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CITI: How bad is the EM growth picture?

The EM growth picture is the worst it has been outside episodes of financial crises or collapsing commodity prices. The slowdown is broad-based and not driven by a few large markets in crisis, as was the case in 2015. Moreover, the reduction is spread across indicators.

We have often highlighted this for export growth, but it also holds for private consumption and, in particular, for investment. n The growth premium towards DM has been eroded. This is worrying as it is one of the most attractive features of EM when it comes to attracting investment, particularly FDI. And commodity exporters in particular had only just started to close the negative gap towards DM growth that had opened up after the oil price collapse in 2014 and their unemployment levels are still above trend.

n In absence of a US-China agreement, it is difficult to become optimistic about EM growth prospects going forward. This raises the question whether EM can generate growth on their own in order to lean against external headwinds. We think to some degree, but we are sceptical about the amount of policy pace available. n On the face of it, EM should have some space for fiscal intervention; gross public debt stocks in EM are on average around 50% of GDP. But for many EM, fiscal space also depends on the external environment and market perceptions. The market does not base its assessment only on levels of different indicators, but also on deviations from expected readings of these metrics.

This would suggest that avoiding a contractionary repricing of the currency and/or rates means keeping external financing needs in check. n Monetary policy space faces similar constraints. Many EM central banks thus find it difficult to cut rates when the Fed is not, as the subsequent outflow of capital and exchange depreciation would be stagflationary. Looser monetary policy in major DM should thus help to open up policy space and provide capital inflows. This appears to be already underway as markets adjust their expectations for DM rates.

n However, this might be more supportive for asset prices than for growth, risking bubbles and fiscal profligacy. For as long as uncertainty about the future of many emerging economies' business model persists, investment is likely to remain lacklustre, no matter how favourable financing conditions are. This lack of productive outlets increases the risk that lower interest rates and capital inflows fuel asset bubbles and/or lead to fiscal profligacy. If not carefully managed, the upcoming round of global policy easing might chip away at financial stability without doing much for long term growth prospects.

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