A Changing Global Environment
Facing Emerging Markets
June 2011
Deutsche Bank
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Fernando Losada
Fernando.Losada@db.com
Global economic outlook
CPI
inflation
(%)
GDP
growth (%)
2009
2010
2011F
2012F
2009
2010
2011F
2012F
Global
-1.2
4.9
4.0
4.4
5.4
3.6
4.1
3.6
G7
-3.5
2.8
2.0
2.9
3.2
1.5
2.6
1.9
US
-2.6
2.9
3.2
3.9
3.8
1.6
3.0
2.6
Japan
-5.2
4.0
-2.1
1.9
1.4
-0.7
0.5
-0.5
Euroland
-4.1
1.8
1.5
1.5
3.3
1.6
2.5
1.9
5.7
9.6
8.0
7.6
6.5
5.2
4.6
4.3
9.1
10.3
9.4
8.6
5.9
4.6
4.0
3.3
EMEA
-4.7
4.3
4.3
4.7
11.1
6.5
6.7
6.3
LatAm
-2.7
6.1
4.3
4.1
10.0
8.8
8.9
8.5
Argentina
-3.1
9.2
6.9
3.3
14.8
25.2
27.1
28.8
Brazil
-0.2
7.5
3.6
4.4
5.9
4.9
6.4
5.2
Colombia
0.2
4.3
5.0
5.4
7.7
3.2
3.5
3.5
Mexico
-6.5
5.5
4.4
3.9
6.5
4.4
3.5
3.5
Peru
0.9
8.8
7.0
6.5
0.3
2.1
3.1
2.6
Venezuela
-2.9
-1.4
2.0
2.3
26.9
27.2
25.0
25.0
EM Asia (ex-Japan)
China
1
Source: DB Global Markets Research (May 2011)
The wheels of risk are turning
• Global macroeconomic environment is
changing near term in three ways:
– Concerns about US double dip have faded. Gradually,
focus is turning to timing of withdrawal of monetary stimulus
and sustainability of fiscal stance.
– Europe is becoming less of a driver for global markets.
European policy makers likely to avoid extreme scenario of
uncontrolled default and/or Eurozone breakup.
– EM economies have turned from being a source of
disinflation to becoming a medium term source of inflation.
2
The wheels of risk are turning – bonds and equity
• While we continue to believe that US interest rates will
eventually have to increase, Fed core members
(Bernanke, Yellen, Dudley) are still dovish.
• Inflation is edging upwards on the back of fuel prices.
• However, the combination of the negative output gap
closing at a slow pace, very high unemployment and
the housing sector still in trouble suggests no hikes
are imminent.
• Outlook for US and EU equity markets is moderately
positive on the back of attractive valuations, while
valuations across EM look somewhat stretched.
3
The wheels of risk are turning - FX
• We expect the dollar to be weak against other
central currencies over the medium term, as
the Fed will remain one of the most dovish
central banks.
• We see room for Asia FX appreciation, but we
favor countries with high external growth beta
and C/A surpluses versus economies led by
domestic demand growth with C/A deficits.
4
Oil – A renewed challenge
• Energy price-induced slowdown of the global
economy is a justified concern.
• Every US recession since 1973 has been preceded or
coincided with a sharp oil price increase.
• Two important differences exist nowadays relative to
the 1970s, however:
– Monetary policy is extremely accommodative, allowing the
economy to better absorb an oil price shock.
– The energy share of the economy is lower than before;
household energy consumption currently at 9% of GDP versus
17% in the early 1970s.
5
Some simple US oil arithmetic
• WTI prices at USD100/barrel are consistent with retail
gasoline prices in the US at USD3.40/gallon.
• Every dollar increase in WTI price results in a
USD0.026 increase in gasoline prices, i.e. WTI price
should increase by USD38/barrel for gasoline prices
to rise by USD1/gallon.
• A USD1/gallon increase in gasoline prices leads to a
USD140bn “tax” on personal consumption per year.
• WTI prices averaged USD79.40/barrel in 2010. WTI at
USD110/barrel would offset the positive boost from
the payroll tax reduction announced at the end of last
year.
6
Impact of oil prices on PCE
WTI price (USD/barrel)
Retail gasoline
(USD/gallon)
“Energy tax” on personal
consumer expenditure (USDbn)
2010
79.43
2.84
67
2011
90.00
3.15
49
95.00
3.28
66
100.00
3.41
84
105.00
3.54
102
110.00
3.67
120
115.00
3.80
138
120.00
3.93
156
125.00
4.06
174
150.00
4.72
263
7
Oil spike: Winners and losers
• In general, EM fares better than DM during oil
spikes.
• In previous oil crises, increases of USD10/barrel
were associated with drops of 0.4% in DM growth
and 0.2% in EM growth.
• In the EM universe, countries likely to benefit
from higher oil prices include Colombia,
Kazakhstan, Russia and Venezuela.
• Countries such as Hungary, Israel, Turkey and
Ukraine will probably be net losers.
8
Over the medium term, OECD countries face a potential debt
overhang
EM debt dynamics compares favorably with developed world
Government debt
% of GDP
% of GDP
Advanced Countries
Developing countries
120
120
100
100
80
80
60
Forecast
40
20
20
0
0
2007
2008
2009
2010
2014
Advanced
Economies
EM Countries
60
40
2006
Advanced economies have a tougher fiscal challenge ahead
-6
-4
-2
0
• EM’s fairly loose fiscal stances look tight vis a vis DM.
• Less indebted EM should grow faster, continuing to attract capital.
• But complacency in EM may hurt later on…
9
+2
+4
Required primary balance in order to stabilise debt/GDP in 2010
Source: IMF WEO, DB Global Markets Research
+6
IMF 2003 WEO warned about public debt crises in EM!
10
Source: IMF WEO
Greece
Hungary
Ireland
UK
Japan
Egypt
Portugal
Romania
Poland
Pakistan
France
Ukraine
Italy
Cz. Rep.
Malaysia
USA
Vietnam
Spain
Colombia
Mexico
India
Austria
Germany
Belgium
China
Netherlands
Turkey
Brazil
Philippines
Thailand
Taiwan
Indonesia
Israel
S. Africa
Switzerland
Venezuela
Australia
Argentina
New Zealand
Sweden
Canada
Singapore
Korea
Denmark
Finland
Russia
Chile
But now EM debt outlook looks relatively strong
Adjustment needed to stabilize public debt ratios
Primary Balance, % of GDP
+15
11
Range of primary balance 2005-09
Required Primary Balance
+10
+5
0
-5
-10
-15
Source: IMF, Haver, DB Global Markets Research
Fiscal effort in developed countries will have to be
substantial over the next few years
IMF projections of public sector debt/GDP ratios: High and
increasing in developed countries, low and stable in LatAm
250
200
150
100
2009
2014
50
0
12
Source: DB Global Markets Research
EM economies enjoy structural advantages
EM‟s growth differential vs advanced economies
Population age is also favoring EM outlook
Dependency Ratios
90
Growth differential EM vs Industrial Countries (pp)
7
Growth differential EM vs Industrial Countries
6
Avg differential per decade
5
80
70
60
4
50
3
40
2
30
EM
1
20
Industrial
0
10
-1
0
1950 1959 1968 1977 1986 1995 2004 2013 2022 2031 2040 2049
-2
1980 1983 1986 1989 1992 1995 1998 2001 2004 2007
Source: IMF, Haver, DB Global Markets Research
13
EM economies have achieved policy improvements
EM ratings indicate improvement in fundamentals
Credit model predictions based on our forecasts
BBB+
Asia
BBB
BBBBB+
EMEA
BB
BB-
Latin America
B+
B
99
00
01
02
03
04
05
06
07
08
09
10
Source: IMF, Haver, DB Global Markets Research
14
The ultimate proof of improvement: lower measures of
market risk
Degrees of mean reversion in EM currencies
REER Half Life (in months)
EMFC volatility
1995-2004
35%
FX
2005-2010
50
30%
45
28%
25%
Commodity
40
29%
29%
Activity
24%
25%
35
20%
30
25
15%
13%
11% 11%
20
10%
10%
15
7%
10
7%
6%
5%
5
0%
0
Brazil
Mexico
Russia
Turkey
Source: DB Global Markets Research
15
Bra
Mex
Rus
Tur
LatAm FX valuation: Real Effective Exchange Rates
(Jan 2005=100)
Source: Global Market Research, IIF
16
EM financial markets have significant room for
further development
EM has less than half the financial depth of
developed countries
17
Such a gap is even bigger in
Latin America
Source: DB Global Markets Research
LatAm: Commodity blessing this time around
Net commodity export by country (% of GDP)
35
30
EMEA
Asia
LatAm
25
20
Energy
Metals
Food
15
10
5
0
-5
-10
18
Source: DB Global Markets Research
MXN
BRL
PEN
COP
ARS
ECU
CLP
VEB
KRW
HKD
PHP
PKR
INR
CNY
THB
IDR
MYR
SKK
ILS
CZK
RON
TRY
HUF
PLN
EGP
UAH
ZAR
RUB
KZT
-15
EM: Rebalancing challenge I
Net savings by region (% of world GDP)
ADVANCED
EMEA
EMASIA
MEAST
Investment by region (% of world GDP)
LATAM
EMEA
1.50
8.0
1.00
7.0
6.0
0.50
5.0
0.00
4.0
3.0
-0.50
2.0
-1.00
1.0
-1.50
0.0
19
Source: DB Global Markets Research
EMASIA
MEAST
LATAM
ADVANCED (lhs)
20.0
18.0
16.0
14.0
12.0
10.0
8.0
6.0
4.0
2.0
0.0
EM: Rebalancing challenge II
FDI to emerging markets (% of world GDP)
EMEA
0,30%
EMASIA
LATAM
Primary balances (% of each regional GDP)
5,00
4,00
0,25%
3,00
0,20%
2,00
1,00
0,15%
0,00
0,10%
-1,00
0,05%
-2,00
-3,00
0,00%
LATAM
-4,00
2004
20
Source: DB Global Markets Research
EMEA
2005
EM ASIA
2006
2007
2008
2009
EM Monetary Policy: Differentiated sensitivity to EU shock
Source: DB Global Market Research
21
EM Rates are sensitive to global drivers
Rates sensitivities to macro drivers
2Y Rates
Activity
63
BRL
14
CLP
4
MXN
2
COP
5
PEN
3
HUF
6
PLN
0
CZK
2
ZAR
3
TRY
16
ILS
CPI
57
17
28
0
10
0
49
6
5
58
18
Policy Rate
59
29
56
94
81
52
26
95
59
54
43
CDS
26
0
15
10
0
56
15
0
11
38
0
10Y US Rate
43
35
51
19
37
49
24
26
86
64
81
10Y Rates
Activity
44
BRL
9
CLP
10
MXN
1
COP
2
PEN
1
HUF
6
PLN
0
CZK
0
ZAR
4
TRY
35
ILS
CPI
53
12
40
0
41
0
32
6
1
46
28
Policy Rate
37
0
16
44
0
18
6
55
53
17
8
CDS
52
0
51
66
0
49
18
0
42
53
0
10Y US Rate
56
26
53
20
57
48
8
26
84
64
62
NOTE: Shocks of 100 bp for each of the variables
referred to (activity measured in YoY terms)
22
Source: DB Global Market Research
23
0
25
EMEA
Source: DB Global Markets Research
Romania
0
Czech
Republic
5
Poland
5
Slovakia
10
Hungary
10
30
X to China
M from China
20
15
10
5
0
M from China
India
ASIA
Indonesia
Singapore
25
Malaysia
Thailand
Philippines
South
Korea
Taiwan
Mexico
Colombia
Venezuela
X to China
Turkey
15
Argentina
30
Ukraine
United Arab
Emirates
15
Brazil
25
Israel
20
Chile
LATAM
Russia
South Africa
Kazakhastan
20
Peru
EM: Chinese sensitivity
Existing trade links (% of GDP)
30
X to China
M from China
The banking contagion channel to EM
Regional loan exposure (USD bn)
Spain
Portugal
Greece
LatAm
AR
BR
CL
CO
MX
PE
367
14
147
54
12
129
11
8
0
8
0
0
0
0
0
0
0
0
0
0
0
Total as share of
Total Credit to
Private Sector
27%
34%
20%
43%
19%
36%
24%
EMEA
10
17
35
4%
Asia
5
0
0
0%
Source: DB Global Market Research
24
IMF medium term forecasts sums it up: LATAM is expected to regain the
4% growth path after having the milder 2009 recession and the stronger
2010 recovery, only behind non-Japan Asia and Middle East
25
Source: IMF
Latin America:
Economic Outlook
26
Growth is slowing down but still remains robust
GDP growth
% YoY
10
2009
2010
Inflation
2011
% YoY 27.1 28.8
18
2012
2010
2011
2012
25.0 25.0
16
8
14
6
12
4
10
2
8
0
6
4
-2
2
-4
0
-6
-2
-8
ARG
ARG
BRA
CHI
COL
MEX
PEN
BRA
2009
2010
2011
2012
CHI
COL
MEX
PEN
VEN
2010E
2011F
2012F
-2.5
6.1
4.3
4.2
Priv. consumption
-0.3
5.7
5.1
4.5
Investment
-9.5
13.8
7.4
5.9
6.2
8.3
8.4
8.0
Exports, USD bn
609.8
776.8
890.7
942.4
Imports, USD bn
534.9
703.8
813.2
897.2
Industrial production
-7.6
7.4
4.9
4.6
Unemployment (%)
7.8
6.8
6.6
6.5
Fiscal bal. (% of GDP)
-3.0
-2.4
-2.2
-2.1
CA bal. (% of GDP)
-0.4
-0.9
-1.1
-1.7
Inflation
BRA
MEX
2009
Real GDP grow th
5
4
3
2
1
0
-1
-2
-3
-4
-5
ARG
COL
LATAM forecasts
(% yoy unless stated)
% GDP
CHI
VEN
Current account balances
27
2009
PEN
VEN
Source: DB Global Markets Research
Argentina: Nervousness on the rise



28
Growth has remained strong, hovering around 9%, but policies
are certainly unsustainable as state intervention prevents
investment.
In the absence of stronger investment, expansionary policies
simply push inflation up.
The government will have to eventually abandon the current
policy setup as the exchange rate can not be the only tool to
maintain stable (although very high) inflation. The peso is not yet
overvalued but the pace of appreciation is too fast.
Argentina: Election and beyond



29
The outcome of the coming presidential election will determine
the future policy path. Currently, the most likely scenario is reelection.
This could be positive if moderation is achieved. Otherwise,
another round of massive capital flight is likely to occur,
becoming the market-driven adjustment mechanism.
Fundamentals are strong but somewhat “for the wrong reasons”.
Nonetheless, a marginal improvement in policies could make
Argentina a solid performer for years.
Brazil: Lower growth, higher inflation?
• The real economy is on a deceleration phase and
will most likely grow below potential this year.
• Inflation expectations deteriorated sharply since
4Q10 but appear to have stabilized now, although
at relatively high levels.
• The Central Bank has made it clear that it will
tighten monetary policy at a slow, gradual pace,
complementing the hikes with „macro prudential‟
measures.
• The currency has appreciated the most among
EM peers but flows are still supportive.
30
Brazil: Necessary adjustment, sooner or later
• Annual inflation surpassed the ceiling of the band
in April for the first time since July 2005. Although
we expect it to decline towards year-end, it will
remain above the medium term 4.5% target for the
foreseeable future.
• Protracted high inflation is to impose political
costs on President Rouseff, which in turn could
elicit a more energetic policy response, although
probably not this year.
• Credit origination is decelerating after last year‟s
macro prudential measures, although slowly.
31
Chile: Less exciting but still exemplary




32
The pace of economic activity moderated during the last quarter but we
expect it will accelerate again in the coming months helped by the
consolidation of a global recovery path. The economy is vulnerable to
oil price shocks and energy bottlenecks, so developments there will
affect performance.
Inflationary pressures are becoming more evident amid a closing output
gap and a tight labor market. This notwithstanding, we project inflation
to be back within the CB range during 2012.
We expect the Central Bank to continue hiking interest rates although
conditioned to the tightening pace in the US. Intervention rates could go
up to 5.75%-6.00% within the next twelve months but the final position
will depend on global rates.
CLP has been trading in the low part of the expected range on the back
of strong domestic growth, elevated copper prices, and the expected
increase of rates differentials. Additionally, the CB seems to be less
worried about appreciation now. Volatile commodity prices, however,
remain a serious risk.
Colombia: A successful convergence play
• Recovery in economic activity picking up speed.
• Negative output gap to close during 2H11.
• Inflationary pressures building up on the back of
recovering domestic demand coupled with supply
side shock since 4Q10.
• BanRep on the initial phase of monetary tightening
cycle.
• Average annual headline inflation likely to increase
vis a vis 2010, although remaining within the upper
part of the target band.
• Colombia within a new “inflation regime”, with
equilibrium rates near target levels.
33
Colombia: A successful convergence play
• BanRep to normalize monetary policy gradually until
reaching short term real interest rates of some 250bp.
• BanRep to act slowly and preemptively amid global
market uncertainty.
• We expect target repo rate at 4.75% by Dec 2011, with
another 125bp worth of hikes in 2012.
• MinFin worried about currency appreciation, daily
dollar purchase strategy to continue along with dollar
deposits abroad.
• Chances are good for COP curve flattening, as
BanRep engages in tightening exercise and fears of
substantial inflation in the medium term recede.
34
Mexico: Recovery under way
• Initial phase of the recovery was led by exports.
• Growth is now more balanced, with exports,
domestic consumption and investment becoming
significant contributors.
• Negative output gap likely to close down during
2H11.
• GDP to grow by more than 4% this year. But is
that growth pace sustainable?
35
Mexico: Ties to the US
• Industrial production cycles closely related.
• Full commercial and financial integration of both
economies, with well over 80% of Mexican
exports sold in US markets.
• Gradual recovery in US economic activity
currently benefiting Mexico.
• Questions remain about the sustainability of the
US recovery and the possible convergence
towards lower average GDP growth rates.
• Comparative advantage points to energy complex
but constitutional barriers prevent private
participation in the sector.
36
Mexico: Inflation and interest rates
• After a spike during 4Q10, annual inflation has
edged downwards and it appears to be under
control.
• The current environment of high commodity prices,
however, poses challenges to the sustained
convergence towards medium term target levels.
• In addition, domestic demand is no longer
depressed, thus contributing to fuel inflation at the
margin.
• Banxico will probably stay on the sidelines this
year, but it remains vigilant and ready to hike since
the beginning of 2012.
37
Mexico: Currency dynamics
• The exchange rate suffered during 2008-09 as a
result of the deterioration in the US economic
outlook.
• MXN recovered gradually with the stabilization and
eventual improvement of expectations about US
growth.
• MXN currently responding to robust foreign capital
flows and more stable global outlook.
• Appreciation pressures to continue, so Banxico
unlikely to be able to reverse the trend. Policy
actions likely to be geared towards reducing
volatility and slowing down pace of appreciation.
38
Peru: Among the region‟s top growth performers
• We expect a very soft deceleration in the growth
pace, towards potential levels, during 2011-12.
• Average growth performance 2010-2012 likely to
remain at the top of LatAm.
• Inflation to remain well behaved (at or below
3%), on the back of expansion of productive
capacity and conservative monetary policy.
• PEN to remain well supported by financial and
especially strategic foreign investment. We
expect it to be near 2.70/USD by year-end.
39
Peru: The region‟s top growth performer
• The real economy is still operating above
potential, which suggests that Central Bank will
continue tightening the policy rate through yearend and beyond.
• We expect target policy rate at 4.75% by Dec
2011, with further hikes in 2012 likely.
• Central Bank to continue intervening in the FX
market to avoid stronger currency appreciation.
• PEN curve to flatten both because of increase in
short end and compression in long end post
presidential elections, assuming expectations of
no change in policy regime.
40
Venezuela: Slow recovery amid high oil prices
• The real economy has been recovering since 2H10,
although at a slow pace. We expect GDP to expand by
at least 2% this year.
• Inflation is to remain at the highest levels in the
region, along with Argentina, because of supply
bottlenecks and very active fiscal spending.
• With oil prices hovering around USD100/barrel, the
current account surplus is likely to be at least
USD20bn this year.
• The robust supply of dollars from the trade account
suggests the authorities will fuel the demand for
imports via Cadivi and Sitme to reduce shortages,
especially ahead of next year‟s election.
41
Venezuela: Presidential election
• President Chavez still holds the upper hand to
win reelection next year.
• His popularity suffered last year but has been
recovering in 2011, because of the robust fiscal
transfers and the public approval of the handling
of the flooding emergency.
• The opposition is to do a good election if it lines
up behind a coalition candidate, although it is still
early to determine whether there will be such a
unanimous choice.
42
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Macroeconomic fluctuations often account for most of the risks associated with exposures to instruments that promise to pay fixed or variable interest rates. For
an investor that is long fixed rate instruments (thus receiving these cash flows), increases in interest rates naturally lift the discount factors applied to the
expected cash flows and thus cause a loss. The longer the maturity of a certain cash flow and the higher the move in the discount factor, the higher will be the
loss. Upside surprises in inflation, fiscal funding needs, and FX depreciation rates are among the most common adverse macroeconomic shocks to receivers. But
counterparty exposure, issuer creditworthiness, client segmentation, regulation (including changes in assets holding limits for different types of investors),
changes in tax policies, currency convertibility (which may constrain currency conversion, repatriation of profits and/or the liquidation of positions), and
settlement issues related to local clearing houses are also important risk factors to be considered. The sensitivity of fixed income instruments to macroeconomic
shocks may be mitigated by indexing the contracted cash flows to inflation, to FX depreciation, or to specified interest rates – these are common in emerging
markets. It is important to note that the index fixings may -- by construction -- lag or mis-measure the actual move in the underlying variables they are intended to
track. The choice of the proper fixing (or metric) is particularly important in swaps markets, where floating coupon rates (i.e., coupons indexed to a typically shortdated interest rate reference index) are exchanged for fixed coupons. It is also important to acknowledge that funding in a currency that differs from the currency
in which the coupons to be received are denominated carries FX risk. Naturally, options on swaps (swaptions) also bear the risks typical to options in addition to
the risks related to rates movements.
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