Summary
Emerging markets (EMs) have generally shown significant resilience over the past five years, facing down a series of shocks arising from the COVID-19 pandemic, the inflationary outcome of the Russia-Ukraine war and the US Federal Reserve hiking interest rates sharply within an 18-month period. Not only did EMs survive this period, but in some ways they have thrived. Indeed, as the world fragments and realigns geopolitically, EMs have found themselves generally well-placed to benefit from these global shifts—including some that are likely to benefit under the new tariff regime. This compares to earlier years when EMs would often face crises (whether debt, balance of payments and/or in banking systems) from global shocks. That EMs are in a favorable position now is no accident, and this report identifies and examines the developments that have enabled the current resilience in EMs.
- Trade diversification has made EMs less reliant on individual trading partners. While the United States and China remain the two largest trading hubs around which most world trade takes place, most EMs have not singularly aligned with one of these, thus enabling them to trade in whichever way is most advantageous to them. In addition, trade between EMs has generally increased as well. EMs have thus become less vulnerable to shocks emanating from a particular trading partner—including the effects of tariffs.
- Reshoring has boosted prospects in a number of EMs, whether that comes from “China plus one” diversification, friendshoring or nearshoring. These EMs have become (or are in the process of becoming) more embedded in global supply chains, supporting their balance of payments both through inward investment flows into production facilities flows and as they export the products. We also believe that tariff imposition is likely to underpin the shift to reshoring already underway globally.
- Policy responses with respect to both monetary and fiscal policy have improved significantly across EMs over the past couple of decades. Adoption of sound, credible policies and nurturing of institutions (such as inflation targets, fiscal rules and independent central banks) have helped policy formulation and improved the market’s perception of the credibility of policymakers.
- Financing flows into EMs have improved markedly compared to previous years, with much of the flow now being longer-term (such as for fixed investment) rather than “hot money” (short-term, easily reversible flows such as portfolio flows) that previously characterized inflows. In addition, as local financial markets have deepened, EMs have been able to source a greater portion of their funding domestically, leaving them less vulnerable to a balance of payments shock.
- Structural reforms to foster growth and/or attract foreign investment have further entrenched progress and boosted structural growth rates.
- In sum, we see that the current strong position of EMs in a geopolitically fragmenting world is the result of some decades of consistent commitment to reforms, as well as savvy positioning within a multipolar world. We expect certain EMs to be able to continue to benefit as global realignment of political and trading blocs continues.
- Even with this stronger basis, there are risks to EMs, some within their control and some not. A potential global trade war poses a risk to growth in many of these countries. In addition, some of the outcomes of structural improvements (such as higher reserves and fiscal space) depleted somewhat during the pandemic shock and have not yet fully recovered, limiting EM’s ability to deal with potential future adverse events.
Conclusion
In sum, EMs have taken on board the lessons learned from past crises and implemented monetary, fiscal and other policy reforms that have greatly stabilized their macro environments. In addition, a variety of pro-growth and efficiency reforms in various EMs appropriate to their individual circumstances has made them attractive to global companies looking to expand or move their supply chains, thereby placing them in a position to benefit from global reshoring trends. Current risks to the outlook mainly stem from the possible effect of tariffs and a potential trade war—an evolving situation as at the time of writing. However, we also believe that a higher global tariff regime would underpin the shift already underway toward regionalization, which would benefit a number of EMs, as would diversification of import sources away from the United States.
Global Macro Shifts is a research-based briefing on global economies featuring the analysis and views of Dr. Michael Hasenstab and senior members of Templeton Global Macro (TGM). Dr. Hasenstab and his team manage Templeton’s global bond strategies, including unconstrained fixed income, currency and global macro. This economics team, trained in some of the leading universities in the world, integrates global macroeconomic analysis with in-depth country research to help identify long-term imbalances that translate to investment opportunities.
Primary contributors to this issue
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Active management does not ensure gains or protect against market declines.
Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. The government’s participation in the economy is still high and, therefore, investments in China will be subject to larger regulatory risk levels compared to many other countries.
WF: 5416048