Emerging market growth may have peaked

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Steve Johnson

The IMF predicted in October that gross domestic product growth across emerging and developing economies would hit 4.9 per cent this year, up from 4.6 per cent in 2017 and the fourth straight year of acceleration.

Consensus forecasts reported by Goldman Sachs in November also pointed to growth of 4.9 per cent this year, while Goldman pencilled in a far punchier 5.6 per cent, a figure it has since revised down to 5.3 per cent. Recent consensus numbers collated by Citi pointed to growth of 4.8 per cent.

However, analysis by Capital Economics, a consultancy, suggests that EM-wide economic growth peaked at the end of the third quarter of 2017 and fell to a year-on-year rate of 4.4 per cent in December, from 4.7 per cent in November, as the first chart shows. Initial economic data for January suggests this figure may have dipped as low as 4 per cent at the start of 2018, Capital says.

“The consensus on growth in emerging markets remains too rosy,” says Neil Shearing, chief emerging markets economist at Capital Economics. “In the context of a synchronised global upswing where the world is broadly divided into the US, Europe, Japan and emerging markets, one of the stories of the year is that EM growth in aggregate decouples, insofar that growth falls.”

Charles Robertson, chief economist at Renaissance Capital, an investment bank focused on emerging markets, says the tone of EM economic data turned at the start of February, meaning “the acceleration [in growth] has stopped,” although the picture varies widely between countries.

Maarten-Jan Bakkum senior emerging markets strategist at NN Investment Partners, a Dutch asset manager, says his proprietary EM-wide growth momentum measure has turned negative, as illustrated in the second chart.

“Emerging market growth momentum is weakening,” Mr Bakkum says. “We’re not too worried about it yet, but if it stays negative for some time than it’s a concern.”

Capital Economics’ in-house tracker gauges suggest the slowdown is broad in nature. Its measure of EM retail sales growth fell from 6.2 per cent year-on-year in November to a nine-month low of 5.3 per cent in January, although it stresses this is still a reasonably strong reading.

Likewise, growth in industrial production slowed from 4.1 per cent in November to 3.8 per cent in December. Export growth also slowed in December, although this may have been distorted by there being fewer working days in December last year than there was a year earlier.

The regional picture is much more mixed, however. Much of the purported slowdown is emanating from China, where Capital Economics’ activity proxy suggests growth fell from a peak of 6.6 per cent year-on-year in the middle of 2017 to 5.2 per cent in December, as seen in the third chart.

“EM growth as a whole has peaked because China has peaked and that is a third of the EM world,” says Mr Shearing, who believes that, stripping out China, emerging market growth is probably still rising.

Mr Robertson agrees, forecasting that Chinese GDP growth will come in at 6 per cent this year, rather than 6.5 per cent targeted by Beijing, an eventuality “that would reduce the overall EM number because China is so big”.

His view is largely driven by a sharp reversal of the “boom” in lending witnessed prior to the Communist party congress in October last year.

“Since October there has been a big slowdown,” Mr Robertson says. Total social financing, a broad measure that includes bond and equity issuance as well as new loans from banks, increased just 7 per cent in the year to February, down from growth rates of 20 per cent in August and September 2017.

That, in turn, has a knock-on effect on growth elsewhere, he argues, with China’s credit boom supportive of rising commodity prices, such as the rally in oil prices to $70 a barrel in January, before “Chinese lending growth shuddered to a halt”.

Mr Bakkum foresees a more fundamental, long-term shift in China’s economy, with the gap between the rate of credit growth and nominal GDP growth, once as wide as 15 percentage points, now having virtually disappeared.

“From now onwards we will see genuine deleveraging,” he says. “Post the global financial crisis China has been credit driven. That is changing”.

Capital’s GDP trackers also point to weakness elsewhere in emerging Asia, with activity “dragged down by a sharp slowdown in industrial output in Korea, Singapore and the Philippines” at the end of 2017.

Growth also appears to be softening in emerging Europe, with the region’s three largest economies, Russia, Turkey and Poland, all reporting broadly weaker data in recent months. Mr Shearing believes growth in the region will peak around the middle of the year.

“This is now starting to come through in the business surveys,” he says. “We are seeing capacity constraints in Poland and Hungary.

“In Turkey, inflation is stuck at double-digit rates, fiscal policy is starting to be loosened, the central bank is starting to sound more hawkish but is not yet tightening, the trade deficit is widening again and credit growth is rising. Having looked at credit growth for the past 20 years, these things never end well.”

However Latin America appears to be a bright spot, with Capital’s tracker holding steady at a five-year high in December, as the final chart shows.

Mr Bakkum is more upbeat about prospects for EM ex-China however, with his data, based on a GDP-weighted average of 19 major countries, showing that credit growth in EM ex-China has started to accelerate for the first time since 2011.

Mr Robertson is optimistic about a continuing pick up in growth in Russia and South Africa, whose economies have “been so weak that their improvement can continue for some time,” as well as in India.

Nevertheless, when it comes to asset prices, he warns that “markets pay an awful lot of attention” to the rate of change of growth, and while the gap between emerging and developed market growth has been rising since 2015, “with US growth picking up a little bit and China slowing a little bit, it’s not going to be as good a story in 2018”.

Overall, Mr Shearing expects emerging market growth to fall from 4.5 per cent in 2017 to 4.2 per cent this year and 4 per cent in 2019.

If he is correct, the peak in EM growth will be markedly below that seen in other cycles, with growth cresting at 7.4 per cent in 2010, 8 per cent in 2006 and 5.8 per cent in 2000, according to IMF data.

Mr Shearing argues this is indicative of the fact that potential growth in emerging markets “has fallen a long way in recent years” and is now as little as 3.5-4.5 per cent.

“Whereas EMs grew at an average annual rate of 6 per cent over the past decade, we expect growth over the next decade to average less than 4 per cent,” he says.

Mr Shearing attributes the slowdown to an absence of the big drivers of productivity growth witnessed in the 1990s and early 2000s, such as liberalisation in Latin America, the rebuilding of economies in the former communist eastern Europe and the opening up of China, “all turbocharged by globalisation”.

Moreover, emerging market countries are, in general, richer than ever before, so their scope for catch-up growth is more limited, and “it is becoming harder to catch up because of changes in the global economy. When it comes to manufacturing, we are now consuming less stuff,” he says.

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