LONDON, KYIV, 7 NOVEMBER 2013: 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).

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.”

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.

UKRAINE: Exports to set to kick-start growth as weakness at home continues

Weak industrial output and exports continue to delay any recovery. While growth will be a little better than zero this year, a gradual recovery in the EU and Russia will enable an export-led return to growth in Ukraine in 2014-16. However, the upturn will also require renewed bilateral or multilateral loans to finance the large budget and external deficits. We forecast GDP growth of 2.5% in 2014 and then a pickup to almost 5% in 2016. Although, uncertainty ahead of presidential elections in early 2015 may dampen prospects.

Having fallen sharply over the past year, inflation will accelerate to some 5-6% in 2014-17 as a large fiscal deficit (close to 6% of GDP in 2013) forces withdrawal of subsidies on energy and consumer goods. This may help investment by deepening the fall in real interest rates but will delay monetary easing and may put pressure on the Ukrainian hryvnia –already at risk from the wide external deficit and falling reserves due to debt repayments.

Alexei Kredisov, Managing Partner for EY in Ukraine, Co-Leader of the Emerging Markets Center at EY Global: “Lower imports are helping to contain the large current account deficit (seen falling to 7.4% of GDP in 2013) but heavy debt service costs and lower reserves mean that a new IMF standby or fresh bilateral loans are needed soon. Prospects for greater capital inflows would be enhanced by an association agreement with the EU, although this could exacerbate tensions with Russia. In order to attract foreign investment Ukraine requires structural reforms and business environment improvement”.

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.”