The Fed’s decision not to begin tapering just yet has reverberated throughout the global economy, but emerging markets are particularly affected because tightening monetary policy in the US pulls capital out of EM economies. So far we’ve only heard from two EM central banks, India and South Africa, and both acknowledge that they have only received a temporary reprieve. EM countries’ best bet is to grow exports, but Citi Head of EM Economics David Lubin isn’t optimistic that they’ll pull it off.

Emerging market exports causing deficit

“The prospect of US monetary tightening is, as always, a factor that pulls capital away from emerging market,” writes Lubin. “The countries that suffer most from this process are those that have the greatest dependence on capital inflows.” The problem is that EM deficits haven’t been caused by rising imports, something governments have policy tools to deal with, but by falling exports. In the past, EM exports have been closely tied to developed market imports, and that could be true again in the coming months, but there is some reason for skepticism.

emerging market export vs g10 import

While GDP growth increased in many DM countries last quarter, GDP growth for BRIC was flat. “It is absolutely possible that there is a lag between a G10 pick-up and an EM export response,” writes Lubin, but he gives three reasons why we might actually be seeing a decoupling of DM imports and emerging market exports.

Japanese recovery

First, since the Japanese recovery is predicated on a cheap Yen, import substitution seems likely. The domestic portion of chemicals, iron, and steel supply is already rising, and this effect could spread to other sectors, reducing import growth from emerging markets.

japan steel chem domestic supply

Import compression

Second, DM growth may not help as much as it has in the past. The Eurozone recovery will be less friendly towards emerging market exports than previous growth because it is being accompanied by import compression. In the past, only Germany had a current account surplus, but now most of the Eurozone is following suit, partially a result of ongoing deleveraging. Also, the growth of emerging market ’s share of US imports is falling. Lubin notes that you can’t draw too much from this, “but the trend isn’t encouraging.” The sensitivity of EM imports to US industrial production has also fallen, giving further reason to see a decoupling between a US recovery and EM exports.

Finally, emerging markets are driven by Chinese demand as much as by developed markets, and that demand is leveling off. “We’ve repeatedly emphasized how ‘China-dependent’ EM is as an asset class and as a group of economies,” writes Lubin. If China manages to funnel its oversupply of manufacturing into its under-supply for services, many EM exporters could be left high and dry.

export momentum to china and from EM