April 2023

Accuracy Talks Straight #7 – Economic point of view

Hervé Goulletquer
Senior Economic Adviser, Accuracy

2023: an emerging year?

Emerging markets and developing economies (EMDEs) have struggled through the succession of crises experienced over the past three years: health (Covid), geopolitical (the Russo-Ukrainian war, tensions in the South China Sea and growing Sino-American rivalry), economic (the return of inflation) and financial (the rise in interest rates and the dollar in a context of (primarily public) debt that calls for vigilance).  Their growth, if we exclude China, declined more in 2020 than that of advanced economies, and the subsequent rebound was more modest. The gap will not be filled this year or next.

Monde : les économies les moins développées souffrent le plus

Investment in infrastructure in EMDEs seems to have particularly suffered from this rather unfavourable dynamic. If we believe the Global Infrastructure Hub (November 2022), investment in this area in 2021 grew by 8.3% in high-income countries and fell by 8.8% in their medium- or low-income equivalents. Indeed, in that year, 80% of infrastructure projects were implemented in developed economies. How can we then not intuit that the return to more confidence for growth prospects is a prerequisite to the recovery of infrastructure investment in the EMDEs!

One more thing before looking ahead: the multiplying effect of the change in financial conditions on the growth profile needs to be measured. The tightening of monetary policy by the main central banks makes financing EMDEs much more difficult. And this observation is all the more pertinent given that their credit rating is weak. According to the World Bank’s findings, bond issues for all countries concerned fell by USD 250 billion in 2022 (much more than during the crises scattered over the past 15 years!), whilst the differences in sovereign spreads increased by 1,740 basis points (17.4%) for low-rated, energy-importing countries.

According to the IMF, the economic growth of EMDEs is projected to stabilise at around 4% this year and next year too. With the aid of a magnifying glass, we might discern a very slight upward trend (respectively +4.0% and +4.2%, after +3.9% in 2022). But the cloud of uncertainty, at such a complex time for the global economy, doubtless overshadows the extent of this acceleration. Though the quantification proposed may seem enviable compared with the projected performance of advanced economies, it is somewhat lacklustre compared with past performances closer to 5.5%.

Où va la croissance de la zone émergente ?

How then should we understand what might appear like a reserve in the IMF’s assessment?

First, there is the nature of the rebound expected for the Chinese economy. The announced return to better fortunes represents good news for the rest of the world. Fine, but to what extent?  To answer the question, we need to push a little further our understanding of the economic recovery over there. Its origin lies in the removal of restrictions placed on the movement of people. The direct beneficiaries will therefore be those people. As consumers, they will most likely favour services. This is what we were able to observe in Europe and the United States, after all. Moreover, it seems reasonable to prioritise the assumption of measured support through a proactive economic policy.  Favouring the trio ‘consumption – services – limited support via economic policy’ ultimately means not following the typical pattern of a Chinese recovery. This time, it is the result of fiscal and monetary stimulus, debt and investment. This difference between today and yesterday makes it easy to see the limits to the benefit that other countries should derive from China’s announced improvement. A quick glance at the composition of China’s imports shows this. The proportion going to households is small.

Then, there is US monetary policy. Its calibration conditions both part of the movement of the interest rate curves across the world and the level of the dollar against numerous other currencies, does it not? Though it is possible to consider that the majority of the rise in the Federal Reserve’s base rate has been undertaken (it is now on average at 4.63%), two aspects should be detailed: where will the ceiling be for the current phase of rises and how long will it stay at that level? Faced with inflationary pressures that send no clear signals of slowdown and with a labour market that is still tight, we might want to answer higher and longer than the market consensus estimates. We must therefore conclude that the US interest rate environment, if it becomes less adverse than it was, will not be immediately conducive to the formation of beneficial financial and economic conditions for EMDEs

Lastly, there is the ability of each emerging or developing country to relay, through its own monetary policy capacities, the initiatives taken by Washington. That depends on the economic and foreign exchange balances. The situation is quite variable from one economy to another. If we rely on the sample presented below, only a minority has a real downside potential other than marginal on its policy rate, as long as the US situation allows it.

A la recherche des marges de manoeuvre pour baisser les taux directeurs dans le monde émergent

And then, stepping away from the economy, but bearing in mind the implications that may appear in this area, how can we not be interested in the political developments to come!In this area, a certain number of topics should be closely monitored; some are already old and therefore well identified, whilst others have until now drawn less attention:

• China: risk of conflict with Taiwan, US economic sanctions, increase in youth unemployment and undersizing of the retirement system

• Brazil: risk of political instability following Lula’s election

• Saudi Arabia: rapprochement with Russia and strategy to reduce oil production, considered hostile by the United States

• Israel: risk of war with Iran and consequences of the arrival of the far-right to government

• Russia: continuation of the war in Ukraine

The electoral cycle, with in particular the presidential and/or parliamentary elections in Nigeria, Turkey, Argentina and Lebanon.

This multidimensional view leads to the conclusion that the auspices for 2023 do not appear particularly favourable for the economies of EMDEs. However, the capital markets are sending a much more optimistic message. Since last autumn, emerging zone bonds and equities have performed well compared with those of the developed world, especially the US. How can we explain this contrast?

In fact, the investors and market operators have gambled that the world economy, and particularly the US economy, will not fall into recession. Despite often low unemployment rates, the central banks will succeed in bringing inflation to levels more or less compatible with the defined targets, and without leading to a fall in activity for several quarters. In this context, the appetite for risk comes back and the emerging markets are taking advantage of it!

Des marchés obligatoires émergents qui reprennent des couleurs sur fond de taux longs américains mieux orientés

Retour à meilleure fortune des marchés actions émergents ?

On what side should we come down: the fundamental analysis or the view of the financial markets? It is very difficult to say! Let us simply remember that the bets for a soft landing of the economy are difficult to win, and doubtlessly even more so when the labour markets remain tight.

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