China is developing faster than India
Outlook 2018The emerging markets are growing faster
Since the financial and economic crisis of 2008 and 2009, the world economy has grown very unevenly and has grown weakly compared to previous business cycles. Instead of achieving growth rates of four or five percent, the global economy has grown by just over three percent in recent years. Initially, the industrialized countries were primarily responsible for the lower growth, later on there were political undesirable developments in some emerging countries, which had a dampening effect on growth. In 2015, these negative effects were exacerbated by the drop in raw material prices. Their decline peaked in spring 2016, and since then most prices have recovered significantly. At the same time, the economic outlook for emerging economies has also improved.
In its latest forecast, the International Monetary Fund assumes that growth in the emerging markets will accelerate from 4.6 to 4.9 percent in the next year. However, it is noticeable that the IMF remains very cautious overall with its outlook and points to the many remaining risks. In our opinion, however, due to the strong economic momentum currently being observed in these countries, it is very likely that the actual economic development in 2018, as it was in this year, will be better than indicated in these forecasts.
The cautious attitude of many forecasters is mainly due to the fact that growth expectations in the years after the financial crisis were almost always too optimistic. In the meantime, the forecast errors from the past have been recognized and “learned” from them to make more cautious assessments (theory of adaptive expectations: earlier forecasts are compared with the actual results and the new expectations take into account the forecast errors of the past). But this caution is misleading for 2018. We expect growth in the emerging markets of over five percent.
China: solid growth despite weaker real estate market
In almost all emerging countries, the economic framework conditions have improved in recent months. If the IMF's forecasts are correct, economic output will decline this year in only twelve of the 154 countries classified as emerging markets compared to the previous year (Venezuela is the largest of the countries affected). For 2018, the Monetary Fund is forecasting a recession for only five of these countries. This is the lowest number since 1980. We believe it is likely that economic growth in the emerging markets will accelerate further over the next year. A value of almost five percent will be achieved in 2017, and the growth rate should be above this value in 2018.
Has participated in this development China, the second largest economy in the world and by far the largest emerging market, has a decisive share. This year, the Chinese economy will grow by 6.8 percent compared to the previous year and thus even slightly faster than last year. This is mainly due to the sustained strong domestic demand, but also to the recovery of the export economy in the wake of the revival of the world economy and world trade. For 2018, there are signs of a somewhat lower economic dynamic, this is mainly due to the weakening of the real estate market. After house prices rose sharply in many cities in 2016, the Chinese government and the central bank began to deliberately slow down the market this year by tightening credit conditions and restricting the options for buying a (second) property. However, the reins could be loosened somewhat in the course of next year after the recent price declines, so that economic growth should only slow down moderately.
The IMF is forecasting a growth rate of 6.5 percent for 2018, although China has regularly grown somewhat more strongly in recent years than the Monetary Fund originally expected. This could happen again in 2018.
India: Reforms temporarily create uncertainty
In the other three major emerging markets India, Brazil and Russia should accelerate economic growth in the coming year. In India, growth this year was slowed by the cash reform resolved by the government at the end of last year and the “major” tax reform implemented in the middle of the year, the introduction of a new and uniform value added tax. The uncertainties associated with these measures have proven to be a brake on investments this year. However, the planning risks for corporate spending should slowly subside, so that the Indian economy will grow again by more than seven percent in 2018 compared to the previous year. However, there remains a certain risk that investments will remain weak if corporate confidence in the economic policy of the Modi government is permanently damaged.
Russia and Brazil: boost commodity prices and loose monetary policy
Russia and Brazil As the main beneficiaries of the ongoing recovery in commodity prices, they will continue their economic catch-up after the severe recession years in 2015 and 2016 in the coming year. In contrast to the IMF, which is forecasting somewhat weaker economic dynamism for both countries in the coming year, we expect accelerated GDP growth of at least two percent for both countries. At the moment, exports in both countries are growing by around 20 percent compared to the previous year. Falling unemployment and falling inflation rates at the same time are increasing the purchasing power of consumers, so that in 2018 domestic demand will generate stronger growth impulses in both countries. In addition, the more expansionary monetary policy of the central banks of Russia and Brazil is supporting growth. The Russian central bank has cut interest rates by 175 basis points this year and the Brazilian by as much as 625 basis points.
Eastern Europe: finally back on track for growth
In all three major emerging market regions, i.e. in Asia, Latin America and Eastern Europe, the growth prospects have improved significantly. For the emerging Asian countries, China is the most important trading partner, which means that they reflect the current economic situation in the Middle Kingdom. It is similar with Latin America. Due to the geographical proximity, the US economy is also an important influencing factor there, but the influence of raw material prices on the economy is even more dominant. For countries like Brazil, Chile and Peru, the prices of iron ore, copper and nickel play a decisive role in determining whether the economic situation is improving or worsening. In the case of the most important industrial metals, China now accounts for more than 50 percent of global demand, so China's influence on many Latin American economies is immense.
The situation is different in the case of Eastern Europe. For these countries, the close economic ties to Western Europe are crucial for their future economic outlook. Even if the political situation in some (south) east European countries is to be questioned critically, the economy in most countries has recovered strongly. The European Bank for Reconstruction and Development (EBRD) has just revised its growth forecasts for Turkey, Latvia, Slovenia, Estonia, Romania and Poland all upwards. If, contrary to our expectations, the Chinese economy should develop weaker, this would have a direct negative impact on many countries in Asia and Latin America. Eastern Europe would be relatively immune to this as long as there is no new crisis in Western Europe. Increasing exports to the euro zone and domestic demand spurred on by higher wages can shield Eastern Europe from the negative consequences of an unexpected economic weakness in China, at least for a certain period of time.
For the investor, this means that both emerging market equities and bonds are or will remain an interesting option for their own portfolio. In view of the good economic framework conditions, the stock markets in the industrialized countries also have further price potential. However, we only consider bonds from these countries to be attractive in exceptional cases.
Carsten Kludeis chief economist at M.M.Warburg & CO
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