China, as we all know, was the first country to be severely impacted by the coronavirus, but it is also the first to chart a path back toward some kind of normalcy. Today, China’s economic recovery continues ticking along and we are even seeing some indicators showing growth relative to last year. It’s important to highlight that the weighting of China in the MSCI Emerging Markets index also continues to grow and is now almost at half of the index. 
However, beyond China, we think that the outlook for emerging economies is challenging in the near-term. Importantly, though, as we start to see signs of success among other emerging markets in managing the Covid-19 outbreak, we do see some tailwinds on the horizon.
Short-term challenges: Healthcare and income-loss worries
It cannot be ignored that there are some short-term challenges that emerging markets will have to face. First, the outbreak of Covid-19 has been severe in most of these countries, with nations such as Brazil, South Africa and India finding the virus difficult to contain. The charts below show the daily new cases for the major emerging market economies, with Brazil, South Africa and India all experiencing over 10,000 new cases per day. More concerning, the testing rates in these countries remains quite low, suggesting that the actual number of infections may be much higher.
Source: Russell Investments
Source: Russell Investments
The difficulty in containing the outbreak is twofold
First, given the lower levels of income (and lower fiscal space, which we will discuss in more detail below), individuals are less likely to take time off from work if they become infected by the virus, due to fears over loss of income.
Second, the healthcare systems in these nations are generally poorly equipped for this kind of outbreak.
Muted stimulus response also a challenge
The other major challenge for emerging markets is that the stimulus response from authorities has been more muted than in developed markets. While the central banks of emerging market nations went into the crisis with more firepower than their developed peers – allowing them to cut interest rates more aggressively – the asset purchase programs in these nations have not been as expansive. It is worth noting that in some countries, including Brazil and Indonesia, there is still room for further rate cuts if necessary, given that real rates (i.e., cash rates adjusted for inflation) are still positive.
On the fiscal side, emerging market governments in general have had less room to introduce big budgetary measures. The Bank of International Settlements notes that emerging markets budgetary and guarantee measures amount to about 3 per cent, compared to closer to 15 per cent in developed markets (a percentage that is likely to increase further when US lawmakers reach a deal on a second coronavirus stimulus package).
And lastly, a further challenge comes in the form of the combination of limited exports and high levels of external debt, which may also pose a financing risk for some emerging market nations. In particular, Indonesia, Brazil and Russia stand out as having high levels of external debt – of which about 10-15 per cent is in shorter-term debt. We see this as less of a risk than the previous two but a factor that investors should continue to keep an eye on as we move into the next phase of the Covid-19 crisis and towards a global economic recovery.
Tailwinds for emerging markets: A weaker US dollar?
Having focused on the shorter-term headwinds, it’s important to note that we do foresee some tailwinds for emerging-market assets, particularly as emerging market countries pull through the Covid-19 crisis.
Top among these is that the resurgence of global growth tends to be good for higher beta – or more volatile – equities, such as emerging markets and Europe. In essence, the desire to hold US dollars fades as more countries begin to recover economically, which in turn weighs on the US dollar. Ultimately, this provides some breathing room for economies with high levels of external debt, such as the ones mentioned above.
Of course, to the extent that this leads to currency appreciation, this could provide a small headwind to export attractiveness. We have seen this dynamic start to play out already, as shown below, with most emerging market currencies appreciating against the US dollar since the trough in the S&P 500 on 23 March.
Source: Russell Investments
The bottom line
Today, emerging-market economies outside of China are confronted with a slew of near-term challenges, primarily due to difficulties in controlling the Covid-19 outbreak as well as fiscal-stimulus constraints. Assuming that these nations are better able to manage the virus over the next several months, we believe that the higher beta nature of these economies, coupled with a weakening of the US dollar, could become tailwinds as the global economic recovery continues.
Alexander Cousley is a senior investment strategy analyst at Russell Investments. The views expressed above are his own and should not be taken as investment advice.