SABB/HSBC Emerging Markets Index Q3 2012: Recovery in emerging markets remains elusive as sluggish global trade hits growth

The SABB/HSBC EMI Index slipped to 52.1, from 53.2 in the second quarter, with the rate of emerging market growth at its weakest for a year and its second-slowest since Q2 2009, when the global economy began to recover from the 2008 financial crisis. Despite continued growth, service sector expansion touched its weakest level for a year while manufacturing output declined marginally, at a similar rate to the previous contraction seen in the final quarter of 2011.

Among the four largest emerging economies, Brazil and China underperformed India and Russia in the third quarter. Brazilian private sector firms noted a broad stagnation in both manufacturing and services activity. Service sector output failed to expand for the first time in three years while flat manufacturing at least represented a stabilization following a modest decline during the second quarter. Chinese output rose only marginally, a consistent trend since the second half of 2011, while goods production fell for the fifth successive quarter.

Growth rates stabilized at sub-par levels in both India and Russia although Russian manufacturing demonstrated some resilience, registering the strongest performance in six quarters in terms of output growth and outperforming the county's service sector for the first time since Q1 2011. In contrast, Indian manufacturing posted its worst quarter in 2012, although growth in the service sector accelerated slightly.

Dr Murat Ulgen, HSBC's Chief Economist for Central and Eastern Europe and sub-Saharan Africa, said: "Emerging economies are being impacted by the misery of the developed world as the deteriorating global trade cycle, weaker external demand and falling new export orders hit manufacturing output and the services outlook. The loss of momentum also partly stems from domestic policy choices for restraint after a very resounding recovery in late 2009 and 2010. The end result is disappointment as the emerging world, in particular China, continues to surprise to the downside. So where do we go from here? We are still tempted to see the loss of momentum in the emerging world as cyclical, rather than structural. As such, monetary and fiscal stimuli will likely have an impact on activity although this may take longer than usual as the structural problems in the developed world continue to weigh on trade and undermine the confidence of consumers and businesses around the globe. The much vaunted recovery in emerging markets may be delayed as a result."

Nonetheless, emerging markets still present better opportunities. The world's big central banks have thrown a safety net under the financial system with the provision of unprecedented liquidity and the massive expansion of their balance sheets. It may help stop things from getting worse in the developed world, but that safety net also gives emerging markets a good springboard. That assumes policymakers do not repeat the mistakes of excessive credit-driven growth in the West, keep their balance sheets clean and their economies competitive with access to cheaper global capital and investments in productivity-boosting areas.

New export orders for emerging markets manufacturers fell for the third successive quarter across the world's emerging markets, representing the strongest decline since Q1 2009. Combined with the slowest increase in service sector new business for four quarters, the overall pace of new business was the weakest since Q2 2009.

Looking ahead, although manufacturing was mainly responsible for third quarter weakness, the longer-term outlook for the services economy deteriorated to its lowest level since the survey began in 2005. Service sector sentiment moderated across all of the four largest emerging economies, with Brazil posting the most substantial deterioration quarter-on-quarter. This was in marked contrast to the second quarter, when service providers were at their most optimistic for two years. China's service providers were still the least optimistic overall in the third quarter, while their Indian counterparts were the most confident.

The latest SABB/HSBC Emerging Markets Index (EMI) revealed the weakest input cost inflation in over three years as the average cost of inputs to manufacturers fell for the first time since Q2 2009, driven largely by China which saw a fourth successive quarterly decline in prices. In the service sector, input cost inflation was the slowest in 11 quarters, with China the weakest amongst the four largest emerging economies.

With the moderation in economic growth across the emerging world during the third quarter, emerging market companies continue to be reticent regarding employment growth.

The average rate of employment growth across both sectors was the joint-weakest since workforces resumed their rise in Q3 2009. Overall workforce growth was centered on the service sector, where the rate of growth was in line with the modest trend of the last five quarters. Conversely, manufacturers continued to trim their workforce, marking a fourth consecutive quarter of marginal job shedding.