EM: Faster, higher, stronger?
There is little change to our growth expectations this quarter for the emerging markets. China performed better than we had forecast in the first half of the year, but this looks to us to be the result of unsustainable stimulus. Higher-than-expected inflation has pushed back our rate cutting cycles in Russia and Brazil. India too looks likely to engage in easing as current central bank governor Raghuram Rajan steps down in September, likely in favour of a more dovish appointee.
Overall we expect stronger growth going into 2017, despite the deceleration seen in China. Much of this comes from a recovery in Russia and Brazil, though India also continues its steady march upwards as reform momentum helps encourage investment.
China: pace to flag after too strong a start
Chinese GDP growth was unchanged in the second quarter of the year, at 6.7% year-on-year. Data shows acceleration coming through the primary and secondary industries, with the tertiary sector slowing marginally. This suggests that growth and stability for now trump the need to reform the economy. We would also note however that this time last year saw an outsize contribution from the services sector thanks to the equity market boom, so some payback was inevitable.
Given the downturn in the data, it may seem an odd time for us to drop our scenario of a Chinese hard landing. In the near term, the state has sufficient resources to contain any flare ups in the economy or financial system. We would be less sanguine over the next three years.
Currency policy retains a clear weakening bias. However, capital outflows seem to have reduced and markets appear unperturbed by the ongoing weakness of the renminbi. We expect further gradual depreciation over the foreseeable horizon.
Brazil: leaving the starting blocks
Data suggests a recovery of sorts is underway in Brazil. First quarter GDP growth improved on the back of government spending, net exports, and investment. This should persist for most of the third quarter.
Business confidence surveys show the revival in sentiment has extended, reaching levels last seen in early 2014. We could conclude that the formation of a new government has returned investment confidence to the economy.
In terms of monetary policy, inflation has proven stickier than expected, making a rate cut difficult to justify. Our own inflation forecast has been revised up, with 75bps of cuts this year at most.
Russia: still fighting to compete
The Russian economy contracted 0.6% year-on-year in the second quarter of 2016, in line with our forecast but a better performance than expected by the market. The number is also an improvement on the first quarter.
Industrial production has expanded throughout the quarter in year-on-year terms as it recovers from low levels. This has likely been helped in part by a weaker currency. Retail sales are still anaemic, with the consumer facing headwinds of high unemployment, so consumption is unlikely to have been particularly strong.
The outlook from here remains one of gradual recovery. We expect positive year-on-year growth by Q4, and a positive overall growth performance in 2017. The economy is also going to face fiscal headwinds given the balanced budget goal. The planned rate of reduction has been a cut to the deficit of 1% of GDP each year, with presidential elections in early 2018 likely weighing against more aggressive consolidation.
India: another hurdle finally cleared
After a decade of waiting, India has finally passed a bill clearing the way for the implementation of a unified Goods and Services Tax (GST). By unifying tax rates across goods and services, removing taxes on the movement of goods and shifting the basis of taxation to consumption rather than production, the GST should remove a wide range of distortions and inefficiencies, benefiting investment, growth, and tax revenues in the medium to long run.
A boost to investment sentiment is sorely needed in India, given the performance of the private sector in this regard. According to HSBC, private sector investment contracted 1.4% in the 2016 fiscal year. Accounting for 75% of investment demand, this has a significant impact on headline investment growth despite strong public spending. Credit growth has also been weak, and may explain some of the softness. A planned bank recapitalisation and clean up should shore up credit support from 2017. Budgeted public capital expenditure also remains strong, and can have a beneficial crowding in effect on private investment.
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