Long-Term Outlook: China and Emerging Markets

Emerging Markets

Excerpted from the Aegon AM Long-term Outlook

As the Covid-19 pandemic enters a second year and vaccine deployments are being scaled up to inoculate populations, concerns are rising about how well the global recovery and emerging markets (EM) will fare in the long-term. Our view is a multi-speed economic rebound in which some regions (Greater China, Middle East, and Emerging Europe) rebound faster than Latin America and Africa. The resurgence of cases related to the Delta variant (and future Covid-19 strains) will challenge emerging markets to manage fiscal and monetary policies and achieve a sustainable trend recovery.


For this article, we differentiate our forecasts and narrative of China and an emerging market universe that includes China. China is the second largest economy of the world and has significant impact and linkages with the other emerging economies. The emerging market universe is diverse due to development stage, market access, income levels, and global linkages and these defy a uniform narrative. While emerging economies are dissimilar, they have generally made remarkable progress in establishing rule-based fiscal and forward-looking inflation-targeting frameworks.


China and emerging markets took bold measures during the Covid-19 pandemic. On the fiscal side, economic measures included government spending, liquidity support, asset purchases, and assistance from multilateral financial institutions (IMF, World Bank). Emerging market central banks eased monetary policy aggressively following similar actions of advanced economies. Higher fiscal deficits have also added to already elevated government debt in many emerging markets. Without these policies, emerging markets would have faced far worse economic contraction in GDP and materially risked the post-pandemic recovery. China was able to contain the Covid-19 virus and inoculate its population faster than the rest of emerging economies.


The long-term economic outlook for China and emerging markets is based on how quickly the negative effects of the Covid-19 pandemic on human capital, employment, financial systems, politics, growth, and inflation can be managed. Unlike China with debt in domestic currency, other emerging economies have sizeable external debt and/or foreign investors that own a sizeable share of domestic debt. Emerging markets must keep debt service costs manageable and, in some countries, seek debt forgiveness under the G20 Debt Service Suspension Initiative Common Framework. The recent hawkish tilt by the Federal Reserve (Fed) and global inflation spike is likely to be temporary as cost-side inflationary pressures ease in the next few years. We have taken a close look at the economic and financial trends, putting aside the short-term Covid-19 headwinds, and we see a better China and Developed Market (Europe and US) outlook, which would be very supportive for Emerging Markets (ex. China), given the strong trade and capital linkages. With the global recovery getting stronger, the external positions for commodity EM producers will keep getting stronger. The cyclical rebound for EM should continue, boosted by pent-up demand and investment. This improvement in global economic activity is highly dependent on continued vaccination efforts. The demand side globally should remain strong, bolstered by reopening economies, ongoing vaccination, and increased confidence. Supply-side constraints bring uncertainty in the near term but should dissipate over time, and our outlook for a resilient, broadening recovery in the long-term remains unchanged. The recovery is still likely to be asynchronous not only between EM and DM, but also intra-EM.


The US monetary policy appears to be in a transition with expectation of rate hikes in 2023 and the Fed is expected to start tapering of its asset purchases ahead of monetary tightening. China has already transitioned to a neutral monetary policy with the recently announced cut of the reserve requirement ratio (RRR). This RRR reduction demonstrates the People’s Bank of China (PBoC) is determined to anchor liquidity expectations and make sure market participants do not fear liquidity tightening. Growth rebalancing continues with retail sales and manufacturing investment continuing to catch up, while property investment growth has lost some momentum. Meanwhile, activity data in China shows growth rebalancing continues, with key indicators for private domestic demand seeing stronger growth momentum. This is in line with growth engines gradually being expected to shift from property investment to manufacturing investment and household consumption in the coming years. The momentum in exports from the continued recovery of the global economy should remain robust. Global trade data points to China’s firm position in global supply chains, notwithstanding the tariffs and trade tensions with the United States. The National People’s Congress (NPC) was held in Beijing from 5 to 11 March 2021 and saw Beijing reintroduce the annual GDP growth target (above 6%) for this year and stated it will continue to set annual GDP growth target in the coming years. Our long-term growth forecast for China is based on expectation that Beijing’s growth guidance will keep future GDP targets at around the 6% level. The CPI inflation outlook for China remains modest, necessitating prudent and flexible PBoC monetary policy, while keeping the supply of money and aggregate financing in step with economic growth in nominal terms. Most central banks in Asia are likely to follow the PBoC’s example and not turn hawkish in the near term. In contrast, other EM central banks are already responding or will shortly begin to respond to closing output gaps and inflation pressures. Political developments will likely remain fluid in many EM countries, which can be an additional source of differentiation. With regards to emerging markets, we expect a slowing pace of global liquidity growth while factoring the impact of Fed tapering for EMs, Covid-19 vaccinations, higher interest rates, and stronger external positions. A potential concern for the long-term outlook for EMs is the trend of growth appearing to be decelerating in the years leading to the Covid-19 pandemic, both on an absolute and relative to DMs. The underlying trend in EM GDP growth has slowed from a peak of around 7% just before the Global Financial Crisis (GFC) to around 4.5% currently. This slowdown has largely been led by the decline in China’s potential growth. With expectation that China will target GDP growth rate to around 6%, normalization of global growth activity suggests a return to around 5% for emerging markets. We factor in a decline in protectionism and significant reversal of de-globalization trend as global trade agreements are implemented and unilateral tariffs (aka protectionism) decline for emerging markets.


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