December 2015
Schroders
Talking Point
EM forecast update: an uneven recovery
Keith Wade, Chief Economist
Another quarter, another downgrade for emerging market growth, but there is some good news on the horizon.
Extending our forecast period out to 2017, we begin to see growth improving outside of China, with India
continuing its gradual gains, while Brazil and Russia should begin to stage recoveries after a testing period.
China: stimulus will not stop the slowdown
Though we still await the official growth target for 2016, it has been heavily hinted that 6.5% is the new goal.
This growth rate would mean China reaches the objective set in 2010 of doubling GDP and incomes by 2020.
Unfortunately, we do not believe China is capable of safely growing at 6.5% a year for the rest of this decade.
The slowdown we have witnessed in economic growth is driven by a host of structural factors, rather than
being cyclical in nature. With none of these problems resolved, there is no reason the deceleration should
plateau at 6.5% for the next four years. Indeed, we expect a marked deceleration in 2016 compared to this
year and a continued, slower decline thereafter.
Stimulus can, of course, be ramped up further, but given how much stimulus we have seen this year, it is
unlikely this will be enough to deliver acceleration in growth. Monetary policy has struggled to reduce the
effective lending rate at a time of deflation and in any case, there is falling demand for credit. The one positive
from all this excess capacity is that the attendant deflationary pressures should keep Consumer Price Index
(CPI) inflation contained well below the 3% target, providing ample room for monetary easing.
Finally, the possibility of currency devaluation continues to be a matter of much debate. The renminbi remains
overvalued by some 15 – 20% on a real effective exchange rate basis, and a move to a free float would
undoubtedly see a large depreciation. However, the authorities for now appear wedded to a cautious approach,
with an eye on the likely political and financial stability consequences of such a move. Our base case scenario
remains a gradual weakening of the currency over the next two years, though we would attach a growing
weight to a larger one-off devaluation as growth slows and domestic exposures to the yuan/US dollar
exchange rate are reduced.
Brazil: more pain, little gain
The political situation has continued to deteriorate in Brazil, such that policymaker focus now is almost entirely
on the fallout from the Petrobras corruption scandal. Without any economic reform efforts or indeed anything
resembling coherent policy, we are forced to downgrade; 2016 is set to be another very disappointing year for
growth. However, a recovery should be underway in 2017.
On the fiscal and supply side concerns, the political situation all but guarantees a lack of productive legislation
until a new government comes to power. This means investment and consumption decisions are likely to be
deferred. However, market forces are beginning to generate an improvement in other metrics. For example,
unit labour costs have finally begun to decline as unemployment builds, which ought to lead to an improvement
on the trade balance, as seems to be happening. Unfortunately, if Brazil is to rely on this kind of adjustment,
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rather than market reforms, we will need to see much more destruction of domestic demand before the
process is complete.
India: a dimming hope
We applied a small downgrade to the outlook but still expect India to grow faster than any other emerging
market economy. We have still had no substantive reform progress, but one encouraging development was
the policy announcement for gas price liberalisation. This will greatly improve the incentives for natural gas
investment. Though the immediate economic impact will be limited, it strengthens the medium-term outlook but,
more importantly, reassures that the government remains committed to liberalising and reforming India’s
economy.
For now, growth looks set for a modest acceleration, likely driven by consumption rather than investment.
Private sector banks are reportedly happy to provide consumer credit and see little demand for corporate
lending, so we expect this to be a key growth driver in India in 2016.
Russia: rumble resolved?
Russia’s Q3 GDP data has beat both expectations and the previous quarter, contracting 4.1% compared to
4.6% previously. This is still an extremely poor economic performance, but it does mark a likely inflection point,
particularly in combination with data from the industrial side of the economy, where production has been
recovering gradually. The consumption side continues to deteriorate, as might be expected given rising
unemployment and falling wages, but by compressing import demand this may actually help the net export
contribution and the current account.
Meanwhile, the fall in the oil price has taken most of its toll, and barring further large falls we should not see an
additional drag on growth in 2016 and 2017. Furthermore, government spending is set to remain somewhat
supportive given the planned 3% budget deficit. As a result, we forecast a gradual recovery over the next two
years, with growth essentially flat next year and growing 1.5% in 2017 once balance sheets are repaired and
investment begins to grow from a lower base.
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