China has begun the rapid relaxation of zero COVID-19 policy. In our view, emerging markets (EMs) that are exposed to China's consumption will benefit the most from this policy shift. In particular, EMs that are large recipients of Chinese tourists could benefit significantly as travel picks up after a couple years of virtually no outbound Chinese tourism. These include Thailand, and Vietnam.

We expect consumption activity to recover more strongly than investment because real estate fixed investment isn't on a firm recovery path. EMs that typically benefit from greater demand for infrastructure-heavy industrial metals, such as South Africa, Brazil, Chile, and Peru, may see terms of trade improvements if the recent increase in commodity prices is sustained. However, the benefits to growth in those EMs will not materialize until China's property market recovers more decisively and results in greater export volumes of metals, or prices remain high for a sustained period to fuel income growth.

Greater mobility in China reduces the risk of port or manufacturing disruptions, which could be positive for EMs with significant manufacturing linkages with China. However, weakening demand in advanced economies, they key buyers of manufactured goods, is likely to prevent those benefits from fully materializing.

Growth Drivers In China As It Reopens

China's exit from its stringent COVID-19 strategy toward the end of last year will be a key driver of stronger GDP growth in 2023. We currently forecast 4.8% growth in China this year, compared with 3% in 2022 (see "China’s Earlier Policy Shift Advances Its Recovery," Jan. 18, 2023). Two opposing COVID-19-related drivers are at play: improved social mobility and business activity, and reduced workforce productivity (due to illness or mortality). Our current base case assumes the former driver will have a bigger impact than the latter in 2023 (see "China’s COVID Wave: Q1 2023 Will Be Critical," published on Dec. 21, 2022).

In our view, consumption will lead the recovery, with investment more muted. That said, signs suggest policymakers have started to focus more on supporting investment in real estate, including a major easing of restrictions on bank lending to property developers, among other signs. This could lead to a more notable pickup in investment in infrastructure later in the year.

What This Means For Chinese And Asian Corporates

We do not expect the Chinese government to back-track on its COVID-19 easing. Officials have given no such indications, and the boom in passenger volumes and cinema ticket sales, among other reporting during the Lunar New Year, suggest fears of infection have been receding over past weeks. Meanwhile, the government, at the highest level of the State Council, has emphasized the need to support growth.

Sustained reopening will help China's GDP growth reach our base case of 4.8% in 2023 and may allow some businesses to recover faster than we previously expected. Sectors that stand to benefit first are those more reliant on consumption and mobility. For example, we expect China's retail sales growth to reach 5.8% this year, and we have revised up our mass gross-gaming revenue forecasts for Macao on the back of the reopening.

Infrastructure and real estate, however, may take longer to recover. COVID-19 lockdowns have obstructed the deployment of government stimulus and compounded the country's property crisis. The latest reporting continues to show synchronized declines in overall fixed asset investments and real estate fixed asset investment. Reversing those trends will be challenging. Homebuyers remain cautious, leading us to expect home sales to decline another 5%-8% this year, after falling in 2022. Local governments also remain under fiscal strain, squeezed by rising outlays for COVID-19 and stimulus and declining revenues from land sales, a key part of their income.

For Asia, the above implies that travel and consumption are likely to be the main transmission channels for the China reopening impetus. Tourism and export sectors from Thailand to Korea are already pinning hopes of a boost to recovery this year from Chinese tourists and consumers. Upstream oil and gas, and mining sectors in China as well as across Asia may also benefit if the reopening continues to push up energy and commodity prices. This leaves capital goods, real estate, and domestic services with delayed or less direct benefits, and thermal power and downstream energy and metals sectors with risks of cost and margin pressures.

EMs With High Exposure To Chinese Outbound Tourism Will Benefit The Most

One of the most noticeable impact on EMs from China's reopening will likely be the resumption of outbound tourism. Several EMs, mostly in Asia, traditionally have benefited from a large share of tourists coming from China--a trend that came to halt during the pandemic (see chart 1), with large negative repercussions to GDP growth in those countries. In the case of Vietnam, Thailand, and the Philippines, at least 1 in every 5 tourist arrivals came from China before he pandemic. In the case, of Indonesia, and Malaysia, it was at least on in every 10.

Chart 1

The resumption of Chinese outbound travel into these countries will likely have a large impact on their economies, especially in EMs where inbound tourism is a relatively large share of GDP. In Thailand and Vietnam, for example, tourism exports where roughly 10% of GDP before the pandemic (see chart 2). The speed in the recovery of tourism in those EMs will be subject to potential COVID-19-related travel restrictions imposed by those governments on Chinese arrivals. However, any such measures imposed are likely to be temporary, and tourism flows are likely to recover as the year progresses.

Chart 2

EMs Exposed To Chinese Investment In Infrastructure May Take Longer To Benefit

The evolution of Chinese investment in infrastructure as its economy reopens will be key to several EMs that supply infrastructure-related industrial metals, such as Chile, Peru, Brazil, and South Africa. Chile stands out, with copper exports representing over 15% of GDP in 2021 and about two-thirds of those going to China. Peru is also one the largest exporters of copper to China (roughly 6% of GDP). Brazil and South Africa export significant volumes of iron ore to China and could also benefit from higher Chinese investment in infrastructure.

Table 1

The initial reaction of metal prices to the relaxation of COVID-19 restrictions has been positive. Iron ore prices are up over 50% since early November 2022 (when the initial signs of a policy shift in China came to light), and copper prices are up roughly 20% since then. Higher prices certainly help EM exporters of industrial nominally, by improving trade balances, and often benefit fiscal accounts through taxes/royalties on mining sectors. Tight copper supply in key producers, such as in Chile where output has been declining and in Peru where political instability has disrupted production, could add upward pressure on prices if those issues are not resolved.

Unless high metals prices remain for a prolonged period and fuel higher income growth, the impact on real GDP growth will take hold once volumes, and not just prices of metals, increase. For example, in 2019, iron ore prices were up on average by nearly 45%, yet iron ore output declined in both Brazil and South Africa that year. Therefore, for EM metals exporters to see growth benefits from the reopening in China, a more decisive improvement in its property sector may be needed--that significantly increases demand for metals.

The outlook for the Chinese property sector remains subject to a lot of uncertainty, following a series of defaults of major developers last year, as well as a recent decline in prices of real estate. While we don't expect a sharp rebound in real estate activity, a barrage of recent government support measures should slow the downturn.

Table 2

Weakening Global Demand Will Dampen A Potential Improvement In Manufacturing…

The loosening in mobility restrictions in China could also eventually ease any remaining supply-chain disruptions, potentially benefiting EMs with significant manufacturing linkages with China. However, initially some disruption to production could take place as large numbers of people become temporarily ill after catching the virus. Beyond that, once manufacturing production normalizes, it will likely be muted by expected weakness in global demand--unless the outlook for the main advanced economies brightens.

EMs in Asia are have the largest linkages with China's manufacturing sector (see table 3). In addition, supply-chain linkages tend to be high in the computer and electronics sector. Vietnam, Thailand, Malaysia, and the Philippines have sectors with large supply-chain linkages with China that represent a higher share of their economy (see table 4). Outside of EM Asia, Mexico stands out, with about a fifth of value added in its computer and electronics sector coming from Chinese inputs.

Table 3

Table 4

In EMs with higher supply-chain linkages with China (Vietnam, Thailand, Philippines, Malaysia, and Mexico), in most cases manufacturing output is well above pre-pandemic levels (see chart 3). The main laggard is Thailand, where manufacturing output is still 3.5% below its level at the end of 2019. Among the worst-performing manufacturing segments in Thailand is the computer and electronics sector, which is still 13% below its pre-pandemic level.

Chart 3

…And Offset Inflationary Pressure From China's Reopening

As EM authorities continue implementing measures to re-anchor inflation expectations by tightening monetary policy, some fear that the reopening of China's economy could threaten to set back those disinflationary efforts. Reopening China's economy will certainly have an impact on price pressures domestically and globally, given its size and role in manufacturing and commodity markets. Prices for energy and industrial metals have already begun to rise. Brent prices have risen 10% since mid-December, and S&P Global's GSCI Industrial Metals index is up more than 9% in the same period. Our sense is that higher commodity prices from earlier and speedier abandonment of stringent COVID-19 policies in China will slow expected disinflation in 2023 only marginally--not enough to shift the stance among central banks in EMs, which is to pause or even begin cutting this year.

On the demand side, the impact of Chinese consumers releasing pent up demand may be gradual. Domestically, most goods markets in China face oversupply. Moreover, the overhang of "excess saving," while significant, is substantially smaller in China than in the U.S. and Europe, mainly because the government has largely abstained from providing fiscal support to households during the COVID-19 period. Price gains in China will more likely be centered on contact-based services that were affected the most by mobility restrictions, and these will have a limited spillover effect on the rest of the world. As a result, the demand-side impact of the Chinese reopening on EM inflation is likely to be relatively small, and will be muted by weakening demand in most of the rest of the world.

Supply-side dynamics that have been the main driver of inflation in EMs (food and energy) since the start of the Russia-Ukraine conflict in 2022 will remain a major swing factor. In our late November economic outlook, we penciled in Brent prices to average $85 per barrel in 2023 (versus $101 in 2022); even if Brent prices were to revert to $100, the impact would be relatively modest. Such an upward revision to our oil forecast implies that compared to what we had previously expected, EM fuel inflation would be on aggregate 2.5 percentage points (ppts) higher--and headline EM inflation 0.3 ppts higher--all else equal.

Chart 4

Chart 5

Furthermore, to the extent that China's reopening increases commodities prices further, these would improve terms of trade of several EMs and potentially lead their currencies to appreciate at the margin, relieving inflationary pressure. Most EM currencies have appreciated against the U.S. dollar in recent months, and a terms of trade improvement could further this trend.

Chart 6

The Impact On Financing Conditions

China's reopening has increased risk appetite for investors, and EMs have seen an uptick in portfolio inflows over the past few weeks. Overall, these factors have been supportive for financing conditions, which have also improved over the past few weeks for other factors, including less pessimism toward growth in Europe and the U.S. amid better-than-expected economic data. However, challenges persist. While EM speculative-grade issuers have been able to tap the market, this has come at considerably higher interest rates than in recent years (see chart 7); reflecting expectations that tight monetary conditions will remain in place for a prolonged period.

Chart 7

We expect financing conditions will remain volatile over the first half of 2023 as investors assess the path of U.S. interest rates and inflation. More signs of easing inflation could fuel more optimism because it could temper expectations for additional tightening by the U.S. Federal Reserve, and point toward the end of its rate-hiking cycle. Such conditions could also continue to support EM currencies against the dollar. Consequently, a "cheaper dollar" would reduce inflationary pressures for EMs, potentially increasing investor appetite for EM assets. Conversely, higher-than-expected inflationary pressures in the U.S. would likely have to opposite effect, increasing expectations for more tightening by the Fed. This could tighten financing conditions and weaken EM currencies.

In our view, the recent improvement in financing conditions triggered by China's reopening could be short-lived if other factors weaken investor sentiment. In particular, those that keep the Fed on a tighter monetary policy stance for longer, such as higher-than-expected inflation and renewed pessimism toward global growth, could pare back the recent improvement in financing conditions.