Emerging markets are on a path to strong recovery from the pandemic, though with significant variations across regions.

Emerging markets bounced back sharply in recent months, albeit lagging developed markets. Looking ahead, we expect global EM growth (based upon our GDP expectations) to accelerate to 6.7% in 2021 from a 1.6% contraction last year, thanks to improving terms of trade, strong commodity prices and a recovery in exports—with significant variation across regions.

Asia in particular will likely drive the recovery. We see China and India, where output is already back at 2019 levels, growing by 9% and 12%, respectively in 2021. For China, this comes after a potential softening in the first half of the year, given a recent COVID-19 outbreak in Hebei that triggered pandemic control measures. That could lead to a temporary setback in domestic travel and consumption; moreover, we have not seen preapprovals for local government issuance (including special bonds), which may drive the credit impulse to dip further.

EMEA is a mixed bag, with Central and Eastern Europe currently weighed down by sharp regional restrictions but set to benefit as the €672.5 billion European Recovery and Resilience Facility is rolled out. Turkey is still enjoying the carryover from the credit splurge of last year but must contain the consequent erosion in reserves and external balances. Facing massive socioeconomic challenges even before the pandemic, South Africa is likely to lag the most, while also tackling a COVID-19 variant that has so far proven to be more resistant to vaccines.

Commodity exporters Chile and Peru are set to lead in Latin America, benefiting from a pick-up in the Chinese demand, particularly in the second half of the year. Brazil should enjoy strong tailwinds from exports but should also demonstrate commitment to its spending cap, with a gradual reduction in fiscal spending likely to reduce its risk premium. Having held back monetary and fiscal support in 2020, Mexico could see slower recovery even as it benefits from stronger growth in the U.S.

The one wild card for EM in 2021 will be the progress in mass vaccinations, where EM, except for Israel and some Gulf countries, has so far lagged developed markets. This is partly because the pandemic was much better-contained in Asia to begin with, but still represents a potential obstacle to normalization. We are seeing some hopeful indications, with Russian and Chinese vaccines becoming more widely available and South Korea and some Latin American countries making progress in securing vaccines.

The rise in EM public debt ratios—almost 10 percentage points of GDP in two years—is also worth monitoring, even if the rise is more contained than developed markets given EM’s smaller growth shock and lower average fiscal stimulus.

Market Implications

We believe that the cyclical recovery should support EM FX, although we have reduced some risk with the recent sharp move in U.S. rates. In hard currency, we expect frontier economies to benefit from the resumption of global trade and mobility. This includes Egypt and Ivory Coast. We also favor BBB- markets such as Romania and Croatia that could be supported by the European recovery funds.