Note: Some of the thoughts expressed in this piece can be found in my November 26 interview with Sri Jegarajah and Nancy Hungerford of CNBC Asia Squawk Box.
Global recession risks have abated, along with our forecasts, but underlying growth momentum is far from strong. This sluggish growth includes the engines of global growth in the United States and China. Developed Europe and Latin America continue to lag. The MEA region, follows, which continues to struggle to adjust to the new oil normal and where a handover from public to private demand remains slow. Across commodity rich countries, government support, off-balance sheet or on, will continue to be a support to growth in Russia and the GCC for example, while public sector remains a bigger beneficiary of recent rate cuts. While Asian balance sheets look strongest, debt levels are rising, reducing growth momentum, while trade and political uncertainty are likely to continue to delay long-term investment.
The political and economic vulnerabilities in many key economies will likely remain mutually reinforcing, as governments have little scope to engage in planned expenditure switching or major spending expansions. Businesses continue to face policy uncertainty, not least on trade, which amplifies demand uncertainty among consumers. The latter though, especially in China, remain more concerning, especially as policy space remains more constrained. While trade conflicts (and the less tractable technology conflict) are not the only or primary challenge for the global economy, the chance of a new bout may add to volatility of macro performance. A Phase 1 U.S. -China deal either in Q1 remains a possibility, and a continuation of status quo (no new tariffs) would be supportive of global markets, but would be unlikely to boost growth much given the likely persistence of the technology conflict, lack of clarity about long-term rules and reliance on central bank support.
Supportive central bank policy supports risk assets despite stretched valuations, will do less to support local credit expansion and investment. Only a few countries (Russia, India, Saudi Arabia) are likely to step up meaningful government spending plans, while the U.S, and China remain more modest, and Europe remains largely on hold. The general growth momentum, coupled with ample supply will keep oil and natural gas prices (and associated economies) under pressure, though a major drop is unlikely. The good news; EM external balances have improved, requiring less finance, but this is more a sign of sluggish growth and import contraction rather than a meaningfully strong growth prospects. Still, it should support local currencies and fixed income, especially as global yield seeking continues.
Fiscal stimulus scope is limited. Despite some hopes for a major fiscal push to support scarce investment and infrastructure, few countries seem likely to act either due to political constraints, the need to address contingent liabilities (Mexico, South Africa) or address other political claims or because of existing deficits swelled by weaker growth and revenues. Chinese authorities are selectively targeting fiscal expansion but remains concerned by over-spending and more inefficient investment. Don’t expect a big fiscal or credit stimulus from China, which should limit its potential support of global demand. China for example continues to rely more on exports and to limit its imports by a greater degree than in the recent past.
Monetary support Better for markets than Macro: Central Banks are already in easy to neutral mode and policy settings in many countries near-recessionary level, suggesting that only modest additional cuts are likely. Countries with more space to cut include Russia, Brazil, Indonesia, India, Mexico, though the bigger easing cycle of 2019 is unlikely to be repeated – aside from Turkey. Moreover, only some of the rate cuts are being passed through to borrowers, with governments benefiting more than households and small businesses. Financial transmission challenges continue to limit the willingness of banks to lend and bank rates have failed to fall as quickly as interest rates. These trends suggest that borrowing costs for the public sector (both governments and SOEs) will benefit more from these trends.
Latin America Continues to Stagnate
Regionally, Latin America will continue to lag other regions, though resource rich Africa and the Middle East will be a close second. Latin America continues to struggle to exit from the commodity-related downturns after 2015. East Asia continues to be the relative outperformer in terms of global growth, though China’s domestically driven slowdown and credit challenges in India will limit the expansion.
The struggle to grow and associated political pressures which took violent form in Chile and elsewhere in recent week add to these concerns, though countries vary in their ability to manage the shocks – with Peru and Colombia likely to have more institutional resilience than Bolivia. Chile too continues to have some of the strongest technocratic leadership, and relatively well funded position – however, there is likely to be a persistent risk premium in the bonds and investors are likely playing too significant comfort from those institutions, especially given the relatively dismal prospects for copper and metals in 2020.
Brazil remains a bright spot in Latin America as growth seems to have bottomed out and the necessary but insufficient pension reforms help to stabilize debt at a high level. Meanwhile, energy and agriculture exports continue to grow, albeit complicating the outlook for OPEC in its upcoming meeting, and Petrobras’ balance sheet looks relatively strong compared to many of its regional peers. Still, growth will struggle to beat the 2% mark, unless there are meaningful investment projects, something that may be politically difficult. Looking ahead, the political coalition which brought through the pension reforms may struggle to agree on further tax adjustments. Clarity on the future of the oil and gas industry will be important for the medium-term investment outlook – Brazilian authorities will be digesting the results of the recent failed auction for deep-sea oil. Note that joining OPEC in any capacity (even joining the OPEC+ broader grouping), looks to be more of a ploy for status and investment rather than one that actually serves their near and long-term interest. A country like Brazil with growing oil output (200-300K/d) would find it difficult to join a group that is shrinking output.
The bitter debt restructuring and financing challenge faced by Argentina will be a drag on the region, due to additional competition in select agricultural products, and likely further FX devaluation and credit stress. The country is likely to face additional recession.
Meanwhile Mexican growth and fiscal outlook remains under strain. Its not surprising that switching expenditure remains challenging given weak growth, the costs of changing political priorities and the sizeable contingent liability of Pemex. Consumption will remain the main growth driver, and the current status quo on USMCA would be a positive sign. Passage of the USMCA remains a possibility, as congressional actors look to have some non-impeachment achievements, but its still a political challenge , with likely less than 50% chance of coming to the floor. Any effort by the US to threaten an exit from NAFTA would be quite negative for markets, but would also be counterproductive to the US (as a weaker MXN would increase Mexico’s trade diversion benefits). It would also raise further questions about the U.S, ability to achieve and push through deals.
Colombia stands out as one of the few EM countries with a sizeable external deficit, itself spurred by slow fiscal adjustment. While some of the drivers of those trends are positive – continued infrastructure and associated imports, COP is set to be an adjustment tool, dampening that domestic demand and limiting the scope of the central banks.
Meanwhile political stalemate in Venezuela is presiding over deteriorating economic and social outcomes. Representatives of the opposition suggested that the GDP of Venezuela has shrunk to $60 billion, reflecting major mismanagement, low oil prices and sanctions, which reinforced other drivers of a major output and massive painful import contraction. Opposition surrogates continue pre-negotiating a financing deal, with the 2020 Citgo bond a ticking time bomb to focus attention. There are several obstacles to a early financing deal or one at all. Not much can happen with Maduro still in power as the sanctions are contingent on government change. Moreover, as Venezuela has not had formal ties with the IMF and other global financial institutions, it would take many months to assess the real underlying damage in the economy, to assess a degree of needed debt restructuring and needed investment in the energy sector. Some investors continue to hope that Venezuela can produce its way out of the medium-term debt challenge, arguing only for a maturity extension. This does not seem plausible given the massive funding needs (over $150 billion over 5-10 years for the energy plans alone, let alone the rest of the economy.
Ziemba Insights 