Negative credit conditions to make 2023 challenging for emerging markets: Moody's

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Emerging markets will face a difficult economic and financing environment that will permeate to sovereigns, companies and banks in 2023, said credit ratings agency Moody's in its 2023 Outlook Report.

"Next year will present a challenging backdrop for emerging markets (EMs). Our negative outlook on credit conditions for EMs will permeate to sovereigns, companies and banks. Although higher-rated EM issuers have the credit fundamentals to weather the turn in the cycle, weaker entities with ratings of B or below are vulnerable given their limited financing options and reduced capacity to absorb shocks," said the report.

Moody's has referred to the weak growth in advanced economies, persistent inflationary pressures, the Russia-Ukraine conflict, tight financial conditions, and a subdued growth outlook for China, as the causes for its negative outlook for emerging markets next year.

Trends will, however, be more nuanced across the corporate landscape. "Exposure to sovereign risk will be a credit constraint for many EM companies. EBITDA performance will be nuanced in specific sectors but higher borrowing costs and inflation will lower profit growth and hurt demand as consumers' purchasing power weakens. Negative credit pressure in China's property sector will be high," said the report.

However, despite the deteriorating credit condition as well as the rise in problem loans, provisioning charges, and operating expenses, most emerging market banking systems have been given a stable outlook. This reflects the expectations that banking systems can absorb these challenges.

Lower government revenue, competing policy priorities and eroded fiscal buffers could make climate change mitigation and adaptation financing more scarce, while extreme weather events are becoming more common.

US interest rates will be higher for longer

According to the report, the direction of the US monetary policy, that continues to be hawkish, suggests that interest rates will remain higher for longer, even as core inflation softens.

"We expect the Fed to take the Fed funds rate to 5 percent at its February 2023 meeting, before pausing to assess the effect on the economy. Our baseline scenario is that of a mild US recession by the second quarter of 2023," Moody's said in its report.

Commodity prices will also have an impact on emerging markets. While prices have fallen recently, an escalation of the Russia-Ukraine war could drive them back up.

Commodity prices could also ease due to a slowdown in global growth, particularly from a slowdown in demand from China. But this would in turn reduce overall import demand and reduce financial flows as well. "The Asean region is most exposed to slowing growth in China, although countries and producers that have capacity to fill the gaps created by China may benefit," said the report.

Growth will accelerate in 2024

Even in a situation where the market improves faster-than-expected, growth in 2023 would still be weak relatively, due to scarring from the downturn. However, although emerging market credit conditions are expected to trend negatively next year, improvement in global consumption and improvement will lead to emerging markets growth to accelerate in 2024, said the report.