Emerging Markets December 2011

Emerging markets outlook

Emerging Markets FX

Provides advice, analysis and foreign exchange products to clients within emerging markets.For further information, call +46 8 700 90 20Analyst: Hans Gustafson +46 8 700 91 47


Is published four times a year and is forecastingcurrency developments for selected emerging market countries with a time horizon of 3 months.

Low growth and high debt – a tricky balancing act

Emerging markets analysis — 30 December 2011

We expect significant volatility on the currency market early next year with unusually large differences in currency performance between different emerging markets. Weak economic development in Europe, with significant budget constraints and banks shrinking their balance sheets, will hit most East European countries hard. In recent years a number of these countries have only grown through exports to the eurozone, which is a growth factor that is now fading. The recent weakening of currencies has meant that imported inflation is now increasing in many East European countries, forcing interest rate hikes or expectations of hikes in countries which are instead in need of economic stimulus. The situation is most problematic for Hungary, which is the most indebted country in the region and has a government that is pursuing a highly populist economic policy. ECB’s long-term repos at low rates will ease the financial pressure on banks in the eurozone, but lending capacity will be extremely limited in 2012 and this will impact most East European countries hard. However, we do not share the highly negative view that many have on China. We expect the Chinese economy to weaken, but do not expect a hard landing. The Chinese property market needs to cool down and the oversupply needs to be absorbed, but

China is a centrally controlled economy and adjustments to economic conditions have worked relatively well in the past. Furthermore, leverage in the Chinese property market is much lower than in the West. The balancing act for Chinese economic policy, however, is more difficult now as structural inflation is higher than before. Assuming that China has a soft landing, we see continued support for commodity prices, especially for energy-related commodities. Supply is limited in many commodity markets and extraction costs are high. This provides continued support for countries like Russia. The Russian economy is growing on the back of strong domestic consumption. In the long run a membership of the WTO is very positive for the modernisation of the Russian economy. We expect that economic growth in the US will be slightly below trend growth during 2012 year as a result of an extension of temporary tax cuts and monetary policy stimulus measures. For this reason we are positive towards developments in Mexico which is also attracting major foreign investments. Euro zone is in a recession and there are large uncertainties over how things will play out. We therefore expect a negative trend for the euro against the US dollar during the first quarter of 2012.

FX/FI research — Swedbank Large Corporates & Institutions of 8

Emerging markets outlook Emerging markets outlook

Forecast Forecast

FX forecast 3 months vs euroFX forecast 3 months vs euro

Poland Spot Rate EUR/PLN

Source: Reuters EcoWin

feb10

apr jun aug okt dec11

feb apr jun aug okt dec12

EU

R/P

LN

3,8

3,9

4,0

4,1

4,2

4,3

4,4

4,5

4,6

EU

R/P

LN

3,8

3,9

4,0

4,1

4,2

4,3

4,4

4,5

4,6Russia Spot Rate EUR/RUB


feb10



EU

R/R

UB

37

38

39

40

41

42

43

44

EU

R/R

UB

37

38

39

40

41

42

43

44

The zloty has continued to weaken as financial uncertainty has increased in Europe. Poland is affected by the risk of contagion via the banking system, large parts of which are foreign-owned. Poland has better economic fundamentals than many neighbouring countries in Eastern Europe, but it is nevertheless highly sensitive to lower exports and restraint in the activities of the banks.

Poland’s economy has continued to grow at a good rate. GDP increased by an annual rate of 4.3 percent in the third quarter. Domestic demand is still the driving force. Growth in the retail sector has been consistently high. This is due to the significant rise in wages. Industrial production has gained renewed impetus since the summer, growing by almost 9 percent in real terms in November. This high growth and the currency depreciation have resulted in higher inflation. In November inflation was 4.8 percent, which is well above the central bank’s upper tolerance level of 3.5 percent. The key interest rate was raised by 100 points to 4.5 percent during the year. Underlying inflation and inflation expectations are high and we therefore expect at least one more interest rate increase of 25 points in 2012. The major problem for Poland is its budget deficit which amount to around 8 percent of GDP and government debt that is approaching the statutory ceiling of 55 percent of GDP. However, unlike many other countries in the region, Poland recently received positive comments from Moody’s regarding the possibilities for improving budgetary performance.

PolandStrong growth and large reserves

Negative debt trajectory

RussiaStronger economic growth

Increased political uncertainty

The ruble performed poorly in the autumn in conjunction with uncertainty following the parliamentary election. The losses suffered by the governing United Russia party is of high concern for Putin ahead of the presidential election in March, and we consequently expect an even more expansive fiscal policy. We are positive on the ruble on the back of high interest rate carry and continued healthy domestic growth.

Growth in the Russian economy was healthy in the third quarter, with GDP growing by 4.8 percent. It is encouraging that domestic consumption and investments are now contributing to growth. Retail trade is increasing by around 9 percent. Real wages are increasing and credit growth has taken off on the back of historically low interest rates. Russia’s WTO membership is very positive in the long term and will help to reduce the narrow dependence on energy production. The rate of inflation has fallen during the year owing to lower food prices. We expect higher inflation in 2012 due to a weaker RUB, even stronger growth in lending and an expansive fiscal policy. However, the central bank recently cut the repo rate to 8 percent, which is more of symbolic value ahead of the forthcoming presidential election. However, during the year short-term interbank rates increased and are now at levels higher than 6 percent. In the medium term we believe that the turmoil following the parliamentary election in December may act as a catalyst for an orientation towards a modernization of the economy. We do not expect any ”Arab spring” in Russia as average incomes are significantly higher in Russia, but the political challenges should not be overlooked.



Forecast Forecast


Hungary Spot Rate EUR/HUF


feb10



EU

R/H

UF

260

270

280

290

300

310

320

330

EU

R/H

UF

260

270

280

290

300

310

320

330Czech Republic, Spot Rate, EUR/CZK


feb10



EU

R/C

ZK

23,75

24,00

24,25

24,50

24,75

25,00

25,25

25,50

25,75

26,00

26,25

EU

R/C

ZK

23,75

24,00

24,25

24,50

24,75

25,00

25,25

25,50

25,75

26,00

26,25

While the Czech Republic has low government debt, its economy is highly sensitive to a recession in Europe and the domestic economy is being weakened by budgetary savings. Market conditions for the forint are negative in the first quarter of 2012.

Hungary is the most indebted economy in Europe. With junk bond credit rating, an unwillingness to make sustainable adjustments of the economy for the long term and a law that reduces the central bank’s independence, it is difficult to be anything other than negative towards the development of the currency. The high interest rate is the only factor preventing a collapse in the forint.

Economic recovery since the 2008 financial crisis has been modest in the Czech Republic. In real terms the economy has been stagnant since 2007. The economic prospects appear bleak, with leading indicators pointing to falling industrial production. PMI has plummeted from a peak of more than 60 at the start of the year to 48.5 at present. Consumer confidence has collapsed entirely to its weakest level since 1999. This is not so surprising against the background of weak economic growth, which means that the government needs to make even tougher savings to achieve its target of a budget deficit of 3.2 percent for 2012. In addition, wage increases have been very low and the retail sector has been weak. Inflation has risen as a result of the VAT hikes during the year, reaching 2.5 percent in November which is above the central bank’s target of 2 percent. In 2012, however, we expect no change to the key interest rate, which has been at a historical low level of 0.75 percent since 2010. The Czech economy is highly vulnerable to a recession in Europe since the country’s share of exports as a percentage of GDP is among the highest in Europe. Nevertheless, with government debt at less than 40 percent of GDP the Czech Republic is one of the financially strongest countries in Europe.

In the autumn Hungary’s credit rating was cut to junk status by both Standard & Poors and Moody’s. The government has turned to the IMF and EU for financial assistance but discussions broke off following strong disagreements. We believe that economic reality will eventually force the Hungarian government to give in and adjust its economic policy to the requirements of the IMF and the EU. The question is how messy things will get before this happens. Government debt is 75 percent of GDP but the major problem is the high level of external debt. Total external debt amounts to 140 percent of GDP. Hungary is consequently extremely sensitive to European banks’ continued shrinking of their balance sheets. Growth prospects appear very bleak as exports, which account for more than 75 percent of GDP, are now plummeting. The retail sector has been weak since 2007 and consumer confidence has collapsed during the year. The weakening of the currency has led to higher inflation, forcing the central bank to raise the key interest rate by 125 points to 7 percent during 2011. This is despite the very weak economic growth. Hungary thus finds itself in a particularly vicious circle.

Czech RepublicLow general government debt and credible budget policy

Extremely high dependency on exports to Europe

HungaryHigh interest rate

Lack of credible economic policy



Forecast Forecast


Turkey, Spot Rate, EUR/TRY


feb10



EU

R/T

RY

1,8

1,9

2,0

2,1

2,2

2,3

2,4

2,5

2,6

EU

R/T

RY

1,8

1,9

2,0

2,1

2,2

2,3

2,4

2,5

2,6South Africa, Spot Rate, EUR/ZAR


feb10



EU

R/Z

AR

8,5

9,0

9,5

10,0

10,5

11,0

11,5

EU

R/Z

AR

8,5

9,0

9,5

10,0

10,5

11,0

11,5

The rand has recovered relatively well compared with many other emerging market currencies since its collapse in September. We are neutral towards the rand at this point since we expect stable commodity prices and moderate growth. The rand is sensitive to the downside if commodity prices fall and if global risk sentiment weakens.

Turkey currently finds itself in a sensitive position due to the size of its large current account deficit and the uncertainty surrounding monetary policy. We expect a smooth adjustment of the deficit, but the risk of a turbulent development is not insignificant. We are therefore currently neutral on the lira.

Prior to the financial crisis growth in South Africa was between 5 and 6 percent. At that time growth was being driven by preparations for the 2010 Football World Cup. Growth over the past year has been more modest, at around 3 percent. Exports have continued to increase at a fast pace, particularly to Asia which has been South Africa’s largest export market since 2009. Domestic demand is strong and this is reflected in significant import growth and car sales. Imports rose by 48 percent in November compared with the same period in 2010. Retail sales have been high over the past year, increasing by 7.5 percent. The deficit in the current account has increased from -1.5 percent of GDP in 2010 to -3.8 percent in the third quarter in line with the decline in the trade balance. Inflation has risen to 6.2 percent from 3.4 percent at the end of 2010 and is expected to increase slightly more as a result of the depreciation of the rand in the autumn. During 2010 the central bank kept the policy rate unchanged at a record low level of 5.5 percent. We do not expect any change in the policy rate any time soon, but there is a risk of a hike in the first quarter if the domestic economy does not cool down.

Turkey currently has one of the highest growth rates in the world. The country also has one of the world’s largest current account deficits. This is the result of an incorrectly calibrated and overly relaxed monetary policy over the past year. The lira has fallen by 20 percent against the U.S. dollar and inflation has risen sharply from 4.5 percent at the start of the year to 9.5 percent in November. The current account deficit is now around 11 percent of GDP and is largely financed by short-term portfolio inflows. The central bank has recently tried to slow the significant deprecitaion of the currency through interventions. During the year the key interest rate has been cut to 5.75 percent, while the overnight rate has been raised to 12.5 percent. This has created significant uncertainty over monetary policy, which has weakened the currency. We expect that the central bank will soon be forced to adopt a more restrictive monetary policy with regular policy rate hikes. The lira now has a low valuation measured by the real effective exchange rate and the nominal effective exchange rate with the USD is at a record low. Turkey is one of the countries with the best conditions for growth in the medium to long term. In the short term, however, the risk of a hard landing is high.

South AfricaStrong terms of trade

Very high sensitivity to negative risk sentiment

TurkeyHigh growth and strong bank sector

Risk of a hard landing following incorrect calibration of monetary policy



Forecast Forecast


Mexico, Spot Rate, EUR/MXN


feb10



EU

R/M

XN

15,0

15,5

16,0

16,5

17,0

17,5

18,0

18,5

19,0

EU

R/M

XN

15,0

15,5

16,0

16,5

17,0

17,5

18,0

18,5

19,0Brazil, Spot Rate, EUR/BRL


feb10



EU

R/B

RL

2,15

2,20

2,25

2,30

2,35

2,40

2,45

2,50

2,55

2,60

EU

R/B

RL

2,15

2,20

2,25

2,30

2,35

2,40

2,45

2,50

2,55

2,60

The Mexican peso is very competitive at its current levels

and should be able to appreciate in value given that the US

economy is maintaining its momentum. Future investments in

auto production and a high interest rate differential are also

positive factors for the peso.

Mexico has good possibilities of withstanding a recession in Europe. The economy is growing at a rate of 4.5 percent and growth looks like continuing on the back of relatively strong growth in the US. Automotive production is growing strongly and statistics from November show a production rate of approximately 2.5 million vehicles, at annual rates, compared with the previous peak of 2.1 million vehicles in 2008. Mexico has in recent years become much more attractive to foreign auto-makers, who are drawn by the cheap currency, relatively low wages and low transport costs. This positive development appears to be continuing. Nissan has stated that it will be investing USD 2 billion in a new production plant that will produce 600,000 vehicles a year. This will enable Nissan to produce 1.3 million cars in Mexico compared with the 1 million it currently produces in Japan. The domestic economy is maintaining good momentum, driven by increased consumer credit. Inflation is at 3.5 percent but surveys of inflation expectations point to lower inflation in future. We consequently expect the central bank to keep the policy rate at 4.5 percent in the first quarter of 2012.

The real continued to weaken in the autumn as a result of the weaker economy and uncertainty about the Chinese economy, which is now one of Brazil’s key markets. We expect continued weak growth and interest rate cuts and we are therefore neutral on the real.

Brazil’s growth has slowed considerably. GDP increased by only 2.2 percent in the third quarter, compared with 7 percent in the same period in 2010. PMI has been under 50 since June and industrial production, at annual rates, has been declining since September. Retail growth has fallen from a peak of 12 percent in 2010 to 5 percent in October and car sales have slowed. Wages increased by 7 percent in November, which is down significantly from the 12.5 percent increase at the start of the year. Unemployment, however, is at its lowest in modern times, which may explain why consumer confidence is relatively high. The central bank raised the policy rate from 8.75 to 12.5 percent in July this year. Surprisingly they started to lower the policy rate in September, despite inflation by that time didn’t show any clear sign of slowing. Inflation then peaked in August at 6.8 percent and has since fallen to 5.7 percent in November 2011. Expectations on inflation are now falling rapidly and growth in lending is declining. We expect further reductions in the interest rate from the current 11 percent to 9.5 percent in 2012.

BrazilStrong domestic consumption

High currency valuation and negative leading indicators

MexicoCompetitive manufacturing industry

High sensitivity to a slowdown in the US



Forecast Forecast


The Chinese economy is headed for a slowdown following the tighter monetary policy introduced at the start of 2010. PMI is below the 50 point mark and exports have lost momentum. We expect that growth will slow to about 8.5 percent in 2012. Domestic demand, however, is healthy and is leading to continued high import growth. Retail trade is growing by around 17 percent, wages are increasing by almost 20 percent and service sector PMI is showing continued good momentum. The overheated property market has already started to cool down, according to opinion polls, and we expect a well-ordered adjustment as traditionally happens in China. Nevertheless, risks are now higher than at previous times of overheating periods as the unregulated non-bank credit system has grown in size. Inflation has peaked but will be higher than we are used to owing to demographic development leading to a tighter labour market. The central bank has started easing its monetary policy by cutting reserve requirements for some banks. If the economy were to undergo more significant weakening, we would expect the government to introduce strong stimulus measures for infrastructure investments.

GDP grew by 6.9 percent in the third quarter, which is the lowest rate of increase since the start of 2009. This decline has primarily taken place in the industrial sector. Industrial production has been unchanged over the past 12 months and leading indicators point to a continued slowdown within industry. The decline in the service sector, however, was lower and the farming sector has strengthened slightly. Inflation has come down from levels above 15 percent in 2010 but has stabilised at relatively high levels of just under 10 percent. The central bank has signalled a pause after raising the policy rate by 225 points this year and 375 points since the low point in 2009. The significant depreciation of the currency during 2011, in combination with high food prices, means that we cannot rule out further interest rate hikes next year. The considerable tightening of monetary policy has had a significant dampening effect on monetary growth, which is now almost unchanged from the year earlier period. The high rate of inflation has eroded purchasing power and, together with substantially higher interest rates, has weighed on the domestic economy. This is reflected in such indicators as car sales, which performed very poorly in 2011.

We are not among those who expect a hard landing for China as it is a centrally controlled economy. Nevertheless, we believe that the risks are unusually high in view of global weaknesses and structurally high inflation in China. We expect the CNY to strengthen at an annual rate of 4-5 percent against the USD, which will also result in a strengthening against the euro in the first quarter of 2012.

The Indian rupee is a currency that has a very strong

correlation with global risk sentiment. We do not expect a

stable investment climate in 2012 and believe that the rupee

will swing up and down with the changes in the risk sentiment.

China, Spot Rate, EUR/CNY


feb10



EU

R/C

NY

7,75

8,00

8,25

8,50

8,75

9,00

9,25

9,50

9,75

EU

R/C

NY

7,75

8,00

8,25

8,50

8,75

9,00

9,25

9,50

9,75India, Spot Rate, EUR/INR


feb10



EU

R/I

NR

55,0

57,5

60,0

62,5

65,0

67,5

70,0

72,5

EU

R/I

NR

55,0

57,5

60,0

62,5

65,0

67,5

70,0

72,5

ChinaStrong domestic consumption

Lower export growth

IndiaLarge domestic market and high carry

High inflation and negative leading indicators



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Anders Eklöf Tel: 46 8 700 91 38


Emerging markets

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Fixed income

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Emerging Markets December 2011

Economy & Finance

Transcript of Emerging Markets December 2011