Emerging markets (EMs) are facing a challenging year, with several important risks to growth. EMs will have to navigate rising U.S. interest rates, elevated inflation, and the repercussions of the Russia-Ukraine conflict, at a time when most economies are still recovering from the pandemic-induced downturn (see "Economic Outlook Emerging Markets Q2 2022: Growth Slows Amid Higher Commodity Price Inflation," published March 28, 2022). An additional risk to EMs, in our view, is a sharper-than-expected economic growth slowdown in China.

We expect GDP growth in China just shy of 5% in 2022--its slowest expansion in recent history. The Chinese economy's low-tolerance COVID-19 strategy has led to recurring strict lockdowns, keeping a lid on the consumption recovery, and in some cases also disrupting industrial production. The potential for further COVID-19 outbreaks, the stress in the country's property market, and the implications of the war in Ukraine pose significant risk to our China baseline growth scenario. The official growth target of around 5.5% for 2022 would require significant policy support, and policymakers are prioritizing COVID-19 control measures over the growth target (see "Asia-Pacific Economic Risks, Thy Name Is Inflation," March 27, 2022).

Slower-than-expected growth in China could unfold in several ways, with different direct implications for EMs. Weaker growth in China would have important implications beyond EMs, given the size of the economy and its impact on global trade and global financial conditions, which would also indirectly affect growth in EMs through those channels. A Chinese economic slowdown could be consumption-driven, investment-driven, or both (a hard landing), and each of those would have different implications for EMs and the rest of the world.

The Most Immediate Risk To Growth In China Is More COVID-19-Related Disruptions

In the short term, the biggest risk to Chinese growth is likely the potential for more COVID-19-related lockdowns, which would lead to primarily a consumption-driven slowdown. We see three main direct channels of transmission to growth in EMs from COVID-19-related lockdowns in China:

• Lower goods consumption: Restrictions on movement will affect direct purchases of goods, some of these produced in EMs, which may not be fully offset through online purchases. Consumption of goods may also decline as households increase precautionary savings in the face of COVID-19-related uncertainty.
• Lower services consumption: Lockdowns could restrict consumption of services. We already assume Chinese tourism abroad will be broadly restricted this year, but if those restrictions are extended further, several EMs that are key recipients of Chinese visitors would see a further delay in the recovery of their tourism sectors.
• More supply-chain disruptions: Lockdown policies allow for manufacturing production to continue with limited interruptions under "closed loop" arrangements where factories operate in pandemic-control "bubbles." As such, while there has been some production disruption, it has been fairly limited, even though risks to manufacturing activity have increased. Transportation and logistics are likely to see greater disruption, and there is some disruption already with costal freight throughput contracting in March. Such disruptions may also include flow of intermediate inputs used in production across several sectors in EMs. Supply-chain bottlenecks could prolong pressure on inflation across most EMs, through higher prices of final goods affected by disruptions.

However, the full impact on EMs would have to consider the Chinese policymakers' reaction to COVID-19-driven economic weakness. One possible approach policymakers would use to respond to such a scenario could include a traditional recipe of higher infrastructure-related investment. This would support infrastructure-related commodities, benefitting producers of those commodities, many which are major EMs. That said, it is important to note that the government's longer-term strategy of deleveraging could dissuade it from putting too much emphasis on debt-driven infrastructure stimulus. In addition, lockdowns could also disrupt construction, which would lower the impact of infrastructure measures, and consequently also the benefits to EM commodity producers.

Lower Goods Consumption

The exposure through this channel is clearly more acute in EM Asia, where consumer goods exports to China tend to be relatively higher than other EM peers (see table 1). Malaysia stands out--consumer goods exports to China account for about 2.5% of its GDP. Thailand and Indonesia also have among the highest levels of consumer goods exports to China, but at under 1% of GDP it is significantly lower than Malaysia's.

Table 1

Lower Services Consumption

The impact from lower services consumption would translate mostly through further delays in restarting outbound Chinese tourism, which we already expect to take some time given current restrictions. EMs in Asia stand out as the most exposed, as the share of tourists coming from China tends to be large and tourism-related sectors have a large contribution to GDP. This the case especially in Thailand, where before the pandemic tourism exports were above 10% of GDP (and arrivals from China accounted for over 25% of the total before the pandemic). Malaysia and the Philippines also have exposure to more delays in restarting Chinese tourism, albeit much lower than is the case in Thailand (see charts 1-2).

Chart 1

Chart 2

More Supply-Chain Disruptions

The computer and electronics sector is the most exposed to supply-chain disruptions (see table 2)--the median EM total output from that sector has 10% value added coming from China. And it's not just EM Asia. Mexico, for example, has the highest value-added share coming from China in the computer and electronics sector at nearly a fifth of total output. An important caveat to make is that unless lockdowns take place in key manufacturing hubs, disruptions to those supply chains may be limited.

Table 2

However, by looking at how important the sectors at significant risk of supply-chain disruptions are to a given EM economy as a share of GDP, the conclusion is clear. The most vulnerable EMs are in Asia, especially Thailand, Malaysia, and the Philippines (see table 3).

Outside of Asia, there are couple of EMs that also stand out: Mexico (due to its computer and electronics, and autos exposure) and Turkey (exclusively due to its computer and electronics exposure). If supply-chain disruptions are not quickly resolved, higher prices on final goods could hit most EMs through higher inflation, at a time when many central banks are attempting to re-anchor inflation expectations around their targets through tighter monetary policy.

Table 3

In the event that COVID-19 disruptions start to materially challenge China's official target of around 5.5% GDP growth for 2022, the government could deploy stimulus measures geared toward greater infrastructure investment. These measures would increase demand (and potentially prices) of infrastructure-related commodities, such as iron ore and copper, benefiting EMs that export those commodities. Chile stands out, with copper exports representing over 15% of GDP in 2021 and about two-thirds of those going to China. Brazil and South Africa are the next two largest exporters of metals (mostly iron ore), and they could also benefit from higher Chinese investment in infrastructure. However, as discussed previously, construction itself may be disrupted by lockdowns. Also, disruptions to logistics could affect imports of commodities, which could lower the benefits to EM commodity producers.

Chart 3

Property Sector Weakness Is Another Key Short-Term Risk

Further weakness in property construction is also a risk to growth in China in the short term. Lockdowns could further hurt the property sector by lowering sales. In the event that propping up the property sector is a part of the policy response to a COVID-19-driven slowdown (higher investment in infrastructure), that risk may be pushed further down the road, and amplified. This is especially the case if, as discussed previously, infrastructure measures are not as effective as they have been in the past.