A challenging time for emerging markets
01 July 2020 | Markets and economy
Commentary by Jonathan Lemco, Vanguard senior investment strategist
The COVID-19 pandemic presents emerging markets with a colossal challenge. This challenge is not of their own making, and the way out won't be easy. The International Monetary Fund (IMF) said as much in late June, lowering its forecast for growth in emerging and developing economies for both 2020 and 2021, even as it raised its 2021 forecast for advanced economies.
Of course, individual emerging markets are more different than they are alike, and the pace and trajectory of recovery are likely to vary, perhaps significantly, from region to region and country to country. The progression of COVID-19, more than anything else, will dictate the terms.
But all is not lost for emerging markets, or for patient investors who embrace the greater risk/reward trade-offs that these markets can provide.
A disease-progression story first
Any economic forecast these days is fraught with uncertainty, dependent on the degree to which the pandemic spreads and countries curtail activity to keep it from doing so. The IMF's especially pessimistic near-term view for Latin America and the Caribbean is telling, and reflects the disease's spread there.
As recently as April, the IMF had foreseen the region's economy contracting by –5.2% in 2020. In its June forecast, the IMF sees the region contracting by –9.4%. That's a difference of more than 4 percentage points, compared with a reduction of less than 2 percentage points in the outlook for all other emerging and developing regions—and for advanced economies—in the same time frame.
2020 and 2021 emerging markets growth outlooks
Note: Numbers reflect full-year GDP growth or contraction percentage compared with the previous year.
Sources: Vanguard, using data as of June 24, 2020, from the International Monetary Fund.
Brazil, Latin America's largest economy, trails only the United States in confirmed cases, with more than 1.3 million, and deaths, with more than 58,000. Mexico, the region's second-largest economy, is second among emerging-market nations in COVID-19 deaths—ahead of India, Russia, and China. Peru and Chile rank in the top ten among confirmed cases globally.1
So much about virus progression and economic recovery depends on the difficult decisions governments make. Early containment measures in many countries in Asia, with cultures accustomed to compliance, appear to be paying off in reduced disease incidence.
Beyond efforts to contain the virus, policy-makers in most of the world's largest economies adopted a “whatever it takes” fiscal approach to prop up vulnerable businesses and individuals. Central banks' liquidity provisions helped stabilize financial markets. Where emerging markets lack the capacity, if not the desire, to respond at a similar scale, they benefit from the spillover effects of functioning markets.
In fact, portfolio flows to emerging markets that had collapsed in recent months have begun to return. New bond issues are increasingly being met with more demand than there is supply, an indication that international investors are hungrily chasing yield. They acknowledge that emerging economies face serious challenges but are nonetheless attractive when the best-yielding developed markets—the United States, Canada, and Australia—are barely positive and most others have negative yields.
Many emerging markets depend on commodities exports, particularly oil, and would welcome a rebound in prices. Oil has bounced back in the last two months from prices that had briefly turned negative when broad virus-induced market disruptions were at their greatest. But they're not back to where emerging markets need them to be amid diminished demand and a supply dispute between Russia and Saudi Arabia that has subsided but not disappeared.
Another challenge for emerging markets—the U.S.-China trade dispute—predates the coronavirus. Some emerging markets, such as Vietnam, Indonesia, and Mexico, may benefit as supply chains are reconfigured. But the lack of a stable economic relationship between the world's two largest economies carries widespread lost-opportunity costs.
Implications for investors
In the years since the 1997–1998 Asian financial crisis and Russia's 1998 debt default punished them in currency and other financial markets, many emerging-market countries have learned some valuable lessons. They've acknowledged the economic hazards of corruption, patronage, and unconstrained infrastructure development, and embraced the importance of low debt loads, sufficient reserves, adequate growth, low inflation, flexible exchange rates, and political stability. Some have done better than others.
The pandemic aside, the attributes that have attracted investors to emerging markets, such as their growth potential amid favorable demographics, remain intact.
To the extent investors believe that an active approach is best-positioned to capitalize on the differences within emerging markets, we espouse low-cost active as a way to remove headwinds. Whether investors choose actively managed or index funds, Vanguard remains steadfast in our belief in global diversification, including a portion of portfolios in emerging markets, and investing for the long term.
1Johns Hopkins Coronavirus Resource Center as of June 30, 2020.
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