Declining growth trend in rapid-growth markets, structural reforms needed to realise potential

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A weak outlook for domestic demand in rapid-growth markets (RGMs), and subsequent weaker trade flows are expected to  drive their GDP growth down next year according to EY’s quarterly Rapid-growth markets forecast (RGMF) (pdf, 2.3mb) out today.

A flight from risk has driven sharp falls in many RGM currencies, sharp rises in bond yields and an underperformance of equities. RGMF now expects growth next year to be 4.7% considerably lower than the 5.7% that was predicted in the July forecast. The move is driven by downward revisions to Latin America and Asia.

Rain Newton-Smith, senior economic adviser to the EY Rapid-Growth Markets Forecast says, “Our forecast for the rapid-growth markets has been revised down significantly since July. Despite steady growth over the past few years the RGMs were hit hard by external pressures including the prospect of tapering of quantitative easing in the US and turmoil in the financial markets. Weaker domestic demand and concerns over structural weaknesses will also dampen growth.”

Rajiv Memani, Chair of the Emerging Markets Committee at EY comments, “Governments in emerging markets must introduce structural reforms and ease regulatory restrictions to restore investor confidence. There is an opportunity now to make progress as the U.S has recently delayed its quantitative easing program to next year and there is also increased buoyancy in the developed markets, which is resulting in capital flows into the rapid-growth markets. It is  critical for the rapid-growth markets to take full advantage of the depreciation in their currencies for benefit of their export-oriented sectors and become more competitive with required shifts in policy.”  

Implications for South Africa

The EY RGMF provides some interesting insights from a South African perspective. The comparative data on 25 markets shows that South Africa is certainly not alone in terms of the risks and challenges its economy currently faces.

Michael Lalor, Africa Business Center Leader at EY comments, “The vulnerability heatmap we have developed, which compares economic risks across all 25 markets, reveals the areas we already know are problematic for South Africa - foremost among these being the current account deficit, relatively weak import cover and currency devaluation. In other areas though, we are relatively well positioned; in terms of government debt levels, for example, we are ranked somewhere in the middle relative to other markets”.

Overall, South Africa ranks in the moderate to higher risk category on the vulnerability heatmap, similar to Brazil, Poland, and the Czech Republic, and ahead of the likes of India, Indonesia, Egypt, Ghana, Argentina, Vietnam and Turkey.

Lalor says, “The facts indicate that, while there are serious risks that need to be addressed, South Africa is not facing an economic crisis. Furthermore, our Finance cluster has an exceptional track record stretching back over the past two decades. This certainly provides confidence in the ability of our current Finance Minister and his team to effectively manage the South African economy over the next few years".

“The key challenge looking forward for the South African government as a whole though will be to make the shift to a consistent focus on implementing the National Development Plan (NDP). The emphasis that was given by Minister Gordhan in his Medium Term Budget Policy Statement to the implementation of the NDP is therefore very encouraging. The extent to which government is able to make this shift successfully will determine which of the diverging RGM growth paths South Africa follows", concludes Lalor.

Currency falls adding to RGM challenges

India, Indonesia, Turkey and Brazil are struggling with sharp currency depreciation as well as having to tighten monetary policy despite weak growth as a result of external pressures. These countries as well as Argentina and Egypt all show elements of vulnerability to currency and other financial crises according to the RGMF heatmap of vulnerability for RGMs which ranks each country under seven indicators of risk.
Rain comments, “The common challenges running through these countries are relatively high current account deficits, levels of government debt and inflation. Economic reforms will be necessary to help ensure sustainable growth going forward.”

By contrast, countries in the Middle East such as Saudi Arabia, Qatar and the UAE have a more robust with low levels of government and external debt. The RGMF heatmap also suggests that the sharp falls in Columbia’s currency many not be justified on the basis of fundamentals. It has low inflation and relatively moderate levels of government and external debt.

High inflation and borrowing weigh on investment and consumption

While some RGM currency and equity markets have started to recover, the impact of falls in many of the financial markets will be felt for some time. The fall in currencies and rise in risk premiums in the rapidly growing economies have added to the challenges for RGMs, especially as weaker currencies add to inflationary pressures. Higher inflation is a particular issue for Argentina and Ghana, where the forecast predicts CPI inflation above 10% for the whole of this year.

The increases in bond yields and policy rates have led to much higher borrowing costs (in domestic and foreign currencies) – for RGM governments, businesses and households.
Rain comments, “The higher cost of borrowing will translate into lower investment. Consumption will be hit by falls in financial wealth, the greater cost of consumer credit and higher prices for imported goods, particularly commodities. These challenges will all lead to much weaker than expected growth in the RGMs next year.”

Prospects for China are brighter than for other BRICs

While the outlook for the majority of RGMs is subdued, prospects for China are looking bright. The lower rate of growth in China is part of a deliberate effort by government and central bank to curb the rapid growth in credit and set the economy on a more sustainable path. Financial sector reform and the development of the recently opened Shanghai free-trade zone are also key to spurring trade and innovation in China.

However, while the outlook for China is relatively positive there are significant challenges for the other BRIC nations. Brazil remains restricted by a low growth and high inflation dynamic, with inflation expected to be above 6% this year and growth well below 3%. Interest rates are also predicted to expected to rise further which could hamper the investment growth.

RGMF forecasts that growth in Russia this year will be 1.4% significantly down from 2.7% envisaged in the July forecast. Although longer term GDP growth will rebound to close to 4% there remains concern about demographic profile and the limited pace of policy reform in certain areas.

GDP growth in India has dropped to 5% in 2012 compared to almost 9% in the years from 2005-10. Both inflation and the current account deficit remain  high. Although announcements have been made to improve India’s efficiency in recent months however; to further improve India’s business environment greater infrastructure investment is required.

More policies required to boost medium-term growth

The forecast highlights that in too many of the RGMs policy focus has been too short-term in dealing with currency flows rather than looking towards medium-term growth. In addition, with some of the major RGMs facing elections over the next year it has been harder to build political consensus for economic reforms.

Rain comments, “Over the next three years, we will see more divergences in growth prospects between those RGMs that are willing and able to implement growth-boosting economic reforms and those that are not.”

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Following on from EY’s successful integration in 2008 of 87 countries into one area from across Europe, Middle East, India and Africa (EMEIA), the firm has launched its Africa Business Center™ (ABC), which aims to enhance the effective and efficient links between its geographic reach and areas of expertise. The firm enjoys representation in 33 countries across Africa.

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