Emerging markets forecast update: oil on troubled waters
We have made small changes to our economic growth forecasts in emerging markets this quarter. The most notable forecast changes have been large downward revisions to our inflation estimates, owing to a more favourable crude oil price outlook and an improvement in domestic dynamics.
This sees substantial downward revisions to the inflation outlook for all BRIC economies bar Russia, for whom cheaper oil means a weaker currency and hence more imported inflation.
BRIC GDP growth forecast summary
Source: Thomson Reuters DataStream, Schroders Economics Group. 25 February 2019. Previous forecast from November 2018. The forecasts included should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change.
China: trade truce warrants some mild optimism
Our previous forecast for China assumed that the trade war with the US would escalate further and extend to all Chinese trade with the US. The revised base case sees tariffs held at current levels and a truce in trade, which improves the outlook both for trade and investment in China. This drives our small upgrades to Chinese growth for this year and next.
While this is a positive development, we would emphasise that the economy is still set for an ongoing slowdown, trade war or no trade war, with actual underlying activity to exhibit more weakness than headline GDP.
For the time being, stimulus announcements have not been of sufficient magnitude to materially alter our view. The sharp increase in January credit data may turn out to simply have brought forward activity from later in the year.
The National Congress was held shortly after we completed our forecast updates, but this did not unveil a big increase to overall infrastructure spend. A new growth target of 6 to 6.5% was announced at the congress, signalling that policy levers will likely be used to keep growth above 6% this year, but an aggressive push is not on the cards.
We remain of the view that policy is constrained and so we will not see explosive stimulus as in previous downturns. We anticipate that the central bank will continue to ease monetary policy, but with currency stability now on the table in trade talks with the US, the scope for a weaker renminbi (the corollary of monetary easing) is much less.
Brazil: Bolsonaro boost still expected but political risks have risen
President Bolsonaro is now in office, and economic confidence is high, in a promising sign for economic activity, as highlighted in the chart below. Investors will take further courage from the administration's proposal for pension reform, which was more ambitious than many had expected. Economy Minister Guedes is clearly being given a free rein here, and that bodes well.
Brazil's investment revival should continue
Unfortunately for the minister, his hard work risks being undermined by the scandals already surfacing around Bolsonaro's government. After just 48 days, Secretary General Bebianno, accused of siphoning money from an electoral fund during last year's campaign, has been fired. The president's family have also faced allegations.
This is all rather inconvenient for the 'anti-corruption' candidate, and risks undoing the coalition building needed to pass a contentious pension reform. Civil servants, who see some of the largest changes, are already preparing to resist the reform. We see considerable risk that the reforms will face delay and ultimately greater dilution than the market may be expecting.
However, this was already our base case, and does not impact our outlook for growth or inflation. We have revised slightly lower our growth forecast for 2019, as 2018 was a little softer than expected in the final quarter, with growth slipping to 1.1% year-on-year.
More positively, inflation is also revised down thanks to cheaper oil and consistently low headline inflation prints, which leads us to forecast a more dovish central bank. We now expect no interest rate hikes this year, from an expectation for one 50bp rise previously. This provides some additional support to growth in 2020.
India: inflation trajectory more favourable but elections key to reform agenda
Having downgraded India in our last forecast update, we see no reason to make significant changes to our growth outlook this month. That said, there is potential upside risk to our forecast: credit growth is picking up, albeit very gradually, and the central bank has taken a definite dovish turn under its new governor, again provoking controversy.
Where we do make a change is to the inflation outlook. India is especially sensitive to global food and oil price moves, and the latter in particular have been very favourable since our last update. Domestic food inflation has also continued to surprise to the downside, suppressing headline inflation. However, core inflation, excluding food and energy prices which are typically more volatile, has remained high. Given the newly dovish bias of the central bank we expect another interest rate cut this year, most likely before the general elections in April and May.
The outcome of these elections remains uncertain; our low conviction base case is for a Modi victory but with a reduced majority, which threatens the reform agenda. At this point, marquee reforms seem highly unlikely, and India may have to settle for gradual change rather than revolution.
Geopolitically, while India is thankfully insulated from the US-China trade war, regional tensions with Pakistan have flared once again. India's bombing of Pakistani territory, targeting alleged militants in retaliation for an attack on Indian soldiers in early February, has put some pressure on Indian assets; should matters escalate there is an obvious downside risk to growth.
Russia: oil will hit the currency but not growth
Russia is an obvious loser from lower oil prices, but happily for the growth outlook, planned spending is budgeted for on the assumption of a ‘break even’ Brent oil price of $43 in 2019 – it was close to $65 per barrel as at 8 March 2019.
The impact will be felt more on the currency side, resulting in a higher inflation forecast for Russia and necessitating a higher policy rate from the central bank. We do not foresee a huge increase in hawkishness, however, as the correlation between oil and the rouble is weaker than it was. This is partly due to the central bank’s efforts to help rebuild international reserves in times of higher oil prices. When oil moves above a certain price it has been buying foreign currency and vice versa, with the effect of smoothing fluctuations in the rouble and tempering the impact on inflation. Further, the VAT increase at the start of 2019 has proved less inflationary than feared.
The VAT increase is part of the latest economic plan as laid out in the new May decree. The tax hike lays the ground for increased investment spending, and a pick up in growth in 2020. There is also an upside risk to growth from the trade truce, which should boost global activity and potentially oil prices as a result. To the downside, the threat of sanctions has still not fully receded.
Craig Botham is Emerging Markets Economist at Schroders. Read more of our Emerging Market insights.
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