Emerging markets ‘have space’ to kick-start growth
All major EMs can ease either fiscal or monetary policy, research claims
Every major emerging market country has room to loosen either fiscal or monetary policy, or both, to counter the sharpest slowdown in developing world growth for a decade, according to a major investment house.
In July the IMF slashed its forecast for emerging market growth to just 4.1 per cent for the calendar year 2019, 0.3 points below its April estimate and the lowest figure since the height of the global financial crisis in 2009.
However, Patrick Zweifel, chief economist at Pictet Asset Management, a Swiss investment house with $190bn of assets under management, argued that, in contrast to a developed world beset by negative real (and in some cases nominal) interest rates and often large fiscal deficits, emerging nations have the policy freedom to tackle slowing growth.
“Lots of people are talking about whether [further] monetary policy [easing] is still an option for most developed markets and there is a lot of discussion about whether these countries should consider fiscal policy [instead],” Mr Zweifel said.
“This is a problem that emerging markets do not have, so they have much more room to counter the slowdown,” he said.
Pictet’s analysis of 19 major emerging markets found that every country had either (or both) positive real interest rates — giving them room to ease in Pictet’s opinion — or an expected 2019 fiscal deficit of less than 3 per cent of gross domestic product — potentially allowing them the space to loosen policy, as the first chart shows.
Russia, South Korea, the Philippines, Indonesia and Thailand are in a position to loosen fiscal and monetary policy, according to Pictet, a potential growth driver at a time when economic activity across the globe has been buffeted by rising trade tensions and the seeming failure even of negative interest rates in the eurozone and Japan to kick-start growth.
Mr Zweifel said it was unusual for so many emerging nations to have scope to relax policy simultaneously, especially in terms of monetary policy.
Mr Zweifel said: “Sometimes you have a lot of countries that don’t have any room on the monetary policy side. They can’t cut rates, they have to keep them high because they are facing external liabilities, so if they don’t want to face the collapse of their exchange rates they don’t have any choice but to maintain [tight] monetary policy.”
He argued that, with the exception of Turkey and Argentina, the leading emerging markets “are not in an environment where cutting rates would lead to disproportionate falls in their currencies”.
He added: “Even the countries that have started to cut rates, such as Turkey, India and Indonesia, have even more room to cut further, which has been a bit of a surprise to me.”
On the fiscal front, the average budget deficit across the 19 countries has fallen to the equivalent of 1.9 per cent of GDP, the joint-lowest level since 2009, as depicted in the second chart.
Mr Zweifel said he expected to see more easing in monetary and fiscal policy, given that EM GDP growth, which he puts at “slightly below 4 per cent” is “clearly below its potential”, estimated at 4.5 to 5 per cent.
Moreover, “there is no inflationary pressure,” he said, with headline consumer price inflation well under control in Asia and Latin America, while the deterioration in the Europe, Middle East and Africa region, shown in the final chart, is largely due to Turkey, where overly lax monetary policy and a collapse in the lira led to a ferocious bout of inflation.
Pictet saw particularly large scope for pro-growth policies in Russia, where “high real rates” (2.7 per cent, based on the Swiss group’s inflation forecast) and “very low public debt” (12.6 per cent of GDP) mean “it is extremely well positioned”.
Mr Zweifel is also optimistic about South Korea which “has cut rates once [in July] “and is likely to do another cut in October,” while Seoul “has announced a pretty strong fiscal stimulus increasing government spending by 8 per cent,” although this has yet to be passed by congress.
India has also sought to revive flagging growth by unveiling a bold $20bn package of corporate tax cuts. While this has raised concerns about affordability, Mr Zweifel argued it was “quite a good decision that will have a long-term impact”, such as helping attract companies seeking to relocate because of the US-China trade war.
“My best guess is that there is still a lot of investment that can be done in India, so we are not talking about Trump’s tax cuts, where the economy was already running above trend and there was little scope for further investment,” he said.
The countries that are most constrained are in eastern Europe, where Hungary, Poland and the Czech Republic all have negative real rates, but Mr Zweifel argued these were among the few EM states that do not need any stimulus as they are already growing at a strong pace.
Not everyone agreed with his upbeat take on the outlook for emerging markets, however.
Maarten-Jan Bakkum, senior emerging markets strategist at NN Investment Partners, argued that most developing countries could only ease monetary policy if cross-border financial flows were strong — something that was more dependent on expectations of future US Federal Reserve policy that anything EM countries themselves had control over.
“[EM] central banks have been cutting rates since the beginning of this year mainly because of Fed expectations moving towards more easing,” he said. “That theme can go further but it’s not a given and it’s not something determined endogenously in EMs, it’s exogenous.”
He added: “If flows are weak, central banks cannot cut, that is clear. Emerging markets are very sensitive to global risk appetite and sentiment about global trade conflict and the Fed. I’m not sure that EMs have a lot of room on their own to ease monetary policy.”
Mr Bakkum feared emerging markets typically had less room still to ease fiscal policy. While China, South Korea and Taiwan may have some space to stimulate their economies, others faced headwinds that limited their policy freedom, he argued.
South Africa is struggling to plug a financial black hole at Eskom, the stricken state electricity monopoly, Brazil is still battling to put state finances on a sustainable footing, Turkey is constrained as a recession has weakened public finances, India has used up its remaining firepower and Russia’s scope to increase spending is dependent on oil prices.
“Emerging markets do not have more room for fiscal easing than developed markets,” he added.
John Paul Smith, partner at Ecstrat, an investment consultancy, was more downbeat still, arguing that even when emerging countries have had the space to cut interest rates it has not delivered concrete benefits.
“The last year and a quarter, central banks in emerging markets have had much more room to relax than anybody thought. The problem that I have is that the easing was initially relatively reactive, as a response to slow growth, but I can’t think of any example of where growth has picked up because of easing, apart from one, Turkey,” he said.
Moreover, Mr Smith believed “we are seeing the limits of easing in some countries”, such as Brazil, where the real tumbled 8.7 per cent against the dollar since it cut rates by 50 basis points on July 31, followed by another half-point cut this month, and growth has still remained weak.
On the fiscal side, Mr Smith argued China “can’t stimulate more because they are stimulating a lot already, and if they do they will just increase moral hazard”, as evidenced by a rebound in the shadow banking sector, which took its largest share of total lending since at least 2013 in the second and third quarters of the year.
“A lot of companies are being offered loans but are turning them down because they are not getting the orders,” he added.
Mr Smith lamented the lack of pro-growth structural reforms, aside from “a little in Brazil and India” and, even in the latter, he feared the attempt to revive “animal spirits” by cutting corporate taxes was unlikely to succeed until there was greater clarity around the country’s fledgling bankruptcy process, which would encourage banks to increase lending.
Like Mr Bakkum, Mr Smith feared the fate of emerging markets was still largely determined by the actions of the developed world, rather than anything they themselves had control over.
“You don’t want to buy emerging markets full stop,” he said. “The outlook for growth is dismal. It has been dismal, it’s still dismal and it will continue to be dismal unless they get serious about reform.
“I think the only chance for emerging markets is if there is a fiscal stimulus in the developed world and they get external help. EMs have reached the limits of their autonomy,” Mr Smith added.
“At some point there will be some sort of helicopter money in the west or something to address the demographic issue, unsticking money held by older people [who are not spending it]. That’s the next time EM will outperform, but I believe we will see one major emerging market going into crisis before we get to that point.”