Elliot Smith
An
Indian naval officer walks past the logo of India’s central bank, the
Reserve Bank of India (RBI), in Mumbai on November 9, 2016.
Punit Paranjpe | AFP | Getty Images
Emerging market (EM) central banks will likely begin more aggressive loosening of monetary policy following the
U.S. Federal Reserve’s emergency interest rate cut, analysts anticipate.
The weakened global economic outlook in the wake of the
coronavirus outbreak
has led to speculation that a host of major central banks around the
world will lower rates following the Fed’s 50 basis point cut earlier
this week.
While policy easing in emerging markets has so far been
confined to Asia, where the economic fallout is expected to be most
severe, analysts expect that central banks across the emerging market
landscape are preparing their own monetary policy arsenal.
In a
note Wednesday, Capital Economics Emerging Markets Economist Edward
Glossop projected additional rate cuts across emerging Asia, but also in
Brazil, India, Mexico, Poland and South Africa.
Glossop
highlighted that economic activity in emerging markets will continue to
deteriorate and that data released so far, such as February’s PMI
(purchasing managers’ index) readings, had not fully captured the impact
of the coronavirus, as they were taken prior to the surge in cases
outside of Asia.
More broadly, Capital Economics expects that the
virus will continue to spread and detrimentally impact gross domestic
product (GDP) growth in most major EM countries.
“Of the large
inflation-targeting EMs, Mexico and Egypt will suffer a sharp drop in
tourism revenues (which amount to 7% and 5% of GDP, respectively),”
Glossop said.
“Central and Eastern Europe will be hit by
disruption to supply chains and slower global growth. And the likes of
Brazil, Chile, South Africa and Russia will suffer a hit to exports due
to lower commodity prices.”
Emboldened by the Fed
What’s
more, inflation is unlikely to pose a barrier to easing in most cases,
Glossop said, highlighting that recent falls in EM currencies are likely
to nudge inflation up by only 0.2-0.3%, which in most countries will be
offset by the impact of lower oil prices.
“Similarly,
supply-chain bottlenecks may push up prices of some goods, but this
should be broadly offset by weaker demand-side pressures,” he added.
Aside
from the emerging markets which naturally follow the Fed due to their
pegs to the dollar, Glossop pointed out that central banks in Mexico,
Turkey and Egypt also pay close attention to U.S. monetary policy, and
could use the Fed’s dramatic cut as “cover” to further trim their own
policy rates. Even those less influenced by the Fed will likely feel
more confident in decisions to ease policy, Glossop suggested.
By
the end of 2020, Capital Economics is forecasting a reduction of 60
basis points in India, 50 bps in Mexico, and 25 bps in Brazil, Colombia,
Poland, the Czech Republic and South Africa.
Outperforming EM equities
Lower
rates and a weaker dollar could provide a tailwind for emerging market
equities, according to UBS Global Wealth Management CIO Mark Haefele,
who rated emerging market equities overweight on expectations that they
will outpace developed peers this year.
In a note Thursday,
Haefele highlighted that EM equities have begun to outperform developed
markets in recent days, driven in part by China’s comparative progress
in containing the coronavirus while the U.S. and Europe descend into
panic. He projected that this outperformance will continue in the weeks
ahead.
“We expect growth differentials between emerging
and developed markets to widen in favor of emerging markets this year,”
he said.
“Moreover, EM equity valuations are lower than for
developed markets stocks, while regionally we expect the highest rates
of earnings growth in 2020 to be in Asia ex-Japan (12.4%) and Latin
America (15%), compared with just 6% in the US and a 1% contraction in
Europe.”
Among the emerging markets, UBS analysts are particularly
keen on Brazil, which they see as a “rare early cycle story in a world
of maturing growth” as the country moves from a state- to a market-led
economy.
“The recovery should drive superior earnings growth (20%
vs. 13% for EMs based on our estimates),” the UBS CIO office said in a
recent update.
“Record low real interest rates are also supporting
domestic and international funds’ allocation to equities, while
potential BRL (Brazilian Real) appreciation could also provide an
additional source of upside.”
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