The crisis in Ukraine, the lingering effects of COVID-19, and the changing monetary and fiscal responses to these events have presented a set of unfolding risks and opportunities for both developed and emerging markets. Foremost among them is inflation. Some emerging markets are much more vulnerable than others to the challenges raised by this volatility.
A change in reality
Russia’s invasion of Ukraine in February 2022 has materially altered the global economic environment. Wide-ranging sanctions against Russia implemented by the US and its allies have injected new volatility into supply chains, which were already under pressure as post-pandemic reopening in some countries coincided with ongoing COVID restrictions in others.
Ukraine and Russia are major commodity exporters. The war has pushed food prices to record highs,1 with US President Joe Biden noting that the two countries are Europe’s breadbasket for wheat.2 Ukraine produces half the world’s neon gas, a key input for semiconductor production.3 Volatility is everywhere, with oil prices topping USD140 in early March before falling back below USD100.4 Natural gas prices have soared.5 All this is feeding into inflation, which was rising sharply even prior to the conflict.
Yet despite all this, equity markets are showing a strange resilience. It is as if they have become desensitised to shocks. They may also have yet to fully take into account the synchronised nature of the monetary tightening that is about to take place. Q1 2022 was not just notable for its extreme geopolitical and economic volatility – it was also the quarter during which the US Federal Reserve approved its first interest rate hike in more than three years.6 We expect the fed funds rate to be raised to 2% by the end of the year, from a target range of 0.25-0.5% currently.7
A house divided in emerging markets
One consequence of the volatility is that it has split emerging and frontier markets into two camps. The Haves are those whose economies are in a position to capitalise on the diversification of global supply chains driven by these overlapping crises. The Have Nots are unable to seize this upside, and for them there is no silver lining in the gathering clouds. Of these, rising food prices – which have a history of feeding into political risks – are potentially the most destabilising.
In Sub-Saharan Africa, despite a fragile recovery, potential bright spots help to explain why we’re not seeing a blanket withdrawal by foreign portfolio investors. Uganda, for example, is relatively resilient given its consumption of domestically sourced staples. It is also on the verge of becoming an oil producer, as is Senegal, while Tanzania and Mozambique are now likely to see more interest in their offshore gas deposits. South Africa is a major producer of metals such as palladium, rhodium and platinum, which are also exported by Russia – potentially to South Africa’s advantage as Russian exports face sanctions.
Likewise, in North Africa and the Middle East, the Haves are those with oil and gas – although even they would prefer less oil price volatility – but there are also Have Nots. Egypt is a major importer of wheat from Russia and Ukraine, and its tourism industry has become increasingly dependent on visitors from the two countries. The war has disrupted these flows, and food security is now a major looming risk.8 In many other countries, inflation is likely to result in higher subsidy bills for food, fuel and fertilisers, expanding balance sheets. This could delay not only fiscal repairs from the pandemic but also long-term investments needed for future growth.
Asia anchored by its giants
Asia is likewise divided, though here the divide is more marked by policy differentiation. In the hawkish camp sit countries such as Singapore and South Korea, the latter leading the charge on rate hikes and finding itself in a relatively good position decent growth and manageable inflation. At the other end of the scale, China and Thailand are pursuing a dovish approach to monetary policy, while countries like Indonesia fall into the neutral category.
On China, Standard Chartered is more bullish this year than the consensus. This reflects monetary easing by the People’s Bank of China and a more streamlined and effective policy mix. Our growth forecast of 5.3% is below the government’s 5.5% target but above market expectations, following a strong start to the year and the government’s commitment to front-loaded fiscal stimulus – although China’s current Omicron outbreak presents a downside risk.
Until recently, India would have fallen into the dovish camp, but the Reserve Bank of India has now switched to a more hawkish narrative, and we expect it to hike by 100 basis points over the coming months. India posted 8.0% growth in FY22, but we expect this to moderate to 7.7% in FY23 – India’s economic recovery is uneven and “K shaped”, with lower-income jobs and SMEs slower to recover. The government is coming under greater political pressure to raise food and fertiliser subsidies in the face of rising inflation, which could weaken investment spending over time.
That said, India’s challenges must be placed in context, especially when looking at some of its closest neighbours. Sri Lanka is seeing mounting political and civil unrest amid shortages of fuel and food, while in Pakistan, Prime Minister Imran Khan lost a no-confidence motion in parliament; while this was due to a complex set of reasons, high inflation was a contributing factor.
The West and the rest
Monetary policy and quantitative tightening by the Fed, the ECB and other major developed-market central banks are likely to dampen growth and the performance of financial markets. However, given the likely alternative being that decades-high inflation squeezes spending power, they see policy tightening as the lesser of two evils –overriding concerns that rate hikes may not be the correct medicine for inflation driven by supply shocks rather than excess domestic demand.
In the longer term, there is a risk that the use of the dollar as a weapon against Russia and countries that trade with it will accelerate the de-dollarisation of the global economy as major emerging markets diversify their reserve currencies. But reserve currencies need to be fully convertible and with open capital accounts, features that some of the dollar’s rivals lack.
Stagflation is a risk in developed markets, with real incomes already falling and the household savings accumulated during lockdowns being quickly eroded. Globally, however, the bigger concern is the divide between the Haves and Have Nots in emerging markets. With coffers drained by the response to COVID-19, the overlapping crises of the pandemic and the war in Ukraine risk dragging middle-income countries into the low-income bracket – a reversal of fortunes that could feed into yet more political risk, with adverse economic repercussions.