Concerns escalated during the latter half of the year on fears over a further slowdown in EM economies, particularly China, as well as the continued sell-off in commodity markets.
Growth expectations across EM countries were largely revised downwards throughout 2015. Despite continued signs of recovery in the US and European consumer sector, the slowdown in the global production cycle and in China took a toll on EM exports, impacting commodity and manufactured goods exporting countries alike.
This led to sharp falls for a number of EM currencies, with spot levels across the board reaching all-time high levels in nominal terms. The Malaysian ringgit, Indonesian rupiah, South African rand, Turkish lira, Russian ruble, as well as generally all of Latin America’s currencies, continued to struggle under a mix of negative idiosyncratic and external drivers.
The local bond yields in these countries also suffered. Due to the sharp FX depreciation, deteriorating inflation dynamics and capital outflows, central banks in these countries had to remain on the hawkish side (with the exception of Turkey), rather than on the dovish side that we believe the economic slowdown would suggest.
On the other hand, central banks of countries with current account surpluses in Asia have been less restrained in their monetary policies as inflation dynamics and outflows are more contained. The central banks of China, India and Taiwan took advantage of a continued low inflationary environment to ease monetary policies in an attempt to bolster growth and stabilise financial markets. In general, central banks in the region are likely to favour currency depreciation or resist appreciation as policy interest rates start reaching record lows, particularly for Korea and Thailand.
Central and Eastern Europe remained the most resilient region through 2015. This region has continued to benefit from the proximity to Western Europe, where the economic recovery remains on track.
Growth to re-emerge in 2016
EM sovereign and corporate fundamentals are still going through a negative trend as a result of the oil price shock, US dollar strength and idiosyncratic geopolitical developments. Additionally, domestic demand is on a weakening trend as countries face challenges of necessary deleveraging after years of strong credit growth.
Nevertheless, we remain comfortable with underlying EM sovereign credit quality – which is supported by still strong public sector balance sheets, low external debt ratios and flexible exchange rate regimes. The lack of pass-through of strong domestic demand growth from developed markets to EM has so far been disappointing, but there is a reasonable chance growth will re-emerge in the course of 2016. Additionally, the effect of Chinese monetary policy easing and fiscal stimulus should also support economic growth as we move through the early part of 2016.
While we continue to be cautious in the near term regarding the fundamental outlook for EM, we see support for owning the asset class from valuations and the technical picture is supportive as well, due to low net issuance levels.