It’s clear from the price action after dovish holds from the Fed and the ECB that the liquidity story is not enough to sustain EM.  Instead, we feel that slowing global growth remains an overarching concern.  The OECD recently cut its global growth forecast for this year from 3.5% to 3.3%.  This is a significant slowdown from 3.6% growth in 2018, though the OECD sees 2020 growth picking up slightly to 3.4%. 

We are less sanguine.  With the US joining the slowdown club of China, Japan, and the eurozone, the four biggest economies are now in a synchronized slowdown.  The US is a special case, as above-trend growth of 3% last year is simply mean-reverting to 2% trend growth.  It’s hard to know what will turn things around, as the OECD sees all but the eurozone slowing next year.  

Trade tensions are likely to remain high, and that’s negative for EM.  While a trade deal with China is possible in Q2, this will not end global trade tensions by any stretch.  The US will then square off with Europe.  The US also fired warning shots recently across the bows of India and Turkey.  Lastly, there are indications that the Democratic-held Congress will not pass the USMCA without significant revisions.  

Within EM, there are still several idiosyncratic stories that bear watching.  Elections will be held in India, Indonesia, and South Africa.  Elsewhere, Brazil and Mexico are still feeling the repercussions of the elections held last year.  Erdogan is maintaining a tight grip in Turkey, and there are risks that he eventually forces the central bank to cut rates sooner than warranted.

Emerging Market Country Profiles

The long-awaited pension reforms have been submitted to Congress but are already experiencing some pushback.  Estimates for completion by September seem too optimistic, while the initial estimates for BRL1.2 trln in savings over the first ten years will likely be whittled down during the horse-trading.

To make matters worse, the economy remains very sluggish.  This has helped keep the budget deficit wider than desired, making pension reforms even more vital.  With inflation stuck in the bottom half of the 2.75-5.75% target range, markets have pushed out tightening expectations into 2020.  Indeed, there is even growing speculation that the next move in rates will be down, not up.  

Monetary policy is even harder to predict now given the new bank leadership.  Led by the new chief Roberto Campos Neto, the bank has to decide if there is room for lower rates before pension reform has been passed.  Growth this year is forecast by the IMF at 2.5%, up from 1.1% last year.  This strikes us as too optimistic.

Emerging Market Country Profiles

The Mexico City airport fiasco called into question his commitment to contracts and the rule of law.  His Morena party pushed through a controversial move to lower or eliminate bank fees.  Lastly, AMLO has proposed making it harder for foreign firms to invest in Mexico’s oil industry, reversing the liberalization measures taken by his predecessor Peña Nieto.

The cumulative effect has been a loss of confidence in AMLO’s government.  This was reflected in S&P’s recent decision to cut the outlook on its BBB+ rating from stable to negative.  Our own sovereign rating model views Mexico at BBB and so we believe the risks of an actual downgrade are significant. 

The economy remains sluggish, hamstrung by Banco de Mexico’s aggressive tightening cycle last year.  The IMF sees growth this year around 2%, little changed from 2018.  Inflation has fallen back within the 2-4% target range for the first time since December 2016.  If inflation remains under control and the peso remains stable, we think the bank will contemplate an easing cycle in H2.

Emerging Market Country Profiles

Policymakers recently announced the growth target for this year of 6.0-6.5%, down from “around” 6.5% last year.  Many stimulus measures have already been taken, and recent data suggest some stabilization is being seen.  Yet the structural slowdown will continue, and policymakers can only hope to ease the path ahead.  We expect more stimulus to come if the trade war drags on into H2.

As of this writing, a US-China trade deal has not been reached.  However, signs point to some sort of compromise, perhaps as early as Q2.  A Trump-Xi summit has not been set yet but would offer the best opportunity to announce a deal.  Yet we do not expect anything groundbreaking to be announced, as China will surely not agree to the types of structural reforms being demanded by the US.

The good news is that China has not weaponized the yuan.  That is, it has not undertaken any sort of competitive devaluation to help boost exports and offset the impact of the US tariffs.  In fact, the yuan has been trading more “freely” than ever before.  By this, we mean that the correlation between the yuan and MSCI EM FX is running near .70 currently and down slightly from the cycle high near .80 in February.  In other words, the yuan is trading more like wider EM and not being run as any sort of quasi-peg.

Emerging Market Country Profiles

The vote is spread out due to the difficult logistics involved.  All 543 seats will be contested.  Polls suggest the ruling BJP-led coalition will get the most seats but may fall short of the 272 needed for a majority.  Nahendra Modi is aiming to win a second term but may need to expand his coalition to do so. 

Tensions with Pakistan appear to have died down, at least for now.  Yet the hostilities may end up helping Modi in the elections.  The opposition Congress Party is led by Rahul Gandhi, and has done well in recent state elections but is not yet strong enough to mount a challenge to Modi. 

The central bank nudged rates up last year to help support the rupee and limit the inflation pass-through.  Inflation has since fallen near the bottom of the 2-6% target range, while the rupee has firmed.  This allowed the Reserve Bank of India to start cutting rates earlier this year.  Modi has opened the fiscal taps ahead of the elections; the addition of monetary stimulus should further boost growth.   The IMF sees growth picking up to 7.5% in FY2019 and 7.7% in FY2020.

Emerging Market Country Profiles

Parliamentary and presidential elections will be held simultaneously for the first time ever.   Recent polls suggest President Joko Widodo will easily win a second term, defeating Prabowo Subianto for a second straight time.  A second term would allow Jokowi to continue his structural reform agenda.

The economy is faring well compared to much of the region.  This is due in large part to the fact that Indonesia is much less export-dependent, with a large domestic market that can be tapped.  Furthermore, Jokowi has boosted fiscal spending ahead of the elections to help shore up his support. 

The central bank hiked rates aggressively last year to help support the rupiah and limit the inflation pass-through.  Inflation has fallen to the bottom of the 2.5-4.5% target range, while the rupiah has firmed.  These conditions should allow Bank Indonesia to start cutting rates this year, probably before mid-year.  If so, easing would add to the growth tailwinds.

Emerging Market Country Profiles

President Ramaphosa will be running for the first time after taking over from Jacob Zuma last year.  Support for the ANC has rebounded under Ramaphosa, with polls suggesting it will win nearly 60% of the vote.  This is up from the all-time low of 54% won in the 2016 municipal elections and would give Ramaphosa the presidency.  He is still struggling against the entrenched Zuma wing of the ANC but has made headway in cleaning up the cabinet.  

The February budget statement contained no tightening measures.  Rather, it announced a multi-year bailout of state-owned power company Eskom that will balloon the deficit.  The government basically signaled that it could tighten no further ahead of the crucial elections.  Rather than worrying about a downgrade, the ANC is clearly focusing on shoring up its support.

Our own sovereign rating model shows South Africa’s implied rating down a notch this quarter to BB-/Ba3/BB-.  Moody’s and Fitch ratings of Baa3 and BB+, respectively, are seeing heightened downgrade risk.  Loss of investment grade from Moody’s would lead to ejection from WGBI.  Even S&P’s BB rating appears too high now.

With the sad Zuma chapter of the nation’s history now ended, we are the most constructive that we have ever been on South Africa.  But it won’t be easy.  Ramaphosa will remain saddled with a weak economy and high unemployment.  Corruption and structural inefficiencies must be addressed if South Africa is to ever come close to reaching its potential.     

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