Economic Outlook Emerging Markets Q4 2023: The Lagged Effects Of Monetary Policy Will Test Resilience (2024)

We continue to expect most emerging markets (EMs) to grow below trend in the remainder of 2023 and into 2024. Second quarter GDP reports were, in many cases, stronger than expected, though largely owing to factors we expect to be transitory.

Domestic demand is benefiting from improving labor dynamics, fiscal support, and excess private sector savings since the pandemic. These factors are cushioning the impact of tight monetary policy. But as these dynamics unwind in the coming quarters, we expect high interest rates to have a more noticeable impact on activity.

Table 1

Unfavorable Global Backdrop Will Keep Export Growth Subdued In Coming Quarters

Since our previous quarterly update, the probability of a U.S. recession starting within the next 12 months has moderated but remains elevated. This has important implications for several EMs, especially those in Latin America.

Mexico, in particular has benefited from continued U.S. consumer strength, but we expect demand to soften in the coming quarters. The challenges facing the U.S. consumer will be more apparent in the coming quarters, namely the depletion of excess household savings, the resumption of student loan repayments in October, and continued high interest rates (see "Economic Outlook U.S. Q4 2023: Slowdown Delayed, Not Averted," published Sept. 25, 2023).

We expect eurozone weakness to continue spilling over to several EMs in the coming quarters. Hungary and Poland, in particular, saw real GDP decline in the second quarter, characterized by a contraction in exports. Manufacturing production has also deteriorated in these countries (see chart 2), which will keep GDP growth subdued into 2024 (see "Economic Outlook Eurozone Q4 2023: Slower Growth, Faster Tightening," published Sept. 25, 2023).

We lowered our growth forecast for China to 4.8% in 2023 and 4.4% in 2024, due to persistent weakness in the property sector and lower consumer confidence.We believe policymakers are unlikely to use significant stimulus to support the economy and will instead prioritize financial stability (see "Economic Outlook Asia-Pacific Q4 2023: Resilient Growth Amid China Slowdown," published Sept. 24, 2023).

Emerging Asia is most exposed to consumption in China, but China's slowdown is centered around domestic activity, which will mitigate some of the impact. Several economies in the region--such as Thailand, Vietnam, the Philippines, and Malaysia--have been benefiting from the gradual revival of outbound Chinese tourism, which could fall given weaker consumer confidence in China.

Higher Energy Prices Could Slow Disinflation, But Central Banks Are Likely To Continue Cutting Rates

Inflation continues to slow across most EMs, although the path will likely be bumpier in the coming quarters. Median consumer price inflation reached 5.3% year on year in August, after peaking at 8.2% year on year last August. However, renewed upward pressure in energy prices is likely to slow the pace of disinflation in the coming months.

Furthermore, core inflation, which is running above headline inflation in about half of the EMs we cover, will likely remain high early next year if wage increases are large in response to prolonged high inflation.

We expect more rate cuts in the coming months, but central banks will take it slow. The central banks of Chile, Brazil, Poland, and Peru started to reduce their benchmark policy rates in the third quarter. China and Hungary have also been easing policy by adjusting several of their monetary instruments.

We expect most major EM central banks that haven't yet lowered interest rates to start doing so in 2024. However, given the uncertain trajectory of inflation and the pace of interest rate normalization by the major central banks around the globe, we expect EM central banks to cut rates gradually.

Structurally high interest rates, in the absence of structurally higher growth expectations, will constrain investment growth. As of the first half of 2023, fixed investment as a share of GDP in the median EM is 1 percentage point lower than it was before the pandemic. A material improvement in investment growth will be hard to justify amid a higher average cost of capital and interest rate burden--as interest rates are likely to remain higher than normal for some time--and without higher average expected returns (growth).

That said, high real interest rates mean most EMs have more space than usual to ease monetary policy in the next economic downturn, especially if the U.S. Federal Reserve also lowers interest rates. The median real interest rate across the major EMs that we cover is about 125 basis points above its 10-year average.

Forecast Update

The growth narrative for EMs remains generally unchanged from our June publication. We continue to expect domestic demand to moderate across most EM economies while softening growth in key trading partners will keep exports subdued. This implies below-trend real GDP growth in most EMs over the next year.

We did make several forecast changes, due in most cases to second-quarter GDP surprises or idiosyncratic factors (see table 2). We made the largest downward revisions to real GDP growth in Argentina (high inflation, political uncertainty), Peru (social unrest, impact of El Niño), and Vietnam (manufacturing sector weakness). We made the largest upward GDP growth revisions to Brazil (strong agricultural output, ongoing fiscal stimulus), Mexico (manufacturing sector outperformance, domestic demand resilience), and Turkiye (domestic demand resilience).

Table 2

Regional Summaries

Latin America

We have increased our 2023 real GDP growth forecast for the region to 1.6%, from 1.1%, but have lowered our 2024 projection to 1.2% (from 1.5% previously). The main upward growth revisions in Latin America are for Brazil and Mexico.

We now expect the Brazilian economy to expand 2.9% this year, driven by strong agricultural production and the continued impact of fiscal stimulus measures on household spending. We expect growth to slow to 1.2% in 2024 as those factors become less supportive.

In Mexico, we now see 3.0% growth this year (from 1.8% previously), driven by strong consumption (helped by robust remittances), resilient manufacturing output, and a sharp uptick in public nonresidential investment. The strength of Mexico's manufacturing sector has been driven by robust U.S. demand, and, to a lesser extent, nearshoring-related activity (see "For Mexico, Nearshoring's Potential Benefits--And Obstacles--Are Significant," published Feb. 1, 2023). We expect growth in Mexico to cool to 1.7% in 2024, mainly on weaker U.S. demand.

We lowered our growth profiles for Argentina, Peru, Colombia, and Chile. In those countries, GDP growth contracted in the second quarter relative to the first quarter. The outlook for Argentina, in particular, is highly uncertain given the upcoming presidential election and its implications for economic policy, but we now expect GDP to decline in 2023 and 2024.

Emerging EMEA

We lowered our GDP growth projections for Central and Eastern Europe (CEE) economies after most saw GDP contract in the second quarter and because we expect continued weakness in exports to advanced European economies. This was particularly pronounced in Hungary and Poland, for which we lowered our real GDP growth expectations for this year and next.

Meanwhile, upside surprises to second-quarter GDP growth in Saudi Arabia, South Africa, and Turkiye prompted us to increase our 2023 growth projections for those countries. In Saudi Arabia, we expect a sharp GDP deceleration in the second half of the year considering ongoing oil production cuts. Inflation and GDP forecasts for South Africa remain subject to significant risks, especially the further risk of load-shedding, although recently we have seen some improvement. In Turkiye, the current resilience of domestic demand will start to fade in the coming quarters, with monetary conditions rapidly tightening as the central bank shifts to more orthodox policy.

Emerging Asia

We lowered our 2023 GDP growth forecast for Emerging Asia by 20 basis points to 4.5%, mainly because of slower global goods trade. We kept our 2024 GDP growth forecast unchanged at 5.0%. Southeast Asian economies that are more tied to the global manufacturing cycle, such as Thailand, Malaysia, and Vietnam, have underperformed.

Domestic demand has prevented a sharper slowdown in growth in most Emerging Asian economies, helped by improving labor markets. Services activity has been resilient even as the re-opening momentum fades. Continued tight monetary policy settings and fiscal consolidation will contribute to slower demand growth next year.

Inflation rates did not rise as sharply in the region compared with the rest of the world. Part of the reason is that several economies regulate energy prices, which prevented a spike in energy price inflation. Core inflation rose only gradually, as inflation expectations remained anchored. We expect central banks to remain on hold through the rest of the year and cut interest rates in 2024.

Risks To Baseline Growth

We believe the risk of disinflation being interrupted by the recent increase in energy prices, or the potential impact of El Niño on food prices, is high. This would renew upward pressure on interest rates and accelerate the expected slowing of domestic demand. It could also worsen the current account balances of net importers of energy, increasing the sensitivity of capital flows to interest rates in those economies.

The risk that the U.S. economy goes from our current baseline of a "soft landing" to an outright recession is elevated. This would have significant negative implications for the global economy, with an outsize effect on EMs that share strong economic ties with the U.S., such as several Latin American countries.

Alternatively, a stronger-than-expected U.S. economy, while a generally positive development for EMs, could in the short term push interest rates and the U.S. dollar higher (with negative implications for EM inflation through foreign exchange pass-through effects).

Downside risks around the trajectory of the Chinese economy have risen since the last quarter, but most of the spillover effects seem to be concentrated in EM Asian economies at the moment.

Finally, in several EMs, a heavy and divisive electoral agenda this year and next could take a toll on investment due to lack of policy visibility.

Appendix

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Related Research

• Economic Outlook U.S. Q4 2023: Slowdown Delayed, Not Averted, Sept. 25, 2023
• Economic Outlook Eurozone Q4 2023: Slower Growth, Faster Tightening, Sept. 25, 2023
• Economic Outlook Asia-Pacific Q4 2023: Resilient Growth Amid China Slowdown, Sept. 24, 2023

The views expressed here are the independent opinions of S&P Global Ratings' economics group, which is separate from, but provides forecasts and other input to, S&P Global Ratings' analysts. The economic views herein may be incorporated into S&P Global Ratings' credit ratings; however, credit ratings are determined and assigned by ratings committees, exercising analytical judgment in accordance with S&P Global Ratings' publicly available methodologies.

This report does not constitute a rating action.