Global Economic Environment Tests EM Resiliency

As most emerging market (EM) economies continue to recover from the COVID-19 pandemic since our March forecast publication, global macroeconomic headwinds, including geopolitical and financial conditions, have deteriorated further.   The optimism of early 2022 has given way to worries of a sharply weakened global economy ahead of us on the account of a longer-than-expected Russia-Ukraine conflict, higher energy and commodity prices, economic damage from pandemic lockdowns and restrictions in China, and faster monetary policy normalization in the U.S., Eurozone, and many other major central banks. The focus of the global macroeconomic outlook has become the ability of central banks--most notably the U.S. Federal Reserve--to return to its 2% inflation target while avoiding a sharp downturn.

S&P Global Ratings reduced growth projections for key large economies and increased inflation forecasts across the board during the current (June) global forecast round.   The United States and Eurozone growth forecasts for 2022 were revised down marginally from our interim May forecast update-- to 2.2% and 2.6%, respectively--and a bit more for next year (see table 1). For China, we have now lowered our baseline 2022 growth forecast to 3.3% (previously 4.2% in May interim forecast), considering the slower-than-expected easing of COVID-19 restrictions and shallow recovery of domestic demand so far in the second quarter. Consequently, global growth is now forecasted to come in weaker in 2022 and 2023. Concurrently, inflation forecasts are now higher in both years globally, and likely peaking on a year-over-year basis generally during this year's second and third quarter stretch, individual country variation notwithstanding.

Despite the challenging global economy, GDP growth held up relatively well across most of the EMs in the first quarter. However, momentum stalled (at best) in the second quarter and weakening growth is on the cards for the next few quarters, especially in the EM-EMEA and LatAm economies.  

Solid activity growth in both commodity importers and commodity exporters in the first quarter partly reflects resilient domestic demand on the back of ongoing momentum from the pandemic recovery, and in some cases, the lingering effect of government stimulus measures. Domestic demand has kept economies afloat during this recovery in some countries where external demand has yet to recover to pre-pandemic level (Argentina, Thailand, Saudi Arabia, Chile). In some cases, recovery in exports have outshined that of domestic demand (Brazil, Mexico South Africa, Indonesia) (see chart 1). That said, recovery from COVID-19 has broadly continued in the service sector. Export momentum eased generally in line with global trade slowdown after the bounce-back in 2021. The demand for EM manufactured goods is likely to weaken further as softer global growth becomes a headwind. In addition, consumer demand growth was due to naturally shift from tradable goods to non-tradeable services as the service sector normalizes and strengthens with fading impact from the COVID-19 pandemic.

Chart 1

There are signs of slowing growth momentum (the change in the change) in the second quarter, however, led by softening in manufacturing output and new export orders in many outside of commodity exporters. Lockdowns in China have not had a major impact on manufacturing production in other parts of EM, so far, but it hasn't helped business confidence either. The S&P Global EM Manufacturing PMI for May suggests that the easing of virus-related disruptions in China supported a small rebound in EM manufacturing last month, reflection of improving industrial conditions in China. The Russia-Ukraine conflict is taking an increasing toll on Emerging Europe. Severe flooding in KwaZulu-Natal province and worsening power cuts dealt a big blow to South Africa's economic activity, with preliminary estimates on mining and manufacturing showing a sharp decline in April. The South African Reserve Bank's composite leading business cycle indicator decreased by 0.3% in April 2022 and by 4.7% on an annual basis, the largest year-on-year contraction since May 2020.

Forecast Update

Table 1

Upside growth surprises in several EM economies in the first quarter and revisions to 2021 second half triggered a small upward revision to our 2022 GDP growth forecast for our sample of EMs, excluding China, offsetting an increasingly weaker global economy.  The statistical lift for the entire 2022 from the better-than-expected first quarter is most apparent in EM-EMEA with an overall forecast upgrade of 1.1 percentage points (ppt) (see tables 2 and 3). All countries in our EM-EMEA sample had better than expected performance. In Latin America, a better than expected first quarter performance—primarily in Brazil more than anywhere else-- led to a 0.2 ppt upward revision in Latin America as a whole. Poland and South Africa in EMEA as well as LatAm led by Brazil, Chile and Mexico are on track to experience a contraction in the near stagnant third quarters. Turkey will see contraction the second half of this year following a relatively resilient first half.

Overall, we revised down our GDP growth forecast for EM-Asia, excluding China--GDP growth in 2022 by a 0.3 percentage point, compared with the outlook three months ago, all of which is because of the downward revision to India. Emerging Asia has more scope to benefit from China emerging out of lockdowns of April and May, although we assume there will be lingering impact of "zero Covid policy" on Chinese growth (mainly on consumption, tourist travel which are counted as exports of receiving country) with a potential for further disruption as a key downside risk. Growth forecast for EM, excluding China, in 2023 is unchanged at 4.1%, with many countries facing protracted recoveries to their pre-pandemic trend amid lingering inflation shock.

Table 2

Table 3

Authorities are relaxing regulations for international travelers, which supports tourism in the EM world and modestly boosts the economy.   The recovery in tourism has gained steam in Turkey, thanks to improvements in the pandemic and competitive lira. In the first four months of 2022, foreign visitor numbers were 2.7 times higher than last year, with the gap to pre-pandemic levels narrowing to 12%, compared with 46% in 2021. Arrivals from Europe and other regions are surging, while a decline in the number of visitors from Russia has been contained so far (18% drop January-April compared with the same period in 2021).

However, the story is a bit different in places where tourists from China accounted for a significant share of overall arrivals in pre-pandemic, namely EM Asia. While China's borders remain closed there's unlikely to be a full tourism recovery. Thailand, the country well-known to have been affected by the pandemic's tourism drought has the largest tourism sector in Asia, relative to the overall economy. Tourist arrivals there were only about 10% of pre-COVID-19 levels in April. This proportion will rise throughout the year with a steady recovery in tourism arrivals, but we do not expect tourism to normalize through our forecast horizon, and the scars in the sector will take time to heal.

Higher energy and food commodity price pressures mean upward revisions to consumer price inflation for the remainder of 2022 and 2023.  Inflation has consistently surpassed expectations with underlying price pressures in the last five months more acute in emerging Europe and Latin America. We have raised our projections for inflation for all EM economies except Saudi Arabia where the stronger U.S. dollar, against which the Saudi Riyal is pegged, helped contain inflation (see table 4). These revisions are driven by higher energy and commodity prices, weaker exchange rates, and, in a few cases, larger pass-through as economies recover and core inflation picks up amid decreasing slack.

Table 4

S&P Global Ratings now assumes that Brent will average $100 per barrel (bbl) the remainder of 2022 and $85 per bbl in 2023 (see more in "S&P Global Ratings Raises Oil And Natural Gas Price Assumptions On Further Market Price Step-Ups," June 8, 2022), $15 higher compared with our March assumptions.

Energy prices are persistently higher and appear likely to remain elevated for longer as the Russia-Ukraine conflict and sanctions continue. Demand for oil and products continues to trend upward even as additional supply constraints affect markets already tightly balanced at the start of 2022 before the conflict.

More importantly, fertilizer shortages, export controls, disrupted global trade, and escalating fuel and transport costs has been and will continue to exert upward pressure on the cost of food staples as well.   Rising food prices and diminishing supplies will last through 2024, and possibly beyond, in S&P Global Ratings' view (see more in "The Global Food Shock Will Last Years, Not Months," June 1, 2022). Households in emerging economies spend much more on food than on energy (see chart ), and therefore food price increases are having a much more negative affect on their budgets than energy price increases of the same magnitude. However, higher energy prices feed through to producer prices, both domestic and global, and then at least partly to core consumer prices (see more in "Which Emerging Markets Are Most Vulnerable To Rising Food And Energy Prices?," April 21, 2022).

Chart 2

Across the EMs, we are now likely to see tighter monetary policy rates than anticipated, despite weaker growth outlook.   Part of the reason for the tighter stance is the Fed has pivoted to a more hawkish stance by increasing rates at a faster clip. We now expect the Fed to raise the federal funds rate above 3.5% by mid-2023, a much swifter pace of normalization and to a higher envisioned terminal level (more than 1 ppt) than just three months ago. The current rate hike cycle has the advanced economies catching up to the prior moves in EMs in Latin America and EMEA (see chart 3). However, most EM economies are still expected to have their real interest rates below their peaks of the previous Fed tightening cycle by year's end (chart 4). In Poland and EM Asia, real rates are likely to be negative or barely positive in the next six months as implied by market pricing. Nonetheless, most central banks in EM excluding EM-Asia (where inflationary pressures were moderate till early 2022) had already been raising their policy rates prior to the Fed's lift-off, and as a result, domestic financial conditions have tightened. More recently, risk-off sentiment has taken hold regardless of the terms of the trade argument, and external financing conditions have tightened, with sizeable currency depreciations across EM currencies against the dollar.

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Chart 3

Chart 4

The speed and scale of monetary tightening will be different across the EM economies.   Higher inflation expectations and a more hawkish tilt by the Federal Reserve and other major global central banks will continue to pressure EM central banks to raise rates in the coming quarters. Maintaining anchored inflation expectations and protecting capital flows are top of mind for policy makers. The risk is especially prevalent in the case for net energy importing EMs already with current account deficits. This is the case in Chile, Poland, India, the Philippines, and Thailand, where the current account deficits run the risk of being pressured from sustained elevated energy prices, at the margin, in the coming quarters that could more than offset food trade surplus in some of these countries and recovery in service exports from tourism. That said, central bank reserve buffers typically remain healthier compared with past cycles (Turkey, Argentina, Chile and to a lesser extent Colombia stand out as a few pockets of concern), which may have success in slowing the pace of currency decline if need be.

Latin American countries have already increased the magnitude of their interest rate hikes to match the Fed's larger increases in recent meetings, and we now see a higher terminal interest rate for the current tightening cycles across the board. In Poland, the central bank has already raised the key rate by 425 bps to 6% this year, and we expect it will bring the key rate to 7.5% by the end of 2022 to tackle broad-based inflation running well above the target of 13.9% in May. Once inflation is on a firm downward path next year (albeit at a higher level compared with our March forecast), we will see some EM central banks start lowering rates, most notably Brazil and Chile in Latin America and Poland in EMEA.

At the same time, inflation in South Africa breachedthe target range of 3%-6% in May (though close to the upper band), while core inflation is contained. The South African Reserve Bank will likely only gradually normalize monetary policy over 2022-2024 compared with other EM central banks given its more contained core inflation and higher degree of slack in the labor market. In Saudi Arabia, we expect additional monetary policy tightening in lock step with the Fed. As result of a stronger US dollar, against which the Saudi Riyal is pegged, and tighter monetary policy, inflation will likely slow to 2.8% this year and 2.6% the next, from 3.1% in 2021. Turkey is a notable exception, with the central bank set to remain on hold despite acute exchange rate and inflationary pressures.

EM-Asia, a laggard in the current rate hike cycle, will also tighten monetary policy further as a result of now rising inflation and greater capital flow pressures. India is now briskly normalizing policy to deal with high inflation, but the region's policymakers are not yet tightening monetary policy significantly. Long term bond yields have risen, however, given higher global long-term yields.

In all EMs except Argentina, annual average real interest rates (derived as policy rate minus CPI inflation) are forecasted to be increasing in 2023, although in economies such as Philippines, Thailand, Poland, Turkey and Argentina, they will be still negative.

Table 5

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

Macroeconomic outlook remains challenging, despite upside growth surprises.  Quarter one GDP growth in major EM EMEA economies surprised to the upside, both in commodity-importing countries in Emerging Europe (Poland, Turkey), as well as in commodity exporters (Saudi Arabia, South Africa). Domestic demand showed resilience to negative shocks, helped by continuing momentum related to the post-pandemic recovery, and in some cases policy stimulus. Trade performance diverged, with exports falling in Poland and Turkey on the previous quarter, but expanding strongly in South Africa. After a solid first quarter, we expect slower growth in the coming quarters, amid mounting headwinds from a prolonged Russia-Ukraine conflict, accelerated tightening of monetary policy by the U.S. Fed and other major central banks, and weaker global growth prospects. Elevated food and energy prices have fueled inflation, with weaker exchange rates adding to price pressures (outside of Saudi Arabia). The hit to consumer purchasing power, tighter financial conditions, and fading effects of post-pandemic recovery will weigh on domestic demand throughout the year.

The sensitivity to these developments varies across economies. The Russia-Ukraine conflict is taking an increasing toll on emerging Europe, and high frequency and leading indicators point to a slowing growth momentum in Poland and Turkey. With the conflict lasting longer than initially anticipated, the risks of more severe disruptions to trade, supply chains, and energy supply have risen. At the same time, energy exporters in MENA are enjoying windfall revenues (which more than offsets higher food imports bills), but slower global growth and tighter financing conditions will moderate these gains. Meanwhile, several commodity-importing MENA economies are among the most vulnerable to current developments, being net importers of both food and energy, and sourcing a large part of their cereal supplies from Russia and Ukraine (see "Food Price Shock Reverberates Through MENA Economies," May 26, 2022).

To read our full report on EM EMEA, click here.

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

Resilience so far this year, but weakness expected ahead.  Latin American economies have been more resilient than expected to the current mix of external headwinds, so far this year. The major economies in the region expanded on average 0.9% quarter-on-quarter in the first quarter of 2022, following 0.7% growth in the last quarter of 2021. Domestic demand held up relatively well across most of the region, reflecting ongoing momentum from the pandemic recovery downturn, and in some cases, the lingering impact of government stimulus measures. In some countries, exports also picked up, most notably in Brazil, helped by strong commodity exports. The lockdowns in China have not had a major impact on manufacturing production in Latin America, so far, despite fears of potential supply-chain disruptions filtering throughout the region. However, the recent tightening in global financial conditions, coupled with continued upward supply-side pressures on inflation, and an increase in uncertainty over global growth, are likely to weaken growth in the region the remainder of 2022 and into 2023.

Taking all these factors into consideration, our GDP growth forecast for Latin America increased to 1.9% from 1.7% previously, but decreased for 2023, to 1.7% from 2.1% previously. Risks to our GDP growth forecasts are mainly to the downside. In the current environment of high inflation, weak employment dynamics, and high economic uncertainty, policy predictability in the region is low, with potentially negative implications on investment. Another key risk to the region is a potentially weaker-than-expected U.S. economy, which would impact Mexico the most due to the strong trade links between both countries, but the associated deterioration in confidence and financial conditions would also imply lower growth for the rest of the major Latin American economies.

To read our full report on Latin America, click here.

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

Reopening drives growth momentum in emerging Asia.  Emerging Asia's economy is recovering as the region re-opened gradually following intermittent lockdowns in 2021. Recovering consumer demand is a key growth driver and is likely to remain resilient over the next few months. We expect steady growth for the region of 6.4% in 2022 following a 6.6% growth in 2021, even in the current uncertain global environment. First quarter growth in the region was broadly resilient. It was in line with expectations in Indonesia (5.0% y/y) and Thailand (2.2% y/y). In Indonesia, public consumption growth was significantly weaker relative to last year which offset steady private demand and trade growth. First quarter growth was strong in Malaysia (5.0% y/y) and the Philippines (8.3% y/y) on strong private demand. India's growth over the calendar first quarter was slightly weaker than expected (4.1% y/y), and in contrast to the rest of the region's consumer activity growth weighed on overall growth.

Inflation will rise during the second half of 2022 across emerging Asia, but for now it remains moderate relative to the U.S. or Europe. The recovery in consumer demand began in late 2021, and as a result core consumer price pressures have only started picking up now. Food and energy prices will be influential in the inflation trajectory. Energy price inflation remains high except in Malaysia and Indonesia. The two economies are net energy exporters and are not passing some of the energy commodity cost increases to consumers. Food price inflation is moderate but is now rising. A significant proportion of agricultural product trade is intra-regional but will nevertheless be affected by rising global food inflation. Capital outflow pressures remain moderate. There have been significant equity outflows out of India and the Philippines, but other portfolio outflows are limited. Emerging Asia currencies have depreciated less against the U.S. Dollar relative to the major currencies. However, rising U.S. interest rates pose a risk of heightened capital outflow pressures.

To read our full report on EM Asia, click here.

Risks To Baseline Growth Forecasts Squarely On The Downside

The risks to our baseline forecasts have picked up since our last forecast and remain firmly on the downside.   The Russia-Ukraine conflict is more likely to drag on and escalate than end earlier and deescalate, in our view, pushing the risks to the downside. As S&P Global Ratings noted in a previous global macroeconomic outlook report, a hard downside scenario would involve a broad-based trade rupture between Russia and the German-centered industrial complex, taking down growth, incomes, employment, and confidence, and spreading to the rest of the global economy. A second worry is inflation remaining higher for longer, requiring central banks to raise rates more than is currently priced in, risking a harder landing, including a larger hit to output and employment. In a particularly bad variation of this risk, fuel and food inflation would remain high even if core inflation (which central banks more directly control) declines, leading to stagflation. That's a surefire recipe for regression in living standards, deterioration in policy credibility, and an environment of social unrest.

China matters for the rest of EMs.   The economic impact on China from its latest COVID-19 lockdowns were more severe than we anticipated. S&P Global lowered China's 2022 real GDP growth forecast to 4.2% in May from 4.9% in March, and now further to 3.3% given only a small rebound tracking in May and June. With restrictions on people's movements eased only gradually, new restrictions imposed in other areas and overall sentiment remaining poor, the recovery is slower than in 2020.

China's underlying growth drivers are important to EM growth prospects. Consumer spending was hit harder by the lockdowns than investment and industrial production, which mitigates the impact on other economies, as China's consumption is less import intensive. Nonetheless, China's imports have weakened severely, in part because of the impact of the property downturn on commodity imports. It hasn't gone unnoticed that S&P Global Rating's GSCI industrial metals prices peaked in March and has since trended down now at levels last seen in August 2021, (which is still elevated co mpared with pre-pandemic highs), hinting at shallower industrial demand for China and its peers. Emerging markets in Asia are the most at risk from weakening Chinese consumption and tourism. Thailand, Malaysia, and the Philippines stand out as having the highest exposure in emerging markets from this angle. They are also among the most at risk from further supply-chain disruptions, albeit manufacturing continues to operate with limited disruptions under pandemic restriction. 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. Raw industrial metals and minerals exporters like South Africa, Brazil and Chile are vulnerable to unfavorable downward price shocks in the global industrial sector (see more in "Which Emerging Markets Are Most At Risk From Slower-Than-Expected Growth In China?" April 26, 2022).

Appendix

Table 6

Table 7

Table 8