Emerging Markets; compelling opportunities against risky backdrop

Perhaps against general expectations, emerging markets have fared reasonably well in the wake of Covid-19, so far avoiding the second waves which the US and Europe are currently experiencing, suggesting that the economic impact on emerging markets will be lower in the coming months. While much Western commentary has centred on government testing regimes and vaccine development, the principal weapons against Covid-19 have been much more accessible: from social distancing, to mobility restrictions, to handwashing and mask-wearing - these were adopted globally in the early stages of the pandemic to fight the Covid-19 virus, deployed as effectively in emerging markets as developed markets. Indeed, while developed markets have moved faster than emerging markets to develop, purchase, and distribute vaccines for their populations, emerging markets have had a much more powerful, inbuilt structural advantage: younger populations.

Given Covid-19 is more harmful to older people, developed market governments are likely to implement a strategy were the older members of the population are prioritised and inoculated first. With fewer elderly people within emerging market populations, the impact of the virus is generally reduced as a lower proportion of the population is at significant risk, it therefore follows that they will need fewer vaccines initially, and could have a faster rollout than development markets. That being said, it is likely the prohibitive cost of both the Pfizer and Moderna vaccine will leave emerging markets reliant upon the cheaper AstraZeneca vaccine, which has a lower efficacy rate or a Chinese alternative.

Experience matters

A further advantage which emerging markets possess is experience. Developed market governments face big challenges around how to distribute a vaccine which likely requires two doses and cold storage as well as ensuring that the vaccine will have sufficient uptake to be effective in protecting populations. In recent years, many emerging market countries have conducted various vaccination campaigns: for example, against Polio, and the successful rolling out an Ebola vaccine which required cold storage across Africa. Vaccine take up in emerging markets is likely to be higher than the US or Europe where surveys suggest some reluctance to take the vaccine when offered.

What to watch in emerging markets through 2021

As ever, viewing emerging markets as a single block is fraught with risks. Differentiation between each country is key to understanding idiosyncratic risks to growth across this heterogenous space.

Emerging market central bank policy framework is also important, moving into 2021 there are signs that inflation is beginning to rise in emerging markets. A significant amount of this rise is in headline inflation numbers, driven by higher food prices which could be further impacted by higher energy prices. It is likely, central banks can look through rising inflation in the near future as easing cycles are likely to be on hold given currency volatility and little incentive for emerging markets central banks to tighten. Therefore, the policy backdrop should remain relatively benign.

From a global policy perspective in 2020, a difference has emerged between commodity exporters and importers. One of the reasons Asia did well in 2020 was that these countries are more focused on importing commodities, rather than export. The weak dollar has played a role in this, making the importing of commodities cheaper and therefore beneficial to the Asian economies.

As a result of the pandemic, some emerging market countries have seen their balance sheets weaken as their debt has increased, however, those countries with dollar denominated debt could potentially benefit from a weak USD. Given the debt levels, importance of monetary policy, and idiosyncratic dynamics it is likely that equities will be viewed more attractively in the future. Emerging market equities remain cheap on a relative basis and have lagged other asset classes significantly.

Perhaps the most important emerging market economy, China, has successfully supressed the Covid-19 pandemic and is staging a strong V-shaped recovery after using both fiscal and monetary policy extensively. As a result, China is likely to be one of the strongest global growth areas in 2020 and is even seeing the consumption side of the economy picking up which could be beneficial for other emerging market countries.

With the dichotomy of strong growth, yet low inflationary pressures, and China’s position in the business cycle, it is likely that the Peoples Bank of China’s (PboC) policy rate will remain accommodative. However, it is likely that it won’t ease any further and could perhaps rise slightly over the near-term, but we expect China to be mindful of scuppering any recovery.

On the fiscal front, it is likely the fiscal support will be scaled back given a recovery is gaining momentum, but the scale back will be a balancing act in order to avoid impacting domestic credit markets.

For China to continue its current growth rates, engagement in global initiatives, such as pushing for a green renewables strategy; supporting of Iran accords as well as participating vaccine diplomacy is important. China must also navigate the risks of a new US administration and work to build a better relationship than the current one which has seen levels of distrust rise markedly. With high levels of economic interdependency, it is unlikely that China would want to see an escalation and potential cold war with the US and the west.

Compelling opportunities against risky backdrop

Moving into 2021, we expect that emerging markets will continue to do well if they can avoid or mitigate any second waves or economic consequences of Covid-19. It is likely that China will lead the way to growth, if it can find the fine balance of growth, monetary and fiscal policy alongside engaging with the rest of the world.

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