A likely increase in trade protectionist policies among major economies will hurt GDP growth in most emerging markets over the next couple of years. However, the magnitude of the impact will depend on the details of those policies, which will become clearer in the coming months.

For now, we assume only a modest increase in tit-for-tat tariffs between the U.S. and China in 2025 and no new tariffs for the rest of the world. In this scenario, the impact on GDP in most major emerging markets (EMs) outside of China is relatively modest. EMs in Southeast Asia are among the most vulnerable to weaker demand from China.

However, the risk of more aggressive trade protectionist policies, and consequently a greater hit to growth, is high. Trade-related uncertainty will likely result in a period of higher-than-normal volatility in EM assets, potentially increasing risk premia and tightening financial conditions, especially among EMs with weaker macroeconomic fundamentals.

Global Trade Policies Remain Highly Uncertain

While we think it's highly likely U.S. President-elect Donald Trump's administration will increase protectionist policies, the range of possible outcomes is wide and uncertainty is high. In our macro baseline, we opted to include only a modest increase in tariffs between the U.S. and China.

We assume the U.S. will raise the effective tariff on Chinese imports to 25% from around 14% currently, starting in the middle of 2025. We expect China to reciprocate by also increasing its effective rate on U.S. imports to 25%.

We do not assume universal tariffs by the U.S., such as the 10% and 20% rates discussed during Trump's campaigning. We also do not anticipate changes to the United States-Mexico-Canada Agreement (USMCA) before the scheduled July 2026 review, nor do we expect major modifications after the review.

As a result, we now forecast Chinese GDP growth of 4.1% in 2025 and 3.8% in 2026, 0.2 percentage point (pp) and 0.7 pp less than in our September baseline (see "Economic Outlook Asia-Pacific Q1 2025: U.S. Trade Shift Blurs The Horizon," Nov. 24, 2024). China's fiscal response to weaker growth will matter. It has announced only modest new growth-enhancing fiscal expansion so far, with no significant new support for households and consumption. But Finance Minister Lan Fo'an on Nov. 8 said China would "actively utilize" the room for a rise in the official budget deficit in 2025, suggesting some degree of extra fiscal support next year.

In the U.S., our GDP forecast changes have been more modest. The hit to growth from tariffs is not as large as in China, given the larger size of the U.S. domestic market. This factor, combined with stronger-than-expected data over the past quarter and the likely extension of the Tax Cuts and Jobs Act next year, underpins our GDP growth projections of 2.0% for both 2025 and 2026 (see "Economic Outlook U.S. Q1 2025: Steady Growth, Significant Policy Uncertainty," Nov. 26, 2024).

Southeast Asia Is More Vulnerable To Slower Chinese Growth

Because the GDP impact of our trade policy assumptions is larger in China than in the U.S., we expect EMs with closer trade ties to China to be more vulnerable to weaker demand. These are mostly in Southeast Asia and tend to have large shares of final goods exports that go to China (see table 1). Their supply chains are also closely integrated with China's, which means weakness in Chinese exports translates into weaker export performance in their economies.

However, tariffs could also have some positive ramifications for these economies. Higher U.S. tariffs on Chinese exports, in the absence of additional tariffs in Southeast Asian EMs, would make the latter more competitive and could attract more foreign direct investment, including from U.S. firms. But this would likely take some time, especially in highly specialized sectors where delinking from Chinese production is complex and capital intensive.

We expect Chinese investment into these countries to continue despite tariffs, which will also help GDP growth. Furthermore, domestic demand has been recovering strongly across most of Southeast Asia, which will cushion the blow.

Table 1

Some major EMs outside of Asia also have large trade exposure to Chinese demand, especially through commodities. Chile and Peru stand out with significant industrial metals exports, especially copper, to China.

However, even assuming tit-for-tat tariffs between the U.S. and China, we don't expect large hits to growth in Chile and Peru, given structurally higher demand for several metals. For example, demand for commodities that are inputs in the energy transition process, such as for copper in the production of electrical vehicles, is likely to remain strong even in a world of higher tariffs.

Trade Diversion Of Chinese Exports To EMs Could Be Significant

U.S. tariffs on Chinese exporters could accelerate their push into other markets, including EMs. When then-President Trump first announced tariffs on Chinese imports in January 2018, some Chinese goods that had been directed to the U.S. went instead to other markets. Since that time, the share of U.S. imports coming from China has noticeably decreased, while some EMs' and other advanced economies' shares of imports from China have increased (see chart 1).

The impact of this potential trade diversion on EMs is threefold:

• First, domestic manufacturers in EMs will face fierce competition from very cost-efficient Chinese manufacturers, potentially displacing some of their production.
• Second, EM firms exporting to other EMs will also face higher competition from Chinese goods going to those markets.
• Third, greater imports of lower-priced goods from China could have a disinflationary effect.

The net effect would depend on the magnitude of trade diversion and the given imported goods' weights in consumer baskets.

Chart 1

Intermediate Goods Could Also Come Under Scrutiny

One shift in trade flows in recent years has been a higher share of intermediate Chinese inputs being imported into EMs, as China-based manufacturers have moved to higher value-added production and diversified their supply chains (see chart 2). This means that in many cases, goods produced in EMs and exported to other parts of the world have more Chinese inputs than in the past.

If trade tensions between the U.S. and China continue to increase, EM producers with high intermediate goods from China could also face more stringent rules of origin for goods sold in the U.S. market.

Chart 2

This is especially the case for countries with large bilateral trade deficits with the U.S., whose economies could come under more scrutiny by the incoming U.S. administration. The U.S.'s largest five trade deficits with EMs after China are with Mexico, Vietnam, India, Thailand, and Malaysia (see chart 3). Among those five EMs, the share of intermediate imports from China is the highest in Vietnam (33%), followed by Thailand (25%).

Chart 3

Financial Conditions Will Matter As Monetary Normalization Slows

We now expect fewer interest rate cuts by the U.S. Federal Reserve than in our previous macro baseline. Continued strength in U.S. household spending and expected trade tariffs' impact on inflation expectations will likely slow the Fed's monetary policy normalization. We now expect the federal funds rate to end 2025 at 3.50%, compared with our previous expectation of 3.00%.

We also expect greater caution among most major EM central banks, and we've therefore toned down our expectations for their interest rate cuts in 2025 (see chart 4). On balance, we expect a stronger U.S. dollar against most EM currencies in 2025 than in 2024.

Chart 4

Long-term U.S. interest rates have also been heading higher in recent months, which has pushed up long-term yields across most major EMs, though most are still below the highs of 2022-2023. However, uncertainty regarding U.S. trade and fiscal policy could contribute to higher term premia and further raise long-term EM yields, consequently tightening financial conditions for EM borrowers.

Forecast Update

We have lowered our real GDP growth forecasts for EMs excluding China by 10 basis points (bps) for both 2025 and 2026, to 4.3% and 4.4%, respectively (see table 2). We made the largest downward revisions to our 2025 GDP growth projections for Saudi Arabia (down 60 bps), Hungary (down 40 bps), and Mexico (down 30 bps):

• In Saudi Arabia, our revision reflects lower oil production assumptions than previously anticipated.
• In Hungary, persistent weakness in Germany and manufacturing continues to produce lower-than-expected GDP growth.
• In Mexico, the downward revision indicates higher uncertainty regarding its trade relationship with the U.S., which we believe will take a toll on investment.

We made the largest upward revision to our 2025 GDP growth projection for Argentina (up 50 bps), due to better-than-expected inflation and economic activity results in recent months, which we expect to continue into early 2025.

Table 2

Regional summaries

Latin America:  We continue to expect growth in the region to average just over 2% in the coming years, which is lower than in most other EMs. The main changes to our country-specific GDP forecasts are for Mexico (down) and Argentina (up).

In Mexico, we now project GDP growth of 1.2% in 2025 (compared with 1.5% previously). Several sources of uncertainty underpin our view that fixed investment will be weaker than we previously anticipated:

• First, under U.S. President-elect Trump, the threat of changes to the USMCA, scheduled for review in mid-2026, could delay investment decisions. Our baseline scenario assumes no major changes to the USMCA, neither before nor during the review process.
• Second, U.S. immigration policy toward Mexico is also likely to be contentious under the incoming U.S. administration, which could influence proposed changes in trade policy and weaken investment as well as remittances.
• Third, recently approved Mexican reforms--such as changes to the judicial system--that in some cases still require secondary legislation could also delay investment decisions until there is more clarity on the implications of those bills.

In Argentina, we now project growth of 3.8% next year, after an anticipated contraction of 3.5% in 2024 (we previously projected 3.3% growth for 2025). President Javier Milei's administration has delivered on the fiscal front, returning the budget to surplus in a very short period and making significant progress on lowering inflation. The economy returned to sequential growth in the third quarter, a trend that has likely continued in the fourth quarter, and we expect some momentum to flow into 2025. That said, the downside risks to our growth outlook are substantial: Foreign reserves remain very low, and exchange rate policy is highly uncertain.

In Chile, we maintained our GDP growth forecasts of 2.4% for 2024 and 2.2% for 2025. Activity in the nonmining sectors remains subdued, and business confidence is still relatively weak. However, we expect monetary easing and higher copper prices will support growth.

In Peru, we raised our GDP forecasts marginally to 2.9% for 2024 and 2.8% for 2025, compared with 2.7% for both years previously. The increase reflects a recovery in consumption during the second half of 2024, helped by pension fund withdrawals and a rebound in primary exports. In 2025, we expect private investment to recover as several new mining and infrastructure projects begin.

In Brazil, growth continues to surprise to the upside. We project GDP growth of 3.1% in 2024 and 1.9% in 2025 (we previously projected 2.8% for 2024 and 1.8% growth for 2025). Fiscal stimulus, which is keeping household consumption high, continues to propel growth. This has kept a positive output gap of about 1.5% of GDP, by our estimates, increasing inflation expectations and prompting the Brazilian central bank to restart interest rate hikes. We expect interest rates to rise into early 2025, until inflation expectations start to return toward the central bank's 3% target.

In Colombia, we kept our growth projections unchanged at 1.7% for 2024 and 2.5% for 2025. While investment is starting to slowly recover, we expect it to remain relatively weak in the coming quarters due to uncertainty over several reforms proposed by President Gustavo Petro, as well as over the government's fiscal path. Growth in Colombia is likely to remain relatively weak until investment recovers more markedly.

EM EMEA:  We now expect slightly lower growth for the region in 2024 and 2025 than we did last quarter, mostly due to weaker-than-expected third-quarter economic activity data in Central Europe and Eastern Europe.

In Hungary, we now project 1.0% GDP growth in 2024 (down from 1.8%), while in Poland we expect 2.8% (down from 3.0%). High-frequency indicators point to weaker momentum in investment and household consumption, partly due to weak growth in Germany and elevated real interest rates. For 2025, we project growth of 3.1% for Poland and 2.6% for Hungary, but high global interest rates remain a key downside risk.

We kept our GDP growth forecasts for Turkiye unchanged at 3.1% for 2024 and 2.3% for 2025. High-frequency indicators point to a mild GDP contraction in third-quarter 2024, in line with our expectations. We anticipate an upcoming minimum wage increase to support stronger growth in the first quarter of next year.

Following recent OPEC+ announcements, as well as developments in global oil markets, we lowered our assumptions for Saudi Arabia's oil production to 9.5 million barrels per day in 2025 (from 9.7). That, together with lower-than-expected non-oil sector growth in the third quarter, prompted us to lower our growth projections for Saudia Arabia to 0.8% in 2024 and to 4.7% in 2025.

 We increased our GDP growth forecasts for South Africa to 1.0% in 2024 and 1.6% in 2025, both up 10 bps, due to better-than-expected growth in retail sales and the introduction of a two-pot pension scheme. The scheme allows partial withdrawals of retirement funds, which we expect to support household consumption in the short term. Ongoing infrastructure issues (particularly related to transportation) continue to constrain growth, but momentum for reform offers potential upside for the medium- and long-term growth outlooks.

EM Southeast Asia:  Uncertainty is heightened in the economic outlook for EM Southeast Asia. The region has a relatively high reliance on trade and external demand, both of which changes in U.S. trade policy may disrupt.

In addition, Southeast Asia has increasing interlinkages to China's economy via final demand in China and as an investment source. China's foreign direct investment into Southeast Asia has been increasing markedly in recent years. We expect the slower growth in China will slow demand in Southeast Asia, but we expect investment inflows from China to continue.

Notwithstanding the higher uncertainty, economies in the region are performing well:

• Domestic demand is broadly resilient, with services, including information technology, communication services, and finance, propelling economic activity.
• The recovery of tourism is also a significant theme this year, with travel-related activity growing strongly. Tourism growth should fall back to normal levels over 2025.
• In manufacturing, the electronics sector continues its outperformance, while trade more broadly is steady.

Meanwhile, inflation is under control in the region, and some central banks have begun easing monetary policy as a response. Goods prices could face more pressure, however, if trade frictions between the U.S. and China increase, given goods flows will likely make their way into the rest of Asia.

Nonetheless, the higher U.S. long-term yields have led to capital outflow pressure in EM Asia. Central banks are sensitive to capital flows and exchange market pressures and, as a result, will be cautious in easing monetary policy.

We made large upward revisions to growth in Malaysia and Vietnam. The common factor is both economies' involvement in strongly performing global electronics supply chains. Domestic demand has also held up well in both economies. In Vietnam, the financial and real estate sectors are recovering after challenges in 2023.

In India, our near-term outlook is unchanged, and we expect domestic-oriented high growth to continue. However, we expect growth to moderate in the fiscal year beginning April 2025. Consumer growth momentum is gradually slowing with pockets of weakness in the rural sector and the large urban middle-income segment. Manufacturing competitiveness is another challenge amid globally high spare capacity.

In the Philippines, we expect modestly slower growth compared with our previous forecast, given softer consumption growth. The central bank is now easing monetary policy, and ongoing infrastructure investment will support the medium-term outlook.

Our forecasts are broadly unchanged in Indonesia and Thailand. Inflationary pressures are contained in both economies, and domestic demand is broadly steady. Bank Indonesia is likely to cut interest rates more gradually, given the resurgence of capital outflow pressures. The country's outlook will depend on emerging economic sectors such as electric vehicles and clean energy batteries. For Thailand, ongoing fiscal stimulus will support near-term growth.

Risks To Baseline Growth

The risks to our growth forecasts are firmly to the downside, given the uncertainty surrounding U.S. trade policy under President-elect Trump's administration. While for now we assume a relatively small increase in tariffs between the U.S. and China, the risk is high that these measures could end up more aggressive than we expect.

Another risk is that tariffs could be applied to other countries. Under these more aggressive trade protectionism scenarios, we would expect a large hit to global trade and consequently global demand. That would also likely result in higher risk premia, further tightening financial conditions for EMs, especially for those with weaker macroeconomic fundamentals.

Finally, geopolitical risks remain high, especially those associated with the Russia-Ukraine conflict. The war continues to escalate with the launch of ballistic missiles. Uncertainty surrounding the conflict could increase risk aversion toward EM assets and also influence commodity prices.

Appendix Tables

Table 3

Table 4

Table 5

Table 6

Table 7