14 February 2017
Weak investment in emerging markets has been a key cause of the economic lethargy experienced over the past three years. Commodity-producing countries cut capex in response to falling prices and manufacturing exporters reduced capex in response to weak external demand. In addition, China, the largest source of investment in the EM universe, was suffering from policy uncertainty and a correction in the housing market that significantly reduced private investment. Following years of sluggish investment, we think EM business capex will improve over 2017, albeit selectively. First, the rebound in commodity prices is spurring capex in commodity exporting countries following years of contracting investment growth. Second, DM investment is rebounding which will support the EM trade and investment cycle, especially in Asia.
Nevertheless, the capex outlook is decidedly mixed. Outside of Asian manufacturers, most of the improvement is set to come from government investment (infrastructure or SOE-led investment) or private investment in commodity sectors. There are few indications that private, non-commodity business investment is set to meaningfully improve among EM economies. This nuance is important due to the fact that EM governments have limited room on the public balance sheet to support sustained investment growth and, more importantly, few EMs have, due to slow progress on reforms, improved the environment for private business investment. Should commodity prices turn down, capex would again be under pressure.
Taking a country-by-country view among the BRIC countries, investment appears to be accelerating in China and Russia, relatively lacklustre in India, and still weak in Brazil. Starting with China, most indicators point to a recent acceleration in capex above what is indicated by the monthly fixed-asset investment (FAI) figure. We think the monthly FAI data suffers from measurement and reliability issues and does not accurately portray capex as would be measured by gross fixed-capital formation. Using output value of construction and machinery sales as two proxies closely correlated to capital goods imports and more likely representative of new investment, one can see the substantial rebound from lows in Q1 2015 (see Chart 10). The surge in capex has been primarily driven by housing and infrastructure, so sustainability is a question with credit growth and housing investment set to slow. The government will have to do more to liberalise sectors and level the playing field between private and state firms in order to encourage all-important private investment. Russian investment looks set to pick-up faster than initial forecasts following a three-year investment drought owing to the impact of the OPEC deal, a stronger ruble, and the perception of subsiding geopolitical tensions (see Chart 11). Capex in India is still heavily driven by public capex. A rebound in private investment is being held back due to pressured bank balance sheets, slow credit growth and low capacity utilisation; additionally, the demonetisation move could further delay corporate investment plans. Lastly, capex in Brazil will continue to be held back by still-high interest rates, high corporate leverage, low capacity utilisation and political uncertainty. Bottom line – EM economies will continue to see differentiation and divergence as they move through different stages in their capex cycles.
Alex Wolf, EM Economist