Springtime for Emerging Economies? Not Everywhere. Posted on May 12, 2016 by Monica Defend

After a tough start to the year, some rays of sunlight are coming from Emerging Markets (EM). A weaker US dollar, a stabilization of commodity prices and a smoother than expected path of tightening from the Federal Reserve Board are potential tailwinds to EM economic outlook overall. However, the

picture varies across different countries due to specific domestic economic and political conditions. A closer focus on each area/country is worthwhile. From a regional perspective, EM Asia (ex-Korea) has gained the most in terms of macro momentum since the end of 2015. For example, despite a rocky start to the year, China has been improving thanks to a clear pro-growth fiscal stance taken by the Government (see also our blog Is the Turnaround of China’s Economy Real?). Also in terms of external resilience (which takes into consideration the current account deficit, external debt and reserves, among others indicators), Asia ranks at the top of the EM universe, led by China and India. Emerging Markets, Europe and Asia (EMEA) has marginally improved its economic situation, with the decline in Russian exports slowing, as well as inflation moving lower. South Africa has also improved its picture thanks to lower inflation, but its outlook remains quite clouded in our view, and the country is likely to join the sub investment grade club this year.

Source: Ceic, Bloomberg, Pioneer Investments, data as of May 10, 2016. The score measures the macroeconomic momentum among the

EMs. The growth momentum has measured with the latest six months’ changes in GDP forecasts. Related to the demand side, we have

the internal demand (Private consumption and Investments) and external demand (exports) as momentum measures and with respect

their position versus their growth trend. Public finance momentum has measured with changes in government debt over one year and

fiscal balance dynamics through the current fiscal year. The three month forward inflation expectations have measured versus the

Central Banks target. Lastly, the gap between real policy rates and real GDP growth for next three months measures the liquidity

conditions in each economy.

Latin America remains the area with the worst macro outlook, although even this region has benefited from the rally in commodities.

Brazil – potential game changer ahead? Here the scene is dominated by Brazil, with the news of the impeachment of President Dilma Rousseff once again capturing market attention. Following the Senate vote, Rousseff has been temporarily removed from her role until a final vote is held, likely to take place by July 2016. With Rousseff ultimately impeached, Vice President Temer will keep the Presidential role until new elections take place in 2018. Although there is some uncertainty related to the final outcome of the political impasse, the debate currently focuses on who will join Temer’s Government, in particular at the Ministry of Finance. As was clearly demonstrated last year, rating agencies are closely watching the country’s debt sustainability and the selection of an effective and highly regarded Minister of Finance could bring some short-term relief.

Overall, we do not think that the impeachment per se is a game changer for Brazil. The Government-to-be is unlikely to bring about any much-needed structural changes for two main reasons: 1. It is unlikely to be strong enough to overcome political resistance and pass the

painful measures necessary to address the current awful economic conditions. 2. Temer was on the side of the Rousseff Government as recently as one month ago.

It’s uncertain how committed to painful reforms the “new” Government will be. We believe that a new democratically elected Government could be a game changer, but we do not see this option on the horizon earlier than the officially fixed date of 2018.

Economic conditions are still dire. Brazil GDP fell by 5.9% YoY in Q4 2015 and is expected to fall by 5.7% in Q1 2016. Domestic economic activity is collapsing while some support is coming from the external side, food and commodity exports specifically. We expect to see some good inflation figures in the short term, opening the door to a possible dovish intervention by Brazil’s central bank. But inflation is likely to decline mainly because of a base effect kicking in.

In conclusion, we are finally seeing some positive signals from EM. However, the next few months will be crucial to see if the early spring will transform into a pleasant summer. Country and security selection will continue to be the name of the game for investing in EM, offering opportunities for active management.