The growth outlook of emerging markets (EMs) has improved, prompting their central banks to act even more cautiously.

A later Fed cutting cycle, still sticky inflation, fiscal slippage, and political uncertainty reinforce our view that an emerging market easing cycle will prove more dispersed than we had expected.

EM growth on solid footing

The EM activity outlook has improved for 2024. Several better-than-expected data prints in Q1 helped keep growth broadly around trend (Chart 1).

Chart 1. EM growth holding up

Receding headline inflation has boosted real incomes, while less restrictive monetary policy and pre- and post-election fiscal easing have also played roles in supporting growth. Having contracted or stalled in late 2023, growth bounced back into expansion in markets such as Malaysia, Thailand, Poland, Brazil, and Mexico, while India continued to outperform.

More broadly, economic activity across EMs has been surprising to the upside, according to the Citi Economic Surprise Index, and the factors that helped to support growth in Q2 look set to persist in the near term.1

Purchasing managers’ indexes (PMIs) indicate that the services sector has been key to keeping growth around trend. In May, the EM services PMI aggregate hit its highest point since June 2023, with the new orders sub-index rising sharply.

There have also been signs of a pick-up in manufacturing (Chart 2), which has helped to increase growth in more economies.

Chart 2. Global manufacturing in an upturn

The EM manufacturing PMI has hovered at above historical averages since February, albeit with the Central and Eastern European (CEE) economies, such as Czechia, Hungary, and Poland, still struggling due to structural headwinds impacting Europe’s industrial base.

Trade data suggest that the global goods cycle is on a stronger footing, which tends to boost growth in EMs. Electronic goods exports have rebounded from their 2023 lull for Taiwan and South Korea, and there are signs that Malaysia is also beginning to benefit, with exports returning to positive year-over-year growth (7.3% in May).

Despite the encouraging outlook for global trade, one area of concern for several EMs is the competition from China, as the country’s exports have shown more strength than the rest of Asia (Chart 3).

Chart 3. Exports have improved, but more so in China

Policymakers in several countries have responded to domestic business complaints. Brazil, Turkey, Thailand, and Vietnam have raised tariffs or launched anti-dumping investigations.

Central banks’ cutting cycles will slow

Despite the better outlook for growth, activity across EMs remains curtailed by still restrictive monetary policy stances in most economies. While four of the major EM central banks cut rates in June, caution is growing among policymakers.

Rate cuts have continued, but at a slower clip, as the scope for further easing from the early cutters has shrunk. Central banks in Chile and Hungary have reduced the size of their latest cuts, while in Brazil, Mexico, and Peru, policymakers have paused rate-cutting cycles at recent meetings. Central banks in Asia and South Africa are yet to begin easing. An explanation for this that stretches across markets is the repricing of the Fed’s policy path. In January, markets were pricing a soft landing, with six Fed cuts, but as the US economy has proved resilient and the last mile challenges of disinflation have persisted, expectations are shifting to later cuts.

Indeed, FOMC members signaled just one rate cut this year at their June meeting despite a relatively soft May inflation print, and we now expect the Fed to hold off until December before easing. This will keep external financing conditions tight for EMs and maintain pressure on low-yielding currencies, primarily in Asia. As such, we struggle to see many central banks in Asia beginning their easing cycles ahead of the Fed, with only the Philippines and India likely to move before the end of the year. The former will see inflation ease to around target through the second half of 2024, while the latter will take solace from easing food inflation.

Outside of Asia, central banks in Latin America (LatAm) will also be mindful of their respective rate differentials with the US in determining their policy paths. The European Central Banks (ECB) easing cycle in CEE will offer some breathing space for central banks, but the Fed path will still matter. Nevertheless, characterizing the caution witnessed across EMs as purely a function of the Fed ignores the idiosyncrasies. Diverging inflation paths and varying degrees of political headwinds will likely lead to greater variance in policy decisions, which will mean some central banks hold off easing until 2025, further dispersing the EM easing cycle.

Last mile inflation challenges are not over

Headline inflation has fallen further across regions, but the disinflation process is now slowing (Chart 4). The favorable base effects from energy and food prices have faded, while the disinflationary impact of weaker economic activity in the latter stages of 2023 also looks to have abated.

Chart 4. Disinflation process fading

Additionally, some governments have begun to roll back subsidies and reinstate taxes as part of their post-pandemic fiscal consolidation.

On a regional basis, Asia stands out as having inflation broadly within central banks’ respective target ranges, with only South Korea overshooting. In LatAm and Emerging Europe, Middle East, and Africa (EMEA), bringing inflation back to target has proved harder, with the measure still sitting above this level in Colombia, Mexico, and Romania.

Similarly, there has been a significant easing of core inflation across the board. However, the concern is that service inflation is proving sticky (Chart 5), and inflation could rebound if wage growth remains strong.

Chart 5. Services inflation an issue for some EMs

Service sector strength and resilient labor markets are challenging the disinflation process, leading policymakers to be cautious about last mile challenges. Hungary is a good example; headline and core inflation stood at 4% year over year in May, at the upper bound of the central bank (MNB)’s target range. But core inflation dynamics look considerably worse. Our sequential measure of underlying inflation has surged to 6.9%, and real wage growth came in at 10% year over year in March. These dynamics raise the prospect of the MNB making a policy mistake with further easing, having cut 25 bps at its June meeting. At its next meeting, it will likely join the group of central banks that have paused their easing cycles.

We continue to flag Brazil, Colombia, Mexico, Hungary, and Poland as markets where last mile challenges appear most prevalent due to services dynamics. This may ultimately curtail these central banks' ability to deliver further cuts in 2024.

Politics complicates the policy path

Politics is playing a major role in determining the path of EM easing cycles, adding to the uncertainties for central banks. The flurry of major EM elections in the first half of 2024 and the US election in November play into our view that the monetary easing path will be bumpy for policymakers.

Surprise outcomes in elections in India, Mexico, and South Africa highlight how political risk can be underestimated. Market volatility spiked across all three markets around each election, creating differing challenges for central bankers. On the one hand, Claudia Sheinbaum’s victory in Mexico’s elections sparked a negative market reaction over fears of fiscal slippage and the potential for reforms to politicize the judiciary. The sell-off in the peso and potential for further market volatility associated with the US election will likely keep Banxico hawkish. On the other hand, a market-friendly coalition between the African National Congress party and the Democratic Alliance has been a boost for South African assets. This should give the country’s central bank (SARB) scope to ease before the end of the year as inflation recedes further.

Meanwhile, India’s election result is unlikely to have a notable impact on the central bank’s decision path in the near term. That said, the election highlighted the significance of food inflation for the economy, and we expect this to be a key determinant in the country’s monetary outlook. Elsewhere, political appetite for fiscal consolidation is also waning, given voter pressures. The desire among governments to offset some of the drags from tighter monetary policy and the inflationary squeeze on household incomes risks delaying the disinflation process.

For example, the National Bank of Poland has been on hold since November 2023, partly due to the lack of urgency for fiscal consolidation under the new government. And in Indonesia, market jitters over the new government’s fiscal plans risk also delaying the easing cycle. Similar market concerns over fiscal paths in Brazil, Colombia, and Mexico have resurfaced in LatAm.

1 The Citigroup Economic Surprise Index is constructed using weighted historical standard deviations of surprises (difference between actual releases and Bloomberg surveys) different macroeconomic indicators, where the weights depend on the announcement’s effect on the foreign exchange markets.

Important information

Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed, and actual events or results may differ materially.

Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.