Addressing the legacy of the crisis in the EM: the right policy mix in an uneven recovery

The current pandemic has hit all emerging economies without distinction, with the apex felt during the first half of 2020. Having said that, the depth of the scars it left has been different from country to country. Across the regions, Eastern Europe and CEE3 (Hungary, Poland and Czech) in particular have proven to be the most resilient, as well as North Asia (China, Taiwan and South Korea). Within Asia, it’s worth highlighting the remarkable differences between South and North, with northern countries managing the pandemic and reopening more effectively than the southern countries (India GDP fell by around 24% YoY in Q2 2020), which are still struggling to come out of the first wave.
Although economic conditions when everything began were not the healthiest possible, a return to the pre-crisis economic status is proving slower and more challenging than expected. The pandemic is far from being under control and we are witnessing new outbreaks or second phases across many countries followed by local and targeted lockdowns. Based on daily economic activity data, the robust rebound in place since the easing of the Great Lockdown has stabilised since August and then shifted downward in some countries. Economic activity has slowed down in countries where new targeted lockdowns have been enforced (e.g., in Indonesia, Malaysia and Israel) as well as in countries where the infection rate has temporarily increased above the recent average even in the absence of any new enforced restrictions (e.g. in South Korea in September).
Domestic as well as external demand have driven the current rebound. In the first phase of the crisis, rapidly available cash benefits or transfers have supported consumption in countries where wage subsidies were less effective, due the prominence of the informal sector. Sector-wise, the rebound has mainly concerned manufacturing while services have lagged behind. Tourism is one of the worst-affected sectors in this pandemic. There were zero international tourist arrivals in August for the fifth month in a row in Thailand, where tourism accounts for around 12% of GDP. On a more positive note and still on the external side, EM exports have rebounded robustly since June 2020. Although the recovery in exports has been broadly based, it is worth noting the vibrant tech production and export cycle that favours North Asia countries and generally the tech sector/ companies across the world. Earnings of the MSCI China Index, which has expanded the weighting of new economy companies since 2015-16, are more and more dependent on the EM exports cycle than on general world trade dynamics, highlighting the importance of regional integration.
With regard to inflation, a benign trajectory is underway and we expect only a gradual pick-up in 2021 vs 2020, due to the wider slack in the economy (which existed in part in some countries already before the crisis). The yearly smooth inflation figures could hide some more challenging and volatile dynamics along the year, certainly around Q2 2021, when a spike will be made possible by the very low base in Q2 2020 (driven by the oil price collapse). Provided that the inflation picture remains benign and, generally speaking, within or very close to the CBs targets, the recent mild pick-up reflects the importance of other non-core components in the price basket, as Food. The pandemic has produced a large amount of supply disruption (still difficult to quantify), as well as food export restrictions and this has been immediately reflected in high inflation in the emerging markets. One of the first reactions by many governments around the world was to guarantee adequate supplies of food, facilitating imports (through tariff reductions, streamlining of border procedures, and relaxation of labelling requirements), and/or restricting exports. The World Trade Organization (WTO) on June 18 prohibited members from banning food exports and several of these measures have subsequently been removed. Weak demand and supply disruption are mutually offsetting and though we envisage the first factor as dominant on the background, it’s fair to say that the possibility of temporary spikes in inflation above the CB targets (different from the past inflation highs) can’t be ruled out. Depending on the structure of the economy and efficiency in the price formation mechanism, these spikes could assume a less temporary shape, as has been happening in India, where inflation has remained above the quite wide RBI band for most of the year.