Key calls for EMs in 2020 - Capital Economics
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Key calls for EMs in 2020

Emerging Markets Economics Focus
Written by Emerging Markets Team
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2020 will be a year in which EM GDP growth edges up and many major central banks catch investors by surprise. This Focus outlines our key calls for next year.

  • 2020 will be a year in which EM GDP growth edges up and many major central banks catch investors by surprise. This Focus outlines our key calls for next year.
  • 1. Policymakers in China will ease monetary policy significantly as the economy slows. Growth in China has slowed less than we had anticipated this year due to the resilience of housing construction. But with housing sales and starts weak, this tailwind will fade in 2020. The “Phase One” trade deal with the US, if it lasts, will provide only a small offsetting boost. Policymakers will come under increasing pressure to put a floor under growth. We anticipate 50bp of cuts in the 7-day reverse repo rate next year, compared with market expectations for a 25bp increase. That reduction will, in turn, pull the renminbi back through 7.00/$.
  • 2. Recoveries elsewhere will disappoint. We expect GDP growth in most major EMs, China apart, to strengthen in 2020, but the pace of recovery will generally be weaker than most anticipate. We are particularly downbeat relative to the consensus on India, South Africa, Mexico, Colombia and Malaysia. That said, parts of Asia, such as Vietnam and Taiwan, are likely to spring an upside surprise, even as China’s economy slows.
  • 3. Interest rate surprises likely in China, Brazil, Mexico, India, Turkey and South Africa. We generally expect more EM monetary easing in 2020, albeit at a slower pace than this year. We think that monetary policy will be looser than investors are anticipating in Brazil and China. (See our first key call.) In contrast, our interest rate views are more hawkish than investors’ in South Africa, Mexico, India and Turkey. Indeed, in the latter two countries, central banks are likely to hike rates by late 2020.
  • 4. EM export growth to recover. We were right to forecast a slump in EM export growth this year, and we think that EM exports will return to growth in 2020. The Asian electronics inventory cycle – a major drag on export growth earlier this year – has turned. Higher prices of some key commodities – including oil and copper – should support exports too. However, with the recovery in global growth likely to be slow, a strong rebound in underlying demand for EM exports is unlikely.
  • 5. Emerging Asian equities to underperform. We expect that returns on emerging market equities in 2020 will fall well short of those in 2019. At a regional level, while many analysts have tipped equities in Emerging Asia to outperform, we think that they will underperform – due largely to a slowdown in China.
  • Finally, a call for the new decade, rather than the new year:
  • 6. EM catch-up growth to end in the 2020s. We think that the widespread EM catch-up growth of the 2000s was a one-off. It was supported by a series of structural reforms that won’t be repeated. Many institutional forecasters expect widespread EM convergence to resume in the 2020s. But we think that just over half of EMs will converge with incomes in the developed world over the next decade.
  • Capital Economics Emerging Markets Team
    London: +44 20 7811 3916, Singapore: +65 6595 5190

Key calls for EMs in 2020

This Focus is one of a series of notes outlining our expectations for the world’s economies and financial markets in 2020. Links to the companion pieces can be found on our website.

2019 will be remembered as a year in which global growth slowed (and recession fears surfaced), the US-China trade war escalated and major central banks shifted firmly into easing mode. The latter development bolstered risk appetite, and is a key reason why two of our key calls for 2019 – that many EM central banks would raise interest rates and EM financial markets would falter – did not materialise.

But we got our other calls right. We correctly forecast that “[EM] growth will slow, and by more than most currently anticipate”. And we were right to expect a steep downturn in EM export growth and an escalation of the US-China trade war. At a country level, one big win was our call that Argentina’s elections would trigger renewed concerns about public debt sustainability.

On now, to 2020 (and beyond)…

1. Policymakers in China will ease monetary policy significantly as the economy slows

China’s growth will slow further in 2020 and, in response, policymakers will need to cut rates by more than most expect.

The good news is that external headwinds to China’s economy should ease next year. We don’t expect any Phase Two trade talks with the US to yield concrete results and even the Phase One deal may break down. But there appears to be little appetite in the US for expanding tariffs on Chinese goods much further. Meanwhile, we expect growth in many of China’s key trading partners to stage a mild recovery.

That said, we don’t think a mild improvement in external demand will be enough to offset further domestic weakness. The property sector, which remains the key support for growth in China, is primed for a correction. Not only is the current pace of construction unsustainable given underlying housing demand, but authorities have been restricting flows of financing to the sector. As a result, growth in property construction has started to level off and is likely to decline in the coming quarters.

We anticipate that growth on our China Activity Proxy – our attempt at tracking China’s economic growth without relying on official GDP figures – will fall from 5.2% this year to just 4.5% next year. And we think that GDP will be growing by just 4% by the end of 2020. (See Chart 1.)

Chart 1: Official GDP & China Activity Proxy (% y/y)

Sources: CEIC, Bloomberg, Capital Economics

This will put pressure on policymakers to provide more support and, with the fiscal deficit already wide, the PBOC will have to do most of the work. Admittedly, African Swine Fever, which has halved China’s pig herd in the past year, has pushed up inflation recently. But the disease should be brought under control during 2020. And in any case, core consumer and producer price inflation remain sluggish, suggesting that demand-side pressures remain weak. This leaves policymakers with plenty of space to ease monetary conditions.

Markets are pricing in broadly flat interest rates across 2020 as a whole. By contrast we anticipate a further 50bp decline in the PBOC’s 7-day reverse repo rate. (See Chart 2.) We think that will be enough to stabilise growth by the end of the year although, with monetary transmission less effective at stimulating credit growth than in the past, not enough to drive a strong rebound.

Chart 2: PBOC 7-Day Reverse Repo Rate (%)

Sources: CEIC, Bloomberg, Capital Economics

The combination of looser monetary policy and an escalation in the trade war will cause the renminbi to come under renewed pressure. We expect it to weaken to 7.5/$ during 2020 (from 7.0/$ currently).

2. Recoveries elsewhere will disappoint

We expect growth in most other EMs to pick up in 2020, but the pace of recovery will generally be weaker than most anticipate.

This year’s slowdown was widespread. Of the 70 EMs that we cover, growth weakened in 55, the most since 2009. With the important exception of China, this slowdown is not likely to continue into 2020. Governments have responded to this year’s downturn by announcing fiscal stimulus packages. More EMs set to loosen fiscal policy next year than at any point since the global financial crisis. The pass-through from past monetary easing should keep credit conditions supportive. And EM export growth will also recover. (See our fourth key call.)

But growth will be weaker than most expect in the majority of cases. (See Chart 3.) At a country level, we hold below-consensus views on growth in Malaysia and Colombia, where governments are likely to buck the EM trend and tighten fiscal policy. We are also more downbeat than most on the prospects for Mexico, South Africa, Hong Kong and India.

Some countries will spring an upside surprise. In particular, Vietnam and Taiwan should continue to benefit from the US-China trade war . Even with the latest truce, US tariffs remain high, giving Chinese exporters an incentive to re-rout shipments to circumvent them. Over time, a gradual decoupling of the US and Chinese economies should encourage more investment in Vietnam and Taiwan too, as an alternative to China. Finally, we expect growth in Turkey to surpass expectations next year, but the recovery is looking increasingly unsustainable. Policy has been loosened aggressively, which will cause fresh macroeconomic imbalances to build and make the economy vulnerable to another crisis.

Chart 3: Difference Between Capital Economics & Consensus 2020 GDP Growth Forecast (%-pts)

Sources: Focus Economics, Capital Economics

3. Interest rate surprises likely in China, Brazil, Mexico, India, Turkey and South Africa

We agree with the widely-accepted view that many EM central banks will trim rates a bit further in the coming months. (See Chart 4.) But this time next year, we think that investors will have been wrong on rates in a number of major countries.

Chart 4: CE EM Interest Rate Diffusion Index

Sources: Refinitiv, Capital Economics

In a few cases, our forecasts are much more dovish than investors’. We expect that Brazil’s central bank will keep the Selic rate at 4.50% for the foreseeable future, while we also anticipate interest rate cuts in China (see our first key call) and Chile in 2020. In contrast, investors are pricing in rate hikes in all three countries. We also think that interest rates will be lowered by much more than most anticipate in the Czech Republic.

Elsewhere, though, we think that investors’ expectations for rates are too dovish in South Africa and Mexico, despite chronically weak growth in both countries. In the former, we don’t expect any rate cuts (whereas investors do). In the latter, we expect fewer cuts than are being priced into markets.

Market expectations for interest rates in India also appear too dovish to us. The economy should be growing at over 6% by the end of 2020 which will push up core inflation. This will put pressure on the central bank to act. We are firmly non-consensus in expecting the RBI to hike interest rates within the next few quarters, possibly before the end of 2020. By contrast, financial markets expect interest rates to stay on hold for the next two years.

Finally, with inflation set to rise and the currency likely to come under pressure, we think that Turkey’s central bank will have to reverse course and hike rates. Investors are discounting further rate cuts. (See Chart 5.)

Chart 5: CE Forecast For Policy Rate In 12 Months’ Time Less Rate Implied By Swap Markets (bp)

Sources: Bloomberg, Capital Economics

4. EM exports to return to growth

We were right to forecast a slump in EM exports this year, and we think that they will return to growth in 2020.

We estimate that the dollar value of EM exports fell by 1.5% over 2019 as a whole – the worst performance since 2016. While the trade war, and weakness in key economies have taken the headlines, the main drags on EM trade actually came from commodity prices and shocks to Asian electronics exports.

Both of these are likely to unwind next year. We expect prices of major commodities, including oil and copper, to edge up over 2020. And it would only need the level of Asian exports to remain stable, as they have been since early 2019, for the headline y/y growth rate to soon take a step higher. (See Chart 6.) The latter shift could boost overall EM export growth by around 1%-pt.

Chart 6: Emerging Asia Exports (US$, % y/y, seasonally-adjusted.)

Sources: Bloomberg, Capital Economics

However, it’s important to stress than a lot of the improvement in EM export growth will be the result of arithmetic effects rather than a pick-up in underlying demand. Indeed, with the recovery in global growth likely to be slow, external demand will stay subdued next year. All told, we expect that EM exports to grow by around 1-2% next year, which would be much weaker than the double-digit rates of growth achieved during 2017-18.

5. Emerging Asian equities to underperform

We expect returns to emerging market equities in 2020 to fall well short of those in 2019. And, after outperforming peers in Latin America and EMEA for much of the past decade, we think that equities in China, Taiwan and South Korea – which account for some 80% of the MSCI EM Asia – will underperform. This is for three reasons.

First, in contrast to most other EMs, we expect growth in China’s economy to weaken next year (see our first key call).

Second, although a “Phase One” trade deal has been agreed, we don’t think that this marks the end of the trade war. There remains a major risk of a decoupling between the US and China, which would make life harder for the tech firms that feature heavily in the MSCI EM Asia index. (See Chart 7.) The nomination by the Democrats of a candidate from the left of the party to challenge Donald Trump could put China’s economic relationship with the US back at centre stage.

Chart 7: MSCI Index Weights of Selected Sectors (%)

Sources: Bloomberg, Capital Economics

Third, we expect the prices of some key commodities, in particular oil and copper, to make up some lost ground, as supply growth remains weak, and demand stabilises. That would give more support to equities in Latin America and EMEA, given their larger weighting of commodity producers.

All told, we expect the MSCI EMEA and MSCI Latin America indices to end next year roughly 3% higher than they are now in dollar terms. In contrast, we forecast that the MSCI EM Asia will be a touch lower.

Turning to other EM assets, we generally expect local currency government bonds to perform poorly. That said, local currency bonds in China, Brazil and Chile are likely to do better – given our more dovish views on monetary policy in these countries compared to those discounted in financial markets. Finally, we think most EM currencies will weaken by another 5-10% against the dollar next year. As a result of high inflation, the Argentine peso and Turkish lira will suffer the largest falls. But there should be scope for the Peruvian sol and Chilean peso to appreciate against the dollar, thanks in part to higher copper prices (and in Chile’s case, a correction following the large sell-off on the back of recent protests).

6. EM catch-up growth to end in the 2020s

We usually limit our key calls to the coming year. But on the cusp of a new decade it seems appropriate also to look further ahead.

A defining feature of the next decade in our view will be that the widespread EM catch-up growth of the past two decades will come to an end. Most forecasters expect this trend to resume.

There are lots of ways of measuring catch-up growth. One is to look at whether GDP per capita is rising faster than in the US. This can be done in nominal terms – but in practice the trend in nominal incomes tends to be swamped by exchange rate moves. Focusing on real income gives a more stable view. On this measure, a majority of EMs have fallen further behind the US this year. That hasn’t happened since the turn of the millennium.

The consensus view is that this is an anomaly. But catch-up was not the norm throughout the twentieth century until the late-1990s, and we do not believe it will be the norm over the coming decade.

The 20 years after the mid-1990s were an exceptional period. Productivity growth surged across most of the emerging world due to a confluence of factors including China’s opening up and the knock-on effects on commodity prices, the end of communism in Eastern Europe, and market liberalisation in India and Latin America.

Importantly, these were one-offs. There are no major EMs left to integrate into the global economy. If anything, the risk is that some of the gains from opening up to international trade are lost as the current wave of globalisation stalls or goes into reverse. EMs have reaped the benefits of shifting to more prudent macroeconomic policymaking. Moreover, the process of reform and market liberalisation has stalled in many large emerging markets.

The stalling of “catch-up” growth in aggregate does not mean that it won’t happen at all. Just as some Asian economies prospered in the 1970s and 1980s, so well-placed and well-managed economies will do well in the 2020s. But catch-up won’t be as fast or as widespread it was in the past two decades. We estimate that only just of half of the EMs we cover will enjoy income convergence with the US over the next five years, compared with 80% a decade ago. (See Chart 8.)

Forecasters such as the IMF seem to think that widespread income convergence will return. The Fund’s latest forecasts imply that 80-85% of EMs will enjoy income convergence over the next few years. The difference therefore is that while we foresee a rerun of the early-1990s, the IMF is expecting a boom period akin to the mid-2000s.

Chart 8: Emerging Markets Catching Up
(% of Total Number of EMs)

Sources: IMF, Capital Economics


Capital Economics Emerging Markets Team London: +44 20 7811 3916, Singapore: +65 6595 5190