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Global Emerging Markets

Country allocation review, H1 2021

Insight
24 June 2021 |
Active ESG
Prospects for the world economy have brightened. However, uncertainty remains owing to the uneven pace of vaccinations and the lifting of lockdown restrictions. Against this backdrop – and with global debt at elevated levels and inflation continuing to rise in emerging markets – we consider our half-year country allocations for global emerging markets.

World GDP: recovering, but still short of pre-pandemic projections….

Prospects for the world economy have brightened. In its latest Economic Outlook, the OECD sees global GDP growth at 5.8% this year and 4.4% in 2022 – up from its previous estimates of 5.6% and 4.0%, respectively. But for several economies, the rate of expansion this year is unlikely to recover lost output from 2020. For example, euro area GDP declined by 6.7% in 2020 and it is likely to grow by only 4.3% this year. Similarly, South Africa faces a long recovery time after GDP shrunk by 7% in 2020 and it is likely to increase by 3.8% in 2021. Conversely, in the developed world, Australian, Canadian and the US economies are accelerating this year, recovering the full economic loss triggered by the Covid-19 pandemic. Meanwhile, in the emerging world, full economic recoveries are expected in Korea, India, Indonesia, and possibly Turkey.

Figure 1. Economic outlook projections: real GDP growth

% year-on-year, colours indicate the direction of revisions since the December 2020 Economic Outlook

2020
2021
2022
World
-3.5
5.8
4.4
Australia
-2.5
5.1
3.4
Canada
-5.4
6.1
3.8
Euro area
-6.7
4.3
4.4
Germany
-5.1
3.3
4.4
France
-8.2
5.8
4.0
Italy
-8.9
4.5
4.4
Spain
-10.8
5.9
6.3
Japan
-4.7
2.6
2.0
Korea
-0.9
3.8
2.8
United Kingdom
-9.8
7.2
5.5
United States
-3.5
6.9
3.6
2020
2021
2022
G20
*3.1
6.3
4.7
Argentina
-9.9
6.1
1.8
Brazil
-4.1
3.7
2.5
China
2.3
8.5
5.8
India*
-7.7
9.9
8.2
Indonesia
-2.1
4.7
5.1
Mexico
-8.2
5.0
3.2
Russia
-2.6
3.5
2.8
Saudi Arabia
-4.1
2.8
3.8
South Africa
-7.0
3.8
2.5
Turkey
1.8
5.7
3.4
Economic outlook projections: real GDP growth

Source: OECD Economic Outlook, as at 31 May 2021.

Despite the recovery, world GDP will be about US$3tn less by the end of 2022 compared to the OECD’s pre-pandemic estimates.

Figure 2. World GDP (Index 2019 Q4 = 100)

Graphique showing World GDP (Index 2019 Q4 = 100)

Source: OECD, as at 31 May 2021.

On a per capita GDP basis, few emerging economies are likely to recover to pre-pandemic levels before the end of this year. Moreover, the pace of economic recovery is sluggish in some cases – and there’s disparity in economic conditions – with Saudi Arabia, South Africa, and Argentina taking the longest time to recover fully.

Figure 3. How long to recover to pre-pandemic GDP per capita?

Graphique showing how long to recover to pre-pandemic GDP

Source: OECD Economic Outlook, as at 31 May 2021.

…and there’s a high level of uncertainty in estimates

The vaccine availability is limited, and the rollout is uneven. Several developed nations have successfully vaccinated over 50% of the population (with at least one dose of the vaccine), while Asia and several less developed economies are lagging behind. The uneven pace of vaccinations and restrictions on full mobility adds uncertainty to growth estimates. According to the OECD, Asia’s growth rate will fall below 5%, Latin America will grow by only 1%, and world GDP will expand by about 3% in a downside scenario.

Figure 4. 2022 GDP growth by region

Year-on-year, %

Graphique showing 2022 GDP growth by region

Source: OECD, as at 31 May 2021.

Global debt hits record high in 2020

The worldwide debt-to-GDP ratio reached 275% of GDP in 2020, with developed markets at 300% and emerging markets at 225%. These are elevated levels (see figure 5). As a result of record low borrowing costs and the need to stimulate economies fiscally, policymakers have borrowed more to cushion the loss of economic output. However, debt needs to stabilise, leaving limited fiscal space for future shocks.

Figure 5. Total debt to GDP (%)

Graphique showing total debt to GDP (%)

Source: BIS, HSBC, as at 1 March 2021. Total debt includes household debt, government debt and non-financial corporates debt. Excludes financial corporates debt.

Monetary policy action is likely to be less accommodative

Inflation continues to rise in most emerging markets. There are very few markets (notably, Indonesia, Colombia, and China) where inflation is subdued and below the central bank target. In most markets, inflation is either within the band or it has risen above the target level, prompting a turn in the monetary policy.

Figure 6. Consumer price inflation and inflation target range (year-on-year, %)

Graphique showing consumer price inflation and inflation target range

Source: IMF (EM Inflation and Monetary Policy Update), as at May 2021.

Although the inflation expectation survey does not suggest a significant risk of inflationary pressures over the medium term, most emerging markets are expected to maintain real policy rates below zero.

Figure 7. Inflationary pressures are not expected over the medium term

Graphique showing inflationary pressures are not expected over the medium term

Source: IMF (EM Inflation and Monetary Policy Update), as at May 2021.

Rising near-term inflationary pressure and possible normalisation of the US monetary policy is likely to prompt central banks to tighten policy, with swap markets already expecting policy tightening in several emerging markets – primarily, Latin America over the next few years, while they’ve turned hawkish in Poland and Hungary. In addition, inflation is running ahead of the upper band in several countries where the swap market is expecting policy tightening (e.g., Brazil, Mexico).

Figure 8.  Policy tightening is expected in several emerging markets

Graphique showing policy tightening is expected in several emerging markets

Source: IMF (EM Inflation and Monetary Policy Update), as at May 2021.

EM vulnerability assessment: rising inflation and rates are a risk

Economies in EMEA (ex-Russia) are the most vulnerable due to low import cover, high inflation, and a high proportion of short-term foreign debt. In addition, the rising US 10-year bond yield (in real terms) will have implications across emerging markets – particularly, in countries with a high dependency on foreign capital. Most EM economies have a positive spread over the US 10-year in real terms despite maintaining negative real policy rates.

Figure 9. Emerging markets vulnerability assessment

FX reserves USD billion
Import Cover in months
Current Account (% of GDP)
Inflation (CPI YoY%)
Short Term Foreign Debt USD (Billion)
Short Term Foreign Debt as % of GDP
Short Term Foreign Debt as % of FX Reserves
Real Policy Rate
Local 10 yr yield Spread vs US 10 Yr
Spread vs US 10 Yr (REAL)
ASIA (average)
665
13.9
3.3
2.4
252
12.5
38.5
-0.19
1.99
2.55
China
3,170
16.3
1.5
1.5
1316
9.2
41.5
2.9
1.7
3.3
South Korea
439
10.4
4
1.7
166
9.8
37.7
-1.2
0.6
2.0
Taiwan
543
20.7
12.8
1.4
197
28.1
36.3
-0.3
-1.0
0.7
India
598
18.1
-0.9
5
102
3.6
17.1
-1.0
4.5
2.6
Indonesia
132
11.2
-0.7
2.2
46
4.1
34.7
1.3
4.9
5.8
Malaysia
106
6.7
4.3
2.3
101
27.8
95.6
-0.6
1.8
2.6
Thailand
236
15.5
3.7
1.2
75
13.8
31.6
-0.7
0.3
2.2
Philippines
93
12.4
1.45
4.1
12
3.3
13.3
-2.1
3.1
2.1
LATAM (average)
193
12.9
0.7
4.4
49
5.3
31.4
-1.77
5.18
3.85
Brazil
339
23.5
-0.8
5.45
75
4.1
22.1
-2.0
7.5
5.1
Mexico
194
6.1
2.0
4.55
49
3.9
25.4
-0.6
5.0
3.6
Chile
48
9.0
0.9
3.3
22
7.9
46.5
-2.8
3.0
2.8
EMEA (average)
163
10.3
0.4
7.2
73
10.1
113.0
-0.30
6.28
2.18
South Africa
43
7.6
1.3
4.1
28
7.9
63.9
-0.6
7.5
6.5
Poland
116
6.0
3.2
3.7
62
10.5
53.6
-3.6
0.4
-0.2
Turkey
44
2.4
-5.1
15.8
141
18.5
321.0
3.2
16.4
3.7
Russia
447
25.1
2.2
5.2
60
3.5
13.3
-0.2
0.9
-1.2

Source: Bloomberg, Hermes analysis, as at 1 June 2021.

EM growth and valuation – valuation not too expensive, supported by growth (2021) in most cases

EM valuation vs. growth:

  1. Re-rated and growth > EM: India, Indonesia, Korea, and the Philippines
  2. Re-rated but growth < EM: Thailand, China, and Taiwan
  3. Cheap vs. history and growth > EM: Chile, Mexico, Brazil, S. Africa, and Turkey
  4. Cheap vs. history and growth < EM: Malaysia

Figure 10.  EM: valuation (standard deviation) vs. EPS CAGR

Graphique showing EM: valuation (standard deviation) vs. EPS CAGR

Source: Bloomberg estimates, as of 1 June 2021.

Growth beyond 2021: likely to taper off meaningfully for most markets

Most emerging economies will likely grow by about 30%+ compound annual growth rate (CAGR) between 2020 and 2023 due to the low base effect in 2020. When the low base effect is excluded, only a handful of economies (China, India, Indonesia, Thailand, Philippines, South Africa, and Turkey) will increase by double-digit figures in FY2 and FY3. The prospect for several economies depends on the continuation of commodity price hikes, further opening of economies post lockdown, vaccination rates, and the pace of reform, which will determine sustainable growth in the medium term.

Figure 11. Earnings growth moderating post 2021

EPS CAGR (2020-23)
EPS CAGR (2021-23)
EPS Growth – FY1
EPS Growth – FY2
EPS Growth – FY3
EM
25%
10%
59%
10%
10%
China
17%
16%
19%
17%
16%
Korea
32%
9%
96%
9%
9%
Taiwan
16%
5%
41%
3%
7%
India
35%
13%
93%
14%
13%
Indonesia
24%
23%
26%
20%
26%
Malaysia
18%
-4%
79%
-8%
0%
Thailand
21%
14%
36%
15%
12%
Philippines
32%
21%
58%
28%
14%
Brazil
40%
-4%
201%
-6%
-3%
Mexico
38%
7%
130%
8%
6%
Chile
33%
11%
92%
16%
6%
S. Africa
33%
16%
75%
15%
18%
Poland
30%
2%
114%
-2%
5%
Turkey
32%
17%
66%
17%
18%
Russia
28%
5%
92%
5%
4%

Source: Bloomberg estimates, as of 1 June 2021.

Country conclusions

China: Overweight
Korea: Overweight
Taiwan: Neutral
India: Overweight
Indonesia: Reduce overweight
Russia: Neutral
Turkey: Neutral
South Africa: Neutral
Mexico: Reduce overweight
Brazil: Neutral

Global Emerging Markets: Country allocation review

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Risk profile

  • This document does not constitute a solicitation or offer to any person to buy or sell any related securities or financial instruments.
  • The value of investments and income from them may go down as well as up, and you may not get back the original amount invested.
  • Past performance is not a reliable indicator of future results and targets are not guaranteed.
  • Investments in emerging markets tend to be more volatile than those in mature markets and the value of an investment can move sharply down or up.

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