The short-term EM outlook is closely linked to China’s growth prospects, given the links to the commodity sector. We expect China’s growth to slow very gradually from 7% currently to around 6.5% in 2018 and 6% in 2019. We are worried about China’s debt but, as discussed in various blogs, see state-owned banks and ample fiscal space as safeguards against a financial crisis and rapid slowdown.
EMs more broadly have sufficient fiscal and monetary space, which bodes well for short-term growth. Average government debt stands at 45% of GDP compared to 55% in the early 2000s and 65% in the late 80s. Real policy rates are still far from levels where they constrain growth, providing a sufficient buffer against higher Fed rates.
Most encouraging from a short-term angle is that EMs have started to deleverage since early-2016. By this we mean that their credit gap - the gap between debt-to-GDP and its long-term trend - is falling. This means no more negative growth impulse as long as the pace of deleveraging does not pick up unnecessarily.
Turning to the medium-term growth outlook for EM, we find further reasons for optimism.
EM credit ratings which fell since end-2014 have been rising again in 2017. They are still firmly in investment grade territory putting EM in a better place than they have been for most of their rating history.
Globalisation which stalled in the five years following the global financial crisis is advancing again. The pace has come down from the heydays of 1993-2008, but is comparable to earlier historical episodes. This is good news for EM, many of which are integrated into the global production chain and rely on exports for development.
The picture of EM’s manufacturing prowess, their motor of industrialization, is more mixed. We observe a bifurcation with incumbents like South Korea, Mexico or Poland gaining market share, but latecomers like Brazil, South Africa or Philippines losing market share. This trend if not reversed could hold back the latters’ convergence with advanced economies.
While 'new dawn' is probably too strong, and we retain our longer-term concerns, I believe that the short-term outlook for emerging market growth has not been this good in a while. How do we express this view? The firmer growth outlook should support emerging market assets. With the equity outlook clouded by some of our risk scenarios and the potential impact of a strengthening US dollar on earnings, we prefer to express this view currently in emerging market debt.