151216 em outlook

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Emerging Markets Outlook

16 December 2015

The ‘Force’ abates: modest recovery in 2016

Introduction

In late November, we published our Global economic outlook, Cautious optimism warranted.

In the first chapter of this publication, our Chief economist Han de Jong explains that the

global outlook for 2016 and beyond hinges on a couple of questions. A crucial one is

whether emerging economies can deal with the challenges they have struggled with in 2015.

His answer is a cautious ‘yes’, although he adds that the risks of a less favourable

development than we are forecasting in our base case are relatively high. In this publication,

we zoom in on developments in EMs and their prospects, the divergence between various

regions/countries and the risks that could interfere with our base scenario of a modest

economic recovery for EMs in 2016-17.

EM growth drops to lowest level since global crisis Growth divergence has widened across regions …

% yoy % yoy

Sources: Thomson Reuters Datastream, IMF Sources: Bloomberg, Thomson Reuters Datastream, ABN AMRO

As headwinds intensify, EM growth drops significantly in 2015

2015 has been a tough year for EMs. On average, EMs are still growing faster than

advanced economies, but the relative momentum has turned and EM growth is clearly

below trend. EM growth has continued to fall since 2010, with a strong slowdown in 2015

(by 0.7 %-point, to 3.7%). This reflects several headwinds. First, the negative effects of the

sharp drop in commodity prices on commodity exporters outweigh the positive windfall

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Group EconomicsEmerging Markets Research

• In 2015, emerging markets (EMs) faced several negative forces: lower

commodity prices, weak global trade and China/Fed induced capital outflows

• Divergence between regions and amongst BRICs has widened

• With headwinds fading and FX corrections supporting external adjustment,

we expect economic growth in EMs to recover modestly in 2016-17

• However, risks (Fed lift-off/capital outflows/tighter financial conditions, high

debt, China hard landing, geopolitics) are still clearly tilted to the downside.

Arjen van Dijkhuizen

Senior Economist

Tel: +31 20 628 8052

[email protected]

2 Emerging Markets Outlook - The ‘Force’ abates: modest recovery in 2016 – 16 December 2015

effects for net importers. Second, weak external demand from key trading partners (China

as well as some advanced economies) has also affected non-commodity exports. Third, a

deterioration in market sentiment versus EMs in the course of 2015 – relating to the China

slowdown and Fed rate hike fears – triggered net portfolio outflows (particularly in the

summer), contributing to a further tightening of financial conditions in EMs.

Divergence between regions and key EMs has increased

These headwinds have not impacted all EMs equally. Latin America, Russia, Central Asia,

the Gulf region and Africa have been hardest hit by the drop in commodity prices. Domestic

conditions vary as well: economic policies, the scope for stimulus, structural issues, political

instability. All these factors help to explain the divergence between regions and countries.

Growth in emerging Asia (around 6%) is slowing a bit, but remains relatively robust. While

China is continuing a gradual slowdown, India is growing by ±7.5%, making it the fastest

growing emerging giant. Regional growth in emerging Europe has fallen by around 2.5 %-

points compared to 2014, to -1%. This is driven by Russia (-4%, due to lower oil prices and

Western sanctions) and Ukraine (-10%), but Central Europe is doing well helped by the

eurozone’s recovery. Latin American growth has fallen by 1.5%-point to around -0.5% this

year. Here, the largest economy Brazil (our estimate for 2015 is -3%) was hit by a poisonous

cocktail of low commodity prices, political turmoil, weak policies and structural issues.

… and BRICs an EMs face strongest capital outflows since global crisis …

% yoy USD bn

Sources: Bloomberg, Thomson Reuters Datastream, ABN AMRO Source: Institute of International Finance

In Q3-2015, EMs faced with largest capital outflows since global crisis

Risk sentiment for EMs deteriorated sharply in the course of 2015, reflecting China-related

concerns, falling commodity prices and a looming Fed rate hike. Net portfolio outflows from

EMs rose in the summer, contributing to a further tightening of financial conditions. IIF data

show that in Q3-2015, net portfolio (equity and debt) outflows amounted to USD 33 bn. This

exceeded the levels seen during both the taper tantrum in June 2013 and in late 2014. In

October, capital flows to EMs partly returned, after dovish signals from G3 central banks. In

November, however, EMs were faced with another wave of outflows (albeit at relatively low

levels), driven by the stronger pricing in of a Fed lift-off in December 2015. For 2015 as a

whole, EM net portfolio inflows are projected to be the weakest since 2008. The IMF

estimates total net inflows in January-November 2015 at USD 44 bn, compared to an

average net inflow of USD 270 bn in the period 2010-2014.

… explaining the sharp correction in EM asset prices and currencies

The reversal in capital flows in the course of 2015 has gone hand in hand with a sharp

correction in EM currencies and stock markets. Our EM currency index dropped to record

lows versus the USD, even surpassing the levels seen during the global crisis (chart). This

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partly reflected US dollar strength, bolstered by an improving US growth momentum and

rising expectations of a Fed rate hike. Commodity currencies weakened the most versus the

USD, including the Brazilian real, the Colombian peso, South African rand, the Malaysian

Ringgit, and the Russian rouble. Meanwhile, the underperformance of EM stock markets

versus those of advanced economies has widened further in 2015.

… putting pressure on EM currencies and stocks World trade disappoints in 2015

Index, 2000 = 100 Index vs. USD Indices, 2005 = 100

Sources: Bloomberg, Thomson Reuters Datastream, ABN AMRO Sources: CPB, Thomson Reuters Datastream.

Weak global trade and lower demand from China add to headwinds

Weak global trade added to the EM’s headwinds in 2015. Global trade growth has declined

in recent years, remaining relatively weak compared to global real GDP growth. This goes

hand in hand with the slowdown in global industrial production. All this also translates into a

disappointing EM export performance. Growth in EM export volumes fell to 1.1% yoy in

January-September 2015, compared to 4.6% in 2013 and 2014. This slowdown was driven

by emerging Asia, reflecting weak external demand from China but also from advanced

economies like Japan. China’s merchandise imports fell by around 15% yoy so far in 2015,

although this contraction is largely explained by the drop in import (including commodity)

prices. We estimate that Chinese merchandise imports have contracted by around 5% in

2015 in volume terms.

We expect some EM headwinds to fade in 2016 …,

Going forward, we expect several of the headwinds that plagued EMs in 2015 to fade in

2016 (see also our Global economic outlook, Cautious optimism warranted):

1. Commodity prices. Commodity prices have been falling since 2011, but the pace

accelerated in late 2014 and 2015. Many commodity markets continue to be plagued

by excess supply. Lower than expected demand from China, disappointing global

growth and the increased productive capacity in recent years have created an

imbalance between supply and demand in many commodity markets that will take time

to disappear. However, as we anticipate that investors’ net short positions will be

(partly) closed and that high-cost producers will cut production, we believe commodity

markets will have a less negative impact on EMs in 2016 than they did in 2015;

2. Global trade. Next year, we expect that global trade will benefit from a moderate pick-

up in global growth and a rebound in global industrial production and manufacturing.

3. China imports. We also foresee an improvement in China’s imports in 2016, as we

expect the country’s slowdown to remain gradual and negative base effects to fade out.

… while currency depreciation will support external adjustment

Although the sharp depreciation of many EM currencies versus the US dollar poses inflation

risks and raises debt service cost of USD-denominated debt, it also has beneficial effects.

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Depreciation helps strengthen competitiveness, which supports exports, while simulta-

neously contributing to the squeezing of imports. This mechanism, which has already

started working, leads to an adjustment of external imbalances. The chart below shows the

current account for five EMs in our so-called fragile six: Brazil, Colombia, Indonesia, South

Africa and Turkey (see our September publication, The top six EMs most at risk). The

currencies of these countries have all depreciated relatively sharply versus the US dollar. In

all cases, the current account deficit has started to come down in the course of 2015.

FX correction helps external adjustment …, … but raises debt servicing costs in local currency terms

Current account balance, USD bn, 4-quarter moving average External and corporate debt denominated in USD, in % GDP

Source: Thomson Reuters Datastream Sources: BIS, EIU. * Estimated maximum dollar share

We expect emerging markets’ growth to modestly recover in 2016-17

Tighter credit conditions will remain a headwind, but EMs should benefit from fading

headwinds (stabilisation of commodity prices, pick-up in global trade and fading import

weakness in China) and currency depreciation, which will support external adjustment. All in

all, we expect growth in EMs to stage a modest recovery (in line with global growth), from

3.7% in 2015 to 4.2% in 2016 and 4.6% in 2017. Still, divergence between regions/countries

will remain high:

Emerging Markets: Economic growth forecasts

% yoy 2013 2014 2015* 2016* 2017*

Emerging Asia 6.5 6.3 6.1 6.0 5.8

- China 7.7 7.3 7.0 6.5 6.0

- India 6.9 7.3 7.5 7.5 7.5

Emerging Europe 1.7 1.3 -1.0 1.7 2.4

- Russia 1.3 0.6 -4.0 0.5 1.5

Latin America 2.4 1.2 -0.4 0.4 2.4

- Brazil 2.7 0.2 -3.0 -2.0 1.5

Emerging markets 4.6 4.4 3.7 4.2 4.6

World 3.0 3.1 2.9 3.3 3.4

Source: ABN AMRO Group Economics. * Forecasts for 2015-2017 are rounded

- Emerging Asia will continue to outperform other regions, but the gradual slowdown will

continue, driven by China. India will still be Asia’s fastest growing giant. We see some

room for improvement in export-oriented economies, as external demand should

strengthen on the back of improving world trade.

- The outlook for emerging Europe has improved. Following a deep crisis, we expect

Russia to grow modestly this year. The economies in Central Europe should continue

to propel ahead, supported by the Eurozone’s continuing recovery. In the case of

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Turkey, there is not much scope for acceleration, given its external and political

fragilities.

- We anticipate that Latin America will see a revival of exports, which will kick-start a

cautious economic recovery in 2016. However, persistent structural problems and the

impact of restrictive economic policies will continue to prevent an exuberant recovery.

Risks still clearly tilted to the downside

Still, we see a number of risk factors that could derail our base scenario of a modest

economic recovery in emerging markets in 2016/2017.

1) Fed rate hikes. With the Fed lift-off expected in December, we expect 75 bps in

additional rate hikes by the Fed in 2016. This could trigger a new wave of portfolio

outflows, contributing to a further tightening of financial conditions in EMs. This risk

could be even greater should the Fed hike faster than expected and/or if the lift-off

would trigger a sharp increase in bond yields in advanced economies. For several EMs,

this risk is mitigated by a large share of FDI in external financing (e.g. Brazil) or a

sizeable stock of foreign exchange reserves (e.g. China, energy exporters).

2) High private debt levels ... There has been a rapid accumulation of private debt in EMs

since the global financial crisis. This debt load is concentrated in emerging Asia and

mainly driven by China, but other countries in Asia (e.g. Korea, Hong Kong, Singapore,

Thailand, Malaysia) and elsewhere (e.g. Brazil, Chile, Turkey) also have high debt

levels. Such high debt burdens could prove to be a drag on the economy, certainly in

the case of rising interest rates, as they could depress domestic demand and may lead

to repayment problems for borrowers and a deterioration of asset quality for banks.

3) … and high dollar debts. In the case of US dollar denominated debt, risks are

exacerbated by the weakening of EM currencies versus the dollar. BIS data show that

the level of USD denominated corporate debt in countries like Turkey, Russia, Mexico

and Indonesia correspond to 10% of GDP or higher (see chart on previous page).

4) Hard landing China. Our base scenario assumes an ongoing gradual slowdown of

China’s economy in 2016-17. Obviously, given the country’s relevance in the global

economy, global trade and commodity markets, a faster-than-expected slowdown

would pose a key risk to our EM outlook.

5) Global trade remains weak. Should global trade (including imports from China) continue

to disappoint, this could jeopardise our projection of a pick-up in EM exports.

6) No stabilisation/rebound of commodity prices. Sustained excess supply in commodity

markets and/or disappointment on the demand side could mean commodity prices stay

lower for longer or fall even further. That would pose greater risks for commodity

exporters.

7) Geopolitical risks. Our base scenario could be threatened by geopolitical risk factors,

given the wide range of potential triggers: unrest in the Middle East, tensions between

Russia and Ukraine/Turkey/NATO, political risks in Europe (rise of anti-establishment

parties, Brexit, independence movements) and Latin America, conflicting claims in the

South Chinese Sea etcetera.

In conclusion

In summary, in our base scenario we expect emerging markets to stage a modest recovery

of GDP growth in 2016-17. However, against the background of the looming Fed rate hikes

– the first in almost a decade –, high EM debt levels and ongoing uncertainty regarding

China’s transition, we feel that risks are still clearly tilted to the downside. That said, there is

also a small possibility of positive surprises coming from the EMs. These could stem, for

instance, from a stronger-than-expected pick-up in global growth and EM exports or an

overall improvement in risk sentiment benefiting commodity prices and EMs more generally.


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