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Our conclusions

Weak growth in emerging markets in 2015 will lead to lower policy rates, with few exceptions. This is underpinned by a favorable inflation backdrop.

Globally expansive monetary policy, which will continue throughout 2015, delays emerging markets’ overdue deleveraging. This raises the vulnerability of emerging economies again.

The combination of weak growth, lower policy rates, and fragile external fundamentals will weigh on emerging market currencies in 2015.

Currencies of small and open EM economies exporting to the US should do better than those of large, domestically oriented economies.

A fragile emerging markets growth model

The emerging markets growth model has become increasingly fragile over recent years. Both the rates of growth (Fig. 1), as well as the quality of growth (Fig. 2) are deteriorating. Fixed investment which was the driving force of growth over recent years, is declining sequentially, as Fig. 2 shows. China still displays higher levels of investment growth, but even there, the rates of growth are slowing.

What’s particularly worrying is that emerging markets consumption, which has been relatively stable over the last 10 years, is now also on a downward trend. The decline in consumption growth suggests that emerging markets growth is coming down structurally and is unlikely to bounce back at least over the next 12 months.

Exports need to do the main lifting

The decline in emerging markets (EM) investment and consumption means that exports need to do the main lifting for the EM growth engine. Small, open and export-oriented economies are best positioned to see their overall growth improve again via exports to the United States. In particular Korea, Taiwan, but also Mexico are in a good position for this to happen. Fig. 3 shows some evidence for a small rebound in Asian net exports.

On the other hand, more domestically oriented economies, as well as those that export not to the United States are in a weaker position. In particular Russia, Brazil, and Turkey will find it hard to grow their exports. At the same time it’s clear that in the current weak global growth environment, exports will not be able to meaningfully lift emerging markets growth throughout 2015.

Fig. 1: Growth continues to slow in emerging markets

Industrial production growth vs. previous year, 3mma

Source: World Bank, Emerging Views; indicators are GDP-weighted.

Fig. 2: A fragile emerging markets growth model

Contribution to quarterly EM GDP growth, ex-China

Source: World Bank, IMF, Central banks, Emerging Views; indicators are GDP weighted.

Fig. 3: Net exports help support growth somewhat

Monthly overall net exports, 6mma, in USD bn

Source: World Bank, Emerging Views; indicators are GDP-weighted

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Developed markets Emerging markets

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

201420132012201120102009200820072006200520042003

Net exports Fixed investment

Consumption Overall GDP

-10

-5

0

5

10

15

20

25

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Asia Latin America EMEA

Weak growth, falling rates, delayed deleveraging

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Inflation is not a worry

Given the weak growth backdrop, inflation is not a worry right now in most emerging economies. Fig. 4 shows that inflation in emerging markets (EM) is close to the target inflation rate, and well below EM central banks’ upper inflation target. The exceptions to this are Russia, where import sanctions drive up inflation, as well as Turkey and Brazil where credit growth is still too fast.

As inflation comes down, real rates rise, and this will trigger further policy rate cuts across emerging markets throughout 2015. The most obvious candidates for policy rate cuts this year are China, India, but also Turkey. These policy rate cuts, coupled with weakening fundamentals will weigh on emerging market currencies in 2015, in particular against the US dollar. At the same time, EM currencies will remain volatile this year.

Global backdrop delays deleveraging

While several emerging economies were on good track with scaling back credit growth (Fig. 5) and current account deficits (Fig. 6), the global backdrop now further delays this deleveraging. Expansive monetary policy in Europe, as well as in several emerging markets, coupled with low commodity prices mean that current account deficits are less of a pressing issue for emerging economies.

As Fig. 6 shows, emerging markets’ current accounts have been deteriorating again in the latest quarter. Given our expectation of lower policy rates in emerging markets throughout 2015, we do not expect current accounts to improve this year. This increases emerging markets’ vulnerabilities again. We expect this to be the case in particular for South Africa, Turkey, Brazil, and Indonesia.

Positive for fixed income, not for equities

On the whole, we expect 2015 to be a relatively more positive year for emerging markets fixed income than for emerging market equities. The ongoing decline in emerging economies’ growth rates makes us pessimistic about emerging stock markets. Conversely, falling policy rates should stimulate emerging market bond returns.

Having said that, we remind investors to remain cautious with increasing exposure to emerging market currencies this year in a big way. Investors should focus on currencies of small, open and export-oriented economies that benefit from better growth in the United States. Furthermore, we would expect emerging market sovereign bonds to do better than corporate bonds this year, given governments’ large cash reserves and lower dependency on the business cycle.

Fig. 4: EM rates will fall throughout 2015

EM inflation, inflation targets, and policy rate

Source: World Bank, IMF, Central banks, Emerging Views; indicators are GDP-weighted

Fig. 5: Emerging market credit growth still too high

Credit growth vs. previous year, 2qma

Source: World Bank, IMF, Emerging Views; indicators are GDP-weighted

Fig. 6: Current accounts deteriorating again

Current accounts to GDP, 2qma and latest

Source: World Bank, Central banks, Emerging Views; indicators are GDP-weighted

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

20142013201220112010200920082007200620052004

Inflation target range

Inflation mid-target

Inflation

Policy Rate

-10%

-5%

0%

5%

10%

15%

20%

25%

201420132012201020092008200720052004

Excess credit growth Credit growth Nominal GDP growth

-3%

-2%

-1%

0%

1%

2%

3%

4%

201420132012201020092008200720052004

Emerging markets ex-China

Emerging markets

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