Post on 16-Oct-2020
Emerging Markets ExplorerEM Liftoff on US Fed Hike
March 2015
Strategy — Get Ready for EM Catch Up Macro — Global Economic Recovery Watch — The Fed
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Emerging Markets Explorer
CONTENTS
Executive Summary................................................................................................................................................................................... 3
SEB EM Forecasts and Track Record ...................................................................................................................................................... 4
Macro Overview: Liftoff in EM Assets to Follow US Rate Hike ............................................................................................................ 5
Theme: China — Focus on the Currency, Not Interest Rates ............................................................................................................ 10
Two Scenarios ...................................................................................................................................................................................... 11 Theme: Effects of Lower Oil Prices ........................................................................................................................................................ 13
Strategy: Based on Medium-term EM Strength ....................................................................................................................................15
Trading Recommendations ................................................................................................................................................................15 Fixed Income: Diverging Dynamics ...................................................................................................................................................15
Election Monitor ...................................................................................................................................................................................... 18
Country Section ....................................................................................................................................................................................... 19
Asia ............................................................................................................................................................................................................ 19
China .................................................................................................................................................................................................... 19 Hong Kong ........................................................................................................................................................................................... 19 India ...................................................................................................................................................................................................... 19 Indonesia ............................................................................................................................................................................................. 20 South Korea ......................................................................................................................................................................................... 20 Malaysia ............................................................................................................................................................................................... 20 Philippines ........................................................................................................................................................................................... 21 Singapore ............................................................................................................................................................................................. 21 Taiwan .................................................................................................................................................................................................. 21 Thailand ............................................................................................................................................................................................... 21
Emerging Europe ..................................................................................................................................................................................... 22
Czech Republic ................................................................................................................................................................................... 22 Hungary ............................................................................................................................................................................................... 22 Poland .................................................................................................................................................................................................. 23 Romania ............................................................................................................................................................................................... 24 Russia ................................................................................................................................................................................................... 24 Turkey .................................................................................................................................................................................................. 25 Ukraine ................................................................................................................................................................................................. 26
Latin America ........................................................................................................................................................................................... 26
Brazil ..................................................................................................................................................................................................... 26 Chile ...................................................................................................................................................................................................... 27 Mexico .................................................................................................................................................................................................. 28
Sub-Saharan Africa ................................................................................................................................................................................. 29
Botswana ............................................................................................................................................................................................. 29 Ghana ................................................................................................................................................................................................... 29 Kenya .................................................................................................................................................................................................... 29 Nigeria .................................................................................................................................................................................................. 30 South Africa ......................................................................................................................................................................................... 30
Disclaimer ................................................................................................................................................................................................. 32
Contacts ................................................................................................................................................................................................... 33
EDITOR
Per Hammarlund
CONTRIBUTORS
Olle Holmgren
Andreas Johnson
Magnus Lilja
Peiqian Liu
Dennis Masich
Dag Müller
Fredrik Skoglund
Anders Söderberg
Louise Valentin
Sean Yokota
Disclaimer: See page 32
Contacts: See page 33
Cut-off date: 12 March, 2015
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Emerging Markets Explorer
Executive Summary
TRADE RECOMMENDATIONS (MORE ON P. 15)
USD/MXN Look to sell USD/MXN
on US Fed Rate hike
USD/RUB Look to sell USD/RUB at 65.0
for move to 57.0
EUR/CEE4Look to sell EUR vs
PLN, RON, and HUF
USD/Asia Go long USD vs CNY, AUD,
MYR, SGD, and THB
MACRO OVERVIEW
Our outlook for Emerging Market (EM) assets, in particular EM currencies and equities, is cautiously optimistic, primarily for
three reasons. First, economic weakness in the euro zone appears to have bottomed out. Although it will not be stellar, we
expect real GDP growth to accelerate slightly from 1.0% in 2014 to 1.2% in 2015. Second, the US economy is gaining
momentum, and looks set to expand by 3.5% in 2015. Third, we believe that China will continue to deliver strong, albeit moderating growth of 7.0% in 2015.
While EM assets will suffer during the first half of the year, and potentially into the third quarter due to uncertainty over the
timing and pace of the US Fed monetary policy tightening and the effects of ECB quantitative easing, especially on Central
and Eastern Europe (CEE), an improvement in the global economic outlook will support EM assets in the latter part of the
year. However, there will be important exceptions, and differentiation among countries will be crucial. Countries such as
Brazil and Turkey look particularly vulnerable, while countries with strong fundamentals and ties to the US and Chinese economies look set to benefit. After years of sub-par returns on EM investments, it is time to get ready for re-entry.
THEMES
Market’s attention has been on China’s monetary easing where the central bank (PBoC) has delivered 2 interest rate cuts
after 2 years on hold. Most China analysts including SEB expect more to follow. Monetary easing has been an ongoing trend
for the last 12 months. Instead of interest rates, investors should focus on the recent change in foreign exchange policy. We
are starting to see the central bank’s behaviour shifting to allow USD/CNY fixing to rise (i.e., weaken CNY vs USD). In addition
to shorting CNY vs USD, we think the best way to invest would be to continue to be short commodities and the Australian Dollar (AUD), or in Asia to be short the Malaysian Ringgit (MYR) or Singapore Dollar (SGD).
Since July 2014, oil prices have fallen by some 50% from USD 110-115 per barrel to current levels around USD 60. The price
fall has been driven by a combination of factors. Increasing supply is one explanation. At the same time, demand growth in
China and Europe has moderated and contributed to the downturn. Oil price downturns are usually positive for the world
economy and global GDP growth. However, country-specific effects vary widely. The big winners will be economies that are
heavy users of energy and dependent on oil imports. Taking a look at the BRIC economies and Turkey reveals that there are two clear winners (India and Turkey), one obvious loser (Russia) and two economies where effects will be limited.
STRATEGY
Monetary policy is being eased in key Asian economies. In addition to shorting CNY vs USD, we think the best way to invest
would be to continue to be short commodities and the Australian dollar (AUD), or in Asia to be short the Malaysian ringgit
(MYR), Singapore dollar (SGD), or Thai baht (THB). The Mexican peso is currently under pressure due to the low oil price and
concerns over corruption involving both President Nieto and Finance Minister Videgaray. However, fundamentals are good
and MXN will benefit from the US economic recovery as well as a gradual increase in the price of oil in 2H’15. The Russian ruble (RUB) will continue to trade with oil, and we recommend buying RUB when we see a sustainable rise in oil prices.
In our fixed income portfolio, we are increasing the weight in Hungary, given a potential upgrade of the country’s rating. We
are pulling Turkey to market weight, after the political turmoil surrounding the central bank. We are going underweight in
South Africa, due to a potential downgrade. And, finally, in Poland, we are going slightly underweight, after the central bank
signalled that the rate cutting cycle may be over. The bonds were looking rather expensive, even pre-announcement.
However, we are keeping our overweight positions in Russia, Brazil and Mexico. We still believe that EM FX is currently looking very cheap and it is likely to perform well post the initial US rate hike.
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Emerging Markets Explorer
SEB EM Forecasts and Track Record
SEB EM FX Forecasts (end of period) SEB EM Policy Rate Forecasts (end of period)12-Mar-2015 Spot 2Q-15 3Q-15 4Q-15 1Q-16 4Q-16 12-Mar-2015 1Q-15 2Q-15 3Q-15 4Q-15 1Q-16
vs. EUR Asia
PLN 4.15 4.20 4.15 4.07 4.05 3.90 China lending 5.35 5.35 5.00 4.75 4.75 4.75
HUF 305 311 309 302 300 290 China deposit 2.50 2.50 2.25 2.00 2.00 2.00
CZK 27.3 27.5 27.5 27.5 27.5 25.5 China RRR 19.50 19.50 19.00 18.50 18.00 18.00
RON 4.45 4.50 4.45 4.39 4.30 4.15 Korea 2.00 1.75 1.50 1.50 1.50 1.50
TRY 2.75 2.84 2.85 2.86 2.85 3.00 India 7.50 7.50 7.25 7.00 7.00 7.00
RUB 64.8 70.4 61.8 56.1 53.0 50.0 Indonesia 7.50 7.50 7.25 7.25 7.25 7.25
RUB BASKET 62.9 68.5 60.8 55.5 53.0 50.0 Malaysia 3.25 3.25 3.25 3.25 3.50 3.50
vs. USD Philippines 4.00 4.00 4.00 4.00 4.00 4.00
RUB 61.3 67.0 60.0 55.0 53.0 50.0 Thailand 1.75 1.75 1.50 1.50 1.50 1.50
TRY 2.59 2.70 2.77 2.80 2.85 3.00 Taiwan 1.88 1.88 1.88 1.88 2.00 2.00
PLN 3.92 4.00 4.03 3.99 4.05 3.90 Emerging Europe
HUF 288 296 300 296 300 290 Poland 1.50 1.50 1.50 1.50 1.75 2.00
CZK 25.8 26.2 26.7 27.0 27.5 25.5 Czech 0.05 0.05 0.05 0.05 0.05 0.25
UAH 21.67 30.00 30.00 30.00 30.00 30.00 Hungary 2.10 1.90 1.60 1.60 2.00 2.50
ZAR 12.35 11.95 12.20 12.50 12.70 13.00 Turkey 1W repo 7.50 7.50 7.50 7.75 9.00 10.00
KES 91.8 92.0 93.0 94.0 95.0 Turkey O/N borrowing 7.25 7.25 7.25 7.25 7.50 8.00
NGN 199 200 200 200 200 Turkey O/N lending 10.75 10.75 10.75 11.00 11.50 12.00
BRL 3.17 3.20 3.30 3.40 3.45 3.80 Romania 2.25 2.00 2.00 2.00 2.25 2.50
MXN 15.44 14.70 14.40 14.10 14.00 13.00 Russia Key Rate 15.00 13.00 10.00 8.00 8.00 8.00
CLP 633 650 660 670 670 580 Ukraine 30.00 30.00 30.00 30.00 20.00 20.00
CNY 6.26 6.35 6.25 6.20 6.25 6.10 Latin America
CNH 6.27 6.35 6.25 6.20 6.25 6.10 Brazil 12.75 12.75 13.25 13.50 14.00 14.00
HKD 7.76 7.80 7.80 7.80 7.80 7.80 Chile 3.00 3.00 3.00 3.00 3.50 3.75
IDR 13,189 13,500 13,000 12,800 12,800 12,500 Mexico 3.00 3.00 3.00 3.50 3.75 4.00
INR 62.7 64.0 63.0 60.0 60.0 56.0 Sub-Saharan Africa
KRW 1,129 1,140 1,130 1,110 1,110 1,050 S. Africa 5.75 5.75 5.75 6.00 6.25 6.75
MYR 3.69 3.73 3.70 3.65 3.67 3.35 Nigeria 13.00 13.00 13.00 13.00 13.00 13.00
PHP 44.3 45.5 44.0 43.0 43.0 41.0 Kenya 8.50 8.50 9.00 9.00 9.00 9.00
SGD 1.39 1.40 1.38 1.37 1.38 1.30 Source: Bloomberg, SEB
THB 32.8 35.0 34.5 34.0 34.0 33.0
TWD 31.6 32.7 32.5 32.3 32.5 30.5
EUR/USD 1.06 1.03 1.02 1.00 1.00 1.00
USD/JPY 121.4 125 128 130 135 140
EUR/SEK 9.07 9.40 9.10 9.00 9.00 9.00
USD/SEK 8.54 9.13 8.92 9.00 9.00 9.00
SEB Real GDP Forecasts EM FX Recommendations: Track Record2011 2012 2013 2014 2015 2016 # of recommendations Hit Ratio P&L
SEB EM Aggregate 7.4 6.4 4.9 4.8 4.7 4.9 2008 11 72.7% 22.8%
Asia 2009 14 50.0% 10.4%
China 9.3 7.7 7.7 7.4 7.0 6.7 2010 11 54.5% 19.5%
India 6.5 4.4 4.6 5.3 7.3 7.6 2011 8 50.0% 17.8%
Indonesia 6.5 6.3 5.8 5.0 5.4 5.7 2012 12 58.3% 4.0%
South Korea 3.7 2.3 3.0 3.3 3.5 3.5 2013 8 50.0% 1.2%
Singapore 6.2 3.4 4.4 2.9 3.2 3.6 2014 7 42.9% -4.3%
Philippines 3.6 6.8 7.2 6.1 6.2 6.3 Total 71 54.9% 71.4%
Malaysia 5.4 6.5 5.1 5.8 5.2 5.3 Average P&L per year 2008-2014 10.2%
Hong Kong 2.9 2.9 2.9 2.4 3.1 3.5 Average P&L per recommendation 2008-2014 1.00%
Thailand 0.1 6.5 2.9 0.8 3.5 3.7
Emerging Europe
Poland 4.8 1.8 1.7 3.3 3.0 3.4
Czech Republic 1.0 -1.4 1.1 1.3 2.4 2.9
Hungary 1.3 -2.7 3.2 3.4 2.5 2.4
Turkey 5.3 1.3 4.5 1.7 3.3 4.2
Romania 2.3 0.6 3.5 2.6 3.0 3.3
Russia 4.3 3.4 1.3 0.6 -5.5 -1.0
Ukraine 5.2 0.3 0.0 -6.5 -5.0 0.0
Latin America
Brazil 1.4 1.8 2.2 -0.2 -0.5 1.5
Chile 5.8 5.5 4.2 1.6 2..5 3.8
Mexico 4.3 3.6 1.1 2.2 3.3 4.0
Sub-Saharan Africa
South Africa 3.3 1.8 2.9 1.4 2.2 2.3
Nigeria 16.2 12.6 12.6 6.5 5.0 7.0
Kenya 4.8 5.1 4.1 5.0 5.8 6.0Source: IMF, OECD, Bloomberg, SEB
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Emerging Markets Explorer
Macro Overview: Liftoff in EM Assets to Follow US Rate Hike
Our outlook for Emerging Market (EM) assets, in particular
EM currencies and equities, is cautiously optimistic,
primarily for three reasons. First, economic weakness in the
euro zone appears to have bottomed out. Although it will
not be stellar, we expect real GDP growth to accelerate
slightly from 1.0% in 2014 to 1.2% in 2015. Second, the US
economy is gaining momentum, and looks set to expand by
3.5% in 2015. Third, we believe that China will continue to
deliver strong, albeit moderating growth of 7.0% in 2015 and 6.7% in 2016.
While EM assets will suffer during the first half of the year,
and potentially into the third quarter due to uncertainty
over the timing and pace of the US Fed monetary policy
tightening and the effects of ECB quantitative easing,
especially on Central and Eastern Europe (CEE), the
improvement in the global economic outlook will support
EM assets in the latter part of the year. However, there will
be important exceptions, and differentiation among
countries will be important. Countries such as Brazil and
Turkey look particularly vulnerable, while countries with
strong fundamentals and ties to the US and Chinese
economies look set to benefit. We expect the CEE 4 (Czech,
Hungary, Poland, and Romania) currencies to weaken hand
in hand with the EUR against the USD in the first half of the
year, but to strengthen slowly as growth picks up and
convergence with the richer EU economies resumes in the
second half. After years of sub-par returns on EM investments, it is time to get ready for re-entry.
BRIGHTENING GLOBAL OUTLOOK
EM currencies have taken a severe beating since 2011.
While the weakness is partly a result of USD strength, that is
not the whole story. On an aggregate level, EM currencies
are now weaker than they were during the global financial
crisis and the last period of exceptional USD strength in
2001–2002. We think that level of gloom in EM is not justified.
Despite renewed political uncertainty regarding a potential
Greek exit from the euro zone, weakness among the EU
economies appear to have bottomed out. Importantly for
the CEE economies, there are signs of a gradual
improvement in Germany, further boosted by expectations
that German exports will benefit from the depreciation of
the EUR. We do not expect that Greece will choose to leave
the euro zone, or that it will be forced out. Forcing Greece to
leave would probably do more damage than good to the EU
by calling into question the commitment to hold the EMU
together should one of the large economies such as Spain
or Italy face renewed financial market pressure. In any case,
while the risk of a Greek exit should not be ignored,
contagion risks should be smaller and more manageable now than they appeared in 2011.
Growth in the EU will be far from spectacular. Yet, the CEE 4
are highly integrated with the German economy, serving as
suppliers to the German export sector. With German
consumer and business sentiment rising gradually along
with exports, the CEE 4 will benefit on the back of good
economic fundamentals. While their currencies may weaken
somewhat versus the USD, rising money market rates and stock markets should more than compensate for that.
More importantly for the global economy is that the US
economy is picking up steam. Although the US is not as
commodity hungry as China, rising growth in the world’s
largest economy will eventually lift expectations for EM too.
A steady strengthening of the US labour market along with
rising real wages and improving consumer and business
sentiment provide fertile ground for consumer-led growth
in the coming years. Lower gasoline prices and a wealth
effect from rising home prices will also support
consumption. In addition, slack is being reduced, which
together with rising demand should boost capital spending.
In sum, we see broad-based growth picking up in the US over the coming years.
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Emerging Markets Explorer
The world’s second largest economy, China, will slow, but
grow by a still strong 7.0% this year. The reorientation away
from investment- and export-led growth to consumption
and services will dampen commodity demand growth and
weigh on economic sentiment primarily in commodity-
dependent countries in Latin America and Africa. However,
rising per capita income and consumption in China will
benefit Asia generally, although some higher-value-added
sectors in countries such as Korea and Japan will likely see rising competition from Chinese companies.
INFLATION TO RISE IN THE SECOND HALF 2015
We expect the first half of the year to be challenging for EM.
The main reason is uncertainty about the timing and pace
of US monetary policy tightening. The USD appreciation
looks stretched on a short-term technical basis, but with the
ECB, BOJ, and PBoC moving in the opposite direction to the
Fed by easing monetary policy, very little stands in the way
of further USD strength. SEB believes that the Fed will hike
in September this year, and that it will continue to hike in
small steps throughout 2016 in order to avoid excessive
USD strength, and not to choke the recovery. Nevertheless,
market uncertainty will likely continue to boost US assets
relative to EM before the event. However, once the Fed’s
plans are clearer and inflation expectations rise again, EM
rates will go up at a faster rate than in the US, attracting
new capital inflows. The decision to hike will be more or less
fully anticipated by markets, which should boost risk
appetite and EM assets, much as it did at the start of the
last rate hiking cycle in the US between June 2004 and June 2006.
The chart above plots a nominal EM FX index consisting of
BRL, IDR, INR, TRY, and ZAR (equally weighted) against a
basket of 50% USD, 25% EUR, 12.5% GBP, and 12.5% CHF.
The currencies weakened sharply against the basket in the
run up to the initial hike, but strengthened by more than
16% during the first 18 months of the cycle. The key factors
behind the strengthening were investor certainty that the
FOMC would tighten monetary policy at a measured pace,
an improving global growth outlook, and the initiation of a
global commodity boom. Now, the first two of those three
factors look likely to fall into place. While another surge in
commodity prices is unlikely, rising global growth will put a floor under the declines that have occurred since June 2011.
A key risk to the outlook is lower than expected inflation in
emerging markets. At the outset of 2014, we thought that
the most likely surprise towards the end of 2014 could be
higher inflation. However, it turned out to be lower inflation,
due to persistent slack in productive capacity, and lower
energy prices. For 2015, history is unlikely to repeat itself,
and inflation in EM should be boosted by weak currencies,
reduced slack, and gradually increasing energy prices. In
other words, the global monetary easing cycle (save for a
couple of exceptions) will come to an end early in the third
quarter. Rising rate expectations will widen spreads against
the US and, especially Japan and the EU, which will lift EM returns.
EM OUTLOOK: FX, BONDS, AND EQUITIES
All EM currencies that we track have weakened against the
USD over the past year, except PHP, which is largely flat.
Many EM currencies now look very cheap. The worst
performers have been in CEE and Latin America, and the
best in Asia, with the CNY, THB, and INR depreciating only
marginally. However, although, the CEE currencies
(together with the EUR) currently look particularly
undervalued against the USD, they are unlikely to stage a
sharp recovery over the 6-month forecast period, due to
EUR weakness. We expect EUR to weaken to 1.02 against
USD by the end of the year, and although the CEE will likely strengthen against EUR, they will weaken against USD.
The Latin American (except MXN) and South African
currencies will also remain under pressure during the first
half of this year on a weak outlook for commodity prices.
However, the current pace of USD appreciation and EM
depreciation is not sustainable, and we expect currencies
such as the CLP, COP, and PEN to retrace at least some of
the losses suffered over the last year on the back of a
stabilisation of commodity and oil prices. For MXN, the price
of oil is particularly important, as a recovery will boost
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Emerging Markets Explorer
investor sentiment in the important energy sector and ease concern over public finances in 2016.
In contrast to the weakness and stagnation against USD
expected in the CEE and most of Latin America over the
next 3–6 months, most of the Asian currencies that we
track (except THB and TWD) look set to remain largely
stable, or even strengthen slightly against the USD after a short period of weakness in the second quarter of the year.
After falling sharply in January, most EM benchmark
government yields are now back to where they were, or
higher than in December. The exceptions are Russia,
Romania, China, India, Colombia, and Czech. The roller
coaster ride is the result of stronger-than-expected data
from the US, which has caused capital to flow back to safe
haven currencies such as USD, JPY, and GBP. Nevertheless,
despite the uptick, yields in CEE, Turkey, and South Africa,
as well as in most of Latin America will remain near record
lows over the next 1–3 months, due to low inflation
expectations, and still-low global interest rates. They will
fluctuate at historically elevated levels in Brazil and Russia.
They will continue to trend down in South Africa, China, and
India, due to moderating inflation expectations, monetary
policy easing, and growth concerns. Bouts of risk aversion
will provide a floor under rates. Rates will rise in 3Q'15 as
the Fed moves closer to hiking and the growth outlook
improves. Renewed tensions between Russia and the West may also put upward pressure on EM rates.
We don't make forecasts for EM equities, and limit our
comments to pointing out that EM equities have continued
to underperform relative to those in more developed
markets. As with general EM FX indexes, they now look very
cheap and may now perform relatively better compared to
QE infused stock markets in more mature economies,
especially in the US. Similarly to the FX markets, Asian
equities will likely fare better than their Latin American and Emerging European counterparts.
RISKS TO OUR OUTLOOK
Some risks to our outlook have been mentioned in the text
above, but a few additional political and economic risks
could also upend prospects for a gradual recovery in EM assets in the second half of the year.
China has the financial resources to manage a property
market correction. However, given questions about the
reliability of government statistics, risks of a crash cannot
be completely dismissed. Also, the choices that China will
make over the next year or two in terms of interest rate
liberalisation and with whom it chooses to cooperate will be
pivotal. Recent overtures with Russia are probably largely
symbolic, as Russia and most of the other countries that are
hostile to the West and, in particular, the US will not do
much to lift China’s wealth and standing among nations.
Nevertheless, tensions between China and the US, as well as Japan, are not far below the surface.
Excluding the oil and gas sector, Russia is too small as a
trading partner to have a major impact — positive or
negative — on the global economy. However, if the conflict
in eastern Ukraine were to escalate further and Russia
intervene militarily more openly, relations with the US and
EU could start down a slippery slope of tit-for-tat sanctions.
We believe that the conflict in eastern Ukraine will freeze
largely along the current lines. Kiev cannot afford to
continue the war, while Russia does not need the rebels to
take additional territory to prevent Ukraine from joining
Nato. Nevertheless, rational choices do not always prevail when national sentiment is stirred.
In addition, although it may lie further into the future than
our 6-month forecast horizon, risks of a disorderly
unwinding of central bank QE programmes on a global basis
should not be ignored. We are in uncharted territory QE
with yields at historically low levels in what used to be high-
risk countries. The potential latent volatility could be
substantial, if we see a sudden re-pricing of risk globally, something of which in particular the BIS has warned.
Last, but not least, country-specific risks loom as large as
ever. Brazil is in the midst of the largest corruption scandal
in modern history, crimping investment and curtailing the
government’s ability to consolidate public finances. But the
woes for Brazil does not end with potential rating
downgrades, as it also faces the worst drought in 80 years.
Turkey’s political environment is deteriorating with
President Erdogan openly pressuring the central bank to
ease monetary policy. Additionally, the fight against the
Gulenists also risks undermining Turkey’s administrative
(government) institutions, jeopardising long-term governability.
Along with rising expectations on India has come the
potential for disappointment. With improvements in the
management of the Reserve Bank of India and strong
support in parliament behind the new reform-minded BJP
government, investor enthusiasm is well placed. However,
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Emerging Markets Explorer
India is a large and motley democracy and potentially only a terrorist attack away from a new war with Pakistan.
In addition, the technical picture points to significant challenges ahead.
TECH CORNER
The dollar bull market is the clearest when looking at it
through emerging markets lenses. Historically we know that
when the dollar enters a major bull trend (like in the mid-
1990s and the late 1970s) the result will be an emerging
market crisis somewhere around the globe. The first victim this time has been Russia, with Brazil as the runner up.
The impulsive rally in the dollar index has not only broken
above the “neckline” (in a similar fashion to the 1996 and
1981 upside breaks) confirming the major bull market that
begun 2008 and has broken above the falling top line from
1985 (and the Plaza accord) indicating that this rally
actually might be more powerful than the 1992–2001 one.
Such an outcome would put severe pressure on emerging market currencies for the foreseeable future.
Historically there’s also a strong correlation between a
rising dollar and underperforming emerging market
equities. As can be seen in the chart above the major dollar
index break higher 1996 led to the exit from a multiyear top
formation in the MSCI EM/DM relative performance graph.
With the recent major break higher in the dollar index the
risk for emerging market equities to underperform its major peers is marked.
The emerging markets bond index is still, like last year, in
the process of ending the right hand shoulder of a long-
term, head-and-shoulder top formation. The recent minor
bounce (from the December low point) looks corrective and
we thus see an increasing downside risk. A break below
105.50 (weekly close) would be the confirmation point for
the next sell off, which primarily will be targeting the 98-area (and secondarily the 88-area).
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Emerging Markets Explorer
SEB EM FX Forecasts (end of period)
12-Mar-2015 Spot 1M 2Q-15 3Q-15 4Q-15 1Q-16
vs. EUR
PLN 4.12 4.20 4.20 4.15 4.07 4.05
HUF 303 311 311 309 302 300
CZK 27.3 27.5 27.5 27.5 27.5 27.5
RON 4.43 4.50 4.50 4.45 4.39 4.30
TRY 2.75 2.84 2.84 2.85 2.86 2.85
RUB 64.5 69.6 70.4 61.8 56.1 53.0
RUB BASKET 62.5 67.0 68.5 60.8 55.5 53.0
vs. USD
RUB 60.9 65.0 67.0 60.0 55.0 53.0
TRY 2.59 2.65 2.70 2.77 2.80 2.85
PLN 3.89 3.93 4.00 4.03 3.99 4.05
HUF 286 291 296 300 296 300
CZK 25.7 25.7 26.2 26.7 27.0 27.5
UAH 21.75 30.00 30.00 30.00 30.00 30.00
ZAR 12.19 11.70 11.95 12.20 12.50 12.70
KES 91.7 92.0 92.0 93.0 94.0 95.0
NGN 200 200 200 200 200 200
BRL 3.13 3.13 3.20 3.30 3.40 3.45
MXN 15.46 15.00 14.70 14.40 14.10 14.00
CLP 638 620 650 660 670 670
CNY 6.26 6.35 6.25 6.20 6.25
CNH 6.28 6.35 6.25 6.20 6.25
HKD 7.77 7.80 7.80 7.80 7.80
IDR 13,183 13,500 13,000 12,800 12,800
INR 62.6 64.0 63.0 60.0 60.0
KRW 1,126 1,140 1,130 1,110 1,110
MYR 3.69 3.73 3.70 3.65 3.67
PHP 44.2 45.5 44.0 43.0 43.0
SGD 1.38 1.40 1.38 1.37 1.38
THB 32.8 35.0 34.5 34.0 34.0
TWD 31.6 32.7 32.5 32.3 32.5
EUR/USD 1.06 1.07 1.03 1.02 1.00 1.00
USD/JPY 121.2 121 125 128 130 135
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Emerging Markets Explorer
Theme: China — Focus on the Currency, Not Interest Rates
Market’s attention has been on China’s monetary easing
where the central bank (PBoC) has delivered 2 interest rate
cuts after 2 years on hold. Most China analysts including
SEB expect more to follow. Monetary easing has been an ongoing trend for the last 12 months.
Instead of interest rates, investors should focus on the
recent change in foreign exchange policy. We are starting to
see the central bank’s behaviour shifting to allow USD/CNY
fixing to rise (i.e., weaken CNY vs USD). In addition to
shorting CNY vs USD, we think the best way to invest would
be to continue to be short commodities and the Australian
Dollar (AUD), or in Asia to be short the Malaysian Ringgit (MYR) or Singapore Dollar (SGD).
WHAT’S HAPPENING TO INTEREST RATES?
Effective March 1, the PBoC reduced the 1 year deposit and
lending rate by 25bps to 2.50% and 5.35% respectively
(see chart below). This adjustment is very similar to the one
on November 22 where in addition to easing, the maximum
deposit rate flexibility was increased to 1.3 times the official
deposit rate from 1.2 times. PBoC stated that it eased to
reduce real rates since inflation is falling, to spur lending
and to continue structural reform in interest rate liberalization.
Similar to the November adjustment, we don’t see the cut in
deposit rate to be much of a stimulus. After the last cut,
most major banks raised deposit rates to 3.3% (the deposit
rate of 2.75% times 1.2), higher than the benchmark rate of
3% before the rate cut. The maximum deposit rate will be
3.25% (2.50% times 1.3) so banks will only reduce deposit
rate by 5bps to prevent deposits from moving to
competitors. The one difference this time was that the cuts
in deposit and lending rate are the same amount, whereas
in November the lending rate was cut by a bigger 40bps.
The asymmetric cut last time put more pressure on bank’s
margins but this time the margin pressure will not be as large.
Going forward, we expect 2 more cuts over the next 2
quarters as we expect the economy to ease further and
inflation to remain tame (chart below). For markets, equities
will rise from the slightly-earlier-than-expected easing. Buy
Chinese equities is one our top investment themes for 2015 and it will continue to benefit from further easing.
MORE IMPORTANT DEVELOPMENT IS THE BEHAVIOUR CHANGE IN FOREIGN EXCHANGE POLICY
Media and market attention has been on interest rates, but
we think the bigger policy shift is happening in foreign
exchange (CNY). CNY has been weakening recently but it
has been limited by the daily fixing by PBoC and the +/-2%
daily trading band. USD/CNY is trading close to the top of
the band and any further rise was limited unless PBoC’s
policy shifted to allow for weaker CNY. We think that moment has come.
The chart below shows the difference between our daily
USD/CNY fixing forecast versus the set PBoC fixing at
9:15am Beijing time. We use this to track whether PBoC is
shifting exchange rate policy. In normal markets like 2013,
the chart oscillates up and down, like a heart rate. It shows
that central bank is letting market movements dictate the
fixing and our forecast misses randomly up and down.
However, in early 2014 the fixing was consistently set
higher than our forecast and showed a deliberate policy
shift to take USD/CNY higher. Then in May 2014, the policy
shifted back to normal where we again missed equally on
both sides and with a small shift lower, showing a bias to
take USD/CNY lower. But as you can see, starting February
this year, we are seeing fixing higher, which signals another
policy shift to take USD/CNY higher. If PBoC wants to weaken CNY, it’s best to get out of the way and join them.
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Emerging Markets Explorer
USDCNY Model-to-Fixing Difference
Source: Bloomberg, SEB calculations
Two Scenarios
The reason and intention behind a weaker CNY will have
different consequences. Differentiation needs to be made on whether a weaker CNY is a “cause” or “effect”.
THE MOST LIKELY SCENARIO — “EFFECT”
The most likely reason why authorities are allowing for
weaker CNY is an “effect” from weaker relative
fundamentals. China’s growth is slowing and long term
expectations for China’s growth are also shifting lower to
what authorities call a “New Normal”. On the other hand,
the US economy is accelerating and trend growth appears
to be returning to historical norms. Capital becomes
attracted to the more profitable US economy relative to
China and that flow reversal weakens CNY. In addition,
Chinese households and corporates are adjusting to two-way CNY volatility and hedging by selling CNY.
Capital outflows have occurred before even though China
technically has a regulated capital account. The chart below
shows the capital outflow derived from the balance of
payments data and it includes “errors and omissions”,
which catches masked capital flows. We had capital outflow
during the 2008 Lehman crisis, in 2012, and starting in Q2 2014.
THE DISASTER SCENARIO — “CAUSE”
The alternative, negative scenario is when CNY weakness is
a “cause” where the authorities are devaluing the currency
to gain exports market share and increase growth at the
expense of the rest of the world. This would fit the scenario
of China joining the global currency war. Currency wars
typically have 3 stages. First, countries manipulate foreign
exchange levels through direct intervention, or indirectly
using interest rates. Second, countries set capital controls
to manipulate and protect their currencies. Third and the
most potent stage is when countries attempt to directly
change the volume of trade with sanctions and tariffs. If
China devalues to gain export market share, we will
accelerate to stage 3 and the US and Europe will likely react
with trade restrictions. This will be negative for the global
economy and especially for China that ranks #1 in market
share in global merchandise trade and most dependent on
free flow of global trade. Since this scenario would be
similar to shooting yourself in the foot, we think CNY weakness is an “effect” more than a “cause”.
HOW TO PLAY IT?
The most logical way to hedge in a weaker CNY is to sell
CNY versus USD. However, the move will not be limited to
just CNY. In the chart below, we have analysed the
sensitivity of how other currencies and assets reacted in the
last 3 scenarios of CNY weakness (2008 Jun–Dec; 2012
Feb–Sep; 2014 Feb–Sep) and taken the average, lastly
ranking them in ascending order. The figures show the
sensitivity in percentage to moves in USDCNY. The most
vulnerable assets are commodity related, with gold being
number one, followed by oil and the Australian Dollar
(AUD). So a 10% move higher in USD/CNY leads to 15%
loss in the value of gold and 12% loss in AUD. IDR and MYR
are the most vulnerable of the Asian currencies, followed by
SGD. We prefer to be short SGD or MYR because the cost of
carry is low and SGD has lagged the general currency weakness move in Asia so far.
Sensitivity to USDCNY
Source: Bloomberg
The only one resilient to CNY weakness is the Japanese Yen
(JPY) where it will strengthen by 0.4 times the loss in CNY.
JPY still remains the safe haven currency. What we found
-60
-50
-40
-30
-20
-10
0
10
20
30
Dec
-13
Jan
-14
Feb
-14
Mar
-14
Ap
r-14
May
-14
Jun
-14
Jul-1
4
Au
g-14
Se
p-14
Oct
-14
Nov
-14
Dec
-14
Jan
-15
Feb
-15
Model to fixing difference in pips, 5 day mv avg
normal policy shift
normal
-0.4
0.10.2 0.3 0.3
0.4 0.5 0.6 0.6 0.6 0.7 0.7 0.7
1.0 1.0 1.01.2
1.31.5
-0.5
0.0
0.5
1.0
1.5
2.0
JP
Y
BR
L
CH
F
KR
W
MX
N
TH
B
TW
D
PH
P
RU
B
EU
R
INR
TR
Y
SG
D
ZA
R
MY
R
IDR
AU
D
OIL
GO
LD
Sensitivity to USDCNY
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Emerging Markets Explorer
interesting was the resilience in Korean Won (KRW) but that
may be since KRW weakness recently have been driven by a weaker JPY and JPY strength may lead to KRW strength.
ONE CAVEAT
We are considering the current CNY weakness to be an
“effect” of weaker relative fundamentals and in this
scenario, developments in China’s biggest trading partner,
the EU, plays a significant part. One additional reason why
USD/CNY fixing will rise further is because the EUR/USD is
weakening. USD/CNY fixing is starting to reflect market
foreign exchange rate movements across China’s key
trading partners and not just focusing on the level versus
the USD. President Xi has pledged to have market forces
play a bigger role in resource allocation in his first major
policy announcement in November 2013 Third Plenary
Meeting. CNY policy is moving with the overall policy
direction in allowing markets to dictate the level. What this
means is that we expect CNY to weaken because we are
expecting the euro to weaken towards 1.05. If we are wrong
and euro starts to strengthen, we think CNY depreciation
also stops. This is different if we view the current CNY
weakness to be a “cause” where in that scenario, CNY will
weaken regardless of where EUR is headed. In addition, if
China is weakening the currency irrespective of changes in
other foreign exchange rates, we think all bets would be off
and it will be best to buy the safest assets such as gold and US Treasuries.
NOT FINISHED HERE — SECONDARY IMPACTS
In our main scenario that CNY weakness is the “effect” of
weaker economy, there would be other monetary consequences.
First, we’ll see accelerated monetary easing, which we are
already starting to see. The currency policy directly impacts
domestic liquidity conditions. As the chart below shows, FX
reserves on average are still growing, especially when
adjusted for valuation changes due to the weaker EUR-denominated reserves PBoC holds (green line).
China FX Reserves
Source: Bloomberg
The currency is still technically undervalued where in order
to prevent the currency from appreciating, the central bank
has to print extra CNY and buy USD or other assets. That
printing causes domestic liquidity to increase (represented
in the chart below by the light green area) and add to the
growth in the monetary base. In 2009 and 2010, in order to
limit domestic liquidity due to the large inflows, the central
bank had to remove liquidity by sterilization (sell bonds,
hence the red line is negative and subtracting from total
base money growth). Also, reserve requirement ratios were hiked as another form of tightening liquidity.
Contributions to Base Money Growth
Source: CEIC
Going forward, with less net inflow from capital outflow, the
central bank will have to add more liquidity to keep base
money growing at the same pace. This has already been
happening from 2012-2014 with addition of liquidity by
PBoC. The central bank will have to do more going forward
by cutting reserve requirement ratios further and open market operations that will drive interest rates even lower.
The second consequence is the impact of China
accumulating less FX reserves or even depleting its
reserves. That means China will be buying less US
Treasuries and Euro denominated assets. This combined
with adjustment in US monetary policy outlook will raise
term premiums in US Treasury market. The rise in US bond
market uncertainty will likely trickle through to higher volatility in most major asset classes.
ADJUSTING POSITIONING BY GOING LONG USD VS AUD, MYR, SGD
Due to the change in China’s FX policy, we will close our
short USD/CNH option and add a basket of short AUD, MYR
and SGD vs USD in allocate 100% weight in our Asia FX Portfolio.
-150
-100
-50
0
50
100
150
2000
2500
3000
3500
4000
4500
10 11 12 13 14 15
MoM change (RHS)
Total (LHS)
MoM valuation adj (RHS)
China FX reserves (USD mn)
-20
-10
0
10
20
30
40
09 10 11 12 13 14 15
% yoy 3mma, contribution to base money growth
FX res contribution
Sterilization contribution
Base money adjusted for RR
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Emerging Markets Explorer
Theme: Effects of Lower Oil Prices
Since July 2014, oil prices have fallen by some 50% from
USD 110-115 per barrel to current levels around USD 60.
The price fall has been driven by a combination of factors.
Increasing supply is one explanation. Production has
increased, especially in the US due to the shale oil industry,
but also in Brazil and Canada. At the same time, demand
growth in China and Europe has moderated and contributed
to the downturn. The OPEC countries have not sacrificed
their market shares in order to prop up oil prices resulting in
growing oil stockpiles that push down prices. SEB predicts
an average Brent crude price of USD 60 in 2015 and USD 70 in 2016. In November 2014, the forecast was USD 85/barrel.
Oil price downturns are usually positive for the world
economy and global GDP growth. However, country-
specific effects vary widely. The big winners will be
economies that are heavy users of energy and dependent
on oil imports. Taking a look at the BRIC economies and
Turkey reveals that there are two clear winners (India and
Turkey), one obvious loser (Russia) and two economies where effects will be limited.
GLOBAL EFFECTS: GROWTH STIMULUS AND LOWER INFLATION
An oil price downturn leads to a transfer of resources from
oil exporting to oil importing countries. Since the inclination
to consume is normally higher in the latter, oil price
downturns are usually positive for the world economy. The
most important channels are stronger household
purchasing power, lower costs for input goods and monetary policy easing due to lower inflation.
However, there is reason to be cautious regarding the
positive growth impact of cheaper oil this time around. Due
to higher post-crisis indebtedness, consumers in importing
countries may use their increased room for consumption to
pay off debt and increase savings instead. Also, the net
effect on US growth will be smaller than before due to the
considerable expansion of the country’s oil industry. SEB
expects that a 50% decrease in oil prices results in a global GDP stimulus of 0.75% over a two-year period.
COUNTRY-SPECIFIC EFFECTS ON EM ECONOMIES
India: Clear Benefits
India is one of the main beneficiaries of lower oil prices due
to large energy imports and dependence on agriculture.
Energy is the main input into fertilisers. Subsidies on fuel,
fertilisers and food have been one of the main factors
behind India’s substantial budget deficit. The decline in
energy prices contributed to the government’s decision in
October 2014 to deregulate diesel prices and raise domestic
natural gas prices. This implies that the positive growth
effect of increased household consumption instead
materialises in the form of reduced government
expenditure for energy subsidies. However, as presented in
the budget published recently, government will be able to
increase spending on infrastructure providing a positive growth effect.
The fall in energy prices and food prices have been the main
drivers of the sharp decline in CPI inflation, as well as
inflation expectations. The Reserve Bank of India (RBI) has
already cut its key interest rate arguing that slower inflation
provides room for a shift in the monetary policy stance. More cuts are expected, which will boost GDP growth.
Russia: Deep Recession in 2015
Russia is highly dependent on energy exports. Oil
represents about 60% of total exports and more than half
of government revenue. The failure to diversify away from
energy exports is one of the main factors that are driving
Russia into a deep recession in 2015. The rouble is highly
correlated with oil prices and the recent downturn has pushed the rouble to record lows.
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Emerging Markets Explorer
The weaker rouble will have a big impact on the economy.
Inflation has accelerated to close to 17% year on year,
driven by rising import prices. It will deal households a
powerful blow through a sharp weakening of real wages.
The financial turmoil and currency weakening has forced
the central bank to hike the key interest rate to 15%
currently. High interest rates will trigger a further downturn
in capital spending that has been weak for a long time due
to underlying structural problems. The lower oil price also
rules out expansionary fiscal policy and creates pressure on
the balance of payments. All in all, the fall in oil prices will
result in a broad and deep fall in GDP in 2015. SEB expects GDP to decrease 5.5 per cent.
China: Limited Benefits Despite Large Oil Imports
As the world’s second largest net importer of oil in absolute
terms, China is benefitting from lower oil prices, primarily
through a strengthening of the trade balance. However,
heavy reliance on coal means that the share of oil in total
energy consumption is relatively small at 18 per cent.
Therefore, the main channel for exposure is the transport
sector and CPI inflation is not very sensitive to oil price
changes. Price controls further reduce the impact of lower
prices on inflation. The growth impact of the lower oil price
is small, but there are some other benefits. Similarly to
India, cheaper oil will support the government’s efforts to
reduce energy subsidies. Efforts to deal with environmental
problems will also be simplified, for example by making it easier to phase out dirty vehicle fuels.
Turkey: Smaller Twin Deficits
Turkey relies heavily on foreign fuel. Net imports of oil
products represent more than 6% of GDP. The main benefit
of the oil price drop will be a reduction in the import bill and
in the current account deficit. The budget deficit will also be
reduced since a smaller energy import bill implies less
public spending on transfers to state owned energy
companies. Lower petrol price inflation will also provide a
boost to household real income. The fall in oil prices has
improved the growth outlook, but there are several
remaining vulnerabilities in the form of high dependence on
foreign financing and an unsustainable surge in private sector credit.
Brazil: Mixed Effects
The effect on Brazil will be mixed. Crude oil exports are
increasing, but Brazil is still a net importer of oil products.
Lower oil prices make it more difficult to attract investment
to develop the vast offshore oil reserves. Fuel prices are
subsidised by state owned oil firm Petrobras; oil is imported
at world prices and sold at a capped rate. Therefore, the
effect on household consumption is expected to be small.
On the other hand, there are also short-term gains of lower
oil prices. Petrobras can spend less on subsidies, creating more resources to spend on production.
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Emerging Markets Explorer
Strategy: Based on Medium-term EM Strength
Trading Recommendations
GO LONG USD VS AUSTRALIA (AUD), CHINA (CNY), MALAYSIA (MYR), SINGAPORE (SGD), AND THAILAND (THB)
Monetary policy is being eased in key Asian economies. In
addition to shorting CNY vs USD, we think the best way to
invest would be to continue to be short commodities and
the Australian dollar (AUD), or in Asia to be short the
Malaysian ringgit (MYR), Singapore dollar (SGD), or Thai baht (THB).
LOOK TO SELL USD/MXN
Mexico will forge ahead with reforms in the energy sector by
making contract terms attractive enough for investors
despite the fall in oil prices. Mexico stands to be one of the
first beneficiaries of the pick-up in the US economy, when investors have more clarity on the pace of US rate hikes.
LOOK TO SELL USD/RUB
We do not believe that Russia will openly intervene militarily
in Ukraine, as a frozen conflict is enough to prevent Ukraine
from joining NATO and to make integration with the EU very
expensive (for the EU). The ruble currently looks
undervalued and will benefit from a gradual recovery in the price of oil.
LOOK TO SELL EUR/PLN, HUF, RON
Emerging Europe, especially Poland and the Czech, is a
convergence story about to happen. We believe that once
the EU starts a sustainable recovery, even if slow, the CEE 4
currencies will resume their gradual appreciation against
the EUR. In the short term, the trade would also protect
against a potential temporary rebound of the EUR against the USD.
Fixed Income: Diverging Dynamics
The first half of the year is likely to be characterized by
divergence, as developed markets (most importantly the US
and the EU) start to growth faster before pulling along the
EM economies. How are policy makers in emerging markets
going to react to recent shocks in the form of a drop in oil
prices, and rising global deflationary trends? Some
countries, especially in the CEE area, have followed other
central banks’ lead in an orderly fashion, such as Poland,
Romania and Hungary, by clearly communicating their
strategy and cutting rates. However, others have been more
opportunistic and seized the opportunity to cut rates in the
view of a temporary relief in inflationary pressures (e.g.,
China and Indonesia). There are also countries with a
structurally high underlying inflation, such as Turkey, that
may well regret current easing steps down the line, as
higher US rates raise market stress and oil prices increase
from current levels. When the dust settles, we should see a
gradual improvement in EM growth, as the effects of
stimulatory monetary policies kick in and political uncertainties, such as Ukraine/Russia crisis, subside.
High hopes have been placed on lower oil prices to give
some EM countries a much-needed fillip. And also they
raised concerns for oil exporters, how those are going to
weather this downturn. Effects of lower oil prices are not
straight forward. Whilst some EM countries are crude oil
exporters, many of them also import refined products. And
lower energy prices might not benefit the end consumer, as
often energy prices in these countries are subsidized and
governments seize the opportunity to remove these
subsidies. Hence, consumers may not get the full benefit of
lower prices, which, in turn, may lead to only a small impact on inflation.
EM BONDS: WHERE DO WE STAND?
For now, the general topic in the EM bond space remains
focused on much similar things as in our previous
publication. All eyes are on the US rate move and world-
wide inflation. Although, it can be argued that there is more
room now for rate cuts in most CEE countries, the process is
surprisingly complex, with many nuances that need to be
considered. We expect most CEE central banks to follow the
ECB’s path of monetary easing in some form, but there is
not much certainty of action. It has been mentioned that
the deflationary pressure is often imported into the region and not the CEE countries’ “fault”.
Looking closer at EM bonds, the fixed income benchmark,
the GBI EM Global diversified, spread to UST is 485 bps,
which is slightly below the average value, but that could be attributed to the recent move in UST.
It is hard to see any real buying opportunities in Ukraine at
this stage. But Russian asset prices are mainly driven by oil,
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Emerging Markets Explorer
which can be perceived as a positive thing to a certain
extent. It would seem to indicate that investors have shifted
their focus away from the geopolitical noise. The future
path of oil prices is still very uncertain, but for now, it seems to have reached a bottom.
EM BONDS: CHALLENGES AHEAD
Developments in the EM sovereign credit space are likely to be affected by three factors in the near-term:
1. Monetary tightening in the US;
2. ECB’s quantitative easing program. It already had a
strong impact on EUR denominated bonds from the
CEE countries that are eligible under this program.
Yields have contracted between 10 and 30 bps since
the announcement of the buying program; and
3. Decline in oil and commodity prices. These may have
a long-lasting impact on external balances of EM
countries.
Obvious risks weighing on that space are debt restructuring
in Ukraine, a deepening recession in Russia and a likely
default in Venezuela. The outlook for EM FX remains
negative until the Fed hikes. Although, as history shows, it
tends to stabilize following the Fed move. In fact, USD may
peak at the time of the first rate hike. There are also
challenges facing EM corporate credit that may weigh on
the sentiment of an entire country’s debt, as the recent
cases of Petrobras in Brazil and Kaisa in China illustrate. To
make matters worse, policy credibility has recently come
into question across the region, be it in Russia, Turkey, or Venezuela.
Many of these risks are likely to be mitigated by strong
underlying inflows into EM funds. A large number of bond
repayments and coupon payments are also going to be an additional source of substantial amounts of liquidity.
Looking at hard-currency debt, it is difficult to say whether
it is poised to outperform local currency debt or not in the
months to come. One thing that we are fairly certain of is
that EUR-denominated bonds are likely to gain a greater
importance due to their ECB purchasing program eligibility.
A large portion of new issues out of CEE is likely to be in
EUR. Perhaps, as much as 30-50% of EM sovereign new
issuance this year might be denominated in EUR. We have
already started seeing that, with Croatia and Mexico placing EUR-denominated bonds.
There would seem to be very little juice left in local CEE
rates. And those are also sensitive to moves in UST rates,
due to their investor base, i.e., US accounts chasing higher
yields. In general, local currency spreads to UST are either
record tight or close to it. Historically, this can be taken as an indicator that USD bonds should outperform.
But, having said the above, spreads to DM government
bonds for hard currency EM bonds, especially in low-beta
names, are quite tight as well, leaving those exposed to
external shocks. These tight valuations are unappealing and
warrant some caution. Higher quality EM credits can be
used for capital preservation in times of heightened global
uncertainties and volatility, but one should not expect any stellar performance from these bonds.
In Latin America, Brazil’s valuations appear attractive. But
renewed downgrade risk amid deterioration in the growth
outlook, political risk, and Petrobras’ scandal will continue to exert pressure on Brazilian assets in the near term.
SEB EM BOND BASKET UPDATE
Since our last EM Explorer cut off in October 2014, our
portfolio has delivered a return of 0% in local currency and
-16.6% in USD terms. During the same period, GBI EM returned 0.63% in local currency and -12.3% in USD terms.
At the time of writing our last Explorer, we were hoping for a
positive resolution of the situation in Ukraine in the near
future. That proved to be wrong, the situation around
Eastern Ukraine is still far from being resolved and, if
anything, it has become more entangled. The Minsk-2 truce
agreement is fragile and implementation risk is high. Falling oil prices intensified the fall in RUB and bond prices.
All currencies in our portfolio had a negative development
over the past six months, with Russia and Brazil, where we
had our largest overweight positions, standing out. Russia
and Brazil bonds added the most stress on the yields’ side
to our portfolio, as well. Following S&P and Moody’s
downgrades of Russia’s sovereign ratings to junk, Brazil and
South Africa may be next, risks that are currently in the process of being priced in.
RE-SHUFFLING OUR PORTFOLIO
We are increasing the weight in Hungary, given a potential
upgrade of the country’s rating. We are pulling Turkey to
market weight, after the political turmoil surrounding the
central bank. We are going underweight in South Africa, due
to a potential downgrade. And, finally, in Poland, we are
going slightly underweight, after the central bank signalled
SEB Bond Portfolio Oct 8 2014 to Mar 10 2015GBI-EM weight
SEB weight Yield
Duration years
08 October 2014 `ìêêÉåÅó= içÅ~ä=êÉíK rpa=êÉíK
Poland 10% 10.0% A- 2.30% 4.4 JNQKVB NKSB JNPKRBHungary 5% 3.0% BB 2.67% 2.8 JNRKSB PKNB JNOKVBS. Africa 10% 10.0% BBB- 7.45% 3.6 JVKOB QKMB JRKSBTurkey 8% 12.0% BB+ 9.41% 3.0 JNPKPB SKMB JUKMBS. Korea 0% 5.0% A+ 2.26% 1.9 JQKPB NKRB JOKVBRussia 9% 15% BB+ 9.71% 6.4 JPRKTB JNRKNB JQRKQBIndonesia 7% 5.0% BB+ 7.90% 2.3 JSKRB RKNB JNKTBMalaysia 10% 10.0% A- 3.10% 3.2 JNNKTB MKMB JNNKSBBrazil 10% 15.0% BBB- 11.91% 2.0 JOPKPB OKPB JONKSBMexico 10% 15.0% BBB+ 4.45% 2.8 JNPKQB NKNB JNOKRB
Average 100.0% BBB 6.9% 3.5 JNTKNB MKMB JNSKSBGBI-EM: 0.63% -12.3%
mÉêÑçêã~åÅÉ=ëáåÅÉ=çÅí=U
Rating S&P
(LT-FC)
17
Emerging Markets Explorer
that the rate cutting cycle may be over. The bonds were looking rather expensive, even pre-announcement.
However, we are keeping our overweight positions in
Russia, Brazil and Mexico. We still believe that EM FX is
currently looking very cheap and it is likely to perform well post the initial US rate hike.
The new portfolio composition can be seen below.
New SEB EM Bond Basket Mar 10 2015GBI-EM weight
SEB weight Yield
Duration years
10 March 2015
Poland 10% 10% A- 2.15% 4.2Hungary 5% 5% BB 1.87% 2.5S. Africa 10% 8% BBB- 7.19% 3.3Turkey 10% 10% BB+ 8.63% 2.7S. Korea 0% 4% A+ 1.92% 1.5Russia 4% 15% BB+ 13.34% 6.0Indonesia 9% 8% BB+ 6.98% 1.9Malaysia 10% 10% A- 3.55% 2.9Brazil 10% 15% BBB- 13.63% 1.7Mexico 10% 15% BBB+ 4.75% 2.5
Average 100.0% BBB 7.5% 3.1
Rating S&P
(LT-FC)
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Emerging Markets Explorer
Election Monitor
The following elections are due in Q2 and Q3 2015 in the EM markets that we cover. The table contains dates, our predicted winners and the pre- and post-impact of the elections on the countries’ currencies and economies.
Country Election/Date Predicted
Winner Currency
Impact Election Impact
Nigeria General
(March 28th)
The People’s
Democratic Party
(PDP)
Negative/
Neutral
The election has been postponed six weeks due to
security concerns related to Boko Haram. The ruling
People’s Democratic Party (PDP) is the likely winner,
but it is rapidly losing ground to the newly formed
All Progressives Congress (APC), leaving the
outcome highly uncertain. The APC has indicated
that they are more willing to fight corruption and
press ahead with structural reforms than the ruling
PDP. A key concern surrounding the election is
election fraud which may spark civil unrest.
Poland Presidential
(May 10th)
Civic Platform
(PO) Positive
Incumbent President Bronislaw Komorowski is likely
re-elected as President for the second time. He will
run as an individual but is supported by the ruling
Civic Platform (PO). He has managed to stay in the
middle of the road, avoiding controversies and
focusing on national defence and families. This has
made him very popular and he has currently over
60% support. The main opponent is Andrzej Duda
from Law and Justice (PiS) although polls show he
has only 17% of the votes. Polls show that also PiS
voters supports Komorowski.
Turkey General
(June 7th)
The Justice and
Development
Party (AK Party)
Negative
The incumbent President, Tayyip Erdogan, is
seeking a supermajority in parliament. He has made
no secret of wanting to amend the constitution to
increase the power of the presidency. Erdogan is the
founder of the AK party, which currently holds 313
of the 550 seats in parliament. He will try to boost
his popularity ahead of the election by providing
fiscal and monetary stimulus. It will result in a
widening of the current account and budget deficits
as well as accelerating inflation and further lira
weakness.
Poland Parliamentary
(October 26th)
Civic Platform
(PO) Positive
Civic Platform (PO) has been ruling for seven years
and will likely stay in power by forming a coalition
government with the Polish Peasants Party or the
Democratic Left Alliance. Economic growth and the
Ukraine conflict has helped PO’s popularity.
However, PM Ewa Kopacz is perceived as a weak
leader and she has not performed well in regional
elections. Poor communication skills and
controversial nominations weigh on her popularity,
but if she manages upcoming coal sector reforms
well, she will collect important points. Opposition
party Law and Justice (PiS) is popular in regional
elections, but would have to form a coalition with
right-wing Nowa Prawica, which will be a tall order.
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Emerging Markets Explorer
Country Section
Asia
China
Economic growth will slow to 7.0% in 2015 compared to
7.4% in 2014. China’s economy runs on two main engines:
a) external demand through exports; and b) domestic
demand measured through construction activity. In 2014,
both engines stalled, but the outlook for exports in 2015
should improve on the back of US growth. Domestic
demand via construction is stabilizing from looser policy.
However, the recovery will be weak because the
government has switched from targeting quantity in
monetary stimulus (i.e. amount of loans banks need to
provide) to price (adjusting interest rates). The economy is
not as responsive to interest rate adjustments and the
government will have to do more monetary easing to
support the economy. We expect 50bps cut in deposit rates
and 150bps cut in reserve requirement ratio. Another part
of the economy suffering and the main drag on growth in
2015 is capital expenditure. With lower housing activity,
many steel and cement factories will not increase capacity and some will be even shut down.
CNY will oscillate this year and we expect it to finish around
6.20 by year end. Over the long run, the currency will
continue to appreciate since the current account remains in
surplus and politically, it is easier than depreciate the
currency and risk trade tensions with EU and US that can
reduce trade volumes by double digits. The change this
time is that we can no longer just sit on a long CNY vs USD
position because volatility has increased and the trade can
move 4% against you in one day. Over the short run, as
written above, we think USD/CNY will head higher towards
6.40 and prefer to be short CNY. On rates, we want to
receive since we expect more rate cuts. With lower inflation
and economic activity, they will have room to ease. This will
benefit equities and the substitution effect moving from
housing investment into the equity market will also be a key driver.
CNH TECH CORNER
The market is headed towards a medium-term target at a
6.37 "Equality point". As a slightly more ambitious objective,
the late 2012 high of 6.39 could also be used. Support is
hardening around the mid-2014 high of 6.27 and the
ascending 8-week "Tenkan-Sen" (a rolling 8-week, high-low
average), which comprises a medium-term “fair value”
around which the market oscillates. The Tenkan-Sen works
as a trend and level identifier, finding dynamic-support at 6.25 currently.
Hong Kong
The tension between Hong Kong and mainland China
persists even though the protests in Hong Kong faded and it
is unlikely to go away anytime soon. Discontent in Hong
Kong has been a multi-year trend and rooted in social and
economic inequality. The Chinese government appears to
make this conflict a war of attrition. The protests hurt the
Hong Kong economy and Beijing has a bigger pocket to
withstand the pain. On the other hand, we don’t expect a
mass violence since the situation in Hong Kong has not
deteriorated enough. Unemployment rate is still low and
GDP per capita is high that residents have much to lose if
the situation becomes violent. So we see a muddle through scenario and weigh on Hong Kong’s economic performance.
We don’t like HKD and look to use it as a hedge for USD
strength. USDHKD is trading at the very bottom of the peg
at 7.75 and cannot get any stronger from a more positive
macro environment. Hong Kong inherits US interest rate
policy from the USD peg and low rates have pushed up
asset prices in Hong Kong. However, there are several risks
for a weaker HKD. One, as the US economy recovers, US
yields rise from a hawkish Fed. The rise in rates through the
peg will pressure Hong Kong rates to rise and lower Hong
Kong asset prices. Both of these will make HKD weaker.
Furthermore, long USDHKD can act as hedge if China or
general global risk re-emerges. Long USDHKD is also a small positive carry hedge.
India
For 2015, Prime Minister Modi’s ascent to power will only
make a small difference to the economy and will recover
only to 5.8% compared to 5.3% in 2014. Instead of
focusing on reforms, the recovery will come from monetary
easing. January’s inflation at 5.1% has finally fallen within
RBI Governor Rajan’s target of 4% +/-2%. Some of this was
due to lower commodity prices and this will give room for
more easing. The RBI has delivered a 25bp rate cut in an
unscheduled meeting in mid-January. We see another
75bps of easing in 2015 to decrease the policy repo rate to
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Emerging Markets Explorer
7.00%. This will give room for businesses to start the capex
cycle and for households to increase consumption. Over the
medium term, Mr. Modi is improving the growth outlook by
moving government spending away from subsidies (hand-
outs that win votes) to investment and this will improve the investment outlook.
The lower oil price and removal of fuel subsidies will
improve India’s trade balance. For 2015, we don’t see much
movement in INR but we would like to go long to pick up
carry of around 6% annualized once we get over the current
taper tantrum. We see USD/INR return to 60 by year end.
For rates, we prefer to receive the front end, since we
expect more rate cuts and economic growth to regain traction.
Indonesia
The economy will have a small recovery to 5.4% in 2015
from 5.1% in 2014. Indonesia can typically grow 6% or
higher but it is facing two headwinds. First, export recovery
is slow because thermal coal, natural gas and palm oil prices
are its main exports and their prices remain low. In addition,
the mineral export bans remain in place and hurt export
volumes. Second, credit demand is slowing and will
decrease domestic investment and consumption. The
central bank eased rates by 25bps to 7.5% in the last policy
meeting to support lending and inflation is falling post the
fuel price hikes. We think the central bank can ease another
25bps in Q2 to further support growth since inflation should
continue falling. The upside risk to growth we see is more
public investment as President Jokowi is encouraging more
infrastructure project but they will have more of an impact
in 2016 than 2015. The one risk we are seeing is political
infighting that can delay Jokowi’s attempt to reform.
Jokowi’s ability to centralize power appears to be taking
longer than expected and can hinder the high expectations markets hold for this popular President.
IDR is weakening from general USD strength, a current
account deficit that is slow to improve, and policy easing.
We think the last rate cut was premature and shows that
the central bank is more comfortable with a weakening IDR.
Also, FX policy appears to have changed where instead of
protecting levels, the central bank is letting IDR depreciate
gradually and limit large moves. With a stronger USD, we
could see continued weakness in IDR. On rates, we
recommend receiving since we see another cut and longer
end bond yields will likely drop because growth will be low
with inflation. With currency weakness, hard currency debt
is better than local currency. Equity market should do well from easing and low rates.
South Korea
The economy has been weak from lacklustre exports to US,
Europe and China. Domestic demand has also been weak
since the private sector debt is one of the highest in the
world. The high debt is the result of historical economic
policy of relying on credit to sustain high growth. With
everyone leveraged up, trend growth will likely fall as Korea
abandons the “borrow and grow” strategy. In addition,
Korea will likely have lower inflation. With less investment,
demand for funding will decrease and creates “excess”
savings, which will drive interest rates lower. One change
we see recently is from President Park. She is starting to
relax some populist measures against Chaebols where she
has learned that help from Chaebols are needed to get the
domestic economy going. The dead property market has
gained relief where major property projects are getting
approved faster than expected. The policy shift can reverse Korea’s underperformance.
Korean Won (KRW) has been weakening following the
Japanese Yen (JPY) despite the high current account
surplus. The likely causes of weakness are speculative
positions and foreign selling in the equity market. Short
term, we expected further KRW weakness because we
expect the central bank to ease rates 50bps to bring the
policy rate to 1.5% from 2.0%. BoK has stubbornly held
interest rates on hold due to rising household debt.
However, this was the same routine in early 2012 but later
embarked on cuts, following the rest of the world in easing.
We expect BoK to be pragmatic and repeat the same
pattern this time. Since we expect cuts, we still prefer
steepeners and not receive or hold bonds in short end rates
since the currency weakness can eat away the interest gains.
KRW TECH CORNER
The market likes it above the rolling 21week high-low
average (aka "Kijun-Sen"), which identifies dynamic support
at 1,088, followed by a prior 1,074 below. A 5-wave impulse
is unfolding, now developing its 5th
leg higher. This should
be followed by a 3-wave correction before another 5-leg
sequence is initiated. Overhead attraction/resistance are
found at primarily 1,168 and secondly at 1,189.
Malaysia
We expect Malaysia’s economy to slow to 5.2% in 2015
from 5.8% in 2014 from fiscal contraction. PM Najib gave
cash hand-outs in 2013 to influence the last election and he
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Emerging Markets Explorer
will be reversing them in 2015, which will weigh on growth.
The measures are unfavourable to the public but positive
for long term economic growth. A 6% VAT tax will
commence in April 2015 and slow consumption. Similar to
Indonesia, exports will face headwinds since Malaysia is
reliant on palm oil and natural gas exports. The lower
commodity prices will also weigh on revenue projections
and slow public and private investment. In 1H 2015,
Malaysia will announced the 11th Five year plan and will
likely continue the path towards more private sector
involvement and increase in infrastructure spending,
especially in the energy sector (natural gas) over the long term.
MYR has suffered from rising US yields and lower
commodity prices. Foreigners own more than 40% of the
government bond market since Malaysia was stable and
offered higher yields relative to the US. However, possible
rise in US yields are leading to unwinding of these positions
and hurting MYR. Also, lower commodity prices are hurting
Malaysia’s the most in Asia because they have historically
had a large current account surplus to support MYR but that
is diminishing rapidly. We expect MYR to weaken in 1H but
we think most of the big moves have taken place already.
We expect interest rates to be on hold at 3.25% with a small
risk of easing to support the economy. We would be bias to receive front end rates.
Philippines
The economy should accelerate to 6.2% in 2015 compared
to 6.0% in 2014. Philippines faced economic headwinds
last year from typhoon Haiyan and policy tightening but we
expect a small rebound as the economy normalizes and
public investment will rise heading into the 2016
Presidential election. Furthermore, base effect from the
typhoon will push up growth and fiscal stimulus. President
Aquino’s term ends in mid-2016 and he will want the
economy to be strong going into it for the election as well
as for his legacy. Public spending has faced bottlenecks and
those will likely to be spent to prop-up the economy. The
recovery will not be strong as usual since monetary
contraction will weigh on growth. Interest rates had been
set at or below CPI for the last several years that has
propelled credit growth and domestic consumption. The
central bank maintained policy rates stable recently as
inflationary pressures eased but it may start hiking interest
rates again later this year in reaction to rising US rates and that will weight on consumption in 2015.
PHP has outperformed other Asian currencies since it has a
solid current account surplus and the central bank has
hiked rates in preparation for US hikes. However,
Philippines cannot fight the Fed and PHP will play catch-up
to rest of Asia especially in the 1H 2015 and peak at 46. On
rates, we prefer paying the long end since we expect more
fiscal spending to come through and the economy to
rebound in 2015. Policy rates will be on hold at 4% with risks of a hike towards end of 2015.
Singapore
The Singapore as a small, open economy will improve to
3.2% growth in 2015 compared to 2.9% last year on
improved export outlook. We don’t expect a huge rebound
since Singapore is following China in improving the
composition and quality of the growth. Singapore is limiting
immigration to boost low income residents’ job potentials and attempting to reduce income inequality.
The big change we expected and saw recently was MAS
loosening policy by slowing the pace of appreciation in the
SGD NEER. Inflation has fallen below 0% from lower oil and
property tightening measures. Core inflation remains
elevated at 1.5% but it will follow headline and ease
towards 1.0% and give room for more easing. We think in
the next meeting in April, MAS will re-center the mid-point
of the band to the current SGD NEER level (form of
devaluation), lower the appreciation path from 1.5% to 0%
and may even widen the band from +/-2% to 3% to allow
more flexibility. Also, interest rates are heavily influenced by
the US and will rise, which will also put downward pressure
on the economy and especially the property market that has
benefited from the low interest rate environment. This will be negative for the equity market as well.
Taiwan
Taiwan should benefit from an export recovery in the US
since exports are over 70% of GDP and sensitive to global
demand. Relations with China turned sour last year from
anti-China student protests but things are stabilizing and
trade should resume. However, the ruling KMT party is
losing more and more elections to the DPP who are more
anti-China and that will slow the rise in property prices and domestic demand.
TWD will also weaken from the stronger USD and the
central bank is likely content with a weaker TWD to support
growth and exports with very little inflationary pressure.
When the USD strength stabilizes, TWD will also be late in
appreciating since the central bank usually intervenes to
reduce the volatility. Hence, we see TWD to be a good short candidate against USD.
Thailand
Thailand’s economy will normalize since the military has
taken over the economy and protests that have been
disrupting the economy have stopped. We see the economy
recovering to 3.5% in 2015 after a dismal 0.8% growth in
2014. Consumption will rebound from people returning to
work and to the stores. Public investment will also rise as
government deadlock ends and the military has full
authority to reallocated funds. Tourism should return and help the small and medium sized enterprises.
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Emerging Markets Explorer
Our top short in Asia for 2015 is THB based on three
reasons. First, we think THB is over-valued relative from
strong performance in 2014. With a weak economy, the
interim government will support a weak currency to restart
exports. Second, the central bank will ease policy by 50bps
to restart the economy. Inflation has been falling and policy
rates can be cut to restart the engine. Third, political risk
has not disappeared, but has just been pushed back. Until
Thailand has elections and the elected government is
accepted by the public, protestors can easily be back on the
streets. Until the political system is resolved, long term economic growth will be difficult.
Emerging Europe
Czech Republic
We forecast EUR/CZK to trade at 27.5 over the coming 12
months. The Czech National Bank’s (CNB) EUR/CZK floor at
27.0 will remain in place at least until mid-2016. If anything,
the CNB will raise the floor, if we see substantial weakening in PLN, HUF and RON.
In December and January, inflation retreated back to 0.1%
y/y after being on an upward trend since last summer. CPI
has stalled due to deflation stemming from the Eurozone. In
addition, there is still plenty of spare capacity and
continued high unemployment, 7.5% in February, which
keeps a lid on wage increases. Due to the global
disinflation, we believe inflation will remain subdued during
2015. The inflation target (2% +/-1%) will be difficult to
reach as long as the euro remains weak. The repurchase
rate is already close to zero (0.05%), leaving the CNB with
few options but to alter its cap on the exchange rate to avoid deflation.
GDP grew modestly by 1.5% y/y in Q4’14 compared to
2.4% y/y in Q3. Manufacturing is the backbone of the
economy and grew by 6.9% y/y 2014. Exports are
important, in particular to the German market, which has
been the main driver of economic recovery. However,
domestic demand has picked up lately, supported by
declining (but still high) unemployment, increased
minimum wage and a lower VAT rate for certain items.
When looking at retail sales, households are spending more
as we saw an increase to 5.9% in 2014, up from 5.2% in
2013. For these reasons, we expect GDP to pick up to 2.4% in 2015 and 2.9% in 2016.
With ECB’s quantitative easing program launched (€60bn
per month), several countries in Europe with pegs or semi-
pegs to the euro have acted pre-emptively. The Swiss
National Bank let go of its 1.20 floor and the Danish Central
Bank introduced negative interest rates, in order reduce
pressure on their currencies to appreciate. This has led to
speculations that the CNB will also abolish its semi-peg.
However, there are significant differences to keep in mind
when comparing the CZK with CHF and DKK. First, given
that the Czech Republic is not a safe haven, the koruna
does not face the same upward pressure as, e.g., CHF and
DKK. Second, the exchange rate floor has only had a
moderate impact on the (in comparison small) CNB’s
balance sheet. Third, due to legal complications,
introducing negative interest rates has been ruled out by
policymakers. Hence, if anything, it is more likely that the
floor is raised as we see an increasing need to further loosen the monetary policy.
Hungary
We forecast EUR/HUF to reach 313 during Q1’15 and
starting in Q2, we expect the forint to begin to strengthen,
taking the pair down to 300 in one years’ time. The
Hungarian economy is undergoing a fragile recovery, but
the upcoming ECB easing program (€60bn per month) will contribute to HUF appreciation against the euro.
CPI has showed deflation since September (latest print: -1%
y/y in February) and we expect it to continue to hover in this
territory due to global deflationary pressures, a negative
output gap and subdued import prices. For these reasons,
we expect the 3% inflation target to be reached in 2017 at the earliest.
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Emerging Markets Explorer
The Hungarian economy grew by 3.4% y/y during 2014
supported by an increase in investments and private
consumption. Above-trend growth was supported by two
temporary factors: frontloaded spending of EU structural
funds and a strong year for the agricultural sector. We
expect GDP growth to normalize to 2.5% during 2015 for
three reasons: 1) base effects, 2) the ECBs QE program and 3) new easing cycle, taking the base rate down to 1.6%.
The National Bank of Hungary (NBH) has left the base rate
unchanged at 2.10% since July 2014. However, following
ECB, Poland and possibly the Czech Republic and Romania,
we expect the NBH to start a new easing cycle and cut by
20bps at their next meeting on March 24th. With deflation
in the economy, the CPI and the HUF are on the CBs radar
and if it falls further, looser monetary policy is in the cards.
Given that the ECB has cut its rate and is about to roll out a
large stimulus package, we believe the NBH will follow suit
and cut rates by 50bps to 1.6% during Q2 in order to stabilise the forint vs. the euro and to stem deflation.
Hungarian households have HUF 3.5trn of mortgages
denominated in Swiss franc. The loans were taken in the
boom years before the crisis in 2008 due to attractive Swiss
rates and expectations of a stronger forint. Luckily for the
households, the Forint has not suffered that much after the
Swiss National Bank de-pegged the franc from the euro in
January as, the exchange rate from CHF to HUF was set
already in November. Hence, the impact has been limited, unlike the situation the neighboring country Poland.
Poland
We forecast EUR/PLN to trade in the range between 4.10
and 4.20 throughout the year. Growth has been weak and
inflation low but economic activity is picking up and
fundamentals look strong. However, the slowdown in the
Euro area and geopolitical woes are putting a lid on
Poland’s growth potential. Therefore, we expect GDP growth to remain at 3% in 2015.
As the other countries in Eastern Europe, Poland has a
deflationary price pressure, well below the 2.5% +/-1%
target. In January, CPI printed -1.3% y/y. The National Bank
of Poland (NBP) expects inflation to stay below target until
2017. This has been the main reason for cutting the base
rate; 50 bps in October and another 50bps in March taking
the rate down to 1.5%. We expect the base rate to remain at
this level until Q4’15, as NBP has stated that the easing cycle is over.
As in Hungary, Polish households took up mortgages in CHF
in 2006-2007. Unlike Hungary however, Polish borrowers
are exposed to movements in CHF/PLN as a conversion rate
has not been set. Compared to Hungary, the percentage of
total mortgages in Poland is smaller (PLN 131bn) and CHF
lending was restricted to only very solid Polish borrowers.
Hence, there is rather limited need for damage control in
Poland but, the situation has still caused plenty of protests
and law suits, primarily against banks as they are viewed to
have tricked customers. This is starting to become a
political issue in Poland as borrowers want the government to force banks to take a larger hit.
On October 25th, Poland will hold parliamentary elections.
It will be a tight race between the incumbent party Civic
Platform, a Christian democratic party, and Law and Justice,
a conservative and populist party. Read more on the upcoming election in the Election Monitor on page 18.
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Emerging Markets Explorer
PLN TECH CORNER
The market is confined to an “ever contracting” range. The
"Triangle" should be a long-term bullish formation, but it
has failed to deliver numerous times and sideways trading
outside the range would force reassessment and a
4.09\4.40 “Box” considered instead. Outside this “Box”
there is more support at 4.03 and resistance at 4.43 to
violate to foresee a fresh trend beyond the very short-term
perspective.
Romania
We expect the Ron to strengthen gradually in 2015, taking
EUR/RON down from the current 4.45 level to 4.30 in Q1’16.
The Romanian economy will benefit from ECBs easing
program, lower domestic interest rates, lower taxes as well as low inflation.
As in many other countries in Eastern Europe, Romania is
experiencing downward pressure on inflation. In February, it
printed 0.4%, far below the National Bank of Romania’s
(NBR) 2.5% +/-1% target range. Falling oil prices and global
deflation pressure are the main contributors. We expect
inflation to continue to ease as ECBs QE program is rolled
out and oil prices likely to remain subdued. The NBH is likely
to continue on its easing path that was resumed last
August. The rate is currently at record low of 2.25% and in
order to curb falling prices and boost growth, we pencil in
further cuts this year. Another 25bps is expected, taking the rate down to 2% in Q2.
GDP growth is expected to stay flat at 3% during 2015. We
see three factors in support of a recovery. First, the easing
cycle will continue in order to combat disinflation. Second,
once budget revenues increase enough to allow tax cuts
without impacting the deficit, the government will lower
several taxes, among others the VAT from 24% to 20%.
Third, inflation will remain low and wage growth will be
significant, which will boost consumer spending, the key
driver of growth in Romania. However, the economy is also
very dependent on the Eurozone with 70% of exports going
to the area. A potential European downturn will hurt the Romanian recovery.
Since September 2013, Romania has a precautionary
standby agreement with the IMF worth €2bn. Lower taxes
and increased spending is not compliant with the IMF’s
demands as they wish to see a cautious fiscal policy and a
continuation of structural reforms. Romanian authorities
have failed several times to reach an agreement with the
IMF on the arrangement that expires in September.
However, this disagreement should not pose a major threat
as the financial markets have sailed through the Ukraine
crisis relatively unscathed and with an upbeat economic outlook, investors will stay optimistic.
Russia
We expect the correlation between RUB and oil prices to
remain strong throughout the year. Given the risk of
renewed pressure on oil in 2Q’15, before oil demand
catches up with supply, USD/RUB may again move up to
67.0 in the short term. However, with oil prices expected to
recover towards $70 per barrel towards the end of the year,
USD/RUB should fall back to 55.0. The forecast is also
predicated on the assumption that the conflict in eastern
Ukraine remains largely frozen and that Russia does not
intervene militarily and occupy a larger territory more
openly than it currently does. Such a scenario could draw
much more severe sanctions, and would likely send the RUB tumbling again.
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Russia is facing a severe recession with real GDP expected
to contract by 5.5% in 2015 and by 1% 2016. The fall in the
price of oil and the RUB in combination with counter
sanctions on imports of food have caused inflation to soar
to almost 17% y/y in February. Real wages will take a severe
hit causing a sharp contraction in consumption. However,
the outlook for investment is not much better due to
continued Western sanctions on banks, oil-exploration
technologies, and a very poor business climate. The central
bank will likely cut the policy rate gradually over the course
of year, as it has had virtually no effect on the RUB. A
contraction of domestic demand will ensure that the current
account continues to record a surplus. However, it will be
offset by large capital outflows, ensuring continued pressure on reserves.
RUB TECH CORNER
The December–March contracting range is thought to be a
medium-term bullish continuation formation, which would
host a very ambitious upside objective — depending on
where the range breakout actually happens — if it is broken.
The target is currently obscured as a “known unknown”.
The (shallow) ”C-wave low” in this formation may or may
not be in place at 59.30 (which would be better understood
on a bullish initiative over 64.21) or it remains to be printed
closer to a short-term 78.6% Fibo retracement ref at 55.97.
In any case, it is a bullish setup waiting for a rouble
“accident” to happen through a later break above 71.80 and later also 78.00.
Turkey
We forecast USD/TRY to reach 2.70 in Q2, 2.77 in Q3 and
2.80 in Q4, implying a modest 2.5% depreciation against
the EUR. The TRY will benefit from low oil prices, which will
help contain the current account deficit. However, this will
not be enough to counter its vulnerability to external
financing conditions stemming from its elevated inflation, political risk and large current account deficit.
Turkey is one of the largest net importers of energy (5% of
GDP) among Emerging Markets. The slump in oil prices will
narrow the country’s current account deficit, push down
inflation, lower interest rates and boost private sector credit
growth. Lower oil prices will also free up public spending,
which will be reallocated from heavily subsidised
households energy bills into other parts of the economy.
However, the dependence on short-term portfolio inflows
to finance the large current account deficit (5.5% of GDP)
will ensure that the lira remains vulnerable to global capital flows.
The depreciation of the lira against the dollar raises
concerns over the servicing costs of the high level dollar
denominated debt. At the same time, lira weakness against
the dollar will not translate directly into an improvement in
export competitiveness due to the weakness of the euro.
Little incentive to deal with the situation exists as the
country is heading into general elections in June. Policy
rates are likely to remain too low, ensuring that inflation
remains uncomfortably high, putting a cap on real wages
and rekindling worries of a private sector credit bubble. To
lift growth in the longer perspective investments and
structural reforms are necessary. We expect GDP growth of 3.3% 2015 and 4.2% in 2016.
Inflation increased by 7.6% y/y in January, well above the
CBRT’s 5% target. It is driven by the depreciation of the lira,
low level of economic slack and lack of confidence in
CBRT’s independence and commitment to the inflation
target. The slump in oil prices will slow inflation but core
inflation will remain uncomfortably high (8.6% y/y in
January). The intense political pressure on CBRT will likely
remain until EUR/TRY reaches roughly 2.95, that is only
slightly above the average rate in 2014. We expect the
CBRT to loosen monetary policy further until Q2, after
which it will be forced to hike once Fed initiates its hiking
cycle. The CBRT will react primarily to capital flows (TRY fluctuations), not inflation.
Turkey will hold general elections on June 7th. The
incumbent President, Tayyip Erdogan, is seeking a
supermajority in parliament. He has made no secret of
wanting to amend the constitution to increase the power of
the president. Erdogan is the founder of the AK Party, which
currently holds 313 of the 550 seats in parliament. He will
try to boost his popularity ahead of the election by
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providing fiscal and monetary stimulus. It will result in a
widening of the current account and budget deficits, as well as accelerating inflation and further lira weakness.
TRY TECH CORNER
The long-term uptrend is solid. The upper end of the trend-
channel may slow things down temporarily but a break
above 2.70 should be expected for transportation towards
interesting long-term Fibos at 3.10\3.15. Support is likely strong just south of the 2.40 mark.
Ukraine
On March 11, the IMF Executive Board approved a new $17.5
billion, four-year Extended Fund Facility (EFF) for Ukraine,
setting off $5 billion for immediate release. The approval
will provide some support for the battered UAH, but with
reserves remaining very low and with the loss of key export
industries to the rebels in the Donbass region, pressure on
the UAH will remain throughout the year. We see USD/UAH averaging around 30.0 in 2015.
Ukraine is facing a full-blown economic crisis with inflation
accelerating to 25% last year. The IMF expects real GDP to
contract by 5.5% in 2015, but we think that the risks are
skewed to the downside. The IMF also forecasts inflation to
be 27% in 2015, while the current account deficit should
narrow to less than 2% of GDP, due to the sharp
depreciation of the exchange rate causing a sharp
contraction of domestic demand. Fiscal adjustment will also
hold back GDP, and will present a severe drag on economic
activity for several years with public, and publicly
guaranteed debt peaking at close to 95% of GDP in 2015.
The IMF program assumes that private creditors will
contribute funds to the government by restructuring existing debt. However, no deal has been announced yet.
Latin America
Brazil
We forecast USD/BRL to reach 3.20 in Q2, 3.30 in Q3 and
3.40 in Q4. The BRL will remain under pressure by weak
economic growth, US rate hike expectations, tighter fiscal
and monetary policies, power rationing, looming credit
rating downgrades, corruption scandals and concerns over the governments’ ability to consolidate public finances.
The government is cutting fiscal spending, subsidies and
private sector lending to deal with the deterioration of the
fiscal accounts and BRL weakness. In the short term this will
accelerate price increases further, weaken economic growth
and weigh on the currency. In addition, the country is
experiencing its worst draught in 80 years. Its heavy
dependence on hydropower makes power rationing a
probable scenario this year, which will shave off 0.5%–
1.0% of GDP growth. We expect growth to contract by
0.5% in 2015 and expand by 1.5% in 2016. In the long term, growth will be driven by a cyclical rebound.
Hopes are set high on the government improving its fiscal
stance after the appointment of Joacquim Levy as the
Finance Minister and Nelson Barbosa as the Budget and
Planning Minister. They have already launched an austerity
programme including fuel tax hikes, subsidies cuts and
tighter credit policies. However, efforts may be undermined
by the Petrobras corruption scandal, which reduces the government’s influence over congress.
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Emerging Markets Explorer
Inflation has been accelerating reaching 7.7% y/y in
February, above the 4.5% +/-2% target band. It has been
driven by structural bottlenecks such as a weak
infrastructure network and a high level of inflation
indexation, as well as pass-through effects from BRL
weakness and fuel tax hikes. The slump in oil prices is
unlikely to have a significant impact on inflation since fuel
prices are regulated by the government. We see inflation
averaging above the 6.5% upper target limit in 2015. This
will ensure that monetary policy remains tight. We believe
the Selic rate will be hiked by 50bps to 13.25% in Q2, before peaking at 14.0% by the end of the year.
After widening from 2.1% in August 2012, Brazil’s current
account deficit appears to be stabilising around 4.0% of
GDP. The main cause of the break in the widening trend is
the depreciation of the BRL, which has increased the
competitiveness of the domestic industry. Tighter fiscal and
monetary policies will also help contain the current account
deficit going forward. However, a key risk to the capital
account is the upcoming US rate hike which makes capital inflows harder to attract.
BRL TECH CORNER
The recent move through resistance at 2.47 & 2.65 (now
presumably strong support together with long-term
dynamic supports in this area) has opened up the path back
towards the 2002 high of 3.9650. Short-term conditions
look stretched, but few seems to care and as long as more
pronounced signs of a sellers’ response (other than in the
dailies) do not show, extension is likely towards refs at 3.27 and 3.44.
Chile
We forecast USD/CLP to reach 650 in Q2, 660 in Q3 and
670 in Q4. The peso is highly correlated to the copper price
which has been falling since 2011. The decline has
deteriorated Chile’s terms of trade, resulting in lower export
revenues and weaker domestic demand. Strong wage
growth together with stable unemployment and low oil
prices will lift domestic demand this year, although it will not be enough to stop the pesos descent.
Economic growth has suffered from the decline in copper
prices. The copper industry represents almost 20% of GDP
and two thirds of total exports. The trend is unlikely to
reverse as exports to China, representing 8% of GDP, is
starting to soften as its demand for metals is decreasing
amid the slowdown in the property sector. However, the
effect of lower copper prices will be partly offset by the
slump in oil prices as Chile is the region’s largest net energy
importer. The economy will receive little support from the
robust recovery in the US, since it only accounts for 13% of
total exports while 39% are destined to the EU and China.
The budget deficit looks set widen as the government will
increase public spending by almost 10% this year to jump
start the economy. The main targets are infrastructure,
education and healthcare. It will be financed by hiking
taxes, amongst others increasing corporate taxes to 27%
from 20%. Strong wage growth together with stable
unemployment and monetary easing will support domestic
demand and economic growth this year. We forecast GDP to increase by 2.5% this year and 3.8% in 2016.
Chile’s inflation increased to 4.5% y/y in January, above the
central bank’s 3% +/-1% target, from 3.0% y/y a year
earlier. It has been driven by higher food prices, a weaker
peso and loose monetary policy. The peso has depreciated
12% against the dollar since June, while the central bank
has cut the policy rate by 100bps to 3.00%. The cuts signal
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Emerging Markets Explorer
that the central bank is currently more concerned with low
growth than above-target inflation. However, high inflation
limits the scope for further monetary easing. We expect the
central bank to keep the policy rate unchanged at 3.00% until Q4’15, when tightening should begin.
A strong peso and low competitiveness left the current
account deficit at 3.4% of GDP in 2013, which together with
negative net FDI made the peso vulnerable to external
shocks. However, the currency’s depreciation over the past
two years has improved the trade balance and the current account deficit has narrowed to 1.9% of GDP in Q3’14.
Mexico
We forecast USD/MXN to reach 14.70 in Q2, 14.40 in Q3
and 14.10 in Q4. The MXN will benefit from the pickup in US
activity, reform initiatives and tighter monetary policy. A low
oil price is a key risk as it forces cuts in fiscal spending to
replace lost tax revenues. It also reduces the appetite to invest in the energy sector.
Mexico is particularly well placed to gain from the recovery
in the US economy. More than three-quarters of exports are
destined to the US, representing 25% of GDP. In addition,
President Enrique Peña Nieto has set in motion a wide-
ranging reform program including fiscal, education,
telecom, banking, labour, judicial, electoral, and, most
importantly, energy sector reforms. However, if oil prices
averages USD 50pb, government revenues from the energy
sector will decrease by 25% (2% of GDP). The government
has already announced spending cuts of 0.7% of GDP this
year, but may be forced to cut further to prevent the budget
deficit (roughly 4% of GDP in 2014) to spiral in 2016, when the government’s oil prices hedges will have to be renewed.
Lower oil prices may also reduce investors’ appetite to
participate in auctions of exploration blocks that are
relatively expensive to develop. Investments have also been
dented by corruption allegations and security concerns. We
expect GDP growth to expand by 3.3% in 2015 and 4.0% in
2016. It will be driven by a cyclical rebound supported by
strong US demand and implementation of structural reforms.
Inflation reached 3.1% y/y in January, just above the 3%
inflation target. We don’t believe that inflation will be a
concern to the central bank this year as GDP growth is
insufficient to generate any significant price pressure. In
addition, low oil prices, fiscal spending cuts and last year’s
tax hike falling out of the annual reading will cap prices. We
think that that the central bank will keep its policy rate on
hold at 3.00% until Q3. Concerns over peso weakness
stemming from a tighter US monetary policy will force the bank to hike rates by 50bps in Q3 and 25bps in Q4.
MXN TECH CORNER
The 2009 high has just been violated. An earlier bullish
"Triangle" breakout posts an ambitious 18.00 objective, but
levels at 16.97\17.22 also works fine as a tentative target
area, if remaining resistance at 15.89 is erased. Medium-
term support is likely strong in the 15.55/14.43-area,
centring on the June 2012 high of 14.60.
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Emerging Markets Explorer
Sub-Saharan Africa
Botswana
The Botswana pula operates under a crawling peg
arrangement against a basket consisting of 50% ZAR and
50% SDR currencies. We expect USD/BWP to trade higher this year on the back of ZAR weakness.
Botswana is the world’s largest diamond producer. Fuels
and mining products represents 85% of total exports and
65% are destined to the European Union. This makes the
economy inherently exposed to commodity prices and the
recovery in the Europe. The diamond industry is expected to
be exhausted within 20-30 years, making economic
diversification vital. The non-mining sector is struggling due
to disruption in water and electricity supply as well as high
unemployment and income inequalities. Investments in
infrastructure and the labour together with efforts to
diversify the economy will partly offset the effects of the
slowdown in the diamond sector. We expect GDP to grow
by 4% this year driven by a cyclical recovery in the mining sector.
Inflation softened to 3.6% y/y in January from 4.5% y/y in
September on the back of lower oil prices and modest
domestic demand. The lower price pressure prompted the
Bank of Botswana (BoB) to cut its policy rate by 100bps to
6.50% in Q1’15. The BoB targets inflation at 3%¬–6% and
we will likely receive additional accommodative measures from the bank in H1’15.
Ghana
The cedi will continue to depreciate against the dollar this
year as it is weighed by stubbornly high inflation and large
current account and budget deficits. Fiscal and monetary
policies will likely not be tight enough ahead of the 2016 general elections.
Economic growth has been supported in recent years by the
start of oil production, ample fiscal spending and rapid
credit growth. The budget deficit ballooned to 7% of GDP in
2014 and the current account deficit is likely to widen from
9.4% of GDP in 2014 due to the slump in commodity prices.
This has resulted in credit rating downgrades and made
fiscal consolidation vital to restore investor’s confidence.
The government has taken steps to rein in spending and
increase revenues in the 2015 budget including wage and
hiring freezes, VAT hikes, and subsidy cuts. In addition, the
country is to finalize a deal with the IMF for a USD 1bn
multi-year loan facility conditional to improved fiscal
discipline. However, strong labor unions and the 2016
election make the complete implementation of the
proposed fiscal measures improbable. Electricity disruption,
high unemployment and income inequalities will provide a
further drag on growth this year. In the long term, growth
will be supported by a cyclical rebound in commodity prices
and stronger foreign demand. We believe GDP will increase by 4% in 2014.
Inflation increased by 16.4% y/y in January, well above the
8% +/-2% target. It has been driven by the sharp
depreciation of the GHS, subsidy cuts, fiscal spending and
credit growth. The policy rate is currently kept at 21% and is
unlikely to be loosened significantly this year as the slump
in oil prices will begin to fall out of the annual inflation numbers in H2.
Kenya
We forecast USD/KES to follow its long term trend and
reach 92 in Q2, 93 in Q3 and 94 in Q4. Security concerns,
following last year’s terrorist attacks, has caused a sharp
drop in tourism and hit the economy hard. The current
account and budget deficit remains large which makes the
country vulnerable to external shocks. However, most
sectors of the economy are experiencing robust growth which supports stability.
Last year’s terrorist attacks by the Islamic militant group Al
Shabab shaved off 3% of GDP in Q3 as several countries
issued travel warnings to Kenya. Furthermore, it reduced
investors’ confidence and lowered foreign capital inflows
which put pressure on the shilling. Steps have been taken to
improve the security situation, including the nominations of
a new Police Inspector General and removal of corrupt
leaders. The economy is one of the most diversified in the
region although the agriculture sector is large (25% of
GDP), making it exposed to weather conditions. The main
drivers of growth are; rising foreign investments, stronger
foreign demand and a recovery in the tourism industry. The
currency’s vulnerability to capital flows stems from its large
current account and budget deficits (8% and 6%
respectively). The USD 2.75 Eurobond issue, to help fund
infrastructure projects, together with the USD 688mn
precautionary loan facility from IMF will improve investors’
confidence and financial stability. We expect GDP to increase by 5.8% in 2015 and 6.0% next year.
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Emerging Markets Explorer
Inflation increased by 5.6% y/y in February and has been
falling since August on the back of lower oil prices despite
the depreciation of KES. Developments of oil prices and
weather conditions, due to the large agriculture sector, will
be the main drivers of prices this year. The central bank
kept its policy rate stable at 8.5% last year as inflation fell to
within the 5 +/- 2.5% target. The bank will keep its policy
rate tight this year due to the currency’s vulnerability to external financing conditions.
Nigeria
We forecast USD/NGN to stabilise at close to 200 in 2015.
The slump in oil prices has put pressure on fiscal accounts
which together with security concerns and corruption allegations has reduced investor confidence.
Nigeria has been hit hard by the slump in oil prices. It is the
sixth largest net oil exporter in the world with oil and mining
products accounting for 95% of exports. The fall in prices
has widened the fiscal deficit, which is expected to reach
2.8% this year, close to the 3% statutory limit. The current
account deficit will balloon to almost 7% of GDP in 2015.
However, the country will endure the downturn in oil prices
due to its low level of public debt and the room to raise
corporate taxes. Nevertheless, this year’s budget will be
trimmed by reducing capital spending in much-needed
infrastructure. This increases the urgency of the
implementation of structural reforms, but they are likely to
be delayed as the country is heading into general elections on March 28th, increasing political uncertainty.
Security concerns stemming from the insurgence of the
Islamic militant group Boko Haram in northeast Nigeria has
become an increasingly pressing matter as they step up
attacks and thefts from pipelines. We expect GDP to increase by 5.0% this year and 7.0% in 2016.
Inflation is remaining stable at uncomfortably high levels
(8.2% y/y in January) and is mainly driven by expansionary
fiscal and monetary policies. The price acceleration may
increase due to NGN depreciation, increased public
spending ahead of the election and the disruption of trade
flows following the insurgence of Boko Haram. The central
bank has raised the policy rate by 100bps to 13%, widened
FX fluctuation bands, increased reserve requirement and
tightened capital controls to defend the naira. We expect
further measures to be taken this year as the naira will likely
remain under pressure. The government delayed general
elections for six weeks to March 28th
due to security
concerns related to Boko Haram. The ruling People’s
Democratic Party (PDP) looks currently likely to win, but it
will be a very tight race against the newly-formed All Progressives Congress (APC).
South Africa
We forecast USD/ZAR to reach 11.95 in Q2, 12.20 in Q3 and
12.50 in Q4. ZAR is vulnerable to external financing
conditions stemming from its large budget and current
account deficits. Structural bottlenecks put a cap on growth
while power shortages, potential rating downgrades and
violent labour market disputes may exert additional
pressure on ZAR. The slump in oil prices provides some relief but will not be enough to stop ZAR depreciation.
Domestic demand has been the main driver of growth, but
it is now slowing due to decelerating credit growth to highly
indebted households. The current account has ballooned
after years of accommodative fiscal and monetary policies
which has made the currency vulnerable to external shocks
due to its dependence on short-term portfolio inflows. The
government has been largely ineffective in implementing an
investment based growth model following the post-
commodity boom era. The underlying problem is large
income inequalities and high unemployment (25%), which
reflects a highly fragmented society. Essentially there are
two South Africa; one poor, largely tribal-based and one rich
with living standards and education levels on par with Western Europe.
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Structural reforms and investments are needed to lift
growth. However, parliament is politically fragmented and
investors’ confidence is low following rolling power
outages, strikes and credit rating downgrades. The slump in
oil prices has provided some relief by shrinking the current
account deficit, lowering interest rates and allowing for
potential fuel tax hikes. Nevertheless, the economic outlook
for the country remains dim. We expect GDP to increase by 2.2% in 2015 and 2.3% next year.
Inflation slowed to 4.4% y/y in January, within the 4%–6%
target range, driven by lower energy and food prices.
Nevertheless, core inflation remains elevated at 5.8% y/y.
The underlying price pressure stems from an inability of the
SARB to insulate the economy from the global business and
commodity cycles. Nevertheless, inflation expectations
remain stable in the medium term. SARB will likely keep
rates on hold for now, but will be forced to hike when the
US does. We believe that the SARB will start hiking the policy rate in Q3, and follow the Fed up.
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