Deutsche Bank
Markets Research
Emerging Markets
Economics
Foreign Exchange
Rates
Credit
Date
12 February 2015
Emerging Markets Monthly
Rising Tide, Leaky Boats
Taimur Baig
Robert Burgess
Gustavo Cañonero
Drausio Giacomelli
Hongtao Jiang
Sameer Goel
(+65) 64 23-8681
(+44) 20 754-71930
(+1) 212 250-7530
(+1) 212 250-7355
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(+65) 64 23 6973
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12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Key Economic Forecasts
Real GDP (%)
2014F
2015F
2016F
Consumer prices (% pavg)
2014
2015F
2016F
Current account (% GDP)
2014F
2015F
2016F
Fiscal balance (% GDP)
2014F
2015F
2016F
Global
3.4
3.5
3.7
3.7
3.3
3.8
0.7
0.5
0.4
-3.0
-3.3
-2.9
US
2.4
3.4
3.1
1.6
0.6
2.7
-2.6
-2.9
-3.2
-2.9
-2.6
-2.9
Japan
0.3
1.3
1.7
2.7
1.3
0.9
0.4
2.2
2.4
-7.1
-6.3
-5.4
Euroland
Germany
France
Italy
Spain
Netherlands
Belgium
Austria
Finland
Greece
Portugal
Ireland
0.8
1.5
0.4
-0.4
1.4
0.7
1.0
0.3
0.0
1.2
0.8
4.5
1.3
1.4
1.1
0.5
2.4
1.7
1.3
1.2
0.9
2.5
1.4
3.7
1.6
1.7
1.6
1.3
2.3
1.1
1.6
1.8
1.4
3.0
1.6
3.5
0.4
0.8
0.6
0.2
-0.2
0.3
0.5
1.5
1.2
-1.4
-0.2
0.3
-0.3
0.1
-0.1
-0.2
-1.0
0.1
0.2
0.8
0.6
-1.8
0.1
-0.1
1.2
1.6
1.1
1.0
1.5
1.4
1.5
1.7
1.3
1.0
1.3
1.7
2.4
7.2
-1.8
1.8
0.4
10.9
1.0
0.7
-1.2
0.5
0.5
4.5
2.2
8.0
-1.8
2.4
1.8
11.4
1.5
1.2
-1.2
1.5
0.8
5.5
2.0
7.9
-1.5
2.2
1.8
11.5
1.0
1.5
-0.9
2.0
1.0
6.0
-2.6
0.4
-4.4
-3.0
-5.4
-2.5
-2.8
-2.3
-2.6
-1.3
-4.7
-3.6
-2.5
0.2
-4.2
-2.7
-4.3
-2.0
-2.8
-1.6
-2.2
0.5
-3.5
-2.9
-2.3
0.3
-3.9
-2.7
-3.4
-1.9
-2.5
-1.2
-1.6
1.9
-3.3
-2.8
Other Industrial Countries
United Kingdom
Sweden
Denmark
Norway
Switzerland
Canada
Australia
New Zealand
2.4
2.6
1.9
0.9
2.2
1.7
2.5
2.7
3.2
2.5
2.5
2.3
1.7
2.4
1.8
2.6
2.8
2.8
2.6
2.3
2.8
1.8
2.5
2.0
2.7
3.5
2.5
1.5
1.5
-0.2
0.6
2.0
0.0
2.0
2.5
1.2
1.0
0.9
0.5
1.0
2.0
0.4
1.3
1.1
0.6
1.8
1.7
1.5
1.5
2.0
0.8
2.0
2.2
2.4
-0.9
-5.0
5.9
6.8
10.5
11.0
-2.0
-2.9
-3.5
-0.6
-4.0
5.3
6.5
10.0
10.8
-1.7
-2.8
-5.5
-0.4
-3.5
4.8
6.0
9.5
10.5
-1.4
-2.4
-4.7
-2.1
-4.9
-2.0
-1.0
10.0
0.0
-0.8
-2.9
-0.7
-1.5
-3.9
-1.5
-2.5
9.5
0.4
0.0
-2.5
-0.1
-0.6
-2.0
-1.0
-2.0
9.0
0.8
0.3
-1.9
0.4
Emerging Europe, Middle East & Africa
Czech Republic
Egypt
Hungary
Israel
Kazakhstan
Nigeria
Poland
Romania
Russia
Saudi Arabia
South Africa
Turkey
Ukraine
United Arab Emirates
2.2
2.4
2.2
3.4
2.4
3.9
6.0
3.3
2.5
0.6
3.5
1.4
2.7
-6.9
3.5
0.6
2.5
3.7
2.4
3.1
2.1
4.8
3.3
2.9
-5.2
2.0
2.8
3.5
-4.5
2.0
1.6
2.7
3.8
2.3
3.3
2.6
5.7
3.5
3.0
-3.4
2.4
2.9
3.7
1.5
2.8
6.0
0.4
10.1
-0.2
0.5
6.8
8.1
0.0
1.1
7.9
2.7
6.1
8.9
12.1
2.3
7.5
0.3
12.0
-0.5
0.5
8.4
11.0
0.3
1.4
13.3
1.6
3.9
6.6
18.9
1.9
5.7
1.9
9.0
2.8
1.8
8.3
9.0
1.5
2.3
7.0
2.4
5.7
7.1
9.8
2.6
2.2
-1.0
-0.8
3.8
2.8
2.0
2.7
-2.6
-1.0
3.1
13.5
-5.5
-5.8
-3.5
12.2
-0.6
-0.8
-1.6
3.8
3.5
2.1
-0.6
-2.9
-1.4
3.6
-4.5
-4.0
-4.9
-2.5
2.9
0.3
-0.6
-2.0
3.7
3.4
1.6
1.2
-3.1
-0.7
4.3
-0.9
-4.7
-5.2
-2.0
5.7
-2.1
-1.3
-12.7
-2.9
-2.8
5.3
-2.9
-3.4
-2.2
-0.5
-1.9
-4.0
-1.3
-5.5
5.0
-5.0
-2.1
-10.5
-2.7
-3.4
2.4
-4.2
-2.9
-2.5
-2.1
-16.2
-3.1
-1.8
-4.5
-6.2
-3.9
-2.2
-9.5
-2.4
-2.9
1.9
-3.6
-2.7
-2.6
-1.7
-11.2
-2.2
-1.6
-3.0
-3.4
Asia (ex-Japan)
China
Hong Kong
India
Indonesia
Korea
Malaysia
Philippines
Singapore
Sri Lanka
Taiwan
Thailand
Vietnam
6.5
7.4
2.2
7.2
5.0
3.3
5.9
6.1
3.0
7.7
3.5
0.5
6.0
6.4
7.0
2.9
7.5
5.0
3.3
4.5
6.5
3.0
7.5
3.8
3.5
6.2
6.3
6.7
3.0
7.5
5.5
3.7
4.5
6.6
3.5
7.0
3.5
3.0
6.2
3.5
2.0
4.4
7.2
6.4
1.3
3.1
4.2
1.0
3.3
1.2
1.9
4.1
2.9
1.8
3.5
5.3
6.2
1.5
3.0
2.5
0.6
3.5
0.3
0.3
4.0
3.5
2.7
3.2
5.8
4.8
2.1
2.5
3.5
1.6
5.5
0.9
2.2
5.5
2.4
3.1
2.2
-1.5
-2.6
6.3
5.7
4.6
18.9
-2.9
12.7
1.9
4.3
2.7
3.4
2.0
-1.4
-1.7
6.8
2.9
4.2
19.6
-1.8
15.1
2.5
3.5
2.3
3.3
1.8
-1.7
-1.2
5.6
3.3
2.2
18.2
-1.4
12.9
2.2
0.0
-2.4
-2.1
2.6
-4.5
-2.2
0.0
-3.5
-1.8
6.9
-5.0
-2.0
-2.8
-5.8
-2.8
-3.0
2.9
-4.0
-1.7
-1.0
-3.4
-2.2
6.8
-5.0
-1.7
-2.5
-5.3
-2.7
-3.0
3.0
-3.8
-1.7
-1.1
-2.8
-2.4
6.6
-4.5
-1.4
-2.0
-5.3
Latin America
Argentina
Brazil
Chile
Colombia
Mexico
Peru
Venezuela
0.8
-1.0
0.0
1.6
4.7
2.0
2.7
-3.6
0.7
-1.5
-0.7
2.6
3.5
3.0
4.7
-4.3
2.6
3.0
1.5
3.2
3.3
3.4
5.2
1.0
12.5
38.5
6.3
4.4
2.8
4.0
3.2
60.0
12.4
27.5
7.3
3.4
3.6
3.2
2.4
80.0
11.4
21.7
5.8
3.3
3.1
3.3
3.1
85.0
-3.0
-1.6
-4.2
-1.7
-4.6
-2.3
-5.1
1.6
-3.1
-0.9
-4.0
-1.2
-5.5
-2.5
-4.7
-2.2
-3.3
-1.5
-4.1
-1.0
-5.5
-2.7
-4.7
-1.7
-5.7
-6.5
-6.7
-1.6
-2.7
-4.2
0.2
-14.8
-5.8
-7.1
-5.6
-2.5
-3.0
-3.8
-0.1
-22.6
-3.9
-5.5
-4.3
-2.2
-2.7
-3.5
0.6
-6.6
Memorandum Lines: 1/
G7
Industrial Countries
Emerging Markets
BRICs
1.7
1.7
4.6
5.9
2.4
2.3
4.3
5.1
2.5
2.4
4.7
5.4
1.5
1.4
5.4
4.3
0.6
0.5
5.3
4.4
2.0
1.9
5.1
4.2
-1.0
-0.5
1.6
1.3
-0.7
-0.4
1.1
1.6
-0.8
-0.5
1.1
1.6
-3.3
-3.2
-2.8
-2.9
-2.9
-2.8
-3.7
-3.4
-2.7
-2.6
-3.2
-3.2
1/ Aggregates are PPP-weighted within the aggregate indicated. For instance, EM growth is calculated by taking the sum of each EM country's individual growth rate
multiplied it by its share in global PPP divided by the sum of EM PPP weights.
For Egypt numbers are reported for financial year ending June.
Source: Deutsche Bank
Page 2
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Table of Contents
Emerging Markets and the Global Economy in the Month Ahead
Heightened uncertainty about the path of US monetary policy, the fate of the euro, and political or geopolitical risks from
within have exposed further EM's weaknesses, policy limitations, and - in many cases- failure to adapt to these
circumstances. We expect a benign backdrop for rates and credit to prevail but high uncertainty and tight valuation
(especially in credit) bodes for caution...……………........ ..................................................................................................... 4
This Month’s Special Reports
Brazil: A Recession is Looming
Fiscal tightening, rising interest rates, lower commodity prices, the financial difficulties faced by oil company Petrobras
and the growing risk of water and energy shortages all conspire against Brazil’s economic recovery. Although we are not
yet assuming energy rationing, we believe the risk is already affecting investment decisions, so we have cut our 2015
GDP growth forecast to -0.7% from 0.3%.……………...... .................................................................................................. 13
Does India Need a Fiscal Stimulus?
There are many ways to revive India’s growth momentum without having to resort to a setback in fiscal consolidation.
India’s revenue ratios are poor by international comparison, public sector debt burden is considerable, and the cost of
servicing that debt is very high. Deficit and debt reduction efforts are essential in improving the economy’s sovereign
rating, enhance market access, and free up room for public and private spending in growth critical areas...………........ 22
Turkey Trip Notes: Is Heightened Volatility the New Normal?
Our trip to Turkey in late January was dominated by the intensified political externality ahead of the June general
elections. Distorted policy signals from the CBT resulted in what we consider an undue sell-off in Turkish markets. There
seems to be a consensus view that Turkey credit will fare comfortably in 2015 with the current account deficit and
inflation both expected to improve visibly. Notwithstanding that the AKP is still the dominant party, the political
backdrop appears marginally more uncertain than we had expected...……………........ .................................................... 26
South Africa Trip Notes: Cheap Oil But Not Enough Energy
We spent a couple of days in South Africa last week where fixed income investors are attracted by the combination of
cheap oil, falling inflation, and a cautious central bank. On the other hand, a worsening electricity crisis, lack of progress
on structural reforms, and nervousness about the Fed provide limits to this optimism....……………........ ........................ 30
Asia Strategy ....................................................................................................................................................................... 34
EMEA Strategy .................................................................................................................................................................... 41
Latam Strategy .................................................................................................................................................................... 48
Asia Economics .................................................................................................................................................................. 55
EMEA Economics ............................................................................................................................................................... 83
Latam Economics ............................................................................................................................................................. 108
Theme Pieces ................................................................................................................................................... 128
Deutsche Bank Securities Inc.
Page 3
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Emerging Markets and the Global Economy in the Month Ahead

Markets have been buffeted by several difficult
developments over the past month. Strong payrolls
in the US have challenged the notion that Fed lift
off could be deferred to next year. The boost from
ECB easing has been tempered by the return of
Greek risk. Recent data confirm that growth in
China has slowed further.

Important parts of EM are failing to adjust to reality.
The situation is especially precarious in some of the
large emerging economies such as Brazil, Turkey,
South Africa, and Russia, which have taken
political and policy decisions conducive to
“pushing” rather than “pulling” capital.

Better-quality credits have been favored by risk
aversion, but valuation is unappealing. We
overweight Turkey, Indonesia, and Hungary, but
underweight Chile and Peru as inexpensive hedges
against China’s growth risks. We are also
underweight Russia. In relative value, we favor
flatteners on a number of curves, including
Indonesia (Pertmina), Colombia, and Mexico
(Pemex), short basis in Brazil and the Philippines,
and a few cash switches to capitalize on temporary
pricing dislocations.

Regionally, we are relatively more constructive Asia
local markets, where we maintain INR and IDR
longs (vs. SGD) but nevertheless prefer shorting
SGD, TWD, MYR, THB, and CNH vs. USD. We
continue to favor long bonds in India, Indonesia,
Thailand and China, in this order, hedged by
Malaysia (5Y) and Korea (1Y1Y) payers.
The weakness within
The month of January was plagued by negative
developments for global markets that are likely to
extend into February – at least. The fear of Eurozone
breakup has resurfaced post-elections in Greece and
European authorities will have to balance a difficult act
between local demands and moral hazard. In the US,
strong payrolls are unlikely to change the Fed’s course
of action as long as wages and core prices remain
subdued, but they do change the balance of risks as
we expect investors to be a lot more sensitive to
possible upticks in inflation.
The news flow out of EM has hardly been more
encouraging, amid lingering conflict in Ukraine,
increasing risks of Presidential impeachment in Brazil
(particularly as Petrobras flirts with technical default),
heightened political interference in Turkey’s monetary
policy, and overall disappointing growth figures out of
China. This list is far from exhaustive. By-and-large, EM
growth prospects have remained immune to further
ECB accommodation and a more upbeat US outlook.
Worse, EM policymakers’ reach seems rather limited
be it for tight output gaps (mainly in Asia), FX pressures
(pervasive across LatAm, Turkey and South Africa), and
overall fiscal constraints. Under these circumstances,
EM growth seems poised to continue to provide a
weak pull – if any – for foreign inflows.

We see some signs of overshooting in Mexico,
where we expect the short end (along with South
Africa’s 1Y1Y) to outperform Israel, and the long
end to outperform South Africa (where we expect
steepening). We also see some room for
retracement in Chile and Colombian rates. We
favor long MXN/COP and short CLP/PEN.

Despite higher risks, we also position tactically for
some retracement in Turkey via TRY/ZAR and a
steepener in the cross-currency curve while
keeping moderately underweight bonds. In
contrast, we believe Brazil faces deeper
vulnerabilities and wait for stronger policy response
and more constructive politics to seek retracement
trades.
US: Higher anxiety. The strong payroll numbers and
some recovery in earning increased the likelihood of a
June lift-off that could be signaled as early as February
(at the formerly Humphrey-Hawkins semi-annual
monetary policy testimony) or March. The gains were
broad-based (more than 60% of industries added jobs)
and – with the combined 147k revisions of November
and December – they pushed the three-month average
to 336k – the fastest pace since late 1997. Accordingly,
markets will likely monitor closely the upcoming data
releases – especially inflation – and statements by
FOMC members. Although the “patient” language may
be removed with additional tweaks in forward
guidance, the Fed has already indicated that it will
continue to monitor a broad set of economic variables
regardless. From this perspective strong payroll gains
are a necessary but hardly a sufficient condition for the
Fed to act.

We expect the ECB to continue to provide a strong
anchor for CE3 rates and overweight long-end
bonds in Hungary and Poland vs. EU peripherals
(especially Spain). Stay short GBP/PLN, and also
short ILS, but take profit on long HUF.
The strong payrolls contrast with overall disappointing
output growth. PMIs have been overall supportive but
broadly unchanged, while last week’s data suggest
that real GDP growth will be revised down by half a
Page 4
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
point to 2.1% later this month. Also, the index of
aggregate hours point to a 3% rate this quarter (vs.
indications closer to 4% previously). To be a concern
for monetary policy, tighter labor markets have to
translate into wage and price pressures, but these are
at most incipient.
Core inflation is hovering close to 1% and – despite the
uptick in payroll and ECI – they are still hovering
around 2.5% 2.2% in the case of payrolls). That claims
are running near a 15-year low suggests that labor
markets will remain strong, but the uptick in
unemployment was a reminder that elevated long-term
unemployment and low participation bide the Fed time.
In addition, productivity growth is running at
historically very low levels, which raises concerns
about profitability and pricing power (chart). If the Fed
does move by mid-year, it would likely have to signal a
very gradual path and the yield curve seems poised to
stay very flat if it does.
Q4 2014 GDP projections
Q4
Country
Composite
National
PMI +
PMI
Surveys
IP^
DB
Consensus*
E ur o a r ea
0.2
0.3
Ger m a ny
0.3
0.3
0.3
0.2
0.2
0.3
0.2
Fr a nc e
-0.1
0.3
0.1
-0.1
0.1
Ital y
Spai n
0.1
-0.2
-0.1
-0.1
-0.1
0.0
0.3
0.6
0.3
0.7
0.7
Source: Markit, Haver Analytics LP, Deutsche Bank
* qoq consensus forecasts are calculated using yoy consensus data from Bloomberg Finance LP
^Assumming IP is unchanged at November level in December
Q1 2015 GDP projections
Low productivity contrasts with strong payrolls
Source: Markit, Haver Analytics LP, Deutsche Bank
* qoq consensus forecasts are calculated using yoy consensus data from Bloomberg Finance LP
** The low consensus can be due to the stronger than expected Q4-2014 flash GDP release and
undejusted annual projections
^ Assuming PMIs and national surveys unchanged at January level
Source: BEA, BLS, Haver Analytics & DB Global Markets Research (US Economics Weekly 2/6/15)
EU: Containing political contagion. DB revised up the
region’s GDP forecast by 0.3pp to 1.3% and 1.6% for
2015 and 2016, respectively, helped by the recent drop
in oil prices, and the more aggressive QE – and thus a
weaker euro. The latest PMIs seem to validate this
cyclical rebound and are in line with DB’s Q1 GDP
forecasts (chart) amid downside risk for France. While
ECB stimulus announcement may have underpinned
the biggest jump in PMIs since mid-2013, tense
negotiations between Greece and the EU may have the
opposite effect. Employment has risen and capacity
seems to be tightening. But the surveys have indicated
that external demand remains weak and this will likely
delay the benefits of a weaker euro.
Deutsche Bank Securities Inc.
Rather than the economy, however, the negotiations
with Greece will likely remain in focus for investors
over the next month. The available backstops and the
additional insurance QE provides go a long way in
curbing contagion. We are also encouraged by the
stance taken by the governments of Portugal, Spain,
Italy and France in resisting meaningful concessions to
Greece to safeguard their own reform agenda and
contain advances of eurosceptics. Still, Podemos is
closely trailing Rajoy’s party ahead of upcoming
general elections, which highlights non-trivial risks of
political contagion. Some concessions on maturities,
interest rates, and timing of targets, in addition to
ELA’s rolling “stick” suggest that a compromise could
be reached. But we expect protracted and tense
negotiations to continue to weigh on the euro –
especially if they spillover to the periphery.
EM: Missed Opportunities
The global backdrop remains a moderately supportive
one for EM. Fed lift off is getting closer but is likely to
be gradual; and, so far at least, the impact of additional
support from the ECB has outweighed concerns about
broader contagion from Greece. That emerging
markets have been unable to take much advantage of
this reflects the various weaknesses within EM. Growth
Page 5
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
in China continues to falter, Brazil is facing recession,
and Russia is almost certainly already in one. Even the
oil importers have struggled to take advantage of their
windfall. The additional monetary room for maneuver
provided by lower oil prices has been substantially
eroded in Turkey, for example, by renewed doubts
about the independence of its central bank.
Growth looks set to surprise to the downside in the first
half of the year in China, where the economy faces a
double whammy from a slowdown in property markets
and declining fiscal revenues. The latter is partly a
reflection of declining land sales, which account for
35% and 23% of local and total government revenues,
respectively. This in turn is reducing the availability of
funds for investment. We think the government
recognizes this and will start to loosen fiscal and
monetary policies aggressively in the coming months,
including another cut in reserve requirements and
2x25bps of rate cuts. Nevertheless, we see rising
downside risks to our growth forecast of 7% for this
year.
that what will matter most in the budget that will be
presented later this month is the quality rather than the
quantity of spending.
Brazil faces much bigger challenges, with several
factors now conspiring against the economy, including
fiscal tightening, rising interest rates, lower commodity
prices, the financial difficulties faced by oil company
Petrobras, and the growing risk of water and energy
shortages in response to continued low rainfall. These
headwinds will likely be enough to tip the economy
into recession this year, as we discuss later in this EM
Monthly (see “Brazil: A recession is looming”). The
Petrobras bribery scandal, for example, has impaired its
ability access capital markets and finances its
investments. Given its size, accounting for 10% of total
investment in the economy, this could exert a
significant drag on growth. Similarly, while we are not
yet assuming energy rationing, the risk is likely already
affecting investment decisions. We have accordingly
revised down our growth forecast for this year by a full
percentage point and now expect the economy to
contract by 0.7%.
China: government revenues under pressure
Brazil: a recession is on the horizon
Real GDP growth (YoY%)
8
6
4
2
0
-2
2006 2007 2008 2009 2010 2011 2012 2013 2014e 2015f
Source: Deutsche Bank, Wind, MoF
Source: Haver Analytics, Deutsche Bank
Recent revisions to the national accounts data in India
paint a rather different picture of recent growth,
suggesting that the economy has been growing at an
annual rate comfortably above 7%. We are somewhat
puzzled by these new data, which are hard to reconcile
with other indicators (e.g. the PMI survey) which are
consistent with growth of closer to 5%. While we have
been compelled to revise our growth forecasts upward
by a full percentage point on the back of these new
data, we do not think economic policy will be unduly
influenced by them. In particular, we see the RBI
remaining dovish (delivering another 75bps of rate cuts
by mid-year), while the government remains committed
to boosting spending and investment. On the latter
point, as we discuss later in this EM Monthly (see
“Does India need a fiscal stimulus?”), we think that
further deficit and debt reduction remain essential and
Page 6
South Africa is no stranger to energy rationing. As we
discuss later in this EM Monthly (see “South Africa:
Cheap oil but not enough energy”), the energy crisis
has if anything worsened as years of mismanagement
and lack of maintenance has pushed the system to
breaking point in recent months. New electricity
generating capacity meanwhile has been further
delayed. This is a major constraint on growth. Lower oil
prices are providing some relief, especially for inflation.
The cautious response to this from the SARB, focusing
on core inflation and inflation expectations, contrasts
with some of the more trigger happy rate-cutting
central banks, and should provide some support for the
rand. Nevertheless, the ongoing energy crisis and a
continued lack of progress on structural reforms will
likely limit the upside for the economy.
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Turkey should have been one of the biggest
beneficiaries of lower oil prices given the size of its
energy import bill. Indeed investor sentiment towards
the country turned notably more positive as oil prices
continued to fall sharply late last year. As we discuss
later in this EM Monthly (see “Turkey: is heightened
volatility the new normal?”), inflation appears set to
decelerate sharply in the next few months and the
current account deficit should narrow. The room for
maneuver that this could have provided, however, has
been eroded by comments that have undermined
confidence in the central bank and triggered a further
sharp depreciation in the lira.
Turkey: monetary policy and the lira
USDTRY
2.2
CBT rules out
intra-meeting
cut follwing
release of
January
inflation data
2.3
2.4
2.5
2.6
15 Jan
29 Jan
Source: Bloomberg Finance LP, Deutsche Bank
Finally, turning to Russia, lengthy discussions in Minsk
earlier this week have resulted in another ceasefire
agreement, which will begin at midnight on February
15. The details of the agreement are still emerging as
we go to print. Whether it represents a turning point
remains to be seen. But our initial reaction is that there
must be a significant risk that, like the previous
agreement reached in Minsk five months ago, this one
will fail to hold. Separately, as discussions in Minsk
were ongoing, the IMF announced that it has reached
provisional agreement on a new USD 17.5bn program
for Ukraine. This will form part of a broader USD 40bn
support package, including private sector involvement.
Our initial take is that the latter will most likely involve
a maturity extension of existing Eurobonds, although
we cannot rule out a deeper restructuring.
Strategy: Weak “pull”, weaker push
Important parts of EM are failing to adjust to reality.
Even in the few countries that enjoy a market-friendly
mandates such as India and Mexico, domestic (pull)
forces may not suffice to secure foreign investments
should the Fed advance its schedule. The situation is a
lot more precarious in large emerging economies such
Deutsche Bank Securities Inc.
Under these circumstances credit markets tend to
outperform while currencies play the role of shock
absorbers (chart). But credit valuation is unappealing
and we expect higher quality EM credits to – at most –
serve the purpose of capital preservation while global
and EM uncertainty is high. We overweight Turkey,
Indonesia, and Hungary, but underweight Chile and
Peru as an inexpensive hedge against China’s growth
risks. In relative value, we favor flatteners in a number
of curves, including Indonesia (Pertmina), Colombia,
and Mexico (Pemex), short basis in Brazil and the
Philippines, and a few cash switches to capitalize on
temporary pricing dislocations.
Regionally, we are relatively more constructive Asia,
where we maintain INR and IDR longs (vs. SGD). Still,
we favor long USD vs. SGD, TWD, MYR, and THB. We
also stay long USD/CNH. We continue to favor long
bonds in India, Indonesia, Thailand and China, in this
order. In response to higher risks to receivers we
recommend shorting Malaysia (5Y) and Korea (1Y1Y).
CBT announces possibility of intrameeting rate cut if January inflation
falls significantly
1 Jan
as Brazil, Turkey, South Africa, and Russia, which have
taken political and policy paths conducive to “pushing”
rather than “pulling” capital. In addition to the latter,
downside risks to China’s growth, and EM
policymakers’ limited maneuverability (on both fiscal
and monetary fronts) suggest that investors will remain
particularly sensitive to any sign of reversal in what we
still believe to be a broadly disinflationary backdrop.
Although LatAm still seems most vulnerable to US
rates and commodities, we see some signs of
overshooting in Mexico, where we expect the short end
(along with South Africa’s 1Y1Y) to outperform Israel
and the long end to outperform South Africa (where we
expect bull-steepening). We also see some room for
retracement in Chile and Colombian rates. Policy risks
are a lot higher in Turkey, but we also position for
some retracement via long TRY/ZAR, and a steepener
in the cross-currency curve while keeping moderately
underweight bonds.
We expect the ECB to continue to provide a strong
anchor for CE3 rates, but short-end pricing seems too
aggressive and we favor still payers. However, we
overweight long-end bonds in Hungary and Poland vs.
EU peripherals (especially Spain). We maintain short
GBP/PLN, and also short ILS, but take profit on long
HUF.
Brazil seems now in overshooting territory in both rates
and FX, but we see no nominal anchor that could
trigger a reversal in the absence of a more forceful
policy response and a more constructive political
dynamics.
Page 7
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Asset prices adjust to external and internal dynamics
Returns of various asset classes
2014
YTD 2015
UST (10-15Y)
where the macro framework has improved somewhat,
but its implementation has been seriously questioned
under the possibility of impeachment.
The chart below shows that external drivers (mainly oil
prices) have accounted for most of USD/RUB volatility,
but with oil prices range-bound, much now hinges on
the implementation of the new Minsk accord agreed on
between Merkel, Hollande, Poroshenko and Putin. We
fear that implementation again will be frustrating and
insufficient to deter further escalation of sanctions
down the road. Altogether, the outlook for EMFX
highest yielders remains on balance very uncertain.
S&P
IG
EMBI-G
DB-EMLIN (hedged)
EM Corp Credit
HY
EU Eq
DB-EMLIN
EM Eq
EMFX (Total Return)
Accounting for external and internal drivers of EM
EMFX Spot
currencies
Com'dty
vol attributable to extrenal factors (ann.)
-20% -15% -10% -5%
0%
5%
10% 15%
Source: Deutsche Bank
30.0
14
Asia has been our favored region as it benefits from
lower commodities prices and also from lower rates
and credit vulnerabilities. However, Asian CB’s have
stepped up the pace of intervention. Ex-China Asian
CBs have added $32bn to reserves in January – more
than the $23bn added during Q4 as a whole. India,
Taiwan, and Indonesia led the buying, while Malaysia
reduced its already low (1.1x short-term debt) reserves
coverage and Singapore’s reserves were roughly
unchanged in the period. This in part reflects the
relative flows outlook for these currencies and,
accordingly, we maintain our long INR and IDR
recommendations (vs. SGD). Despite our preference for
Asia FX across EM regions, we continue to favor long
USD vs. SGD, TWD, MYR and THB (in this order of
preference). We also believe that CNH will face
additional stress ahead and maintain long USD/CNH
call spreads
External drivers (encompassing the EUR/USD, UST,
and commodities) have accounted for a large share of
recent FX volatility across EM as the chart below
shows. In contrast, idiosyncratic risks have been
prevalent in Turkey and Brazil. We believe that signs of
overshooting are much more evident in Turkey, where
valuation is more appealing, overnight rates are at the
upper end of the corridor, and the external deficit is
firmly on a downtrend. Still, a credible monetary
anchor remains elusive. This problem is deeper in Brazil,
Page 8
2H2014
2015 ytd
12
FX: Liquidation mode
We expect EMFX to be the last asset class to stabilize
as it has been hit on two fronts: 1) increased demand
for hedge associated with foreigners’ local holding, and
2) credit outlook deterioration in the more vulnerable
cases. Reduced rates volatility and some tightening in
credit spreads are thus pre-requisites for retracement
across EMFX, in our view.
87%
83% 65%
10
81% 44%
66%
8
71%
77%
6
65% 73%
54% 64%
53%
54%
4
26% 73%
2
0
RUB HUF COP CZK
BRL
PLN ZAR
ILS
MYR CLP MXN IDR KRW INR
TRY PEN
Source: Deutsche Bank
Note: the fraction of volatility attributed to external factors (out of total volatility) is above the bars.
Elsewhere differentiation has favored currencies where
imbalances are lower as in CEE. We have taken profit
on our HUF long recommendation, as we cannot rule
out further easing, while in PLN we continue to
recommend short GBP/PLN as a way to capture a
reversion of the current very divergent policy outlooks.
We are of the view that LatAm currencies remain most
vulnerable, as the growth outlook for the region has
deteriorated from already quite low levels, the repricing
of commodities may not yet be over, and CBs have
little incentive to contain currency depreciation.
Valuation, the now more cautious Banxico stance, and
relative exposure to oil prices support MXN
outperformance vs. COP, in our view. Recent inflation,
confidence and CB statements have limited CLP losses,
but structural headwinds point to a subdued recovery
at best and likely easing later in the year. In addition,
we believe that China risks (and thus copper prices)
remain biased to the downside. At current levels this
backdrop favors short CLP vs. PEN (where positioning
is very light). In Brazil, we recommended investors
build long USD/BRL below 2.60 targeting 2.75, but – as
upcoming recession weighs on politics – we believe it
is too early to position for retracement.
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
On a more encouraging note, investors have been
overly concerned about portfolio outflows should the
Fed hike by mid-year (or at a faster pace). As the charts
below show, however, valuation now provides better
cushion and potential outflows seem manageable.
Although the stock of foreign holdings as a share of
reserves is large in several cases (especially in MXN,
ZAR, and PLN – see first chart), the actual outflows
during “taper tantrum” were meaningful as a share of
reserves only in ZAR (9% - second chart).
Foreign holdings: Risk of outflows seem overstated
15%
REER dev from 10Y avg
THB
10%
5%
PEN
MYR
0%
RON
INR
-5%
TRY
IDR
CZK
-10%
COP
BRL
PLN
MXN
HUF
ZAR
-15%
-20%
-25%
-30%
RUB
foreigner holdings of local bonds/fx reserves
-35%
0%
15%
10%
20%
30%
40%
50%
60%
70%
80%
REER dev from 10Y avg
THB
10%
PEN
5%
Domestically, EMFX, closed output gaps in some cases,
or residual inflationary pressures have again
highlighted the limited room EM policymakers have to
accommodate external shocks. Accordingly, EM CBs
have been more cautious than their DM counterparts,
especially where rates have been more sensitive to FX
as the chart below indicates. Since foreign positioning
in local bonds remains relatively heavy (as discussed
above), we expect EM CBs to maintain a relatively
more conservative stance while a June hike by the Fed
is in the cards. Looking ahead, as disinflationary forces
and tension in Greece seem likely to persist – possibly
preventing front-loaded Fed action – we expect EM
yields to retrace.
MYR
0%
INR
RON
CZK
-5%
-10%
Rates: Constrained by risk
We maintain a medium-term constructive view on rates,
but we find valuations unappealing at this increased
level of uncertainty – both external and domestic. On
the external front, the ECB will likely remain a reliable
anchor for yields for long, but strong payrolls have cast
doubts on whether “low-for-long” will also hold at the
Fed. The latter remains our baseline scenario on
expected low inflation (including the upcoming US CPI
prints due later this month). However, tighter US labor
markets have skewed risks, in our view, and we expect
investors to be more sensitive to prices/activity upside
surprises. The wide gap between Greece and EU
proposals opens another flank against EM rates – both
via credit and FX channels, but it could also delay the
Fed.
COP
TRY
BRL
HUF
EMFX weakness can constrain monetary policy
PLN
IDR
MXN
ZAR
60
move from 2015 lows (1Y rate, bp)
-15%
TRY (8%,133bp)
50
-20%
-25%
40
-30%
RUB
taper tantrum local bond outflows/fx reserves
-35%
-2%
1%
3%
5%
7%
30 COP
20
Asia: Buy USD/CNH 6.30/6.50 call spread;
short SGD/INR (target 44); short SGD/IDR
(target 9000). Buy USD/MYR (target 3.73),
USD/SGD (target 1.40), USD/TWD (target
33.50), USD/THB
(target 35.0). Short
EUR/KRW (target 1180).

EMEA: Hold long 3m EUR/CZK 31/29 callspread; short GBP/PLN (target 5.35); short
tactically ZAR vs. long TRY (target 4.90). Stay
long EUR/ILS (target 4.55).

LatAm: Buy MXN/COP (target 166); buy
PEN/CLP (target 210). Sell a 3M USD/COP put
@2,350 (ref spot 2,424) and buy a 3M
EUR/MXN put @16.85 with knockout @15.5
(ref spot 17.08).
Deutsche Bank Securities Inc.
MXN
9%
Source: Deutsche Bank

BRL
CLP
INR
ZAR
10 CZK HUF
PLN
ILS
0
0.0%
RUB
EUR
KRW
2.0%
4.0%
6.0%
8.0%
10.0%
move f rom 2015 lows (USD/FX,%)
Source: Deutsche Bank
Policy trade-offs are looser in Asia, where commodity
deflation has faced limited FX counteraction, policymaking is credible, risk-reward is still appealing, and
imbalances are less severe. We continue to favor long
bonds in India, Indonesia, Thailand and China, in this
order of preference. Given higher event risks and still
unfavorable positioning, we recommend short in
Malaysia (5Y) and Korea (1Y1Y) as a hedge.
Page 9
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Although policy constraints seem more severe in
LatAm, the recent dislocations have created some
opportunities, in our view. The higher-than-expected
inflation in Chile and overall change in sentiment
corrected the undershooting in breakevens. But the
curve now implies a more aggressive tightening cycle
than warranted by gauges of business cycle strength
and also the outlook for China and copper prices. As
the chart below shows, the Mexican curve prices in an
even more aggressive tightening cycle (all plotted vs.
the US) despite the fact that core inflation is running at
historical lows, FX pass-through has been limited, and
output gap has widened. This contrasts with Israel,
where economic conditions are now comparable to
Mexico’s, but a much milder cycle is priced. The priced
policy cycle seems too dovish in Poland and Hungary,
where we favor short-end payers. In Hungary, we also
see little premium priced in the 3Y sector of the curve
vs. 1Y and 10Y. We find more premium in South Africa,
where – rather than a cut – we expect the SARB on
hold this year.
valuation most compelling in the belly of the Brazil
curve, but we believe that the CB may have to respond
with more aggressive tightening and congress has yet
to show more support for the adjustment. Although CB
prospects remain fluid in Turkey, its inversion bode for
tactical steepeners.
Assessing 2s10s slope dislocations vs. the US curve
R-square (carry in parenthesis)
100%
USD (-13bp)
80% flat
HUF (8bp)
60%
MXN (-12bp)
ZAR (-2bp)
40%
RUB (70bp)
COP (5bp)
20%
TRY (11bp)
INR (16bp)
-1.5
Comparing policy cycles across EM – and vs. the US
2Y1Y-1Y 1Y(bp, EM -US)
steep
KRW (4bp)
EUR (3bp)
0%
20
PLN (6bp)
ILS (3bp)
CZK (1bp)
-0.5
CLP (-3bp)
0.5
z-residual
1.5
2.5
Source: Deutsche Bank.
Z-residuals from 2Y regression on 2s10s US swaps
MXN
USD
0

Asia: Long 10Y IGBs (target 7.2%). Pay INR 1Y/5Y
NDOIS steepener (target -20bp). Buy 10Y-20Y
IndoGBs (target 6.5-6.75%). Receive 5Y THB IRS
(target 2%); open 1Y/5Y THB IRS flattener (target
0bp). Pay 5Y MYR ND-IRS (target 4.25%); open
2Y/5Y SGD flatteners (target 40bp); pay 2Y SGDUSD IRS spread (target +50bp); pay KRW 1Y1Y
swaps (target 2.10%).

The risk of foreign outflows – even if more often a risk
than reality – should continue to weigh on duration.
Still, with better-anchored long-term inflation and credit
prospects, we favor Mexico vs. South Africa. As the
chart below shows, Mexico’s long-end seems
dislocated vs. the US after the recent selloff. We also
favor bonds in Poland and Hungary vs. Euro-area
peripherals. Note that carry favors a flatter curve in
both Hungary and Poland despite low absolute yields.
Foreign holdings are relatively low in Israel, where we
recommend receiving in the long end vs. Czech
Republic.
EMEA:. Pay 3Y CZK IRS (target: 75bp); short CZGB
May-24 vs. Israel (Mar-24). Enter HUF FRA 18x21
payers or 1x4 – 18x21 steepeners. Short HUF
1Y1Y; short the belly in 1s3s10s butterfly. Enter
PLN 18x21 payer or pay PLN 2Y fwd 1y rates.
Receive 15x18 ZAR FRA; enter long outright ZAR
1Y1Y (target 6.15%). Enter 1Y1Y-10Y ZAR IRS
steepener (target 165bp). Short ILS 1Y1Y IRS vs.
USD (target 25bp). In Russia cash, switch to
moderate underweight. Position into a TRY XCCY
2m-2Y steepener (target 0).

LatAm: Receive TIIE1Y1Y vs. ILS1Y1Y (target
380bp), receive TIIE 10s vs. ZAR 10s (target 190bp).
In Chile, scale into 1s3s flatteners (target 30) and
keep the spread trade receiving CLP/CAM vs. US
(target 200bp). In Peru, buy the SOB20s (target
4.30%). In Colombia, receive IBR2Y vs. COLTES24s
NDF (target 270bp). Stay neutral Brazil.
Although the risk of outflows still applies, we are most
concerned about the domestic developments in Russia
(where easing was premature, in our view), Turkey
(where a transition may be in the making at the CB),
and Brazil (where politics could become dysfunctional
and threaten the ongoing macro adjustment). We find
Credit: On thin ice
Heightened “Grexit” fears and the rise in US yields
dampened the search for yield triggered by ECB’s QE.
EM sovereign credits had a strong performance over
the past month, nevertheless, helped by the recent
recovery in oil prices that fueled a fairly strong reflux
-20
COP
HUF
-40
-60
back-loaded
KRW
CLP
ILS
ZAR
PLN
EUR
TRY
CZK
-80
-100
front-loaded
INR
1Y1Y-1Y (bp, EM -US)
-120
-160
-110
-60
-10
40
Source: Deutsche Bank
Priced changes in yields are calculated vs. US swaps equivalent.
Page 10
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
into credit funds (more so to US HY and IG than EM
and favoring oil producers) and policy response to
China’s disappointing economic releases.
EM BBB (ex-Russia) vs. US BBB: close to “taper
tantrum” tightest
EM BBB ex RU - US BBB
Spread differential (bps)
In our view this overall solid performance is built on
feeble anchors. First, the recovery in oil prices may
prove to be short-lived, as the rally was mostly driven
by short covering on a slew of coincident market
developments, while fundamentals in the oil markets
remain weak. Credit markets should reflect the poor
outlook for the next couple of years rather than shortterm fluctuations1.
100
80
60
40
20
0
-20
-40
Second, the prospect of sovereign defaults (Venezuela
and Ukraine) and the risk of losing investment grade
(for Russia sovereign/quasi-sovereigns, which is our
baseline, and less so for Petrobras) remain a drag for
EM credit markets. While the pricing of default seems
advanced, the risk of downgrades seems underappreciated. Losing investment grade in Russia
sovereign and quasi-sovereigns would mean close to
USD100bn bonds becoming HY in the global credit
market. If such a risk were to materialize in Petrobras
(not our baseline), the number would likely increase to
USD150bn, in comparison with USD310bn total new
issues in the US HY space in 2014. Such an event
could trigger a re-pricing of credit risk in the global
credit market and have a particularly negative effect on
EM.
Finally, there is still downside risk to China’s growth.
China’s stimulus (which came earlier than expected)
was in response to what our economist calls an
unexpected fiscal slide, whose risk will continue to play
out, and is perhaps under-estimated by the market. The
risk of Chinese authorities to under-deliver on the
stimulus front (due to higher tolerance for lower
growth and a desire to reign in fiscal risk) cannot be
underestimated, in our view.
We believe these risks warrant a higher risk premium
across EM credits than what the market is pricing. EM
BBB sovereign spreads (ex-Russia) currently trade at
+20bp vs. US BBB spreads, close to the tightest since
June 2013 – after tapering was priced.
-60
May-13
Sep-13
Jan-14
May-14
Sep-14
Jan-15
Source: Deutsche Bank
The reduced risk premium in EM sovereigns is also
shown in the results of our implied rating model (see
the two graphs below). First, by overlaying EM
sovereign spread/rating data points with those of
global credit market counterparts (duration matched) in
the first graph, it is clear that the majority of EM
sovereigns have a tighter spread than most of the likerated tickers in the global space. The second graph
shows that most EM low- and mid-beta credits are
trading with a higher implied rating than their actual
ratings. This contrasts with EM’s negative rating
migrations path, with a positive migration path in the
best credits stalling (e.g., Mexico, Peru, Colombia, etc.)
and weaker credits facing downgrade pressures (e.g.,
Russia, South Africa, and Brazil).
Most EM sovereign credits are tighter vs. like- rated
global credits
7.50
Ln(Spread)
7.00
NG
6.50
JM
RU
6.00
5.50
5.00
4.50
QA
4.00
CL
LB
EM
HR SV DO
BR TR
ID
ZA
MXCO
HU
PA UY
LV
LT
PE
PH
PL
3.50
0.0
5.0
10.0
15.0
20.0
Rating
Note: Background blue bubbles indicate model inputs of (rating, spreads) of close to 200 global
credit tickers where a comparable spread level matching the average duration of the EM
benchmark can be derived with a certain level of confidence using a curve-fitting algorithm taking
consideration of the shape of the curves. The red squares are EM bond spreads / rating transformed
to match the same duration using the same algorithm.
Source: Deutsche Bank
1
The median forecast by analysts available on Bloomberg is for WTI to
average below USD60pb in 2015, still a negative scenario for EM oil
exporters.
Deutsche Bank Securities Inc.
Page 11
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
In low beta space, Brazil has been in focus due to the
Petrobras’ problems and increasingly dysfunctional
politics. We remain neutral on the credit, as wide
spreads already reflect considerable credit risk. We
remain overweight in Turkey and Indonesia, two of the
main beneficiaries of lower oil prices; they have also
weakened post NFP, but we do not expect a sustained
rise in UST yields in the near term to significantly
remove their attractiveness. We hold underweight on
Chile and Peru, partly as a proxy hedge against China’s
growth risk.
Sovereign credits are rich from an implied rating
perspective
Market implied rating vs actual rating
+2
0
-2
-4
-6
BR
CL
CO
HU
ID
Curr deviation (impl vs. actual)
MX
PE
PH
PL
TR
ZA
10-90% range + median (past 3Y)
Source: Deutsche Bank
This bodes for defensive positioning. The external push
factors are fairly strong after the ECB QE
announcements and “risk-off” favor credit. But EM
weakness remains pervasive and valuation does not
look very appealing. More encouraging, technicals
have improved with some moderate inflows finally
returning to EMD funds after two months of outflows
and the ease in primary market pressure. But even in
terms of technicals there is room for concern. It
remains to be seen whether inflows are forming a
sustainable trend (as the latest bout was partly driven
by the recent rise in oil prices). Moreover, we will likely
see increased issuance in March as sovereigns have a
strong incentive to front-load issuances given the Fed’s
likely calendar.
Among the “troubled” credits, the landscape remains
roughly the same as last month. Ukraine is pricing a
moderate PSI scenario which is consistent with our
baseline. There have not been any meaningful credit
changes in Venezuela that could lessen the likelihood
of default – enhanced liquidity and some devaluation
measures notwithstanding. In Russia, higher oil prices
and ceasefire agreement caused some short covering,
but we do not see a reason to move away from our
Underweight recommendation as we continue to
foresee heightened volatility. The truce looks fragile
and focus shifts to implementation. Losing investment
grade remains our baseline.
Page 12
In relative value, we see two main themes that have
developed over the past two weeks: dramatic
steepening of the cash curves as investors reduced
duration in the face of rising UST yields; and the sharp
widening in CDS/Bond basis as a result of rising UST
yields, lack of issuances and return of inflows. We
identify curves where these recent moves have become
excessive and are subject to a correction, and enter
curve flattener and short basis trades.
Summary of recommendations

Overweights: Indonesia, Turkey, Hungary

Underweights: Russia, Chile, Peru

CDS/bond Basis: Sell RoP 5Y CDS vs. 21s, Sell
Brazil 5Y CDS vs. 19Ns

Curve trades: Mexico 44s vs. 23s, Colombia
45s vs. 24Ns, Indonesia 42s vs. ID 22, Pemex
44s vs. 24s, Pertamina 44s vs. 23s

Cash switches: Russia 20s vs. 30s, Brazil 21s
vs. BR 19Ns, ECOPET 43s vs. 45s

Select long or shorts: Long Pertamina 44s,
Short Chile 25s, long Bonar 17s in Argentina
Drausio Giacomelli, New York, +1 212 250 7355
Robert Burgess, London, +44 20 7547 1930
Hongtao Jiang, London, +1 212 250 2524
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Brazil: A Recession is Looming
Fiscal tightening, rising interest rates, lower commodity
prices, the financial difficulties faced by oil company
Petrobras and the growing risk of water and energy
shortages all conspire against Brazil’s economic
recovery. Although we are not yet assuming energy
rationing, we believe the risk is already affecting
investment decisions, so we have cut our 2015 GDP
growth forecast to -0.7% from 0.3%.
The likely decline in GDP in 2015 and the much largerthan-expected consolidated primary fiscal deficit of
0.6% of GDP posted in 2014 will make it more difficult
for Finance Minister Joaquim Levy to deliver the
targeted primary surplus of 1.2% of GDP this year.
While we still expect the government to announce a
sizeable spending cut after Congress passes the 2015
budget, we think that additional tax hikes would be
necessary to guarantee the 1.2% target. Raising more
taxes could aggravate the recession and face strong
resistance in Congress, which is becoming increasingly
hostile to President Dilma Rousseff. Consequently, we
cut our 2015 primary surplus forecast to 0.8% from
1.2% of GDP.
We do not believe that cutting the primary surplus
target would necessarily make Brazil lose its current
investment grade status. It is important to bear in mind
that a primary surplus of 1.2% of GDP is not enough to
restore public debt sustainability, and would be just the
first step toward restoring fiscal solvency, to be
followed by additional tightening in the next years.
Under
current
economic
conditions,
jumping
immediately to 1.2% might be just too costly. In our
opinion, the government could improve its fiscal policy
significantly by promoting transparency, making a
strong effort to rein in discretionary spending,
introducing reforms to fix structural problems, and
indicating the pathway for further improvement in the
next years.
Nevertheless, given the combination of low economic
growth, high inflation, large current account deficit and
lack of structural reforms, agencies that currently rate
Brazil two notches above investment grade (e.g.
Moody’s, with its negative outlook) might decide to cut
Brazil by one notch, aligning their ratings to Standard &
Poor’s and raising market volatility.
The correction of administered prices (especially of
electricity) and the hike in fuel taxes have increased the
pressure on inflation, prompting us to raise our 2015
IPCA forecast to 7.2% from 6.6%. We have also raised
our year-end SELIC rate forecast to 12.75% from
12.50%, and our year-end FX forecast to BRL2.90/USD
from BRL2.80/USD.
Deutsche Bank Securities Inc.
We now expect GDP to contract by 0.7%
this year
Several factors conspire against Brazil’s economic
recovery this year:
1.
Fiscal tightening has a short run contractionary
effect. One of the government’s main challenges is
to repair its fiscal accounts, raising its primary
balance to 1.2% from -0.6% of GDP last year.
Although this move would be crucial in restoring
policy credibility and confidence (therefore paving
the way for the economy to recover in the future),
its
short-term
effects
would
likely
be
contractionary.
2.
High inflation demands tight monetary policy. As
inflation remains high due to the overdue
adjustment in administered prices, the central bank
has raised interest rates by 125bps since October
and has signaled that the tightening cycle has not
yet ended.
3.
The decline in commodity prices (ex-oil) is hurting
Brazil’s terms of trade.
4.
Petrobras will likely cut investments. The Petrobras
bribery scandal has impaired the ability of the
country’s largest company to access capital
markets and finance investments. The state-run oil
company accounts for approximately 10% of total
investments in Brazil. Assuming a 20% decline in
Petrobras capex this year, its negative drag on
growth could reach at least 0.4% of GDP.
5.
Several construction companies allegedly involved
in the bribery scheme are also under intense
financial pressure and will likely have to reduce
their activities as well, further undermining
investments in infrastructure.
6.
Water rationing in the state of São Paulo is
practically inevitable at this juncture. The risk of
water and energy rationing has increased
significantly due to the continuation of
exceptionally low rainfall at the beginning of the
year. The crisis is particularly acute because the
authorities failed to act preemptively last year,
fearing potentially negative implications for the
elections. Water rationing in the state of São Paulo
is practically inevitable at this juncture, as its main
reservoirs are almost empty. São Paulo accounts
for approximately 30% of Brazil’s GDP and water
shortage is already affecting production in some
sectors (e.g. foodstuff, metallurgical and textiles).
Page 13
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
The second largest state economies of Rio de
Janeiro and Minas Gerais also face an increasing
risk of water rationing. It is difficult to estimate the
impact of the water crisis on GDP, but we would
put a conservative estimate at 0.2% of GDP.
7.
We believe that a 10% rationing for six months
could cut GDP growth by approximately 1%. The
drought has also depleted the reservoirs of
hydroelectric power plants, which account for
roughly 70% of Brazil’s electricity generation. The
national aggregate reservoir levels are down to
only 20% and failure to recover to at least 35% by
the end of the rainy season in April could prompt
the authorities to declare energy rationing.
Presently, rationing would most likely be less
severe than the 20% rationing of 2001, when
hydroelectric power plants accounted for roughly
90% of supply and the national electrical grid was
not well integrated. A more likely scenario this time
would be a rationing of between 5% and 10%. We
believe that a 10% rationing for six months could
cut GDP growth by approximately 1%.
Reservoir levels
90%
2012
80%
2013
70%
2014
60%
2015
We forecast zero growth for 2014
The latest indicators have attested to the weak
economic performance at the end of 2014. Industrial
production declined 2.8% MoM in December, 1.6%
QoQ in 4Q14 and 3.2% in 2014. Other indicators have
remained quite weak too, especially consumer and
business confidence in most sectors of the economy.
We believe that 4Q14 GDP fell 0.1% QoQ. Therefore,
we have lowered our 2014 growth forecast to zero
from 0.1%.
We cut our 2015 GDP growth forecast to -0.7% from
+0.3%. For 2015, in light of what was discussed above,
we cut our forecast to -0.7% from +0.3%. Although we
are not yet assuming electricity rationing, we believe
that the uncertainty surrounding the energy situation is
already
affecting
sentiment
and
undermining
investment. Investment continues to be the key
variable to rekindle growth, as global growth remains
sluggish, fiscal solvency issues prevent further
expansion in government consumption and credit
constraints and rising unemployment hurt household
consumption. We estimate that fixed-asset investment
fell approximately 7% in 2014 and we project another
decline of roughly the same magnitude this year.
Investment indicators
140
2002=100
130
50%
120
40%
110
30%
20%
100
10%
Production of capital goods
Construction materials
90
Source: ONS
Source: IBGE
Industrial production
110
2002 = 100
105
100
95
Business confidence
155
140
Services
Retail
Construction
Industry
125
90
110
85
80
95
80
Source: IBGE
Source: FGV
Page 14
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
We expect unemployment to rise significantly this year
The unemployment rate averaged 4.8% in 2014, down
from 5.4% in 2013, and the lowest on record. Although
the average number of employed workers fell 0.1% last
year, the labor force contracted by 0.7%. The
contraction in the labor force may be explained by
slower population growth, increase in government
transfers, and rise in school attendance among
youngsters. However, the labor participation rate is
unlikely to decline further, at the same time that job
origination will most likely fall due to negative GDP
growth. We expect average unemployment to climb to
6.0% in 2015.
For 2016, we also lowered our GDP forecast to 1.5%
from 1.9%, assuming that the water and energy
problems will be alleviated by then, that Petrobras will
stabilize and that the fiscal adjustment will continue,
reducing the risk of losing the investment grade status
and shoring up confidence. We remain skeptical about
structural reforms (upon which faster growth depends).
Unemployment
10
%
Unemployment
9
Seasonally-adjusted
8
7
A more distant fiscal target
The government has raised fuel taxes, as expected
The authorities have announced more measures to
raise the primary fiscal surplus this year. As market
participants had widely expected, the government has
raised the CIDE tax on fuel. Although a 90-day grace
period was required for the tax to be effective, the
government astutely raised another tax (PIS/COFINS)
temporarily in order to start collecting revenues right
away. The authorities expect to collect BRL12.2bn with
the CIDE tax in 2015. The downside, of course, is the
average 8% increase in gasoline prices (which adds
roughly 30bps to the IPCA consumer price index).
A more surprising move was the hike in the IOF tax on
consumer loans to 3.0% from 1.5%, which the
government expects to generate BRL7.4bn this year.
The previous economic team used the IOF extensively
as an instrument to stimulate consumption and it was
probably difficult for President Dilma Russeff to accept
a tax hike that should further dampen consumption.
The government has also raised the PIS/COFINS tax on
cosmetic products, a measure that will generate an
estimated BRL0.4bn only in 2015. Finally, the
authorities have decided to raise the PIS/COFINS tax on
imports as of June, expecting it to generate BRL0.7bn.
Of the three aforementioned measures, this is the only
one that will require congressional approval.
Estimated fiscal savings (% of GDP)
6
5
4
Source: IBGE
Increase in primary balance of local governments to 0% of
GDP
Increase in IPI tax on cars, appliances
0.2
Increase in CIDE tax, PIS/COFINS on imports, IOF tax on
consumer loans
New rules for unemployment benefits and pensions
0.4
Elimination of electricity subsidies
0.2
Total
Consumer confidence
150
140
Consumer confidence
Current conditions
Expectations
130
120
110
100
90
80
Source: FGV
Deutsche Bank Securities Inc.
0.1
0.3
1.2
Source: Federal government, Deutsche Bank Research
The fiscal adjustment’s starting point is much worse
than expected. However, the fiscal adjustment’s
starting point is much worse than expected. The public
sector posted a consolidated primary fiscal deficit of
BRL32.5bn (0.63% of GDP) in 2014, the first primary
deficit since 1997. The deficit compared to a surplus of
1.9% of GDP in 2013. The central government posted a
deficit of BRL20.5bn, while the states and
municipalities had a deficit of BRL7.8bn and SOEs a
deficit of BRL4.3bn. In December alone, the
consolidated deficit reached BRL12.9bn (compared to
our forecast of BRL2bn), as states and municipalities
posted a much larger-than-expected deficit of
BRL11.3bn. The nominal deficit (which includes
interest on the public debt) surged to 6.70% of GDP in
2014 from 3.25% in 2013, the largest since 1998. The
net public debt climbed to 36.7% of GDP in 2014 from
33.6% of GDP in 2013, while the gross public debt
jumped to 63.4% from 56.7% of GDP.
Page 15
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Primary fiscal balance
5.0%
Public debt (% of GDP)
%
65
% of GDP, 12m
4.0%
60
3.0%
55
2.0%
Target
1.0%
Primary balance
50
45
Adjusted balance
0.0%
40
-1.0%
35
-2.0%
30
Source: BCB, Deutsche Bank Research (adjusted balance excludes extraordinary revenues
Finance Minister Joaquim Levy would still need at least
0.8% of GDP, according to our calculations. We believe
that roughly half of this amount could be achieved
through spending cuts, which are to be announced
after Congress passes the 2015 budget, (likely by the
end of February). In terms of extraordinary revenues,
we are assuming that what the government collects
this year (e.g. by outsourcing its payroll management)
will be just enough to match last year’s amount. The
remaining 0.4% of GDP would therefore have to be
obtained by either raising more taxes or by undoing
some of the tax cuts introduced in the previous years
(especially the reduction in payroll taxes), which could
exacerbate the recession.
% of GDP, 12m
-7%
-6%
-5%
-4%
-3%
-2%
-1%
0%
Source: BCB
In light of last year’s record primary deficit, reaching
the surplus target of 1.2% in 2015 would be
tantamount to an adjustment of 1.8% of GDP. In
addition, the government would likely have to get
another 0.2% of GDP to cover an increase in
mandatory spending. The measures announced so far
should save approximately 1.2% of GDP (assuming that
the government will manage to obtain BRL18bn in
savings from the changes in unemployment benefits
and pension rules, which is far from granted due to
growing political resistance against these measures).
Federal spending on social security and welfare
Bolsa Familia
LOAS, RMV
9%
Unemployment benefits, abono
Social security
8%
0.5% 0.7% 1.1%
10%
7%
We are cutting our 2015 primary surplus forecast to
0.8% from 1.2% of GDP. Furthermore, we believe that
the authorities should be prepared to deal with
additional pitfalls. We see three main risks: First,
although it is possible that the normalization of
payments that had been delayed during the year
contributed to a deepening of the fiscal deficit in the
last months of 2014, transparency is low and the size
of potential fiscal “skeletons” inherited by the new
economic team remains unclear. For example, the
fiscal watchdog TCU, claims that there is an
unaccounted stock of approximately BRL40bn in
financial transactions. Second, lower-than-expected
GDP growth could hurt tax collection and further
complicate the fiscal adjustment. We estimate that
every 1% decline in real GDP could reduce total tax
revenues by approximately 0.4% of GDP. Third, there is
a risk that the National Treasury may have to provide
some financial aid to Petrobras. Therefore, we are
cutting our 2015 primary surplus forecast to 0.8% from
1.2% of GDP.
7.7%
6%
Gross public debt
Net domestic debt
Net public debt
Source: BCB
Nominal fiscal deficit
-8%
% of GDP
5%
Source: STN, Portal da Transparência
Page 16
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Central government primary fiscal balance (BRLbn)
2013
2014
change
%
change
1,181.1
105.3
1,224.0
114.7
42.9
9.4
3.6%
9.0%
Corporate income tax
IPI tax
IOF tax
187.5
47.1
29.4
194.5
51.6
29.8
7.0
4.5
0.4
3.7%
9.6%
1.3%
Import tax
PIS/COFINS/CSLL
37.2
319.2
36.7
313.3
-0.5
-5.9
-1.4%
-1.8%
2.9
8.0%
Total revenues
Personal income tax
Royalties
36.5
39.4
Concessions
Dividends
Social security
22.1
17.1
307.1
7.9
18.9
337.5
Total spending
Transfers
1,104.1
190.0
1,241.3
210.2
137.2
20.2
12.4%
10.6%
202.7
44.7
219.8
54.4
17.1
9.7
8.4%
21.7%
10.2
33.5
7.9
188.6
63.2
357.0
9.0
37.9
9.2
223.1
77.5
394.2
-1.2 -12.0%
4.4 13.1%
1.3 17.0%
34.5 18.3%
14.3 22.6%
37.2 10.4%
77.0
-17.2
-94.2 -122.4%
1.6%
-0.3%
-14.2 -64.1%
1.8 10.5%
30.4
9.9%
2003. In 12 months, the IPCA climbed 7.14%, the
largest gain since September 2011. Administered
prices surged 2.50% MoM in January, led by electricity
and bus fares. We do not expect much relief in
February (we forecast 1.10% MoM), as the index will
be hit by higher fuel prices (due to the tax hike) and by
the seasonal adjustment in school tuitions. We expect
the 12-month IPCA to climb to 7.57% in February,
further distancing itself from the 6.50% ceiling of the
inflation target’s tolerance band.
IPCA
1.4%
MoM%
1.2%
Personnel
FAT (inc. unemployment
benefits)
Subsidies
LOAS
CDE (energy)
Administrative
Investments
Social security
Primary balance
(as % of GDP)
MoM%
YoY%
YoY%
8.0
7.0
1.0%
0.8%
6.0
0.6%
0.4%
5.0
0.2%
0.0%
4.0
Source: IBGE
Source: STN
We believe Brazil could keep the investment grade even
with a lower primary surplus target this year
A crucial question is whether failure to meet the
primary surplus target of 1.2% of GDP would cost
Brazil the investment grade status. It is important to
bear in mind that a primary surplus of 1.2% of GDP is
not enough to restore public debt sustainability (we
estimate that something closer to 2.5% would be
needed). The 1.2% target was presented as the feasible
first step toward restoring fiscal solvency, to be
followed by additional tightening in the next years
(when the target would be raised to 2.0% of GDP).
Under
current
economic
conditions,
jumping
immediately to 1.2% might be just too painful and
economically inefficient. In our opinion, the
government could improve its fiscal policy significantly
by promoting transparency, making a strong effort to
rein in discretionary spending, introducing reforms to
fix the structural problems, and indicating the path for
further improvement in the next years.
Higher inflation
Administered prices are putting pressure on inflation
The government’s decision to finally normalize
administered prices is already putting a lot of pressure
on inflation. The IPCA consumer price index rose 1.24%
MoM in January, the steepest increase since February
Deutsche Bank Securities Inc.
IPCA breakdown
17%
YoY%
15%
13%
Headline Inflation
Services
Administered
Core Inflation
Food
11%
9%
7%
5%
3%
1%
Source: IBGE
We raised our 2015 IPCA forecast to 7.2% from 6.6%.
We estimate that the increase in fuel taxes and public
transportation, together with the government’s
decision to eliminate electricity subsidies, will likely
make administered prices climb a hefty 10% this year.
Consequently, although the deceleration in economic
activity will contribute to a slowing of the inflation of
non-tradable goods and services, we raised our 2015
IPCA forecast to 7.2% from 6.6%.
Page 17
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
IPCA breakdown
weight
IPCA and inflation targets
2008
2009
2010
2011
2012 2013
2014 2015F
Food
16% 10.7%
0.9% 10.7%
5.4% 10.0% 7.6%
7.1%
6.5%
Tradables *
23%
4.4%
4.0%
3.8%
3.9%
2.7% 5.4%
4.7%
5.2%
Non-tradables *
39%
6.9%
5.6%
7.6%
8.8%
7.6% 8.2%
7.9%
7.0%
Monitored
23%
3.5%
4.7%
3.1%
6.2%
3.7% 1.5%
5.3% 10.0%
100%
6.0%
4.3%
5.9%
6.5%
5.8% 5.9%
6.4%
8.0
YoY%
7.0
6.0
IPCA
7.2%
5.0
4.0
3.0
Source:IBGE, DB forecasts
(*) excluding foodk
2.0
1.0
The COPOM raised the SELIC overnight rate by 50bps
to 12.25% in January, in line with market expectations.
The COPOM minutes sent a somewhat ambiguous
message, claiming that “the scenario of convergence
of inflation to 4.5% in 2016 has become stronger”
(even though the BCB claimed that its inflation
forecasts for 2016 remained “relatively stable” and
above the target), but also stating that the progress
obtained in the fight against inflation was “not yet
enough.” Our interpretation of the document was that
the tightening cycle was not over yet, but the BCB kept
the door open for another 50bp hike or a 25bp hike at
the next meeting on March 4.
We expect the SELIC rate to climb to 12.75% in March
The BCB finds itself between the proverbial rock and a
hard place, as inflation expectations remain
unanchored (despite some decline in long-term
forecasts, market participants still do not see inflation
dropping below 5% before 2019), while economic
activity is collapsing. Our impression is that it will be
difficult for the COPOM to reduce the tightening pace
to 25bps in March, as February inflation will likely
accelerate to 7.6% YoY, approximately. Thus, we now
expect the BCB to raise the SELIC by 50bps to 12.75%
in March, and keep the door open for a 25bp hike or no
hike in April. Then, some deceleration in 12-month
inflation in 2Q15 and further deterioration in economic
activity will likely prompt the BCB to interrupt the
tightening cycle in April and abandon its pledge to
make inflation converge to the 4.5% target in 2016 (we
forecast 5.6% for next year).
Expected IPCA, Focus survey
7.2
%
2015
2016
6.7
2017
6.2
5.7
5.2
Source: BCB, Focus survey
Page 18
Source: IBGE, BCB, DB forecasts
Our scenario now contemplates the SELIC rate peaking
at 12.75% in March, initiating an easing cycle at the
beginning of 2016, and dropping to 10.50% by the end
of that year. Should energy rationing become
necessary and put even more pressure on inflation
(through even higher energy prices and a weaker BRL),
we believe the BCB would prefer to accommodate the
supply shock and focus on the deceleration in
aggregate demand. Therefore, we would probably still
not see the SELIC rate above 13% in that scenario.
Regarding the latest reshuffle at the BCB board, we do
not expect it to lead to significant changes in the
conduction of monetary policy. BCB President
Alexandre Tombini has appointed economist Tony
Volpon as Director for International Affairs. Volpon,
currently the head of emerging markets research at
Nomura Securities, is the first director chosen by
Tombini from outside the BCB ranks. We believe it is
positive that Tombini has decided to bring an outsider
with large experience in the private sector. On the
other hand, Economic Policy Director Carlos Hamilton
will leave the BCB and will be replaced by current
International Affairs Director Luiz Awazu Pereira. In our
opinion, Hamilton was the most hawkish member of
the COPOM, and his departure could give the
committee a somewhat more dovish tone.
A weaker BRL ahead
A current account deficit of 4.2% of GDP in 2014.
Although the Brazilian economy did not grow last year,
the current account of the balance of payments posted
a record USD90.9bn (4.2% of GDP) deficit, compared
to USD81.1bn (3.6% of GDP) in 2013. The increase in
the deficit was mainly due to the trade balance
(a USD3.9bn deficit in 2014 versus a USD2.4bn surplus
in 2013) and equipment leasing (-USD22.7bn vs. –
USD19.1bn), reflecting mainly an increase in the
leasing of oil equipment. The balance of payments still
posted a surplus of USD10.8bn in 2014, as foreign
direct investment totaled USD62.5bn (down from
USD64bn in 2013, and significantly lower than the
current account deficit of USD90.9bn), foreign portfolio
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
investment amounted to USD31.7bn (down from
USD37.0bn), long-term external borrowing reached
USD71.8bn (vs. USD60.8bn), debt amortization totaled
USD49.8bn (vs. USD60.1bn), Brazilian assets abroad
led to a loss of USD40.8bn (following the USD48.5bn
deficit in 2013), and short-term capital flows reached
USD22.3bn (vs. USD17.2bn).
FDI no longer finances the entire current account deficit.
We forecast that the current account deficit will decline
to USD77bn in 2015, as we expect lower oil prices and
the domestic recession to compensate for the fall in
export prices. However, because GDP measured in
dollars will be smaller, the deficit will not fall below
4.0% of GDP. We project USD60bn in FDI this year.
Since foreign direct investment is no longer enough to
finance the current account deficit, Brazil is more
dependent on portfolio flows that are more volatile and
vulnerable to global liquidity conditions.
Main export products (USDbn)
Product
2013
2014
2014/13
Share of
total
Soybeans
31.03
31.41
1.2%
14.0%
Mining (incl. iron
ore)
35.09
28.44
-18.9%
12.6%
Oil and fuel
22.40
25.18
12.4%
11.2%
Transportation
material
Meat
32.19
21.76
-32.4%
9.7%
16.30
16.93
3.9%
7.5%
Chemicals
14.68
15.10
2.9%
6.7%
Metallurgical
products
13.33
14.50
8.8%
6.4%
Sugar
11.98
9.48
-20.9%
4.2%
Mechanical
products
Pulp & paper
9.00
8.75
-2.8%
3.9%
7.16
7.22
0.9%
3.2%
Coffee
5.25
6.47
23.2%
2.9%
TOTAL
242.21
225.12
-7.1%
100.0%
sovereign debt. Although we still do not expect S&P to
put its Brazil rating below investment grade, Moody’s
and Fitch currently rate Brazil two notches above
investment grade and we would not be surprised if at
least one of them (e.g. Moody’s, with its negative
outlook) were to downgrade Brazil this year.
Consequently, we revised our year-end FX forecast to
BRL2.90/USD from BRL2.80/USD. While we believe
that the risk is now tilted toward an even weaker
currency, we continue to assume that the government
will continue to work on adjusting its policies to restore
confidence and pave the way to a gradual economic
recovery in 2016.
Balance of Payments (USDbn)
Current account
2011
-52.5
2012
-54.2
2013
-81.1
2014
-90.9
2015F
-77.0
Trade balance
29.8
19.4
2.4
-3.9
6.0
Net interest
payments
Profits and dividends
-9.7
-11.8
-14.2
-14.1
-14.5
-38.2
-24.1
-26.0
-26.5
-24.5
International travel
-14.7
-15.6
-18.3
-18.7
-17.0
Other services
-22.7
-24.9
-28.3
-29.6
-29.0
3.0
2.8
3.4
1.9
2.0
111.1
73.1
75.2
101.8
77.0
66.7
65.3
64.0
62.5
60.0
Transfers
Financial account
FDI
Portfolio investment
Long-term
disbursements
Brazilian assets
abroad
Short-term capital,
others
Long-term
amortization
7.1
10.7
37.0
31.7
30.0
83.6
57.8
60.8
71.8
75.0
-20.9
-29.3
-45.0
-37.2
-40.0
12.3
8.4
18.4
22.9
15.0
-37.7
-39.7
-60.1
-49.8
-63.0
Source: BCB. DB forecast
Source: SECEX
The government seems to accept a weaker BRL.
While the BCB continues to intervene in the FX market
by offering USD100mn in FX swaps every day, the
outstanding stock of these instruments has reached
approximately USD110bn, and we believe it will be
increasingly difficult to continue extending the program
(which is now scheduled to expire at the end of March).
As a matter of fact, Finance Minister Joaquim Levy
recently stated that he does not intend to keep the FX
“artificially overvalued.” While the BCB (not the
Finance Ministry) is in charge of FX policy, we believe
that this statement could be an indication that the
government is willing to accept a weaker exchange
rate.
We revised our year-end FX forecast to BRL2.90/USD.
Prospects of negative GDP growth this year do not
bode well for the BRL either, especially when it could
prompt the rating agencies to downgrade Brazil’s
Deutsche Bank Securities Inc.
Current account and foreign capital flows
100
U
USDbn,
12m
80
Current account deficit
FDI
Portfolio
60
40
20
0
-20
Source: BCB
José Carlos de Faria, São Paulo, (+55) 11 2113-5185
Page 19
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Selected current account components
-40
USDbn, 12m
-30
-20
-10
Profits & dividends
Interest
International travel
Leasing
0
Source: BCB
Monthly forecasts
IPCA MoM%
IPCA YoY%
SELIC%
Feb-15
1.10
7.57
12.25
Mar-15
0.60
7.23
12.75
Apr-15
0.55
7.11
12.75
May-15
0.45
7.09
12.75
Jun-15
0.30
6.99
12.75
Jul-15
0.40
7.41
12.75
Aug-15
0.35
7.51
12.75
Sep-15
0.50
7.44
12.75
Oct-15
0.40
7.42
12.75
Nov-15
0.50
7.41
12.75
Dec-15
0.60
7.21
12.75
Jan-16
0.70
6.64
12.25
Source: DB forecasts
Long-term forecasts
GDP %
IPCA %
BRL/USD eop
Selic avg.
2010
7.5
5.9
1.67
10.0
2011
2.7
6.5
1.88
11.7
2012
1.0
5.8
2.04
8.5
2013
2.5
5.9
2.34
8.4
2014E
0.0
6.4
2.66
11.0
2015F
-0.7
7.2
2.90
12.7
2016F
1.5
5.6
3.00
11.0
2017F
2.7
5.2
3.10
10.5
2018F
3.0
5.6
3.21
10.5
2019F
2.5
5.2
3.31
11.7
2020F
2.5
5.0
3.41
11.0
2021F
2.8
5.0
3.51
10.5
Source: National Statistics, DB forecasts
Page 20
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Main Macroeconomic Forecasts
2009
2010
2011
2012
2013
2014E
2015F
2016F
Economic Activity
-0.3
7.5
2.7
1.0
2.5
0.0
-0.7
1.5
Nominal GDP (R$bn)
3,239.4
3,770.1
4,143.0
4,392.1
4,844.8
5,111.1
5,413.7
5,742.2
Nominal GDP (US$bn)
1,625.6
2,143.9
2,475.1
2,252.6
2,245.4
2,171.7
1,928.9
1,965.9
GDP per capita (US$)
8,489.8
11,093.9
12,696.1
11,306.0
11,174.9
10,719.8
9,444.0
9,547.2
Household consumption (%YoY)
4.4
6.9
4.1
3.2
2.6
0.9
0.0
1.0
Investment (%YoY)
-6.7
21.3
4.7
-4.0
5.2
-7.4
-7.6
3.9
Industrial production (%YoY)
-7.4
10.5
0.4
-2.3
2.3
-3.2
-3.0
2.5
Unemployment Rate (%)
8.1
6.7
6.0
5.5
5.4
4.8
6.0
6.5
Real GDP (%YoY)
Prices
IPCA (%)
4.3
5.9
6.5
5.8
5.9
6.4
7.2
5.8
IGP-M (%)
-1.7
11.3
5.1
7.8
5.5
3.7
5.7
5.0
Fiscal Accounts
Primary balance (% of GDP)
2.0
2.7
3.1
2.4
1.9
-0.6
0.8
1.5
Nominal balance (% of GDP)
-3.3
-2.5
-2.6
-2.5
-3.3
-6.7
-5.6
-4.3
Net government debt (% of GDP) year end
42.1
39.1
36.4
35.3
33.6
36.7
38.4
40.6
Trade balance (US$bn)
25.3
20.2
29.8
19.4
2.4
-3.9
6.0
12.0
Current account balance (US$bn)
-80.0
External Accounts
-24.3
-47.3
-52.5
-54.2
-81.1
-90.9
-77.0
Current account balance (% of GDP)
-1.5
-2.2
-2.1
-2.4
-3.6
-4.2
-4.0
-4.1
Foreign direct investment (US$bn)
25.9
48.5
66.7
65.3
64.0
62.5
60.0
65.0
239.1
288.6
352.0
378.6
375.8
374.1
374.1
374.1
277.6
351.9
404.1
440.6
482.8
554.7
581.7
606.7
17.1
16.4
16.3
19.6
21.5
25.5
30.2
30.9
8.8
10.8
11.0
7.3
10.0
11.8
12.8
10.5
1.74
1.67
1.88
2.04
2.34
2.66
2.90
3.00
Debt Indicators
Gross external debt (US$bn)
Gross external debt (% of GDP)
Interest and exchange rates
Overnight interest rate (%, eop)
Exchange rate (BRL/US$, eop)
Exchange rate (BRL/US$, average)
Source: National Statistics, DB forecasts
Deutsche Bank Securities Inc.
Page 21
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Does India Need a Fiscal Stimulus?



The short answer is no. Ahead of the FY15/16
budget, to be presented at end-February, questions
have been raised in the policy circle about the need
for loosening the fiscal stance. Having experienced
sub-par growth and fiscal-monetary consolidation
in recent years, the view gaining traction is that the
economy
could
do
with
some
policy
accommodation. With inflation receding and global
growth environment stagnant, perhaps the time
has come for a pause in the deficit-reduction
strategy. Indeed, the argument goes, if growth
recovery will have to be predicated on a rebound in
public spending creating complementarities for the
private sector, the priority must be to boost plan (or
capital) spending expeditiously.
We think that there are many ways to revive India’s
growth momentum without having to resort to a
setback in fiscal consolidation. India’s revenue
ratios are poor by international comparison, public
sector debt burden is considerable, and the cost of
servicing that debt is very high. Deficit and debt
reduction efforts are essential in improving the
economy’s sovereign rating, enhance market
access, and free up room for public and private
spending in growth critical areas. Besides, having
embarked on a battle to arrest high inflation and
inflationary expectations, caution is warranted with
respect to adding fiscal impulse to the economy.
Moreover, what matters most is the quality of the
spending rather than the quantity; the envelope
available for capital spending in a typical budget
has historically been ample, but the allocations
have been seldom fully spent. What matters most
is focusing on high quality, high multiplier projects
as opposed to simply ramping up the rate of
spending. Finally, India’s experience with growth
and deficit shows clear dividend of fiscal
consolidation on economic performance, albeit
with a lag.
Instead of entertaining a fiscal stimulus, we think
the authorities should focus on a budget that
contains realistic assumptions, improves efficiency
of revenue collection, and focuses on high quality
spending. There is no trade-off between fiscal
discipline and growth at this juncture, in our view.
A fiscally prudent budget and investment friendly
structural measures would be complementary, and
lay the ground for long-term sustainable growth, in
our view.
The inappropriateness of fiscal stimulus
Ahead of the FY15/16 budget, to be presented at endFebruary, questions have been raised in the policy
circle about the need for loosening the fiscal stance.
Having experienced sub-par growth and fiscalmonetary consolidation in recent years, the view
gaining traction is that the economy could do with
some policy accommodation. With inflation receding
and global growth environment stagnant, perhaps the
time has come for a pause in the deficit-reduction
strategy. Indeed, the argument goes, if growth
recovery will have to be predicated on a rebound in
public spending creating complementarities for the
private sector, the priority must be to boost plan (or
capital) spending expeditiously.
We think that there are many ways to revive India’s
growth momentum without having to resort to a
setback in fiscal consolidation. Despite the fact the
government has been attempting to reduce the deficit
in recent years, and debt/GDP has eased primarily due
to high inflation, much remains to be done before the
fiscal position is in a comfortable positions. At the
onset, it is important to recognize that India’s fiscal
metrics are poor by emerging market standards.
Poor fiscal metrics
Deficit
We begin by examining India’s cyclically adjusted
general government fiscal deficit over the past decade,
plotted against the average to 29 EM economies as
well as 7 Asian economies. Note that the figures
presented in this analysis do not reflect the latest
revision to India’s national accounts. The ratios
presented here however are broadly unaffected due to
data revisions as they have mostly affected growth
rates, not the level of aggregate GDP.
India’s deficit is glaringly large in this comparison, with
the major setback from the oil shock of 2008 yet to be
corrected in a meaningful manner. The fact that despite
stringent efforts India’s cyclically adjusted balance is
still around 7% of potential GDP (about 500bps higher
on average than its peers) underscores the urgency of
continuing on the path of reforms.
Indeed, the windfall from the recent collapse in oil
prices will make it particularly easy to stay on the path
of consolidation, especially now that the government
has taken decisive steps to reduce energy subsidies
drastically.
Page 22
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
General Government Cyclically Adjusted Balance
% of potential
GDP
India
EM average
Asia
0
General Government Expenditure
% of GDP
India
35
EM average
Asia
30
-2
25
-4
20
15
-6
10
-8
5
-10
2006 2007 2008 2009 2010 2011 2012 2013 2014
Considering the heightened degree of uncertainty in
the global economic landscape, and the lesson from
2008 that global shocks can have major long lasting
impact on the fiscal situation, there is no room for
fiscal complacency, in our view.
General Government Revenue
India
2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: CEIC, IMF, Deutsche Bank
Source: CEIC, IMF, Deutsche Bank
% of GDP
35
0
EM average
Asia
30
25
Expenditures
While India lags its peers in tax collection, its spending
ratio is not at all behind at the general government
level. Just between subsidies and interest costs, the
public sector has spent over 6% of GDP in recent years,
which explains the high fiscal deficit. Given the alreadyhigh expenditure ratio, we don’t think the authorities
should push for further spending boost. Far more
preferable would be a re-composition of spending, with
cuts in poorly targeted and inefficient allocations and
increases in growth critical areas.
Debt
The consequence of the poor revenue and deficit
figures is high debt. Although debt/GDP ratio has come
down in recent years (thanks to high inflation and
financial repression that has largely kept real interest
rates negative), India’s general government debt is still
far higher than the EM average (see next chart).
20
15
10
5
0
2006 2007 2008 2009 2010 2011 2012 2013 2014
General Government Gross Debt
Source: CEIC, IMF, Deutsche Bank
% of GDP
2007
80
Revenues
The flipside of the poor fiscal deficit is poor revenue
and expenditure outturn. As the above charts show, on
the revenue side, India’s collections are substantially
less than its peers. Going forward, we understand that
the authorities are keen to provide some incentives to
investment through tax cuts, but there should be no
disagreement that on aggregate the economy is undertaxed. In order to boost spending on health, education,
and infrastructure, the authorities need to take decisive
measures to widen the tax net. There are hopes that
GST reform would begin to raise the revenue ratio, but
that is not likely for a number of years. In the interim,
the authorities need to consider enforcing compliance
and bring large parts of the services and agriculture
sectors in the tax net.
Deutsche Bank Securities Inc.
2014
70
60
50
40
30
20
10
0
India
EM average
Asia
Source: CEIC, IMF, Deutsche Bank
Page 23
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Servicing this high level of debt is very costly. India’s
central government spends nearly a quarter of its total
spending on servicing the large debt burden. Despite
the decline in the debt/GDP ratio in recent years,
interest spending has begun to rise again, both as a
share of GDP and a share of total spending. Indeed,
interest spending is bigger than any other line item in
India’s current expenditure (e.g. defense, subsidies,
health, and education) budget. Bringing this down
would create valuable space for other far more
important expenditures.
Capital spending has lagged budgeted target
considerably in recent years
plan spending
as % of GDP
Budget
Actual
5.0
4.5
4.0
Interest spending taking up a large chunk of the
3.5
budget
% of total spending, left
%
% of GDP
% of GDP, right
30
25
4.5
4.0
20
3.5
15
3.0
10
2.5
5
0
2.0
FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14
Source: CEIC, Deutsche Bank
Quality vs. quantity
It is also important to recognize that what matters most
is the quality of the spending rather than the quantity.
Recent budgets have routinely allocated close to 5% of
GDP in capital spending, a nontrivial amount by any
measure. But these generous allocations have not
materialized in a discernible pick up in the investment
cycle. Moreover, faced with fiscal pressure in recent
years, the authorities have resorted to holding back
plan spending toward the end o the fiscal year.
As the following chart shows, the challenge in recent
years has been chronic under-achievement on capital
spending. If the authorities aim at high quality, high
multiplier projects worth 4-5% of GDP as opposed to
simply ramping up the rate of spending, they will
handily achieve the goal of providing a boost to the
economy, in our view.
3.0
FY11/12
FY12/13
FY13/14
FY14/15*
Source: CEIC, Deutsche Bank. FY14/15 is DB estimate.
Dividend from consolidation
Finally, India’s experience with growth and deficit
shows clear dividend of fiscal consolidation on
economic performance, albeit with a lag. Below we
present the result of a reduced form vector-auto
regression model using annual GDP growth and fiscal
data from 1974 to present. The impulse response
generated by the model shows that a 1% of GDP
reduction in deficit leads to growth rising by 0.4%
within 2 years subsequent to the effort. Most
interestingly, the effect is persistent through the
simulation horizon, suggesting a lasting impact on
growth from fiscal consolidation.
Impulse response of growth to 1 std dev improvement
in fiscal deficit
Impulse
+2 std error
-2 std error
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
1
2
3
4
5
6
7
8
9
10
Source: CEIC, Deutsche Bank. Impulse response estimated by running a reduced form VAR of real
GDP growth and fiscal balance over 1974-2014, using annual data. 1 standard deviation of fiscal
deficit is 1.4% of GDP.
Page 24
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
With this discussion in the background, we think the
Indian government should not pursue a fiscal stimulus
in the forthcoming budget. Instead, we think the
authorities should focus on a budget that contains
realistic assumptions, improves efficiency of revenue
collection, and focuses on high quality spending. There
is no trade-off between fiscal discipline and growth at
this juncture, as per our analysis. A fiscally prudent
budget and investment friendly structural measures
would be complementary, and lay the ground for longterm sustainable growth, in our view.
Preparing for a rainy day
Also, it should be noted that India is much more
interlinked with the global economy today than it was a
decade back, and therefore global growth sentiment
and dynamic will also play a key role in shaping India’s
growth trajectory. Given that global growth will likely
be lower in the years ahead compared to its pre-2008
crisis average, it is also reasonable to expect India’s
growth trajectory to remain lower than the pre-2008
period, even after factoring in an optimistic recovery
scenario (and the latest revision to the national
accounts).
In this context, we think it is not advisable for the
Indian authorities to be too aggressive in trying to
stimulate the economy, especially through the fiscal
lever. As the government starts improving the
investment climate, and the rate cut transmission starts
feeding into the real economy, growth would
automatically accelerate, provided global conditions
remain broadly supportive. Such growth would be
sustainable and of good quality and will not carry with
it the risk of stroking macro imbalances in the economy.
India’s real GDP growth (old series) vs. world growth
% yoy
India, lhs
12
World, rhs
% yoy
6
10
5
8
4
6
3
4
2
2
1
0
0
1980
1985
1990
1995
2000
2005
2010
Source: CEIC, IMF, Deutsche Bank.
India’s real GDP growth (old series) vs. EM average
% yoy
12
India
EM
10
8
6
4
2
0
1980
1985
1990
1995
2000
2005
2010
Source: CEIC, IMF, Deutsche Bank.
Taimur Baig, Singapore, (65) 64 23 8681
Kaushik Das, Mumbai, (91) 22 7180 4909
Deutsche Bank Securities Inc.
Page 25
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Turkey Trip Notes: Is Heightened Volatility the New Normal?
We spent three days in Istanbul and Ankara in late
January, meeting with local banks, political analysts,
local journalists, former and current bureaucrats in
charge of economy management, and the Central Bank
of Turkey (CBT) during the release of its latest Inflation
Report. Turkey remains a country of contrasts and
impatience. Differing factions hold opposing visions for
the future, potentially a sign of growing polarization
within society. The CBT's hitherto credibility-building
attempts have been cut short due to intensified political
externality. Notwithstanding that most of the long
election cycle is behind us and the AKP is still the
dominant party, the political backdrop appears
marginally more uncertain than we had expected.
Back from our trip, we have four key takeaways:




Inflation appears set to decelerate visibly this year,
particularly in the first half, in line with the CBT's
updated projections, on the back of lower energy
prices, favorable base effects, dwindling impact of
earlier FX pass-through, and expected meanreversion in food prices.
Governor
Basci’s
conditional
commitment
regarding holding an interim MPC meeting in early
February, in our view, is a reflection of intensified
political externality ahead of the June general
elections. With the decline in annual CPI remaining
(just) shy of the 1pp threshold set by Governor
Basci, the Committee in the end opted to convene
at the pre-specified date (February 24). This
resulted in what we consider an undue sell-off in
Turkish markets, with the lira reaching its all-time
high against the USD. The events that unfolded in
early February could well be a precursor of what
lies ahead: heightened market volatility due to
ongoing political externality and distorted policy
signals from the CBT.
There seems to be a consensus view that Turkey
credit will fare comfortably in 2015. With the ECB
and oil winds in its sail, the current account deficit
is likely to improve. Locals have differing views on
the growth impact of low oil prices, yet better real
GDP growth than in 2014 appears unanimously
expected.
On the political side, the AKP looks set for another
victory, hovering around 45% in the latest polls.
Pro-Kurdish HDP appears determined to contest in
the elections as a single party, and if successful,
could become ‘king-maker’ in the new Parliament.
Local political analysts noted the high likelihood of
a change in the economy management following
the June elections with Ministers Numan
Kurtulmus and Nihat Zeybekci referenced as
potentially taking the helm.
Page 26
In the rest of this note, we present additional
observations on the CBT's Inflation Report, the
Treasury’s 2015 financing program and domestic
politics.
CBT: Political externality distorts the Bank’s policy
signaling
In its first Inflation Report of the year, the CBT lowered
its end-2015 CPI forecast by 0.6pp to 5.5%YoY on the
back of lower oil prices and a slightly larger negative
output gap. The new trajectory foresees inflation
decelerating quickly in the first half of the year and
touching the 5% target in early Q3 before edging up
slightly through year-end. On the policy front, the Bank
indicated that it remains committed to keeping the
yield curve flat using its liquidity tools and signals a
cautious approach in responding to ongoing
disinflation.
Governor Basci's remarks in the Q&A session seemed
at times somewhat at odds with the more cautious
stance signaled in the report. He suggested that
CBT shifted down its CPI projections
10
YoY%
10
Actual
YoY%
9
9
8
7
8
July
2014
6
October
2014
7
January
2015
6
5
4
14Q1
5
CBT target
14Q3
15Q1
4
15Q3
16Q1
16Q3
Source: CBT and Deutsche Bank
depending on the January CPI outcome, the Committee
could convene in early February, versus the scheduled
MPC meeting on February 24. In his own words, the
threshold triggering an extraordinary meeting could be
another large drop – to the tune of 1pp – in annual
headline CPI (DBe: 7.0%YoY after 8.2% in December),
to which the Committee would respond by lowering
policy rates systematically. Basci also signaled
potential further easing by saying that the Bank had
been keeping the one-week repo rate close to the
inflation rate and could adjust the policy rate going
forward in tandem with the decline in inflation by
providing only a marginally positive ex-post real policy
rate.
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
CBT’s new underlying assumptions
J an - 15
Oct - 14
J u l - 14
A p r- 14
Ou t p u t Gap
(%)
Q4 13
Q1 14
Q2 14
Q3 14
Q4 14
- 1.60
- 1.55
-1.50
- 1.50
- 1.50
-1.40
-1.30
-1.30
-
-1.50
-1.40
-1.30
-
Food P ri ces
(End-year % Chg.)
2014
2015
2016
2017
9.0
8.0
8.0
12.5
9.0
8.0
8.0
9.0
8.0
8.0
-
9.0
8.0
8.0
-
Imp ort P ri ces
(USD, A vg. A nnual % Chg.)
2014
-
-2.7
-1.8
0.5
2015
- 7.3
- 3.3
-0.3
0.1
2016
4.5
-
-
-
Oi l P ri ces
(A verage, USD)
2014
2015
2016
55
64
102
92
-
108
106
-
106
102
-
E x p ort - wei g h t ed Gl ob al P rod .
In d ex (A vg. A nnual % Chg.)
2014
2015
1.9
2.0
1.9
2.4
2.0
2.6
2.3
2.6
Source: CBT and Deutsche Bank
index (6.3%) also remained well above the 5% inflation
target. We suspect this unexpected deterioration seen
in (the momentum of) core inflation was the main
reason behind the CBT’s decision to not hold an
emergency meeting this week.
A borderline drop in January CPI, core worsens
momentum-wise
17.5
%
Core Index: H (SA, 3mma, annualized)
Core Index: I (SA, 3mma, annualized)
Headline CPI (NSA)
15.0
12.5
10.0
7.5
5.0
2.5
The second important remark was the possibility of
letting interbank O/N repo rates go up to the late
liquidity lending rate, which currently stands at 12.75%
via tighter liquidity if need be. As a reminder: apart
from the one-week policy rate, there are currently three
other ways for banks to directly fund themselves
overnight from the CBT. First, there is a preferential
rate at 10.75% for primary dealers. Second is the
marginal funding rate (or the upper bound of the
corridor) at 11.25% open to all banks. And third, there
is the late liquidity window where banks can obtain
funding between 16:00-17:00pm if they are unable to
get it from the market during the day. So while the late
liquidity window is normally a last-resort facility, it now
seems plausible to expect that the Bank could use it as
a second and higher upper bound if there is need to
contain (very) excessive pressure on the currency.
We think such fine-tuning in liquidity strategy is likely a
precursor to cut(s) in the upper bound. Also, it is an
indication that the CBT is concerned about the impact
of easing on the lira, particularly given the ongoing offmarket FX sales to BOTAS (USD1.2bn in January after
USD1.5bn previously) via the Treasury. This backdrop
further convinces us that the shift in the CBT's rhetoric
just a week after the January MPC meeting is mostly
due to intensified political externality ahead of the June
general elections.
CBT 's inflation
target
Uncertainty
band
0.0
Jan-11
Aug-11
Mar-12
Oct-12
May-13
Dec-13
Jul-14
Source: Haver Analytics, CBT, and Deutsche Bank
Going forward, the CBT will likely keep liquidity
conditions tight and the yield curve flat to fend off
excessive weakness and volatility in the lira. We
maintain our call for 75bps of easing during the first
half of 2015, yet now think that it will come through
mostly from the upper bound with other policy rates
(including one-week repo) remaining on hold. It is true
that Governor Basci signaled the MPC could lower the
one-week repo rate in tandem with the decline in the
CPI. However, we are not fully convinced that market
conditions at the moment and ahead, particularly the
lira’s trajectory, will be conducive for an accelerated,
large, and comprehensive rate-cutting cycle. We think
any undue easing triggered by intensified political
externality may need to be recouped quickly later in the
Renewed FX pass-through ahead?
4.0
3.5
p.p.
YoY%
FX pass-through to annual headline CPI
Basket/TRY (RHS)
35
30
25
3.0
20
2.5
In the end, January CPI decelerated only to 7.24%YoY
from 8.17% previously, 7bps shy of the 1pp threshold
specified by Governor Basci. As such, immediately
after the CPI release, the Central Bank of Turkey (CBT)
published a brief statement on its website and declared
that there will be no interim meeting and the MPC will
convene at the pre-specified date to assess the inflation
outlook in detail. There was no major surprise in the
breakdown of January CPI. However, I index – one of
the CBT’s favorites – jumped acutely to 6.2% (in
annualized seasonally adjusted terms) from 5.3%. H
Deutsche Bank Securities Inc.
Simulated
path if basket
remains at 2.6
in H1-15
2.0
1.5
10
5
1.0
0.5
Jan-13 May-13 Sep-13
15
0
-5
Jan-14 May-14 Sep-14
Jan-15 May-15
Source: Haver Analytics, CBT, and Deutsche Bank
Page 27
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
year – depending on market conditions. Another factor
we will be monitoring closely in the near term is
renewed FX pass-through, a possibility already signaled
by the slight worsening in seasonally adjusted core
indicators in January.
Exports to oil-producing countries continue to soften
80
12m cum, YoY%
% share
in total
60
30
40
Turkey credit should fare comfortably in 2015
There appears to be a consensus view that Turkey
credit will perform comfortably over the course of 2015.
With the ECB and oil winds in its sail, the current
account deficit is likely to improve, capping upside risk
on the USD/TRY. Locals expressed different views on
the growth impact of low oil prices, but a better print
than in 2014 seems unanimously expected. Some see it
reaching above 4.5%YoY with the Brent averaging
around USD50/bbl, while others are less optimistic,
pointing to second-round effects via subdued exports
to oil-producing countries (accounting for c27% of total
exports).
Growth is likely to pick up in 2015 despite limited
positive carry-over
33.1
DB Forecast
TRYbn
32.8
32.5
35
20
25
0
-20
20
-40
-60
Jan-08
15
Apr-09
Jul-10
Oct-11
Jan-13
Apr-14
Oil-producing countries
Russia
Iraq
Oil-producing countries (% share in total, RHS)
Source: Haver Analytics and Deutsche Bank
The Treasury appears comfortable with its 2015
borrowing target (TRY99.7bn) and its achievability. The
main strategy is to borrow mostly in TRY using fixed
rate instruments, and to lower the share of debt with a
rate re-fixing period of less than 12 months. The team
does not expect a change in the program at least until
the June elections.
As regards external financing, the Treasury aims to tap
the markets for around USD4.5bn in total this year.
USD1.5bn was raised in January, with the rest to be
issued in several tranches and in diversified ways (i.e.
in EUR, JPY and lease certificates), depending on
market conditions.
32.2
31.9
31.6
31.3
31.0
14Q1
14Q2
14Q3
14Q4
15Q1
15Q2
15Q3
15Q4
Seasonally adjusted quarterly real GDP
Average annual real GDP
Real GDP in Q414
Source: Haver Analytics and Deutsche Bank
Our partial equilibrium regression suggests an average
10% drop in oil prices leads to a ~0.3pp rise in headline
GDP growth. That said, when the adverse secondround impact is taken into account, the net impact
seems (much) lower. In any case, given the possibility
of a larger monetary and fiscal stimulus ahead of the
June general elections, the improvement in the
economy activity could be more than expected.
On the inflation front, like the CBT, we expect a visible
drop in inflation close to the 5% target in the first half
2015, yet we still believe rapid deterioration is possible
in Q4 due to unfavorable base effects – and renewed
FX pass- through from potential sustained TRY
weakness.
Page 28
2015: Treasury debt service and financing program
Domestic debt service
Market
Public (non-comp. Sales)
External debt service
Eurobond
Other
Total debt service (TRYbn)
P ri n ci p al
67.0
59.1
7.9
12.1
6.2
5.9
79.0
In t erest
40.3
32.8
7.5
9.5
7.9
1.5
49.8
Tot al
107.3
91.9
15.4
21.6
14.1
7.4
128.8
Financing
Total borrow ing
Domestic
External
Non-borrow ing sources (*)
Total financing (TRYbn)
99.8
88.0
11.8
29.1
128.9
Notes: Total domestic roll-over ratio for 2015 is estimated at 82%. (*) Includes cash primary
balance, privatization revenues, the revenues from 2-B land sales, receipt from SDIF, etc.
Source: Under secretariat of Treasury and Deutsche Bank
The fiscal side overall continues to appear strong
relative to the EM peers. An upside surprise in the
central budget deficit (1.1% of GDP penciled in for
2015 after a better-than-expected 1.2% last year) is in
the cards due to the CBT dividend (transfer) and higher
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
net revenues from the minimum wage increase (6% in
each half of the year). The impact of declining oil prices
on the budget is mostly neutral as lower transfers to
BOTAS compensate for the reduced revenues from the
special consumption tax on energy products and the
VAT on imports of oil and gas. The roll-over rate this
year could be lower than the 82% mentioned in the
program, on a conservative assumption for
privatization revenues (TRY7.8bn) compared to the
Medium Term Program (TRY11.8bn).
Another factor that markets also care about is whether
Deputy Minister Ali Babacan, responsible for economic
management, and Finance Minister Mehmet Simsek
Latest polls still point to another AKP victory
2014 local elections (% of the popular vote)
60
2014 Presidential elections
AKP: 51.8%
CHP+MHP: 38.4%
HDP: 9.8%
50
40
Fiscal balances are no longer Turkey’s Achilles heel
3
45
Current range of support for
parties based on various poll
results **
30
20
10% election threshold
10
2
42
1
0
0
39
-1
36
-2
Fiscal balance (LHS)
Primary balance (LHS)
Cent Govt Debt (% of GDP)
-3
30
11
12
13
14E
15F
CHP
MHP
HDP*
SP
BBP
Others
Notes: (*) Combined results for HDP and BDP in 2014 local elections. (**) Based on 6 published
poll results in January. Undecided voters are distributed according to the leaning by polling
companies.
Source: SONAR, ORC, MAK, Gezici, Pollmark, Metropoll, Supreme Electoral Council, and
Deutsche Bank
33
-4
10
AKP
16F
Source: Haver Analytics and Deutsche Bank
There is an open-ended agreement between BOTAS,
the Treasury and the CBT for off-market FX purchasing
of BOTAS. It was around USD1.2bn in January and is
expected to get lower in the coming months. The
Treasury acts only as an intermediary between the CBT
and BOTAS. Separately, we believe the level of
Treasury guarantee for the external debt of local
administrations and SOEs remains manageable at
USD1.8bn.
remain in the cabinet after the elections. While Minister
Babacan had been expected to hold a coordinating role
after June, several local analysts noted that the
likelihood of a major change in the economy
management team following the elections now seems
much higher, with current Ministers Numan Kurtulmus
and Nihat Zeybekci referenced as potentially taking the
helm.
Current seat allocation in the GNAT
Seat allocation in the Parliament (# of seats)
400
350
300
250
Domestic politics: 2 things to watch
Prima facie, the ruling AKP looks set for another victory,
hovering around 45% in the latest polls. Local political
analysts claim that the party aims to bag at least threefifths of the seats (330) available in the Parliament,
which is needed to take the planned constitutional
changes – for creating an Executive Presidency – to
referendum.
The main unknown stems from the pro-Kurdish HDP’s
decision to contest in the elections as a single party
rather than running with independent candidates. In its
recent formal communiqué, the Supreme Electoral
Board also included the HDP among the eligible
political parties to run in the Parliamentary elections, so
there is no legal obstacle for the party to field
candidates. If the party successfully exceeds the 10%
threshold – as potentially signaled by a few of the polls
– local journalists estimate that it could become ‘kingmaker’ in the new Parliament with 55 to 72 seats.
Deutsche Bank Securities Inc.
200
150
100
50
0
AKP
CHP
MHP
Indep.
HDP
Others
2011 Parliamentary elections
Current
Absolute majority (50%+1)
3/5 majority (constitution changes via referendum)
2/3 majority (outright constitution changes)
Source: Supreme Electoral Board (YSK), The Grand National Assembly of Turkey, and Deutsche
Bank
Kubilay M. Öztürk, London, +44 207 545 8774
Page 29
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
South Africa Trip Notes: Cheap Oil But Not Enough Energy

We spent a couple of days last week in South
Africa with investors, meeting with the South
African Reserve Bank, the Chamber of Mines,
Eskom and other economic and political
commentators. Despite the worsening electricity
crisis, the mood among fixed income investors at
least was relatively upbeat. We attribute this to a
combination of the external backdrop (cheap oil
and falling inflation) and orthodox monetary policy
in South Africa. This positive sentiment was
tempered somewhat by the strong US payrolls
number released at the end of our trip.
Nevertheless, in a world where negative yields are
becoming increasingly common, the high real
yields on offer in South Africa would continue to
attract interest.

Overall, South Africa is catching the same wave
that has supported other oil-importing EMs over
the past few weeks. Low oil prices are providing
significant relief on inflation (set to dip below 4%)
and the current account deficit (likely to narrow to
below 5% of GDP). Growth and the fiscal balances
may also benefit though by how much is less clear.

Scope for positive surprises may be kept in check
by energy constraints, which was another theme
on the trip. Risks to growth from supply constraints
are unlikely to lift over the next two to three years
or at least until the first three units of the large new
Medupi and Kusile power plants come on line.
Most felt that poor supply would thus offset the
benefit of lower oil prices.

From a policy perspective, the SARB will not be
quick to cut rates, providing support for the rand.
In addition, locals feel that the need to aggressively
adjust tax policy this year may have lessened due
to lower oil prices and weaker growth. With the
new Finance Minister also quickly establishing his
credibility by delivering a tight mid-year budget
statement last October, there are plenty of reasons
to like long end bonds. For once, locals seem to be
similarly minded.

Wage negotiations in the public sector will be
critical, not only in setting the tone for the gold
sector’s negotiation later this year, but also for the
SARB who will be closely monitoring the extent of
price rigidity going forward. The sense is that
employers, and government, may be able to take
advantage of lower inflation this year to manage
labour costs more carefully this year. However, for
the mining sector, in particular, where inflation
rates for the average worker are arguably higher
than the national average, employers will have to
be more cautious if labour unrest is to be avoided.
Page 30

Beyond low oil prices, however, the underlying
fundamentals remain challenging. In addition to
electricity constraints, union rivalry has become a
key concern for business and the public sector.
Poor confidence will thus weigh on capacityenhancing investment spending and job prospects
may remain weak. Meanwhile, there has been a
recent uptick in the number of individuals living
below the poverty line. These factors will make
next year’s municipal elections challenging for
the ANC, especially in light of increasing voter
apathy.
Oil relief welcomed given electricity
supply constraints
Growth to settle at or below potential of 2-2.5%
Economic growth near 2% this year was the general
view in meetings that we attended. Though slightly
better than the 1.4% last year, when strikes shaved
around 1% from growth, it was unclear how much
relief lower oil prices will bring given the negative cost
pressures associated with reduced electricity supply.
Overall, poor electricity conditions will be a
considerable constraint on the economy, which quite
literally does not have enough power to grow by more
than 3% (a significant consideration in SARB thinking).
Be that as it may, lower inflation (set to reach as low as
3.5% in Q2), household savings arising from lower oil
prices and reduced input costs from the decline in
other energy costs (including coal) would provide some
support for the economy.
It would take 5 years to restore electricity capacity to
80%
The power situation has deteriorated markedly in the
last six months as years of mismanagement (and lack
of maintenance) have pushed the system to breaking
point while new electricity generating capacity has
been further delayed. The first unit of Medupi will only
generate power in the second half of this year, while
the first unit of Kusile has been delayed by two years to
2H17. Over the next two years, around 1000MW are
likely to come on-stream as private sector renewable
energy projects come into full service, which will help
to reduce the need to run the open cycle gas turbines
(OCGTs), which rely heavily on costly diesel fuel. Thus,
power shortages are going to remain the norm for at
least another two to three years. But it may take the
power utility up to five years to complete the
maintenance backlog, which will help to restore
available energy capacity from the current 75% to 80%
- this compares to the international standard of 85%.
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Figure 1: Available capacity (as at September 2014),
Figure 2: Remuneration per worker has been easing
but since then conditions deteriorated significantly
since 2013
86
%
%
82
78
By year-end
the EAF fell to
68%
74
30 % yoy growth
12
25
10
20
8
15
6
10
4
5
2
0
0
-5
Mar-18
Mar-17
Mar-16
Mar-15
Mar-14
Mar-13
Mar-12
Mar-11
Mar-10
Mar-09
70
14
Public
sector
strikes
-10
2006 2007 2008 2009 2010 2011 2012 2013 2014
Energy availability (LHS)
Unplanned capacity loss factor
Public sector*
Private sector
Source: Eskom
*Public sector excluding parastatals, and including private sector NGOs/ Source: Deutsche Bank,
StatsSA
And electricity tariffs will likely accelerate further.
While Eskom will receive a R20bn cash injection from
government to fund its R200bn funding gap this year,
cash flow would remain constrained. Aside from
raising funds through bond issuances, DFI’s and other
vehicles, there are two alternative options to raise
tariffs: 1) reopening the Multi-Year Price Determination
(MYPD3) process – in which Eskom was granted 8%
tariff increases over a five-year period up to 2017/18
and 2) applying to the regulator to access funds from
the regulatory clearing account (RCA)2, which allows
Eskom to adjust tariffs in addition to the 8% already
granted. Through the RCA mechanism Eskom has
claimed an additional 5% for this year and is yet to
apply for the 2014/15 increase which could possibly be
awarded next year. However, owing to a significant
escalation in diesel requirements alongside significantly
reduced electricity sales, there could be much heftier
price escalations in store next year. Claiming through
the RCA will probably become norm going forward,
due to the public, political, regulatory and
administrative burden involved in reopening the
MYPD3. This is not ideal from a planning perspective,
but for now this should allow credit rating agencies to
give Eskom the benefit of the doubt.
As it stands, nominal remuneration per worker has
been moderating over the last few years (Figure above).
Ratings agencies will monitor the settlement closely
given promises in the mini-budget last year to cap
public sector employment while sticking to inflationrelated wage increases. Assumptions in the mid-term
budget of 6.6% for employee compensation reflected
increases of no more than 1% over inflation (which
forecast at 5.9% for 2015).
Union rivalry could upset peaceful negotiations
For the gold and coal sectors their existing two-year
wage deal will end in June this year. Gold mines are
bracing for tough negotiations as unrealistic
expectations may have built up from the perceived
success of the platinum sector’s settlement last year.
Moreover, union rivalry between the National Union of
Mineworkers (NUM) and the militant AMCU (short for
Association of Mineworkers and Construction Union)
could be destabilizing. Unlike the public sector, the
Chamber of Mines, who negotiates on behalf of the
gold mines, may find it more difficult to get away with
settlements 1% above CPI this year.
Figure 3: Union representation in the gold sector –
AMCU gaining territory
Public sector wage negotiations to set the tone for this
year’s wage round
Public sector wage negotiations could go either way.
Most think National Treasury will ultimately be able to
secure a sensible agreement (to take effect in April),
especially given lower inflation this year. But the risk of
a damaging strike and/or a high settlement cannot be
discounted given the role that the public sector unions
have played in supporting President Zuma, for which
they will likely want to be compensated.
70
60
50
40
30
20
10
0
NUM
AMCU
Dec-14
UASA
Solidarity No union
Sep-13
2
The RCA is a mechanism that reconciles the variance between projected
and actual revenue and certain costs, as the price determination is initially
based on projections and assumptions.
Deutsche Bank Securities Inc.
Source: Chamber of Mines
Page 31
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
While strike activity cannot be ruled out, there are
several structures in place within the gold sector’s
centralized collective bargaining framework that should
prevent lengthy industrial action. This contrasts
strongly with the platinum sector where negotiations
occur at a company level and where ‘the winner takes
all’ principal have led to significant member poaching
amongst unions. Discussions to build a central
collective bargaining structure for the platinum sector
are progressing well, which means negotiations could
be a little more conciliatory next year. But, whether
negotiations will be peaceful in the gold sector this
year will depend on whether AMCU’s membership
has increased significantly from the 25% share it was
in December last year.
Policy likely to remain unchanged
SARB likely to remain conservative over the cycle
The SARB were, as ever, cautious and continue to be
guided by the orthodox inflation targeting playbook.
They were unperturbed last January when many
accused them of being woefully behind the curve in
hiking. Likewise, they are unlikely to over react to the
fact that other central banks have been quick to cut on
the back of cheap oil. They would look through the
drop in headline inflation to 3.8% and focus instead on
the core rate (which will fall to 5.1% next year from
5.5%) and inflation expectations. Neither seems likely
to fall rapidly enough to justify near-term rate cuts,
with retailers, for example, likely to use the opportunity
to rebuild margins. Inflation expectations by pricesetters, i.e. unions and business, will likely be
scrutinized ever so closely. But as illustrated below,
their price expectations have seldom dipped below the
target ceiling, barring 2003-2007 during exchange rate
appreciation.
Figure 4: Inflation expectations have been sticky to the
downside
14
A sustained rebound in the rand could change this
equation (i.e. a continuation of the recent appreciation
in the trade weighted index). But the SARB remain
concerned about Fed rate hikes, which they think
would almost inevitably hit the rand and local bonds.
Moreover, the issues they grapple with relate to the
structural nature of electricity restrictions, which would
cap potential economic growth (c. 2.0-2.5%). Since the
widening of the output gap is supply driven, and not
reflective of slack in the economy, it is not clear
whether this could translate to cost push pressures
down the line. Any downside movement in core
inflation, or inflation expectations, would have to be
sustained for the Bank to shift its view.
Fiscal policy consolidation on track
The prevailing sense among many market participants
is that Minister Nene does not need to do much in the
budget later this month other than stick to the
consolidation plan outlined last October. This involved
a cumulative R25bn cut in the nominal spending
ceilings over the next two years while tax and other
administrative measures would improve revenue by
R44bn over the next three years. Treasury need to raise
R12bn in the 2015/16 fiscal year to keep its
consolidation on track.
We sense that this target will be comfortably met by a
combination of more effective tax compliance activities,
bracket creep, and potentially larger adjustments to the
fuel levy. Lower inflation means that tax thresholds
could be adjusted by less than the increase in nominal
wages (c. 8% last year), thus automatically raising the
effective tax burden on consumers. Rating agencies
would like to see tax hikes, which in practice would
mean a VAT increase to raise any meaningful revenue,
but even they will probably allow the Finance Minister
to take a pass on that this time around.
Figure 5: GDP deflator should improve given rise in
terms of trade
15
yoy %
12
10
10
8
5
6
0
4
-5
2
0
2000
2003
2006
2009
Spread in inflation expectations
2012
2015
Inflation
* Inflation expectations range between financial analysts on the low end and business and trade
unions at the high end. Source: Deutsche Bank, BER
Page 32
-10
2004
2006
2008
Terms of trade
2010
2012
2014
GDP-GDE deflator
Source: Deutsche Bank, SARB
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Fiscal revenue could benefit from lower oil environment.
Firstly, VAT revenues could be lifted by higher
consumer demand, even if some of the benefit goes
toward debt repayment. Secondly, terms of trade gains
should bolster tax receipts as corporate margins
improve - even though export commodity prices have
been weak, they are still holding up well relative to oil
prices. Finally, from a top-down perspective, positive
terms of trade growth should lift the GDP deflator, thus
leading to a higher nominal GDP growth rate, all else
being equal (Figure above). At current price levels, the
GDP deflator should exceed domestic inflation by at
between 1.5% and 2.5%, much higher than the 0.1%
embedded in October’s mid-term budget forecasts.
Maintaining the same revenue elasticity for an increase
in nominal growth would conservatively lead additional
revenue of R10bn - R20bn.
In sum, we note policy will thus remain neutral to
slightly restrictive, which is good for the exchange rate.
But, there has been little obvious progress on structural
reforms which may prevent significant appreciation in
the short-term. In recent weeks it emerged that a
higher proportion of individuals are now falling below
the poverty line than previously estimated. This is partly
related to a higher incidence of individuals remaining in
long-term unemployment with 37.4% of unemployed
searching for work for more than five years in 2014 vs
22.8% in 2008. In turn, the momentum that has been
building behind some modest changes to labour law
(e.g. compulsory strike ballots) has faded. If anything,
further backward steps (e.g. the introduction of a
national minimum wages) are more likely.
Danelee Masia, South Africa, 27 11 775 7267
Robert Burgess, London, 44 20 7547 1930
Deutsche Bank Securities Inc.
Page 33
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Asia Strategy

It is tough to get excited about the EM construct in
the current disinflationary environment, and indeed
in a backdrop where the tail is fattening around an
otherwise benign view of global macro. That said,
given the continued uncertainty about shape and
pace of Fed lift off, and the forthcoming balance
sheet expansion by the Europeans, there remains a
bid for ‘better quality’ EM. And most of Asia, like
we have argued before, fits the bill nicely. Policy
credibility has improved significantly; valuations are
less punitive, and external imbalances have
benefited (mostly) from lower oil prices. The
political environment too is mostly benign, though
arguably, there is increased focus on whether the
honeymoon period in both India and Indonesia is
gradually coming to an end. With commodity
disinflation in tow, Asian central banks should get
more positively inclined towards easing monetary
conditions, at least till such time as the Fed starts to
normalize rates. Indeed, in addition to overt easing
(in places like China, India and Singapore), central
banks have also stepped up their pace of dollar
buying to keep their currencies competitive.
Adjusting for valuation changes, we estimate that
Asia (ex-China) added close to $32bn to their spot
reserves in the month of January, versus $23bn in
all of Q4.

The best long USD plays in Asia are, in our opinion,
SGD, TWD, MYR and THB, in order of preference.
We are happy to be long INR and IDR, funded out
of regional low yielders like SGD. And we like
owning USD/CNH call spreads to capture what we
believe should be increasingly market driven PBoC
currency policy. We continue to like the bond
stories in China, India, Indonesia and Thailand. And
we are short rates in Malaysia (5Y) and Korea (1Y1Y,
tactically) to hedge an overall overlent bias to our
rates portfolio.

In external market, we are turning tactically Neutral
on Asia sovereign credit following a strong
outperformance vs. corporates YTD and the
expectation of more modest returns in the
immediate future in the wake of rising UST yields.
Relative stabilisation of Brent oil price puts
Malaysia CDS in the spotlight, but we refrain from
selling it for now as expect quite weak BOP data.
Below consensus macro data from China of late
warrants closing our Sell call on its 5YCDS. We
continue to see value in long-end Pertamina vs.
Indo sovereign and believe there is ~2pts of upside
remains in MONGOL bonds (Buy). PHILI spread
cash curve has turned even more bell-shaped due
to strong Asian demand for the front end. We
believe that it makes sense to sell 5Y basis via CDS
and 2021s.
Page 34
Local Markets
CHINA
—
FX: Long USD/CNH 6.30/6.50 call spread
—
Rates: Overweight duration
Policy accommodation to drive lower rates. With
disappointing January PMI and lower than expected
January inflation reading, it is only a matter of time, we
feel, before PBoC pulls the trigger on further monetary
policy easing. The risk of RMB liquidity tightening due
to capital outflows requires medium term liquidity
injection to stabilize base money supply growth, and the
lack of alternative medium to longer term liquidity tools
leaves PBoC with only one effective policy choice system wide RRR cuts. Over the past couple of weeks,
the resumption of reverse repo operations in the open
market, the RRR cuts and Wednesday’s SLF expansion
indicate clearly that PBoC is keen to use a combination
of policy tools to address any liquidity risk, which is key
to efficient monetary policy transmission. We think (a)
Money market rates should fall. Liquidity pressure
ahead of the Chinese New Year should ease and
liquidity smoothing operation should continue. We
expect the average overnight and 7D repo rates to fall
by roughly 20bp following the cut and we reiterate our
view that the 7D repo rate to average at the 2.75%-3%
range later this year. (b) Long bonds position remains
attractive. The RRR cut and SLF program expansion
supports our long cash bonds view. We reiterate our
expectation for 10Y CGB to test 3.2% later this year. (c)
IRS/NDIRS curve still seems rich. We think the heavy
overlent positioning on the swap curve and the sizable
negative carry makes it less appealing to add at current
levels. We are biased to trade the curve from the long
side, but only opportunistically. (d) Curve risk is biased
towards steepening, with falling money market rates. In
particular the market will likely price in more aggressive
policy easing soon given the timing of this cut came as
a surprise to us and the market. DB Economics is
calling for two cuts to happen in March and Q2, instead
of Q2 and Q3 (see China: A RRR cut by PBoC likely
driven by the fiscal slide, Feb 4th). (e) Top-rated onshore
credit bonds will outperform. While improving liquidity
should drive the overall credit market to rally, we hold
our view that credit differentiation remains one of the
main themes this year considering growth momentum
is likely to weaken and credit event risks are elevated.
(f) CNH CCS rates will be volatile. CNH CCS curve
behavior depends on the following factors: (1) onshore
liquidity easing tends to ease offshore CNH liquidity
pressure because narrowing onshore and offshore
interest rate basis will weaken the demand for RMB
remittance to the onshore market for interest
rate/financing arbitrage purposes; (2) liquidity easing is
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
likely to reinforce the market expectation for further
RMB deprecation against the USD, and further offshore
selling of RMB and RMB assets will tend to shrink the
offshore RMB liquidity pool in the near term, pushing up
the front end of the CCS curve; (3) the balance of
onshore offshore equity flow under the Stock Connect
suggests net RMB remittance under the Northbound
trading (by over RMB70bn). The widening A-H premium
means there is likely more investment flows under the
Southbound trading, which supplies offshore RMB
liquidity; (4) corporate liability hedging demand will pull
down the CCS curve (2Y+). Anecdotal evidence
suggests a pickup of liability hedging demand as
corporates started financing in the offshore RMB bonds.
While we think the 3Y CCS rates are excessively high
(around 3.7%), we feel volatilities of USDCNH spot and
forward market in the near term is likely to keep the
balances of RMB cross border flows and the CCS curve
relatively volatile. We will re-consider receiving outright
3Y CNH CCS rate at better levels.
HONG KONG
—
FX: Neutral
—
Rates: Marketweight duration
Peg remains intact. The surprising move by SNB
demonstrated that monetary policy is becoming
increasingly unpredictable and raised market concerns
that the HKD peg could change, too. While the peg has
raised a number of concerns over the years, we believe
it remains the best option for Hong Kong. We continue
to expect the HKMA to maintain the integrity of the
HKD peg and to do all it needs to in order to keep the
system intact. Why? First, there is no suitable
alternative. One of the long held arguments in favour
for HKD de-peg is that the Hong Kong economy is
becoming increasingly more correlated to China. This is
evident by the rising cross-border flows between the
two economies. In 2014, cross-border trade accounted
for just over 50% of HK’s total merchandise trade. CNH
liquidity in Hong Kong has also grown notably, as
shown in the ongoing rise in RMB deposits as a % of
total deposits. However, RMB is still not a viable
alternative until it becomes fully convertible. This
message was also echoed by the HK Financial
Secretary John Tsang in the Financial Secretary Office
blog stating that Hong Kong is still a small open
economy, and currency stability via the USD peg
remains essential. In addition, if HKD was re-pegged to
RMB, Hong Kong will be ‘importing’ China’s monetary
policy, which could significantly disrupt Hong Kong’s
economy, which is holding up well as of now. Second,
FX reserves accumulation is not a concern in Hong
Kong, unlike in Switzerland. Since the introduction of
the EUR/CHF peg, Switzerland‘s reserves doubled and
the accumulation of foreign assets was becoming
politically unpopular, particularly since SNB was buying
a sizeable amount of European assets. For Hong Kong,
Deutsche Bank Securities Inc.
however, this is not the case. Reserve accumulation by
HKMA has been (1) gradual (5-6% per annum) and (2)
seen as policy success given Hong Kong’s economy is
still growing well and part of that success has been due
to the existence of the peg.
INDIA
—
FX: Short SGD/INR, target 44
—
Rates: Long 10Y IGBs, target 7.2%. Pay 1Y/5Y
NDOIS steepener, target -20bp.
Let’s stay focused. There has been no dearth of
distractions lately to the India fixed income story. First,
RBI disappointed many (including us) by not following
through with a rate cut at its scheduled policy meeting
in February, even though all enabling factors seemed to
have been still in place. Next, the revisions to the India
GDP data has left the market confused about both how
to reconcile the same with other signs that the
economy continues to struggle, as well as implications
for further fiscal and monetary accommodation. And
finally, the first major loss for PM Modi’s party in the
elections for Delhi state assembly have raised concerns
of the government’s continued commitment towards its
reformist economic agenda, and in particular, fiscal
consolidation. It has been tough for markets to stay
focused through all of this, though note still that INR is
the best performing EM currency year to date, and has
received inflows of close to $7bn in its equity and fixed
income markets in the first 6 weeks of the year. Indeed,
in our recent investor meetings in the US, we were
struck by how everyone either owns or wants India.
RBI’s inaction in February was a surprise, but equally
there was nothing in the statement to suggest that they
are either re-thinking or deviating from their easing bias.
The GDP revisions we think should have little immediate
bearing on policy, though probably more relevant to the
debate around whether the central bank will be inclined
to take policy rates to below 7% in this cycle. As for the
political developments, we think it’s important not to
overanalyze
the
implications,
or
simplistically
extrapolate this episode to a sentiment swing across
the country. The Budget end of this month will be the
first, and important, signal for whether the
government’s agenda has got impacted in any
significant manner by this political development. It will
also be seen as an important benchmark by global
investors for whether the Modi government is ready for
a more substantive lift off on its reform program. Key is
to stay focused. We are convinced that India rates story
has more room to play out, though mostly in cash
bonds. The ND-OIS curve, we have been arguing for a
while, has got over extended on a technical basis. We
are biased to think the curve will steepen there. The
currency still offers a good carry-vol proposition, though
ultimately RBI’s willingness to let the currency
appreciate will be tied in closely to its success in
breaking inflation sustainably lower.
Page 35
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
INDONESIA
—
FX: Short SGD/IDR, target 9000
—
Rates:
Long
10Y-20Y
IndoGBs,
overshoot to 6.5-6.75% region
target
'Better quality' carry. Since the last time we wrote in
these pages, the market has finally come to appreciate
the 'better quality' EM carry characteristics for
Indonesia. Disinflation has proven to be quicker than
most had anticipated. The external accounts have been
slow to adjust, though the trade balance did manage to
record a small surplus at the end of last year. And Bank
Indonesia has been building on its credibility premium
by going steady on rates, and emphasizing on the need
to adjust the external imbalances. The immediate
political noise after a divisive election last year has
tapered off, though the President's popularity has taken
a big hit (Indonesia Survey Circle put his ratings at 42%
in January from 71% in August last year) in the
aftermath of the controversy surrounding the national
police chief nomination. It remains to be seen how this
ends up impacting his ability to balance between an
obstructionist Parliament and possible discord within
his own coalition. The improvement in the macro
economy has brought carry seeking flows back in full
force, with $3bn+ in net foreign buying year to date,
second in the region only to India, and helping in 3 very
successful auctions with an equivalent of 17% of local
currency financing needs already completed. Offshore
accounts we would argue are now well allocated to
Indonesia, and the positive impact from lower oil prices
is well internalized. The spread for 10Y to policy rate
has already compressed to near its tightest levels in
recent years. Given though that the interbank liquidity
domestically is priced more off the FASBI point (which
is a lot lower than the policy rate), we could well see an
overshoot in the rally, and with yields trading down to
6.5-6.75% region.
MALAYSIA
—
FX: Long USD/MYR, target 3.73
—
Rates: Pay 5Y ND-IRS, target 4.25%
Wary of the stress points. In late-December, the
Ministry of Finance published a letter encouraging
government-linked companies and asset managers to
refrain from overseas investment, and focus on the
domestic market to support growth and the currency. A
shift in their investment behavior therefore should
provide a short-term reprieve to USD demand and
support domestic bonds. At the same time, the
inclusion of GIIs in a major global bond index is
supportive for sentiment from offshore demand
perspective. The MGS market indeed reacted positively
to these developments. For now, the MGS market has
thus managed to decouple from the stress in FX and
credit. But it is a risk we are worried about as
Malaysia’s medium-term challenges still loom large. We
Page 36
would not chase cash bonds at current levels. Indeed,
10Y MGS is appearing a tad expensive on our
multivariate model framework. Meanwhile, current
pricing in swaps space is already accounting for the
KLIBOR versus OPR spread to revert towards the ‘oldnormal’. Market is looking for KLIBOR to be lower by
another 15-20bp over the next 6 months. It can
eventually move to price in some policy easing too, but
we would argue that the bar for BNM to cut rates, and
join the global easing party, is very high. Right now
rates are trading like risk free assets, but we remain
wary that they could flip to trading more like risky/credit
sensitive assets, particularly if the currency comes
under further pressure. The curve is already very flat,
and any re-pricing will lead to steepening of the curve.
We continue to like being short Malaysia rates as a
hedge to our overall overlent bias on the portfolio.
PHILIPPINES
—
FX: Neutral
—
Rates: Marketweight duration.
Performance speaks for itself. Top 3 in terms of
currency performance year to date (spot returns) in EM,
and comfortably in the top quartile of bond market
performance. As we said in these pages last month, it
looks the sweet spot is here to stay for the Philippines.
The drop in energy prices over the past few months has
driven inflation to well within comfort zone (2-4% target
for the year) for the central bank, which is increasingly
unlikely to have to tighten rates at all this year. Growth
is well supported by remittances and the expectations
of pick up in public spending ahead of the 2016
Presidential elections. Correlation to global asset price
volatility is low, though the beta to UST move is still
something to be wary of. Treasury balances are in good
shape. To be sure, we would be happier to see credit
growth reined in a bit more. But there is little overall to
fault the benignly positive fundamentals of the
Philippines fixed income story. We don’t particularly like
the valuations though. Besides, politics is set to become
more volatile in the lead up to the elections next year.
The President has been widely criticized for his handling
of a botched police operation in the south of the
country, and for his backing of the national police chief,
whom he has finally been forced to let go of. A possible
hardening of the stance by lawmakers on giving more
autonomy to the region might end up increasing the
political risk premium.
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
SINGAPORE
—
FX: Long USD/SGD, target 1.40
—
Rates: Receive 2Y/5Y flatteners, target 40bp.
Pay 2Y SGD-USD IRS spread, target +50bp.
Another surprise party. Last month, MAS joined a
growing list of central bank surprises for the markets. In
an unexpected off-policy cycle meeting, MAS reduced
the slope of their policy band, without making any
change to its width or level. We now assume MAS is
running a 1% p.a. slope, with a +/- 2% bandwidth.
Indeed, we had expected a slope reduction, but not
before the scheduled April review. The surprise was
attributed to a large shift in MAS' core inflation outlook.
MAS now sees core inflation averaging 0.5-1.5% in
2015, down from their 2-3% forecast in October.
Importantly, Singapore includes energy prices in its
measure of core inflation, and thus the dramatic decline
in global oil prices cannot have been ignored. In the
context of lower core inflation expectations, a 2% slope
had become too tight to defend. Historically, core
inflation and the YoY change in the policy slope have
been closely aligned, which suggest MAS is now
running a 1% bias. Note that off-policy reviews are
uncharacteristic of MAS. The last time an unscheduled
policy change was made was after the 9/11 attacks in
2001. To us, this move highlights the theme du jour:
central bank policy is becoming more unpredictable as
policy makers do whatever it takes, without delay, to
respond to inflation mandates. Like the BoJ, ECB, BoC
and RBI in recent weeks, MAS too has explicitly opted
for inflation credibility over predictability. We see three
fallouts from the decision. One, MAS might opt for
band-widening as a discreet form of easing at its next
meeting. MAS has three degrees of freedom: the slope,
the centering and the width of the band. We do not
think MAS will move to a neutral slope, which has only
been done around recessions. MAS is also unlikely to
re-center the mid band lower, as this has only happened
after they had run a neutral bias for at least one policy
cycle. Band-widening however has been employed
around periods of "international financial market
volatility." These conditions arguably exist again. Wider
bands would give the market more room to push SGD
weaker against its basket, thus functioning as a covert
easing. Two, MAS will likely talk to the market more. By
moving at an unscheduled meeting, there was maybe a
tacit acknowledgement that MAS' semiannual meeting
calendar was insufficient for the policy demands of
today's volatile markets. MAS did not foresee the
dramatic drop in oil prices in October, and could not
wait till April to respond. Aside from dollar pegs, there
is no other major central bank that meets as
infrequently as MAS. Along with their ongoing increase
in transparency, it might now be natural for MAS to
increase the frequency of its policy meetings too. And
three, there will be greater scrutiny of intervention and
reserves trends going forward. MAS' reserves have
quietly declined over the past two years. When
compared to the peak, the drop in Singapore's reserves
Deutsche Bank Securities Inc.
has been second only to Malaysia in the region. Given
the incremental move to an easier bias, SGD NEER
could now be pressured towards the bottom band,
compelling further intervention. While Singapore does
not face concerns over reserves adequacy, a more rapid
decline in reserves could begin to attract these
questions. After a long period of unchanged policy,
Singapore's policy landscape will get more interesting
in the months to come. We believe the changes should
favor our bearish bias on SGD. We stay long USD/SGD,
targeting a move to 1.40, the next major resistance level,
by mid-year.
SOUTH KOREA
—
FX: Short EUR/KRW, target 1180
—
Rates: Short 1Y1Y swaps, target 2.10%
Fasten your seat belts. We are shifting to a modest
underweight bias on duration and suggest reducing
long-end receivers into any rally. And we maintain our
tactical trade of paying 1Y1Y with a target of 2.1%. The
Korea curves have fully priced in a 25bp cut in 1H. The
risk, if any, we feel is for BoK to disappoint the markets,
because of; 1) growing emphasis by policymakers on
structural reforms; 2) heightened debate on household
debt; and 3) BOK’s reluctance to use the policy rate to
tackle the currency. Despite a series of global central
bank easing measures, the BOK has consistently
remained hawkish. We think BOK will stay unanimously
on the sidelines at the 17th February MPC. Market
consensus is for hold, but for the decision to be not
unanimous. We do not want to chase the rally in the
long end at these levels, and have taken profit on our
10Y IRS received position at 2.10%. The strong bull
flattening in the Korea curves had been supported both
by 1) global lower yields and 2) strong domestic
technicals. While we still think global yields should stay
long for the time being; we are concerned about the
risk of increase in DV01 supply to the market. The
reform in the household debt structure has become an
important agenda for all policymakers. In this regard,
the FSC (Financial Service Commission) unveiled its
plan of converting KRW20tr of existing floating/bullet
loans into fixed rates/amortization loans. We believe
this plan will likely work out well and consequently
increase MBS issuance after March (Please see Asia
Pacific Rates Strategy: Korea MBS supply at risk on 5
February). The annual MBS issuance in 2014 declined
to KRW14.5tr from 20.3tr and 22.7tr in 2012 and 2013,
respectively. The extending maturity and growing size
in MBS issuance should crowd out the domestic
demand for long-dated KTBs to some extent. Long-end
investors such as pensions and insurers hold around
50% of MBS outstanding.
Page 37
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
TAIWAN
—
FX: Long USD/TWD, target 33.50
—
Rates: Marketweight duration
Neutral on duration. We are neutral on duration. Since
last October, the correlation between 10Y TGB and UST
has tightened. At below 1.50% for 10Y TGB yields
however, TGB yields tend to be more sensitive to UST
correction. Taiwan domestic technicals are not very
bullish for TGBs. The long-term investors have
consistently raised the weight of foreign assets
especially in 2H last year. Lifers added TWD1.7tr of
foreign assets, but reduced 163bn of government
bonds in 2014. We estimate foreign assets accounted
for 42.5% of lifers’ portfolio as of December 2014,
implying that there is room for 2.5% to their regulatory
hurdle of 45% for foreign asset holdings. If we assume
CAGR of 10% in insurers’ asset this year, 45% of
foreign asset can mean as much as TWD1.3tr of
overseas net investment. In line with this, lifers’
government bond portfolio will likely reduce gradually
further, especially in 1H. Disinflation story on the back
of lower oil prices have been well priced in the TGB
yields, as Taiwan inflation figures have surprised the
market to the downside. Nonetheless, other frequent
macro indicators such as IP, export orders and
commercial sales, all beat market anticipations,
implying that the growth momentum will persist. As a
consequence, while the global lower yields theme is
alive, domestic technicals may not strengthen the rally.
regression model suggests that the policy rate should
be nearer 1.5%, if inflation were to average just below
1% this year. BoT has slashed policy rates to as low as
1.25% twice in the past; and has admitted recently that
it has room to lower rates if required. Meanwhile,
liquidity onshore remains ample and it is chasing a
limited supply of bonds, while market positioning is still
very light. We remain constructive on Thai rates. Any
back-up in rates would be shallow, we feel. Thailand
still offers the most attractive forward looking real yields
in the region. Yields have traded below the policy rate in
the past on different occasions, and we expect they will
likely do so again in this current disinflationary and
globally lower rates environment.
Sameer Goel, Singapore, +65 6423 6973
Swapnil Kalbande, Singapore, +65 6423 5925
Perry Kojodjojo, Hong Kong, +852 2203 6153
Linan Liu, Hong Kong, +852 2203 8709
Mallika Sachdeva, Singapore, +65 6423 8947
Kiyong Seong, Hong Kong, +852 2203 5932
THAILAND
—
FX: Long USD/THB, target 35.0
—
Rates: Receive 5Y IRS, target 2%. Long 1Y/5Y
IRS flattener, target 0bp
Technicals
remain
supportive. Mild
signs
of
consumption and tourism revival, and expectations of
pick up in public and private spending are keeping the
BoT to stay on the sidelines, despite the economy
entering negative inflation territory. However, our
economists argue that if demand does not turn around
soon, expectations that deflation will be temporary
could prove to be wrong, making policy calibration
particularly difficult. Arguably, core inflation is stable for
now and the drag in headline inflation is due to supply
side factors. But we are concerned about the eventual
pass through, especially as household debt is elevated
and monetary conditions are tightening with real rates
now at 5 year highs. Also, BoT’s expectation for
inflation to pick-up in H2 hinges on the assumption of a
rebound in oil prices, which is still far more certain. DB
Economics expects BoT to stay on the sidelines for the
duration of the year, but they admit that rate cuts could
be back on the agenda if inflation continues to surprise
on the downside month after month, and incipient signs
of an investment recovery begin fading. Indeed, our
Page 38
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
underperformed Exim India and SBI 5Y CDS. These
now – for the first time in history – trade flat/tighter
than Indo 5Y CDS.
Credit
CHINA
—
Close our Sell 5Y CDS trade;
—
See select opportunities in financial quasis that
underperformed following the recent RRR cut;
Lately China macro developments have been trending
lower, including such factors as exports, GDP, fiscal
revenues, FX reserves and inflation. Our economics
team has been quite vocal of its expectation of an
economic deceleration and a fiscal drag in China so the
data releases were not a surprise to us. What is
important here is that the government has been
proactive in its monetary policy decisions to mitigate
financial risks on the level of local governments and to
spur economic development. The PBoC's new policy
shows the government has been working on new
regulatory tools to deal with such risks. DB economists
continue to expect growth to slow sharply in Q1 to
6.8% (Consensus 7.2%), and that the government
would ease monetary and fiscal policies aggressively in
the next few months. DB sees one interest rate cut in
March and another cut in Q2 and also expects a RRR
cut in Q2.
Having tightened from ~104bp in mid-Jan to the
current ~94bp, we believe there is limited upside to our
Sell recommendation on China 5Y CDS until we see
tangible results from the ongoing policy easing. At the
same time, we observe material underperformance of
bond spreads for China Asset Management Companies,
especially China Orient, which is included in EMBI. The
entire China IG space reacted quite positively to the
recent RRR cut by PBOC, but AMCs lagged. As AMC’s
are not allowed to attract customer deposits, their
entire funding is a mix of wholesale funds and bilateral
loans. Bank loans account for as much as 60% of the
total mix. The news of a RRR cut in China is credit
positive for AMCs as they will be the net recipients of a
part of ~USD100bn liquidity released to the market as a
result. We particularly highlight ORIEAS ‘18s and ‘19s
currently trading at ~210bp and ~240bp z-spread
respectively as amongst our preferred Buy picks.
Risks:
spike in domestic corporate default rates,
worsening of RMB liquidity, failure by the recently
announced government stimulus to yield tangible results.
In the long end of the curves, quasi-sov bonds have
been trading YTD in the upper part of the historic range.
We note that Pertamina’s long-end spreads look
particularly attractive. Talking about Indonesia vs. EM –
we believe that the widening spread dynamic is more
justified for EM with Indo being the most prominently
improving energy story in Asia, and arguably in EM,
with its fuel subsidy reform paving the way for a
positive rerating trend. While EM is more susceptible to
negative headwinds from the declining oil prices, Indo
remains the net importer of oil and is benefitting from
the low oil price environment.
Furthermore, looking at Pertamina bond’s spread
evolution we note that the curve has become
increasingly steep. In fact, PERTIJ ‘44s are trading at a
historic wides vs. PERTIJ ‘23s of ~110bp (considering
that the tightest print was ~50bp in Aug-14). Equally,
PERTIJ ‘43s & 44s nearly touched ~120bp two weeks
ago (~100bp now) vs. INDON which is 40-50bp wider
than six months ago. We recommend Buying PERTIJ
longer dated bonds and consider ‘42s and ‘44s (at
current mid z-spread of 360bp and 362bp respectively)
as most attractive entry points, given lower cash price.
Key risks: Aggressive new issuance, further drop in
global commodity prices, Fed-related sentiment
deterioration, abuse of energy sector’s budget for the
benefit of the sovereign, government’s fiscal slippages.
MONGOLIA
—
Remain Positive;
—
Having rallied ~8-10pts in the past three weeks
we see up to ~2pts of juice remaining in cash;
—
Range-bound copper prices are the main
physiological barrier for investors, but IMF talks
and rising FX reserves should overweigh;
Figure 1: Mongolia vs. peers, mid-YTM, %
13
12
—
Staying Overweight;
—
Sell 5Y CDS as, despite being less volatile than
EM peers, it continues to UP India quasis.
—
Recommend Buying Pertamina long-end;
We believe it still makes sense to stay O/W Indo. INDO
5Y CDS has unjustifiably – in our opinion –
Deutsche Bank Securities Inc.
MONGOL 18
DBMMN 17
11
10
INDONESIA
MONGOL 22
ZAMBIN 22
SENEGL 21
9
8
7
6
5
Source: Deutsche Bank, Bloomberg Finance LP
Page 39
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
We had already commented earlier on Mongolia’s 2014
trade balance turning positive and amounting to
USD538m surplus, which was better than expected.
Total value of exports from Mongolia increased by 45%
yoy in volume terms and by 35% yoy in USD value
terms and amounted to USD5.78bn. Copper
concentrate is indeed the biggest component of exports,
but its share in total exports has actually doubled yoy to
45% in value terms despite the negative move in spot
market prices. At the same time, Mongolia has lowered
its dependence on coal exports as the volumes grew
only 7% yoy while the monetary contribution by coal
exports shrunk to 15% from 26% in 2013.
It is important to note that despite a slide in commodity
prices globally in 2014, Mongolia was able to
considerably increase total exports value by USD1.5bn
yoy, of which USD1.4bn was driven by a net growth in
production volume. We believe it is not unreasonable to
assume that exports in 2015 are set to grow further as
(i) China has recently increased its monthly purchases
of Mongolian copper by nearly 2.5x vs. a year ago, and
(ii) The production of copper and gold at Oyu Tolgoi
mine has been fully resumed following a fire incident in
Dec-14, which in fact did not derail the company from
reaching its 2014 production targets. Moreover, the
mine is forecasting its 2015 output to rise by 25% and
10% on average to 185kMT for copper and 650oz for
gold respectively.
Bank of Mongolia has been maintaining a relatively
stable stock of foreign currency reserves in Jul-Nov
2014 (~USD1.35bn), which is quite remarkable
considering that in 1H14 its volume nearly halved since
Dec-13 and MNT has depreciated by ~14% in 2014 and
by further ~4% YTD. Furthermore, FX reserves grew by
22% MoM in Dec-14 and reached USD1.65bn. At the
same time BoM’s gold reserves doubled in 2014 to 6.4
tonnes partially offsetting a decline in foreign currency
reserves over the same period. The most prominent
news relating to Mongolia’s credit story of late, in our
view, is the decision of the parliament to ease
restrictions on government borrowings by raising the so
called “debt ceiling” to 60%, which (i) is more
realistically reflecting an impact on GDP by global
commodity prices; (ii) allows the government to borrow,
considering that the current ratio is below the new
threshold. The revised “debt ceiling” will be reduced
gradually to 55% in 2016, 50% in 2017 and 40% in
2018 to be more in line with IMF’s recommendations.
The government is also in the formal talks with IMF that
has its official mission in the country this week. This
may not necessarily culminate in the establishment of a
stand-by agreement, but at least would help Mongolia
to find viable ways to instill economic stability. We
recommend Buying MONGOL ‘18s, ‘22s and DBMMN
‘17s that currently yield ~6.8%, ~7.3% and ~8.1%
respectively. MONGOL ‘18s and DBMMN’17s, for
example, are still trading at ~200bp higher yield vs. the
Page 40
lows seen in 2014. Risks: sharp downward move in
central bank reserves and/or commodity prices, spike in
MNT volatility, large domestic corporate defaults.
PHILIPPINES
—
Neutral positioning;
—
3Y-10Y part of the cash curve is most
susceptible to UST volatility;
—
Sell 5Y basis via 5Y CDS and 2021s;
Philippines curve continues to enjoy strong support
from local and Asian accounts, which was boosted
further following a better than expected GDP data
release in Jan. The demand for the shorter duration
bonds on PHILIP curve has resulted in the 5Y basis
widening to the 12M highs of ~60bp and together with
our EM Credit Strategists (Srineel Jalagani and Hongtao
Jiang) we see the most attractive short basis trade at
the moment.
Philippines’ cash bonds have been expensive in
comparison with peers for an extended period of time,
but the recent outperformance of cash bonds vs. 5Y
CDS is nevertheless very pronounced. The spreads of
the Philippines bonds at the 5Y sector is practically the
tightest in EM, with PHILIP ‘21s also looking very
expensive to the curve. We expect a retracement and
recommended entering a short basis via 5Y CDS vs.
PHILIP ‘21s (entry: 58bps; target: 25bps). We do not
foresee any more issuances from Philippines this year,
after the USD 2bn of issuance in early January. Key
risks: aggressive issuance by quasi-sovereigns, weakness
in fiscal data, global liquidity shock, escalation of
geopolitical tensions with China, continued rise in UST.
Figure 2: Time series of PHILIP 5Y CDS vs. ‘21s
CDS Spread - Bond Libor Spread (bps)
60
50
40
5Y CDs - RoP '21s
30
20
10
0
-10
Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15
Source: Deutsche Bank, Bloomberg Finance LP
Viacheslav Shilin, Singapore, +65 6423 5726
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
EMEA Strategy
In FX, it is clear that the benefits of lower oil prices
have yet to become more visible in EMEA. Market
needs evidence. In the meantime Grexit fears, (and
soon maybe Brexit fears?), the just started Minsk talks
and somewhat higher US yields on the back of the US
NFP will continue to weigh on EMEA FX. We remain
long EUR/ILS on the basis that the BoI will be sensitive
to a further deterioration in competitiveness vis-à-vis
one of its main trading partners. We target 4.55, and
risk 4.3350. Elsewhere we have taken profit on our
short EUR/HUF, whilst we remain in our short GBP/PLN,
still waiting for a re-pricing in the current very divergent
policy paths to be reflected in FX. Finally we position
for some mean reversion in TRY/ZAR, where the sell-off
in the Lira seems to have silenced at least for now
political calls for further rate cuts. Target 4.90, stop @
4.69.
For the first four weeks of the year EMEA Rates have
been the main beneficiary from the collapse in energy
prices. Since then, however, stronger data in the US,
EMFX weakness, geopolitical concerns around Russia
and Greece and last but not least some stabilization in
Oil prices have led to extreme volatility with a bearish
sentiment. Local curves bear-steepened and reverted
some of the aggressive easing priced for central banks
across the region. Although valuation in EMEA rates
still looks rich in absolute terms and market pricing
remains significantly more dovish on EMEA central
banks than at the start of the year we keep our view
that sentiment for local markets remains favorable in
the near term in particular compared to other regions.
We justify this with improved domestic growth
dynamics, falling price pressure and upcoming QE by
the ECB. In the short-end we favor in CEE to position
for rate path normalization without ignoring the risk of
further easing in the near-term best expressed by
paying long-end FRAs, short-end fwd-IRS payers or
short-end steepeners. In South Africa we see again
room for markets to price a delay in the start of the
hiking cycle and recommend 1Y1Y IRS receivers. In
Israel we like shorts in 1Y1Y vs USD given rate
expectations divergence at the widest level since midwhile in Turkey we favour short-end steepener. On the
government bond front, in CEE Hungary remains our
favourite long position, followed by Poland which still
looks attractive vs Euro-area peripherals. In Israel, long
end bonds still provide an attractive yield pick-up
relative to countries with a similar low inflation profile
(Swiss and Czech). In South Africa bonds in the shortend look cheap while we switch from underweight to
neutral on Turkish bonds given the recent
underperformance. On Russia we close our long
position in 10Y OFZs following the aggressive rally and
uncertainty around the piece process in the Ukraine.
Deutsche Bank Securities Inc.
In credit, we are neutral on Ukraine. Market is pricing a
moderate PSI scenario, which is consistent with our
baseline. We are underweight on Russia. The truce
remains fragile with high implementation risk. We stay
overweight on Turkey and Hungary, and neutral on
South Africa. In relative value, we favor cash curve
flatteners in South Africa, and enter switching from the
30s to 20s in Russia.
Local Markets
Czech
FX: We are long a 3m EUR/CZK 31/29 call-spread from
Jan 14th (indicative cost 0.26% of EUR notional).
Rates: In short rates position into 3Y IRS payers (target:
75bp / stop: 20bp). On the government bond front keep
country view “underweight” and on selective bonds
underweight Apr-19, Sep-20 and Sep-22. As RV-trade
enter a short in May-24 vs. Israel (Mar-24).
Rationale: Encouraging economic activity data in
recent weeks including further improved sentiments
surveys, strong mfg PMI readings and robust GDP
prints – is reinforcing the view that domestic growth
dynamics can counter-act risks stemming from the
euro area slowdown and geopolitical uncertainty
around Ukraine/Russia. On the monetary policy front
the CNB left interest rates once again unchanged at
0.05% in line with expectations. On the back of the
SNB letting go of the FX floor in Switzerland and QE
announcement by the ECB, markets had positioned for
negative interest rates in Czech to defend the current
floor vs the Euro. However, markets did not challenge
the FX-floor and upward revisions to the CNBs growth
outlook have reduced the probability of further
accommodation in Czech. Hence expectations of
negative rates have been reduced and short end rates
have repriced significantly in particular in long-end
FRAs.
Given record low rate levels, almost no carry, and now
again market’s rate expectations priced more or less in
line with DB forecasts over the next 24 months suggest
receivers are unattractive. Instead we keep our bearish
bias in the short-end but do not expect any significant
moves further up from here in the very near-term given
still low spot CPI. Further out the curve we continue to
favour shorts in bonds rather than swaps given the
tight swap-spreads. As cross-country trade we favour
short vs. countries which have a similar inflation profile
but provide a more attractive yield level.
Page 41
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
On the FX front high frequency activity and inflation
data has picked up of late, reducing the probability of
the CNB raising the floor after their dovish rhetoric was
ramped up towards the end of last year.
Czech Republic - PPI leading CPI lower
normalization path priced for 16/17ff would only be
justified in case of a prolong period of continues low
domestic inflation pressure in combination with a
significant slowdown in economic activity- which is
both currently not our base case scenario. On local
bonds however, we remain constructive and highlight
the attractive yield pick-up to Euro-area peripherals. In
addition ECB QE should lead to additional inflows
supporting mainly the longer end, while on the
domestic front the NBH has still room for further easing
– if necessary.
The belly of the curve in HUF looks too rich compared
to the wings.
125
100
75
50
Source: Deutsche Bank, Bloomberg Finance LP
25
0
Hungary
Rates: In money market position into long-end FRA
payers best expressed in 18x21 or favour 1x4 – 18x21
steepeners. In short-end IRS enter shorts in 1Y1Y or as
a curve trade favour a 1s3s10s butterfly short the belly.
On the local bond front keep the country view
“overweight” and in selective bonds favor Feb-16, Jun19, Nov-20 and as a cross-country trade a long in Oct28 vs. Poland (Apr-28) – (target 50bp / stop 150bp)
Rationale: Despite a continued decline in YoY inflation
(currently a new all-time low of -1.4% YoY), the NBH
has left rates unchanged at 2.10% since July last year.
The main reason for this inaction is the fact that
deflation has been primarily imported and more
importantly that the domestic economic backdrop
continues to be robust, with business sentiment close
to all-time highs, retail sales solid and underpinned by a
persistent decline in unemployment. Also, the external
balances remain firmly in surplus, with the C/A surplus
hovering around record highs. Nonetheless, the
persistent drop in YoY CPI has seen the market pricing
in further rate cuts (-30bp by September) and
combined with Grexit fears and a lack of progress in
Ukraine, this should provide a floor in EUR/HUF for
now.
On the rates front we position for rate path
normalization without ignoring the risk of further
easing in the near term. The short-end looks already
quite rich and the very gradually rate path
Page 42
Jan/15
Oct/14
Jul/14
Apr/14
Jan/14
Oct/13
Jul/13
Apr/13
Jan/13
Oct/12
Jul/12
Apr/12
Jan/12
Oct/11
Jul/11
Apr/11
Jan/11
Oct/10
Jul/10
Apr/10
Jan/10
FX: Neutral after having hit our out revised (Feb 6th)
trailing 0.5% stop on our short EUR/HUF (initiated Jan
14th) for a +3.9% total return.
-25
1Y-3Y-10Y
Average
Lower
Upper
Source: Deutsche Bank / Note: Calculated: 2*3Y – (1Y+10Y)
Poland
FX: We are short GBP/PLN from the EM Macro and
Strategy Focus on Jan 16th, targeting 5.35, stop
revised to 5.75 (5.72).
Rates: In money markets position into 18x21 payer. In
short-end rates we favour payers best expressed in 2Y
fwd 1y rates. As cross-country RV-trade we favour a
short 1Y1Y vs. South Africa. In cash keep country view
“moderately overweight” and on selective bonds
overweight Apr-17, Apr-18 and Jul-25 while
underweight Jan-16 and Oct-20. We also like swapspread wideners in the long end best expressed by
being short Oct-23. As cross-country trade remain long
(Sep-22) vs Euro-area peripherals (preferred Spain)
while short Apr-28 vs Hungary (Oct-28)
Rationale: A comfortable current account position,
helped by lower oil imports, and capital flows
supported by ECB easing will continue to provide
support for the zloty. At the same time persistent
deflation will increase the pressure on the NBP to ease
policy further in order to maintain real rates at a level
which is growth supportive. The Bank held rates
unchanged at 2.00% on Feb 4th, but signaled a cut on
March 4th, in conjunction with the Bank revising its
now dated inflation and growth forecasts (from back in
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
October last year). Growth projections will be broadly
unchanged, if anything revised up slightly, while
inflation forecasts are likely to be revised significantly
lower on the back of the drop in energy. This will
rationalise a further cut, with the big question if the
NBP will cut by 50bp, and then signal that this would
represent the end of the easing cycle, or if they will
continue to reluctantly edge rates lower in 25bp steps.
The rates market is currently fully priced for a 25bp cut
on Mar 4th, and for a total of around 70bps of further
easing in this cycle.
On the rates front the situation has not changed. On
the back of the last interest rate decision short-end
rates remained hardly unchanged despite the NBP
signaling further easing in the near-term reflecting the
aggressive easing already priced. While we see 2550bp of cuts as a likely scenario, we still see the
current interest rate path priced as too dovish – even
more so than in Hungary - given strong growth and the
expected pick-up in CPI in late 2015. We nevertheless
highlight that also a further rally in global rate markets
cannot be ruled out. Hence we favor shorts vs
countries where still a relatively hawkish interest rate
path is priced (South Africa) or vs countries where
subdued inflation pressure could lead to low rates for
longer (Israel) or even further rate cuts (Hungary). On
local bonds, however, we remain constructive but turn
a bit more cautious. We find the yield-pickup vs Euroarea peripherals as attractive and expect further
support by QE in Europe, but keep a short vs. Hungary
which remains our favorite long position in CEE.
Poland’s comfortable C/A position
ILS. As slope trade remain positioned into 1Y1Y-10Y
IRS steepener (target 159bp / stop 50bp). In cash we
favour to overweight Sep-17 (203) and Dec-18 (204)
while underweight Sep-16 (159) and Feb-23 (2023).
Rationale: Markets in South Africa have been extremely
volatile over the last few weeks which make medium
term views rather challenging. While rates were well
supported by external disinflation at the beginning of
the year, they came under severe pressure following
strong NFP data in the US, some stabilization in oil and
(although less so) geopolitical uncertainty around
Ukraine/Russia and Greece. Deterioration in risk
sentiment has also resulted in FX weakness over the
past week in particular. Ironically the pressure has
occurred at a time of a further decline in inflation
pressure and some long-awaited bright spots on the
domestic economic front with improvements in the C/A
deficit, a better than expected employment report for
Q4-14 and a strong manufacturing production release.
While our last receiver position performed well and hit
the target before selling off aggressively we now see
the short end yet again as attractive to position into
receivers. South Africa is pricing a relatively hawkish
rate path normalization with 30bp of hikes expected by
end-15 and 90bp of hikes priced by end-16. Given the
expected fall in headline CPI over the coming months
and the still fragile domestic economy we see any
near-term rate hikes as rather unlikely and expect
markets to price in (once again) a delay for the start of
the hiking cycle. 1Y1Y provides a very attractive roll of
20bp over 3m while in terms of slope the IRS curve
looks – despite the recent steepening – still historically
flat and steepeners provide a) an attractive carry and b)
protection against higher global volatility or a US rate
normalization in the long-end of the curve. In terms of
local bonds we turn a bit more cautious but still see
short end bonds from a RV-perspective as cheap and
would overweight in particular 203 and 204 going into
the next few weeks.
Within EMEA markets South Africa remains the most
hawkish priced
Country
Source: Deutsche Bank, Bloomberg Finance LP
South Africa
FX: Position for some mean reversion going short ZAR
vs long TRY. Target 4.90, stop @ 4.69..
Rates: In money markets receive 15x18 FRA, while in
IRS position into a long outright 1Y1Y (target 6.15% /
stop: 7.10%) or as a cross-country trade a long 1Y1Y vs
Deutsche Bank Securities Inc.
Sw iss
Sw eden
Europe
Czech
US
Israel
UK
Norw ay
Poland
Hungary
South Africa
Turkey
Russia
today
-0.94%
-0.10%
0.02%
0.05%
0.11%
0.25%
0.50%
1.25%
2.00%
2.10%
5.75%
7.75%
15.00%
end
'15
-0.84%
-0.24%
-0.01%
0.02%
0.55%
0.22%
0.72%
0.78%
1.33%
1.87%
6.01%
7.59%
11.09%
vs
cum
end
vs
cum
YTD pricing
'16
YTD pricing
-64bp
+9bp -0.49% -45bp +44bp
-27bp -14bp -0.05% -31bp
+5bp
-1bp
-2bp
0.02% -1bp
+1bp
+2bp
-3bp
0.21% +12bp +16bp
+0bp
+45bp 1.37% -3bp +127bp
-25bp
-3bp
0.54% -60bp +29bp
-3bp
+22bp 1.11% +8bp
+61bp
-12bp -47bp 0.76% -20bp -49bp
-12bp -67bp 1.53% -18bp -47bp
-22bp -23bp 1.90% -42bp -20bp
-67bp +26bp 6.57% -68bp +82bp
-61bp -16bp 7.98% -27bp +23bp
-118bp -391bp 8.91% -134bp -609bp
Source: Deutsche Bank, Bloomberg Finance LP
Page 43
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Israel
Spread in 1Y1Y vs. USD at the widest level since mid-07
FX: We remain long EUR/ILS (EMEA Compass Feb 5th),
targeting a move to 4.55, with a stop @ 4.3350.
6.0
100
5.0
50
-200
0.0
-250
Feb/15
Sep/14
Nov/13
Apr/14
Jan/13
Jun/13
1Y1Y USD
Aug/12
Oct/11
Mar/12
Dec/10
May/11
Feb/10
1Y1Y ILS
Jul/10
Page 44
-150
1.0
Sep/09
However, on local government bonds we remain
constructive and overweight duration. Bonds in Israel
still provide an attractive yield pick-up relative to other
countries with similar low official rates couple with a
similar inflation profile (Czech, Switzerland).
-100
2.0
Nov/08
Despite a minor selloff since then interest rate
expectations for Israel vs US have widened to new
record levels. Markets are now pricing 10bp of hikes by
end-15 and 45bp by end- 16 vs hikes of 35bp and
120bp, respectively, in the US. Given the relatively high
sensitivity in ILS-rates to a normalization in US-rates
we believe policy divergence of this magnitude is
unlikely and expect the spread in the short-end to
narrow driven either by markets scaling back on the
relatively aggressive hiking cycle priced for the US or
markets pricing a more hawkish BoI. Given still
subdued inflation pressure we see limited scope for an
early start of the hiking cycle (H2- 15) in Israel. Hence
we recommend to position for rate normalization in the
fwd-space. The spread in 1Y1Y USD-ILS is at the
widest level since mid-07 and also provides a positive
roll 12bp over 3m.
3.0
Apr/09
In rates we have been positioned for markets to price
out the early hiking cycle from the beginning of the
year, and our 2Y fwd 1y receiver rallied by more than
60bp and hit our target of 75bp by end-Jan. The
rationale was based on a comparison with other low
inflation countries (Czech/Swiss), and the fact that both
the external (including a very dovish ECB) and domestic
backdrops (low inflation pressures and subdued
growth), were supportive.
-50
Jan/08
Rationale: The fundamental picture has not changed; a
subdued inflation outlook coupled with robust but not
particular strong domestic activity data had led to
record low policy rates and continued talks about an FX
floor. On the back of the SNB abandoning its floor,
however, exchange rate regimes elsewhere are under a
lot of scrutiny, making a similar floor in Israel
improbable. Nonetheless, ramped up intervention is
likely after the upward trend in USD/ILS has reversed
somewhat of late, in particular if CPI continues to be
extremely subdued.
0
4.0
Jun/08
Rates: In IRS position into a short 1Y1Y IRS vs USD
(target 25bp / stop 125bp). In cash keep country view
“overweight” by being long Oct-17 and Feb-19 while
short Feb-17 and Jan-18. As RV-trade in local bond
enter a long in Mar-24 vs Czech (short May-24) or
Switzerland.
spread in bps - rhs
Source: Deutsche Bank, Bloomberg Finance LP
Russia
FX: Outlook very binary and dependent on the outcome
of the Minsk talks.
Rates: In cash switch from back to moderately
underweight on the back of the recent strong rally and
continues geopolitical uncertainly.
Rationale: Much hinges on the implementation of the
Minsk
agreement
between
Merkel,
Hollande,
Poroshenko and Putin. The new accord is basically a
repeat of the deal back in September, i.e. including an
immediate cease-fire, a demilitarization zone and
Ukraine taking control over its borders. Back then of
course the ‘agreement’ was quickly reneged on, and
violence resumed. Because of this investors are likely
to assess developments as they come.
But IF the new Minsk accord is implemented, it would
be a clear positive and if it holds there would then be a
good chance that EU sanctions would expire on July 31,
2015. In this scenario Russian assets will rally. In FX
RUB is then likely to re-couple with crude, suggesting
scope for an initial move down towards 64.00, which
could extend further if recent crude gains are
consolidated and a cease-fire takes hold. It should also
underpin Russian equities, with the P/E ratio on the
Russian MSCI currently at 3.89, just above the 2008
trough, and comparing with a P/E of 12.2 for broader
EM and 17.9 for developed markets. For bonds our
rich/cheap analysis suggests a preference for May-19,
Dec-19 and Jan-28 (tgts 12.50% / 12.50% / 10%
respectively). However, a significant rally over the last
couple weeks and a shockingly high inflation number
for January makes us turn more cautious on OFZs.
Hence, expectations for a longer period of inflation well
above target and the negative carry (local rates
currency hedged) makes us believe that levels of 12.5013.00% are not justified in the 10Y sector – as long as
geopolitical uncertainty remains high.
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
USD/RUB spot vs DB’s short-term ‘fair-value’ estimate
neutral stance on duration for now. However, we
highlight that the short-end is at the most inverted level
since mid-12 and any cut in the upper-end of the
corridor – as expected by DB-Economics – should lead
to a flatter curve (2Y underperforming the very short
end). In addition and despite the recent rally in B/Es we
still favour I/L-bonds in particular in the long end (May24). Comparing the current level in B/Es vs DB-forecast
for the next two years we see that the current levels
are not expected to be reach once over the next 24
months. No other market in EMEA shows this
persistent divergence between DB forecasts and B/Es.
While global disinflation will certainly continue to
weigh on sentiment, we believe that a major part of
this is already priced into B/Es and current valuation in
I/L-bonds looks cheap.
2m-2Y XCCY spread at flattest level in over three years
14.0
200
2m FX implied
Source: Deutsche Bank
2Y XCCU
Spread in bp - rhs
150
12.0
Turkey
100
10.0
50
8.0
FX: We recommend a tactical long TRY/ZAR, targeting
4.90, with a stop @ 4.69.
-150
Jan/15
Nov/14
Sep/14
Jul/14
May/14
Mar/14
Jan/14
Nov/13
Sep/13
Jul/13
Deutsche Bank Securities Inc.
2.0
May/13
Local rates suffered under the FX weakness and were
the main underperformer in EMEA over the last couple
weeks. While local curves bear-flattened long-end
bonds underperformed its peers and 10Y bonds are
once again trading with a higher yield than South
Africa. Position remains tricky at the moment and is
driven by daily changes in sentiment. While we change
our “underweight” call for duration on local bonds we
nevertheless see positioning as tricky at the moment
given the daily change in sentiment. Hence we keep a
-100
Mar/13
Rationale: With o/n rates towards the upper end of the
corridor, CBT is keeping liquidity tight, but that has not
been enough to prevent a weaker Lira against a
backdrop of political pressure for further rate cuts,
Grexit fears, and the strong US non-farm payrolls last
Friday. At the same time the benefits of the collapse in
crude are not yet visible on the inflation front, and will
only lead to a gradual reduction in the external deficit.
Meanwhile TRY valuation is increasingly appealing,
with the TRY basket now towards the upper end of the
range for the past 12 months. Also, the Lira still offers
an attractive [non-commodity] carry. However, if this is
sufficient for USD/TRY to have reached an inflection
point will depend on whether the political bias for
further rate cuts persist even after the sell-off in the
Lira over the past 5-6 weeks.
-50
4.0
Jan/13
Rates: In short end position into a 2m-2Y steepener in
XCCY (target 0 / stop: 150). In cash keep a “moderately
underweight” while in selective bonds underweight
Jan-20 and Sep-22 while overweight Jul-19 and Mar-24.
0
6.0
Source: Deutsche Bank, Bloomberg Finance LP
Henrik Gullberg, London, +44 20 754-59847
Christian Wietoska, +44 20 754-52424
Raj Chatterjee, Mumbai, +91 22 718 11601
Credit
Russia
—
Underweight
—
Switch from 30s to 20s
Russia’s credit spreads have tightened quite sharply
over the past week on higher oil prices and hopes of a
peace agreement and rallied more following the
ceasefire agreement out of Minsk. Focusing first on the
agreement, we see the truce as fragile and
implementation risk means continue volatility in the
coming months. The deal is almost identical to the
agreement reached in Minsk last September, which fell
apart within a matter of weeks. It does not deal
decisively with the issue of the political status of
eastern Ukraine. Nor does it properly address the issue
of the lack of control Ukraine has over its border with
Russia.
Page 45
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
While it remains to be seen whether the recent oil
recovery is sustainable, the risk of downgrade to junk is
acute – S&P acted in January and Moody’s will likely
follow suit within the next couple of months. Russia’s
credit spreads are at elevated levels (5Y CDS at
~500bp), which is more consistent with a BB-/B+ rating.
This means that from an analytical point of view the
downgrade to junk is more than priced in. However,
the market pricing embeds a significant amount of risk
premium to compensate for a potential crisis situation
as a result of a further drop in oil prices, continued geopolitical confrontations, and ongoing sanctions
(including the associated limited access to markets,
banking sector stress, and corporate default concerns).
Such risks will not be removed until there is a
sustainable solution to the geo-political confrontation
(which the current ceasefire agreement does not
necessarily equate to in our view).
The recent volatility has benefited the benchmark
2030s bonds, which have significantly outperformed
while the 20s cheapened to the curve. We recommend
switching from the 30s to the 20s (current: 55bp;
target: -10bp; stop: 70bp).
Russia 30s have significantly richened vs. the 20s
Par equivalent spread difference (bps)
60
40
RU 20s - RU 30s
20
0
-20
-40
-60
Feb-14
What kinds of debt re-scheduling scenario is the
market pricing? If we assume that all bonds maturities
are extended by ten years and there is no change on
the coupon levels, the implied notional haircut is 20%
on average under the assumption of 12% exit yield.
Looking at it from a different angle, if we assume
bonds coupons are reduced to 5%, but there is no
notional haircut, the current market prices correspond
to about 13% exit yields for a new 10Y bond, as shown
in the graph below. These are consistent with a PSI
scenario that is likely worse than what actually take
place.
Currently, there is not much clarity on how big part of
the gap private investors is supposed to fill. The last
IMF program factored in other (non-IMF) official
support of about USD 15bn; if this is kept the same, it
would then leave a gap of some USD 7-8bn to be filled
by the private sector. On the other hand, Finance
Minister Jaresko commented that Ukraine is expecting
only USD9.2bn from other official lenders – this implies
that there could be USD 13.3bn to come out of debt
operations. While the former suggests a maturity
extension with some grace period on coupon payments
would be enough, the latter suggests some haircut or
reduction of coupon payments would be needed if we
assume the bonds owed to Russia cannot be
rescheduled. However, the actual terms would be
result of negotiations. The market pricing seems to be
consistent with average of these two scenarios. In
addition, even if the actual scenario could be more
benign than what the market is pricing, it should be fair
for the market to price in some risk premium on top of
the NPV to compensate for any uncertainty that may
arise from the negotiations. The overall viability of the
whole program in this environment, however, remains
seriously questionable.
NPVs of a 5% coupon Ukraine bonds with varying
Apr-14
Jun-14
Aug-14
Oct-14
Dec-14
Feb-15
tenors and exit yields
NPV analysis with varying yield/maurity (coupon = 5.0%)
Source: Deutsche Bank
80
Ukraine
70
—
Neutral
Following late January indications that Ukraine has
requested an EFF program to replace the existing SBA
and it would consult with sovereign debt holders, the
bond market quickly moved to reflect a scenario of
maturity extension on the Eurobonds with a reduction
of coupons and/or a moderate notional haircut3. While
such a scenario is not far from our base case, we
cannot rule out something deeper.
10.00%
60
11.00%
12.00%
50
13.00%
Ukraine USD eurobonds
14.00%
40
0
2
4
6
8
Tenor
10
12
14
Source: Deutsche Bank
3
See Special Report – Sovereign Credit: Stress Testing the Weakest Links,
15-Jan-15.
Page 46
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Turkey
—
Overweight
—
Take profit in 10s30s curve flattener
Turkey gave back some of its outperformance during
the past week as oil rebounded and UST yields rose,
but we continue to see reasons to stay Overweight. We
are not convinced the recent oil rebound is sustainable,
as it is at odds with the fundamentals in the oil market.
We do not yet see significant risk for UST yields to rise
persistently in the near term. It is likely something we
will worry about later in the year.
The positive impact of lower oil prices on the real
economy has continued to be reflected in the recent
economic releases and forecasts, especially in
improved outlook in external balances and inflation
numbers. The main risk to our positive view on
Turkey’s credit spreads, besides higher UST yields, is
negative political developments, such as the ones
undermining central bank credibility.
Turkey’s 10s30s cash curve has flattened from its
steepest levels in a year as the new issues of 43s got
absorbed. We recommend taking profit in the 10s30s
cash curve flattener of 43s vs. TR 23s (entry: 63bp;
current: 39bp).
South Africa
—
Neutral. Electricity constraints pose a
significant risks but downgrade pressure also
eased
—
Maintain cash curve flatteners (41s vs. 25s)
After recent underperformance due to worsening
outlook in the energy sector and rising UST yields,
South Africa’s sub-index spreads have widened to
+40bp over investment grade average ex-Russia. It
looks increasingly attractive, but we refrain from being
Overweight at this point given rising electricity
constraints and higher UST yields. We continue to
favor cash curve flatteners via 41s vs. 25s (current:
35bp; target: 8bp).
Hungary
—
Overweight, for now
REPHUN bonds have continued to outperform and
become really expensive. With its 10Y bonds yield at
4.2%, it is trading like a BBB/BBB+ credit. So the rich
valuation has put our long-held Overweight position to
the test. In addition to a significant reduction in its
external vulnerability over the past few years, it is also
a beneficiary of all of the following factors: lower
energy prices, accommodative monetary policy in the
eurozone, and strong technicals with no issuance
planned in 2015 and close to USD2.8bn in repayments
(USD1.7bn of which is due in February). The days of
outsized outperformance of this credit are likely over,
but all these supportive factors seem to remain in place
for the foreseeable future. Hungary will likely continue
to behave like a low beta credit, despite its subinvestment grade rating. The REPHUN curve is flatter
than comparables and has flattened to below its
historical average in terms of slope. We favor the 10Y
sector, with the 23s being the cheapest bonds.
Hongtao Jiang, New York, (1) 212 250 2524
The fall in oil prices have contributed to a more
favourable macro outlook in South Africa (inflation to
dip below 4% and CAD to below 5%), but growth
continues to face challenges due to structural issues
and lack of structural reforms to tackle the problems. A
deteriorated power situation and continued uncertainty
regarding the public sector wage negotiation also
weighed on fundamentals, posing a significant nearterm risk. In addition, South Africa will remain one of
venerable credits under the scenario of US rate
normalization, but that is not a significant near-term
risk despite the stronger-than-expected US January
employment report. The risk of credit ratings
downgrade (especially from Fitch, which has it at BBB,
with a negative outlook) exists down the road, but the
pressure should abate somewhat as a result of
moderately stronger growth and an improving current
account deficit.
Deutsche Bank Securities Inc.
Page 47
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
LatAm Strategy

LatAm FX: Long MXN/COP (target 166); Long
PEN/CLP (target 210); Sell a 3M USD/COP put
@2350 (ref spot 2424) and buy a 3M EUR/MXN put
@16.85 with knockout @15.5 (ref spot 17.08).

Rates: Stay neutral Brazil. Receive TIIE1Y1Y vs ILS
1Y1Y (target 380 bp), receive TIIE 10s vs SA 10s
(target 190bp). In Chile scale into 1s3s flatteners
(target 30) and keep the spread trade receiving
CLP/CAM vs US (target 200 bp). In Peru buy the
Sob20s (target 4.30%). In Colombia receive IBR2Y
vs COLTES24s NDF (target 270 bp)

Credit: In Venezuela, the market has moved to
price somewhat higher recovery value due to oil
rebound; we remain in favor of the low priced
bonds. Argentine bonds look expensive, but will
likely remain stable in the short term. We prefer the
shorter duration bonds on the local law curve
(Bonar 17s). In Brazil, valuation is very attractive
but near term momentum remains negative due to
growth concerns and Petrobras’ problems; we stay
neutral for now, and favor short basis and 5s10s
curve flatteners. We are Neutral on Mexico, but see
value in cash curve flatteners on both UMS and
Pemex. Colombia’s credit spread looks a bit too
tight following the recent recovery in oil prices, but
we remain Neutral for now and favor cash curve
flatteners. We stay Underweight on Peru and Chile
(short Chile 10Y bonds).
Local Markets
BRAZIL
—
FX: Neutral
—
Rates: Neutral
FX: In the past two weeks BRL has gone from being
under 2.60 vs. USD (which we had viewed as too
strong) to above 2.85 (down >11%), as everything
seemed to go wrong for the local economy and the
ambitious fiscal target has been put in question.
Valuation is now more reasonable, and we have taken
profit on our MXN/BRL position, but downside risks are
still there, as further negative developments related to
water/energy rationing, the Petrobras saga, and/or the
political arena could very plausibly push the BRL even
further. On the upside, a return to a carry-positive
global environment and/or a higher than expected rate
hike in the March meeting (not our base case) could
see retracement in the currency. We remain neutral for
now given the significant uncertainty.
Rates: As recently noted by our economist, the signs
of a recession in Brazil are getting stronger by the day.
From the significant activity/investment slumps,
Page 48
prospective increase in unemployment, disappointing
forward looking indicators, deterioration of inflation
expectations, fiscal and political challenges, all pointers
suggest a difficult year with low (possibly negative)
GDP growth and inflation hovering above the upper
bound of the band. And despite the dovish tone of the
recent BCB’s communiqués, it is hard to rationalize a
deceleration (not to mention a pause) in the pace of
hikes with the continued rise in inflation (and
unraveling of inflation expectations). We believe that
rates will eventually adjust (our economist suggests a
terminal a terminal rate of 10% in 2016) and that not
only are eventual cuts underestimated but hikes might
be overestimated which would in principle bode well
for receivers in the Jan16-Jan18 sector of the curve. As
an example, the pricing in the front end does seem
aggressive – as of writing, 150 bp of hikes still puts the
Jan16 in the money (breakevens imply) which for us
looks exaggerated. However, risk premium (read
inflation and credit) might persist an in spite of the
fundamental value the risk of receivers could be
prohibitive in our view. Stay on the sidelines for now
waiting for an entry point for Jan16 receivers
CHILE
—
FX: Long PEN/CLP (target 210)
—
Rates: Enter 1s3s CLP/CAM flatteners (target 30),
receive CLP/CAM vs US in 10s (target 200 bp).
FX: Recent economic data (manufacturing, retail sales,
business confidence, and economic activity) has
recently surprised on the upside, igniting cautious
optimism on economic recovery and, together with the
high inflation print, erasing further easing from the
rates curve (see below). Our economist views the
positive economic readings as insufficient to indicate
the beginning of a recovery, however (nor to preclude
further cuts). Moreover, we expect copper, down more
than 11% ytd, to continue trading weak, given our
China economist’s bearish view. While we expect CLP
to outperform once copper stabilizes and the local
economy turns (especially given its low beta to US
tightening), we believe that the currency, which
appears overvalued vs. financial drivers (while
appearing
undervalued
on
more
fundamental
measures) will weaken further in the short-term. We
like being long PEN/CLP (target 210), partially hedging
potential copper strength (a less likely scenario in our
view) and enjoying much better carry than long
USD/CLP.
Rates: Hawkish BCCh minutes followed by couple of
positive data points later (business confidence and high
inflation in particular) led to a significant re-pricing of
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Chile’s front end. From almost 2 cuts being priced
in ’15 to basically nothing and some hikes priced in
2016 the re-pricing affected mostly the 2/3 years
sectors of the curve and naturally resulted in the
overshooting of front end steepeners, inflation
breakevens and flattening in the longer tenors. In a
nutshell a lot has changed in the last week of
January/first week of February and it feels that we are
for now sitting in a cross-road. In the front end in, in
our view, a wait and see game. We think that the front
end steepeners will eventually fade as the markets wait
for more numbers. Our economist is still bearish the
economy and advocates for cuts which bodes well for
front end receivers/flatteners. However, if the economy
proves us wrong (on the upside) we see two possible
scenarios: flatteners in the front end if the BCCh reacts
earlier to strength or steepness in the belly if the
market perceives that the BBCh as behind the curve.
One can combine this view by receiving 3s in a fly vs
1s5s, a spread that has been trading close to its recent
highs or simply receive 1s3s as we see the odds of
further steepening as low. Further down the curve we
keep our spread compression trade vs the US (10Y)
sector on the divergence of the natural rates.
COLOMBIA
—
FX: Long MXN/COP (target 166); Sell a 3M
USD/COP put @2350 (ref spot 2424) and buy a
3M EUR/MXN put @16.85 with knockout
@15.5 (ref spot 17.08).
—
Rates: Receive IBR2Y vs COLTES24s NDF
(target 270 bp)l
FX: COP continues to follow oil, trading range-bound
since the beginning of the year, with massive swings at
times. Given the weak prospects for material oil
recovery and what we expect to be a gradual but
painful materialization of lower prices on the economy
and on external accounts (already evident on some
fronts, see Colombia country section), we continue to
believe that a significant rebound in COP is not likely.
To express this, we like buying MXN/COP, based on
our oil view, the differing exposure of these currencies
to oil prices, and current levels (see also MXN section).
Alternatively, we re-iterate our recommendation of
expressing the view of low probability of COP rebound
by selling USD/COP puts, which appear too expensive
relative to this view. For example, consider financing a
3M EUR/MXN put struck at 16.85 (with knockout
@15.5) (ref spot 17.08) by selling a 3M USD/COP put
@2350 (ref spot 2424) (bbg indicative pricing), or less
aggressive versions of this trade (strikes that are further
out of the money on both legs).
Rates: The rally in oil resulted in the re-pricing of the
cuts in the front end in IBR and a relief rally (vs IBR) of
the much battered back end issues of the IBR curve.
Deutsche Bank Securities Inc.
On the economic front while inflation remains above
3% and forward looking indicators upbeat, activity has
not reflected the effects of the slump in oil prices. We
could therefore see the front end once again pricing a
more dovish path for BanRep going forward. Further
down the curve, the back end of TES continues to
show interesting relative value opportunities. After the
correction on the T19s (which were too rich) we see
the 24s as the richest point of the curve. We would
suggest selling 24s, switching to the 28s or maybe the
30s for those willing to keep the duration exposure.
Altogether we favor a hybrid exposure receiving IBR2Y
vs TES24s as the back end in general looks rich in TES
given the low levels of oil prices.
MEXICO
—
FX: Long MXN/COP (target 166); Sell a 3M
USD/COP put @2350 (ref spot 2424) and buy a
3M EUR/MXN put @16.85 with knockout
@15.5 (ref spot 17.08).
—
Rates: Receive TIIE1Y1Y vs ILS 1Y1Y (target
380 bp), receive TIIE 10s vs SA 10s (target
190bp). and buy the MUDI40s vs TIPS40s
(target 200 bp)
FX: A combination of EMFX-wide weakness and
disappointing local data have weighed on MXN in
recent weeks, and it has recently crossed the 15.0
mark vs. USD for the first time, in spite of the rebound
in oil and the hawkish signs from Banxico (and
corresponding rates repricing). Growth expectations for
the next several years have deteriorated, and the
recently announced spending cuts (and lower
probability of further monetary easing) are not helping
sentiment. Prospects for deepwater oil drilling projects
are dim, and would require oil to stage a dramatic
rebound (say to the $70 level) in order to become
relevant again, which seems unlikely. Having said all
that, we believe that at current levels MXN is oversold.
First, it appears too cheap when regressed vs. financial
drivers such as US equities and rates and oil prices.
Second, the currency seems to have oversold on the
plunge in oil prices given the low dependence of
external accounts and the local economy on oil. The
reduction in expected FDI flows seems to have been
more than priced in already, and our economist still
expects $5-10bn of additional FDI flows as a result of
the energy reform (having expected about $20bn prior
to oil repricing). Third, the competitiveness of local
industry should improve as result of recent MXN
weakness (and more medium term, due to certain parts
of the energy reform), and our economist expects
stronger spillovers of US growth into local
manufacturing activity and exports. Finally, positioning
remains favorable. We like buying MXN vs. COP. The
cross currently appears displaced vs. oil prices, and
should do well if these continue to decline (which we
Page 49
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
see as more likely than an oil recovery. In addition to
significant oil recovery, increased chances of US
tightening (i.e. hawkish hints by Yellen / firming
inflation) might also hurt this cross, as MXN is more
susceptible to portfolio outflows than COP. However,
at current levels and with positioning where it is, we
see this risk as reduced.
An alternative
implementation which also incorporates our bearish
EUR view is financing a 3M EUR/MXN put struck at
16.85 (with knockout @15.5) (ref spot 17.08) by selling
a 3M USD/COP put @2350 (ref spot 2424) (bbg
indicative pricing, see also COP section).
Rates: It has been a wild ride for the front end in
Mexico. From pricing cuts before Banxico’s January
meeting to selling off together with the recent spike in
oil and upbeat US numbers point, the 1Y1Y moved up
by more than 60 bp from the lows returning all the
gains in front end receivers for the month of January.
We believe that while still heavily dependent on the
Fed, little has changed in Mexico’s economic backdrop
of benign inflation and disappointing economic activity.
The front end of TIIE is pricing a pace of hikes that
seems excessive in our view – given the low levels of
pass through we see hikes in tandem with the Fed as
opposed to 2x as fast as implied by the curve.
Moreover, if the Fed does not hike we would not rule
out a cut given the activity slump. Altogether the
backdrop support front end bull flatteners in TIIE vs US
or laggards of the latter – we particularly like receiving
in the 1Y1Y point in TIIE vs ILS. Further down the curve
the premium seems excessive from the 5Y sector on –
a 2s10s flattener (either outright or in a box vs US) is a
structurally sound trade but foreign participation in the
back end might bring some steepening before
flattening ensues due to hedging activity in the 10Y
sector of the MBONOs curve. We therefore prefer to
receive TIIE vs South Africa (10Y), a spread we believe
should be structurally higher (credit and inflation
differentials) in a market that shares similar level of
foreign participation. On the latter the back end
continues to outperform vs swaps even though some
of the recent distortion has been corrected. Bonds
continue to look cheap in the 3Y-5Y year sector boding
well for either hybrid flatteners (paying 2s vs Jun20s for
example) or buying bonds in the 3Y sector (Dec18s vs
swaps). As a core position we still like receiving the
long end of the MUDIs vs TIPs.
PERU
—
FX: Long PEN/CLP (target 210)
—
Rates: Buy the Sob20s (target 4.30%).
FX: PEN has been an underperformer so far this year,
down about 3.5% vs. USD ytd (and about 11.5% since
July). While terms of trade have deteriorated with the
drop in commodity prices, and while the economy has
surprised on the downside recently, prompting BCRP to
cut rates (and leave the door open for further easing),
Page 50
we believe that PEN is oversold. We expect central
bank support of PEN to continue and possibly increase,
in case depreciation pressures persist (BCRP President
Velarde recently indicated that the currency had
weakened too far in his opinion and that the
fundamental value vs. the dollar was 2.94-3.00
(currently 3.08)), and NDF positioning is stretched,
limiting further downside (currently over $9bn, up from
$2bn in July). Taking into account the high carry
(currently about 5% at the 3M horizon, annualized) and
exposure to copper prices, we like buying PEN/CLP,
targeting 210.
Rates: We have recently highlighted the richness of the
S31s and recommended switching out of it. The front
end (S20s) offers attractive yield pick-up and exposure
to monetary policy. While copper has shown some
signs of improvement, declining inflation, disappointing
activity and dovish signs from the CB suggest further
room for cuts. Attractive carry and exposure to
monetary policy suggest therefore shortening the
duration to the front end – we like the S20s.
Guilherme Marone, New York, (212) 250-8640
Assaf Shtauber, New York, (212) 250-5932
Credit
ARGENTINA
—
Neutral; stable in the near term, but volatility
may be on the rise later if HY investors take
profit
—
Stay long Bonar 17s
While the expected government change in October
remains a good anchor for asset prices in Argentina
and enhanced external liquidity will likely ensure a
muddle-through scenario for the current government,
the risk of HY investors taking profit cannot be ignored.
Valuation does not look attractive for bonds in default
but trade at a 9% yield. The global bonds have rallied
by 18% from recent lows in December 2014 and 75%
from the lowest levels after the litigation risk emerged
(observed in March 2013). Now with plenty of
(potential) opportunities in the US energy HY sector
(and other EM names as well) there may be good
reasons for some HY holders to take profit, while many
EM dedicated investors are not yet ready to re-enter
given that bonds are still in default. Such risk is not our
baseline at the moment, and it also does not appear to
be a significant worry for the near term. We stay
Neutral at this point – Argentina will no longer be as
much of an outperformer as it was in 2014, but it will
likely remain relatively stable in the coming months.
We continue to favor short duration local law bonds
and stay long on Bonar 17s (we also switch from
Boden 15s to Bonar 17s).
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
BRAZIL
—
Neutral,
—
Short 5Y basis; hold cash 5s10s flatteners and
also switch from 19Ns to 21s
The risk of credit rating downgrade on Brazil was all
but diminished a month ago on a better fiscal prospect
under the new economic team. Such risk is now back
on the table due to Petrobras’ problems and, more
importantly, a worse-than-expected growth prospect.
The contagion risk from Petrobras is well-documented,
and investors are especially worried about the potential
contingent liabilities should the company fail to
properly report is corruption-related write-offs,
exposing itself to litigation and potentially resulting in a
technical default (though this is not our company
analyst’s baseline). However, that alone would not
necessarily lead to a downgrade on Brazil’s credit
rating, as Moody’s recently clarified: “adding
Petrobras’ debt to the country’s outstanding debt stock
(bringing Debt/GDP to ~70%) would not trigger a
downgrade of the sovereign to junk as long as Brazil
maintains a strong balance of payments.” The agency
recently downgraded Petrobras to Baa3 and left it on
credit watch for a further downgrade (to junk). It rates
Brazil at Baa2, but with a negative outlook.
However, even if we put the Petrobras problem aside,
the downgrade risk resurfaces on a gloomy growth
outlook. As our economist puts it, fiscal tightening,
rising interest rates, lower commodity prices, the
financial difficulties faced by oil company Petrobras,
and the growing risk of water and energy shortages all
conspire against Brazil’s economic recovery. We have
cut our 2015 GDP growth forecast to -0.7% from 0.3%.
The poor growth prospect, combined with difficult
political dynamics (the congress is becoming
increasingly hostile toward President Rousseff) make it
more difficult for Finance Minister Levy to deliver the
targeted primary surplus of 1.2% of GDP this year. We
cut our 2015 primary surplus forecast to 0.8% from
1.2% of GDP. This would not necessarily make Brazil
lose its current investment grade status, but a
downgrade to BBB- seems likely later in the year,
especially if the Petrobras problem is not resolved
quickly.
The market has re-priced recently to reflect both the
Petrobras contagion risk and the worse macro prospect.
At +60bp above the EM sovereign investment grade
average (ex-Russia), our model suggests that the
market is pricing a 1.5 notch downgrade to a rating
scale between BB+ and BBB-. This pricing is especially
pronounced if we take into consideration that the
market is pricing on average a 1.2 notch upgrade for
other IG sovereigns (ex-Russia), based on the same
model. So credit spreads have likely overshot
Deutsche Bank Securities Inc.
fundamentals on Brazil sovereigns. However, given
continued uncertainty around Petrobras, near term
momentum is not on Brazil’s side. We remain Neutral
for now, but we expect Brazil’s spread to recover down
the road as the situation with Petrobras stabilizes.
The market is pricing a 1.5 notch downgrade on Brazil
BR Rating Profile
11
10
9
8
7
actual rating
6
May-13
Sep-13
Jan-14
May-14
implied rating
Sep-14
Jan-15
Source: Deutsche Bank
Regarding the sovereign curve, the CDS/bond basis has
widened recently on higher UST yields. 5Y basis on
19Ns look excessively wide, as a result of the richness
of 19Ns. We recommend selling basis via short 5Y CDS
vs. 19Ns (entry: 123bp, target: 80bp; stop: 140bp).
The 10s30s cash curve has flattened over the past two
weeks (which enabled us to take profit in the 45s vs.
10Y CDS recommendation), but it remains steep (based
on historical standards). We are neutral right now
regarding 30Y bonds vs. 10Y bonds.
At the shorter end of the curve, the 19Ns remain
excessively rich to the curve. While maintaining our
5s10s curve flattener recommendation (23s vs. 19Ns),
we also view a switch trade from 19Ns to 21s as
attractive (entry: 104bp, target: 55bp; stop: 120bp), due
in part to the recent cheapening of the 21s.
CHILE
—
Underweight, stay short 25s
Chile, which has 17% of its GDP in mining and minerals
exports, is the most exposed EM economy to the
weakness in this sector (and to China’s macro risk). The
fiscal and monetary stimulus helps in curbing some of
the impact on economic growth, but further potential
weakness in the sector will likely have a negative
impact on Chile’s credit performance4.
4
We note that copper, just like crude, is also a commodity that is oversupplied (due to strong production growth), while facing slower growth in
global demands, especially from China. Copper makes up close to 20% of
Page 51
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Chile’s credit standing is unlikely to be materially hurt
by the recent slide in copper prices over the past few
months, because of the outstanding government
balance sheet quality (public sector external debt/GDP
is less than 15%), but the tight spread offers an
inexpensive hedge vs. a potentially deeper risk scenario
in copper and mining commodities and in China’s
growth. Chile bonds look every expensive in the
context of global credit market pricing after the recent
rally, as indicated by our Market Implied Rating model.
This suggests that the market has not priced in the risk
discussed above at all. Valuation in Chile 10Y bonds
(which are also expensive to the long end) look
especially tight (at a mere 60bp over labor), offering an
inexpensive hedge via a short position. The current
levels of bond yields (2.7%) are materially below the
average of the past two years (see the graph below).
We recommended short Chile 25s on 22-January-15 at
a price of 102.4 (rates un-hedged) as an inexpensive
proxy hedge against further potential fallout of China’s
growth, with the associated further slide in copper
prices, and we maintain this position.
market 5 will likely be consistent with a weakening
external account for Colombia in terms of widening
CAD and reduced support from FDIs. Therefore, we see
limited scope for Colombia to continue recovering and
we stay Neutral at this level. We continue to favor the
long end of the curve. The 10s30s has flattened from
very steep levels, but Colombia remains one of the
steepest curves in EM. On Ecopetrol, the 45s have
richened again vs. 43s and we maintain the 43s vs. 45s
switch.
Ecopetrol 43s are still looking very cheap to the 45s
50
Libor Spread Difference (bps)
45
40
35
ECOPET 43s - ECOPET 45s
30
25
20
15
10
Chile bond yields are close to the tighter end of the
past 2Y range
CH '22
Mid Yield (%)
4
5
May-14
Jul-14
Sep-14
Nov-14
Jan-15
Source: Deutsche Bank
CH '25
Avg CH '22 Yield (past 2yr)
3.75
MEXICO
3.5
3.25
—
Neutral
3
—
We favor flatteners in both UMS (44s vs. 23s)
and Pemex (44s vs. 4.875 24s)
2.75
2.5
2.25
Jan-13
May-13
Sep-13
Jan-14
May-14
Sep-14
Jan-15
Source: Deutsche Bank
COLOMBIA
—
Neutral
—
Favor cash curve flatteners (45s vs. 24s).
Switch from Ecopetrol 45s to 43s.
Colombia’s credit spread has recovered by some 15bp
vs. the EM investment grade sovereign average (exRussia) over the past two weeks as a result of the
rebound in oil prices. We are skeptical on how
sustainable this oil recovery will be and see the risk of a
renewed slide in the near term. Short-term oil price
variation aside, the rather poor outlook for the oil
all metal demand from the Chinese property markets, which is under
pressure and facing further downside risk.
Page 52
The impact of lower oil prices on Mexico’s external
balance and public finances is more of a medium term
concern rather than a current one, due to offsetting
factor of gasoline imports and FX depreciation as well
as oil hedges at USD76/bbl. To that end, a net positive
effect of the spending cut by the government in the
medium term is to prevent an additional deterioration n
the debt/GDP ratio, even though they come with a near
term cost on growth. Nevertheless, the overall negative
impact of lower oil prices has been fairly reflected in
Mexico’s credit spreads, which have widened from 40bp vs. the investment grade average ex-Russia last
October to the current -20bp. We covered Underweight
last month and maintain a Neutral position this month.
Recently, the 10s30s curve in Mexico has re-widened
to historically steep levels (80bp) and is the steepest
among major EM credits. We see it as attractive in
entering the cash curve flatteners of Mexico 44s vs.
23s (entry: 78bp. target: 60bp; stop: 90bp).
5
The median forecast by analysts available on Bloomberg is for WTI to
below USD60pb in 2015, still a negative scenario for EM oil exporters.
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Pemex bonds sold off significantly in December and
January, but have recovered part of the loss during the
past two weeks as oil prices rebounded. We see the
current Pemex/UMS spread differential (80bp at the
10Y sector and 100bp at the 30Y sector) as fair.
However, the Pemex curve is exceptionally steep (see
the graph below). We also recommend cash curve
flatteners on Pemex via long Pemex 44s vs. 24s
(current: 103bp; target: 70bp; stop: 120bp). Pemex
issued USD6bn in January (with more concentration at
the long end), completing its issuance plan for this year.
Mexico and Pemex 10s30s have sharply steepened
recently
85
Par equivalent Spread Difference (bps)
80
Par equivalent Spread Difference (bps)
100
MX 44s - MX 23s
75
110
90
70
Pemex 44s vs. Pemex 24s
Pemex 44Ns - Pemex 25s
65
80
60
70
55
The liquidity position in Venezuela has been enhanced
by transactions happened recently such as the
monetization of Dominican Republic’s Petrocaribe debt,
resulting in close to USD2bn in cash. The transactions
will likely add about USD3.75bn liquidity, equivalent to
an oil-price increase of about USD6bn based on
1.65mbpd cash-generating oil exports. However, this
hardly changes anything in light of the more-thanUSD30bn external financing gap if oil prices (for the
Venezuela mix) average less than USD50pb in 2015.
While some meaningful changes to the current policy
mix may increase recovery value on the bonds (hence
increasing the price of the bonds), the government has
disappointed the market with a less-than-expected
devaluation by leaving 70% of the transactions at the
6.3 Bolivar/USD rates. Actually, even with at a deeper
devaluation we believe it would help little in terms of
lowering the default risk; it would, however, help
increase recovery value at the margin.
60
50
45
50
40
Feb-14
40
Feb-14
May-14
Aug-14
Nov-14
Feb-15
May-14
Aug-14
Nov-14
Feb-15
Source: Deutsche Bank
Venezuela and PDVSA bond repayment schedule, next
12 months
Monthly Repayments (USD bn)
VE Principal
PDVSA Principal
3.5
VE Interest
3.0
PERU
PDVSA Interest
2.5
VENEZUELA
—
Neutral; default/restructuring is our base case
scenario, but most bonds are already trading at
recovery
—
We favor the very low priced bonds at the long
end of the curves
Deutsche Bank Securities Inc.
2.0
1.5
1.0
0.5
Feb-16
Jan-16
Dec-15
Nov-15
Oct-15
Sep-15
Aug-15
Jul-15
Jun-15
0.0
May-15
After having recovered from January losses, Peru’s
Sub-index spread is now trading at parity with the EM
investment-grade average (ex-Russia). Peru is the
second largest metals and mining exporter in EM (at
9% of GDP) after Chile, with this sector contributing
about 12% to the government’s revenue. Given that
Peru is in the middle of an investment boom in this
sector, its current account has shown a high level of
volatility over the past two years (due to US rate
concerns and a fall in commodity prices). The recent
investments are expected to significantly increase
copper production in the coming years, but the risk is
whether any further drop in copper prices will offset
the ramped-up production. In any case, over the near
term, the risk of a further drop in copper prices could
weigh on Peru’s performance, notwithstanding its
strong government balance sheet. Valuation looks tight
and we remain Underweight on Peru in light of such
risk, a recommendation we have held for a few months.
Apr-15
Underweight
Mar-15
—
Source: Deutsche Bank
A credit event within the next 12 months remains our
base case scenario, with February 2016 bearing the
highest event risk due to the over USD2.0bn sovereign
principal and coupon repayments, but the risk of a
default in 2015 is also very high. Given the recent
remarks by the VP of economy Marco Torres, we
believe that the EUR-15s will be paid. After that, May
2015 will likely be another pressure point as PDVSA
will be due to pay a large amount of interest.
In terms of asset selection, we continue to recommend
the most conservative approach and we favor the
lowest priced bonds with a coupon due within the next
two months to minimize the potential loss at a near
term default – this suggests that PDVSA 27s and 37s,
and Venezuela 38s are the most defensive choices (see
the table below). For investors that are more confident
that the government can survive 2015 without
Page 53
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
defaulting, we extend the horizon to the end of January
2015 and update this analysis. Under that scenario,
these three bonds remain among the most attractive.
P/L of Venezuela and PDVSA bonds under scenario of
end-of-April default and varying recovery assumptions
Bond
P'15
P'16
P'17
P'17N
P'21
P'22
P'24
P'26
P'27
P'35
P'37
V'16
V18O
V'18N
V'19
V'20
V'22
V'23
V'24
V'25
V'26
V'27
V'28
V'31
V'34
V'38
Cpn
5.00
5.13
5.25
8.50
9.00
12.75
6.00
6.00
5.38
9.75
5.50
5.75
13.63
7.00
7.75
6.00
12.75
9.00
8.25
7.65
11.75
9.25
9.25
11.95
9.38
7.00
Next Cpn
Date
Oct
Apr
Apr
May
May
Feb
May
May
Apr
May
Apr
Feb
Feb
Jun
Apr
Jun
Feb
May
Apr
Apr
Apr
Mar
May
Aug
Jul
Mar
Current
Dirty PX
90.5
62.1
46.0
63.2
41.3
48.0
34.8
34.3
34.4
42.4
34.2
71.5
59.1
40.0
39.4
36.4
50.9
40.0
39.3
39.0
46.3
44.7
41.3
42.4
39.6
38.2
Cpn b/f
def
2.5
2.6
2.6
0.0
0.0
6.4
0.0
0.0
2.7
0.0
2.8
2.9
6.8
0.0
3.9
0.0
6.4
0.0
4.1
3.8
5.9
4.6
0.0
0.0
0.0
3.5
Claim
w/ PDI
100.0%
100.0%
100.3%
104.2%
104.1%
102.6%
102.7%
102.8%
100.3%
104.4%
100.3%
101.0%
102.8%
102.9%
100.4%
102.4%
102.4%
104.3%
100.4%
100.2%
100.3%
101.2%
104.4%
102.8%
102.8%
100.6%
P/L at default w/ recovery
25%
30%
35%
-70%
-64%
-59%
-56%
-48%
-39%
-40%
-29%
-18%
-59%
-51%
-42%
-37%
-24%
-12%
-33%
-23%
-12%
-26%
-11%
3%
-25%
-10%
5%
-19%
-5%
10%
-38%
-26%
-14%
-19%
-4%
11%
-61%
-54%
-47%
-45%
-36%
-28%
-36%
-23%
-10%
-27%
-14%
-1%
-30%
-16%
-2%
-37%
-27%
-17%
-35%
-22%
-9%
-26%
-13%
0%
-26%
-13%
0%
-33%
-22%
-11%
-33%
-22%
-10%
-37%
-24%
-12%
-39%
-27%
-15%
-35%
-22%
-9%
-25%
-12%
1%
Source: Deutsche Bank
Meanwhile, we continue to recommend selling some of
the bonds due within the next couple of years, such as
Venezuela 16s and PDVSA 16s and 17Ns. The market
has simply not priced in enough default risk on these
bonds. For example, Venezuela 16s are still trading
close to 70pts, representing more than 50% loss at
default. We believe the risk of default before the
maturity of this bond (26-Feburuary-16) is exceedingly
high.
Hongtao Jiang, New York, (212) 250-2524
Srineel Jalagani, Jacksonville, (212) 250-2060
Page 54
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
China
Aa3/AA-/A+
Moody’s/S&P/Fitch
A weak Q1 as expected
The weak macro data reinforces our view that the fiscal
slide has led to a sharp contraction of domestic
demand and the growth will slow sharply in Q1. The
slowdown in property investment alone cannot explain
why demand weakened faster in January. We believe
the full impact of the fiscal shock started to show in Q1.
Fiscal slide dragged production and imports
The official PMI dropped to 49.8 in Jan from 50.1 in
Dec, the first time below 50 since Sep 2012. New
orders dropped to 50.2 from 50.4, output to 51.7 from
52.2, and finished goods inventory rose to 48 from 47.8.
The business expectation index dropped to 47.4,
lowest level since the initiation of this index (Jan 2013).
The PMI for large firms dropped by 1.1ppt to 50.3 in
Jan from 51.4 in Dec, the biggest drop for these firms
since May 2012. We believe this reflects that the
decline of fiscal revenue for local governments started
to affect state-owned enterprises including LGFVs. This
is consistent with the unusually weak funds available
for FAI whose growth dropped sharply to 5.9%yoy in
Q4 from 13.5% in Q2 and 11.1% Q3. It also explains
why the HSBC PMI improved while the official PMI
dropped, as the later has more weight for large firms.
China's export growth dropped by 3.3% in Jan. Import
growth dropped by 19.9%. Trade balance soared to
historical record of US$60. On 3mma basis, export
growth dropped from 8.6%yoy in Dec to 3.7%yoy in
Deutsche Bank Securities Inc.
China merchandise imports and exports
Trade Balance, USD 100 mn
Value of Exports, yoy%, rhs
Value of Imports, yoy%, rhs
700
600
40
30
500
20
400
300
10
200
0
100
0
-10
-100
-20
-200
Oct-14
Dec-14
Aug-14
Apr-14
Jun-14
Feb-14
Oct-13
Dec-13
Aug-13
Apr-13
Jun-13
Feb-13
-30
Oct-12
-300
Dec-12
Main risks: We see rising downside risks to our
GDP forecast of 7% in 2015. We are comfortable
with our forecast of a sharp slowdown in H1 to
6.8%. The downside risks are mostly in H2. We
expect a rebound to 7.1% in Q3 and 7.2% in Q4, as
we see aggressive policy easing on both fiscal and
monetary fronts. But policy stance has been tight
so far with little signal to change, particularly on
the fiscal front.
Jan; Imports declined from -1.7%yoy to -9.6%yoy in
Jan, slowest growth since mid-09. We believe the fiscal
slide is the key driver for the surprisingly weak imports.
Aug-12

Economic outlook: We reiterate our view that the
economic growth will surprise on the downside in
H1, as the economy faces a "double whammy" due
to property slowdown and a fiscal slide. We believe
the fiscal slide has started, as total government
fiscal revenue dropped by 0.1% yoy in Q4 2014,
and it will worsen quickly in H1 2015. We think the
fiscal slide happened as a surprise to the market
and the government. We believe the policy makers
have started to realize the impact of the fiscal
shock on the economy, and they will likely loosen
fiscal and monetary policies aggressively in H1.
Jun-12

Source: Deutsche Bank, WIND
The surprise in imports is not due to commodity prices
drop. Note that commodity prices already dropped
significantly in 2014, yet import growth only dropped
by 2.3% yoy in December 2014, as import volume
picked up and offset the drop in prices. In January both
import prices and volume declined (oil volume growth 0.6%yoy in Jan, +13.4% in Dec; iron ore -9.4% yoy in
Jan vs. +18.4% in Dec; coal -53.2%yoy in Jan vs.23.2% in Dec). Excluding commodities and processing
trade, imports growth slowed by 12.2%yoy in Jan (0%
in Dec). This suggests a sequential slowdown in
domestic demand is the key driver.
We disagree with the view that the weakness is caused
by seasonal effect of spring festival or over-involving of
last Jan. Note that consumption-oriented product
categories that are intact to above factors showed
significant slowdown as well. The growth of auto
imports, for example, dropped to -9.5%yoy in Jan from
+7.1% in Dec. In addition, the seasonal adjusted total
imports still reported a decline of 14.4%yoy.
We reiterate our view that RMB is unlikely to
depreciate significantly in 2015. As a baseline, we
expect CNY exchange rate against USD to be 6.2 at
year end, flat from 2014. We see risks are skewed
toward a small depreciation, but strong trade surplus
makes it unlikely to depreciate by more than 5%.
Page 55
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
A RRR cut by PBoC likely driven by the fiscal slide
The announcement by The PBoC on Feb 4 cut the
reserve requirement ratio (RRR) by 50bp for all the
banks, and cut the RRR by an extra 50bp for some
municipal and rural commercial banks whose lending
to small enterprises reached certain threshold level.
The PBoC also cut the RRR for China Agriculture
Development Bank by 450bp.
Government revenues growth, quarterly
The RRR cut is broadly in line with our expectation,
though it happened one month earlier than we
expected. We expected the PBoC would cut RRR in
early March when the economic data for Jan and Feb
become available. The PBoC did not wait to see the
data, which suggests to us the economic momentum
probably surprised on the downside for the
government.
We expect more easing measures to come. We
continue to expect another RRR cut of 50bp in Q2. We
also continue to expect two interest rate cuts, but we
revise our call on timing, and expect the two cuts to
happen in March and Q2, instead of Q2 and Q3. We
expect the interest rate cuts to be symmetric, with
25bp each time for both benchmark deposit and
lending rates. More importantly, we expect a pickup of
M2 growth to 14% in 2015 (Consensus 12.7%).
The RRR cut likely releases liquidity of RMB640bn into
the bank sector. We think the impact on the real
economy is positive but it is not enough to stabilize the
economy, as it helps to raise loan supply but loan
demand may remain weak. We believe a more
proactive fiscal policy is necessary to boost final
demand. So far the fiscal policy follows a tightening
stance, particularly on local government side. We
expect the fiscal stance to loosen in coming months,
with central government fiscal spending picking up and
quasi-fiscal spending through policy banks rising. If
such fiscal policy loosening does not materialize, we
see downside risks to our GDP forecast of 7% for 2015.
Fiscal slide forces local gov't to cut 2015 growth target
China’s Ministry of Finance disclosed the 2014 full-year
fiscal data. As we expected, local government land
proceeds dropped sharply by 21% yoy in Q4 2014,
dragging the local government total fiscal revenues
growth to -3% yoy in Q4 vs. 20% in Q1 2014, 12% in
Q2 and 5% in Q3. Total government fiscal revenue
(including both local and central) dropped to -0.1% in
Q4, compared to 15% in Q1, 10% in Q2, and 5% in Q3.
For 2014, local government revenues grew by 7.6%
and total government revenues by 7.2%, both the
slowest in two decades. We expect the trend to
continue in H1 2015 with total government revenue
growth down to -2% and -3% in Q1 and Q2. Note that
the value of land auctions dropped sharply in H2 2014,
and it usually leads local government land proceeds by
one-to-two quarters. This suggests that the fiscal slide
will worsen in H1 2015.
Page 56
Source: Deutsche Bank, Wind, MoF
Moreover, economic growth in 30 of the 31 provinces
and municipalities missed their yearly targets in 2014.
The resource-rich Shanxi province saw the biggest
shortfall, with its 4.9% annual GDP growth in
comparison to the pre-set goal of 9%. Other provinces
that have missed their expectation by more than 2.5ppt
include Liaoning (5.8% vs. 9%), Heilongjiang (5.6% vs.
8.5%) and Yunnan (8.1% vs. 11%). Tibet is the only
province that has met its target (12% vs. 12%).
Land auctions value leading land proceeds of
local governments
Source: Deutsche Bank, CREIS, WIND
Indeed, the gap between the target and reality widened
after the RMB4tr stimulus launched in 2009 ran out of
steam. There were 1, 13 and 17 provinces that fell
short of their targets in 2011, 2012, and 2013
respectively. Aggregating the regional figures by their
weights in the economy, we find that the actual growth
in 2014 fell short of expectation by 0.9ppt. Such a gap
is much wider than the 0.5ppt in 2013 and 0.1ppt in
2012. In 2011, the weighted-average growth exceeded
the target by 1.5ppt.
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Given the sluggish economic growth and fiscal
pressure from dropping land sales, local governments
have become much less ambitious than before. All of
the 27 provinces and municipalities that have
concluded their local People’s Congress have lowered
their growth target for 2015. The decline is as
significant as 1.5ppt in simple average and 1.3ppt in
weighted average, while the central government has
edged down its growth target by 0.5ppt, from 7.5%
last year to 7% for 2015. The municipality of Shanghai
has even eliminated its 2015 economic growth target,
as “the government is paying more attention to
developing a pilot free-trade zone and to economic and
social reforms”, according to Mayor Yang Xiong.
Growth slows in 2014 with signs of
weakness in H12015
The National Bureau of Statistics released 2014 annual
macro data for China on 20 January. The headline
annual numbers are broadly in line with our
expectations, with weak economic activity and rising
fiscal pressure. Meanwhile, there are signs of structural
improvement in the economy as labor market remained
resilient amid slower urbanization, consumption and
service sector gaining weight in the economy.
Headline GDP looks fine but signs of weakness loom
GDP growth slowed marginally to 7.3% in 2014Q4
from 7.4% in Q1-Q3, the lowest level since 2009Q1.
Growth slowed more in sequential qoq saar terms to
only 6.1% from an average of 7.4% in Q1-Q3. The
preliminary number of 2014 annual GDP growth rate is
7.4%, down from 7.7% in 2012 and 2013. The
deceleration in economic activities is also reflected in
industrial production (IP) and fixed asset investment
(FAI). IP grew 8.3% in 2014, down from 9.7% in 2013.
Mining and ferrous metal processing sectors saw the
biggest drop in annual IP growth rate, down 2.8 ppts
on average to 5.4% in 2014. FAI grew 15.7% in 2014,
down from 19.6% in 2013. Specifically, growth in
manufacturing FAI decelerated to 13.5% from 17.8% in
2013, property investment decelerated to 10.5% from
19.8% in 2013, and infrastructure investment (including
power and heating sectors) slowed slightly from 21.2%
in 2013 to 20.6% in 2014.
December data reveal more worrisome signs of
weakness in property and infrastructure investment.
Production of cement, power and crude steel grew 1.4%, 1.3% and 1.5% yoy in December, much slower
than the 2014Q1-Q3 growth rate of 3.0%, 4.4% and
2.3%, respectively. Property investment fell sharply
from 11.9% ytd yoy in November to 10.5% in full year
2014. Moreover, the effect of the fiscal slide has
started to show on the economy. Growth in total funds
available for FAI fell to 5.9% yoy, 3mma, in December
from 8.5% in November and 11.4% in October, its
lowest level since 1999. Note that it also slowed
sharply in Q1 2012 when land sale revenue slowed.
Deutsche Bank Securities Inc.
Low inflation provides room for policy easing
Inflation has been low persistently in 2014, with
monthly CPI edging down gradually from 2.5% in May
to 1.5% in December (compared with an average
monthly rate of 3.0% during 2005-2013), while PPI
reached a 27-month low to -3.3% in December 2014.
M2 grew 12.2%, which is the lowest annual growth
rate since 1990. Outstanding total social financing
(TSF) grew 14.1% yoy, the lowest level since 2006.
Risks in real economic activities and a benign inflation
environment as described above will most likely
prompt the PBOC to ease monetary policy in 2015 by
cutting the benchmark interest rate by 50bps and the
reserve requirement ratio by 100 bps. This, together
with more active fiscal spending as we expect, will
help pull the economy back to 7%+ yoy growth rate in
2015H2.
In the property sector, despite the narrowing sales
value decline from the August 2014 trough of -8.9% ytd
yoy to -6.3% full year 2014, investment growth
dropped sharply to 10.5% in 2014 from 19.8% in 2013.
In addition, funds available for developers worsened
from 0.6% yoy ytd Jan-Nov to -0.1% full year. Going
into 2015, we expect property investment to slow
moderately nationwide at least until mid-2015, but
more aggressively in tier 3 and 4 cities and the
commercial property market. Note that in the past
housing cycles, the turning point of property sales led
that of property investment growth by an average of
seven months.
FAI vs. fund available
Source: Deutsche Bank, WIND, CEIC
Ongoing structural changes: slower urbanization,
resilient labor market, rebalancing economic structure
The economy is showing signs of significant structural
changes. The urbanization progress has slowed. As of
December 2014, 54.8% of Chinese population lives in
the urban area, up 1ppt from that of 2013, the slowest
pace since 1995. Urbanization ratio rose 1.3ppts per
year on average from 1995 to 2013.
Page 57
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
The job market remains tight, despite the growth
slowdown in 2014. The labor market demand-supply
ratio rose from 1.1 in 2013 to 1.15 by end-2014, the
highest level since 2001. We expect the tight labor
market to sustain, driven by the tightening of labor
supply. Labor force declined by 3.7mn in 2014. We
believe that it has passed a structural turning point and
will continue to decline in foreseeable future.
Household disposable income per capita continued to
outperform GDP growth, up 8% in real terms in 2014.
Such trend together with social security reforms is
likely to boost consumption but may put pressure on
corporate profitability.
The other silver lining of the slowdown is that
economic imbalance could improve slightly, with
growth contribution from consumption up 3ppts to
51.2 in 2014 and investment-to-GDP ratio edging
down. Moreover, growth in service sector (8.1% yoy)
outpaced that of the industrial and construction sector
(7.3% yoy) in real value-added terms, and the FAI in the
tertiary industry grew (16.8% yoy) faster than FAI in the
secondary industry (13.2% yoy) in nominal terms. This
may be the beginning of a multi-year process to
unwind the imbalance in China which should help put
the economy onto a more sustainable path.
Consumption contribution to GDP growth
China: Deutsche Bank forecasts
2013
National income
Nominal GDP (USD bn)
Population (m)
GDP per capita (USD)
Zhiwei Zhang, Hong Kong, +852 2203 8308
Audrey Shi, Hong Kong, +852 2003 6139
2015F
2016F
9,484 10,366 11,087 12,219
1,361 1,366 1,373 1,380
6,970 7,586 8,073 8,853
Real GDP (YoY%)1
Private consumption
Government consumption
Gross capital formation
Export of goods & services
Import of goods & services
7.7
7.6
8.2
9.0
6.7
7.3
7.4
7.6
8.3
6.8
5.6
4.6
7.0
7.5
8.0
6.3
5.4
3.9
6.7
7.3
8.4
6.0
4.5
3.0
Prices, Money and Banking
CPI (YoY%) eop
CPI (YoY%) ann avg
Broad money (M2) eop
Bank credit (YoY%) eop
2.5
2.6
13.6
14.1
1.5
2.0
12.3
13.4
2.4
1.8
14.0
13.8
2.7
2.7
14.0
13.5
Fiscal Accounts (% of GDP)
Budget surplus
-1.9
-2.1
-3.0
-3.0
Government revenue
Government expenditure
Primary surplus
22.7
24.6
-1.4
23.0
25.1
-1.6
22.5
25.5
-2.5
22.0
25.0
-2.5
2,209
1,950
259
2.8
182.8
2.0
117.6
3,821
6.1
2,209
2,001
208
2.0
321.3
3.1
160.0
3,906
6.2
2,333
2,081
252
2.3
376.9
3.4
150.0
4,021
6.2
2,473
2,154
319
2.6
403.2
3.3
150.0
4,055
6.2
15.3
15.1
0.2
9.4
863
78.4
17.4
17.2
0.2
10.0
1,037
75.0
20.4
20.2
0.2
10.5
1,164
75.0
23.4
23.2
0.2
11.0
1,344
75.0
External Accounts (USD
bn)
Merchandise
exports
Merchandise imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI (net)
FX reserves (USD bn)
FX rate (eop) CNY/USD
Debt Indicators (% of GDP)
Government debt2
Domestic
External
Total external debt
in USD bn
Short-term (% of total)
Source: Deutsche Bank, WIND, CEIC
2014F
General (YoY%)
Fixed asset inv't (nominal)
19.6
15.7
15.0
14.0
Retail sales (nominal)
13.1
12.0
12.8
12.5
Industrial production (real)
9.7
8.2
7.6
7.0
Merch exports (USD nominal)
7.8
0.0
5.6
6.0
Merch imports (USD
7.2
2.6
4.0
3.5
nominal)
Financial Markets
Current 15Q1F 15Q2F 15Q4F
1-year deposit rate
2.75
2.50
2.25
2.25
3.43
10-year yield (%)
3.2
3.2
3.5
CNY/USD
6.24
6.30
6.28
6.20
Source: CEIC, DB Global Markets Research, National Sources
Note: (1) Growth rates of GDP components may not match overall GDP growth rates due to
inconsistency between historical data calculated from expenditure and product method. (2)
Including bank recapitalization and AMC bonds issued
Page 58
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Hong Kong
Aa1/AAA/AA+
Moody’s/S&P/Fitch


Economic outlook: The 2015 Policy Address by CY
Leung laid emphasis on promoting the new
economy, attracting qualified talent as well as
balancing the housing demand with supply. These
focuses revealed the most worrisome structural
problems that Hong Kong confronts at present–
unsatisfactory economic diversity, competition
from the Mainland, out-flowing middle class as
well as long-existing property sector risks. Previous
government measures in these respects, however,
have had little success. These challenges, if not
tackled properly, would imply further downside to
the economy in the coming decade.
Risk: Retail sales growth dropped unexpectedly in
Dec and PMI fell back to contractionary area in Jan,
echoing our previous argument that “it’s too early
to call a rebound”. The short-term outlook is still
associated with uncertainties in consumption
patterns,
business
environment,
monetary
conditions, as well as external pressure from a
slowing Mainland.
“measures to develop high value-added maritime
services”, “HKD 5bn injection into the Innovation and
Technology Fund”, “setting up an Enterprise Support
Scheme” and “injecting funding into the Film
Development Fund” has just in turn proved the fading
competitiveness of these sectors as well as the slow
progress of previous government actions.
Taking R&D expenditure as an example. In his election
manifesto in 2011, Leung promised that he will work to
raise Hong Kong’s R&D expenditure to 0.8% of GDP,
from 0.72% in 2011. However, the data for 2013 was
still as low as 0.73%, far behind other three “Asian
Tigers”. In the meantime, the ratio for Mainland China
rose significantly from 1.39% in 2006 to 2.1% in 2014.
More noticeably, in Shenzhen Nanshan, a district
known for technology innovation just across the border
from Hong Kong, the R&D spending was as high as
5.8% of GDP in 2014.
R&D as % of GDP, international comparison
0%
Progress or stagnation?
Hong Kong’s Chief Executive CY Leung delivered his
third Policy Address to the Legislative Council on Jan
14. In his speech he discussed various subjects,
including economic development, housing, poverty
alleviation, population, social welfare, environmental
protection, health care, education, immigration and the
constitutional system. Overall, we view this Policy
Address less positively those of 2013 and 2014 and we
see considerable difficulties in diversifying Hong
Kong’s economic structure and attracting talent.
Faltering economic structure reform
Mr. Leung specifically mentioned measures to benefit
innovation & technology sectors, “new economy”
industries such as insurance, and the entertainment
and media sectors. This demonstrated Mr. Leung’s
determination to promote growth as well as the
urgency for the Hong Kong to switch its growth engine.
Nonetheless, many measures on shipping, innovation
and technology and movie sectors were largely similar
to previous years. The fact that Leung proposed
Deutsche Bank Securities Inc.
4%
HK 2006
0.79%
HK 2011
0.72%
HK 2013
0.73%
Leung's target in election
0.80%
China 2006
China 2011
Singapore 2012
2.10%
Nanshan, Shenzhen, 2014
8%
1.84%
2.10%
Taiwan 2011
6%
1.39%
China 2014
Korea 2011
As Leung stressed: “Democratic development and
economic progress in Hong Kong present a host of
opportunities, but there are choices we have to
make….On the economy, between progress and
stagnation…”, Hong Kong has reached a crossroads –
and critical decisions have to be made.
2%
2.45%
4.04%
5.80%
Source: Deutsche Bank, World Bank, HK C&SD, China NBS, Shenzhen Nanshan NBS
Meanwhile, there are several services industries
showing promising development outlook with
favorable policies. For instance, the government will
establish the Insurance Authority, so as to explore
ways to facilitate the further development of Hong
Kong’s insurance industry. Note that the insurance
sector has demonstrated the strongest growth among
all Hong Kong services export segments from 2011-13.
We view this move as a supplement to the
establishment of the Financial Services Development
Council in 2013, so as to develop Hong Kong into a
more comprehensive financial center in China’s capital
account liberalization and RMB internationalization.
Page 59
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
However, as the emerging sectors are relatively small
(insurance exports account for less than 1% of total
services exports) and with growing competition from
Mainland China financial hubs, especially Shanghai
(SHFTZ) and Shenzhen (Qianhai), the exploration for
new growth poles may take longer than expected.
Hong Kong insurance exports standing out
30%
Exports of Services, NSA, yoy%
25%
Exports of Insurance services, NSA, yoy%
20%
15%
10%
5%
0%
-5%
-10%
Hong Kong: Deutsche Bank Forecasts
2013
2014F
2015F
2016F
273.7
7.19
38071
288.0
7.26
39672
302.6
7.31
41372
317.7
7.35
43223
2.9
4.2
2.7
3.3
6.5
6.9
2.2
2.0
2.9
-2.1
2.1
1.9
2.9
2.6
2.9
1.7
5.1
4.8
3.0
3.0
3.0
2.6
5.0
5.0
Prices, Money and Banking
CPI (YoY%) eop
CPI (YoY%) ann avg
Broad money (M3, eop)
HKD Bank credit (YoY%, eop)
4.3
4.3
12.5
8.2
3.5
4.4
9.5
8.3
3.0
3.5
9.0
8.0
3.0
3.2
9.0
8.0
Fiscal Accounts (% of GDP)1
Fiscal balance
Government revenue
Government expenditure
Primary surplus
0.6
20.9
20.4
0.6
2.6
20.9
18.3
2.7
2.9
20.3
17.4
2.9
3.0
20.0
17.0
3.0
External Accounts (USD bn)
Merchandise exports
Merchandise imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI (net)
FX reserves (USD bn)
FX rate (eop) HKD/USD
508.7
534.9
-26.2
-9.6
5.6
2.1
-14.9
311.2
7.76
519.3
545.1
-25.8
-9.0
6.2
2.2
-17.2
330.0
7.78
545.6
571.6
-25.9
-8.6
6.1
2.0
-18.0
350.0
7.80
573.1
600.2
-27.1
-8.5
5.9
1.8
-20.0
370.0
7.80
9.9
9.1
9.3
9.5
8.7
8.9
0.5
0.5
0.4
426.2 455.2 459.5
1166.4 1300.0 1400.0
74.1
74.0
74.0
9.0
8.6
0.4
456
1450
74.0
National Income
Nominal GDP (USD bn)
Population (mn)
GDP per capita (USD)
Real GDP (YoY%)
Private consumption
Government consumption
Gross fixed investment
Exports
Imports
Source: Deutsche Bank, HK C&SD, Haver Analytics
Nurturing and recruiting talents – a crucial mission
Unlike previous Policy Addresses, which focus more on
unleashing the potential of the existing workforce, the
2015 Address emphasized nurturing local youth and
recruiting talents and professionals from outside Hong
Kong. The Chief Executive promised to 1) set up a HKD
300 mn Youth Development Fund to support innovative
youth development activities, including assisting young
people starting their own business; 2) implement a pilot
scheme to attract the second generation of Chinese
Hong Kong permanent residents who have emigrated
overseas to return to Hong Kong; 3) refine existing
talent and professionals admission schemes; 4) study
the drawing up of a talent list to attract high-quality
talent in a more focused manner; and 5) suspend the
Capital Investment Entrant Scheme (CIES).
The highly contentious suspension of CIES marked, in
our view, a turning point of HK’s external policies. As
the city faces a growing risk of brain-drain from outflowing middle class, the mission of attracting genuine
talent and entrepreneurs now weighs over that of
attracting more capital inflow. A continuous effort on
this front could prove a decisive factor in Hong Kong’s
long-term outlook.
Audrey Shi, Hong Kong, +852 2203 6139
Debt Indicators (% of GDP)
Government debt1
Domestic
External
Total external debt
in USD bn
Short-term (% of total)
General
Unemployment (ann. avg, %)
Financial Markets
Discount base rate
3-month interbank rate
10-year yield (%)
HKD/USD
3.4
3.5
3.5
3.5
Current
0.50
0.38
1.53
7.75
15Q1
0.50
0.45
1.60
7.78
15Q2
0.75
0.55
1.65
7.80
15Q4
1.25
0.85
1.75
7.80
Source: CEIC, DB Global Markets Research, National Sources
Note: (1) Fiscal year ending March of the following year. Debt includes government loans,
government bond fund, retail inflation linked bonds, and debt guarantees.
Page 60
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
India
Baa2/BBB-/BBBMoody’s/S&P/Fitch

Economic outlook: New GDP data release suggests
a dramatically different economic landscape, with a
much stronger growth outturn (driven by surging
consumption) than previously understood by
analysts and policy makers. While expressing
considerable doubts about the data, we are
compelled to revise our real GDP forecasts upward.
In this new data climate, India has been
transformed from an economy struggling to go
past 5% growth to being comfortably in the 7%+
growth range.

Main risks: Confusion about the GDP data could
complicate policy communication, as further
monetary easing and fiscal spending push would
have to be justified against an already buoyant
growth environment.
GDP revision warrants a cautious read
Newly released national accounts data by the Central
Statistical Organization, revising the base year from
FY04/05 to FY11/12, widening sample coverage, and
updating a number of key surveys, have managed to
keep nominal GDP nearly unchanged while changing
the composition of growth quite strikingly. “GDP at
market prices” will henceforth be referred to as GDP in
the government data releases, instead of the earlier
practice of considering GDP at factor cost as the
primary GDP indicator.
The data show that real GDP grew 7.5%yoy in OctDec’14 quarter, down from 8.2% in the previous
quarter (under the old series, the GDP estimate was
5.3%yoy in July-Sep). According to this new data series
(which uses 2011/12 as the base year and applies a
new methodology for estimating national accounts
data), average growth in the first three quarters of
FY14/15 (April-Dec’14) was 7.4% and the Central
Statistical Organization’s estimate of 7.5% annual
growth for FY14/15 implies yet another 7.5% likely
growth outturn in Jan-March’15.
Before the release of the new GDP series, we were
forecasting real GDP growth to rise to 5.5%yoy in
FY14/15, from 5.0%yoy in FY13/14; while the expected
pace of acceleration remains same under the new data
series (real GDP growth is estimated to rise to 7.4% in
FY14/15, from 6.9%yoy in FY13/14), the newly
estimated growth rate has clearly surprised.
Deutsche Bank Securities Inc.
On the expenditure side of GDP (at 2011/12
prices), government final consumption expenditure
growth was up 31.7%yoy in Oct-Dec’14 (from 5.8%yoy
in July-Sep’14), though this is at odds with the pace of
total government spending (which was up just 5.5%yoy
in Oct-Dec’14, suggesting flat in real terms). Similarly,
it is difficult to reconcile the “public administration,
defence & other services” and “financial, real estate &
professional services” sub-sector growth (at constant
prices) of 20% and 15.9%, respectively, in Oct-Dec’14.
The CSO’s nominal (11.5%yoy) and real GDP growth
(7.4%yoy) estimates for FY14/15 imply that the GDP
deflator is likely to be 4.1% for this fiscal year.
Growth rates of GDP
% yoy
Old GDP
series, real
GDP
New GDP New GDP New GDP
series, real series, series, GDP
GDP
nominal
deflator
GDP
April-June'14
5.7
6.5
12.8
6.3
July-Sep'14
5.3
8.2
12.8
4.6
Oct-Dec'14
-
7.5
9.0
1.5
Annual FY14/15
(advance est.)
-
7.4
11.5
4.1
Source: CSO, Deutsche Bank
Overall, we are unsure about how to reconcile this new
data with indicators that show companies struggling
with earnings and investment, banks seeing rising bad
loans, credit growth slowing, and exporters reporting
negative growth.
Stalled projects were at a record high in FY14
INR bn
Stalled/shelved
Projects completed
7000
6000
5000
4000
3000
2000
1000
0
FY00 FY02 FY04 FY06 FY08 FY10 FY12 FY14
Source: CMIE, Deutsche Bank
The chart below shows that real GDP growth under the
old series had moved in tandem with the composite
PMI, with the PMI bottoming in FY14 at 49.0 (annual
average), below the threshold 50 mark. Real GDP
growth was 5.0%yoy in FY14, according to the oldGDP series, which is consistent with the composite
PMI trend.
Page 61
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Looking at this chart, it becomes clear that the newly
published revised GDP figures, which estimate India’s
FY15 GDP growth to have increased to 7.4%yoy (from
6.9% in FY14), are at odds with the trend of other high
frequency indicators such as the PMI.
Composite PMI and real GDP growth
Composite PMI, lhs
Real GDP (old series), rhs
Real GDP (new series), rhs
65
%yoy
10
60
8
55
6
50
4
45
A temporary pause
Trying to strike a balanced tone, the RBI left key policy
rates unchanged in the February 3 monetary policy
review, while it cut the SLR by 50bps to 21.5% of the
deposit base. This will free up about INR420bn of
liquidity, for banks to increase their lending to
productive sectors of the economy.
We had thought that although not much had changed
since the mid-January off-cycle rate cut, the central
bank would cut again in order to realign monetary
policy action with scheduled meetings. But given the
recent statement, it is clear that the RBI will remain
flexible in terms of taking off-cycle actions. With the
budget coming in a few weeks from now, the next rate
cut now seems likely to be off-cycle, perhaps in the
first week of March.
2
FY10
FY11
FY12
FY13
FY14
FY15F
We expect another 75bps rate cut by mid-year
CPI
Forecast
% yoy , %
Source: Haver Analytics, CSO, Deutsche Bank
12
Taken at face value, the revised GDP data suggest no
room for fiscal expansion and a degree of
circumspection in monetary policy accommodation in
the period ahead. But surely the prevailing political
economic dynamic under which all relevant actors have
committed to aiming for higher growth would not allow
for the new GDP data to be a restraint on policy. We
therefore see the central government committed to
boosting spending and investment while the RBI
remains dovish.
10
8
6
4
2
2012
Regardless of lingering questions about the data, we
are compelled to revise our GDP forecasts. We now
see the economy expanding by 7.5% this year and next,
driven by a likely pick up in consumption and
investment, i.e. we see the unfolding of a domestic
demand driven growth path in the quarters ahead.
GDP
2014
2015
2016
RBI will try to maintain 1.5-2.0% +ve real interest rate
%
4
2014
2015F
2016F
2
1
7.2
7.5
7.5
Private consumption
5.8
7.9
7.2
0
Government consumption
5.5
7.8
6.7
-1
Gross fixed investment
2.5
6.1
9.3
Exports
3.8
5.2
11.5
Imports
-2.2
2.8
11.5
Source: CSO, Deutsche Bank
2013
Source: CEIC, Deutsche Bank
Real interest rate (Repo rate - CPI inflation)
Forecast
3
GDP forecast
% yoy
Repo
Forecast
-2
-3
-4
2013
2014
2015
2016
Source: CEIC, Deutsche Bank
Page 62
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Looking ahead, we think that given global
developments, inflation pressure will remain muted for
the course of this year. It is clear that CPI inflation will
remain subdued (below 6%) in 1Q of 2015 and WPI
inflation will probably turn negative due to the recent
petrol and diesel price cuts. Pressure on food prices
seem to have also eased considerably, which has been
the main driver of inflation in recent years and our daily
food price tracker continue to show disinflation in
various food items, particularly vegetables. Moreover,
inflation expectations have moderated considerably
and the government has re-affirmed its commitment to
meet the FY15 fiscal deficit target of 4.1% of GDP.
Conditions for further policy easing to continue are
firmly in place, in our view.
The RBI will not only cut in early-March, in our view,
but more cuts await in the first half of this year. What
turns out to be the terminal rate in this cycle would
depend on the path of inflation and growth. Assuming
inflation tracks around 5-6% for the rest of the year, the
central bank would be comfortable taking the repo rate
down to 7%, in our view. This would imply a real repo
rate of around 1%. Recent deliberations from the RBI
suggest the central bank would not want real rates to
be any lower than that while it attempts to anchor
inflation expectation. Even if inflation were to be
somewhat lower, i.e. real rates turned out to be 1.52.0%, we don't think the central bank would feel
compelled to bring the repo rate below 7%.
consumers are still seeing pump prices decline (petrol
and diesel pump prices in rupee terms are down 17%
and 16% since July 1), they are not enjoying the full
benefit of the global correction due to the excise duty
hikes. This is an astute move by the government, in our
view. It will create some savings this year (perhaps
0.2% of GDP, given the lateness of the measure), but
there should be considerable fiscal windfall in FY15/16,
with a revenue upside of 0.6% of GDP, as per our
calculations. Considering that subsidies would be
declining by about 0.4% GDP due to the liberalization
of diesel price and other favorable commodity-related
developments, we see a total fiscal windfall of 1% of
GDP for the coming fiscal year.
Excise duties used to be a substantial part of revenue
intake before the global oil price spike of 2008 (see
chart below). Since then duties were cut to stem the
rise in local prices, but recent developments have
created a window to reverse the decline.
Excise duties were cut when oil price spiked in 2008;
time has come to make up for that loss
% of GDP
3.5
3.0
2.5
2.0
1.5
The central bank is keen to see further progress in
fiscal consolidation and capital spending, which it
seems necessary to lower inflation and boost growth.
Given the new GDP data which makes growth appear
much stronger, we don't think the RBI would be
emboldened to cut rates by more than 75bps in this
cycle. Note that a harder goalpost awaits the monetary
authority from next year onward, as an inflation target
of around 4% for 2016 and beyond appear to be its
preferred target.
Astute fiscal move
With inflation fears receding and current account
deficit concerns abating due to the lower cost of fuel
products, not only has the RBI become emboldened to
ease monetary policy, the government has also seized
the window of opportunity to strengthen its fiscal
stance. Given that revenues have continued to surprise
on the downside so far in this fiscal year, reflecting lack
of economic momentum, the likelihood of attaining the
4.1% of GDP fiscal deficit target in FY14/15 had been
slipping, but low oil price has come as a significant
source of comfort to the authorities.
Since November, excise duties on petrol and diesel
have been raised four times, constituting a cumulative
increase of 84% and 187% respectively. While Indian
Deutsche Bank Securities Inc.
1.0
0.5
0.0
Source: Government of India, CEIC, Deutsche Bank
Three things we would like to see in the FY16 budget

Tax reforms. The government of India is keen to
pursue GST at the central and state level, which we
welcome. We are however worried that there is
little clarity on the roadmap of the implementation
plan. This budget should provide a clear roadmap
of not just the dates when the tax law takes effect,
but how and when administrative reforms
(accounting,
human
resource,
information
technology) will be carried out.
The discussion on GST is risking drowning out
other much needed tax reforms, such as base
broadening, efficiency of collection, and enforcing
compliance. India has one of the lowest tax/GDP
ratios in the EM universe; an effective way to sell
the idea of more tax compliance would be to link
future service delivery with greater revenue
generation.
Page 63
12 February 2015
EM Monthly: Rising Tide, Leaky Boats


Spending reforms. Having tackled energy sector
subsidies, the government needs to spell out its
plan to rationalize food and fertilizer subsidies (a
combined cost of USD31bn or nearly 1.5% of GDP).
Cost savings through reform of the public sector is
also a key. Plan spending is growth critical, and
there should be clear time bound plans about
where the money would go.
Realistic targets. The government has cut back on
spending year after year as its revenue and deficit
targets have proven to be unrealistic. More
attention should be given to prepare realistic and
modest projections. Also, the practice of treating
privatization or disinvestment as a revenue item
needs to stop. Most, if not all, economies treat
such proceeds as one-off and therefore as a
financing item. While this would make the reported
deficit larger, it would also bring India's fiscal
accounting in line with the rest of world.
Mixed PMI trend
India’s manufacturing and services PMI continued to
reflect contrasting trend in January, as was the case in
December. In December, manufacturing PMI had
increased to 54.5, from 53.3 in November, but in
January, it moderated once again to 52.9, which was
even lower than the November reading. Services PMI
on the other hand increased to 52.4 in January, after
having dropped to 51.1 in December, from 52.6 in the
previous month. Given the volatility in the monthly
reading, we rely more on the 3-month moving average
trend, which shows that both manufacturing (53.6 vs.
53.1) and services (52.1 vs. 51.3) sector growth has
improved in January over December. The composite
PMI increased to 53.3 in January, from 52.9 in
December, with its three month moving average also
improving to 53.3, from 52.5 in the previous month.
Manufacturing, services and composite PMI
Manufacturing PMI
Services PMI
Composite PMI
3mma
65
60
55
India: Deutsche Bank Forecasts
2013
2014F
2015F
2016F
1881
1236
1523
1989
1253
1587
2191
1271
1725
2456
1288
1906
6.9
6.2
8.2
3.0
7.3
-8.4
7.2
5.8
5.5
2.5
3.8
-2.2
7.5
7.9
7.8
6.1
5.2
2.8
7.5
7.2
6.7
9.3
11.5
11.5
6.9
7.4
7.5
7.5
Prices, Money and Banking
CPI (YoY%) eop
CPI (YoY%) avg
Broad money (M3) eop
Bank credit (YoY%) eop
9.9
10.1
14.8
14.2
5.0
7.2
11.1
10.1
5.4
5.3
15.0
14.5
6.0
5.8
16.0
16.5
Fiscal Accounts (% of GDP) 1
Central government balance
Government revenue
Government expenditure
Central primary balance
Consolidated deficit
-4.5
9.3
13.8
-1.2
-7.0
-4.5
9.3
13.7
-1.2
-7.0
-4.0
9.5
13.5
-1.0
-6.2
-3.8
9.7
13.5
-0.8
-5.8
National Income
Nominal GDP (USD bn)
Population (mn)
GDP per capita (USD)
Real GDP (YoY %)
Private consumption
Government consumption
Gross fixed investment
Exports
Imports
Real GDP (FY YoY %) 1
External Accounts (USD bn)
Merchandise exports
Merchandise imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI (net)
FX reserves (USD bn)
FX rate (eop) INR/USD
Debt Indicators (% of GDP)
Government debt
Domestic
External
Total external debt
in USD bn
Short-term (% of total)
General
Industrial production (YoY %)
50
45
Financial Markets
Repo rate
3-month treasury bill
10-year yield (%)
40
INR/USD
Source: CEIC, Deutsche Bank
319.7 333.6 354.5 384.6
466.2 478.8 507.9 562.8
-146.5 -145.1 -153.5 -178.2
-7.8
-7.2
-7.0
-7.1
-49.2
-29.9
-28.9
-43.6
-2.6
-1.5
-1.4
-1.7
26.3
25.0
30.0
35.0
293.9 321.8 367.9 401.9
61.8
63.3
64.0
65.0
66.9
63.6
3.3
22.7
426.9
21.7
64.6
61.5
3.1
23.6
469.6
22.7
62.4
59.5
2.9
24.0
526.0
23.3
61.3
58.6
2.7
24.0
589.1
23.9
0.1
1.8
2.9
4.6
Current
15Q1
15Q2
15Q4
7.75
8.30
7.73
7.50
8.20
7.60
7.00
8.00
7.40
7.00
7.60
7.20
62.2
62.5
63.0
64.0
Source: CEIC, Deutsche Bank. (1) Fiscal year ending March of following year.
Taimur Baig, Singapore, +65 6423 8681
Kaushik Das, Mumbai, +91 22 7180 4909
Page 64
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Indonesia
Baa3/BB+/BBBMoody’s/S&P/Fitch

Economic outlook: Growth is likely to hover around
5% as the economy continues to grapple with a
slowing commodity sector but consumption
resiliency is maintained. Inflation is likely to be in
the 6-7% range during the first half of the year,
while a major disinflationary phase would ensue in
Q4, allowing the BI to cut rates.

Main risks: Despite neutralizing the opposition
threat in the parliament over the past few months,
president Jokowi has not managed to govern
disruption-free, as seen in the controversy around
the nomination of the police chief. This calls to
question the president’s political dexterity and
raises the risk of possible pitfalls ahead.
A virtuous macro cycle is around the
corner
Indonesia’s economy is experiencing an unprecedented
reversal in its inflation outlook. Just a month after a
33% fuel price hike pushed inflation up to 8.4%, global
price declines and a newly announced automatic price
adjustment formula has combined to eliminate not just
risks of second round effect of the price increase, but
the rate of inflation has begun to decline along with
lower fuel and transportation prices.
CPI inflation eased to 7% in January, helped by a 4%
decline in the transportation/communication part of the
index and 6.5% decline in the energy price index. Even
more heartening was the fact that food inflation was
benign, with the food and processed food components
of the index up just 0.6%mom each. January is a high
food inflation month in Indonesia, with the food
component typically jumping by 2-3%mom; therefore
this month’s developments are particularly striking.
Core inflation remained steady at 5% (it was 4.8% nine
months ago).
Looking at the inflation trajectory for the rest of the
year, inflation would hover around 6-7% through Q3,
but decline sharply thereafter, assuming food and fuel
prices remain steady. Indeed, as per our revised
forecast, inflation could fall below 4% by December.
This could pave the way for substantial rate cuts by BI
in Q4, in our view. We see the BI rate declining to 7%
by December (from the present level of 7.75%).
Trade data for December yet again offered a mixed
picture of the economy. The welcome aspect of the
recent fuel price revision and global oil price decline
has started to show up in the imports data, with
oil+gas imports down 19.7%yoy. Overall demand
seems to be holding up, with non-oil import growth
Deutsche Bank Securities Inc.
virtually flat (-1.7%yoy). But the weak commodity price
environment is hurting the exports environment;
oil+gas exports were down 30.9%yoy and, even non
oil+gas exports were down 9.6%. The net impact of the
trade developments was a near-flat trade balance, with
a small trade surplus of USD187bn.
While inflation developments are considerably positive,
the poor quality trade data show that all is not going in
Indonesia’s direction right now. The commodity price
headwind will continue to hurt exports, and unless noncommodity related exports pick up, Indonesia’s
external balances will remain under scrutiny.
2014 growth outturn likely to be mirrored
in 2015
Q4 GDP data was released recently with a new base
year (2010 prices) and methodology (SNA 2008),
although the underlying picture of the economy
remained broadly unchanged. Compared to a year ago,
most key sectors are growing somewhat more
modestly. For instance, real private consumption rose
by 5%yoy in Q4, compared to 5.4% in Q4 2013, and
real exports were down 4.5% compared to +9.4% a
year ago. While investment does not seem to be
weakening any longer (+4.3%yoy), the overall growth
environment (+5% in 2014) is unlikely to see a major
up-shift in momentum in 2015, in our view. In addition
to the headwind from the commodity sector, the extent
to which the government manages to accelerate
infrastructure spending is still open to question.
Weak exports putting a lid on growth
cont. to GDP
growth, %yoy
4.0
Priv cons
Gov cons
Investment
Net exports
3.0
2.0
1.0
0.0
-1.0
-2.0
-3.0
Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14
Source: CEIC, Deutsche Bank
Page 65
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Budget revision
Indonesia: Deutsche Bank forecasts
Faced with opposing fiscal developments, stemming
from downside to commodity related revenues and
upside from fuel price liberalization, the government
announced its revised 2015 budget a few weeks ago.
On the revenue side, the projected loss of lower
commodity revenues is offset by a rather heroic
assumption of enhanced tax administration efforts to
boost income tax, VAT, and excise revenues by 27%,
10%, and 12% relative to the original budget.
National Income
Nominal GDP (USD bn)
Population (mn)
GDP per capita (USD)
We find these projections unrealistic given the macro
environment. In addition to being skeptical about the
efficacy of tax administration measures, our subdued
growth forecast (5%, relative to the authorities’ 5.8%)
also makes us doubt such revenue buoyancy
expectations. On the spending side, the nearly 3% of
GDP worth of expected subsidy reduction is used to
increase generously (by 30% to 100%) allocations for
agriculture, transportation, social welfare, public works,
housing, and infrastructure.
We welcome the reorientation of spending, but doubt
that even a fraction of these increases are feasible
given capacity constraints and the likely shortfall in
revenues. Our expectation that both revenues and
spending would be much lower than projected in the
revised budget leaves us with a deficit forecast of 1.7%
of GDP, a little lower than the government’s projection
of 1.9% of GDP.
Indeed, we are concerned that Indonesia has missed a
trick in taking advantage of the fuel price decline.
While the authorities have announced a transparent,
formula-based twice-monthly fuel price adjustment
mechanism, they could have followed India’s route in
splitting the difference between international price
developments and local pass-through by hiking excise
duties to shore up revenues. So far, it appears that
local prices will adjust to the full extent, which bodes
well for the inflation outlook, but it would have been
more prudent to stem the local pump price reduction
somewhat while diverting some of the savings to
increase revenues.
We think that the authorities may not be fully
recognizing the risks stemming from weak commodity
sector activities to the revenue side of the budget. As
those risks get realized through the course of the year,
some of the projected rise in growth-critical spending
will have to be scaled back, in our view.
Taimur Baig, Singapore, +65 6423 8681
2013
2014F
901.7
248.8
3,624
887.1
252.2
3,518
Real GDP (YoY%)
Private consumption
Government consumption
Gross fixed investment
Exports
Imports
5.6
5.4
6.9
5.3
4.2
1.9
5.0
5.1
2.0
4.1
1.0
2.2
5.0
5.3
7.2
6.6
-0.7
-3.2
5.5
5.5
4.0
6.5
5.3
5.6
Prices, Money and Banking
CPI (YoY%) eop
CPI (YoY%) ann avg
Core CPI (YoY%)
Broad money (M2)
Bank credit (YoY%)
8.1
6.4
5.0
12.8
20.1
8.4
6.4
3.3
6.2
5.1
4.8
4.5
12.0
17.0
4.5
13.0
16.0
4.0
15.0
18.0
Fiscal Accounts (% of GDP)
Budget surplus
Government revenue
Government expenditure
Primary surplus
-2.3
15.7
18.0
-1.1
-2.2
16.4
18.6
-0.2
-1.7
16.1
17.8
0.3
-1.7
16.1
17.8
0.3
External Accounts (USD bn)
Merchandise exports
Merchandise imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI (net)
FX reserves (USD bn)
FX rate (eop) IDR/USD
182.1
176.3
5.8
0.7
-29.1
-3.4
12.2
99.4
12270
181.1
170.2
10.9
1.3
-22.2
-2.6
11.9
112.0
12440
189.3
168.5
20.8
2.2
-15.6
-1.7
12.0
114.0
12250
202.4
174.9
27.5
2.7
-12.1
-1.2
15.0
118.0
12750
Debt Indicators (% of GDP)
Government debt
Domestic
External
Total external debt
in USD bn
Short term (% of total)
22.4
11.4
11.0
30.5
265.0
18.9
25.9
14.9
11.0
34.1
293.0
18.8
27.0
15.5
11.5
33.3
311.0
18.3
28.0
15.5
12.5
32.4
331.0
18.1
6.0
6.5
4.0
6.0
5.0
6.0
6.0
5.9
General
Industrial production (YoY%)
Unemployment (%)
Financial Markets
BI rate
10-year yield (%)
IDR/USD
2015F
2016F
951.6 1,057.2
256.6 261.1
3,709 4,049
Current 15Q1 15Q2 15Q4
7.75
7.75
7.75
7.00
7.20
7.00
7.00
7.20
12,700 12,600 12,500 12,250
Source: CEIC, DB Global Markets Research, National Sources
Page 66
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Malaysia
A3/A-/A-(Neg)
Moody’s/S&P/Fitch


Economic outlook: Despite the headwind from the
commodity sector, industrial production has been
rising at a healthy clip, retail sales and property
prices are stable, and inflation is benign. Growth
downside has emerged due to the slowdown in the
energy sector, but the risks are still manageable.
Main risks: Sustained weakness in trade could
undermine confidence about the external account,
currency, and debt servicing capacity of corporate
with foreign currency debt.
Adjusting to the commodity headwind
Substantial debt burden
% of GDP
But there is a palpable feeling of the tide turning along
with falling exports and contracting earnings from the
commodity sector. As a major commodity exporter,
Malaysia continues to face more stress than any other
Asian economy given the ongoing oil price decline. In
recent years 30-40% of public sector revenues have
come from commodity related tax, royalty, and
dividends, hence the downside to the budget and
economy are considerable this year.
Compounding the problem is Malaysia’s high debt
burden (see chart), which is one of the highest in the
region. If global disinflationary tendencies become
more entrenched then Malaysia’s households and
corporate will see sustained earning pressure and
associated debt servicing difficulties, even in the
presence of low interest rates.
The combination of a worsening growth outlook and
high debt is a dangerous one, and perhaps is the key
concern among investors at the current juncture. A
recovery in oil price would reduce but not eliminate this
risk. Sooner or later, Malaysia’s high debt levels would
have to be dealt with by the authorities, and it has to
be done before the debt burden becomes a constraint
on economic activities.
Deutsche Bank Securities Inc.
Latest
100
80
60
40
20
0
Households
Malaysia’s headline indicators don’t yet indicate an
economy undergoing a major slowdown. Industrial
production rose by 7.2%yoy in December, indicators of
retail sales and property prices are still printing positive
growth rates, and car sales were up 5.8%yoy to end
2014. In all likelihood, we estimate that Malaysia
recorded a healthy 5%+ real growth last year.
2009
Corporates
Government
(incl. guaranteed
debt)
Source: CEIC, Deutsche Bank
Fiscal revision
Faced with a rapidly worsening outlook, the
government of Malaysia announced a revision to the
growth and fiscal outlook in mid-January. We think the
new GDP growth forecast of 4.5-5.5% (from 5-6%)
could yet turn out to be optimistic if exports remain
under pressure and investments get delayed or
cancelled. Similarly, raising the fiscal deficit target to
3.2% of GDP from 3% is a step in the right direction,
but the risk remains that staying under the even higher
target will be difficult, especially if growth surprises to
the downside, which won’t be helped by the USD1.5bn
in spending cuts contained in the revised budget.
In recent months we have seen investors turn bearish
Malaysia, as reflected in capital outflows, fairly sizeable
exchange rate depreciation (12% against the USD since
July 1), and reserves losses (USD15bn during the same
period). With nearly half of the government debt held
by foreigners, and the current account heading toward
a deficit, the risk of continued pressure on Malaysian
assets is high.
Rethinking the path of inflation and
monetary policy ahead
In light of recent developments, we have re-worked our
inflation and monetary policy forecasts. We now see
inflation considerably lower in the near term than
previously seen (2.9% at end 2015). The impending
GST introduction will have a more muted impact on
inflation due to declining energy prices and waning
demand than previously envisaged.
Page 67
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
As per our new forecast, inflation would peak at
around 3.5% toward the middle of this year and then
ease modestly, averaging 2.5% thereafter (through
2016). With growth risks rising, the probability of Bank
Negara raising rates this year has diminished
considerably, in our view. Indeed, we think that an
unchanged policy rate path is ahead through the
course of 2015 and 2016.
Revising down the inflation forecast
%yoy
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
Dec-14
Old
Jun-15
New
Dec-15
Jun-16
Dec-16
Malaysia: Deutsche Bank forecasts
2013
National Income
Nominal GDP (USD bn)
Population (mn)
GDP per capita (USD)
2014F
2015F
2016F
313.3 330.4 337.9 368.4
29.9
30.4
30.8
31.3
10,462 10,846 10,701 11,668
4.7
7.2
6.3
8.5
0.6
2.0
5.9
6.8
5.5
4.3
5.1
3.7
4.5
4.2
6.2
5.2
4.5
6.2
4.9
6.2
2.1
2.2
2.7
4.7
Prices, Money and Banking (YoY%)
3.2
CPI (eop)
2.1
CPI (ann avg)
7.3
Broad money (eop)
9.7
Private credit (eop)
2.7
3.1
5.8
7.3
2.9
3.0
8.3
8.4
2.6
2.5
8.6
8.6
Real GDP (YoY%)
Private consumption
Government consumption
Gross fixed investment
Exports
Imports
Fiscal Accounts (% of GDP)
Central government surplus
Government revenue
Government expenditure
Primary balance
-3.9
21.6
25.5
-1.8
-3.5
20.5
24.0
-1.3
-3.4
21.2
24.4
-1.1
-2.8
21.7
24.5
-0.5
External Accounts (USD bn)
Goods exports
Goods imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI (net)
FX reserves (eop)
MYR/USD (eop)
215.6
181.3
34.4
11.0
12.3
4.0
-1.7
134.9
3.28
222.2
183.2
39.0
11.8
18.7
5.7
-4.2
131.5
3.48
220.7
189.9
30.8
9.1
9.8
2.9
-2.9
116.8
3.75
234.2
205.7
28.5
7.7
12.3
3.3
-2.9
101.0
3.60
Debt Indicators (% of GDP)
Government debt1
Domestic
External
Total external debt
in USD bn
Short-term (% of total)
70.6
68.9
1.7
70.6
212.3
48.6
67.8
66.1
1.7
64.3
202.6
48.4
68.4
66.8
1.6
62.9
206.7
48.7
64.6
64.6
1.6
56.6
204.5
48.6
3.4
3.1
4.3
3.0
1.6
3.1
2.4
3.0
Current
3.25
3.80
3.81
3.59
15Q1
3.25
3.85
4.00
3.65
15Q2
3.25
3.90
4.30
3.70
15Q4
3.25
4.00
4.30
3.75
Source: CEIC, Deutsche Bank
One risk to the policy rate outlook is however the state
of the currency. The ringgit’s 9.2% slide against the
USD since last June has been striking, the worst in EM
Asia. If the currency’s slide and portfolio outflows
become disorderly, Bank Negara may well have to raise
rates to defend the currency and restrain import
demand. We however see this as no more than a tail
risk scenario.
We expect Bank Negara to stay on the sideline
overnight
policy rate
Old
New
4.00
3.75
3.50
General (ann. avg)
Industrial production (YoY%)
Unemployment (%)
3.25
3.00
Dec-14
Jun-15
Dec-15
Jun-16
Dec-16
Source: CEIC, Deutsche Bank
Taimur Baig, Singapore, +65 6423 8681
Page 68
Financial Markets (%, eop)
Overnight call rate
3-month interbank rate
10-year yield
MYR/USD
(1) Includes government guarantees
Source: CEIC, DB Global Markets Research, National Sources
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Philippines
Baa3(Pos)/BBB-/BBBMoody’s/S&P/Fitch


Economic outlook: A strong finish to 2014 puts the
economy well above its potential output level and
expected to continue growing above potential. The
commodity price decline in recent months has
taken inflation down towards the bottom of the
target band but this only postpones rate hikes
rather than presenting a case for cuts.
Main risks: Bank credit has been growing very
rapidly, and households’ and firms’ exposure to
non-bank lending is unknown. Rate hikes, when
they come, could impart a greater drag on activity
than anticipated.
A question of when rates go up, not if
GDP growth versus trend
9
%yoy
8
7
6
5
4
3
2
1
0
The economy ended 2014 on a solid footing, with GDP
growth of 2.6%QOQ(sa) making up for the soft 0.7%
print in Q3. Second-half growth averaging 1.6% was
only slightly below the first half’s average of 1.8%. On
a year-on-year basis, growth of 6.9% in Q4 pulled fullyear growth up to 6.1%, slightly higher than our 5.9%
forecast. The difference is not material, and we keep
our 2015 growth forecast unchanged at 6.5%. Note
that this implies a slight moderation in the sequential
pace of growth.
Household consumption growth has been remarkably
stable at 1.1% - 1.5% on a QoQ(sa) basis over the past
two and a half years with the exception of 2013Q3
when growth reached 2.2%. Accounting for two-thirds
of real GDP, household consumption is the main driver
of growth in aggregate demand and we see few risks
to this segment of demand. Household debt appears
to be low at only 7% of GDP. We caution, though, that
this includes only bank loans to households. True
indebtedness may be much higher to the extent
households have borrowed from non-banks.
Fixed investment growth has been more volatile than
consumption, often responding more to external
demand than domestic demand. And export growth
was very strong last year at 12.1% versus the pre-crisis
average of about 9%. A strong rebound in construction
activity – up 6.5%QoQ(sa) after an already robust 5.7%
growth in Q3 – offset a decline in durable goods
investment to put overall fixed investment up 8.1%yoy.
But at only 22% of GDP, there is both lots of room for
further investment growth and also a need for more
investment.
Deutsche Bank Securities Inc.
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
Sources: CEIC and Deutsche Bank Research
However, we think investors should not expect the
central bank to offer much support. The strong finish
to 2014 must have allayed any concerns about a
slowdown that might have fed into an easing bias. A
mechanical estimate of the output gap – seasonally
adjusted GDP versus its long-run trend – yields an
estimate of about 1.6%, a six-year high. With GDP
growth having been above the trend growth rate for
most of the last three years, the output gap that
opened up in 2011 was closed two years ago and the
economy is now genuinely at risk of over-heating.
It may seem odd to speak of over-heating in an
economy where headline inflation has fallen by 2.5%
and core by 1.2% over the past five months. But with
food and beverages accounting for 40% of the CPI
basket and fuel prices un-taxed (and therefore highly
volatile) commodity price swings have a marked
impact on inflation in the Philippines. We estimate that
a 10% decline in crude oil prices, for example, leads to
about a 0.8% decline in the inflation rate – the highest
sensitivity by far among all economies our economists
follow. But as the drop in oil prices in the second half
of 2014 drops out of the YoY calculations, the
measured inflation rate in the Philippines will rise. This,
coupled with the 100bps decline in the inflation target
effective last month means, in our view, that interest
rate hikes have been postponed rather than a case
being made for cuts.
Page 69
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Interest rate and inflation outlook
8
%
CPI
Philippines: Deutsche Bank Forecasts
repo
2013
2014F
2015F
2016F
272.1
98.2
2764
284.5
99.9
2802
301.6
101.6
2969
326.3
103.3
3159
7.2
5.7
7.7
11.9
-1.1
5.4
6.1
5.7
0.1
8.5
12.1
5.8
6.5
6.4
7.0
6.4
6.3
8.0
6.6
5.4
14.1
7.7
5.6
7.1
Prices, Money and Banking (YoY%)
CPI (eop)
4.1
CPI (ann avg)
2.9
Broad money (M3, eop)
31.8
Private credit (eop)
10.6
2.7
4.2
9.6
16.2
3.6
2.5
10.0
14.0
3.9
3.5
11.0
12.0
Fiscal Accounts (% of GDP)1
Fiscal balance
Government revenue
Government expenditure
Primary surplus
-1.4
14.9
16.3
1.4
-1.8
15.9
17.7
0.8
-2.2
15.8
18.0
0.6
-2.4
15.9
18.3
0.3
External Accounts (USD bn)
Goods exports
Goods imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI (net)
FX reserves (eop)
PHP/USD (eop)
44.5
62.2
-17.7
-6.5
10.4
3.8
-0.2
83.2
44.4
46.7
63.5
-16.8
-6.0
12.8
4.6
1.7
79.5
44.6
51.4
71.3
-19.9
-6.6
12.6
4.2
1.2
76.4
46.0
55.7
82.4
-26.7
-8.2
7.2
2.2
0.5
72.9
47.4
Debt Indicators (% of GDP)
General government debt2
Domestic
External
External debt
in USD bn
Short-term (% of total)
53.3
33.5
19.8
21.5
58.5
19.2
54.6
35.6
19.1
19.7
55.4
16.1
56.6
37.8
18.8
19.5
57.6
16.6
56.5
38.4
18.1
18.8
58.1
17.0
General (ann. Avg)
Industrial production (YoY%)
Unemployment (%)
13.9
7.1
7.4
6.8
9.0
7.0
8.8
6.8
Current
6.00
4.00
1.54
3.4
44.3
15Q1
6.00
4.00
1.60
3.50
44.6
15Q2
6.00
4.00
1.80
3.60
45.3
15Q4
6.00
4.00
2.00
3.80
46.0
National Income
Nominal GDP (USD bn)
Population (mn)
GDP per capita (USD)
7
6
Real GDP (YoY%)
Private consumption
Government consumption
Gross fixed investment
Exports
Imports
5
4
3
2
1
10
11
12
13
14
15
16
Sources: CEIC and Deutsche Bank Research
The conventional monetary policy transmission
mechanism appears to work very well in the Philippines.
Credit to the private sector is highly responsive to
fluctuations in real lending rates. The latter have risen
120bps already over the past four months and we
expect they will be about 200bps higher, on average,
this year than last year. That would imply, we expect,
only a moderate deceleration in credit growth.
Domestic credit from depository institutions to the nongovernment sectors is only 45 % of GDP, up from 36%
in 2010, which doesn’t seem especially problematic.
But even a slowing of credit growth could pose
problems for some corporate and households, and if
there are large unreported debts – to non-banks - -then
systemic risk would be higher.
Real interest rates and credit to the private sector
%yoy,3mma
20
Credit to PS
%,3mma
-2
Real rate (-4) (RHS)
-1
18
0
16
1
14
2
12
3
4
10
5
8
6
6
7
07
08
09
10
11
12
13
14
15
16
Sources: CEIC and Deutsche Bank Research
Michael Spencer, Hong Kong, +852 2203 8305
Page 70
Financial Markets (%, eop)
Policy rate (BSP o/n repo)
Policy rate (BSP o/n rev repo)
3-month T-bill rate
10-year yield (%)
PHP/USD
(1) Refers to general government. (2) Includes guarantees on SOE debt.
Source: CEIC, DB Global Markets Research, National Sources
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Singapore
Aaa/AAA/AAA
Moody’s/S&P/Fitch

Economic outlook: Growth is positive but lackluster,
with exports becoming a drag once again.

Main risks: MAS’ off-cycle moved reflects
nervousness about fast changing global inflation
and financial market conditions. Slowing China
could be disruptive to Singapore through the trade
and financial markets channels.
An inevitable softening of NEER
appreciation bias
Joining a growing club of central banks that has opted
to take off-cycle measures lately, MAS made a
surprising announcement of policy adjustment on
January 28. The announcement was unexpected in its
timing (the next scheduled meeting is in April), but the
content of the decision was not. Indeed, in our January
Monthly, we wrote the following: “As long as there is
confidence that modest growth will prevail and
inflation concerns nonexistent, a change in the slope
(i.e. a flatter trajectory) of the NEER band may well be
on the cards.”
The policy statement left the real GDP growth forecast
for the year unchanged at 2-4% (our forecast is 3%),
but the central bank’s inflation forecast was lowered.
The MAS now sees CPI-All Items inflation to be in the 0.5–0.5% range (in October, the monetary authority’s
forecast was 0.5–1.5%). Meanwhile, MAS Core
Inflation is expected to be 0.5–1.5% this year, down
from the earlier forecast range of 2–3%.
realistic though, with its policy statement flagging the
risk of a sharp rebound in oil price, wage pressure from
a tight labor market, and the impact of expansionary
fiscal policy, especially on subsidies for the elderly.
The decision to lower the slope of appreciation of
course comes after a period when the pace of
appreciation has slowed in any case (see chart below).
We don’t think this decision means major weakness of
the currency ahead, as the MAS is keen to keep
monetary conditions stable, which includes preventing
interest rates from spiking (higher rates is an outcome
of FX weakness under Singapore’s monetary policy
operation framework). But SGD will not fight the USD
this year, that much is clear.
Gradual appreciation of the nominal and real effective
exchange rates continue while SGD weakens against
the USD
NEER
REER
SGD/USD, right
115
1.20
1.25
110
1.30
105
1.35
100
1.40
2012
2013
2014
2015
Inflation heading to negative territory
Source: CEIC, Deutsche Bank
CPI, Headline,yoy%
10.0
CPI Momentum, 3m/3m, SA, ann.
8.0
6.0
4.0
2.0
0.0
-2.0
-4.0
2007 2008 2009 2010 2011 2012 2013 2014
Source: CEIC, Deutsche Bank
A 6.5% decline in the import price index, driven
primarily by the 50% drop in global crude oil price over
the past six months, was the main reason for the
downward revision to the inflation forecast. The MAS is
Deutsche Bank Securities Inc.
The decision to move in dovish direction comes when
despite the low inflation environment, growth markers
are subdued. Excluding autos, real retail sales growth
was in negative territory for most of last year, finally
making it into positive territory in the fourth quarter.
Tourist arrival declined through the course of the year
as well. Industrial production also ended the year in the
red. While the labor market is tight and income growth
is positive, overall economic conditions are not
particularly buoyant.
External demand has been on the weak side as well.
Since contracting sharply in September (-8.8%, mom,
sa) non-oil domestic exports have retraced some of the
lost ground but still by no means displaying strong
growth potential. Demand from key trading partners
has been poor, with exports in contraction territory visà-vis the US, EU, China, Japan, and Indonesia. While
Page 71
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
overall EM demand is holding up, it is simply not
sufficient to make up for shortfall from large
industrialized economies as well as China.
Trade remains weak
%yoy, 3mma
NODX
30
20
10
0
-10
-20
2008
2009
2010
2011
2012
2013
2014
Source: CEIC, Deutsche Bank
Labor market
Recently published
interesting insights:
report
on
employment
offer

2014 ended with overall seasonally adjusted
unemployment rate remaining low (1.9%), as the
resident (from 2.8% to 2.6%) and citizen (from
2.9% to 2.6%) unemployment rate declined over
the fourth quarter. Local employment grew faster,
as foreign workforce growth continued to
moderate.

Redundancies rose slightly in the fourth quarter,
amidst business restructuring. In 2014, 12,800
workers were laid off, higher than the 11,560 in
2013.

There has been was a sustained increase in median
income for Singaporeans over the last five years.
Median monthly income from work of full-time
employed citizens increased by 30% (from
SGD2748 to SGD3566) during this period.

Boosted by public sector initiatives to raise the
incomes of low-wage workers, income growth at
the 20th percentile kept pace with the median
income growth during 2009-14. Real income of the
poor has risen at the average rate of 1.6% p.a.
Taimur Baig, Singapore, +65 6423 8681
Page 72
2013 2014E
National Income
Nominal GDP (USD bn)
Population (mn)
GDP per capita (USD)
295.8
5.4
54594
299.0
5.5
54357
2015F 2016F
301.4 320.4
5.6
5.7
53819 56215
Imports
40
-30
2007
Singapore: Deutsche Bank Forecasts
Real GDP (YoY%)
Private consumption
Government consumption
Gross fixed investment
Exports
Imports
Prices, Money and Banking
CPI (YoY%) eop
CPI (YoY%) ann avg
Broad money (M2)
Bank credit (YoY%)
3.9
2.6
9.9
-1.9
3.6
3.1
3.0
1.6
-0.3
-3.6
3.3
1.6
3.0
1.2
2.2
-0.6
4.5
3.8
3.5
3.6
1.3
2.1
6.5
6.7
1.5
2.4
7.9
13.8
-0.2
1.0
2.5
10.6
1.9
0.6
3.7
10.0
1.6
1.6
5.0
11.0
Fiscal Accounts (% of GDP)
Fiscal balance
Government revenue
Government expenditure
7.1
21.9
14.8
6.9
22.1
15.2
6.8
22.3
15.5
6.6
22.3
15.7
External Accounts (USD bn)
Merchandise exports
Merchandise imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI (net)
FX reserves (USD bn)
FX rate (eop) SGD/USD
437.6
369.8
67.8
22.9
54.5
18.4
36.9
273.1
1.26
450.7
373.5
77.2
25.8
56.4
18.9
20.0
316.5
1.31
468.7
384.7
84.0
27.9
59.0
19.6
25.0
350.4
1.35
482.8
396.2
86.5
27.0
58.4
18.2
30.0
384.4
1.30
110.9
110.9
1.0
410
1208
68.8
118.4
118.4
1.0
407
1214
69.0
121.8
121.8
1.0
392
1220
70.0
123.9
123.9
1.0
383
1226
69.5
2.4
2.8
0.7
2.6
3.0
2.5
4.0
2.5
Current
0.68
2.04
1.35
15Q1
0.70
2.00
1.33
15Q2
0.80
2.40
1.35
15Q4
1.00
2.55
1.35
Debt Indicators (% of GDP)
Government debt
Domestic
External
Total external debt
in USD bn
Short-term (% of total)
General
Industrial production (YoY%)
Unemployment (%) (eop)
Financial Markets
3-month interbank rate
10-year yield (%)
SGD/USD
Source: CEIC, DB Global Markets Research, National Sources
Note: includes external liabilities of ACU banks.
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
South Korea
Aa3/A+/AA\Moody’s/S&P/Fitch

Economic outlook. Weak growth momentum to
prompt a rate cut going forward despite rising
household debt.

Main risks. Social spending requirements point to
increasing tax burden.
Limited upside to consumption
Weak start to 2015, with exports dragged down by
Russia and EU… Despite low base effects, exports fell
0.4% in January, vs. 3.6% growth in December. Not
surprisingly, exports to the US continued to fare far
better than those to Europe, reflecting the state of their
respective economies. In particular, exports to the US
rose 10.8% in January, even after reporting strong
growth of 22.1% in Q4 2014. In contrast, exports to EU
fell faster at 25.7% vs. 3.7% fall in Q4. Within Asia,
exports to China fell 4.5% in January after a very
modest growth of 0.5% in Q4, albeit better than the
21.5% fall in exports to ASEAN in January, after 0.6%
fall in Q4. Exports to Russia fared the worst, falling
63%, vs. 38.0% fall in Q4, while exports to the Middle
East fell 22.1% vs. 9.4% growth in Q4.
sideways, growing at a modest pace of 3.3% in
January, vs. 3.5% growth in Q4.
…boding ill for growth in Q1, after a very weak finish in
Q4… Growth surprised sharply to the downside in Q4,
falling to 0.4% qoq sa from 0.9% in Q3. Worse still, this
was driven by both weaker domestic demand (0.5% in
Q4 vs. 1.3% in Q3) and sustained fall in exports (-0.3%
vs. -2.2%). On a yoy basis, domestic demand rose at
2.3% in Q4 vs. 3.6% in Q3, contributing 2.1ppts vs.
3.3pppts, while the net trade contribution to growth
rose to 0.8ppts from 0.1ppts due to weakness in
imports. For the year, domestic demand contributed
2.8ppts to 3.3% growth and we see little change in
2015. Within this, private consumption contributed
0.9ppts in 2014, down from 1ppts.
Two-legged weakness
%yoy contribution to growth
14
Exports
Domestic demand
10
6
EU and EMEA drag on Korean exports
2
-2
% Contribution to growth 3mma
Rest of the world
10
US
8
EU
China
6
Total exports
4
-6
-10
2007 2008 2009 2010 2011 2012 2013 2014
Sources: CEIC, Deutsche Bank
2
0
-2
-4
-6
2012
2013
2014
2015
Sources: CEIC, Deutsche Bank
In terms of goods, while there was little surprise in
petroleum products leading this weakness in exports,
falling 34.1% in January vs. a 10.2% decline in Q4, a
23.9% fall in auto exports (vs. 0.9% fall in Q4) indicate
ongoing struggle within the sector. As it is, domestic
autos are facing increasing competition from imports.
Imported auto sales in Korea rose 34% in January,
accelerating from 25.5% growth in Q4. As a result, the
share of foreign car sales to total domestic sales stood
at 15% in January vs. 12% in 2014. Meanwhile,
electronic and electronic parts export growth moved
Deutsche Bank Securities Inc.
…while growth in private consumption remains
limited… Despite support from lower rates and low oil
prices, we see only a limited improvement in private
consumption this year, given household debt burden
and ageing population, albeit any sustained recovery in
housing prices poses risks to this view.
Korea is posed for quite a rapid increase in ageing
population, to become the second oldest by 2050, from
the youngest OECD economy at the moment. This in
turn has already brought about meaningful changes in
household expenditure. Already, it has prompted a
faster rise in tax and non-consumption expenditure on
social security and pensions. Together their share of
overall expenditure rose to 15% in 2014 (4-quarter
average), from 12% in 2007, while the share of
consumption expenditure fell to 73.1% from 78.1% in
the same period. An ageing population points to
increasing social spending – Korea currently has one of
the lowest rates of public social spending at 9% of GDP
in 2012, vs. the OECD average of 21% – and its tax
Page 73
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
implications have become highly politicized. With the
government now back tracking on its tax hikes for
salaried workers, there are increasing calls to opt for
corporate tax hikes, given Korea’s relatively low rate of
22% vs. the OECD average of 23%. Consumption
patterns have also changed. Already, together with
increasing wealth and available healthcare services,
expenditure on healthcare rose rapidly in Korea, above
9% vs. the OECD average of 4%. Over the past decade,
Korea saw the share of household expenditure on
healthcare rising to 7% from 5.3%, as its growth
outpaced the overall expenditure. For details, please
see our special reported titled South Korea: Striving for
healthy growth, published July 2014.
Ageing population is also another reason for the
increase in debt by households. Note that a significant
proportion of the loans to those aged 50 or older were
used for business purposes. Please see our Special
report titled South Korea: Self-employed but in debt,
published October 2012. Indeed, in its recent report,
the BoK noted its concerns about increasing the share
of loans to those aged 50+ (to 50.7% in Q1 2014 from
42% in 2009) given the rapid increase in their default
share, to 31% in 2013 from below 20% in 2009.
…moving beyond challenge to rate cuts, as inflation
falls… Despite its growth and inflation forecast cuts,
however, the BoK left its policy rate unchanged in
January, striking a relatively hawkish tone, amid
sustained acceleration in household loans, to 7.4%yoy
in Q4 from 6.2% in Q3. In response to the weak growth
in Q4, the Bank of Korea (BoK) cut its 2015 GDP growth
forecast to 3.4% from 3.9%. In the same vain, we also
cut our GDP forecast by 0.3ppts to 3.3% for 2015. As it
lowered its assumption on oil prices, to USD69 per
barrel vs. USD99 earlier, the BoK also cut its 2015
inflation forecast by 0.5ppts to 1.9%, vs. 1.3% in 2014
and our forecast of 1.5%. While the BoK considers risks
to its inflation outlook to be quite balanced, we see
them tilted to the downside.
Although we recognize the BoK’s dilemma, we
continue to expect it to deliver a 25bps rate cut in
March in response to weak economic data and rate
cuts by other central banks in the region, which are
also reflecting ongoing challenges to their own growth.
Having said that, we do not rule out an earlier rate cut,
i.e. 17 February, if economic or political conditions take
a turn for the worse. Interesting enough, as far as the
rate impact is concerned, a study by the BoK suggests
that it is not the interest rates or financial regulations
(like LTV/DTI) but housing prices and income growth
that are the dominant drivers of loan growth. For its
part, to limit household burden, the government has
also proposed providing low, fixed rate mortgages.
Juliana Lee, Hong Kong, +852 2203 8312
Page 74
South Korea: Deutsche Bank forecasts
2013
2014F
2015F
2016F
1305
50.2
25980
1410
50.4
27962
1349
50.6
26656
1405
50.8
27665
Real GDP (yoy %)
Private consumption
Government consumption
Gross fixed investment
Exports
Imports
3.0
2.0
2.7
4.2
4.3
1.6
3.3
1.7
2.8
3.3
2.8
2.0
3.3
2.3
4.4
3.6
4.1
4.0
3.7
2.6
1.5
4.1
5.0
4.5
Prices, money and banking
CPI (yoy %) eop
CPI (yoy %) ann avg
Broad money (Lf)
Bank credit (yoy %)
1.1
1.3
7.4
4.1
0.8
1.3
7.7
6.3
2.1
1.5
8.0
7.0
2.1
2.1
8.0
7.0
Fiscal accounts (% of GDP)
Central government surplus
Government revenue
Government expenditure
Primary surplus
1.0
22.0
21.0
1.9
0.0
21.4
21.5
1.0
-1.0
21.0
22.0
0.1
-1.1
20.3
21.4
-0.1
External accounts (USDbn)
Merchandise exports
Merchandise imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI (net)
FX reserves (USDbn) 1
FX rate (eop) KRW/USD
617.1
536.6
80.6
6.2
79.9
6.1
-15.6
346.5
1050
621.5
528.7
92.9
6.6
89.3
6.3
-20.7
363.6
1099
617.4
519.8
97.6
7.2
91.8
6.8
-20.0
372.6
1170
642.6
552.1
90.5
6.4
79.9
5.6
-18.0
386.7
1130
Debt indicators (% of GDP)
Government debt2
Domestic
External
Total external debt
in USDbn
Short-term (% of total)
34.8
34.3
0.5
31.9
416.1
27.7
35.4
34.8
0.7
30.6
430.0
27.4
37.2
36.4
0.8
32.1
432.0
27.8
38.9
38.0
0.9
31.1
437.0
28.6
0.2
3.1
0.0
3.6
3.0
3.4
3.5
3.4
Current
15Q1
15Q2
15Q4
2.00
2.12
2.35
1090
1.75
1.89
2.50
1120
1.75
1.90
2.80
1150
1.75
1.90
3.00
1170
National income
Nominal GDP (USDbn)
Population (m)
GDP per capita (USD)
General
Industrial production (yoy %)
Unemployment (%)
Financial markets
BoK base rate
91-day CD
10-year yield (%)
KRW/USD
Source: CEIC, Deutsche Bank estimates, Global Markets Research, National Sources
Note: (1) FX swap funds unaccounted for (2) Includes government guarantees
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Sri Lanka
B1(stable)/B+/BBMoody’s/S&P/Fitch


Economic outlook: We expect Sri Lanka’s real GDP
growth to slow down to 7.5% and 7.0% in 2015
and 2016 respectively (from 7.7% in 2014), led by
slowdown in investment momentum, as the
government tries to bring in more transparency in
awarding projects.
previous year’s outturn. With nominal GDP growth
expected to be lower this year, the revenue
estimates appear to be realistic, in our view.

Expenditure estimates indicate sharp slowdown in
capital expenditure. The previous government had
estimated total expenditure to be 19.5% of GDP in
2015, similar to the last year’s outturn of 19.4% of
GDP. Recurrent expenditure was estimated to be
13.5% of GDP, while capital expenditure outlay
was pegged at 6.0% of GDP according to the older
estimate. The recent budget projections show total
expenditure to be 18.7% of GDP in 2015, a 0.7% of
GDP improvement over last year’s outturn. The
expenditure compression is likely to happen
entirely on the capital expenditure front, which is
likely to fall to 4.6% of GDP in 2015, from 5.4% of
GDP in 2014 (vs. 6% of GDP in the earlier estimate).
Recurrent expenditure on the other hand is
expected to increase to 14.2% of GDP, from 14.0%
of GDP in the previous year (vs. 13.5% of GDP in
the earlier estimate). The government’s decision to
spend considerably lesser on capital expenditure vs.
the previous years’ average (5.4% of GDP spent on
an average between 2012-2014) is likely to impact
growth to some extent, unless a considerable part
of the expenditure compression is on account of a
cut in wasteful expenditure and pilferage.

We retain our 2015 headline fiscal deficit forecast
at 5.0% of GDP for now, but change our revenue
and expenditure estimates, in the backdrop of the
latest developments. We pare down our revenue
(14.3% of GDP vs. 14.5% of GDP) and expenditure
projection (19.3% of GDP vs. 19.5% of GDP earlier)
by 20bps, as compared to our earlier estimate,
which helps maintain the headline fiscal deficit
projection at 5.0% of GDP. The only difference
between our and the government estimates is in
case of capital expenditure, where we expect the
government to eventually end up spending more
than what the authorities have indicated (by about
0.5% of GDP).
Main
risks:
Excessive
capital
expenditure
compression could have an adverse impact on
growth.
Fiscal health is poorer than it appears
The new government presented an interim budget on
29th January, which pegged the 2015 fiscal deficit
target at 4.4% of GDP, a tad lower than the previous
projection of 4.6% of GDP. However, the government
has clarified that this number fails to reflect the actual
stress on the public finance, as it does not take into
account contingent liabilities related to state owned
enterprises. Clearly, the budget deficit would have been
considerably higher, if such off balance sheet liabilities
were included. Accounting for such liabilities, the
government estimates that Sri Lanka’s total public debt
to GDP ratio was 88.9% by end-2014, instead of the
earlier reported figure of 74.4%.
Debt/GDP ratio close to 90% with contingent liabilities
% of GDP
110
Debt-GDP ratio
105
100
95
90
85
80
75
70
1990
1994
1998
2002
2006
2010
2014
Source: Ministry of Finance, CBSL, Deutsche Bank
As far as the budget numbers are concerned, we note
the following:

Revenue numbers are much more realistic than the
older estimate. The previous government had
estimated total revenue and grants to improve to
14.9% of GDP in 2015, from 14.4% of GDP in 2014,
which was overly optimistic, in our view. The
current budget has estimated total revenue to be
about 14.3% of GDP in 2015, a tad lower than the
Deutsche Bank Securities Inc.
Fiscal forecast: Government vs. Deutsche Bank
% of GDP
2014
2015, old
budget
forecast
Total revenue and grants
14.4
14.9
14.3
14.3
Total expenditure
19.4
19.5
18.7
19.3
Recurrent
14.0
13.5
14.2
14.2
Capital and net lending
5.4
6.1
4.6
5.1
-5.0
-4.6
-4.4
-5.0
Budget deficit
2015, new 2015, DB
budget
forecast
forecast
Source: Ministry of Finance, Deutsche Bank
Page 75
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
CBSL in a wait and watch mode
Sri Lanka: Deutsche Bank Forecasts
2013
2014F
2015F
2016F
The CBSL, under the newly appointed Governor Arjuna
Mahendran, kept all key policy rates unchanged in the
January monetary policy review. Going forward, the
central bank expects the inflation trajectory to remain
well within its comfort range (CPI inflation was 3.2% in
Jan 2015), aided by the recent fuel price cut (15-20%
cut in petrol and diesel prices). The authorities also
expressed comfort about the ongoing improvement in
private sector credit growth (increased to 6.5%yoy in
Nov’14, from 5.1%yoy in Oct’14) and remained
confident about the sustainability of the robust growth
momentum through 2015 (DB forecast: 7.5% real GDP
growth in 2015). Solely based on the inflation trajectory,
further rate cuts could be justified, but this is unlikely,
given that the policy rate is currently at a record low,
credit growth has already bottomed and has started
rising and growth momentum continues to be strong.
National Income
Nominal GDP (USD bn)
Population (mn)
GDP per capita (USD)
66.9
20.5
3268
75.7
20.6
3665
85.2
20.8
4094
96.0
21.0
4577
Real GDP (YoY %)
Total consumption
Total investment
Private
Government
Exports
Imports
7.3
3.2
9.7
10.0
9.5
5.9
-0.3
7.7
5.0
11.1
12.0
8.0
7.0
4.0
7.5
6.8
10.1
11.0
7.0
8.0
8.7
7.0
6.6
9.1
9.6
7.0
7.0
8.0
Prices, Money and Banking
CPI (YoY%) eop
CPI (YoY%) avg
Broad money (M2b) eop
Bank credit (YoY%) eop
4.7
6.9
16.7
7.5
2.1
3.3
13.0
7.5
6.2
3.5
16.5
20.0
4.1
5.5
16.0
18.0
Fiscal Accounts (% of GDP)
Central government balance
Government revenue
Government expenditure
Primary balance
-5.8
13.9
19.8
-0.8
-5.0
14.4
19.4
-0.6
-5.0
14.3
19.3
-1.2
-4.5
14.6
19.1
-0.7
External Accounts (USD bn)
Merchandise exports
Merchandise imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI (net)
FX reserves (USD bn)
FX rate (eop) LKR/USD
10.4
18.0
-7.6
-11.4
-2.6
-3.9
0.9
7.2
130.8
11.4
19.4
-8.0
-10.5
-2.2
-2.9
1.9
9.0
131.3
12.2
20.4
-8.1
-9.5
-1.5
-1.8
1.0
10.0
132.0
13.2
21.8
-8.6
-8.8
-1.4
-1.4
1.0
11.0
133.0
Debt Indicators (% of GDP)
Government debt
Domestic
External
Total external debt
in USD bn
Short-term (% of total)
78.3
44.2
34.1
46.7
31.3
18.6
75.4
43.0
32.4
45.5
34.4
18.6
72.5
40.6
31.9
44.2
37.9
19.4
69.7
38.3
31.4
43.4
41.6
20.3
7.5
4.4
8.0
4.5
8.5
4.5
9.0
4.5
Current
8.00
15Q1
8.00
15Q2
8.00
15Q4
8.50
132.7
133.0
131.8
132.0
Inflation and policy rate forecast
%yoy
12
CPI inflation, lhs
Forecast
Policy rate, rhs
Forecast
10
%
12
11
8
10
6
9
4
8
2
0
2009
7
2010
2011
2012
2013
2014
2015
Source: CBSL, Deutsche Bank
With the interim budget out of the way, it will be
interesting to see how the monetary authorities react
based on the revised fiscal deficit target, composition
of the expenditure outlay and quality of fiscal
consolidation. The central bank’s reaction to the
ongoing rupee depreciation (LKR has depreciated
against USD by 1.3% since the beginning of 2015)
would also be watched closely, in our view. We think
there is a possibility for rupee to touch the lows seen
during July-2012 (134 against the USD), but we don’t
expect any disorderly depreciation beyond that.
Kaushik Das, Mumbai, +91 22 7180 4909
General
Industrial production (YoY %)
Unemployment (%)
Financial Markets
Reverse Repo rate
LKR/USD
Source: CEIC, DB Global Markets Research, National Sources
Page 76
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Taiwan
Aa3/AA-/A+
Moody’s/S&P/Fitch

Economic outlook: Stronger-than-expected finish to
2014 and relatively positive start to 2015.

Main risks: Economic policy response to boost
growth limited by politics.
Starting the year on a positive note
Income growth outpaced productivity
%yoy
20
Average earnings
Labour productivity
Private consumption (rhs)
6
15
4
10
Strong finish to 2014, albeit due to weak imports….
Taiwan’s GDP growth accelerated to 1.2%qoq sa in Q4
2014 from 0.7% in Q3. On a yoy basis, however, given
high base effects, GDP growth fell to 3.2% in Q4 from
3.6% in Q3. Having said that, this was higher than our
forecast of 2.8% and we attribute this positive surprise
to weak imports. Despite modestly weaker-thanexpected export growth of 5.6% in Q4, vs. 7.5% in Q3,
a sharper deceleration in import growth, to 4.6% in Q4
from 9.1% in Q3, left the net trade contribution to GDP
growth sharply higher at 1.1ppts in Q4 vs. -0.3ppts in
Q3. For the year, imports rose 5.3% in 2014 vs. 3.3%
in 2013, while export growth accelerated to 5.6% from
3.5%, with the net contribution to growth rising to
0.7ppts in 2014 vs. 0.4ppts in 2013.
Net trade contribution rose due to weak imports
%yoy contribution to growth
20
Domestic demand
15
Net trade
5
2
0
0
-5
-10
-2
2006
2008
2010
2012
2014
Sources: CEIC, Deutsche Bank
Supporting this recovery was sustained growth in
employment (continuing to rise at 1% in 2014) and
increasing income growth. Average earnings continued
to rise, from 2.6% in 2013 to 3.8% in 2014 (up to
November). Note that the rate of increase in industry
earnings, at 3.3% in 2014 (up to November) was
slower than the 3.7% gain in productivity. This is a
departure from the trend that we saw over the previous
two years during which time earnings rose faster than
productivity.
Sustained recovery in auto and motorcycle sales
10
5
%yoy
120
0
Retail Trade Index: Automobiles and
Motorcycles and Related Parts 12mma
-5
-10
-15
2008
100
2009
2010
2011
2012
2013
2014
80
Sources: CEIC, Deutsche Bank
Weaker private consumption contributed to lower
import growth. Private consumption rose at a slower
pace of 2.3% in Q4 vs. 2.9% in Q3, with the
contribution to growth falling to 1.2ppts in Q4 from
1.6ppts in Q3. Having said that, however, private
consumption fared better in 2014 vs. 2013, rising 2.7%
vs. 2.4%, adding 1.5ppts vs. 1.3ppts to overall growth.
Deutsche Bank Securities Inc.
60
2000
2002
2004
2006
2008
2010
2012
2014
Sources: CEIC, Deutsche Bank
Interestingly enough, the most striking change in the
behavior of the retail trade in Taiwan, is the diminishing
share of information/communication equipment and
electrical appliances, to 9% in 2008 from 11.1% in 2014.
By contrast, motor vehicle sales saw their share of
retail trade rising to 14.4% in 2014 from 10.7% in 2008.
Including services, there was a marked rise in
expenditure on recreation and cultural activities, to 9%
of total in 2014, vs. 7.3% in 2008.
Page 77
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Amid weaker exports and private consumption growth,
investment growth fell relatively sharply to 2.2% in Q4
vs. 8% in Q2, adding only 0.5ppts to overall growth in
Q4 vs. 1.8ppts in Q3. At the moment, with only
headline investment data available, we cannot
determine if this weakness was largely due to
destocking or weakness in facility and construction
investments. High frequency data suggest that the
latter was an important contributor to the weakness.
Imports of capital goods fell 2.8% in Q4 vs. 13.7% in
Q3, while construction commenced fell 6.5%yoy 3mma
in November vs. a 0.7% rise in Q3. For the year,
investment rose at a faster pace of 4% vs. 3.3% in 2013,
contributing slight more to overall growth at 0.9ppts in
2014 vs. 0.8ppts in 2013.
Taiwan exports fare better
Sources: CEIC, Deutsche Bank
…and positive start to 2015…. This year started off on
a positive note with exports rising 3.4% in January vs.
2.8% in December. While this may have been
supported by the holiday effects, this stands out
compared to the poor results in Korea and China during
the same month. Imports fell 4.8% with weak oil prices
the main drag, leaving a larger trade surplus of
USD4.8bn in January vs. USD4.5bn in December.
Together with stronger-than-expected growth in Q4,
this positive start to the year has prompted us to revise
up this year’s growth to 3.8%, from 3.6% earlier.
…but sustained low inflation points to steady rates in
2015. Despite stronger growth in 2015, we see low
inflation keeping the Central Bank of China (CBC) on
hold this year, despite the Fed rate hikes ahead, as
other central banks in the region ease their policy rates.
Inflation fell 0.9% in January from 0.6% in December,
also depressed by high base effects (the LNY holidays
in January last year). We have brought down our
inflation forecast further to 0.3% from 0.7% for this
year. We also see the CBC managing FX risks by
guiding the TWD in line with other currencies in the
region.
Taiwan: Deutsche Bank forecasts
2013
2014F
2015F
2016F
513.0
23.4
21949
529.6
23.4
22614
529.3
23.4
22604
543.6
23.5
23139
Real GDP (yoy %)
Private consumption
Government consumption
Gross fixed investment
Exports
Imports
2.2
2.4
-1.2
5.0
3.5
3.3
3.5
2.7
3.1
1.9
5.7
5.6
3.8
2.9
0.1
3.6
7.9
6.8
3.5
2.7
1.0
3.2
6.7
5.8
Prices, money and banking
CPI (yoy %) eop
CPI (yoy %) annual average
Broad money (M2)
Bank credit1 (yoy %)
0.3
0.8
4.3
2.7
0.6
1.2
5.8
4.3
1.3
0.3
6.5
4.5
0.7
0.9
6.5
4.5
Fiscal accounts (% of GDP)
Budget surplus
Government revenue
Government expenditure
Primary surplus
-1.4
16.1
17.5
-0.4
-2.0
15.5
17.4
-0.9
-1.7
15.3
17.1
-0.6
-1.4
15.3
16.7
-0.3
External accounts (USDbn)
Merchandise exports
Merchandise imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI (net)
FX reserves (USDbn)
FX rate (eop) TWD/USD
304.6
267.6
37.0
7.2
57.4
11.2
-1.0
416.8
29.8
313.5
271.5
42.0
7.9
67.1
12.7
-11.0
418.9
31.7
331.3
270.4
60.9
11.5
80.0
15.1
-14.0
432.0
32.5
349.9
296.6
53.3
9.8
70.2
12.9
-14.0
438.3
32.0
Debt indicators (% of GDP)
Government debt2
Domestic
External
Total external debt
in USDbn
Short-term (% of total)
39.6
39.1
0.5
33.1
170.1
91.5
39.5
39.1
0.4
37.2
195.7
91.5
39.5
39.1
0.4
38.8
205.4
91.5
39.3
38.9
0.4
39.7
215.7
91.5
0.8
4.2
6.2
4.0
6.5
4.0
5.5
4.0
Current
1.88
0.81
1.62
31.5
15Q1
1.88
0.81
1.65
31.5
15Q2
1.88
0.83
1.85
32.0
15Q4
1.88
0.85
2.00
32.5
National income
Nominal GDP (USDbn)
Population (m)
GDP per capita (USD)
General
Industrial production (yoy%)
Unemployment (%)
Financial markets
Discount rate
90-day CP
10-year yield (%)
TWD/USD
Source: CEIC, Deutsche Bank Global Markets Research, National Sources
Note: (1) Credit to private sector. (2) Including guarantees on SOE debt
Juliana Lee, Hong Kong, +852 2203 8312
Page 78
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Thailand
Baa1/BBB+/BBB+
Moody’s/S&P/Fitch

Economic outlook: Mild signs of consumption and
tourism revival have given rise to the hope that the
economy may have put the worst of this cycle
behind.

Main risks: If demand does not turn around soon,
the duration of the period of deflation could prove
to be more protracted than expected, making
policy calibration particularly difficult.
Signs of a bottom
Thailand has joined a number of regional economies in
entering negative inflation territory. While core inflation
was sticky at 1.6%, headline inflation printed -0.4% in
January, a point sufficiently below the 1-4% inflation
target that it necessitated a formal explanation by the
Bank of Thailand.
Indeed, recent statements by the BoT governor seem to
suggest that a rate cut could well be on the table,
especially if growth momentum were to slow once
again. Given recent global developments and lingering
uncertainties, we think it is important for central banks
to keep whatever small room is available to act. BoT is
going to be no exception, in our view. We are
maintaining our forecast of unchanged monetary policy
through the course of the year, but the chance of a rate
cut grows as inflation surprises to the downside month
after month. If incipient signs of an investment
recovery begin fading, rate cut would be firmly back on
the agenda, in our view.
Disappearing inflation, for the time being
%yoy
Headline
Core
5.0
In its note, the central bank explained that it did not see
a whole lot more than declining energy prices
contributing to the ongoing downward slide in inflation.
It expects global oil prices to gradually recover in line
with a more balanced global oil market in the second
half of year, which should cause headline inflation to
rise back within the inflation target range. BoT’s
inflation forecast therefore sees no more than a quarter
or two of below-target inflation.
The central bank does not consider the ongoing
developments being caused by weak demand; indeed
low energy prices should boost demand, and by
extension raise inflation expectations, as per the BoT’s
statement. In any case, we have noted that indicators
of investment have begun to pick up, while
consumption data show no vigor but clear signs of
bottoming. The economy is finding its footing, it
appears to us.
The BoT statement stresses that there has been no
evidence suggesting that the public expects a
sustained decline in the general price level, which
could lead to delays in consumption and investment.
The current monetary policy stance is seen as
conducive to supporting the economic recovery.
We see merit in the BoT’s statement, but worry if the
economy is capable of handling even the short term
consequence of the deflationary dynamic, which is a
rise in real interest rates. As per our forecast, real rates
would be in the highest territory in more than 5 years
through the course of 2015. While the economy does
not appear to be mired in dysfunction, it is highly
indebted (especially Thai households). A rising (real)
rate environment would clearly be the opposite of
what’s needed to support the fledgling economic
recovery.
Deutsche Bank Securities Inc.
4.0
3.0
2.0
1.0
0.0
-1.0
2010
2011
2012
2013
2014
2015
Source: CEIC< Deutsche Bank
Can the economy handle a spike in real rates?
Policy rate
minus inflation
3.00
2.50
2.00
1.50
1.00
0.50
0.00
-0.50
-1.00
-1.50
-2.00
2011
2012
2013
2014
2015
Source: CEIC, Deutsche Bank. Dotted line denotes forecasts.
Page 79
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Tourism an emerging upside risk
Thailand: Deutsche Bank Forecasts
A mild recovery in tourism is on the cards. The
authorities have taken a number of measures over the
past six months to assuage concerns about political
instability, including relaxing martial law from tourist
intensive areas and easing visa requirement for Chinese
and Russian tourists.
National Income
Nominal GDP (USDbn)
Population (m)
GDP per capita (USD)
Still, until a full withdrawal of military rule takes place,
some tourists will struggle to secure travel insurance.
Furthermore, sharp weakness of the euro and
economic turmoil in Russia could act as a major
roadblock for tourism.
One hope is that the downside from European and
Russian tourism would be neutralized by the ongoing
surge in Chinese tourism. Although the growth
environment has faded somewhat in China as well,
there has been no apparent slowdown in tourism from
China to Thailand. The average growth rate of Chinese
tourist arrivals to Thailand has been striking, more than
60% per year over the last three years. Likely
continuation of a visa fee waiver will keep Chinese
tourism strong, in our view.
Indeed, Chinese tourist arrivals set a new record in late
2014, with around half a million arrivals in November
and December. This may well be a silver lining on an
otherwise gloomy environment.
A turn in tourism, at last
3mma
Tourist arrival. Yoy%
Hotel occupancy tate
60
80
50
70
40
30
60
20
50
10
0
40
-10
-20
30
2010
2011
2012
2013
2014
2013
2014F
367.8
64.8
5677
364.3
65.1
5,596
362.8
65.4
5,545
369.9
65.8
5,625
Real GDP (yoy %)
Private consumption
Government consumption
Gross fixed investment
Exports
Imports
2.9
0.3
4.9
-2.0
4.2
2.3
0.5
0.6
2.7
-2.8
-1.3
-5.0
3.5
1.0
3.8
1.0
2.0
4.4
3.0
2.3
4.2
2.0
6.3
6.1
Prices, Money and Banking
CPI (yoy %) eop
CPI (yoy %) ann avg
Core CPI (yoy %) ann avg
Broad money
Bank credit1 (yoy %)
1.7
2.2
1.0
7.3
9.4
0.6
1.9
1.6
7.5
8.0
1.4
0.3
1.5
8.0
9.0
2.2
2.2
1.5
9.0
9.0
Fiscal Accounts2 (% of GDP)
Central government surplus
Government revenue
Government expenditure
Primary surplus
-2.0
19.0
21.0
-0.7
-2.8
18.5
21.3
-1.5
-2.5
19.0
21.5
-1.2
-2.0
19.0
21.0
-0.7
External Accounts (USDbn)
Merchandise exports
Merchandise imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI (net)
FX reserves (USDbn)
FX rate (eop) THB/USD
225.4
218.7
6.7
1.8
-2.5
-0.7
12.8
167.3
32.9
230.0
210.4
19.5
5.4
7.0
1.9
245.0
229.4
28.2
7.8
9.0
2.5
264.6
252.3
37.0
10.0
8.0
2.2
12.0
172.0
32.9
15.0
180.0
35.0
18.0
190.0
35.0
Debt Indicators (% of GDP)
Government debt2,3
Domestic
External
Total external debt
in USDbn
Short-term (% of total)
45.3
43.4
1.9
36.7
135.0
45.0
46.6
45.6
1.0
38.3
140.0
45.0
46.7
45.7
1.0
40.2
145.0
45.5
46.7
45.8
0.9
41.0
150
45.8
2.6
0.8
1.0
0.9
5.0
1.0
5.0
1.1
Current
2.00
2.18
2.64
32.6
15Q1
2.00
2.25
2.25
33.6
15Q2
2.00
2.25
2.25
34.2
15Q4
2.00
2.45
2.50
35.0
General
Industrial production (yoy %)
Unemployment (%)
Source: CEIC, Deutsche Bank
Taimur Baig, Singapore, +65 6423 8681
Financial Markets
BoT o/n repo rate
3-month Bibor
10-year yield (%)
THB/USD (onshore)
2015F 2016F
Source: CEIC, Deutsche Bank Global Markets Research, National Sources
Note: (1) Credit to the private sector & SOEs. (2) Consolidated central government accounts; fiscal
year ending September. (3) excludes unguaranteed SOE debt
Page 80
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Vietnam
B2/BB-/B+
Moody’s/S&P/Fitch

Economic outlook. Strong start to the year ahead
of the Tet holidays.

Main risks. Private foreign capital may be hard to
attract amid increasing global market volatility.
Staying strong ahead of the Tet
Domestic demand accelerates
60
50
Electronics and phones exports continued to accelerate
%yoy contribution
Strong start to 2015, ahead of the Tet holidays in
February… Retail sales picked up meaningfully in
January, well ahead of the most important (longest)
holiday of the year. The Tet holiday falls on 16-23
February this year vs. 28 January to 5 February last
year. Retail sales (discounted by CPI inflation) rose
13.9% in January 2015 vs. 12.7% in Q4 2014. In
preparation for the February holidays, imports also
surged 33.8% in January vs. 14.7% in Q4 2014. More
importantly, machinery and equipment imports rose
46.4% in January vs. 25.6% in Q4, suggesting stronger
investment growth. Meanwhile, auto vehicle imports
surged 141.3% in January, albeit down from a 171.6%
rise in Q4. Ahead of the holidays, firms also ramped up
production, leaving industrial production growth
sharply higher at 20.0% in January 2015 vs. 13.4% in
Q4 and January 2014. This is a positive start to the year,
albeit supported partly by the Tet holiday effects, with
the government aiming for GDP growth of 5.4% in Q1
vs. 4.8% growth reported in Q1 last year.
%yoy
importance of high-tech products in Vietnam’s overall
exports, the share of which rose to 26% in January
from 23% in 2014 vs. 24% in 2013 and 18% in 2012.
Retail sales
45
40
35
30
25
20
15
10
5
0
-5
-10
Other goods
Phones & Spare Parts
Computer & Electronic Components
2013
2014
2015
Sources: CEIC, Deutsche Bank
In contrast, the number of tourists fell 9.7%yoy in
January vs. a 13% fall in Q4, led by a 24.7% fall in
Chinese tourists in January vs. a 26.1% fall in Q4,
pointing to sustained weakness in services exports.
With goods exports rising at a relatively slower pace vs.
imports, Vietnam saw its goods trade deficit worsening
modestly, to USD0.5bn from USD0.2bn in Q4. Barring
external shocks, we see little pressure on the dong
from domestic factors, amid low inflation.
Trade deficit amid rebound in domestic demand
Imports of machinery and equipment
%yoy 3mma
40
80
30
Exports
60
20
Trade Balance (rhs)
USD bn
4
3
Imports
10
40
2
0
20
1
0
0
-10
-20
-30
2009
Jan 15
2010
2011
2012
2013
2014
Sources: CEIC, Deutsche Bank
On the external front, despite the general weakness in
commodity exports, total export growth accelerated to
12.6% in January 2015 vs. 10.8% in Q4, with exports of
computer and electronic components and phones and
spare parts continuing their strong recovery, rising
43.1%yoy 3mma and 27.6%, respectively, in January vs.
33.5% and 15% in December, after growth of 6.7% and
14% in 2014. The latter points to the increasing
Deutsche Bank Securities Inc.
-20
-1
-40
-2
-60
2010
2011
2012
2013
2014
-3
2015
Sources: CEIC, Deutsche Bank
…while falling commodity prices help the SBV to lower
lending rates … While domestic demand continues to
recover, weakness in commodity prices guided overall
inflation lower. In particular, the CPI saw its third
consecutive month of decline (0.2%mom) in January,
with the yoy rate at 0.9% in January vs. 1.8% in
Page 81
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
December, marking its lowest level in 14 years. While
transportation costs fell 10.4% in January vs. 5.6% in
December, housing and construction costs followed,
continuing to decline – by 4% in January vs. 2% in
December, reflecting both falling commodity prices and
sustained adjustment in the housing/construction
sector.
With lower inflation, although the SBV has not yet
lowered its policy rates, it has released a directive
asking banks to lower their medium-term and longterm lending rates by 100-150bps. It seeks credit
growth of 13-15% this year vs. the 12% target last year,
to support GDP growth of 6.2%. To support financial
intermediation at home, the VAMC seeks to unload a
further VND100tr of bad debt from banks this year,
bringing its total purchase to VND235tr, about 6% of
total loans.
Credit supported growth
%yoy
60
Loan
%yoy
10
GDP (rhs)
50
9
40
8
30
7
20
6
10
5
0
4
1998
2003
2008
2013
Sources: CEIC, Deutsche Bank
Note: Light colored lines represent the government targets
…while
the
government
seeks
foreign
capital/investments. The SBV has also allowed full
ownership of weak banks, subject to the prime
minister’s approval, to further bank restructuring.
Meanwhile, to support the housing market, the housing
law relating to foreign ownership of properties was
relaxed with 50-year extensions allowed; this could
affect up to 30% of apartments, for example. The
government seeks to attract more private sector
participation, and, in some cases, foreign participation
in infrastructure projects and restructuring of SOEs,
with a rather ambitious plan towards the end of the
year. As a political mandate would be critical in this
regard, we see the authorities treading carefully to
ensure stability and growth, while laying the foundation
for more aggressive reforms in 2016, after the election.
Juliana Lee, Hong Kong, +852 2203 8312
Vietnam: Deutsche Bank forecasts
2013
2014F
2015F
2016F
171.3
89.7
1905
186.2
90.7
2052
201.3
91.7
2198
219.4
92.6
2370
Real GDP (yoy %)
Private consumption
Government consumption
Gross fixed investment
Exports
Imports
5.4
5.2
7.3
5.3
11.5
10.5
6.0
5.6
7.3
6.7
12.0
12.0
6.2
5.9
7.0
7.0
15.0
16.2
6.2
6.0
7.0
7.5
14.5
16.0
Prices, money and banking
CPI (yoy %) eop
CPI (yoy %) ann avg
Broad money (yoy %)
Bank credit (yoy %)
6.0
6.6
16.0
12.4
1.8
4.1
16.5
12.0
6.6
4.0
18.0
13.5
4.8
5.5
19.0
14.0
Fiscal accounts1 (% of GDP)
Federal government surplus
Government revenue
Government expenditure
Primary fed. govt. surplus
-5.6
22.9
28.5
-4.3
-5.8
21.1
26.9
-4.3
-5.3
21.0
26.3
-3.8
-5.3
21.0
26.3
-3.4
External accounts (USD bn)
Merchandise exports
Merchandise imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI (net)
FX reserves (USD bn)
FX rate (eop) VND/USD
132.0
124.0
8.0
4.7
10.0
5.8
9.0
26.3
21095
147.0
141.0
6.0
3.2
8.0
4.3
9.0
40
21335
168.0
163.0
5.0
2.5
7.0
3.5
9.5
48
22000
198.0
200.0
-2.0
-0.9
0.0
0.0
9.5
52
22500
52.0
23.0
29.0
39.1
67.0
17.9
59.5
29.5
30.0
38.1
70.5
18.4
62.0
31.0
31.0
38.3
76.0
18.4
64.0
32.0
32.0
37.5
80.0
18.8
7.9
3.6
7.8
3.4
8.2
3.2
8.5
3.2
Current
6.50
21335
15Q1
6.00
21500
15Q2
6.00
21800
15Q4
6.00
22000
National income
Nominal GDP (USD bn)
Population (m)
GDP per capita (USD)
Debt indicators (% of GDP)
Government debt2
Domestic
External
Total external debt
in USD bn
Short-term (% of total)
General
Industrial production (yoy %)
Unemployment (%)
Financial markets
Refinancing rate
VND/USD
Source: CEIC, Deutsche Bank Global Markets Research, National Sources
Note: (1) Fiscal balance includes off-budget expenditure, while revenue and expenditure include
only budget items. (2) Taken from the government estimate.
.
Page 82
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Czech Republic
A1(stable)/AA-(stable)/A+(stable)
Moodys/S&P/Fitch

Economic outlook: Fiscal expansion, a continuation
of accommodative monetary policy and the decline
in oil prices should all provide a meaningful support
to growth this year. Consumer sentiment has also
improved markedly and we maintain our
expectation for reasonably robust domestic-led
growth in 2015. A recent upward revision to our
GDP growth forecast for Germany also removes
some of the downside risks to growth for the
Czech Republic.

Main risks: Oil prices have started to climb back up
after 7 months of decline and we see a risk that the
CNB expectation for cuts in regulated utility prices
in Q3 does not materialise. Higher-than-expected
inflation could prompt the CNB to consider exit
from the fx target sooner than the current
commitment of not before H2 2016.
An improving outlook
We returned from a recent trip to Prague with a
positive impression. Despite some moderate slowdown
in momentum through end 2014, activity data are
improving once again and a combination of looser
fiscal policy, still expansionary monetary policy and a
boost from low oil prices are all expected to support
growth this year. Confidence indicators have also
turned up and house prices are rising. Both the Czech
National Bank (CNB) and Ministry of Finance have
recently upgraded their GDP growth expectations for
this year and while we leave ours unchanged for now
we recognize the reduced downside risks from our
improved outlook for Germany. Barring any unexpected
weakness in Q4 GDP, early 2015 should finally see the
Czech economy return to its pre-crisis level of output.
Sentiment continues to improve. The improvement in
sentiment in Czech Republic is striking. The EC
economic sentiment index currently stands close to its
highest level since the crisis and is currently well above
its long term average. All components show significant
improvement and consumer confidence is close to
record highs. The sentiment series published by the
Czech statistics office also point to across the board
improvement with construction showing a particularly
marked improvement. Some of this could be related to
an improving labour market with accelerating
employment growth and declining unemployment.
House price growth has also been in positive territory
in the past several quarters.
Deutsche Bank Securities Inc.
To the extent that sentiment remains upbeat our
expectation for continued domestic-led growth remains
secure. Retail sales growth should remain pretty robust
and consumer spending an important source of growth.
As 2015 is the last year to spend funds under the 20072013 EU budget allocation, this year should also see
another meaningful boost from investment. The latest
GDP growth projections from the CNB (2.6%) and the
Ministry of Finance (2.7%) have both been revised
slightly upwards and are slightly above our own 2.5%
projection. The recent upward revision to our German
GDP growth forecast, to 1.4% from 1.0% previously,
has reduced some of the downside risks to our Czech
forecasts while the slump in oil prices should also act
as a boost to disposable incomes. The CNB
commitment to maintaining the exchange-rate target
until at least H2 2016 should also mean some support
to growth from very accommodative monetary policy.
Consumers are feeling much happier
% balance (seasonally adjusted)
20
10
0
-10
-20
-30
-40
Jan-07
Industrial confidence
Consumer confidence
Jan-09
Jan-11
Jan-13
Jan-15
Source: Haver Analytics
CNB expect 2015 inflation to be the lowest in the
country’s history. The improvement in sentiment
should help to allay any CNB concerns over the
second-round impact of low inflation. CPI remained
positive at 0.1% YoY as of January despite the
introduction of a second lower VAT rate of 10% (the
CZSO estimated this subtracted -0.07pp from headline
CPI) and the one of the largest MoM declines in fuel
prices on record at -8.1%, which subtracted another
0.3pp from headline CPI. The health component also
cut 0.2pp from MoM CPI due to a 9.1% MoM decline
on the back of removal of prescription fees and fees on
outpatient treatment. In YoY terms, the housing, water,
electricity, gas and other fuels component flipped back
into positive territory at 1.2% (versus -0.6% in
December and a year of negative readings) as last
year’s 10% cut in electricity and gas prices dropped out
of annual comparisons.
Page 83
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
The January CPI print was in line with the recently
revised CNB projections. The Bank now forecast 2015
CPI (pavg basis) at just -0.1% versus 1.2% in the
November projections with the low in inflation coming
in Q3. The rationale here is that gas prices follow oil
prices lower with a lag and then impact on regulated
household utility prices. If the CNB projections are
realized 2015 will see the lowest inflation rate in Czech
history and will come on top of a low 0.4% for 2014.
Moreover, the Bank’s projections see CPI only back at
target at the end of the policy horizon with the average
inflation rate below target and 2015 below the lower
bound of the CNB target. Inflation is lower than when
the Bank introduced its fx target in November 2013 and
inflation expectations (currently 1.5%) are also a little
lower. Nevertheless, we do not expect a near-term
move to weaken the currency with the key difference
the structure of inflation. The Bank’s measure of core
inflation (adjusted inflation excluding fuel) stands at
1.2% YoY as of January and has gradually accelerated
since April versus negative readings through most of
2013. The Bank’s measure of monetary-policy relevant
inflation (adjusted for the first-round impact of indirect
tax changes) is however in negative territory at -0.1%
YoY in January, unchanged from December. This is
down fairly sharply since late 2014 but also comes on
the back of lower fuel prices.
CNB extends its exchange-rate commitment. Given the
low headline CPI and the significant downward revision
to the latest CNB inflation projections the CNB have
mentioned the possibility of moving its exchange-rate
commitment weaker in each of the last two policy
statements. There was a change in language between
the December and February statements with the
February statement saying the bank “stands ready to
move the level of the exchange-rate commitment if
there were to be a long-term increase in deflationary
pressures capable of causing a slump in domestic
demand, renewed risks of deflation in the Czech
economy and a systematic decrease in inflation
expectations”. In contrast, the December statement
noted that it would be necessary to “consider moving
the exchange-rate commitment” under the same list of
conditions. We discussed this change with two CNB
Board members at the recent analyst meeting in
Prague. They downplayed the change in language
saying this did not represent a shift in policy and that
the statement was intended to reflect the fact that the
external environment (and the CNB projections) had
changed significantly from the December meeting.
considerable uncertainty with Board members
stressing that it was the trend that mattered and there
was no quantitative target.
The CNB also extended the duration of the exchange
rate commitment at the February meeting with a
pledge that the CNB “would not discontinue the use of
the exchange rate as a monetary policy instrument
before the second half of 2016”. Previously the
language was 2016. As things stand it is not our base
case that the CNB will move the target weaker and to
the extent that market dynamics move the currency
weaker CNB will not act against this. We expect the
target could be in place for a very long time and past
the end of Governor Singer’s term in June 2016. As
things stand, the most likely candidate for Governor
looks to be Jiri Rusnok, the newest Board member and
the only one appointed by the current President. While
a majority would be needed on the Board to agree on
any change in policy, comments by Rusnok on the exit
strategy, or indeed, any decision to move the peg
weaker, will be important to watch.
On the flip side, with oil prices now turning round we
see some risk that the CNB assumption of a cut in
regulated utility prices in Q3 does not materialize.
Higher-than-expected headline inflation, if combined
with any move up in core inflation, inflation
expectations and a stronger GDP growth momentum,
could trigger a discussion on exit from the exchange
rate target earlier than the current commitment.
Although our base case remains that the inflation
buffer will not be sufficient this year, higher-thanexpected inflation will nevertheless highlight the likely
difficulty of exit. Negative rates are an option (albeit
with some required legal changes to remove the
definition of penalty interest rates as a multiple of the
CNB policy rate) but certainly not something that
would be announced in conjunction with the removal
of the target after the recent SNB experience.
The fiscal stance is now significantly more pro-growth
4
2
% GDP
Cyclical Balance
Structural Balance
One-off measures
Total Balance
0
-2
Page 84
Forecast
-4
The February statement also made any move in the fx
target contingent on i) the effectiveness of ECB QE, ii)
the evolution of the CZK and iii) domestic wage
developments. Wage growth has been consistently
lower than CNB projections for a while despite fasterthan-expected growth in employment, a rising number
of vacancies and a decline in unemployment. The
Bank’s forecast for wages were said to be subject to
-6
-8
1997 1999 2001 2003 2005 2007 2009 2011 2013 2015
Source: Ministry of Finance
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Fiscal policy is decidedly pro-growth. Final fiscal data
for 2014 will be available in April but as things stand
the Ministry of Finance expect a 1.3% of GDP general
government deficit. This would be unchanged from
2013 but with the difference coming from the
structural deficit which is expected to come in at 1.0%
of GDP versus zero in 2013. This is the first time in the
post-crisis period that fiscal policy has been
expansionary and came mainly on the back of higher
spending (in line with the announced fiscal stance of
the CSSD-led coalition in place for the past year). The
estimated 1.3% of GDP deficit is better than originally
expected as despite the low inflation environment VAT
and corporate tax receipts came in higher than
previous Ministry of Finance estimates.
On the
spending side, improved cash management meant that
overall disbursements were lower than previously
expected despite a rising public sector wage bill and
payments to the public health system. The sale of some
mobile frequency bands also helped support revenues.
This year is expected to see a widening in both the
headline and structural fiscal deficits leaving the fiscal
stance decidedly pro growth. On the spending side, as
2015 is the last year to use funds allocated under the
2007-2013 EU budget period government investment
spending is expected to remain elevated while the
public sector wage hike as of January, the
reintroduction of the earlier pension indexation rule and
compensation this year for cuts in earlier years all add
to an expectation of a rise in the spending/GDP ratio. In
terms of revenues, the introduction of the lower 10%
VAT rate from January (effective on baby foods, books
and medicines) and higher tax credits for second and
any additional children will weigh on revenues.
But debt is declining. The Ministry of Finance projects
the headline deficit at 2.0% of GDP this year but with a
0.2pp one off accruals impact from the renewal of a
lease on fighter jets. Given the expected drop in debt in
2014, in both absolute terms and as a share of GDP,
the expansionary fiscal stance in Czech Republic is not
a cause for concern. Full-year data for state debt,
which accounts for 95% of general government debt,
shows a decline of CZK20bn and leaves general
government debt at an expected 43.2% of GDP at end
2014. The Czech Parliament is still discussing the
introduction of a debt rule written into the constitution
that would trigger consolidation measures should the
debt/GDP ratio cross 55%. Even if the law is introduced
the likelihood of the threshold becoming binding in the
foreseeable years is exceptionally low.
Caroline Grady, London, +44(20)754-59913
Czech Republic: Deutsche Bank Forecasts
2013
2014F
2015F
2016F
209
10.6
19 745
196
10.6
18 540
184
10.6
17 340
184
10.6
17 398
- 0.7
0.4
2.3
- 5.0
0.3
0.3
2.4
1.5
1.8
4.3
8.5
9.0
2.5
1.7
2.0
4.4
5.5
5.7
2.7
2.0
2.3
3.7
5.8
5.8
Prices, Money and Banking
(YoY%)
CPI (eop)
CPI (period avg)
Broad money (eop)
1.4
1.4
4.8
0.1
0.4
4.7
0.8
0.3
5.0
1.8
1.9
5.3
Fiscal Accounts (% of GDP)
Overall balance
Revenue
Expenditure
Primary Balance
- 1.3
40.7
42.0
0.1
- 1.3
41.7
43.0
0.2
- 2.1
41.9
44.0
- 0.6
- 2.2
42.3
44.5
- 0.7
External Accounts (USD bn)
Goods Exports
Goods Imports
Trade Balance
% of GDP
Current Account Balance
% of GDP
FDI (net)
FX Reserves (eop)
USD/FX (eop)
EUR/FX (eop)
135.2
125.5
9.6
4.6
- 2.8
- 1.3
4.0
48.5
19.9
27.5
149.4
139.1
10.3
5.1
- 2.0
- 1.0
5.0
49.8
22.91
27.5
145.6
135.8
9.8
5.1
- 1.5
- 0.8
5.2
50.3
26.19
27.5
142.9
133.2
9.7
5.2
- 1.1
- 0.6
5.5
50.8
27.37
26.0
Debt Indicators (% of GDP)
Government Debt
Domestic
External
External debt
in USD bn
Short-term (% of total)
45.7
33.0
12.7
48.2
100.7
27.7
44.3
31.5
12.8
48.6
97.7
26.8
44.9
31.5
13.4
49.4
94.0
26.8
45.6
32.6
13.0
47.7
89.6
27.1
0.1
7.7
4.9
7.7
5.3
7.2
5.5
6.8
Current
15Q1F
15Q2F
15Q4F
0.05
24.5
27.6
0.05
24.8
27.5
0.05
25.2
27.5
0.05
26.2
27.5
National Income
Nominal GDP (USDbn)
Population (mn)
GDP per capita (USD)
Real GDP (YoY%)
Private Consumption
Government
consumption
Gross fixed investment
Exports
Imports
General (ann. avg)
Industrial Production
(YoY%)
Unemployment
(%)
Financial Markets
Key official interest rate
(eop)
USD/CZK (eop)
EUR/CZK (eop)
Source: Haver Analytics, CEIC, DB Global Markets Research
Deutsche Bank Securities Inc.
Page 85
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Hungary
Ba1(stable)/BB(stable)/BB+(stable)
Moody’s/S&P/Fitch


Economic outlook: The government’s late 2014
decision to convert the fx mortgage stock at fixed
exchange rates meant the Hungarian economy was
largely unscathed from the sharp CHF appreciation
in January. The growth outlook remains reasonably
strong, the risk of deflation becoming entrenched
looks low and the downside risks to growth from
the external environment are easing.
Main risks: The government has announced a
reduction in the bank tax as of next year and a
commitment not to introduce any further measures
that will hit the sectors’ profitability. This is positive
but not enough to offset the numerous negative
policies towards the banking sector during the past
several years which have the potential to limit
lending and long-term growth.
A favourable start to the year
The Hungarian economy has had a pretty good start to
2015. The government’s late 2014 decision to convert
the country’s fx mortgage stock at fixed exchange
rates meant that households were spared between
HUF500-700bn after the January 15th SNB decision to
abandon its exchange rate cap against the EUR. The
SNB move allowed the government to state that it was
“the right decision” to fix the exchange rate and stress
how much households had been spared. Recent macro
data have also been reasonably robust and the
announcement to lower the bank tax as of 2016 is also
a positive. On the political side, the visit to Budapest by
German Chancellor Angela Merkel was accompanied
by headlines on potential new investment in Hungary.
Whether or not this materializes is not clear but even
with a drop back in investment we retain our fairly
constructive view on the macro outlook for this year
and expect domestic demand to be the main source of
growth. Downside risks from the external backdrop
remain but are less pronounced than before.
income in fx or iii) the payment to income ratio is
sufficiently low. This means that the stock will not drop
to zero but should nevertheless become very low.
Although the loans were formally switched into forints
as of February 1st the exchange rates were fixed as of
December leaving no impact on households from the
sharp Swiss franc appreciation following the January
15th SNB announcement. The remaining fx
vulnerabilities in Hungary are limited to those
households deciding to opt out of the mortgage
conversion in addition to the HUF225bn (EUR0.7bn) in
non-mortgage fx loans plus the corporate fx loan stock.
For corporates, the outstanding fx loan stock stands at
HUF3299bn as of December, equivalent to around 10%
of GDP. Only around 15% of this is denominated in
CHF with the vast majority in euros. Some balance
sheet impact from the SNB move will therefore be
evident for corporates but much less so than was
previously true for households with corporates more
likely to have access to fx hedges as well as fx revenue
streams.
Around half of corporate loans are in FX but only 15%
of this is denominated in Swiss francs
9000
8000
%
HUF bn
USD
% 66
CHF
62
7000
EUR
58
6000
HUF
54
5000
Ratio of FX Loans, rhs
50
4000
46
3000
42
2000
38
1000
34
0
Jan 03 Jul 04 Jan 06 Jul 07 Jan 09 Jul 10 Jan 12 Jul 13
30
Source: NBH (chart shows the currency breakdown of corporate bank loans)
Law on conversion of fx loans and fair banks became
effective as of February 1st.
The law fixing the
exchange rate for converting fx loans at 256.47 on
CHF/HUF and 308.97 on EUR/HUF came into effect as
of February 1st. From this date the household fx
mortgage stock will drop considerably from the
HUF3330bn reported as of December 2014 and the
converted loans linked to 3-month BUBOR, with an
interest rate premium that is in line with the original
loan terms but not < 1% and > 4.5% for mortgages (or
not > 6.5% for home equity loans). Household can opt
out if i) the interest rate on the new loan would be
higher than on the original loan, ii) they have a regular
Page 86
In addition to the law on conversion of fx loans into
forints the fair banking bill also came into effect on
February 1st. This bill includes the loan modification
conditions which will mean refunds for unilateral
interest rate changes and other charges and fees. The
NBH estimate the refunds at EUR3bn, equivalent to
almost 3% of GDP which, for most households, will
come in the form of lower monthly installments (a 2530% reduction according to MNE). Only households
with loans already repaid will see cash refunds paid out
and for the 170,000 mortgages paid down under the
discounted early repayment scheme in 2011 the refund
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
will be adjusted to take the exchange rate discount into
account. Although positive for households, the fair
banking bill will lower the interest income and earnings
potential for banks going forward (the NBH estimates
that banks may lose around HUF 100bn each year
because of the lower interest rates on the converted fx
loans). It also comes on top of the bank tax in place
since 2010 and various other costs to the banks as part
of earlier fx mortgage relief. The benefits to growth
from lower household vulnerabilities will therefore be
offset to some extent by lower lending activity going
forward.
2015 growth outlook looks positive despite a drop back
in investment. The elimination of household fx risk and
forthcoming refunds should serve to boost consumer
confidence this year and support spending growth.
Rising real wage growth, low and well-anchored
inflation expectations and an improved outlook for
Germany will also help the macro dynamics. One
uncertainty is on investment growth, with bumper
investment growth in 2014 – due to a combination of
the NBH Funding for Growth Scheme (FGS),
accelerated absorption of EU funds, low interest rates
and the wider improvement in demand – making
another year of strong investment growth difficult to
achieve. The early February visit to Budapest by
German Chancellor Angela Merkel was accompanied
by press reports of a new BMW factory and the
possibility of Daimler extending its current production
facilities. It is difficult to know whether these projects
will materialize and, moreover, over what timeframe.
Recent comments from NBH Governor Matolcsy that
the Bank is considering widening the scope of FGS to
large corporates could, if enacted, provide some
support for the investment outlook this year. As things
stand FGS is expected to run until end 2015 and
Matolcsy said recently the Bank hoped to extend
HUF1trn in FGS funding in 2015 versus >HUF500bn
last year. Given that larger corporates already had
access to more favourable financing rates than SMEs
the effectiveness of an extension to large corporate is
likely to be less than for the SME sector. Nevertheless,
to the extent that there is appetite for borrowing and
banks have been reluctant to lend some positive
impact should be evident.
Bank tax to fall from 2016. The recent announcement
of a reduction in the bank tax as of next year, plus a
commitment not to introduce new laws which will hurt
banking sector profitability, is a much-needed positive
for the sector. The bank tax will fall from 53bps on end
2009 assets to 31bps on end 2014 assets which our
banking analyst estimates should translate into 40-50%
relief for most banks. A further decline is set for 2017
and overall revenue from the tax is set to drop by
around HUF60bn in 2016 (around 0.2% of GDP) and
HUF22bn for 2017. The announcement came as part of
news that the government, alongside the EBRD, will
Deutsche Bank Securities Inc.
acquire a 15% share of Austria’s Erste Bank and that
Erste will launch a EUR550mn lending program in
Hungary. The Erste deal comes after the state
purchases of MKB Bank and Budapest Bank last year
and fits with the government’s earlier pledge to
increase domestic ownership in the banking sector.
The recent announcement by Raiffeisen that it plans to
gradually close its retail bank could also present an
opportunity for the government to again increase its
presence in the banking market.
The price and timing of the Erste deal are not yet clear
making it difficult to know if this will impact on the
2015 budget. Given the government’s efforts to reduce
the deficit during the past years we expect that the
purchase and tax reduction will be done in such a way
to keep the deficit comfortably below 3% of GDP (the
2015 deficit target stands at 2.4% of GDP). Official
comments are that the shortfall in revenues from the
bank tax will be compensated by higher lending and
therefore employment and investment. This seems
optimistic given our earlier discussion on limit
profitability and lending going forward.
Deflation deepens on the back of declining fuel prices.
Deflation has intensified in Hungary with the January
inflation print of -0.2% MoM and -1.4% YoY coming in
lower-than-expected and marking another all-time low.
Declining fuel prices were the main downward push to
prices with a 7.7% MoM drop subtracting 0.6pp from
headline inflation (this is the most pronounced negative
contribution from fuel since our data beings). Food
price inflation was positive (1.3% MoM) for the first
time since May which offset some of the downward
pressure from declining fuel prices. The continued
decline in YoY inflation comes despite the base effect
in December as the late 2013 cut in household
electricity prices has now dropped out of annual
comparisons.
Underlying inflation has been reasonably stable
% YoY
6.0
5.0
Core ex indirect taxes
Demand sensitive inflation
Sticky price inflation
4.0
3.0
2.0
1.0
0.0
Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15
Source: Haver Analytics
Page 87
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
In a statement published after the release of the
inflation data the Ministry of National Economy pointed
to the still-positive core inflation saying this “indicates
there is no deflation risk in Hungary”. Core inflation (sa)
remained positive in January but at 0.7% YoY this is
down sharply from the 3.4% reading in January 2014.
The NBH measures of underlying inflation – demand
sensitive inflation (core inflation ex processed food
prices) and sticky price inflation – now stand at 1.5%
YoY and 1.9% YoY respectively, which although down
slightly from December “remain in a range between
1.5-2.0% characterizing a period of nearly two years”,
according to the NBH, and “continue to indicate a
moderate inflation environment”. These comments do
not point to a February rate cut while the minutes from
the January meeting also noted that “members agreed
that the Council should decide on the possibility of
changing the base rate after a comprehensive
assessment of the outlook for inflation and the real
economy and in view of the March issue of the
Inflation Report”.
We expect a 25bps cut in March taking the policy rate
to 1.85%. The case for a March rate cut looks to be
strong with the size dependent largely on the extent of
the downgrade in the Bank’s inflation forecasts. The
current NBH assumption of oil at USD72.1/barrel this
year will be lowered and the starting point for the
forecasts will also drop from the current -0.1% YoY for
CPI in Q1 2015. More important that the updated 2015
inflation forecasts (currently 0.9%, pavg basis versus
our own -0.5% forecast) will be the quarterly profile
and how quickly inflation comes back up to the Bank’s
3% target. Base effects from additional utility price cuts
in 2014, an ending of the protracted MoM declines in
energy prices and normalization of food price dynamics
should be enough to push inflation back into positive
territory by late summer. The low base from the
protracted fuel price declines of late 2014 and early
2015 will then drop out of annual comparisons and
should mean YoY inflation starts to accelerate more
quickly from Q4. We expect inflation back close to
target by Q2 2016 which is only one quarter later than
the current NBH baseline.
Given the substantial easing already done (490bps), the
low level of the policy rate (2.1%) and the supply-side
nature of deflation and the expected return of inflation
close to target in 2016, it is difficult to see significant
rate cuts from here. Real rates have nevertheless risen
sharply since the NBH ended its easing cycle in July
and currently stand at 3.5% (ex-post). A one-off rate cut
to account for this move would be easy for the NBH to
justify and would allow the Bank to make it clear that
this is not the start of a new easing cycle. A return to
the 25bps rate cuts of 2013 is our best guess on the
magnitude taking the policy rate to 1.85%.
Hungary: Deutsche Bank Forecasts
2013
2014F
130
9.9
13 045
130
9.9
13 084
105
9.9
10 581
110
10.0
11
019
1.1
- 0.1
4.0
5.8
5.3
5.3
3.4
2.1
0.8
11.8
6.3
7.2
2.4
2.5
0.6
4.5
5.9
6.6
2.3
2.1
0.6
3.8
4.9
5.2
Prices, Money and Banking
(YoY%)
CPI (eop)
CPI (period avg)
Broad money (eop)
0.4
1.7
2.0
- 0.9
- 0.2
3.0
1.6
- 0.5
4.5
2.6
2.8
5.5
Fiscal Accounts (% of GDP)
Overall balance
Revenue
Expenditure
Primary Balance
- 2.4
48.0
50.4
2.1
- 2.9
46.2
49.1
0.9
- 2.7
45.0
47.7
1.1
- 2.4
46.5
48.9
1.4
External Accounts (USD bn)
Goods Exports
Goods Imports
Trade Balance
% of GDP
Current Account Balance
% of GDP
FDI (net)
FX Reserves (eop)
USD/FX (eop)
EUR/FX (eop)
95.8
91.1
4.7
3.7
0.3
0.3
3.7
43.0
216
297
103.5
98.9
4.6
3.5
5.2
3.8
13.8
40.7
261
316
98.6
94.5
4.2
3.4
4.8
3.7
17.6
31.5
300
315
94.9
90.9
4.0
3.2
4.6
3.6
11.7
26.6
337
320
Debt Indicators (% of GDP)
Government Debt
Domestic
External
External debt
in USD bn
Short-term (% of total)
75.9
39.5
36.4
127.9
166
16.7
76.7
43.3
33.4
120.0
156
16.3
76.3
44.2
32.1
112.0
136
14.6
75.9
45.0
30.9
110.0
141
14.1
1.4
10.3
7.6
7.9
7.0
7.6
6.0
7.2
Current
15Q1F
2.10
294
310
1.85
279
310
National Income
Nominal GDP (USD bn)
Population (mn)
GDP per capita (USD)
Real GDP (YoY%)
Private Consumption
Government consumption
Gross Fixed Investment
Exports
Imports
General (ann. avg)
Industrial Production (YoY%)
Unemployment (%)
Financial Markets
Key official interest rate
(eop)
USD/HUF (eop)
EUR/HUF (eop)
2015F 2016F
15Q2F 15Q4F
1.85
285
310
1.85
300
315
Caroline Grady, London, +44(20)754-59913
Source: NBH, Haver Analytics, DB Global Markets Research
Page 88
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Israel
A1(stable)/A+(stable)/A(stable)
Moodys/S&P/Fitch


Economic
outlook:
Economic
activity
has
rebounded somewhat after the conflict in Gaza last
summer; we expect the economy to continue
building steam in the coming months. Inflation,
however, will likely remain negative for the next
few months, driven by food and fuel price deflation
as well as utility price cuts. Despite this, the
positive outlook on the economic front should lead
to rates being on hold, though further easing
cannot be ruled out if inflation continues to
underwhelm and the shekel appreciates further.
Main risks: The domestic political backdrop will
remain uncertain in the build up to early elections
(March 17th), while the economic recovery is still
fragile and subject to pressure from the weakness
in global demand. Geopolitical risks remain ever
present and could spike upwards if the election of
a more right wing government leads to renewed
tension with Hamas.
Economy continues to rebound after
Operation Protective Edge
Q3 GDP figure revised upwards, while recent high
frequency data are also encouraging
The final GDP figure for Q3 was reported at 0.2% QoQ
(annualized); while this was significantly below the
average growth in the first half of the year (2.4%) –
reflecting the effect of the conflict in Gaza (Operation
Protective Edge) in the summer – it represents a
significant upward revision from the -0.4% figure
initially reported. In terms of the details, private
consumption continued to increase on the back of
gradually tightening labour market conditions and low
inflation, while fixed investment declined in QoQ terms
for the third consecutive quarter. Net exports also
contributed negatively to GDP as imports picked up to
a strong 12.6% but exports remain weighed down by
the weakness in global demand.
The more recent high frequency data also indicate
acceleration in economic activity in Q4, with various
indicators rebounding after Operation Protective Edge.
The Composite State of the Economy index – which
comprises seven high frequency indicators and tracks
well with GDP – continues to rise steadily and recorded
1.7% YoY growth in December. Companies Survey
data show an improvement in all industries in Q4, while
consumer confidence also picked up significantly in
January on the back of price declines of various
products (particularly fuel, food and electricity); tourism
has also started to rebound quite rapidly. However,
industrial production continues to decline and the
Purchasing Managers’ Index is firmly entrenched in
contractionary territory (December print was 45.8, the
seventh consecutive sub-50 reading), highlighting the
still fragile nature of the rebound in economic activity.
Deutsche Bank Securities Inc.
High frequency data point to an impending pickup in
GDP growth
2.5
2
1.5
1
0.5
0
-0.5
-1
2007 2008 2009 2010 2011 2012 2013 2014
State of the Economy index (QoQ %)
Real GDP (QoQ %)
Source: Deutsche Bank, Haver Analytics
Labour market conditions meanwhile are gradually
tightening, a fact also highlighted by the Bank of Israel
(BoI) after its latest monetary policy meeting. The
unemployment rate is at 5.7%, close to all-time lows,
while wage growth is also positive (real wages
increased by 2% in 2014, aided by the low inflation).
Further, the Knesset (the legislative branch of the Israeli
government) recently approved the raising of the
minimum wage in three increments from ILS 4300 (just
over USD 1100) per month to ILS 5000 in 2017; the
first of these increments takes effect in April this year,
with the minimum wage rising to ILS 4650 per month.
While GDP growth is expected to print at 2.4% for
2014 (weighed down by the weak Q3 print), we expect
it to pick up to 3.1% next year and 3.3% in 2016, i.e.
near its trend rate, as domestic demand picks up pace
and the global economic recovery becomes more
firmly established. The weaker shekel – which since
August has depreciated by over 13% versus the dollar –
should further support economic growth.
Disinflationary headwinds persist
The headline inflation rate for December was reported
at a slightly lower-than-expected -0.2% YoY, bringing
the average for the year to a subdued 0.5%. This was
the fourth consecutive month of negative inflation;
further, the trend of low inflation is expected to
continue in January, with headline YoY CPI forecasted
to fall further to -0.3% (i.e. back to the levels observed
in October last year). As has been the case for the past
few months, fuel and food price deflation will represent
the main drags on the headline rate. However, cuts to
water and electricity prices – which were implemented
in January – will exert further downward pressure and
are expected to subtract 0.4-0.5pps from headline
inflation. Inflation expectations have also followed
headline inflation lower – one-year-ahead inflation
expectations are at 0.5%, well below the BoI’s 1%-3%
Page 89
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
inflation target. While the BoI believes this reflects the
impact of one-off utility price cuts, the medium-term
inflation expectations are also low, only just above 1%
(which would be a cause for concern for the central
bank).
Headline inflation and inflation expectations have
trended lower
5
YoY %
4
3
2
1
0
-1
2010 - Jan
2012 - Jan
2014 - Jan
1-year ahead inflation expectations
5-years ahead inflation expectations
Headline inflation
Source: Haver Analytics, Deutsche Bank
The low inflation expectations, global disinflationary
environment and persistent weakness in oil prices
should keep headline inflation subdued, and most likely
in negative territory, for the next few months. However,
we then expect inflation to start correcting naturally as
the effect of last year’s shekel depreciation passes
through to inflation, the economic recovery gathers
steam and wages continue to rise; food prices, which
are mean-reverting, should also begin to add upward
impetus to inflation. As a result, we forecast inflation to
end this year at 1.1% (in line with the BoI’s projections),
but only average 0.5% for the year, with the full-year
average weighed down by the expected negative
inflation in the first few months of the year. With the
disinflationary headwinds from weak global demand
and oil prices, combined with the still fragile economic
recovery, the risks to our forecast remain to the
downside; further, the subdued medium-term inflation
expectations highlight the possibility that the current
low inflation environment could become entrenched.
Rates likely to remain on hold but further easing cannot
be ruled out
Despite the low spot inflation, we expect rates to
remain on hold (at 0.25%) as the activity and labour
market data remain broadly encouraging; the BoI also
highlighted the acceleration in economic activity in Q4
as one its reasons for keeping rates on hold last month.
In addition to the BoI’s positive outlook on the
economy, the MPC statements in the last two months
had a more neutral (rather than dovish) tone, noting
that the central bank considers the policy rate as
appropriate for supporting "the continuation of the
recovery in economic activity, and the return of
inflation to within the (1%-3%) target range"; previous
references to the fact that the full impact of recent rate
cuts had yet to be felt were removed from the last two
statements.
Page 90
However, if inflation continues to underwhelm and if
the recent appreciation trend of the shekel continues,
we think the BoI could be prompted to undertake
further easing. The BoI has not specified how any
potential easing would be delivered, maintaining that it
will continue to monitor local and global economic
developments and "examine the need to use various
tools to achieve its objectives". In our view, while a
small (10-15bps) rate cut is possible, the BoI would
likely in the first instance deliver this easing, if required,
in the form of increased fx intervention. The BoI is of
course already intervening, but has only purchased a
modest USD 7.3bn of fx since January 2014; of this
total amount, USD 3.8bn was bought as part of the
program aimed to offset the effects of natural gas
production on the exchange rate, therefore
discretionary intervention represented less than half of
the total amount (with the last discretionary purchase
made in July 2014). Further, the BoI could also deliver
easing by not fully sterilizing its intervention (through a
reduction in its issuance of Makam bills). In the
aftermath of the Swiss National Bank's actions,
however, the introduction of a Swiss-style fx floor is
less attractive. Additionally, BoI purchases of
government bonds – which was used to deliver easing
in 2009 – are also unlikely given that bond yields are
much lower now (compared to 2009) and there is
lesser need to provide liquidity to the banking system.
Regulatory obstacles threaten gas production
There has been a renewal of uncertainty regarding the
development of recently-discovered offshore natural
gas fields in Israel. Following intense political pressure
to increase competition in the energy sector, in
December the Israeli Antitrust Authority (IAA)
announced that it would be re-opening antitrust
investigations into whether US-based Noble and
Israel’s Delek Group hold monopoly control of Israel’s
gas reserves. These two firms together hold 85% of
Leviathan gas field, which was discovered in 2010 and
is expected to begin production in 2018; Leviathan is
one of the world’s largest offshore gas finds in the last
decade, with estimated reserves of 22 trillion cubic feet.
Noble and Delek also hold a controlling stake in the
nearby Tamar gas field, another large offshore gas
resource which was discovered in 2009 and began
production in 2013.
The recent decision by the IAA to re-open
investigations represents an about turn on the March
2014 announcement that it would not consider the two
companies as having monopoly control if they divested
interests in the smaller Tanin and Karish offshore gas
fields. The turnaround has increased uncertainty
regarding the country’s regulatory framework for gas
production, and could adversely impact investment in
Israel’s energy sector. Indeed, in response to the IAA’s
most recent decision, Noble Energy has suspended
front-end engineering work on Leviathan; thus, the
development of the field has been put in jeopardy.
Further, the antitrust investigation announcement has
delayed important gas export deals with Jordan,
Cyprus and Egypt, and as a result Israel could lose
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
market share to other countries in the region (e.g.
Qatar and Algeria) that are looking to boost gas exports.
A delay in production from Leviathan will likely be very
costly, with the energy authorities in Israel estimating
that any delay in developing the field past 2018 would
cost Israel ILS 3bn (almost USD 800mn) per year.
An agreement between the IAA and the two firms is
only likely after political tensions subside post the
general elections in March. However, we believe that
the incentives for a compromise are large as the parties
will likely want to avoid protracted legal proceedings;
therefore a settlement is likely to be reached in the
months after the elections. A compromise would need
to balance the continued development of the Leviathan
reservoir and investment in the energy sector with the
facilitation of competition in the sector and lower
energy prices for Israeli households. One option is the
creation of a state firm that would buy the gas for the
domestic market to keep the prices down, while Nobel
and Delek would be allowed to keep their holdings in
the Tamar and Leviathan fields. However, it is more
likely that any outcome will involve at least some
divestment by the two companies and possibly also
involve different firms marketing the gas produced by
the two fields; Israeli Energy Minister Silvan Shalom
recently stated that the gas companies would have to
give up some of the reserves they have (Bloomberg).
Prime Minister Netanyahu likely to be re-elected
Early elections for the Knesset will be held on 17th
March. These elections were called late last year after
PM Netanyahu removed his finance and justice
ministers following disagreements on various issues
(including defence spending and tax breaks). Early
elections are not uncommon in Israel, with the average
lifespan of the government amounting to only half of
the full four-year term. The latest polls 6 continue to
indicate that Netanyahu will be re-elected as PM; the
government itself is expected to be comprised of a
centre-right coalition – according to the polls,
Netanyahu’s Likud party is set to secure the most seats
(25) in the 120-member Knesset, with its coalition
partner Jewish Home party also expected to perform
well. The main opposition comes from the centre-left
Zionist Camp (comprising the Labor and Hatnuah
parties). While the exact makeup of the governing
coalition is difficult to predict, we do not expect any
major changes in economic policymaking and the
market impact of the elections is likely to be limited.
Gautam Kalani, London, +44 207 545 7066
Israel: Deutsche Bank Forecasts
2013
National Income
Nominal GDP (USD bn)
Population (mn)
GDP per capita (USD)
2014F
2015F
2016F
290
302
280
294
8.1
8.2
8.4
8.5
36 057 36 787 33 507 34 495
3.2
3.3
3.5
1.1
1.5
- 0.1
2.4
3.1
3.5
0.0
3.0
3.5
3.1
3.1
2.3
2.0
5.0
4.0
3.3
3.3
2.0
3.0
7.0
6.0
Prices, Money and Banking (YoY%)
1.8
CPI (eop)
1.5
CPI (period avg)
6.6
Broad money (eop)
- 0.2
0.5
5.2
1.1
0.5
4.7
2.0
1.8
5.2
Fiscal Accounts (% of GDP)
Overall balance
Revenue
Expenditure
Primary balance
- 3.1
25.6
28.7
- 0.6
- 2.8
26.2
29.0
- 0.2
- 3.4
26.0
29.4
- 0.8
- 2.9
26.3
29.2
- 0.3
External Accounts (USDbn)
Goods Exports
Goods Imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI (net)
FX reserves (USD bn)
ILS/USD (eop)
ILS/EUR (eop)
62.0
71.3
- 9.3
- 3.2
6.9
2.4
7.1
81.8
3.47
4.79
65.4
73.8
- 8.4
- 2.8
8.6
2.8
5.0
86.1
3.89
4.72
69.3
77.1
- 7.8
- 2.8
9.7
3.5
4.6
92.9
4.05
4.25
73.4
81.3
- 7.9
- 2.7
10.1
3.4
4.9
99.8
3.95
3.75
Debt Indicators (% of GDP)
Government debt
Domestic
External
Total external debt
in USD bn
Short-term (% total)
66.4
54.8
11.5
32.8
95. 4
39.2
66.7
55.1
11.6
30.2
91. 2
36.9
67.2
55.5
11.7
31.1
87.0
34.8
66.2
54.7
11.5
28.3
83. 2
32.8
General (ann. avg)
Industrial production (YoY%)
Unemployment (%)
- 1.3
6.2
1.0
6.0
1.6
5.8
2.2
5.8
Curr
ent
0.25
15Q1
15Q2
15Q4
0.25
3.95
4.39
0.25
3.99
4.35
0.50
4.05
4.25
Real GDP (YoY%)
Private. consumption
Government consumption
Gross fixed investment
Exports
Imports
Financial Markets
BoI Policy rate
ILS/USD (eop)
ILS/EUR (eop)
3.88
4.38
Source: BoI,CBS, Haver Analytics, DB Global Markets Research
6
Average of poll results from the following 6 pollsters: Maagar Mochot, Panels, Teleseker, Smith,
Dialog, Midgam
Deutsche Bank Securities Inc.
Page 91
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Nigeria
Ba3(stable)/BB-(negative)/BB-(stable)
Moody’s/S&P/Fitch


Economic outlook: Lower oil prices are likely to
lead to a sharp deterioration of fiscal and external
accounts and cloud the growth outlook. The Nov.
25 depreciation failed to alleviate pressure on the
currency and eroding FX reserves make the current
level of the naira difficult to sustain given the
prospects of prolonged low oil prices. Bold fiscal
and monetary policy responses are likely to be
delayed by the postponement of the presidential
election.
Main risks: The absence of prudent policy
responses to the falling oil price would amplify
pressure on the exchange rate and FX reserves.
The authorities might only be able to prevent a
disorderly depreciation by a further tightening of FX
regulations but this would lastingly damage
Nigeria’s appeal to offshore investors. A
deterioration of political stability following the
postponement of the presidential election or an
increase in ethnic violence would lead to a sharp
growth slowdown.
Oil price drop and elections pose litmus
test to the economy
Election delay causes significant economic and political
risks
On Feb. 7 Nigeria’s electoral commission announced a
postponement of the Feb. 14 presidential election by
six weeks to Mar. 28 due to security concerns.
According to the electoral commission voting would
not have been possible in high security risk areas in the
northern states most affected by the Boko Haram
insurgency and more than 1m displaced people would
not have been able to vote. Additionally, the electoral
commission was struggling to distribute voter-ID cards
in time, with up to 20m voters still waiting to receive
their cards.
The largest election on the African continent, with
some 68.8m eligible voters, pits the incumbent
President Goodluck Jonathan from the centre-right
People’s Democratic Party (PDP) against Muhammed
Buhari from the oppositional centre-left All Progressive
Congress (APC). The PDP has dominated every election
since the end of military rule in 1999, but this year the
main opposition parties have unified for the first time in
a single block, the APC. This means that the upcoming
presidential election is likely to be Nigeria’s first truly
competitive election. According to recent polls,
Jonathan and Buhari are head to head. A survey by
Afrobarometer puts support for the PDP and the APC at
42% each with about a tenth of the voters still
undecided.
Page 92
Head to head race expected
Voting intentions among likely voters*
50%
40%
30%
20%
10%
0%
PDP
APC
Other Parties Don't know/
Refused to
say
* Survey conducted in Dec 2014, published Jan 27.
Sources: Afrobarometer, Deutsche Bank
In Nigeria, voting is traditionally determined among
ethnic and religious lines. President Jonathan is a
Christian from the South and enjoys large popularity in
the southern and south-eastern states, including the
oil-producing Niger delta. Buhari, who served a short
stint as president in the 1980s and lost the 2011
presidential election by a large margin against
Jonathan, is a Muslim and his main support comes
from the poor, Muslim-dominated north-eastern states.
Buhari’s appeal to northern voters is further boosted by
his military background and strong stance against
corruption and indiscipline that is seen as beneficial for
fighting the Boko Haram insurgency more effectively.
The delay of the election could amplify political unrest
in opposition strongholds in the north-east as well as in
the commercial capital Lagos. The APC has staunchly
insisted on keeping the Feb. 14 date for the elections,
saying that the only reason the PDP is pushing for a
delay is that it sees momentum shifting towards Buhari
in recent months.
The postponement of the election is also adding to
concern among foreign investors who have already
reduced Nigerian holdings and is likely to put policy
responses to Nigeria’s economic challenges further on
hold. We had expected the central bank and the
ministry of finance to act more decisively once the
election dust had settled. Now the period of political
uncertainty has been prolonged at least until early April.
In fact it could take much longer until a working new
government is in place. The close polls imply that the
election could only be decided in a runoff. In order to
win the election a candidate has to obtain a qualified
majority, i.e. the candidate has to get more than 50%
of the total vote and at least 25% of the vote in at least
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
two-thirds of the states. If neither Jonathan nor Buhari
garner the needed vote, the runoff will be held seven
days after the final results are released. If those
margins are still not achieved, a third runoff would be
held within a week, winnable by a simple majority.
Recent developments have also increased the risk that
the final results will be disputed by the losing side,
especially if the outcome is close. A disputed and
unclear election result and subsequent legal challenges
would further prolong the period of political uncertainty
and leave the economy without guidance.
Naira continues to slide, liquidity dries up
Among the most pressing economic challenges Nigeria
is facing at the moment is the impact of the lower oil
price on the currency. As expected, the Nov. 25
devaluation has not been sufficient to alleviate pressure
on the naira. On the interbank market the naira has
been trading outside the upper limit of the new target
band (NGN/USD 168 +/-5%) ever since the devaluation,
reaching NGN/USD 200 on Feb 10. Nevertheless, the
Central Bank of Nigeria (CBN) abstained from a further
weakening of the official target rate and also decided
to keep the benchmark interest rate unchanged at 13%.
Consequently, the gap between the official wDAS rate
and the interbank rate has widened.
Widening gap between the official and the interbank
exchange rate
NGN/USD
200
195
190
185
180
175
170
165
160
155
150
35
30
25
20
15
10
5
0
Gap (rhs)
Interbank
wDAS
Sources: Central Bank of Nigeria, Deutsche Bank
To prevent an even larger depreciation of the interbank
rate the CBN stepped up its USD sales on the interbank
market, but as a result FX reserves fell further to USD
34 bn in early Feb. (FX reserves are down 20% yoy). To
shore up the currency without causing a further erosion
of FX reserves, the CBN is increasingly resorting to
administrative measures. It reduced the net-open
exchange limit at the end of each trading day from 1%
of shareholder funds to 0.5% (in an initial step the limit
was even lowered to 0%, but the CBN subsequently
backtracked slightly) and it now requires banks to use
all the FX bought at the interbank market within 72
hours. Additionally, currency dealers agreed to halt
Deutsche Bank Securities Inc.
trading if there is more than a 2% intraday slide of the
naira. These measures helped to slow the fall of the
naira, but came at the cost of significantly reducing
liquidity. Reportedly, average daily trading volumes
declined from USD 300-500m in summer 2014 to only
around USD 20-40m in January. In response to the lack
of FX liquidity JP Morgan announced that Nigeria
might be dropped out of its local currency government
debt index. Losing membership in the index would be a
further blow for portfolio inflows and the currency.
Given the prospects of sustained lower oil prices and
FX reserves below 5 months of import cover, we think
that the current level of the naira will be difficult to
sustain. The REER is still about 30% overvalued based
on its historical relation with oil prices and the Bureau
de Change (BDC) exchange rate already trades at
around NGN/USD 210. We had expected the central
bank to wait until after the election and then to weaken
the official naira target further and allow the naira to
depreciate towards a level more in line with
fundamentals. The new election date, however, means
that the risks to such a strategy are rising. Postponing
the exchange rate adjustment until April or May would
require either continuous FX interventions and/or a
further tightening of administrative FX regulations. The
former would result in a drop in FX reserves to below
USD 30 bn, and while the latter would help to preserve
FX reserves, it would further damage Nigeria’s appeal
to offshore investors and also increase the required
magnitude of the FX adjustment once it is
implemented. Consequently, we change our 2015 endyear forecast for the exchange rate to NGN/USD 220.
The weaker exchange rate has not yet spilled-over into
higher inflation. In December CPI inflation remained
widely unchanged at 8.0% yoy. Nevertheless, given
Nigeria’s large reliance on imported consumer goods,
including food (imported food has a 13% share in the
CPI basket), we think that the weaker naira will drive
inflation to double digits over the next months.
Mounting fiscal challenges
By propping up the local currency value of oil sales the
weaker exchange rate helps to cushion the impact of
lower oil prices on the budget, but the effect is small
compared to the expected 40% drop in the average
annual oil price. We estimate that federal oil revenues
in 2015 will be about NGN 1800 bn (USD 9.2 bn) lower
than in 2014. The government reacted to the expected
revenue shortfall by lowering the budget benchmark oil
price twice since October 2014 from 78 USD/bbl to 65
USD/bbl, but it is still above the current oil price and
our forecast of an average 2015 Brent oil price of 59
USD/bbl. This means that without further consolidation
the fiscal deficit is expected to widen to more than 4%
of GDP. Despite a low public debt level of only around
12% of GDP, Nigeria’s ability to finance significant
deficits is limited by the lack of deep domestic debt
markets and the fact that debt service costs account
Page 93
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
already for about one fifth of total federal government
expenditures. With the Excess Crude Account (ECA)
largely depleted there is also very little room left to
finance the revenue shortfall by tapping fiscal buffers.
Fiscal impact of lower oil revenues only partly
cushioned by weaker exchange rate and lower subsidy
costs
NGN bn
8000
7000
Exchange rate effect
6000
Oil price effect
5000
4000
3000
2000
1000
0
-1000
2014
Gross oil revenues
2013 2014 2015F 2016F
National Income
Since
the (USD
election
of 510.0 537.0 510.9 519.3
Nominal
GDP
bn)
President
PopulationAbdel
(mn) Fattah el-Sisi 170.0 173.0 177.0 180.0
in
authorities 3,020 3,104 2,886 2,885
GDPlate
per May
capitathe
(USD)
have announced a series of
concrete
Real
GDP measures
(YoY %) to reduce
5.5
6.0
4.8
5.7
Egypt’s
large fiscal deficit
Priv. Consumption
11.0
6.5
6.2
6.5
from
current level of 12%
Govt its
consumption
1.4
5.0
-1.0
2.0
of GDP. El-Sisi rejected an
Investment
10.5
8.0
6.0
7.0
initial budget draft and
Exports
-8.5
2.0
-3.0
1.0
demanded
a
stronger
Imports
2.0
5.0
1.5
4.0
reduction of the deficit. The
most important measures
Prices, Money and Banking (YoY %)
taken are:
CPI (eop)
8.0
8.0
10.0
9.0
CPI (ann. avg)
8.5
8.1
11.0
9.0
Broad money (eop)
1.2
5.0
4.0
5.0
Bank Credit (eop)
7.8
6.0
4.0
6.0
2015
Subsidy expenditures
Net oil revenues
Net oil revenues are defined as gross oil revenues minus subsidy
payments
Sources: Budget Office of the Federation, Deutsche Bank
Consequently, we think that the government will try to
contain the deficit by lowering the budget oil price
towards 40-50 USD/bbl (Angola lowered it to 40
USD/bbl). A further cut in the benchmark price would
require additional measures of fiscal consolidation.
Among the most likely revenue generating measures is
an increase of the VAT. The VAT is currently low at just
5%, so the authorities have some space for raising
taxes without unduly damaging the economy. Doubling
the VAT to 10% would boost revenues by an estimated
NGN 600 bn. On the expenditure side the government
will reduce capital expenditures and try to contain
current expenditures. Reportedly, there are already
plans to reduce capital expenditures by up to 75% in
2015.
Another potential source of fiscal savings stems from a
lower energy subsidy bill. Public spending on subsidies
falls automatically as the crude oil price drops. The
government has already lowered its estimate for
expenditures on subsidies from NGN 971 bn to NGN
290 bn. However, reducing subsidy costs further by
scrapping fuel subsidies altogether is complicated by
increasing political pressure to pass on the lower crude
oil price to domestic consumers. In January the
authorities reduced the retail fuel price from NGN 97
per litre (at this price subsidies would no longer be
necessary at a crude oil price of 60 USD/bbl) to NGN 87
per litre thus denting the outlook for more fiscal
restraint.
Oliver Masetti, Frankfurt, +49 69 910 41643
Page 94
Nigeria: Deutsche Bank Forecasts
Fiscal Accounts* (% of GDP)
Following the election of
Overall
balance
President
Abdel Fattah el-Sisi
in Revenue
late May the authorities
Expenditure
have
shifted their focus on
Primary
balance
fiscal consolidation.
El-Sisi
rejected an initial budget draft
External
Accounts a(USD
bn)
and demanded
stronger
Goods
Exports
reduction
of the fiscal deficit,
Goods
which Imports
is estimated to have
Trade
balance
reached
12% of GDP at the
end
FY 2013/14 (ending
% ofofGDP
June). account
The balance
announced
Current
measures
% of GDP aim at cutting
expenditures
by reducing
FDI
(net)
subsidies
as(USD
well as
FX reserves
bn)at raising
revenues
by
increasing
taxes.
NGN/USD (eop)
The most important measures
taken
are:
Debt Indicators
(% of GDP)
-2.6
11.2
13.8
-1.7
-2.9
11.3
14.2
-2.0
-4.2
8.4
12.6
-3.2
-3.6
9.8
13.4
-2.5
95.1
51.4
43.8
8.6
20.0
3.9
3.0
42.9
160.0
93.8
54.5
39.3
7.3
14.3
2.7
3.0
34.5
183.0
62.5
48.0
14.5
2.8
-3.0
-0.6
2.5
29.0
220.0
78.5
55.0
23.5
4.5
6.5
1.2
4.0
33.0
225.0
Government debt
10.6
11.3
12.6
13.9
Domestic
8.9
9.2
10.4
11.5
External
1.7
2.0
2.2
2.4

fuel
TotalReduction
external debt in
2.2
2.3
2.8
3.0
subsidies
in USD bn
11.1
12.5
14.5
15.5
Short-term
(% offor
total)
2.7
4.0
4.0
4.0
The prices
gasoline
and diesel have been
General
increased
(ann. Avg)
by 40%-78%,
whileproduction
the price(YoY
of %)
less
Industrial
0.8
2.5
2.0
4.0
widely used
Unemployment
(%)natural gas
24.0
24.0
23.0
22.0
for vehicles was raised
by Markets
175%. (eop)
However, current 15Q1 15Q2 15Q4
Financial
despite
Policy
Rate these fuel price
13
13
13.5
13.5
hikes,(eop)
retail prices still
NGN/USD
200
205
220
220
remain well
below world
* Consolidated
Government
Sources:averages.
IMF, Central BankDiesel
of Nigeria, National
Bureau of Statistics, DMO, Deutsche Bank
prices
for example increased by
64% to USD 0.25 a litre,
but still amount to only
about one-fifth of the
world average pump
price for diesel of USD Deutsche Bank Securities Inc.
1.42 per litre.

Reduction in electricity
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Russia
Baa3(neg)/BB+(neg)/BBB-(neg)
Moody’s/S&P/Fitch

Economic outlook: Economic prospects dimmer
against the backdrop of higher sanctions and
weaker oil price outlook. The authorities are
preparing the stimulus package as the CBR cuts
rates, prompting further weakening of the
exchange rate.
Main risks: Elevated geopolitical risks relate to
Ukraine, scale of sanctions, and oil prices.
Domestic demand experiences
turbulence
Russia: GDP growth by expenditure components
8
0.4
6
0.4
4
% yoy

1.6
1.8
0.1
1.0
1.2
2
3.3
2.8
3.9
0
-2
1.5
2.4
-0.1
-0.9
-2.4
-2.7
-2.1
1.0
-0.6
-0.6
-4
Towards the end of last year Russia’s macroeconomic
parameters experienced a notable deterioration, which
was mainly fuelled by the sizeable depreciation of the
rouble. The latter occurred on the back of rapidly
worsened external conditions (weakening of energy
prices, presence of financial sanctions against Russian
corporates) as well as market expectations of possible
imposition of capital controls. In order to cope with the
challenges, the authorities are actively pursuing the
launch of fiscal stimulus with the use of sovereign
funds. In addition to the domestic headwinds, the
external pressures continued to build up. The rating
downgrades continued in January with S&P
downgrading Russia to BB+ with a negative outlook,
which was the first time since 2005, when the rating
was downgraded to below investment grade.
Key economic indicators: turbulence area reached
Following the deterioration of the key economic
indicators in November, the December prints continued
to worsen considerably, mainly on the consumer side.
The rise in inflation, to 11.4% yoy in December –
spurred by food import restrictions and rapid rouble
depreciation (>70% yoy), has weighed on real wage
growth and real disposable income. Real wages turned
negative in December, posting a 4.7% yoy decline after
-1.2% yoy in November; real disposable income
declined by 7.3% yoy after posting -3.9% yoy in
November. The sizeable depreciation and mounting
inflation expectations led households to emphatically
increase spending, most notably on non-food items –
very much in line with the consumer patterns observed
in Q4 2008, when higher non-food consumption was
seen as a means of preserving wealth. Retail sales rose
by 5.3% yoy in December (the highest growth rate
since August 2012) from a range of 1.7-1.8% yoy over
the past several months. Unemployment increased by
0.1pp to 5.3%.
Deutsche Bank Securities Inc.
2010
Households
2011
Govt
2012
Fixed Investments
2013
Exports
2014
Imports
GDP
Source: Rosstat, Deutsche Bank
On the production front, industrial production surprised
with an acceleration to 3.9% yoy in December after 0.4% yoy in November on the back of strong
performance in manufacturing, which was up by 4.1%
yoy
after
-3%
yoy
in
November,
and
gas/water/electricity supply and distribution (+3.4% yoy
in December after 0.7% yoy in November). Mineral
extraction gained 3.0% yoy, after 2.5% yoy in
November and 1.9% yoy in October. The decline in
fixed asset investment slowed, falling by just 2.7% yoy
in December after 4.7% yoy in November.
In terms of growth dynamics Russia’s GDP expanded
by 0.6% yoy in 2014 compared with 1.3% yoy in 2013,
with most of the indicators decelerating in 2014.
Household consumption decelerated to 1.9% yoy in
2014 after 5.0% yoy in 2013, public sector expenditure
fell to 0.5% yoy. On the investment side, gross capital
formation declined by 5.7% yoy in 2014, with fixed
asset investments down by 2.5% yoy. The external
sector was the only one which palpably propped up
growth: exports declined by 2% yoy, while imports
were down 6.8% yoy. It is worth highlighting that 2014
appeared to be the first year showing such a steep
deceleration of household consumption, which was
adversely affected by uncertainty factors and low real
wage growth, given accelerating inflation. Russia’s
consumption growth in 2014 was the lowest since
2001 (except for the 5.0% yoy decline in 2009).
Looking at the year ahead, the Ministry of Economy
has prepared a revised version of economic projections.
Given the average oil price is at the level of USD50/bbl,
the economy is expected to contract by 3% yoy with
investment declining by 13% yoy and consumption
dropping by 8% yoy. Inflation is expected to remain in
double digits (12% yoy), while capital flight is likely to
reach USD115/bbl (compared to USD90/bbl projected
earlier).
Page 95
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Russia: CBR interest rates vs. CPI
20.0
18.0
16.0
14.0
12.0
10.0
8.0
6.0
4.0
2.0
RUB-leg FX-swap
1W auction depo
Russia: Overall and non-oil fiscal balance, %GDP
1D fixed repo
CPI, %yoy
1W auction repo
1M AVG RUONIA
Apr-15
Jun-15
Feb-15
Oct-14
Dec-14
Aug-14
Apr-14
Jun-14
Feb-14
Oct-13
Dec-13
Aug-13
Apr-13
Jun-13
Feb-13
Oct-12
Dec-12
Aug-12
Apr-12
Jun-12
Feb-12
Oct-11
Dec-11
Aug-11
Apr-11
Jun-11
Feb-11
0.0
Dec-10
Fiscal balance: supported by weaker rouble
The federal budget ended the year with a deficit of
RUB328bn (0.5% GDP). The sizeable depreciation in the
rouble exchange rate attenuated the pressure on the
revenue side of the budget coming from lower oil
prices. Revenues amounted to RUB14,496bn, of which
oil revenues were RUB7,433bn (in line with the planned
amount) and non-oil revenues RUB7,062bn (4.5%
higher than planned). Expenditure was 6.5% higher
than planned, at RUB14,496bn. In our view, in 2015,
the fiscal sector is likely to be under pressure from
lower oil prices and GDP decline, which will weigh on
revenues. At this stage, we project the budget deficit to
exceed 2% of GDP this year, with prices recovering to
USD60/bbl and the economy witnessing a recession of
5% yoy.
Monetary sector: CPI breaches 15% level
On the monetary front, inflation in Russia continued to
accelerate in January. Consumer prices growth
reached 3.9% mom for the second month in a row,
pushing the headline figure to 15% yoy, the highest
level since the crisis of 2008-09. Core inflation was also
up, by 3.5% mom, with the headline yoy figure at
14.7% yoy. The main drivers, which pushed consumer
prices upwards, were food items, where growth
exceeded 20% yoy. We believe the inflation rate is
likely to rise further, as the economy continues to
adjust to the new FX conditions. Earlier this week,
Procter and Gamble announced an increase in prices of
its products by 30-50% by March 2015.
(%)
In our view, adverse external conditions (low oil prices,
presence of economic sanctions), as well as elevated
interest rate conditions will remain in place throughout
2015. We expect Russia’s GDP growth to be negative
at -5.2% yoy in 2015. The main negative impact likely
to be experienced by Russia’s economy is from lower
investment – undermined by lower oil prices, rouble
depreciation and high interest rates. Household
consumption growth is likely to come under pressure
(turning to a decline, of more than 6% yoy) from higher
inflation and higher unemployment.
o/n fixed depo
Source: Rosstat, CBR, Bloomberg Finance LP, Deutsche Bank
10
% GDP
5
0
-5
-10
-15
2005
2006
2007
2008
Surplus/deficit, % GDP
2009
2010
2011
2012
2013
2014
Non-Oil Budget deficit, % GDP
Source: Rosstat, EEG, Bloomberg Finance LP, Deutsche Bank
In view of the radical changes in key macroeconomic
parameters the authorities are revising their fiscal
projections, which were based on projections of
USD100/bbl oil prices and the rouble exchange rate
reaching RUB/USD 38. The anti-crisis programme of
the government announced at the end of January is
aimed at: (1) supporting import substitution; (2) SME
support in the form of lower financial and
administrative costs; (3) lower lending rates in systemic
economy sectors; (4) indexation of social spending; (5)
support for the labour market; and (6) banking system
support. The overall plan assumes spending of more
than RUB1.3tr (excluding RUB1.0tr from the 2014
budget earmarked for the recapitalisation of the
banking system).
Page 96
Despite the acceleration of inflation, the CBR has
decided to cut the key rate from 17.0% to 15.0% in
January, given higher risks of an economic slowdown.
According to the CBR, the previous emergency hike
resulted in a stabilization of inflation and exchange rate
expectations. The CBR expects monthly consumer
price growth to moderate from January 2015 but the
annual inflation rate to maintain an upward trend, with
a peak to be reached in 2Q15. In the medium term, the
CBR believes that the rouble depreciation will affect
consumer prices further, leading to a surge in headline
inflation in the coming months. However, inflation and
inflation expectations should decelerate later on, as the
economy gradually adjusts to new external conditions
and as the impact of pass-through effects on prices
fades away. The CPI may also moderate on the back of
subdued economic activity and tighter fiscal policy.
The CBR decision to cut rates ran counter to market
expectations, with no additional FX liquidity provision
tools being offered. In our view, it is too early to talk
about the suppression of the upward trend in inflation,
as the lagged effect of recent currency weakness
continues to feed through. As a result, we would
expect further pressure on the exchange rate and
inflation, while the gains to growth from lower rates, in
our view, are moderate and weakened by ongoing
volatility in financial markets.
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
On the trade side, Russia’s CA surplus increased by
73% yoy from USD34.1bn in 2013 to USD56.7bn in
2014. The trade balance improved by 6% yoy to
USD186bn; exports of goods declined by 6% yoy in
2014, while imports were down by 10% yoy in 2014.
The deficit in the services account declined in 2014
from USD58.3bn to USD54.6bn on the back of lower
imports. Investment income balance improved by 15%
yoy in 2014 with the deficit declining from USD67.2bn
to USD56.9bn.
Russia: CA items dynamics
15
13
11
% GDP
9
7
Russia: CBR interest rates vs. CPI
800
700
600
500
USDbn
External sector: capital outflows exceed USD150bn in
2014
On the external front, net capital outflows intensified in
4Q14 to USD72.8bn, the highest level since 4Q08
(USD132bn). Overall, the headline figure over 2014
reached the level of USD151bn (USD130bn if adjusted
for FX swap operations). Both financial and nonfinancial sectors registered significant outflows,
amounting to USD30.6bn and USD42.8bn, respectively.
400
300
200
100
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Non-financial sector
Financial sector
General Government
Monetary authroties
Source: CBR, Deutsche Bank
Overall, the pace of deleveraging corresponds to the
rapid rouble depreciation in 4Q14 (the rouble weakened
from USD/RUB36.3 pavg in 3Q14 to RUB/USD47.9
pavg in 4Q14). Should such a fast pace of deleveraging
continue alongside the expected USD120bn of
redemptions in 2015 (data as of 2Q14, and may be
lower due to early principal repayments), the
authorities would need to provide further fx support to
the banking system/economy in order to ensure
financial and rouble stability.
5
3
1
-1
-3
-5
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
TB in Goods, % GDP
TB in Services, % GDP
Investment Income Balance, % GDP
CA, % GDP
Source: CBR, Rosstat, Deutsche Bank
At the same time, Russia’s debt declined from
USD730bn in 4Q13 and USD680bn in 3Q14 to
USD600bn in 4Q14, a drop of almost USD130bn over
the past year. Overall, the pace of external deleveraging
increased in the last quarter and reached 18% yoy. In
2013, the debt amount increased by USD92bn, or 15%
yoy. The non-banking sector exhibited the fastest pace
of deleveraging in absolute terms, as it paid out
USD46bn (-11% qoq) with debt liabilities to direct
investors and direct investment enterprises and loans
repayments reaching USD16bn and USD28bn,
respectively. The banking sector’s external debt
decreased by USD21bn (-11% qoq). In relative terms,
the most rapid pace of deleveraging was exhibited by
the public sector with debts decreasing by one third
from USD48.3bn in 3Q14 to USD41.5bn (-14% yoy) in
4Q14.
Deutsche Bank Securities Inc.
S&P downgrades Russia to below investment grade
In January Standard and Poor's downgraded Russia's
foreign currency sovereign credit rating to BB+ from
BBB- citing increasing limitations to Russia's monetary
policy flexibility and weakening economic growth
prospects with the risks of deterioration of external and
fiscal buffers mounting due to external pressures and
increased government support for the economy. These
pressures (sanctions, oil price shock) have already
resulted
in
extreme
volatility
in
the
hard
currency/interest rate markets and served to
accentuate rouble depreciation, adversely affecting the
stability of Russia's financial system.
The outlook remains negative as S&P believes that
monetary policy flexibility could deteriorate further, e.g.
via the imposition of exchange controls. The rating
could be downgraded further if external and fiscal
buffers deteriorate at a materially faster pace over the
coming year.
Page 97
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Russia: 5Y CDS for EM countries (S&P rating)
Russia: Deutsche Bank forecasts
2013
2014F
2015F
2016F
National Income
Nominal GDP (USDbn)
2 096
1 974
1 574
1 757
Population (m)
143.3
143.7
143.7
143.8
GDP per capita (USD)
14 621
13 788
11 002
12 289
1000
900
800
700
600
500
400
300
Real GDP (YoY %)
200
India(BBB-)
Indonesia(BB+)
Bulgaria(BB+)
Turkey(BB+)
Morocco(BBB-)
Vietnam(BB-)
Dubai
S. Africa(BBB-)
Croatia(BB)
Brazil(BBB-)
Tunisia(BB-)
Bahrain(BBB-)
Egypt(B-)
Cost Rica(BB)
Pakistan(B-)
Lebanon(B-)
Cyprus(B+)
Russia(BB+)
Ukraine(CCC-)
Venezuela(CCC)
0
Kazkahstan(B…
100
Note: Venezuela CDS is c.5,000
Source :Bloomberg Finance LP, Deutsche Bank
In our view, the downgrade came in as an expected
event as the agency had already placed Russia’s credit
rating on watch for downgrade since December. It
would take a second ratings agency besides S&P for
Russia to lose its investment grade status and be
removed from some global investment grade credit
indices. Moody’s, which downgraded Russia to Baa2
and placed it on negative watch for further downgrade
on 16 January, is likely to follow suit over the next
couple of months. Fitch also recently downgraded
Russia to BBB- (with a negative outlook); though it has
not placed Russia in the downgrade “watch list” as yet.
Spreads are at an elevated level (5Y CDS close to
550bp), more than pricing in the scenario of Russia
losing investment grade status.
Yaroslav Lissovolik, Moscow, +7 495 933 9247
Artem Zaigrin, Moscow, +7 495 797 5274
1.3
0.6
- 5.2
- 3.4
Private Consumption
4.7
1.9
- 6.8
- 3.2
Government consumption
0.4
0.5
- 1.4
- 0.8
- 0.3
- 2.5
- 11.5
- 5.6
Exports
4.1
- 2.0
- 8.6
2.4
Imports
3.9
- 6.8
- 16.1
4.3
CPI (eop)
6.5
11.4
9.5
7.9
CPI (period avg)
6.8
7.9
13.3
7.0
Broad money (eop)
14.0
10.3
9.6
10.4
Private Credit (eop)
18.1
16.3
12.1
13.1
- 0.4
- 0.5
- 2.1
- 1.7
Revenue
19.3
20.0
15.5
15.7
Expenditure
19.7
20.5
17.6
17.4
Primary Balance
0.1
0.1
- 1.3
- 1.0
Goods Exports
523.3
500.8
380.5
402.3
Goods Imports
343.0
307.8
227.5
230.6
Trade Balance
180.3
193.0
153.0
171.7
% of GDP
9.2
9.8
9.7
9.8
32.8
61.4
56.1
75.5
4.3
Gross Fixed Investment
Prices, Money and Banking (yoy%)
Fiscal Accounts (% of GDP)
Overall balance*
External Accounts (USDbn)
Current Account Balance
1.7
3.1
3.6
FDI (net)
- 15.6
- 10.2
- 5.2
5.6
FX Reserves (eop)
510.0
385.0
350.0
345.7
USD/FX (eop)
32.73
56.38
55.60
54.30
% of GDP
Debt Indicators (% of GDP)
Government Debt**
11.7
13.2
14.5
15.6
Domestic
8.1
10.5
10.9
11.6
External
3.6
2.7
3.6
4.0
External debt
32.9
32.6
32.8
29.4
732
600
520
470
Industrial Production (yoy%)
0.0
2.6
- 6.7
- 2.1
Unemployment (%)
5.5
5.0
6.0
5.8
Current
15Q1F
15Q2F
15Q4F
15.00
65.45
15.00
60.80
15.00
57.50
13.00
55.60
in USDbn
General (ann. avg)
Financial Markets
Policy rate (Key rate)
USD/RUB (eop)
* - central government, ** - general government
Source: Official statistics, Deutsche Bank Global Markets Research
Page 98
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
South Africa
Baa2 (stable)/BBB- (stable)/BBB (stable)
Moody’s/S&P/Fitch

Economic outlook: The upcoming Budget Review
in two weeks’ time should be a positive market
surprise in our view. We do not see significant
adjustments to tax policies, and expect fiscal
deficits to improve by 0.5% of GDP in 2014/15 and
2015/16, respectively. This is partly due to much
tighter control on expenditure and lower debt
service costs, which should be well-received by
credit ratings agencies.
Budget balance for FY14/15 broadly on track
With growth having disappointed markedly in 2014, it
comes as will come as no surprise that some revenue
slippage is likely. However, when comparing the yearto-date deficit to the historical budget performance,
then there seems to have been a notable improvement
over the last two months of last year compared to June
and October.

Main risks: Electricity constraints to growth have
escalated and remain a significant risk to the
outlook. Renewed pressure on the exchange rate
coupled with the negative domestic supply side
shock could reinstate rate hikes this year. But for
now we see rates on hold until in 2Q16.
Budget for FY14/15 largely on track
0%
Year-to-date deficit as % of budget forecast
20%
40%
Budget 2015: Positive traction will come
as a surprise to markets
60%
2014-15
80%
The Finance Minister will be delivering his Budget
Review in Parliament on the 25th of this month.
Markets would like to see a continuation of the
credibility he gained after the October mid-term budget.
Not only did he cut the nominal spending ceiling by
R10bn and R15bn over the next two fiscal years, but he
also had to ensure that the negative knock-on effects
from last year’s poor growth would not derail the
revenue trajectory that was outlined in February. This
included proposals to raise revenue by R12bn, R15bn
and R17bn in the next three fiscal years, starting with
2015/16. These measures would ensure that the
consolidated government budget would improve from 4.1% in FY14/15 to 3.6%, 2.6% and 2.5%, respectively
in each consecutive year.
To lower the expenditure ceiling, budgets on nonessential goods and services would be fixed at 2014/15
levels, funding for vacant posts withdrawn and
transfers to cash-flush public entities would be lowered.
Cost-containment in other parts of the budget was also
announced, including measures to contain growth in
the wage bill in line with inflation. The expenditure
ceiling still includes unallocated funds worth R5bn,
R15bn and R45bn in the next three fiscal years (ending
FY17/18), which serve as buffers against any
fiscal/economic shocks. On the revenue side, proposals
(which will be announced in the upcoming budget) will
“be designed to limit as far as possible any negative
impact on growth and job creation.” In our view, the
negative onslaught of electricity constraints on growth,
would reduce the chance of an increase in VAT, and
possibly limit any changes (other than the usual ‘sin
tax’ adjustments) to capital gains taxes, the fuel levy,
and possibly personal income tax adjustments of highnet worth individuals.
Deutsche Bank Securities Inc.
100%
Shaded area represents range of outcomes for the
preceding four years
120%
April
July
October
January
Source: Deutsche Bank, National Treasury
… as revenue collections are broadly on budget:
Lengthy industrial action appears to have weakened
corporate tax collections by up to R12bn last year,
while the weaker global backdrop has also reduced tax
revenue from international trade by some R7bn.
Fortunately, the overall revenue performance (71.8% of
budget) is not significantly different from the long-term
average performance, thanks to an overrun in personal
income tax, VAT, and the buffer from non-tax revenue
of c. R3bn which is mostly due to revaluation effects of
assets and liabilities.
Revenue collections not as disappointing vs history
MTBPS est.
(Rbn)
Apr-Dec
(Rbn)
Personal income
341.5
Corporate income
VAT
YTD % of full year estim ate
Rbn over/under
vs 2013/14
vs
average
Current
2013/14
7-yr ave
246.6
72.3
70.7
70.6
5.2
5.6
214.9
155.5
72.2
78.0
75.0
-12.1
-5.7
4.9
262.7
188.3
72.1
69.9
69.8
4.7
Fuel tax
47.5
35.5
74.7
74.5
73.7
0.1
0.5
Int. trade
50.5
28.7
71.7
70.9
70.5
-7.1
-6.9
66.5
50.8
76.4
72.5
76.8
2.6
-0.3
Total tax revenue
983.6
705.4
71.7
72.3
71.9
-6.1
-1.4
SACU payments
Departmental
revenue (non-tax)
51.7
38.8
75.0
75.1
74.3
0.0
0.4
24.8
20.0
80.9
82.5
69.5
-0.4
2.8
956.6
686.7
71.8
72.4
71.7
-5.9
0.5
Other
Total
Source: Deutsche Bank, Treasury
Page 99
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Treasury is also keeping a tight lid on total expenditure
which appears to be undershooting previous budgets
by R12.6bn according to our estimates. Half of this
appear to be from lower debt service costs and could
reflect more favourable bond market movements and
prudent debt management. Non-interest expenditure
has therefore undershot budget by a small margin,
which if sustained will be positive news for stabilizing
government’s debt ratio. This could be a reflection of
moderating stuff numbers, improved administrative
procedures and a recovery in finances of struggling
provinces.
Macroeconomic framework: NT likely to be more
cautious on income effects of oil
2014
2015
2016
2017
Priv. Cons.
Gov. Cons.
Investment
Exports
Imports
Re a l GDP
NT
1.9
1.8
2.7
3.1
1.0
1.4
DBe
1.2
1.9
-0.5
1.2
-0.2
1.4
NT
2.3
1.5
3.6
4.2
4.1
2.5
DBe
2.8
1.4
2.6
3.3
3.1
2.8
NT
2.8
1.5
4.7
4.7
5.0
2.8
DBe
3.4
2.4
6.0
7.0
7.0
3.5
NT
3.0
1.5
5.1
5.2
5.6
3.0
CPI
GDP infla tion
Curre nt a ccount
6.3
6.1
-5.6
6.1
6.3
-5.5
5.9
5.8
-5.4
3.9
8.2
-4.0
5.6
5.7
-5.2
5.8
6.4
-4.7
5.4
5.6
-5.0
Source: Deutsche Bank, National Treasury
Treasury adhering to non-interest spending ceilings
100%
Year-to-date non-interest expenditure as % of
budget forecast
80%
60%
40%
20%
2014-15
Shaded area
represents range of
outcomes for the
preceding four
years
0%
April
July
October
January
Source: Deutsche Bank, National Treasury
If we go by these estimates alone, then the Budget
target of -4.1% for FY14/15 should be quite
comfortably met, with some scope of a positive
surprise in the region of -3.6% – this improvement is
also partly a function of the higher GDP that stemmed
from last year’s revisions to the national accounts.
From a market perspective, this outcome will be a
positive surprise, supporting our bullish expectations
for a rally in bond yields.
Previewing 2015/16 fiscal metrics – further traction
likely despite growth concerns
Since the mid-term budget in October last year, the
recovery in economic growth foreseen at the time has
been weakened by severe electricity constraints. In
spite of lower oil prices, which we see providing a
larger boost to consumer demand than consensus, the
NT may side with the more cautious GDP growth
forecasts presented by the IMF and SARB which is
closer to 2% in real terms. Given the effects of
electricity constraints on exports and investment, in
particular, revisions should be made to export and
investment growth, which appear too optimistic
against the existing backdrop. Importantly, a reduction
in capital expenditure forecasts may be net positive for
tax collections in the short-term due to a reduction in
VAT refunds (i.e. fiscal drainage).
Page 100
…as nominal GDP should lift thanks to lower oil prices
Downward revisions to growth are thus possible, but
we still believe the NT could arrive at a nominal GDP
growth estimate somewhat higher than the 8.5%
forecast for FY15/16. Thanks to the impact of lower oil
prices on the terms of trade, the GDP deflator should
conservatively increase to 7% (vs 5.8%) even though
lower consumer prices may be partly counteractive
(Figure below).
GDP deflator has been severely constrained by
negative terms of trade over the past two years.
15
yoy %
10
5
0
-5
-10
2004
2006
2008
Terms of trade
2010
2012
2014
GDP-GDE deflator
Source: Deutsche Bank, SARB
We estimate that every 0.5% increase in nominal
growth should in theory raise an additional R5bn to
R6bn of revenue. Given our assumptions that
consumer demand should pick up from a low base, we
think revenue could overshoot by some R10bn. As
highlighted in our feedback note in the theme piece
“Cheap oil but not enough energy”, the risk of VAT
hikes this year, has been significantly reduced.
Treasury may even decide to raise the fuel levy by a
larger margin, which could supplement its revenue by
R5bn-R10bn.
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
In sum, we see a 0.5% reduction in the fiscal deficit to 3.6% and -3.1% in FY14/15 and FY15/16 compared to
estimates presented in October’s budget. The knock-on
impact for the primary deficit and government’s debt
ratio is significant, and should help to offset the recent
increase in government’s contingent liabilities resulting
from additional guarantees granted to SAA.
Significant improvement seen in fiscal efforts to
consolidate the budget deficit
Revenue
1013
FY 15
FY 14
DBe*
NT
DBe*
( Ra nd billions)
1094
1094
1199
1209
Expenditure
Non-interest
Interest
Overall balance
Primary balance
1147
1040
108
-135
-27
1247
1126
121
-153
-32
1235
1120
115
-141
-26
29.3
33.2
30.1
29.5
33.6
30.3
27.9
31.5
28.6
3.1
3.3
2.9
3.3
3.1
3.3
3.3
Overall balance
-3.9
-4.1
-3.6
-3.6
-3.1
-2.6
-2.5
Primary balance
-0.8
-0.9
-0.7
-0.3
0.0
0.7
0.8
FY 13
Actual
Revenue
Expenditure
Non-interest
Interest
FY 16
1323
1435
1344
1211
133
-135
-2
1437
1292
145
-114
31
1553
1397
156
-119
37
28.0
31.1
28.0
30.2
32.8
29.4
30.0
32.5
29.2
NT
1344
1211
133
-144
-11
( % G DP)
29.7
33.3
30.0
NT
FY 17
NT
Source: Deutsche Bank, National Treasury
The Budget will contain some details around the
package aimed at alleviating Eskom’s immediate cash
constraints. Through the sales of government’s noncore assets, around R20bn will be raised, half of which
is due by June. Financial support for SOEs should also
be accompanied a new framework involving greater
government oversight, stricter reporting conditions or
plans to draw the private sector into the capital
projects. Details on the latter may be thin, but could be
outlined from interactions currently being held between
industry specialists, government and Eskom in the socalled “war room”. With regard to other elements we
would look out for, progress on improving municipal
service delivery, outstanding taxes and debt
management, and measures to enhance the allocation
of infrastructure grants and delivery of capital projects
(former FinMin Mr Pravin Gordhan’s portfolio). Private
sector involvement in state-owned enterprises’
investment projects (especially in electricity) will
hopefully be dealt with, but we doubt any meaningful
details will emerge in this regard.
Danelee Masia, South Africa, 27 11 775-7267
South Africa: Deutsche Bank Forecasts
2013
2014E
2015F
2016F
364.4
53.0
6876
352
53.5
6 578
377
54.0
6 981
431
54.6
7 901
2.2
2.9
3.3
7.6
4.5
1.8
1.4
1.2
1.9
-0.5
1.5
-0.2
2.8
2.8
1.4
2.6
3.3
3.1
2.9
2.7
1.4
3.4
2.5
3.4
5.4
5.8
5.5
6.1
5.1
4.2
5.6
5.8
-4.1
29.0
33.0
-4.0
28.0
32.0
-3.1
28.0
31.1
-2.2
28.1
30.3
-1.0
-0.9
0.0
0.9
External Accounts (USDbn)
Goods exports
Goods imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI (net)
FX reserves (USD bn)
ZAR/USD (eop)
ZAR/EUR (eop)
96.2
103.2
-7.0
-1.9
-21.0
-5.8
1.6
49.0
10.1
13.2
91.5
98.9
-7.4
-2.1
-19.2
-5.5
-0.7
48
11.0
13.9
90.8
92.6
-1.8
-0.5
-14.9
-4.0
1.5
49
11.0
11.5
99.7
104.3
-4.6
-1.1
-20.3
-4.7
1.5
51
10.5
9.98
Debt Indicators (% of GDP)
Government debt 1
Domestic
External
Total external debt
in USD bn
43.9
39.9
4.0
37.5
137
45.7
41.7
4.0
40.5
142
46.3
42.3
3.9
37.5
140
46.0
45.5
3.5
33.9
145
Current
15Q1
15Q2
15Q4
5.75
6.10
7.60
11.83
13.39
5.75
6.10
7.0
11.4
12.6
5.75
6.10
6.8
11.3
12.3
5.75
6.15
7.0
11.0
11.5
National Income
Nominal GDP (USD bn)
Population (mn)
GDP per capita (USD)
Real GDP (%)
Priv. consumption
Gov’t consumption
Gross capital formation
Exports
Imports
Prices, Money and Banking
CPI (YoY%, eop)
CPI (YoY %, pavg)
Fiscal Accounts (% of GDP)
Overall balance
Revenue
Expenditure
Primary balance
Financial Markets (eop)
Policy rate
3-month Jibar
10-year bond yield
ZAR/USD
ZAR/EUR
1, 2
(1) Fiscal years starting 1 April.
(2) Starting with the November2013 EM Monthly, numbers are presented using National Treasury’s
new format for the consolidated government account.
Source: Deutsche Bank, National Sources.
Deutsche Bank Securities Inc.
Page 101
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Turkey
Baa3 (negative)/BB+ (negative)/BBB- (stable)
Moody’s / S&P / Fitch

Economic outlook: Inflation is set to improve visibly
in H1 before accelerating later in the year due to an
unfavourable base and the possibility of re-kindled
FX pass-through. Growth this year and next is likely
to remain ordinary in Turkish standards. Measured
monetary easing is still possible, yet market
conditions are key.

Main risks: Political risk premium is on the rise,
distorting policy signalling by the CBT. Structural
deficiencies, i.e. low FX reserves, corporates’
currency mismatch, etc., could bind again in case
global risk appetite retreats further. Political
backdrop appears marginally more uncertain ahead
of the June general elections.
Riding the roller coaster
What a start to the year! Everything initially seemed to
be working just fine for the Turkish assets. Long rates
were heading to south thanks to the improved outlook
for inflation and external balances, and reached their
lowest levels in mid-January since the taper tantrum.
TRY had to endure a short sell-off in mid-December
due to the intensified market strains over Russia, but it
was nearly 6% firmer against the USD by the second
week of January. Similarly, Turkey’s CDS spreads
compressed by c45bps in the same period. External
backdrop was also fairly conducive. The ECB
announced a larger-than-expected monetary stimulus.
The Brent crude oil prices dipped further to USD45/bbl,
and supported the macro outlook further.
Turkish assets on a roller coaster ride
140
Nov'14 = 100
Nov'14 = 100
USDTRY
5yr CDS
5yr bond yield
BIST100 (RHS, inverted)
130
80
85
120
90
110
95
100
100
90
105
80
Nov-14
110
Dec-14
Dec-14
Source: Reuters and Deutsche Bank
Page 102
Jan-15
Jan-15
Feb-15
Things, however, have turned upside down since late
January. Focus in the global markets shifted from the
ECB’s gigantic quantitative easing program to the
Greek election results and its meaning for the fate of
Euro zone. Oil prices rose by 30% from their trough,
before tentatively stabilizing around USD55/bbl. A
strong January jobs report in the US kept the June liftoff by the Fed on the table. Domestic backdrop has
also become less market supportive. Intensified
political externality ahead of the June Parliamentary
elections took its toll on the CBT and distorted its policy
signaling (please see our separate piece ‘Turkey Trip
Notes: Is heightened volatility the new normal?’ for
further details). The result was a renewed sell-off in
Turkish assets, with the lira reaching its all-time high
against the USD.
Were the events that unfolded recently all unexpected?
Our answer would be ‘no’. Yet, what really surprised us
is their timing. In our 2015 Outlook, we already laid out
the global commodity price disinflation, the ECB’s
accommodative policies, the Fed’s forthcoming rate
hikes, the June general elections and geo-political
backdrop as the main drivers for the Turkish assets and
economy this year. Our expectations were that positive
factors (i.e. the ECB’s QE and oil story) would likely
dominate in the first half before domestic politics and
the Fed’s normalization cycle had an impact later in the
year. However, the effect of negative drivers has been
fairly front-loaded, and we reached levels, particularly
in the lira, which we had envisaged for the year-end.
While this does not mean the prevailing adverse trend
would necessarily endure during the rest of year,
something external has got to give for Turkish assets to
perform again. This could be in the form of renewed
(and consistent) declines in oil prices, and/or the ECB’s
QE program again taking the spotlight following a
partial (and even temporary) resolution to the Greek
saga, or a softening in geo-political strains regarding
the Ukraine/Russia issue. On the domestic side,
political risk premium also needs to come down for a
sustainable rebound. The lira should also be kept in
check to ensure that the ongoing disinflation process
remains uninterrupted. Hence, while there is room for
Turkish assets to become again the darling of investors,
we need to see some of the aforementioned
prerequisites satisfied first.
In the rest of this monthly update, we present our latest
growth and inflation outlook, along with the possible
policy path the CBT could adopt.
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Yet Growth to remain still ordinary in Turkish standards
Latest supply side indicators, such as industrial
production, PMI, capacity utilization rate, all implied
that the expected uptick in the economic activity
during the final quarter of 2014 (after 1.7% in JulySeptember period) could be fairly limited. While we
have seen some visible improvement in demand
indicators (i.e. white goods and vehicle sales) in H2 14,
consumer confidence still remained downbeat. All this
means that 2014 full-year growth is unlikely improve
much from 2.8%YoY recorded in 2013. Our latest
estimations suggest it could transpire within 2.5%2.8% range, mostly probably closer to the lower end,
barring any retrospective revisions and unforeseen
stock changes.
base effects and dwindling impact of earlier FX passthrough. Transportation indeed recorded its sixth
consecutive monthly deflation in January, thanks to
~3.9% decline in the cost of private transportation.
After having remained stagnant in December, food
prices rose by 3.5%MoM last month - owing to adverse
weather conditions, but in annual terms they were still
down 1.7pp, reflecting the impact of a favorable base.
A bottoming-out in oil prices globally and in Turkey
100 = July '14
100
90
Decline
-16.1%
80
A mediocre pick-up in private consumption is likely
35
YoY%
YoY%
2013
average
30
8
4
25
2
20
0
15
-2
10
2012
average
-6
Jan-13
Jul-13
Jan-14
-10
Jul-14
Jan-15
Private consumption (RHS)
Consumer loans (13wma, FX-adjusted, annualized)
Consumer confidence (RHS)
Source: Haver Analytics, CBT, TurkStat, and Deutsche Bank
We have slightly revised up our real GDP growth
forecasts to 3.5-3.7% region for this year and next
(versus 3.3-3.5% previously), mostly based on three
changes in our underlying assumptions. First, DB
Economics recently revised up the Euro zone growth
outlook (to 1.3%YoY and 1.6% for 2015 and 2016,
respectively from 1.0% and 1.3% in January), yet
slightly downgraded the US growth estimate for 2015
(to 3.4% from 3.7%). Given relative share of these
regions in Turkey’s total exports, net result is a slightly
better outlook for external sales. Second, while the
cash budget made a strong start to the year, we are
now working with a larger fiscal spending assumption
ahead of the June general elections. And third, we
think 2014 is likely to provide a favorable base for this
year, particularly via stock changes. Meanwhile, we
still believe private consumption and investments are
set to display a measured rebound in 2015, thanks to
the credit impulse finally turning positive, but subdued
confidence is likely to put a cap on the upside.
Renewed FX pass-through ahead?
There is no doubt that CPI inflation is finally heading to
south on the back of the ongoing global commodity
disinflation, a mean-reversion in food prices, conducive
Deutsche Bank Securities Inc.
Brent (global, USD)
-40.5%
Brent (global, TRY)
-40.5%
Ex-refinery price (local, TRY)
50
-48.5%
Petrol pump price (local, TRY)
40
Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Latest
Source: Haver Analytics, CBT, and Deutsche Bank
-8
2014
average
Jul-12
60
-4
5
0
Jan-12
70
6
Yet, there are fledgling signs that the ongoing
disinflation process may not be that straightforward as
it had been widely assumed. January services inflation,
for instance, were higher in annual terms (8.7%),
mostly due to rising communication costs. Core I index
- one of the CBT's favorites - jumped acutely to 6.2%
(in annualized seasonally adjusted terms) from 5.3%
previously.
Renewed FX pass-through ahead?
12
YoY%
(t-3)
YoY%
10
30
20
DB
Forecasts
8
10
6
0
4
If basket weakens to
its all time-high
2.83/TRY by end-2015
2
Core goods (LHS)
0
Jan 10
-10
Basket/TRY
-20
Jan 11
Jan 12
Jan 13
Jan 14
Jan 15
Source: Haver Analytics, Deutsche Bank
Pump prices have also displayed a nearly 3% rise since
early February on the back of slightly more expensive
oil globally and the weaker lira. The latter is also a great
concern for the inflation trajectory in the second half of
Page 103
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
cap the upside risks on the lira, barring any unforeseen
shifts in the global or geopolitical backdrop. 2015, as
FX pass-through in Turkey - while significantly curtailed
in recent years - is still strong (a sustained 10% TRY
weakness increases the annual CPI by 1.2-1.5pp in 6
months’ time). Overall, while we still think CPI inflation
is set to decelerate visibly in the coming months, we
slightly revised up our trough from 5.3%YoY (in July) to
5.6%, and expect annual average inflation to transpire
around 6.6% (versus 6.5% previously).
CBT: show me the anchor?
The near-term priority for the CBT, in our view, is to
ensure that the lira is kept in check. It is true that TRY in basket terms - still remains below its all-time high
(2.83) recorded in January last year. However, the USD
is still the main external funding currency for Turkey,
and it is also the psychological barometer for the public
to gauge the current economic conditions. Hence, we
do not think the Bank would find the current (levels
and) volatility seen in USDTRY conducive for the macro
and financial stability. Accordingly, the CBT could
resort to three instruments to stem further lira
weakness: i) liquidity tools; ii) FX intervention (daily
auctions and outright); and iii) policy rates. The Bank
already keeps the liquidity conditions fairly tight with
the interbank O/N repo rate having again neared to the
upper bound (at 11.25%) despite a 50bps cut in oneweek repo in January. If deemed necessary, the CBT
could push short-term money market rates up to the
late liquidity window (12.75%) by changing the
operational framework for its liquidity management.
Second, the Bank could directly focus on the FX market
by increasing the amount in its daily selling auction
(USD40mn currently) or via outright intervention. Yet,
given that the CBT still sells FX to BOTAS off the
market (via Treasury) and its net usable reserves stands
at a meager USD33.7bn, the room for maneuver seems
rather limited on this front.
ROM: finally an automatic stabilizer?
70
%
USDTRY
1.50
60
1.75
50
40
2.00
30
20
2.25
10
0
0911
2.50
0612
0313
1213
0914
FX ROM upper limit (% of total TRY RRs)
FX ROM utilization rate
USDTRY (RHS, inverted)
Source: Haver Analytics, CBT, and Deutsche Bank
Page 104
Despite the latest changes (i.e. remuneration of TRY
required reserves), we also do not think the reserve
option mechanism (ROM) has fully become an
automatic stabilizer to curb excessive FX moves. There
was a drop in its utilization rate in December (51.6%),
but this was still more related to the fact that banks
had relatively curtailed access to short-term financing
from abroad at the time due to the adverse market
contagion from Russian fears. The only silver lining is
that the residents’ FX deposits again started to serve as
a soft buffer, and the lira would have been probably
much weaker now if it had not for ~USD14bn of FX
deposits liquidated by the locals since early December.
Finally, the CBT could opt for rate hikes as a last resort,
but only probably after we see the TRY again reach
2.83 levels against the basket.
Resident FX deposits again serve as a buffer
160
USDbn
150
Basket/TRY
2.8
Resident FX deposits
2.6
Basket/TRY (RHS, inverted)
140
2.4
130
120
2.2
110
2.0
100
90
Jan 11
1.8
Jan 12
Jan 13
Jan 14
Jan 15
Source: Haver Analytics, CBT, and Deutsche Bank
The Bank is still committed to keeping liquidity
conditions tight and yield curve flat to ward off further
volatility and weakness in the lira. On top of this,
during the Inflation Report Briefing in late January,
Governor Basci hinted the Bank had been keeping the
one-week repo rate close to the inflation rate and could
adjust the policy rate going forward in tandem with the
decline in inflation by providing only a marginally
positive ex-post real policy rate. He also mentioned the
possibility of letting interbank O/N repo rates go up to
the late liquidity window, if need be.
Out of these two new anchors, we find the latter one
more plausible and (also) implementable. Yet, we have
some doubts about the validity of the former. First, it is
not even supported by the historical data (except for
December 2014 and January 2015). Second, it is at
odds with the forward-looking nature of an inflationtargeting central bank. As such, the subsequent market
reaction was expectedly adverse, which in the end
prompted the Bank to call off the interim MPC meeting.
Hence, we still think the Bank’s former anchor on
policy rates, i.e. 2% ex-ante real interest rate to bring
inflation down sustainably, is the relevant one.
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Turkey: Deutsche Bank Forecasts
Yield curve has shifted up since early February
8.50
%
8.25
Latest
8.00
7.75
4
CBT: 1-week
repo rate
7.50
3
09-Feb-15
14-Jan-15
2014F
2015F
2016F
821. 9
75.8
10839
796. 5
76.8
10372
779. 3
77.8
10022
838. 3
78.7
10646
4.1
5.1
6.2
4.2
- 0.3
9.0
2.7
1.2
6.5
- 1.5
7.4
- 2.3
3.5
3.1
7.4
2.5
3.9
6.4
3.7
3.7
4.7
5.1
6.4
8.4
Prices, Money and Banking (YoY%)
7.4
CPI (eop)
7.5
CPI (period avg)
22.2
Broad money (eop)
33.3
Bank credit (eop)
8.2
8.9
11.9
19.3
7.1
6.6
10.6
20.7
7.4
7.1
11.0
21.4
Fiscal Accounts (% of GDP)
Overall balance 1
Revenue
Expenditure
Primary balance
- 1.2
24.9
26.1
2.0
- 1.3
24.3
25.6
1.6
- 1.8
23.0
24.8
0.9
- 1.6
22.3
23.9
1.0
External Accounts (USDbn)
bn)
Goods Exports
Goods Imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI (net)
FX reserves (eop)
TRY/USD (eop)
161.8
241.7
- 79.9
- 9.7
- 64.7
- 7.9
8.8
110.9
2.14
169.0
232.6
- 63.6
- 8.0
- 45.8
- 5.8
5.5
106.3
2.32
171.6
225.4
- 53.9
- 6.9
- 37.9
- 4.9
7.4
108.0
2.51
183.4
244.2
- 60.8
- 7.3
- 43.7
- 5.2
8.5
112.3
2.62
37.4
25.7
11.7
47.4
390
33.5
35.9
24.5
11.4
52.3
416
33.0
35.3
24.1
11.2
54.9
427
31.0
34.1
23.5
10.6
53.8
451
30.0
3.4
9.1
3.6
10.0
3.8
9.8
4.2
9.6
Real GDP (YoY%)
Private consumption
Government consumption
Gross fixed investment
Exports
Imports
7.25
1
7.00
2013
National Income
Nominal GDP (USD bn)
Population (mn)
GDP per capita (USD)
2
02-Feb-15
6.75
26-Jan-15
6.50
1Y
2Y
3Y
5Y
7Y
10Y
Source: Deutsche Bank
The Bank has now a challenging task of responding
systematically to the macro background, keeping the
lira in check, and addressing the ongoing political
externality – all at the same time. Assuming that the
MPC still remains firmly committed to keeping the yield
curve flat, a change in one-week repo rate seem less
likely under the current market conditions (or before
any of prerequisites aforementioned above take place).
However, the Bank still could lower the upper bound
(marginal funding rate) by 75bps in the near term to
provide some monetary stimulus to the economy. Such
strategy would require leaving the upper bound still in
the double-digit territory to keep lira’s yield support
competitive. The late liquidity window, meanwhile, is
likely to be kept unchanged (at 12.75%) to preserve the
flexibility to respond to extraordinary conditions.
Market conditions still remain key for policy rates in the
foreseeable future.
Debt Indicators (% of GDP)
Loan pricing is mostly done through the upper bound
20
%
Basket
/TRY
18
2.8
2.6
16
14
2.4
12
10
Government debt 1
Domestic
External
Total external debt
in USD bn
Short term (% of total)
2.2
8
2
6
4
1.8
General (ann. avg)
Industrial production (YoY)
Unemployment (%)
2
0
Jun-10
1.6
Feb-11
Oct-11
Jun-12
Feb-13
Oct-13
Jun-14
Consumer loans (wa rate)
Commercial loans (wa rate)
1w repo policy rate
Marginal funding rate (upper bound)
Late liquidity window
Basket/TRY (RHS)
Source: Haver Analytics, CBT, Deutsche Bank
Financial Markets (eop)
Policy rate (repo)
Overnight lending rate
Effective funding rate
10-year bond yield
TRY/USD
Current 15Q1F 15Q2F 15Q4F
7.75
11.25
7.95
7.90
2.49
7.75
10.50
8.00
8.15
2.46
7.75
10.50
8.10
8.30
2.47
M
8.25
10.50
8.60
9.00
2.51
(1) Central government
Source: Deutsche Bank, National Sources.
Kubilay M. Öztürk, London, +44 20 7545 8774
Deutsche Bank Securities Inc.
Page 105
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Ukraine
Caa3(neg)/CCC-(neg)/CCC(-)
Moody’s/S&P/Fitch

Economic outlook: Ukraine faces significant
challenges in reaching macroeconomic stability,
with economic slowdown exacerbated by fiscal
and external imbalances.

Main risks: a lack of financing sources in relation to
undertaking debt repayments, against a backdrop
of economic contraction.
Concerns on external funding
On the economic front, industrial production continued
to decline at the end of the year. In December, the IP
accelerated its decline to 17.9% yoy from the -16% yoy
range experienced in September-November, which
compares with a decline of 4.7% yoy in 2013. Fixed
asset investment continued its downward slide, with
the decline reaching as much as -23% yoy in 3Q14
after -17.5% yoy in 2Q14 and -14.2% yoy in 1Q14. On
the consumer side, 2014 household consumption was
down 9.6% yoy compared to +5.6% yoy in 2013. The
decline in consumption continued to be driven by the
hryvnia depreciation, the acceleration in inflation, the
decline in the real wage growth (down 14% yoy in
December and -6.5% yoy in 2014) and the rise in
unemployment (from 9.0% in 2Q14 to 9.3% in 3Q14).
According to the December projections of the Ministry
of Economy, GDP contracted by 7% yoy in 2014.
On the monetary front, the monetary authorities expect
the economy to contract by 4-5% yoy with inflation
decelerating to 17% yoy in December 2015, which may
occur assuming financial aid is obtained. The fiscal
projections for 2015 were made on the assumption of 4.3% yoy economic growth and 13.1% yoy inflation.
Consumer price growth accelerated to 3.1% mom in
January from 3% mom in December and 1.9% mom in
November. As a result, the inflation rate increased in
annual terms from 24.9% yoy in December to 28.5%
yoy in January. The key concern on the inflation front
remains the significant depreciation of the hryvnia,
with hryvnia depreciating to the level of USD/UAH25.0
(from USD/UAH16.0) at the beginning of February
implying >200% yoy depreciation compared to the 39%
depreciation witnessed in 2008-09.
At the beginning of February, the NBU discontinued
conducting daily FX auctions, which had been used to
determine indicative USD/UAH exchange rates and set
official exchange rates on the basis of market
fundamentals. Since November, the NBU had
determined the rates on the back of FX auctions. In
order to relieve the pressure on the hryvnia, the NBU
increased interest rates by 550bp (to 19.5%). The
decision was predicated on the ongoing build-up of
Page 106
inflationary pressure, with CPI increasing to 25% yoy as
of end-2014. The market reaction resulted in the
depreciation of the hryvnia by another 40%, with the
exchange rate exceeding USD/UAH24.0. While the
decision to effect a transition to fully-fledged inflation
targeting could indicate the commitment of the NBU to
preserving its extremely low reserves (USD7.5bn as of
end-2014), it may also be intended as a step towards
signing another agreement with the IMF for a new
lending programme.
In the fiscal sphere, the implementation of the 2014
budget resulted in the budget deficit increasing by 20%
yoy to UAH78bn with revenues increasing by 5.2% yoy
to UAH357bn and expenditure amounting to
UAH430bn (+6.6% yoy). According to our estimates,
the 2014 deficit exceeded 5.0% of GDP. As for 2015,
the 2015 budget envisages an increase in defence
spending to 5.2% of GDP as well as lower social
spending. Revenues are set at UAH475bn (26% higher
than in 2014), while expenditure is to be roughly
unchanged at UAH527bn, with the deficit projected at
3.7% of GDP (excluding Naftogaz deficit). As for the
state-run Naftogaz, the government plans to spend
UAH32bn in 2015, in the event that the price of natural
gas stays below “market levels.” At the same time,
according to the authorities, the budget is subject to
revision in February after the decision on further
financing by the IMF.
On the external front, the country ended 2014 with a
CA deficit of USD5.2bn, 4% of GDP. This marked a
significant improvement in the external balances from
the 2013 figures - in 2013, the CA deficit was
USD16.5bn, 8.7% of GDP. The improvement came on
the back of FX adjustments as well as a decline in
external trade activity with Russia, its main trading
partner. Overall, exports were down 15% yoy, which
was due to the suspension of industrial activity and the
destruction of infrastructure in the East of Ukraine.
Imports were down on the back of the weakening of
the real effective exchange rate and the notable decline
in GDP. At the same time, the financial account
experienced a deficit of USD8.1bn vs. a surplus of
USD18.5bn in 2013. As a result, the reserve asset
position declined by USD13.3bn vs. an increase of
USD2.0bn in 2013. As of 1 January 2014, the
international reserves were at historical lows of
USD7.5bn vs. USD20bn as of the beginning of 2014.
In terms of debt repayments, in 2015 Ukraine faces
USD7.8bn FX in sovereign external debt redemptions
as well as significant payments for gas to Gazprom.
According to Naftogaz, the gas needs of the country in
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
the 2014/2015 heating period are 26.7bcm, which,
taking into account gas reserves (15bcm as of endNovember) and domestic production, could amount to
around USD2bn in fuel imports. We also note the risks
of early USD3bn Eurobond redemptions claims from
Russia (which are planned to be paid in December
2015) after sovereign debt exceeds 60% of GDP. In fact
according to Russia’s Finance Minister Anton Siluanov
Ukraine has asked Russia for debt relief on the USD 3
bn Eurobond debt, which according to Siluanov Russia
was not prepared to grant (source: Interfax).
Ukraine: Deutsche Bank forecasts
2013
2014F
2015F
2016F
176
45.4
4 024
101
45.0
2 242
101
45.0
2 237
110
45.0
2 449
0.2
6.5
2.3
- 6.5
1.2
- 6.9
- 6.2
- 1.2
- 3.1
- 6.2
- 4.5
- 5.2
- 0.5
- 1.6
- 2.5
1.5
0.6
- 0.4
1.5
- 0.5
Prices, Money and Banking (YoY%)
0.5
24.9
CPI (eop)
- 0.3
11.9
CPI (period avg)
14.0
18.6
6.0
9.8
Broad money (eop)
Private Credit (eop)
National Income
Nominal GDP (USDbn)
Population (mn)
GDP per capita (USD)
Real GDP (YoY%)
Private Consumption
Government
consumption
Exports
Imports
Ukraine: government’s FX external/domestic debt
schedule
Repayments (USD bn)
8
UKRAIN - Pri
UKRGB - Pri
UKRGB - Int
UKRAIN - Int
6
4
2
0
2015
2016
2017
2018
2019
2020
2021
2022
2023
Source: Deutsche Bank, Bloomberg Finance LP
The main challenge facing Ukraine remains finding the
refinancing sources, given the ongoing deterioration in
the fiscal and external balances. In January, Ukraine
requested a larger and longer-term bailout programme
from the IMF to replace its Stand-By Agreement (SBA)
and the launch of consultations with sovereign bond
holders. Earlier, the IMF identified a USD15bn financing
gap in Ukraine in 2015 after a USD17bn bailout that
Kiev agreed in May 2014 — topped up to USD27bn
with contributions from other donors — proved
insufficient.
The new program would be an Extended Fund Facility
(EFF) replacing the current SBA. This means that the
maturity of new IMF lending would be longer (5-10
years instead of 3-5 years). The IMF confirmed the
Ukrainian authorities’ request for an EFF, which came
during the work of the IMF mission in the country. As a
result, the length for the mission’s operations was
extended to 11 February. According to Finance
Minister Jaresko, the EFF may be accompanied by
further support, namely, USD2bn of guarantees from
the United States, EUR1.8bn from the EU, EUR500m
from Germany, EUR100m from Poland and USD300m
from Japan.
17.6
11.7
13.1
9.6
9.5
5.8
8.5
4.2
Fiscal Accounts (% of GDP)
Overall balance
- 4.5
Revenue
24.2
Expenditure
28.7
- 5.5
24.6
30.1
- 4.5
23.6
28.1
- 3.0
22.9
25.9
External Accounts (USD bn)
Trade Balance
- 19.6
% of GDP
- 11.2
Current Account Balance - 16.5
% of GDP
- 9.2
FDI (net)
4.3
FX Reserves (eop)
20.4
USD/FX (eop)
8.24
- 7.9
- 7.7
- 3.6
- 3.5
- 2.3
12.0
15.77
- 5.5
- 5.2
- 2.7
- 2.5
- 1.5
10.0
29.20
- 4.5
- 3.8
- 2.3
- 2.0
1.9
15.0
33.00
Debt Indicators (% of
GDP)
Government
Debt
Domestic
External
External debt
in USD bn
36.7
14.7
22.0
79.8
140
62.0
17.7
44.3
102.0
104
74.0
20.8
53.2
108.0
116
82.0
23.6
58.4
109.2
128
General (ann. avg)
Industrial Production
(YoY%)
Unemployment (%)
- 4.3
7.2
- 10.3
10.0
- 3.2
9.2
2.8
8.4
Financial Markets
Current 15Q1F
15Q2F
15Q4F
Policy rate (refinancing
rate)
USD/UAH (eop)
19.50 25.00
25.52 25.00
20.00
26.70
15.00
29.20
Source: Official statistics, Deutsche Bank Global Markets Research
Yaroslav Lissovolik, Moscow, +7 495 933 9247
Artem Zaigrin, Moscow, +7 495 797 5274
Deutsche Bank Securities Inc.
Page 107
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Argentina
Ca (stable)/SDu (stable)/RD (stable)
Moodys /S&P/ /Fitch

Economic outlook: Only few months before
finishing its term, the government is not expected
to negotiate a resolution to the holdout litigation.
Furthermore, fears of inflation acceleration are
likely to promote a gradual and moderate nominal
ARS depreciation, intensifying the existing
overvaluation of the currency. As a result,
international reserves will continue to be rationed
and economic growth will remain the main
casualty of current policy making. Current levels of
international reserves are, nevertheless, enough to
allow the economy to muddle through until the
coming October presidential election

Main risks: Controlling inflation amid increasing
Central Bank financing will remain a challenge
despite tight restrictions on capital and trade flows.
The immediateness of the Presidential elections,
nonetheless, is likely to be a major stabilizing factor.
International reserves accumulated over the last
few months of 2014 may buy necessary time until
next year’s presidential election, but they will not
prevent the risks associated with a fragile
economic and social environment.
Fine-tuning muddling through
Political scandals reflect the government`s time decay
This year started with a new political scandal affecting
the government. Alberto Nissman, a top federal
prosecutor that early in January launched a
controversial allegation against President Cristina
Kirchner (CFK) was found death, leading to fevered
speculations in the country and abroad. The preliminary
evidence seemed to suggest Mr. Nissman committed
suicide, but the prosecutor´s relatives and closed
friends rejected that idea. Furthermore, the
investigation revealed a number of loopholes in
Nissman`s own security, raising doubts about the
whole episode and the government´s responsibility.
Mr. Nissman had accused President CFK and other
high ranking officials of involvement in a plot to cover
up Iran`s alleged role in the 1994 bombing of the AMIA
Jewish community center in Buenos Aires, where 85
people died. He suspected that the government wanted
to whitewash Iran in order to secure lucrative trade
deals, exchanging Argentina`s soybeans for oil.
Interesting, President CFK herself immediately
supported the hypothesis of suicide but later on she
casted doubts on this theory. Indeed, at the end,
President Kirchner alleged Nissman had been
manipulated by rogue agents inside the intelligence
forces that wanted to hurt CFK´s government. Ms CFK
said she had no proof of her allegations, but stressed
she had no doubts either.
Page 108
Meanwhile, the lack of clarity in the whole
investigation has been raising speculations about the
real responsibility for the death, hurting the popularity
of the government. Indeed, the public opinion seems to
criticize the government for either failing to protect an
important prosecutor accusing the President, or to
control its own secret services. Actually, recent opinion
polls have confirmed that the majority of the population
believes the government of CFK was somehow behind
the death of the prosecutor. For example, a poll by
Rouvier reported by the local newspaper La Nacion
indicated that 48% of 800 people surveyed believe the
government is responsible in one way or another, while
54% of 1000 surveyed by Gonzalez y Valladares, and
reported by Perfil, think that the government had a bad
reaction to the prosecutor death`s news.
The same opinion surveys suggest that opposition
forces are benefiting from the scandal. According to
the poll by Gonzalez y Valladares, former Chief of
Cabinet Sergio Massa is leading the electoral race
today, with 30.8% vote intention, 1.8% more than a
month ago. Based on the same poll, Buenos Aires City
Mayor Mauricio Macri has increased 1.9% its vote
intention, to reach 23.1%, while Buenos Aires Governor
Scioli vote intention was down 2% to reach 25.2%.
The government is trying to overshadow the whole
episode emphasizing the recent trip to China by
President CFK, or a new pension increase, but without
much success. The existing political situation,
nevertheless, is likely to jeopardize any hope for a more
constructive policy making in the months to come. For
example, but as expected, the government has not
offered any new hint regarding its intention to address
the holdout litigation. Debt negotiation was hardly a
topic in the last few weeks. Partly, this represents the
real strategy of the current administration regarding the
holdout case: avoiding any serious effort o political cost
for something that appears irrelevant for performance
in the short period of time left for this government.
As noted, the government seems to have genuine
intention of finding a comprehensive resolution for all
existing holdout creditors. At the same time, however,
the authorities do not seem willing to pay any cost and
is not be in any hurry to achieve such a resolution.
Meanwhile, the Euro dispute is being analyzed in the
British courts, and threats over possible acceleration of
the Par bonds continue. The latter noted, it is our
understanding that the incentive of most bond holders
remain not too accelerate, while the very same
acceleration process is legally complex.
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
The following chart however evidences the growing
burden a stronger exchange rate could become for the
economy. Unfortunately, helped by controls, the
government is likely to maintain the status quo
regarding the exchange rate policy until the end of its
mandate. The challenge to re-align relative prices will
be left for the new government, that might have
potential capital inflows and financing to smooth the
needed correction in the exchange rate market.
REER and trade performance
USDmn
10000
Thus, with USD31.2bn in reserves (USD22.0bn net of
banks deposits in the CB) to confront a projected
current account deficit of USD4.8bn as long as tight
trade restrictions remain, and another bulk of a
minimum of USD10bn of capital account deficit, there
is not much that the Central Bank could do to ease
trade and capital account conditions. This almost
guarantees hard currency scarcity to continue in 2015,
which also negatively affects export incentives as long
as the exchange rate is maintained artificially strong, as
is likely to be the case in this election year. More
importantly, hard currency scarcity means that imports
of intermediate and capital goods will remain severely
restrained, further complicating a potential economic
recovery.
Deutsche Bank Securities Inc.
4.0
8000
3.0
6000
2.0
4000
1.0
2000
0.0
Dec-14
Dec-13
Dec-12
Dec-11
Dec-10
Dec-09
Dec-08
Dec-07
Dec-06
Dec-05
Dec-04
Dec-03
0
Dec-00
This notwithstanding, hard currency financing is likely
to remain significantly
constrained. Individual
allowances to buy dollars for hoarding purposes
demanded almost USD4.0bn of international reserves
in 2014 and could require an even higher amount this
year. In addition, the federal government and provinces
face external debt amortizations of USD8.3bn in 2015,
of which only USD1.8bn is with multilateral agencies,
with a decent likelihood of being rolled over. Likewise,
the non-financial private sector has USD24bn in trade
financing and USD4.0bn from other financial sources
due in 2015. As noted, the Central Bank authorities
have been able to prevent the cancellation of private
sector trade lines, forcing steady financing from
multinational companies, but we believe this strategy is
already exhausted.
Exports
Imports
Real Official Exchange Rate ARS/USD (Adjusted by CPI) rhs
Dec-02
Fine-tuning reserves and muddling through
The USD31.4bn reached by international reserves by
the end of 2014 gave the government some peace of
mind regarding the external financing between now
and the election. However, already incorporated the
revenues from the auction of 4G concession services,
part of the Chinese currency swap, and some export
anticipation, the Central Bank had to sell reserves again
during January. Indeed, a growing dollar demand for
hoarding, and the vacation season demanded some
USD520mn from the Central Bank vaults last month.
This however, was not totally perceived in the total
level of reserves as the government was able to use
another trance from the Chinese swap, and preserved
payments blocked by the US court that are
accumulating USD1.3bn as of now.
That is why the new Central Bank authorities have
intensified its exchange rate market monitoring,
penalizing as many players as possible in the last few
weeks, with almost 10 exchange houses being charged
with more than ARS50mn in penalties for apparent
violations of exchange regulations. The goal is to
discourage participation in the non-official market. This
is also unlikely to change until a new government is
elected in October this year.
Dec-01
As we discussed in our previous monthly, the fact that
the authorities have been able to secure some special
financing sources late last year also reinforces the
government`s holdout strategy. Indeed, reduced needs
of accessing international markets partly eliminate
obligation to seek a definite debt resolution at any cost.
Source: Central bank,INDEC, and Deutsche Bank
Containing devaluation, inflation and growth
Therefore, despite the recent calm in exchange rate
markets and successful accumulation of international
reserves by the Central Bank, external financing is likely
to remain limited. In addition, while the government
insists on controls, like on price setting, imports and
exports, or any form of external flow, not much should
be expected on the exchange rate policy front. Indeed,
given high inflation and the authorities’ rejection of the
need to contain demand pressure, the exchange rate is
likely to depreciate gradually. In our view, the
government sees the January 2014 devaluation as a
failure, only promoting inflation acceleration, without
many advantages regarding relative price changes.
This expectation about policy making should imply that
the economy will continue to be weak, with inflation
decelerating a bit; however, import controls and
increased real exchange rate appreciation will
jeopardize any rebound in external trade and domestic
production. Thus, real income will continue to fall and
business confidence will be subdued until early August,
Page 109
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
when the potential outcome of the October Presidential
election is potentially cleared by the primary elections
of the leading parties.
As a result, it is not surprising that economic activity
continues to struggle. The official statistical unit INDEC
reported that economic activity contracted by 0.1%
MoM during November in seasonally adjusted figures.
This confirms stagnation, with inter-annual growth in
economic activity remaining barely 0.2% YoY. INDEC
did not report any detail regarding individual sector
performance but private sector estimates point to a
contraction of 1%-2% in 2014. Likewise, INDEC also
reported that its industrial production index contracted
by 1.0% MoM in seasonally adjusted terms during
December. This brings last December production to
2.3% below the previous year. The sectors that
reported the main contractions were motor vehicles (10.5% YoY), followed by textile industry (-9.3% YoY)
and substances and chemical products (-5.0% YoY).
Conversely, the sectors that represented the main
gains in production were basic metal industries (+2.5%
YoY), followed by oil refining (+1.3 %YoY) and food
industry (+1.1 %YoY).
Activity indicators
30%
25%
20%
15%
10%
5%
0%
-5%
-10%
-15%
-20%
Nov-14
Nov-13
May-14
Nov-12
May-13
Nov-11
May-12
Nov-10
May-11
Nov-09
May-10
Nov-08
May-09
Nov-07
May-08
Nov-06
May-07
Nov-05
May-06
EMAE, %YoY 3m MA
IPI FIEL, %YoY 3m MA
Tax Revenue (CPI adj.), %YoY 3m MA, rhs
Source: Central bank,INDEC, and Deutsche Bank
Some stability in the exchange rate market and
contained macro uncertainty suggests that the
economy could fall less than initially expected this year,
but still declining by 1.5%. As noted, 2015 might see
some deceleration in inflation anchored by a stronger
real peso.
Inflation deceleration is becoming evident according to
official as well as private sector estimates, but
unofficial estimates are considerably above the official
ones. INDEC released its December report over
inflation, completing a whole year with the new official
consumer price index (IPCNu). As for this indicator,
prices have increased 23.9% YoY and 1% MoM in
December, or below expectations as per Bloomberg´s
poll that had pointed to an increase by 1.1%MoM.
Private sector estimates of consumer price inflation are
close to 39% YoY.
Page 110
Against the anchoring role of a rigid exchange rate, the
government continues to pursue an expansionary fiscal
policy, mostly financed by money printing. During 2014,
the government financing received by the Central Bank
was ARS160bn, 70% more than in 2013, representing
almost 40% of the money base. Indeed, November´s
fiscal results suggest that spending has continued to
grow faster than revenues. Treasury Secretary reported
a primary surplus of ARS 388mn and a nominal deficit
of ARS 3.4bn in November 2014. This compares with
primary deficit and a nominal deficit of ARS 6.7bn and
ARS 9.4bn respectively the previous year. Such an
improvement in the fiscal accounts was due to a 54.9%
YoY increase in total revenues, and a 39% YoY increase
in total expenditure. However, a 217% YoY increase in
rents from properties essentially explained such a
turnaround in the fiscal exercise. Actually, excluding
those rents, the primary balance in November last year
becomes a deficit of ARS 14.7bn compared with a
primary deficit of ARS 11.4bn in November 2013. Tax
revenues were the other sources of income increase,
advancing 43% YoY. Wages, transfers to the private
sector, and the deficit of public companies led the
expenditure side, advancing YoY 45%, 46%, and 149%
respectively. Based on current trends, the 2014 fiscal
exercise excluding rents from Social Security holdings
and Central Bank reserves (estimated to represent
around 3.0% of GDP in 2013) is likely to end up
implying a primary deficit of almost 5.0% of GDP and a
nominal deficit above 6.5% of GDP.
Without expectation of any major fiscal restraint, the
increasing government financing in pesos remains a
challenge given the continued deterioration in peso
demand. Specifically, the monetary base has been
growing less than inflation since early last year, partly
helped by some increased issuance of Central Bank
paper, representing the mirror image of declining
demand for pesos as inflation accelerates. In other
words, the government’s obsession to keep fueling
demand growth with expansionary policies is
progressively encountering limits to its own continuity.
Thus, the Central Bank might be able to control the
exchange depreciation, but it is unlikely to dominate
the non-official parity, which most likely will reflect the
growing disequilibrium in the peso market.
Active alliances ahead of 2015 electoral calendar
Benefited by recent political scandals affecting the
government, as the death of the federal prosecutor
discussed in the lines above, the opposition seems to
be actively organizing its stance ahead of the October
presidential election. For example, the right wing PRO
led by Mauricio Macri signed an agreement with Lilita
Carrio, currently member the broad socialist alliance
UNEN, to unify forces after competing in the same
party primaries. This has pushed other members from
the same socialist alliance to discuss the possibility of
following the same curse. In particular, provincial
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
representatives of the Radical Party, also members of
UNEN, have already started negotiation to join forces
with Macri party. National leaders of the Radical Party
are yet critical to such a potential alliance, but some
key members, like Mendoza Senator Ernesto Saenz,
seem to be promoting such a path. Indeed, the
relatively lagged position of the UNEN as a presidential
ticket is likely to continue promoting alliances within
the opposition forces in the month ahead.
A busy electoral year will start with the election of
Mendoza city mayor on February 22, a bad but
expected news for the government. This will be
followed by primaries in Salta, Santa Fe, and the City of
Buenos Aires in April. But attention will first
concentrate on the announcement of national alliances
on June 10, followed by the general election in the
Province of Santa Fe on June 14. The latter could be
critical in suggesting whether the right wing PRO led
by Buenos Aires city mayor Macri could be a serious
national competitor as we expect. It will continue with
the presentation of the national lists on June 22.
Nevertheless, the focal point will be on August 9, when
the country goes to the national primaries, which will
signal the real possibilities of the main candidates.
These are likely to once again prove instrumental in
aligning the opposition vote, separating the serious
contenders from mere participants in the contest.
General elections will be held on October 25, while the
run-off is set for November 22.
We have repeatedly noted the critical role next year’s
presidential elections will play in Argentina’s credit
consideration. The legal impediment for President CFK
to seek re-election provides an important anchor
regarding the expectations of a more constructive
policy change. The latest opinion surveys have failed to
show any clear lead ahead of the presidential election.
Likewise, they still show up to 50% support for some
policy continuity. This notwithstanding, the three main
leaders – former Chief of Cabinet Sergio Massa,
Buenos Aires Governor Daniel Scioli, and BA City
Mayor Mauricio Macri are believed to be supportive of
policy improvement in one way or another. Based on
our negative economic outlook, it is reasonable to
expect opposition forces to take some advantage in the
coming months. However, Congress is expected to
remain divided, although a strong presidential regime is
likely to help the new leader initially, as it has always
been the case in Argentina. Worth noting, many of the
laws introduced by the Kircherism provide strong
discretionary power for the Executive power, but might
do much less harm under a more market/private sector
friendly administration, not demanding a rapid revision
of these laws for an important improvement in
business sentiment.
Argentina: Deutsche Bank forecasts
2013
2014E
2015F
2016F
510
41.5
12.3
467
41.9
11.1
509
42.4
12.0
555
42.9
13.0
2.9
4.6
5.1
1.2
1.7
9.3
-1.0
-2.3
4.1
-3.2
-9.3
-11.2
-1.5
-2.6
3.1
-5.8
-2.8
-8.9
3.0
5.7
1.5
6.1
5.0
21.0
Prices, Money and Banking
CPI (YoY%, eop) (*)
CPI (YoY%, avg) (*)
Broad money (M2, YoY%)
Bank credit (YoY%)
27.9
25.3
24.0
31.3
37.7
38.5
22.0
22.0
27.3
27.5
20.0
23.4
18.5
21.7
20.0
17.5
Fiscal Accounts (% of GDP)(**)
Budget surplus
Gov't spending
Gov't revenue
Primary surplus
-4.6
34.2
29.6
-2.8
-6.5
34.7
28.2
-4.7
-7.1
36.1
29.0
-5.1
-5.5
36.5
31.0
-3.4
External Accounts (USDbn)
Merchandise exports
Merchandise imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI (net, cash basis)
FX reserves (USDbn)
FX rate (eop) ARS/USD
81.7
73.7
8.0
1.6
-7.1
-1.4
2.4
30.6
6.52
71.7
64.9
6.8
1.5
-7.7
-1.6
3.5
31.4
8.47
62.9
55.1
7.8
1.5
-4.8
-0.9
2.5
22.0
9.75
69.6
65.8
3.8
0.7
-8.6
-1.5
4.0
29.1
12.55
Debt Indicators (% of GDP)
Government debt
Domestic
External
Total external debt
in USDbn
Short-term (% of total)
16.0
3.1
12.9
27.7
141.1
36.9
17.5
3.4
14.0
30.9
144.3
36.0
16.0
3.8
12.2
26.7
136.0
38.2
18.3
3.4
14.9
29.3
162.5
32.0
General
Industrial production (YoY)
(nominal)
Unemployment
(%)
0.6
7.1
-4.7
7.5
-2.7
9.6
4.5
8.5
Current
26.8
20.3
8.69
15Q1
27.0
20.5
8.76
15Q2
28.0
21.3
9.07
15Q4
29.0
22.5
9.75
National Income
Nominal GDP (USDbn)
Population (m)
GDP per capita (USD thousand)
Real GDP (YoY%)
Priv. consumption
Gov't consumption
Gross capital formation
Exports
Imports
Financial Markets (EOP)
98ds Lebac rate
1-month Badlar
ARS/USD
Source: DB Global Markets Research, National Sources
*Inflation reported by Congress, **Central government
Gustavo Cañonero, New York, (212) 250 7530
Deutsche Bank Securities Inc.
Page 111
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Brazil
Baa2(negative)/BBB-(stable)/BBB(stable)
Moody’s/S&P/Fitch

Economic outlook: Fiscal tightening, rising interest
rates, lower commodity prices, the financial
difficulties faced by oil company Petrobras and
some of the country’s main construction
companies and the growing risk of water and
energy shortages all conspire against Brazil’s
economic recovery, prompting us to cut our 2015
GDP growth forecast to -0.7% from 0.3%.

Main risks: Last year’s worse-than-expected
budget balance and likely recession make it more
difficult for the government to meet the 2015 fiscal
target. Energy rationing could also further dampen
growth. Slow growth, high inflation and rising
unemployment could produce social unrest.
Negative growth in 2015
Several factors conspire against Brazil’s economic
recovery this year. One of the government’s main
challenges is to repair its fiscal accounts, raising its
primary balance to 1.2% from -0.6% of GDP last year.
Although this move would be crucial in restoring policy
credibility and confidence (therefore paving the way for
the economy to recover in the future), its short-term
effects would likely be contractionary. As inflation
remains high due to the overdue adjustment in
administered prices, the central bank has raised
interest rates by 125bps since October and has
signaled that the tightening cycle has not yet ended.
The decline in commodity prices (ex-oil) is hurting
Brazil’s terms of trade. The Petrobras bribery scandal
has impaired the ability of the country’s largest
company to access capital markets and finance
investments. The state-run oil company accounts for
approximately 10% of total investments in Brazil.
Assuming a 20% decline in Petrobras capex this year,
its negative drag on growth could reach at least 0.4%
of GDP. Several construction companies allegedly
involved in the bribery scheme are also under intense
financial pressure and will likely have to reduce their
activities as well, further undermining investments in
infrastructure. On top of all these negative factors, the
risk of water and energy rationing has increased
significantly due to the continuation of exceptionally
low rainfall at the beginning of the year. The crisis is
particularly acute because the authorities failed to act
preemptively last year, fearing potentially negative
implications for the elections. Water rationing in the
state of São Paulo is practically inevitable at this
juncture, as its main reservoirs are almost empty. São
Paulo accounts for approximately 30% of Brazil’s GDP
and water shortage is already affecting production in
some sectors (e.g. foodstuff, metallurgical and textiles).
The second largest state economies of Rio de Janeiro
Page 112
and Minas Gerais also face an increasing risk of water
rationing. It is difficult to estimate the impact of the
water crisis on GDP, but we would put a conservative
estimate at 0.2% of GDP. The drought has also
depleted the reservoirs of hydroelectric power plants,
which account for roughly 70% of Brazil’s electricity
production. The national aggregate reservoir levels are
down to only 20% and failure to recover to at least 35%
by the end of the rainy season in April could prompt
the authorities to declare energy rationing. Presently,
rationing would most likely be less severe than the 20%
rationing of 2001, when hydroelectric power plants
accounted for roughly 90% of supply and the national
electrical grid was not well integrated. A more likely
scenario this time would be a rationing of between 5%
and 10%. We believe that a 10% rationing for six
months could cut GDP growth by approximately 1%.
Brazil: National reservoir levels
90%
80%
2012
2013
70%
2014
60%
2015
50%
40%
30%
20%
10%
Source: ONS (February until Feb 4)
We cut our 2015 GDP growth forecast to -0.7% from
+0.3%. The latest indicators have attested to the weak
economic performance at the end of 2014. Industrial
production declined 2.8% MoM in December, 1.6%
QoQ in 4Q14 and 3.2% in 2014. Other indicators have
remained quite weak too, especially consumer and
business confidence in most sectors of the economy.
We believe that 4Q14 GDP fell 0.1% QoQ. Therefore,
we have lowered our 2014 growth forecast to zero
from 0.1%. For 2015, in light of what was discussed
above, we cut our forecast to -0.7% from +0.3%.
Although we are not yet assuming electricity rationing,
we believe that the uncertainty surrounding the energy
situation is already affecting sentiment and
undermining investment. Investment continues to be
the key variable to rekindle growth, as global growth
remains sluggish, fiscal solvency issues prevent further
expansion in government consumption and credit
constraints and rising unemployment hurt household
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
consumption. We estimate that fixed-asset investment
fell approximately 7% in 2014 and we project another
decline of roughly the same magnitude this year. For
2016, we also lowered our GDP forecast to 1.5% from
1.9%, assuming that the water and energy problems
will be alleviated by then, that Petrobras will stabilize
and that the fiscal adjustment will continue, reducing
the risk of losing the investment grade status and
shoring up confidence. We remain skeptical about
structural reforms (upon which faster growth depends).
The authorities have announced more measures to
raise the primary fiscal surplus this year. As market
participants had widely expected, the government has
raised the CIDE tax on fuel. Although a 90-day grace
period was required for the tax to be effective, the
government astutely raised another tax (PIS/COFINS)
temporarily in order to start collecting revenues right
away. The authorities expect to collect BRL12.2bn with
the CIDE tax in 2015. The downside, of course, is the
average 8% increase in gasoline prices (which adds
roughly 30bps to the IPCA consumer price index). A
more surprising move was the hike in the IOF tax on
consumer loans to 3.0% from 1.5%, which the
government expects to generate BRL7.4bn this year.
The previous economic team used the IOF extensively
as an instrument to stimulate consumption and it was
probably difficult for President Dilma Russeff to accept
a tax hike that should further dampen consumption.
The government has also raised the PIS/COFINS tax on
cosmetic products, a measure that will generate an
estimated BRL0.4bn only in 2015. Finally, the
authorities have decided to raise the PIS/COFINS tax on
imports as of June, expecting it to generate BRL0.7bn.
Of the three aforementioned measures, this is the only
one that will require congressional approval.
Figure 1: Estimated fiscal savings (% of GDP)
Increase in primary balance of local governments to 0% of GDP
Increase in IPI tax on cars, appliances
Increase in CIDE, PIS/COFINS, IOF
New rules for unemployment benefits and pensions
Elimination of electricity subsidies
Total
0.2
0.1
0.4
0.3
0.2
1.2
Source: Federal government, Deutsche Bank Research
However, the fiscal adjustment’s starting point is much
worse than expected. The public sector posted a
consolidated primary fiscal deficit of BRL32.5bn (0.63%
of GDP) in 2014, the first primary deficit since 1997.
The deficit compared to a surplus of 1.9% of GDP in
2013. The central government posted a deficit of
BRL20.5bn, while the states and municipalities had a
deficit of BRL7.8bn and SOEs a deficit of BRL4.3bn. In
December alone, the consolidated deficit reached
BRL12.9bn (compared to our forecast of BRL2bn), as
states and municipalities posted a much larger-thanexpected deficit of BRL11.3bn. The nominal deficit
(which includes interest on the public debt) surged to
6.70% of GDP in 2014 from 3.25% in 2013, the largest
Deutsche Bank Securities Inc.
since 1998. The net public debt climbed to 36.7% of
GDP in 2014 from 33.6% of GDP in 2013, while the
gross public debt jumped to 63.4% from 56.7% of GDP.
In light of last year’s record primary deficit, reaching
the surplus target of 1.2% in 2015 would be
tantamount to an adjustment of 1.8% of GDP. In
addition, the government would likely have to get
another 0.2% of GDP to cover an increase in
mandatory spending. The measures announced so far
should save approximately 1.2% of GDP (assuming that
the government will manage to obtain BRL18bn in
savings from the changes in unemployment benefits
and pension rules, which is far from granted due to
growing political resistance against these measures).
Finance Minister Joaquim Levy would still need at least
0.8% of GDP. We believe that roughly half of this
amount could be achieved through spending cuts,
which are to be announced after Congress passes the
2015 budget, (likely by the end of February). In terms of
extraordinary revenues, we are assuming that what the
government collects this year (e.g. by outsourcing its
payroll management) will be just enough to match last
year’s amount. The remaining 0.4% of GDP would
therefore have to be obtained by either raising more
taxes or by undoing some of the tax cuts introduced in
the previous years (especially the reduction in payroll
taxes), which could exacerbate the recession.
Furthermore, we believe that the authorities should be
prepared to deal with additional pitfalls. We see three
main risks: First, although it is possible that the
normalization of payments that had been delayed
during the year contributed to a deepening of the fiscal
deficit in the last months of 2014, transparency is low
and the size of potential fiscal “skeletons” inherited by
the new economic team remains unclear. For example,
the fiscal watchdog, TCU, claims that there is an
unaccounted stock of approximately BRL40bn in
financial transactions. Second, lower-than-expected
GDP growth could hurt tax collection and further
complicate the fiscal adjustment. We estimate that
every 1% decline in real GDP could reduce total tax
revenues by approximately 0.4% of GDP. Third, there is
a risk that the National Treasury may have to provide
some financial aid to Petrobras. Therefore, we are
cutting our 2015 primary surplus forecast to 0.8% from
1.2% of GDP.
We raised our 2015 IPCA forecast to 7.2% from 6.6%.
We estimate that the increase in fuel taxes and the
government’s decision to eliminate electricity subsidies
will likely make administered prices climb a hefty 10%
this year. Consequently, although the deceleration in
economic activity will contribute to a slowing of the
inflation of non-tradable goods and services, we raised
our 2015 IPCA forecast to 7.2% from 6.6%. Under
these circumstances, we believe that the BCB is not yet
done hiking rates, a message that was clearly
conveyed by the COPOM minutes, in which the
authorities claimed that, “the progress obtained in the
fight against inflation is not enough yet.” We expect
Page 113
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
the 12-month IPCA to climb to approximately 7.6% in
February, making it difficult for the BCB to reduce the
rate hike to 25bps. Thus, we now expect the BCB to
raise the SELIC by 50bps to 12.75% in March, and keep
the door open for a 25bp hike or no hike in April. Then,
some deceleration in 12-month inflation in 2Q15 and
further deterioration in economic activity will likely
prompt the BCB to interrupt the tightening cycle in
April and abandon its pledge to make inflation
converge to the 4.5% target in 2016 (we forecast 5.6%
for next year).
Fundamentals continue to point to a weaker BRL.
Although Brazil did not grow last year, it posted a
sizeable current account deficit of USD90.9bn (4.2% of
GDP). Foreign direct investment (USD62.5bn in 2014) is
no longer enough to finance the C/A deficit. As a result,
Brazil is more dependent on portfolio flows that are
more volatile and vulnerable to global liquidity
conditions. We forecast that the current account deficit
will decline to USD77bn in 2015, as we expect lower oil
prices and the domestic recession to compensate for
the fall in export prices. However, because GDP
measured in dollars will be smaller, the deficit will not
fall below 4.0% of GDP. While the BCB continues to
intervene in the FX market by offering USD100mn in
FX swaps every day, the outstanding stock of these
instruments has reached approximately USD110bn,
and we believe it will be increasingly difficult to
continue extending the program (which is now
scheduled to expire at the end of March). As a matter
of fact, Finance Minister Joaquim Levy recently stated
that he does not intend to keep the FX “artificially
overvalued.” While the BCB (not the Finance Ministry)
is in charge of FX policy, we believe that this statement
could be an indication that the government is willing to
accept a weaker exchange rate. Prospects of negative
GDP growth this year do not bode well for the BRL
either, especially when it could prompt the rating
agencies to downgrade Brazil’s sovereign debt.
Although we still do not expect S&P to put its Brazil
rating below investment grade, Moody’s and Fitch
currently rate Brazil two notches above investment
grade and we would not be surprised if at least one of
them (e.g. Moody’s, with its negative outlook) were to
downgrade Brazil this year. Consequently, we revised
our year-end FX forecast to BRL2.90/USD from
BRL2.80/USD. While we believe that the risk is now
tilted toward an even weaker currency, we continue to
assume that the government will continue to work on
adjusting its policies to restore confidence and pave
the way to a gradual economic recovery in 2016.
José Carlos de Faria, São Paulo, (+55) 11 2113-5185
Brazil: Deutsche Bank forecasts
National Income
Nominal GDP (USDbn)
Population (m)
GDP per capita (USD)
2013 2014E
2015F
2016F
2,245 2,172
201
203
11,175 10,720
1,929
204
9,444
1,966
206
9,547
Real GDP (YoY%)
Private consumption
Government consumption
Gross capital formation
Exports
Imports
2.5
2.6
2.0
5.2
2.5
8.3
0.0
0.9
1.5
-7.4
2.0
0.1
-0.7
0.0
0.6
-7.6
1.0
-3.0
1.5
1.0
0.6
3.9
3.0
2.0
Prices, Money and Banking
CPI (YoY%, eop)
CPI (YoY%, avg)
Money base (YoY%)
Broad money (YoY%)
5.9
6.2
7.6
11.2
6.4
6.3
7.3
5.0
7.2
7.3
6.5
4.0
5.8
5.8
6.0
5.0
Fiscal Accounts (% of GDP)
Consolidated budget
balance
Interest payments
Primary balance
-3.3
-5.1
1.9
-6.7
-6.1
-0.6
-5.6
-6.4
0.8
-4.3
-5.8
1.5
External Accounts (USDbn)
Merchandise exports
Merchandise imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI (net)
FX reserves (USDbn)
FX rate (eop) BRL/USD
242.0
239.6
2.4
0.1
-81.1
-3.6
64.0
375.8
2.34
225.1
229.0
-3.9
-0.2
-90.9
-4.2
62.5
374.1
2.66
220.0
214.0
6.0
0.3
-77.0
-4.0
60.0
374.1
2.90
230.0
218.0
12.0
0.6
-80.0
-4.1
65.0
374.1
3.00
Debt Indicators (% of GDP)
Government debt (gross)*
Domestic
External
Total external debt
in USDbn
Short-term (% of total)
48.3
-14.8
56.7
21.5
482.8
6.7
52.0
-15.3
63.4
25.5
554.7
6.5
54.3
-15.9
65.6
30.2
581.7
6.5
55.6
-15.0
66.8
30.9
606.7
6.5
2.3
5.4
-3.2
4.8
-3.0
6.0
2.5
6.5
Current
12.25
12.3
2.78
15Q1
12.75
12.3
2.75
15Q2
12.75
12.5
2.80
15Q4
12.75
12.0
2.90
General
Industrial production (YoY%)
Unemployment (%)
Financial Markets (EOP)
Selic overnight rate (%)
10-year Pré-CDI rate (%)
BRL/USD
(*) Includes central government, states, municipalities and SOEs.
Source: National Statistics, Deutsche Bank forecasts
Page 114
Deutsche Bank Securities Inc.
12 February 2015
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
EM Monthly: Rising Tide,
Chile
Aa3 (stable)/AA- (stable)/A+ (positive)
Moodys /S&P/ /Fitch


Economic outlook: The economy closed 2014 with
a weak tone, hoping for public impulses to revive
private demand. Inflation is finally easing, helped
by low oil prices and an economic slowdown, but
yet slowly. Subdued investment appetite might
remain for a while, while consumption demand
denotes a sharp contraction. The latter is likely to
provide room for the Central Bank to cut rates one
or two more times, but only after inflation provides
real signs of slowing, as economic growth will
remain anemic for now.
Main risks. The authorities expect economic
growth to accelerate in the months to come,
helped by the current monetary stimulus, the low
base effect, and public investment. Although the
uncertainty surrounding the tax reform might be
fading, the risk is for labor and education reform to
further harm business sentiment. Furthermore,
weak demand for commodities and declining labor
force growth will remain medium-term burdens for
growth. Overall business pessimism represents the
main threat to a potential rapid recovery
A difficult balancing of policies
Still a lackluster recovery
The last monthly economic activity proxy, IMACEC,
came out above expectations posting 2.9% YoY growth
during December 2014, whereas in the seasonally
adjusted comparison, the index expanded by 1.0%
MoM. The monthly variation was the result of higher
numbers reported in services and commerce, as well
as higher value added in mining. Although this
surprised upwards, the recovery trend remains anemic,
demanding further data to determine the robustness of
the current turn around in economic activity. A
depressed business confidence continues adding
uncertainty to investment decisions, while a weak
commodity cycle and consumer confidence anticipate
some prudent behavior remaining for the time being.
Meanwhile, the industrial production index (IPI)
advanced by a modest 0.9% YoY in December,
returning to a more positive territory after the 3.0% YoY
drop reported in November. The figure was the result
of positive performances in manufacturing and utilities,
while mining continues to contract. Manufacturing
advanced by 3.1% YoY, coming out above expectations
as per Bloomberg’s poll that pointed to a drop of 1.1%
YoY during December. The increase was the result of
improvement reported in eight of the 13 categories
measured by the indicator. Meanwhile the mining
index contracted by 0.9% YoY, mainly due to weak
numbers in iron and copper production. Activity in
Deutsche Bank Securities Inc.
utilities advanced by 2.0% YoY, mainly supported by
higher electricity generation (+2.9% YoY). Finally, retail
sales expanded by a modest 1.9% YoY during
December.
Despite the subdued trend in economic activity, the
labor market has remained rather resilient. The
unemployment rate was up to 6% during the OctoberDecember moving quarter, representing a decrease of
0.1pp compared to the previous period. The quarterly
variation was the result of higher increases in
employment (+0.6% MoM) vis a vis labor force (+0.5%
MoM). The sectors that reported the strongest
employment generation during the October-December
moving quarter were agriculture (+8.5% YoY), social
and health services (+11.3% YoY) and public
administration (+5.4% YoY). Conversely, the main
drops in employment were reported in wholesale
commerce (-1.7% YoY), construction (-3.0% YoY), and
real estate, business and renting activities (-3.2% YoY).
On average for the year, the unemployment rate was
up to 6.4% during 2014, being 0.5pp higher than the
same figure of 2013. The annual variation was the
result of an increase in employment of 1.5% YoY, being
lower than the 2.0% YoY increase recorded in the labor
force. In addition, most of the employment growth has
been concentrated in independent workers, usually
associated with a weak recovery link than growth in
the formal corporate labor force.
Activity and inflation tradeoff
3 MMA IMACEC %YoY
Headline CPI %YoY
Core CPI %YoY
10%
8%
6%
4%
2%
0%
Jan-11
-2%
Jul-11
Jan-12
Jul-12
Jan-13
Jul-13
Jan-14
Jul-14
Jan-15
Source: Central Bank, INE, and Deutsche Bank
Although slowing, inflation is still surprising upwards
Consumer prices increased by 0.1% MoM during
January, coming out above expectations that pointed
to a drop of 0.3% MoM for the aforementioned period.
This brought annual inflation to 4.5%. The main
increases were seen in alcoholic beverages and
tobacco (+4.0% MoM), healthcare (+1.4% MoM) and
Page 115
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
recreation and culture (+0.8% MoM). Conversely, the
main drops were reported in apparel (-2.8% MoM) and
transport (-1.6% MoM). Finally, Core CPI, the preferred
measure of the Central Bank, advanced by 0.6% MoM
during January, still representing a relatively high print
for the Chilean economy, and suggesting the monetary
authority will remain concerned about inflation
performance for a while.
Chile: Deutsche Bank forecasts
2013
The Central Bank remains worried about inflation
The minutes of the January policy meeting showed a
relative strong consensus among Central Bank board
members, concerned about wage and core inflation.
Board members appear also concerned about
increasing risk aversion globally, the inability to use
counter cyclical fiscal policy given steady decline in
copper prices, and a slow recovery pace locally.
However, given slightly better economic numbers in
Chile, and, more importantly, still high wage and core
inflation, Central Bank members do not see any room
for a change in policy stance. Interesting, they explicitly
recognized that they do not believe in the sharp fall
expected in inflation ahead as denoted by market
expectations. The latter turned out to be true,
considering the latest inflation data coming well above
market expectations. Thus, for the time being, the
Central Bank needs to see much lower inflation before
acting and that might not happen in just one month or
two. Although we believe eventually lower inflation will
convince the Central Bank to cut again, this is not at all
present in these last minutes.
In our view, despite explicit inflationary concerns, the
recent comments and analysis by the Central Bank do
not close the door for additional monetary easing as
soon as inflation is confirmed coming down in the
months to come, as expected. Thus, more monetary
help is likely to occur by April- May. Once this happens,
the Central Bank will cut rates again, probably to 2.5%
from 3.0% today, or even further, depending on the
actual economic performance in the months ahead.
Gustavo Cañonero, New York, (212) 250 7530
2015F
2016F
National income
Nominal GDP (USDbn)
277.1
252.8
243.6
261.6
Population (m)
17.6
17.7
17.9
18.1
GDP per capita (USD 1000)
15.7
14.3
13.6
14.4
Real GDP (YoY%)
As discussed, the sharp increase in inflation in previous
months was associated with temporary factors, such
as supply shocks, depreciation of the local currency,
and the effect of tax reform in some categories of
foods and alcoholic beverages. In the months ahead,
we expect to see declining YoY inflation being
confirmed, helped by lower oil prices. This might still
take a few months, but inflation is likely to look
trending to the 3% target at some point by 2Q this year.
2014E
4.1
1.6
2.6
3.2
Priv. consumption
5.6
1.7
3.1
3.3
Gov't consumption
4.2
7.0
9.3
4.7
-2.3
-12.3
4.1
3.0
Exports
4.5
0.3
-9.6
0.4
Imports
2.6
-9.8
-0.1
3.1
CPI (YoY%, eop)
2.8
4.6
3.1
3.0
CPI (YoY%, avg)
1.9
4.4
3.4
3.3
Broad money (YoY%, eop)
13.9
10.4
9.4
10.5
Credit (YoY%, eop)
10.0
9.4
8.2
10.1
Investment
Prices, money and banking
Fiscal accounts (% of GDP)
Consolidated budget balance
-0.5
-1.6
-2.5
-2.2
Revenues
21.0
20.9
21.6
23.2
Expenditures
21.5
22.5
24.1
25.4
Exports
76.7
76.5
72.9
74.4
Imports
74.6
68.9
71.0
74.6
Trade balance
2.1
7.1
1.9
-0.1
% of GDP
0.8
2.8
0.8
0.0
-9.5
-4.2
-2.9
-2.6
-1.0
External Accounts (USDbn)
Current account balance
% of GDP
-3.4
-1.7
-1.2
FDI (net)
-9.3
-8.5
-7.8
-7.0
FX reserves
41.1
40.5
40.6
41.0
523.8
607.4
640.0
610.0
12.8
13.2
14.1
14.7
11.1
11.5
12.3
12.8
1.7
1.5
1.4
1.2
49.9
56.0
58.9
57.9
130.7
134.2
137.5
143.1
15.7
13.7
12.1
15.9
Industrial production (%)
3.9
0.4
-1.0
0.5
Unemployment (%)
6.0
6.3
6.5
6.6
Spot
3.0
15Q1
3.0
15Q2
2.5
15Q4
2.5
FX rate (eop) USD/CLP
Debt indicators (% of GDP)
Government debt
Domestic
External
Total external debt
in USDbn
Short-term (% of total)
General (avg)
Financial markets (eop)
Overnight rate (%)
3-month rate (%)
USD/CLP
3.4
3.3
3.0
3.0
601.7
607.4
630.0
637.5
Source: DB Forecasts and, National Statistics
Page 116
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Colombia
Baa3 (positive) /BBB (stable) /BBB (stable)
Moody’s /S&P/ /Fitch

Economic outlook: We believe that the negative
impact from external demand should take a toll on
the activity numbers to be released in the coming
months. Accelerating inflation should preclude the
Central Bank from easing its monetary policy in the
coming months. Trade balance numbers are
already showing a widening deficit to multi-decade
historic high levels. The currency depreciation
impacted neither imports nor non-traditional
exports, implying that this deficit will likely
continue widening in the coming months.

Main risks: The high dependence on oil among the
external and fiscal accounts remains the main
vulnerability due to the high level of uncertainty of
where the oil price will settle in the coming years.
We believe that private consumption and
investment could add to the deceleration, due to
the increase in uncertainty on tax and spending
policy changes to close the widening fiscal gap. .
Deceleration in activity expected
Early impact from the oil plunge
The index of economic activity released by Dane shows
a steep deceleration in October and November to
annual growth rates of 3.6%YoY and 3.4%YoY,
respectively, from an average of 4.7%YoY during the
first nine months of the year. Activity in the mining
sector after the steep fall in oil prices and in coal
production could be the main cause of this deceleration
in economic activity. As shown in the graph below, the
last two months confirmed the downward trend
evidenced in economic activity that coincides with the
fall in oil prices during the last quarter of the year. We
expect this index to show continued deterioration
during December, depicting below-average annual
growth of 3.5%YoY during the fourth quarter.
Manufacturing activity, excluding coffee milling,
continued to be stagnated. In November, the headline
index fell by 0.9%YoY, after zero growth in October and
1.5%YoY in September. Most of the manufacturing
sectors fell, with the largest negative contribution to
the overall index coming from textile manufacturing
(-0.8%YoY), sugar refining (-0.6%YoY) and oil refining
(-0.6%YoY). On the other hand, the activity in sectors
like chemicals processing and milling contributed
positively with 0.7%YoY and 0.6%YoY, respectively.
The fall in oil refining activity should reverse the
negative contribution from mid 2015 as the Cartagena
refinery revamp ends and full production starts. For the
other sectors, the currency depreciation should give a
positive impact. However, in our opinion, this effect
will likely take time to materialize and impact the
overall activity numbers.
Deutsche Bank Securities Inc.
Economic Activity Index shows deceleration
Source: Deutsche Bank and DANE
Accelerating inflation precludes monetary easing
Inflation accelerated to 3.82%YoY in January, which is
largely attributing to the acceleration in food prices
(5.41%YoY). Core inflation (excluding food and energy)
accelerated as well in January to 3.1%YoY, after being
below the mid level of the target price range since
2012. Even though inflation expectations have not
increased along with the headline rate, the context of
large currency depreciation, a mostly closed output gap
along with a rapidly decreasing unemployment rate
and loose credit conditions should not warrant extra
monetary policy easing (at least during the first half of
the year and likely for most of 2015).
As shown in the graph below, the headline rate has
been accelerating from below 2%YoY during the first
quarter of 2013 to close to 4% in the most recent
month. Even though non-tradables inflation has
remained around 3.5% during the last years, inflation
from tradable goods has accelerated markedly, pushing
up the headline rate. We believe that the latest
depreciation trend will likely continue accelerating
tradable goods inflation in the coming months, fueling
the headline rate and eventually inflation expectations.
Page 117
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Inflation pressures building up
Colombia: Deutsche Bank forecasts
Nominal GDP (USDbn)
Population (m)
GDP per capita (USD)
Real GDP (YoY%)
Private consumption
Government consumption
Gross fixed investment
Exports
Imports
Source: Deutsche Bank and DANE
In the graph below, the contributions to inflation are
depicted for the year 2014. Food, housing and
transportation were the sectors with the largest
contribution to the headline index. Among food, the
largest contributions were related to food consumed
outside of the home (0.3%), tubers and plantains
(0.3%), meats and products derived from meat (0.2%),
as well as milk, cooking oil and eggs (0.2%). For 2013,
food inflation contributed with a growth rate of only
0.2%YoY. In our opinion, food inflation should take the
pressure off of the headline rate and recede in the
coming months (due to base effects). However, other
sources of price pressure could resurface during the
year, reverting only when domestic demand
decelerates toward the end of the year.
Prices, Money and Banking
(YoY%)
CPI (eop)
CPI (annual average)
Broad money (eop)
Private Credit (eop)
Fiscal accounts (% of GDP)*
Overall balance
Revenue
Expenditure
Primary balance
External accounts (USDbn)
Goods Exports
Goods Imports
Trade balance
% of GDP
Current account balance
Food and housing – the largest contributors
% of GDP
FDI (net)
FX reserves (eop)
COP/USD (eop)
Debt Indicators (% of GDP) (*)
Government debt
Domestic
External
External debt (**)
in USDbn
Short-term (% of total)
Source: Deutsche Bank and DANE
General (annual average)
Industrial production (YoY%)
Trade deficit at historic highs
In November, the trade deficit reached USD1.53bn,
which we attribute to a steep fall in exports to
USD3.8bn from around USD5bn during the same
month last year, and an increase in imports to
USD5.3bn versus USD5bn for the same month last
year.
Unemployment (%)
Financial Markets (end
period)
Policy rate (overnight rate)
3-month rate (DTF Rate)
COP/USD (eop)
2013
2014F
2015F
2016F
378.2
47.0
8,047
370.4
47.0
7,880
382.3
48.0
7,966
399.3
53.3
7,492
4.6
4.2
5.8
6.2
5.5
4.5
4.7
5.0
5.7
10.0
-3.5
6.0
3.5
4.5
5.0
5.0
-3.0
4.0
3.3
4.0
2.0
4.7
-1.0
3.0
1.9
2.0
15.0
13.0
3.7
2.8
14.5
14.0
3.2
3.6
14.0
12.0
3.6
3.1
13.0
10.0
-2.4
16.8
19.1
-0.1
-2.7
16.8
19.5
-0.4
-3.0
17.0
20.0
-0.7
-2.7
16.0
18.7
-0.4
60.0
57.0
3.0
0.8
-12.7
-3.4
15.0
42.0
1950
57.0
58.0
-1.0
-0.3
-17.0
-4.6
14.5
47.0
2376
45.0
51.0
-6.0
-1.6
-21.0
-5.5
12.0
48.0
2570
50.0
54.0
-4.0
-1.0
-22.0
-5.5
13.0
46.0
2650
37.3
27.5
12.0
24.1
91.0
38.1
27.0
11.1
24.3
90.0
38.5
28.0
10.5
24.3
93.0
36.0
27.0
9.0
23.8
95.0
13.0
12.5
13.0
13.3
-2.6
1.8
3.0
3.5
9.5
8.2
7.8
7.5
Current 15Q1F 15Q2F
4.50
4.50
4.50
4.40
4.60
4.70
2364
2500
2530
15Q4F
4.50
4.70
2570
Source: Deutsche Bank estimates, and National Sources
Armando Armenta, New York, (212) 250 0664
Page 118
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Mexico
A3 (stable)/BBB+ (stable)/BBB+ (stable)
Moody’s/S&P/Fitch
Economic activity (%YoY, 3-mo avg)
10
8
6
4
2
0
-2
-4
IP
-6
Services
-8
Sep-14
Jan-14
May-14
Sep-13
Jan-13
May-13
Sep-12
Jan-12
May-12
Sep-11
Jan-11
May-11
Sep-10
Jan-10
May-10
-10
Sep-09
Main risks: We expect spending cuts to have a
moderately negative effect on growth in 2015 and
2016. However, they could have a net positive
effect in the medium-term by preventing an
additional deterioration in the debt-GDP ratio, a
situation that may be more precarious as global
interest rates go up due to the normalization of
monetary policy in the US. Moreover, if the fiscal
targets are met with effective cuts, the credibility of
economic policy could improve and the excessive
dependence of public spending on oil revenues
would be reduced going forward. Otherwise, public
finances could become a source of risk for the
Mexican economy in the medium term and raise
some concerns. In this context of slow recovery,
we see the depreciation of the exchange rate as a
positive factor that could boost manufacturing
exports and magnify the effect of the US cyclic
upturn on the Mexican economy in the coming
years.
1.8%YoY in the same month. Weak industrial output
growth was caused by large drops in power, water and
mining that offset solid gains in manufacturing and
construction. On the other hand, services maintained
its resilience and expanded 0.3%MoM and 2.3%YoY,
while primary activities kept subtracting from total
growth. We see the resilience of services being tested
by slow industrial output, which keeps recovering but
at a speed below expectations. Thus, the Mexican
economy grew 2.3%YoY in October-November,
anticipating a relatively disappointing fourth quarter but
still a moderate acceleration with respect to 3Q2014.
Jan-09

Economic outlook: Recent activity data point
towards a weak last quarter of 2014 and a slow
start of 2015. In general terms, we see a moderate
recovery with non-autos manufacturing and
construction of infrastructure still underperforming,
along with sluggish private consumption and
investment. On top of this, the government
announced substantial spending cuts for this year,
which will likely subtract from GDP growth, so we
now expect the Mexican economy to grow 3%YoY
in 2015. CPI inflation continued on a fast descent
due to the base effect of new taxes in 2014 and a
drop in prices of telecommunications and
electricity, along with a stronger seasonal easing of
some food prices. This effect on prices was not
offset by increased gasoline prices and/or the passthrough effect of the exchange rate depreciation,
which has not even shown up on any component
of CPI, thus prompting downward reviews to
expected inflation for 2015. In this context of weak
growth and low inflation expectations, we see
Banxico on hold until the Fed starts hiking later in
the year. However, as the MXN appreciates,
disappointing activity persists and the passthrough effect on CPI remains small, the probability
of a rate cut increases.
May-09

Source: INEGI
Weak economic activity in 4Q2014
The overall growth picture did not improve in
December, as industrial production fell on a monthly
basis at 0.3%MoM, dragged mainly by a relatively large
drop in manufacturing activity, -1.6%MoM. This is
puzzling, as we expected that the FX depreciation may
have started to permeate into stronger activity through
a broad-based recovery of exports. However, growth of
manufacturing remained biased to motor vehicles,
while the rest came out weaker. On the other hand,
construction activity continued to post solid gains,
propelled mainly by housing while infrastructure
remained essentially flat. Now that infrastructure
development faces some headwinds from the spending
cuts announced by the government recently,
uncertainty about construction activity has increased
and we are still skeptical about the possibility that
housing activity keeps boosting construction in the
medium-term.
And a slow start in 2015
Economic activity grew below expectations in
November at 2.0%YoY and 0.5%MoM, a result that
was anticipated by a disappointing industrial
production reading, which grew only 0.2%MoM and
Summing up, industrial output grew 1.8%YoY in 2014,
propelled mainly by manufacturing, 3.8%YoY, followed
by construction, 1.8%YoY. On the side of
manufacturing, the strongest component remained
motor vehicles, 11.7%YoY in 2014. On the side of
Deutsche Bank Securities Inc.
Page 119
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
construction, the picture was mixed, as the buildings
component (mostly housing) grew 2.8%YoY, while
infrastructure fell 2.7%YoY. Thus, the composition of IP
growth seen in 2014 did not change much with respect
to 2013, except for a renewed dynamism of housing.
Industrial production and components (Jan12=100)
135
Total
Construction
Manufacturing
Motor vehicles and parts
130
125
120
115
110
105
100
95
highest mark on record for that month of the year and
a solid gain of 6.8%YoY, leading total production of
motor vehicles to a record of 3.2m units in any given
12-month period. Strong production of autos and light
trucks is prompted mainly by external demand, as
domestic sales continued to grow but more slowly than
exports in absolute terms. Sales abroad reached 204.9k
units in January, up 15.2%YoY, thus keeping the
positive trend started in 2010, so total exports also
reached an all-time high of 2.7m units in the last 12
months. Domestic sales stood at 103.7k units in
January, up 21.3%YoY and the largest number on
record for that month of the year. We see Mexico’s
domestic sales for autos now solidly at around 1.1m
units per year, so much of the potential for the
automotive industry rests on the internal market, which
we estimate at almost 2m units per year, given
Mexico’s population and income.
Nov-14
Jul-14
Sep-14
May-14
Jan-14
Mar-14
Nov-13
Jul-13
Sep-13
May-13
Jan-13
Mar-13
Nov-12
Jul-12
Sep-12
May-12
Jan-12
Mar-12
90
Motor vehicles (million units)
3.7
Taking the few indicators available for December 2014,
we anticipate that overall activity will have stayed on a
moderate- recovery in the last month of the year (to be
released next Monday February 16 along with full-year
GDP). Thus, considering that the Mexican economy
grew 1.9%YoY in the first eleven months of the year,
such a moderate pace is likely to deliver a GDP growth
of 2%YoY for the whole 2014. In this scenario, GDP
would have grown well below the long term average
for the second year in a row (2.5%YoY for the last 30
years).
With respect to 2015, available indicators for January
suggest that autos will remain an important engine for
growth in the coming months. Total monthly auto
production reached 266.4k units in January, the
Page 120
Production (last 12mo, m)
2.7
2.2
Exports (last 12mo, m)
1.7
Sales (last 12mo, m)
1.2
Jul-14
Jan-15
Jul-13
Jan-14
Jul-12
Jan-13
Jul-11
Jan-12
Jul-10
Jan-11
Jul-09
Jan-10
Jul-08
Jan-09
Jul-07
Jan-08
Jul-06
Jan-07
Jul-05
0.7
Jan-06
On the side of domestic demand, available data for
December suggest that private consumption continued
on a mild recovery. The National Retailers Association
announced that same-store sales grew 1.3%YoY in
December and merely 0.8%YoY in the full year. This
anticipates that the broader retail sales indicator
prepared by INEGI will continue to show a moderate
recovery in the coming months but as consumer
confidence has deteriorated and bank loans for
consumption keep growing below 2%YoY, we do not
anticipate an acceleration of private consumption yet.
By the same token, investment has maintained a
positive trend that could lose steam ahead as its most
dynamic component, imported machinery and
equipment, may contract due to the depreciation of the
exchange rate and start trending downwards in the
coming months. This is strongly suggested by the
2.3%MoM fall of investment in November.
3.2
Jan-05
Source: INEGI
Source: AMIA
Leading indicators for early 2015 suggest that activity
will continue to expand but signals remain mixed:

HSBC and Markit Economics released their
purchasing
managers’
index
for
Mexico
manufacturing in January, which stood at 56.6
points, up from 55.3 last month, the highest
reading since December 2012 and setting the index
well above the 50-point threshold that anticipates
an expansion. The employment sub-index rose to
its highest level since October 2012. Similarly, the
new orders sub-index rose with respect to the
previous month and is now at the highest reading
since December 2012.

The leading indicator prepared by IMEF also rose
above expectations and the 50-point threshold that
anticipates an expansion. The company-weighted
index continued to outperform the general index
and rose to 52.6 points, suggesting that the
recovery in manufacturing activity remains biased
towards big businesses. However, the seasonallyadjusted index for non-manufacturing activity fell
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
2015 announced budget cuts (USD$bn)
6
4
Pemex
CFE
2.2
Public investment
Current expenditure
0.7
Source: SHCP
Considering that cuts in Pemex and CFE will mostly hit
capex, almost three quarters of the budget adjustment
announced today is directed to reduce investment. No
details on the implications for Pemex or CFE were
released immediately but the Federal Government
announced the cancellation of the project to build a
passenger train in the Yucatan peninsula and the
Deutsche Bank Securities Inc.
3.0
3.4
2.0
2
1.1
0
-2
-4
2016e
2015e
2014e
2013
2012
2011
2010
2009
2008
-6
Source: INEGI and DB Research
The negative effects of the cuts on economic growth
are still uncertain, as not many details have been
released by either the government, Pemex or CFE. On
one hand, government spending had a marginal effect
on overall activity in 2014, so the cuts should not make
much difference with respect to the inertial path of the
economy. However, even if we attach a small effect to
public spending on growth, we see two negative
implications with respect to a scenario with no cuts:

The recovery of construction of infrastructure may
take longer, so construction will largely depend on
housing activity, which may lose steam ahead.

The cuts may create uncertainty throughout 2015
and delay government payments to contractors,
thus inhibiting investment and disrupting to some
extent the financing chain through suppliers
(approximately 70% of short-term financing to
firms is through suppliers).
1.2
4.1
Long-term avg
(1980-2013)
2007
Against this backdrop of weak indicators, the Ministry
of Finance (MoF) announced that the Mexican
government will cut 2015 spending by 0.7% of GDP
(MXN$124.3bn or USD$8.3bn) as a consequence of
sustained low oil prices. Even though oil revenues are
reportedly hedged at USD$76bbl, so the original 2015
budget could be met, the MoF said that they aim at
saving to smooth a foreseeable fiscal adjustment in
2016 (as oil revenues then are not hedged). 50% of the
cut will come from Pemex, 8% from CFE and the
remaining 42% from the Central Government. Of the
latter, 65% will come from current expenditure and
35% from public investment.
GDP growth (%YoY)
2006
Leading indicators on the demand side also point
towards a slow start in 2015. In January, consumer
confidence came out below expectations and dropped
with respect to December 2014, a 1.0%MoM fall. Four
out its five components dropped on a monthly basis,
particularly the sub-index measuring the perceived
capacity to purchase durable goods, which had largely
accounted for the overall recovery of consumer
confidence in late 2014. Only the sub-index measuring
expectations about the future of the Mexican economy
increased. It is worth highlighting that now the overall
index is 7.8% above its January 2014 level, due mainly
to a low base of comparison. We do not expect
consumer confidence to continue improving in the
coming months due as the perception on the overall
economic activity has deteriorated recently.
suspension of the high-speed rail project to connect
Mexico City and Queretaro. The cuts were originally
said not to affect the plans for the new Mexico City
airport, but the government announced later a 60% cut
to the corresponding budget for 2015. The MoF
mentioned that they expect the reductions to have a
marginal effect on growth in 2015 and did not modify
their official forecast.
2005
to 49.2 points (contraction), thus suggesting that
services may keep low steam due to the persistent
weakness of manufacturing.
As
expected,
activity
indicators
and
major
announcements had a negative effect on expectations.
The last Banamex survey of economic analysts shows
that growth prospects for 2015 deteriorated and the
average forecast is now 3.20%YoY, down from
3.36%YoY in the previous survey. However, it is worth
noticing that the difference between the 2015 average
forecast in the Banxico and Banamex surveys, levied
right before and after the cuts announcement
respectively, is very small. This implies that either
further downward revisions following the cuts may be
in the pipeline or the market is dismissing the negative
effect of the cuts. We tend to agree with the first view
and now we estimate GDP growth in 2015 at 3.0%YoY
(down from our previous forecast of 3.2%YoY).
Page 121
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Inflation has been lower than expected in early 2015.
The bi-weekly CPI inflation for the second half of
January came at 0.09%, below expectations, putting
the monthly rate at -0.09%MoM, the lowest for that
month in the last 10 years, and the annual rate at to
3.07%YoY. Similarly, the bi-weekly core inflation rate
came out well below expectations at 0.07%, putting
the annual rate at 2.34%YoY. Inflation in January was
largely driven by the unexpected bi-weekly CPI drop in
the first half of the month, which was a consequence
of two effects.
CPI inflation (%YoY)
5.0
4.5
4.0
3.5
3.0
CPI
2.5
Core
These two effects were larger than the impact of higher
gasoline prices, up 1.9% in early January, which was
also cushioned by reduced electricity prices.
CPI inflation in January (%MoM)
1.2%
Jan-15
Nov-14
Jul-14
Sep-14
May-14
Jan-14
Mar-14
Nov-13
Jul-13
Sep-13
May-13
Jan-13
Mar-13
Nov-12
Jul-12
Sep-12
A drop in the core’s “other services” sub-index,
largely driven by the elimination of domestic longdistance charges.
May-12

Jan-12
A large bi-weekly fall in the non-core’s fruits and
vegetables sub-index (mainly tomato), that
exceeded the average seasonal reduction for early
January.
Mar-12
2.0

Source: Deutsche Bank
Against this backdrop of weak growth and low inflation,
Banxico left the policy rate unchanged at 3% in
January. This decision was anticipated but the market
was pricing a relatively high probability of a cut shortly
before the announcement. Prospects of a cut were
largely fed by the recent indicators of weak economic
activity and by the surprising CPI drop of early January.
Nevertheless, in our view, current levels of the
exchange rate and persisting risks of pass-through
effects on inflation, did not leave much room for a cut.
1.0%
0.8%
0.6%
0.4%
0.2%
0.0%
-0.2%
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
Source: INEGI
After the surprising CPI drop in the first fortnight of
January, the big question open was whether inflation
dynamics had changed significantly and the headline
rate will keep coming significantly below expectations.
In our view, inflation resumed its normal seasonal
behavior in the second half of the month but we see a
slower CPI as an indicator that abundant slack prevails
in the economy. Against this backdrop of falling noncore and government-controlled prices, the FX
depreciation has failed to show up on CPI so far (the biweekly core’s non-food merchandise sub-index grew
less than in previous years). The latest CPI is likely to
prompt further downward revisions to expected
inflation for 2015 (consensus now at 3.13% by yearend as per the last Banamex survey).
Page 122
We see that the continued weakness of economic
recovery, improved prospects for inflation and the
possibility that the Fed may keep rates down for longer,
have prompted a dovish tone from Banxico.
Furthermore, following the pattern of low inflation in
January and improved expectations, markets may
continue to price the probability of a policy rate cut by
Banxico in the coming months, particularly if the MXN
strengthens somewhat and activity indicators remain
weak. However, we maintain our view that Banxico will
hike in tandem with the Fed later this year. This view is
strongly supported by the central role that the US
monetary policy outlook has in Banxico’s latest
communications.
Oil prices and public finances
As mentioned before, we expect spending cuts to have
a moderately negative effect on growth in 2015 and
2016. However, they could have a net positive effect in
the medium-term by preventing an additional
deterioration of public finances, a situation that may be
precarious as interest rates go up due to the
normalization of monetary policy in the US. In this
regard, if the fiscal targets are met with effective cuts,
the credibility of economic policy could improve and
the excessive dependence of public spending on oil
revenues reduced going forward. This could be a
structural improvement for public finances if carried
out successfully over the next few years.
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
This is a key issue for the medium and long term
prospects of the Mexican economy. According to our
estimates and growth forecasts, a fiscal effort that
subtracts roughly 0.5 percentage points from the broad
deficit (Public Sector Borrowing Requirements or
PSBR), every year in the next three years, should
stabilize the debt-GDP ratio by 2018 (such a reduction
was suggested in the fiscal reform passed in late 2013,
but the PSBR were not reduced accordingly in the 2015
Economic Program, see: Data Flash – Mexico: 2015
Economic Program). However, this is a fragile scenario
as a smaller fiscal correction, lower GDP growth and/or
higher financing costs could make the debt-GDP ratio
to keep growing by the end of the current
administration. This would raise some concerns as the
debt-GDP ratio approaches 50%, as a reasonable doubt
about the next administration’s willingness or capacity
to carry out an aggressive fiscal correction, through
either spending cuts or higher taxation, would emerge.
Mexico: Deutsche Bank Forecasts
2013
2014F
2015F
2016F
1238
119
10400
1314
121
10860
1395
124
11253
1492
126
11841
Real GDP (YoY%)
Priv. consumption
Gov't consumption
Investment
Exports
Imports
1.1
3.8
2.2
-0.1
1.4
2.0
2.0
2.8
2.4
1.7
3.5
4.1
3.0
2.9
2.3
2.2
4.9
4.8
3.4
3.1
2.3
2.6
5.5
5.3
Prices, Money and Banking
CPI (Dec YoY%)
CPI (avg %)
Broad Money
Credit
4.0
3.8
11.5
10.0
4.1
4.0
11.0
16.0
3.1
3.2
12.0
21.0
3.4
3.3
12.5
24.0
Fiscal Accounts (% of GDP)
Consolidated budget
balance*
Revenue
Expenditure
Primary Balance
-2.9
16.8
19.7
-0.9
-4.2
17.6
21.8
-1.5
-3.8
17.2
21.0
-1.6
-3.5
17.0
20.5
-1.4
External Accounts (USD bn)
Exports
Imports
Trade Balance
% of GDP
Current Account Balance
% of GDP
FDI
FX Reserves
MXN/USD (eop)
376.6
378.6
-2.0
-0.2
-22.3
-1.8
13.0
186.5
13.0
387.3
394.1
-6.9
-0.6
-30.3
-2.3
22.0
210.0
14.8
397.8
413.1
-15.3
-1.6
-35.1
-2.5
25.0
220.0
14.2
411.1
435.0
-24.2
-2.1
-40.5
-2.7
30.0
225.0
14.0
Debt Indicators (% of GDP)
Government debt**
Domestic
External
Total External Debt
in USD
Short term (% of total)
40.4
24.7
15.7
20.3
251.1
18.0
43.6
26.6
17.0
21.5
283.7
17.0
44.6
27.3
17.3
22.9
324.9
19.0
44.9
27.4
17.5
24.5
374.3
18.0
0.9
4.6
2.1
4.3
3.4
4.0
3.6
3.8
Spot
15Q1
15Q2
15Q4
3.00
3.30
14.60
3.00
3.40
14.30
3.00
3.50
14.10
4.00
4.50
14.20
National income
ional Income
Nominal
GDP (USD bn)
Population (m)
GDP per capita (USD)
Public debt (% of GDP)
46
44
42
40
38
36
34
2018e
2017e
2016e
2015e
2014e
2013
2012
2011
2010
2009
2008
32
Source: SHCP and DB Research
On the other hand, if the deficit is reduced steadily in
the next years, investors’ confidence on Mexico’s
macroeconomic stability could be further cemented.
This would be relevant as global monetary conditions
tighten and emerging markets find increasingly
challenging to finance their current account and fiscal
deficits. Moreover, given the deterioration about
Mexico’s medium-term prospects for growth and the
political environment, fiscal discipline could help
economic policy to gain more credibility. In this regard,
we see the budget cuts as a move in the right direction
and its implementation will be a major challenge for the
government in 2015 and 2016.
Alexis Milo, Mexico City, (52 55) 5201-8534
General (ann. avg)
Industrial Production
Unemployment
Financial Markets (eop)
Overnight rate (%)
3-month rate (%)
MXN/USD
*Corresponds to PSBR
**Corresponds to PSBR accumulated balance
Source: DB Global Markets Research, National Sources
Deutsche Bank Securities Inc.
Page 123
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Peru
Baa2 (positive)/BBB+ (stable)/BBB (neutral)
Moodys /S&P/ /Fitch


Economic outlook: The recovery in economic
activity should take longer to materialize due to the
effect on domestic demand from the fall in export
volumes and prices. Inflation continues close to the
upper level of the target range, but can be largely
explained by high food prices. The BCP surprised
cutting 25bps from the intervention rate in the
January meeting. Further cuts are unlikely to be
discarded in the coming months, if inflation eases
and activity growth continues to disappoint.
Overall, the activity from the tradable sectors of the
economy continues to drag down overall economic
activity, while activity in non-tradables, although it
continues to be stable, is unlikely to compensate and
drive the recovery.
Recovery in economic activity still on hold
Main risks: A deeper-than-expected deceleration in
China could put further pressure on copper prices
in the coming months, extending the negative
impact from external demand. The slowdown in
consumption and investment (public and private)
could continue creating risks for another year of
subpar growth.
The recovery fails to gather momentum
Activity and expectations continue to be stagnant
The data released on growth of economic activity in
November disappointed after breaking the trend of an
acceleration that had started in June. Manufacturing
and fishing activity fell during the month, while retail,
construction, and financial (among other sectors) were
the largest contributors of growth for the year.
Agriculture increased 5.32% during the month, largely
as a result of favorable weather, as explained by INEI,
the national statistical agency. Fishing fell an
astonishing 69% during the month following a ban in
activity for some parts of the country due to seasonal
factors. The increase in mining activity (0.40%)
continued to disappoint during the month, with metals
mining falling 1.05% due to lower copper (-3.62%) and
molybdenum (-13.5%) volumes, and the lower negative
contributions of iron, silver, and tin. The lower volumes,
according to economic authorities, are related to lower
quality from the mines and the temporary halt in
activity on others. Natural gas and hydrocarbon related
exploitation contributed positively to overall mining
during the month.
The fall in manufacturing (-13.05%) is largely due to
activity related to the primary sector (fishing and
mining), while intermediate goods manufacturing
compensated by growing at a rate of just 3.2% during
the month. Construction activity grew 3.68%, with
cement consumption growing 4.52% and investment in
civil works 1.87%. The retail sector also grew 3.78%,
with wholesale activity increasing 4.29% and retailers
4.01%. However, automobiles sales decreased 1.40%
during the month.
Page 124
Source: Deutsche Bank and INEI
Expectations continue stagnant
As shown in the graph above, the failure of the
different sectors to reignite economic growth (even
though the trend in recent months had shown some
recovery) kept expectations on economic activity from
recovering during the last three months. Although
economic expectations clearly bottomed in August
2014, the recovery has not been as strong as was
previously expected due to the failure in a rebound in
economic activity. However, as shown in the same
graph, credit access and financial conditions have
remained flat in the opinion of economic agents, even
after 75bps of cuts in the intervention rate since June.
Inflation remains high due to food prices
The slowdown in economic activity has not been
accompanied by a deceleration in inflation. Moreover,
in January, inflation remained above the upper level of
the target range, due to growth in food and beverage
prices (0.79%) during the month. Health (0.35%),
apparel (0.23%), housing, fuel and electricity (0.15%)
also contributed positively to the figure, while
transportation and communication prices fell by 1.36%.
Deutsche Bank Securities Inc.
12 February 2015
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
EM Monthly: Rising Tide
Contributions to headline inflation in 2014
Peru: Deutsche Bank forecasts
2013
Source: Deutsche Bank and INEI
As shown in the graph above, most of the contribution
to the headline inflation rate during 2014 was related to
food and beverage inflation. In 2013, this sector was
also the main contributor to the headline rate (2.9%
YoY), with 0.8% contribution, while transportation,
communication, and entertainment (each with 0.5%)
followed. During 2014, bread and cereals, as well as
meat and meat products (each with 0.7% of the
contribution to the growth rate in food and beverage
prices) explain almost 80% of this variation. Other
sectors did not contribute more than 0.1% to the total
contribution to the index’s inflation.
BCRP should continue loosening cautiously
In January, the BCRP surprised market participants by
delivering an unexpected 25bps cut in the reference
rate, the same day in which the activity numbers
showing the deceleration experienced in November
were released. Statements from Central Bank President
Julio Velarde left the door open for further cuts in the
coming months. In our opinion, the Central Bank will
likely enter into a ‘wait and see’ mode for the rest of
the quarter, and resume with an extra cut during the
second quarter of the year.
The exchange rate policy continues to rely on
extending certificates of deposit to stem expectations
of future depreciation without aggressively intervening
in the spot market. In our opinion, the Central Bank will
likely allow further depreciation in the spot rate to
counteract the negative effect of the terms of trade
shock as a result of the lower copper prices and
volume of production. However, the confidence of the
economic authorities regarding a recovery in external
demand reversing the depreciation trend drives the
strategy of the Central Bank in its continued
intervention in the forward market.
2014F 2015F 2016F
National Income
Nominal GDP (USD bn)
Population (m)
GDP per capita (USD)
206.6
30.5
6,774
205.4
31.0
6,626
211.1
31.5
6,702
218.2
32.5
6,712
Real GDP (YoY%)
Private consumption
Government consumption
Gross fixed investment
Exports
Imports
5.8
5.3
6.7
10.5
-0.9
3.6
2.7
4.0
5.2
1.2
-3.0
1.0
4.7
4.0
5.0
7.0
2.0
3.0
5.2
4.8
5.5
4.8
5.0
4.0
Prices, Money and Banking
(YoY%)
CPI (eop)
CPI (ann. avg)
Broad money (eop)
Private Credit (eop)
3.0
2.5
15.0
15.0
3.2
3.2
16.0
15.5
3.1
2.4
15.0
16.0
2.2
3.1
14.4
17.0
0.40
21.3
20.9
1.5
0.20
21.1
20.9
1.2
-0.10
20.8
20.9
0.9
0.60
21.5
20.9
1.6
42.2
42.2
-0.03
-0.02
-9.4
-4.6
9.2
64.0
2.80
37.9
41.2
-3.3
-1.6
-10.5
-5.1
8.5
62.0
2.98
39.6
43.0
-3.4
-1.6
-9.9
-4.7
7.5
63.3
3.10
43.4
46.0
-2.7
-1.2
-10.3
-4.7
7.7
65.4
3.26
20.3
10.1
8.8
25.6
52.9
14.8
20.3
10.7
8.9
27.3
56.0
14.5
25.2
10.4
8.9
28.6
60.4
15.0
20.0
10.4
8.5
30.6
66.8
17.0
4.9
5.9
3.5
5.7
6.5
5.3
6.0
5.5
Current
3.25
4.24
3.06
15Q1F
3.50
4.49
2.90
Fiscal accounts, % of GDP
(*)
Overall balance
Revenue
Expenditure
Primary balance
External accounts (USD bn)
Goods Exports
Goods Imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI (net)
FX reserves (eop)
PEN/USD (eop)
Debt Indicators (% of GDP)
Government debt (*)
Domestic
External
External debt
in USD bn
Short-term (% of total)
General (ann. avg)
Industrial production (YoY%)
Unemployment (%)
Financial Markets (%, eop)
Policy rate
3-month rate
PEN/USD (eop)
15Q2F 15Q4F
3.75
4.00
4.74
4.99
2.95
3.03
(*) General Government
Source: DB Global Markets Research, National Sources
Armando Armenta, New York, (212) 250 0664
Deutsche Bank Securities Inc.
Page 125
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Venezuela
Caa1 (negative)/B (negative)/B+ (negative)
Moody’s/S&P/Fitch


Economic outlook: The economic and political
situation continues to worsen in Venezuela. A path
to solve the crisis generated by the expected
deterioration in external accounts from the realized
fall in oil prices and the weak public external asset
position has not been met by a change in policy
direction. President Maduro’s announcement of a
large financing deal with China most likely implies
gradual
disbursements
and
conditional
expenditures that are unlikely to close the financing
gap extended through several years. The
announcement of the revamp of the exchange rate
system disappointed the market, given that there
were no major changes to the existing one.
closer to what was evidenced a decade ago. In our
opinion, the current imbalances and distortions, as well
as the imperiled capacity of goods and services supply
would create massive shortages, adding more political
pressure to an already delicate situation.
Imports have already fallen after peaking in 2012
Main risks: Our baseline scenario continues to be a
steep fall in imports, economic activity, and a
financial default in the next two years. The external
currency needs could imply large external financing,
but the current yields and the policy mix would
preclude markets from providing it.
No clear plan to solve the severe crisis
Announcements do not address causes of crisis
After the recent trip to Russia, China, and fellow OPEC
member countries, President Maduro acknowledged
that the deep fall in oil prices will likely be persistent
and that expectations of a recovery are unlikely to be
realized in the short to medium term.
In a speech to the National Assembly, the president
vowed to protect social expenditure and to solve the
crisis by prosecuting members of the private sector
involved in hoarding and smuggling schemes that have
been part of an “economic war” waged against
Venezuela by a coalition of the private sector, the
opposition, and foreign countries. Representatives of
super market stores were jailed on charges of sabotage
and hoarding in recent days, in an attempt to place the
blame for the growing scarcity conditions on the
representatives of the private sector without
addressing the causes of the macro economic
imbalances and the looming deep economic crisis.
As shown in the graphs below, 2014 goods and
services imports had already fallen by USD 14bn due to
the weakening of the external asset position that took
FX reserves in the Central Bank to around USD 20bn. In
our opinion, the shortfall in external financing during
2015 (using our baseline scenario of around USD 50
per barrel of the Venezuelan crude mix and 2014 total
imports) would add up to around USD 30bn. Trying to
lower this deficit by cutting imports further would likely
take total goods and services imports to an amount
Page 126
Source: Deutsche Bank and BCV
The political crisis continues and could worsen
Political demonstrations could reignite the clashes
between opposition and government forces that last
year left 42 casualties and hundreds of demonstrators
in jail (including opposition leader Leopoldo Lopes).
Even though the opposition continues without clear
leadership and differing strategies, in the coming
months there are incentives to re-unite and face the
National Assembly elections that will be held toward
the end of the year.
Much ado about nothing in the exchange rate reform
Minister Rodolfo Marco-Torres and Central Bank
President Nelson Merentes unveiled the details of the
revamp of the exchange rate system during a press
conference. The information comes after President
Maduro announced that the details of a new system
would be revealed in two addresses on December 30th
and January 15th.
In the new system, the CENCOEX VEF/USD 6.3 rate
was kept in order to supply the food and drug sector
(and the inputs for their production), and the SICAD
and SICAD 2 mechanisms were merged at a rate that
will start at the SICAD rate of around VEF/USD 12, with
the possibility of movement on this rate. According to
the authorities, 70% of the import needs for the
economy will likely be supplied at the VEF/USD 6.3 rate
and 30% at the SICAD rate.
Deutsche Bank Securities Inc.
12 February 2015
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
EM Monthly: Rising Tide
Moreover, according to the authorities a new third
system called SIMADI (System of Marginal Foreign
Exchange) could allow private agents as well as public
and private banks, PDVSA, the Central Bank, and
regular citizens to demand and supply hard currency at
a rate that would be determined by supply and demand.
A cap of USD 300 per day and USD 3,000 per month
was announced for non-corporate buyers. More details
of the system had not yet been unveiled as we went to
press.
Venezuela: Deutsche Bank Forecasts
2013F
National Income
Nominal GDP (USDbn)
Population (mn)
GDP per capita (USD)
Real GDP (YoY%)
Private consumption
Government consumption
Gross fixed investment
The table below shows the expected average exchange
rates and the share of total imports for the Venezuelan
economy. The government would face an average
exchange rate of 13.5 (a weighted average between
the 6.3 and the SICAD rate), while the private sector’s
imports would amount to 10% of total imports. The
remaining imports would be supplied at a combination
of the new SIMADI and the black market exchange
rates with an implied exchange rate for imports of
around 40 VEF/USD.
Devaluation under an inefficient system
Exports
Imports
CPI (eop)
CPI (ann. avg)
Broad money (eop)
Private Credit (eop)
Fiscal accounts (% of GDP) (*)
Overall balance
Revenue
Expenditure
External accounts (USDbn)
Goods Exports
Goods Imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI (net)
If there is enough supply from government entities in
the third system, it could put a stop to the black market
rate depreciation, a marker for many goods and
services that is related to the increase in the inflation
currently running at around 60% on an annual basis.
In our opinion, the measures announced would not
have a positive impact on the economy’s performance
or solve the disequilibrium, arbitrage opportunities, and
price differentials for inputs of production and final
goods that have fueled inflation, scarcity, and a halt in
production in many economic sectors. We believe that
this new mechanism does not solve the inefficiencies
that have increased the vulnerability and the external
funding gap after the steep fall in exports. Using
current oil prices as the average for the year, the cash
flow deficit for the Venezuelan economy will likely
amount to more than USD 30bn.
2015F
2016F
448
31
734
31
561
31
14,693
23,691
1.3
4.2
-3.6
-4.0
-4.3
-5.0
1.0
5.6
3.3
-9.0
5.5
-5.0
3.0
-1.5
-1.7
1.8
-6.2
-9.7
-3.5
-5.5
-5.0
-2.0
1.3
5.5
56.5
40.0
70.0
60.0
90.0
80.0
95.0
85.0
65.0
55.0
50.0
45.0
45.0
50.0
40.0
30.0
-7.9
25.7
-14.8
19.1
-22.6
20.7
-6.6
33.1
33.6
-4.2
33.9
-5.5
43.3
-7.1
39.6
-3.3
90.0
55.0
76.7
40.0
40.5
36.0
45.0
38.0
35.0
36.7
4.5
7.0
7.8
5.0
0.8
1.1
10.0
2.2
11.7
1.6
-12.5
-2.2
-11.0
-1.7
0.0
21.7
1.0
21.0
1.5
18.0
1.5
20.0
6.30
6.30
15.0
25.0
35.9
16.2
27.8
16.4
35.2
20.2
30.0
17.4
19.7
19.7
11.4
11.4
15.0
15.0
12.6
12.6
102
9.8
98
10.2
99
8.1
99
8.1
1.0
8.3
-1.0
8.5
0.5
8.0
0.5
9.0
Current
15.6
6.3
15Q1F
16.0
6.3
15Q2F
16.5
6.3
15Q4F
17.0
15.0
663
32
18,092 20,712
Prices, Money and Banking (YoY %)
Primary balance
Source: Deutsche Bank Research and Ecoanalitica
2014F
FX reserves (eop)
VEF/USD (eop)
Debt Indicators (% of GDP) (*)
Government debt
Domestic
External
External debt
in USDbn
Short-term (% of total)
General (ann. avg)
Industrial production (YoY%)
Unemployment (%)
Financial Markets (end period)
Lending Rate
VEF/USD (eop)
(*) Non-Financial General Public Sector
Source: DB Global Markets Research, National Sources
Armando Armenta, New York, (212) 250-0664
Deutsche Bank Securities Inc.
Page 127
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Theme Pieces
January 2015



EM Vulnerability Monitor
Sovereign Credit: Stress Testing the Weakest Links
China's Unexpected Fiscal Slide
December 2014






Stress Testing the EM Outlook
FX in 2015: Shock Absorber
Rates in 2015: Diminishing Returns
Sovereign Credit in 2015: Divergent Performances
EM Performance: The Role of Technicals, External
and Domestic Factors
Asia's Frontier Economies: Outperformance in a
slowing world
November 2014





Commodities and EM Once Again
Brazil: Taking Stock after the Election
Slowing China, Slowing Asia
EM Oil Producers: Breakeven Pain Thresholds
Turkey Trip Notes: In Search of a Story to Present
October 2014





Assessing EM Vulnerabilities
Venezuela: To Pay or Not to Pay, is that the
Question?
Remember, Not All EM Currencies Are Equal
EU Structural Funds and Their Impact: 10 Questions
Answered
Analyzing Relative Value Using Snapshot
September 2014






Brazil: Marina Silva Changes Election Dynamics
What Explains Disappointing Asian Exports?
Diminishing Expectations in Latin America
Mexico: Undertaking Pemex and CFE Pension
Liabilities
A Growth and Investment Model for India: 2014-2020
Will the Russia Crisis Derail Recovery in Central
Europe?
July 2014






Argentina: Flirting With Default While Aiming at
Resolution
Inflation in Turkey: What Goes Up Struggles to Come
Down
India: Urbanization and Economic Well-Being
Philippines:
Investments'
Growing
Economic
Importance
Idiosyncrasies to Drive CEE FX in Different Directions
Notes from Russia: Dealing with Structural
Challenges and Geopolitics
June 2014







May 2014






India: the Next Government's Fiscal Challenges
Characterizing Elusive Growth in Latin America
Euro Area Still a Powerful Driver of EMEA Export
Performance
Introducing the EM Derivatives Focus
China: Road to Sustainable Local Government
Financing
Venezuela: the Value of Opportunistic Adjustment
April 2014




China: A year of Economic Rebalancing
India: Evidence of a Turnaround in the Investment
Cycle
Breakeven Oil Prices
Implications of Increase in Foreign Participation in
Colombia
March 2014







Bailing Out Ukraine
Russia Macro Implications of Increased Geopolitical
Risks
EMFX:“Good EM/Bad EM” Tail Opportunities
Central Europe: a Good EM Story
Is the Philippine Peso a (CA) Deficit Currency?
India’s Heterogeneous State Finances
LMAP – The Next Generation
February 2014





Vulnerabilities, Policy Inaction, and Stigma in the
Recent EM Sell Off
Divergent Pricing of Local and External Sovereign
Bonds
India: CPI Target Means Higher Rates for Longer
Asia Vulnerability Monitor
Inside Fragile EM: Trip Notes from Turkey and South
Africa
January 2014



Page 128
Mexico's Energy Reform in Perspective
India: the Next Government's To-Do List
Indonesia: The Challenge from Commodities
Brazil: Ten Questions About the Elections
South Korea: Labour at a Crossroads
Hungary: Explaining Subdued Inflation and Declining
Export Competitiveness
Asia Vulnerability Monitor
The Durability of Current Account Adjustment in
Central Europe
Can DTCC Positioning Data Predict EMFX?
Argentina
GDP
Warrants:
More
Attractive
Risk/Reward than Bonds
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Contacts
Name
Title
Telephone
Email
Location
EMERGING MARKETS
Burgess, Robert
Regional Head, EMEA
44 20 754 71930
robert.burgess@db.com
London
Cañonero, Gustavo
Regional Head, LatAm
1 212 250 7530
gustavo.canonero@db.com
Buenos Aires
Evans, Jed
Head of EM Analytics
1 212 250 8605
jerrold.evans@db.com
New York
Giacomelli, Drausio
Head of EM Research
1 212 250 7355
drausio.giacomelli@db.com
New York
Head of EM Sovereign Credit
1 212 250 2524
hongtao.jiang@db.com
New York
Regional Head, Asia
852 2203 8305
michael.spencer@db.com
Hong Kong
Global Research
1 212 250 5851
nellie.ortiz@db.com
New York
Andean Economist
1-212 250 0664
armando.armenta@db.com
New York
Senior Economist, Brazil
5511 2113 5185
jose.faria@db.com
Sao Paulo
EM Derivatives and Quant Strategist
1 212 250 8640
guilherme.marone@db.com
New York
Senior Economist, Mexico
5255 5201 8534
alexis.milo@db.com
Mexico
Shtauber, Assaf
EM Strategist
1 212 250 5932
assaf.shtauber@db.com
New York
Vieira, Eduardo
Head of EM Corportates
1 212 250 7568
eduardo.vieira@db.com
New York
Senior Economist, Central Europe
44 20 754 59913
caroline.grady@db.com
London
EMEA FX Strategist
44 20 754 59847
henrik.gullberg@db.com
London
Economist, Central Europe
44 20 754 57066
gautam.kalani@db.com
London
EMEA Sovereign Credit Strategist
44 20 754 51382
winnie.kong@db.com
London
Chief Economist, Russia and CIS
7 495 933 9247
yaroslav.lissovolik@db.com
Moscow
Economist, Egypt
49 69 910 41643
oliver.masetti@db.com
Frankfurt
Senior Economist, South Africa
27 11 775 7267
Jiang, Hongtao
Spencer, Michael
Ortiz, Nellie
LATIN AMERICA
Armenta, Armando
Faria, Jose Carlos
Marone, Guilherme
Milo, Alexis
EMERGING EUROPE, MIDDLE EAST, AFRICA
Grady, Caroline
Gullberg, Henrik
Kalani, Gautam
Kong, Winnie
Lissovolik, Yaroslav
Masetti, Oliver
Masia, Danelee
danelee.masia@db.com Johannesburg
Ozturk, Kubilay
Senior Economist, Turkey
44 20 754 58774
kubilay.ozturk@db.com
Popov, Eugene
Head of CEEMEA Corporate Credit
44 20 754 56460
eugene.popov@db.com
London
EM Corporate Credit
44 121 615 7073
himanshu.porwal@db.com
Birmingham
Porwal, Himanshu
Wietoska, Christian
London
Rates Strategist
44 20 754 52424
christian.wietoska@db.com
London
Economist, Russia, Ukraine, Kazakhstan
7 495 797 5274
artem.zaigrin@db.com
Moscow
Head of Asia Credit Research
65 6423 6967
harsh.agarwal@db.com
Singapore
Head of Economics, Asia
65 6423 8681
taimur.baig@db.com
Singapore
Credit Analyst, China Property
852 2203 5930
jacphanie.cheung@db.com
Hong Kong
Economist, India, Pakistan, Sri Lanka
91 22 71584909
kaushik.das@db.com
Mumbai
Economist, Malaysia,Philippines
65 6423 5261
diana.del-rosario@db.com
Singapore
Head of Asia Rates & FX Research
65 6423 6973
sameer.goel@db.com
Singapore
Rates Strategist
65 6423 5925
swapnil.kalbande@db.com
Singapore
FX Strategist
852 2203 6153
perry.kojodjojo@db.com
Hong Kong
Senior Economist, South Korea, Taiwan, Vietnam
852 2203 8312
juliana.lee@db.com
Hong Kong
Rates Strategist
852 2203 8709
linan.liu@db.com
Hong Kong
FX Strategist
65 6423 8947
mallika.sachdeva@db.com
Singapore
Rates Strategist
852 2203 5932
kiyong.seong@db.com
Hong Kong
Hong Kong
Zaigrin, Artem
ASIA
Agarwal, Harsh
Baig, Taimur
Cheung, Jacphanie
Das, Kaushik
Del-Rosario, Diana
Goel, Sameer
Kalbande, Swapnil
Kojodjojo, Perry
Lee, Juliana
Liu, Linan
Sachdeva, Mallika
Seong, Ki Yong
Shi, Audrey
Shilin, Viacheslav
Tan, Colin
Zhang, Zhiwei
Deutsche Bank Securities Inc.
Economist, China, Hong Kong
852 2203 6139
audrey.shi@db.com
Credit Analyst, Banks & Sovereigns
65 6423 5726
viacheslav.shilin@db.com
Singapore
Credit Analyst, IG Corporates
852 2203 5720
colin.tan@db.com
Hong Kong
Chief Economist, China
852 2203 8308
zhiwei.zhang@db.com
Hong Kong
Page 129
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Policy Rate Forecast
Projected Policy Rates in Emerging Markets
Policy Rate Forecasts
-
Current policy rate
Q1-2015
Q2-2015
Q3-2015
Q4-2015
Q4-2016
Czech
0.05
0.05
0.05
0.05
0.05
0.25
Hungary
2.10
2.10
2.10
2.10
2.10
2.75
Israel
0.25
0.25
0.25
0.50
0.75
2.00
Kazakhstan
5.50
5.50
5.50
5.50
5.50
5.50
Poland
2.00
2.00
2.00
2.00
2.00
2.25
Emerging Europe, Middle East & Africa
Romania
Russia
2.50 
2.25 
2.25 
2.25 
2.25 
3.00 
17.00 
17.00 
17.00 
15.00 
13.00 
9.00 
South Africa
5.75
5.75
5.75
5.75 
5.75 
Turkey
8.25
7.75
7.50
7.50
8.00
9.00
Ukraine
14.00
25.00
20.00
15.00
15.00
10.00
China
2.75
2.75
2.50
2.25
2.25
2.25
India
7.75 
7.50
7.00 
7.00 
7.00
7.00
Indonesia
7.75
7.75 
7.75 
7.75 
7.00 
7.00
Korea
2.00
1.75
1.75
1.75
1.75
2.75
Malaysia
3.25
3.25
3.25
3.50
3.50
3.75
Philippines
4.00
4.00
4.25
4.25
4.50
5.00
Taiwan
1.875
1.875
1.875
1.875
1.875
2.375
Thailand
2.00
2.00
2.00
2.00
2.00
2.00
Vietnam
6.50
6.00
6.00
6.00
6.00
6.50
Brazil
11.75
12.50
12.50
12.50
Chile
3.00
2.75
2.50 
2.50 
2.50 
2.50 
Colombia
4.50
4.50
4.50
4.50
4.50
5.00
Mexico
3.00
3.00
3.00
3.50
4.00
5.00
Peru
3.50
3.50
3.75
4.00
4.00
4.75
6.50
Asia (ex-Japan)
Latin America
12.50 
10.00
/ Indicates increase/decrease in level compared to previous EM Monthly publication; a blank indicates no change
Source: Deutsche Bank
Source: Deutsche Bank
Page 130
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
Appendix 1
Important Disclosures
Additional information available upon request
For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this
research, please see the most recently published company report or visit our global disclosure look-up page on our
website at http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr
Analyst Certification
The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s). In addition,
the undersigned lead analyst(s) has not and will not receive any compensation for providing a specific recommendation
or view in this report. Drausio Giacomelli/Jed Evans
Deutsche Bank debt rating key
CreditBuy (“C-B”): The total return of the Reference
Credit Instrument (bond or CDS) is expected to
outperform the credit spread of bonds / CDS of other
issuers operating in similar sectors or rating categories
over the next six months.
CreditHold (“C-H”): The credit spread of the
Reference Credit Instrument (bond or CDS) is expected
to perform in line with the credit spread of bonds / CDS
of other issuers operating in similar sectors or rating
categories over the next six months.
CreditSell (“C-S”): The credit spread of the Reference
Credit Instrument (bond or CDS) is expected to
underperform the credit spread of bonds / CDS of other
issuers operating in similar sectors or rating categories
over the next six months.
CreditNoRec (“C-NR”): We have not assigned a
recommendation to this issuer. Any references to
valuation are based on an issuer’s credit rating.
Reference Credit Instrument (“RCI”): The Reference
Credit Instrument for each issuer is selected by the
analyst as the most appropriate valuation benchmark
(whether bonds or Credit Default Swaps) and is detailed
in this report. Recommendations on other credit
instruments of an issuer may differ from the
recommendation on the Reference Credit Instrument
based on an assessment of value relative to the
Reference Credit Instrument which might take into
account other factors such as differing covenant
language, coupon steps, liquidity and maturity. The
Reference Credit Instrument is subject to change, at the
discretion of the analyst.
Deutsche Bank Securities Inc.
Page 131
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
(a) Regulatory Disclosures
(b) 1. Important Additional Conflict Disclosures
Aside from within this report, important conflict disclosures can also be found at https://gm.db.com/equities under the
"Disclosures Lookup" and "Legal" tabs. Investors are strongly encouraged to review this information before investing.
(c) 2. Short-Term Trade Ideas
Deutsche Bank equity research analysts sometimes have shorter-term trade ideas (known as SOLAR ideas) that are
consistent or inconsistent with Deutsche Bank's existing longer term ratings. These trade ideas can be found at the
SOLAR link at http://gm.db.com.
(d) 3. Country-Specific Disclosures
Australia and New Zealand: This research, and any access to it, is intended only for "wholesale clients" within the
meaning of the Australian Corporations Act and New Zealand Financial Advisors Act respectively.
Brazil: The views expressed above accurately reflect personal views of the authors about the subject company(ies) and
its(their) securities, including in relation to Deutsche Bank. The compensation of the equity research analyst(s) is
indirectly affected by revenues deriving from the business and financial transactions of Deutsche Bank. In cases where
at least one Brazil based analyst (identified by a phone number starting with +55 country code) has taken part in the
preparation of this research report, the Brazil based analyst whose name appears first assumes primary responsibility for
its content from a Brazilian regulatory perspective and for its compliance with CVM Instruction # 483.
EU
countries:
Disclosures
relating
to
our
obligations
under
MiFiD
can
be
found
at
http://www.globalmarkets.db.com/riskdisclosures.
Japan: Disclosures under the Financial Instruments and Exchange Law: Company name - Deutsche Securities Inc.
Registration number - Registered as a financial instruments dealer by the Head of the Kanto Local Finance Bureau
(Kinsho) No. 117. Member of associations: JSDA, Type II Financial Instruments Firms Association, The Financial Futures
Association of Japan, Japan Investment Advisers Association. This report is not meant to solicit the purchase of specific
financial instruments or related services. We may charge commissions and fees for certain categories of investment
advice, products and services. Recommended investment strategies, products and services carry the risk of losses to
principal and other losses as a result of changes in market and/or economic trends, and/or fluctuations in market value.
Before deciding on the purchase of financial products and/or services, customers should carefully read the relevant
disclosures, prospectuses and other documentation. "Moody's", "Standard & Poor's", and "Fitch" mentioned in this
report are not registered credit rating agencies in Japan unless "Japan" or "Nippon" is specifically designated in the
name of the entity.
Malaysia: Deutsche Bank AG and/or its affiliate(s) may maintain positions in the securities referred to herein and may
from time to time offer those securities for purchase or may have an interest to purchase such securities. Deutsche Bank
may engage in transactions in a manner inconsistent with the views discussed herein.
Qatar: Deutsche Bank AG in the Qatar Financial Centre (registered no. 00032) is regulated by the Qatar Financial Centre
Regulatory Authority. Deutsche Bank AG - QFC Branch may only undertake the financial services activities that fall
within the scope of its existing QFCRA license. Principal place of business in the QFC: Qatar Financial Centre, Tower,
West Bay, Level 5, PO Box 14928, Doha, Qatar. This information has been distributed by Deutsche Bank AG. Related
financial products or services are only available to Business Customers, as defined by the Qatar Financial Centre
Regulatory Authority.
Russia: This information, interpretation and opinions submitted herein are not in the context of, and do not constitute,
any appraisal or evaluation activity requiring a license in the Russian Federation.
Kingdom of Saudi Arabia: Deutsche Securities Saudi Arabia LLC Company, (registered no. 07073-37) is regulated by the
Capital Market Authority. Deutsche Securities Saudi Arabia may only undertake the financial services activities that fall
within the scope of its existing CMA license. Principal place of business in Saudi Arabia: King Fahad Road, Al Olaya
District, P.O. Box 301809, Faisaliah Tower - 17th Floor, 11372 Riyadh, Saudi Arabia.
United Arab Emirates: Deutsche Bank AG in the Dubai International Financial Centre (registered no. 00045) is regulated
by the Dubai Financial Services Authority. Deutsche Bank AG - DIFC Branch may only undertake the financial services
activities that fall within the scope of its existing DFSA license. Principal place of business in the DIFC: Dubai
International Financial Centre, The Gate Village, Building 5, PO Box 504902, Dubai, U.A.E. This information has been
distributed by Deutsche Bank AG. Related financial products or services are only available to Professional Clients, as
defined by the Dubai Financial Services Authority.
Page 132
Deutsche Bank Securities Inc.
12 February 2015
EM Monthly: Rising Tide, Leaky Boats
(e) Risks to Fixed Income Positions
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 short-dated 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.
Hypothetical Disclaimer
Backtested, hypothetical or simulated performance results have inherent limitations. Unlike an actual performance
record based on trading actual client portfolios, simulated results are achieved by means of the retroactive application of
a backtested model itself designed with the benefit of hindsight. Taking into account historical events the backtesting of
performance also differs from actual account performance because an actual investment strategy may be adjusted any
time, for any reason, including a response to material, economic or market factors. The backtested performance
includes hypothetical results that do not reflect the reinvestment of dividends and other earnings or the deduction of
advisory fees, brokerage or other commissions, and any other expenses that a client would have paid or actually paid.
No representation is made that any trading strategy or account will or is likely to achieve profits or losses similar to
those shown. Alternative modeling techniques or assumptions might produce significantly different results and prove to
be more appropriate. Past hypothetical backtest results are neither an indicator nor guarantee of future returns. Actual
results will vary, perhaps materially, from the analysis.
Deutsche Bank Securities Inc.
Page 133
David Folkerts-Landau
Group Chief Economist
Member of the Group Executive Committee
Raj Hindocha
Global Chief Operating Officer
Research
Michael Spencer
Regional Head
Asia Pacific Research
Marcel Cassard
Global Head
FICC Research & Global Macro Economics
Ralf Hoffmann
Regional Head
Deutsche Bank Research, Germany
Richard Smith and Steve Pollard
Co-Global Heads
Equity Research
Andreas Neubauer
Regional Head
Equity Research, Germany
Steve Pollard
Regional Head
Americas Research
International Locations
Deutsche Bank AG
Deutsche Bank Place
Level 16
Corner of Hunter & Phillip Streets
Sydney, NSW 2000
Australia
Tel: (61) 2 8258 1234
Deutsche Bank AG
Große Gallusstraße 10-14
60272 Frankfurt am Main
Germany
Tel: (49) 69 910 00
Deutsche Bank AG London
1 Great Winchester Street
London EC2N 2EQ
United Kingdom
Tel: (44) 20 7545 8000
Deutsche Bank Securities Inc.
60 Wall Street
New York, NY 10005
United States of America
Tel: (1) 212 250 2500
Deutsche Bank AG
Filiale Hongkong
International Commerce Centre,
1 Austin Road West,Kowloon,
Hong Kong
Tel: (852) 2203 8888
Deutsche Securities Inc.
2-11-1 Nagatacho
Sanno Park Tower
Chiyoda-ku, Tokyo 100-6171
Japan
Tel: (81) 3 5156 6770
Global Disclaimer
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