EM Key Themes: Difficult Path To Normalisation In 2022

Fitch Solutions / Country Risk / Global / Mon 22 Nov, 2021

fs disclaimer

At Fitch Solutions, we have identified key themes that we believe will affect emerging markets (EMs) in 2022. 

1) Covid-19 risks will fade in most EMs but linger in Sub-Saharan Africa (SSA).

2) Growth will slow in most EMs.

3) Commodity prices will ease.

4) Inflation will peak in 2022, but markets are overestimating the EM tightening cycle.

5) Political risk will rise, particularly in Brazil, Hungary and the Philippines.

6) Latin American growth will disappoint.

7) BRICS Outlook.

Covid-19 Risks Will Fade In Most EMs But Linger In SSA

While Covid-19 risks will remain elevated in a few countries, we expect that residents in most EMs will be able to return to most of their pre-crisis activities next year. The main justification for this view is rapid vaccine drives, which have accelerated across the EM world. In richer EMs, the share of the population has caught up (or, in some cases, exceeded), that in developed markets (DMs). Lower-income EMs have made less progress, but they have still significantly increased their coverage (see chart below).

Most EMs Catching Up

Global – Population Fully Vaccinated, %

Source: Our World in Data

While many EMs have used vaccines that are less effective than the mRNA products favoured in DMs, this has still led to a significant decline in new cases and deaths across the EM world (see chart below). We expect that this will continue into 2022, particularly as new vaccines and therapeutic treatments become more available.

EM Cases Easing

Global - Daily New Covid-19 Cases, '000s

Source: Our World In Data

This will encourage the progressive removal of Covid-19 restrictions and the easing of consumer fears that have discouraged economic activity. We expect that the Chinese authorities will retain strict anti-Covid policies – which also serve other political ends – but we believe that policymakers in other EMs will progressively weaken and abandon their ‘zero-Covid’ strategies as risks fade. This will boost consumer spending and help economies to normalise.

We are less optimistic about the healthcare situation in SSA, where vaccine drives have fallen far behind other EM regions (see first chart). Outside of South Africa, SSA’s Covid-19 restrictions were generally looser and less economically restrictive than those in other EMs. Full lockdowns will remain unlikely and, where imposed, ineffective. However, we believe that some restrictions will remain in place, discouraging foreign travellers.

Growth Will Slow In Most EMs

There are two key reasons why EM growth will slow in 2022, easing base effects and structural shifts in China. Most EMs’ economic performance in 2021 was flattered by the comparison with 2020; as base effects fade, growth will naturally slow. We estimate that aggregate EM GDP rose by an 11-year high of 6.2% in 2021, a pace that was never likely to be sustained. As conditions normalise, we expect that growth will slip to 4.8%, just slightly above the 4.5% average recorded between 2015 and 2019 (see chart below).

Most Regions Slowing Down

EMs – Real GDP Growth, %

Source: Fitch Solutions Forecasts

Two EM regions, however, will buck this trend. We expect that growth will accelerate in the Middle East and North Africa (MENA) and SSA. Both regions’ economies performed worse than EM peers’ in 2021 as a result of weak oil production, elevated political risk and (particularly in SSA) the slow distribution of vaccines. Both regions’ recoveries will get into gear in 2022, though growth will remain slower than the EM-wide rate and their accelerations will be on a smaller scale than the slowdowns seen elsewhere (see chart above). 

Beyond this statistical fluke, EM growth will be dragged down by the structural slowdown of the Chinese economy. We expect that China’s economic growth will slip from 7.8% in 2021 to 5.4% in 2022. Excluding the pandemic, this would be the worst result since 1990. China’s economic growth is, to a lesser extent, affected by the statistical factors described above. We also think that the Chinese authorities will maintain stricter anti-Covid restrictions than peers elsewhere, depressing consumption. This will be painful within travel, but also hurt other EMs that have come to rely on Chinese outbound tourism. Problems in the real estate sector will also drag on growth next year. However, weaker growth in China is not a one-off, as it is part of a longer-term slowdown in economic activity that has been in place for several years.

Like Japan and Korea before it, China has begun to exhaust the quick drivers of economic growth by closing the productivity gap with DMs. As the country becomes richer and more technologically advanced, its rate of potential growth will gradually converge with DMs’. The government will also have to grapple with increasingly complex policy challenges involving China’s declining workforce, and large private sector debt loads. The problems posed by a slowing China will be particularly acute for Asian manufacturing economies and for resource-dependent EMs, which have benefitted disproportionately from the country’s rapid industrialisation (see chart below).

Slowing China Will Be Painful

EMs – Exports To China, % of total

Source: Fitch Solutions

Commodity Prices Will Ease  

After bouncing back sharply in 2021, we expect that most commodity prices will slip back from recent highs in 2022. We expect a particularly sharp correction in oil prices as a result of slowing economic growth, improved gas supply and rising output. We expect that oil prices will fall sharply in the second quarter, which will weigh on fiscal positions in oil-exporting EMs. Though prices will fall from their current levels, we still think the average price over 2022 as a whole will be essentially unchanged from 2021 (USD72.00 per barrel, up from USD71.50) (see chart below).

Oil Prices Will Trend Down

Global – Brent Crude Price, USD per barrel

Source: Bloomberg, Fitch Solutions forecast

We expect that other commodity prices, which also jumped in 2021, will also trend down in 2022 (see chart below).

Prices Headed Down

Global – Commodity Prices, % change in annual average price

e/f = estimate/forecast. Source: Fitch Solutions

Even so, we expect that the prices of most major commodities will be, on average, higher in 2022 than they were before the Covid-19 crisis. Coal is the key exception, which we expect to average just USD75 per tonne, a touch below its pre-crisis cost. The fuel’s underperformance will continue; we expect that shifting energy demand will push coal prices down over the coming years. Other commodity prices will also slip, albeit more gently (see chart below). 

Prices Above Pre-Crisis Levels, Will Trend Down

Global – Commodity Price Indices, 100 = 2019 Average

f = forecast. Source: Fitch Solutions

Inflation Will Peak But Markets Are Overestimating Tightening Cycle

We believe lower commodity prices will reduce inflation across EMs. The partial or full resolution of some of the temporary supply chain problems that are currently leading to shortages will help too. Overall, we think that inflation across the EM world will ease from an average of 5.5% in 2021 to 5.1% in 2022, even if it remains faster than in recent years (see chart below).

EM Inflation Will Soon Peak

EMs – Annual Average Inflation, % y-o-y

Fitch Solutions Forecasts

This figure, however, understates the degree by which inflation in most EMs will slow. We think that one-off food price factors will cause inflation in China to pick up slightly. If the country is excluded from the calculation, EM inflation will ease from an average of 9.1% in 2021 to an average of 7.3% in 2022.

This view that inflation will ease next year is the main reason why we think that market expectations have gotten ahead of themselves and that EM central banks will soon slow their tightening cycle. For example, we expect that Brazil’s selic rate will be hiked from 7.75% to 8.25% by the end of 2022, whereas the markets are currently pointing to the rate ending next year at 13.00%. The Czech republic is the only major EM where we think that policymakers will hike by more than the markets currently expect (see chart below).

Markets Getting Ahead Of Themselves

EMs - End-2022 Policy Rate, %

Note: Fitch Solutions forecasts. Source: Bloomberg, Fitch Solutions

We think that Turkey will remain a key outlier; policymakers there will probably continue to bow to political pressure by cutting their key interest rate. This will only worsen the country’s long-running inflation and currency depreciation problems.

Elections And Political Risk

The accelerating normalisation of economic and social life in 2022 will create new challenges for political leaders, whose focus will shift from crisis management to longer-term planning. In most countries, this will involve tightening fiscal policy and removing the remaining stimulus programmes, many of which have become popular. We think that attention will focus on elections in three of the countries often seen as examples of the recent right-wing populist wave. While a populist candidate will almost certainly win next year’s vote in the Philippines, we think that populist forces will suffer a setback in Hungary and lose power in Brazil.

A one-term limit will prevent Philippine President Rodrigo Duterte from running for re-election in 2022, but it is likely that his successor will be another populist. The highest-profile candidates (Duterte-ally Bong Go, Bongbong Marcos, Manila mayor Isko Moreno, and former boxer Manny Pacquiao) would all probably continue the current president’s efforts to weaken political institutions and to impose violent crackdowns against alleged criminals. The Duterte family will, in any event, remain prominent; the incumbent is running for senate, and his daughter, Sara, is a candidate for vice president. In one key change, the election will probably result in a more confrontational policy towards China. We doubt that any of the main candidates would continue President Duterte’s accommodative policies towards the China, which is increasingly unpopular in the Philippines.

In Hungary, we expect Prime Minister Viktor Orbán’s party will narrowly win the 2022 legislative election, but lose its two-thirds majority in parliament. Hungary’s traditionally divided opposition has united behind a small-town mayor, which we believe will help them to chip away at the ruling party’s core support in rural areas. While the government’s tight grip on the media and temporary hikes to social spending make an outright opposition victory unlikely, we think that the prime minister’s position will be weakened, opening the way for a more competitive political landscape in the future.

Risks are probably highest in Brazil, where polls suggest that the President Jair Bolsonaro will potentially lose his re-election bid. A win by a more traditional figure would likely be positive for Brazil’s economic outlook, but the incumbent has responded to his worsening poll numbers by hinting that he might not respect the result of the election. The increasingly fraught campaign will probably lead to significant swings in business sentiment, depressing investment. Our core view is that Bolsonaro is unlikely to be re-elected, and would likely fail in any effort to subvert the constitutional process. Even so, such an effort would be highly destabilising for the markets.

Latin American Growth Will Disappoint

Even if Brazil avoids a full-blown political crisis, we expect that Latin America will be the slowest-growing region of the EM world in 2022, a position it will have held for five of the past 10 years. We expect that the region will only regain its 2019 level of real output in 2022, and that its recovery will lag other regions’ over the coming years. Indeed, even in 2025, we think that Latin America’s economy will have grown by less over the post-crisis period than traditionally slow-growing DMs (see chart below).

Stuck In The Slow Lane

Global - Real GDP Index, 100 = 2019

Source: Fitch Solutions

Several factors are behind this underperformance. First, Latin America’s economies suffered a larger fall in output than their EM peers during the Covid-19 crisis as a result of high infection rates and – in many countries – limited fiscal support. Second, political risk will weigh on investment. Political disputes are not just deepening in Brazil – Chile’s constitutional progress is becoming more fraught. While the political situation in Mexico is more stable, the president’s pro-cyclical dedication to tight fiscal policy has starved the economy of investment. Beyond Mexico, much of the region also lost out on two of the factors – elevated oil prices and rising demand for manufactured goods – that drove rapid EM growth elsewhere. We expect that economic growth in Latin America will average just 2.6% between 2022 and 2025, compared with 4.6% across EMs as a whole.

BRICS Outlook

Brazil: Weakest BRIC In 2022

We expect that Brazil’s economy will expand by just 1.9% in 2022, the worst performance among the BRIC economies (see chart below). Indeed, there is now a growing risk that the country will actually return to recession next year. Several factors are driving this underperformance.

Brazil Well Behind

BRICS - Real GDP Growth, %

e/f = estimate/forecast. Source: Fitch Solutions

One is elevated inflation, which we think will prompt policymakers to continue to raise their key Selic rate in early 2022. While we believe that inflation will ease later in the year, allowing for interest rate cuts, we still expect that the tightening cycle will weigh on demand. We also think that rising political tensions surrounding the elections will hit business sentiment, deterring investment.  

Russia: Pandemic Risks Continue

We expect that growth in Russia will slow from 3.8% in 2021 to 2.3% in 2022. This is partially because of continued Covid-19 worries; the country’s vaccine programme has been less successful than its European peers’, and we expect that restrictions will continue to be imposed in early 2022. Indeed, it is one of the few EMs where cases are likely to end 2021 by rising rather than falling (see chart below).

Pandemic Headwinds Are Rising

Russia – New Covid-19 Cases & Deaths, 7-day moving average

Source: Our World in Data

Rising oil output and still-elevated energy prices will provide a boost to growth. While the German energy regulator’s November 16 decision to delay the Nord Stream 2 pipeline will cap gas exports in early 2022, we think that the project will come online in the first half of the year.

India: The New Growth Leader

We expect that India’s economy will expand by 7.6% in 2022, the best performance among the BRICS economies. This will, in fact, be a sign of things to come. We think that economic growth in India will exceed that of China's over the duration of the 2020s (see chart below).

India Out Ahead

BRICS - Real GDP Growth, %

Source: Fitch Solutions forecast

India’s strong outperformance in 2021 and 2022 will be, to a large extent, driven by one-off factors. India’s deep recession in 2021 (GDP fell by 7.3%) created a flattering basis for comparison this year, and China’s property-driven slowdown in 2022 will keep India in top position among big EMs. Going forward, however, we think that India’s faster-growing workforce and continued economic liberalisation will keep trend growth above China’s.

China: Property Sector Will Prompt Slowdown, Not Crisis

We expect that economic growth in China will slow from 7.8% in 2021 to 5.4% in 2022. This reflects both the effect of problems in the property sector and also structural changes in China’s economy that will limit headline growth (see chart above). We expect that Chinese policymakers will succeed in managing the fallout of the financial problems that started at major property developer Evergrande. Indeed, the authorities eased funding rules in November, which caused local bond markets to regain some of their recent losses (see chart below). 

Bond Market Sentiment Rebounded Following Easing Measures

China - Investment Grade & High-Yield Bond Indices

Source: Bloomberg, Fitch Solutions

Even if such measures avoid an acute crisis, however, we expect that problems in the sector will weigh on the economy in 2022. We also doubt that China will, like other EMs, remove its remaining Covid-19 restrictions next year. The country’s government remains dedicated to a Zero-Covid strategy, which it sees as having significant political benefits.

South Africa: Recovery Will Slow

We expect that economic growth in South Africa will ease from 4.0% in 2021 to 2.5% in 2022 as base effects fade. The pandemic worsened many of South Africa’s underlying socio-economic problems, and we expect that this will create economic scaring that weighs on output in 2022. Unemployment, for instance, hit a new high in 2021 and will remain elevated in the near term (see chart below).

Unemployment Hits New High

South Africa – Unemployment Rate, %

Note: Dip in Q220 largely reflects the inability of the unemployed to seek work given lockdown measures. Source: Statistics South Africa, Fitch Solutions

We expect that trend growth will remain between 2.0% and 3.0% over the coming years, because reforms to deal with structural problems are unlikely. While we expect that the country’s reformist President Cyril Ramaphosa will remain in office next year, the ruling party’s poor performance in local elections has weakened his hand within the party. This will probably prevent Ramaphosa from pushing through with any new, meaningful reforms.

This report from Fitch Solutions Country Risk & Industry Research is a product of Fitch Solutions Group Ltd, UK Company registration number 08789939 ('FSG'). FSG is an affiliate of Fitch Ratings Inc. ('Fitch Ratings'). FSG is solely responsible for the content of this report, without any input from Fitch Ratings. Copyright © 2021 Fitch Solutions Group Limited. © Fitch Solutions Group Limited All rights reserved. 30 North Colonnade, London E14 5GN, UK.

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