By Chetan Ahya, Morgan Stanley’s Chief Economist and Global Head of Economics
When Will EMs Get on the Global Reflation Train?
The global economy has been on a strong run since its historic contraction last quarter, and the V-shaped recovery has played out even faster than we initially expected. Since Covid-19 was a common exogenous shock to economies worldwide, its economic impact has tracked the timeline from the start of lockdown measures to the lifting of these restrictions. As all economies are now reopening, economic output is on the road to pre-Covid-19 levels, with some already there but others still lagging.
The area where the pace of recovery has remained weak is the emerging economies outside China (EMXC), which account for roughly 25% of global nominal dollar GDP. Unlike the post-GFC period, most large EMXC economies lacked sufficient fiscal policy buffers entering the pandemic, limiting their ability to provide countercyclical fiscal policy support. While the EMXC recovery has been relatively weak and some of these economies also face structural challenges, we think that the cyclical outlook for the group will improve from 1H21, aided by multiple factors:
- Rising support from external demand: The external demand picture for EMXC economies (which are more dependent on global trade) has brightened significantly. The new orders-to-inventories ratio for our global manufacturing purchasing managers’ index, which has been a strong leading indicator for global industrial production and global trade volumes, recorded its strongest reading since 2011 in August, and with an ongoing recovery in DM consumer spending, demand for EMXC exports is likely to boost their growth outlooks.
- China’s reflationary impulse: China has already been on a strong recovery path. Our chief China economist Robin Xing expects China’s GDP growth to accelerate to potential growth of 6%Y by the end of this year given reduced constraints from Covid-19 public health restrictions and ongoing strong policy support. Indeed, China’s credit impulse has reached its highest levels since mid-2016, and we expect the government to continue implementing expansionary fiscal policy in 2021 with its augmented deficit at 13.2% of GDP.
- Availability of a vaccine from 1Q21: EMXC economies stand to benefit the most from a vaccine, which we expect will be available to the population from 1Q21. While a vaccine will not be a push-button switch because the whole population will not have immediate access, we believe that economic activity will ramp up well before virological herd immunity is attained. By providing protection to vulnerable populations early on, a vaccine will likely reduce both the stress on public health systems’ capacity and the number of fatalities – the only hard constraints that keep policy-makers from loosening Covid-19-related restrictions. As a result, we see EMXC experiencing meaningful growth acceleration from 2Q21 onwards, rounding out a global synchronous recovery.
- Lagged impact of EM monetary easing: With limited help from fiscal easing, EM central banks have been forced to implement aggressive monetary easing in response to the Covid-19 growth shock. Real policy rates have declined to -0.5% and the top EMXC central bank balance sheets have expanded at the fastest pace in recent history. Given a decline in private business confidence, this balance sheet expansion has not yet translated into a broad pick-up in credit growth. However, as private confidence improves with the support of the factors discussed above, we should see an increase in credit demand in 1H21. Moreover, against the backdrop of persistently easy Fed policy and a weak US dollar, EM central banks will feel little pressure to remove accommodative policy in order to shore up exchange rates or foreign capital flows. This will give EM monetary authorities more policy leeway to let domestic economies accelerate.
In sum, we expect a more broad-based global synchronous recovery from 2Q21 as EMXC growth accelerates. However, the rebound could still encounter some speed bumps over next three to four months. We will be watching:
- US fiscal policy and election-related uncertainty;
- The risk of a potentially severe wave of Covid-19 infections/fatalities that may force policy-makers to take more drastic curtailment measures; and
- Idiosyncratic political risks in EMXCs.