Press release

Investors retreat from rapid-growth markets but medium-term outlook is positive

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LONDON, 11 JULY 2013: A weak recovery in trade and investment across rapid-growth markets will keep the outlook in 2013 subdued, according to EY’s quarterly Rapid-growth markets forecast (RGMF) out today.

Recent weeks have witnessed a reversal of portfolio flows from developed markets to rapid-growth markets (RGMs) as investors reassess risks relative to prospects in advanced economies. Concerns have been raised over whether returns on new investments are suffering and the pace of economic reform is slowing. Most RGM currencies have also experienced a decline in value over the past few weeks.

These stumbling blocks have dented near-term growth prospects in RGMs. As a result, the forecast predicts a slower recovery in RGMs, with growth of 4.6% expected in 2013, similar to the expansion in 2012. However, the main drivers of strong growth in emerging markets remain intact. In the medium-term, RGMs will grow by close to 6% in 2015-16, much faster than the advanced economies.

Despite overall growth being lower than expected fortunes are mixed among the RGMs and some are still likely to prosper. Although slower than expected growth in China has impacted certain Asian markets, others, like Indonesia and Vietnam, continue to forge ahead, while Chile and Colombia are expected to do well in Latin America. However, the BRICS and countries in Central and Eastern Europe are expected to experience more moderate growth as they continue to be hit hard by the recession across the Eurozone.

Rajiv Memani, Chair of the Emerging Markets Committee at EY comments, “Despite a period of increasing confidence in the prospects for the global economy, it seems that this era of turbulence and unpredictability is not yet behind us. In the short-term we believe growth prospects for the rapid-growth markets will be subdued however, there is better news for the medium-term where growth will be driven by expanding middle classes and further development of trade flows between RGMs.”

Rain Newton-Smith, senior economic adviser to the EY Rapid-Growth Markets Forecast says,

“Perhaps the biggest surprise of the first half of 2013 has been the weaker-than-expected recovery in trade and investment, and its impact across the RGMs. Caution is the watchword. Growth this year will be disappointing, and we think the real uptick will be deferred until 2014.”

Weak currencies lead to increasing competitiveness
Newton-Smith comments, “Sustained currency weakness may indicate higher inflation (from higher import prices, as in the case of India), which could hold back activity. But it also makes exports more competitive and could act as a spur to world trade growth.”

Brazil’s manufacturing sector, for example, has been struggling for several years with competitiveness issues caused in part by an overvalued exchange rate. However, the recent rapid depreciation of the Brazilian real could help to make the country more competitive and spur innovation in its manufacturing sector.

The manufacturing sector in Mexico, on the other hand, is much more competitive. As a result, it has rapidly expanded its exports of higher-value-added goods, such as cars. Nonetheless, having weathered the global downturn well in 2011 and 2012, more recently Mexico has been affected by the more subdued world trade flows.

The Indian economy remains subdued, and the fragile performance from the manufacturing sector looks set to continue in the coming months. However, the cut in rates that has happened recently should help activity to build more momentum in H2 2013, enabling a strong recovery with the economy set to grow by around 7.5% in 2015-16.

Slower-than-expected growth in China impacts Asian RGMs
Investment orders indicators in the major economies in recent months have been relatively soft and world trade growth has been subdued. While demand in some of the advanced economies has held up reasonably well, domestic demand in some of the key RGMs has faltered. Trade flows, particularly in Asia, have been weaker than expected in Q2 2013.

If the slowdown in China, in particular, were to be more severe than is currently expected it would have significant implications for other countries in Asia and worldwide – including countries sensitive to commodity prices that Chinese demand has supported. RGMF has lowered its GDP growth forecast for China to 7.5% this year, down from the 8% expected in the previous forecast. However, the pattern of growth is more balanced, with consumption contributing over half of the overall economic growth in China in Q1 2013. This should benefit countries such as Vietnam, as it could supply the growing consumer demand.

If Chinese demand wanes significantly this could well impact many economies, including Brazil and India where there is a danger that the pace of structural reform could slow.

Low interest rates providing less of a boost to domestic demand
Low interest rates and strong credit growth are providing less of a boost to domestic demand in RGMs, with some concerns over whether the returns to new investments are falling and the pace of reform is slowing.

Investment growth in emerging Europe, for instance, has been subdued over the past few quarters. RGMF now expects Russia to grow by less than 3% this year, due to the heightened concerns about the recovery of investment spending.

In Poland the economy held up well relative to the Czech Republic in 2011 and H1 2012. RGMF expects GDP in the Czech Republic to fall by around 1% this year, and there are promising signs that consumer spending and investment are beginning to improve.

Newton-Smith comments, “Loose monetary conditions and good access to credit should support growth in most RGMs as the year progresses. But with business and consumer confidence still relatively weak, the recovery in RGMs will be more gradual.”

Foreign direct investment will help to sustain growth
During 2012, for the first time, FDI into emerging economies exceeded flows into developed markets. FDI flows are building between southern countries.

Strong FDI flows, easier access to credit  and the growth of entrepreneurship is fuelling the development of new businesses and sectors within RGMs and helping to diversify economies. Africa, for example, is attracting more FDI, particularly from Asia, and not just to natural resources. The service industry is developing fast in the continent, with finance, real estate and insurance representing more than 20% of South Africa’s GDP.

Looking ahead
Memani concludes, “Strong growth prospects and improved risk management have led to increased demand for investment into RGMs over the past decade. At the same time, quantitative easing in the US, UK and Japan has increased the supply of liquidity. These flows have helped to lower interest rates in RGMs and spurred domestic investment.

A rising middle class, particularly in Asia, and the further development of trade flows between RGMs such as Turkey and the Middle East as domestic demand expands, will help to underpin medium-term growth in emerging markets.” 

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