3 ECONOMIC CHALLENGES FACING EMERGING MARKETS IN 2017

Peru 2017 | ECONOMY | FOCUS

After a very unstable end to 2015, the world economy experienced rapid recovery in the first months of 2016 as commodity prices improved and capital markets strengthened. However, events such as the Brexit referendum sparked global uncertainty and negatively impacted investor sentiment in global markets. Moving into 2017, we look at three major challenges facing emerging markets like Peru over the coming year.

The Rise of Protectionism

The populist surge in Europe and the US over the past year has encouraged protectionist economic policies in both continents. The British vote to leave the European Union and the election of Donald Trump in the US have shown that a sizable proportion of citizens in developed nations are ready to oppose free trade and economic globalization. Populist leaders and their parties garnered a broader support base and made considerable inroads into European parliaments throughout 2016.

Recently, the Italian Five Star Movement (M5S) demonstrated its political influence by motivating people to vote against the constitutional referendum proposed by former Prime Minister Matteo Renzi. If M5S became the ruling party in Europe's third largest economy, they too could hold a referendum to decide whether or not to leave the EU. Elsewhere, France is set to hold presidential elections in 2017, and Marine Le Pen's National Front is among the parties leading the polls.

On the other side of the Atlantic, President-elect Donald Trump has threatened to cancel NAFTA and it seems likely that he will not favor new FTAs. Deemed a form of “economic malpractice" by IMF Managing Director Christine Lagarde, protectionism in developed nations threatens to hinder economic growth in emerging economies over the course of 2017.

A Strong Dollar and Federal Reserve Hikes

The Federal Reserve (FED) finally raised its interest rate in December 2016 for the second time in the last decade. Markets had been expecting this increase in borrowing costs for nearly a year.

Since the 2008 financial crisis, the US central bank had maintained its key lending rate at close to zero. Having analyzed the relevant macroeconomic indicators and taking into consideration the stock market rally following Trump's election, the FED board saw a window of opportunity to lift its interest lending rate.With loans now more expensive, banks will be lending less, leading emerging currencies to depreciate further against the dollar. Consequently, assets and bonds in emerging markets could become less attractive to investors, as the amount of debt denominated in US dollars becomes a burden for these economies.

However, interest rates are still relatively low, and are not expected to pose an immediate threat to emerging countries. The benchmark stands at between 0.5% and 0.75%, low compared to the 2006 rate which neared 6%. The FED is set to make three additional increases in 2017, depending on developments in the US economy over the year.

Commodity Prices

Despite expected volatility, many commodity prices grew considerably in the final months of 2016. This increase came partly as a result of the OPEC deal to curb oil production as well as Trump's election promises for infrastructure projects, which pushed up the prices of copper and other metals.

This year-end rally has been welcomed by emerging economies, which are typically reliant on their mining and oil industries. If prices continue to rise, developing countries will have more foreign exchange earnings and will be able to draw up larger annual budgets, a scenario which would come as a relief after a two-year struggle to balance high growth rates and low commodity prices.

According to Bloomberg, an overall increase in commodity prices is expected in 2017. Economic optimism in China and the US is expected to underlie expansionist economic policies and also to increase investment in infrastructure. President-elect Trump has promised to lower taxes and pursue a USD1 trillion infrastructure plan, both of which would be sure to boost commodity prices, the US being one of the world's largest consumers of raw materials. Commodity investors will remain cautious, however, given the volatile developments of the past two years.