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Easing global growth weighs on exports and commodities
Expectations of higher interest rates in developed economies,
stronger dollar and rising inflation put pressure on EM central
banks to tighten
These factors pose notable risks to EM growth in 2022
Robust vaccination uptakes, as well as supportive fiscal and
monetary policy have facilitated a strong "post-pandemic" recovery
in economic activity across developed markets (DMs) so far this
year. While these three factors have not been as prevalent in
emerging markets (EMs), booming demand conditions in the world's
more advanced economies have benefited EMs, particularly
exporters.
However, global economic growth has been slowing quite
drastically in the second half of 2021 as the post-lockdown boom
petered out and supply-issues intensified. Now, easing growth,
rising inflation, expectations of tighter monetary policy in
developed economies and a stronger US dollar are all compounding to
weigh on EMs. As a result, investors are losing confidence in the
EM growth story and many EM central banks are beginning to tighten,
which could place further strain on EM growth prospects heading
into 2022.
EM outlook skewed to the downside
Recoveries across developed and emerging markets have been far
from synchronous, according to PMI™ survey data from IHS Markit
(see chart 1). Developed world growth greatly exceeded that of EMs
throughout all of 2021, primarily due to the difference in the
handling of the pandemic as DMs kept stringent virus-combatting
measures in place for longer, delaying the timing of the rebound.
Regardless, the subsequent slowdown in growth in DMs since the
middle of 2021 has clearly weighed on EM economies, although
encouragingly the November PMI survey data did show EM
manufacturing output rising at the strongest pace in five
months.
Chart 1: EM v DM manufacturing output
growth
A positive side effect of rising global economic activity for
EMs tends to be improved export growth and rising commodity prices.
The logic follows that rising commodity demand and prices boosts EM
exports both in volume and value terms, and therefore benefits EM
growth. Not only this, but ultra-loose monetary policy in the
global economic powerhouses has also allowed EM central banks to
keep interest rates, and debt servicing costs, low, fostering good
growth conditions. However,
headwinds to economic output remain at large and the support
that the factors listed above lend to EM growth are starting to
dissipate.
Chart 2: EM manufacturing demand vs. global commodity
demand proxy
Most notably, although commodity prices have, until recently,
had a strong year, we've seen evidence of weakening demand
pressures in commodities for some time. Using IHS Markit Global
PMI™ Price Pressure and Supply Shortage Indicators (for more
information on these indices, please see below), we've
controlled for the effect that supply has on prices to proxy
commodities demand. This is important analysis for EMs,
particularly in the current environment given that commodity prices
are mainly rising due to intense supply shortages. The results can
be seen in chart 2, which shows an historically strong relationship
between our global commodity demand tracker and the PMI New Orders
Index for EMs. Weakening demand pressures in commodities has
coincided with an easing of new order growth at EM
manufacturers.
The next problem - inflation - is more acute at DMs, but EMs may
ultimately pay the greater price. While price pressures at DMs have
touched multi-decade highs this year due to the surge in demand for
materials, shortages of inputs at suppliers, transport bottlenecks
and poor global shipping container availability, input cost
inflation at EMs has remained relatively contained (see chart
3).
Chart 3: DM v EM Manufacturing input price
inflation
That said, the EM Input Prices PMI has been well above its
historical average this year which, alongside expectations of
tightening by the Federal Reserve and other DM central banks, has
caused EM monetary policy to also tighten. Given how damaging
inflation can be to an EM economy, interest rates often have to be
more pro-active than reactive to protect the domestic currency and
the central bank's credibility. Unfortunately, credibility
protection comes at the cost of economic growth, and we've already
seen many EMs raise rates this year despite growth underwhelming
(see chart 4).
Chart 4: EM central banks tighten policy as growth
languishes
Lastly, amid fading risk appetite and growing expectations of
higher interest rates in the US, the US dollar has strengthened,
and JP Morgan's Index of EM currencies has dropped by almost 10%
this year alone. As EM currencies weakens, domestic financing costs
rise, and EM central banks are forced into action either by
intervening in the FX market or by increasing interest rates.
Chart 5: EM equities slip into decline as commodity
demand deteriorates
A less favourable external economic environment, combined with
tighter EM monetary policy, has made EM assets less desirable from
an international investors perspective. The trend in total US
dollar returns from EM equities has subsequently deteriorated, in
line with the signal from our global commodity demand tracker.
Summary
In summary, monetary policy across EMs has tightened in response
to rising inflation and expectations of higher interest rates
across the developed world. With the global manufacturing sector
struggling amid intense supply-chain dislocations, steep cost
pressures and slowing demand, weak global growth is likely to
persist. The combination of these factors undoubtedly skews the
outlook for EMs in 2022 further to the downside.
Demand conditions facing EMs will be a crucial barometer of
economic health to monitor in the coming months, especially if
supply issues persist or intensify and put more upward pressure on
commodity prices. As rising commodity prices are usually seen as a
positive signal for EM growth prospects, focusing on the demand
component here will enable us to determine how accommodative global
economic conditions are for EM growth. We will be keeping a close
eye on The EM Manufacturing New Orders PMI and our global commodity
demand tracker over the coming months to monitor how the EM
economic environment is evolving.
*IHS Markit Global PMI™ Price Pressure and Supply Shortage
Indicators are derived from IHS Markit's monthly Purchasing
Managers' Index™ (PMI) business surveys. These surveys are highly
regarded worldwide for providing accurate and timely data on
economic trends.
SSIs are calculated from the number of purchasing managers
that report a specific item to have been in short supply during the
survey month. An adjustment is made each month to allow for any
month-to-month variation in the total number of survey respondents.
Indices are presented as a multiple of the long-run average since
2005.
PPIs are calculated from the number of purchasing managers
that report a specific item to have been up in price during the
survey month (less the number reporting an item down in price). An
adjustment is made each month to allow for any month-to-month
variation in the total number of survey respondents. Indices are
presented as a multiple of the long-run average since 2005. For
more information on how you can get these data series, please
contact economics@ihsmarkit.com.
Purchasing Managers' Index™ (PMI™) data are compiled by IHS Markit for more than 40 economies worldwide. The monthly data are derived from surveys of senior executives at private sector companies, and are available only via subscription. The PMI dataset features a headline number, which indicates the overall health of an economy, and sub-indices, which provide insights into other key economic drivers such as GDP, inflation, exports, capacity utilization, employment and inventories. The PMI data are used by financial and corporate professionals to better understand where economies and markets are headed, and to uncover opportunities.