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EM Monitor - growth differential BETWEEN EMERGING and DEVELOPED MARKETS in 2021

January 2021

Full steam ahead for emerging markets?

Five reasons why we believe the EM GDP growth differential with developed markets should widen in 2021

Widening growth differential

After contracting in 2020 – albeit far less than developed markets – we forecast real GDP growth in emerging markets to rise strongly in 2021, further widening the gap with developed markets. Growth will be led by the Asia ex Japan region (8.5 per cent), followed by EMEA (4.5 per cent) then Latin America (+3.6 per cent).

Widening growth differential

Fig. 1: GDP growth Emerging Markets vs Developed Markets

fig 1 The GDP growth gap between emerging markets and developed markets should widen

Source: Pictet Asset Management, CEIC, Refinitiv, January 2021

 
Main EM activity indicators have already rebounded above pre-Covid levels (see Fig.2  below) apart from 'services', which are less important for emerging economies than developed markets.
Back to rude health

Fig. 2: Emerging Markets main activity indicators 

fig 2 showing a rebound in em activity indicators to above pre-Covid levels apart from for services

Source: Pictet Asset Management, CEIC, Refinitiv, CPB Netherlands, Google LLC, https://www.google.com/covid19/mobility/
*GDP-Weighted average of 39 countries leading indicator / **GDP-weighted average of countries new orders & capacity utilisation

This time, is it different?

What makes us think the timing is right for emerging markets? After all, emerging markets have endured a lost decade in terms of returns whilst the US economy, fueled by stimulus, has raced ahead. Many EM assets − equities, bond, currencies  appear very cheap today.  

So why do we now think  the timing is right?

Admittedly, we have had this view for a while, so why do we think the time is now right? Below are our five reasons why we think emerging markets might deliver. 

1. Weak US dollar and low US yields

EM currencies stand at historical lows against the dollar (see chart below). Our base case is the US dollar to weaken after years of strength, which will boost emerging markets, especially those with liabilities denominated in the US currency.
Can it go lower?

Fig.3:  EM currencies valuation 1980-2020

Fig 3 showing EM currencies at historic low valuation

Source: Pictet Asset Management, CEIC, Datastream. January 2021
*Unweighted 31 EM exchange rates vs USD **based on relative prices, relative productivities & net foreign assets 

This consensus view of weaker US dollar could be derailed in two scenarios: if the global picture gets very bad, or if the US is doing better than the rest of the world. 

First: we believe that globally we are through the worst, and emerging markets in particular. Vaccine deployment supports a constructive economic outlook, barring another exogenous black swan event.

The second scenario of the US outpacing global growth under the Biden administration is a possibility. Following the 2020 COVID relief package of $900bn, a second tranche of about US1tn is likely to be adopted in Q1. As a result we upgraded our forecast of US real GDP growth to 5.5 per cent for 2021. But this is still lower than our 6 per cent estimate for global growth.

Strong US growth could push US rates and the stronger dollar higher, which would affect the debt of most vulnerable EM countries. Yet, this risk remains contained since the Fed is committed to maintain rates low for long and EM imbalances are generally low with vulnerabilities in only two countries: Turkey & South Africa. 

2. Global trade is looking strong again

Emerging market industrial production has rebounded, whilst developed markets are still depressed as shown below left. We believe this has been driven in part by emerging markets meeting the demand for goods from locked-down developed markets where government payouts have supported retail consumption (see strong developed retail sales in right hand chart).
Global demand & supply recoveries in EM & DM

Fig. 4a: EM vs DM industrial production  / Fig.4b: EM vs DM retail sales 

Fig 4a  4b charts showing strong industrial production in emerging markets and support for retail sales from developed markets

Source: Pictet Asset Management, CEIC, Refinitiv, January 2021

 

Export growth is also on a positive trend (chart below left). Asian leadership in technology seems to be the driver (green line in right chart) and we believe this is a long-term structural trend. Moreover, since EM growth is two-times more sensitive to global trade than developed market, we expect the current synchronized recovery to be one of the main drivers of the widening growth gap between the two regions.
Asian technology leads the way

Fig. 5a (left): World real exports (%Y/Y) & export orders /
Fig. 5b (right) : World real exports & selected Asian nominal tech exports (%Y/Y)

fig 5a 5b charts showing strong exports from emerging markets

Source: Pictet Asset Management, CPB Netherlands, CEIC, Refinitiv, January 2021

3. China's continued strength

Another fundamental driver of EM outperformance is China’s ever greater role in terms of trade and financial linkages. All China's main activity indicators are above pre-pandemic levels driven by strong domestic and overseas demand. Consumption, which had been lagging, has gained momentum thanks to much better labour market conditions. Credit impulse remains expansionary. We expect real GDP growth to surge to 9.5 per cent in 2021 from 2.3 per cent in 2020. 

We expect China's real GDP growth to surge to 9.5 per cent in 2021.

President Xi’s 14th five-year plan and 2035 long-term targets show that China’s ambition is to reach a “high income” status by 2025 and to double its real GDP per capita by 2035.

4. Commodity prices likely to remain in a positive trend

Strong commodity prices are another key element to support EM outperformance given many EM countries' dependence on exports (Latam, Russia, South Africa, Indonesia). Two key determinants of commodity prices are the US dollar and World GDP growth (a simple proxy for commodity demand). As outlined above we expect the USD to weaken, and for every 1 per cent decline in the dollar (vs US main trade partners), commodity prices rise by 2 per cent. We are also constructive on global GDP growth. As shown in Figure 6 above, commodity prices are already up by 15 per cent y/y, in line with the global demand recovery. 
In sync...

Fig.6: World GDP growth (left axis) & commodity price growth (right axis)

fig 6 chart showing correlation of commodity prices and global growth

Source: Pictet Asset Management, CPB Netherlands, CEIC, Refinitiv, January 2021

 

5. Asia is through the 2nd wave of Covid

Asia is the main engine of emerging markets growth and the region now seems past the second wave of Covid, despite a rising number of cases in Malaysia and Indonesia. The number of daily new confirmed cases in Asia represents (as of 19 January) just 5.7 per cent of global total, down from 36 per cent at the peak in October. This compares to 15 per cent for the EMEA region and 18 per cent for Latam.
Through the worst of it?

Fig. 7: Daily new confirmed COVID-19 cases in EM region (%world case)

fig 7 chart showing covid cases have fallen especially in Asia

Source: Pictet Asset Management, CEIC, Refinitiv, January 2021
*12 countries / **21 countries / ***9 countries


 

Risks to our bullish view:

The main risk to our bullish case for emerging markets is continued dollar strength. However other EM tail risks that cannot be discounted are the following:

  • Commodity prices plunge in case of new significant covid infections waves or/and lower than expected vaccines efficiency
  • Broad-based vaccines availability & effective mass immunity might be harder to achieve than anticipated
  • Medium and long-term inflationary risks stemming from large money printing & QE programs
  • Rising income inequality within EM and relative to DM and potentially more social unrest