Emerging economies started 2021 on a positive note
In emerging countries, the economic rebound that followed the Covid19 shock started in late spring or in the summer and then strengthened in Q4 2020, supported by the easing of restrictions on mobility, the gradual adjustment of activity to reduced face-to-face interactions and continued policy support. China has led the way, being the first in-first out of the crisis. More generally, in Asia, industrialized economies have been boosted by a strong rebound in exports since Q2 2020, led by buoyant demand for electronics. Export performance has also strengthened in Central Europe whereas it has remained sluggish in Latin America and in Africa and the Middle East. Yet the later regions have recently started to benefit from rising commodity prices. On the domestic demand front, private consumption has generally recovered the most rapidly while investment has picked up more slowly, except in China.
Emerging markets also benefited from a spectacular rebound in foreign portfolio investment flows in Q4 2020, led by capital flows to China. This contributed to currency appreciation, surging equity and bond asset prices and a broad easing in financing conditions – until the first half of February 2021.
We estimate that real GDP of emerging economies contracted by -2.6% in average in 2020 and should grow by 6% in 2021, with very uneven performances amongst countries. Activity benefited from a stronger-than-expected momentum in late 2020-early 2021, and favourable external factors continue to support growth recovery (further catching-up in global trade, rising commodity prices and lower domestic borrowing costs than pre-Covid19 crisis levels). However, many downside risks darken short-term prospects.
But many clouds remain on the horizon
Firstly, activity will depend on the evolution of the epidemic, the speed of vaccination campaigns and the easing of lockdown measures. In its baseline scenario, the IMF assumes that vaccination will provide effective nationwide protection in advanced economies and some emerging countries in Q3 2021 and then across most countries by H2 2022, but any forecast remains highly uncertain at this stage. At the same time, the impact of epidemic outbreaks on activity could lessen gradually thanks to improving therapies and tracing and more targeted restrictions.
Secondly, policymakers’ capacity to maintain support measures is expected to lessen, especially on the fiscal front given last year’s deterioration in public finances and lower budget deficits expected in 2021. Monetary conditions should remain broadly supportive in the short term, but the space for additional easing of the policy stance has narrowed as interest rates are standing at record-low levels while inflation is starting to rise. A number of central banks are able to pay little attention to rising inflation as it remains mostly a commodity price-driven inflation problem while the economic outlook is still uncertain. However, some countries may be increasingly forced to change their monetary policy stance in response to higher inflation, especially in case of with renewed investor stress. This has already been the case of Turkey, where monetary policy has started to be tightened since August in order to address strong exchange rate pressures. It may soon be the case of Brazil. Meanwhile, in order to ease local bond market and fiscal financing pressure while deferring interest rate increases, some central banks may resort to additional asset purchase programs. In 2020, 18 emerging countries implemented such programs, with moderate asset purchases ranging from less than 2% of GDP in most countries to 6% in Poland, for instance. This leaves some room to continue in 2021. Beyond the short term, however, there is a risk that a prolonged use of quantitative easing starts to erode central bank credibility.
Thirdly, financing conditions for emerging-market borrowers may rapidly deteriorate in case of changing global monetary conditions and rising risk aversion, especially as investors increasingly monitor the long-term consequences of the Covid19 crisis for macroeconomic fundamentals. In fact, this risk has started to materialize over the past month, with foreign capital inflows losing steam and tensions on emerging external bond yields.
Lastly, the economic recovery path could derail rapidly in case of new shocks, because of the large scars left by the Covid19 crisis on public finances, the corporate sector and the labor markets.
Monitoring sovereign risk and credit risk in emerging countries
The economic crisis resulting from the Covid19 pandemic has led to a broad increase in sovereign risk in emerging countries. The deterioration in public finances reflects the duty of governments to support their population faced with an unprecedented economic shock, thus the increase in sovereign risk does not reflect macroeconomic mismanagement. Yet, credit events (defaults and debt restructuring) are multiplying, especially in Sub-Sahara Africa, even if the liquidity support provided by official creditors (IMF emergency financing lines, G20-Paris Club Debt Service Suspension Initiative) has helped to keep countries afloat. Among the major emerging countries, Brazil, South Africa and India need to be monitored even if their solvency is not at stake, given their heavy debt burden and large financing needs in 2021.
Credit risks have also increased over the past year. Measures implemented in 2020 to support corporates and households should remain partly in place in the months ahead, continuing to attenuate and delay the increase in defaults. However, corporates’ liquidity and solvency issues should grow whenever the support measures are unwound. Meanwhile, rising credit costs and low interest rates may increasingly weigh on banks’ ability to lend. In many countries (especially in Africa, Latin America but also India and China), policymakers will be under growing pressure to address the vulnerabilities that worsened last year (high corporate debt, rising public debt, weakening banking systems). Resorting to macro-prudential measures and structural reforms aimed at enhancing economic growth prospects would help respond to this problem.
