Favorable demographics and nascent vaccine rollouts appear set to curtail the COVID-19 virus ravaging many emerging markets (EM), paving the way for sharply accelerating economic growth in the second half of this year and a wind-down of this global human tragedy. Emerging markets on average have younger, less vulnerable populations, with just 7.4% age 65 and older, compared with 18.4% in developed markets (DM)*. In many countries, these younger populations have already been infected at high rates, creating a natural immunity – estimated at over 50% in many Latin American countries – which serves as a bridge of sorts across a period of belated vaccine rollouts, lowering the risk of contagion to the most vulnerable segment of society.
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Current vaccination campaigns appear on track to achieve 60% population coverage in the third quarter in Central Europe and Chile, followed by a much larger set of EMs in the fourth quarter (China, Brazil, Mexico, Korea and Malaysia). But even where 60% thresholds may not be reached until the first half of 2022 in the likes of Turkey, South Africa, India and the Andean region of Latin America, young populations with higher rates of natural immunity should alleviate the need for persistent or stringent lockdowns. Combining estimates of natural immunity with vaccination forecasts suggests at least 70% immunity rates by the fourth quarter of 2021 for the vast majority of our investable EM universe.
External factors should support EM Investments…
As an expected wave of re-openings sweeps the developing world, a serendipitous set of external dynamics could fuel the post-pandemic recovery in the EM asset class. A broad index of commodity prices (Commodity Research Bureau) has returned to levels not seen since mid-2015, following a 68% yearly rebound – a potential key economic driver for the many emerging markets that rely on commodity exports. Also, real short-term U.S. interest rates have recently fallen to 50-year lows, a situation likely to support EM investments by fueling capital flows to the developing world as investors search for yield.
…although tourist-dependent nations may lag economic recovery
Not all EM economies will recover at a similar pace, however. For now, we believe tourism will be the last sector to normalize, remaining a damper on growth in a non-negligible subset of emerging markets – a drag that appears well priced into markets such as Thailand, Turkey and the Dominican Republic.
But even here, regional differences will be important. Turkey, the Dominican Republic, and Central Europe are set to benefit from proximity to developed economies with high vaccination rates, while Southeast Asia looks set to lag as vaccination progress in their two main sources of regional tourism – China and Japan – is slow.
Headline risks may overstate actual risks, presenting opportunities…
As always, there are risks and uncertainties to our forecasts, which our global team monitors closely. But we believe these risks aren’t as severe as headlines would suggest and, in fact, are somewhat transitory.
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China is withdrawing stimulus. Through a combination of strict lockdowns and strong credit stimulus, China was first to normalize growth after the initial virus outbreak last year. Since then, China has begun to withdraw stimulus, even amid slow vaccination progress across North Asia, heightening risk to economic growth should virus case rates rise, particularly in light of this region’s older population. Nonetheless, in that event, we believe these economies have plenty of fiscal space to cushion such shocks.
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Social unrest could stir as stimulus is withdrawn. Although higher rates of natural immunity across large swaths of Latin America and Central Europe compensate for slower vaccination campaigns, full economic re-openings will be slower and fiscal stresses greater than in other emerging markets. The withdrawal of policy stimulus will almost certainly be challenged, especially in countries facing election cycles (e.g., Latin America in 2021-22), potentially stirring social unrest. Still, this kind of uncertainty typically is embedded in asset prices and peaks just before the actual election, offering potentially attractive opportunities as risk premiums fade after the vote.
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Soaring headline inflation may force further monetary policy normalization. The confluence of fast-recovering DM demand and structural commodity supply constraints has delivered the biggest headline inflation surprise (above expectations) in most emerging countries since 2008. The severity of the shock has been sufficient to force partial normalization in monetary policy in countries with the most accommodative stances, such as Brazil. Nevertheless, weak domestic demand, large negative output gaps and appreciating exchange rates give strong reasons to believe the inflation spike will be transitory. To be sure, we believe local markets have overpriced policy rate hikes – as is their tendency.
Investment implications
A strong manufacturing cycle and decade-high commodity prices are dominant drivers of what we expect to be a strong recovery in EM growth over the remainder of 2021. Accelerating EM growth should push demand for local currencies, followed by sovereign credit. EM local rates (bonds denominated in local currency) face a trickier path; investors demand higher real rate premia to compensate for higher debt levels and stubbornly large primary deficits. Nonetheless, this catch-up phase should still be conducive to harvesting high carry in markets with steep curves as inflation peaks and fiscal deficit pressures ease during what we see as an oncoming cyclical upswing.
Learn more about EM Debt at PIMCO: Well Positioned for Opportunity.
*Our World in Data
© PIMCO
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