Better-than-expected growth in several emerging market (EM) economies in the first half triggered a small upward revision to our 2022 GDP growth forecast for our sample of EMs excluding China. However, this masks what we expect will be a weaker second half.  We revised down slightly our 2022 growth forecasts for Poland (proximity to German industrial nexus and the war); South Africa (increased electricity interruptions); and Thailand, Philippines, and Peru (all weaker-than-expected second-quarter domestic demand). Saudi Arabia stands out as it continues to clock strong performances both in the oil and non-oil sectors, and it's on pace to become the fastest-growing economy in the G20.

As for China, we expect muted growth in the second half of 2022, translating to 2.7% GDP growth for 2022 (versus 3.3% in June).  Restrictions imposed under the government's zero-COVID-19 stance, very poor real estate activity, and sentiment remain a drag on growth.

For 2023, we lowered our growth forecast for EMs by 0.5 percentage points (see table 1).  The bulk of the downward revision comes from Latin America, but a slower China, combined with likely recessions in the eurozone and the U.S. within the next 12 months, means all regions are affected. Weaker external growth, along with a turn in the electronics cycle, will lead to weaker trade the rest of this year and the next. Private consumption growth is likely to moderate as elevated inflation erodes purchasing power and the boost from the post-pandemic reopening fades.

Table 1

Global Policy Uncertainty

Macroeconomic conditions continue to reflect elevated global economic policy uncertainty and financial stress (see charts 1 and 2): 

• China is still committed to its zero-COVID-19 policy;
• The Russia-Ukraine conflict (and the proxy economic war with the West) continues with no end in sight;
• Governments face a tricky trade-off between public debt management and macroeconomic stability; and
• Major central banks (excluding Japan and China) remain steadfast in pursuing hawkish monetary policy to address above-target inflation.

Chart 1

Chart 2

Some downside risks outlined in the previous forecast update (in June) have since materialized.  In China, economic growth momentum weakened again in the third quarter as new COVID-19 outbreaks and mobility restrictions took hold. The central government has stepped up policy support recently, but it remains modest. We assume the government will start to adjust its COVID-19 stance, gradually lifting restrictions in 2023, likely after the first quarter. We also don't expect the property sector to recover swiftly. In Europe, natural gas flows from Russia have been disrupted following the shutdown of the Nord Stream 1 gas pipeline for an unspecified period.

The U.S. Federal Reserve, which pivoted to a hawkish stance in June, has become "decidedly hawkish" since August (in its communications).  CPI inflation data in the U.S. continued its upside surprises. We now pencil in the federal funds rate reaching 4%-4.25% in the first quarter of 2023--a much faster pace of rate hikes, and to a terminal level 50 basis points higher than envisioned just three months ago.

We further trimmed our growth projections for key large economies in our current global forecast update.  We cut our growth forecasts for China to 2.7% (was 3.3%) in 2022 and 4.7% (was 5.4%) in 2023, and in the eurozone and the U.S., a recession--loosely defined as two consecutive quarters of contraction--is now more likely than not within the next 12 months.

Economic Activity In EMs: Decelerating But Hanging In There

Meanwhile, economic activity eased in many of the EMs in the second quarter, with private consumption carrying the burden of growth (chart 3).  Few exceptions aside (Brazil, Colombia, Indonesia, and Turkey), real GDP growth in the EM countries eased in the second quarter, as we anticipated in most cases. India, China, Philippines, Poland, Chile, and South Africa outright contracted. Still, the cyclical recovery of private consumption and tourism kept economies somewhat resilient in the face of deteriorating external economic conditions. Private consumption spending has benefited from ongoing government support to households.

Chart 3

The more timely high-frequency indicators depict a varied picture for the third quarter.  Of the 13 EMs with data, almost half saw their manufacturing purchasing managers' indices (PMIs) in expansion territory (and improved versus July in many cases). Poland, Turkey, Mexico, and China were in contraction territory. There were surprisingly large rebounds for Colombia and South Africa, both moving from contraction to expansion (above 50) in August.

Weaker external demand for merchandise goods and souring consumer moods seem to be playing an important role.  The new export orders PMI moved further down--below the 50 threshold (indicating contraction)--across EMs in August, excluding South Africa, India, Vietnam, and Saudi Arabia (see chart 4). In addition, elevated prices of food and fuel exacerbated households' worries about affordability. The Ipsos' Global Consumer Confidence Index was below the 2019 average in August for most EMs (India and Saudi Arabia were exceptions).

Chart 4

The combination of fading global risk appetite and continued upside surprises on the Fed's rate hike forward guidance has meant that the dollar has strengthened against EM currencies (as well as advanced economies).  Since the beginning of the year, the U.S. dollar has strengthened 10% against median EM currencies, less than the dollar's 14% appreciation against advanced economy currencies (see chart 5). A lower gain against the EMs partly reflects composition bias in the aggregate exchange rate index and EMs staying disciplined and ahead of the U.S. in their own rate hikes.

In the early months of the Russia-Ukraine conflict this year, the dollar was only slightly stronger against emerging markets, as rising commodity prices nearly split emerging markets down the middle, benefiting commodity exporters but hurting commodity importing EMs. That balance has shifted since early June when the Fed turned hawkish, which caused emerging market currencies to fall almost across the board (see chart 6)--notwithstanding a brief period of relief in August (when the markets anticipated a Fed pivot).

It is not surprising that currencies have declined the most for Argentina (IMF bailout) and Turkey (unorthodox monetary policy), followed by Poland and Hungary (war proximity). Changing tides in growth and terms of trade outlook, in conjunction with a reversal in commodity prices, have added to exchange rate pressures as well in Latin America and South Africa. Exchange market pressures have been offset in some cases with significant interventions in the foreign exchange markets (Chile and India).

Mexico and Peru, which were never considered "currency carry trade" plays, are now considered carry plays (unlike Brazil, which was always the carry play in Latin America). (Currency carry trade is a strategy that involves borrowing a low-yield [low interest rate] currency to buy a higher-yield [high interest rate] currency--to profit from the difference in interest rates.) Policy rates in both Mexico and Peru are now the highest they have been since inflation targeting was followed explicitly. In Mexico, fiscal risk is very low compared with many other EMs, given the muted government stimulus response to the pandemic. In Peru, 2021 was a very bad year for the Peruvian sol, which was hit by a string of political crises, where the president faced several impeachment proceedings. So Peru's currency is facing a bit of a recovery from a bad year.

Chart 5

Chart 6

Regional Outlook Summaries

Emerging EMEA: Exposure to external shocks and varied policy responses shape the outlook

(Poland, Saudi Arabia, South Africa, and Turkey)

After a strong first quarter, economic activity in several key emerging EMEA economies has slowed, and we expect that worsening geopolitical and financial conditions will drag on growth through the rest of the year and into early 2023, particularly in emerging Europe. Some downside risks outlined in the previous forecast have materialized--notably the disruption of energy flows from Russia to Europe following the shutdown of Nord Stream 1, as well as faster tightening of monetary policy by the U.S. Fed and other major central banks. Domestic demand is softening as persistently high inflation is eroding consumer purchasing power and financial conditions tighten. At the same time, foreign demand is cooling amid a global slowdown.

There are notable bright spots in the overall challenging regional economic outlook. Turkey is benefiting from a booming tourism season--likely to extend into winter--which has boosted growth, employment, and foreign currency revenues. The South African government's decision to raise the licensing threshold for small-scale power generation projects to 100 megawatt suggests that private investment in the country's renewable energy sector is likely to receive a boost from 2023. And for energy exporters, such as Saudi Arabia, terms of trade remain very favorable, even though oil prices have come off their peaks.

Taking into account different exposure of emerging EMEA economies to external shocks, as well as varied policy responses, we scaled down our growth expectations for Poland and South Africa for 2022 but raised them for Saudi Arabia and Turkey. Poland is particularly closest to the fallout from the Russia-Ukraine conflict. We shaved off another 0.9 percentage points from its growth forecast to now 1.2% in 2023. In contrast, we raised our 2023 growth forecast for Turkey by more than a percentage point as additional policy support is anticipated ahead of parliamentary and presidential elections in 2023, concurrent with deeply negative real interest rate. But risks of another bout of financial market volatility, exchange rate depreciation, and abrupt adjustment are rising.

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

Latin America: A period of below-trend growth ahead

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

Given the stronger growth so far this year in Latin America, we revised up our 2022 GDP growth projection to 2.8% from 2.0% previously. However, we now see slower growth of just 1.0% in 2023, compared with 1.8% previously expected. The main reasons for the downward revision are slower GDP growth in main trading partners, mainly the U.S. and China; tighter financial conditions; and less slack in domestic demand.

Latin American economies so far this year have continued to show resilience to the difficult--and evolving--external dynamics (supply-side shocks to inflation, rising interest rates, and growing uncertainty about global growth). The major economies in the region expanded, on average, 1% quarter over quarter in the second quarter, matching the growth experience in the first quarter and surpassing our expectations. One of the main reasons for better-than-expected economic performance in the region has been ongoing strength in domestic demand. This is partly explained by government support to household consumption, such as a recent decrease in fuel taxes and more cash transfers in Brazil. The ongoing recovery from the pandemic downturn also supports domestic demand. Several sectors, especially those in services, still have some slack relative to before the pandemic and continue to close the gap.

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

Emerging Asia excluding China: Reopening supports domestic demand but external outlook is gloomy

(India, Indonesia, Malaysia, Philippines, Thailand, and Vietnam)

We expect strong growth of 5.4% for Southeast Asia in 2022, mainly owing to domestic demand, followed by a moderation to 4.9% in 2023 as reopening momentum fades and external conditions become more challenging. In Malaysia, we raised our 2022 growth forecast by 50 basis points to 6.6% as first-half economic performance was very strong. We modestly lowered 2022 growth forecasts in the Philippines and Thailand by 20 basis points and 30 basis points, respectively, owing to weaker-than-expected consumption growth.

Reopening momentum is driving domestic demand for several Asian emerging markets. Malaysia and Indonesia are seeing robust private consumption growth, while consumption growth slowed from the prior quarter in Thailand and the Philippines. Consumption growth is likely to remain resilient but will moderate. Weaker global growth is likely to weigh on external demand and trade in the region. Weaker trade, in turn, will slow manufacturing and trade-related activity.

Economic recovery is continuing in India with strong service sector activity and resilient high-frequency data. However, the April-June quarter was weaker than expected. Consumer demand is recovering, and we expect a pickup in growth momentum from the prior quarter, which will support growth through the rest of the year. Our overall growth forecast is unchanged at 7.3% for this fiscal year, followed by 6.5% for fiscal 2023/2024.

To read our full report on Asia-Pacific, click here.

Upward Revisions To Consumer Price Inflation And Policy Interest Rates

We have raised our inflation projections for 2022 and 2023, but we still see inflation moving lower in almost all countries (see table 2).  Headline inflation has moderated in some EMs (although it remains elevated), in part reflecting easing of prices of energy and food--price caps on fuels has helped in some cases. In Brazil, CPI prices in August fell on a month-over-month basis for the second consecutive month. Core inflation (excludes food and energy) declined on a month-over-month basis in India. And more generally, supply chain issues have eased. Container shipping costs have dropped from their 2021 peaks. PMIs for supplier delivery times have also improved over the last few months. Commodity prices, excluding coal and natural gas, have moved down from their stratospheric highs in the spring, though they're still above pre-pandemic levels (see chart 7). Last month, the input and output price components of manufacturing PMI dropped to their lowest levels since mid-2020 (see chart 8).

Chart 7

Chart 8

Still, we expect core inflation to stay above central banks' targets across the EMs (excluding China, Saudi Arabia, and Vietnam) for the rest of the year and well into next year as past increases in energy prices and higher import prices from currency depreciation spill into broader core items.

On a sequential basis, inflation appears to have peaked in Latin America in the first half of 2022. But, it will remain elevated owing to second-round effects, as higher energy and food prices are passed through to services prices.

Upside risks to energy inflation are still significant, in particular in economies in Central and Eastern Europe that are highly exposed to very high and volatile European gas prices. Energy subsidies can, in part, alleviate inflationary pressures, but they come at a fiscal cost. We expect inflation in Poland to peak in first-quarter 2023 and ease only gradually after that, remaining in double digits in 2023.

In Saudi Arabia, we think that the headline rate is close to its peak on a quarter-over-quarter basis and will slow in the fourth quarter and into 2023. On a year-over-year basis, this translates into inflation peaking in the first quarter of 2023 and moving back down to 2% by year-end 2023. The government's cap on local fuel prices will continue to contain energy inflation if global prices again start to climb. In South Africa, we also raised our forecast for CPI inflation, to over 6% (on a year-over-year basis)--which is above the upper bound of the central bank's target--until mid-next year and only a gradual decline over the next several quarters.

In emerging Asia, inflation is likely to rise further as domestic demand recovers. We expect core inflation to pick up even though headline inflation may ease given global commodity prices have come down recently. One exception is Indonesia, where the government raised fuel prices to reduce subsidy burdens. We expect the energy price jump in Indonesia to contribute to about 2-2.5 percentage points of headline inflation in 2023, and we raise our 2023 inflation forecast to 6.2% from 4% previously.

Table 2

Higher inflation expectations and more of a hawkish tilt by the U.S. Fed and other major global central banks will continue to put pressure on EM central banks to raise rates in the next few quarters.  Central banks in Latin America, most of which have been increasing interest rates for well over a year now, are approaching the end of their hiking cycles. However, in light of the persistent inflation--which will remain above targets for some time--central banks will tread a cautious path in normalizing monetary policy. We don't expect central banks in the region to start lowering interest rates at least until the second half of 2023. Central bank action in the region will continue to be highly influenced by the Fed's interest rate decisions.

In emerging EMEA, we maintain our expectations for Poland's central bank to raise its key rate to 7.5% (currently 6.75%) by the end of 2022 and start lowering rates in the second half of 2023, once inflation is firmly on a downward path. Turkey's central bank, meanwhile, lowered the policy rate (since our last publication in June) by 200 basis points to 12%, pushing the real interest rates even further into negative territory. At the moment, there are no signs of a monetary policy reset, and our baseline assumption is for the policy rate to remain at 12% this year and next, with a high probability of further cuts. Considering rising inflation risks and accelerated Fed tightening, we now expect the South African Reserve Bank to raise the key policy rate to 6.75% by the end of the year (was 5.5%) and further to 7% by the first quarter of next year. As inflation starts to get under the upper bound of central bank's target (i.e., below 6%), it will begin cutting, but only gradually with an eye on the U.S. Fed. In Saudi Arabia, with the Fed poised to implement further rate hikes in the coming months, we expect additional monetary policy tightening in lock step.

In Southeast Asia, central banks have been slower than global peers in tightening monetary policy as core inflationary pressures had been contained. There were capital outflows in the first half of the year, but central banks have buffers to manage these by utilizing foreign exchange reserves. Now, however, inflation is picking up noticeably and U.S. interest rates are rising further. This will prompt regional central banks to move. We expect rate hikes out of all the regional central banks, with the quickest rate hikes in the Philippines, where we forecast a year-end 2022 policy rate of 5%. In Indonesia, we expect the policy rate to reach 4.5% by the end of 2022 and 5.5% by the end of next year, compared with the current policy rate of 3.75%.

Table 3

Maintaining anchored inflation expectations and protecting capital flows are top priority for policymakers. Higher global interest rates will continue to weigh on EM central banks in the form of capital outflows and depreciation.  The risk is especially prevalent for net energy importing EMs already with current account deficits. This is the case in Chile, Poland, India, the Philippines, and Thailand, where sustained elevated energy prices could lead to higher current account deficits. In the coming quarters, that could more than offset food trade surplus in some of these countries and recovery in service exports from tourism.

Prices for industrial metals have also moderated after the rally earlier this year affecting metal exporters, such as South Africa, Peru, Chile, and Brazil. Countries with large current account deficits, most notably Chile, are finding their currencies in the crosshairs, prompting foreign exchange interventions. To be fair, most EM currencies continued to come under pressure amid the hawkish stance by developing markets' central banks and the general risk-off mood. That said, central bank reserve buffers typically are healthier than in past cycles (with the exceptions of Turkey, Argentina, Chile, and to a lesser extent, Colombia), which may slow the pace of currency decline, if needed.

Risks To Baseline Growth

The global factors driving downside risks to our baseline forecasts haven't changed.  First, the Russia-Ukraine conflict is more likely to drag on and escalate than end earlier and deescalate, in our view. As we noted in a previous global macroeconomic outlook, 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, which we continue to stress, is inflation remaining higher for longer, requiring central banks (led by the U.S. Fed) 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 social unrest.

But not all is doom and gloom.  The assumption from our China macro team that China will move away from its zero-COVID-19 policy after the first quarter next year would have a positive knock-on effect for the rest of the year. Chinese households and corporations have relatively high savings, which could be deployed as confidence returns. In particular, if Chinese tourists start traveling after the first quarter, that should help the tourism sector's recovery (especially in Southeast Asia).

For energy exporters, such as Saudi Arabia, terms of trade remain favorable in 2023 (Brent oil price average $85/barrel assumed), even though oil prices have come off their peaks. But it is more than just the oil sector for Saudi Arabia, where the ongoing growth in the non-oil sector should help offset the anticipated decline in oil production in 2023. Alongside strong oil-sector dynamics, the economy's structural diversification away from oil and upstream crude production continues, with the non-oil private sector accounting for well over half of GDP, significantly higher than a decade ago. However, much of the non-oil sector is in petrochemicals and hydrocarbon-related activities. The government will continue to pursue its ambitious Vision 2030 diversification program via:

• Investment in the non-oil economy,
• "Saudi-ization" of the workforce (replacing expatriates with Saudis),
• An increase in female participation in the workforce,
• Attempts to improve the business environment, and
• Socioeconomic liberalization.

For more, see "Saudi Arabia 'A-/A-2' Ratings Affirmed; Outlook Remains Positive On Strong Fiscal And Economic Growth Dynamics," Sept. 16, 2022.

In South Africa, where the government lifted the licensing threshold for small-scale power generation projects to 100 megawatt, private investment in the renewable energy segment of the economy is likely to get a boost from 2023 onward.

The energy crisis in Europe has increased prices (and demand) of alternative sources of energy, such as coal, which is an important export item for Colombia, Indonesia, Brazil, India, Malaysia, and South Africa. For instance, Colombian coal export volumes rose 25% quarter over quarter in the second quarter (70% in nominal terms). Assuming shortages in natural gas/oil-generated energy continue into 2023, demand for coal could remain strong.

Appendix

Table 4

Table 5

Table 6