Key points
- Monetary policy: With substantial progress made in bringing down inflation, emerging market (EM) central banks look set to kick off monetary policy easing cycles ahead of their developed market counterparts.
- China’s slowdown: The world’s second largest economy is facing a challenging period amid weakness in the property sector. Downside risks are growing, threatening to create negative feedback loops.
- Economic growth: EM growth appears resilient in the face of a slowing global manufacturing cycle and Chinese economy, but it’s uncertain if it can persist.
- Inflation: Important to monitor food prices going forward as they could face upside risks from El Niño and the termination of the Russia‑Ukraine grain deal. This may delay some interest rate cuts, but it’s unlikely to derail them.
- Rates, credit, and currencies: While our enthusiasm around EM currencies has abated, the outlook for EM local rates is more positive amid disinflation and central banks rate‑cutting cycles.
After a solid first‑half performance, what does the remainder of 2023 look like for emerging markets (EM)? It could be more of the same, but it will be important to keep an eye on China and whether the slowdown there drags down the rest of EM and weighs on sentiment. For now, we are seeing resiliency on the growth side, while inflation has come down quickly. On the monetary policy front, several countries are positioned to embark on an interest rate‑cutting cycle soon—striking out ahead of their developed market peers—which is an encouraging sign that EM is maturing as an asset class.
Monetary Policy—Interest Rate Cycle Turning
With substantial progress made in bringing down inflation, EM central banks are about to start easing—leading the turn in the interest rate cycle. Not only did they start raising interest rates before developed markets, but they also hiked more. This creates a cushion for EMs to commence cutting, even though most developed markets are unlikely to be in that position anytime soon. However, there is uncertainty in terms of how far EM central banks can go in this cycle. It's possible that rates will not return to pre‑hiking levels as conditions are different. EM central banks also need to be mindful of currency stability as they cut. Ongoing US dollar strength and the march higher of US rates pose potential headwinds, particularly for low‑rate countries that lack a sufficient carry cushion.
Chile has already kicked off its easing cycle, and we expect other Latin American countries to join them over the next few months. In Central and Eastern Europe, Hungary has begun easing, and we anticipate that the Czech Republic will soon follow suit. Bucking the trend is the Asia region, where it's likely to be 2024 before cutting commences. Inflation problems there were generally not as deep, so central banks didn't need to hike as much.
China's Slowdown—Property Sector Weighs
China's economy is slowing and at a faster pace than anticipated. A flurry of negative developments surrounding the property and trust sectors are likely to undermine confidence in the world's second largest economy and possibly lead to further weakness. Downside risks are growing, threatening to create negative feedback loops amid weak confidence and challenges in the manufacturing sector and labour markets.
To support the economy, the People's Bank of China has begun easing monetary policy, a trend we expect to continue over the coming weeks and months. But with credit demand low, the monetary transition mechanism may be weak—so it remains to be seen just how effective easing measures will be.
On the fiscal front, the response from authorities has been incremental. If this approach continues, it's going to take time to revive household and business confidence. So far, there appears to be an aversion to the types of large‑scale stimulus the authorities have implemented in the past due to the risk of higher debt ratios. Instead, they appear keen to structurally reorient the economy and put it on a more sustainable long‑term path even if it costs some growth in the near term. If the challenges continue to deepen, the resolve of the Chinese authorities will likely be tested. We think that authorities will ultimately want to guard against the risks of negative feedback loops becoming a bigger financial crisis or dragging the economy into recession. Fiscal policy will likely have to be the main lever to manage these risks, though there is ongoing debate over how much to do and the design of any fiscal program (even more modest ones).
This post was funded by T. Rowe Price
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