Emerging market economies (EMEs) have diverse economies, driven by factors such as natural resource wealth, manufacturing, and service sectors, but also face significant challenges such as poverty, inequality, and political instability. Emerging Markets have offered a variety of growth prospects over the last 25-30 years. Spectacular growth, cheap labour, abundant natural resources, pent-up consumer demand – emerging markets have it all. They are also sharply affected by current global challenges, including inflation, rising global interest rates and trade disruptions, as well as the macro and structural policy priorities. A fast changing often volatile environment also characterises emerging market nations.
Unique Challenges for Emerging Markets:
The confluence of COVID-19 pandemic and the persisting Russia-Ukraine conflict, and the unrest in the Middle East, has resulted in a surge of inflation not seen for decades. The associated economic challenges are huge, making this a difficult time especially for EMEs.
As recent questions about energy and food security and supply chain disruptions have vividly demonstrated, navigating these waters will be difficult even for the world’s most advanced economies, but it will be particularly challenging for emerging market economies given that they are often characterised by significant additional vulnerabilities.
With weakened fiscal accounts after the pandemic many EMEs are facing the limits of the additional support they can provide to their populations and rising global interest rates will raise the cost of financing public debt which in some countries is executed by significant exchange rate exposure. Rising inflation and subsequent interest rate hikes create unique challenges for emerging markets in particular. Previous episodes of rising global interest rates have generally been very difficult times for EMEs.
There are also more longer-term structural challenges arising from recent events. For instance, what will be EMEs export prospects in a changing global trade environment? What is the role for EMEs in the energy transition and the global fight against climate change? And finally what kind of structural policy reforms can foster a stronger, more inclusive and also more sustainable recovery?
A Robust US Dollar Poses Challenges for Emerging Economies :
Many EMEs are significantly exposed to developments in the global economy be it for imports of food and other essential goods or through the dependence on external financing. With weak institutional frameworks many EMEs are struggling to deliver strong policy responses.
The upward trajectory of the US dollar since January 2024 is set to continue as market scepticism grows over the Federal Reserve’s capacity to cut rates compared to other central banks. But a strengthening dollar can have negative implications for emerging markets. First it can lead to capital outflows as investors move money back to the US asset Market in search of better returns – this shift can weaken emerging market currencies making imports more expensive and accelerating inflation in those economies. It also raises the cost of servicing dollar denominated debt which many emerging economies carry. This can pressure their financial systems and leave less money available for development projects. Additionally a stronger dollar can diminish the global competitiveness of emerging market exports potentially slowing economic growth. These dynamics underscore the challenges a robust US dollar poses for emerging economies impacting their overall economic stability and growth trajectories
This current juncture holds many challenges for emerging market economies with lower incomes; the populations are likely to suffer more from significant cutbacks in consumption due to the rising prices
EMEs Remain Major Players in the Global Economy:
Despite these challenges, emerging markets continue to offer attractive investment opportunities and are an important driver of global economic growth. Emerging markets such as China, India and Brazil, have become major players in the global economy challenging the dominance of developed countries and reshaping the future of international trade and investment.
China’s ongoing deflationary trends and overcapacity issues are reshaping global trade dynamics and economic forecasts. As the country continues to invest heavily in manufacturing while struggling with weak domestic demand, the resulting deflationary pressures are likely to have far-reaching implications for global markets and emerging economies. But India and Indonesia are a long-term story within emerging markets.
Emerging markets such as India and Indonesia, whose populations are growing at a solid pace, stand to benefit as demographics begin to play a bigger role in investment decisions, according to Fidelity International and BlackRock Investment Institute. The investors are focusing on the two nations in emerging Asia, due to an expected boom in infrastructure spending, which in turn bodes well for the countries’ economies. Both India and Indonesia coincidentally had elections this year, showcasing to the world their ambition to transition into major economic powerhouses with their dynamic population a key strength. The two countries stand out at a time when rapid ageing has plagued peers in the region, including China.
India is the Most Resilient Emerging Market:
According to the global financial services firm Lazard, India has maintained its fastest economic growth and is actively taking steps to become a global manufacturing centre. In its latest report titled “Outlook on Emerging Markets,” the global firm recognised India’s strong demographic dividend, and said that the country will reap the benefit of its younger population, helping it to drive growth until 2060. “With a young and growing labour force–nearly 80 percent of its population is under the age of 50–and a rising middle class with real wage growth, India has a demographic dividend tailwind, in our view, and the country is projected to grow quickly until the 2060s,” the report stated.
This June Indian government bonds enter JP Morgan’s Global Bond index for emerging markets. Indian bonds are to have a weight of 10% in the index. The inclusion will however be phased out with 1% weight getting added every month until the full weight of 10% is reached in March 2025. In addition Indian bonds also enter the Bloomberg local currency index which will see a flow of about $3 to $4 billion dollars in January 2025. These index inclusions are likely to have a far-reaching impact of almost $35 billion dollars or nearly three lakh crore. Three trillion rupees of Indian bonds could be bought in a space of a little over one year.
Going forward, as the dollars rush in, government borrowing costs could fall, as will that of corporations. Indications are that almost $10 billion have already come in ahead of the index inclusion. The performance of the other emerging market local currency markets hasn’t been great this year. That is likely to encourage investors managing local currency funds to allocate more into India.
According to the International Monetary Fund’s External Sector Report on currency, capital flows and financial imbalances, gross capital inflows into emerging markets excluding China last year rose to $110 billion or 0.6% of their economic output, the highest level since 2018.
This indicates some resilience among emerging markets despite sharply higher U.S. interest rates that have drawn funds into dollar assets. A higher weighting for India will position it to become the new anchor for emerging market equities, likely driving increased flows into the country.
