Emerging markets outlook 2013: more bulls than bears

The first half of next year will be favourable for emerging markets, where growth will recover moderately, as the fears of a break-up of the eurozone recede and if the US lawmakers find a solution to avoid falling off the “fiscal cliff,” various analysts predict.

“Next year will be one where global growth stabilizes,” Ralf Preusser, head of European Rates Research at Bank of America Merrill Lynch, told journalists in London.

“The trough should be in the first quarter; inflation should not be a problem in 2013,” Preusser added.

The recession in the eurozone will deepen in the fourth quarter of this year because of a general attempt to reduce inventories, but in 2013 “headwinds from fiscal tightening should ease, inventory reduction should come to an end and a gradual recovery in global growth would help the euro area return to moderate growth,” analysts at Danske bank said in an outlook for the region.

The peripheral eurozone countries are going through “important structural reforms,” they said, with unit labour costs falling and all sectors deleveraging, a process that is set to continue at a slower pace.

“At the end of this process, we could see a sudden boost to growth as confidence returns and economies have become much more competitive,” the Danske bank analysts said, but added that the timing for this was uncertain.

They also said that the deal on Greece “has kicked the problem further down the road;” some analysts were more optimistic, saying that the deal actually showed that European governments were resigned to losses on their holdings of Greek debt.

Strategists at Societe Generale believe that the backdrop for the eurozone “should ultimately improve” and that Spain was likely to request a financial bailout, which “may trigger a relief rally, especially in EMEA.”

US FISCAL CLIFF RESOLUTION

In the US, Societe Generale’s global economics team believes that a “temporary extension” of the expiring fiscal measures is likely to be approved by the end of the year, with a final resolution being agreed in the spring.

“While the eurozone will remain in a process of adjustment for several years, the US should lead the way to a more sustainable recovery in 2013,” according to Societe Generale’s economists.

“Furthermore, monetary policy in the advanced economies will remain accommodative next year, which will also provide support to emerging market economies.”

Bank of America Merrill Lynch analysts predict that the recovery in the US housing sector will continue, with prices increasing by 3% next year and housing starts by more than 25%, stimulating jobs in construction and relating sectors such as building materials, furniture and financials.

But dangers still remain, according to analysts at Capital Economics who, although believing the worst fears about the US fiscal cliff are “overdone,” say that economic growth will remain sluggish and unemployment high.

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Their outlook for the eurozone is much gloomier, with a deeper recession next year which will lead to the break-up of the currency bloc at some point.

By contrast with the consensus of analysts, who expect growth in emerging markets to pick up next year, Capital Economics say that even though they remain a brighter spot, emerging markets’ growth is likely to slow to around 4.5% from this year’s approximately 5%.

ASIA WILL LEAD

China’s recovery has already started and the country’s economy will shine next year, growing above 8%, according to most analysts.

Restocking in China may have started due to the improved economic outlook and Bank of America Merrill Lynch analysts believe it is likely to add 23 basis points to the country’s GDP in 2013.

They also point to credit data, which have turned positive recently, and the fear of capital flight receding.

In foreign exchange, “high-beta Asian FX is really the place to be next year,” Societe Generale analysts say. Based on their forecasts, an Asia FX index that excludes China’s pegged currency points to 4.6% appreciation for the period to June 2013.

Capital Economics, while admitting that Asia will be the fastest-growing emerging region, points out the fact that China’s economy is now lifted by earlier stimulus, but without significant further policy support it is unlikely to accelerate – and they believe further support will not be forthcoming.

Sub-Saharan Africa will be the second fastest-growing region, the Capital Economics analysts say, on the back of strong growth in Nigeria and Ghana. But, they add, “political uncertainties will weigh on growth in both South Africa and Kenya.”

Societe Generale’s strategists expect Latin American currencies to outperform over the next 6 months, as they see the Brazilian real and the Mexican peso rebounding on the back of improvement in US macroeconomic conditions.

However, the “currency war” theme will come back, becoming dominant in Latin America and partially offsetting the positive impact of ample liquidity and better growth prospects, they warned.

Argentina and Venezuela “look set for hard landings,” according to Capital Economics economists, who also predict that falling commodity prices and slower credit growth will “take the steam out of the region’s consumer credit boom.” Brazil “looks particularly exposed” to that risk, they added.

WORST PERFORMER

The oil producing economies in the Middle East should hold up well even if oil prices fall, as they have built surpluses, but for resource poor countries the picture will be very different.

Private capital inflows have been decreasing for the Middle East and North African countries, strategists at Societe Generale noted, forecasting that Morocco, Tunisia and Egypt will “remain deeply in deficit” as these countries use spending on subsidies for goods and services and on wages as a tool to contain social pressures.

“Further credit downgrades and some currency weakness could follow for the region’s distressed economies since no noticeable improvement is foreseen on the fundamentals,” they said.

The region with the most risks is, according to most analysts, emerging Europe, where economies are closely linked to the eurozone, both via the trade channel but also due to the presence of Western European banks, which have been deleveraging.

Capital Economics named emerging Europe “the worst performer among emerging markets in 2013.”

External headwinds remain significant and they will be compounded by local problems, with most governments in the region adopting further fiscal austerity while credit tightens and unemployment remains high.

Only Poland has room for significant monetary policy response, while many countries in the region, notably Hungary and the Czech Republic, will “remain in recessions of their own,” the Capital Economics analysts predicted.

The region also runs the risk of perceived policy errors, with Hungary dropping its commitment to inflation targeting according to the analysts from Societe Generale and with the Czech Republic facing new policy challenges as the rates fell to near zero.

Turkey and Russia, two big emerging markets, are positive exceptions in the region, Turkey because it diversified its exports away from Europe and its central bank’s unorthodox policies have helped ease pressure on the current account deficit to some extent, and Russia because of its energy resources but also because of its opening of the local bond market more to foreign investors from next year.