region. The main channel of transmission to the region is commodity prices. Most of the major Latin American economies are net commodity exporters if you combine food, metals, and energy-related commodities. This means commodity producers in the region could benefit from higher prices, assuming demand for those goods does not fall more than their respective increase in price. However, on the flip side, domestic consumers will pay for higher commodity prices through higher inflation, especially regarding food and energy prices, which combined account for about one-third of the typical consumer price basket in Latin America. In our view, the net impact of the current increase in commodity prices on 2022 GDP in Latin America is negative.

Inflation, which has already been running well above central banks' targets for several quarters now (both observed and expected), is now likely to stay high for longer (see chart 11). This will encourage central banks to continue and, in some cases, step up their monetary policy tightening cycle. In recent months, interest rate expectations have gone up more than inflation expectations across the major economies in the region, which means that domestic financing conditions have generally tightened this year. However, we still expect central banks in the region to start cutting interest rates in 2023 as inflation heads back toward central banks' targets.

Chart 11

Two downside risks to our 2022 growth outlook for Latin America are worth highlighting: China and domestic social/political dynamics. China's zero-covid policy means that pandemic developments that trigger more lockdowns could lower demand more than expected, potentially hampering Latin American commodity exports to China. Further lockdowns could also continue to disrupt supply chains if the production of related inputs is interrupted, taking a toll on key manufacturing hubs in Latin America, such as in Mexico and Brazil, and also increasing inflation across other parts of the region through higher final prices on those goods. Finally, the recent increase in food and energy prices, at a time when labor market dynamics remain relatively weak increase the risk of social unrest in Latin America, lowering policy predictability--an unfavorable dynamic for investment.

See our Latin America macroeconomic outlook for further details on our forecasts for the major economies in the region: "Economic Outlook Latin America Q2 2022: Conflict Abroad Amplifies Domestic Risks," published March 28, 2022.

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

While the region saw a strong recovery during the final quarter of 2021, a slowdown in global demand and the impact from the Russia-Ukraine conflict will impede growth. These headwinds will lower the expansion of exports and manufacturing, which were key growth drivers in 2021, while greater uncertainty and higher energy prices will weigh on domestic consumer sentiment. As a result, we lowered our 2022 growth forecast for Asian EMs, excluding China, to 6.7% from 6.9% in November.

High energy prices will be a pain point for the region's consumers and in some economies will pressure current account balances. Malaysia is well positioned to weather higher energy prices as a net energy exporter, primarily of gas. However, energy price increases may not pass through to domestic consumers, which could offset some of the benefit to producers. Indonesia is also a net energy exporter. But much of the surplus is driven by coal exports, and the country is an oil importer, which will mean oil product consumers will still feel the pinch of higher oil prices. The other economies in the region are net energy importers and will face higher energy prices and import costs. India's economy remains vulnerable to higher energy import costs as the current account balance is still negative.

While consumer price inflation remains low, it will rise this year, with pressures from higher energy and food prices. Excluding energy and food, core consumer price inflation is now rising gradually in the region as well. This situation is challenging central banks. Broadening inflationary pressure will strengthen the case for tighter policy and higher interest rates, especially given the significant rise in interest rates by the U.S. Federal Reserve that we expect. But weaker confidence and risk sentiment will weigh on growth and core price pressures. Central banks would want to avoid tightening policy in such an environment if they can.

Chart 12

Chart 13

Central banks are balancing the opposing forces of weaker confidence and potentially higher inflation. Our baseline forecast is for only modest monetary policy normalization despite higher prices. But lower risk appetites combined with the significant increases in U.S. yields that we expect this year could drive capital outflows from EMs. Southeast Asian central banks will watch capital flow pressures, and if these escalate, there could be more monetary policy tightening in the region than in our baseline.

(See our Asia-Pacific outlook for further details on our forecasts for the major emerging market economies in the region: "Asia-Pacific Economic Risks, Thy Name Is Inflation," published March 28, 2022.)

Appendix

Table 6

Table 7

Table 8