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EM Matters Summary

Core Content

EM Matters is an analysis of Emerging Market (EM) economic trends for November 2015. The report highlights the ongoing challenges EMs face, particularly due to the interplay of China's economic slowdown, falling commodity prices, and FX weakness. It also provides macroeconomic convictions for key regions – CEEMEA, LatAm, and Asia – and outlines the implications of these trends for EMs' future outlook.

Main Regions and Key Views

CEEMEA

• Russia: Aggressive rate-cutting cycle is expected, with the CBR targeting 250bp of rate cuts by end-Q1 2016, significantly more than the consensus of 137bp.
• Turkey: A rapid growth slowdown is imminent, with GDP growth expected to drop to 2% in 2016, well below the market consensus of 3.2%.

LatAm

• Brazil: The recession is deepening, with real GDP growth expected to be -3.0% in 2016. Inflation is expected to remain above target, delaying rate cuts until 2017.
• Colombia: The El Niño phenomenon is expected to intensify, pushing inflation higher by at least 100bp. This will create significant monetary policy challenges.

Asia

• India: There are signs that the capex cycle is finally turning, with capital goods production growth picking up. This is seen as a positive development for growth.
• Indonesia: The current account deficit is expected to widen to 3.5% of GDP in 2016, despite narrowing earlier in the year due to lower oil prices and improved public capex execution.

Key Trends and Pressures

• China's Negative Feedback Loop: EMs have been trapped in a cycle of slowing Chinese growth, a strong USD, and falling commodity prices. This has led to current and capital account shocks, FX weakness, and asset price declines.
• Steel Exports and Industrial Deflation: China's industrial output is being sustained by a surge in steel exports, but this is driven by excess capacity and not sustainable growth. The country's nominal growth is slowing, which is driving down nominal interest rates and exacerbating capital flight.
• FX Reserve Drain and Liquidity Constraints: The outflow of FX reserves has tightened financial conditions, increasing the downside risks for EMs. China's FX reserves have turned negative year-on-year for the first time since the Asia crisis.
• Protectionist Pressures: As China's exports increase, protectionist measures in other countries, such as Vietnam's planned 10% tariff on Chinese steel, are likely to intensify.
• RMB and Global Deflationary Pressures: The RMB's de facto USD peg is under pressure, and any movement away from it could further contribute to global deflationary pressures.
• SDR Inclusion and Fiscal Stimulus: The inclusion of the RMB into the IMF's SDR and well-designed fiscal stimulus could help relieve capital account pressures and lift growth expectations.

Regional Pressure Points

• Russia: Inflation is expected to decline sharply, allowing for monetary easing. However, growth remains weak, and the CBR may prioritize growth over inflation.
• Turkey: A major slowdown in economic activity is expected in Q4 2015 and 2016, driven by weak credit growth and falling consumer and business sentiment.
• Brazil: The BCB is likely to delay rate cuts due to the combination of weak growth and high inflation. The economy faces a deep recession and fiscal challenges.
• Colombia: El Niño is expected to cause a significant rise in food-price inflation, creating a tough policy environment for the central bank.

Outlook and Risks

• EM Relief Rally: A weak September NFP report triggered a relief rally in EMs, particularly in the IDR, but this was short-lived as October's stronger NFP data rekindled USD strength and commodity price pressure.
• Continued Downward Pressure: Commodity prices and the RMB are expected to remain under downward pressure, which could derail the Fed's tightening cycle.
• Fiscal Dominance in Brazil: The country is moving towards a situation where fiscal concerns may dominate monetary policy, potentially leading to a loss of central bank credibility.
• Monetary Policy Challenges: In Colombia, inflation expectations are backward-looking, which could be affected by the El Niño-induced food-price inflation.

Key Forecasts

• GDP and CPI Inflation: Forecasts for 2016 are below consensus for several EMs, with inflation remaining above target in Brazil and Colombia.
• Sovereign CDS and Implied Ratings: These indicators suggest that EMs are under increasing credit risk, with sovereign CDS and implied ratings reflecting this.
• Heat-Map Analysis: A detailed analysis of EM vulnerabilities is provided, highlighting the most at-risk economies.

Conclusion

The report underscores the persistent challenges facing EMs, with China's economic trajectory being a central factor. While there are signs of short-term relief, the long-term outlook remains uncertain, driven by structural issues, FX pressures, and the potential for renewed global deflationary forces. The central banks in these regions face difficult choices as they navigate the complex interplay of inflation, growth, and fiscal sustainability.