Old Mother Hubbard
Went to the cupboard
To give the poor dog a bone.
When she came there
The cupboard was bare
And so the poor dog had none
The nursery rhyme, while two hundred years old, neatly articulates the conundrum facing emerging markets as we move further into 2021, writes Eurizon SLJ portfolio manager Alan Wilson.
Since the onset of the covid-19 crisis, policymakers have been forced into ever increasing extremes to counterbalance the unprecedented hit to economic activity and financial stability.
The crisis has proved a watershed moment for emerging market central banks; policymakers have crossed the Rubicon by introducing quantitative easing and direct private sector support alongside conventional rate cuts and liquidity injections.
At the same time, the weakening efficacy of monetary policy and the flaring of domestic populist tensions has necessitated aggressive fiscal policy participation, bringing the overall policy setting in line with Modern Monetary Theory.
Looking forward, we believe that enhanced and coordinated stimulus will be required for a protracted period, both to support the nascent economic recovery and to keep borrowing affordable for governments.
With monetary and fiscal policy reaching ever increasing extremes, this begs the question; is the policy cupboard bare?
Vaccine conundrum
The duration and magnitude of policy support is a function of the ongoing disruption from the pandemic.
As such, the discovery of a vaccine, in record time, is both a triumph for scientific community and a welcome breakthrough for developed and emerging economies.
That said, with the largest inoculation programme in history, vaccine supply is highly unlikely to keep pace with demand.
The resulting vaccine shortfall – which is likely to stretch further into 2021/22 – has resulted in a scramble to secure supply lines across different providers/delivery technology; even with regulatory approval yet to be confirmed, total sales stand at 7.1 billion doses, with an additional 2.6 billion doses under negotiation.
Furthermore, developed economies have stolen a march on their emerging counterparts (Figure 1); 3.8 billion doses have been secured by higher income economies, far outstripping supply agreements of lower middle (1.7 billion doses) and upper middle-income economies (829 million doses).
As a result, we believe that developed economies are highly likely to lead the post-covid recovery over the coming quarters.
That said, while emerging markets are likely to play catch-up early this year, there is still optimism for 2021 as a whole (Figure 2).
The budding recovery from the depths of the covid crisis has thus far been facilitated by the V-shaped upswing in both industrial production and goods demand.
We believe that this source of support is likely to continue next year.
Why?
Firstly, infrastructure and housing stimulus expenditure in China is likely to offer support to emerging markets via ongoing demand for commodities and construction machinery.
Guidelines from China’s 14th Five Year Plan –industrialisation via preserving the manufacturing sector’s share of GDP – could further reinforce this trend.
The prospect of supplementary global infrastructure spending, for example in the United States, could underpin this theme.
Secondly, we believe that the early-stage economic recovery is likely to broaden beyond industrial production and goods demand; we expect a concurring recovery in services emerging market vaccination programmes to gather pace over the course of 2021.
Looking forward, while emerging markets wait patiently for vaccination access, enhanced and coordinated stimulus will be required for a protracted period to support the early-stage economic recovery, combat muted inflation pressure and to keep borrowing affordable for governments.
Since the onset of the covid-19 crisis, EM central banks have been forced into ever increasing policy stimulus; total combined rate cuts have reached almost 4000bps over the course of 2020.
Likewise, as the efficacy of monetary policy has weakened and domestic populist forces have flared, we have also seen an ever-increasing role played by fiscal policy (Figure 3); combined stimulus in emerging markets is approaching an eye popping $1.3trn over this year.
With monetary and fiscal policy on track to reach ever increasing extremes, the question remains; is the policy cupboard bare?
From a monetary policy standpoint, we note increasing signs of policy exhaustion in several emerging market central banks which have reached the effective lower bound.
While conventional rate cuts remain a viable option for many central banks, such as Turkey/Mexico/Russia, in a small yet increasing subset such as Brazil/Czech/Poland it isn’t.
It is unlikely that emerging market central banks will enter the unchartered waters of negative interest rate policy given the spectre of destabilising capital flight.
Therefore, we believe that the existing emerging market policy mix – enhanced/coordinated monetary and fiscal stimulus – will continue next year, particularly in the countries that have reached the effective lower bound.
As such, we expect tension between the ongoing requirement for unconventional monetary/fiscal stimulus and the need for consolidation in 2021.
We believe that emerging market economies with deteriorating debt dynamics are likely to come under pressure this year, particularly when many are projected to break the IMF’s 80% Debt/GDP financial stability yardstick.
Both Brazil and South Africa stand out, where the IMF projects Debt/GDP to accelerate towards 100% over the next three years.
As such, we believe that it is fair to conclude that the policy cupboard seems increasingly bare in these cases.
Conversely, fiscal consolidation over the last five years has left Russia in a strong fiscal position, comfortably below the treacherous IMF threshold.
There is no one-size-fits-all answer for emerging markets – we believe it pays to be selective, with cross-country policy capacity divergences a key consideration for 2021.
This article was written for Expert Investor by Alan Wilson, a portfolio manager at Eurizon SLJ.
