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Our Blog

Should emerging markets fear The Fed?

30 July 2015
Emerging, Fed, Markets

Economic performance among the key emerging economies remains mixed.  India remains the standout emerging economy performer with various economic reforms introduced since the election contributing to what is best described as an economic rejuvenation.  However, conditions remain tough in Brazil and Russia.  Both are in recession as the central bank in Brazil tries to rein in inflationary pressures and the Government seeks to return to a primary budget surplus, while Russia continues to struggle as a result of lower oil prices, Ukraine-related sanctions and high interest rates.

Emerging economy GDP growth
Annual average % change


Source: IMF and AMP Capital

In India growth for the 2015 fiscal year came in at 7.3%, up from 6.9% in the prior year.  The pick-up in growth has coincided with a significant decline in inflation, and a narrowing of both the current account and fiscal deficits.  One cloud on the horizon for both growth and inflation, at least in the near term, is the poor monsoon season, which will impact both agricultural production and food prices.  The Reserve Bank of India has cut interest rates a total of 0.75% this year with further cuts from here likely to be determined by food prices.  We continue to expect stronger growth of around 8.0% this year.

In Brazil the economy remains weak on the back of tighter monetary and fiscal policy which has led to a deterioration in both business and consumer confidence.  The labour market held up pretty well in the early stages of the slowdown but has deteriorated more recently.  The unemployment rate now stands at 6.7%, up from 4.9% a year ago.  The latest inflation report from the Brazilian Central Bank signaled a negative output gap for the first time this cycle.  This supports our view that the recent tightening in monetary policy is near its end, and that spare capacity and expectations of lower inflation ahead may see the central bank beginning to ease conditions from early next year.

Brazil unemployment rate
Percent


Source: IBGE

The experience of the Latin American debt crisis in 1982 and the Mexican currency crisis in 1994 tells us to be wary of capital outflows from emerging economies during periods of tightening US monetary policy.

Notwithstanding their own idiosyncrasies, we believe most emerging economies are generally in better shape now than they have been during previous episodes of rising US interest rates.  It’s the reform agenda embraced by many emerging economies following the Asian Financial Crisis that we expect will see many emerging economies come through the next round of higher US interest rates better than they have before.  Those reforms include more flexible exchange rate regimes, lower levels of external debt, higher levels of foreign reserves and better capitalized banking sectors.

Other factors to consider this time around are, firstly, the pace of US interest rate increases will be slow and gradual.  Furthermore, while we expect the Fed to be raising US interest rates, others of the major developed central banks, including the ECB and BoJ, are easing monetary policy aggressively.

This blog post has been prepared to provide general information and does not constitute 'financial advice' for the purposes of the Financial Advisors Act 2008 (Act). An individual investor should, before making any investment decisions, consider the information available in the relevant Product Disclosure Statement and seek professional advice. While every care has been taken in the preparation of this document, AMP Capital Investors (New Zealand) Limited and the AMP Group (together, 'AMP') make no guarantee that the information supplied is accurate, complete or timely and do not make any warranties or representations in respect of results gained from its use. The information is not intended to infer that current or past returns are indicative of future returns. The views expressed are those of the author and do not necessarily reflect those of AMP. These views are subject to change depending on market conditions and other factors.

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