Economic Outlook Emerging Markets Q2 2023: Global Crosscurrents Make For A Bumpy Deceleration (2024)

(Editor's Note: The views expressed in this article are those of S&P Global Ratings' economics team. While these views can help to inform the rating process, sovereign and other ratings are based on the decisions of ratings committees, exercising their analytical judgment in accordance with publicly available ratings criteria. Our forecasts were developed during a period of high market volatility and significant policy changes, and therefore have wider than normal confidence bands. Emerging markets countries in our sample are Argentina, Brazil, Chile, Colombia, Mexico, and Peru in Latin America; Hungary, Poland, Turkiye, Saudi Arabia, and South Africa in EMEA; and China, India, Indonesia, Malaysia, the Philippines, Thailand, and Vietnam in Asia.)

We expect our core emerging market countries in Europe, the Middle East, and Africa (EM-EMEA; excluding Saudi Arabia), as well as countries in Latin America (LatAm), to grow well below longer-run trends in 2023, while India and countries in Southeast Asia will grow a tad under their respective trends. We see growth across these EMs gradually returning to their respective potential growth rates in 2024 and 2025.

We forecast the annual average Consumer Price Index (CPI) inflation for a median EM to reach 5.6% this year, from 7.4% last year. We see inflation for emerging markets in Asia-Pacific (EM-Asia; excluding the Philippines) and South Africa within their respective central bank target ranges in 2023 and expect inflation in other EMs (excluding Turkiye and Argentina) to return to central bank target ranges by end-2024.

Decelerating inflation and slowing growth eases pressure on EM central banks to hike, but the Fed's forward guidance on interest rate policy indicates "some additional policy firming may be appropriate." We have penciled in another 25 basis points (bps) hike for the Federal Reserve's benchmark rate, reaching 5.00%-5.25% by mid-2023, and holding it there--given the lag with which monetary policy affects economic activity and inflation. We expect the Fed to lower rates gradually starting in 2024. As such, most EM central banks--in part to protect capital flows and the value of their currency--are unlikely to loosen monetary policy (for now). Turkiye and Vietnam are notable exceptions.

Scrutiny Of The Global Banking Sector Joins Existing Policy Crosscurrents

Conditions in the global financial markets have become fluid more recently. Financial stress has risen more than we had envisioned at this point in the U.S. monetary cycle, thus realizing some downside risk that our past outlook publications had identified. The uncertainty in credit conditions moving forward adds to the global crosscurrents that emerging markets were already facing:

• The Russia-Ukraine conflict (and the proxy economic war with the West), which continues with no end in sight;
• Governments' tricky trade-off between public debt management and macroeconomic stability; and
• Major central banks' (excluding Japan and China) steadfast pursuit of hawkish monetary policy to address above-target inflation. In the U.S., inflation is likely to come down only gradually and the Fed is poised to raise policy rates further.

The abrupt demise of Silicon Valley Bank (SVB) and Signature Bank, and UBS' hasty takeover of Credit Suisse (CS) are reminders of banks' sensitivity to confidence and liquidity. At the time of this writing, economic data has taken a backseat to scrutiny of bank balance sheets. Confidence in global financial markets is in flux and broader credit risk remains elevated despite the deal for UBS to buy Credit Suisse (a global systemically important bank [GSIB]) and a joint pledge by the Fed, the Bank of Canada, the Bank of England, the European Central Bank (ECB), the Swiss National Bank, and the Bank of Japan to support dollar liquidity through more frequent (daily, was weekly) U.S. dollar swap lines (see "Global Credit Conditions: A More Difficult Way Out," March 20, 2023). It doesn't take more bad news today for markets to be skittish than it did two weeks ago.

It's too soon to assess the fallout from the collapse of three U.S. regional banks and one GSIB--but for now, we think the macro effects will be limited. In our base case, we assume the Fed, the ECB, and other central banks will use liquidity measures to address bank balance sheet risk while continuing to use interest rates hikes as their primary tool to address inflation (see "The Macro Fallout From The Silicon Valley Bank Collapse Appears Limited For Now," March 16, 2023). Because the Fed is acquiring assets through its newly launched liquidity program (the Bank Term Funding Program), the Fed's balance sheet rundown will be temporarily disrupted in conjunction with the long-standing discount window lending. As the banking system stabilizes, we assume the Fed will continue the net downsizing of its portfolio.

In EMs, direct spillovers from the failure of these banks appears small, and evidence of adverse effects through risk aversion channels are ambiguous, at best, based on foreign exchange markets. The moves in EM currencies were relatively small between March 10--when the U.S. Federal Deposit Insurance Corp. put SVB in receivership--to March 20, two days before the March meeting of the Federal Open Market Committee. Many even strengthened against the dollar, perhaps helped by expectations for a lower path for U.S. rates. A handful of EM currencies that came under relatively more pressure were largely in Latin America (see chart 1), probably reflecting concerns about the U.S. economy (given the trade channel). The Hungarian forint weakened in response to the global banking turmoil but has rebounded against the dollar in the last week to basically the same level as before SVB's collapse.

U.S. and eurozone to weaken sharply while China growth rebounds

We still expect GDP growth will be well-below potential growth for the U.S. and eurozone (downside risk has increased). Bank lending will become more selective at the margin following the recent banking turmoil, but the overall macro story is unchanged. Although we slightly raised our growth forecasts in the two economies for this year on the strength of recent data, we expect they will remain close to recession in 2023 and early 2024 (see "Economic Outlook U.S. Q2 2023: Still Resilient, Downside Risks Rise" and "Economic Outlook Eurozone Q2 2023: Rate Rises Weigh On Return To Growth," March 27, 2023).

On the positive side, China's economy is on track to rebound this year. S&P Global Ratings revised up China's GDP growth forecast for this year by 70 basis points (bps) to 5.5% and 30 bps for next year to 5.0%, helped by the announcement that China will soften its stance on the property sector and the rapid easing of COVID-19 policies (see "Economic Outlook Asia-Pacific Q2 2023: China Rebound Supports Growth," March 26, 2023). The country has quickly moved on from the pandemic, with retail sales and investment recovering and conditions in the housing market improving. We expect consumption and services to lead the rebound.

S&P Global Ratings is of the view that China's GDP growth target of "around 5%" for 2023 is relatively unambitious and provides room for policy to respond to inflation or financial risks, if needed. Indeed, as indicated at the National People's Congress meetings, macroeconomic policy is likely to be supportive but not significantly expansionary.

Stronger than expected start of the year

Economic data has been generally stronger in the last three months, both relative to late 2022 and to expectations (in EMs as well as advanced economies). Sustained labor market strength in the U.S., a milder winter in Europe, and China's reopening are already felt in business sentiment data globally. EM's manufacturing PMIs in the first months of 2023, albeit weak in many countries, showed signs that the industry has fared better than it did in late 2022. There was a broad-based increase in new export orders even as the overall state of external demand facing EMs was weak for most (under 50, indicating a contraction; see chart 2). The OECD weekly GDP tracker showed an uptick in growth for EMs (excluding China) in the first quarter so far to 4.1% year over year, from 3.3% in the fourth quarter (see chart 3). According to this measure, activity is rising in countries like India (Asia); Turkey and Poland (EMEA); and Argentina, Brazil, Colombia, Chile, and Mexico (Latin America). Whereas activity in Indonesia (Asia) and South Africa and Hungary (EMEA) is slowing modestly. (See "Emerging Markets Real-Time Data: Activity Picked Up In Early 2023 Amid Global Macro Crosscurrents," March 10, 2023)

Forecast Update

GDP growth

We expect real GDP growth to slow sharply this year in most EMs after remarkably strong performance in 2022, with China and Thailand as notable exceptions (see table 1). Countries in EMEA (excluding Saudi Arabia) and Latin America are poised to expand well below longer-run trends in 2023, while India and Southeast Asia will grow a tad under their respective trends. We then expect growth across EMs to gradually return to their respective potential growth rates in 2024 and 2025 as the external environment starts to normalize, inflationary pressures recede, and central banks begin to ease.

Common drivers of slowing growth in 2023 are:

• Fading post-pandemic catch-up/recovery momentum,
• Weakened demand from key major trading partners,
• Still-elevated prices eating into disposable income growth, and
• Higher interest rates globally and locally holding back consumption and investment.

Table 1

Although our projections on aggregate are more or less unchanged from our November forecast, as usual there are differences across regions and countries (particularly within EMEA).

In LatAm, we now see growth at 0.9% in 2023, sharply lower than 3.7% in 2022. We slightly raised our forecasts for this year, followed by a lower growth path in 2024-2025 compared to our November forecast. This is driven primarily by upward revisions to 2023 GDP for the two biggest economies of the region, Brazil and Mexico. The slightly slower rebound in the next two years is partly because we now expect U.S. growth to slow later in 2023 than previously anticipated and higher expected Fed policy rates, which raised our interest rate forecasts across most of LatAm. With growth well below potential, we expect unemployment rates to rise this year (see table 4 in "Appendix"). Amid low economic growth, lack of visibility about the fiscal response could generate investor uncertainty (a downside risk to baseline growth), especially in economies that have had recent changes in government, such as Brazil and Colombia.

We slightly lowered our growth forecasts for EM-Asia (excluding China). Quicker-than-expected reopening from China will provide some boost to the region in 2023. Returning Chinese tourists will also aid the tourism sector in Southeast Asia--especially in Thailand, where tourism is set for a strong year after more than two years of pandemic-driven doldrums. However, we don't believe China's reopening will be enough to offset falling external demand from slower U.S. and Europe growth (see "Asia-Pacific In 2023: China Rebound Cannot Offset Western Slowdown," Feb. 22, 2023). Emerging Asia still relies heavily on final demand in these large global economies. The value added in Vietnam, India, the Philippines, and Thailand is more exposed to final demand from the U.S. and Europe than from China. Malaysia and Indonesia have about even exposure to China and the West. We see marginal improvement in unemployment rates this year and beyond (except in the Philippines, where we expect over 1 percentage point of improvement in 2023).

Energy dynamics play an outsize role in our EM-EMEA forecasts, and our forecasts for this region are more uncertain. Some improvements in the eurozone energy outlook and economic growth prompted us to revise up slightly our GDP projections for Hungary and Poland in 2023 and 2024, respectively. We continue to expect household consumption to recover in 2024 and we believe investment in Hungary and Poland will benefit from foreign direct investment in manufacturing (especially in Hungary) and increased public defense spending (in Poland).

As for Saudi Arabia, after very strong real GDP growth of 8.7% in 2022 (the highest among the leading rich and developing economies that make up the Group of 20), we expect economic growth to moderate but remain resilient, averaging 2.6% in 2023-2026. We believe the non-oil sector will drive growth given the country's cautious approach to oil production. Our view remains supported by the country's improved non-oil sector dynamics and ongoing structural and social reforms. The economy will continue to benefit from large investment projects toward the country's Vision 2030 program, largely funded by the Public Investment Fund (the country's main sovereign wealth fund with a wide mandate to invest abroad and domestically) and the National Development Fund.

By contrast, prospects for South Africa have dimmed in the near term as it faces severe electricity shortages. The economy contracted by 1.3% on a quarterly basis in fourth-quarter 2022 as electricity cuts rose sharply over the period. We now anticipate severe electricity disruption during the first half of the year, bringing the economy to a near standstill. The government has introduced measures to encourage private sector and renewable electricity generation, but it will take time for additional power supply to materially improve electricity availability for the wider economy. Uncertainty surrounding electricity dynamics remains high.

In Turkiye, we have lowered our 2023 GDP growth forecast by 0.3 percentage points, mainly reflecting the earthquake that hit the country in early February and partially offset by an improved outlook for energy prices. We expect the consequences of the earthquake will weigh on household consumption, goods exports (mainly agriculture), and services exports (tourism). At the same time, post-earthquake reconstruction efforts should support investment in the second half of 2023 and into 2024. There is high uncertainty around the overall impact of the earthquake on Turkiye's macroeconomic outlook. Another key uncertainty relates to policy settings after parliamentary and presidential elections scheduled for this May.

Inflation

Headline inflation has peaked in most EMs and inflationary pressures have begun to recede (see charts 4 and 5). To be sure, inflation on a year over year basis remains elevated and above central bank targets for most. Headline inflation for the median EM averaged 6.9% (y/y%) in January and February, compared to 7.7% at its peak in mid-2022. It remains a touch higher than we anticipated so far this year (for varying reasons across individual countries, including roll backs on fuel subsidies/tax exemptions). Meanwhile, across most EMs, energy price inflation is moderating while food inflation remains elevated but is not accelerating.

Despite the deceleration in headline inflation, it was a tad higher than we expected in LatAm, given greater-than-expected increases in wages and higher-than-expected prices for some regulated services, such as urban transportation. Headline inflation edged up in the beginning of the year in other regions given higher core inflation and, in some cases, governments clawing back some of their price-curbing measures (such as fuel price caps in Hungary and decreased value-added tax rates on fuel in Poland). In EM-Asia, inflation is moderating in Indonesia, Malaysia, and Thailand; continues to increase in the Philippines; and is stabilizing somewhat in India and Vietnam. Core price pressures appear stable generally in EM-Asia.

While we believe China's reopening will increase price pressures domestically and globally, consumer inflation in China should rise much less than it did in the U.S. and Europe in 2022. The impact on global energy and commodity markets won't match that of the reopening of the rest of the world and the Russian invasion of Ukraine last year. Domestically, most goods markets in China face oversupply and excess savings are weaker than they were in the U.S. and Europe.

We expect inflation to decline further in the coming months given sharp base effects and easing core price pressures from slowing growth and the fading global goods shortages. It won't be a smooth glide down, but we forecast annual average CPI inflation for a median EM to reach 5.6% this year (was 5% in our November forecast), from 7.4% last year, with EM-Asia (excluding the Philippines) and South Africa within their respective central bank target ranges in 2023, and other EMs (excluding Turkiye and Argentina) returning to their central bank target ranges by end-2024. Nevertheless, there is upside risk to our inflation forecast given potentially higher-than-expected energy prices and stickier-than-expected core prices (especially among economies in Central and Eastern Europe).

S&P Global Ratings kept its 2023 and 2024 Brent oil price assumptions steady at $90/barrel (bbl) and $80/bbl, respectively, as supply fundamentals and geopolitical risk premium remain supportive of higher prices (see "S&P Global Ratings Cuts 2023 European, U.S., And Canadian Gas Price Assumptions On Lower Demand," Feb. 23, 2022). Meanwhile, Russia has agreed to extend the Black Sea grain deal--which should help contain food inflation at the margin--but this is still at risk of getting scratched depending on the evolving war.

Table 2

Monetary policy

Given expected disinflation, several central banks have signaled an end to their rate hikes, including Brazil, Chile, Poland, and Hungary. As the Fed continues to raise interest rates, however, capital outflow pressures in EMs should remain intact generally. Central banks--in part to protect capital flows and the value of their currency--are unlikely to do more than pause rate hikes while the Fed has yet to definitively signal an end to tightening.

Since we no longer expect the Fed to start cutting interest rates this year, we also no longer expect most central banks in LatAm to start lowering interest rates this year. The two notable exceptions are Chile and Brazil, where we see interest rate cuts in the second half of 2023 (later than our previous assumption), due to a more rapid decline in inflation and clearer signs of economic deterioration.

In EM-Asia, there is some runway for gradual monetary policy tightening. Inflation has not abated completely in the region, and we expect (Fed-induced) capital outflow pressures. Consequently, we expect higher interest rates on average for 2023 compared to last year. We expect central banks in the region to reach their terminal rates this year and then hold before beginning to cut next year toward a lower longer-run neutral rate.

Similarly, in EM-EMEA, considering high inflation and exchange rates pressures, we do not expect South Africa, Hungary, and Poland to cut interest rates in 2023. However, we expect Hungary to drop some of the emergency measures introduced last October to defend its currency. Turkiye, meanwhile, following a pause over December-January, resumed interest rates cuts in February in the aftermath of the earthquake, lowering the policy rate by 50 bps to 8.50%. The central bank noted that it would prioritize supportive financial conditions following the earthquake. We expect an additional 50 bps rate cut before the elections, which means real interest rates will remain deeply negative in the coming months.

Table 3

Interest rate differentials and developments in the current account consistent with our forecasts put U.S. dollar exchange rates within a narrow holding pattern this year and the next (see tables 5 and 6 in "Appendix").

Some Positive Factors, But Downside Risks Still Dominate Evolving Risks To Baseline Outlook

COVID-19 is endemic now, hence it is a neutral factor in our balance of risks. In fact, China's earlier-than-expected rapid exit from its zero-COVID-19 policy has increased optimism for Chinese GDP growth this year. For now, we expect EM-Asia to benefit the most from the reopening of the Chinese economy, mainly through a revival in Chinese tourism in those countries (see "Which Emerging Markets Benefit The Most From A Reopening In China?," Feb. 1, 2023). However, if the reactivation of the Chinese economy is accompanied by a stronger recovery in property and infrastructure that increases demand for industrial metals (investment was stronger than many expected in the first two months of the year), then several exporters of those commodities would benefit--including Brazil, Chile, Peru, and South Africa--and could potentially see a higher growth impetus than in our baseline.

There are a few other upside risks to our growth forecasts that are worth noting. First, more resilient-than-expected U.S. and eurozone economies, which have kept demand for several exports stronger than we expected, especially manufactured goods out of Mexico (for the U.S.) and EM-EMEA (for the eurozone). Second, growing prospects of nearshoring, driven by supply-chain diversification out of China, could benefit LatAm--especially Mexico, given its strong manufacturing ties with the U.S. That said, there are several obstacles that could slow or prevent Mexico from fully reaping the benefits of nearshoring, such as issues around water and energy supply for new manufacturing operations and concerns over security.

The long shadow of the Russia-Ukraine conflict and a further sharp tightening of global credit conditions remain key downside risks for EMs. The heightened sensitivity to the banking sector given high interest rates and since the collapse of SVB clearly tip the overall balance of risk to the downside. If external account vulnerability became more acute and risk aversion spiked in a more damaging scenario (see "If Clouds Turn To Rain" below), EMs with lower reserve adequacy (see chart 7)--an intersection of larger current account deficits (see chart 8), lower central bank liquid reserves, and significant dollar-denominated debt--such as Argentina, Chile, Colombia, Hungary, Malaysia, South Africa, and Turkey, may fall in the crosshairs.

As shown during the COVID-19 pandemic, central banks in EMs have tools to counter contagion risks (via liquidity provisions or broadening deposit insurance). Nonetheless, recent developments underscore that we are in for a bumpy ride.

Related Research

• Economic Outlook Eurozone Q2 2023: Rate Rises Weigh On Return To Growth, March 27, 2023
• Economic Outlook U.S. Q2 2023: Still Resilient, Downside Risks Rise, March 27, 2023
• Economic Outlook Asia-Pacific Q2 2023: China Rebound Supports Growth, March 26, 2023
• The Macro Fallout From The Silicon Valley Bank Collapse Appears Limited For Now, March 16, 2023
• Emerging Markets Real-Time Data: Activity Picked Up In Early 2023 Amid Global Macro Crosscurrents, March 10, 2023
• S&P Global Ratings Cuts 2023 European, U.S., And Canadian Gas Price Assumptions On Lower Demand, Feb 23, 2023
• Asia-Pacific In 2023: China Rebound Cannot Offset Western Slowdown, Feb. 22, 2023
• Which Emerging Markets Benefit The Most From A Reopening In China?, Feb. 1, 2023
• What A Hard Landing For The U.S. Economy Would Mean For Emerging Markets, Aug. 3, 2022
• Emerging Market Economies Are Vulnerable To A Downturn In Europe, July 19, 2022

Appendix

Table 4

Table 5

Table 6

The views expressed here are the independent opinions of S&P Global Ratings' economics group, which is separate from, but provides forecasts and other input to, S&P Global Ratings' analysts. The economic views herein may be incorporated into S&P Global Ratings' credit ratings; however, credit ratings are determined and assigned by ratings committees, exercising analytical judgment in accordance with S&P Global Ratings' publicly available methodologies.

This report does not constitute a rating action.