"Opportunities and challenges surround the future of emerging markets,"  stated Alexandra Dimitrijevic, global head of analytical research and development at S&P Global Ratings, opening the fourth annual Global Emerging Markets Conference in London on Oct. 3, 2024.

Rising geopolitical fragmentation is generating trade tensions and forcing a re-thinking of supply chains. These trends are threatening the benefits to emerging markets (EMs) from favorable demographics, a rising role in the global economy, and--potentially--the energy transition.

EMs also face still wide technological and labor productivity gaps with advanced economies, significant exposure to physical climate risk with reduced fiscal space to fight it, and high interest rates.

From Macro To Credit: A Positive Picture With Pockets Of Risk

Emerging economies are diverging.  We expect growth in most EMs to accelerate in 2025, but remain below potential. In the coming decade, we believe EMs will continue catching up to advanced economies in terms of GDP but will maintain lower GDP per capita levels.

The Federal Reserve's ongoing monetary easing should create space for local central bank rate cuts and capital inflows. "Yet, this time the shift will be from a restrictive policy rate level to a neutral one. Not all EMs will equally attract capital inflows: growth differentials will matter more in this easing cycle, with EM Asia best positioned at the moment" affirmed Elijah Oliveros-Rosen, chief EM economist at S&P Global Ratings.

This comes after nine months of favorable financing conditions, strong issuance, and stable rating performance, which could continue--as long as we see a soft landing in the U.S.

Pockets of risk discussed were:

The implications of U.S. elections for our macro baseline.  (For more on our baseline expectations for EMs, see "Economic Outlook Emerging Markets Q4 2024: Lower Interest Rates Help As Pockets Of Risk Rise, Sept. 24, 2024.)

• A disruption brought about by contesting votes could increase market volatility, generating capital outflows and dollar strengthening.
• Expansionary fiscal policy might increase inflation, potentially derailing the Fed's monetary easing cycle, which could keep other central banks from cutting rates.
• Increasing protectionism stemming from China-U.S. trade tensions and a potential increase in imposed tariffs could also generate inflation and weigh on China's economic growth. (For more on the potential implications of the U.S. elections, see "Credit Conditions North America Q4 2024: Set For Improvement-With Eyes On The Election," Sept. 25, 2024.)

A slowing Chinese economy, dragged by struggling real estate.  Higher tariffs could undermine China's GDP growth. A slower Chinese economy is bad news for many EMs, because it's a key destination for their exports. Moreover, lower growth in China might mean lower commodity prices, hurting EM commodity exporters.

Conflicts in the Middle East and Russia-Ukraine.  One obvious consequence is rising oil and gas prices: if prices increase further, net energy importers are more vulnerable, including some in EM Asia (Thailand and the Philippines) and EM Europe (Hungary).

Frontier Markets And Rising Regulatory Complexity

EMs have been fairly resilient, with recent monetary easing reducing borrowing costs, according to the panelists. Sovereign upgrades during 2024 mirrored the positive trend.

"You can argue that some of those [upgrades] reflect more favorable global financing conditions, and a reversal of the 2022 terms of trade shock, but part of it reflects domestic structural reforms, such as in Turkiye, Saudi Arabia, [and] Oman," said Frank Gill, managing director sector lead at S&P Global Ratings.

Geopolitical risks loom for sovereigns, triggering higher defense expenditure amid mounting leverage.  Exceptions include India, Egypt, Chile, and Indonesia.

Conflicts are not uncommon to the market, which can acclimate to them--for example, tensions between India and Pakistan or North Korea and South Korea. The influence of these long-lasting conflicts on asset prices has faded over time as conditions stabilize and the effects are priced in. Still, geopolitical risks are difficult both to price and to hedge, intensifying market complexity.

This is evident in frontier markets, which are recovering and look promising, according to the panel's asset managers.  Defaults in Zambia, Ghana, and Sri Lanka underscore that a higher number of creditors and newly introduced frameworks from international institutions promoting financing facilities--such as the IMF--delay settlements.

Frontier markets remain a favorable asset class, however, as recovery values are typically higher than the initial troughs on bonds' pricing. Rating-wise, refinancing needs challenge frontier markets, which often can't rely on domestic markets and depend extensively on government borrowing (given the lack of equity financing, private capital, and foreign direct investment).

If it is true that a more diversified pool of lenders should enlarge financing possibilities, credit cycles are getting more synchronized: losing a specific type of financing could mean losing access to all other options.

Trade Evolution

"You never pay enough attention to supply chain risks,"  according to Chris Rogers, head of supply chain research at S&P Global Market Intelligence. The competition to attract manufacturing-–particularly for the energy transition--is increasing, especially for resources that require cumbersome planning (such as nickel in Indonesia).

Long-term investments have to cope with metal prices fluctuating widely month to month. In addition, supply chain visibility is key: if a downside risk materializes, a company should know the extent of damage to its supply.

Increasing raw material costs have unevenly affected commodity players.  Commodities represent 45% of EM trade. Overall, diversification and connecting upstream and downstream markets creates winners and losers from a credit perspective, with some commodity players shifting their supply chains from one region to another. (We use "upstream" to refer to the exploration and production of commodities and "downstream" to refer to the refinement, processing, and distribution of commodities.)

We believe financing conditions and political outcomes will challenge the supply chain agility displayed by some players. High borrowing costs led to reduced capital expenditure, which is good for leverage but detrimental for future operating margins, and changing policies could shift the trajectory of fundamentals in the long run.

In China, COVID-19 and geopolitical tensions have led manufacturers to channel capital expenditure outside of the country.  These investments are mostly going to other EMs, given lower hostility and tariffs than in developed markets. The "China plus-one" investments in Southeast Asia and nickel and lithium investments in Indonesia and Argentina, respectively, are good examples.

However, this effort to diversify manufacturing and sales raises execution risks. "The ability to control your supply chain partly depends on the policies of the countries in which your facilities are located" noted Charles Chang, managing director and Greater China country lead at S&P Global Ratings.

In terms of funding channels, local markets are increasingly competing with dollar markets, given healthy liquidity and lower rates in India and China, for example.

We anticipate leading supply chain developments in: 

• India, given the deep domestic market and low labor costs;
• China, which is still displaying solid returns; and
• Gulf Cooperation Council corporates, because the region has strong fundamentals, a strategic geographic position, and is starting to diversify (see Saudi Arabia).

Related Research

• Look Forward Journal: Emerging Markets - A Decisive Decade, Oct. 16, 2024
• Widening Middle East Conflict Poses Risks For Regional Sovereign Ratings, Oct. 9, 2024
• Credit Conditions Emerging Markets Q4 2024: Risks Loom Amid A Fragile Stability, Sept. 25, 2024
• Credit Conditions North America Q4 2024: Set For Improvement-With Eyes On The Election, Sept. 25, 2024
• Economic Outlook Emerging Markets Q4 2024: Lower Interest Rates Help As Pockets Of Risk Rise, Sept. 24, 2024