War, inflation add worries to emerging market woes

“EMs were already lagging developed economies in gross domestic product growth post covid because the latter got much higher stimulus to tackle the pandemic,” said Madhavi Arora, lead economist at Emkay Global Financial Services. “Now, EMs are more dependent on importing food and energy-related items from developed economies. So, whenever there is a commodity upcycle, the way we are witnessing now, most Asian economies would see a negative impact on their macros,” she said. So, Arora cautions that trade growth for EMs in the remainder of the year would be lower than expected earlier.

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As such, the impact on EMs will vary based on each country’s exposure to the warring nations. However, business momentum is fading. The widely followed purchasing managers’ index (PMI) shows a divergence in business activity between EMs and DMs.

The composite emerging market output index fell to 46.8 in March from 51.3 in the previous month. A reading above 50 indicates expansion. The composite output index is a weighted average of the manufacturing and services business activity indices. In comparison, the composite developed market output index rose to 56 in March from 54.7 in the previous month.

“High energy and imported food prices will lift inflation in the more developed and rich EMs. For poor EMs that have no commodity base to fall back on, the picture is more challenging, so they face much higher inflation, balance of payments, and debt servicing problems,” said Jeffrey Halley, senior market analyst, Asia Pacific, at broking house Oanda. Further, energy and food shortages are causing social unrest in some countries.

Simply put, the economic growth gap between EMs and developed markets is set to get wider and corporate earnings in EMs are unlikely to remain immune.

The overall 2021 earnings season for the Asia ex-Japan pack has disappointed market expectations, analysts at Nomura Singapore Ltd pointed out. They caution of downside risk to 2022 consensus estimates amid slowing global growth, a peaking semiconductor cycle, which is a large contributor to Asian earnings, and elevated commodity prices. Earnings growth estimates for 2022/2023 are 10% each for MSCI Asia ex-Japan, and are below consensus estimates, said the Nomura report on 10 April. It has also trimmed its base case 2022 forecast for MSCI Asia ex-Japan index by around 11% to 820 versus 925 previously. So far this year, the MSCI Asia ex-Japan index has declined by 9.44% versus the 6.79% and 7.07% drops in MSCI World Index and MSCI DM Index, respectively.

Meanwhile, in the case of India, some macro risks that investors need to watch out for are rising import bill weighing on the Indian rupee, slower-than-anticipated growth in rural consumption, and faster and larger interest rate hikes by the Reserve Bank of India (RBI). At its latest meeting, RBI kept the repo rate on hold at 4%. However, it said its focus has shifted to inflation from growth.

“Though the terms of trade may improve for Indian agriculture due to the disruption caused by the Russia-Ukraine conflict in the global agricultural chain, on a real basis, rural wages growth is negative,” Arora said. Elevated inflation in non-food related items is higher than growth in wages for the rural population, she said.