(Editor's Note: In this series of articles, we answer the pressing Questions That Matter on the uncertainties that will shape 2024—collected through our interactions with investors and other market participants. The series is aligned with the key themes we're watching in the coming year and is part of our Global Credit Outlook 2024.)

Many emerging markets (EMs) are bound to navigate the challenging global macroeconomic backdrop in 2024 better than their peers. Structural trends that will allow these EMs to mitigate the impact from global headwinds are nearshoring (Mexico, India, and Vietnam) and energy transition (Indonesia, Chile, and the Philippines, among others).

How This Will Shape 2024

EMs will face tough global macroeconomic conditions in 2024.  A soft landing in the U.S. (with an elevated risk of a hard landing), persistent weakness in the eurozone, soft Chinese demand, and two major wars (Russia-Ukraine and Israel-Hamas) will act as a drag on growth in EMs. All of these dynamics are taking place amid global interest rates that are likely to remain high. Therefore, we expect most EMs to grow below trend next year, with risks mostly on the downside.

There are bright spots in EMs' complex panorama.   Many EMs are noticeably better positioned than their peers to thrive despite these challenges. Structural trends, such as nearshoring, will allow them to offset some the impact from global economic woes. In the medium term, energy transition will also benefit many EMs that produce or hold large reserves of key metals.

What We Think And Why

Supply-chain relocation will remain a key trend that could benefit many EMs.   Nearshoring and friendshoring have gained attention as supply-chain disruptions during the COVID-19 pandemic made a case for manufacturers to diversify locations of their operations to minimize production disruptions. Tensions between the U.S. and China, especially over technology, may have also encouraged companies to move some manufacturing production out of China. Mexico's long-standing manufacturing linkages with, and access to, the U.S. market make it an obvious potential beneficiary for nearshoring. Since then, the nearshoring activity in Mexico has picked up, as seen in the strong construction pace of industrial parks in the northern part of the country, as well as an uptick in foreign direct investment (FDI) so far this year (see chart 1). Given high external financing costs, having strong FDI inflows will be particularly important for external account stability.

Chart 1

Vietnam has also been a key beneficiary of changing trade dynamics and supply-chain relocation.   The country's trade ties with the U.S. have been quickly increasing expanding even before the pandemic. Vietnam's exports to the U.S. have jumped fourfold since 2013 (see chart 2), and accelerated following the Trump administration's imposition of tariffs on China in 2018. The country has recently become the sixth-largest trading partner of the U.S. Vietnam will remain one of the fastest growing EMs in the next three years, supported by policies that favor global trade integration to foster domestic economic growth. Nevertheless, maintaining a strong global supply-chain presence will require sustained investments and reforms. Vietnam confronts significant challenges, considering its infrastructure, labor, and resource constraints. Insufficient expansion of power generation capacity means that the country could face electricity shortages especially during summer seasons.

India is set to become the third-largest economy by 2030.  And we expect it will be the fastest growing major economy in the next three years (see chart 3). A paramount test will be whether India can become the next big global manufacturing hub, an immense opportunity. Developing a strong logistics framework will be key in transforming India from a services-dominated economy into a manufacturing-dominant one. Unlocking the labor market potential will largely depend upon upskilling workers and increasing female participation in the workforce. Success in these two areas will enable India to realize its demographic dividend. A booming domestic digital market could also fuel expansion in India's high-growth startup ecosystem in the next decade, especially in financial and consumer technology. In the automotive sector, India is poised for growth, building on infrastructure, investment, and innovation.

Overall, Mexico is not the only EM that could benefit from the reconfiguration of global-supply chains. Countries with strong and stable trade ties with the U.S., such as Vietnam and India, are also gaining attention inin this area. Outside of Asia, EMs with wide access to the eurozone market and with included manufacturing sectors, such as Poland, are also bound to benefit from that trend.

Charts 2 and 3

The energy transition will position some key EMs in the spotlight.   Ongoing global efforts to accelerate energy transition and the achievement of sustainable development goals will boost the demand for key metals. In particular, copper, cobalt, nickel, and lithium are critical in electrical vehicle (EV) and battery production and performance. Currently, the leaders in mining and processing these metals are mostly EMs, including China (copper, cobalt, nickel, and lithium), Chile (copper and lithium), and Indonesia (nickel; see charts 4 and 5). However, there are initiatives across advanced economies to ensure supply diversification and strategic access to these metals, which will likely boost investments in other EMs with large reserves of these metals. This is a major opportunity for key EMs such as Chile, Peru, Mexico, Indonesia, Argentina, The Democratic Republic of Congo, and the Philippines, which hold some of the world's largest reserves of these metals. Particularly, we view Indonesia's substantial reserves of nickel, a key material needed to make EV batteries, as well placed to turn its EV battery manufacturing into a major export industry. The Indonesian government's supportive policies (ranging from lower value-added tax on EVs to labor liberalization and reduction in corporate tax) foster a more favorable landscape for foreign investors.

Charts 4 and 5

What Could Go Wrong

Many EMs will hold elections in 2024. Low levels of policy predictability can undermine investor sentiment and derail existing investment potential. EMs that will have elections next year include Indonesia, India, South Africa, and Mexico, among many others. EMs, about which we discussed above, still have work to do to reap a bonanza from the abovementioned structural opportunities. For instance, enhancing policy visibility will be critical in attracting investments into these developing trends.

Structurally high interest rates, in the absence of structurally greater growth expectations, will constrain investment growth. A sharp rise in investments will be hard to justify amid higher average cost of capital and interest rate burden--as interest rates are likely to remain higher than normal for some time--and without larger average expected returns (growth).

Related Research

• Economic Outlook Emerging Markets Q1 2024: Challenging Global Conditions Will Constrain Growth, Nov. 27, 2023
• Indonesia Counts On Batteries To Power Exports And Taxes, Aug. 24, 2023
• S&P Global Ratings Report Shines Spotlight On India's Economic And Capital Markets Potential Over Next Decade, Aug. 3, 2023
• For Mexico, Nearshoring's Potential Benefits--And Obstacles--Are Significant, April 4, 2023