Emerging Markets Digest: October 2024

In the last edition of the Emerging Markets Digest in April, we highlighted how emerging markets had been in a relative goldilocks period of recovering growth and moderating inflation with expectations for future Fed rate cuts alleviating pressure on emerging market assets. But we also highlighted that there were many risks on the horizon, some of which have materialized and others which continue to loom overhead.

Over the last several months, for example, growth trends in the major economies turned from surprising to the upside, to surprising to the downside (figure 1). This was particularly the case for China and the euro area, but also, perhaps surprisingly, for the US. Despite this, emerging markets, appeared more resilient with less negative growth surprises, even as emerging market sentiment indicators deteriorated more than in advanced economies (figure 2).
 

More recently, the US has led an upward trend in growth surprises, which brings with it both good and bad news for the emerging market outlook. A stronger growth outlook in the US tends to support global demand for traded goods and services. Indeed, strong consumer demand in the US has coincided with strong US import growth (up 7.6% year-over-year in August and nearly reaching (in USD terms) the post-pandemic high of early 2022, figure 3). This has helped support global trade volumes after a period of relative stagnation in 2023. While we do expect US growth to moderate going forward (from 2.8% in 2024 to 1.9% in 2025), as much of the recent strength was supported by a temporary supply shock to the labour market, and the impact of higher interest rates has yet to fully filter through to the housing market, the relative soft landing of the US spells good news for the global economic landscape. This is especially important given the increasingly delayed recovery in the euro area and the economic headwinds facing the Chinese economy (see below for details).

The downside to the surprising resilience of the US economy and labour market is the mixed signals it sends regarding the path and pace of the Fed’s easing cycle. As noted in the last edition of this publication, the pushback of the expected timing of Fed policy, initially foreseen by markets starting earlier this year, not only kept financial conditions tight and put pressure on many emerging market currencies versus the US dollar, but it also made financial markets more volatile. The data-dependence of the Fed made markets—and bond markets in particular—very sensitive to any new data that might move the needle on expected Fed easing.

In the lead-up to the Fed finally easing by a larger-than-normal 50 bps, benchmark yields, particularly the yield on 10-year US Treasuries, dropped to a low of 3.63% in mid-September (the Fed cut on the 18th of that month), and the trade-weighted dollar declined after a long-run of strength. Hence, some clarity on Fed policy helped ease pressure on emerging markets. A Fed that’s finally easing policy also means other smaller central banks concerned about inflation import from currency weakness versus the dollar, and more generally capital outflow pressures stemming from interest-rate differentials, have more space to ease policy if necessary. While many emerging market central banks, which had previously hiked rates strongly in the face of the 2021-2022 inflation surge, had already started easing cycles in 2023, a more hawkish Fed kept many central banks on a cautious path.

In the weeks following the Fed’s jumbo-sized rate cut, expectations for a frontloaded Fed easing cycle have eased somewhat on stronger US labour market and activity data, and the data-dependence of the Fed has become again more prominent in markets. Indeed, the 10-year yield gave back much of it’s recent declines since mid-September, rising again to 4.2% as of 25 October. All this to say, financial market volatility is not fully behind us, which makes the landscape more complicated for emerging market central banks.

The relevance of a strong external environment for emerging markets recently also highlights an important vulnerability that has been on the horizon for some time but becomes more pressing in the lead up to the US election. Namely, rising trade tensions and protectionist tendencies from the major economies puts the global growth outlook, and the growth outlook for many emerging markets, on the back foot. Of course, some emerging markets reaped benefits from the 2018 trade war between China and the US as businesses shifted supply chains and rerouted trade through third countries. For example, as US imports from China declined, US imports from Mexico surged, at the same time as China’s exports to Mexico increased (figure 4). A similar pattern can be seen in trade dynamics with other emerging markets, including Vietnam and Hungary.
 

But besides the uncertainty brought about by generally increased protectionist tendencies (which are likely to persist regardless of the US election outcome), the tariff measures proposed by Trump are much higher and wider-reaching than what he imposed during his first term (see: The impact of Biden’s new tariffs (kbc.com) for details). Trump’s threat to put a 100% tariff on vehicles from Mexico is an important example, which if pursued would likely wreak havoc on US-Mexico trade (the USMCA trade deal is up for renegotiation in 2026). Increased protectionism would also raise uncertainty globally, and bring down global growth, affecting especially small open economies like many emerging markets.

China

Recent data releases continue to paint a gloomy picture of the Chinese economy. GDP growth slowed to 4.6% year-on-year in the third quarter, down from an already disappointing 4.7% year-on-year in the second quarter. While a September uptick in industrial production (0.6% month-over-month) and retail sales (0.4% month-over-month) likely prevented the growth outturn from being even worse, other September data point to still sluggish momentum and growing slack in the economy, especially in the private sector. Private fixed asset investment continued to contract (-0.2% YTD year-on-year) for the second month in a row, total social financing (a measure of credit growth) decelerated further to 7.9% year-over-year and was supported mostly by government bond issuance, and consumer confidence remains weak while household savings remain elevated. Inflation data for September also point to slack, with headline inflation decelerating to 0.4% year-on-year. Stripping out food price inflation, which has been elevated the past two months, prices fell 0.2% year-on-year. Producer prices also continued their decline (-2.8% year-on-year) for the twenty-third month in a row. While this does not change our 2024 average inflation outlook (0.5%), we downgraded our 2025 outlook from 1.6% to 1.4%.

Looking forward, however, risks to the downside might be declining as policymakers have clearly signaled their willingness to address growth concerns through a new stimulus package. A first step included more sizable than usual monetary policy easing (including cuts to the Reserve Requirement Ratio and 7-day Reverse Repo Rate), increased support for the real estate market, and new support for equity markets, the latter of which responded with exuberance to the announcement. Policymakers then followed up with pledges to complement monetary policy stimulus with fiscal policy stimulus, a much-needed element given weak demand for credit amid the housing market correction. While details on the total size of this spending, and importantly, how exactly it will be directed into the economy are still lacking, policymakers mentioned support to highly indebted local governments, subsidies to low-income households, and a recapitalisation of banks that have been suffering from weaker profitability (amid lower interest rates and weak credit demand) and increasing loan losses.

More details should be forthcoming in the coming weeks and will be crucial for determining to what extent the new stimulus push will address China’s underlying problem of a weakened private sector or whether it will just be another sugar boost to help the government reach its growth target that quickly fizzles out. For now, we have upgraded the outlook for the fourth quarter, raising the 2024 growth forecast from 4.7% to 4.8%. This generates sizable overhang effects for 2025, which together with a slight upgrade to Q1 growth, raises our annual average growth outlook from 4.2% to 4.6%. The outlook overall, however, may still change as stimulus details become clear.

India

As expected, following a strong FY 23-24 outturn of 8.2% GDP growth, the pace of economic activity in India has moderated somewhat to a still strong 6.7% yoy in Q2 2024 supported by growth in consumption, investment, and exports. Sentiment indicators point to solid but moderating growth for both manufacturing and services (PMIs at 57.1 and 58.8, respectively). However, industrial production growth fell in August (-0.14% yoy), led by declines in electricity production and mining, but also some weakness in manufacturing. We forecast real GDP growth of 6.5% in FY 24-25 (somewhat lower than the latest IMF WEO update of 7%).

Meanwhile, the downward trend in inflation has been bumpy, with food prices (9.2% yoy) sending the September headline figure (5.5% yoy) sharply higher. Core inflation has also ticked up but remains below the RBI’s 4% target at 3.5% yoy. The expected start to RBI easing therefore continues to be pushed back given still strong growth, geopolitical (commodity price) risks, volatile food price inflation, and uncertainty related to US monetary policy (which has now eased partially). We expect a first 25 bps cut only in Q1 2025, bringing the policy rate to 6.25%, with still cautious easing thereafter.

Latin America

The economic environment for Latin American countries has been mixed in recent months. The start of the easing cycle by the US Fed should be supportive for the region but China’s persistent growth slowdown is a cause for concern. Meanwhile, many economies in the region are still struggling with structural challenges including budget deficits, elevated debt ratios, population ageing and low pension coverage.

The start of the US Fed easing cycle in September is typically a positive for Latin America as it stimulates capital inflows through increased investments, and it reduces the downward pressures on the region’s currencies. As long as the US economy stays on track for a soft landing, Latin American countries should benefit from the recent monetary policy shift.

Risks to the growth outlook for the Latin American countries are mostly tilted to the downside. For one, if the US economy would weaken more than expected, this would negatively impact demand for Latin American exports. Economic weakness in China, a key importer of commodities from the region, is another risk for Latin America. Recently, this risk has declined somewhat as the Chinese government announced plans for monetary and fiscal support measures. The jury is still out on how effective these measures will be as few details have been released on the scope and scale of the plans. Another risk is the further escalation of existing political tensions and or social unrest, which could weigh on economic growth in the region. In Argentina, austerity measures and (declining but still) sky-high inflation are causing poverty rates to soar and protests to intensify. Mexico has seen unrest following plans to overhaul the judicial system.

One positive risk to the growth outlook in the medium term is the potential conclusion of the Mercosur-EU trade agreement. The negotiating parties have signaled that the deal, which has been in the works since 1999, could be approved by the end of 2024. There are no guarantees that this timeline will be met, however, as there are still significant points of contention.

There is also first-order political risk stemming from the US presidential election in November, as Latin America is disproportionately exposed to the country due to its geographical proximity, high level of economic integration and widespread migration. Expectations are that a win for Donald Trump would result in lower economic growth, higher inflation, steeper borrowing costs, severe restrictions on migration and more complicated foreign relations, especially regarding China. If Kamala Harris wins, the regional outlook would be more benign, although some tightening of US policies on migration and China is still to be expected.

Inflation rates have come down substantially in recent years across the region (figure 5). But while Mexico and Brazil have seen inflation bottoming out (and even increasing of late), Colombia and Argentina’s inflation rates are still declining. Argentina is a clear outlier in the region. It not only reached its inflation peak very late, namely at the beginning of 2024, but it also has an extremely high inflation rate compared to the other Latin American countries.
 

Most Latin American economies reduced their monetary policy rates following the inflation declines (figure 6). Despite the start of Fed easing, appetite for additional cuts seems to be fading in the region, with Brazil even deciding to hike its policy rate again last September on the back of the pick-up in inflation it has seen in recent months. The Brazil central bank signaled more increases are likely given the challenging inflation outlook, which is driven by stronger-than-expected economic activity.

South Africa

While the South African economy has continued to register only modest growth in recent quarters (0.35%, 0.03%, and 0.44% qoq in Q4 2023, Q1 2024 and Q2 2024, respectively), the outlook is improving somewhat, and the economy is on track to grow 0.9% in 2024 and 1.6% in 2025. An improvement in sentiment indicators of late (Composite PMI: 51 in September, consumer confidence still negative but returning to pre-pandemic levels) is particularly encouraging. Inflation has also continued to decline steadily, with both headline and core inflation falling below the central bank’s 4.5% target in recent months (headline reached 3.8% yoy in September while core reached 4.14%). The South African Reserve Bank (SARB) attributes much of this to a stronger rand in addition to lower energy and food prices. The drop in inflation, together with the Fed’s September rate cut, allowed the South African Reserve Bank (SARB) to implement a first 25 bps rate cut in September, bringing the policy rate to 8.0%. We expect continued further gradual easing throughout the first half of 2025, bringing the policy rate to 7.25%.