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China slowdown could have ripple effect on emerging markets

By Debabrata Das

10:56, 15 November 2021

 Cape Town CBD at night
Cape Town CBD at night - Photo: Shutterstock

The potential ripple effect from China’s slowing economy could threaten emerging markets (EM) already struggling from the economic impact of low vaccination rates. 

A crippling power crunch in China led to its gross domestic product (GDP) growing at the slowest pace in a year during the third quarter. There are also concerns that the debt repayment issues among its property developers will lead to a prolonged period of slower growth.

According to researchers at Aviva Investors, “relatively low vaccination rates, slowing Chinese growth and terms of trade that may have largely peaked” put several headwinds in front of emerging economies. 

Impact on emerging markets ‘not uniform’

“There are also growing concerns about the potential ripple effects of a cooling Chinese economy; again, the impact will not be uniform across emerging markets. Countries such as Peru, Chile and Brazil are heavily dependent on Chinese demand for commodity exports, Nafez Zouk, Carmen Altenkirch, emerging markets analysts, at Aviva Investors, wrote in a note.

“Thailand relies on Chinese tourists, and supply chains in the Philippines and Malaysia are deeply intertwined with the Chinese economy,” they added. 

According to Zouk and Altenkirch, with commodity prices cooling from all-time highs, the improvements in current account balances of several emerging market economies “may wane in 2022”.

Commodity prices cool 

Signs of a cool-down in commodity prices affecting emerging markets economies are already visible, especially in South Africa. The South African rand had been one of the best-performing currencies in the world during the first half of 2021, however, it has weakened recently as commodity prices soften.

This view was backed by economists South Africa’s Nedbank in a recent note.

“Over the past two months, the rand drifted lower, hurt by choppy risk sentiment, softer commodity prices, and the widely expected tapering of US bond purchases in early November.

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“The slowdown in China is likely to weigh on commodity prices in the final months of this year and early next year,” said Nedbank.

USD/ZAR movements over the past one weekUSD/ZAR movements over the past one week - Photo:

EM sovereign debt issuance up

Aviva’s Zouk and Altenkirch highlighted that emerging market economies have resorted to issuing large amounts of debt to support economic activity, leading to sovereign debt-to-GDP ratios surging to a record high in 2020.

These ratios are set to rise further. Aviva Investors' note cites IMF research which predicts EM government debt is set to climb to nearly 70% of GDP by 2026, up from 51% in 2018.

Despite this Zouk and Altenkirch were optimistic that strong support for emerging market debt would enable governments to continue their borrowing spree.

“Since the pandemic erupted in early 2020, emerging market bonds have enjoyed several tailwinds that continued longer than might have been envisaged. These tailwinds will not disappear overnight and so most countries will continue to be able to fund their deficits without much difficulty,” the note said.

Countries at risk

Certain countries, however, will “be in trouble” unless they can keep growing their economy faster than their debt burdens.

According to their research, Romania, the Czech Republic and Bahrain all face such risks. Further, South Africa and Brazil are even more at risk as “real economic growth will almost certainly be insufficient to prevent large primary deficits”.

Read more: China GDP growth slows in third quarter on power crunch

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