Deutsche Bank
Markets Research
Emerging Markets
Economics
Foreign Exchange
Rates
Credit
Date
5 December 2013
Emerging Markets 2014 Outlook
Diverging Markets
Taimur Baig
Marc Balston
Robert Burgess
Gustavo Cañonero
Drausio Giacomelli
Michael Spencer
(+65) 64 23-8681
(+44) 20 754-71484
(+44) 20 754-71930
(+1) 212 250-7530
(+1) 212 250-7355
(+852 ) 2203-8305
Special Reports
Diverging Markets
Rates in 2014: Refocusing on EM Fundamentals
Sovereign Credit in 2014: Back in the Black
FX in 2014: Diverging Currencies
EM Performance: Too Much Ado About Technicals
Asia’s Frontier Economies: Plenty of Alpha
Brazil: Overview of 2014 Presidential Elections
US Manufacturing and Mexican Growth
Foreign Demand for EM Local Currency Debt
________________________________________________________________________________________________________________
Deutsche Bank Securities Inc.
Note to U.S. investors: US regulators have not approved most foreign listed stock index futures and options for US
investors. Eligible investors may be able to get exposure through over-the-counter products. DISCLOSURES AND
ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MICA(P) 054/04/2013.
5 December 2013
EM Monthly: Diverging Markets
Key Economic Forecasts
Real GDP (%)
2013F
2014F
2015F
Global
2.8
US
Japan
Consumer prices (% pavg)
2013F
2014F
2015F
3.7
3.9
3.1
1.8
3.2
3.5
1.6
1.6
0.7
1.3
0.3
-0.2
0.5
0.2
-1.8
-1.5
-1.1
0.1
0.4
-1.0
-4.3
-1.7
0.5
1.2
1.5
1.3
0.6
0.5
0.4
1.2
1.4
0.9
0.8
0.8
2.0
1.4
1.4
1.9
0.5
1.3
1.2
1.6
1.8
1.5
2.0
1.3
2.0
1.5
1.7
1.1
1.5
1.7
2.8
1.2
2.1
2.4
-0.6
0.6
0.8
1.5
0.7
0.2
1.8
1.9
1.7
2.7
2.7
2.5
2.3
1.8
2.4
2.0
2.8
3.7
3.2
2.0
2.5
1.5
2.6
2.0
2.8
3.6
2.4
Emerging Europe, Middle East & Africa
Czech Republic
Egypt
Hungary
Israel
Kazakhstan
Poland
Romania
Russia
Saudi Arabia
South Africa
Turkey
Ukraine
United Arab Emirates
2.2
-1.2
2.1
0.7
3.6
5.3
1.4
2.2
1.5
3.7
1.9
3.7
0.3
5.1
2.9
1.7
3.0
1.8
3.7
4.8
3.0
2.6
2.4
4.3
2.9
3.4
1.5
3.1
Asia (ex-Japan)
China
Hong Kong
India
Indonesia
Korea
Malaysia
Philippines
Singapore
Sri Lanka
Taiwan
Thailand
Vietnam
5.9
7.7
3.2
4.3
5.5
2.8
4.8
7.0
3.5
7.2
1.8
3.0
5.3
Latin America
Argentina
Brazil
Chile
Colombia
Mexico
Peru
Venezuela
Memorandum Lines: 1/
G7
Industrial Countries
Emerging Markets
BRICs
Euroland
Germany
France
Italy
Spain
Netherlands
Belgium
Austria
Finland
Greece
Portugal
Ireland
Other Industrial Countries
United Kingdom
Sweden
Denmark
Norway
Switzerland
Canada
Australia
New Zealand
3.5
Current account (% GDP)
2013F
2014F
2015F
Fiscal balance (% GDP)
2013F
2014F
2015F
3.4
0.0
0.0
-0.2
-3.3
-2.9
-2.5
2.5
2.3
-3.0
-2.6
-2.7
-3.8
-3.1
-2.0
2.7
1.5
0.8
1.1
2.1
-9.5
-8.0
-6.6
1.4
1.6
1.5
1.5
1.1
1.8
1.4
1.7
2.0
-0.4
0.9
1.1
1.5
1.8
1.3
1.5
1.2
1.8
1.6
1.8
1.9
0.0
1.1
1.3
1.8
7.1
-1.7
0.6
1.2
12.8
-0.5
3.2
-0.8
0.0
0.5
3.5
1.4
7.0
-1.5
1.3
1.5
11.7
0.5
3.5
-0.4
1.0
1.5
4.0
1.3
7.1
-1.3
1.8
1.8
12.3
0.5
3.5
0.7
2.0
2.0
4.0
-2.9
0.1
-4.1
-3.1
-6.5
-3.9
-3.0
-2.1
-2.7
-4.5
-5.4
-7.4
-2.4
0.2
-3.3
-2.9
-5.3
-3.3
-2.9
-1.8
-1.8
-3.4
-4.4
-4.9
-2.0
0.4
-2.9
-2.9
-4.0
-3.0
-2.7
-1.6
-0.7
-2.5
-3.3
-2.8
2.7
0.1
0.7
2.3
-0.1
1.1
2.3
1.1
2.2
1.1
1.5
2.6
0.5
1.9
2.2
1.9
2.0
2.0
1.9
2.0
1.0
2.4
2.1
2.3
-3.5
6.5
6.3
12.5
12.5
-2.7
-2.4
-4.6
-3.2
6.0
6.1
12.0
12.1
-2.5
-2.1
-3.9
-2.8
6.0
6.0
11.5
11.8
-1.8
-1.7
-6.0
-6.0
-1.5
-2.0
11.0
0.7
-1.4
-1.8
-1.7
-4.8
-1.0
-1.8
10.5
0.8
-0.9
-1.7
-0.3
-4.1
0.5
-1.5
10.0
1.0
-0.3
-0.9
0.3
3.5
2.2
4.2
2.0
4.2
5.2
3.9
2.6
2.8
4.3
3.5
4.4
2.0
3.4
4.8
1.4
6.9
1.8
1.6
6.0
1.0
4.1
6.7
3.8
5.7
7.5
-0.4
1.5
4.5
0.9
8.6
1.7
2.0
5.6
2.3
2.3
5.2
3.6
5.1
6.4
1.4
2.5
4.7
2.0
10.5
2.8
2.2
6.3
2.7
3.2
4.7
3.5
5.3
6.8
2.9
2.5
0.7
-0.6
-2.1
1.2
1.6
1.3
-1.4
-1.6
1.7
16.4
-6.6
-7.5
-10.2
17.9
0.2
-1.1
-0.4
1.0
1.9
2.0
-1.6
-3.1
1.7
9.8
-5.6
-6.5
-7.5
14.1
-0.4
-2.5
-2.8
0.6
2.1
1.5
-2.5
-3.0
1.0
8.0
-5.0
-6.0
-7.0
13.0
-1.1
-3.1
-14.7
-2.9
-3.6
5.3
-4.8
-2.5
-0.6
11.9
-4.1
-2.3
-4.0
9.7
-0.8
-2.7
-13.2
-2.9
-3.0
4.8
4.0
-2.2
-1.1
7.7
-4.0
-2.3
-4.5
7.1
-1.6
-2.6
-14.3
-2.7
-2.5
3.3
-3.1
-2.2
-1.3
7.4
-3.5
-2.3
-4.2
7.4
6.9
8.6
5.0
5.5
5.2
3.9
6.0
6.8
3.5
7.5
3.5
4.2
5.8
6.8
8.2
4.5
6.0
5.5
3.6
5.8
7.0
4.2
7.5
3.4
5.0
6.3
3.5
2.6
4.1
6.3
7.0
1.1
2.1
2.9
2.3
7.0
0.8
2.2
6.6
3.9
3.5
3.5
5.5
6.7
1.8
3.0
4.1
2.8
7.0
0.9
3.2
7.3
4.0
3.2
3.2
6.3
6.5
2.8
2.9
3.3
3.5
7.4
1.2
2.4
9.8
1.5
2.4
-0.9
-3.4
-3.9
5.7
3.6
4.0
14.7
-4.1
10.8
-0.3
3.2
1.5
2.2
3.7
-3.0
-3.3
4.5
4.5
4.1
15.5
-3.1
9.4
0.2
2.0
1.1
1.9
2.7
-3.5
-2.8
3.6
6.3
4.4
14.5
-2.7
8.1
-0.6
-3.1
-3.0
-2.0
2.8
-7.5
-2.2
-0.7
-4.2
-2.0
7.3
-5.8
-3.0
-3.0
-6.0
-2.8
-1.8
3.2
-7.3
-2.4
-0.1
-3.8
-2.4
6.9
-5.5
-2.0
-3.2
-6.2
-2.5
-1.5
3.5
-7.0
-2.6
0.1
-3.3
-2.2
6.8
-5.0
-1.1
-3.3
-5.5
2.3
2.4
2.2
4.3
4.0
1.2
5.2
1.5
2.6
1.6
1.9
4.2
4.3
3.2
6.0
0.5
3.1
2.8
1.7
4.5
4.5
3.6
6.5
3.5
9.0
24.9
6.2
1.7
2.6
3.7
2.5
40.0
9.9
28.5
5.8
2.8
3.1
3.8
2.7
47.5
8.9
23.6
5.4
3.0
3.6
3.7
2.9
43.0
-2.4
-1.2
-3.6
-3.2
-2.6
-1.4
-5.0
1.7
-2.3
-1.6
-3.2
-3.8
-2.7
-2.0
-5.5
4.3
-2.5
-2.0
-3.5
-3.2
-3.0
-2.2
-4.5
4.2
-3.5
-3.6
-3.2
-0.9
-2.4
-2.9
1.0
-14.3
-3.8
-3.8
-3.8
-0.5
-2.3
-4.0
0.6
-11.5
-3.7
-3.6
-3.4
-0.4
-2.2
-3.6
0.5
-13.5
1.3
1.2
4.5
5.6
2.3
2.2
5.3
6.4
2.5
2.5
5.4
6.4
1.4
1.4
4.7
4.3
2.3
2.1
5.1
4.4
2.0
2.0
5.0
4.3
-1.2
-0.7
0.7
0.4
-0.9
-0.6
0.6
0.4
-0.7
-0.5
0.1
0.0
-4.3
-4.0
-2.7
-3.2
-3.5
-3.3
-2.5
-3.2
-2.6
-2.4
-2.5
-2.9
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.
Page 2
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Table of Contents
Diverging Markets
EM economies and asset markets have disappointed, leading to a growing perception that better opportunities lie
elsewhere. This is too simplistic. Some economies will continue to struggle but growth elsewhere will remain relatively
strong, albeit below past peaks. Investment appetite for EM may also be lower than in recent years. This could see some
markets overshoot to the downside in the near term as expectations adjust. But there is still sufficient value in EM to
justify a material allocation in global portfolios over the longer term. Spotting the divergence within EM will be the key to
extracting it. ............................................................................................................................................................................ 04
Rates in 2014: Refocusing on EM Fundamentals
Closer to their historical norm, we expect term premia in EM curves to track more closely with growth potentials and
inflation trends in 2014. Accordingly, we expect country specifics to continue to play an important role in performance.
Overall, we find that the cushion to absorb a potentially faster pace of global growth is more limited in the short end and
belly, expecting EM curves to bear-flatten as normalization proceeds and volatility subsides. ........................................... 15
Sovereign Credit in 2014: Back in the Black
While EM assets are likely to face continued headwinds in 2014, we believe the dramatic negative shift in the wider
perception of EM debt cannot be repeated in 2014 given the return of risk premium. With continued taper risk, we start
the year with a neutral overall exposure, but believe EM sovereign spreads have potential for moderate tightening,
offsetting a rise in US yields, offering about 6% return in 2014........... ................................................................................ 20
FX in 2014: Diverging Currencies
Despite still being exposed to a tapering/guidance related hurdle we see a better potential for EMFX as an asset class in
the upcoming year. While EMFX will probably continue to be a shock absorber to global risks, the prospects of a more
benign economic backdrop should not only help EMFX but evidence the nuances between EM economies that are likely
to grow in 2014........... ........................................................................................................................................................... 34
EM Performance: Too Much Ado about Technicals
We find little evidence of technical bottlenecks determining EM performance – both of domestic and external sources.
Instead, this seems to originate in cyclical – fundamentals-related – weakness in demand rather than secular portfolio
shifts. ...................................................................................................................................................................................... 39
Asia’s Frontier Economies: Plenty of Alpha
We focus on eight selected frontier economies of Asia that hold promise for a better tomorrow, not just for their
population but for investors seeking alpha in an increasingly correlated world. Most of these economies, because of their
early stages of development and lack of market depth, are by and large uncorrelated to global markets, thus offering a
useful investment strategy ..................................................................................................................................................... 45
Brazil: Overview of 2014 Presidential Elections
Barring a significant deterioration in economic conditions, the most likely scenario for next year’s elections is that
President Dilma Rousseff will be re-elected due to her high approval ratings, low unemployment, extensive welfare
policies, and her party’s powerful political structure. While we believe some policy adjustments will be inevitable
(especially on the fiscal front), we expect Rousseff to maintain strong government intervention in the economy, and do
not anticipate significant progress in structural economic reforms during her second term........... .................................... 49
US Manufacturing and Mexican Growth
Manufacturing activity has recovered more slowly in Mexico than in the US throughout late 2012 and 2013, partly
explaining subpar GDP growth in Mexico recently. Using manufacturing disaggregate data for both countries, we find
that those activities characterized by the highest correlation between the two countries grew more slowly in the US in
2013. Furthermore, we estimate that if the recovery of US manufacturing had been generalized across activities this year,
manufacturing output south the border would have been approximately 4% larger. Such broad base growth is expected
for 2014, likely adding 70bps of GDP growth to the Mexican economy. ............................................................................. 54
Foreign Demand for EM Local Currency Debt
Foreign holdings of EM local currency debt have increased 3-fold in the past 4 years, adding USD500bn of additional
investment. This increase has been driven by the emergence of global local currency bond funds, but in recent months
appetite for such funds, as indicated by mutual fund flows, appears to have reversed. In this report we look beyond the
EPFR flow data to understand the global dynamics of non-resident demand. We examine the data which is available from
each country on non-resident bond holdings ........................................................................................................................ 57
Deutsche Bank Securities Inc.
Page 3
5 December 2013
EM Monthly: Diverging Markets
Diverging Markets
„
„
„
We have witnessed a dramatic shift in the
perception of EM as an investment destination.
After many years during which EM was touted as
an outperformer, there is now a perception that
better opportunities lie elsewhere.
Others, including Brazil, Russia, South Africa, and
Venezuela, will struggle to deliver tough reforms
and their economic performance will reflect this.
„
Given this outlook, we expect appetite for EM
investment to be lower going forward than in
recent years, but offering sufficient value to justify
a material allocation in global portfolios. As the
shock waves from the crises in developed markets
dissipate, and as fund flows become less dominant,
the correlation between EM (local currency) fixed
income and DM fixed income should decline,
increasing the value of EM as a diversifier once
again.
„
In the near term, however, as investors re-calibrate
their expectations for the performance of the asset
class valuations could continue to overshoot to the
downside. This is already taking place in currencies,
the natural shock absorbers that actually render
EM less fragile, and in sovereign credit.
There are several, related, factors which have
contributed to this shift:
—
Growth has weakened, especially in the larger
economies, just at the time when expectations
of growth in DM have been improving;
—
Capital flows to EM slowed sharply on fears of
Fed tapering, exposing vulnerable external
positions in a number of cases;
—
Several countries have seen large scale
protests as growth has not kept pace with
popular aspirations that were raised during
earlier phases of rapid expansion;
—
EM asset markets have underperformed.
We believe that investors’ perceptions have been
exacerbated by cyclical factors, but structural
bottlenecks should not be discarded – especially in
the larger economies. It is becoming increasingly
inappropriate, however, to base investment in the
asset class on sweeping judgments of economic
outperformance
or
excess
risk
premium.
Differentiation has increased.
„
The differences relative to developed markets are
no longer large relative to the variation within the
asset class. The future of EM will be one of
divergence within these markets rather than one of
collective outperformance or underperformance.
„
Key to such divergence will be the paths taken in
adjusting to rising global interest rates. With the
possible exception of Ukraine, this is highly unlikely
to trigger a classic EM crisis. It will, however, be a
painful process for those countries with large
external financing needs, though India is now
relatively better positioned to weather this storm.
„
„
In the years to come, there will be a premium on
reform as tailwinds that favored EM over the last
decade fade. Asia remains best placed to deliver
high growth, albeit not as rapid as in the recent
past. Chile, Colombia, Peru, and Turkey, should
enjoy relatively healthy expansions. Mexico and
much of central Europe, which have been among
the poorest performers in recent years, are set to
see growth accelerate. A little further down the line,
we could also see brighter days in Argentina if
elections in late-2015 lead to a change of policies.
Page 4
Introduction: the past and present of EM
After many years during which EM was touted as an
outperformer, there is now a perception that better
opportunities lie elsewhere. Circumstances that led to a
golden age for EM will not be repeated. Economies are
closer to maturity, most of the low hanging fruits of
reform have been picked, and the external backdrop
has become more challenging. Growth has slipped
accordingly.
Asset
market
performance
has
disappointed. Does this simply represent the difficult
teenage years for EM or is it symptomatic of a deeper
malaise?
The Golden Age of Emerging Markets
The decade leading up to the 2008 financial crisis were
transformational
years
for
emerging
markets,
characterized
by
several
unusually
favorable
developments:
„
The great moderation and years of robust
expansion in the US provided a tremendously
strong foundation for the global economy.
„
The establishment of the single market and single
currency in Europe provided a second powerful
engine for growth and reform, especially for
emerging European countries that joined an
enlarged European Union.
„
Within EM, the widespread adoption of
macroeconomic stabilization policies following the
crises of the 1990s and early 2000s tamed inflation
and brought public finances under control. Fixed
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
exchange rate regimes were ditched. Ability to
borrow in local currency increased.
„
The emergence of China and, especially, its
integration into the global trading system was a
hugely positive supply shock for the world.
Exiting demographic windows
Exit year
2080
2060
The associated super cycle in commodities
provided a fillip for previously struggling natural
resource producers.
2040
„
Favorable demographics further underscored EM’s
advantage over DM.
2000
„
Lastly, and most recently, cheap and plentiful
external
financing
following
unprecedented
monetary expansion in core markets has cushioned
the slowdown in global activity.
„
The broadening appreciation of such factors helped to
fuel an unprecedented increase in investment into
emerging asset markets. Nowhere has this been more
evident than the boom in EM fixed income markets in
recent years. Dedicated EM debt mutual funds, for
example, now manage well over USD 300bn of assets
compared to a pre-crisis peak of USD100bn. Foreign
holdings of Mexican local currency bonds have risen by
USD 110bn over this period, a pattern that has been
replicated to varying degrees in Brazil, Malaysia,
Poland, Russia, South Africa, Turkey, and beyond.
The future will be more challenging
These tailwinds have faded and, in some cases, turned
into headwinds. We see six key challenges for EM in
this regard:
„
Global growth will be stronger than it is today but
below the peaks seen from 2003-07.
„
The cost of external financing will increase as the
Fed and other major central banks slowly start to
withdraw monetary stimulus.
„
A possible multi-year dollar upswing will challenge
the competitiveness of some EMs.
„
Demographics will turn less favourable, more
imminently for some countries, such as Russia,
than others.
„
Commodity prices may be well supported at
current levels but are past their peak.
„
Growth models within EM are past their sell by
date in some cases, with their excessive reliance
on demand vs. supply.
Exit year shows the point at which countries exit the "demographic window " when the working age population is most prominent, defined (by the UN) as the period when the proportion of children falls below 30 percent and proportion of people over 65 is still below 15 percent. 2020
1980
1960
1940
FRA
USA RUS CHN BRA TUR MEX
IDN
IND
ZAF
Source: UN, Deutsche Bank
Growth in EM is already fading, especially in the larger
economies. While growth reached 10% during the
immediate post-crisis rebound, it has decelerated to
5% over the last couple of years. Against this backdrop,
meeting the demands of newly aspiring populations
will be more difficult. Social tensions are to be
expected and the political environment will become
noisier. Public protests, such as those recently
witnessed in Brazil, Russia, South Africa, and Turkey,
are likely to become a more regular occurrence.
This more challenging environment is already weighing
on the performance of emerging asset markets.
Relative to most other asset classes, emerging FX and
fixed income markets sold off more aggressively during
the summer when tapering fears were at their most
acute and rebounded less strongly as these fears
dissipated. Benchmark indices for both local currency
and hard currency debt, for example, remain down
around 5.5-6% this year. This has left many investors in
The inflows to EM debt funds have been disappointed
Return on inflows of hard ccy funds
%
30
Return on inflows of local ccy funds
%
15
10
20
5
10
0
-5
0
-10
-10
Jan 10 Jan 11 Jan 12 Jan 13
-15
Jan 10 Jan 11 Jan 12 Jan 13
Note: Each bubble represents a month of inflows to EMD funds, with the
size of the bubble being proportional to the amount of inflow (in USD)
and the y-axis indicating the cumulative average fund performance since
the inflow occurred.
Source: Deutsche Bank
Deutsche Bank Securities Inc.
Page 5
5 December 2013
EM Monthly: Diverging Markets
EM sitting on losses or only marginal gains. We
estimate that less than 40% of the mutual fund inflows
to EM local currency assets since the start of 2010 are
in the money, with less than 20% having cumulative
gains in excess of 5%. For EM hard currency
investment, the picture is only a little better: 56% of
inflows are in-the-money, with 33% above 5%
cumulative gains.
Mind the gap: trend growth in EM and DM
Trend GDP growth %
9
BRICS
8
7
EM
6
5
While portraying EM as a single asset class has always
been overly simplistic, it used to be broadly sufficient
given the powerful collective forces that drove
performance during their golden age. The distinction
between EM and DM was significant enough that the
details could be ignored. This no longer applies: the
differences within EM and DM are now more
significant than the distinctions between the two
groups.
The future of EM is thus likely to be one of diverging
performance. Higher US interest rates will raise the bar
for some and perhaps even trigger a crisis in the odd
case. Others will sail through largely unscathed. Some
countries are emerging from deleveraging and are
poised to enjoy significant acceleration activity. Others
overly reliant on cheap credit or high commodity prices
need to undertake painful reforms to avoid further
deceleration in growth. Social discontent may be the
catalyst they need for change. These are the factors
that will determine the divergences in performance and
to which we now turn, starting with long-term growth
prospects.
Diverging growth prospects
In aggregate, we estimate that the potential growth
rate of EM will decline from a peak of 6.5% prior to the
crisis to about 5% over the next five years, driven
primarily by a deceleration in the larger EM economies.
This is disappointing and explains much of the current
pessimism towards EM. If we exclude the BRICS
economies, however, the drop in growth is much less
dramatic, from a peak of 4.2% to around 3.6% over the
next five years.
Within EM, however, the pattern will be far from
uniform. Reform priorities differ from country to
country. In a few cases, there are still lingering first
generation macroeconomic stabilization issues that
need to be addressed. Russia, for example, needs to
complete its transition to inflation targeting. Others,
such as Brazil, Indonesia, and Turkey, have broadly the
right frameworks in place but have not always
implemented them effectively, resulting in episodes of
high inflation. At the other end of the spectrum,
Argentina and Venezuela have not even hinted at
fighting inflation.
4
Non-BRICS EM
3
2
G7
1
0
1980
1985
1990
1995
2000
2005
2010
2015
Source: Haver Analytics, IMF, Deutsche Bank
Among the larger EM economies, however, the
priorities lie mostly in the area of structural reforms.
China, for example, has relied on capital accumulation
and the absorption of surplus rural labor into more
productive activities in urban areas. Very high rates of
investment have inevitably resulted in diminishing
returns. The labor force will also start declining within
the next few years. Maintaining high growth rates will
therefore require much greater efficiency in the use of
capital and labor. This will in turn require deregulation
and a shift from state-owned to private enterprise.
Commodity producers will no longer be able to ride the
super cycle in prices that made consumption-led
growth an easy option. Greater investment is needed to
foster faster productivity growth and diversification into
other areas of economic activity. Some, including
Russia and South Africa, will also need to encourage
more investment in natural resources just to maintain
their comparative advantage in these areas. Few have
made much progress. Among major EM commodity
EM commodity producers fail to diversify
Manufacturing exports as % of total goods exports (2000=100)
120
100
CHL
80
ZAF
IDN
60
RUS
BRA
40
2000
2002
2004
2006
2008
2010
2012
Source: Haver Analytics, Deutsche Bank
Page 6
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
producers, manufactured goods, for example, account
for a lower share of total exports today than they did a
decade ago.
What of the prognosis for reforms? Asia remains best
placed to deliver high growth, albeit not as rapid as in
the recent past. Chile, Colombia, Peru, and Turkey,
should enjoy relatively healthy expansions. Mexico and
much of central Europe, which have been among the
poorest performers in recent years, are set to see
growth accelerate. Others, including Brazil, Russia,
South Africa, and Venezuela have not signaled any
sense of urgency in responding to this new reality .
Potential growth rates in EM
Potential growth (%)
12
10
2003-07
2014-18
8
6
various sectors, especially retail, to more foreign
investment; and capital account liberalization.
Additional reforms are underway, including an
ambitious deregulation of the banking sector.
Regardless of the nature of coalition that governs India
after elections next year, economic performance will
likely be better.
Outside the big two in Asia, the low hanging fruits of
reform appear most evident in Indonesia. The recent
economic slowdown has been mainly cyclical and a
function of loose macroeconomic policies, which led to
overheating and worsening of external balances.
Recent steps to tighten policies are thus welcome.
Blessed with a large and young population, a rich
commodity base, stable democracy, a thriving civil
society, improving governance, and low leverage (the
combined debt of public sector and households is less
than 50% of GDP), the economy is ripe for an
acceleration in growth provided the right policies are
deployed to encourage investment. Regardless of the
outcome of next year’s election, it is likely that reforms
in the mining sector and labor market will resume and
should further support growth.
4
2
G7
EM
CHN
UKR
IND
RUS
HUN
POL
ARG
BRA
KOR
ZAF
TUR
MAL
CHL
COL
THA
PHL
MEX
IDN
0
Countries ranked by change in change in potential growth (lowest to highest)
Source: Haver Analytics, IMF, Deutsche Bank
High or higher growth
While China will not return to the double-digit growth
rates of the past, it should be able to sustain growth
rates in excess of 7% for the rest of this decade. The
deregulation of interest rates will raise the cost of
capital and weigh on growth. Allowing capital to be
reallocated away from a state sector to the private
sector, on the other hand, should allow productivity
growth to be maintained. Financial deregulation and
the opening up of protected sectors to private investors,
both domestic and foreign, will be needed to deliver
this. The reforms announced last month go a long way
in this direction. The improving outlook in the US and
Europe should also help the process of adjustment to a
somewhat lower but more durable growth trajectory.
Recent reforms in India are also likely to pay dividends.
Despite an economic slowdown and a fairly
unfavorable political environment, the government has
implemented an impressive range of reforms,
including: fuel price reform and fiscal consolidation;
energy sector reform, especially tariff liberalization; the
unlocking of numerous projects stuck at various stages
of regulatory and administrative approval; opening up
Deutsche Bank Securities Inc.
Elsewhere in Asia, Malaysia, with the recent conclusion
of elections, has a fairly unimpeded half-decade
window to carry out reforms to reduce its dependence
on the commodity sector, embrace high valued added
manufacturing, reduce public sector intervention in the
corporate sector, and consolidate fiscally. The latest
budget offers some hope in this regard. The Philippines
is keen to boost its infrastructure for both
manufacturing and tourism, and in that respect the key
reform would be to set up regulation and operating
mechanism for public-private partnerships. Thailand
could also offer good returns given its productive
manufacturing and labor base, thriving tourism and
agriculture
sectors,
and
a
well
anchored
macroeconomic policy framework. But it would first
need to deal with seemingly perennial political unrest
and upgrade its infrastructure where there has been a
gap between announcements and implementation.
In EMEA, we see the challenges in Turkey as mostly
cyclical in nature. Favorable demographics, a welldiversified export sector, and relatively low levels of
leverage should support growth over the medium term,
though participation in the labor market remains low
(especially among women) and excessive reliance on
foreign savings will leave the economy prone to boom
and bust cycles. The year ahead may be difficult given
the twin challenges of Fed tapering and important
domestic elections. But thereafter the economy should
be able to sustain growth rates comfortably in excess
of 4%.
In central Europe, after years of underperformance,
much of the region (Hungary being an exception) is
primed for a relatively strong upswing. The drag from
Page 7
5 December 2013
EM Monthly: Diverging Markets
years of fiscal consolidation and deleveraging in the
private sector is now starting to fade, confidence is
returning, and domestic demand should respond
accordingly. Competitiveness has improved as
manufacturers have successfully plugged into the
German supply chain, leaving them well placed to take
advantage of strengthening global and European
recoveries. Vulnerabilities have also been reduced as
balance sheets have been rebuilt and external positions
strengthened, leaving the region more resilient to rising
US rates.
Strong and weak performers in Latin America
Gross investment (% GDP)
26
Stronger performers
PER
24
COL
CHI
22
ARG
MEX
20
Competitiveness gains in central Europe
Share of German export market (September 2007 = 100)
160
BRA
VEN
18
ROM
15
20
25
30
35
40
45
Government primary expenditure (% GDP)
Source: Haver Analytics, Deutsche Bank
140
POL
120
CZE
100
HUN
80
Sep-2007
Sep-2009
Sep-2011
Sep-2013
Source: Haver Analytics, Deutsche Bank
Mexico has been the market destination of choice in
Latin America over the last year. Despite strong fiscal
and monetary institutions, deep local pension markets,
and a liberal trade regime, performance in recent years
has been lackluster, partly due to US weakness. A new
administration, however, has already delivered labor
market, financial, and fiscal reforms. Proposals to allow
greater private investment in the energy sector are set
to be passed by the end of the year and would be
another step in the right direction given Mexico’s
abundant natural resources. Together with a pick up in
the US, this should support moderately stronger
growth in Mexico.
Elsewhere in the region, Chile, Colombia, and Peru
have already delivered significant reforms over the past
decade or two. They have seen some slowdown in
growth recently and remain relatively dependent on
commodities but are still delivering solid productivity
gains and should remain the fastest growing
economies in the region.
Low or lower growth
Brazil has relied for too long on consumption-led
growth. This was sustainable so long as commodity
prices were on an upward trend. Financial deepening,
from a low base, also helped. But these tail winds have
faded. Potential growth has probably already dipped
Page 8
below 3% and will remain there if nothing changes.
Low investment, among the lowest in EM at less than
20% of GDP, is the main constraint to higher growth.
There are various reasons for this. The lack of a proper
regulatory framework for infrastructure projects has
also taken a heavy toll on long term investment. Public
investment in infrastructure has been squeezed by
higher spending on public wages and social transfers.
The latter has discouraged savings while high
corporate tax rates to pay for this spending have
weighed on private investment. Public debt dynamics
are still favorable: little or no adjustment in the overall
fiscal position would be needed to keep debt on a
sustainable path. Reforming the tax regime or the
social security system against this backdrop should
therefore be possible. In our view, however, the
likelihood of such changes, even after elections next
year, is still low – for ideological reasons.
Russia has made significant strides on macroeconomic
reforms, which have helped to reduce inflation to
historically low levels and maintained a buffer of oil
savings. But experience elsewhere shows that this will
not be enough and indeed potential growth is probably
not much more than 3% right now. Like China,
resource allocation needs to become more efficient,
which will necessitate a reduction in the role of the
state, including in the banking sector. Investment also
needs to increase, which will require a better
investment climate, better governance, and more
transparency. Russia must also deal with the
challenges of an ageing population, which will bite
sooner than in all other major EMs. Plans are in place in
each of these areas, which have delivered some
results: Russia joined the WTO last year and this year
and reached the top 100 in the World Bank’s Doing
Business survey this year. But implementation has
been hesitant and is likely to remain so.
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Despite its strong institutions and first rate local capital
markets, structural impediments have also weighed on
both growth and the external accounts in South Africa.
Public infrastructure has suffered from years of lack of
investment, resulting in power shortages and a lack of
capacity in the port and rail systems. These are being
addressed. Significant new power generating capacity
is set to come on stream late next year, for example.
But it will be some years before these bottlenecks are
fully resolved. There are few grounds for much
optimism beyond this. Labor markets are not
functioning properly, resulting in strikes and high wage
settlements that are in turn limiting employment
growth, eroding competitiveness, and discouraging
investment. Despite significant public spending (higher
than in the US), the education system is delivering
outcomes that are among the worst in the world.
Education outcomes in EM
Best
7
Quality of maths and science education
6
5
South Africa
Argentina has followed a similarly myopic path over the
last decade, using commodity income to finance
consumption while deterring investment. Recent midterm elections, however, confirm a new social
preference for more balanced policies. General
elections are still nearly two years away. But with vast
relatively unexploited natural resources and an
economy that is basically unleveraged, there are
reasons to be optimistic about the longer-term outlook
if the electorate turns its back on the last decade of
failed policies.
Adjusting to the end of easy money
If the factors discussed above will play out over the
next several years, the near-term economic
performance of EM will be determined as much by
how its economies adjust to rising US rates and the
end of easy money. The impact on global liquidity
conditions may be partially offset by continued
aggressive monetary expansion by the Bank of Japan
and, potentially, the ECB if it feels the need for another
long-term refinancing operation. Nevertheless, past
and recent experience suggests that adjusting to higher
US rates will be a bumpy ride for many – emerging and
developed.
4
Deutsche Bank Securities Inc.
% GDP
10
8
6
4
2
0
-2
-4
ZAF
TUR
UKR
ISR
IND
IDR
THA
POL
MEX
CHL
BRA
COL
CHN
ROM
CZE
-8
RUS
-6
PHL
Venezuela has spent most of its commodity windfall
and emerged with little to show for it. After years of
increased state intervention in the economy financed
by high oil prices and debt, the country now finds itself
saddled with excessive regulation, inefficient state
companies, and a rigid exchange rate regime. With
President Maduro seemingly fully committed to
maintaining this “Bolivarian Revolution” of deceased
President Chavez, this will likely mean low growth,
high inflation, and rationing of basic goods. Debt
service remains manageable, but on a clear
deteriorating path.
EM Basic Balances
HUN
Hungary will likely see a moderate cyclical recovery but
its longer-term prospects remain constrained by the
excesses of the past. The stock of public and private
debt has fallen but remains onerous at over 230% of
GDP. It is running small current account surpluses and
modest fiscal deficits. But without much faster growth,
which would in turn require a more supportive
business climate, it will require years of tight policies to
reduce debt levels to more comfortable levels.
We had a fire drill over the summer when fears of Fed
tapering first surfaced. After an initial wave of selling
that largely reflected market positioning, attention
quickly shifted towards fundamentals. The so-called
fragile five EM economies (Brazil, India, Indonesia,
South Africa, and Turkey) that were characterized by
TAI
Source: World Economic Forum – The Global Competitiveness Report 2013-14, Deutsche Bank
There are two main features of EM economies that
make them potentially sensitive to rising global interest
rates: first, reliance on external financing flows, which
are likely to become both less abundant and more
costly; and second, high leverage levels in some cases,
in either the public or the private sectors, which will
see debt service costs rise as interest rates increase.
KOR
ZAF
MEX
BRA
COL
ARG
PHL
TUR
THA
POL
RUS
CHN
IDN
UKR
1
KOR
2
SGP
Worst
3
Basic balances are the sum of the current account balance and foreign direct investment.
Source: Haver Analytics, Deutsche Bank
Page 9
5 December 2013
EM Monthly: Diverging Markets
large external imbalances and high inflation generally
saw the biggest corrections in their currencies and
local rate markets.
Should we expect the same pattern repeat itself as and
when the Fed finally does begin to taper its asset
purchases? We have already seen a significant
adjustment in asset prices. Currencies in the fragile five,
for example, have recovered a little in recent weeks but
still look moderately cheap relative to our measures of
longer-term fair value.
markets has actually hit new peaks in recent weeks.
Even in Turkey, which has been in the eye of the taper
storm, the share of foreign holdings of domestic debt
securities is barely 2ppts below its May peak.
The fragilities that led to underperformance in the first
place have also not changed all that much in the last
few months although we would expect to see some
more differentiation within the fragile five.
„
The change of governor at the Reserve Bank of
India and a greater emphasis on tackling inflation
has gained some credibility. The external accounts
are also improving and we expect the current
account deficit to dip to 3% of GDP next year.
„
Monetary policies in Brazil, Indonesia, and Turkey,
have also been tightened. Real policy rates are still
very low in Indonesia and Turkey, however, despite
relatively robust domestic demand and credit
extension. Fiscal policy has been loosened further
in Brazil ahead of elections.
„
South Africa’s vulnerabilities reflect structural
weaknesses rather than loose macroeconomic
policies. As such, they are less amenable to a quick
fix. Public infrastructure investment will continue to
boost imports for the next year or two but is
necessary to support long-term growth. More
worrisome is the performance of exports, where
high wage settlements, strikes, and low investment,
have undermined any competitiveness gains from
the weaker rand.
Currency valuation in the fragile five
Overvalued
Misalignment (vs. productivity‐adjusted PPPs)
15
Apr
End Nov
10
5
Undervalued
0
-5
-10
-15
BRL
TRY
IDR
INR
ZAR
Source: Haver Analytics, Deutsche Bank
On the other hand, we have seen relatively little
reduction in foreign exposure to local currency EM debt
markets. EM debt mutual funds have experienced
significant and ongoing outflows, but these investors
represent a relatively small part of the overall foreign
investment. Institutional funds meanwhile began
adding exposure once again as soon as July. The share
of foreign ownership of Brazilian local currency debt
Foreign ownership of local currency debt is not far
from the peak
Currencies will likely come under further pressure if
capital flows remain soft or weaken further. This is
highly unlikely to trigger a payments or solvency crisis
of the kind that once characterized EM. Currency
mismatches are generally small and certainly much
lower than in the past. Even in Turkey, where the short
FX position of companies has increased in recent years
to about 20% of GDP, this is offset by the long FX
position of households. Weaker exchange rates will not
therefore blow up balance sheets in the way that we
have seen in past major EM crises.
USD bn
800
700
The process of adjustment may nevertheless be painful
in terms of growth, especially if domestic liquidity
conditions need to be tightened further to keep
inflation in check. The large stock of foreign holdings of
local currency debt in these markets is another source
of potential risk. While foreign investors proved
relatively “sticky” during the summer, a further round
of selling could put upward pressure on yields and
squeeze growth.
Sum of all foreign holdings
AUM of EMD LC mutual funds
600
500
400
300
200
100
0
Mar 09
Mar 10
Source: Deutsche Bank
Page 10
Mar 11
Mar 12
Mar 13
Only Ukraine today has the features of a classic EM
crisis with a fixed and overvalued exchange rate, a
current account deficit that exceeds any in the fragile
five, currency mismatches, and very limited reserves to
defend the currency. The reduced availability and rising
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Government debt maturities in EM
Average remaining maturity (years)
16
2007
14
Government debt in EM
% GDP
140
2007
120
2012
100
80
60
40
20
EM
G7
UKR
MYS
ZAF
HUN
POL
CHL
THA
CHN
MEX
KOR
RUS
BRZ
COL
PHL
TUR
IND
IDN
ARG
0
Countries ranked by the change in government debt (highest to lowest)
Source: Haver Analytics, IMF, Deutsche Bank
At the same time, most countries have also been able
to take advantage of favorable financing conditions to
lengthen the average maturity of their debt. Once more,
only a handful of countries saw the average maturity of
their debt shorten over the last few years and in these
cases maturities were either already long and/or debt
levels low. Again, Hungary stands out as having seen
its debt level rise significantly from an already elevated
level while the maturity of that debt has shortened
further to less than four years.
12
10
8
6
4
2
ZAF
PHL
MEX
IND
THA
TUR
COL
BRZ
POL
IDN
MYS
ARG
HUN
CHL
0
RUS
Overall, EM sovereigns appear least vulnerable. As is
well known, EM sovereign credit metrics are generally
healthy, especially when stacked up against most
developed markets. Government debt levels in EM are
still only about 40% of GDP on average, barely onethird of the level in G7 countries, and not much higher
than before the global financial crisis. There are just a
handful of EM countries that have seen their debt ratios
increase by more than 10% of GDP (Ukraine, Malaysia,
South Africa, Hungary, Poland, and Venezuela) in the
last five years. But only in Hungary has this taken
government debt to levels that might be deemed
obviously excessive.
2012
KOR
cost of financing will likely require substantial domestic
adjustment and significant external financial assistance.
But Ukraine will be viewed as an exception and a crisis
there will not lead to a reappraisal of the rest of EM.
Countries ranked by the change in average maturites (shorter to longer)
Source: Haver Analytics, IMF, Deutsche Bank
Private debt levels, however, have increased more
rapidly over this period. Total credit to the non-financial
sector, from both bank and non-bank sources,
increased from 72% of GDP on average in 2007 to over
90% by early 2013. Our view, therefore, is that it will
likely be at the level of corporate and household debt
that the normalization of interest rates will probably be
most problematic. Across the three EM regions, the
risks appear greatest in Asia. Not only are debt levels
there much higher, averaging 130% of GDP versus
about 80% in EMEA and 40% in Latin America, but also
they have generally risen much more in Asia than in the
other regions, especially in China and Korea (and more
so for companies than for households).
Private debt levels in EM
Credit to non‐financial private sector (% GDP)
220
200
180
160
140
120
2007
100
2013
80
60
40
20
ZAF
ARG
MEX
IDN
RUS
IND
MYS
THA
POL
TUR
BRZ
KOR
HUN
CHN
0
Source: BIS, Deutsche Bank
Deutsche Bank Securities Inc.
Page 11
5 December 2013
EM Monthly: Diverging Markets
Implications for EM investment
performance
is obviously a key factor underpinning all three, but it is
useful to split the three up given their specific impact
on the various ways of investing in EM.
Since late May, mutual fund investors have steadily
and consistently withdrawn money from EM fixed
income. Strategic institutional investors have thus far
held firm, but there is evidently a re-assessment of EM
excess return potential taking place. The outcome of
this could have a profound impact on the performance
of the asset class for over the medium term. So, how
should we look at the excess return potential of EM
fixed income?
First, the more rapid growth of productivity supports
the real appreciation of currencies. This obviously
impacts any investment in local currency assets.
Higher real rates lead to a direct outperformance of
local currency fixed income assuming constant real
exchange rates. Finally, improving sovereign balance
sheets lead to stronger credit ratings and tighter
spreads for sovereigns (and often also for corporate
borrowers as the country risk premium declines) and
hence outperformance of hard currency debt. The
charts below illustrate the evolution of these three
variables in recent years.
Structural drivers of excess returns
In simplistic terms, we can think of the investment case
for EM relying upon structural macroeconomic drivers
that deliver trend outperformance (versus DM), and
short-term cyclical factors (macro, technicals, and
valuation) which result in oscillations around this
underlying trend, with frequent overshoots to the
upside and downside. At present there is a great deal
of focus on near-term factors, such as the timing of a
Fed tapering, and the impact that it has on capital
flows and currencies. We would view these as part of
the short-term cyclical factors. Nevertheless, as
discussed, there is also a re-assessment of the trend
potential of EM that is ongoing and impacting
performance of the asset class.
Note that when we consider ‘EM’ in aggregate in our
analysis, we weight the component countries/markets
according to the main benchmarks against which most
global fixed income investment is managed.
In all three cases the recent dynamics of these drivers
are not as powerful as they were in the 2002-07 period.
In the past couple of years, annual relative productivity
growth has slowed to just 0.8% from an average of
3.0% in 2005-07. Sovereign ratings migration has also
slowed, with effectively no improvement in average
credit quality, compared to an average pace of
improvement of 0.25 rating notches per year in 200307. The one aspect that remains robust is aggregate
real rates. While real rates are not as high as they were
at the start of the 2002-07 period, relative to US real
rates they remain at the high end of the range of the
past decade.
In terms of the macro-economic drivers, over the
medium-term, three factors ultimately dominate:
productivity growth relative to the trade partners, the
real interest rate premium over developed markets and
improving sovereign balance sheets. Economic growth
The structural drivers of EM outperformance are not as powerful as during the 2002-07 period
Real rate differential vs US
8
Per-capita PPP GDP vs US
125
120
Average credit rating of EM sovereign USD debt
9
6
10
115
4
110
11
2
105
0
100
95
2005
2007
2009
2011
2013
-2
2004
12
2006
2008
2010
2012
2014
'02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13
As a proxy for productivity, we construct indices
Individual country real rates are constructed on
We take the average sovereign ratings from
of relative per-capita PPP GDP between
the basis of DB’s EMLIN sub-index yields minus
Moody’s S&P and Fitch and then construct an
individual EM countries and the US. These are
ex-post y/y inflation. From this we subtract 5Y
aggregate based on the weights of DB’s EM USD
then aggregated to provide a global EM index
TIIPS yield. Country real rates are aggregates
Sovereign index. On the scale above 9
using the weights of the GBI-EM Global
using the weights of the GBI-EM Global
corresponds to BBB/Baa2, 10 to BBB-/Baa3, etc.
Diversified.
Diversified.
Source: Deutsche Bank
Page 12
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
The decline in the pace of relative productivity growth
is at the heart of the shift in attitude towards EM.
However, it is not universal. Latin America has slowed
to 0.3% from 3.8%, EMEA to 0.2% from 1.5%, but in
Asia the slow-down has been more modest, falling to
2.4% from 3.0%. This pattern can also be seen in the
differential behavior of real exchange rates, with the
trend in both Latin America and EMEA stalling after
2007, but continuing to appreciate until more recently
in Asia.
Regional real exchange rates and productivity
and with real yields hovering at around 2% above the
US, there seems little justification to assume significant
outperformance by EM in the coming few years.
Absent a benign economic shock at the core, which
seems highly unlikely, reforms will likely be the key to
changing this picture, by reinvigorating growth. As
discussed above, the outlook is mixed with growth set
to remain relatively high in some cases, to recover from
low levels in others, but to remain low or fall further
elsewhere. These divergences should be reflected in
the long-term performance of asset markets within EM.
What does this mean for the medium-term
performance potential of EM fixed income? Can we
derive an expectation for returns using as a basis our
sober assessment of macroeconomic prospects?
differentials
Latin America
140
Productivity (proxy) differential
130
Real exchange rate
Local currency fixed income:
In simple terms, over the medium-term, an investment
in local currency fixed income should deliver a USD
return from two sources: (i) real appreciation of the
currency relative to the dollar, fueled by productivity
gains and (ii) an excess return from the relative real rate
differential.
120
110
100
90
2005
2007
2009
2011
2013
EMEA
140
130
The chart below illustrates the trade-off between these
two variables: excess real rates (current 5Y) on the yaxis and growth differential (DB forecast for next 2years as a proxy of productivity) on the x-axis for a
range of EM local markets.
Drivers of long term value in local markets
120
Real rate differential vs US, %
110
BR
4
100
NG
3
90
2005
2009
2011
2013
PL
Asia
RO
140
CL
MX
1
CZ
130
PE
GBI
ZA
2
CO
TR
RU
HU
2007
ID
TH
KR
MY
IL
0
PH
120
-1
-2
-1
110
3
4
Dark blue points represent major local markets (GBI-EM Global
Diversified weights > 5%)
Diagonal lines represent constant values (0, +1.5%, +3.0%) of real rate
differential + 0.4 x growth differential.
100
90
2005
0
1
2
2014-15 growth differential vs US, %
2007
2009
2011
2013
* Real exchange rates are re-based such that Dec-2004 = 100
Productivity differentials are re-based so that there is no average misaligment
between the two series over the entire period.
Source: Deutsche Bank
The likelihood of broad acceleration in relative
productivity growth across EM seems low. As such,
Deutsche Bank Securities Inc.
Source: Deutsche Bank
Empirically we find that a coefficient of 0.4 for the
relationship between real exchange rates and percapita PPP GDP (our proxy for productivity). We can
use this coefficient to see the trade-off between growth
and real rates. For instance, we estimate the trend
Page 13
5 December 2013
EM Monthly: Diverging Markets
excess return for an investment in domestic currency
fixed income to be approximately RealRateDiff + 0.4 x
GDPDiff. This relationship is shown by the diagonal
lines on the chart, illustrating excess returns of 0%,
+1.5% and +3.0%.
While there is a fairly wide dispersion of expected
returns in the sample, it is interesting that all but two of
the major markets have excess returns between 1.1%
and 2.0%. For the GBI-EM (the most widely followed
benchmark) we obtain an excess return of +2.0%.
Given that this is a USD return in excess of US nominal
rates, it can be thought of as somewhat analogous to a
credit spread.
Despite a wide range of forecasts, excess returns for
many major EM markets lie in the 1.5-2.0% range
Expected excess return, %
+5.0
+4.5
justified by fundamentals. Historically EM sovereigns
traded tighter than equivalently rated DM corporate
credits. This was arguably justified during the time in
which EM sovereigns were on a strong, secular
upgrade path. However, in recent years, with the pace
of upgrades slowing substantially, such a premium was
no longer justified. However, the pendulum has now
swung in the opposite direction; EM sovereigns are
trading cheaper than similarly rated DM corporate
credits. This discount is not justified by fundamentals.
There is admittedly a risk of a rating downgrade for
some high profile sovereigns, but fundamentally,
balance sheets of EM sovereigns remain extremely
healthy.
Furthermore, with the market becoming
increasingly diverse (the EMBI Global now consists of
60 different sovereign credits), the performance of
idiosyncratic high yielders (such as Venezuela and
Argentina) is having a much-reduced impact on the
performance of the rest of the market.
EM sovereign spreads imply a rating 1 notch below the
+4.0
actual
+3.5
Average credit quality of EM sovereign USD debt
+3.0
+2.5
A
+2.0
A-
+1.5
As implied by the
spread at which it
trades
BBB+
+1.0
BBB
Israel
Czech…
Philippines
South Korea
Thailand
Romania
South…
Malaysia
Hungary
Russia
Poland
GBI-EM
Chile
Mexico
Turkey
Indonesia
Peru
Colombia
Brazil
0
Nigeria
+0.5
Source: Deutsche Bank
Is this sufficient to persuade the USD500+bn of
strategic institutional money currently invested in the
market to remain put?
We think it should be.
Considered in the context of other fixed income
opportunities an excess return of 200bp over US
nominal rates is material (basically double where real
US rates are priced to settle in five years!). Furthermore,
considering the substantial uncertainty that remains
regarding the future prospects for the global economy,
retaining a degree of diversification, and a foothold in
what still represents approximately 50% of the global
economy, is surely prudent. Lastly, USD 500bn remains
a very small proportion of the global fixed income
investment set.
Sovereign Credit
Assessing the excess return potential of sovereign
credit is somewhat more straightforward than for local
currency fixed income. The competing asset class(es)
are more obvious: developed market corporate credit.
The extent to which EM sovereign credit has
underperformed DM corporate credit during 2013 is
quite remarkable and, as far as we are concerned, not
Page 14
BBBBB+
Actual rating
BB
BB2003
2005
2007
2009
2011
2013
Source: Deutsche Bank
The premium offered by EM over DM corporate credits
provides a cushion, while EM rating migration pauses.
However, if EM countries seize the nettle of reform as
we discussed earlier, then it could trigger a renewed rerating of the asset-class. In this sense, persistently
positive growth differentials, albeit lower than in the
recent past, should also help. Given the underlying
strong balance sheets, this could happen relatively
abruptly, albeit not in the immediate future.
While external risks remain high and currencies the
shock absorber, we see credit (sovereigns and also
selected corporates) as the safest entry point (cyclically).
Structurally, the upside local markets offer remains
quite attractive – even if diminished.
Marc Balston, London, 44 20 754 71484
Robert Burgess, London, 44 20 754 71930
Drausio Giacomelli, New York, 1 212 250 7355
Gustavo Cañonero, New York, 1 212 250 7355
Taimur Baig, Singapore, 65 64 23 8681
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Rates: Refocusing on EM Fundamentals
„
The re-establishment of term premium that started
in 2013 is advanced and is now more comparable
to historical norms. It is obviously insufficient to
absorb possible bouts of volatility that could
accompany tapering and potential testing of
forward guidance.
„
With more premia embedded in longer tenors
across both EM and DM, we expect term premia to
track more closely with growth potentials and
inflation trends in 2014. Accordingly, we expect
country specifics to continue to play an important
role in performance.
„
„
„
„
We find that the cushion to absorb a potentially
faster pace of global growth is more limited in the
short end and belly of most EM curves. We favour
payers in Turkey and Israel but favour receivers in
Poland. We see residual value in receiving in
Hungary, while in South Africa the value in the
front end is now sizeable. In Asia we like paying
the front end of the Malay curve versus Thai, as
well as paying the front end of Korea and Taiwan
(maintaining a steepening bias).
There is a significant gap between current and
‘neutral’ policy rates, yet only a modest growth
upturn in the years ahead is priced by the midsector of EM curves. On account of attractive
valuation, low carry burden and high beta to US
rates, we find paying the ‘belly’ of the 2s5s10s
butterfly attractive in Mexico, Czech Republic and
(less so) Hungary.
As normalization proceeds and volatility subsides,
we expect EM curves to bear-flatten in 2014. The
Turkish curve stands out as a good candidate for
bear flattening. We also like flatteners in South
Africa and Israel, while favouring (bull)-steepeners
in Russia. In LatAm, we favour flatteners in Mexico
and Brazil and, less so now, steepeners in Chile. In
Asia we recommend buying bonds in India,
receiving in the long end of Singapore vs. US, but
paying Hibor-Libor spread. Still in Asia we like
paying spreads in China, Malay vs. Thai rates,
2Y/5Y Korea IRS outright and 2Y/5Y Taiwan
spreads.
Inflation premium also seems subdued. We find
the inflation premium too low in Turkey and favour
linkers vs. nominal bonds in Brazil and Chile.
Re-pricing: Part II
EM local markets started 2013 under booming inflows
and at very tight valuations despite prospects of
acceleration in global growth throughout the year. In
several “high-yield” markets, long-dated tenors barely
offered enough compensation for inflation. In some
Deutsche Bank Securities Inc.
cases, long-dated real yields turned negative as inflows
built. As we end the year, valuation and flows are still
on opposite sides, while the outlook for the US
economy is brighter again. However, now real yields
are back firmly in positive territory – even if still low by
historical standards in most cases. Despite better
valuations, however, outflows from local markets
persist, although at a much slower pace than in the
summer months.
Interest rate differentials vs. the US have recovered as
USTs sold off. The chart below presents the spread
between the market-weighted average of EM and
similar-duration US real yields (5Y sector). The two
charts cover not only “traded” real yields, but also a
more comprehensive sample of nominal bonds deflated
by inflation expectations in countries where linkers are
non-existent. The yield differential in favour of EM
ranges from 200-400bp and it is now hovering around
almost 350bp in the broader sample.
Interest rate differentials recover despite UST sell-off
Spread of EM 5Y (deflated) real yields vs.US 5Y TIIPS, bp
400
350
300
250
200
150
100
Dec 08
8
Nov 09
Oct 10
Sep 11
Aug 12
Jul 13
LatAm and EMEA 5Y linkers' yield index vs. US 5Y TIPS (%) LatAm vs. TIPS
EMEA vs. TIPS
6
4
2
0
2005
2007
2009
2011
2013
Source: Deutsche Bank, Bloomberg Finance LP
Page 15
5 December 2013
EM Monthly: Diverging Markets
This suggests that concerns about persistent outflows
and the absence of EM premium over developed
markets may be exaggerated – especially in LatAm.
Under DB’s baseline scenario for policy rates and US
rates (3.25% for UST10Y), we expect the EMLIN index
to return 4% this year vs. -8.7% so far in 2013. This
compares with -2% we forecast for UST in 2014.
In our view, the re-establishment of term premium that
started in 2013 is advanced.1 From the negative levels
of early 2013, term premia are now more comparable
to historical averages (or higher). They are obviously
insufficient to absorb possible bouts of volatility that
could accompany tapering and potential testing of
forward guidance. However, with more cushion priced
in longer tenors across both EM and developed
markets, we expect them to track more closely growth
potentials and inflation trends in 2014. Accordingly, we
expect country-specifics to continue to play an
important role in performance.
Although the global economy is improving, growth
risks remain two-sided, as 2013 reminded us
repeatedly. This will likely translate into range trading
for longer tenors. However, we find that the cushion to
absorb a potentially faster pace of global growth is
more limited in the short end and belly of most EM
curves, as we discuss in the following sections. There
is still a substantial gap between current and “neutral”
policy rates, while the mid-sector of EM curves prices
in modest growth upturns in the years ahead. Inflation
premium – though positive across EM – also seems
subdued.
In most emerging economies, labour markets are not
far from full employment and we have found no
(structural) systemic change in these economies’
linkages to developed markets. As we discuss in a
separate piece2, we believe that most EMs are on the
cusp of acceleration in growth. Several important
countries such as Brazil, South Africa, Turkey, Russia,
and India will likely lag for structural reasons, but they
already face persistently high inflation nevertheless.
Under this backdrop, is “monetary policy premium”
adequate? We find it to be low under our baseline
scenario of return to trend growth – even if gradually
so. In the charts below, we compare market pricing,
our estimates of “neutral” policy rates and the basic
elements of a Taylor rule to assess “monetary policy
premium”. In the first two charts, the horizontal axis
gauges the time it takes for yields as implied by the
forwards to meet our estimates of neutral policy rates.
We note that since these curves price some term
premium, this probably underestimates the implied
time to achieve neutrality. The charts compare this
“time to convergence” with our estimates of output
gaps and the differential between inflation expectations
and targets.
Assessing “monetary policy premium”
2.0
Expected inflation in excess of target (%)
TRY
1.5
BRL
1.0
MXN
0.5
COP
ILS
0.0
These may prove adequate should global growth
continue to recover gradually, but limited monetary
policy premium and the possibility that forward
guidance is tested (especially if the US accelerates as
we expect) suggest that local yield risks remain
exposed to further re-pricing in the year ahead –
possibly not as sharply as in 2013 at current valuations,
however. We expect EM curves to bear-flatten in 2014
once the dust settles.
KRW
payers
ZAR
receivers
‐0.5
CLP
PLN
INR
USD
HUF
CZK
RUB
‐1.0
EUR
‐1.5
Convergence time to "neutral" priced in (months)
‐2.0
0
2
12
24
36
48
ILS
BRL
HUF
COP
0
ZAR
PLN RUB
‐1
The short end: Testing “forward guidance”
The ability of EM central banks to commit to keeping
policy rates low for a prolonged period of time is
limited, in our view. Not only are output gaps lower,
but also inflation risks are higher. In only a few cases
(including Chile, Russia, Israel, and CE3) are inflation
expectations hovering below (by only a small margin)
or at the target.
72
Output gap (%)
1
EM specifics: Assessing curve premium
60
‐2
INR
payers
CZK
CLP
KRW
EUR
MXN
receivers
TRY
‐3
‐4
USD
‐5
Convergence time to "neutral" priced in (months)
‐6
0
12
24
36
48
60
72
Note:
1. We include India for completeness, even though the current policy rate is higher than our
estimated neutral rate. Convergence time is plotted as 0 months.
2. In Turkey, Korea and the Czech Republic, forwards do not converge to our estimated neutral
policy rates within 72 months.
Source: Deutsche Bank
1
US 10Y5Y is trading above 4.5%, which is consistent with growth and
inflation prospects of 2%. The re-pricing in 2013 has amounted to about
150bp and the bulk of it stemmed from the re-pricing in term premium. In
our view, UST pricing should follow more closely steady-state inflation and
growth.
Page 16
2
See “Diverging markets, in this publication.
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
India, Russia, CE3, and Chile lead in terms of monetary
policy “cushion”, with inflation hovering below target
and negative output gaps. These are followed by Israel
and Colombia. Among those, receivers in Poland seem
to stand out on lower inflation risks per carry.
In contrast, there is less “central bank premium” in
Brazil, Turkey, and – to a lesser extent – South Africa.
In these countries, there is less room to manoeuvre
given higher inflation and smaller gaps. The signals are
more mixed in Mexico, where inflation and output gaps
have opposite signs. The same is true in Korea, but in
this case the time to convergence to neutral is quite
long, suggesting upside risks to yields. Turkey stands
out as the most mispriced of these markets, in our
view: Not only is inflation too high and the output gap
too low, but also the curve prices too slow a
normalization path.
be adequate for developed countries that still face the
leftovers of debt overhang. Arguably, a subdued upturn
is likely in the case of the BRICS, where credit cycles
and policy expansion post-crisis were also severe – yet
not as deep as in developed markets. For most
emerging economies, however, growth normalization
appears within reach over the next year or two. The
chart below plots the gap between 2Y, 3Y ahead and
2Y spot vs. the neutral rate – the current policy rate gap.
Only a few EM curves offer positive premium for
receivers (notably Brazil, India, Russia, and Mexico). In
contrast, we see value in payers across several
countries such as Turkey, Korea, Europe, the Czech
Republic and the US. Not surprisingly, Turkey again
stands out.
Pricing a subdued cycle in the years ahead
Among the high-inflation countries, while temporary
easing in inflation pressures may bring small cuts in
Russia, shorten the cycle in Brazil and extend the
SARB’s pause – thus attracting short-term receivers –
we caution that inflation in these countries has an
important inertial component – especially in Brazil.
With underlying inflation running well above headline
in Brazil, achieving neutrality requires overshooting
neutral rates.
Looking beyond the intra-EM differences, the overall
time to convergence seems excessive. Even where
premium is highest, it would still take about 40 months
to convergence. Historically, business cycle upturns
have closed these gaps in shorter time frames. “Low
for long” may be credible in countries such as Israel,
Chile, and the Czech Republic, which do not show any
imminent pressure points on inflation and capacity
utilization, but the time priced to “neutrality” (more
than four years) still suggests that risks are biased to
higher rates even in these cases.
„
We favour payers in the short end of Turkey and
Israel, receivers in Poland, and tactical receivers in
Hungary, Russia, and South Africa. In LatAm, Brazil
stands out as the best front-end receiver (amid
high volatility, however) followed by Colombia and
Chile. As disinflation runs its course in Asia, we like
paying the front end of the Malay curve versus Thai
as a trade on divergent inflation/policy outlooks.
Long time to convergence contrasts with more
growth-sensitive markets in North Asia; we thus
favour paying the front end of Korea and Taiwan
(maintaining a steepening bias).
The belly: A mild business cycle priced in
Forward guidance and scepticism surrounding global
growth may extend the life of short-end receivers. Even
under this dovish scenario, however, the value
proposition in mid sector of EM curves is questionable,
in our opinion. The delayed normalization priced may
Deutsche Bank Securities Inc.
2Y3YF ‐2Y (bp) 400
receivers
350
300
MXN
250
HUF
200
BRL
150
50
ILS
payers
PLN
CLP
CZK
TRY
RUB
‐100
0
KRW
Policy rate gap
0
‐200
USD
EUR
100
INR
COP
ZAR
100
200
300
400
Source: Deutsche Bank
Where do we find the best protection trades against
possibly stronger business cycles? As we have
highlighted 3 , despite their negative carry, 2s5s10s
butterflies are rather depressed across several EMs,
trading through pre-May levels in some cases, while
displaying a high correlation with global risk proxies
(namely the slope of the US volume curve). This
suggests that butterfly payers can be used as proxy
hedges for a potential surge in front-end rates volatility,
whether predicated on stronger-than-expected pick-up
in activity or risks regarding the unbundling of tapering
and forward guidance.
We look for butterfly payers that combine attractive
valuation, lower carry burden, and the highest beta to
US rates front end volatility (DGX index) as a proxy of
the perceived strength of the global cycle. We favour
the highest “payout” in the sense of the highest
potential upside vs. lowest carry and drawdown.
The chart below indicates that paying the belly in 1:2:1
2s5s10s butterflies in Mexico, Czech Republic, and
3
See “Trading Pre-Taper Anxiety”.
Page 17
5 December 2013
EM Monthly: Diverging Markets
(less so) in the US combines potential upside (y-axis)
and significant exposure to a stronger cycle (x-axis),
while having relatively low carry burden (r-squares and
3M carry in bp are expressed as the first and second
numbers in the brackets).
for bull-steepening (which could be triggered by
possible easing), Mexico shows more value in the
longer end (bull-flattening). Hungary, South Africa, and
Israel seem too steep, with value concentrated in
longer tenors.
Butterflies: Where to pay
Pricing long-term growth, after term premium
60
Upside Potential (bp)
(MXN 84%,‐8)
300
Excess term premium (bp)
TRY
50
10
(TRY ‐33%,3)
0
‐0.2
0
‐0.4
150
(EUR 72%,‐4)
(CLP 49%,‐4)
favored defensive trades
(PLN 69%,‐2)
50
0.6
0.8
1
In EM, we favour paying the belly in Mexico, Czech
Republic and less so in Hungary as defensive
trades. In Asia we favour paying 5Y outright in
China and also the belly in Korea and Taiwan.
The long end: Looking beyond tapering
Extending the analysis of the previous sections, we
now look at premium in longer tenors. To do so, we
again compare “neutral” vs. forwards 4 . The vertical
axis in the chart below shows this “excess term
premium” embedded in the forwards. The horizontal
axis presents the “monetary policy premium” (the
difference between what is priced in 2Y, 3Y forward vs.
2Y spot and the “policy rate gap” – the distance from
“neutral”). The chart segments EMs into four quadrants,
according to these premia.
Comparing term premium and monetary premium to
gauge the relative value between the longer and
shorter tenors of EM curves, the chart below suggests
that EM value is concentrated in bear-flatteners. This is
consistent with our view that premium is higher in the
longer end of EM curves with little cushion for a faster
pace of economic recovery in the shorter tenors. This is
also in line with tapering being the most imminent risk,
while forward guidance is yet to be tested.
Again, Turkey stands out as the best candidate for
bear-flattening. Korea appears as a clear short-end
payer, but with no clear curve trade. Mexico and Russia
show value in receiving, but while Russia bodes well
4
We use 3Y forwards as our starting date as we believe that this time
frame reduces potential mis-pricings related to differences in monetary
policy paths. We use the average 2s10s slope during 2004-08 (before the
crisis) as a proxy of “neutral”, comparing it with the slope 3Yforwards.
Page 18
PLN
CLP
KRW
RUB
INR
‐100
(pay 2s, long 2s10s steepener)
‐150
Source: Deutsche Bank
„
BRL
CZK
‐50
1.2
MXN
ILS
COP
EUR
0
Beta do DGX
0.4
ZAR
USD
100
(ZAR 44%,7)
0.2
(rec 2s, long 2s10s flattener)
HUF
(USD 88%,‐15)
(ILS 47%,‐9)
30
(pay 2s, long 2s10s flattener)
200
(HUF 76%,‐11)
40
20
250
(CZK 80%,‐6)
‐220
‐180
‐140
‐100
(rec 2s, long 2s10s steepener)
‐60
‐20
20
60
100 140 180 220
Monetary policy premium (bp)
Source: Deutsche Bank
Brazil also stands out as too steep. Fiscal risks and a
central bank that prefers to chase inflation risks
combined with election uncertainty that could mount
into 2Q/3Q bodes for caution, but at over 13% (and
14%+ in forwards) we find nominal rates in Brazil
outright too high and the curve too steep. We expect
the central bank to continue to tighten – cornered by
high inflation – even if gradually so. Fiscal slippage
seems to be peaking. However, rates and FX will likely
be most volatile in Brazil as elections (not market
stability) look to be an absolute priority for this
government.
„
In EMEA we favour flatteners in Turkey, South
Africa and Israel, while favouring steepeners in
Russia. In LatAm we like flatteners in Mexico,
Brazil and see residual value in steepeners in Chile.
We also continue to favour receiving the long end
in Mexico versus the US. In Asia we recommend
buying 5-7Y bonds in India, receiving in the long
end of Singapore vs. US, but paying Hibor-Libor
spread. Still in Asia we like paying 2Y/5Y IRS
spreads in China, Malay vs. Thai rates, 2Y/5Y Korea
IRS outright and 2Y/5Y Taiwan spreads
Nominal bonds or linkers?
Inflation across EMs has been low except in cases
where central banks have been negligent. However,
the benefits of lower food prices and lacklustre global
growth will likely start to fade during 2014 under our
baseline scenario. Subdued oil prices could provide a
reprieve, but these prices have been subsidized (and
lagging) in many important emerging markets. Also, as
discussed above, output gaps are not nearly as high as
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
in developed countries. In addition, central banks will
likely err on the side of higher inflation than lower
growth. Moreover, in many important markets such as
Brazil, Turkey, and South Africa, inertia seems to have
pushed the baseline level up.
Inflation premium (defined as breakevens – consensus
inflation) is negative in Chile, Colombia, and Israel (see
chart below). This is in line with inflation risks, which
we deem low especially in Chile if oil prices recede in
2014 as we expect. Liquidity may be binding in Israel
and Colombia, but – in Chile – linkers are most liquid
and – at negative premium – they seem an attractive
defensive trade. We also favour long breakevens in
CLP.
In South Africa, premium seems adequate, given our
view of persistent economic slack and some currency
appreciation. Yet, in Brazil, it just looks too high.
Underlying inflation is running near 8% so that sub100bp of premium seems low – especially given the
risk of additional BRL weakness. In Turkey, liquidity is
also a hurdle for linkers. Besides, food prices are
running a little above trend and will probably correct
downwards; domestic liquidity conditions are now
finally being tightened, which should also help. In both
cases, however, there are risks to the upside, primarily
from the potential for further exchange rate weakness.
Thus, we find the premium to be too low.
The external technical risk remains potentially quite
high. As the last chart shows, foreign holding of local
debt has increased despite the outflows from local
markets over the past year. In Hungary, Poland, South
Africa, Mexico, and Malaysia, foreign holdings remain
substantial and in excess of 30%. Historically, foreign
investors (a source of long-term savings via insurance
and pension funds) have been important anchors for
the extension of local curves. They have been quite
resilient to several monetary policy shocks, but it would
be premature to discard the risk of a more substantial
rotation away from fixed income.
Our baseline view is that the global economy simply
cannot afford such a marked reallocation, as it is still
quite leveraged. The Fed’s own reluctance to validate
more aggressive re-pricings of US fixed income seems
to concur with our baseline view. However, these are
unusual times. Even if significant outflows do not
materialize, investors should remain prepared for bouts
of hedging – either via paying swaps or buying USD –
as was the case throughout 2013.
Supply risk contained
5%
INR
Net Supply 2014 (% GDP)
4%
2%
Assessing inflation premium
CZK
MXN
TRY
1%
COP
RUB
SGP CLP
HKD
0%
PEN
Inflation Premia (bp)
150
BRL
100
ZAR
HUF
3%
KRW
TWD
CNY IDR
PHP MYR
ILS
PLN
THB
Net Supply 2013 (% GDP)
‐1%
‐2%
50
‐2%
‐1%
0%
1%
2%
3%
4%
5%
0
Source: Deutsche Bank
-50
Foreign holding: Resilient, but still the wild card
-100
50%
-150
BRL
CLP COP MXN
ILS
TRY
ZAR
2Y
BRL
CLP COP MXN
ILS
TRY
ZAR
5Y
Source: Deutsche Bank
„
We favour linkers vs. nominal bonds in Brazil, Chile,
and Turkey – liquidity permitting.
Final remarks: Technicals and other idiosyncratic risks
Technicals remain mostly an external risk, in our view.
Although in some cases amortization increases
substantially in 2014, the outlook for net supply (supply
in excess of redemptions) seems manageable – and
actually benign in several countries. The chart below
shows the net financing picture in 2014 (y axis) vs. the
net financing picture in 2013 (x axis), both expressed
relative to GDP (%). Except for CZK and MXN, the
outlook for net supply seems benign.
Deutsche Bank Securities Inc.
% of outstanding
Sep‐12
Highest
Sep‐13
40%
30%
20%
10%
0%
CZ HU PL
RU ZA
TR
BR MX IN
ID
KR MY TH
Source: Deutsche Bank
Drausio Giacomelli, New York, +1 212 250 7355
Guilherme Marone, New York, +1 212 250 8640
Siddharth Kapoor, London, +44 20 7547 4241
Page 19
5 December 2013
EM Monthly: Diverging Markets
Sovereign Credit in 2014: Back in the Black
„
While EM assets are likely to face continued
headwinds in 2014, we believe the dramatic
negative shift in the wider perception of EM debt
cannot be repeated in 2014 given the return of EM
risk premium.
„
With continued taper risk, we start the New Year
with a neutral overall exposure. However, as rate
uncertainty recedes after the initial taper shock and
Fed continues with its dovish guidance as we
foresee, we believe EM sovereign spreads have
potential of some moderate tightening, offsetting
the rise in US yields and offering about 6% return
in 2014.
„
We expect some moderate improvement in EM
credit fundamentals overall in 2014, especially in
the ‘fragile’ countries, but foresee continued
negative ratings drift as in 2013.
„
We are not optimistic on the short-term outlook for
funds flows, but we believe supply/demand
balance is likely to be more supportive, as for the
first time since 2007 we project principal and
interest repayments to be slightly more than gross
issuances.
„
In terms of credit differentiation, we apply our
valuation model based on country-specific macro
factors and adjust the results with impacts of
current account balances – a main driver for
credit’s rate sensitivity in 2013.
„
We recommend an overweight exposure to
Colombia,
Russia,
Poland,
and
Hungary,
underweight exposure to Brazil, Indonesia, and
Ukraine, while maintaining a neutral exposure to
the rest, notably Argentina, Venezuela, Turkey, and
South Africa.
„
In relative value, we retain a cash curve steepening
bias in the near term given rate uncertainty. The
CDS/bond basis is settling in a tighter range
currently but we look to trade a potential bounce in
the basis as rate volatility recedes later in 2014.
Introduction
2013 has been a very significant year for emerging
market sovereign credit. A perfect storm of factors
transpired to push EM spreads to their cheapest levels
in over a decade, relative to developed market
corporate debt. The most important question facing us
as we look forward to 2014 is whether this past year
was a discrete adjustment, or whether appetite for EM
sovereign debt has been so damaged that we face an
extended period of underperformance.
Page 20
With declining QE from the Fed and relatively lackluster
aggregate economic growth, emerging markets assets
are likely to face continued headwinds in 2014.
However, these headwinds should not brew into a
storm like in 2013. We expect a further rise in US 10
year yields, but for this to be constrained with 5Y-5Y
forward around 4.5%. Furthermore, we believe the
dramatic negative shift in the wider perception of EM
debt cannot be repeated in 2014. Sentiment is already
poor and expectations have adjusted downwards.
These factors should put a limit on further
underperformance of EM sovereign credit relative to
developed market corporate. However, given the shock
of 2013, we believe EM sovereign debt is not cheap
enough to motivate the sharp reversal in fund flows
which would be a necessary condition for a substantial
spread compression relative to DM corporate.
As a result, while the major theme of 2013 was of the
systematic underperformance of EM sovereign credit,
we expect diversity within the asset class and divergent
performance of individual EM credits to be the
dominant theme of 2014.
2013 in perspective: a revelation of fading
tailwinds
It has been a year to forget for EM sovereign credit
In 2013, EM credit has been one of the worst
performers among all asset classes, suffering a major
re-pricing on the deterioration in EM’s relative
fundamentals vs. the developed world and a dramatic
shift in the perception of EM as an investment
opportunity, triggered by the prospect of QE taper.
Portfolio rebalancing due to rising interest rates, a topic
that has been talked about throughout the year, has not
materialized to the same extent (or in the same form) as
expected for the general credit market, as inflows to
both global investment grade and high yields have
returned and both asset classes are seeing credit
spreads at the tightest levels since 2007. Instead,
rebalancing has been more pronounced in the form of
unwinding of inflows into EM debt funds accumulated
during previous years.
Year to date, EM sovereign credit, measured by the
EMBI-Global benchmark, returned -7.5%, significantly
underperforming Global IG (-1.3%) and in stark contrast
with Global HY (+7%). Within EM, the relative
performance patterns cannot be found across credit
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
ratings, or yield levels, but follow more external
account dynamics and duration of the curve.
Attributed performance of DB-EMSI subindices
-25
-20
-15
-10
-5
0
5
10
15
20
25
CL
PL
MY
PE
MX
RU
BG
Yield
UST
Spread
Total
ZA
BR
… as well as weaker appetite for EMD
Funds flows, according to EPFR survey, have turned
decidedly negative for EM fixed income. EM hard
currency funds have experienced outflows of USD18bn
(according to the EPFR survey) up to the end November
of this year after having taken in USD37bn in 2012 and
USD55.9bn in total in 2009-12.
The tide of money flows has turned against EMD
Inflows to EM hard currency bond funds, USD bn
6
4
2
PA
0
TR
-2
CO
ID
-4
UY
-6
PH
-8
EM
HU
SV
VE
LB
-10
-12
Jan 09
Jan 10
Jan 11
Jan 12
Jan 13
Source: EPFR Global
EC
UA
AR
EG
Source: Deutsche Bank
… as a major repricing of EM fundamentals has taken
place
The main driver for the underperformance of EM
sovereign credit (or EM fixed income in general), in our
view, should be seen from a fundamental perspective,
as the growth differential between EM and DM has
been shrinking; capital flows to EM slowed sharply on
fears of Fed tapering, exposing vulnerable external
positions in a number of EM economies. Social unrest
in some countries (Brazil, Turkey), and rising default
concerns among the high-yielders – whether it be due
to litigation (Argentina) or increasingly binding macro
conditions (Venezuela and Ukraine) – also have not
helped matters.
… which was reflected in the reversal of credit ratings
momentum
Deterioration in fundamentals has been reflected in a
halt to the positive migration trend seen in prior years
when credit rating upgrades outnumbered downgrades.
During 2013, EM sovereigns had 19 upgrades vs. 22
downgrades, even though there were still more
upgrades than downgrades if we include only the
major credits, such as those that are DB-EMSI
constituents (10 upgrades vs. 8 downgrades, to be
precise – see Appendix A for details).
Deutsche Bank Securities Inc.
In comparison with other asset classes, the recent
patterns of funds flows suggest that investors continue
to disfavor EM assets in recent months. While riskier
assets tend to attract stronger inflows or see smaller
outflows, EMD has fared worse than both the less risky
Global IG and riskier Global HY. EMD seems hostage to
both the risk of UST re-pricing (especially for loweryielding credits) and investors’ negative assessment of
EM fundamentals. While Global IG fund flows have
benefited from the existence of the short-duration
sector, which has seen strong inflows in recent
months, more than offsetting the outflows from
intermediate- and long-duration sectors, EM funds are
seen as a whole and are suffering from withdrawal of
funds by retail investors.
But there is a silver lining: risk premiums have returned
to EM credits
As we highlighted recently, the systematic re-pricing
across EM credits over the summer has not only
corrected the richness of EM credit spreads relative to
developed markets, but it has also created some risk
premium. EM sovereigns have cheapened on average
by around 2 notches according to our market-implied
credit rating measure. The following graph shows that
while most credits have now recovered from the endAugust highs in market-implied rating vs. actual rating
differentials, the majority of these credits are still
considerably cheap to the actual rating. Even if we
consider that rating actions typically lag market
movements, the extent of pessimism still looks
Page 21
5 December 2013
EM Monthly: Diverging Markets
excessive compared with our ratings outlook for EM
sovereign credit.
Market-implied vs. actual credit rating in EM sovereign
credits
Market implied rating vs actual rating
+6
Current deviation
end of Aug level
25-75% range + median (past 3Y)
+4
+2
0
-2
Outlook for 2014: waiting for the
headwinds to fade
While the underperformance of EM sovereign credit
versus DM credit may continue into the start of 2014,
we do not expect it to be the dominant theme of the
year (as it has been in 2013). We believe that EM
sovereign credit is cheap; but is it cheap enough to
offset the damage which has been done to the
perception
of
the
asset
class?
After
the
underperformance of 2013 investors would no doubt
be looking for more than 50bp to convince them to reengage.
Egypt
Ukraine
Ecuador
Lebanon
Venezuela
El Salvador
Turkey
Hungary
Philippines
Uruguay
Indonesia
Colombia
Brazil
Panama
South Africa
Peru
Russia
Mexico
Poland
-6
Malaysia
-4
Source: Deutsche Bank
EM credit valuation looks reasonably attractive, in our
view – although not extreme. EM BBB spreads widened
from 30bp tight to global BBB spreads before May to
35bp wider at the current level.
EM BBB spreads vs. Global BBB spreads
EM BBB - US Corp BBB
100
50
0
-50
-100
-150
-200
-250
-300
Nov-04 Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 Nov-10 Nov-11 Nov-12
We
project
moderate
improvements
in
EM
fundamentals
For 2014, we project a moderate cyclical pickup in
average EM growth (70bp), but it will not be enough to
curb the narrowing trend in the EM vs. DM growth
differential. In the table below, we summarize our 2013
and 2014 forecasts for major EM economies in terms of
growth, fiscal balance, inflation, and current account
balance. Given that near-term economic performance
of EM economies will be to a large extent determined
by how they adjust to rising US rates and the end of
easy money, the latter indicator, current account
balance, remains very important. To that end, we note
that current account balances in a few “fragile”
countries, such as Indonesia, Turkey, South Africa,
Brazil, and Ukraine, will see some moderate
improvements on the back of macro adjustments and
in some cases combined with policy responses. We
project growth pickups in most major EMEA
economies, as well as most LatAm low-yielding
countries (with the exception of Brazil).
Projected changes in growth, fiscal deficit, inflation
and current account balance for select EM sovereigns
GDP Gro wth
Source: Deutsche Bank
Chile
B razil
Co lo mbia
M exico
P o land
P eru
P hilippines
S. A frica
Russia
Indo nesia
Turkey
Hungary
Ukraine
Venezuela
A rgentina
2013 2014
4.3 4.2
2.2 1.9
4.0 4.3
1.2 3.2
1.4 3.0
5.2 6.0
7.0 6.8
1.9 2.9
1.5 2.4
5.5 5.2
3.7 3.4
0.7 1.8
0.3 1.5
1.5 0.5
2.4 1.6
Chg
-0.1
-0.3
0.3
2.0
1.6
0.8
-0.2
1.0
0.9
-0.3
-0.3
1.1
1.2
-1.0
-0.8
Fiscal B alance
2013
-0.9
-3.2
-2.4
-2.9
-4.8
1.0
-2.0
-4.1
-1.1
-2.2
-2.3
-2.9
-4.5
-14.3
-3.6
2014
-0.5
-3.7
-2.3
-4.0
4.0
0.6
-2.4
-4.0
-0.6
-2.4
-2.3
-2.9
-4.2
-11.5
-3.8
Chg
0.4
-0.5
0.1
-1.1
8.8
-0.4
-0.4
0.1
0.5
-0.2
0.0
0.0
0.3
2.8
-0.2
Inflatio n
2013 2014
2.4 2.9
6.2 5.8
2.6 3.1
3.7 3.9
1.0 2.3
2.5 2.7
2.9 4.1
5.7 5.1
6.7 5.2
7.0 6.7
7.5 6.4
1.8 1.7
-0.4 1.4
40.0 47.5
24.9 27.8
Chg
0.5
-0.4
0.5
0.2
1.3
0.2
1.2
-0.6
-1.5
-0.3
-1.1
-0.1
1.8
7.5
2.9
CA
2013
-3.2
-3.6
-2.6
-1.4
-1.4
-5.0
4.0
-6.6
1.8
-3.9
-7.5
1.6
-10.2
1.7
-1.2
2014
-3.8
-3.2
-2.7
-2.0
-1.6
-5.5
4.1
-5.6
1.7
-3.3
-6.5
1.3
-7.5
4.3
-1.6
Chg
-0.6
0.4
-0.1
-0.6
-0.2
-0.5
0.1
1.0
-0.1
0.6
1.0
-0.3
2.7
2.6
-0.4
Source: Deutsche Bank
Page 22
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
… but policy adjustments face political constraints in
many cases
As we pointed out in a recent report 5 − the heavy
political calendar in 2014 (in some cases combined
with poor political dynamics) also weigh on market
sentiment. There will be presidential/general elections
in 12 EM countries in 2014 (including India, Indonesia,
Turkey, South Africa, and Brazil) and a number of local
or congressional elections. Presidential elections in
Ukraine and Argentina, scheduled further away in
March and October 2015 respectively, already have
profound impact on the asset prices in these two
countries even now. While the elections will likely not
have a negative impact in countries such as Colombia,
they may act as a major constraining factor in terms of
policy adjustments (e.g. Brazil, Indonesia) or as a
catalyst for social tension (e.g. Turkey, South Africa).
… and the credit rating momentum remains negative
Given the turn of the trend in May and that rating
agencies have been mostly lagging market pricing in
their actions, we expect the trend for credit rating
migration for EM sovereigns to remain mildly negative
in 2014. See graph below.
The trend of upgrades vs. downgrades is currently
negative for EM sovereigns
Proportion of upgrades
downgrade in any of the BBB credits will be offset by
likely upgrades in Mexico, Colombia, and Peru 6 .
Overall, the concentration of EM sovereign credits in
the BBB bracket remains intact, and the negative rating
drift will be more reflected in the high yielders
(Argentina, Venezuela, and Ukraine) and some smaller
markets (such as Egypt) − see the table in Appendix A
for a list of our projections on ratings actions to take
place from now through the end of 2014 for major
sovereigns7.
Retail fund inflows unlikely to return before the tapering
path is clear
Given the fundamental outlook, we expect appetite for
EM investment to be lower going forward than we
have seen in recent years. This will likely be reflected in
continued outflows over the near term – given that
flows failed to pick up in September and October when
EM outperformed, the outlook for the next few months
is unlikely to improve, especially if UST yields continue
to rise. Valuations do look attractive, but are perhaps
not substantial enough to entice investors to return
while QE tapering uncertainty remains at the forefront
of attention. However, anecdotal evidence suggests
strategically mandated money has remained “sticky”
and there is no reason for us to believe this will change
in 2014 with rates volatility more priced in than the last
summer and valuation much improved.
40%
30%
20%
10%
0%
10%
20%
30%
Proportion of downgrades
40%
'00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14
Source: Deutsche Bank
However, it is important to note that, despite the
overall negative momentum, no major sovereigns
currently rated within the BBB bracket will face the risk
of losing their investment grade status. The main
credits under downgrade risk include Brazil and South
Africa, both by one notch. Turkey and Indonesia, which
in our view should not be rated at investment grade,
still have positive to stable outlooks assigned by the
ratings agencies. On the other hand, we believe any
5
See Special Report - EM Sovereign Credit: Fundamentals Re-pricing and
Credit Differentiation, 11-Oct-13.
Deutsche Bank Securities Inc.
But the supply/demand picture looks more supportive
For the first time since 2007, we project principal and
interest repayments to be slightly more than gross
issuances in 2014, with the amount of about USD90bn
in supply, around $1bn less than the amount of total
repayments (principal and interest). During the previous
years, net supply had been significantly positive (see
the graph below). The main reasons for this are: a).
record amount of issuances during the past couple of
years have increased the debt stock and hence the
amount of cash flows back to investors; and b). there
have been a number of issuers that took advantage of
the delay in QE tapering to begin pre-funding for 2014.
6
We expect a pause in the positive migration trend in the Philippines in
2014, given an increase in its infrastructure spending due to, among other
things, the need to finance the damage made by the recent typhoon.
7
Our projections are based on our economists’ forecasts, rating agencies’
current outlooks (and how long they have kept the current outlook if it is
Positive or Negative) and their comments on conditions for upgrades and
downgrades, as well as our views on the evolution of macro fundamentals
that may impact rating decisions.
Page 23
5 December 2013
EM Monthly: Diverging Markets
More supportive supply/demand balance with almost
flat net supply in 2014
The table below illustrates the range of potential
returns the EM benchmark might offer investors in
2014 under varying scenarios of rates and spreads.
Total return projections for EMBI-Global under varying
scenarios of spreads and UST yields
EMBI-Global Spreads
10Y UST Yield
280
Source: Deutsche Bank
The largest sovereign issuers in 2014 – in terms of net
supply – include Indonesia (USD3bn), Russia
(USD2.8bn), and Romania (USD2.8bn). Most other
credits will have gross issuances to cover principal and
interest repayment. Also see Appendix B for details of
our projections of sovereign issuances, broken down in
total repayment and net supply, which add to gross
issuance.
EM sovereign credit vs. DM credit in 2014
Given our views on the fundamentals as well as
technical conditions discussed above, and also
according to our fundamentals based model (see
below), our baseline projection for the EMBI Global
spreads is to tighten moderately, by some 30bp (from
the current 360bp to 330bp. Our moderately
constructive view on EM Sovereign credit spreads
reflects – to a large extent - the more attractive
valuation as EM credits’ sensitivity to the baseline
scenario of tapering and rate re-pricing has been
largely priced in and on the assumption that even after
taper starts the Fed will likely maintain its
accommodative stance to keep rates lower for longer
via its forward guidance. Deutsche Bank’s baseline
forecast for UST 10Y yield is 3.25%.
Under these assumptions, our baseline projection for
benchmark total returns would be close to the yield
(around 6%). While this is lower than the long term
average performance of the asset class, in context it
would be impressive. It would represent a dramatic
improvement from the -8% so far in 2013, and in an
environment that has been characterized as a bear
market for fixed income it would be an outlier. It will
also compare favorably with our credit analysts’
baseline projections on the total returns of US High
Yield (5%) and US Investment Grade (1.6%), as those
credit spreads are currently at multi-year lows.
Page 24
300
320
420
440
460
2.00% 18.3% 17.0% 15.7% 14.4% 13.2% 11.9% 10.6%
9.4%
8.1%
6.8%
5.5%
2.25% 16.5% 15.2% 14.0% 12.7% 11.4% 10.2%
8.9%
7.6%
6.3%
5.1%
3.8%
2.50% 14.8% 13.5% 12.2% 10.9%
9.7%
8.4%
7.1%
5.9%
4.6%
3.3%
2.0%
2.75% 13.0% 11.7% 10.5%
9.2%
7.9%
6.7%
5.4%
4.1%
2.8%
1.6%
0.3%
3.00% 11.3% 10.0%
7.4%
6.2%
4.9%
3.6%
2.4%
1.1%
-0.2% -1.5%
8.7%
340
360
380
400
480
3.25%
9.5%
8.2%
7.0%
5.7%
4.4%
3.1%
1.9%
0.6%
-0.7%
-1.9% -3.2%
3.50%
7.8%
6.5%
5.2%
3.9%
2.7%
1.4%
0.1%
-1.1%
-2.4%
-3.7% -5.0%
3.75%
6.0%
4.7%
3.5%
2.2%
0.9% -0.4%
-1.6%
-2.9%
-4.2%
-5.4% -6.7%
4.00%
4.3%
3.0%
1.7%
0.4% -0.8% -2.1%
-3.4%
-4.6%
-5.9%
-7.2% -8.5%
4.25%
2.5%
1.2%
0.0% -1.3% -2.6% -3.9%
-5.1%
-6.4%
-7.7%
-8.9% -10.2%
4.50%
0.7% -0.5% -1.8% -3.1% -4.3% -5.6%
-6.9%
-8.1%
-9.4% -10.7% -12.0%
4.75% -1.0% -2.3% -3.5% -4.8% -6.1% -7.4%
-8.6%
-9.9% -11.2% -12.4% -13.7%
Source: Deutsche Bank
The scenarios that we consider most likely are
circumscribed by the rectangle in the table above,
while extreme scenarios yielding double-digit returns
either side of 0 cannot be ruled out but appear unlikely,
in our view. The extreme scenarios are a substantial
delay of taper pushing US yields lower accompanied by
spread tightening to the lows seen earlier this year, or,
on the opposite side, a faster-than-expected rise in UST
that triggers further re-pricing of EM credit spreads.
Quantifying Divergence
In our 2013 Outlook, published a year ago, we
introduced a new framework 8 to link relative spread
changes of EM sovereigns to a variety of macroeconomic factors. In summary, this framework
expressed the spread of an EM sovereign on the basis
of:
a)
The relationship between credit spreads and
credit ratings in developed market credit.
b)
An average spread of EM relative to DM
c)
A theoretical rating of the EM sovereign as
implied by a simple model of fundamentals.
The model in (c) allowed us to derive a macro-implied
rating, which we then applied to the relationship from
(a)+(b) to obtain a spread. Looking back at what
happened over 2013 we find that we were fairly close
to the mark on (a) – we forecast 190bp for the
8
See Sovereign Spreads – Macro Drivers, December 2012
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
developed market BBB spread (it is now 204bp), but we
did not anticipate the sharp move wider in EM vs DM,
captured by (b). How did we fair on (c)? Given our
expectation that divergence within EM will be a
dominant theme in 2014, it is useful to reflect on the
extent of divergence in 2013, even if this was not a
dominant theme.
… adding in CA balance increases the fit further
Actual change in market-implied rating
6
5
BR
TR
4
PE
CL
3
In our model, we forecast changes in implied credit
quality of each sovereign credit, based on forecast
changes in the three key macro-economic factors in the
model (CPI, FX reserves/GDP and Public Sector
External Debt as a % of GDP). These are all relatively
slow moving variables, but we also find that marketimplied credit quality of sovereigns is also relatively
slow moving. Our ultimate forecasts were not very
accurate with a very low correlation between the
forecasts and the eventual market moves. However,
interestingly it seems that the model would have
performed well, had we provided it with accurate
macro forecasts.
Had our macro forecasts been accurate, the model
would have predicted out/under-performers…
Actual change in market-implied rating
6
5
BR
TR
4
ID
ZA
CL
PHRU
MX
2
PL
1
0
PH
2
CO
RU
PL
1
HU
0
0
1
2
3
4
5
Model-implied change in market-implied rating
(perfect macro forecasts, with model augmented with 2013 CA levels)
Source: Deutsche Bank
It is worth emphasizing this point: simply by using the
changes in three pre-identified macro variables
(inflation, FX reserves and external debt), we can
explain a very significant degree of the relative
movement of all major (high grade) EM sovereigns.
Furthermore, we can also explain the extent to which
the model missed movements using just one additional
macro variable. So, while we still have work to do
improving our macro forecasts, it seems that the model
is of value in translating those macro forecasts into
relative country performance. This was of course the
original goal of the model.
CO
PE
3
MX
ID
ZA
HU
-1.0
-0.5
0.0
0.5
1.0
1.5
Model-implied change in market-implied rating (perfect macro forecasts)
Note: market-implied ratings are analogous to rating notches, the sign is analgous to
spreads. A change of +1 in the market-implied rating is equivalent to a 1-notch rating
downgrade.
Looking forward to 2014…
The table below illustrates the implications of our 2014
macro forecasts for the model-implied change in
ratings across major EM sovereign credits. We have
included the major high yield credits in the table for
Model-implied relative spread changes implied by our
macro forecasts
Source: Deutsche Bank
Furthermore, in hindsight we know that current
account dynamics became a key issue of concern in
2013 (and remains so). Can this explain the extent to
which the model failed to predict relative country
performance? The chart below suggests that to a large
extent, yes. Regressing the actual market moves
against the model forecasts (with perfect foresight) and
with the CA balance for each country, we obtain a fit
with an R-sq of 0.77.
Chile
B razil
Co lo mbia
M exico
P o land
P eru
P hilippines
So uth A frica
Russia
Indo nesia
Turkey
Hungary
FX
CP I Res.
+0.07 +0.02
-0.07 -0.00
+0.08 +0.00
+0.03 -0.04
+0.22 +0.10
+0.03 -0.13
+0.20 +0.05
-0.10 +0.01
-0.25 +0.07
-0.05 +0.02
-0.18 -0.04
-0.02
+0.11
Ukraine
Venezuela
A rgentina
+0.30
+1.26
+0.49
+0.22
-0.24
+0.10
Ext.
Debt.
-0.07
-0.01
-0.37
+0.04
+0.06
-0.15
-0.28
-0.09
---0.06
-0.58
To tal
+0.01
-0.09
-0.28
+0.04
+0.37
-0.25
-0.03
-0.18
-0.18
-0.03
-0.29
-0.48
M ean
Rev.
-0.30
-0.01
+0.16
+0.05
+0.03
-0.03
+0.21
-0.24
+0.14
+0.12
-0.27
-0.23
Net
-0.29
-0.10
-0.12
+0.09
+0.41
-0.28
+0.18
-0.43
-0.04
+0.09
-0.56
-0.71
Spd
chg
-8
-5
-6
+4
+15
-14
+7
-25
-2
+6
-39
-52
-0.01
+0.93
+0.09
+0.51
+1.96
+0.68
-0.54
+0.41
-0.35
-0.03
+2.37
+0.33
-8
+893
+89
Source: Deutsche Bank
Deutsche Bank Securities Inc.
Page 25
5 December 2013
EM Monthly: Diverging Markets
completeness, although we would discount the results
for these even more than for the high grade credits.
The values against the three macro factors are all
expressed in terms of the marginal implied change in
rating. They are derived by taking our forecasts for the
change in the macro variables, multiplied by the
appropriate model coefficient9. As we did last year, we
also assume a small degree of mean-reversion of the
model residual for each credit (based on the empirical
mean reversion). Finally we translate the forecast
change in the model-implied rating into a change in
credit spread. Based on the experience of 2013, we
apply a multiplier of 1.6x to obtain the spread change
to account for the fact that the market has a tendency
to over-react to changes in macro variables.
As discussed above, relative current account balances
played an important role in the relative performance of
different sovereign credits in 2013. With QE taper
remaining an ongoing dominant issue, this factor will
likely remain important in the near future. Therefore, it
is useful to consider the exposure of each country and
how we could use this to adjust the results of the
macro model to help ensure that our near-term view
accommodates this risk. The table below shows the
impact of the current account on the implied rating of
each country, assuming that the impact is 50% of that
in 2013. This 50% is based on the fact that we expect a
50bp rise in 10Y yields as opposed to the 100bp seen in
2013. However, this is likely a very conservative
assumption, since relative to forwards, our forecast
move in 10Y yields is very different in 2014 to what we
saw in 2013 (-8bp vs. +80bp).
Impact of the current account on the implied rating
(assuming the impact in 2014 is 50% of that in 2013)
Turkey
+0.76
So uth A frica
+0.57
P eru
+0.44
Indo nesia
+0.29
B razil
+0.25
Co lo mbia
+0.22
P o land
+0.19
M exico
+0.14
Chile
Russia
+0.02
-0.05
Hungary
-0.20
P hilippines
-0.28
Source: Deutsche Bank
9
CPI = +0.17, FX = -0.09, ExtDebt = +0.15
Page 26
It is important to note that the impact of the current
balances on the implied rating also reflects sensitivity
of each credit to the level and volatility of US rates.
2013 has been a year that features an unusually high
(positive) correlation between EM credit spreads and
US rates, and the rank of spread sensitivity to US
rates10 among credit is closely related to the current
account balances, as shown in the following graph.
Therefore, if we assume the relative sensitivity to US
rates in EM credits is sustained in 2014, the table
above should provide an important guide for us to
measure the impact of potential selloff in US treasuries
on the back of QE tapering.
Spread sensitivity to US rates and US rates volatility is
closed related to their current account deficits
Current account balance (% of GDP)
6
4
PH
HU
2
RU
CL
0
MX
-2
PL
-4
BR
CO
-6
PE
-8
-10
ID
ZA
TR
-12
-50
0
50
100
150
Credit spread sensitivity to US 10Y Treasury yield
Source: Deutsche Bank
Portfolio recommendations
As discussed above, we hold a moderately constructive
outlook on EM sovereign credit spreads in 2014.
However, given the still-uncertain US rate outlook over
the near term, we would start the year with a neutral
exposure, but look for opportunities to increase
exposure to overweight. Our projected spread
compression will likely begin to materialize only later in
the year, as the initial taper shock is absorbed and the
Fed offers a clearly communicated forward guidance
(which we believe will remain on the dovish side).
10
We measure the sensitivity of EM credit spread relative to US treasury
yield using a two-step regression. In the first step, we try to separate the
effect between UST yield volatility and UST yield level by regressing the
former on the latter, and save the residuals, which reflect the dynamics in
volatility that are not explained by US yield move. We apply the residuals in
the second step by regressing the credit spread against UST yield and the
residuals. The coefficient on UST yield captures the credit spread
sensitivity to UST after controlling for UST volatility, and is shown in the
chart against current account balance.
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
In terms of strategic country allocations, we would
identify the following countries as providing compelling
reasons for being over-/under-weight. We also present
our outlook on some major sovereign credits for which
we currently recommend neutral exposure, including
Argentina and Venezuela.
Overweights….
Colombia
Fundamentals remain sound − growth is recovering,
inflation subdued, CA balance is deteriorating
somewhat but the deficit is more than 100% financed
by FDI, which remains stable. This is reflected in our
projection of positive rating migration to BBB flat from
the current BBB- in 2014. Social unrest in the last
summer (and poor handling of it) has hurt the
popularity of President Santos, causing the curve to
underperform, but will unlikely hurt his standing in his
re-election endeavor, boding well for policy continuity.
Colombia, hence, is one of our strategic overweights in
2014, the only one we have among the LatAm low beta
sovereigns.
Poland
Our model suggests some downside on Poland credit
market, mainly due to a moderate deterioration in
select factors. However, we believe there are two
factors that are not considered in the model but could
be important for Poland in 2014, namely, the economic
growth – as a main beneficiary of EU recovery − and
the sharp improvement in fiscal balance. Our
economists expect GDP to grow by 3% next year,
which is almost the highest in EMEA and is a
significant improvement from this year's 1.4%. Fiscal
account will be boosted by more than 8% over the next
year based on our estimates, thanks to the mediumterm benefits of the pension reform, leaving more
space for government spending. We believe the growth
factor and solid fiscal performance could be a key
source for credit differentiation, and hence expect
Poland to outperform. Valuation is tight among EMEA
credits, but still compares favorably with LatAm low
beta credits.
Russia
Our model tells a fair story on Russia credit in our view,
which shows the supportive fundamentals but richness
in valuations. Other factors outside of the model also
suggest a potential rally in 2014, including a pickup in
growth, improvement in fiscal balance, and the
country's better position in the scenario of QE tapering.
All the changes are expected to be moderate though,
and hence the scope of outperformance is likely to be
modest.
Deutsche Bank Securities Inc.
Hungary
Hungary appears to be the best performer according to
our model forecast, as a reflection of the expected
improvement in fundamentals, continued cheapness
relative to the model (despite the performance in 2013),
and the more resilient position in the face of global
liquidity tightening (positive adjustment on current
account balance). We still see room for continued
outperformance in 2014. Nevertheless, it is worth
highlighting that the model results are largely driven by
one single factor – a drop in public external debt to
GDP (which is mainly due to our expectations of
significant currency appreciation rather than changes in
debt stock). Hungary is unusual among present day EM
economies in that it has a large share of foreigncurrency denominated debt. It therefore benefits more
than most from FX appreciation. Given the extent of
the rally in 2013, the scope for further outperformance
is likely to be more limited than the model suggests, if
we take into account of a more complete view of the
fundamentals.
Underweights…
Brazil
It is quite clear that Brazil’s growth model, relying on
public sector spending fueled consumption, is hitting a
wall now with the fading tailwinds. Our economist has
just revised his growth forecast for 2014 – a year
initially thought of as one of cyclical recovery − to a
mere 1.9%. In our view, the prospect of lower growth,
the recent deterioration in the fiscal performance, and
lower-than-expected fuel price increases for Petrobras,
etc., do not bode well for Brazil to keep its BBB credit
rating. The negative rating migration trend, in stark
contrast with its regional peers (Mexico, Peru, and
Colombia) warrants continued underweight position,
one we have held through 2013.
Even though the base model above suggests moderate
tightening in Brazil’s credit spreads, likely due to the
current cheapness in the valuation, we note that if we
consider the worsening fiscal performance and
continued policy risk, some of the factors the market
has been focusing more on recently, Brazil would likely
be in a less favorable position than the model suggests.
Ukraine
President Yanukovich hopes to secure re-election in
spring 2015 but is finding himself between a rock and a
hard place. Doing a deal with Europe makes long-term
economic sense but would have involved releasing his
main political opponent and inviting further economic
pressure from Russia. Not doing it – which was his
latest choice − has re-energized a previously
Page 27
5 December 2013
EM Monthly: Diverging Markets
disorganized opposition: the scale of recent
demonstrations has been much on a par with the
“Orange revolution” in 2004. The prospects of Ukraine
pivoting decisively toward Russia have always been
low but have now diminished further. Equally,
Yanukovich’s ability to muddle through to another
election victory in early 2015 has been reduced and
there is now a real risk that he could lose power. Our
base case is that the protests will die down in the
coming days and weeks; but if not, things could spiral
out of control. With the economy already teetering on
the brink of an economic crisis, the heightening nearterm political uncertainty seems too much risk to take
at the moment. We therefore finally reduced our
positioning recommendation to underweight (from
neutral) and will likely keep a strategic underweight on
Ukraine credit – depending on the political
development.
In terms of macro fundamentals, it is well known that
Ukraine has all the hallmarks of an old-style EM
accident waiting to happen: a current account deficit of
8% of GDP, a fixed and overvalued exchange rate,
increasing recourse to dollar financing, and rapidly
depleting foreign exchange reserves. The country is not
facing a solvency problem: government debt is less
than 40% of GDP and a combination of domestic
adjustment and external financing should be enough to
right the ship. A deal with the IMF, which remains an
option of last resort for President Yanukovich, would
involve un-pegging the exchange rate and hiking
domestic gas tariffs. The alternative would be a
Russian bailout but this would also come with strings
attached (e.g. giving up control of the gas pipeline or
joining Russia’s customs union). Neither are vote
winners, but if recent events lead to domestic capital
flight, Ukraine does not have enough reserves to defer
Ukraine’s debt repayment schedule in 2014 looks quite
demanding
Repayment profile to Eurobond and IMF ($, bn)
2.0
1.8
1.6
Eurobond
IMF
1.4
these decisions for very long.
Indonesia
As we have argued, the main problem in Indonesia was
due to policy missteps; it was not structural. For a long
time the Central Bank had been behind the curve, until
recently. Poor political dynamics have constrained
policy adjustment, causing deterioration in the fiscal
performance as well as widening in the current account
deficit (CAD). It has a heavy reliance on international
capital flows and exhibit one of the highest sensitivity
to US rate movements. The beta for its credit spread is
perhaps the highest among all investment-grade
credits in EM.
2014 is supposed to be a year of adjustment to reduce
its imbalances, for which we indeed project slower
growth, lower inflation, narrowing CAD, and hopefully
more orderly adjustment of the exchange rate.
Monetary tightening seems on track recently, but a
prolonged electoral season in 2014 (Congressional
election in April and Presidential in July) may keep the
market on edge due to potential policy uncertainty.
Credit ratings are not facing any pressure given the
positive and stable outlooks assigned by the agencies,
even though the credit exhibits arguably the largest
disconnect between ratings agency’s assessment of its
credit quality (focusing more on stock variables such as
debt ratios) and market’s assessment of its vulnerability
(focusing more on flows variables such as the CAD).
While we retain a cautious view, we note that the
underperformance of Indonesia credit in 2013 has
created a cushion against further volatility. We
currently hold an underweight position, taken in early
November as its credit spreads had recovered most of
its losses during the summer. We keep this position for
now as taper volatility may draw near again, but over
the course of the year we would seek to move
exposure closer to the benchmark. Even though our
base model above suggests a relatively more favorable
position in the portfolio, likely because of its current
wide spreads, we believe volatility exhibited by the
curve during external weakness should weigh on any
investment decisions.
1.2
1.0
Neutrals…
0.8
Argentina
Clearly, our model discussed above does not apply to
Argentina, where idiosyncratic factors dominate market
pricing of the assets. Argentine bonds have been the
best performers in 2013, by far, for a number of
reasons: prospect of political changes, possibility of
out-of-court settlement on the pari-passu case (with
0.6
0.4
0.2
J
F
Source: Deutsche Bank
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M
A
M
J
J
A
S
O
N
D
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
third-party involvement), and more recently signs of
more pragmatic policies since the cabinet changes
(including the settlement with Repsol). Indeed, all these
offer reasons for hope, but with the price of the USD
Discounts having climbed back to October 2012 levels,
we wonder if the market has been overly optimistic
about the chance for the global bond to escape the fate
of a technical default. First, there remains a chance for
the US Supreme Court to make a quick decision (upon
Argentina's filing of its certiorari by February 2014) to
not grant a review on the case, potentially triggering a
technical default during the first half of 2014. Second,
the gap to bridge for a potential settlement with thirdparty involvement is significant: while Argentina offers
about 62-65% of par value (the current market value of
a repeat of the 2010 exchange), the claim by the
holdouts are currently over 300% of eligible claims if
the rules for the exchange are followed. Finally, any
settlement would be more feasible only if the
government changes its position of not negotiating
with the holdout, the possibility of which may not be
high before 2015, in our view.
unlikely within the next couple of years unless oil prices
collapse and stay low for a prolonged period of time11)
if policy were to continue on the current path. The
Amortization schedule shown below, while sustainable,
looks quite demanding over the next few years, and
very much front-loaded. Refinancing risk, especially on
PDVSA, is on the rise. So is supply risk – for refinancing
as well as for supplying dollars to the exchange rate
system. Yields are very high, but justified in our view,
given the bleak fundamentals picture. The best
investment strategy remains staying on the front end of
the curves (PDVSA 14s, with 17.5% yield and
Venezuela 14s, with 14% yield). We also look to enter
the PDVSA curve dis-invesion trade as the long end
looks excessively expensive to the shorter end of the
curve.
Venezuela/PDVSA redemption schedule over the next
10 years
Repayments (USD bn)
10
PDVSA Pricipal
8
Therefore, we remain skeptical and would take a
neutral position going into 2014. In addition, we
continue to view Bonar 17s to offer more attractive
risk-reward to position for positive policy changes as
the risk of pesification on the local law bonds is much
lower than the risk of technical default on the global
bonds, in our view, even considering the possibility of
settlement.
PDVSA Interest
VENZ Interest
9
VENZ Principal
7
6
5
4
3
2
1
0
2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024
Source: Deutsche Bank
Venezuela
While the mayoral elections scheduled in this coming
weekends may be a source of short-term volatility, we
expect a devaluation (by 50%) in the beginning of the
year and possibly also some policy change on the
exchange rate front, temporarily instilling some traction
to the otherwise slippery slope. We therefore start the
year with a neutral position but will take any
meaningful strength as an opportunity to move down
to underweight. Ideology aside, some pragmatism will
have to be in order for chavismo to survive. 2014 is
also a year free of any elections, which is quite rare in
Venezuela. On the other hand, the policy direction is
clearly on a radical path given the composition of
current "committee" of decision makers, with the
exception of some pragmatism in the oil sector
because the government simply need to keep its cash
machine running.
Mexico
With reform progress broadly on track, boding well for
its medium outlook, we are currently overweight
Mexico as a defensive trade. This position seems
justified by fundamentals, which is reflected in a
possible one-notch upgrade to BBB+ by S&P in 2014.
GDP growth is projected by our economists to pick up
significantly in 2014 (3.2% vs. 1.2% in 2013). However,
on the valuation side, the tight spread (at around 100bp
with a relatively long average duration) on the Mexican
curve offers hardly any cushion in the face of rising
UST yields.
With volatility likely lower in 2014
compared with 2013, the low carry offered by Mexico
curve makes it look less attractive. In fact, this has
been in a way reflected in our base model results
shown above, which suggest a moderate widening. We
Given this reality, continued deterioration of
fundamentals − which have accelerated during the
course of past year − is highly likely, and sooner or
later, financing constraints would be binding (though
11
DB’s commodity analysts project 2014 oil prices to be about 10% lower
than the current level. This is negative for Venezuela but not enough to
dramatically its financing profile.
Deutsche Bank Securities Inc.
Page 29
5 December 2013
EM Monthly: Diverging Markets
would take a neutral exposure to Mexico, even though
fundamentally Mexico remains one of our favorites.
Peru
Performance of the Peru curve in 2013 has been
constrained by its long average duration of the curve
and the headlined sharp widening of the CAD (even
though it is more than 100% financed by FDI). For
2014, we project a pickup in growth (6.0% vs. 5.2%)
but some further deterioration of the current account
balance, but it will still be almost 100% financed by
FDI. Our base model suggests Peru’s outperformance,
but with adjustment based on the impact of its wide
current account imbalance (and hence the relatively
higher sensitivity to rate repricing), a neutral position
seems more appropriate. .
The Philippines
The Philippines continue to be a good credit story, with
sustainable strong growth on robust private
consumption and brisk investment. Strong remittances
and healthy current account surplus have helped
insulate RoP from rate volatility, and positive migration
during 2013 has kept its credit spread low. In 2014,
however, higher infrastructural spending (thanks in part
to the recent typhoon damage) will cause some
moderate (but manageable) deterioration in its fiscal
performance, which will in turn likely temporarily halt
its ascension in credit ratings. However, it is the
expensive valuation and low spreads that are the real
reasons for us not being overweight and remain
neutral. Our model suggests a moderate widening in it
credit spread, which is not a surprise given its current
tight valuation, but positive adjustment based on its
favorable current account balance should improve its
position in the portfolio.
Another concern stems from the political front, as both
countries are facing elections next year. The electionrelated uncertainties could cause volatility in the two
markets, and therefore lower the risk-return profile.
Overall, we believe it is prudent to take neutral position
as we enter next year. However, given the cheapness
of both credits indicated by the model, in the event that
the market calmly absorbs the onset of QE tapering, we
would consider to move them to overweight.
Relative Value Themes
In this section we briefly discuss two distinct relative
themes outstanding in 2013, especially after May when
EM curves started to reprice wider: the slope of cash
spread curves (10s30s) and CDS/bond basis.
Cash curve positioning: duration exposure remains
unflavored
While we cannot find any clear relationship in the
historical data between EM spread curve behavior and
volatility in the US rates market, a rise in US rates
volatility has been accompanied by a bear-steepening
of the EM spread curves since last May, as shown in
following graph. This is not a surprise, as the risk of QE
taper has triggered duration reductions amongst
investors. The second graph shows the slope changes
vs. average duration of each cash curve, which
indicates that curves with higher duration exposure
have also suffered more from spread moves.
Rises of US rate volatility have been accompanied by
EM spread curve bear-steepening since May 2013
10s30s Cash Slope
EM Average
DGX (RHS)
120
60
110
55
Turkey and South Africa
Our model suggests a bullish view on both countries,
thanks to the forecast improvement in macro variables
and the cheapness in the current valuations. However,
the picture is less optimistic if we take into account
their large current account deficits, even though our
projection indicates some improvement in 2014. While
taper uncertainty remains high we cannot ignore the
risk that current accounts will again become a
dominant factor for relative performance. Especially in
South Africa, if current account deficit is not improved,
coupled with deteriorating fiscal performance and
acceleration of social unrest, the sovereign credit is
likely to face a downgrade from Moody's. The
downgrade risk should continue to weigh on South
Africa’s credit performance going forward.
Page 30
100
50
90
80
45
70
40
60
35
30
Dec-12
50
40
Feb-13
Apr-13
Jun-13
Aug-13
Oct-13
Source: Deutsche Bank
Given that QE taper remains a dominant risk factor over
the near term, we hold a bias towards more steepening
of the curve over the coming months until the taper
uncertainty has been put behind. In addition, at the
start of the year, we continue to disfavor duration
exposure as positions that are un-hedged against rising
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
rates still play a role in the market, causing steepening
of the spread curve when yields rise. Our view applies
more on the curves that are currently flatter than
comparables, such as the Philippines and South Africa.
A historical view of CDS/bond basis among EM
sovereign credits
Average basis for Model Par Bond
5Y
10Y
60
DB-EMSI sub-index total returns attributed to spread
50
change and UST yield changes, sorted by average
duration of the curve
40
30
20
EMSI Sub‐index Returns, due to spread change or UST change 2
UST
Spread
0
10
0
-10
-2
-20
-4
-30
Jan-10
Jul-10
Jan-11
Jul-11
Jan-12
Jul-12
Jan-13
Jul-13
Average of model par bonds on major EM curves excluding VE, AR, UA and HU
-6
Source: Deutsche Bank
-8
-10
BG MY EG LB PL RU HU EM ZA TR ID CO BR SV PA CL MX PH PE UY
Source: Deutsche Bank
CDS/bond basis: settling at a tighter range but we look
to trade the potential bounce
One of the main themes in terms of relative value in
2013 has been the significant tightening of CDS/bond
basis since last summer, as rate volatility and persistent
outflows have conspired to limit the performance of
EM cash curves vs. CDS. This trend has recently been
aggravated by some real money investors selling CDS
as an alternative way of taking credit exposures. As a
result, the basis has dipped close to the lowest levels
since 2010, at the onset of European financial crisis
when EM debt had significant outflows. This is more
pronounced at the 5Y sector, as the 5Y basis is now
solidly in negative territory.
With continued outflows from EM hard currency debt
funds, we believe the basis will likely continue to trade
within a much lower range than the average levels of
the past few years – with the 10Y basis hovering
between 10bp and 30b on average, and the 5Y basis
staying negative – for the foreseeable future. This may
change, however, under the scenario of a return of
inflows into EM hard currency funds after the initial
taper shock is put behind and provided the Fed then
continues with its dovish-leaning forward guidance,
keeping the US rates anchored, considering the current
attractive valuation of EM credit spreads. If that
scenario materializes, we envision a significant rebound
in the CDS/bond basis to past years’ average range –
30-50bp in terms of 10Y and 0-20bp in terms of 5Y,
offering one of the most attractive relative value
opportunities in EM credit for the next year.
Hongtao Jiang, New York, +1 212 250 2524
Winnie Kong, London, +44 20 7545 1382
Marc Balston, London, +44 20 7547 1484
Contributions by
Srineel Jalagani, Jacksonville, +1 212 250 2524
See appendices on the following pages for additional
tables and graphs.
Deutsche Bank Securities Inc.
Page 31
5 December 2013
EM Monthly: Diverging Markets
Appendix A: Sovereign credit rating: changes in
2013 and forecasted changes in 2014
Appendix B: sovereign issuance projections for
2014
Ratings actions for major EM sovereign credits in 2013
2014 sovereign issuer repayment and projected net
Upgrade
Country
Rating Agency Prev Rating New Rating Action Date
Colombia
SP
BB+
BBB
24-Apr-13
Mexico
FITCH
BBB
BBB+
8-May-13
Peru
SP
BBB
BBB+
19-Aug-13
Peru
FITCH
BBB
BBB+
23-Oct-13
Philippines
FITCH
BB+
BBB-
27-Mar-13
Philippines
SP
BB+
BBB-
2-May-13
Philippines
MOODY
Ba1
Baa3
3-Oct-13
Turkey
SP
BB
BB+
27-Mar-13
Turkey
MOODY
Ba1
Baa3
16-May-13
Uruguay
FITCH
BB+
BBB-
7-Mar-13
Downgrade Argentina
Lebanon
SP
B-
CCC+
10-Sep-13
SP
B
B-
1-Nov-13
El Salvador
FITCH
BB
BB-
16-Jul-13
Ukraine
MOODY
B3
Caa1
20-Sep-13
Ukraine
SP
B
B-
1-Nov-13
Ukraine
FITCH
B
B-
8-Nov-13
Venezuela
SP
B+
B
17-Jun-13
BBB+
BBB
10-Jan-13
South Africa FITCH
Note: the table does not include ratings actions on smaller credits such as Jamaica, Thailand, Latvia,
etc.
Source: Deutsche Bank
Projected upgrades and downgrades for major EM
sovereign credits in 2014
Upgrade
Downgrade
Country
Rating Agency
Current Rating
China
Fitch
A+
Rating F'cast
AA-
Colombia
Moody's
Baa3
Baa2
Colombia
Fitch
BBB-
BBB
Ecuador
S&P
B
B+
Mexico
S&P
BBB
BBB+
Peru
Moody's
Baa2
Baa1
Romania
S&P
BB+
BBB-
Argentina
Moody's
B3
Caa1
Argentina
Fitch
CC
CC-
Brazil
S&P
BBB
BBB-
Egypt
Moody's
Caa1
Caa2
Egypt
Fitch
B-
CCC+
S-Africa
Moody's
Baa1
Baa2
S-Africa
S&P
BBB
BBB-
Ukraine
Fitch
B-
CCC+
Ukraine
S&P
B-
CCC+
Venezuela
Moody's
B2
B3
Venezuela
Fitch
B+
B
supply
2014 repayment and expected net issuances by EM
-3000
Russia
Turkey
Indonesia
Poland
Venezuela
Mexico
Hungary
Romania
Slovakia
Brazil
Slovenia
Colombia
Qatar
South Korea
Lithuania
South Africa
Philippines
Lebanon
Serbia
Israel
Bahrain
Malaysia
Sri Lanka
Bulgaria
Croatia
Costa Rica
Dubai
Kenya
Latvia
Nigeria
Peru
Ukraine
Dominican Republic
Senegal
Mongolia
Morocco
Pakistan
Ecuador
El Salvador
Ghana
Guatemala
Honduras
Jamaica
Montenegro
Panama
Paraguay
Trinidad & Tobago
Tunisia
Uruguay
-1000
1000
3000
5000
7000
Repayment
Est. Net Supply
Source: Deutsche Bank
Source: Deutsche Bank
Page 32
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Appendix C: 2014 repayment profile and issuance projections
2014 EM external debt repayment vs. issuance projections
Source: Deutsche Bank
Deutsche Bank Securities Inc.
Page 33
5 December 2013
EM Monthly: Diverging Markets
EMFX: Diverging Currencies
While likely facing another difficult year, we see a
better potential for EMFX as an asset class in the
upcoming year. We still see tapering and forward
guidance uncertainty as a hurdle for the asset class
at least during the first half of the year. That said,
the prospects of a more benign economic backdrop
should not only help EMFX but evidence the
nuances between EM economies that are likely to
grow in 2014.
2) We are starting the year on better valuation grounds,
with REER across EM near the weakest levels in recent
years (chart);
„
Overall, as long as the rise in yields is orderly,
export oriented economies with competitive real
exchange rates and limited balance sheet risk,
should benefit from a sustained global recovery.
4) While EM growth prospects will likely remain diverse,
many countries are likely in the cusp of an upturn. We
forecast Asian and EMEA economies to grow 1pp
faster, with LatAm accelerating 0.5pp.
„
Conversely, currencies where FX reserves are
insufficient to act as a buffer in the funding market
will continue to be vulnerable to a tightening of
global liquidity.
„
„
Therefore, currencies undermined by sizeable C/A
deficits and/or short-term external debt repayments
may have to weaken substantially in order to
restore competitiveness and shift the burden of
repayments to foreigners.
„
Altogether, while EMFX will probably continue to
be a shock absorber to global risks, we believe that
differences in valuation will once again be an
important driver of returns in 2014.
„
In LatAm, we expect the USD/BRL to underperform
the forwards amid a high (2.25-2.50) range, favor
long MXN vs. COP, RUB, and USD, and long CLP
vs. COP.
„
In EMEA, favor PLN and HUF vs. the EUR, and a
continued grind lower in USD/ILS. Favor ZAR over
TRY and also RUB among the high yielders.
„
In Asia, we favor long CNH, INR vs. USD and PHP
vs. TWD. Sell IDR, MYR, SGD, KRW, THB and TWD
vs. USD.
EMFX in 2014
EM currencies will likely face another difficult year as
they remain the most important absorber to liquidity
shocks. The main hurdles are front-loaded, as tapering
uncertainty is concentrated in the first quarter and
forward guidance seems poised to be tested as the
economy accelerates early in the year.
3) Re-pricing in rates stemming from faster growth
should be less damaging to risk appetite than the sharp
increase in risk premium (from quite low levels) of
2013;
Still, we foresee another year where intra-EM
differentiation and volatility overshadows trend. We
expect a spot return of just 2% in 2014, with Asia
yielding 2%, LatAm -1%%, and EMEA 4.5%. This
compares with -8% year-to-date spot return for a tradeweighted index of EM currencies. Carry – while ex-ante
secondary – should add about 4.5% to spot returns.
Valuation: Better starting point
130
EEMEA REER
Asia REER
Latam REER
120
110
100
2010
2011
2012
2013
Source: Deutsche Bank, Haver Analytics.
Yet, we see better a prospect for EM currencies in 2014
as we find the hurdles ahead to be lower than in 2013:
From a mark-to-market standpoint, we expect EMFX to
remain most sensitive to US rates (and the risks of
liquidity tightening) rather than equities (as a gauge of
improving global growth). This should be more
accentuated early in the year while rates remain
vulnerable to tapering, forward guidance, and
economic data resilience to this uncertainty, and while
the pickup in EM growth we foresee lags.
1) Although US rates are still vulnerable to the repricing of faster growth and tapering, the additional
sell-off in UST DB forecasts in the year ahead is
significantly less (3.25% for 10Y, thus close to what
forwards currently price);
How vulnerable are EM currencies? We actually believe
that current valuation has already made most EM
economies a lot less “fragile” and that tapering is
mostly priced. The real fragilities, in our view, are
concentrated where currencies have not been allowed
Page 34
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
to float, as in Argentina (which seems to have initiated
an adjustment), Venezuela (where we expect a
significant move in January), and Ukraine (where risks
seem most imminent).
We first weigh in global risks (both positive and
negative) and – in the following section – we assess
differentiation across to EMFX.
1) The global backdrop – pros and cons
Sensitivity to US yields: High to start. 2013 was the year
EMFX traded hostage to US fixed income. EMFX
performance has historically (pre-2008) been more tightly
dependent on equities (as a proxy for growth prospects),
but in recent years EM currencies have traded very closely
in line with UST yields and measures of US rates vols
such as DGX and DVX (our gamma and vega proxies for
forward guidance and taper risks, respectively). This
change is shown in the second chart below. While EMFXUS yield correlations have recently exceeded 90% in
many cases, EMFX-US equities betas have flipped to
negative and correlations have dropped substantially (first
chart).
reliable a gauge of growth prospects) and the outlook
for risky assets still hinging on major CB’s ability to
extend accommodation through forward guidance,
EMFX will likely remain aligned with US rates early in
2014. But since we expect the additional re-pricing in
US yields to be less dramatic, and EMFX valuation
already accounts for a good dose of tapering premium
(as the chart below suggests), sensitivities to US yields
will likely drop12. As the year unfolds, we expect EM
currencies to follow growth more closely again,
assuming major central banks succeed in guiding
markets.
Taper premium: EMFX makes room for the end of QE
35
97
30
25
95
20
93
15
91
10
5
89
JPM EMFX Index
87
EMFX: Increasingly more sensitive to UST than US
85
Dec 12
equities
60%
return corr (EMFX Index, US10Y), 120d rolling
0
Vol slope
Mar 13
‐5
Jun 13
Sep 13
‐10
Dec 13
Source: Deutsche Bank, Bloomberg. Vol slope is the difference between DGV and GDX indices – the
slope of the US yields’ vol curve.
40%
20%
0%
‐20%
higher yields, EMFX underperformance
‐40%
May 07 Feb 08 Nov 08 Aug 09 May 10 Feb 11 Nov 11 Aug 12 May 13
100%
r‐sqr 2004/07
EMFX vs US10Y
EMFX vs SPX
PHP
MYR
RUB
80%
BRL
SGD
KRW
CZK
PLN
CLP
INR
KRW
20%
ZAR
CZK
SGD
PLN
HUF
MXN
IDR
HUF
0%
0%
„
COP
60%
40%
Tapering vs. forward guidance: Weighing tail risks. In
contrast with taper, forward guidance seems “priced to
perfection”. DB’s baseline scenario (UST10 at 3.25%) is
benign, but should investors perceive the Fed to be
“behind the curve”, higher funding rates would again
weigh heavily on EM assets and overall risk markets.
We believe that the betas in the chart above capture
well EMFX sensitivities to US yields be it due to low
reserves, high current accounts, foreign exposure to
local markets, or high short-term debt.
20%
MXN
40%
ILS
60%
IDR
PHP
ILS
MYR
RUB BRL
CLP
ZAR
TRY
COP
TRY INR
80%
100%
r‐sqr ytd
The list of EM currencies most sensitive to US
yields remains long: INR, TRY, ZAR, RUB, BRL,
MXN, MYR, PHP, and IDR. CE3 and KRW have
been exceptions.
USD strength may strike. We find this more likely in
2014 as we expect growth and rates differentials
between the US and EU to widen. But as 2013 showed,
EU’s solid current account surplus, volatility in US
economic data, and the Fed’s propensity to err on the
side of more accommodation may keep the EUR/USD
in a range for most of the year – even if with a
Source: Deutsche Bank; weekly returns.
We expect milder EMFX responses to US monetary
policy as the year progresses. With SPX valuations
arguably artificially inflated by QE (and thus less
Deutsche Bank Securities Inc.
12
The chart uses the slope of the UST vol curve (DGV-DGX spread) as a
metric for tapering vs. forward guidance premium. Since forward guidance
has been quite successful, DGX has been tame while DGV has increased
with taper fears.
Page 35
5 December 2013
EM Monthly: Diverging Markets
downside bias. As we approach the releases of EU
banks’ stress test results later in the year and EU
financing risks possibly surge again, EUR funding
should become more appealing.
investors to remain selective. The next section sheds
further light on EMFX heterogeneity.
EM benefiting from growth upturn
Regionally this weighs more heavily on EMEA and also
Asia (vs. the USD), and least so in LatAm, as we
discussed in more depth in “EM Proxies for USD
Strength”. There we show that LatAm can outperform
even the USD under USD strength if commodities are
strong, but this is not our baseline scenario for 2014.
Instead, we show that the best trades under USD
strength under our baseline scenario for 2014 should
be selected LatAm and – barring other risks – RUB, TRY,
and ZAR vs. CE3 FX as indicated in the chart below.
LatAm FX ex-BRL, RUB and TRY vs. CE3 FX stand
out as effective EM proxies for USD strength.
„
Intra-EM proxies for possible USD strength (carry in
brackets)
corr EM cross vs EUR ( 2bd ret, 1y window) ‐50%
Source: Deutsche Bank, Haver Analytics.
MXNPLN (.1%)
TRYCZK (1.9%)
RUBHUF (1.1%)
RUBPLN (1.%)
‐60%
Private inflows have tracked EM growth
CLPCZK (1.2%)
TRYHUF (1.3%)
EMEA and LatAm private flows, USD TRYPLN (1.2%)
CLPHUF (.6%)
‐70%
ILSHUF (‐.4%)
ILSCZK (.3%)
5
250
ILSPLN (‐.4%)
COPHUF (.3%)
COPCZK (.9%)
225
‐2
3
200
COPPLN (.2%)
‐3
6
275
CLPPLN (.5%)
‐80%
EMEA and LatAm avg. growth, %
300
‐1
0
1
2
3
z‐score (1y, levels)
2
175
150
Source: Deutsche Bank, Haver Analytics.
Flows and global trade: These have weighed on EMFX
and will likely continue to do so into 2014, but some
upturn is in sight. Global trade growth has been
hovering around the lows of the past 30 years.
Although we don’t expect a sharp recovery as in 2010,
the acceleration in US and Chinese growth we foresee
bode for improvement (see chart below).
The outlook for capital flows seems less reassuring and
more heterogeneous under increasing US rates.
However, DB forecasts UST 10% at 3.25% (thus close
to what is already priced) and portfolio flows have –
structurally – followed more closely EM growth than
US monetary policy (chart).13 In this sense, the outlook
for private flows could brighten if EM activity catches
up with the global cycle as we expect later in the year.
With EM growth at multi-speed, however, we expect
13
See “Too much ado about EM Technicals” in this publication.
Page 36
0
125
Growth (RHS)
100
Flows
-2
75
-3
2007
2008
2009
2010
2011
2012
2013
Source: Deutsche Bank, IMF.
2) EM specifics: The main drivers of performance
We expect intra-EM currency moves rather than
common trends to dominate performance while: 1) The
outlook for capital flows, global trade, and monetary
policy across EM vs. DM does not provide strong
anchors for trend-appreciation; 2) EM fundamentals
remain marked by multi-speed growth, substantial
differences across policies and politics, and a number
of important elections.
Tightening liquidity risk: How adequate EM reserves
are In our view, most of the “flow” pressure on EM
currencies during 2013 has been speculative in nature.
The impact of these inflows is captured by the betas to
US yields discussed in the previous section. This could
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
evolve to real outflows, however, if foreigners reduce
more aggressively their positions in local markets (see our
rates outlook) or locals and non-residents exit on countryspecific risks such as elections and macro vulnerabilities.
The table below weighs different indicators of reserves
adequacy across EM. Most numbers are well above 100,
suggesting little systemic risk.
„
The cases of Egypt, Ukraine, Argentina, and
Venezuela do bode for caution. Brazil seems most
exposed to locals sending abroad part of the
wealth generated over the past decade, although
reserves are adequate.
EMFX stress test: Gauging the impact of “sudden
stops”
20
Required % real depreciation for a 2% of GDP adj. in the BoP
15
10
5
0
PEN
Assessing EMFX reserves adequacy
F o re ig n re se rve s a s % o f
ST debt
20% of
ST debt
+ CAD
M2
Months Risk- wtd
imports
metric
USD bn
GDP
44.7
20.0
44.8
79.1
25.5
110.1
36.7
512.8
47.3
122.6
22.7
22.9
7.3
31.5
28.4
12.3
21.7
20.5
24.6
13.2
14.9
12.4
172.3
266.6
173.4
213.0
251.7
143.6
165.6
573.0
198.8
104.0
64.5
154.7
133.7
173.4
213.0
218.6
127.3
150.8
573.0
103.4
71.9
44.6
136.8
48.5
305.0
260.6
211.7
179.2
260.0
295.2
125.0
157.4
99.5
3.9
3.7
5.2
20.2
6.1
6.4
6.4
18.3
5.9
6.3
3.3
145.1
63.8
153.9
231.4
125.1
151.7
165.9
268.0
118.3
131.9
51.6
Asia
China
India
Indonesia
Korea
Malaysia
Philippines
Taiwan
Thailand
3496.7
280.2
92.7
329.7
137.8
83.2
409.1
172.2
40.5
15.8
10.4
28.2
44.6
31.0
84.8
44.3
611.8
285.5
205.0
281.6
388.6
874.5
330.0
267.9
611.8
145.2
119.6
281.6
388.6
874.5
330.0
251.7
104.5
442.4
155.1
95.5
156.4
302.1
175.1
243.2
22.9
6.8
6.0
7.9
8.1
16.2
18.4
8.1
162.7
272.3
145.1
159.7
166.2
349.8
291.4
271.8
LatAm
Argentina
Brazil
Chile
Colombia
Mexic o
Peru
Venezuela
37.0
372.0
40.1
41.5
169.2
67.7
23.6
7.4
16.5
14.2
11.0
13.7
32.5
6.2
102.5
1136.8
215.7
338.2
234.9
826.2
96.3
97.4
326.4
153.2
174.0
172.5
355.6
96.3
188.8
220.9
132.8
141.8
121.0
442.2
75.5
5.6
18.6
6.2
8.8
5.4
18.7
5.8
90.7
265.9
149.7
191.1
137.6
424.0
55.1
EMEA
Czec h Republic
Egypt
Hungary
Israel
Kazakhstan
Poland
Romania
Russia
South Afric a
Turkey
Ukraine
BRL
CLP
COP
ILS
TRY
ZAR
RUB
MXN
PLN
HUF
Source: Deutsche Bank, Haver Analytics.
Readiness to benefit from global upturn Currencies
with better valuations and higher openness to trade
should benefit the most from the upturn in the global
economy and trade we expect to prevail over taperrelated uncertainty. As the chart below suggests, CE3
currencies, in particular, are well positioned to benefit
from a continued gradual upturn in global demand,
reflecting not only their openness, but also relatively
competitive real exchange rate valuations. The same
applies to Mexico and Chile. Albeit to a lesser extent,
open and export oriented South Korea, Malaysia and
Thailand should also be amongst the beneficiaries in
this environment.
„
CE3 FX stand out in terms of openness and
valuation
EM benefiting from growth upturn
20
REER rich/cheap
PHP
15
Source: Deutsche Bank, Haver Analytics.
ILS
10
Valuation and exposure to liquidity shocks Valuation
across EMFX has improved, but we find no consistent
signs of substantial overshooting. According to our
fundamental valuation model14, most EM currencies are
slightly undervalued or fair, but in case tighter funding
conditions impose lower current account deficits the
required depreciations would still be severe. The table
below indicates that several EM currencies could still face
double-digit depreciations under such “sudden stops” in
capital flows – especially in LatAm ex-MXN, but also in
TRY, ZAR, and – less so RUB.
14
See “EMFX Valuation Snapshot” published on November 27, 2013.
Deutsche Bank Securities Inc.
CNY
BRL
5
PEN
KRW
CLP
MYR
RUB
MXN
0
ZAR
‐5
IDR
‐10
HUF
CZK
PLN
TRY
‐15
0
20
40
60
80
100
Source: Deutsche Bank, Haver Analytics.
Structural bottlenecks: As liquidity tightens over the
years, FX prospects depend a lot more on reforms. The
appreciation (in real effective terms) of the past years
has often surpassed the pace of productivity gains in
the period.
The chart bellow shows real tradeweighted FX appreciation vs. total factor productivity
Page 37
5 December 2013
EM Monthly: Diverging Markets
across EM vs. its trade partners. The contrast between
China and Brazil is striking. The BRL has appreciated
about 60% since 2005 amid scarce gains in
productivity vs. its partners. Russia also faces structural
bottlenecks, while India, South Africa, Hungary, and
Mexico have failed to generate faster productive gains,
but they have compensated it with weaker currencies.
The prospect of reforms in Mexico could lift the pace of
productivity. We expect the same from China and –
later on – from India. Brazil and Russia, however,
remain focused on demand rather than supply. In
Russia, the absence of a more genuine reforms agenda
renders the currency more vulnerable to lower crude
prices on possibly increased flows from Iraq and the
US in the following years. A sharp drop in crude would
in turn require a sharp correction in the RUB REER,
through a combination of nominal FX depreciation and
internal deflation.
„
BRL and RUB look particularly dependent on
external prices in the absence of a brighter outlook
for productivity
Structural bottlenecks: EMFX appreciation vs.
productivity
Source: Deutsche Bank, Haver Analytics.
In a nutshell
We expect investors will remain selective in 2014 and
their inflows will likely be channeled to currencies with
more attractive valuation, and where the benefits from
growth acceleration are highest vs. the sensitivity to
further re-pricing in US rates. As we have discussed
during this year, carry should remain (ex-ante) a
secondary consideration – at least while EM growth
does not accelerate and EM central banks respond to
rising inflation risks (a more likely scenario as the year
unfolds). Ex-post, however, one should not
underestimate the benefits of carry. EMFX (tradeweighted) is ending the year nearly flat in total return
terms despite its -8% spot depreciation.
Page 38
Regionally, we see the Fed sensitivity trade best
expressed in Asia through upside in USD/SGD and
USD/MYR, followed by being long USDs versus IDR
and THB. In LatAm and EMEA, BRL, ZAR, TRY, and
MXN have been the paths of least resistance, but as
reforms are approved in Mexico and the prospect for
flows improve, we believe that sensitivity to speculative
flows will drop. We also see INR as a trade on the shift
away from crisis management, and prefer to position
tactically long.
Although the KRW has been less sensitive to UST
jitters, we expect the Koreans’ resistance to losing
competitiveness versus the JPY to force USD/KRW
higher. The RUB has been less volatile than ZAR and
TRY, but we expect this to change on 2014 as oil prices
turn less supportive and Russia’s structural bottlenecks
reemerge. Among the oil exporters, we continue to
expect further divergence in performance between
Mexico and Russia and thus MXN/RUB to break new
ground. Within EMEA, we favor ZAR vs. RUB and also
TRY on valuation, relative monetary policy bias, and our
view that South African exports seem to be finally
turning – a trend that seems bound to consolidate
given high PMIs in developed economies. This is in
contrast with TRY, where REER adjustment seems
insufficient and vulnerability to liquidity is higher.
In LatAm, we expect USD/BRL to trade in a wide range
(2:25-50), but to end the year at 2.40 – thus
underperforming forwards. The MXN will likely remain
volatile, but we expect it to start to reap the benefits of
reforms and close the year at 12.50. The divergence in
the economies should continue to push MXN/BRL amid
technical rebounds. Within the oil producers, we
expect MXN to outperform COP as oil production
prospects also diverge. Weighing on COP, we also see
elections (which normally brings weakness), and
Venezuela’s difficult outlook (despite much reduced
trade between these countries). In contrast, the CLP
should benefit from the upturn in China DB foresees,
and possibly lower oil prices.
„
In Asia, we favor long CNH, INR vs. USD and PHP
vs. TWD. Sell IDR, MYR, SGD, KRW, THB and TWD
vs. USD.
„
In EMEA, favor PLN and HUF vs. the EUR, and a
continued grind lower in USD/ILS. Favor ZAR over
TRY and also RUB among the high yielders.
„
In LatAm, we expect the USD/BRL to underperform
the forwards amid a high (2.25-2.50) range, favor
long MXN vs. COP, RUB, and USD, and long CLP
vs. COP.
Drausio Giacomelli, New York, +1 212 250 7355
Henrik Gullberg, London, +44 20 XXXXXX
Guilherme Marone, New York, +1 212 250-8640
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
EM Performance: Too much ado about technicals
„
Investors have increasingly singled out structural
demand weakness (in the form of persistent
outflows) as key to EM’s underperformance in the
latter part of the year.
„
We look into the relationships across basic flow of
funds, growth, performance and the Fed’s balance
sheet data to assess the importance of structural
technical shifts.
„
We find little evidence of technical bottlenecks
determining EM performance – both of domestic
and external sources.
„
Instead, this seems to originate in cyclical –
fundamentals-related – weakness in demand rather
than secular portfolio shifts or QE. Flows have
actually lagged rather than led performance.
Technicals vs. Fundamentals
EM underperformance has been accompanied by
persistent outflows throughout 2013 as demand for
emerging debt assets (EMD) lost ground to developed
markets, tapering fears mounted, and investors shifted
to more growth-sensitive assets. As the following chart
shows, EMD has lost 4.2% AUM (according to the
EPFR survey) up to end-November after having taken in
5.5% and 24.8% AUM in 2011 and 2012, respectively.
In the eyes of many investors adverse technicals (or, a
change in portfolio) have been a crucial driver of EM's
poor returns. Moreover, as many investors understand
that QE has provided a substantial boost to EM inflows
over the last few years, they seem to believe that
technicals will continue to drag down EM's returns in
the years to come as QE phases out and monetary
conditions are tightened further.
As we discuss in this year’s outlook, we continue to
believe that EM will struggle to stand out – the theme
we have pursued since our 2013 outlook15. Cyclically, it
should take a few months – at least – before emerging
economies show clear signs of catching up with the
global upturn. Also, increasing US yields will likely
continue to weigh on fixed income in 2014. However,
the question we are most interested in is whether there
have been clear indications of technicals being, or
could be, an additional (independent) structural drag to
EM performance in 2014.
15
See Emerging Markets 2013 Outlook. 07-Dec-13.
Deutsche Bank Securities Inc.
As we discuss in the following sections, we find EM's
underperformance to hinge on fundamentals (at times
amplified by positioning, of course) rather than on
technical factors such as portfolio relocation or
QE/taper risk. Supporting this view are the significant
outflows from EM equities (on dim and diverse growth
prospects) despite the broader rotation away from fixed
income into equities initiated in 2013.
A closer inspection of the data reinforces this message.
First, from a flow-of-funds perspective, we find that
flows have been quite poor predictors of asset
performance. Second, from a global liquidity standpoint,
we argue that portfolio flows and QE have been
erratically correlated and that portfolio flows have been
more closely associated with growth differentials
instead. Third, from a structural perspective, we find no
clear signs of stretched allocations into EM in global
portfolios.
EM vs. DM debt fund cumulative flows
Funds flow Index (% AUM, Mar 2009 = 100)
250
230
210
190
170
150
130
110
90
Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13
EM HC Bonds
EM LC Bonds
EM EQ
US IG
US HY
US EQ
Source: Deutsche Bank
To complete, we assess net supply (expected issuance
vs. redemptions) across the local and external markets
for the year ahead. We look for possible domesticdriven demand-supply imbalances, but find no clear
signs in this direction.
Funds flows: Leading or lagging indicators?
Available high-frequency portfolio flows data can
provide useful flow momentum information, but they
are poor predictors of asset performance and even of
overall portfolio flows themselves. Simple correlation
and (Granger) causality tests show that: a) weekly fund
flows and asset performances post high positive
contemporaneous correlations; b) it can be strongly
Page 39
5 December 2013
EM Monthly: Diverging Markets
rejected that fund flows lead to performance; c) it
cannot be rejected (at 2% confidence – see chart) that
performance causes flows in each local and external
markets during the period when EPFR data are
available16.
Granger causality: Flows cannot predict asset
aversion), 10Y UST yield, and VIX – tracks EM spreads
(contemporaneously) reasonably well (chart below).
EM BBB spread modeled by growth proxy, VIX, and US
rates
Market spread vs model spread
EM BBB Spread
490
performance
Model Spread
440
Granger causality (5Y sample)
Hypothesis:
390
Flows do NOT cause EM BBB spread: Rejected with only 24% confidence.
EM BBB spread does NOT cause Flows: Rejected with 98% confidence.
340
290
240
Source: Deutsche Bank, EPFR
190
That flows cannot predict returns is confirmed by
simple
correlations
between
returns
vs.
contemporaneous, lagged, and advanced weekly flows
for major EM and DM fixed income and equity asset
classes as we show in the table below. It is interesting
to note that in contrast with some DM asset classes,
EM fund flows post the lowest (basically zero)
correlations with future performance. In other words,
EM flows have been even worse potential predictors of
performance than in DM.
Flows correlate with past performance
Corre l ati o n s w i th
F l ow s
F l ow s
Fund Flows lead or lag in weeks
F l ow s
Flow s
w e e k l y pe rfo rm an ce l agg e d 2 w l agg e d 1 w Sam e w e e k l e d 1 w
led 2w
0.04
0.05
0.07
0.04
0.23
0.10
0.32
0.25
0.20
0.16
513
513
Global IG
Global HY
0.06
0.16
0.08
0.25
0.21
0.56
0.17
0.54
0.06
0.30
469
513
US Treas./Agency
EM EQ
0.02
0.05
-0.03
0.00
-0.02
0.38
0.14
0.50
0.08
0.22
354
513
DM EQ
Av e rag e
-0.03
0 .0 5
-0.07
0 .0 5
0.29
0 .2 5
0.19
0 .3 0
0.06
0 .1 5
513
F l ow s
4W Moving Average of Fund Flows lead or lag in weeks
Flow s
F l ow s F l ow s N o . of
4 w MV pe rfe rm an ce l agge d 2 w l agg e d 1 w Sam e w e e k l e d 1 w
EM HC
0.14
0.26
0.40
0.50
EM LC
0.08
0.18
0.30
0.41
90
Apr-09
Apr-10
Apr-11
Apr-12
Apr-13
Source: Deutsche Bank
When we add flows to this regression, little changes.
Weekly fund flows are hardly statistically significant.
The following table shows the original (basic) model
estimates vs. the extended model with weekly flows
lagged by one to four weeks. Although the weekly
flows lagged by four weeks does show up statistically
significant, the addition of these variables adds nothing
in terms of explanatory power to the model.
N o. of
Obe rv ati o n s
EM HC
EM LC
Corre l ati o n s w i th
140
l e d 2 w Ob e rv ati o n s
0.52
510
0.45
510
Global IG
Global HY
0.23
0.40
0.26
0.55
0.29
0.67
0.29
0.68
0.25
0.57
466
510
US Treas./Agency
EM EQ
DM EQ
0.01
0.23
0.06
0.03
0.41
0.20
0.08
0.62
0.39
0.15
0.73
0.42
0.19
0.68
0.37
510
510
510
Av e rage
0 .1 7
0 .2 7
0 .3 9
0 .4 5
0 .4 3
EM BBB spreads: Flows add little explanation power
Dependent Variable: EM Sovereign BBB Spread (bp)
Sample 5Y; OLS ‐ HAC t‐stat
Model 1: without flows variable
Model 2: with 4 lagged weekly flows
Variable
Coefficient
t‐stat
Variable
Coefficient
t‐stat
UST10
50.5
4.7
UST10
43.9
4.1
Copper/Gold
‐55.7
‐6.0
Copper/Gold
‐48.1
‐5.4
VIX
5.1
5.9
VIX
4.7
5.6
Constant
246.2
6.3
C
234.6
6.6
Flow WK(‐1)
‐2.7
‐0.8
Flow WK(‐2)
‐4.8
‐1.4
Flow WK(‐3)
‐2.8
‐0.8
Flow WK(‐4)
‐11.1
‐2.8
Adj. R‐sq.
81%
Adj. R‐sq.
81%
DW
0.34
DW
0.38
Source: Deutsche Bank
Source: Deutsche Bank, EPFR
We take one step further and use flows as an
additional explanatory variable in a regression model
built on the usual financial drivers of EM spreads to
gauge whether they can add explanatory power. This
simple model for EM BBB spread – with Copper/Gold
price ratio (as a proxy for global growth and risk
16
For further detailed study on equities, see Equity Strategy – Predictive
power of weekly fund flows.
Page 40
The results above are rather static. We take one more
step for completeness and run the usual cointegration
and impulse responses to assess the dynamic
responses to EM spread drivers. Consistently with the
previous findings, the following chart shows that the
response of BBB spreads to a weekly flows shock is
mild in comparison with the response to other variables.
A 1-standard deviation of weekly flows (corresponding
to 0.65% AUM change in weekly flows) results in less
than 1bp widening in the spread.
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Spread response to shocks: Weekly flows are
insignificant
EM BBB spread (bp) ‐ response to 1 stdev shock on independent variables
3
2
1
0
‐1
‐2
UST10
‐3
Copper/Gold
‐4
VIX
Weekly Flow
weeks
‐5
1
2
3
4
In our recent article EM Allocation: Strategic vs. Tactical,
we have argued that there is not much evidence in
support of QE playing a dominant role in pushing
capital flows into EM economies. They were nonexistent during the surge in portfolio flows of 2003-07,
for the record. Focusing on post-crises years, a simple
inspection of gross portfolio flows to EM vs. the Fed
balance sheet (chart above) shows that these have
accumulated even during QE interruptions. As we show
in more detail in the abovementioned article, QE and
EM flows have been erratically correlated across the
local and external markets.
5
6
7
8
9
10
11
Growth pull: Gross portfolio inflows vs. EM GDP
12
growth
Source: Deutsche Bank, Bloomberg, EPFR
Gross Portfolio inflows, % GDP
% GDP
EM Growth
10
Portfolio flows pull and push forces – growth or QE?
Has QE driven EM flows? Before answering this
question, we make a brief disclaimer. Having
established that funds flows do not predict or lead to
performance, we have already diminished their
informational content. Moreover, it is also wellestablished that flows are not necessary for asset
prices to change. However, we do not want to convey
the false impression that we underestimate the
importance of technicals. Portfolio relocations can
certainty make things a lot better or worse and we
believe they have contributed substantially to the
recent corrections across EM currencies, for instance.
We thus want to understand better what causes these
inflows, as they can amplify market movements (even
if lagging). In particular, we want to assess how
important QE (and taper) risks have been as they have
underpinned many investors’ bearish views on EM.
Portfolio inflows: Not interrupted by QE intermissions
USD bn
% GDP
2000
100
1800
90
1600
80
1400
70
1200
60
1000
50
800
40
600
30
400
20
200
10
0
Apr 09
Jan 10
Oct 10
Jul 11
Apr 12
Jan 13
QE periods with approx. monthly pace of purchases (rhs)
Fed balance sheet (lhs)
0
Oct 13
9
8
7
6
5
4
3
2
1
0
Dec-04 Jan-06
Feb-07 Mar-08 Apr-09 May-10 Jun-11
Jul-12
Source: Haver Analytics, IMF
Instead, there appears to be a stronger relationship
between private capital flows and GDP growth (the pull
factor), as the following chart shows. Altogether, the
evidence indicates that EM growth (pull) rather than QE
(push) factors are the dominant drivers of EM inflows.
With EM growth expected to revert to trend (amid
significant heterogeneity across countries), but still
likely lagging a few months the upturn in the US,
cyclical forces remain negative in the near term.
EM aggregate holdings: no structural signs of stretched
allocations
Whether global investors are overweight or
underweight EM is a difficult question to answer, as it
depends on institutional constraints and a precise
estimation of their desired long-term holdings. But
simple assessments of size and expected relative
performance could shed some light on whether EM is
possibly facing capacity constraints. As we suggest
below, the binding constraints seem cyclical rather
than structural.
Gross portfolio inflows into EM (rhs)
Source: Deutsche Bank
Deutsche Bank Securities Inc.
Page 41
5 December 2013
EM Monthly: Diverging Markets
How big (or, how small)? The total size of the liquid EM
fixed income market that is investable for offshore
investors amounts to about USD2.5tr. This pales in
comparison with global investment grade credit, which
is close to USD6tr judging by the size of the iBoxx
Global Corporate credit index (not including the
USD1.25tr of Global High Yields). The following chart
shows the evolution of these major EM fixed income
benchmarks. The EMBI Global (about USD560bn as of
October 2013) is fairly representative of the whole
sovereign/quasi space; the CEMBI Broad (close to
USD670bn) is the liquid part of the USD denominated
EM corporate market, the total market value of which
now exceeds USD1tr; the GBI-EM Global (about
USD1tr) represents the local currency bonds that are
accessible for offshore investors (this, for example,
excludes China).
EM benchmarks are pale in comparison with DM credit
Benchmark market cap, $bn
6,000
Global IG
Global HY
5,000
EMBI Global
CEMBI Broad
4,000
GBI-EM Global
3,000
2,000
1,000
Jun-05
Jul-06
Aug-07 Sep-08
Oct-09 Nov-10 Dec-11
Jan-13
Source: Deutsche Bank
EM fixed income is minute if compared to DM fixed
income more broadly (including sovereigns and
agencies, for instance). The following table presents
data from major EM benchmarks and from SIFMA and
BIS. It suggests that the EM fixed income market
accounts for only about 3.2% of the total fixed income
market in the world.
From a broader investable universe, data tends to be
plagued by double-counting and other estimation
issues, but industry estimates and OECD numbers
point to a huge pool of assets in the amount of over
USD140trn 17 , in comparison with the investable
amount of USD2.5trn EM debt.
17
These include pension funds, insurance companies, and investment
funds (USD25tr, USD22tr, USD30tr, respectively, per OECD), Sovereign
Wealth Funds and Private Wealth Funds (USD5tr and USD42tr,
respectively, per TheCitiUK), FX Reserves (USD11.1tr per IMF), and
alternative investments (USD5tr).
Page 42
EM fixed income: Still a tiny share of the world fixed
income
Fixed Income cash market size, EM and DM
Asset Class
Mkt val (USD bn)
EM Total
2,810
EMBI Global 560
GBI‐EM Global 973
CEMBI Broad 684
Less liquid Corporate 400 **
Other* 200 **
Asset Class
US Total***
Municipal
Treasury
Mortgage Related
Corporate Debt
Agency Securities
Money Markets
EM as % of World Total
3.2%
Asset‐Backed
Rest of DM
DM Total****
* Including non‐USD denominated bonds and Next Generation markets
** Rough estimate only
*** Source: SIFMA
**** Source: BIS
Mkt val (USD bn)
38,292
3,721
11,295
8,118
9,349
2,074
2,518
1,216
46,000
84,292
Source: Deutsche Bank
How does the growth in these benchmarks compare
with the growth in funds flows? We compare
cumulative %AUM EPFR funds flow data (which is
dominated by retail flows18) vs. the growth of local and
external debt markets. The EPFR flows for EMD have
lagged the growth in the market value of EMBI-global,
but it has outpaced the growth of the GBI-EM
benchmark. We note that the EPFR data is partial and
thus inconclusive as to whether global investors are
under- or over-allocated to EM debt – especially in local
markets. However, the sheer size of foreign allocations
to local bonds does bode for caution, even if they have
been remarkably resilient19. This leads to the question
of whether valuations are attractive enough to secure
these investments.
Growth of EM benchmarks and cumulative EPFR funds
flows
EM Hard Currency Debt
EM Local Currency Debt
210
270
240
180
210
150
180
150
120
90
Mar-09
Cumulative Flows
Market value of EMBI-Global
Mar-10
Mar-11
Mar-12
Mar-13
120
90
Mar-09
Cumulative Flows
Market value of GBI-EM
Mar-10
Mar-11
Mar-12
Mar-13
Source: Deutsche Bank; EPFR; Bloomberg Finance LP and Haver
How much upside? In our 2013 Outlook published last
year, we made the case of “diminishing returns” and
characterized the asset class with terms like “Less Gas
in the Tank” and “EM - Struggling to stand out”.
18
EPFR flows do not include the true strategically mandated money, such
as SWFs, big ticket ring-fenced investment mandates, pension find and
insurance company allocations, etc.
19
See our EM rates outlook in this publication.
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
However, unfortunately, the performance has been
even worse than we had predicted. Now, given the
continuation of rising interest rate in the US, it is hard
for us to be optimistic about the asset performances in
2014. However, it is also important to note that after
the re-pricing valuation is now much improved
compared to the end of last year, with a return of risk
premium to compensate the potential deterioration of
the relative fundamentals of EM vs. DM assets.
2013 should reduce the amount of gross primary
market supply from sovereign issuers than otherwise
as we show in the chart below. This combined with
historically high amount of repayments pushes net
supply into negative territory 20 . At the same time,
corporate issuances are also expected to decline from
the record levels of 201321. The bar seems thus lower,
as rollover of existing debt would suffice to cover 2014
needs.
We project EM fixed income to be among
Redemptions more than cover gross issuances for the
outperformers in 2014
first time since 2008 in EM external debt
Returns of various asset classes
Aggregate EM Annual Gross Issuane and
120
100
S&P
80
EMBI-G
60
HY
40
DB-EMLIN
20
IG
0
2008
EM Eq
2014 forecast
Com'dty
-10%
0%
10%
20%
30%
Source: Deutsche Bank
With our baseline projection of EM hard currency
earning the carry in 2014 (6.0%) and local debt
returning 4.2% (un-hedged), and projections of total
returns for various other asset classes, it appears that
EM fixed income assets will be likely seen in a brighter
light in 2014 – provided our projections are correct. A
mean-variance optimization also suggests a material
allocation to EMD (in various forms) for a wide range of
investor risk tolerances if we use these as expected
returns.
A peek into supply and redemptions in 2014
Having discussed external flows we look at possible
imbalances between redemptions and supplies in 2014.
An objective assessment of demand would be ideal,
but – in the absence of substantial shifts in preferences
– these simple data could shed some light on potential
imbalances across external debt and local markets.
Starting with hard currency debt, the outlook for 2014
seems benign. The above-average pre-funding of late
Deutsche Bank Securities Inc.
2013YTD
Issuance
2014F
Source: Deutsche Bank
2013
UST (10-15Y)
2009
2010
2011
2012
Repayments (Principal and interest)
The outlook for local markets supply also seems
supportive. The following tables summarize 2013
redemptions, supply, and our forecasts for 2014. The
net supply change is mostly negative (meaning, lower
supply net of redemptions in 2014 vs. 2013) across all
regions. Mexico and Brazil are exceptions where we
expect net issuance to pick up by 1pp of GDP 0.6pp
(net), respectively, vs. the previous years. In Poland, the
numbers are distorted by the changes in the pension
system, but the overall picture for the region seems
benign except for the Czech Republic where debt is low
and authorities could increase external issuance. We
expect a mild net reduction in supply over redemptions
across Asia, with a more substantial drop in Thailand.
Overall, from a purely technical perspective, domestic
risks seem contained.
20
Also see Outlook for Sovereign Credit in this Publication for more
details.
21
At the time of this writing, we have not yet finalized our 2014 projection
of EM corporate issuances. However, based on tentative information
gathered so far, it should be substantially lower than 2013.
Page 43
5 December 2013
EM Monthly: Diverging Markets
Net domestic issuances (2014 vs. 2013)
L o cal i ssu an ce (l cl ccy, % G D P)
G ro ss
2013
Re de m p.
Net
G ross
2014
Re de m p.
Net
1 4 v s. 1 3
N e t ch g
China
Hong Kong
India
3.0%
1.8%
6.1%
1.1%
1.1%
1.4%
1.9%
0.6%
4.7%
3.0%
1.9%
6.4%
1.2%
1.3%
1.5%
1.7%
0.6%
4.8%
-0.2%
0.0%
0.2%
Indonesia
Korea
Malaysia
3.1%
6.8%
9.4%
1.1%
3.9%
5.3%
1.9%
2.9%
4.1%
3.2%
7.2%
8.5%
1.3%
4.4%
4.9%
1.9%
2.8%
3.6%
-0.1%
-0.1%
-0.5%
Philippines
Singapore
6.2%
6.4%
2.9%
5.5%
3.3%
1.0%
6.1%
7.1%
2.9%
6.2%
3.1%
0.9%
-0.2%
0.0%
Taiwan
Thailand
4.5%
5.0%
2.4%
1.8%
2.0%
3.2%
4.6%
3.5%
2.7%
2.0%
1.8%
1.6%
-0.2%
-1.7%
Brazil
Chile
Colombia
10.6%
2.7%
4.2%
12.0%
1.7%
3.1%
-1.4%
0.9%
1.2%
10.0%
1.8%
4.3%
10.7%
0.8%
3.2%
-0.7%
1.0%
1.1%
0.6%
0.0%
-0.1%
Mexico
Peru
6.6%
1.4%
6.2%
1.6%
0.4%
-0.2%
7.8%
0.4%
6.3%
0.7%
1.5%
-0.2%
1.1%
0.0%
Czech Rep.
3.8%
3.0%
0.7%
4.3%
1.5%
2.8%
2.1%
Hungary
Israel
Poland
5.9%
7.7%
8.6%
3.5%
4.3%
4.2%
2.4%
3.4%
4.4%
7.2%
8.0%
6.1%
4.0%
5.0%
3.7%
3.2%
3.1%
2.0%
0.8%
-0.3%
-2.4%
Russia
S. Africa
1.2%
5.1%
0.6%
0.5%
0.6%
4.6%
1.2%
5.1%
0.5%
1.0%
0.7%
4.1%
0.1%
-0.5%
Turkey
9.7%
8.7%
1.0%
8.8%
7.7%
1.1%
0.1%
Source: Deutsche Bank
Drausio Giacomelli, New York, +1 212 250 7355
Hongtao Jiang, New York, 1 212 250 2524
Page 44
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Asia’s Frontier Economies: Plenty of Alpha
What is a frontier economy, and how and when does it
join the club of more scrutinized emerging market
economies? The answer, for the purpose of this special
publication, is as follows: frontier economies in Asia
are considered to be those with the scale and/or
potential to be comparable to emerging market
economies, but presently lacking in sufficient economic
and financial market depth to be suitable for large
institutional participation in its financial markets.
In this note, we focus on eight selected economies of
Asia that hold promise for a better tomorrow, not just
for their population but for investors seeking alpha in
an increasingly correlated world. The global financial
crisis and the subsequent recovery have shown that
financial markets have been beset with cross-border
transmission of shocks, making diversification difficult.
Frontier markets, because of their early stages of
development and lack of market depth, are by and
large uncorrelated to global markets.
The countries in this study, Bangladesh, Cambodia, Lao
P.D.R., Mongolia, Myanmar, Pakistan, Sri Lanka, and
Vietnam have seen fairly strong growth and impressive
gains in income in recent years. Around the year 2000,
in current prices, all countries were characterized by
per capita income of less than $1000, while today
incomes are higher by 2 (Bangladesh and Pakistan) to 8
(Mongolia) times. In purchasing power parity terms, the
gains are smaller, but still impressive (2 to 3 times, as
seen in chart below).
Per capita income is rising briskly, with a few countries
heading into EM-comparable levels
USD, PPP
2000
2012
2018 proj
10,000
8,000
6,000
4,000
2,000
0
Source: IMF, Deutsche Bank. Gross domestic product based on purchasing-power-parity (PPP) per
capita GDP, expressed in current international dollar
Pakistan has experienced a sharp slowdown lately.
Mongolia is a classic commodity boom story, while
Cambodia, Lao, and Myanmar reflect low hanging fruits
of opening up the economy. Sri Lanka shows
tremendous promise as it shrugs of the drag from
decades of civil conflict, and as per IMF forecasts,
could be heading to the middle income cohort by the
end of this decade.
With the exception of Pakistan, real GDP growth rate
has been robust
%yoy
2003-07
2008-12
2013-18 proj
14
12
10
8
6
4
2
0
Source: IMF, Deutsche Bank
The economies in this study vary widely in size, but
three already have nominal GDP amounting to more
than USD100bn, namely Bangladesh, Pakistan, and
Vietnam. Indeed, these three economies have a
combined GDP of nearly half a trillion dollars and
population of half a billion. These are hefty figures even
by EM standards, and the scale alone is sufficient to
keep investors interested in the coming years.
Two other economies in this study, Myanmar and Sri
Lanka, offer potential scale (both likely to become
USD100bn economies by 2018) and fast growth rates.
The former is coming out of decades in economic
seclusion, while the latter is recovering from a multidecade civil war. Myanmar, if governed prudently,
offers exciting opportunities for investors given its large
population (64 million), extensive natural resource base,
and low wages. Sri Lanka, already endowed with some
of the most educated work force in the region and
world class tourist destinations, could well be on the
cusp of a sharp acceleration in growth, provided
governance improves and the security situation
remains stable.
Indeed, real GDP growth has been robust among these
economies, by and large exceeding 6%, although
Deutsche Bank Securities Inc.
Page 45
5 December 2013
EM Monthly: Diverging Markets
Three economies already in the USD100bn+ GDP club
USD bn
2012
2018 proj
300
250
200
Strong growth, if not managed through prudent
counter-cyclical fiscal and monetary policies, can be
readily associated with high rates of inflation. The chart
below shows that frontier economies tend to struggle
in this area, with all countries in our study experiencing
inflation rates of 6% or higher in the past 5 years. Given
that these economies have large swaths of population
at or below the poverty level, and inflation tends to hurt
the poor the most, the authorities need to work hard at
bringing inflation down if they are serious about
reducing poverty and inequality.
150
100
50
0
Source: IMF, Deutsche Bank
Asia’s frontier economies have their work cut out with
regards to improving the living conditions of their
population. Latest reading from the United Nations
Human Development Index, which is a composite of
life expectancy, education, and income indices, finds
no country in the study in the high cohort, although Sri
Lanka is on the cusp of joining that. Mongolia also
ranks in the middle cohort comfortably as its per capita
GDP and education attainment levels have risen sharply
in recent years. Indeed, Mongolia recently overtook the
Philippines in HDI scores, and is fast converging on
Thailand. Among the rest, Bangladesh has seen a
steady rise in recent years, outpacing its peers, while
Pakistan has seen some setback as both the economy
(especially income inequality) and the security situation
has worsened.
Human Development Indicators; all have transitioned
from low to medium level of development
0.8
0.7
high:
0.76
medium:
0.64
0.6
0.5
0.4
Vietnam, all countries in this study have been running
sizeable current account deficits, ranging from -2% of
GDP in Pakistan to a staggering -33% of GDP in
Mongolia. Both Pakistan and Mongolia are presently
experiencing difficulties in financing their imbalances,
seeing their currencies weaken as a result.
low:
0.47
0.3
Source: United Nations 2013 Human Development Index, Deutsche Bank
Track record with inflation has been broadly poor
%yoy
2003-07
2008-12
2013-18 proj
20
16
12
8
4
0
Source: IMF, Deutsche Bank
Partly due to macro-economic volatility and limited
market access, until recently there was little investor
participation in most of the economies in this study.
Change is underway, however. A few countries have
already managed to attract sizeable foreign direct
investment, with Cambodia, Mongolia, and Vietnam
particularly notable. Mongolia’s tremendous mining
potential has begun to be realized as global energy
giants have poured in money; indeed, in recent years
FDI has amounted to nearly half the nominal GDP.
Cambodia and Vietnam are receiving considerable
attention from China in their apparel (Cambodia) and
manufacturing (Vietnam) sectors. Lao, Myanmar and
Sri Lanka have begun attracting considerable
investment as well. The track record of Bangladesh and
Pakistan, however, has been poor.
While the countries in this study have grown
substantially recently, with potential for more in the
coming years, their key challenge is to assure
macroeconomic stability while moving forward. Take
for instance, the current account position of these
economies. With the exception of Bangladesh and
Page 46
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Country themes
Bangladesh: Despite constraints such as limited
land, risks from climate change and high
frequency of natural disasters, severe energy
shortage, poor infrastructure, periodic political
crises, and grave shortcoming in governance,
Bangladesh’s gains in economic growth and
social indicators in recent decades have been
remarkable. This trend is likely to continue.
Cambodia: Dependent on the US and EU for its
textile and footwear exports, Cambodia also
relies on its neighboring economies to finance its
fiscal and current account deficits.
Laos: Heavily geared to Thailand’s growth, due to
its reliance on the latter for exports, in both
goods and services.
Mongolia: A small country population-wise
(2.9mn in 2012), Mongolia is endowed with an
exceptionally rich natural resource base.
Estimates of the country’s endowments have
been repeatedly revised upward, drawing
considerable FDI. Managing resource extraction
in a prudent and sustainable manner, while
minimizing damaging boom-bust cycles, is the
key challenge.
Myanmar: Myanmar is seeking an ambitious
development strategy that aims to achieve both
high and balanced (inclusive) growth. To this end,
it has started laying the building blocks - physical,
legal and institutional infrastructure, although
much work remains.
Pakistan: Pakistan is endeavoring to transition to
economic and political stability. In the aftermath
of an orderly election, a fresh engagement with
the IMF, and some recent measures taken by the
authorities, the hope is that better days are
ahead.
Sri Lanka: The macroeconomic landscape of Sri
Lanka has undergone a dramatic transformation,
since the termination of the three decade long
internal strife in 2009. Easing of security concerns
and restoration of stability in governance are
paving the way for improved growth prospects.
Vietnam: After years of boom and bust cycles,
the government prioritized stability for two years
and is about to embark on its second reform
push, with the Trans-Pacific Partnership as a
catalyst for comprehensive change.
Deutsche Bank Securities Inc.
Only a few are drawing sizeable FDI
% of GDP
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
Source: World Bank, Deutsche Bank. This chart excludes Mongolia as adding it would distort the
presentation. Mongolia received about 45% of GDP worth of FDI last year., almost all if it in mining.
Beyond FDI, the prospect for portfolio flows has
improved as markets have opened up. ETFs on
Bangladesh, Mongolia, Pakistan, Sri Lanka, and
Vietnam
are
available,
while
equity
market
capitalization in Bangladesh, Pakistan, and Vietnam are
in the USD30-50bn range, making them interesting as
far as scale is concerned.
Stock market capitalization
% of GDP
35.0
30.0
USD
33bn
USD
1.3bn
USD
48bn
USD
19bn
USD
33bn
25.0
20.0
15.0
10.0
5.0
0.0
Source: CEIC, World Bank, Deutsche Bank
Returns have been handsome as well. Pakistan’s
Karachi Stock Exchange, for example, is up 160% over
the last five years, impressive gains even after the 30%
depreciation of the rupee against the USD is taken into
account. Investors in Bangladesh and Vietnam have
seen, despite considerable volatility, net returns of 6080% during this period.
Page 47
5 December 2013
EM Monthly: Diverging Markets
External bond markets for some frontier countries have
become active. While most external debt issued by
these countries are multilateral or bilateral concessional
loans, and local currency debt markets are by and large
off limits to foreign investors, there have been a few
sovereign and sovereign-backed issuances in recent
years (see table below).
Outstanding bonds
USD bn
Sovereign
Sovereign-backed
Mongolia
1.50
0.58
Sri Lanka
3.50
1.75
Vietnam
1.75
--
Source: Deutsche Bank
Finally, the most compelling reason to invest in frontier
countries, beyond their growth potential and associated
dynamic, is their lack of correlation with the global
economic cycle. In the following table we present a set
of growth regressions with G2 growth as the
explanatory variable. This simple framework has proven
to be useful in tracking EM Asia’s growth path in recent
decades. Extending the analysis to our set of frontier
countries, we see that most offer little beta to the G2,
with most their growth rates captured in the intercept
of the regressions. Investors looking for low or
negatively correlated trades in a world of increasingly
Page 48
common shocks will find looking at the countries in this
study useful, in our view.
Growth relationship with G2
Alpha
Beta
Bangladesh
5.8
0.0
Cambodia
5.8
1.4
Lao
7.4
0.0
Mongolia
6.6
0.8
Myanmar
7.6
1.4
Pakistan
3.3
0.7
Sri Lanka
4.7
0.4
Vietnam
6.1
0.3
Source: CEIC, IMF, Deutsche Bank. Growth beta regressions are run with individual country real
growth as dependent variable and GDP-weighted US/EU growth as the independent variable. Alpha is
the intercept while beta is the estimated coefficient on G2 growth.
The detailed report, “Asia’s Frontier Economies: Plenty
of Alpha,” published on 1 December 2013 can be
accessed through the link below:
http://pull.db-gmresearch.com/p/4375BC09/84740784/DB_SpecialReport_2013-1201_0900b8c0879921db.pdf
Taimur Baig, Singapore, +65 6423 8681
Kaushik Das, Mumbai, +91 22 7158 4909
Juliana Lee, Hong Kong, +852 2203 8312
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Brazil: Overview of 2014 Presidential Elections
„
Barring a significant deterioration in economic
conditions, the most likely scenario for next year’s
elections is that President Dilma Rousseff will be
re-elected for another four years in office due to
her high approval ratings, low unemployment,
extensive welfare policies, and her party’s powerful
political structure.
„
While we believe some policy adjustments will be
inevitable (especially on the fiscal front), we expect
Rousseff
to
maintain
strong
government
intervention in the economy, and do not anticipate
significant progress in structural economic reforms
during her second term.
„
However, the mass demonstrations that rocked the
country in June, hurting the president’s popularity,
showed that Rousseff cannot take her re-election
for granted. The election will probably be decided
in two rounds, and an opposition candidate that
manages to tap into the middle-class electorate’s
desire for change could pose a challenge to the
president’s re-election.
Brazil will go to the polls in October 2014 to elect the
president of the republic, all 27 governors (for 26 states
and the federal district), all 513 Lower House
representatives, and 27 senators (1/3 of the Senate). As
usual, financial markets will focus mainly on the
presidential elections.
2014 electoral calendar
10-Jun
From this day on, all election polls must be registered at the
TSE electoral court
Deadline for government officials planning to run in the
elections to leave office
Candidates are allowed to campaign for nomination within
their parties
Beginning of party conventions to nominate candidates
30-Jun
Last day for party conventions
1-Jul
Media is not allowed to broadcast political advertisement
5-Jul
6-Jul
Several restrictions on public sector hiring and spending
come into effect
Candidates are allowed to begin campaigning
19-Aug
Beginning of free advertisement on radio and TV
2-Oct
Last day of free advertisement on radio and TV
5-Oct
First-round vote
26-Oct
Second-round vote
1-Jan
5-Apr
26-May
Source: Tribunal Superior Eleitoral
At this juncture, we believe the most likely scenario is
that President Dilma Rousseff of the Workers Party (PT)
will probably be re-elected for another 4-year term in
October 2014. Despite Brazil’s disappointing economic
growth since 2011, unemployment remains at record
low levels and a large part of the population continues
to benefit from the federal government’s generous
Deutsche Bank Securities Inc.
welfare programs such as the “Bolsa Família.”
Consequently, Rousseff’s popularity remains relatively
high. While the president’s approval rating declined
sharply in the aftermath of the mass demonstrations
that rocked the country in June, it has recovered some
ground since then, as the demonstrations have
dwindled and the government’s responses (revoking
the increase in bus fares and importing medical doctors
from Cuba, for example) have been well received by
the population in general.
President Rousseff’s approval rating
70
60
50
40
30
20
Good/very good
Regular
Bad/very bad
10
0
Source: Datafolha
The incumbent candidate enjoys enormous advantage
over the opposition, as the president is practically every
day on TV, in the newspapers, etc. Moreover, the PT
leads a large coalition of parties that command
enormous financial resources and will benefit from the
largest share of the mandatory campaign on TV and
radio ahead of the election (the time allotments are
proportional to the number of seats in the Lower
House).
The traditional opposition looks weak. The PSDB,
former President Fernando Henrique Cardoso’s party,
has been the PT’s main adversary in the last three
presidential elections. Luis Inácio Lula da Silva beat
José Serra in 2002 and Geraldo Alckmin in 2006, while
Dilma Rousseff beat Serra in 2010. Serra suffered a
major political defeat in 2012, when he was beaten by
the PT’s relatively unknown candidate supported by
Lula (F. Haddad) in São Paulo’s mayoral election, and
has seen his political clout dwindle since then. At this
juncture, although Serra has not yet abandoned his
plans to run for a third time, Senator Aécio Neves
seems to be PSDB’s most likely presidential candidate.
Page 49
5 December 2013
EM Monthly: Diverging Markets
Estimated time of TV advertisement
14%
11%
D. Rousseff (PT)
A. Neves (PSDB)
21%
E. Campos (PSB)
Others
54%
While the scandal has tarnished the PT’s reputation
and reinforced the perception of widespread corruption
in Brasília, it has not prevented the party from growing.
At the peak of the scandal in the second semester of
2005, the president’s political situation became so
difficult that he even considered an agreement with the
opposition whereby he would not run for re-election in
exchange for avoiding impeachment. As the scandal
gradually left the newspaper headlines and the
economy improved, however, the president’s approval
ratings recovered quickly and Lula was easily reelected in 2006. Moreover, when the Supreme Court
trial attracted a lot of media attention last year, it did
not have any meaningful effect on the municipal
elections.
Source: Deutsche Bank
Presidential poll
The PSDB will face enormous challenges in the
campaign, as the party has not been able to find a
strategy to win popular support away from the PT.
While the “Bolsa Família” program was actually
introduced by Cardoso, the PT has expanded it
significantly and reaped all its political fruit. The PSDB
has not been able to capitalize on important
achievements of the Cardoso administration, such as
inflation stabilization and privatization. Although
inflation has risen again, the difficult years of
hyperinflation seem to be lost in the memory of older
generations.
Privatization has dramatically improved economic
efficiency, but it remains a taboo among the majority of
Brazilian voters. In 2006, for example, Alckmin’s
candidacy was hit hard when the PT claimed that he
would privatize state-owned enterprises such as Banco
do Brasil and Petrobras if elected. Consequently, the
PSDB has been forced to take an ambiguous stance on
economic issues, trying to distance itself from the PT’s
populist agenda, but at the same time shying away
from defending a program of market-friendly reforms.
For example, when newspaper, Valor Economico
recently published interviews with economists who
supposedly advised Aécio Neves and supported
controversial proposals such as smaller increases in the
minimum wage, the candidate rushed to clarify that
their opinions did not reflect his view.
Regarding the recent imprisonment of some PT
members and former officials of the Lula administration
(including former PT president and Lula’s chief of staff
José Dirceu), we do not expect significant implications
for the presidential election. These arrests resulted
from a long and controversial trial held at the Supreme
Court (STF) on a group of people accused of
participating in the “mensalão” scandal that surfaced
in June 2005, when federal officials and PT
representatives were accused of siphoning off money
from state-owned companies to buy votes from
politicians of the ruling coalition in Congress.
Page 50
60
51
6-Jun
50
28-Jun
42
40
30
9-Aug
35
12-Oct
30
23
20
26
21
16
14
17
15
13
10
6
7
8
0
0
D. Rousseff (PT)
Marina Silva
Aécio Neves (PSDB)
E. Campos (PSB)
Source: Datafolha
Nevertheless, while Rousseff’s re-election is the most
likely scenario, it cannot be taken for granted. Even
among the country’s economic elites, Rousseff does
not enjoy the same prestige as former President Lula
due to disappointing economic performance marked by
slow growth and high inflation, and especially
increasing government intervention in the economy.
And while low employment and the government’s
massive income transfer programs certainly support
Rousseff’s popularity, one of the most surprising and
important political developments this year was the
wave of mass demonstrations that rocked the country
in June and led to a significant decline in the
president’s approval ratings, showing that the official
candidate is not rock solid.
The movement essentially began with a protest against
an increase in bus fares in the city of São Paulo, from
BRL3.00 to BRL3.20 at the beginning of June. The
protests were initially staged by a small group called
“Movimento Passe Livre” (Free Pass Movement), a
radical left-wing group that advocates free public
transportation. The adjustment in bus fares was long
overdue, and was just enough to keep up with inflation.
The price increase had actually been previously
scheduled for January, but the federal government
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
convinced the mayor to postpone it until the middle of
the year, when inflation seasonality would be more
favorable.
While previous MPL protests had been small, the
demonstrations grew rapidly this time as the middle
class enthusiastically took the streets of many cities to
protest against not only about the cost of public
transportation, but also about its poor quality, bad
healthcare services, inefficient education system,
corruption, crime, etc. High inflation was an important
factor as well, obviously due to its negative effect on
disposable income. Another catalyst for the movement
was the 2014 World Cup, as the government is
spending a huge amount of money on white-elephant
stadiums that may be useless after the event.
The diffuse character of the demonstrations, contrasted
with previous large popular demonstrations, had a
clear target, such as the movements for direct
presidential elections in 1984, and for the impeachment
of President Fernando Collor de Mello in 1992.
Nevertheless, the issues raised in June seemed to have
a common denominator: the middle class’ growing
frustration with the political process, perception that
Brazil’s representative democracy is increasingly
detached from the population, and demand for a better
quality of life.
The large demonstrations gradually tapered off as most
governments quickly rolled back the increases in public
transportation prices and the Confederations Cup (the
football championship that served as dress rehearsal
for the 2014 World Cup) ended, but their implications
could be long-lasting. On the economic front, the
higher demand for better and cheaper public services
puts additional pressure on the country’s fiscal
accounts. It will be quite difficult for local governments
to raise public transportation prices again in the near
future, for example. Moreover, one of the measures
that President Rousseff announced to appease the
demonstrators was an additional BRL50bn (1% of GDP)
to be spent on public transportation (although there
were no details on where the money would come from
and when and where it would be spent).
Traditional parties have failed to capitalize on the
demonstrations,
which
ultimately
targeted
congressmen, mayors, governors, and the president of
the republic alike. According to the latest Ibope poll
conducted in November, 62% of the interviewees said
that they would like to see partial (38%) or total (24%)
changes in the way the country is governed, in contrast
with 2010, when roughly two thirds said that they did
not want any changes.
Moreover, the whole ordeal not only had a significant
impact on President Rousseff’s popularity (even though
her approval ratings remain quite high), but also raised
Deutsche Bank Securities Inc.
questions about the government’s crisis management
skills. Rousseff’s main response was the controversial
proposal to call for a plebiscite to decide on a
constitutional assembly to implement a political reform,
an attempt to share the burden of the demonstrations
with Congress that was received with strong criticism
by the opposition and Supreme Court judges, and was
eventually abandoned.
Former senator and environment minister, Marina Silva
was the main beneficiary of the demonstrations as she
gained 10 percentage points in roughly two months
according to polls conducted by the Datafolha institute.
The rise in the polls can probably be explained by
Marina’s criticism of traditional horse-trading politics,
focus on environmental issues, and credibility gained
by leaving the government when she was not able to
implement her agenda.
Marina Silva served as President Lula’s environment
minister between 2003 and 2008, when she resigned
amid controversy about her alleged reluctance to grant
environmental licenses for large infrastructure projects
and disagreement with the president’s chief of staff
Dilma Rousseff. In 2009, Marina quit the PT and joined
the Green Party, under which she ran for president in
the 2010 elections and finished third with an
impressive 19.3% of the vote in the first round
(especially considering how little TV advertisement
time she had), behind Rousseff (46.9%) and Serra
(32.6%).
Marina left the Green Party in 2011 and tried to build a
new party in 2013, to be called Rede Sustentabilidade
(“sustainability network”). However, Marina and her
supporters were not able to muster the 492 thousand
notarized signatures required by the TSE superior
electoral court to accept the registration of a new
political party in time to participate in the 2014
elections (Rede alleged that 95 thousand signatures
were rejected without proper justification and failed to
reverse the decision in court).
Unable to establish her own party, Marina surprisingly
decided to join the PSB (Brazilian Socialist Party) and
support the presidential candidacy of Eduardo Campos,
the governor of the northeastern state of Pernambuco
and another former minister of President Lula’s. The
decision was surprising because Marina had offers
from other political parties that did not have a
presidential candidate. By joining the PSB and, at least
temporarily, relinquishing her own candidacy, the
former senator kept the Rede Sustentabilidade project
alive and put her political capital at use in the elections,
in a move that some political analysts saw as revenge
against the PT.
Governor Eduardo Campos is the grandson of Miguel
Arraes (1916-2005), a prominent left-wing politician
Page 51
5 December 2013
EM Monthly: Diverging Markets
who was arrested and exiled during the military
dictatorship (1964-1985) and was also elected governor
of Pernambuco three times (once before and twice
after the dictatorship). Campos was elected a Lower
House deputy in 1994, 1998, and 2002. After serving as
President Lula’s minister of science and technology
between 2004 and 2005, Campos won Pernambuco’s
gubernatorial election in 2006 (after starting in third
place in the polls, but receiving President Lula’s
support), and was re-elected in 2010 (when he
obtained approximately 80% of the vote in the firstround vote).
We believe the Eduardo Campos-Marina candidacy
poses a potential threat to Rousseff because it could
break the polarization between the PT and the PSDB
that has been very convenient to the former. As former
Lula ministries from the North and Northeastern
regions, Campos and Marina are practically immune to
criticism usually levied against the PSDB politicians,
frequently portrayed as pro-privatization and anti-BolsaFamilia candidates.
Nevertheless, the alliance will face some challenges.
First, Marina’s and Campos’s groups do not see eye to
eye on several issues. The farmers who support
Campos, for example, diametrically oppose Marina’s
environmentalist views. Second, at least for now,
Marina is much more popular than Campos. The polls
show that her joining the PSB has boosted support for
Campos, but he still has far fewer votes than Marina
had before joining the PSB. Clearly, some former
supporters of hers have migrated to Rousseff. Given
that Marina’s popularity seems strongly related to her
non-conventional approach to politics, it remains to be
seen how many votes she will be able to transfer to
Campos. It is conceivable that, should Campos’s
candidacy fail to take off, Marina could replace him as
presidential candidate, but this does not seem the most
likely scenario at this juncture.
The candidates’ economic views
In our view, Aécio Neves would be the favorite
candidate for Brazilian financial markets, given the
PSDB´s traditional market-friendly views in favor of
reduced government intervention in the economy,
privatization, and the so-called “three pillars” of
economic stability (inflation targeting, fiscal discipline
and floating FX regime).
The second-best alternative for markets would be
Eduardo Campos. The governor of Pernambuco has a
pro-business reputation and has been actively meeting
entrepreneurs and financial market representatives to
promote his agenda. He has been quite critical of
Rousseff’s economic policies, especially due to
lenience with inflation and fiscal profligacy. He has
mentioned reforms as a necessary condition for further
Page 52
growth, although it remains far from clear which
reforms would be his priority and how he would tackle
them.
Marina Silva has adopted a market-friendly approach to
economic themes as well, defending the “three pillars.”
Interestingly, she has a group of prestigious “liberal”
economists advising her, including economics
professor Eduardo Giannetti da Fonseca and André
Lara Resende, one of the architects of the “Real Plan.”
However, Marina could be frowned upon by some
sectors of the economy (especially farmers) due to her
environmental stance.
As for incumbent President Dilma Rousseff, her reelection would likely ensure the continuation of the
main economic guidelines, although probably with
some adjustments. In January 2010, commenting on
the upcoming presidential election, our take on what a
Rousseff administration would look like was not of the
mark:
Rousseff’s left-wing background and track-record in the
Lula administration suggest that she has a strong
interventionist bias, believing that the public sector
should be the main conduit of investment, not only
regulating but also financing and directing the private
sector. […] We also believe that Rousseff would pursue
aggressive industrial policies, using the National
Development Bank to finance “strategic” sectors.
Regarding fiscal policy, media reports suggest that
Rousseff is a steadfast supporter of generous spending
policies. (Emerging Markets Monthly, January 2010).
Aside from inevitable adjustments in short-term fiscal
and monetary policy, we do not see significant
changes in orientation during Rousseff’s second term.
Essentially, we would not expect a strong effort to pass
structural reforms capable of overcoming the main
restrictions to economic growth, especially the low
saving rate. That said, the latest developments in the
privatization area have been very encouraging,
highlighted by the recent success in two airport
concessions. The government has ambitious plans to
offer more concessions in the transportation sector
(roads, highways and ports), and seems to be gradually
coming to terms with the fact that the private sector
will not invest unless it can obtain a rate of return high
enough to compensate for the risks.
There is yet another possibility, a “Plan B” for the PT:
the comeback of former president Lula, who remains
very active behind the scenes, still enjoys enormous
popularity and would likely be more easily re-elected
than Rousseff. We believe markets would react
positively to this scenario on expectations that there
would be an adjustment similar to what happened in
Lula’s first year in office (2003), when the central bank
tightened monetary policy and the government cut
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
fiscal spending and proposed a series of marketfriendly reforms – which the newly-elected president
was in a relatively strong position to approve in
Congress.
There has been intense speculation in the local press
about Lula’s replacing Rousseff as the PT candidate
next year, especially because of the decline in her
approval ratings following the June protests, and more
recent bouts of financial volatility. Newspaper Valor
Econômico recently published a long article claiming
that Lula is displeased with Rousseff’s economic
policies and would love to run for president again, but
only if she decides not to seek re-election – which we
find unlikely. Thus, while we believe that Lula’s
comeback is a real possibility, it would probably require
a significant deterioration in the economy that takes a
heavy toll in Rousseff’s approval ratings – which is not
our baseline scenario at this point.
José Carlos de Faria, São Paulo, (5511) 2113-5185.
Deutsche Bank Securities Inc.
Page 53
5 December 2013
EM Monthly: Diverging Markets
US Manufacturing and Mexican Growth
„
Manufacturing activity has recovered more slowly
in Mexico than in the US throughout late 2012 and
2013. This partly explains subpar GDP growth in
Mexico in the first semester of this year and is at
odds with the high correlation that has
characterized manufacturing activity across the
border.
Mexico and US business cycles
10%
5%
0%
‐5%
„
Using manufacturing disaggregate data for both
countries,
we
find
that
those
activities
characterized by the highest correlation grew more
slowly in the US in 2013. This may explain the poor
performance of Mexican manufacturing and
implies
that
a
broad-based
recovery
of
manufacturing in the US is likely to increase GDP
growth in Mexico in the foreseeable future.
„
We estimate that if the recovery of manufacturing
in the US had been generalized across activities in
2013, manufacturing output south the border
would have been approximately 4% larger. This
scenario would have added 0.7 percentage points
to Mexico’s GDP growth this year. Thus, if
manufacturing activity in the US in 2014 is
dynamic and broad-based, as expected, we
anticipate that it would contribute to Mexican
manufacturing and GDP growth a similar amount
next year.
‐10%
US Manufacturing (YoY)
US GDP (YoY)
‐15%
MX GDP (YoY)
2013Q3
2012Q4
2012Q1
2011Q2
2010Q3
2009Q4
2009Q1
2008Q2
2007Q3
2006Q4
2006Q1
2005Q2
2004Q3
2003Q4
2003Q1
2002Q2
2001Q3
2000Q4
2000Q1
1999Q2
1998Q3
1997Q4
1997Q1
1996Q2
1995Q3
‐20%
1994Q4
The possibility of a growing dislocation of
manufacturing activity with the US has important
implications for the economic outlook of Mexico.
As a result of production linkages developed
following NAFTA, manufacturing in the US became
a major driver of overall economic activity in
Mexico and prospects of recovery south of the
border rest significantly on its outlook.
1994Q1
„
Source: US Census Bureau, Federal Reserve and INEGI
Integration of manufacturing in Mexico and the US
grew stronger over time as a result of NAFTA, but
softened after China entered the World Trade
Organization in December 2001. Chinese heavy
competition in some key US markets, such as electric
components and machinery and equipment, had a
negative effect on Mexican exports and weakened the
linkages of manufacturing across the border. These
years were characterized by a slow growth of
manufacturing in Mexico and had important
implications for overall economic activity. Nevertheless,
as Mexico regained market share in the US due to high
freight costs and rising wages in China, correlation
went back to high levels and exports rebounded (see
the chart below). In fact, the sharp deterioration of US
manufacturing in the 2009 downturn had a major
impact on Mexican GDP, which fell more than in the
US. Such exposure of Mexico to US manufacturing
made it the worst performer in the region during that
episode, particularly in comparison to exporters of
commodities.
Correlation in retrospective
Mexican share of total US imports
Page 54
13.5%
12.5%
11.5%
10.5%
9.5%
8.5%
7.5%
Jan‐13
Jan‐12
Jan‐11
Jan‐10
Jan‐09
Jan‐08
Jan‐07
Jan‐06
Jan‐05
Jan‐04
Jan‐03
Jan‐02
Jan‐01
Jan‐00
Jan‐99
Jan‐98
Jan‐97
Jan‐96
Jan‐95
6.5%
Jan‐94
The North American Free Trade Agreement (NAFTA)
increased significantly the correlation of the business
cycles of the US and Mexico through industrial activity,
particularly manufacturing. Since manufacturing in
Mexico accounts for roughly 48% of industrial
production and 18% of GDP, US manufacturing activity
is a main driver for growth south of the border. Other
large components of industrial activity in the US, such
as construction, have second-order positive effects on
activity in Mexico through channels other than exports,
e.g., remittances. Thus, the outlook for the
manufacturing sector in the US is an important concern
for the performance of the Mexican economy in the
foreseeable future.
Source: US Census Bureau
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Growth prospects for the Mexican economy in 2013
relied heavily on a pickup in US manufacturing.
However, in the first half of this year, recovery of
manufacturing in Mexico was not in line with activity in
the US, so industrial growth surprised to the downside
consistently since late 2012. These diverging paths
raised concerns about the linkages of manufacturing
activity in Mexico and the US. Looking back at the
experience with Chinese competition in the last decade
and a constant redefinition of production processes in
global manufacturing, it is necessary to look at the data
carefully to rule out a possible dislocation in
manufacturing across the border and its potentially
longer lasting effects on growth.
Disaggregated behavior of manufacturing
Subpar performance of Mexican manufacturing with
respect to the US throughout late 2012 and 2013 could
be explained by the following:
„
Deep changes may have taken place and softened
the linkages of manufacturing across the border,
thus reducing the correlation of activity going
forward.
„
US manufacturing may have grown biased more to
activities that do not have close linkages with
Mexican manufacturing in this period.
We rule out that manufacturers’ inventories could have
acted as a buffer, since its ratio to shipments stayed
close to normal levels of around 1.3% throughout late
2012 and 2013. In fact, the correlation of
manufacturing activity across the border is higher
when contemporary data is used, thus suggesting that
linkages are close and inventories are fairly stable. This
is reasonable as some manufacturing industries have
moved toward a just-in-time model to reduce
inventories, which requires fully integrated production
lines across the border.
Manufacturing in Mexico and the US
104
MX (Jan12=100)
US (Jan12=100)
103
102
101
100
99
Source: US Census Bureau, Federal Reserve and INEGI
Deutsche Bank Securities Inc.
2013/09
2013/08
2013/07
2013/06
2013/05
2013/04
2013/03
2013/02
2013/01
2012/12
2012/11
2012/10
2012/09
2012/08
2012/07
2012/06
2012/05
2012/04
2012/03
2012/02
2012/01
98
We thus focus on ruling out the first scenario above,
which would imply that underperformance of Mexican
manufacturing is likely to outlast a US broad-based
recovery. Using comparable monthly disaggregated
data for manufacturing in Mexico and the US, based on
the North American Industry Classification System
(NAICS), we explored the behavior of 18 different
activities. We used a three-digit disaggregation (NAICS
has up to six) to maintain identifiable broad industries
and capture their correlation. It is worth mentioning
that some cross-correlations among sectors may be
present but, they are not captured by our approach.
Manufacturing activities according to NAICS
Food, beverage, and tobacco (FB)
Textiles (TX)
Apparel and leather goods (LT)
Wood products (WD)
Paper (PP)
Printing and related support activities (PR)
Petroleum and coal products (PC)
Chemical (CH)
Plastics and rubber products (PL)
Nonmetallic mineral products (NM)
Primary metals (PM)
Fabricated metal products (MP)
Machinery (MC)
Computer and electronic products (CE)
Electrical equipment, appliance, and components (EE)
Motor vehicles and parts (MV)
Furniture and related products (FR)
Miscellaneous (MS)
Source: US Census Bureau, and INEGI
We found that those manufacturing activities with the
largest positive historical correlation grew fast on
average in the US between 2010 and 2012. However,
such a pattern was broken when the same highly
correlated activities grew more slowly in 2013.
The results are summarized in the figure below. The
blue dots represent the combination of historical
correlation with accumulated growth of the
corresponding US activity in 2010-2012 and the gray
dots represent the combination of historical correlation
(same number in the horizontal axis) and accumulated
growth of the corresponding US activity in 2013 alone.
As we can see, highly correlated activities across the
border tended to grow faster in 2010-2012, but slowed
significantly in 2013. This result explains the subpar
performance of Mexican manufacturing and implies
that a broad-based recovery of manufacturing in the
US is likely to increase GDP.
According to US manufacturing data, the 2013
performance benefited the relative traditional low value
added sectors, like apparel and leather goods, wood
products, and furniture and other products. On the
contrary, growth in the high tech or heavy sectors such
as chemical, metal products, machinery, computer and
electronics, and motor vehicles was rather mediocre so
Page 55
5 December 2013
EM Monthly: Diverging Markets
far this year. These more elaborated products, with
“longer” production process are exactly the sectors
more integrated with the Mexican manufacturing.
Furthermore, this differential performance is expected
to vanish next year, when a broader base recovery is
projected in the US.
Manufacturing correlation and growth
40%
Growth
EE
35%
MP
30%
MC
25%
PM
20%
15%
MV
10%
NM
CE
CH
FR
PR
MV
5%
MC
TT
FR
TT
0%
NMWD
CE
PC
PC
PRPP
PP
PL
LT
FB
PL MP
PM
CH
TX
LT
NM
F B
EE
Correlation
‐5%
TX
‐10%
(0.5)
(0.3)
(0.1)
0.1 0.3 0.5 0.7 0.9 Source: Deutsche Bank
To conclude, we estimate that if the recovery of
manufacturing in the US had been generalized across
activities, Mexico’s manufacturing output would have
been approximately 4% larger in 2013. Considering the
share of manufacturing in total economic activity, this
would have added 0.7 percentage points to Mexico’s
GDP this year. If manufacturing activity in the US in
2014 is dynamic and broad based, as expected, we
anticipate that Mexican manufacturing will bring
additional GDP growth by approximately that amount.
Alexis Milo, Mexico City, (52) 55 5201 8534
The author of this report wishes to acknowledge the
invaluable contributions made by Carolina Martinez and
Andrea Cayumil, employees of Evalueserve, a third party
provider to Deutsche Bank of offshore research support
services.
Page 56
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Foreign Demand for EM Local Currency Debt
„
Foreign holdings of EM local currency debt have
increased 3-fold in the past 4 years, adding
USD500bn of additional investment.
„
This increase has been driven by the emergence of
global local currency bond funds, but in recent
months appetite for such funds, as indicated by
mutual fund flows, appears to have reversed.
„
„
However, mutual funds represent barely 20% of
the total foreign investment in EM local markets
and if we look at this investment more broadly we
find it to be much more robust than is suggested
by the mutual fund flow data.
Examining foreign holdings of local currency
markets in aggregate also allows us to compare
the relative exposure in different markets. We
develop a simple model to demonstrate how the
exposure to different markets is driven by a simple
factor: the relative proportions of two alternative
benchmark approaches to EM local currency
investment – index weighted on the one hand,
market capitalization-weighted on the other.
„
These two approaches to investment appear to
mimic the different underlying pools of investment:
retail and tactical institutional investment on the
one hand and strategic institutional investment on
the other.
„
Looking forward, we expect appetite from retail
investors for EM local debt to remain weak relative
to strategic institutional investment. Given the
considerable differences in the benchmarks of
these two pools, this shift could have important
consequences for the relative appetite for different
markets.
EPFR fund flows and beyond
Over the past four years, foreign investors have
increased their holdings of EM domestic currency
government debt 3-fold, pouring in approximately
USD500bn of additional investment. As a result of this
dramatic portfolio inflow, foreigners now hold over
25% of many EM domestic bond markets and in excess
of 40% in some markets.
This rise in foreign holdings has occurred
simultaneously across a wide range of different
markets and it is evident that it is driven in large part by
the rise of the global EM local currency debt funds.
Since Q1 of 2009, the assets-under-management of
global local currency EM debt funds has risen to over
USD100bn from just USD10bn according to EPFR
global.
Deutsche Bank Securities Inc.
Foreign investor participation in local markets has
increased dramatically in recent years…
Non-resident holdings of domestic currency government bonds, %
50
2009-Q1
45
Latest data
40
35
30
25
20
15
10
5
0
MY HU MX PL ZA ID TR RU RO TH BR KR CZ IN EG
Source: EPFR Global, Haver Analytics, Bloomberg Finance LP, National sources, Deutsche Bank
Inflows and outflows from these global local currency
funds, reported by EPFR Global and others, have
garnered a great deal of attention recently as they have
provided, it would seem, a high frequency window on
the demand for local currency debt. This data reveals a
dramatic shift in appetite in Q2 this year when in a
single month, flows turned from averaging around 3bn
inflow per month to 3bn outflow per month.
…but appears to have undergone a reversal in 2013
Inflows to EM local currency bond funds, USD bn
8
6
4
2
0
-2
-4
-6
-8
Mar 09
Mar 10
Mar 11
Mar 12
Mar 13
Source: EPFR Global
However, while these high frequency flow data are
important, they represent only a fraction of the total
non-resident investment in local currency bond
markets. The key question is: how representative are
they?
The availability and timeliness of data on foreign
holdings within individual markets has improved
significantly in recent years. For instance, by piecing
together data from various national sources we can
Page 57
5 December 2013
EM Monthly: Diverging Markets
now build up a picture of foreign investment in local
markets representing 90% of JPMorgan's GBI-EM
Global Diversified index (the most widely followed
benchmark according to EPFR). The latest data
indicates that foreign investors hold nearly 600bn in
these markets, around 6x the AUM of the universe of
global local currency bond funds covered by EPFR.
Foreign investors returned to local markets in
September, belying the data from EPFR
USD bn
6
USD bn
40
30
4
20
2
10
The funds covered by EPFR represent only a small
USD bn
800
700
600
0
0
fraction of the total foreign holdings
-10
-2
Sum of all foreign holdings of EM local
currency debt*
-4
AUM of EM Local Currency Bond Funds
(EPFR)
-6
Mar 09
Aggregate chg in stocks
-20
EPFR fund flows (lhs)
-30
-40
Mar 10
Mar 11
Mar 12
Mar 13
500
Source: EPFR Global, Haver Analytics, Bloomberg Finance LP, National sources, Deutsche Bank
400
300
200
100
0
Mar 09
Mar 10
Mar 11
Mar 12
Mar 13
* aggregate non-resident holdings for GBI-EM countries (BR, HU, ID, MX, MY, PL,
RO, RU, ZA, TH, TR) and non-GBI countries (CZ, EG, IN, KR).
Source: EPFR Global, Haver Analytics, Bloomberg Finance LP, National sources, Deutsche Bank
Aggregate flows have been more resilient than would
be implied by extrapolating EPFR data…
By examining the month-on-month change in the
nominal stocks of non-resident holdings 22 (in local
currency) we can obtain an estimate of the aggregate
flows in-/out-of these markets. We can then compare
these flows to the flows to/from EPFR funds (see chart
below). We find that there is a relationship in these
two measures of the flows, with troughs and peaks in
both series roughly coinciding. However the broader
measure of flows appears to be more resilient over
time, with periods of reduction having been less
prolonged. This is most evident in the latest period
where we see that aggregate flows were negative for
just two months, returning to positive in July and with
substantial inflows in September and October. It is
worth noting that a substantial amount of the inflow in
September was to Brazil alone (USD8.4bn), but even
stripping this out, the pattern of returning inflows is
fairly consistent. Of the 11 countries for which we
have data for September, 8 saw increasing foreign
investment.
Another striking feature of the changes in non-resident
holdings is how strongly these are correlated between
different countries. We measure the correlations of the
quarterly changes in the non-resident holdings in each
country vs. the changes in the aggregate across all
other EM (ie. excluding the country in question). It is
certainly evident that there is a strong common factor
at work, although it is interesting to note that not all
countries share this factor. Korea, Egypt and Czech
Republic all lie outside the GBI-EM, while Romania has
only recently joined. This likely explains the lower
correlation for these markets and also emphasizes the
importance of global benchmark investment for these
markets.
The curiosities are Hungary (a GBI-EM
member but with a dramatically reduced correlation in
the past two years) and India (not a member, but
sharing in the common flow).
Changes in non-resident holdings across EM are highly
correlated
Correlation of chg in country holdings to chg in aggregate*
1
Past 5Y
0.8
Past 2Y
0.6
0.4
0.2
0
-0.2
-0.4
MY TR PL MX ZA ID TH BR CZ RU IN HU KR RO EG
* The aggregate used to compute each correlation excludes the changes in stocks for
the country examined
Source: Deutsche Bank
22
We measure the changes in the local currency denominated stocks and
then express these changes in USD terms using end-of-period exchange
rates.
Page 58
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
While correlations are consistent across EM, the
associated betas of the changes in exposure vary
greatly.
This can also be seen in the range of
percentage exposure currently seen across EM (as
shown on the first chart in this report). The key driver
of these betas should be the benchmark, or neutral
weights each investor considers for each country. One
possible benchmark is JP Morgan’s GBI-EM Global
Diversified. This is notable in that it is a constrained
index, with no country taking more than a 10% weight
in the index23. While a constrained index such as this
benefits
from
increased
diversification,
the
disproportionately high weights for smaller markets
can become problematic for larger portfolios which
need to execute large portfolio adjustments efficiently.
An alternative approach more suited to such large
portfolios would be a market-capitalisation weighted
benchmark. As the chart below shows, these two
different benchmarks have widely differing weights for
each country.
Alternative benchmarks imply greatly differing weights
Weight, %
F[i,t] is the USD nominal amount of nonresident holdings of market 'i' at time 't'.
—
Wmkt[i,t] is the stock of local ccy govt bonds in
market 'i' at time 't' as a proportion of the total
stock of EM local currency bonds
—
Wgbi[i,t] is the % weight in the GBI-EM Global
diversified in market 'i' at time 't'.24
—
ε[i,t] is the extent to which portfolio managers
are over-/under-weight a country at a given
point in time, assuming there are indeed just
two benchmarked pools of investment
It is admittedly rather heroic to assume that the market
can be divided this simply, but it is surprising how well
it works in practice. The chart below shows the model
fit for the latest value of ‘t’ (the actual stock of nonresident holdings in each country, versus the current
model estimate (based on market cap and GBI weight).
Splitting the investment in EM local markets into two
different pools can explain the variation in holdings…
Actual non-resident holding, USD bn
160
30
25
—
Relative market capitalisation
140
GBI-EM Global Diversified
120
BR
MX
y=x
20
100
80
15
PL
60
10
TR
MY
40
20
5
HU
0
0
BR IN MX KR TR PL RU ZA TH MY ID EG CZ HU RO
Source: EPFR Global, Haver Analytics, Bloomberg Finance LP, National sources
Estimating the extent of benchmark use
If we assume that the entire pool of capital invested in
EM local markets can be divided into two pools: one
benchmarked to the GBI-EM Global Diversified, the
other benchmarked to market cap weights, then simply
by looking at the amount allocated to individual
markets we could estimate the relative proportions in
these two pools. We could also compute this estimate
over time. Essentially we solve for a[t] and b[t] in the
equation…
F[i,t] = a[t] x Wmkt[i,t] + b[t] x Wgbi[i,t] + ε[i,t]
where…
23
Although Brazil and Mexico are the only countries which on a marketcap weighted basis exceed 10% of EM local markets, the GBI-EM cap
ends up binding for many more countries, once the excess from Brazil and
Mexico has been re-allocated.
Deutsche Bank Securities Inc.
ID
CZ
RO
KR
ZA
Non GBI-EM countries
RU
TH
IN
GBI-EM Countries
EG
0
50
100
150
"Predicted" non-resident holding, USD bn
200
Source: EPFR Global, Haver Analytics, Bloomberg Finance LP, National sources, Deutsche Bank
The poor fit for India is unsurprising, it is not part of the
GBI-EM index and restrictions limit the ability of nonresidents to access the market. However, if those
conditions were to change, this analysis gives an
indication of how exposure might change. Mexico is
the biggest outlier on the upside. This is consistent
with the fact that Mexico has been amongst the
24
For the technically inclined, the estimation actually boils down to one
single degree of freedom: the share of the aggregate representative asset
pool allocated to one portfolio type (versus the other). At each point in
time, we assume that allocations follow either one or the other strategy,
and as such no intercept is added to the regression.
The estimation is performed at each time period (t) on the cross-section of
the 15 EM countries we consider. The variety across the countries in the
sample provides us with a good span of the universe of potential market
sizes, supporting the identification. The stability (or continuity over time) of
the estimated share is comforting of the underlying robustness of the
results. We did test pooling the data together in one single panel which
pinned down the average portfolio weights, but the month by month
results detail short-term dynamics which are exactly our focus of interest.
Page 59
5 December 2013
EM Monthly: Diverging Markets
markets on which investors have been most positive in
2013. In the main pack, Russia and Thailand are worth
highlighting. Both have lower holdings than predicted.
In the case of Russia, holdings have increased 3-fold
over the past year as the bonds became eligible for
settlement in Euroclear, but the stock still remains
below the model level. In Thailand it is perhaps
concerns over the potential imposition of capital
controls (as occurred in 2006), coupled with the volatile
politics, which has capped holdings at a lower level
than predicted.
The chart below shows the value of a[t] and b[t], which
represent the estimated stock of capital invested
against each benchmark.
…we can also examine the variation in the apparent
sizes of the two pools over time
USD bn
USD bn
300
Estimated GBI-EM Global Div
pool (lhs)
600
250
Estimated market cap pool
(rhs)
500
200
400
150
300
100
200
50
100
0
Mar 09
0
Mar 10
Mar 11
Mar 12
Mar 13
Source: Deutsche Bank
Clearly both pools have increased substantially in
recent years, but while the growth in the market cap
weighted pool has been relatively steady, the GBI-EM
benchmarked pool has been through a more distinct
cycle (acceleration through 2011 and early 2013, then a
reversal in H2-2013). Note that since the scale for the
market cap pool is twice that of the GBI-EM pool, when
the two lines cross it implies a 1/3:2/3 split.
Implications of a continued shift towards market-cap
weights
Looking forward, we expect to see a continuation of
the recent shift away from mutual funds and towards a
higher proportion of strategic institutional investment.
This occurs as retail investors, with a shorter-term
outlook and more biased by recent performance move
away from EM debt, while for institutional investors the
prospect
for
modest
outperformance
and
diversification are sufficient to justify continued
investment. If this does indeed transpire then it would
imply a further reduction in the proportion of GBI-EM
benchmarked investment, relative to market-cap
weighted investment. This implication of this shift
would differ across countries. Those countries for
which the GBI-EM weight is disproportionately large
relative to their market cap weight would face a larger
share of exposure reduction. The chart below suggests
that Malaysia, Hungary, South Africa and Indonesia are
most exposed to this risk. Hungary is likely more
insulated because the foreign participation in this
market seems uncorrelated with the overall exposure to
EM local markets. The next two countries in line are
Russia and Thailand, but the exposure to both of these
is already sub-par, so they are also perhaps more
insulated.
Many local markets have disproportionately high index
weights
Ratio of GBI-EM weight vs. Effective market cap weight
4
3.5
3
2.5
2
1.5
1
0.5
0
MY HU ZA ID RU TH PL RO TR MX BR EG IN KR CZ
Source: Deutsche Bank
The pattern in the chart above appears to mimic what
we saw earlier in the different pattern of flows between
mutual funds (EPFR) and the wider pool of investment
which incorporates the more strategic institutional
investments.
Such a relationship is likely not a
coincidence. The majority of individual mutual funds
are relatively small in size, hence taking a more
diversified approach to investment – and by extension
taking an outsized exposure to smaller markets – is less
risky than for a very large fund. Larger funds would
need to be wary of owning outsized portions of smaller
markets and hence are more likely to be biased
towards market cap-weighed exposure.
Page 60
Marc Balston, London, +44 20 7547 1484
Lionel Melin, London, +44 20 7545 8774
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
China
Aa3/AA-/A+
Moody’s/S&P/Fitch
„
Economic outlook: We expect GDP growth to
continue its recovery towards 8.6% in 2014, after
accelerating to 7.8-7.9%yoy in 2H 2013 from 7.5%
in Q2. We see five major drivers for the recovery in
2014: 1) reduced overcapacity; 2) deregulation in
sectors
with
massive
under-capacity;
3)
effectiveness of the government’s efforts to
“reactivate money stock”; 4) rising external
demand; and 5) a pro-cyclical fiscal policy.
„
We believe that monetary policy will likely remain
stable in the first half of 2014, and move towards a
tightening bias in the second half. We expect a 2%
RMB appreciation vs. the USD in 2014. On fiscal
policy, we expect fiscal deficit as % of GDP to fall
to 1.8% in 2014 from 2.0% in 2013, but given the
revenue acceleration, fiscal policy in 2014 should
become more expansionary.
„
Reforms will begin to enhance growth in 2014,
mainly by boosting private investments in sectors
such as railway, subway, telco, financial, new
energy, and environment.
„
Main risks: Risks to our 2014 growth outlook
include: 1) weaker- than-expected external demand
recovery; 2) faster-than-expected property price
inflation in China, which may result in harsher
policy reactions from the government; and 3)
unexpected shocks that lead to higher inflation,
which may prompt earlier-than-expected policy
tightening.
2014 China Economic Outlook
We expect GDP growth to continue its recovery
towards 8.6% in 2014, after accelerating to 7.8-7.9% in
2H 2013 from 7.5% in Q2. Our model shows that GDP
growth of 8.5% is the natural rate of growth without
excessive inflation – consistent with a modest 2%yoy
PPI inflation rate – based on growth elasticity to PPI.
The next peak of the on-going uptrend will therefore
likely exceed 8.5% (mid-point of the current economic
cycle) and will probably be close to 9% if monetary
policy is adjusted by policy makers with enough
foresight.
We see five major drivers for the continued economic
recovery in 2014. These are: 1) overcapacity in many
industries is being reduced after nearly two years of
PPI deflation and accompanying capacity reduction. A
reduction in overcapacity implies rising pricing power
of the companies, which in turn will improve
profitability and thus incentive and ability for corporate
to invest; 2) the massive undercapacity in many
Deutsche Bank Securities Inc.
sectors such as health care, railway/subway, valueadded telco services, new energies, vocational training,
entertainment, and culture, together with very
aggressive deregulation by the government, implies
that investment growth in these sectors will accelerate;
3) the government’s efforts to “reactivate money
stock” have worked and money velocity is rising. A
rise in velocity by 2% (half of which is achieved in past
months) should lead to acceleration of nominal GDP
growth by 2ppts without the change in monetary
policy; 4) external demand for Chinese exports will
likely rise given the G3 economic recovery; 5) the procyclical nature of the fiscal policy implies that fiscal
expenditure will accelerate with a higher-than-expected
multiplier in 2014.
Risks to our 2014 growth outlook include: 1) weakerthan-expected external demand recovery; 2) fasterthan-expected property price inflation in China, which
may result in harsher policy reactions from the
government; and 3) unexpected shocks that lead to
higher inflation, which may prompt earlier-thanexpected policy tightening.
For 2015, we expect a modest deceleration of GDP
growth to 8.2% as the PBOC will probably have already
begun the monetary tightening cycle by the end of
2014. Nevertheless, we believe that China’s mediumterm growth potential (i.e., average GDP growth from
2014-17) will likely be 0.5-1ppt higher than the current
market consensus due to the implementation of the
mega reform package announced at the 3rd Plenum.
Five drivers of the cyclical recovery in
2014
We discuss five drivers of the likely economic recovery
in 2014.
Driver for Recovery # 1: Overcapacity is being reduced
Many doomsayers argue that China is facing massive
overcapacity and therefore its economy will continue to
deleverage (i.e., de-invest) and slowdown. The recent
developments in the economy show the opposite. In
several most frequently cited “overcapacity” industries
– solar, cement, shipbuilding, for example – there are
signs that over-capacity is being reduced. According
to one of the largest solar panel producers Yingli, total
capacity industry in the sector was already down by
30% in the past 12 months, and there will likely be
another 20-30% reduction in capacity in the coming 12
months, as in this industry, capacity built a few years
ago become dated and unusable quickly. Together
with the rapid increase in domestic demand on the
Page 61
5 December 2013
EM Monthly: Diverging Markets
government’s push for clean energy, demand-supply
balance will likely become very favorable for the sector
12 months later. In the ship-building industry, although
the level of over-capacity remains high, new orders
received in the first half of 2013 rose 113%yoy. For
cement, our sector analyst estimates that the new
capacity additions in 2014 will be down by 36% as a
result of new government measures to crack down on
new supply, while demand will likely rise strongly as a
result of economic recovery and the acceleration in
urbanization.
At a more macro level, the recent sequential increase in
PPI and acceleration in manufacturing profit growth
were confirmations that over-capacity is being reduced.
From July to October, the PPI rose a cumulatively 1.2%,
compared with a 0.8% drop in the first six months of
this year. Manufacturing profit growth accelerated to
16.8% yoy in September-October, up from 12.8% in the
first eight months of this year. Note that only when
over-capacity is eased companies would gain pricing
power (i.e. PPI would increase) and thus profits would
rise.
Driver for Recovery # 2: “Under-capacity” +
Deregulation = stronger growth
While most people focus on over-capacity as a
downside risk to the economy, it is increasingly evident
that the shortage (“under-capacity”) is severe in many
other sectors especially services.
Given that the
government will implement an “unprecedented” reform
package to deregulate the economy and permit private
investors to enter most industries that are previously
dominated by SOEs, these “under-capacity” industries
will likely see a significant increase in private
investment.
Driver for Recovery # 3: “Reactivation of money stock”
is now working
The government’s efforts to “reactivate money stocks”
since July have worked and is now improving money
velocity.
These efforts include announcing higher
spending targets and deregulation measures in major
sectors such as railway/subway, IT consumption, new
energies, environment and banking.
As a result,
companies in these sectors have begun to expect
higher orders in 2014 and therefore accelerate their
investment activities with existing cash in hands. This
leads to an increase in the velocity of money, which
will allow corporate spending to rise faster even if
money supply growth remains unchanged. In Q3 this
year, trend-adjusted money velocity rose 1%, after
declining for nearly three years. We believe that
increase in velocity (after trend adjustment) will likely
sustain. The M0 growth acceleration in October (by
2ppts to 8%yoy) indicates this trend. We expect a
cumulative 2% rise in trend-adjusted money velocity
between mid-2013 and mid- 2014, which would lead to
a 2% rise in nominal GDP growth. At the micro level, a
rise in money velocity implies that corporate spending
can accelerate without an increase in money supply
growth.
Money velocity (trend adjusted) rises (falls) when
economy improves (decelerates)
Money velocity (trend adjusted) change (lhs)
8%
GDP growth change
18%
14%
10%
4%
6%
2%
0%
In particular, we expect deregulation to attract
RMB100-200bn private investments into the railway
and subway sectors next year.
Major Internet
companies are likely to expand into telco and banking
industries. Note that about 30 major private investors,
including a few Internet companies, have already
applied for banking licenses. We expect most of these
applications be approved. In the new energy sectors,
potential new policies to increase subsidies for gasfired power, solar and wind, as well as to allow high
quality shale-gas reserves for private bidding will also
boost private investment. In the health care sector,
one of the largest private pharmaceutical companies
Fosun Pharma is now planning to invest in 500
hospitals as the government is relaxing controls on
market access. We believe that these sectors can
easily attract up to RMB300bn new private investment
due to deregulation in 2014, which is equivalent to
about 0.5% of GDP.
Page 62
-2%
-6%
-4%
-10%
-14%
-18%
03-07
07-08
09-11
11-13
Q313
-8%
Source: Deutsche Bank., Haver Analytics
Driver for recovery #4: Export demand is rising
Improvement in global demand, especially from G3,
will boost demand for Chinese exports. DB forecast
shows that yoy G3 GDP growth (weighted by Chinese
exports to these destinations) will rise from 1.1% in
2013 to 2.1% in 2014. Based on our regression model,
we predict that China’s real export growth should
recover to around 12% in 2014, up from around 6% in
2013. Assuming that the unit value of Chinese exports
in USD terms will rise by 2% in 2014 (consistent with
our expectation of RMB appreciation vs. the USD), the
export value should grow by 14% in 2014.
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Our model has taken into account a range of variables,
including external demand (G3 GDP growth), the rise in
the unit labor cost, current account balance, and the
exchange rate (REER). The unit labor cost captures the
structural factor that tends to undermine China’s export
competitiveness. However, despite the rising trend of
Chinese labor cost, the strengthening of external
demand as well as the slowdown in REER
appreciation(from about 6% in 2013 to our expectation
of 3% in 2014) would still support a stronger export
sector next year.
Driver for recovery #5: Fiscal pro-cyclicality will
magnifier upward momentum
Higher government spending on infrastructure would
serve as another driver for accelerating economic
activity in 2014. The government’s fiscal revenue is
already improving on rising corporate profitability. In
recent months, fiscal revenue growth accelerated
sharply to 16% in October from 13% in September and
8% in Jan-August. In China, outperformance of revenue
(over budget target) typically translates into stronger
government spending (mostly capex) a few months
later. Capex has a much stronger multiplier effect
(around 2x) than consumption on the economy (0.6x).
Government revenues growth, % yoy
18
16
14
12
10
8
6
4
2
Oct-13
Sep-13
Aug-13
Jul-13
Jun-13
May-13
Apr-13
Mar-13
Feb-13
Jan-13
0
Source: Deutsche Bank, WND
Macro policy outlook
We believe that monetary policy will likely remain
stable in the first half of 2014, and move towards a
tightening bias in the second half. We expect a 2%
RMB appreciation vs. the USD in 2014. On fiscal policy,
we expect fiscal deficit as % of GDP to fall to 1.8% in
2014 from 2.0% in 2013, but given the revenue
acceleration, fiscal policy in 2014 will become more
expansionary.
Deutsche Bank Securities Inc.
Monetary policy: neutral in 1H and tighter in 2H
As for monetary policy, we expect the government to
set an official target of 13% M2 growth for 2014, but
actual outcome will likely be around 14%. This is very
similar to the situation in 2013, when the target was
set at 13% and the outturn was slightly over 14% by
end November. We believe that the overall tone of
monetary policy in the first half of 2014 will be labeled
“prudent” and thus remain largely unchanged from
2013. This is because inflation is within the comfort
zone -- we expect CPI inflation to fall to 2.9%yoy in
December due to the base effect and yoy PPI will
continue to post a deflation of about one percent.
Historically, the PBOC tended to start hike interest
rates when both CPI and PPI inflation rates rose
beyond 4%.
By mid-2014, when the 3mma of yoy CPI inflation
reaches 3.5%, the PBOC will likely shift its policy
stance towards to tightening bias. We believe that the
policy tools for Q3 of 2014 will likely be open market
operations to soak up liquidity, while Q4 could witness
the first benchmark interest rate hike and mark the
beginning of a new monetary tightening cycle.
Exchange rate: 2% appreciation
We forecast a 2% appreciation of the RMB vs. the USD
in 2014 with an increase in its two-way volatility. This
pace of RMB appreciation is significantly more bullish
than what the NDF market is implying (1%
depreciation), but we believe it is justified by the
following. First, stronger economic growth, reforms to
further open up the economy, and further relaxation of
the QFII scheme will likely result in higher net capital
inflows into China. Second, China will likely further
reduce its daily intervention into the FX market, as
pointed out by PBOC governor Zhou Xiaochuanrecently.
This means that the authorities will allow stronger
capital inflows to push up the RMB exchange rate in an
economic up-cycle. Thirdly, the rise in CPI inflation
towards 3.5-4% in 2H of 2014 suggests that the PBOC
will have an additional argument to tolerate more
appreciation, as a stronger RMB implies lower import
prices.
Fiscal policy: de facto expansion
We believe that the government will likely target a
general government (central+local) deficit of 1.8% of
GDP in 2014, down slightly from 2.0% in 2013. This
means that the RMB amount of the fiscal deficit will
remain largely unchanged. This prediction is based on
Premier Li Keqiang’s statement of “no expansion” in
fiscal policy (defined as no increase in RMB amount of
the deficit) but also reflects the need to support many
sectors such as environment, new energies, health care,
railway and other infrastructure, as well as the planned
VAT reform. We believe that, within the general
government budget, the portion of central government
deficit will fall, and the portion of local government
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5 December 2013
EM Monthly: Diverging Markets
deficit will rise. This will allow an expansion of the
local government bond issuance program, in order to
meaningfully implement the “Decision” by the 3rd
Plenum to develop the municipal bond market.
However, for two reasons, we believe that fiscal policy
in 2014 will in fact be more expansionary. First, in the
past few months, fiscal revenue growth accelerated
significantly and annual collection will likely exceed the
original target by 2% (actual growth of 10% vs. the
target of 8%). This would translate into revenue
outperformance of RMB260bn.
Based on China’s
budget convention, we expect these extra revenues be
allocated for spending in 2014 (but not officially
counted as part of 2014 deficit). Second, given our
forecast of stronger GDP growth, fiscal revenue growth
would likely accelerate to around 13% in 2014 (e.g., by
3%, equivalent to 0.6% of GDP). This means that the
cyclically-adjusted fiscal deficit will in fact rise by
0.4ppts of GDP (revenue improvement by 0.6% of GDP
– reduction in official deficit/GDP ratio by 0.2ppts). In
other words, fiscal policy in 2014 will be a positive
contributor to GDP growth acceleration in 2014.
Reforms and Implications
The
"Decision
on
Major
Issues
Concerning
Comprehensively Deepening Reforms” issued by the
3rd Plenum of China’s Communist Party’s is by far the
most profound in a decade, if not decades, measured
by its scope and depth, and will significantly raise
China’s growth potential in the years and decades to
come.
Contents of the reforms
In the following, we discuss these ten major reforms
that we believe are most relevant to investors:
1) Deregulation: According to “Decision”, the private
sector would be permitted to enter most industries
other than those related to national security. The
“Decision”
specifically
mentioned
that
“the
government will create a level playing ground for all
market participants”, and “adopt a negative list for a
unified market access system” (i.e., allowing all
investors to start businesses without government
approval, unless the companies will produce
products/services on the negative list.)
We expect the government to issue specific policies in
the near term to further open the following sectors to
private investors: oil and gas, railway, subway, telco,
banking, insurance, medical services, education, and
culture. For example, in the oil sector, private investors
will likely be allowed to engage in oil and gas
exploration, trading (imports and exports), and pipeline
operations.
Page 64
Our view is that “deregulation” is by far the most
important part of the reform plan as it will significantly
lift China’s growth potential. Our estimate shows that
relative to the “no-reform” scenario, deregulation as
envisioned in the package will likely lift China’s annual
average real GDP growth potential by 2ppts (and
annual average private sector real output growth by
3ppts) for the coming decade (see our report on
“Deregulation and Private Sector Development”
published on September 13). As a result of
deregulation, many service sectors (such as financial,
telecom, railway, subway, new energy and health care),
will likely grow significantly faster than before due to
the removal of supply-side policy restrictions.
On the flip side, deregulation will likely result in a
gradual reduction of the market share of major telco
and oil sector SOEs, but the macro impact is that the
overall efficiency of the economy will be enhanced and
consumers will benefit.
2) Opening up: The reform plan states that China will
grant foreign investors with greater market access to
many services industries, and hints that China would
eventually move towards a pre-establishment national
treatment system (part of TPP requirement).
The
sectors specifically named in the “Decision” to be open
to foreign investments (e.g., via lifting the foreign
ownership limits) include financial, education, health
care, culture, accounting and auditing, logistics,
nursery, elderly care, construction design, and ecommerce.
We believe that the important background is China’s
growing interest in joining negotiations of high
standard FTAs such as TPP. At the end of September,
China submitted its application to join the negotiation
of Trade-In-Service Agreement (TISA), a move that
surprised many observers who continue to believe
China was reluctant to open up its market. This view
was echoed by the “Decision”, which highlights that
China should use “opening up to promote domestic
reforms”.
The key economic benefits for China to join these high
standard FTAs is that it will open up new markets for
China (see our report on “Economic Benefits of TPP
Entry for China” published on October 31), expand the
opportunities and returns for China’s global
investments, and help accelerate the growth of China’s
service industry. The more important benefit is that it
will serve as a commitment device for China to push
forward many difficult reforms such as deregulation.
On the other hand, opening up means increased
competition for some large SOEs with monopoly or
near-monopoly positions in the market.
3) Financial liberalization: The reform plan states that
the government will encourages private investors to
establish small- and mid-sized financial institutions,
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
accelerate interest rate deregulation, and accelerate the
reform towards capital account convertibility.
We expect a few thousand privately owned banks to be
set up in coming 5-7 years as a result of this reform.
We believe that interest rate deregulation will likely be
completed within 2-3 years. The specific steps in
coming years will likely include the introduction of CDs,
further lifting the caps on deposit rates, and eventually
cancellation of the deposit rate ceilings. On capital
account liberalization, we expect further relaxation of
the QDII and QFII quota systems for institutional
investors, permission for individuals and companies to
freely convert between currencies within more relaxed
annual limits, relaxation of restrictions on cross-border
RMB flows under the capital account, and the
establishment of prudential regulations on cross-border
capital flows to replace administrative controls. We
believe that China will be able to achieve basic RMB
convertibility within 3-5 years. During the process,
Shanghai Free Trade Zone will play an important role as
a pilot program via establishing an RMB offshore
market in Shanghai.
Other financial reforms that are included in the reform
package include: 1) establishing a multi-layer capital
market; 2) establishing the bank deposit insurance
scheme; and 3) establishing a government bond yield
curve which better reflects market demand and supply.
Overall, we believe these financial reforms will be
positive for brokers, insurance companies and FX
banks, most positive for privately-owned financial firms.
4) Land and Hukou reforms: According to the reform
plan, the government will grant farmers the legal titles
of land use rights (LURs) as well as the rights to
transfer (sell and buy) LURs, receive rents on LURs,
and pledge LURs as collaterals. The Hukou system will
be further relaxed and social services to be enhanced
for migrant workers in cities via fiscal reforms. We
believe that this reform will substantially increase the
mobility of the 700 farmers (including those already
migrated to cities but without Hukou) in China,
increase their income, and help speed up the pace of
urbanization. The implications are positive for
developers and rural-based banks.
5) Resource pricing reform: The government aims to
complete the resource pricing reform in the coming
few years. As a result of this reform, we expect natural
gas and water prices to be raised substantially, on-grid
power tariffs to become largely competitive, and
refined oil prices to move in line with global prices. We
believe that the natural gas sector will likely benefit the
most, followed by hydro power and water suppliers,
while the oil refining business will enjoy a more stable
margin outlook.
Deutsche Bank Securities Inc.
6) SOE reform: As we had expected, the government
decided to separate non-commercial functions from
SOEs, to list unlisted SOEs on the stock market, to
establish several state asset management agencies to
run the SOE portfolios, and to use the managerial labor
market to recruit professional SOE managers. These
reforms should help enhance the efficiency and
resource allocation of the SOEs and improve the
incentives of SOE managers.
In addition to the above “expected” reforms, two other
reforms announced in the “Decision” exceeded our
expectation. First, the “Decision” explicitly requires an
increase in the SOE dividend payout ratio to 30% by
2020. Second, the “Decision” includes a provision to
transfer SOE shares to the social security fund. This is a
major reform that has been debated for more than a
decade. Its final adoption will substantially improve the
financial sustainability of the pension system in the
longer term.
7) Fiscal reform: According to the “Decision”, the
property (holding) tax legislation process will accelerate.
We believe the property tax will become a key part of
the long-term property stabilization mechanism. This
tax will provide a more stable source of local revenue,
and help reduce the reliance of local governments on
land sales and incentives to push up land prices. The
introduction of the property tax in a greater number of
cities may initially be viewed by some investors as
negative for developers, but would be positive for the
sector in the longer term in our view as it helps reduce
the chance of property bubbles.
Other fiscal reforms announced in the “Decision”
include the expansion of the VAT reform to other
service sectors, increasing taxes and levies on pollution
industries, and improving the transparency of
government budgets.
8) Social security reform: The government decided to
consolidate the civil servant pension scheme with the
enterprise pension scheme, to transfer SOE shares to
the pension system, to prepare a plan for raising
retirement ages.
These reforms will improve the
fairness and the sustainability of the pension system in
the longer term.
At the product level, the government decided to use tax
deferral to incentivize the development of annuities (as
a supplement to the basic pension pillar), and to
develop critical illness insurance (as part of the health
insurance reform) and catastrophe insurance. These
reforms will be positive for the insurance sector by
adding new product lines.
The promotion of private hospitals and the reform of
public hospitals are also highlighted by the “Decision”,
which will benefit companies with hospital assets and
the entire healthcare industry via raising demand for
pharmaceuticals and medical equipment.
Page 65
5 December 2013
EM Monthly: Diverging Markets
9) Developing a municipal bond market: According to
the reform plan, the government will permit local
governments to issue (municipal) bonds independently,
to gradually replace the current financing mechanisms
of LGFVs. We expect the Ministry of Finance to be in
charge of the qualification of the local governments to
issue bonds, and these local governments will be
required to publish their government balance sheets
and obtain credit ratings. This reform will be highly
positive for banks as it helps remove a major overhang
on banks’ NPLs.
10) Relaxing the one-child policy: As we had expected
in our August 6 report titled “Quantifying the impact of
2-child policy”, the “Decision” states that the
government will loosen its decades-long one-child
policy by allowing each couple to have two children if
either the husband or the wife has no siblings. The
“Decision” also mentions that the government will
further adjust and improve its population policy going
forward, implying that a genuine 2-child policy will
become possible a few years later. This reform will
enhance China’s long-term growth potential by slowing
the decline in working age population. In the shorter
run, the reform will benefit sectors such as infant
formula, diaper, baby care products, strollers, clothing,
and education. We expect the number of new-borne
babies to rise by 1.6mn per year during 2014-16 as a
result of the reform.
Impact of reforms
As for impact of these reforms, we see two major
implications. One is that many reforms, especially
deregulation, will improve growth potential of the
country, and the impact is likely be felt as soon as in
2014. This point was elaborated in the first section of
this note.
The second implication is that reforms will help reduce
macro risks and result in a more stable (sustainable)
growth trajectory and less volatile EPS growth. The few
specific reforms that can reduce macro risks include: a
reduction in LGFV risk to banks due to the
development of the local government bond market,
lower demand for non-standardized WMPs due to
interest rate deregulation, a more stable property
market due to the introduction of the property tax,
better fiscal sustainability due to improved fiscal
transparency, and improved pension sustainability due
to the transfer of SOE shares to the pension system as
well as the increase in retirement ages.
Jun Ma, Hong Kong, +852 2203 8308
China: Deutsche Bank forecasts
2012
2013F
2014F
2015F
7986
1355
5894
8957
1362
6576
10271
1369
7502
11712
1277
9172
Real GDP (YoY%)1
Private consumption
Government consumption
Gross capital formation
Export of goods & services
Import of goods & services
7.8
8.4
8.4
7.9
7.0
7.8
7.7
8.0
8.5
7.9
7.0
8.2
8.6
8.7
8.7
9.0
12.0
13.0
8.2
8.7
8.5
8.0
9.0
10.0
Prices, Money and Banking
CPI (YoY%) eop
CPI (YoY%) ann avg
Broad money (M2)
Bank credit (YoY%)
2.0
2.6
13.8
15.0
2.9
2.6
14.5
14.5
3.8
3.5
14.5
14.5
3.5
3.2
14.0
14.0
Fiscal Accounts (% of GDP)
Budget surplus
Government revenue
Government expenditure
Primary surplus
-1.6
22.7
24.3
-0.9
-2.0
22.8
24.8
-1.3
-1.8
23.0
24.8
-1.1
-1.5
23.0
24.5
-0.8
National Income
Nominal GDP (USD bn)
Population (mn)
GDP per capita (USD)
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
2031.5 2204.2 2512.8 2789.2
1856.8 2005.3 2306.1 2582.9
174.7 198.8 206.6 206.3
2.2
2.2
2.0
1.8
193.0 218.8 226.6 226.3
2.4
2.4
2.2
1.9
140.0 120.0 110.0
85.0
3312.0 3550.0 3700.0 3900.0
6.28
6.12
5.98
5.85
Debt Indicators (% of GDP)
Government debt2
Domestic
External
Total external debt
in USD bn
Short-term (% of total)
19.0
18.5
0.5
10.4
830.0
65.0
General (YoY%)
Fixed asset inv't (nominal)
Retail sales (nominal)
Industrial production (real)
Merch exports (USD nominal)
Merch imports (USD nominal)
20.3
14.4
10.0
7.9
4.3
20.4
13.2
9.6
8.0
7.5
22.0
15.0
11.0
14.0
15.0
21.0
14.0
10.2
11.0
12.0
Current
3.00
4.48
6.13
3M
3.00
4.70
6.10
6M
3.00
5.00
6.05
12M
3.25
5.00
6.00
Financial Markets
1-year deposit rate
10-year yield (%)
CNY/USD
18.9
18.0
17.5
18.4
17.5
17.0
0.5
0.5
0.5
10.4
10.7
10.7
930.0 1100.0 1250.0
60.0
60.0
60.0
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 66
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Hong Kong
Aa1/AAA/AA+
Moody’s/S&P/Fitch
„
„
Economic outlook: GDP growth will likely
accelerate in 2014, due to stronger trade growth,
domestic consumption and tourism. Inflation will
likely moderate amid the decelerating trend of
housing rent inflation and a more “normal” food
price inflation outlook during 2014.
Main risks: Sharper-than-expected decline in
property prices and fear of the interest rate upcycle (as early as 2015) could create negative
wealth effects, which may weigh on consumption
and economic growth.
Accelerating growth on external demand
As a highly open economy with total trade at around
4.5 times of GDP, Hong Kong’s economic recovery will
be led by the improving global trade in the coming year
and, in particularly, by the stronger demand from the
US, Euro area and China. DB forecasts that the
composite GDP growth of these economies will
accelerate to 3.8%yoy in 2014 from 2.3%yoy in 2013.
In terms of individual country’s growth outlook, DB
economists expect US GDP growth to accelerate to
3.2% in 2014 from 1.8%, Euro area GDP growth to rise
to 1.2% in 2014 from -0.2% in 2013, and China GDP
growth to accelerate to 8.6% in 2014 from 7.7% in
2013.
GDP growth forecasts for US, Euro area and China
US
Euro area
China
Aggregate
2013F
1.8%
-0.2%
7.7%
2.3%
2014F
3.2%
1.2%
8.6%
3.8%
2015F
3.5%
1.4%
8.2%
4.0%
Source: Deutsche Bank
Given that these three countries and region demand
around 70% of Hong Kong’s total exports, there is a
strong correlation between the growth rate of Hong
Kong GDP and the weighted GDP growth of its major
trading partners US, Euro zone and China, shown in the
chart below based on 2000-2013 historical data.
The high degree of the openness –the ratio of total
exports and imports to GDP- of Hong Kong economy
means that the GDP growth of Hong Kong will rise
faster than that of its trade partners. Our elasticity
study suggests that at current time, 1ppts rise of the
weighted GDP growth of US, Euro area and China
implies 1.9ppts rise of GDP growth for Hong Kong.
Deutsche Bank Securities Inc.
Hong Kong GDP growth vs. composite GDP growth of
the US, Euro area and China
15% HK GDP,
% yoy
10%
5%
0%
-5%
-10%
-4%
G2+CN GDP,
% yoy
-2%
0%
2%
4%
6%
Source: Deutsche Bank, CEIC
External demand was weak in 2013, as both the US
and Euro area faced economic and fiscal challenges.
Against the background of contracting economic
growth in the Euro area, and moderate growth in the
US and its debt ceiling issue, Hong Kong’s
merchandize export growth in the first three quarters of
2013 remained at low single digit levels.
But we do not think this is a “structural” or permanent
phenomenon. The US debt ceiling crisis is unlikely to
repeat in 2014, and the steady recovery of the US
housing market provides an important driver for its
demand for Asian goods including electronics and
furniture. The Euro area should face less fiscal
contraction and crisis countries have gained substantial
cost advantages after sharp wage deflation. Overall
we expect stronger global trade growth in 2014 due to
improving G3 consumer appetite for Asia goods.
Better prospects of incoming visitors and foreign
economies provide support to Hong Kong’s growth
Hong Kong is a service economy in nature. In addition
to financial, real estate, and trade-related services,
other major service sectors include retail, logistics,
accommodation and food services. The performance of
these service sectors is significantly affected by the
tourist industry. During January and September, an
average of 4.4mn visitors arrived Hong Kong on a
monthly basis, among which about 75% came from
mainland China. The number of monthly visitors was
enormous as it was about 60% of Hong Kong’s total
population. Given this background, these incoming
Page 67
5 December 2013
EM Monthly: Diverging Markets
visitors provide an important source of growth for
Hong Kong economy.
GDP growth contribution by components
Consumption
Net export
12%
We observe some deceleration in the growth rate of
incoming visitors this year. The growth rate declined to
13% yoy Jan-Sept, down from 16%yoy in 2012. Going
forward, as global economy recovers in 2014, we
expect the growth rate of visitor arrivals to accelerate
and visitors’ propensity of consumption to rise in light
of rising consumer confidence. This will indirectly
boost Hong Kong’s growth especially via higher retail
sales.
10%
Investment
GDP total, % yoy
8%
6%
4%
2%
0%
-2%
-4%
2013Q3
2013Q2
2013Q1
2012Q4
2012Q3
2012Q2
2012Q1
2011Q4
25%
2011Q3
2011Q1
30%
2011Q2
-6%
Incoming visitors, % yoy ytd
Source: Deutsche Bank, CEIC
20%
15%
Inflation will moderate further
Inflation has risen more quickly this year than we had
expected, mainly due to higher rental inflation and
higher than expected food prices. After the peak of
6.9% in July, inflation has moderately to 4.3%yoy in
October 2013. Yet the level of 4.3%yoy still remains
high compared to the average 2%yoy CPI inflation in
the past decade.
10%
5%
0%
-5%
Jun-13
Jan-13
Aug-12
Mar-12
Oct-11
May-11
Jul-10
Dec-10
Feb-10
Sep-09
Apr-09
Jun-08
Nov-08
Jan-08
-10%
Source: Deutsche Bank
Domestic consumption should remain supportive
Consumption has been the steadiest driver for Hong
Kong’s GDP growth in the first three quarters of 2013.
The average consumption growth for Q1~3 was 3%yoy.
Private consumption remained relatively strong in the
first three quarters of 2013 on the back of broadly
supportive labor market conditions. The labor market
appeared resilient lately, as the unemployment rate
stayed at a low level of 3.3% while both the labor force
and employment kept expanding this year. We see the
unemployment rate to fall a bit more from here on, to
about 3.1% at end-2014 as labor force participation
rate remains on the uptrend and economic growth
accelerates, which will continue to provide support for
private consumption in the following year.
Page 68
Although since the beginning of 2013, the inflation of
private housing rent by CPI measure has been rising
from January’s 4.9%yoy to October’s 7.1%, both the
private property price and private property rental price
inflation have been declining since the beginning of the
year. Historically, the CPI measure of private housing
rent inflation lags the property market prices inflation
by about a year or so. This decelerating trend of
housing rent inflation suggests that the CPI inflation is
likely to trend lower next year. On the assumption that
the government’s recent property measures will result
in stable property prices and assuming more “normal”
food price inflation, it is likely that headline inflation
decline next year.
On the other hand, a tighter labour market may
increase the cost of restaurant meals (10% of the CPI)
and retail goods; and due to the fact that a large
portion of food is imported from China, RMB
appreciation should also push up food prices.
Balancing these two sides, we think that inflation will
moderate to 3.5%yoy in 2014.
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Hong Kong composite CPI (all items, sa), %yoy
Housing price and transaction volume
8%
Agreements for Sale/Purch of Bldg Units, Res
Property Price Index, All Classes (1999=100), rhs
6%
250
20000
4%
15000
2%
10000
0%
5000
200
150
100
50
0
Jan-13
Feb-12
Mar-11
Apr-10
May-09
Jul-07
Jun-08
Sep-05
Aug-06
Oct-04
Dec-02
Aug-13
Apr-13
Aug-12
Dec-12
Apr-12
Dec-11
Aug-11
Apr-11
Aug-10
Dec-10
Apr-10
Dec-09
Aug-09
Apr-09
Nov-03
0
-2%
Source: Deutsche Bank, CEIC
Source: Deutsche Bank, CEIC
Main risk: a sharp decline of property prices
A sharp decline in property price in 2014 is not our
base case forecast. However, in the case of property
prices falling by 15-20%, consumer sentiment is to be
affected in a very negative way, although the banking
system is likely to be strong enough to absorb such a
shock.
With the current low interest rate environment, given
that the property prices stay at historical high now and
the transaction volume remains at a worrisome low
level, the situation does post a risk especially if the US
tapering and Fed rate hikes are more aggressive than
expected. Should a disorderly sharp property price drop
happen, we expect Hong Kong domestic consumption
to be suppressed due to the adverse wealth effect,
which will weigh on growth.
The trigger for a potentially sharper-than-expected
property price decline in Hong Kong is that the US Fed
tightens monetary policy aggressively. DB forecast is
that the Fed may hike rates by around 175bps bps
within the coming 2 years (more likely to happen in
year 2015). Under this scenario of gradual “exit”, we
believe that the HK property prices could still be kept
large stable. However, in case the Fed opts for a much
more aggressive rate hike schedule, the resulting sharp
deterioration in affordability could lead to a panic sell of
properties in Hong Kong and hence hit consumer
confidence and the economy as a whole.
The chart below shows a scenario analysis of the
potential impact of rate hikes on household mortgages
in Hong Kong. The affordability condition is defined as
the monthly mortgage to household monthly income.
We look at a medium income household who live in
private housing (excluding the 47% of population living
in public rental housing and subsidized sale flats) and
has to allocate 44% of its monthly income as mortgage
payment for a 40sqm private housing at current
average price, at current annual mortgage rate of
2.15%. The down payment assumption is 30% and the
mortgage period assumption is 20 years.
Our sensitivity test shows that keeping other variables
constant, a 200 bps rate hike scenario could push up
the mortgage payment ratio to 52%, while a 400 bps
rate hike could result in a rate of 62%, which is close to
the level in 1997 when housing market crashed.
Monthly Mortgage Payment (40sqm flat)/Monthly
Income
90
80
70
60
400 bps hike
50
200 bps hike
40
30
20
10
2013
2011
2009
2007
2005
2003
2001
1999
1997
1995
1993
1991
1989
1987
1985
0
Source: Deutsche Bank. CEIC, HKMA
Lin Li, Hong Kong, +852 2203 6187
Deutsche Bank Securities Inc.
Page 69
5 December 2013
EM Monthly: Diverging Markets
Hong Kong: Deutsche Bank Forecasts
2012
2013F
2014F
2015F
263.1
7.15
36802
282.1
7.20
39159
306.1
7.26
42160
329.0
7.31
44987
Real GDP (YoY%)
Private consumption
Government consumption
Gross fixed investment
Exports
Imports
1.5
3.0
3.7
9.4
1.9
2.8
3.2
5.0
2.7
2.8
7.3
7.8
5.0
6.3
2.4
3.8
11.3
11.4
4.5
5.8
2.2
3.3
12.0
12.5
Prices, Money and Banking
CPI (YoY%) eop
CPI (YoY%) ann avg
Broad money (M3)
HKD Bank credit (YoY%)
3.8
4.1
10.5
5.7
3.8
4.1
10.1
8.9
3.5
3.5
9.5
8.3
3.0
3.2
9.0
8.0
Fiscal Accounts (% of GDP)1
Fiscal balance
Government revenue
Government expenditure
Primary surplus
3.1
21.4
18.3
3.2
2.8
22.1
19.4
2.8
3.2
21.7
18.5
3.2
3.5
22.6
19.1
3.5
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
464.7
487.4
-22.7
-8.6
3.5
1.3
-9.4
317.3
7.76
503.6
547.3
-43.7
-15.5
-9.0
-0.9
-22.9
315.0
7.76
543.9
584.1
-40.2
-13.1
5.8
3.7
-25.1
329.5
7.80
606.4
644.3
-37.8
-11.5
9.0
2.7
-30.8
353.8
7.80
National Income
Nominal GDP (USD bn)
Population (mn)
GDP per capita (USD)
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
8.8
9.0
8.7
8.6
8.3
8.5
8.2
8.2
0.5
0.5
0.4
0.4
397.7 407.7 408.4 395.1
1046.5 1150.0 1250.0 1300.0
71.9
72.0
72.0
72.0
3.3
3.3
3.1
3.0
Current
0.50
0.38
2.16
7.76
3M
0.50
0.38
2.40
7.78
6M
0.50
0.50
2.40
7.78
12M
0.50
0.60
3.00
7.78
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 70
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
India
Baa2/BBB-(Neg)/BBBMoody’s/S&P/Fitch
„
„
Economic outlook: The economy has troughed, and
2014 would likely bring an investment recovery,
further gains in exports, and some strength in
domestic consumption, especially in the rural area.
Inflation would stabilize and then decline from midyear onward, allowing the RBI to ease monetary
policy in the third quarter. Balance of payments
stress would ease due to an improving current
account and stronger capital flows.
Main risks: An improved outlook will still be subject
to considerable risk. Investment sentiments could
suffer a setback if next summer’s general election
leads to a fractured legislature and weak
government. Taper-related volatility could affect
flows and put pressure on the rupee. Supply side
bottlenecks could prevent sizeable disinflation from
taking place, delaying monetary policy easing. Both
bank and non-bank financial sector could see a
substantial rise in bad loans as a lagged effect from
past years’ growth under-performance.
Real economy has troughed
There is some evidence of green shoots of recovery.
Recent data shows that economic momentum is
picking up. Real GDP grew by 4.8%yoy in July-Sep’13
(5.6% when estimated from the expenditure side),
marking an improvement over the previous quarter’s
outturn (4.4%yoy). The improvement was led by a
rebound in agricultural (4.6%yoy vs. 2.7%yoy) and
industrial sector activity (1.6%yoy vs. -0.9%yoy), while
services sector momentum (5.8%yoy vs. 6.2%yoy)
continued to moderate. Private consumption (2.2%yoy
vs. 1.6%yoy) and investment (2.6%yoy vs. -1.2%yoy)
momentum improved somewhat, while exports growth
rebounded sharply from the previous quarter (16.3% vs.
-1.2%yoy). Latest measures of production, trade,
business confidence suggest further strengthening of
the economy in Q4,’13, paving the way for a strong
entry into 2014.
A trough has been reached
India in 2014: Consolidating reforms and
regaining momentum
z-score, 3mma
1.0
IMMI, lhs
Real GDP growth, rhs
% yoy
12
0.5
India is at a crossroads. Two years of growth
slowdown, reflecting both cyclical and structural
factors, met this year with external financing
challenges, rupee volatility, and renewal of inflationary
pressure.
Consequently,
the
authorities
have
undergone an about-turn with respect to monetary
policy, raising rates and tightening liquidity. Also,
despite rather severe cyclical economic weakness,
pledges have been made to keep the fiscal stance at
best neutral.
Couple these developments with rising non-performing
assets in a capital-deficient banking system, weak
consumer and business confidence, worries about
global market volatility due to Fed tapering, and
uncertainty about the outcome of the 2014
Parliamentary elections, it is evident that the economy
remains in a fairly precarious state. Observing the
markets in recent months, however, one sees a
renaissance of animal spirits. India’s markets stabilized
first along with its EM peers in September and then
have recovered considerably. Other than a revival of
risk sentiment externally, domestic investment may
have bottomed at last and trade has marked a
welcome pick-up.
0.0
-0.5
9
6
-1.0
-1.5
2007 2008 2009 2010 2011 2012 2012
3
Source: CEIC, Deutsche Bank. Note: India Macroeconomic Momentum Indicator (IMMI) is a
composite index constituting five high frequency macro variables namely, industrial production,
exports, non-oil imports, bank credit and auto sales. An increase in the z-score of IMMI indicates
improving economic momentum and vice versa.
Firm level micro data corroborate our view that the
worst is likely behind us as far as growth is concerned.
Net sales of large companies have begun to improve in
recent quarters, with the bottom reached in 1H2013.
Margins have also bottomed, reflected in the
improvement of net profit (after tax) as a ratio of net
sales of non-oil non- finance listed firms. Signs have
emerged, at long last, on the investment front. The
value of projects that were categorized both as
“announced” and “under implementation” rebounded
in the past quarter or so.
Project announcements can be seen as a proxy of
business
confidence,
while
projects
under
implementation can be seen as reflecting the success
Deutsche Bank Securities Inc.
Page 71
5 December 2013
EM Monthly: Diverging Markets
of efforts to reduce policy friction. On both counts, the
results are encouraging. These findings are consistent
with our top-down macro data analysis, which also
sees compelling indication that the economy reached a
trough in Q3 (April-June).
We see real GDP rising by 5% in FY13/14, with further
pick-up to 5.5% in FY14/15. The growth narrative
would be driven by a much-awaited revival in
investment as regulatory uncertainties ebb, reforms of
the past year (especially energy sector and FDI) begin
to bear fruit, and monetary policy refrains from acting
as a break to economic activity. Exports, boosted by a
sharp weakening of the rupee and ongoing rise in
external demand, would continue to gain strength.
Consumption may not rise considerably till income and
employment outlook improves, and fiscal can at best
play a neutral role in supporting growth, but the lack of
any major drag would be a key ingredient in pushing
up growth in the coming years, in our view.
A favorable G-2 outlook bodes well for India’s export
demand and overall economy
% yoy
12
India, forecast
G2, right
G2, forecast
% yoy
6
4
8
2
6
0
4
-2
2
-4
-6
2002
2004
2006
2008
With the RBI undergoing a process of transition with its
target variable, perhaps to be finalized following the
submission of the Patel Committee’s report in a
month’s time, observers and analysts are still trying to
understand if focusing on low core WPI (only 2.6%) or
high but easing core CPI (around 8%) or headline
inflation (7-10%) rates would give one a guide to
assessing the inflation situation and the central bank’s
reaction function.
The RBI’s latest projections show a likely flat trajectory
for WPI and declining one for CPI in the coming
months. Still, the prevalent view is that inflation will
remain high for a while, as expectations continue to be
elevated and supply side shocks have yet to abate.
Indeed, a source of alarm has been the latest RBI
survey that shows household inflation expectation
firmly in double digit territory.
We may have seen the worst of inflation
India, left
10
0
2000
Inflation and monetary policy won’t be a
drag next year
2010
2012
2014
% yoy
CPI (IW)
16
CPI new
WPI inflation
12
8
4
0
2007
2008
2009
2010
2011
2012
2013
Source: CEIC, Deutsche Bank
Source: CEIC, Deutsche Bank
This outlook is not without risks.
Two sources of inflation respite can however be
entertained for 2014, namely food and fuel. Food prices
could ease considerably in the coming months as the
output of a record harvest comes to the market. On
fuel, assuming global oil prices fall by about 10% next
year, supported by a relatively favorable demandsupply dynamic, fuel inflation should also moderate to
mid-single digit levels in the 2H of 2014, from about
10% presently. Indeed, thanks to gasoline prices
having reached cost recovery levels and being adjusted
automatically, there could be substantial decline in that
item’s pump price next year.
„
First, banks appear worried that even if growth
doesn’t slow any further, a couple of more quarters
of 5-5.5% growth could cause one more wave of
asset quality deterioration as only a few projects
can be profitable under the prevailing high
borrowing cost and weak growth environment.
„
Second, while India’s recently improving exports
data are comforting but the trend is too new to
conclude if this is just a function of low base or
there is something more substantive with respect
to improved competiveness on account of a
weaker rupee. If exports growth fails to sustain in
the next year, then it will clearly pose a downside
risk to our 5.5% growth estimate for FY15.
Page 72
With the favorable food and fuel price assumptions,
even after factoring in some pick-up in manufactured
goods inflation, India’s WPI has scope to stabilize
around 5.5% in FY15, in our view. Inflation is by no
means on the cusp of becoming a non-issue in India,
and following the likely respite of next year, 2015 could
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
see a return of higher prices if infrastructure
bottlenecks are not addressed adequately. But for the
time being, we think that inflation will not be a major
policy constraining factor next year, especially in the
second half.
How will the RBI deal with this scenario? We don’t
expect the RBI to hike rates further, unless inflation
surprises sharply to the upside. If our inflation
projection turns out to be correct, then the RBI will
likely have scope to cut the policy rate by 75bps in the
second half of 2014. We expect the terminal repo rate
to be 7.0% by end-December 2014 (down from 7.75%
currently), with the effective policy rate converging to
the repo rate within the next few quarters. Looking
further ahead, as growth improves closer to 6%, there
could be renewed pressure on inflation, which will
likely lead RBI to start reversing monetary
accommodation in 2015.
Inflation and repo rate forecast
% yoy
12
WPI, lhs
Repo, rhs
Forecast, lhs
Forecast, rhs
%
9
There are three ways to hold the fiscal line:
„
First, expediting disinvestment, presently in
progress. With Indian markets rallying in the past
quarter, conditions may be favorable for sales of
state’s share in some SOEs.
„
Second, on subsidies, some arrears seem likely. If
diesel prices continue to rise next year, this
practice could become a relic of the past by 2015,
in our view, but for this year, the practice of
delaying payment to oil marketing companies will
likely continue.
„
Third, a sizable cut in capital expenditure is
unavoidable. We expect the government to hold
back at least INR600bn of capital expenditure this
year (full year allocation is INR5.5trn), in order to
keep the overall fiscal deficit contained below 5%
of GDP. This work is also underway.
Fiscal slippage calculation for FY14
Revenue slippages
10
8
8
7
6
6
4
5
2
0
2010
deficit touching 84% of the budget estimate in the first
seven months of the fiscal year (April-October).
4
2011
2012
2013
2014
300
Disinvestments
200
Total revenue slippage (A)
500
Expenditure overshoot
INR bn
Fuel subsidy
200
Fertilizer subsidy
100
Total expenditure overshoot (B)
300
2015
Source: CEIC, Deutsche Bank
Potential risk to fiscal deficit (A + B)
% of GDP
Levers to contain fiscal risk and medium
term issues
It can be argued that years of fiscal stimulus measures,
be it through social spending or generous subsidies,
have driven much of India’s imbalances and economic
distortions. We see no dissention among policy makers
and observers that fiscal consolidation is essential to
improve governance and restore macroeconomic
health, but the experience of the past year shows that a
weak cycle can play havoc with the most wellintentioned fiscal strategy.
India stepped into the present fiscal year with promises
to boost revenue through disinvestment and stronger
tax administration, and contain spending through
energy price reforms. Economic slowdown and rupee
depreciation however have made those promises
difficult to uphold. Weak revenue intake and higherthan-expected subsidy spending have weakened the
fiscal position so far this year, with the gross fiscal
Deutsche Bank Securities Inc.
INR bn
Tax revenue
Savings expected from capital expenditure
Increase in fiscal deficit
800
0.8%
600
200
% of GDP
0.2%
FY14 Fiscal deficit forecast (% of GDP)
5.0%
Source: Deutsche Bank
Next year, the incumbent government will present an
interim budget or vote on account in February (as
elections need to be held before May), which should be
followed by a full-fledged budget post election. We
expect fiscal consolidation to persist, irrespective of the
political outcome, though the improvement in the fiscal
position is likely to be gradual.
The improvement in the fiscal position needs to be
achieved through tax as well as expenditure reforms.
India’s revenue/GDP ratio remains one of the lowest in
the region, and it is difficult to achieve a substantial
improvement unless tax reforms are implemented in an
expeditious manner. The Direct Tax Code (DTC) and
Goods and Services (GST) reforms are pending for a
Page 73
5 December 2013
EM Monthly: Diverging Markets
long time, which when implemented, can prove to be a
game changer. The DTC can go a long way in
broadening the tax base and incentivizing voluntary tax
compliance, while a well designed GST has the
potential to boost India’s growth by an additional 1-2%,
which in turn ought to result in higher revenue
mobilization.
Implementation of the GST has been held back by
some states that are concerned about losing revenues
and tax administration power. The central authorities
have made repeated attempts to placate their concerns,
but with an election around the corner, this reform will
have to wait for the time being. We do however see
GST being implemented over the next couple of years.
The reforms on the expenditure side need to happen
mostly on the subsidies front. The government’s aim is
to bring total subsidies below 2% of GDP, even after
providing for subsidized food (under the Food Security
Act) worth 1% of GDP. This can be only achieved, if
fuel and fertilizer subsidies are cut drastically in the
coming years.
Subsidies
% of GDP
1.5
1.2
Petroleum, lhs
Food, lhs
% of GDP
4.5
Fertilizer,lhs
Total, rhs
4.0
3.5
0.9
3.0
0.6
2.5
0.3
0.0
2.0
1.5
1.0
Source: Government of India, Deutsche Bank
The government has achieved some success on the
fuel subsidy front (diesel price hikes are continuing on
a regular basis), but clearly more needs to be done. As
shown in the table below, total under-recoveries of
OMC’s are still expected to be INR1trillion in FY15 (of
which the government will need to pay about
INR500bn as fuel subsidy), even with a significantly
reduced diesel subsidy.
According to our in-house estimate, if monthly price
hikes endure through next year, then diesel will likely
become completely deregulated by FY16. While this
would help significantly, the next step for the
authorities should be to try and reduce LPG and
kerosene subsidies to the extent that is politically
feasible.
Page 74
Fuel under-recovery estimate by components
FY13
FY14E
FY15E
FY16E
110.5
108.3
105.0
104.0
54.4
62.0
60.0
60.0
Domestic LPG
396
455
444
413
PDS Kerosene
294
313
289
260
-
-
-
-
921
745
275
-
1,610
1,514
1,009
673
Brent Price
USD/INR
Gross underrecoveries, INR bn
Gasoline
Diesel
Total gross underrecovery
Source: Deutsche Bank
Given the large sums and associated leakage, the issue
of efficient and effective administration of subsidies
has taken on considerable importance in recent years.
The 12-digit Unique Identification Number (UID) linked
Direct Benefits Transfer (DBT) scheme, which seeks to
transfer cash directly to the bank or post office
accounts of identified beneficiaries, can play a major
role in this context.
Increased digitization will potentially lead to greater
transparency and less pilferage. At this stage the
scheme is being used only for providing education
scholarships and stipend to underprivileged sections of
the society (fuel, fertilizer and food subsidies, which
account for the bulk of total subsidies, are presently
outside the purview of the scheme at this stage). The
program will take years to yield substantial benefit, and
there will be problems associated with implementation,
but the welfare and fiscal implications are profound.
Going
by
cross-country
experience,
smart
administration of cash transfer programs could reduce
poverty and improve the quality of human capital
substantially.
External account imbalances to abate,
but risks to remain
The rupee crisis of this summer underscored India’s
external sector vulnerability. Comfortable reserves
coverage (over 6 months’ of imports) was not sufficient
to prevent disorderly adjustment of the exchange rate
as global market risk aversions spiked and India’s large
current account deficit was seen as a major weakness.
With taper related worries likely to resurface in 2014,
the question is if India has done enough to avoid being
targeted by investors in the next, inevitable round of
EM sell-off.
A pickup in exports and a sharp contraction in imports
(mainly gold) have reduced the pressure on India’s
trade deficit considerably in recent months. The
improvement in trade deficit bodes well for the current
account deficit, which is expected to narrow to
USD50.5bn (2.8% of GDP) in FY13/14, from USD88bn
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
in FY12/13 (4.8% of GDP), a record high. The financing
of the CAD, which emerged as a key concern in JulySeptember (BOP was net negative by USD10bn), has
also become less onerous with India receiving
USD34bn through the concessional swap windows
(FCNR and bank borrowing) as of end-November.
These measures, along with the Oil swap window,
which helped to reduce Dollar buying demand by
public sector OMCs, has led to a sharp turnaround in
rupee since end-August.
„
GDP growth tends to pick up gradually after of an
election. Within three quarters of an election,
growth rises by as much as 100bps;
„
Inflation tends to ease somewhat before and rise
appreciably after elections. This evidence is broadly
consistent with the literature on political business
cycle which suggests incumbents try to cause
favorable economic outcomes in the lead-up to an
election;
Inflation before and after Lok Sabha polls
Balance of Payments forecast
%qoq, SA
USD bn
FY13
FY14
FY15
Exports
306.6
331.5
359.8
Imports
502.2
496.4
545.5
-195.7
-164.8
-185.8
% of GDP
-10.6
-9.1
-9.1
Invisibles, net
107.8
114.3
123.8
5.9
6.3
6.1
-87.8
-50.5
-62.0
0.0
% of GDP
-4.8
-2.8
-3.0
-0.5
Capital account
85.2
56.9
64.0
-1.0
4.6
3.1
3.1
-1.5
-2.7
6.3
1.9
Trade account
% of GDP
Current account
% of GDP
Overall BOP
3.5
3.0
2.5
2.0
1.5
1.0
0.5
Q-3
Q-2
Q-1
Election
Q+1
Q+2
Q+3
Source: Deutsche Bank
Source: CEIC, Government of India, Deutsche Bank
We expect the BOP dynamic to remain positive in FY15
as well, even after factoring in some pickup in imports
(+10%yoy). We forecast the absolute amount of
current account deficit to be USD62bn in FY15, or 3.0%
of GDP. We see the capital account surplus to be
USD64bn in FY15, which should lead to a net accretion
to FX reserves.
Within the components of the capital account, FII
investment (debt + equity) would be about USD25bn,
FDI USD25bn and the rest of the flows would amount
to another USD14bn. If the authorities manage to get
India included in the global bond indices, the potential
for FII flows will be higher (USD15-20bn at least), but
we have not factored that in our baseline forecast.
„
The evidence suggests that the rupee appreciates,
by 3% on average, within three quarters of an
election;
„
Foreign institutional inflows pick up robustly, rising
by about ½ percent of GDP after an election;
FII flows before and after Lok Sabha polls
% of GDP
2.5
2.0
1.5
1.0
Election year dynamics
Barely six months remain before India’s 16th Lok
Sabha (Lower House) elections, which will see all 552
parliament seats being contested, culminating in the
formation of a government to run the world’s largest
democracy. We have examined macro data from the
last 5 Lok Sabha elections, deploying an event study
approach. We are generally curious about the elections
in any case, but ignoring election related implication for
the economy could leave a gap in our macro analysis
and forecasts, making this study particularly important.
The conclusions are:
Deutsche Bank Securities Inc.
0.5
0.0
-0.5
-1.0
Q-3
Q-2
Q-1
Election
Q+1
Q+2
Q+3
Source: CEIC, Government of India, Deutsche Bank
„
Data on fiscal performance before and after an
election is mixed. We don’t believe the data
supports major fiscal slippage around elections,
which goes against the political business cycle
theory.
Page 75
5 December 2013
EM Monthly: Diverging Markets
Final thoughts
India: Deutsche Bank Forecasts
2012
2013F
2014F
2015F
In this piece we have a made the case for an improved
outlook, but recognize the risks. Investment sentiments
could suffer a setback if the general election leads to a
fractured legislature and weak government. Taperrelated volatility could affect flows and put pressure on
the rupee. Supply side bottlenecks could prevent
sizeable disinflation from taking place, delaying
monetary policy easing. Both bank and non-bank
financial sector could see a substantial rise in bad loans
as a lagged effect from past years’ growth underperformance.
National Income
Nominal GDP (USD bn)
Population (mn)
GDP per capita (USD)
1821
1218
1495
1831
1236
1481
2015
1255
1605
2203
1274
1730
Real GDP (YoY %) 1
Private consumption
Government consumption
Gross fixed investment
Exports
Imports
4.1
5.6
5.2
3.2
4.4
10.7
4.3
2.7
3.7
2.0
6.3
1.4
5.5
4.5
4.3
5.0
11.5
6.7
6.0
5.5
5.0
6.8
13.2
11.0
5.0
5.0
5.5
6.0
Prices, Money and Banking
WPI (YoY%) eop
WPI (YoY%) avg
Broad money (M3) eop
Bank credit (YoY%) eop
7.3
7.5
11.2
15.1
7.0
6.3
14.5
14.0
4.9
5.5
15.0
16.5
6.4
6.3
15.5
18.0
Fiscal Accounts (% of GDP) 2
Central government balance
Government revenue
Government expenditure
Central primary balance
Consolidated deficit
-4.9
9.2
14.1
-1.8
-7.4
-5.0
9.6
14.7
-1.8
-7.5
-4.8
9.5
14.3
-1.8
-7.3
-4.5
9.8
14.3
-1.5
-7.0
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) INR/USD
301.9
503.5
-201.7
-11.0
-91.5
-5.0
22.0
294.9
54.8
323.1
496.4
-173.3
-9.4
-61.7
-3.4
25.0
287.4
63.0
351.4
532.5
-181.1
-9.2
-59.8
-3.0
25.0
289.3
60.0
383.0
587.1
-204.2
-9.3
-73.0
-3.5
30.0
296.9
62.0
Debt Indicators (% of GDP)
Government debt
Domestic
External
Total external debt
in USD bn
Short-term (% of total)
67.1
63.3
3.8
20.7
376.3
24.4
66.8
63.0
3.8
23.4
429.0
25.7
66.4
62.6
3.8
23.8
480.5
27.1
65.2
61.4
3.8
24.9
547.7
28.5
-0.6
-0.4
5.4
3.7
We see 2014 as the year that could well mark a fresh
start for India’s beleaguered economy. Several years of
below-trend growth and ensuing adjustment have
precipitated important fiscal and structural reforms,
restored competitiveness, and brought back a muchneeded sense of realism about India’s potential and
challenges. Regardless of the election outcome, we
expect recent reforms to be durable and investment
momentum to pick up. We look forward to a stronger,
more sustainable Indian economy.
Major reforms announced
1
FDI policy has been liberalized further (100% FDI in single-brand
retail, 51% FDI in multi-brand retail and 49% FDI in registered
aviation company and power exchanges allowed)
2
FDI cap hiked to 100% for the telecom sector and limits also
increased for 11 other sectors
3
Regular diesel price hikes being implemented on a monthly basis
4
Banks freed to offer interest rates without any ceiling on NRE
deposits with maturity of 3 years and above
5
Withholding tax rate cut to 5% from 20% for corporates borrowing
externally
6
FIIs/QFIs now allowed to invest in govt debt without purchasing
debt limits
7
Long term investors like sovereign wealth funds, multilateral
agencies, endowment funds, insurance funds, pension funds &
foreign central banks allowed to invest in government securities
within the overall limit
8
FII debt limit allocation norms rationalized & limits for FII
investment in government securities and corporate bonds
increased
9
Financial package for the power sector - the package envisages
states absorbing 50% of the existing short-term liabilities of power
distribution companies with the remaining 50% to be restructured
Real GDP (FY YoY %)
1,2
Source: Deutsche Bank
Taimur Baig, Singapore, +65 6423 8681
Kaushik Das, Mumbai, +91 22 71584909
General
Industrial production (YoY %)
Financial Markets
Repo rate
3-month treasury bill
10-year yield (%)
INR/USD
Current
3M
6M
12M
7.75
8.60
8.74
7.75
8.40
8.50
7.75
8.20
8.50
7.00
7.50
8.20
62.3
62.5
62.0
60.0
Source: CEIC, Deutsche Bank. (1) By convention, we report “production-side” GDP growth rates
(both FY and CY). The expenditure components may not add up to the headline GDP growth rate
(even for historical data) due to discrepancies between these GDP figures and the “expenditureside” GDP estimates. (2) Fiscal year ending March of following year.
Page 76
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Indonesia
Baa3/BB+/BBBMoody’s/S&P/Fitch
„
„
Economic outlook: Indonesia has a year of slower
economic growth, high but declining inflation, tight
monetary conditions, some lingering volatility of
the exchange rate ahead. The economy is
undergoing demand adjustments that would help
restore sounder fundamentals, but the extent and
duration of the adjustment would depend on
appropriate use of policy.
Main risks: Markets have already singled out
Indonesia among Asian EM economies with the
most imbalances. If quick improvement in inflation
and external account figures do not take place, the
rupiah may face renewed pressure next year.
Embracing adjustment
Strong growth needs to take a breather to facilitate
consolidation. The writing was on the wall: stepping into
2013, we wrote in our last Annual Outlook that it was
unlikely to be a year of smooth sailing for Indonesia as
wages and inflation were rising, external balances were
worsening, currency weakness was likely to persist, and
a lackluster outlook for commodities was going to
weaken a key engine of growth. We asserted that
Indonesia needed strong counter-cyclical policies,
reiterating our long-held but unpopular view that the
economy was undergoing overheating, but worried that
authorities did not see the economy that way and
policies were likely to remain passive till it was too late.
All of those predictions came through during the year,
but more severely than we had anticipated. In addition
to the anticipated dynamic flagged in our Outlook,
Indonesia became vulnerable to a major shift in global
market sentiment around the Fed’s taper related
deliberation, with the ensuing capital flow volatility
hurting the exchange rate. Most strikingly, in the post
non-taper September-November rally, Indonesia did not
participate conspicuously, revealing the market’s
lingering discomfort with its economic prospects.
We will approach the 2014 Indonesia Outlook under the
theme “Embracing Adjustment.” The economy
succumbed to its myriad of imbalances in 2013, but the
adjustments have yet to play out fully. Policies and
economic developments have considerable room to go
before a bottom is reached and the economy is termed
once again fundamentally sound. The year of adjustment
takes on even greater importance as Indonesia goes into
elections during the second quarter, which would bring
in the first new President in a decade after two terms by
Susilo Bambang Yudhoyono.
Deutsche Bank Securities Inc.
Slow growth ahead, but how slow?
Growth has slowed in recent quarters, currently running
at about 5.5%, about a 100bps lower than seen in 2012.
The slowdown has been primarily driven by fixed capital
formation, contributing only about one-fifth to growth
lately as opposed to about 35% in 2011-12. The
slowdown within the investment spectrum has been
most pronounced in transportation and machinery
related investment, understandable given the very strong
pace of growth in these areas in the preceding years.
Also, the lack of buoyancy in the commodity sector has
surely had a chilling impact on investment in mining and
processing. Interest rate hikes may have had a role to
play too, but we think that has played a negligible
impact so far due to monetary policy lags.
Contrary to intuition, net exports have continued to
contribute positively to growth as the slowing of exports
(of goods and services) has been outpaced by the
slowing of imports. Meanwhile, concerted efforts to
tighten fiscal and monetary policies have not had much
of an impact on real consumption, which has been
growing at comfortable 5%+ rate for a couple of years.
The lack of slowdown in consumption is interesting, but
not a puzzle. Income growth has been substantial in
recent years, with per capita GDP, in USD terms, rising
by 65% between 2008 and 2012. Recent rupiah
depreciation and rate hikes clearly have not been
sufficient yet to have a meaningful impact on
consumption behavior.
Finally, public spending, although falling short of
budgeted in virtually every year, has helped prop up
growth. Subsidies, particularly on fuel products, have
been
generous,
helping
consumption.
Public
procurement has been substantial too as infrastructure
spending and transfers to regions have risen in recent
years. The latter, in particular, is significant as it is has
been growing in double digit rates lately, accounting for
nearly a third of total government spending.
In the last quarter of 2013 and for 2014 as a whole, we
can’t see investment or consumption showing strength.
Weakness in investment may intensify as lagged effect
of rate hikes and rupee depreciation begin to raise the
cost of projects (and hence lower the expected returns),
commodity sector remains in the doldrums, and fatigue
from the recent investment binge takes hold. On
consumption, the shoe may finally drop next year for the
same reasons, with income and employment
expectations dented and cost of financing higher.
Page 77
5 December 2013
EM Monthly: Diverging Markets
Level and growth rate of income growth about to taper
Real per capita GDP growth, lhs
6.0
4,000
Per capita GDP in USD, rhs
3,000
4.0
2,000
2.0
1,000
0
0.0
2000
2002
2004
2006
2008
2010
But Indonesia can do something about its commodity
production and demand for imported oil. In these two
areas, major policy mistakes have been made in recent
years, reversal of which is necessary for the external
account dynamic to improve in a sustainable manner.
On production, insufficient investment in the past
decade has caused Indonesia’s oil production to decline
by about 20%, falling to below 1 million barrels per day
in 2012, while the period has coincided with steady rise
in demand. Add to this the lack of sufficient refined
capacity domestically, Indonesia’s increasing reliance on
imported oil is understood.
2012
Weakening of oil+gas balance seems structural
Source: CEIC, Deutsche Bank
Our expectation of trade is also muted, although exports
ought to pick up somewhat thanks to a likely rise in
partner country demand. But unless a major tapering of
imports takes place owing weaker consumer demand,
net exports’ contribution to growth may well be
negligible.
Putting it all together, we see growth hovering in the
low 5% range in the coming year. Our annual average
growth forecast is 5.2%. Risks to this forecast are the
following: on the plus side, partner country demand
could surprise positively, easing external account
imbalances and help revive the rupee, and by extension,
consumer and business confidence. On the negative
side, demand for imports may not ease due to
insufficient tariff adjustment, causing imbalances to
persist, leading to further unrest in asset markets,
dampening sentiments, ultimately causing a disorderly
adjustment of demand.
External sector weakness a key test
Indonesia’s external sector deterioration has been
dramatic. An economy that used to enjoy ample
commodity
and
non-commodity
exports,
and
consequently a comfortable trade and current account
surplus, has gotten stuck in a worrisome deficit precisely
as a time investors are being choosy about deficit
economies. Correcting this imbalance is critical in
resolving Indonesia’s vulnerability in the coming year.
We see three key reasons for Indonesia’s external
account predicament, two of which are within its own
control. The one that Indonesia can’t do much about is
demand for its commodities, particularly coal and palm
oil in the global market place. With oil prices mostly flat
this year, and expectations for weakness to persist in
2014 due to major supply side developments, the
outlook for commodity export prices will remain
subdued, we’re afraid.
Page 78
USD bn,
3mma
3.0
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
2008
non oil+gas balance,lhs
oil+gas balance, lhs
Dubai crude, rhs
USD/barrel,
3mma
125
100
75
50
25
0
2009
2010
2011
2012
2013
Source: Deutsche Bank
On demand, while some rise in demand is
understandable, a ruinous fuel subsidy policy has
artificially inflated it year after year. This year’s 33% fuel
price increase came too little and too late. Indonesians
see the new price (which, at IDR6000/liter, is at the same
level as it was 5 years ago) as a mild price shock, and so
far have barely adjusted their demand accordingly.
Arguably a rising interest rate environment, weaker
rupee, and higher prices would work in combination to
dampen import demand. We however believe that the
best way to bring demand down to sustainable level
would be to eliminate fuel subsidies altogether, and then
use the proceeds to fund investment in improving the
energy mining infrastructure and capacity. Further fuel
price increase is perhaps a no-go on an election year,
but this challenge will have to be picked up by the new
President almost as soon as he or she comes to power.
The rupiah’s dangerous course
When taper-related volatility afflicted the EM universe
this summer, rupiah’s depreciation was not surprising.
The currency’s weakness was seen not much worse
than the currencies of deficit economies. Rupiah defense
was mounted through policy tightening and exchange
rate intervention, swap lines were renewed, and FX
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
transactions were restricted. The measures were
essentially futile and very costly, damaging investor
confidence and causing a sizeable loss of reserves
(about USD20bn between December 2012 and August
2013). To their credit, the authorities have allowed more
liberal movement and settlement of the currency lately
and external bonds have been issued to make up for a
portion of the lost reserves. But pressure on the currency
has not abated as both the trade and current accounts
have not shown much of an improvement. As the chart
below shows, the rupiah has stood out in its movement
against the USD since the end of August. By and large,
EM economies that saw currency depreciation have
sprung back to appreciation with taper worries fading,
but the IDR has continued to weaken. This is a
dangerous time to have such a track record.
Rupiah the odd currency out since end-August
% change against USD, 08/30-12/02
8
6
INR
ZAR
4
MYR
BRL
2
0
-15
-10
THB
-5
0
-2
-4
Given the issues associated with its external deficits,
Indonesia’s fiscal situation seems like a non-issue, with
overall balances seldom exceeding 2% of GDP deficit in
recent years, and debt/GD below 25%, one of the lowest
in the EM universe. Nevertheless, years of large scale
subsidies, without which the budget would have been in
surplus territory, has caused numerous distortion in
consumption pattern and the political economy of fiscal
policy (it took the government over a year to raise fuel
prices in the latest round, for instance).
Three key risks are ahead for the budget, one short-term
and two long-term. First, the sharp depreciation of the
rupiah and ongoing economic slowdown would require
some upward revision of subsidy spending and
downward revision to revenue collection forecasts (the
2014 budget, on a preliminary basis, optimistically
projects rupiah to average 10500 to the USD and growth
to be 6%).These adjustments could readily push the
budget deficit to over 2% of GDP, in our view.
PHP
TRL
-20
Fiscal not a source of vulnerability but
reflects structural distortions
IDR
-6
% ch against USD, 5/22-08/30
Source: Deutsche Bank
Can the rupiah turn a corner in 2014? Our confidence is
low in this regard. Trade and current account adjustment
appears to progressing at an unsatisfactory rate, and
likely periods of global market uncertainty around taper
will leave the rupiah vulnerable, in our view.
Between a projected current account deficit of about
USD 30bn and short-term debt on residual maturity
basis of about USD55bn, the economy will have
USD85bn in gross external financing requirement next
year, which is a tall order even under normal
circumstances. A third of government bonds coming
due next year are denominated in foreign currency, with
a gross issuance requirement of about USD5bn, which
adds another lump to FX demand.
We therefore see the currency hovering around the
11500-12000 range next year, which has worrisome
implications for inflation. Already, the recent
depreciation of the rupiah has undone the impact of the
fuel price adjustment of this year, as the rupiah cost of
importing fuel has surged.
Deutsche Bank Securities Inc.
Second, steady decline in oil production and continued
reliance on fuel subsidies have changed the fundamental
nature of the budget in recent years. The chart below
depicts the worrisome development of net oil revenue in
the budget, which is derived by subtracting all oil and
gas related tax and non-tax revenues from fuel subsidies.
Clearly, the budget has now lost all gains from
Indonesia’s oil+gas resource revenues.
Net oil+gas fiscal revenues
% of GDP
5.0
4.0
3.0
2.0
1.0
0.0
-1.0
2005
2007
2009
2011
2013 F
Source: CEIC, Deutsche Bank
Third, the spending side of the budget is becoming more
rigid, with large increases in public sector wages and
generous commitment to an array of social sector
activities. These would push more burdens on the
revenue side in the coming years.
Page 79
5 December 2013
EM Monthly: Diverging Markets
Inflation and monetary policy challenges
Indonesia: Deutsche Bank forecasts
Past episodes of large fuel price increase have had
minimal impact on inflation after a three/four month
jump in prices. Indeed, inflation peaked and eased
remarkably swiftly in those occasions, paving the way
for monetary policy easing and bond yields falling. This
time is different, in our view. First complication to this
narrative is that monetary policy was ultra easy going
into 2013, and the fuel price increase and accompanying
rate hikes came too late and were too modest to affect
demand. Second, the sharp depreciation to the rupiah,
coupled with the still-strong consumption demand,
would likely cause prices to rise appreciably in 2014.
Third, although this year’s wage increases have been
relatively modest, the substantial cumulative increase in
wages in the last few years will continue to impart
inflationary impulse.
National Income
Nominal GDP (USD bn)
Population (mn)
GDP per capita (USD)
Impulse response from VAR. Inflation rises by 100bps
in response to a 10% depreciation of the rupiah
0.6
0.5
0.4
0.3
2012
2013F
2014F
2015F
878.3
247.2
3553
875.5
250.4
3496
884.7
254.8
3473
985.1
259.2
3800
Real GDP (YoY%)
Private consumption
Government consumption
Gross fixed investment
Exports
Imports
6.2
5.3
1.2
9.8
2.0
6.6
5.5
5.2
3.7
4.6
4.4
2.1
5.2
5.0
3.6
5.0
7.0
6.5
5.5
4.8
4.0
6.5
6.3
5.5
Prices, Money and Banking
CPI (YoY%) eop
CPI (YoY%) ann avg
Core CPI (YoY%)
Broad money (M2)
Bank credit (YoY%)
4.3
4.3
4.4
13.5
24.7
8.4
7.0
5.0
13.0
21.0
6.3
6.7
5.0
13.0
16.0
6.4
6.5
4.5
15.0
20.0
Fiscal Accounts (% of GDP)
Budget surplus
Government revenue
Government expenditure
Primary surplus
-2.3
16.5
18.8
-0.3
-2.2
16.6
18.8
-0.2
-2.4
16.2
18.6
-0.4
-2.6
15.8
18.4
-0.6
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
188.5
179.9
8.6
1.0
-24.4
-2.8
14.0
111.0
9646
182.0
181.7
0.3
0.0
-33.8
-3.9
15.8
93.9
11800
188.4
185.4
3.0
0.3
-29.3
-3.3
14.0
93.0
11700
200.6
195.7
5.0
0.5
-28.0
-2.8
20.0
99.4
12000
Debt Indicators (% of GDP)
Government debt
Domestic
External
Total external debt
in USD bn
Short term (% of total)
23.0
12.2
10.8
28.7
252.4
17.8
22.2
11.2
11.0
29.7
260.0
19.2
22.0
11.0
11.0
32.8
290.0
19.0
22.5
11.0
11.5
30.5
300.0
19.0
8.0
6.8
8.0
6.5
7.0
6.0
7.0
6.0
Current
7.50
8.63
11800
3M
8.00
9.50
12000
6M
8.00
9.50
11800
12M
7.50
9.00
11700
0.2
0.1
0
-0.1
-0.2
-0.3
1
2
3
4
5
6
7
8
9
10
Source: CEIC, Deutsche Bank
Bank Indonesia, under these circumstances, will be
compelled to hike rates by another 50bps in the first
few months of 2014, in our view, and then leave policy
rates unchanged for the rest of the year. On a year
when global rates will likely go up considerably,
Indonesia will not be able to afford an accomodating
monetry policy stance, even if growth falls to 5%.
The new government that takes over next year will
have to embrace reforms to improve investment
sentiment, made harder by the fact that it will inherit a
tepid economy, with risks of serious disorderly
adjustment of the exchange rate. In their attempt to
accelrarate growth, Indonesia’s policy makers ended
up oevrheating the economy in recent years. The time
has now come to adjust from the imbalances that were
create as a result.
Taimur Baig, Singapore, +65 6423 8681
Page 80
General
Industrial production (YoY%)
Unemployment (%)
Financial Markets
BI rate
10-year yield (%)
IDR/USD
Source: CEIC, DB Global Markets Research, National Sources
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Malaysia
A3/A-/A-(Neg)
Moody’s/S&P/Fitch

Economic outlook: Stronger expansion of exports is
expected to buoy GDP growth as domestic
demand moderates from tighter fiscal policy.

Main risks: Slower-than-expected pick-up in US
and eurozone GDP growth and weaker outturn of
domestic demand could derail growth recovery.
Fiscal consolidation continues
Exports to buoy growth
Recovery in exports amid tighter fiscal policy is
expected to drive GDP growth dynamics in 2014-2015.
Despite falling from 115% in 2000, Malaysia’s share of
exports remains high at 87% in 2012 and is still
influential in driving economic activity. Malaysia’s GDP
growth is highly correlated and has a high beta with
US&EU growth. We thus expect Malaysia’s exports to
accelerate—despite softer outlook for commodity
prices going forward—as the US and EU economies
improve. The government’s plan to reinvigorate the
services sector through the Services Sector Blueprint to
be launched in 2014 should also provide a boost to
services exports. The role of exports is important in
supporting the overall economy as domestic demand is
expected to moderate from tighter fiscal policy and
credit conditions going into 2015. However, the strong
dependence on external demand also points to the
fragility
of
the
Malaysian
economy
against
uncertainties in the recovery of the global environment.
A pick-up in US and eurozone growth bodes well for
Malaysia’s economy.
%yoy
8
4
2
0
US&EU GDP growth
Malaysia GDP growth
-4
2001
2003
2005
2007
2009
2011
2013
2015
Note: US and Eurozone GDP growth are aggregated using IMF’s PPP-based GDP weights.
Source: CEIC, IMF World Economic Outlook (Oct 2013), and Deutsche Bank
Domestic demand to moderate
Administrative measures that have been initiated since
September 2013 are likely to constrain domestic
Deutsche Bank Securities Inc.
Investments are also foreseen to decelerate as a result
of fiscal expenditure compression and the sequencing
of projects to address the narrowing of the current
account surplus. The 2014 Budget tabled on 25
October suggests even lower allocations on
development expenditures—economic and social
services—than what had been allocated for 2013. In
line with this tighter government spending, public
investments are forecast by the Ministry of Finance to
contract by 2.7% in 2014 following the accelerated
implementation of projects in the previous year.
Whether a contraction of this magnitude is bound to
happen, we do get a sense of the government counting
more on private investments in the years ahead.
Net exports of goods and services could support GDP
growth despite some moderation in domestic demand.
correlation: 0.80
6
-2
demand to lower growth rates, albeit still robust. In line
with its efforts towards fiscal consolidation, the
government has since reduced fuel subsidies,
eliminated the subsidy on sugar, and raised taxes on
tobacco, property, and palm oil exports. Further moves
to rationalize subsidies and broaden the revenue base
are expected to be carried out in 2014 as the
government commits to gradually reduce the fiscal
deficit, eventually reaching a balanced budget by 2020.
And as announced in the 2014 Budget speech in
October, the government plans to introduce the 6%
goods and services tax (GST) in 2015 to replace the
current sales and services taxes. These measures could
result to higher living costs, putting downward
pressure on private consumption in the years ahead.
The slowdown in the pace of private consumption
could occur despite tight labor market conditions and
the government’s enhanced financial assistance to
targeted groups.
Contribution to GDP growth (basis points)
10
DB forecasts
8
6
4
2
0
-2
-4
-6
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Net exports
Gross Capital Formation
Government consumption
Private consumption
GDP growth
Source: CEIC and Deutsche Bank
Page 81
5 December 2013
EM Monthly: Diverging Markets
Inflation to increase
The government’s stronger resolve to reduce the fiscal
deficit is likely to yield higher inflation in 2014. Most
recently, an average 14.89% hike in electricity tariffs
has been approved with effect on 1 January 2014. This
could push inflation above 3% in the first quarter of
2014, increasing the likelihood of a 25bps hike in the
overnight policy rate in March. A policy rate hike of this
magnitude could also be a measure to curb the growth
in household credit.
with imports growth constrained by a slowdown in
private consumption and the demand for capital goods,
net exports are poised to have a positive contribution
to GDP growth. Likewise, the current account is
expected to remain in modest surplus.
The recovery in the current account could be countered
by a bigger deficit in the financial account in 2014-15.
50
Another 25bps rate hike is possible when the BNM
monetary policy committee meets in May. This move
could be a pre-emptive measure to contain inflation
from another round of subsidy adjustment in mid-2014.
Inflation could also start to moderate in September
2014 when the impact of the fuel subsidy adjustment a
year ago wears off, spurring private consumption in
this period ahead of the GST in 2014.
USD bn
DB forecasts
40
30
20
10
0
-10
-20
-30
-40
BNM could raise the OPR by 25bps in 2014 to put a lid
on inflation and possibly, household credit.
10
Note: Negative/positive value refers to outflow/inflow.Net errors and omissions not included in the
chart.
Source: CEIC and Deutsche Bank
%
Inflation
Overnight policy rate
8
6
4
2
0
-2
-4
Jan-07
Jan-09
Jan-11
Jan-13
Jan-15
Source: CEIC and Deutsche Bank
Although inflation could build up ahead of the
implementation of the GST in April 2015, we do not
expect a significant increase in inflation due to the new
tax system thereafter. An IMF survey of price effects
from the introduction of the GST found that the GST
did not result to a sustained increase in inflation. While
in some cases it was associated with a shift in the price
level upon implementation, increases in inflation were
only observed in succeeding periods if the new tax
came with expansionary wage and credit policies. On
the contrary, we think 2015 will be a year of tighter
liquidity as interest rates normalize.
Current account surplus on a modest recovery
And while the current account surplus has already
recovered from the sharp deterioration in the second
quarter, efforts to prioritize projects with low-import
content and high-multiplier effects are expected to
continue. This directive would have an additional drag
on the expansion of investments moving forward. Thus,
Page 82
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Financial account
Current account
Balance of payments
Financial account to remain in deficit
Meanwhile, Malaysian overseas investments—both
direct and portfolio—are envisioned to increase with
the likes of Malaysia’s pension fund looking at
increasing external exposure within the next one to two
years. These, in addition to the threat of capital flow
reversals from QE tapering and normalization of
interest rates in the US, are likely to keep the financial
account in deficit. This deficit could occur despite some
pick-up in foreign direct investment on the back of a
favorable external environment and the government’s
continued efforts in attracting private investments
under the Economic Transformation Program.
The ringgit and fiscal deficit
Sudden outflows of short-term investments, given
substantial foreign investor presence in Malaysia’s
local currency bond market, expose the ringgit to risks
of instability and weakness. Amid tapering concerns in
the third quarter, the ringgit weakened by 6%qoq
against the dollar as the percentage of foreign bond
holdings also fell. Heightened volatility in the exchange
rate could dampen growth considering Malaysia’s
strong dependence on trade. A weaker currency could
also magnify government spending through increased
subsidies and a higher debt burden. Such scenarios,
coupled with a possible shortfall in revenues from
lower oil prices, increase the likelihood of missing fiscal
deficit targets. Thus, in our view, it might be
challenging to meet the 3.5% of GDP fiscal deficit
target for 2014. However, we also believe that the
government’s stronger commitment towards fiscal
consolidation points to gradually lower fiscal deficits
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
going forward. Efforts to strengthen fiscal position and
improve the current account while spurring private
investments should shield the economy from risks
surrounding the exchange rate.
Malaysia’s high foreign holdings of local currency
bonds pose risks to the stability of the ringgit.
% of LCY bonds outstanding
50
45
40
35
30
25
20
15
10
5
0
2003Q4
2007Q1
2010Q2
Malaysia - GII & MGS
Malaysia - MGS
Thailand
2013Q3
Japan
Indonesia
South Korea
Source: Asianbondsonline, CEIC and Deutsche Bank
The growing household debt
Historically low rates have been associated with credit
and property booms in many parts of Asia. Malaysia is
no exception with its growing household debt. From
60% of GDP in 2008, household borrowing has steadily
increased to an estimated 86% in the third quarter of
this year. These household loans were primarily used
for consumption and purchases of residential
properties and vehicles. Indeed, residential property
prices have soared in Malaysia from an about 3%
average inflation in 2000-2009 to about 11% in the past
two years. Residential property prices have intensified
the most in Kuala Lumpur and states of Johor,
Kelantan, Pulau Pinang, and Sarawak.
borrowing activities. The budget speech in October
saw the increase in real property gains tax and the
removal of the developer interest bearing scheme
(DIBS), measures that are aimed to control excessive
speculative activities in the property market. These
came after the BNM, in July, lowered the maximum
tenure for the repayment of personal and property
loans, prohibited financial institutions from offering
pre-approved personal financing products, and
required them to observe a prudent debt service ratio
when extending credit to borrowers.
Also in July, the BNM expanded its regulatory
oversight through the Financial Services Act to cover
the shadow banking sector—those non-bank financial
institutions—that are partly responsible for the rapid
growth in personal loans. While these recent measures
(that have evolved from those adopted since 2010)
seem to have tempered housing demand mildly in the
third quarter, they also suggest that macro-prudential
measures may not be sufficient to address this risk. In
fact, household sector loan activity has again picked up
pace this year.
Household debt indicators have picked up pace despite
recent macro-prudential measures to curb credit.
Household debt (LHS)
Loan applications
Loans approved
Loans disbursed
% of GDP
90
80
70
%yoy
45
40
35
30
25
20
15
10
5
0
-5
60
50
40
30
20
10
0
2007
2008
2009
2010
2011
2012
2013*
House prices have soared in more recent years.
Note: Latest figure for household debt is as of the third quarter. Others refer to total household
sector loans for the period Jan-October 2013.
Source: CEIC and Deutsche Bank
yoy%, 3mma
25
20
15
Malaysia Johor Pulau Pinang Kuala Lumpur Sarawak Kelantan 10
5
0
-5
2007Q1
2008Q2
2009Q3
2010Q4
2012Q1
2013Q2
Source: CEIC and Deutsche Bank
The government has imposed a series of macroprudential measures to rein in excessive lending and
Deutsche Bank Securities Inc.
While probably less of a systemic banking risk,
Malaysia’s
substantial
household
debt
is
a
macroeconomic concern. The banking system is well
capitalized even with the implementation of the more
stringent Basel III capital adequacy framework.
Households, in general, are also deemed less likely to
default on their debts with the non-performing loan
ratio at a record low of less than 2%. And yet, rising
interest rates could hurt the repayment ability and
purchasing power of these households, slowing down
private consumption that usually accounts for about
50% of GDP. Somehow, the government has already
recognized this risk and is counting on private
investments to compensate for the moderation in 2014.
Page 83
5 December 2013
EM Monthly: Diverging Markets
The government’s 2014 outlook relies on double-digit
investments expansion against moderating private
and public consumption to support growth.
2013E
%yoy
GDP
Malaysia: Deutsche Bank forecasts
2014F
% of GDP
%yoy
% of GDP
4.5-5.0
100
5.0-5.5
100
Private consumption
7.4
51.9
6.2
52.5
Gov’t consumption
7.3
13.5
3.3
13.3
Private investment
16.2
17.3
12.7
18.5
Public investment
5.5
11.4
-2.7
10.5
Export
0.5
91.9
1.6
89
Import
4.4
86.3
2.2
84
E = Estimate; F = Forecast.
Source: MOF Economic Report 2013/2014 and Deutsche Bank
Malaysia’s growing household debt could also put
additional pressure on fiscal finances. The government
has committed to enhance financial support to
vulnerable groups in response to subsidy and tax
adjustments. It currently provides cash assistance
worth MYR3bn under the 1Malaysia People’s Aid
(BR1M) program to 7 million households and single
unmarried individuals earning less than MYR3000 a
month. Borrowers from this income group are also at a
greater risk of default with their leverage positions
considerably higher than those in other income groups.
Thus, eventually higher borrowing costs could push the
government to further increase financial assistance
under BR1M. Already, the government plans to allocate
an additional MYR1.6bn to this program in 2014 to
address households’ greater financial burden from
earlier subsidy rationalization measures. There is a risk
that the additional cost of supporting these heavily
indebted households could exceed savings from
subsidy adjustments, undermining the government’s
accelerated efforts in consolidating fiscal position.
Diana del Rosario, Singapore, +65 6423 5261
2012
2013F
2014F
2015F
305.0
29.3
10398
311.6
29.6
10519
335.9
29.9
11232
368.3
30.2
12196
Real GDP (YoY%)
Private consumption
Government consumption
Gross fixed investment
Exports
Imports
5.6
7.7
5.1
19.9
-0.1
4.7
4.8
7.6
5.1
8.5
-0.1
1.9
6.0
5.7
2.6
5.8
7.1
7.0
5.8
6.1
2.7
5.4
6.5
6.0
Prices, Money and Banking
CPI (YoY%) eop
CPI (YoY%) ann avg
Broad money (M3)
Bank credit (YoY%)
1.2
1.7
13.4
12.5
3.1
2.1
8.6
10.0
2.3
3.0
8.9
9.9
2.4
2.9
10.2
10.2
Fiscal Accounts (% of GDP)
Federal government surplus
Government revenue
Government expenditure
Primary fed. gov’t fiscal
-4.5
22.1
26.7
-2.4
-4.2
22.6
26.8
-1.9
-3.8
20.8
24.6
-1.6
-3.3
21.7
25.0
-1.2
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) MYR/USD
227.9
187.2
40.7
13.3
18.6
6.1
-7.0
139.7
3.05
219.9
185.9
34.0
10.9
13.7
3.6
-7.6
141.6
3.21
237.8
203.2
34.6
10.3
15.2
4.5
-7.2
141.1
3.15
260.0
220.3
39.7
10.8
23.4
6.3
-7.5
141.8
3.13
Debt Indicators (% of GDP)
Government debt*
Domestic
External
Total external debt
in USD bn
Short-term (% of total)
68.5
67.6
1.8
27.0
82.6
36.8
69.7
67.9
1.7
24.5
75.1
40.0
66.7
65.1
1.6
21.2
72.5
44.2
68.3
66.8
1.5
18.9
70.4
44.0
3.9
3.0
2.3
3.1
4.5
3.0
4.5
3.1
Current
3.00
3.20
4.06
3.20
3M
3.25
3.21
4.30
3.25
6M
3.50
3.46
4.40
3.24
12M
3.50
3.71
4.60
3.15
National Income
Nominal GDP (USD bn)
Population (mn)
GDP per capita (USD)
General
Industrial production (YoY%)
Unemployment (%)
Financial Markets
Overnight call rate
3-month interbank rate
10-year yield (%)
MYR/USD
*Includes government guarantees
Source: CEIC, DB Global Markets Research, National Sources
Page 84
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Philippines
Baa3(Pos)/BBB-/BBBMoody’s/S&P/Fitch
„
Economic outlook: Strong growth could be
sustained in the next two years on robust private
consumption and brisk investments.
„
Main risks: Inflation could surprise to the upside on
strong growth, domestic supply-side constraints,
and the surge in domestic liquidity.
On to a higher growth path
The first three quarters of 2013 saw the Philippine
economy accelerate to 7.4%yoy as domestic demand
picked up pace. Investments, specifically in
construction and durable equipment, sustained the
strong growth since 2012 on the back of the
government’s commitment to spend on infrastructure
and boost private sector investments. The strong peso
that resulted from the surge in capital and remittance
inflows also created a favorable environment for
businesses to import construction materials and
equipment at a lower cost. Public consumption
registered double-digit growth in the first half as
general elections in May fueled spending. Meanwhile,
private consumption—comprising over 70% of GDP—
remained the primary growth driver.
Domestic demand, which has driven the Philippine
economy, is expected to remain firm in years ahead.
Contributions to GDP growth (bps)
DB forecasts
10
Strong growth to be sustained
The Philippines is expected to remain on a high growth
path on the back of robust private consumption and
brisk investments. Private consumption will continue to
be driven by substantial inflows of remittances and the
sustained growth in the business processing
outsourcing (BPO) sector. Investments, on the other
hand, will benefit from the government’s plan of
increasing infrastructure spending and the strong
demand for real estate. In addition, reconstruction and
rehabilitation efforts in areas affected by natural
calamities in 2013 are expected to boost investments.
Meanwhile, net exports, which could still remain in
deficit, are foreseen to bear a smaller drag to growth
with the better outturn of exports amid improving
external demand.
Increasing output gap in recent years has been to the
contrary, associated with moderating inflation.
12
%
Inflation
10
8
6
4
2
Output gap (RHS)
%
3
2
1
0
-1
-2
-3
-4
0
2000Q1 2002Q2 2004Q3 2006Q4 2009Q1 2011Q2 2013Q3
8
6
4
Source: CEIC and Deutsche Bank
2
0
-2
-4
2005
2007
2009
Net exports
Government consumption
2011
2013
2015
Gross capital formation
Private consumption
Source: CEIC and Deutsche Bank
The damage caused by Super Typhoon Haiyan on
agricultural production, businesses, and supply chains
in central Philippines is likely to manifest in a
deceleration of fourth quarter GDP to less than 6%. We
earlier reported that the widespread devastation of the
typhoon is only seen to pose 20-40bps downside risk to
2013 growth owing to the small contribution of the
affected areas to the overall economy. If so, the
Philippines could still end the year with 7% growth.
Deutsche Bank Securities Inc.
Increasing inflationary pressures
Benign inflation amid strong growth is a mystery that
has baffled observers of the Philippine economy.
Despite output expanding by a 7.1% average in the
past seven quarters, inflation remained low at 3% in
the same period. While benign domestic inflation can
be attributed to soft global commodity prices, the
strong growth could have opened up a positive output
gap with inherent inflationary pressures. This view
raises concern on the risk of inflation spiking in the
near term, although it is also possible that potential
output has reached a higher level. As to whether this
risk could materialize, inflation is nonetheless expected
to pick up next year owing to the surge in domestic
liquidity growth and typhoon-related disruption in
agricultural production. But coming from a low base
with inflation still at 2.8% from January to October this
year, we think the BSP would only hike policy rates by
Page 85
5 December 2013
EM Monthly: Diverging Markets
a total of 50bps in the latter half of 2014 when inflation
comes close to the upper end of the 3-5% inflation
target. The BSP’s plan of lowering the inflation band to
2-4% in 2015 also increases the likelihood of a more
active policy stance in the latter half of next year.
While food price inflation had demonstrated a
moderating trend since late 2012, it started to pick up
in
September
on
weather-related
production
disruptions. This trend is likely to continue with
Typhoon
Haiyan
having
curtailed
agricultural
production in the affected areas. The Department of
Agriculture (DA), for instance, has estimated rice
production to slow down to 3-4%yoy this year after
posting 8% growth in 2012. The Philippines was earlier
projected to expand rice production by 6% in 2013,
consistent with the rate needed to attain selfsufficiency. However, the increasing frequency and
intensity of weather disturbances in the Philippines
prompted the DA to lower its average growth forecast
in the next three years to 4%. This implies that the
country will have to import more rice in the near term
until public and private investments in this sector result
in greater production to sufficient levels. Already, the
National Food Authority has cleared the importation of
500,000 metric tons of rice from Vietnam and Thailand
that would be added to the depleted buffer stock.
Food inflation is gaining momentum.
12
yoy
10
8
6
4
2
0
-2
Jan-10
Oct-10
Jul-11
Apr-12
Jan-13
Remittances are a stable source of foreign exchange
12
10
8
6
4
2
0
-2
-4
% of GDP
2000
2002
2004
2006
2008
Remittances
Portfolio inflows
2010
2012
FDI
Balance of Payments
Source: CEIC and Deutsche Bank
Remittances from overseas Filipinos, last valued at
8.5% of GDP in 2012 with an annual growth of 6.6%,
have also become a significant source of income for
recipient families. A BSP survey indicates that recipient
households utilize their remittances primarily for food,
education, medical expenses and debt payments.
About 9% of surveyed households also reported using
remittances to buy real estate properties, supporting
the country’s booming property market. These inflows
are expected to remain firm with better job prospects
for Filipinos as the external environment improves.
%
3m/3m saar
Remittances still to bring comfort to the economy
The Philippine economy has benefitted from strong
inflows of remittances. These personal transfers have
resulted to a surplus in the current account despite a
deficit in the goods accounts. They have also provided
a relatively stable source of foreign exchange for the
economy, far surpassing foreign direct investments and
portfolio investments. As a result, the country has
accumulated sizeable reserves making it more resilient
to external shocks.
Oct-13
Remittances fuel private consumption and investment
in housing
Source: CEIC and Deutsche Bank
With food and non-alcoholic beverages bearing a 39%
weight in the CPI basket, inflation could likely be on an
uptrend in the near term. Inflationary pressures could
also build from the surge in domestic liquidity arising
the BSP’s adjustment in the special deposit account
(SDA) facility. Although it is expected that funds taken
out of the SDA facility would eventually find ways in
other forms of investments, a portion could still end up
for private consumption, driving inflation.
% of surveyed
households (1H2013)
Others
Purchase of Car, etc
Investment
Purchase of House
Purchase of Appliances
Savings
Debt payments
Medical expenses
Education
Food
0
20
40
60
80
100
Source: BSP and Deutsche Bank
Page 86
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
The economy could also experience an additional boost
in remittances in the first quarter of 2014 as overseas
Filipinos help family members and relatives recover
from the physical damage caused by Typhoon Haiyan.
Historical data show that remittances have a tendency
to increase more than normal times in response to
strong typhoons.
Remittances tended to increase more than normal
times when strong typhoons hit the country.
USD mn
6
The increasing share of non-essential items in private
consumption growth reflects a growing middle class.
Contributions to growth (bps)
7
Miscellaneous G&S
Transport and communication
6
Utilities
5
Education and health
Food
4
3
2
Quarter before typhoon
Quarter of the typhoon
Quarter after typhoon
5
4
1
0
2009
2010
2011
2012
Source: CEIC and Deutsche Bank
3
2
1
0
Bopha
Durian
Zeb, Babs
Thelma Normal period
Note: Normal period refers to average levels for 2000-2005 when no significant destructions due to
natural disasters were recorded. During refers to the quarter the typhoon was felt (Quarter 0) and
before (after) refers to one quarter before (after) Quarter 0.Quarterly remittances were seasonally
adjusted.
Source: CEIC and Deutsche Bank
The growing BPO industry
Meanwhile, the Philippine’s growing BPO industry is
expected to continue its current growth trajectory at
least in the next two years. This sector has become an
important source of employment among many Filipinos.
The World Bank claims this sector has created a new
middle class that is starting to drive private
consumption, notably of electronics items, household
appliances, clothing and footwear, and recreation
activities, and to some extent, investment in real estate.
The Business Process Association of the Philippines
projects revenues of the BPO industry to reach $20bn
in 2016—about the same size as annual remittances—
from $9bn in 2012 along with 1.5 million new jobs
open to Filipinos. However, it is also worth noting that
the number of projected jobs is still not sufficient to
absorb new entrants in the labor force, unless the
government steps up in boosting agricultural
productivity and manufacturing, among others. The
economy is beset with high unemployment and poverty
rates which the government has to seriously address as
the economy transitions to a high growth path.
Deutsche Bank Securities Inc.
To enter the demographic window in 2015
Going into 2015, the Philippines could enter into a
demographic window—as projected by the United
Nations—with the potential to spur domestic demand.
The demographic window is the period when a greater
proportion of the economy’s population is of working
age. Provided that adequate jobs have been created by
this time, abundance of income-earning consumers
could boost private consumption and investments. This
period will also benefit investors looking to tap the
Philippine domestic market, offsetting the slowdown in
private investments due to tighter credit conditions.
But the government will also have to transform
protectionist policies to attract more foreign investment.
Government to spend more on infrastructure
Investments are also expected to gain from a boost in
public spending. The government has committed to
increase infrastructure spending from 2% of GDP in
2012 to 5% by 2016 to attract private investments in
diverse areas and increase job creation. It also plans to
roll out more projects under the Public-Private
Partnership (PPP) program that has awarded only four
projects since 2010. The first nine months of 2013 saw
a 34%yoy increase in disbursements for infrastructure
and capital outlay that covered roads, flood control and
drainage, and irrigation projects. As of September, the
Department of Budget and Management has released
91.9% of the total 2013 budget, reflecting a faster
budget execution rate relative to last year’s 87.3%.
While the 2014 Budget is still currently under review by
Philippine legislators, President Aquino’s administration
is proposing to increase allocation for infrastructure
projects by 35%yoy to PHP399bn or 3% of GDP.
Reconstruction and rehabilitation efforts in central
Philippines that are expected to commence in 2014
through 2015 (or longer) are also expected to support
the expansion in investments. This rapid expansion in
capital formation that entails importation of high-value
Page 87
5 December 2013
EM Monthly: Diverging Markets
capital goods could limit the increase in the current
account surplus arising from robust inflows of
remittances and BPO receipts.
Fiscal deficit to remain manageable
As the government ramps up spending, there is a risk
of missing the fiscal deficit target of 2% of GDP in the
next two years. Improved tax administration measures,
as demonstrated by the current administration, and
savings from previous fiscal years are, however,
expected to contain the deficit to less than 2.5% of
GDP, which is still deemed sustainable given strong
economic growth and lower interest burden.
The fiscal balance has improved through the years.
% of GDP
0
-1
-2
-3
DB
forecasts
-4
-5
-6
2000
2003
2006
2009
2012
2015
Source: CEIC and Deutsche Bank
Diana del Rosario, Singapore, +65 6423 5261
Philippines: Deutsche Bank Forecasts
2012
2013F
2014F
2015F
250.2
97.6
2562
273.7
99.5
2751
302.0
101.3
2982
342.6
103.1
3324
Real GDP (YoY%)
Private consumption
Government consumption
Gross fixed investment
Exports
Imports
6.8
6.6
12.2
10.4
8.9
5.3
7.0
5.6
10.8
11.5
1.1
5.3
6.8
5.8
5.4
15.9
12.8
13.2
7.0
5.7
3.9
9.9
9.7
8.9
Prices, Money and Banking
CPI (eop, YoY%)
CPI (YoY%) ann avg
Broad money (M3, YoY%)
Credit to private sector
3.0
3.2
6.8
13.4
3.5
2.9
22.0
15.1
3.8
4.1
20.6
11.4
3.7
3.3
14.9
11.2
Fiscal Accounts (% of GDP)
Fiscal balance
Government revenue
Government expenditure
Primary surplus
-2.3
14.5
16.8
0.7
-2.0
14.6
16.7
0.8
-2.4
14.7
17.1
0.3
-2.2
14.7
16.9
0.5
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) PHP/USD
46.3
61.5
-15.2
-6.1
7.1
2.8
1.0
83.8
41.2
50.7
62.9
-12.2
-4.5
10.9
4.0
1.7
85.8
43.6
57.5
73.2
-15.6
-5.2
12.3
4.1
2.0
93.0
43.5
64.4
80.5
-16.1
-4.7
15.0
4.4
2.3
103.2
42.2
Debt Indicators (% of GDP)
Government debt1
Domestic
External
Total external debt
in USD bn
Short-term (% of total)
56.2
34.2
22.0
24.1
60.3
14.1
56.2
33.1
23.1
19.8
54.1
12.9
52.3
31.1
21.2
17.1
51.5
15.5
49.8
30.2
19.6
14.3
48.4
17.1
6.8
8.2
7.8
8.1
3M
5.50
3.50
0.00
3.40
43.6
6M
5.50
3.50
0.06
3.50
43.8
12M
5.50
3.50
0.26
3.50
44.2
12M
6.00
4.00
0.76
3.80
43.5
National Income
Nominal GDP (USD bn)
Population (mn)
GDP per capita (USD)
General
Industrial production (YoY%)
Financial Markets
BSP o/n repo
BSP o/n reverse repo
3-month Tbill rate
10-year yield (%)
PHP/USD
(1) Incl. guarantees on SOE debt.
Source: CEIC, DB Global Markets Research, National Sources
Page 88
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Singapore
Aaa/AAA/AAA
Moody’s/S&P/Fitch
„
„
Economic outlook: Given its close linkage to the US
and EU, Singapore stands to enjoy a year of exportled growth, balancing some likely drag to parts of
the domestic economy.
Main risks: Policy orchestrated tightening of the
labor market could drive up inflation and affect
margins of local businesses. .Taper and rate
normalization could destabilize flows, push up rates,
and cause stress to the property market, household
balance-sheets, and banks
Singapore’s value-added in trade; EU and US matter
much more than China
% of GDP
2000
2009
14
12
10
8
6
4
Waiting for rates to normalize
Singapore is stepping into 2014 with a much-awaited
tailwind. Starting from the third quarter, exports,
particularly electronics, have begun to pick-up along
with a rise in demand in the US and signs of bottoming
out in EU. Worldwide semiconductor demand has
begun to recover from a protracted malaise. There are
encouraging signs that IT spending among both
households and businesses has been gathering pace,
which ought to provide strong support to Singapore’s
electronics sector.
For an economy with an exports/GDP ratio of around
225%, a revitalized external sector is a key positive. In
past years, when the external demand cycle was strong,
net exports accounted for 70-80% of economic growth
in Singapore. Indeed, open economies like Singapore
have
seen
exports
leading
investment
and
consumption, transmitting growth impulse through the
income channel. This time will be no different; exports
will keep Singapore in good shape in the coming year,
in our view, notwithstanding some risk from the
beginning of rate normalization in industrialized
economies, which we will address later in this section.
Singapore’s recovery will rely particularly on a recovery
in the EU, although buoyant US demand would be
substantially beneficial as well. While we expect EU
(1.2%) to lag the US (3.2%) substantially growth-wise
in 2014, it is important to note that both economies are
expected to accelerate in comparable magnitude (by
about 1.4%). Estimates from the OECD show that EU is
the largest source of value-added exports for Singapore.
It is estimated that in 2009, Singapore’s export value
added to EU amounted to 12% of GDP, with the US
second (about 9%), ASEAN third (6.5%), and China a
distant fourth (4.8%). Singapore’s manufacturing,
trade-related activities, and financial services have
considerable exposure to the EU, all of which will likely
see broad-based demand next year.
Deutsche Bank Securities Inc.
2
0
EU
US
China
Source: OECD, Deutsche Bank
The tailwind comes at an opportune moment. Within
Asia, China looks set to have a strong year, but for the
rest of the region, domestic demand has been showing
signs of fatigue, with Singapore no exception. Without
considerable lifting from trade, Asian economies in
general and Singapore in particular would have been
looking at a rather lackluster year, in our view.
Thanks to the pull from exports, we see growth
averaging 3.5% in both 2013 and 2014, although if the
exports recovery turns out to be particularly vigorous,
there will be some upside to the 2014 forecast. This is
a far cry from the expectations among analysts and
policy makers just a few months ago when 2-3% was
seen as the best case scenario for Singapore.
The satisfactory growth figures will unlikely be
accompanied by some inflation pressure. We see
inflation averaging about 2.8% next year, about 50bps
higher than the 2013 outturn. We think that the pick-up
would be considered modest enough to keep MAS on
the sideline through the course of the year. Singapore’s
inflation dynamic will be subject to opposing forces, in
our view. On one hand, we see oil and commodity
prices undergoing a soft patch, and property price and
rentals under some pressure as the MAS’s cooling
measures yield some results. On the other hand, labor
market will remain tight due to tougher immigration
regulation, pushing up the cost of doing business and
exerting upward pressure on service sector inflation.
Auto prices could rise considerably as COE supply and
prices undergo new regulatory changes. Also, if there
is a major USD rally around the taper, that could push
down the SGD and cause some inflation pass-through.
All in all, however, we reckon that inflation is more of
an issue for 2015 than 2014.
Page 89
5 December 2013
EM Monthly: Diverging Markets
The key worry for next year, and the subsequent period,
is how Singapore’s households and businesses deal
with interest rates no longer at their floor, subject to
some risk of abrupt upward adjustments.
The following chart shows that both the US and
Singaporean long-term interest rates have lately
bottomed, and are at the early stages of retracing to
historic norms, which appear several hundred basis
points higher. Given the US Fed’s recent actions and
rhetoric, we think it is highly unlikely that mortgage
holders and borrowers will suddenly see a 200-300bps
jump in debt service costs in the US, and by extension,
Singapore, but our concern is that even a 100bps rise
in interest rates could cause major ripple through the
economy. After all, household debt to GDP is 77%, 10
percentage point higher than the figure just three years
ago. Rising rates could also have an impact on
construction and finance, although we are not
particularly worried about balance sheet strength in
those two sectors.
Get ready for rate normalization
10-yr
yields, %
Singapore
6
5
4
3
2
1
2002
2004
2006
National Income
Nominal GDP (USD bn)
Population (mn)
GDP per capita (USD)
2012
2013F
2014F 2015F
276.7
5.3
52082
295.8
5.4
54580
304.3 318.0
5.5
5.6
55327 56779
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%)
1.9
0.7
-3.3
9.3
1.1
3.8
3.5
2.5
11.7
-0.6
2.1
2.5
3.5
5.5
-1.3
1.6
4.5
4.4
4.2
4.0
4.0
4.0
5.5
4.0
4.3
4.6
10.4
12.9
1.5
2.3
9.7
9.8
3.3
2.8
10.4
10.4
3.6
3.5
11
10.5
Fiscal Accounts (% of GDP)
Fiscal balance
Government revenue
Government expenditure
6.6
22.2
15.6
7.3
21.0
13.7
6.9
22.1
15.2
6.8
22.3
15.5
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
436.0
375.1
60.9
22.0
51.4
18.6
33.6
257.9
1.22
457.8
397.6
60.2
20.4
43.6
14.7
8.0
284.5
1.25
485.2
421.4
63.8
21.0
47.2
15.5
10.0
308.7
1.26
519.2
455.1
64.1
20.1
46.2
14.5
12.0
329.9
1.27
108.7
108.7
0.0
416
1151
69.5
110.6
110.6
1.0
410
1208
68.8
115.1
115.1
1.0
390
1214
69.0
121.2
121.2
1.0
375
1220
70.0
-2.2
2.6
1.7
2.8
1.7
2.6
3.0
2.5
Current
0.40
2.44
1.25
3M
0.50
2.60
1.28
6M
0.70
2.70
1.30
12M
0.90
3.00
1.27
US
7
0
2000
Singapore: Deutsche Bank Forecasts
2008
2010
2012
Source: CEIC, Deutsche Bank
In addition to the risk of rising rates, Singapore could
also be subject to home-bias among investors if global
market volatility rises next year owing to taper
concerns. If asset managers indeed follow the “EM to
DM” theme, Singapore, despite being firmly in the
latter camp, could suffer as regional economies see
volatility of flows and disruption in demand. Rising
trade may lift Singapore in 2014, but it is by no means
an isolated oasis. If the year is going to be turbulent,
expect the same from Singapore.
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.
Taimur Baig, Singapore, +65 6423 8681
Page 90
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
South Korea
Aa3/A+/AAMoody’s/S&P/Fitch
„
Economic outlook: We expect a recovery in exports
to guide GDP growth higher, to 3.9%, in 2014, from
2.8% this year. However, we see a limited rebound
in domestic demand, due to heavy household debt.
9.1% fall in September, after a disappointing Q3
performance, while construction investment growth
rebounded to 16.5%, from 5.6%, amid tentative signs
of a stabilization in the housing market.
„
Main risks: Sharp increases in capital flow volatility
could prompt an FX prudential levy.
…but a subpar recovery in domestic demand due to
household debt... While a sustained rebound in exports
points to stronger facility investment, we believe it will
be limited by a subpar recovery in private consumption,
reflecting the declining propensity to consume, as
households remain burdened by debt. The fact is
Korean households are already stretched. According to
a recent household finance survey by the Korean
government, about 67% of Korean households are in
debt and highly leveraged, with their debt to disposable
income ratio (DTI) at 108% in 2013, up from 106% in
2012. Also, their debt servicing ratio (DSR) rose to
19.5% in 2013, from 17.2% in 2012, weighing on
consumption.
Cyclical upturn, but watch the details
Export-led
recovery…
Barring
an
unexpected
deterioration in the global growth outlook, we continue
to expect South Korea’s GDP growth to accelerate to
3.9% in 2014, from 2.8% in 2013. Leading indicators
(e.g. G2 PMIs) continued to point to a sustained
recovery in Korean exports ahead.
Exports to rebound, guiding overall growth higher
40
%yoy
Index
SK exports
G2 PMI (-Q1, rhs)
30
65
60
20
55
10
50
0
45
-10
40
-20
35
-30
2007
2008
2009
2010
2011
Rising debt-servicing costs for low-income households
2012
2013
30
2014
Debt Servicing Ratio
2012
2013
2nd
3rd
25
20
15
10
5
Sources: CEIC, Deutsche Bank
0
All
In response to the rebound in exports, we saw
production activities pick up, notably in October,
marking a strong start to Q4. South Korea reported a
broad-based rebound in growth in October, with overall
production rising 3.9%yoy, vs. a 1.2% fall in September.
We attribute this improvement not only to holiday
effects (dropped out of the data), but also to the
rebound in exports and domestic demand. In particular,
manufacturing production rose 3%yoy in October, from
a 4% fall in September, as exports expanded 7.3% in
October, vs. a 1.5% fall in September. More importantly,
by destination, this rebound was led by exports to the
EU, which surged 35.1% (vs. an 8.8% fall) and the US,
with a 20.4% rise (vs. a 1.6% fall).
Meanwhile, services rose 2.7% in October, up from a
0.3% fall in September, as retail sales rose 1.5% in
October, vs. a 1.7% fall in September. Equipment
investment also surged, by 14.2%, in October, vs. a
Deutsche Bank Securities Inc.
1st
4th
5th
Sources: BoK, Deutsche Bank
When divided into income groups, the second quintile
households’ DTI and DSR were the worst, at 128% and
21.5%, respectively, in 2013, with the latter rising
sharply from 16.4% in 2012, as their debt-servicing
costs rose 39% amid rising debt and installment and
mixed-type loans 25 . Also, their debt to savings ratio
stood out the worst, at 81.6%, when compared with
other income groups. Meanwhile, although the first
quintile households’ DSR was relatively low, at 17.5%
in 2013, 22% of their loans were used for living
expenses, vs. 6.5% for all households. By work status,
25
Installment and mixed-type loan shares of total loans stood at 31% and
15%, respectively, vs. bullet loan’s 38% in 2013.
Page 91
5 December 2013
EM Monthly: Diverging Markets
the DTI and DSR of self-employed households26, which
constituted about 26% of total households and used
(51% of) household loans for their working capital,
stood out the highest, at 154% and 26.3%, respectively,
vs. the regular worker households’ 88.2% and 17.2%.
Worse still, the share of households with the capacity
to repay their debt on time fell to 59.7% in 2013, from
66% in 2012, while those households without the
capacity to repay their debt rose to 8.1%, from 7%.
Loan portion by interest rate type for households
23.5%
24.1%
Linked CD rates
New COFIX
Outstanding COFIX
10.2%
Debenture
26.5%
Reasons for loans
14.0%
Fixed rate
Other
100
90
Living
80
70
Sources: BoK, Deutsche Bank
Business
60
50
Rental
40
30
20
Other real
estate
10
Own home
0
All
1st
2nd
3rd
4th
5th
Sources: BoK, Deutsche Bank
What matters more is the BoK’s monetary policy, given
that a majority of Korean household borrowing rates
are determined by the short-term funding costs of
financial institutions. Needless to say, higher rates also
pose serious risks to a fragile recovery in housing
prices, and thereby domestic demand. Korean
households hold far more real assets than financial
assets, at about 73% of the total in 2013 (78% for selfemployed households), vs. Taiwan’s 40%. The
remaining financial assets are mostly in deposits, also
suggesting a relatively high wealth impact on private
consumption. Although a sustained rise in household
debt has broadened the Korean authorities’ efforts to
include measures ranging from debt limits to
restructuring, among other things, the weakness in
housing prices has shifted their focus towards
increasing loan maturity and converting loans to fixedrate loans, from deleveraging. There are tentative signs
of recovery in housing prices, supported by the
government measures, including low cost financing for
low income families. However, much of related bills,
including tax breaks, have yet to be deliberated at the
National Assembly.
…while the BoK keeps its policy on hold until 2015…
On a positive note, we expect limited pressure on
households’ interest burden from the policy rate front,
as we see the Bank of Korea (BoK) keeping its policy
rate unchanged until 2015, at which point we expect
economic recovery is better shared among economic
agents. By the BoK’s and our own forecasts, there is
little risk to the central bank’s price stability mandate.
For 2014, we see inflation remaining well below the
target range of 2.5-3.5%, at 1.8% in 2014, while the
BoK’s forecast stands at 2.5%.
Inflation to remain below the BoK target for some time
%yoy
5
CPI inflation
Forecast
4
3
2
1
0
2009
2010
2011
2012
2013
2014
2015
Sources: CEIC, Deutsche Bank
The BoK’s policy response has consistently lagged
behind our Taylor rule model, since the global financial
crisis and we expect this to continue going forward,
especially as the BoK sees the negative output gap
persisting until 2015, while our model sees the output
gap closing in Q3 2014. Hence, with little threat to the
BoK’s inflation objectives, we see little pressure on the
BoK to hike rates, even if there is a sharp reversal of
capital flows.
26
Please refer to our report “South Korea: Self-employed and indebt”
published on 8 October 2012 for details.
Page 92
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
BoK lagged behind our Taylor rule model since 2009
%
6
Policy rate
Taylor
Taylor
5
4
3
2
1
Sharp increases in overseas loans by locals
USD bn
Foreign loans owed by locals
Overseas loans by locals
50
40
30
20
10
0
-10
-20
-30
-40
2006 2007 2008 2009 2010 2011 2012 Oct-13
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15
Sources: CEIC, Deutsche Bank
Sources: CEIC, Deutsche Bank
Note: Outflows with a negative sign
…while the Won remains at risk due to a weaker yen
and foreign investments in local securities… While
South Korea’s external balance has remained strong,
we attribute much of this “positive” to weak domestic
demand, weighed down by subpar growth in both
private consumption and investment. While the
rebound points to narrower current account surpluses,
our concerns remain mostly regarding capital flows.
Although we expect a sustained large current account
surplus next year, albeit smaller in 2014, at 4.4% of
GDP, vs. 5.7% in 2013, as domestic demand rebounds,
the Won faces risks from a sharp reversal of foreign
investments in local securities, further increases in
overseas loans and sustained overseas direct
investment (ODI) by locals.
While investment at home has remained weak, South
Korea’s ODI has remained sizable, at USD15.4bn ytd in
October, albeit down from USD19.8bn in the same
period last year, raising concerns about the country’s
growth potential ahead. Despite the government’s
efforts to liberalize and improve productivity, especially
for those services focused on exports, related bills have
been held up at the National Assembly. Meanwhile,
other investment has continued to post deficits this
year, as locals have repayed their debt and increased
their loans overseas. Locals’ external loan liabilities fell
by USD6.8bn ytd in October 2013, up from USD3.8bn
in the same period 2012, while locals’ overseas loans
rose sharply, to USD254.2bn, from USD3.1bn.
There are obvious concerns that, with the Fed’s
tapering, South Korea may see a sharp reversal of
foreign investment in local debt securities, while local
securities benefit from an improved growth outlook.
Indeed, we have observed as much in recent months,
with foreign investment in the latter falling to
USD0.5bn 3mma in October, from USD1.8bn in July,
while investments in local stock securities rose to
USD5.2bn, after falling USD1.2bn. A weaker yen,
however, poses risks to the latter.
Changing foreign investor preference in stocks vs. debt
USD bn 3mma
10
Fg invt in stocks
Fg invt in debt securities
8
6
4
2
0
-2
-4
-6
-8
2006 2007 2008 2009 2010 2011 2012 2013
Sources: CEIC and Deutsche Bank
Note: Outflows with a negative sign
…suggesting
stronger
buffer
and
prudential
measures… In this regard, there are obvious questions
about the adequacy of FX reserves when taking into
account local financial market exposure to foreign
capital and the latter’s potential impact on the Won.
While FX reserves now cover almost 300% of shortterm external debt in Q3 2013, vs. 126% in Q3 2008,
they only cover 57% of foreign investments in local
securities as of last quarter vs. 76% in Q3 2008. While
Deutsche Bank Securities Inc.
Page 93
5 December 2013
EM Monthly: Diverging Markets
South Korea’s market capitalization stood at 2.1x of its
GDP, the foreign share of its local securities stood at
around 12.5%, similar to South Africa’s 2.9x and 11.6%,
respectively; this compares with India’s 1.7x and 3.2%,
and Indonesia’s 0.6x and 5.2%.
There are various measures that the government may
adopt to reduce the growing external risks to local
financial markets. This time last year, the government
announced its decision to limit forward contracts at
foreign bank branches at 150% of their equity capital,
down from 200%, and lowered the cap on currency
derivatives’ holdings of local banks to 30%, from 40%.
Moreover, it also required financial institutions to report
a detailed breakdown of foreign capital flows by stocks,
bonds and derivatives. The BoK noted, in its recent
report, that “the existing foreign exchange macroprudential policy tools, such as the FX derivatives’
position caps and the FX macro-prudential levy will be
flexibly employed to prevent, ahead of time, excessive
in – and outflows of foreign capital.”
…while the 2014 budget awaits for approval. The
government proposal sees the budget rising by 4.6%,
to KRW357.7tr, next year, with the fastest rise in
expenditure, at 8.7%, in the areas of healthcare,
welfare and employment. Considering the potential
economic and political cost of not being passed, we
think that the budget will be passed, albeit perhaps at
the eleventh hour. If we are wrong, which we think is a
very low probability, and the National Assembly fails to
pass the budget, the government’s discretionary
expenditure, about 40% of the 2014 budget, will be
suspended, while the rest will be allowed to be carried
out with a provisional budget.
While risks to our inflation outlook are skewed to the
upside, as we assume lower oil prices next year, given
our relatively bullish view on G3 growth, risks to our
growth outlook remain to the downside. Other than
lower-than-expected G3 growth, higher oil prices, a
meaningful deterioration in geopolitical tensions in NE
Asia and domestic politics pose downside risks to our
growth outlook. In contrast, a better-than-expected
recovery in housing prices, driven by government
measures, poses upside risks to our growth outlook.
Juliana Lee, Hong Kong, +852 2203 8312
South Korea: Deutsche Bank forecasts
2012
2013F
2014F
2015F
1130
49.8
22704
1210
50.0
24193
1305
50.2
25988
1374
50.4
27291
Real GDP (YoY %)
Private consumption
Government consumption
Gross fixed investment
Exports
Imports
2.1
1.8
3.9
-1.6
3.8
2.1
2.8
1.9
2.6
3.8
4.4
3.4
3.9
2.6
1.5
4.5
8.4
7.3
3.6
2.3
2.6
3.1
7.3
6.1
Prices, money and banking
CPI (YoY %) eop
CPI (YoY %) ann avg
Broad money (M3)
Bank credit (YoY %)
1.4
2.2
8.8
5.0
1.0
1.1
9.0
4.0
2.5
1.8
9.5
6.0
2.9
2.8
8.0
5.0
Fiscal accounts (% of GDP)
Central government surplus
Government revenue
Government expenditure
Primary surplus
1.9
24.5
22.5
2.7
-0.7
23.2
23.8
0.6
-0.1
23.2
23.3
1.4
0.1
23.3
23.2
1.6
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
552.6
514.2
38.3
3.4
43.1
3.8
-18.6
327.0
1064
571.4
510.9
60.5
5.0
68.4
5.7
-11.0
347.6
1070
623.5
568.1
55.5
4.2
58.7
4.5
-14.0
359.2
1060
658.9
610.4
48.5
3.5
49.5
3.6
-12.0
360.9
1090
Debt indicators (% of GDP)
Government debt2
Domestic
External
Total external debt
in USDbn
Short-term (% of total)
36.0
35.3
0.6
36.6
413.6
30.7
36.3
35.4
0.9
34.2
415.0
28.4
36.5
35.5
1.0
30.4
400.0
27.0
34.8
33.7
1.1
28.0
385.0
25.5
1.0
3.2
1.5
3.2
5.0
3.2
4.5
3.2
Current
2.50
2.65
3M
2.50
2.65
6M
2.50
2.75
12M
2.50
2.80
3.73
1061
4.00
1090
4.00
1070
4.20
1060
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
Page 94
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Sri Lanka
B1(stable)/B+/BBMoody’s/S&P/Fitch
„
„
Economic outlook: We expect Sri Lanka to step
into 2014 with an improving growth outlook,
relatively stronger fiscal position, a lower current
account deficit, and higher FX reserves, which
ought to make it lesser vulnerable to deal with
potential external shocks next year.
Main risks: Inflation, FX and debt dynamic remain
poor, which could become an issue if financial
markets become disruptive due to Fed tapering.
Sri Lanka in 2014: Aiming for stability
We expect Sri Lanka to step into 2014 with an
improving growth outlook, relatively stronger fiscal
position, a lower current account deficit, and higher FX
reserves, which ought to make it less vulnerable to
potential external shocks next year. Despite this
seemingly improved macro-picture, there are pockets
of concern which warrant caution in our view. There is
little certainty that inflation will remain in mid-single
digits, especially with growth momentum expected to
remain strong in the coming quarters. Exchange rate
stability is also not a given, particularly against the
backdrop of expected financial market volatility due to
Fed tapering. Finally, any potential sharp depreciation
of the Sri Lankan rupee could put pressure on external
debt financing, which has increased substantially in
recent years. Overall, we remain cautiously optimistic
about Sri Lanka’s economic prospects in 2014, while
acknowledging the existence of several risks that could
potentially derail the anticipated economic recovery
and cause considerable stress. In the following pages,
we present our views of the Sri Lankan economy for
2014 in detail.
Real GDP likely to grow 7.5%yoy in 2014
Sri Lanka’s growth bottomed in 2H of 2012, and since
then economic momentum has continued to accelerate.
Sri Lanka’s real GDP grew 7.8%yoy in 3Q, marking a
sequential improvement in growth from the previous
two quarters (6.8% and 6.0%). Sri Lanka has achieved
an average growth of 6.8% in the first nine months of
2013, which is a slight improvement over the 6.4%
average growth recorded in the corresponding period
of the last year. Improvement in agriculture and
services sector growth has supported the recovery,
even as industrial sector growth has continued its
downward trend. We expect growth momentum to
improve further in the 4Q, led by services and
agriculture. We forecast real GDP growth to be 8%yoy
in 4Q, which would translate into 7.2% growth for 2013,
an improvement over last year’s outturn of 6.4%.
Deutsche Bank Securities Inc.
Output gap and real GDP growth
2.0
Output gap, lhs
Real GDP, rhs
%
% yoy
10
1.0
8
0.0
6
-1.0
4
-2.0
2
-3.0
2003
0
2004
2006
2008
2009
2011
2013
Source: CEIC, Deutsche Bank
We expect growth momentum to remain strong in the
first half of 2014, but some moderation looks likely in
the second half, as a negative base effect kicks in and
US tapering related volatility starts affecting economic
sentiment. Assuming global financial markets do not
become too disruptive, then Sri Lanka should be able
to achieve 7.5%yoy real GDP growth in 2014, and with
some luck may even hit the magic 8% number. On the
other hand, if the Fed tapering leads to prolonged
volatility, then all EM countries including Sri Lanka will
face a downward pressure on growth, in our view.
In 2014, we expect growth to be supported through a
pickup in domestic demand (consumption +
investment), while next exports is likely to subtract
more from growth, as imports start accelerating in the
next few quarters.
Contribution to growth from domestic demand
(consumption + investment) and net exports
C+I, contr. to growth, lhs
NX, contri. to growth, rhs
%
14
%
2
12
1
10
0
8
-1
6
-2
4
-3
2
-4
0
-5
2003
2005
2007
2009
2011
2013
2015
Source: CEIC, Deutsche Bank
Page 95
5 December 2013
EM Monthly: Diverging Markets
With output gap already positive, the Sri Lankan
authorities ought to be cautious about providing further
stimulus to prop up growth. In 2010 and 2011, Sri
Lanka grew at an impressive 8.0% rate, but such high
growth created severe imbalances in the economy,
which eventually led to a sharp slowdown, once the
authorities started to take remedial steps in early 2012.
We hope the same story is not repeated in the next few
years.
Modest rate hike expected next year but
likely to be back-loaded
The CBSL’s inflation fighting track record is poor. The
central bank’s inherent bias towards supporting growth,
has often led to policy errors in the past (2010-11
episode) and posed a risk to macroeconomic stability.
Swift and aggressive monetary tightening could have
prevented building up of imbalances in the past but
would have also led to a slower growth outturn, which
the authorities were not willing to accept. Overall, the
CBSL prefers to be reactive rather than be proactive in
tackling inflation, while being ready to support growth
at every possible opportunity.
This is precisely the state of monetary policy stance at
present. The CBSL unexpectedly cut the policy rate by
50bps in October to 8.50%, when in our view (as well
as the IMF’s), it would have been prudent to hold rates
steady at this stage. True, inflation pressure remains
muted for now and private sector credit growth
remains weak but growth momentum has already
started picking up, and FX pass-through risks can push
up inflation in the next year. Easing monetary policy, at
a time when growth momentum is set to pick up and
inflation is close to bottoming out, indicates the
inherent dovish bias of the CBSL, and raises
overheating risks in the subsequent years.
Inflation and reverse repo forecast
CPI inflation, lhs
Forecast
Reverse Repo, rhs
Forecast
%yoy
12
10
%
12
11
8
6
The 2014 Budget was presented last month by the
Rajapaksa Government, which aims to reduce the fiscal
deficit further to 5.2% of GDP, from an estimated 5.8%
of GDP in 2013. Over the last few years, the Sri Lankan
authorities have shown tremendous resolve in
contininuing with the fiscal consolidation effort, despite
a slowdown in the economy since 2012 and persistent
unsupportive and hostile external environment. Since
2009, the fiscal and primary deficits have been cut by
4% and 2.7% points respectively, a significant
achievement. Going forward, the authorities aim to
reduce the budget deficit further to 4.5% of GDP in
2015 and to 3.8% of GDP by 2016. Along with the
improvement in the fiscal position, the goal is to reduce
the debt-GDP ratio to 65% of GDP, from about 78%
currently.
The fiscal consolidation agenda is critical and needs to
endure, in our view, given that Sri Lanka’s fiscal
position is still weak when compared to the other Asian
economies in the region. Despite the recent
improvement, Sri Lanka’s budget deficit (and
debt/GDP) remains considerably higher than its
regional peers, led by lower than average revenue
collection and higher than average expenditure.
2013 budget deficit – cross country comparison
% GDP
0
-1
-2
-3
-4
-5
-6
-7
Budget Balance
9
2
Source: CEIC, various national sources, Deutsche Bank
8
2010
2011
2012
2013
2014
2015
Source: CEIC, Deutsche Bank
The CBSL will likely hike rates by 50-100bps starting
from 3Q of next year, but no more than that, as the
central bank’s priority would be to achieve 7.5-8%
Page 96
Fiscal consolidation continues, with
greater focus on revenue mobilization
10
4
0
2009
growth in 2014 (DB estimate 7.5%). Our baseline
forecast (does not factor in supply shocks) shows that
inflation will average 7.0% in 2014, but likely to rise to
8.0-8.5% by end-December 2014.
The recent improvement in the fiscal position has been
driven solely by expenditure compression, while
revenue/GDP ratio has continued its downward trend.
This trend has continued in 2013 as well, with
revenue/GDP ratio being almost 1%point lower than
the budget estimate (13.8% of GDP vs. 14.7% of GDP)
and about 30bps lower than the 2012 outturn. To
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
achieve the 2013 budget deficit target, the authorities
have therefore been compelled to cut expenditure more
than had been initially planned in the budget (see table
below).
2013 fiscal position – budget vs. revised estimate
% of GDP
2013BE
2013RE
Difference
Total revenue and grants
14.1
14.7
13.8
-0.9
Total expenditure
20.5
20.5
19.7
-0.9
14.9
14.6
14.1
-0.5
Recurrent
Capital and net lending
Budget deficit
2012
5.6
6.0
5.6
-0.4
-6.4
-5.8
-5.8
0.0
2014 fiscal forecast – government vs. Deutsche Bank
Source: Department of Fiscal Policy, Deutsche Bank
The 2014 budget has tried to address the problem of
falling revenue/GDP ratio by increasing tax rates as well
as the tax base. A 2% Nation Building Tax has been
imposed on banks and financial institutions (aviation
services have been exempted), telecommunication levy
has been raised to 25% from 20%, and application of
VAT in supermarket and trade has been strengthened
to augment revenues. The cumulative effort is expected
to generate additional tax revenue of LKR41.4bn or
0.4% of GDP.
New revenue proposals to broaden the tax base in 2014
LKRbn
1. Extension of NBT to banking and financial institutions
3.7
2. Strengthening the application of Value Added Tax at
supermarket and trade scale (Quarterly turnover of LKR
250mn and exemption limited to 25% of turnover)
15.0
3. Telecommunication Levy to be fixed at 25%
4.0
4. Revision in depreciation of motor vehicle for Customs Duty
2.0
5. Revision in CESS on Primary Commodity Exports and items
vulnerable to undervaluation to ensure domestic value chain
4.0
6. Revision in Special Commodity Levy / Customs Duty for
the support of local value addition
12.8
Total
41.4
Source: Department of Fiscal Policy, Deutsche Bank
The other key measures that have been announced in
the budget include:
„
„
„
„
„
Hike in cost of living allowance for public sector
employees and pensioners;
New monthly pension scheme for farmers over 63
years of age;
Interest free loan for women entrepreneurs;
Appropriate laws to be put in place to prevent
outright purchase of land in Sri Lanka by foreigners
effective from 2014;
Increase in public sector spending related to
community water projects, public transportation,
education and health in rural areas.
Deutsche Bank Securities Inc.
The authorities want to reduce the fiscal deficit to 5.2%
of GDP in 2014, by raising revenues by 1% of GDP
(14.8% of GDP in 2014 vs. 13.8% of GDP in 2013),
which is likely to offset the modest increase in
expenditure (20% vs. 19.7%). The increase in
expenditure is likely to occur on account of a bigger
push toward capital expenditure (6.6% vs. 5.6%),
mainly in areas of infrastructure development (6.0% vs.
5.2%), even as recurrent expenditure is reduced further
to 13.4% of GDP, from an estimated 14.1% of GDP in
2013.
% of GDP
2012
2013RE
2014
Budget
2014DB
forecast
Total revenue and grants
14.1
13.8
14.8
14.0
Total expenditure
20.5
19.7
20.0
19.5
14.9
14.1
13.4
13.5
5.6
5.6
6.6
6.0
-6.4
-5.8
-5.2
-5.5
Recurrent
Capital and net lending
Budget deficit
Source: Department of Fiscal Policy, Deutsche Bank
In our view, the revenue side assumptions are overly
optimistic (even after considering the new tax
measures), just as it was in the previous year. Revenue
collection needs to grow 22%yoy in 2014, to increase
revenue/GDP ratio by 1% point from the previous year.
In the last four years (2009-2013), the average yoy
growth in revenue has been only 13.5%. Expenditure
side assumptions, on the other hand look overstated,
especially on the capital expenditure side, where the
authorities are expecting a 35%yoy increase in 2014,
compared to an average expansion of 11%yoy in the
past four years.
Overall, we expect slippages on the revenue front
compared to the budget estimate (14.0% of GDP vs.
14.8% of GDP), but the revenue/GDP ratio could
possibly be slightly higher in 2014 than 2013 (14.0% vs.
13.8%), given the new tax measures. To meet the
budget deficit target, we expect the government to cut
expenditure, mainly capital expenditure, yet again. In
2012 and 2013, despite higher allocation for capital
expenditure, the actual amount spent was only 5.6% of
GDP. In 2014, we expect the government to eventually
spend less on capital expenditure than has been
assumed in the budget (6% of GDP vs. 6.6% of GDP),
which will likely help to contain the fiscal deficit at
5.5% of GDP.
It is heartening to see the government focusing on
revenue-enhancing measures, rather than depending
solely on expenditure compression to reduce the
budget deficit, as it will be difficult to sustain a deficit
below 5% of GDP, unless revenue/GDP ratio increases
to 15-16% range.
Page 97
5 December 2013
EM Monthly: Diverging Markets
BOP and rupee - not out of the woods yet
Sri Lanka: Deutsche Bank Forecasts
2012
2013F
2014F
2015F
The demand management policies initiated in early
2012 have helped to reduce pressure on Sri Lanka’s
trade and current account deficit. CAD is expected to
narrow to 4.1% of GDP in 2013 (and further to 3.1% in
2014), led by a lower trade deficit and robust invisibles
but the external position still warrants caution, in our
view. Despite expectations of a lower CAD next year
(USD2.3bn), financing could come under pressure if
FDI flows, which help finance bulk of the CAD, turns
out to be lower than expected. Most of the pipeline FDI
is tied with developments in the hotel and tourism
sector, which is seen as one of the key drivers of
growth. However such FDI is generally lumpy in nature
and takes time to materialize, leading to large swings in
the capital account position. If FDI flows disappoint
next year (we estimate at least USD1bn in 2014), the
BOP and exchange rate will remain under pressure.
Potential volatility in global financial markets (related to
the Fed-tapering) could complicate matters further.
National Income
Nominal GDP (USD bn)
Population (mn)
GDP per capita (USD)
59.0
21.1
2799
66.8
21.3
3136
75.9
21.5
3530
88.0
21.7
4051
Real GDP (YoY %)
Total consumption
Total investment
Private
Government
Exports
Imports
6.4
5.6
9.1
10.0
6.0
-7.0
-2.5
7.2
6.2
10.4
11.0
8.0
9.5
9.0
7.5
6.8
11.2
12.0
8.0
9.5
10.0
7.5
6.8
12.0
13.0
8.0
10.0
11.0
Prices, Money and Banking
CPI (YoY%) eop
CPI (YoY%) avg
Broad money (M2b) eop
Bank credit (YoY%) eop
9.2
7.6
17.6
17.6
5.0
7.0
16.3
10.5
8.6
7.0
15.8
15.5
7.0
7.4
17.5
20.0
Fiscal Accounts (% of GDP)
Central government balance
Government revenue
Government expenditure
Primary balance
-6.4
13.2
19.7
-1.1
-5.8
13.8
19.7
-0.7
-5.5
14.0
19.5
-1.1
-5.0
14.2
19.2
-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
9.8
19.2
-9.4
-15.9
-3.9
-6.6
0.8
6.9
127.7
10.1
19.2
-9.1
-13.7
-2.7
-4.1
1.0
7.5
131.0
10.8
20.7
-9.9
-13.1
-2.3
-3.1
1.0
8.5
130.0
11.8
22.8
-11.0
-12.5
-2.4
-2.7
1.5
9.5
128.0
Debt Indicators (% of GDP)
Government debt
Domestic
External
Total external debt
in USD bn
Short-term (% of total)
79.1
42.6
36.5
48.2
28.4
17.0
78.0
41.8
36.3
46.9
31.3
18.6
75.7
40.1
35.6
45.3
34.4
18.6
72.5
38.1
34.5
43.4
37.9
19.4
6.0
4.2
7.5
4.1
8.0
4.0
8.5
4.0
Current
8.50
3M
8.50
6M
8.50
12M
9.00
130.9
130.5
130.5
130.0
The other source of concern is the rapid increase in
short-term external debt. At end-December 2012, Sri
Lanka’s external debt was USD28.4bn, a 103%
increase from pre-crisis 2007 levels. The short term
component of the external debt has risen more rapidly,
touching USD4.8bn by end-Dec 2012 (70.3% of gross
official reserves), from USD1.1bn in 2007 (+335%).
Combination of a large current account deficit and
rising ST external debt makes the economy vulnerable
to any potential external shock, which could eventually
pose a risk for financial system stability.
Reserve adequacy. Sri Lanka’s import cover has
improved from last year (gross official reserves can
now cover about 4.5 months’ of imports, higher than
the threshold 3 months’ of imports criteria considered
as safe by the IMF), but the reserve adequacy position
looks significantly weaker once the short term external
debt is taken into consideration. Sri Lanka’s reserves
cover to ST external debt + current account deficit has
worsened significantly in recent years, with the ratio
falling below 100% (considered as a safe threshold)
since 2011 onward.
FX outlook. Year to date, the Sri Lankan rupee has
depreciated by 2.7%. While we are not factoring in a
trend depreciation of the exchange rate next year
(given our baseline forecast of a narrowing CAD and
stable inflow assumptions), we expect depreciation
pressure intermittently, led by US tapering related
uncertainty. Given the experience of 2011-12, we do
not expect the central bank to intervene actively in the
FX market, but we do expect the authorities to step in
from time to time to smoothen out volatility.
General
Industrial production (YoY %)
Unemployment (%)
Financial Markets
Reverse Repo rate
LKR/USD
Source: CEIC, DB Global Markets Research, National Sources
Kaushik Das, Mumbai, +91 22 7158 4909
Page 98
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Taiwan
Aa3/AA-/A+
Moody’s/S&P/Fitch
„
„
Economic outlook: We see a two-legged growth
recovery ahead, from 1.8% in 2012 to 3.5% in 2014,
as stronger exports push up domestic demand.
Main risks: External shocks pose the greatest risks
for an export-driven economy like Taiwan.
Finally, tailwinds ahead
TW exports
G2 PMI (-Q1, rhs)
Index
55
50
45
40
35
2011
2012
2013
30
2014
Sources: CEIC, Deutsche Bank
…supporting a recovery in domestic demand… Given
its heavy dependence on exports (share of GDP at 74%),
Taiwan’s beta (the elasticity of its GDP growth to G2
GDP growth) remains high at around 1.7 (in 2003present). As exports recover, a reduction in
uncertainties and improved income should support
stronger investment and private consumption ahead.
We expect rising asset prices in turn to provide
additional support to the latter.
Deutsche Bank Securities Inc.
1.5
0.5
0.0
SG TW HK TH MY KR PH SRL CN
IN
ID
Sources: CEIC, Deutsche Bank
65
60
2010
Growth beta (2003-present)
We also expect stronger construction investment, led
by residential housing. In particular, the index for floor
area permitted for building construction rose sharply,
while prices continued to rise in the double digits.
GDP recovery led by exports
2009
2.0
1.0
GDP growth to rebound, led by exports… We see
Taiwan’s GDP growth accelerating to 3.5% in 2014,
from 1.8% this year, led recovery in exports. Indeed,
this year’s growth has disappointed, with weak export
and uncertainties limiting private consumption growth.
However, with G2 growth as the driver of Taiwanese
exports, G2 PMIs point to a relatively sharp rebound in
Taiwanese exports ahead, in our view.
%yoy
60
50
40
30
20
10
0
-10
-20
-30
-40
-50
2007 2008
Taiwan’s historical beta
Rising housing prices and permits for construction
Construction
%yoy
%yoy
Sinyi residential property price index
30
160
Floor area permitted for bldg (rhs)
120
20
80
10
40
0
0
-10
-20
2008
-40
-80
2009
2010
2011
2012
2013
Sources: CEIC, Deutsche Bank
The sustained rise in confidence in housing – the
current price confidence score rose further in Q2 to
139.6, its highest level on record (data started in 2003),
vs. 136.6 in Q1 – points to a continued increase in
housing prices, barring more aggressive prudential
measures. This in turn points to additional support for
private consumption, due to the positive wealth
impact. Note that real estate and household equipment
together constituted about 41% of total household
assets in 2010; the figure for portfolio assets stood at
about 20%. As for the rest, about 12% of households’
assets are in cash/demand deposits; 15% in both
time/fx deposits and life insurance/pension reserves;
and 9% in net foreign assets. Private consumption
Page 99
5 December 2013
EM Monthly: Diverging Markets
may gain further support with recovery in their financial
assets. The historical relationship between Taiwan’s
growth and the TWSE suggests stronger GDP growth
in the quarter ahead.
TWSE points to recovery ahead
%yoy
%yoy
GDP
15
TWSE (-1Q, rhs)
80
60
10
40
5
20
0
0
-20
-5
-40
-10
2002
2004
2006
2008
2010
-60
2014
2012
Sources: CEIC, Deutsche Bank
…although long-term competitiveness is challenged…
While we expect a cyclical upturn ahead, there are
obvious concerns about Taiwan’s competitiveness in
the long run as it lags far behind its peers in free trade
agreements, despite its recent agreement with
Singapore. Unlike countries such as South Korea,
Taiwan does not have bilateral FTAs with its key
trading partners like the US and the EU.
High foreign and services content in total exports
Other services content of total exports
Services industry share of total exports
Domestic content of total exports (rhs)
100%
100%
0%
0%
…while overseas investments rise… Meanwhile,
Taiwanese firms continued to look outward for
investments. Taiwan’s overseas direct investments (ODI)
continued to rise, despite the government’s efforts to
attract them back home, to USD10.8bn in ytd September
2013 vs. USD9.7bn in the same period last year.
Capital outflows countering current account surpluses
Financial Account
USD bn
USD bn
Current Account
25
25
Chg in Reserve (rhs)
20
20
15
15
10
10
5
5
0
0
-5
-5
-10
-10
-15
-20
-15
2006 2007 2008 2009 2010 2011 2012 2013
Sources: CEIC, Deutsche Bank
Although Taiwan runs large CA surpluses, their impact on
its overall external balance remains limited due to
continued capital outflows led by locals. Moreover, while
we expect continued large current account surpluses in
the year ahead, we see this narrowing as domestic
demand rebounds. Meanwhile, higher-than-expected oil
prices pose risks to our trade balance forecast, with
mineral fuel oils and distillation products constituting
about 26% of imports. Excluding the oil trade balance,
Taiwan’s goods trade balance has been much higher,
at 13.2% of GDP in the past ten years (instead of 5.7%
of GDP).
VN
20%
CH
20%
TH
40%
MA
40%
TW
60%
SK
60%
JN
80%
US
80%
for details. Indeed, with the foreign and services
(including those embedded in goods exports) share of
total exports at about 40%, such a comprehensive
trade agreement is critical for Taiwan. At the same time,
China’s push for higher value added production pose
risks to Taiwan and South Korea alike.
Sources: OECD, Deutsche Bank
Although we assume that Taiwan, as an APEC member,
will be included in the Free Trade Area of the Asia
Pacific (FTAAP), it is not part of the Trans Pacific
Partnership (TPP) or ASEAN+3 agreements. Taiwan’s
gains from the FTAAP range from about 4% to 10% of
baseline GDP in 2025, if achieved through ASEAN+3 or
TPP, respectively. Please see our report titled “Toward
free trade across the Pacific”, published on 4 October,
Page 100
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Inflation to remain low
TWSE and TWD correlation rose
NTD/USD (lhs)
35.5
4,000
TWSE
34.5
5,000
33.5
6,000
32.5
31.5
7,000
30.5
8,000
29.5
9,000
28.5
2008
2009
2010
2011
2012
%yoy
4
CPI inflation
Forecast
3
2
1
0
-1
-2
-3
2009
2010
2011
2012
2013
2014
2015
2013
Sources: CEIC, Deutsche Bank
Sources: CEIC, Deutsche Bank
…but the TWD remains relatively well protected… At
the same time, the authorities remain concerned about
the potential negative impact of foreign capital volatility on
local financial market stability and the TWD. The TWD’s
correlation to the TWSE has increased notably since Q3.
However, as a net creditor to the world, we remain
sanguine about the potential impact of the Fed’s tapering
on the TWD, which remains less volatile than its Korean
counterpart. As of end-September 2013, its foreign
external liabilities stood at USD492.6bn (with portfolio
liabilities at USD234.1bn), vs. its assets of USD1294.3bn
(USD391bn).
…with no changes to the CBC rate, with risks to the
downside. Despite disappointing growth and low
inflation, vs. the government’s initial (January 2013)
2013 forecasts of 3.5% and 1.3%, respectively, the
Central Bank of China kept its policy rate unchanged.
Inflation continued to surprise to the downside this
year, averaging 0.8% ytd in October, vs. 1.9% in the
same period last year, largely due to lower food price
inflation. While we expect this to normalize next year, a
relatively benign outlook for other commodity goods
(for example, we expect oil prices to be at least 10%
lower), point to another year of low inflation in 2014,
averaging 0.9%, vs. 0.8% this year, while the CBC sees
it rising modestly higher to 1.2%.
International investment: Enough FX reserves
Taylor rule model points to lower CBC rates
Assets: equities
Assets: bonds/notes
Assets: reserves
Total liabilities
Assets
USD bn
1,400
1,200
1,000
800
%
5
Policy rate
Forecast
Taylor
4
600
3
400
200
2
0
2000
2002
2004
2006
2008
2010
2012
Sources: CEIC, Deutsche Bank
1
0
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15
At the same time, amid sustained pressure on the TWD,
to prevent hot money inflows in particular, the Central
Bank of China (CBC) carried out random inspections of
TWD holdings of foreign investors. It noted that it has
been reviewing TWD accounts held by foreigners on a
daily basis to prevent speculation on the local currency.
According to the CBC, foreign trading of TWD accounts
for 36% of interbank trading. Last year, it asked banks to
start providing proof of demand before embarking on FX
transactions.
Deutsche Bank Securities Inc.
Sources: CEIC, Deutsche Bank
Given such a benign inflation outlook, we see the CBC
not hiking rates until 2015, in line with the Fed’s rate
hikes. This is consistent with our Taylor rule model and
we see little reason for Taiwan to rush to hike rates
earlier, especially given its highly leveraged private
sector. In fact, given the government’s downward
revision to next year’s growth forecast, to 2.6% from
3.4% in the last quarterly review, we see risks to rates
tilted to the downside in the near term. Indeed, our
Page 101
5 December 2013
EM Monthly: Diverging Markets
Taylor rule model suggests that the CBC’s monetary
policy rate could be at least 25bps lower until 2015.
While risks to our inflation outlook are tilted to the
upside as we assume lower oil prices next year, risks to
our growth forecasts remain to the downside given our
relatively bullish view on G3 growth. Other than lowerthan-expected G3 growth, higher oil prices, a
meaningful deterioration in the geopolitical situation in
NE Asia, and domestic politics pose downside risks to
growth.
Juliana Lee, Hong Kong, +852 2203 8312
Taiwan: Deutsche Bank forecasts
2012
2013F
2014F
2015F
475.2
23.3
20421
493.2
23.3
21133
511.5
23.4
21889
529.2
23.5
22519
Real GDP (yoy %)
Private consumption
Government consumption
Gross fixed investment
Exports
Imports
1.3
1.5
0.5
-4.2
0.1
-2.1
1.8
1.4
0.2
3.4
3.2
3.4
3.5
2.2
0.2
4.1
7.2
7.1
3.4
1.9
0.3
2.8
6.7
5.6
Prices, money and banking
CPI (yoy %) eop
CPI (yoy %) annual average
Broad money (M2)
Bank credit1 (yoy %)
1.6
1.9
4.2
3.3
0.4
0.8
5.0
2.5
0.9
0.9
6.0
3.5
1.6
1.2
6.5
4.0
Fiscal accounts (% of GDP)
Budget surplus
Government revenue
Government expenditure
Primary surplus
-2.8
16.4
19.3
-1.0
-3.0
16.4
19.4
-1.1
-2.0
16.7
18.7
0.2
-1.1
17.1
18.2
1.2
External accounts (USDbn)
Merchandise exports
Merchandise imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI (net)
FX reserves (USD bn)
FX rate (eop) TWD/USD
300.4
268.8
31.6
6.7
50.7
10.7
-9.8
403.2
29.2
302.7
268.3
34.4
7.0
53.2
10.8
-12.0
421.5
29.5
323.8
291.8
31.9
6.2
48.0
9.4
-13.0
430.2
29.2
343.6
312.5
31.0
5.9
42.8
8.1
-15.0
429.7
29.6
Debt indicators (% of GDP)
Government debt2
Domestic
External
Total external debt
in USDbn
Short-term (% of total)
45.8
43.9
1.9
27.7
130.8
89.1
47.8
45.9
1.9
28.6
140.0
89.3
48.1
46.2
1.9
27.6
140.0
89.3
47.6
45.6
2.0
26.6
140.0
85.7
0.0
4.2
0.8
4.2
3.8
4.1
3.5
4.1
Current
1.88
0.82
1.71
29.6
3M
1.88
0.82
1.90
29.6
6M
1.88
0.84
1.90
29.4
12M
1.88
0.88
2.00
29.2
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
Page 102
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Thailand
Baa1/BBB+/BBB+
Moody’s/S&P/Fitch
„
Economic outlook: GDP growth, already weak, will
slow further in the near term due to weak
consumption, investment, trade, and political
uncertainty, but an external-sector led recovery is
likely owing to ongoing pick-up in partner country
demand. Having faced numerous shocks in recent
years, the Thai economy has developed a
remarkable degree of resilience that could pave the
way for a quick bounce-back next year.
„
Main risks: Rising global rates could adversely
impact capital flows and the exchange rate; rising
local
rates
could
stretch
heavily-indebted
households and could in turn cause bad loans to
rise; political turbulence could continue into the
new year, hurting tourism and production.
This too shall pass
Thailand has experienced a remarkable fall from grace
over the past year. It entered 2013 with considerable
momentum, characterized by strong consumption and
investment, buoyant capital inflows, an export sector
on the cusp of bottoming out, and a government
making ambitious plans to enhance infrastructure and
improve productivity. Markets were confident and
climbing almost relentlessly, giving rise to concerns
about bubbles. Authorities were concerned about
managing inflows and preventing over-appreciation of
the exchange rate.
Unfortunately the economy is stepping into 2014 with a
series of slippages. Growth has slowed sharply as
various supportive measures from 2012 have expired,
exports have yet to show signs of strength, and
consumers appear fatigued with debt despite low
interest rates. Private investment confidence has been
hurt by political unrest, while public investment has
suffered setbacks as the ambitious infrastructure
investment plan has been challenged and delayed
repeatedly. Consequently, asset prices and the
exchange rate have come under considerable pressure.
Before delving into the challenges in 2014 and beyond,
we first highlight four key traits of the Thai economy
that should encourage investors in taking a
constructive view over the medium term. The title of
our piece, “This too shall pass,” underscores the point
that while Thailand looks unappealing at the present
juncture, a year from now it could well be displaying
considerable upward momentum.
Deutsche Bank Securities Inc.
Strong manufacturing and exports sector
Thailand has one of the strongest manufacturing bases
in EM Asia. Amounting to nearly a third of GDP,
manufacturing has broadened the base of economic
growth in Thailand over the years. Indeed, in terms of
aggregate manufacturing output, Thailand ranks
number 17 in the world. Its key strengths are
automotive, electronics, and IT products, with the
economy moving long past manufacturing low-end
value-added products. Reputed to have one the most
competitive manufacturing bases in the region, the
sector has drawn substantial foreign direct investment
in recent decades, particularly from Japan, which
typically accounts for a third of total FDI to the country.
While
manufacturing
provides
for
domestic
consumption, as well as income and employment
generation, its key contribution is the support provided
to the external sector, making up about 80% of total
exports. Thailand’s markets are wide ranging, with its
goods going principally to industrialized economies and
the ASEAN region. Thai manufacturing’s role in ASEAN
is critical, as the region is expected to generate
substantial demand for autos, parts, machinery, and IT
products in the coming decades. With its track record
of efficiency, sound infrastructure, skilled work force,
built-in capacity, and pipeline investment from Japan,
Thailand can ride ASEAN’s demand successfully
through the rest of the decade and beyond.
Regional linkages
Thailand is geographically situated next to a number of
frontier economies beginning to open up, which puts it
in an advantageous position with respect to market
access. The emergence and opening up of Myanmar,
Lao, and Cambodia will allow Thai businesses to
capture first-mover advantage in numerous projects,
leveraging cultural familiarity and geographical
proximity. Thailand also stands to gain considerably
from trade, tapping into ample commodities available
right next door, and finding a new and large group of
aspirational consumers to purchase its products.
Another advantage of having relatively lower income
neighbors is that as Thailand rises up the income
ladder, it will still have a pipeline of low cost laborers
from those economies. Indeed, this phenomenon is
already visible in the service sector, where despite a
strong baht and a series of minimum wage hikes in
recent years, prices have remained broadly stable. As
long as the social ramification of immigration is
contained, Thailand will continue to have the best of
both worlds, rising income for its population, and cost
competitiveness from cheap foreign labor.
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5 December 2013
EM Monthly: Diverging Markets
Tourism
Blessed with numerous attractions, tourism in Thailand
is a multi-billion dollar business, accounting for nearly
7% of the economy, generating considerable income
and employment. Despite periodic natural disasters
and political upheaval, attraction of Thailand has not
waned; in fact the tourism sector has gone from
strength to strength. Until the latest political
conflagration, 2013 was turning out to be a banner
year for tourism, with visitor arrival up 21%yoy.
Averaging over the last five years, which contain a
number of disruptions, tourism arrival has risen by 11%
per annum.
Overall resiliency
Later in this piece we will discuss the below-par
growth performance of recent years, but that
phenomenon must be seen in the context of Thailand’s
idiosyncrasies. In recent years it has been hit by
numerous shocks; the 2008/09 global financial crisis
affected exports, repeated political upheaval have
dampened confidence, the 2011 tsunami hurt the auto
sector due to its extensive linkage with Japan, and the
worst flood in half a century affected the country in
2H11. Despite these shocks and constraints, the
economy has bounced back repeatedly. Investor and
tourists have returned the moment the situation
stabilized, income and consumption have been
disrupted only temporarily, and perception about the
economy’s productive capacity has not been dented.
Today’s headlines, as bad as they read, should be seen
in this context.
Structural and cyclical stress points
As enthusiastic as the above discussion may be, there
is no denying that the Thai economy has lost its luster,
and has gone from being the darling of the investor
community just a year ago to taking the top spot in risk
rankings. While we have little to say about the ongoing
political situation and will not speculate about the
timing or likelihood of a resolution, there is plenty more
to consider beyond that issue.
Weak growth performance
It is tempting to think of Thailand as one of the Tiger
economies with strong, export-linked growth, but the
fact of the matter is since the global financial crisis
Thailand’s growth performance has lagged its peers.
Normalizing the real GDP of Thailand to 100 in 2006,
and comparing it with the performance of Malaysia,
Indonesia, and the Philippines, it is seen that Thailand’s
path has been far weaker than the path of those three.
Indeed, the Thai economy, at the end of 2012, was
20% larger than where it was in 2006, whereas its
regional peers have grown, on average, by 35% during
the same period.
Page 104
The economy has lagged its peers since the global
financial crisis
Real GDP,
log scale,
2006=100
Thailand
Indonesia
Philippines
Thailand
103
102
101
100
99
98
2006
2007
2008
2009
2010
2011
2012
Source: CEIC, Deutsche Bank
Noting that in the decade before 2007, growth was
almost identical among these peers (about 5% on
average), the question then becomes what has caused
this underperformance. In a recent report, the IMF
argues that Thailand may have been too quick in
withdrawing fiscal support in 2010 (while economic
recovery was still nascent). We think that despite its
impressive capacity to bounce-back, political turmoil
and natural disasters were bigger factors in driving the
underperformance. As noted earlier, 2011 was marked
by natural disaster-related external and domestic
shocks. Earlier, a second fiscal stimulus was on the
cards in 2010, aimed at infrastructure development, but
it had to be shelved due to political turmoil.
Another factor that may explain the slowdown is the
emergence of a middle income trap. With per capita
income exceeding in USD6000 in current dollars (or
$9500 in purchasing power parity terms), unless
Thailand reinvigorates its economy with a sustained
push toward higher productivity and stronger engines
of growth, it may well run the risk of stagnating. We
look at several metrics that may perpetuate this
stagnation later in the piece.
Poor growth supportive strategy
The authorities rightly used deficit spending to support
the economy in the aftermath of the global financial
crisis and the 2011 floods, but quality of the spending
is highly questionable. Instead of focusing on
enhancing infrastructure and productivity, the
authorities designed programs aimed at boosting
incomes and consumption temporarily. Unsurprisingly,
when those measures and schemes expired, little
lasting impact remained.
In addition to one-off measures like the first car rebate,
the authorities have pushed through a costly rice
pledging scheme and raised the minimum wage by 3080% (depending on the region) in recent years, all of
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
which have helped temporarily, but done little to
change the investment climate. If achieving sustainable
growth is the key objective, the government’s flagship
measures, substantial both in terms of financial and
political costs, have not succeeded.
Short term external debt, on residual maturity basis, is
a substantial chunk of the external debt stock
%
45.0
40.0
Debt worries
USD62bn
35.0
Additional cost of such measures has shown up in debt
statistics, both private and public. Encouraged by a
financial sector enjoying ample liquidity and record-low
interest rates, Thailand’s household debt has risen by
45% since the global financial crisis to nearly 80% of
GDP, the sharpest rise in the region. This may explain
why consumers seen uninterested to borrow more, and
underscores the risk in the period ahead when rates
will begin to rise.
30.0
USD172bn
25.0
USD31bn
20.0
15.0
USD55bn
10.0
5.0
0.0
India
Indonesia
Malaysia
Thailand
Source: CEIC, Deutsche Bank
Thailand’s household debt has risen sharply compared
to peers
% of GDP
2007
2013
Steady rise in public sector debt
% of GDP
90
46.0
80
44.0
70
42.0
60
50
40.0
40
38.0
30
20
36.0
10
34.0
0
Indonesia
Malaysia
Philippines
Thailand
32.0
2007
2008
2009
2010
2011
2012
2013
Source: CEIC, Deutsche Bank
Source: CEIC, Deutsche Bank
There is also considerable exposure to external debt.
The next chart shows that Thailand has USD62bn in
refinancing needs next year, which is about 45% of
total external debt stock. While refinancing risks should
not be substantial, there is a chance that taper-related
volatility becomes disruptive, causing at least some
temporary instances of credit crunch or spikes in
financing costs. With its current account in deficit
territory presently, with only a modest upside ahead,
Thailand’s gross external financing requirement is
substantial in the coming year.
Beyond private sector debt, public sector debt has
been rising steadily in recent years, reflecting large
fiscal deficits (which have ranged from 2 to 3% of GDP
even after adjusted for the cycle). Revenue effort has
been weak, with the lowest VAT rate in the region. On
the spending side, there has been a sizeable rise in
recent years, with an added accumulation of
contingent liabilities and a growing inclination to use
off-budget avenues of spending.
Deutsche Bank Securities Inc.
Fiscal missteps
In fact, one can find the genesis of the ongoing political
crisis in the fiscal missteps of this year. Opposition to
the government’s plan to implement a multi-year, offbudget, BHT2trln (about 25% of 2013 GDP)
infrastructure program has been considerable. Many
see this program as non-transparent and likely to
facilitate
contractors
supporting
the
current
administration. While the legislation related to the
program has cleared, it will almost certainly be
challenged in the Constitutional Court. While the
government has said that some of the projects under
the program will go ahead even if the matter remains
unresolved, doubts have risen about the feasibility of
such projects going ahead.
Page 105
5 December 2013
EM Monthly: Diverging Markets
Additional complication has come from the opposition
to the rice pledging scheme and concerns about its
costs. The government is in a bind; on one hand any
attempts to cut the rice pledge price is being met with
opposition from the farmers, while on the other hand
the continuation of the program into 2014 is raising
worries about the magnitude of loss from the program.
We estimate that the total loss in the program could
reach THB350bn (1.5% of GDP per year for three years).
Concluding thoughts
We have flagged Thailand’s positive potential and
negative near-term risks in this piece. It will be difficult
to have smooth sailing in 2014, especially if global
markets enter another period of volatility. We do
however think that an export-led recovery is no more
than a quarter away and just three quarters from now
growth will be strong enough for BoT to begin
normalizing interest rates (see attached table for
detailed forecasts). One big concern is the readiness of
Thai households and corporates to higher interest rates.
Long-term real rates have been rising
%
8.0
Indonesia
Malaysia
Philippines
Thailand
6.0
4.0
2.0
0.0
-2.0
-4.0
-6.0
2007
2008
2009
2010
2011
2012
Thailand: Deutsche Bank Forecasts
2012
2013F
370.5
64.5
5749
372.3
64.8
5748
404.2
65.1
6209
421.8
65.4
6447
Real GDP (yoy %)
Private consumption
Government consumption
Gross fixed investment
Exports
Imports
6.5
6.7
7.5
13.2
3.1
6.3
3.0
1.0
6.1
-0.4
3.8
2.2
4.2
3.0
2.8
3.4
4.0
6.2
5.0
4.8
3.0
7.4
11.4
12.8
Prices, Money and Banking
CPI (yoy %) eop
CPI (yoy %) ann avg
Core CPI (yoy %) ann avg
Broad money
Bank credit1 (yoy %)
3.6
3.0
2.1
10.0
14.2
1.7
2.2
1.0
9.0
10.0
2.6
3.2
1.6
9.0
9.0
3.0
2.4
1.4
9.5
10.0
Fiscal Accounts2 (% of GDP)
Central government surplus
Government revenue
Government expenditure
Primary surplus
-3.5
19.2
22.7
-3.6
-3.0
18.8
21.8
-3.1
-3.2
19.0
22.2
-1.9
-3.3
19.0
22.3
-2.0
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
225.9
219.9
6.0
1.6
0.2
0.0
-2.0
181.6
30.7
229.0
224.0
4.9
1.3
-0.9
-0.3
-3.0
184.7
32.0
251.4
246.7
4.7
1.2
0.9
0.2
-3.0
188.5
31.5
276.8
277.4
-0.6
-0.1
-2.6
-0.6
2.8
190.9
32.0
Debt Indicators (% of GDP)
Government debt2,3
Domestic
External
Total external debt
in USDbn
Short-term (% of total)
43.7
41.5
2.2
35.3
130.7
44.5
45.5
43.6
1.9
36.3
135.0
45.0
46.0
45.0
1.0
34.6
140.0
45.0
46.5
45.5
1.0
34.4
145.0
45.5
2.5
0.8
2.6
0.8
5.0
0.7
5.0
1.0
Current
2.25
2.40
4.17
32.0
3M
2.00
2.30
4.30
32.3
6M
2.00
2.25
4.40
32.4
12M
3.00
3.25
4.50
31.5
National Income
Nominal GDP (USDbn)
Population (m)
GDP per capita (USD)
2014F 2015F
2013
Source: CEIC, Deutsche Bank. Long term rates calculated by taking the difference between the 10yr bond yield and CPI inflation
Finally, we go back to our point on resiliency.
Thailand’s fortune looks poor at this moment, but we
think it will bounce back from the present crisis, just as
it has repeatedly in recent years. We are more
concerned about medium term engines of growth,
which the economy has by the handful (regional trade,
manufacturing, agriculture, tourism), and look forward
to the economy moving beyond the middle-income trap,
having addressed the cyclical and structural concerns
raised in this piece.
Taimur Baig, Singapore, +65 6423 8681
General
Industrial production (yoy %)
Unemployment (%)
Financial Markets
BoT o/n repo rate
3-month Bibor
10-year yield (%)
THB/USD (onshore)
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 106
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Vietnam
B2/BB-/B+
Moody’s/S&P/Fitch
Economic outlook: While we expect stronger GDP
growth of 5.8% next year, led by sustained
rebound in exports, we see ongoing bank reform as
critical in supporting stronger domestic demand
ahead.
„
Main risks: Debt-financed public investment poses
upside risks to inflation and the Dong remains at
risk as global rates rise.
„
Mid-term review and 2014 target
Stronger growth in 2014, led by exports… We expect
stronger exports to guide Vietnam’s GDP growth
higher, to 5.8% in 2014, from 5.3% in 2013. In fact, the
government’s socio-economic plan targets the same
rate of growth for the next year, which was approved
by the National Assembly (NA) last week.
Performance and medium-term targets
% yoy
20
18
GDP growth (lhs)
% yoy
Medium-term growth target (lower bound) (lhs)
25
Inflation
Medium-term inf target (upper bound)
20
16
14
15
12
10
10
8
5
6
4
0
2011
2012
2013
Sources: CEIC, Deutsche Bank
To be specific, we expect strong exports to guide
investment and private consumption higher, assuming
that there is meaningful progress in bank reform by in
2014. Leading indicators (e.g. G2 PMIs) continue to point
to a sustained recovery in Vietnamese exports ahead,
which in turn points to an improvement in investment.
Deutsche Bank Securities Inc.
Export-led recovery
%yoy
60
50
40
30
20
10
0
-10
-20
-30
2007 2008
Index
VN exports
G2 PMI (-Q1, rhs)
65
60
55
50
45
40
35
30
2009
2010
2011
2012
2013
2014
Sources: CEIC, Deutsche Bank
…a rebound in credit…Our assumption of progress in
bank reform, and thereby a recovery in credit growth, is
critical to our growth outlook. We expect more
meaningful progress in bad debt resolution by mid2014, as the VAMC’s efforts gain better traction and
the government pushes for implementation of Circular
02 by mid-year. As of end-November, the VAMC has
issued a special bond worth VND14.7tr (about 50% of
its planned amount) to purchase bad debt from 21
banks. Meanwhile, the SBV requested all banks to
include roll-over debt as bad debt, as defined in Circular
02/2013, by mid-2014, increasing pressure on banks to
resolve their bad debt by 2014. This, in turn, could
provide better growth prospects for Vietnam in 2H.
Credit rose 9% ytd in November, vs. the government’s
target of 12%.
…stronger public investment… Despite this positive
growth outlook, the government kept its budget deficit
target unchanged from this year, at 5.3% of GDP, and
social investment of 30% of GDP, vs. 29.1% in 2013,
suggesting a plan for stronger government investment
to boost growth. Note that the NA has passed a
resolution on the issuance of government bonds worth
VND170tr bonds (about 5% of 2012 GDP) over the next
three years for investment in infrastructure projects –
for the National Highway and the Ho Chi Minh
Highway, and for rural development. We remain
concerned about its debt plan, as the government
moves closer to its debt ceiling of 65% of GDP,
especially as the Fed begins tapering, pointing to
higher global rates. There are also concerns about local
governments’ deficits (not permitted by the laws of the
State Budget, which requires them to balance their
budget), albeit the NA has allowed local governments
to access reserve funds to cover their deficits. Needless
Page 107
5 December 2013
EM Monthly: Diverging Markets
to say, we support the government’s move to improve
oversight of public expenditure/investment and revenue
collection.
Limited inflationary pressure
%yoy
6
FX reserves in months of imports
5
CPI inflation
24
Building stronger protection against external shocks
4
Forecast
3
20
2
16
1
12
8
0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
4
0
2009
2010
2011
2012
2013
2014
2015
Sources: CEIC, Deutsche Bank
…while inflation remains low... Debt-financing of
investments in turn poses upside risks to the
government’s target of 7% for next year. This year,
inflation surprised to the downside, averaging 6.7% ytd
in November, down from 9.5% in the same period of
2012, led by lower food prices (2.5% vs. 9.1%) and
housing pricing inflation (4.7% vs. 10.9%), with the
latter reflecting a weak housing market, more than
countering a sharper increase in healthcare costs
(49.1% vs. 14.9%).
Steady SBV rates until 2015, amid bank reform
Sources: CEIC, Deutsche Bank
Meanwhile, the State Bank of Vietnam (SBV) is looking
for means to reduce the Dong’s volatility and to dedollarize the economy, to improveGl the effectiveness
of its monetary policy. The SBV has accumulated
sufficient FX reserves to cover about 12 weeks of
imports, vs. 10 weeks at end-2012 and six weeks at
end-2011, although the improvement in the external
balance was due partly to sustained FDI inflows and
weakness in domestic demand.
Export composition changing
% of by
goods
0.7
Phones, parts
Computer/Electr parts
Footwear
Aqua products
Textile
Oil
0.6
Policy rate
%
16
Forecast
0.5
0.4
0.3
14
0.2
12
0.1
10
0
2001
8
2003
6
2005
2007
2009
2011
Ytd Nov
13
Sources: CEIC, Deutsche Bank
4
01 02 03 04 05 06 07 08 09 10 11 12 13 14 15
Sources: CEIC, Deutsche Bank
…pointing to steady rates until 2015... Despite a
recovery in domestic demand, we expect inflation to
remain relatively stable, averaging 7.3% in 2014, vs.
from 6.6% in 2013, given our assumption of a fall of
more than 10% in oil prices. This relatively benign
inflation outlook, we expect the SBV to be on hold until
2015, unless monetization of debt takes place or if the
Fed’s tapering has a larger-than-expected negative
impact on capital flows.
Page 108
With limited recovery in the latter, Vietnam’s trade
deficit stood less than USD95mn ytd in October, vs. the
five-year average deficit of USD10.5bn in 2012.
Meanwhile, export growth continued to recover,
supported by strong exports in higher-value goods
while partly weighed down by weak commodity
exports. Looking ahead in 2014, despite a recovery in
domestic demand, we expect Vietnam to see another
year of a current account surplus, albeit smaller than in
2013, supported by sustained inflows of current
transfers.
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Trade activities improving
%yoy 3mma
Trade Balance (rhs)
Exports
Imports
80
60
USD bn
4
3
40
2
20
1
0
0
-20
-1
-40
-2
-60
2007
-3
2008
2009
2010
2011
2012
Moreover, we expect improved treatment for the nonstate sector, moving towards a more equal treatment
of state and private companies. We therefore expect
more profound changes ahead, with Vietnam
continuing to integrate into the world economy.
Considering
the
non-state
sector’s
relative
outperformance in boosting Vietnam’s growth, we
think a general policy move to support the “private”
sector, while improving SOE efficiency/productivity,
will contribute greatly to Vietnam’s balanced growth
agenda.
Non-state sectors lead growth
2013
Sources: CEIC, Deutsche Bank
60
Share, %
2001-05
2006-10
50
…keeping the dong relatively stable, while encouraging
foreign investments… We do see limited risks to FDI,
as long as Vietnam continues with its reform plan,
Barring global financial shocks due to the Fed’s taper.
Vietnam has continued to enjoy large FDI inflows. By
October, FDI stood at USD9.6bn (vs. the five-year
average of USD10.7bn in 2012), while the newly
registered level stood at USD19.3bn (vs. the five-year
average of USD29.3bn in 2012), suggesting improved
implementation.
To support investment at home and limit speculative
flows, the SBV may ban FX deposits by non-residents,
but allow FDI investors to open multi-currency
accounts and use their Dong income in Vietnam for
reinvestment. For its part, to continue to attract foreign
investment, the government has submitted its plan for
approval by the NA to increase foreign investment
limits. The government has proposed raising the limits
on foreigners’ voting share to 60% from 49% in some
listed companies, with no limits for non-voting shares,
and their certificate investment share to 100% from
49%, while allowing foreign securities companies to
increase their holdings in local securities firms to 100%.
This proposal is an integral part of the government’s
broader economic reform plan. In connection, the
authorities are also encouraging joint ventures/strategic
partnerships between FDIs/non-state enterprises
(NSEs) and SOEs/SOCBs, as a part of its broader reform
plan.
…but reform efforts need to be sustained… The NA has
also ratified revisions to the country’s constitution.
Although it has maintained the state sector as the
engine of economic growth, we expect its definition of
the “state sector” to be redefined, allowing the
government’s efforts in SOE reform to continue. The
authorities have already asked the Finance Ministry to
submit a plan for SOE bad debt resolution to be
completed by 2015 and have ordered SOEs to pull
away from peripheral activities and focus on the core
instead.
Deutsche Bank Securities Inc.
40
30
20
10
0
SOE
NSE
FDI
GDP Share
SOE
NSE
FDI
GDP growth contrib
Sources: CIEM, IMF, Deutsche Bank
Naturally, a removal of restrictive barriers to business
and investment activities would effectively level the
playing field, make the business environment more
friendly for all types of enterprises – SOEs, non-state
enterprises and FDIs – and improve the link between
FDIs and local suppliers. We believe changes in
Vietnam to improve its competitiveness are inevitable
as it seeks to move up the global value chain, while
broadening its presence in international trade.
Moving up the value chain
Mid to high skilled abour & tech-intensive share of exports
Vietnam
Myanmar
Laos
Cambodia
China
World
14%
40%
35%
30%
25%
20%
15%
10%
5%
0%
12%
10%
8%
6%
4%
2%
0%
2000
2002
2004
2006
2008
2010
2012
Sources: UNCTAD, Deutsche Bank
…TPP could be a turning point for Vietnam, but political
risks remain. By joining the TPP, Vietnam will commit
itself to economic policy reform, although the speed
may be negotiated. In particular, the TPP would require
Page 109
5 December 2013
EM Monthly: Diverging Markets
its members to ensure “competitive neutrality of policy
with respect to government enterprises”, as well as
“national treatment and enforcement authority,”
among others. Vietnam is pursuing the TPP while it
continues its work on the FTA with the EU and ASEAN
Economic Community (AEC). While there are obviously
difficult details to be negotiated, related to rules of
origin, anticompetitive policies, labor rights, intellectual
property and agricultural products, among others.
Moreover, there are also domestic political risks to the
TPP, largely in other countries, however. The next TPP
ministerial meeting takes place in Singapore from 7-10
December.
As for its potential gains from freer trade by joining the
Trans-Pacific Partnership, according to a study by Petri
and Plummer27, Vietnam may benefit the most, with a
boost to national income of about 11-14% (with exports
increasing about 28-37%) by 2025, depending on
whether it is the TPP-12 (original members) or TPP-13
(plus South Korea). Note that the TPP-12 represents
about 40% of the world’s population and 33% of the
world’s GDP (PPP) (38% nominal). For Vietnam, the
TPP-13 would represent about 50% of its total exports,
while China/HK represents about 14% and ASEAN
about 15%. Also, the TPP-13 is significant in terms of
Vietnam’s move up the value chain, given South
Korea’s importance (via FDI) in Vietnam’s high-tech
sector and related exports. By our own model, Vietnam
remains as the main beneficiary of the TPP, even
following inclusion of China, Thailand and Indonesia.28
While risks to our inflation outlook are skewed to the
upside, as we assume lower oil prices next year, given
our relatively bullish view on G3 growth, risks to our
growth outlook remain to the downside. Other than
lower-than-expected G3 growth, reform fatigue remains
the concern for us when it comes to Vietnam’s outlook.
Vietnam: Deutsche Bank forecasts
2012
2013F
2014F
2015F
140.7
88.8
1585
156.8
89.8
1747
174.5
90.7
1924
195.2
91.7
2129
Real GDP (yoy %)
Private consumption
Government consumption
Gross fixed investment
Exports
Imports
5.2
4.9
7.2
1.9
11.0
3.2
5.3
4.5
6.0
2.0
11.5
10.5
5.8
5.0
7.0
5.0
16.0
15.8
6.3
6.5
6.5
8.0
14.0
15.5
Prices, Money and Banking
CPI (yoy %) eop
CPI (yoy %) ann avg
Broad money (yoy %)
Bank credit (yoy %)
6.8
9.3
18.5
8.7
6.2
6.6
16.0
12.0
8.6
7.3
17.0
14.0
9.5
9.8
19.0
16.0
Fiscal Accounts1 (% of GDP)
Federal government surplus
Government revenue
Government expenditure
Primary fed. govt. surplus
-6.0
27.5
33.5
-4.5
-6.0
27.2
33.2
-4.7
-6.2
27.5
33.7
-4.2
-5.5
28.0
33.5
-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) VND/USD
112.0
109.0
3.0
2.1
8.0
5.7
7.0
25.4
20900
130.0
131.0
-1.0
-0.6
5.0
3.2
8.0
36.0
21200
165.0
168.0
-3.0
-1.7
3.5
2.0
8.0
42.0
21800
195.0
206.0
-11.0
-5.6
-6.0
-3.1
8.0
44.0
22500
53.0
22.0
31.0
43.3
61.0
16.4
56.0
24.0
32.0
40.2
63.0
19.0
60.0
27.0
33.0
39.0
68.0
19.1
61.0
28.0
33.0
37.4
73.0
20.5
4.3
3.2
6.0
3.2
7.5
3.2
8.0
3.0
Current
7.00
21120
3M
7.00
21300
6M
7.00
21500
12M
7.00
21800
National Income
Nominal GDP (USD bn)
Population (m)
GDP per capita (USD)
Juliana Lee, Hong Kong, +852 2203 8312
Debt Indicators (% of GDP)
Government debt
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, DB Global Markets Research, National Sources
Note: (1) Fiscal balance includes off-budget expenditure, while revenue and expenditure include
only budget items.
27
The Trans-Pacific Partnership and Asia-Pacific Integration, by Peter A
Petri, Michael Plummer, and Fan Zhai, published on 24 October 2011.
28
Please refer to Asia Economic Monthly published on 7 November 2013.
Page 110
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Czech Republic
A1(stable)/AA-(stable)/A+(stable)
Moodys/S&P/Fitch
„
Economic Outlook: PMI, IP and consumer
confidence data continue to improve but Q3 GDP
surprised significantly on the downside. We expect
a broad-based economic recovery to pick up pace
in the next two years. On the political front, we
expect an agreement between the Social
Democrats, Christian Democrats and ANO to be
reached – with negotiations already underway –
and a government involving these three parties to
be in place around January. Fiscal policy is
expected to tend slightly toward the looser side,
but not overly so.
„
Main Risks: The main risks – both on the upside
and downside – to growth come from the external
environment. The pace of recovery in the Czech
Republic is heavily dependent on the strength of
growth in the euro area (and particularly Germany).
With a shaky coalition or minority cabinet the likely
political scenario, another early election at midterm is a strong possibility.
Political uncertainty remains, while the
economic recovery is fragile
The economy is showing signs of improvement, but the
recovery is still fragile. A six-quarter long recession
ended in Q2 when output expanded by 0.6% QoQ.
Other economic data had been positive as well. It came
as a surprise, therefore, when GDP fell by 0.1% in Q3,
especially in the context of strong positive growth
elsewhere in central Europe. The details released by the
Czech Statistical Office indicate that the decline was
primarily due to weak household consumption and
strong imports.
remains intact. It is also likely to become increasingly
broad based. Net exports have been the only thing
propping up the economy in the last two or three years
and should continue to contribute positively as activity
in the Czech Republic’s main trading partners,
especially Germany, picks up. The recent depreciation
of the koruna will provide an additional modest boost.
Domestic demand should turn positive, initially as
consumer confidence recovers, but this should also
translate into stronger investment activity as
businesses also begin to feel more confident about
recovery. The drag from fiscal consolidation is also
fading as the fiscal stance turns from sharply
contractionary in 2013 to broadly neutral over the next
year or two.
Even assuming some rebound in Q4, our earlier growth
forecast for 2013 is no longer attainable and we have
therefore revised it sharply lower to -1.2% from -0.5%.
But the recovery should take hold in the coming
quarters and we expect the economy to grow by 1.7%
in 2014 and 2.2% in 2015. As ever, this is heavily
dependent on the pace of recovery in the euro area,
where we are assuming the growth strengthens to
about 1¼-1½% over the next two years. But there are
probably also some upside risks: domestic demand has
been pent up for a few years now and could rebound
more strongly than we are anticipating.
Q3 GDP surprised on the downside after strong
readings in other economic indicators
10
65
60
5
55
50
Recent high frequency data have been encouraging.
The Purchasing Managers’ Index (PMI) has been in
expansionary territory for seven consecutive months
and in November reached its highest level since May
2011. Consumer confidence is improving and the
private savings rate stabilized at 11% in Q2. This should
help to allay the Czech National Bank (CNB) concerns
that consumers would continue to defer their
purchases. CNB intervention to head off possible
deflation (see below) should also help in this regard.
Our measure of macroeconomic momentum – a
composite measure of high frequency indicators that
track well with GDP – is also at its highest level since
August 2011 and signaling a return to more positive
growth rates.
So while the decline in GDP in Q3 remains a puzzle, we
are inclined to think that the economic recovery
Deutsche Bank Securities Inc.
0
45
-5
40
35
-10
30
25
2005 - Q3
2007 - Q3
PMI (pavg)
2009 - Q3
2011 - Q3
-15
2013 - Q3
GDP, % QoQ annualized (rhs)
Source: Deutsche Bank, Haver Analytics
CNB intervenes to weaken the koruna. Given its
concerns about undershooting its inflation target for a
sustained period and possible deflation, and with
interest rates already at zero, the CNB finally eased
monetary conditions further last month by intervening
to weaken the koruna. The CNB pushed the level of
Page 111
5 December 2013
EM Monthly: Diverging Markets
EURCZK to 27, a depreciation of almost 5% relative to
its level over the preceding month, and signaled its
intention to prevent the koruna from appreciating back
beyond this level. It will not prevent the koruna from
weakening further.
The move had been long-discussed but was motivated
by the fact that inflation had been below the 2% target
since January and in October dipped below the 1ppt
tolerance band around this target. Core inflation (i.e.
excluding the impact of regulated prices and tax
adjustments) was running close to zero while
monetary-policy relevant inflation (i.e. adjusted for the
first round impact of indirect taxes) was also below 1%.
The low inflation environment is a result of
administered price cuts, falling fuel prices, and the
absence of any demand pressure given the weak
economy. Additionally, inflation is set to drop further in
the coming months on the back of scheduled electricity
price cuts and likely further falls in fuel prices. Using a
3:1 Monetary Conditions Index (MCI) – in line with
earlier CNB estimates – we note that a move in
EURCZK to 27 is equivalent to more than 150bps in
rate cuts. This index describes the relative impact of
the exchange and interest rates on growth and
inflation; the relatively large impact of a 5%
depreciation in the koruna reflects the importance of
the exchange rate for monetary conditions in a small
open economy like the Czech Republic.
Inflation remains below target
7.0
The CNB’s published estimates of exchange rate passthrough suggest that the 5% depreciation could add
about 1.5ppts to inflation, which would be comfortably
enough to ensure that inflation moves back towards
the inflation target if not a little above. This should
therefore facilitate a return to standard monetary policy.
However, with inflationary pressures expected to
remain muted in the near term, we expect the
intervention to continue for some time, probably
throughout next year; Governor Singer stated in an
interview that the CNB would likely hold EURCZK
around 27 for at least the next 18 months. Inflation is
expected to reach the target in H1 2015, at which point
the CNB will begin to sound more hawkish and
markets will begin to focus on the timing of the first
rate hike.
Political landscape remains uncertain. The early
elections for the lower house of Parliament (Chamber
of Deputies) held in late October saw the Social
Democrats (CSSD) winning the largest number of seats
in Parliament. However, against expectations, a centreleft coalition failed to secure a majority as the
performance of the CSSD and Communists was worse
than opinion polls had suggested.
Seven parties crossed the threshold of 5% of votes
required to enter Parliament; there was a particularly
strong performance by the pro-business, anticorruption ANO party (formed in 2011 by billionaire
businessman Andrej Babis). The reported seat
distribution in the 200-member Chamber of Deputies is
provided in table 1.
6.0
5.0
Chamber of Deputies after October election
4.0
Party
3.0
2.0
1.0
0.0
2005
2007
2009
CPI (YoY%, pavg)
Target lower bound
2011
2013
2015
Current inflation target
Target upper bound
MPs
%
Social Democrats (CSSD)
50
25.0
Action of Disgruntled Citizens (ANO 2011)
47
23.5
Communists (KSCM)
33
16.5
Tradition, Responsibility, Prosperity (TOP 09)
26
13.0
Civic Democrats (ODS)
16
8.0
Sunrise of Democracy (USVIT)
14
7.0
Christian Democrats (KDU-CSL)
14
7.0
Total
200
100.0
Likely CSSD/ANO/KDU-CSL coalition
111
55.5
Source: Deutsche Bank, Haver Analytics
CNB has committed to intervening for as long as it
takes to ensure that it hits its 2% inflation target.
Governor Singer indicated that CNB would look to
weaken the koruna even further only in an
“extraordinary” case. The CNB reported that it bought
foreign currency worth around USD10bn in the first
two weeks of intervention. We do not know yet
whether this intervention has been sterilized. The CNB
balance sheet will be closely scrutinized over the next
few months as markets may begin to question the
effectiveness of the intervention if CNB seeks to
sterilize a significant part of it.
Page 112
Source: CSO, Deutsche Bank
Internal disputes that plagued the CSSD in the
aftermath of the relatively poor election performance
have died down; party leader Bohuslav Sobotka now
has a mandate to form a 3-party coalition with ANO
and the Christian Democrats (KDU-CSL). This grand
coalition would secure 111 seats versus a required 101
for majority. While talks between the three parties are
underway and they have common ground in their anticorruption stance, difficult negotiations lie ahead –
ANO's very pro-business stance conflicts with the
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
CSSD’s plan for higher corporate taxes and higher
taxes for top earners. Additionally, there is friction
between CSSD and the Christian Democrats on the
issue of church property restitution, as the CSSD plans
to reassess the restitution package agreed by
Parliament last year.
However, we believe an agreement will eventually be
reached between the three parties. It is possible that
instead of a grand coalition, the agreement will entail a
CSSD minority cabinet with parliamentary support from
the Christian Democrats and ANO. The uncertainty is
compounded by Babis’ expressed aversion to joining a
coalition government with the Social Democrats. Given
its strong performance in the October election, ANO
might opt for the minority cabinet option and then push
for another early election at mid-term. Even if a grand
coalition is formed, the conflicting views of the parties
on important issues leaves open the possibility of
another early election.
Any agreement between the three parties would
involve substantial compromises from the CSSD on its
agenda to raise corporate taxes and increase spending
on social services, housing and healthcare; these
compromises in the coalition negotiations look set to
impact the 2014 fiscal stance. Further, the current
political limbo means that no tax changes are likely in
the near-term even if the new government manages to
agree on it. To avoid a scenario where the budget is not
approved and is therefore set at 1/12th of the 2013
budget each month we expect that the 2014 budget
will be approved by year-end in line with the draft
version formulated by the interim government. While
we expect easing of fiscal consolidation and a broadly
neutral or slightly loose fiscal stance in 2014 (the
budget is expected to be slightly pro-growth, but not
overly so), the chances of a significantly looser (and
more inflationary) fiscal stance are now lowered. We
see the fiscal deficit stabilizing at around 2.7% of GDP
in 2014.
In terms of timing, President Zeman is likely to appoint
a PM designate around year-end, after which the PM
will have 30 days to form a cabinet and a further 30
days to win a confidence vote in Parliament. If the vote
is unsuccessful the same process and timeline is
repeated before the third mandate to appoint a PM
designate is then transferred to the Parliamentary
speaker. We expect the new cabinet to be in place
around January, with CSSD leader Sobotka as the new
PM designate. In the interim, Jiri Rusnok – who was
appointed by President Zeman as head of the caretaker
government after the previous governing coalition
collapsed in June amidst a bribery/illegal spying
scandal – will continue to serve as PM.
Czech Republic: Deutsche Bank Forecasts
National Income
Nominal GDP (USD bn)
Population (mn)
GDP per capita (USD)
2012 2013
2014F
2015F
196.5 189.7
10.6 10.6
18617 1794
175.3
10.6
16550
174.8
10.6
16468
Real GDP (%)
Priv. consumption
Gov’t consumption
Investment
Exports
Imports
-1.0
-2.1
-1.9
-5.0
4.7
2.5
-1.2
-0.4
-0.6
-4.2
0.5
1.0
1.7
1.0
1.0
0.5
5.1
4.4
2.2
1.5
1.1
2.0
5.7
5.4
Prices, Money and Banking
CPI (YoY%, eop)
CPI (YoY %, pavg)
Broad money (M2)
2.4
3.3
4.5
1.2
1.4
2.2
1.6
0.9
4.6
2.0
2.0
2.0
Fiscal Accounts (% of GDP)
ESA 95 fiscal balance
Revenue
Expenditure
Primary balance
-4.4
40.1
44.5
-2.9
-3.1
39.9
43.0
-1.6
-2.7
40.8
43.5
-1.2
-2.6
41.4
44.0
-1.1
External Accounts (USDbn)
Exports
Imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI (net)
FX reserves (USD bn)
CZK/USD (eop)
CZK/EUR (eop)
131.9
124.5
7.5
3.8
-4.8
-2.4
6.9
37.4
19.0
25.1
138.7
128.3
10.4
5.5
-1.1
-0.6
4.0
42.4
21.6
27.0
139.7
129.8
9.9
5.6
-1.8
-1.1
5.0
42.9
23.5
27.0
127.8
118.8
9.0
5.2
-4.4
-2.5
5.0
43.4
23.6
26.0
Debt Indicators (% of GDP)
Government debt
Domestic
External
Total external debt
in USD bn
Short-term (% of total)
46.2
31.4
14.7
51.8
101.9
25.7
47.8
35.0
12.7
52.2
99.0
27.7
47.0
34.1
12.8
54.6
95.8
26.8
49.6
36.1
13.4
54.4
95.2
26.8
-0.7
6.8
0.8
7.5
3.7
7.0
4.3
6.7
Current 14Q1
14Q2
0.05
27.0
22.5
14Q4
0.05
27.0
23.5
General (% pavg)
Industrial production (YoY%)
Unemployment
Financial Markets (eop)
Policy rate (%)
CZK/EUR
CZK/USD
0.05
27.4
20.2
0.05
27.0
22.0
Source: Haver Analytics, CEIC, DB Global Markets Research
Gautam Kalani, London, +44 207 545 7066
Deutsche Bank Securities Inc.
Page 113
5 December 2013
EM Monthly: Diverging Markets
Hungary
Ba1(neg)/BB(neg)/BB+(stable)
Moody’s/S&P/Fitch
„
Economic Outlook: Moderate economic recovery is
set to continue and become increasingly broad
based over the next two years as domestic demand
improves. In the spring 2014 general election, the
ruling Fidesz party under PM Viktor Orban is set to
win another mandate by a fairly significant majority.
„
Main Risks: Upside and downside risks to growth
come from the pace of the euro area recovery.
Additionally, while inflationary pressures remain
low, the room for manoeuvre in monetary policy
could be influenced by the external environment
and risk perceptions.
Growth outlook is positive, but inflation
remains a concern
Economic indicators show encouraging signs. The
economic recovery is firmly underway, as output
continues to expand – QoQ GDP growth was positive in
the first three quarters of this year, and Q3 GDP
surprised significantly on the upside. Other economic
indicators have been positive as well. Industrial
production reached its highest level for nearly two
years in September, while economic sentiment is also
on the uptick. Our macroeconomic momentum
measure – a composite measure of high frequency
indicators that track well with GDP – is at its highest
level since April 2011, signaling that output is likely to
continue expanding.
Economic recovery is underway
10
1.00
5
0.50
0.00
0
-0.50
-5
Inflation remains low. YoY CPI has been below the
NBH’s 3% target since February this year, mainly due
to weak domestic demand and regulated energy price
cuts. In October, it was at a record low 0.9%; however,
with an 11% cut in household energy prices set to hit in
December and January, we expect inflation to fall
further in the coming months.
Inflationary pressures are likely to remain weak over
the next year, primarily due to slack labour market
conditions, excess capacity in the economy and the
gradual adjustment of inflation expectations; imported
inflationary pressures are also likely to remain muted
given that fuel prices are expected to fall further. As a
result, inflation is expected to average only 1.7% in
2014, and then rise to 2.8% in 2015 on the back of
base effects and improving domestic economic
conditions. The NBH’s three measures of underlying
inflation – core inflation (which excludes indirect taxes),
demand sensitive inflation and sticky price inflation –
are also at low levels (where they are expected to
remain over the near term).
-1.00
-10
-15
2005 - Q3
expand, the National Bank of Hungary’s (NBH) Funding
for Growth scheme is expected to ease financing
constraints for small and medium enterprises (SMEs)
and facilitate a recovery in private investment. Further,
we also see domestic demand expanding as a result of
growth in household consumption, on the back of an
increase in real income arising from the low inflation
environment, a gradual decline in the private savings
rate and an improvement in consumer confidence. We
see output growing by 1.8% in 2014 and 2% in 2015,
as the recovery picks up pace. There is, however, some
upside risk to this forecast – a rapid economic recovery
in the euro area, combined with a possible increase in
the market share of Hungarian exports due to new
capacities in the automobile sector, would push growth
in Hungary even higher.
-1.50
2007 - Q3
2009 - Q3
2011 - Q3
-2.00
2013 - Q3
GDP, % QoQ annualized (lhs)
Macro momentum index (quarterly average)
Monetary policy easing continues; rates expected to be
cut below 3%. Given the low inflation environment, the
NBH has completed 380bps in policy rate cuts since
the easing cycle began in August 2012. After 12 x 25
bps cuts, the MPC opted for 20bps cuts at its last four
meetings, bringing the policy rate to a record low
3.20%.
Source: Deutsche Bank, Haver Analytics
Exports were the main driver of growth in 2013, but the
economic recovery is likely to become increasingly
broad based over the next two years. The downward
trend in investment is forecasted to turnaround – while
public investment implemented from EU funds should
Page 114
The MPC has noted in its recent statements that there
is scope for “further cautious easing of policy”.
However its tone was even more dovish in the latest
(November) statement, and it also noted that “a further
reduction in interest rates is consistent with meeting
the 3% inflation target in the medium term”. We
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
therefore believe that easing is set to continue and the
MPC will cut rates by 20bps again in December. This
would take the policy rate to 3%, which had been
flagged in July by Governor Matolcsy as the likely
bottom for the easing cycle.
However, Deputy Governor Balog two weeks ago
noted that “the bottom limit to interest rate cuts is a
moving target” and that low inflation could persist,
while last week Governor Matolcsy said that the benign
inflation outlook could allow the NBH to keep monetary
policy loose for a sustained period, signaling possible
cuts below this 3% level. These statements, the
persistence of low inflation and a likely downward
revision in the NBH’s inflation forecast in its December
Inflation Report (due to the significantly below
expectation October inflation reading) lead us to
believe that the policy rate will indeed be cut below this
3% level. The ECB’s decision to cut rates is also
conducive to further cuts by the NBH, and the external
environment will be even more supportive if the Fed
delays tapering until March 2014 or beyond.
We expect the easing cycle to bottom out around 2.7%
in Q1 2014, with a possible move to 10bps cuts to end
the cycle. We forecast average Q1 YoY inflation at
1.1% and Q2 inflation at 1.7%, implying that there is
sufficient room to cut the policy rate below 3% while
keeping real rates positive. We expect the first rate
hikes in 2015, as inflation pushes higher.
Inflation and real policy rate profile
3.00
2.50
2.00
1.50
1.00
0.50
0.00
Jul 13
Oct 13
Jan 14
CPI (YoY, %)
Apr 14
Jul 14
Oct 14
Real policy rate (%)
Source: Deutsche Bank
The main risk to this call comes from the external
environment. The MPC has maintained in its
statements that “a sustained and marked shift” in risk
perceptions could influence the room for manoeuvre in
monetary policy, calling for a “cautious approach to
policy” on this basis. It also noted in its November
statement that there has been a “slight deterioration in
perceptions of risk” associated with the economy, in
addition to recent outflows from emerging markets. A
December taper by the Fed would add to these risks,
although the NBH has pursued rate cuts when the Fed
Deutsche Bank Securities Inc.
was hiking rates in the past (2004 and 2005). On the
other hand, there is also a chance of further easing
from the ECB in the short term, which would support
NBH easing.
Incumbent Fidesz party set to win 2014 general
election. The macro environment will be impacted by
next year's general election, which will be held in April
or May (the exact date will be set by the president). As
things stand there is still no strong opposition party or
a well coordinated opposition coalition; the ruling
Fidesz party under PM Viktor Orban is set to win
another mandate by a fairly significant majority.
A poll conducted in November by pollster Median
showed that while 29% of voters did not support any
political party (the lowest level in three years), 48% of
those with a party preference supported Fidesz. The
primary challenge to Fidesz is likely to come from the
main opposition Socialists, who secured only 21%
support in the opinion poll. Meanwhile, the radical
nationalist Jobbik party obtained 16% of the votes; exPM Gordon Bajnai’s E14-PM electoral alliance secured
only 6% support. The Socialist party and E14-PM
signed an agreement on electoral cooperation in
October. While the two parties will have separate PM
candidates and will also run on separate lists in the
general election, they agreed to only field one
candidate in 106 individual wards (Socialists will
choose the candidate in 75 constituencies and E14-PM
in 31).
While Fidesz may not win another two-thirds majority,
this is not likely to mean any meaningful curb on power
given the large number of changes made to the
Constitution through the current term. The election
campaign is likely to centre around highlighting the
successes during recent years such as exiting the
Excessive Deficit Procedure (EU’s budget scrutiny
program) earlier in 2013 after 9 years, repaying the IMF
ahead of time, bringing inflation and the policy rate
down to historically low levels, providing support to
households and SMEs indebted in fx and achieving a
lowering of government debt. Opposition groups will
on the other hand focus on the fact that Hungary still
owes EUR3.5bn to the European Commission, that the
investment ratio has collapsed and that the debt
reduction is due to the re-nationalization of pension
fund assets.
In terms of fiscal policy, the draft budget bill for 2014
pencils in extension of the family tax allowances and
increases in public education sector wages; there is
also likely to be additional revenue from the new road
toll system. We forecast the 2014 fiscal deficit at 2.9%
of GDP, the same level as we expect in 2013. The 2015
deficit is expected to narrow to 2.7% of GDP on the
back of the economic recovery picking up pace and the
drop in public spending linked to the electoral cycle.
Page 115
5 December 2013
EM Monthly: Diverging Markets
Funding for Growth Scheme (FGS) gets supersized for
phase 2. The NBH Funding for Growth Scheme has
been significantly altered during recent months. The
scheme was first announced in April and comprised i)
preferential NBH financing for forint-based lending to
SMEs, ii) preferential NBH financing for converting
SME fx loans into forint and iii) reducing economy-wide
external debt via fx reserves. Initially HUF250bn was
allocated to each of Pillars 1 and 2 above and EUR3bn
to Pillar 3. At the time the NBH stressed that the
measures were targeted, temporary (as the stated
timeframe for operation was June-August) and would
not jeopardize the Bank’s primary objective of
price/financial stability or create a dual interest rate.
The impact on the NBH balance sheet and P&L also
looked relatively small.
However, subsequent modifications – which are
detailed in figure 3 – have substantially altered the FGS.
The most significant change was the September
announcement which saw the overall size of Pillars 1
and 2 increased to HUF2.750trn and the deadline
extended through end 2014 (October through end 2014
is known as phase 2 of the programme).
The FGS has been altered significantly
Timeline of NBH Funding for Growth Scheme
Apr
The FGS w as announced by the NBH comprising i) 0% financing for forint based lending to
SMEs, ii) 0% financing for converting SME fx loans into forints and iii) reducing economyw ide external debt. HUF250bn w as allocated to both pillar i) and ii) and EUR3bn to pillar iii)
and the scheme w as to be effective from June through August
May
The size of pillar i) w as increased to HUF425bn and pillar ii) w as increased to HUF325bn
taking the new total to HUF750bn.
early Aug FGS extended through end September and any unused quota under pillar ii) could be
transferred to pillar i)
late Aug
The pillar iii) deadline w as extended indefinately until a maximum of EUR2.5bn is utilized
Sep
Size of pillar i) and ii) increased by HUF2trn leaving the total at HUF2.750trn. Out of the
additional amount 90% is intended for pillar i) and just 10% for pillar ii)
Source: NBH, DB Global Markets Research
For phase 1, we estimate (with the aid of the August
lending survey data) a take-up rate of around 84% of
the expanded HUF750bn under Pillars 1 and 2, with
Pillar 1 fully utilized and Pillar 2 around 75% utilized.
Pillar 3 looks to have been only 20% utilized (net basis).
Phase 2 of the FGS has been in operation since
October 1st and relates to the addition of a maximum
HUF2trn to Pillars 1 and 2 where 90% is intended for
Pillar 1. At HUF2750bn the total expanded size of the
FGS is equivalent to 9.5% of 2013 GDP and therefore
almost as large as the entire outstanding HUFdenominated corporate loan stock. Assuming the entire
HUF2.75trn under Pillars 1 and 2 is utilized with 90% in
Pillar 1 this would result in a 23% expansion of the
NBH balance sheet versus the end 2012 level. This
Page 116
would be seen in loans to residents on the asset side
and NBH bills on the liability side. It would also mean a
maximum reduction in fx reserves of around
EUR900mn as the portion under Pillar 2 sees external
assets (fx reserves) used to finance HUF loans to
residents.
This supersizing of the FGS conflicts with the initial
NBH statement that the scheme would be temporary,
targeted and have only a small impact on the NBH
balance sheet. The large size of Pillar 1 will also impact
the efficiency of interest rate policy by creating a dual
interest rate between FGS loans which are capped at
2.5% and non-FGS loans which face the policy rate
(3.2%) plus a premium. A desire to limit this duality –
by bringing the policy rate closer to 2.5% – could
become a factor in future interest rate decisions.
Moreover, continued rate cuts would also reduce the
potential cost of FGS to the central bank as the Pillar 1
loans are financed by NBH bill issuance which is
remunerated at the policy rate.
The NBH has estimated the cost of the expanded FGS
at HUF86bn, or around 0.3% of GDP. Governor
Matolcsy said that FGS could add 1.8-2.4% to GDP
growth depending on the share of new investment
loans. Our updated estimates on the impact of credit
on growth suggest a 0.6% impact on GDP for every
10% increase in the real (valuation adjusted) private
credit stock. On the assumption that FGS is fully
utilized, this could increase the real private credit stock
by around 16% and therefore add ~1% to GDP growth
(assuming the household/non-SME corporate loan
stock remains unchanged). It therefore seems unlikely
that the boost to growth will be as large as the NBH
estimate,
particularly
given
the
protracted
household/corporate deleveraging during recent years
and the forthcoming fx mortgage relief scheme.
Uncertainty over fx mortgage relief persists. The
problem of Hungary’s still-large fx-denominated
mortgage stock (approximately EUR12bn outstanding
as of July, or 12.3% of GDP as of end Q2) has
resurfaced in recent months. A July court case brought
the issue back into the spotlight with the country’s top
court ruling in favour of Hungary’s largest bank, OTP,
over a disputed fx mortgage contract with the borrower
arguing that the exchange rate variation was not clearly
identified at the time of taking out the loan. With the
government undoubtedly keen to offer relief to
households ahead of the general election in spring
2014, the government then initiated discussions with
the wider banking sector on what could be done to
further alleviate the burden on households from fxdenominated mortgages.
The banking sector had been given until November 1st
to announce a set of mortgage relief proposals which
are acceptable to the government, i.e. sufficiently
favourable for households. Any new scheme would
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
come on top of a 2011/2012 scheme which allowed for
early repayment of fx mortgages at a 20% discount
from spot exchange rates and a backdated nonperforming loans (NPLs) conversion with a 25%
discount on the principal. It would also be in addition to
an ongoing scheme where eligible households can sign
up for a 5-year exchange rate fix.
The government initially rejected the proposal
submitted by the Banking Association at the end of
October, on the basis that it did not adequately meet
the government’s two main criteria: the phasing out of
fx mortgages as a financial product and ensuring that
forint borrowers are not worse off compared to foreign
currency borrowers. However, Economy Minister
Mihaly Varga more recently stated that the government
has not excluded accepting the proposal after it is
made public and debated. With numerous ongoing
lawsuits relating to fx mortgages, the government is
not likely to undertake any radical steps on mortgage
relief until the legal issues are clarified. It is waiting for
a comprehensive ruling from the supreme court on
whether the fx loans are unconstitutional because they
violated consumer rights. The supreme court is likely to
consider this issue at its 16th December session;
therefore, any solution by the government is unlikely to
occur before the new year, though this could be
delayed further until after the spring election (Varga
recently stated that there is no deadline for the issue).
In the meantime, parliament has approved an extension
and expansion to the existing 5-year exchange rate fix
scheme, which allows indebted households to fix
repayments at CHFHUF 180 (versus a spot rate of 246)
and EURHUF 250 (versus a spot rate of 303), with the
additional principal accruing in an overflow account
where the interest cost on this is split between the
government and the banks. However, this is unlikely to
be the end of relief measures, and any lasting solution
will require a suitable decision by the government on
the extent of relief costs absorbed by the banks – if the
cost to the banking sector is significant, it could
jeopardize financial stability (as banks have already
absorbed major losses from earlier relief schemes) and
have a longer-term impact on lending activity and
future business models for foreign-owned banks. On
the other hand, while the government would want to
provide substantial relief to fx borrowers in advance of
the election, its willingness to take on the cost of new
relief measures is limited by tight fiscal constraints and
the commitment to a sub 3% (of GDP) fiscal deficit. We
expect a new scheme to cover approximately EUR7bn
of fx mortgages. Another issue of concern remains
limiting the adverse moral hazard impact of any relief
package, as the ratio of NPLs (for the whole of fx
mortgages) has already climbed to a substantial 21.7%
on the back of expectations of a new relief package.
Hungary: Deutsche Bank Forecasts
National Income
Nominal GDP (USD bn)
Population (mn)
GDP per capita (USD)
2012 2013F
2014F
2015F
126.0 129.1
10.0
9.9
12646 12985
133.6
9.9
13463
140.0
9.9
14134
Real GDP (% )
Priv. consumption
Govt consumption
Investment
Exports
Imports
-1.7
-1.9
0.0
-3.8
2.0
0.1
0.7
-0.3
-0.2
-3.0
4.0
5.2
1.8
1.6
1.4
1.4
6.7
7.0
2.0
1.6
1.2
3.8
5.1
5.5
Prices, Money and Banking
CPI (YoY%, eop)
CPI (YoY%, pavg)
Broad money (M3)
5.0
5.7
-3.3
0.6
1.8
1.8
2.5
1.7
4.8
2.7
2.8
5.1
Fiscal Accounts (% of GDP)
ESA 95 fiscal balance
Revenue
Expenditure
Primary balance
-2.1
46.2
48.3
2.2
-2.9
46.0
48.9
0.9
-2.9
46.2
49.1
0.9
-2.7
44.8
47.5
1.1
External Accounts (USDbn)
Exports
Imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI (net)
FX reserves (USDbn)
HUF/USD (eop)
HUF/EUR (eop)
97.3
92.8
4.6
3.6
1.3
1.0
2.6
41.9
220.8
291.4
102.3
97.3
5.0
3.9
1.6
1.2
1.5
38.2
236.0
295.0
101.2
96.7
4.5
3.4
1.3
1.0
1.7
37.9
243.5
280.0
97.5
93.7
3.8
2.7
0.7
0.6
2.0
37.7
246.9
271.6
Debt Indicators (% of GDP)
Government debt
Domestic
External
Total external debt
in USD bn
Short-term (% of total)
79.3
44.8
34.5
131.5
165.6
13.9
77.8
39.5
38.3
121.6
157.0
16.7
76.2
38.7
34.4
120.0
160.3
16.4
78.8
46.8
32.0
118.0
165.2
15.7
-1.3
10.9
2.8
11.2
5.4
10.8
5.7
10.4
Current 14Q1
3.20
2.70
302.8 291.3
223.0 236.8
14Q2
2.70
287.5
239.6
14Q4
2.70
280.0
243.5
General (% pavg)
Industrial production (YoY%)
Unemployment
Financial Markets (eop)
Policy rate (%)
HUF/EUR
HUF/USD
Source: NBH, DB Global Markets Research, Haver Analytics
Gautam Kalani, London, +44 207 545 7066
Deutsche Bank Securities Inc.
Page 117
5 December 2013
EM Monthly: Diverging Markets
Israel
A1(stable)/A+(stable)/A(positive)
Moodys/S&P/Fitch
„
„
Economic Outlook: Israel is awaiting a global pickup in activity next year to lift its export sector.
Domestic demand has been supporting the
economy and a strong labour market should
preserve this channel. Some fiscal tightening
measures incorporated in the 2013-2014 budget
are likely to be removed next year on the ground of
better than expected budget balance prospects.
Main Risks: The continued improvement of external
balances from ramping up of natural gas
production and potential pick up in exports will
continue to pressure the Shekel, continuing to
ignite Dutch disease concerns. The Bank of Israel
(BoI) and ministry of finance may continue to fight
the appreciation, but export-sector lobbying impact
may lessen once external demand improves. On
inflation,
contagion
from
housing
market
overheating to rents could be a medium term risk
to both inflation and lower income budgets.
Room for gearing up next year
Recovery of export sector should allow Israel lift off
Domestic consumption (government and households
led) has been a continuous support to Israeli demand
throughout the global slowdown, and has noticeably
accelerated lately with private consumption growing an
average 5.1% QoQ saar over the last four quarters.
Investment in fixed capital has also gained momentum
lately, progressing 16.9% in the third quarter of 2013
(from an annualized 4.4% real quarterly growth in Q2).
The one main historical economic driver in Israel
(weighting 35% of GDP) lagging as of late is the export
sector. The 16.4% retraction in exports dwarfed for
instance the Q3 GDP print to 2.2% QoQ. Nevertheless
looking merely at Sep-Oct export figures, a 29% MoM
pick up in good exports is already recorded. Factoring
in the low-base effect, a high-specialization of Israeli
exports, and the acceleration of demand from a
recovering American market, we are foreseeing sturdy
grounds on which the Israeli trade balance could
leverage.
We expect that some further momentum could be
generated domestically from the construction sector:
construction constitutes half of fixed capital formation,
and while for the past year the sector has stalled, in
2010-2012 it used to contribute 1.2ppts to headline
growth.
Budget deficit targets for 2013 (4.65% of GDP) and
2014 (3%) should be met according to the BoI (and our
own) projections. By year-end, the budget deficit could
be a full percentage point lower than the ceiling,
mechanically freeing some room for December
discretionary spending, and triggered (after the last
Page 118
MPC meeting which disclosed the expected path)
finance Minister Yair Lapid to announce that some of
next year income tax hikes should be abrogated.
Local demand has supported growth through the slowdown, now awaiting exports to take the relay
20
15
ppt contr.
QoQ (saar)
8
6
10
4
5
2
0
0
-5
-2
-10
-15
-20
Q1-09
Inventories
Fixed invt
Govt cons.
Private cons.
Net exports
Real GDP (rhs)
Q1-10
Q1-11
Q1-12
-4
-6
-8
Q1-13
Source: Haver Analytics, Deutsche Bank
Natural gas production is a structural economic change
The Tamar gas field was commissioned on 31-March
2013 and delivered so far the volume of production
expected. The extent of reserves and the regulatory
green light should bring production to gradually
increase into starting exports in 2018. The BoI has
committed to continue its FX intervention program
sized to offset the yearly impact of natural gas
production on the current account: USD 3.5bn worth of
FX reserves will be purchased in 2014, marginally
increasing the monthly average acquisitions from USD
260mn (in 2013) to 290mn. We argue that such a
calibration is not matching the present valuation of the
full long term impact of the structural change, and can
only mitigate the pace of appreciation.
Over the past 12 months, the shekel has appreciated
7.5% against the USD and 8.0% against the official
basket of trading partners’ currencies, making the
Israeli currency the world largest mover this year. We
maintain our view that the appreciation at stake is
structural, and argue that monetary easing, FX
intervention, or even possible capital controls can only
moderate the pace of an valuation change that we had
forecasted 9 months ago to likely take the shekel to 3.5
ILS/USD by 2013-end, and that we see aiming for 3.35
shekel per USD by end-2014. Regarding the BoI FX
intervention, sterilization costs and FX volatility risk
may soon become a concern to a central bank holding
FX reserves already worth 30% of GDP, but a likely
pick-up of external demand may alleviate the pressure
from exporters lobbying, while governor Flug was
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
lately mentioning (see 19-Nov press release) that the
current intervention policies are only “acting to give the
business sector time to adjust to the trends derived
from [long term economic] forces”.
Natural gas production prospects and C/A impact
Source: Deutsche Bank
Upward risk on inflation if housing market overheating
propels rental costs
Our outlook on inflation remains neutral on the back of
the expected offsetting impacts of economic recovery
and currency appreciation. Nevertheless, as the
October print may be hinting, a contagion to rent
inflation (3.7%YoY in Oct from 2.7% in Sep) from that
of house prices (growing 10%YoY in Sep) would
heavily pressure headline CPI figures [given a 25%
weight of rental cost in the basket]. On a risk
perspective, besides the long scrutinized mortgage
composition risk stemming from acceleration in
housing loans in conjunction with overheated house
prices, a trickle down of housing costs into rental
prices would threaten the budget balance of the lower
tranche of the wealth distribution in Israel.
We see the BoI itching to initiate their tightening cycle,
which should be closely tied to US Fed tapering, but its
scale would be balance to protect a domestic economy
recovery and pace the shekel appreciation
We highlight the risk of a swifter than expected move
(hinted by the hawkish tone of the notes accompanying
Nov-25 MPC meeting) as soon as a timing for monetary
tightening by the US Fed is clarified, and could be
defended on the ground of the progressive pick up in
domestic real activity, together with the need to face
up to further housing market overheating risks.
But, on the ground of the benign inflation context, the
still tentative real activity improvements, and concerns
regarding the risks of Dutch disease from an
accelerated appreciation of the Shekel, we maintain
our call for rates on hold into Q1 next year, followed by
a progressive tightening cycle that would bring Israeli
policy rate 100bps higher by end-2014.
Israel: Deutsche Bank Forecasts
2012
National Income
Nominal GDP (USD bn)
Population (mn)
GDP per capita (USD)
2013F
2014F
2015F
258.0 289.1 322.7 359.7
7.9
8.0
8.2
8.3
32,623 35,921 39,375 43,123
Real GDP (YoY%)
Priv. consumption
Gov’t consumption
Gross capital formation
Exports
Imports
3.4
3.2
3.2
3.5
0.9
2.3
3.6
3.5
2.5
-3.0
1.0
-3.5
3.7
3.0
1.7
4.5
6.5
4.5
4.2
3.0
1.8
4.0
9.0
5.5
Prices, Money and Banking
CPI (YoY%, eop)
CPI (YoY %, pavg)
Broad money (M2)
1.6
1.7
8.7
2.0
1.6
13.2
2.1
2.0
3.5
2.2
2.2
4.6
Fiscal Accounts (% of GDP)
Budget balance (excl. credit)
Revenue
Expenditure
Primary balance
-3.9
24.8
28.7
-0.9
-3.6
25.3
29.0
-0.6
-3.0
25.3
28.3
0.0
-2.5
25.1
27.5
0.4
External Accounts (USDbn)
bn)
Exports
Imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI (net)
FX reserves (USD bn)
ILS/USD (eop)
ILS/EUR (eop)
62.3
71.7
-9.3
-3.6
0.8
0.3
7.1
75.9
3.73
4.93
66.1
71.0
-4.9
-1.7
4.7
1.6
8.9
82.2
3.50
4.38
70.0
73.8
-3.8
-1.2
6.1
1.9
9.9
94.9
3.35
3.85
74.2
76.7
-2.5
-0.7
7.6
2.1
11.1
108.6
3.25
3.58
Debt Indicators (% of GDP)
Government debt
Domestic
External
Total external debt
in USD bn
Short-term (% total)
67.1
55.3
11.8
36.3
93.6
38.1
66.7
54.9
11.7
32.5
94.0
35.5
65.3
53.8
11.5
29.4
95.0
36.2
62.6
51.6
11.0
26.4
95.0
36.2
4.6
6.9
1.0
6.5
4.0
6.3
5.0
6.3
Current
14Q1
14Q2
14Q4
1.00
3.52
4.78
1.25
3.46
4.26
1.50
3.43
4.11
2.00
3.35
3.85
General (YoY%, pavg)
Industrial production
Unemployment (pavg)
Financial Markets (eop)
BoI Policy rate
ILS/USD
ILS/EUR
Source: BoI,CBS, Haver Analytics, DB Global Markets Research
Lionel Melin, London, 44 207 545 8774
Deutsche Bank Securities Inc.
Page 119
5 December 2013
EM Monthly: Diverging Markets
Kazakhstan
Baa2(positive)/BBB+(stable)/BBB+(stable)
Moody’s/S&P/Fitch
„
Economic Outlook: Growth performance is
relatively strong, supported by household
consumption expansion.
„
Main Risks: Worsening of the economic
environment adversely affecting the banking sector
and growth.
Growth to slow down
Kazakhstan’s economy was resilient but has shown
some signs of deceleration throughout this year. This
was reflected in forecast downgrades by the rating
agencies and some IFIs, such as the IMF. The EBRD
upgraded forecasts for the Kazakh economy, from
4.9% yoy to 5.6% yoy in 2013 and 5.5% in 2014. The
main drivers for the upgrade were sustainably high
investment growth rates and increasing oil production;
however, the country’s banking system continues to
show weak performance due to problems with
repayment of loans. Meanwhile, the IMF downgraded
forecasts for Kazakhstan, from 5.25% yoy to 5.0% yoy
for 2013. As regards the outlook, the organization
expects growth at 5.2% yoy in 2014 and 6.1% yoy in
2015. CPI is expected at 6.3% yoy in 2013-2014 and
6.2% yoy in 2015.
Over the 9M13 period, the Kazakh economy exhibited
solid 5.7% yoy growth after 5.1% yoy in 1H13 and
4.7% yoy in 1Q13. As for the recent dynamics of the
key economic indicators, in October 2013 industrial
production exhibited acceleration of the growth rate to
3.9% yoy from 2.0-2.9% yoy in June-September 2013.
Across the industries, the main driver of growth
appeared to be the mineral extraction sector, which
gained 3.2% yoy over 10M13, while manufacturing
exhibited slower rates, at 1.3% yoy; gas/heating and
electricity was up by 1.3% yoy, while water supply
registered a decline of 13.3% yoy over 10M13. In other
production activities, agriculture growth accelerated in
September-October to 6.6% yoy in 10M13 and 5.5%
yoy 9M13 from 0.5%-1.8% yoy in prior periods of 2013.
Transportation was up 2.4% yoy in cargos and 10.7%
yoy in passenger turnover.
Fixed assets investments were strong, registering
growth of 9.8% yoy vs. 12.0% yoy in September and
8.2% yoy over 10M13. Construction growth
accelerated to 2.9% yoy over 10M13, following 2.5%
growth yoy in 9M13. Over 10M13, the most attractive
sectors for investments remained mineral extraction
(31.5%), transportation and warehousing (23.1%) and
real estate operations (9.5%).
Page 120
Retail sales retained solid growth of 13.2% yoy in
10M13, cooling from 15.0% yoy in 9M13, supported by
low unemployment, which has stood at 5.2% over the
last six months and by real wage growth and stable
growth in real income at 2.7% yoy over 10M13.
According to the Ministry of Economy, GDP growth for
2014 is projected at 6.0% yoy in 2013-2014; 7.1% yoy
in 2015 and 6.2-6.5% yoy in 2016-2017. CPI inflation is
set in the range of 6-8% yoy for the period of 20132017. Given the DB projections for 2014-2015, we
expect growth to slow to 4.8% yoy in 2014, before
accelerating to 5.2% yoy in 2015.
In the monetary sphere, mom inflation in October
amounted to 0.3%, stable in the range of 0.2-0.3%
mom for the eighth consecutive month. As a result, the
yoy inflation figures decelerated further to 4.9% yoy
from 5.4% yoy in September and 5.8% yoy in October.
Overall, year-to-date inflation stood at 3.6% ytd with
food prices growing by 1.8% ytd, non-food by 2.2% ytd,
and services prices by 7.1% ytd. Meanwhile, the
money supply continued to decelerate on a yoy basis,
falling to 1.1% yoy from 10% yoy in January, putting
additional downward pressure on consumer price
growth. On a year-to-date basis, the money supply
increased 11%. For 2013, the monetary authorities
expect to see an inflation range of 6-8% yoy as a
reasonable target.
In the external sector, the CA moved into negative
territory on the back of a deficit of USD1.5bn in 3Q13
vs. a surplus of USD1.6bn in 1H2013 leading the
overall 9M13 surplus to USD153m vs. USD3.5bn in
9M12. The main driver for the CA going into negative
territory appeared to be declining exports of goods (7.0% yoy in 9M13) and rising imports of goods (6.2%
yoy). Due to a favorable external environment, the
international reserves of NBK reached USD23.69bn,
declining 16% ytd and 2% mom in October. Meanwhile,
the gross reserves of both NBK and NFRK reached
USD92.4bn increasing by 7.4% ytd and 1.8% mom in
October. As for the outlook for 2014, the growth of commodities
production may support external trade leading to a
surplus of 2.0% GDP, while in 2015 it should decline to
1.5% GDP.
On the fiscal front, over 9M13 the republican budget
balance registered a deficit of KZT391bn (1.5% GDP)
with the revenues standing at KZT3.955tr with NFRK
transfer at KZT1.449tr, the expenditures stood at
KZT4.179tr. As for medium-term trends, the authorities
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
target fiscal consolidation. In mid-November, they
approved the parameters of the republican budget for
2014-2016, according to which the spending plan for
2014-2016 assumes a decline in the deficit from
KZT942.4bn (2.4% GDP) in 2014 to KZT977.7bn (2.2%
GDP) in 2015 and KZT963.5bn (1.9 % GDP) in 2016. As
for 2014 alone, the budget revenues are projected to
increase KZT5.77tr (14.7% GDP); excluding transfers
from NFRK, revenues are projected at KAZ4.02tr
(10.2% GDP), while expenditures are set at KZT6.715tr
(17.1% GDP). In 2015 and 2016, revenues are to
increase, by KZT555.8bn vs. 2014 and KZT636.8bn vs.
2015, respectively. On the expenditure side, the
republican budget calls for KZT7.23tr (16.3% GDP) in
2015 and KZT7.88tr (15.6% GDP) in 2016.
In politics, one important development was the
resignation of Grigory Marchenko from NBK’s head
position, replaced by Vice-Premier Kelimbetov. In our
view, the reshuffle is unlikely to lead to a change in the
course pursued by the previous chair. The main
objective of monetary policy in the medium term is
likely to be the gradual introduction of measures
pertaining to inflation-targeting, including via greater
exchange rate flexibility.
Yaroslav Lissovolik, Moscow, +7 495 933 9247
Artem Zaigrin, Moscow, +7 495 797 5274
Kazakhstan: Deutsche Bank Forecasts
2012
2013F
2014F
203.5
16.8
12 111
222.7
16.9
13 177
241.7
264.8
16.8
16.8
14 385 15 764
5.0
11.2
11.4
3.3
4.1
17.2
5.3
10.5
4.3
4.9
4.6
8.6
4.8
7.6
3.7
4.8
5.3
8.5
5.2
6.7
4.2
5.2
5.3
8.2
Prices, Money and Banking (eop)
CPI (YoY%) ann avg
5.1
Broad money (M3)
9.1
Credit
13.4
6.0
11.2
18.5
5.6
12.9
14.8
6.3
12.3
15.2
National Income
Nominal GDP (USDbn)
Population (m)
GDP per capita (USD)
Real GDP (yoy %)
Priv. consumption
Govt consumption
Investment
Exports
Imports
2015F
Fiscal Accounts (% of GDP)
Consolidated budget
3.9
balance
Revenue
26.1
Expenditure
22.2
5.3
4.8
3.3
27.0
21.7
26.3
21.5
25.9
22.6
External Accounts (USDbn)
Exports
Imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI (net)
FX reserves (USDbn)
KZT/USD (eop)
92.1
47.4
44.7
22.0
6.2
3.0
12.4
28.3
150.5
98.4
49.6
48.8
21.9
3.0
1.3
13.1
36.4
154.0
102.8
51.8
51.0
21.1
4.8
2.0
13.4
41.5
157
107.2
54.0
53.2
20.1
4.0
1.5
13.8
47.2
160
Debt Indicators (% of GDP)
Total public debt
Total external debt
12.6
66.0
12.8
63.7
12.7
63.2
12.7
62.3
0.6
4.0
4.3
5.1
General (% pavg)
Industrial production (%
yoy)
Financial Markets (eop)
Spot
1Q14
2Q14
4Q14
Policy rate (refinancing
5.50
5.50
5.50
5.50
rate)
KZT/USD (eop)
154.5
155
156.7
157
Source: Official statistics, Deutsche Bank Global Markets
Research
Deutsche Bank Securities Inc.
Page 121
5 December 2013
EM Monthly: Diverging Markets
Poland
A2(stable)/A-(stable)/A-(stable)
Moodys/S&P/Fitch
„
Economic Outlook: The recovery seems in the
pipeline, thanks to exports already accelerating
from a relatively strong base, domestic demand
ramping up, and a tentative resumption of
investment. Poland will be the largest beneficiary
of EU funds allocated from the 2014-2020 budgets,
which would prompt further public investment
spending (from the 15% co-financing requirement).
Fiscal space should be confirmed once the pension
reform is passed, likely by the end of the year. And
the extension of the accommodative NBP’s
forward guidance should also support the recovery.
„
Main Risks: The slow recovery expected in the Euro
zone (first export destination, 53% of total) may
drag on Poland’s own. Some noise about possible
early elections may arise as the governing coalition
is down to a one-seat majority in Parliament. On
budget financing, domestic vs international market
tapping, and foreign participation in the domestic
government bond market may increase concerns
and volatility.
Waiting for exports and EU funds to
deliver a full-fledged recovery
Exports are already picking up, while sprigs of
improvements in domestic demand are visible.
The fundamentals of the Polish economy look set to
support a recovery going forward. The export sector
has remained unfaltering, growing consistently from
quarter to quarter since the end of 2009, and
progressing an extra 2.5% QoQ (sa) in the third quarter
of 2013, contributing to 1.0pp to headline growth. On
the other hand, the dynamics of the labour market
where real wages have shrunk 4ppt in the same time
frame, while contributing to the competitiveness of the
Polish economy, have also most likely amplified the
domestic demand slowdown despite an unemployment
rate marginally above NAIRU. Potential is hence
looming for domestic consumption to accelerate, and
the 3.2% QoQ (sa) progress in imports put side by side
with a 0.2% QoQ progress in private consumption in
Q3 may be signs of such a pick up, possibly indicating
that the rebound sugegsted by 5 months of PMI in
expansionary region could become tangible. The
lingering risk to a full-speed recovery scenario remains
the expected slow macroeconomic improvement in the
Euro-zone which dwindled share of Polish exports still
account for 53% of the total. Domestically though the
National Bank of Poland (NBP) commitment to keep
their policy rate at an eased level for another six
months may provide the necessary ammunitions to
support the economy, and investment in particular, on
Page 122
which front Q3 GDP detailed that gross fixed capital
formation halted a 5-quarter long slump, mildly
progressing 0.6% QoQ.
On the external financial account front, the drought in
both inward FDI and fixed income securities portfolio
investment flows has been worsening as of late. In the
12 months running to Sep’13 the Polish economy saw
EUR 1.7 bn of foreign investment, which represents a
tenth of the average yearly inflow Poland has gotten
used to receiving in the previous 10 years. While on the
portfolio end, the 12 months ending in Sep’13 recorded
EUR 3.1 bn of foreign investment, down from EUR
10.5bn a year earlier.
C/A improving despite investment income outflows
15
Current Transfers
Balance for Services
C/A Balance Rolling 12mo, Bn EUR
10
Investment Income
Trade Balance
5
0
‐5
‐10
‐15
‐20
‐25
‐30
Jan‐09
Jul‐09
Jan‐10
Jul‐10
Jan‐11
Jul‐11
Jan‐12
Jul‐12
Jan‐13
Jul‐13
from steadily growing exports and a slack in imports
160
Rolling 12mo, Bn EUR
150
140
130
Goods Imports
120
Goods Exports
110
100
Jan‐09 Jul‐09 Jan‐10 Jul‐10 Jan‐11 Jul‐11 Jan‐12 Jul‐12 Jan‐13 Jul‐13
Source: NBP, Deutsche Bank
The lately revamped government emphasizes EU funds
leveraging.
On the political economy front, the ramping of the
Cabinet that occurred on 20-Nov has cost finance
Minister Rostowski his portfolio (offered to Mateusz
Szczurek). We are tempted to link this rotation to the
public displease with respect to the pension reform,
reform which will nevertheless take place.
The elevation of the Development and EU fund Minister
Bienkowska to the status of deputy prime minister and
her portfolio extension to that of the Transportation
ministry highlight an emphasis that the Polish
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
government is putting on EU funded projects in order
to continue maximizing the absorption of EU subsidies.
Poland will still be the first beneficiary of EU funds
through 2014-2020
120
lower house have started and ratification should ensue
by the end of December, perfectly on time for the
budget to reflect the impact of the bill. Some noise
over whether or not the bill abides by the Constitution
may arise but ultimately the pension reform is expected
to pass. The main guidelines of the bill and the Cabinet
modifications can be summarized as follow:
EUR bn, current prices
100
Common Agricultural Policy
„
51.5% of Polish private pension funds (OFE) AuM
still planned to be transferred to the state social
security office ZUS on 3-Feb according the
previously announced rules.
In the details, pension funds assets will be
accepted in the following order in order to reach
the 51.5% of AuM objective: T-bonds and bills,
then Road bonds (BGK issued) and other securities
guaranteed by the Treasury, followed by cash,
banking securities, and municipal bonds. No
corporate bonds or equity will be transferred
„
OFEs’ portfolio restrictions and minimum 75%
equity allocation still under discussion.
The new draft removed the clause setting a
minimum equity allocation of 75% of AuM, but
however maintained the Cabinet's right to set
investment guidelines by asset class for the
pension funds, within the framework of a series of
rules30 set out in the bill itself. A gradually phasing
out minimum on equity allocation (from 75% to
null) has been reported as being under
consideration by PM Tusk. Funds will have until
Feb’15, to meet requirements not respected on
Feb’14. The draft bill maintains the ban on
investment in either Polish or foreign Treasuries,
but pension funds that are left with Treasury
papers after asset transfer in Feb’14, will be able to
hold on to them for the next two years. And
remains in the draft the gradual increase in limits of
investments in FX-denominated assets (10% of
AuM by end-2014, 20% by end-2015 and 30%
afterward).
„
Poles’ selection between OFE and ZUS for future
premiums to be allocated, OFEs advertising and
pre-retirement asset shift.
Poles will have from 1-April 2014 to 31-July to
decide whether their future premiums (19.52% of
gross salary) will be entirely pooled into ZUS of if a
fraction (2.92% of gross salary) will be invested in
OFEs, and the remainders (16.6% of gross salary)
to ZUS. The four-month (instead of three drafted
initially) choice period framework will also apply to
all market entrants. And Poles will have 4-month
windows to modify their pension choices in 2016
and then every four years.
Cohesion & Structural Funds
80
60
40
20
0
PL FR ES IT DE RO UK HU EL CZ PT SK BG HR LT IE AT SE FI DK NL LV BE EE SI CY MT LU
Source: Deutsche Bank
EU budget passed and Poland is to be, yet again, the
first beneficiary of EU funds.
The new 7-year EU multiannual financial framework
(MFF) which period starts on 1-Jan 2014 has just been
agreed upon on 19-Nov by the Parliament and adopted
by the Council. It details the maximum annual amounts
(ceilings) that may be allocated in the budgets of the
next 7 years, totaling EUR 1,082 bn at current prices
[EUR 960bn at 2011 prices]. Poland, once again, is to
be the main beneficiary of these EU funds, potentially
garnering about 11% of the EU-wide envelop.
In the details of the MFF, EU commitments to Poland
amount to about EUR 82bn at current prices [EUR
72.8bn at 2011 prices], from the Structural and
Cohesion 29 funds, plus EUR 32bn at current prices
[about EUR 28.4bn at 2011 prices] under the Common
Agricultural Policy plans. Compared to the current
2007-2013 budget, Poland remains the largest
beneficiary of structural/cohesion fund, and will be
ranked 6th regarding the CAP.
We hence expect the start of a new EU budget period
to foster a revival of public investment spending as
Poland has a 15% co-financing obligation. Emphasis on
energy is likely, although no specific projects have
been officially confirmed so far. The fiscal space
created by the pension reform, both in financing
(reduction in debt servicing and transfers to pension
funds), and debt thresholds terms (see details below)
should offer ample space for this channel to play out.
The Draft bill on pensions overhaul has been approved
by the Cabinet, and is expected to come into force on
31 January 2013
The OFE bill key features have remained unchanged,
except for a few amendments. Discussions by the
30
29
rd
The allocation of Cohesion funds (1/3 of the Structural & Cohesion
commitments to Poland) is conditional on a country’s budget deficit to
stand below the 3% Maastricht criterion.
Deutsche Bank Securities Inc.
Portfolio allocation limits include 90% ceiling on equities, 20% cap on
cash deposits, 10% cap on any security of listed firm in public offer, 10%
cap on closed investment funds, 15% cap on open investment funds and
40% cap on municipal bonds.
Page 123
5 December 2013
EM Monthly: Diverging Markets
The ban on OFE advertising is maintained until 31July 2014, but should be lifted afterwards.
Stringent regulations requiring detailed disclosure
on the state of the funds and the risks inherent to
private funds should be enforced.
Starting ten year before official retirement age,
future pensioners’ OFE accumulated assets will be
transfers at monthly frequencies (amended rule
compared to first draft bill) from OFE accumulated
account to social insurance board ZUS will operate
on monthly frequency. Transfers will amount to 1/n
of assets remaining on the pension fund account,
with n the number of months to retirement age.
The pension overhaul will modify metrics and possibly
market dynamics.
From a debt management perspective, the market
impact of the cancelation of the transferred pension
funds assets will operate along three dimensions. On
an immediate basis, although private pension funds
were not crucial provider of flows on the secondary
market for domestically issued government bonds,
their disappearance from the local bid may generate
some liquidity and volatility tensions next year.
Regarding the creditor base for POLGB, the share of
foreigners holdings should jump from 35% to 45% of
the market (levels only observed in Hungary and
Malaysia at the mid-2013 foreign participation peak)
adding to systemic risk concerns. And the conundrum
comes in full circle once factoring in that the
redemption of OFEs assets will bring the share of
foreign currencies denominated debt in total
government debt close to 35%, already above the debt
management objective of a 30% maximal share.
Further tapping of the international market would add
to the FX denomination problem, while calling on to
domestic market financing would potentially lead to
increase further foreign participant control. Both risks
are highlighted by the ministry of finance, and the draft
bill detailed below gives some hints on the government
intent and expectations.
From a fiscal perspective, once the pension reform has
taken place, the debt to GDP ratio will drop by 7pp and
new debt thresholds will come into effect. Existing 55%
and 60% thresholds and related sanctions (1pp VAT
hike and set of fiscal consolidation measures for the
former; budget surplus for the latter) will remain in
place, while new 43% and 48% thresholds should be
introduced and linked to a permanent expenditure rule
(earlier 50% threshold was already suspended). With
the Ministry of Finance forecasts of the debt ratio to
settle around 46.5-47.5% in the next several years (we
foresee an upside risk on this forecast in 2015, election
year), only the 43%-threshold rules should be triggered.
We do not expect the attached constraints to be
particularly stringent, but Polish powers-that-be will be
judged on their ability to consolidate and lock in the
debt reduction stemming from the pension reform, or
criticized for filling in the resulting fiscal space with
voter-friendly spending.
Page 124
About a third of the budget net financing needs may
get drawn from international markets.
The 2014 draft state budget sets a PLN 47.7bn deficit
target (2.8% of GDP), taking net borrowing needs to
PLN 55.4bn (about EUR 14bn). The details of the draft
bill31 reveal issuance plans weighting on domestic and
international markets.
On the POLGB side the bill sees a net issuance of PLN
31bn (about EUR 7.4bn) worth of marketable bonds
(compared to 39bn in 2013), beyond PLN 58.9bn worth
of redemptions to be rolled over. It estimates a net
placement of only PLN 4bn with foreign investors, who
had absorbed a net PLN 10bn in 2013. While the net
participation of banks is estimated to stay relatively
constant at PLN 21.4bn, the bill is counting on the
‘non-banking’ sector to ramp-up their participation
from 2.5bn this year to 7bn next year. We have no
information on the incentive structure that may lead to
such an outcome.
On the international market side, the draft pencils in
PLN 14bn of net revenues, from PLN 29.2bn of
issuances (about EUR 7bn, USD 9bn) and netting out
PLN 15.2bn worth of amortizations.
EDP exit officially recommended to be postponed until
2015, and pension reform impact on deficit numbers
netted out in next year EU regulatory framework.
With a 2013 deficit at 4.8% of GDP, Poland is missing
previous EC-recommended headline deficit target of
3.6%. In 2014, according to accounting norm ESA-95,
the Commission forecasts a potential 4.6% budget
surplus thanks to the one-off transfer of OFEs assets
(worth 8.5 GDP points). Although the excessive deficit
is corrected in 2014, it is not occurring on sustainable
grounds, so that on a no-policy change basis the
commission foresees Polish deficit to ramp up to 3.3%
of GDP in 2015. Furthermore, from Sep’14, accounting
norm ES-2010 will start to apply, and expunge the
pension reform impact from numbers, according to
which the commission forecast for Polish deficit stands
at 4.2% of GDP in 2014 and 3.9% in 2015. The
commission staff recommendation issued on Nov 15 to
the European council suggests postponing to 2015 the
tentative goal for Poland exit of the Excessive Debt
Procedure, which it sees requiring additional fiscal
measures worth 0.4% of GDP in 2014 and 1% of GDP
in 2015 above and beyond the current planned
measures (in particular the excise taxes hike expected
in January).
Risk of early elections
The PO-PSL coalition is now half way through its term
with the next scheduled general election in two years.
Three defections from PO in September have left the
coalition with only one seat more than that required for
a Parliamentary majority and a more recent scandal has
left two additional MPs suspended. The coalition does
31
See Section 22 of the draft bill reasoning
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
have some support from independents MPs from
Palikot so even if the formal majority is lost it is not
certain that the government would fall. Nevertheless,
the situation is not particularly stable and opposition
PiS may have an incentive to push for early elections as
several opinion polls give them a lead. The caveat is
that PiS would be aware that the opinion polls in
Poland have not been a good predictor of election
results in the past and are no guarantee of a win.
Parliament lower house (Sejm), 460 seats
Party
MPs
%
Civic Platform (PO)
203
44.1
Law and Justice (PiS)
137
29.8
Palikot Party (RPP)
36
7.8
Democratic left Alliance (SLD)
26
5.7
Polish people's party (PSL)
29
6.3
United Poland
17
3.7
Independent
8
1.7
Dialogue Initiative
4
0.9
PO-PSL coalition
232
50.0
Source: Polish Parliament,Deutsche Bank
The NBP’s official forward guidance makes the
tightening cycle unlikely to start before July 2014.
A clear forward guidance was announced at the
November meeting, stating explicitly that the policy
rate should be kept unchanged “at least until the end
of the first half of 2014”.
On the MPC composition front, PO President
Komorowski must appoint a replacement for MPC
member Gilowska by early January at the latest. A
dovish appointment is expected with the government
very critical of the MPC's past slow pace of easing.
This would tilt the dynamic from a broadly balanced
MPC. Given the expressed guidance, the nomination
would have no medium term implication, but may
render hikes harder to pass later in 2014.
The latest NBP inflation report released in November
foresees an inflation profile below the 2.5% YoY pavg
target for the next two year and until the end of the
projection horizon in Q4 2015. Although we agree on
the relatively benign inflation prospects, we expect a
modest acceleration as the economy is emerging from
recession and some administered price cuts drop out of
the yearly window. In that context we see inflation
ramping progressively back up above 2% YoY by Q2
2014, and reach the NBP target by Q4.
All in all, we expect the pick-up in real activity and
likely upward pressure on inflation to pave the way to
next year tightening cycle in Poland. We think that the
first hike may occur in July 2014, an inflation report
month, by which time inflation and growth forecasts
would have been revised upward.
Lionel Melin, London, +44 207 545 8774
Deutsche Bank Securities Inc.
Poland: Deutsche Bank Forecasts
2012
2013F
2014F
2015F
490.0
37.6
13019
509.3
37.6
13563
505.7
37.5
13496
519.0
37.4
13882
Real GDP (%)
Priv. consumption
Gov’t consumption
Gross capital formation
Exports
Imports
1.9
1.2
0.2
-0.5
3.9
-0.6
1.4
0.4
1.7
-2.0
4.5
0.5
3.0
3.0
1.2
4.0
8.0
7.0
3.9
3.5
1.5
5.5
8.5
8.0
Prices, Money and Banking
CPI (YoY%, eop)
CPI (YoY %, pavg)
Broad money (M3)
2.4
3.7
10.0
1.5
1.0
4.9
2.5
2.3
8.1
2.8
2.7
8.7
Fiscal Accounts (% of GDP)
ESA 95* fiscal balance
Revenue
Expenditure
Primary balance
-3.9
38.4
42.3
-1.1
-4.8
36.7
41.5
-2.1
4.0
45.3
41.3
6.2
-3.1
37.5
40.6
-0.9
External Accounts (USDbn)
Exports
Imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI (net)
FX reserves (USD bn)
PLN/USD (eop)
PLN/EUR (eop)
188.4
195.3
-6.9
-1.4
-17.4
-3.5
4.2
96.1
3.09
4.08
202.1
203.5
-1.3
-0.3
-7.0
-1.4
5.9
91.7
3.35
4.19
201.8
203.1
-1.3
-0.3
-8.0
-1.6
5.7
85.5
3.48
4.00
206.7
213.6
-6.9
-1.3
-13.0
-2.5
5.5
83.5
3.55
3.90
Debt Indicators (% of GDP)
Government debt
Domestic
External
Total external debt
in USD bn
Short-term (% of total)
52.7
36.1
16.6
70.5
345.5
24.9
54.9
37.1
17.8
72.0
366.7
24.8
47.4
29.2
18.2
76.6
387.6
25.0
48.2
29.3
18.9
78.7
408.7
24.9
1.4
12.8
2.9
12.9
4.5
11.8
6.0
11.0
Current
14Q1
2.50
4.14
3.37
14Q2
2.50
4.10
3.41
14Q4
3.50
4.00
3.48
National Income
Nominal GDP (USD bn)
Population (mn)
GDP per capita (USD)
General (YoY%)
Industrial production
Unemployment
Financial Markets (eop)
Policy rate
PLN/EUR
PLN/USD
2.50
4.20
3.10
Source: Haver Analytics, CEIC, DB Global Markets Research
* Under ESA-95, the general government balance would improve in 2014 by the value of the assets
transferred to ZUS from OFEs. Under ESA-2010, which comes into force in September 2014, this
one-off transfer would not count as revenue any more.
Page 125
5 December 2013
EM Monthly: Diverging Markets
Russia
Baa1(stable)/BBB(stable)/BBB(stable)
Moody’s/S&P/Fitch
„
Economic outlook: Recovery is not yet entrenched;
deceleration in inflation is progressing more slowly
than expected.
Main
risks:
Persistent
capital
accentuation of economic slowdown
35%
25%
outflows;
Investment yet to recover
In October overall growth figures improved, with GDP
expansion accelerating to 1.8% yoy. The improvement
came partly on the back of the recovery in fixed
investment growth, which has been one of the weakest
segments in Russia’s economy throughout this year.
On the fiscal front, the federal budget continues to run
a surplus, although vulnerability remains given the
weak dynamics in non-oil tax revenues. On the
monetary front, the Central Bank of Russia (CBR)
believes consumer prices are likely to exceed the 6%
target for 2013, with the CBR keeping rates on hold in
October.
Russia’s economic growth remains a key focus
On the real economy front, the indicators continued to
exhibit weakness following disappointing numbers in
September and August. Industrial production declined
by 0.1% yoy in October after recording growth of 0.3%
yoy in September and 0.1% yoy in August. Across the
industries, manufacturing continued to witness a
decline, this time down by 1.7% yoy after -0.7% yoy in
September and -0.2% yoy in August. Mineral extraction
segment growth in October remained close to
September’s growth rate of 1.8% yoy after 1.7% yoy in
September and 2.0% yoy in August, while the
gas/water/electricity segment continued to gain for the
second month in a row, posting 1.9% yoy growth vs
2.9% yoy in September. Regarding other indicators,
fixed asset investments declined 1.9% yoy after
contracting 1.6% yoy in September, 3.9% yoy in
August and 1.2% yoy over 10M13. Continuing its weak
performance so far this year, construction declined
3.6% yoy in October after declining 2.9% yoy in
September and 3.1% yoy in August, while agriculture
posted strong growth of 26.3% yoy in October after
declining 1.4% yoy in September.
On the consumer side, retail sales grew by a strong
3.5% yoy after 3.0% yoy growth in September, fuelled
by a rise of 4.9% yoy in disposable income. Real wages
growth decelerated to 4.1% yoy from 8.2% yoy in
September, while the unemployment rate inched up by
20bp to 5.5%.
Page 126
Russia: key economic indicators dynamics
15%
% yoy
„
5%
-5%
-15%
-25%
-35%
2007
2008
IP, YoY, real, %
2009
2010
Fixed investment, YoY, real, %
2011
2012
2013
Retail sales, YoY, real, %
Construction, YoY, real, %
Source: Rosstat, Deutsche Bank
Overall, Russia's macro figures in October were a
mixed bag, with investments exhibiting the all-toofamiliar negativity, while retail sales posted moderate
positive dynamics. The persistence of the decline in
investment runs counter to the official projections that
are still predicated on a moderate uptick in investment
activity in the final quarter of the year. In the near term,
growth appears to continue to rely on consumption,
which managed to post relatively good figures in
October despite the rise in unemployment and lowerthan-expected growth in real income.
On the broader economic performance, the thirdquarter GDP growth results did not bring any
substantial acceleration, with the headline growth
standing at 1.2% yoy vs. 1.2% yoy in 2Q13 and 1.6%
yoy in 1Q13. Earlier, Economy Ministry officials
acknowledged that stagnation continued in 3Q13. They
reiterated expectations that growth should revive on
the back of base effects in 4Q13, but could be less
buoyant on the back of decelerating consumption.
Overall, the current weak performance of key economic
indicators creates significant risks to the official FY13
GDP growth forecast of 1.8%. Given the weak GDP
growth performance so far this year, we have lowered
our GDP growth projection for 2013 from 2.0% yoy to
1.5% yoy, although we note the possibility of
subsequent revisions to the 2013 GDP growth figure,
particularly on account of higher growth in agriculture
and possible upward revisions to investment.
As for the mid-term perspective, the projected growth
rates would, to some extent, depend on the ability of
the authorities to launch those infrastructure projects
and structural reforms, which could boost the economy
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
and improve the efficiency of state-owned companies
partially, by means of privatization. We have revised
our GDP growth projection from 3.3% to 2.4% for 2014,
given the lack of structural reform effort, the
persistence of capital outflows sapping growth in fixed
investment and risks of further deceleration in
consumer expenditures.
With respect to consumer outlays, we note that the
authorities are increasingly looking to limit the scale of
social spending going forward, which could constrain
further expansion in real disposable income. The latter,
however, could receive some support from lower
inflation, with low unemployment also being a positive
factor. We also project consumer lending to decelerate
from 28% in 2013 to 25% in 2014, which might at the
margin also weaken the growth momentum in
consumption.
In the investment sphere, we expect some acceleration
on the back of lower interest rates as well as the
improvement in global sentiment. We also see some
scope for improvement in construction, with new large
projects, including in New Moscow, potentially
contributing to a recovery in investment activity.
Federal budget surplus declines to 1.1% of GDP in
10M13
According to the fiscal authorities, over 10M13 the
budget recorded a surplus of RUB609bn, declining
from RUB891bn over 9M13. As for October itself, the
budget recorded a deficit of RUB44.2bn. Over 10M13,
revenues amounted to RUB10,740bn (19.7% of GDP)
mainly on the back of more-than-projected oil revenues
of RUB5,360bn (9.7% of GDP), while non-oil revenues
were executed at RUB5,380bn (9.8% of GDP). On the
other side, expenditure amounted to RUB10,131bn
(18.4% of GDP).
Russia: T12M federal budget execution
22.0
0.8
0.6
21.5
0.4
0.0
% GDP
% GDP
0.2
21.0
-0.2
20.5
-0.4
-0.6
20.0
-0.8
19.5
Oct-13
Sep-13
Jul-13
Aug-13
Jun-13
Apr-13
May-13
Mar-13
Jan-13
Feb-13
Dec-12
Oct-12
Budget Revenues, % GDP
Budget Balance, % GDP (RHS)
Nov-12
Sep-12
Jul-12
Aug-12
Jun-12
Apr-12
May-12
Mar-12
Jan-12
Feb-12
-1.0
Budget Expenditure, % GDP
0.7% of GDP compared to a surplus recorded in
January-October 2013.
In November the State Duma in the third (final) reading
approved the state budget of 2014-2016 and
amendments to the state budget of 2013. The draft law
of 2013 budget guides for revenues of RUB12.9tr and
expenditures of RUB13.4tr. The more conservative oil
price assumptions implemented in the old version of
the budget enabled the authorities to decrease the
deficit by 0.1pp of the GDP from RUB521bn (0.8%
GDP) to RUB481bn (0.7% GDP) for 2013. However, as
additional inflows are coming from oil revenues, the
non-oil budget deficit is to increase from 9.7% GDP to
10.3% GDP.
Russia: Budget 2014-16 – key parameters
RUB bn
Revenues
% GDP
Expenditures
2013
2014
2015
2016
12,905
13,569
14,545
19.1
18.5
18.3
15,906
18.3
13,387
13,960
15,361
16,391
% GDP
19.8
19.0
19.3
18.9
Surplus (+)/deficit (-)
-482
-391
-817
-485
% GDP
-0.7
-0.5
-1.0
-0.6
non-oil deficit, % GDP
10.3
9.4
9.6
8.5
Source: Vedomosti, Interfax, Ministry of Finance, Deutsche Bank
In accordance with the approved 2014-2016 budget
draft, the federal budget for 2014 will amount to
RUB13.569tr (18.5%
GDP) in revenues
and
RUB13.960tr (19.0% GDP) in expenditures, with the
budget deficit targeted at RUB391.4bn (0.5% GDP) in
2014. The projected oil price for 2014 is USD101/bbl
(Urals).
We project the budget deficit in 2014 to reach 1.1% of
GDP, which is partly predicated on a lower growth
assumption compared to the official growth forecast of
3.0% yoy. We also expect to see continued difficulties
in non-oil revenue tax performance, although some
progress may be observed in higher dividend payments
by Russia’s state companies next year as the Ministry
of Finance aims to boost non-tax revenues.
Inflation still outside of the target range, as CBR keeps
rates on hold
According to Rosstat, Russia’s CPI accelerated to 0.6%
mom in October from 0.2% mom in September, which
translates into 6.3% yoy in October vs. 6.1% yoy in
September and 6.5% yoy in July-August and more than
7.0% yoy in January-May 2013.
Source: Rosstat, Ministry of Economy, Ministry of Finance, Deutsche Bank
Overall, we believe that in the remainder of the year,
the budget is likely to exhibit the seasonal rise in
spending, with the authorities targeting a deficit of
Deutsche Bank Securities Inc.
Page 127
5 December 2013
EM Monthly: Diverging Markets
Russia: CPI and its components’ dynamics
25%
20%
15%
10%
5%
Jan-07
Apr-07
Jul-07
Oct-07
Jan-08
Apr-08
Jul-08
Oct-08
Jan-09
Apr-09
Jul-09
Oct-09
Jan-10
Apr-10
Jul-10
Oct-10
Jan-11
Apr-11
Jul-11
Oct-11
Jan-12
Apr-12
Jul-12
Oct-12
Jan-13
Apr-13
Jul-13
Oct-13
0%
CPI, YoY, %
Services, %, YoY
Food, %, YoY
Core CPI, %, YoY
Non-food, %, YoY
Source: Rosstat, Deutsche Bank
Across components, growth was mainly attributed to
seasonal hikes in the new harvest of crops and
vegetables. This led to a spike in food prices from 6.3%
yoy in September to 6.9% yoy in October. Non-food
prices also accelerated from 4.7% yoy in September to
5.0% yoy in October, while services prices growth
moderated slightly to 7.7% yoy. The core CPI remained
stable at 5.5% yoy.
On 8 November, the Central Bank of Russia (CBR)
announced that it had decided to keep its key policy
rate unchanged at 5.50%, supported by its assessment
of inflation risks and economic growth prospects.
Russia: CBR policy rates
10.00
CPI,
% yoy
9.00
8.00
RUB-leg
FX-swap
fixed o/n
credit
min-max
fixed 312P
7.00
1D fixed repo
(%)
o/n departures
from refi rate
1W auction
repo
1W auction
depo
4.00
3.00
o/n fixed
depo
Dec-10
Jan-11
Feb-11
Mar-11
Apr-11
May-11
Jun-11
Jul-11
Aug-11
Sep-11
Oct-11
Nov-11
Dec-11
Jan-12
Feb-12
Mar-12
Apr-12
May-12
Jun-12
Jul-12
Aug-12
Sep-12
Oct-12
Nov-12
Dec-12
Jan-13
Feb-13
Mar-13
Apr-13
May-13
Jun-13
Jul-13
Aug-13
Sep-13
Oct-13
Nov-13
2.00
Source: Rosstat, CBR, Bloomberg Finance LP, Deutsche Bank
In its statement the CBR noted that the dynamics of the
key macroeconomic indicators continued to point to a
slow pace of economic growth with production activity
and investment demand remaining subdued as
business confidence continued to deteriorate.
Meanwhile, Russia’s consumer sector remained the
major driver of economic growth supported by real
wage and retail lending growth. The unemployment
rate remained at a relatively low level. In line with that,
according to CBR estimates, weak investment activity
and sluggish external sector growth would likely
constrain economic growth to low rates in the medium
term. In addition, the monetary authorities expect gross
output to stay marginally below its potential level.
Page 128
Russia: Base case monetary policy guidance
eop
target CPI, % yoy
2013
2014
2015
2016
5-6
5.0
4.5
4.0
Monetary base, RUBbn
8583
9130
9788
10500
Money supply, % yoy
12-14
11-13
12-14
12-15
Credit growth, % yoy
15-18
12-16
12-15
13-16
CA, USDbn
32
19
5
-3
Net capital flows, USDbn
-55
-20
-10
5
Source: Vedomosti, Interfax, Ministry of Finance, Deutsche Bank
Looking ahead to 2014, we believe that there is scope
for inflation to decelerate significantly to around 5.0%
on the back of the regulated tariff freeze. We expect
the scale of the inflation slowdown to be up to 1-1.5
percentage points, which should provide enough room
for the monetary authorities to reduce key rates by 2550 basis points. Apart from the interest rate changes
next year per se, a lot depends on how the CBR
conducts its liquidity management operations.
new key rate 1W auction repo/depo
6.00
5.00
Regarding monetary issues, the CBR noted that
inflation in October accelerated to 6.3% yoy, which is
still above the upper band of the inflation target range
(5-6% yoy). The main reasons for acceleration of
consumer prices are believed to be non-monetary
factors, particularly seasonal growth of food prices. As
a result, core inflation rate remained at 5.5% yoy. The
factors that contributed to the inflation dynamics in
October, according to the CBR, are likely to be
significant in the short term; as for the medium term,
the monetary authorities project inflation to decline
further in 2014. However, according to the CBR, more
pronounced downward trends in inflation expectations
are needed to ensure the achievement of inflation goals
in the medium term.
Rouble: oil price risks and persistence of outflows
A the end of November the rouble exhibited signs of
weakness that were likely due to a series of external
and domestic factors, among which jitters around the
stability of the banking system, fears of lower oil prices
as well as co-movements in EM currencies on the back
of QE tapering played a prominent role.
At the end of November the rouble hit a record low
against the basket (55% USD +45% EUR), climbing to
RUB/BASK38.49, the highest level since August 2009.
The rouble also depreciated vs. the dollar by 18 kopeks,
exceeding the level of RUB/USD33.0, while the euro
increased by 32 kopeks to RUB/EUR45.0. Meanwhile,
the CBR increased the targeted basket interval for the
sixth time in a row in November to RUB/BASK32.6539.65.
At the same time, oil prices have not descended much
from the USD110/bbl level. Importantly, however, the
rouble has become significantly less correlated with the
oil price in the past several months. We expect this,
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
however, to be reversed next year, with growing
correlation of the rouble to the oil price being partly a
function of the global developments surrounding the
tapering of stimulus in the US.
Overall, we have revised our rouble exchange rate
forecast for 2014 to take into account the possibility of
continued capital outflows, the reduction in the current
account surplus and a lower oil price. We have revised
our end-2014 forecast to RUB/USD33.6 from
RUB/USD32.3 previously. On the economic policy front,
we do not expect the CBR to actively support the
rouble via large-scale interventions and instead we
believe that the course towards inflation targeting and
greater exchange rate flexibility will be maintained.
Trade balance surplus stable in September
The Central Bank of Russia (CBR) released an update
on external sector activity in September. According to
the monetary authorities, the trade balance (TB) of
goods remained flat on a yoy basis in September and
amounted to USD15.71bn vs. a decline of 4% yoy in
August and a sharp 20% rise yoy in July. Overall,
exports were up by 3.2% yoy in September to
USD44.54bn, while imports expanded by 5.3% yoy to
USD28.83bn. On a ytd basis, the TB in goods declined
by 9% yoy from USD146.84bn to USD133.59bn. Over
9M13, exports amounted to USD382.78bn, -1.3% yoy,
with imports at USD249.19bn, + 3.4% yoy.
Russia: Trade Balance of Goods Dynamics, USDbn
25
60
50
20
15
30
10
USDbn
USDbn
40
20
Russia: Deutsche Bank forecasts
2012
National Income
Nominal GDP (USDbn)
Population (m)
GDP per capita (USD)
2013F
2014F 2015F
2 004 2 218 2 269 2 407
143
143.2 143.2 143.2
14 009 15 496 15 854 16 816
Real GDP (yoy %)
Priv. consumption
Govt consumption
Investment
Exports
Imports
3.4
1.5
2.4
2.8
6.6
0.0
6.0
1.8
8.7
4.8
-0.1
0.1
2.0
7.2
4.7
-0.3
2.6
2.4
5.5
4.9
0.2
3.1
2.6
4.8
Prices, Money and Banking
(eop)
CPI (YoY%) eop
CPI (YoY%) ann avg
Broad money
Credit
6.6
5.1
11.9
19.1
6.4
6.7
11.2
18.0
4.8
5.2
10.3
15.6
5.4
4.7
12.2
15.0
Fiscal Accounts (% of GDP)
Federal budget balance
Revenue
Expenditure
Primary surplus
-0.1
20.5
20.6
0.5
-0.6
19.1
19.7
0.0
-1.1
18.0
19.0
-0.5
-1.3
18.1
19.4
-0.7
External Accounts (USDbn)
Exports
Imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI (net)
FX reserves (USDbn)
RUR/USD (eop)
529.1
335.8
193.3
9.6
74.8
3.7
0.4
537.6
30.5
524.3
347.0
177.4
8.0
38.7
1.7
4.5
520.0
31.8
518.7
344.3
174.4
7.7
37.8
1.7
7.8
514.0
33.6
540.9
364.6
176.2
7.3
24.2
1.0
9.0
503.0
34.2
11.5
8.0
3.5
31.8
636.4
11.8
8.4
3.4
33.1
735.1
12.0
8.6
3.4
33.6
763.2
12.1
8.7
3.4
34.6
832.7
2.6
5.7
0.0
5.5
3.4
6.0
3.6
6.3
Financial Markets (eop)
Spot
1Q14
2Q14
4Q14
Policy rate
RUB/USD
5.50
33.25
5.25
33.1
5.25
33.5
5.25
33.6
5
10
Debt Indicators (% of GDP)
Exports, USDbn
Jul-13
Sep-13
May-13
Jan-13
Mar-13
Nov-12
Jul-12
Sep-12
May-12
Jan-12
Imports, USDbn
Mar-12
Nov-11
Jul-11
Sep-11
May-11
Jan-11
Mar-11
Nov-10
Jul-10
Sep-10
May-10
Jan-10
0
Mar-10
0
Trade balance, USDbn (LHS)
Source: Rosstat, CBR, Deutsche Bank
Overall, as we noted in our report on Q3 2013 CA
contraction, we see some recovery in CA dynamics in
the near term, with the declining trajectory in 2014 still
leaving the overall CA balance in surplus, which in our
view could also persist throughout 2015.
Yaroslav Lissovolik, Moscow, +7 495 933 9247
Artem Zaigrin, Moscow, +7 495 797 5274
Deutsche Bank Securities Inc.
Public debt
Domestic
External
Total external debt
in USDbn
General (% pavg)
Industrial production (% yoy)
Unemployment
Source: Source: Official statistics, Deutsche Bank Global Markets Research
Page 129
5 December 2013
EM Monthly: Diverging Markets
South Africa
Baa1 (negative)/BBB (negative)/BBB (stable)
Moody’s/S&P/Fitch
„
Economic outlook: the outlook remains hesitant
given the lack of local catalysts to growth. There may
be some improvement in export-oriented sectors, but
a retreat in credit growth, a weak employment
outlook and timid confidence levels could weigh on
domestic demand next year.
„
Main risks: the large current account deficit and
reliance on portfolio inflows will ensure that the rand
and bonds remain vulnerable to Fed tapering.
Macro view: Navigating choppy waters
At the end of last year we called the start of a very
difficult growth cycle for the economy in 2013. The lag
between DM growth and SA would lead to an
improvement in export volumes and domestic demand
in 3Q13. Terms of trade weakness was identified as
another constraint to growth, forcing pressure on
domestic income, demand and imports, and by
extension the current account deficit (CAD). Economic
growth expectations were downgraded from 2.7% at
the start of the year to 1.9% currently, mostly on
account of weaker net exports. On these grounds we
underestimated the rigidity of imports (infrastructureled) and the role of a much weaker currency in this
regard. Sluggish demand in trade partner countries and
localised production losses during times of industrial
action were also factors in this regard. The CAD
exceeded our expectations and could average 6.6% for
the year; this despite projections of a slowdown in
gross domestic expenditure to 2.9% (from 4%).
We see growth recovering to 2.9% next year, but even
this may be a stretch, as it would take a significant
turnaround in exports to generate this momentum. In
former publications32 we wrote about the importance of
global demand and the links to a self-sustaining
domestic recovery. In times where domestic growth
catalysts are elusive, it may take at least four
consecutive quarters of sustained growth in externaloriented sectors33 for growth to gather pace in the rest
of the economy. At this juncture, where the domestic
credit cycle is retreating, housing market activity is
pedestrian, net capital flows are virtually negative, and
government is exercising expenditure restraint, money
supply growth should be below nominal GDP growth.
That is to say domestic growth catalysts are virtually
absent. And electricity restrictions may only lift late
next year when Medupi comes on stream. Thus
domestic growth could remain hampered for a while
still. The figure below illustrates this relationship.
South Africa: External and internal sector output gaps risks of sub-trend growth remain high
8
% deviation from trend
* Downswings
4
0
-4
South Africa: Breakdown of GDP growth
6
-8
1980 1984 1988 1992 1996 2000 2004 2008 2012
% point contibution to yoy growth
4
0.8
0.9
0.9
2
2.8
3.2
-0.4
-0.9
-1.2
2010
2011
0
External sector - output gap
0.9
0.8
0.6
0.5
2.3
0.7
0.7
0.4
1.8
1.6
-1.7
-1.2
2012
2013E
-2
Net trade
Government
Inventories
Households
2014F
Investment
DBe1
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
Internal sector - output gap
Source: Deutsche Bank, StatsSA
GDP growth fell to 0.7% qoq saar in Q3, the slowest
growth since the recession in 2009. The weakness was
concentrated in the manufacturing sector, even though
there has been some improvement in export volumes,
as the nine-week long strike weighed significantly on
the automotive sector. The mining sector recovered
lost production in Q3 following industrial action in Q2,
and was ironically the largest contributor to growth in
Source: Deutsche Bank, SARB
The outlook for 2014 is an unexciting one, depending
to a large extent on improving global demand (Figure).
Page 130
32
See EMM, 10 June 2011 and 8 November 2012
33
Agriculture, mining and manufacturing sectors. Internal sectors largely
capture domestic-demand oriented industries, such as trade, finance and
business services, construction and government services.
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Q3. We were surprised to the downside by the
slowdown in tertiary sector value add, where growth
fell to 1.3% (the lowest since 3Q09) led by weakness in
the broader trade and finance sectors. Poor business
confidence and very weak growth in employment in
the traded-goods sectors are weighing on business
service industries.
But at least three factors should support the recovery in
external-oriented sectors next year: 1) the recovery in
US and China and by extension EM exports; 2)
potential productivity gains as the number of mandays
lost due to strikes (4.7 million from January to
September – the highest since 2011)34, should fall after
several industries settled multi-year wage agreements
in 2013; and 3) enhanced price competitiveness
following extensive rand weakness. Improved activity
may not necessarily lead to better working conditions
for workers in these sectors, but it may go a long way
in reducing some of the tensions in the labour market,
where massive labour grievances exist. Income
inequality remains one of the structural reasons behind
social and labour unrest, so strike activity may not
disappear next year, but some improvement is
expected. If productivity in the mining sector was to
improve towards the economy-wide average, the
sector could directly add 0.3% to GDP and indirectly at
least a further 0.7% - taking GDP growth from c. 3.2%
to c. 4%. Under very tight electricity supply
circumstances, the growth potential will be capped at
around 3%. But this point serves to demonstrate the
importance of recovery in external sectors.
South Africa: Labour productivity vs mandays lost due
to strikes
120
2008 = 100
5m
13m
3m
4m
110
100
90
80
2008
Mining
Manufacturing
Total non-agriculture
2009
2010
2011
2012
2013
2014
Source: Deutsche Bank, SARB
That mandays lost due to strikes have escalated this
year is no coincidence. Strikes tend to pick up in years
preceding elections or leadership changes. The current
ructions within Cosatu could still have a major bearing
34
Up from 4.5 million in 2012. In 2011 5.3 million mandays were lost.
Deutsche Bank Securities Inc.
on strike activity and political dialogue given the deep
rifts in the labour union body and disenchantment of
some members with the ANC. The election date is still
not fixed, but should be held within 90 days after the
13th of April when the term of the incumbent
Parliament expires. We expect the ANC to gain around
60% of votes (down from 66%), and for the DA (c.24%
of votes up from 17%) and recent new comers like
Agang and Economic Freedom Fighters (headed by
Julius Malema) to gain some ground. Instability within
Cosatu may also bring old debates back to the fore.
Numsa (the largest affiliate in Cosatu), which is
considering ending ties with the federation, may bring
nationalisation, political control over the central bank’s
rate setting policy, currency intervention, wealth taxes
and increased social spending back onto discussion
tables. This may not all happen ahead of the elections,
but may gain increasing airtime as part of a broader
campaign against existing ANC policies. The EFF in
turn has been vocal on things like land distribution
without compensation and nationalisation. The reemergence of these debates could cause the ANC to
defend its position against the extreme left, forcing it
back onto a more centrist path in our view. Against this
backdrop, the outcome of post-election cabinet will be
closely scrutinised by credit ratings agencies.
The trajectory of state debt cost, public sector wages
and the health of state-owned entities’ balance sheets
are some of the key issues of vulnerability for South
Africa’s credit ratings. The magnitude and speed of the
Fed’s tapering programme and its consequences for
the exchange rate, bond yields and inflation are related
issues that cannot be ignored. Risks to the exchange
rate are significantly skewed to the upside, in our view.
Our revised rand forecasts make allowance for
sustained weakness around R10.5/USD in the first half
of next year (middle-of the range rather than absolute
ceiling). However, in a world where the market may
price an earlier fed funds hike, the rand could
depreciate significantly beyond R11/USD in the short
term. To be sure, the Fed’s tapering profile and how
the market perceives fed funds guidance will coincide
with still-high CAD outcomes and slow growth, making
the rand potentially one of the more vulnerable EM
currencies in 1H14 in our view.
These uncertainties and scenarios may have equally
devastating ramifications for bond yields, which have
already garnered a lot of attention by S&P owing to
implications for government’s debt ratio which should
peak around 48% of GDP. As it stands, the most likely
prospect for rating action exists on South Africa’s local
currency debt, where S&P rates domestic currency
debt at an unusual two-notch premium above foreign
currency debt, and one notch above Moody’s and Fitch
local currency rating. Fitch appears to have taken a
stand against further ratings revisions, citing SA’s
strong institutions, transparency and prudency in
monetary and fiscal policy, strength of the judiciary etc.
Page 131
5 December 2013
EM Monthly: Diverging Markets
as reasons acting against further downgrades. The
market sees downside risks to the sovereign rating
from Moody’s, because it is still one notch above the
S&P and Fitch comparative ratings. A downgrade here
is not unlikely but is not part of our base view.
Inflation has peaked at 6.2% in 3Q14, and likely to
recede towards 5.2% by end-2014. However, there are
numerous conflicting trends. Domestic demand is seen
slowing on aggregate hampering significant passthrough of exchange rate pressure, in our view. Oil
prices are also likely to be substantially lower next year,
helping to offset the expected weakness in the
exchange rate, which has already permeated luxury
goods prices. Overall, however, fuel prices should fall
early next year adding to disinflationary pressures in
headline inflation, though masking a rising trajectory in
core inflation which we expect to peak around 5.7% in
Q2. Headline inflation should ease to around 5.1% in
2014 (substantially below the SARB’s forecast of 5.7%)
from 5.7% while core inflation may push up to 5.6% (in
line with SARB forecasts) from 5.2% in 2013.
South Africa: Inflation profile
14
% YoY
Core CPI*
Headline CPI
12
10
8
6
4
2
0
2005
2007
2009
2011
2013
Source: Deutsche Bank, StatsSA
In our view, rate hikes are likely to remain back-loaded
(starting 2015) rather than front-loaded (consensus).
Though the SARB is concerned over inflation
expectations becoming unhinged, which may
necessitate policy tightening, inflation expectations are
backward looking. As inflation surprises to the
downside (reinforced by lower oil prices), so could
expectations.
Danelee Masia, South Africa, 27 11 775-7267
Page 132
2012
2013F
2014F
2015F
383.3
52.3
7331
350.1
53.0
6609
366.0
53.5
6839
428.8
54.0
7935
Real GDP (%)
Priv. consumption
Gov’t consumption
Gross capital formation
Exports
Imports
2.5
3.5
4.0
4.4
0.5
6.2
1.9
2.7
2.5
3.0
4.3
7.1
2.9
2.4
1.9
3.5
8.7
4.4
3.5
2.9
2.8
4.1
6.7
2.7
Prices, Money and Banking
CPI (YoY%, eop)
CPI (YoY %, pavg)
5.7
5.7
5.4
5.7
5.2
5.1
5.0
5.3
National Income
Nominal GDP (USD bn)
Population (mn)
GDP per capita (USD)
Budget balance
Revenue
Expenditure
Primary balance
Fiscal Accounts (% of GDP) 1, 2
-4.2
-4.1
-4.0
-3.5
32.5
32.8
32.6
32.0
28.3
28.7
28.6
28.5
-1.3
-1.0
-0.9
-0.4
External Accounts (USDbn)
Exports
Imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI (net)
FX reserves (USD bn)
ZAR/USD (eop)
ZAR/EUR (eop)
99.5
104.3
-4.8
-1.3
-20.1
-5.2
0.4
50.7
8.5
11.2
Government debt 1
Domestic
External
Total external debt
in USD bn
Debt Indicators (% of GDP)
42.5
44.8
46.5
47.5
38.6
40.5
42.8
43.7
3.9
4.3
3.7
3.8
37.1
37.1
36.9
33.8
142.3 130.0 135.0
145
*excluding food, non-alcoholic
beverages, fuel & energy
-2
-4
2003
South Africa: Deutsche Bank Forecasts
Financial Markets (eop)
Policy rate
3-month Jibar
10-year bond yield
ZAR/USD
ZAR/EUR
Current
5.0
5.1
8.1
10.2
13.6
94.3
104.6
-10.3
-2.9
-23.0
-6.6
1.1
49.0
10.1
13.2
14Q1
5.0
5.1
8.3
10.5
13.2
104.4
114.6
-10.2
-2.8
-20.3
-5.6
0.8
51.0
9.7
11.2
14Q2
5.0
5.1
8.7
10.2
12.5
114.5
124.5
-9.9
-2.3
-21.3
-5.0
0.8
55
9.3
10.2
14Q4
5.0
5.2
8.7
9.7
11.2
(1) Fiscal years starting 1 April.
(2) Starting with the November 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.
5 December 2013
EM Monthly: Diverging Markets
Turkey
Baa3 (stable)/BB+ (stable)/BBB- (stable)
Moody’s / S&P / Fitch
„
Economic outlook: tighter domestic liquidity
conditions will likely be enough to keep inflation in
check (albeit above target) but will weigh on
growth, which we expect to dip to 3.4% next year.
The current account deficit should narrow to 6.5%
of GDP due to lower gold and cheaper oil imports.
„
Main risks: the economy and the lira will remain
vulnerable to further weakness in capital flows in
an environment of rising US rates. Elections could
add to investor uncertainty.
Surviving the squeeze
The long-term prospects for the economy are among
the more favorable in the emerging world. In the short
term, however, large external financing needs leave the
economy vulnerable to higher US interest rates and
weaker capital inflows. The country is also about to
enter the most important election cycle for many years.
We think the economy will survive the year with its
solid long term prospects intact; but it will be a bumpy
ride and growth will likely be squeezed along the way.
Favorable long term prospects
Turkey appears well placed to ascend the rankings of
the world’s largest economies over the next 10-20
years. It currently ranks 16th when measured in terms
of purchasing power parity. On current trends, it would
reach 13th over the next 15 years, overtaking Spain,
Canada, and Italy in the process.
One should always be cautious about such
extrapolations. Not all is rosy. Private savings are too
low; the economy is heavily dependent on imported
energy; and net foreign direct investment has been on a
declining trend and is now less than 1% of GDP. All of
this leaves the economy dependent on shorter-term
financing from abroad and vulnerable to external
shocks. Domestically, the business climate is so-so,
ranking 69th in the World Bank’s Doing Business Survey,
toward the middle of the emerging market pack.
However, whereas the durability of growth models in
many emerging markets is now being questioned, the
Turkish economy has a number of core strengths that
should enable it to perform well over the next decade
or so, including:
„
Favorable demographics: Turkey has a young and
growing population and will face the burden of an
ageing population much later than many other
emerging and developing countries. It entered its
demographic window, i.e. the period when the
working age population is at its most prominent
relative to the young and old, relatively recently in
2002; it is set to exit this window only in 2037,
much later than Russia (2021) and China (2029), for
example. Turkey has not yet taken full advantage of
this demographic dividend. Participation in the
labor market is very low, especially among women.
Improvements in education would help in
deploying this ample pool of labor more fully in
higher valued added manufacturing and services.
„
Diversified export sector. Having a well diversified
export sector has tended to be associated with
stronger and less volatile growth. Turkey scores
well. By product, its exports are among the most
diversified in the emerging world, similar to China
and Korea. This has supported the solid
performance of exports in recent years. Export
volumes are now 30% above their pre-crisis levels.
The average gain in other emerging markets has
been about 20%. Research and development
spending, however, is quite low, less than 1% of
GDP, which could limit the ability of exporters to
move up the value chain.
„
Relatively low leverage levels. This applies to both
the public and private sector. The fiscal position is
enviable. The budget deficit is set to remain at a
moderate 2% of GDP over the next 2-3 years.
Public debt has fallen from well above to a little
below the emerging market average over the last
decade. With an unchanged primary balance, and
even assuming significantly higher interest rates,
we estimate that the debt level would fall to below
Next stop….Spain
World's largest economies by country rank (PPP basis).
6
8
6
Italy
8
Indonesia
10
12
14
Spain
Turkey
Indonesia
Italy
16
18
10
12
14
16
Turkey
Spain
20
18
20
1992
1998
2004
2010
2016
Source: Haver Analytics, IMF World Economic Outlook, Deutsche Bank
Deutsche Bank Securities Inc.
2022
2028
Page 133
5 December 2013
EM Monthly: Diverging Markets
30% of GDP by the end of this decade. Borrowing
by the private sector on the other hand has
expanded rapidly in recent years as interest rates
have fallen significantly. Credit to the nonfinancial
private sector, for example, has increased from
37% of GDP to 60% of GDP in 2013. This is a
potential concern but the level of leverage is still
below the median for other emerging markets,
which is 73% of GDP.
-1
-2
-3
-4
-5
-7
Total debt (% GDP)
240
Private
Current account balance (% GDP)
0
-6
Leverage levels in Turkey are still relatively moderate
220
The cyclically-adjusted current account deficit
Public
-8
Headline
-9
Cyclically-adjusted
-10
Jun-03
200
180
160
Jun-05
Jun-07
Jun-09
Jun-11
Jun-13
Source: Haver Analytics, Deutsche Bank
140
120
100
80
60
40
20
IDN
ARG
MEX
RUS
TUR
ZAF
IND
POL
BRZ
THA
CHN
MYS
KOR
HUN
0
Public debt is general government debt in 2012 from the IMF World Economic Outlook; private
debt is the stock of bank and non-bank credit to the non-financial private sector estimated by the
BIS. The total is the sum of the two series and is not consolidated.
Source: Haver Analytics, IMF, BIS, Deutsche Bank
Near-term vulnerabilities
We think the current account deficit has peaked. The
drop in gold prices pushed net imports of gold to about
USD 10bn (1.2% of GDP) this year. These imports have
fallen back sharply in recent months. Lower oil prices
should also help to reduce the energy import bill. These
two factors combined could reduce the trade deficit by
about 1.1% of GDP. With some slowdown in domestic
demand and a pickup in exports on the back of
strengthening external demand, this should be enough
to see the current account deficit narrow to 6.5% of
GDP in 2014 from 7.5% of GDP this year.
Turkey also has around USD 160bn of external debt
falling due over the next year. Turkish banks and
companies have had little difficulty in raising external
financing. Debt rollover rates have averaged over 125%
in the last three years. It is not a given that this will
continue, however, especially as US rates begin to rise
and the cost of external financing becomes more
expensive. Given our forecasts for the rest of the
balance of payments, we estimate that debt rollover
rates will need to average about 115% to avoid a drain
on foreign reserves.
Foreign reserves have increased since their low point
over the summer but remain low. Gross reserves
(including gold) have increased to USD 135bn from
USD 120bn in mid-July. But this largely reflects the
USD 14bn increase in FX deposits of the banking
sector parked at the Central Bank of Turkey (CBT). Net
usable reserves (excluding gold) have increased only a
little to USD 43bn as the CBT has continued to sell
modest amounts of FX to the market.
Gross and net foreign reserves
$bn
140
While this is a meaningful improvement, it leaves the
deficit uncomfortably high around the low point of the
economic cycle for Turkey. This is evident when we
adjust the current account for the effects of the cycle,
namely the tendency for imports (exports) to be strong
when domestic (external) demand is growing rapidly.
The cyclically-adjusted line in the chart below is our
estimate of where the current account would be if
domestic and foreign demand had both been growing
at their trend rates. It suggests that the improvement in
the deficit over the last year or two has been almost
entirely cyclical, reflecting the deceleration in domestic
demand. The underlying cyclically-adjusted deficit over
this period has been more or less unchanged at around
6½-7% of GDP.
Page 134
120
100
Gross reserves
80
Net usable reserves
60
40
20
0
Nov 11
May 12
Nov 12
May 13
Nov 13
Source: Haver Analytics, Deutsche Bank
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Private capital inflows slowed dramatically in May and
have remained weak through September, averaging a
little over USD2bn a month. With CBT unable to
intervene in significant amounts and maintaining a
relatively accommodative monetary stance, at least
initially, the lira weakened by 14% in trade-weighted
terms between April and November. Inflation
responded accordingly with both the headline and core
rates accelerating to above 7%.
Lira weakness has pushed inflation higher
YoY%
12%
YoY%
30%
Recession
10%
20%
8%
10%
6%
This would probably be enough to keep inflation in
check if the lira stabilized. However, we think the lira
could come under further pressure when the Fed
begins to taper and US rates drift upwards. Given the
risks that this would pose to the inflation outlook and
also concerns about the balance sheets of companies
that have borrowed heavily in FX, we think the CBT will
therefore likely have to tighten liquidity conditions a
little further, pushing overnight lending rates up by
another 125bps to 9.0% over the next quarter or two.
This will weigh on domestic activity. Welcome
regulatory steps to curb consumer lending will
additionally limit private consumption. Uncertainty
associated with the long election cycle may also see
some investment decisions being deferred. The weaker
lira and stronger external demand, however, should
support exports. On balance, therefore, we see GDP
growth dipping a little further below potential to about
3.4%.
0%
4%
-10%
2%
0%
Jan 06
Core goods prices (lhs)
Lira, lagged 3 months (rhs)
Jan 08
Jan 10
Jan 12
-20%
Jan 14
Source: Haver Analytics, Deutsche Bank
Since cutting interest rates in mid-May, the CBT has
tightened domestic liquidity conditions significantly.
Overnight interest rates have risen by about 350bps to
7.7%, which marks the upper end of the CBT’s interest
rate corridor. It has also effectively dropped the oneweek repo rate, which remains at 4.5%, as its main
policy rate. The overnight lending rate is now
effectively the policy rate.
The election wild card
There are several key elections over the next 18 months,
starting with municipal elections in March, presidential
elections in late-July or August, and parliamentary
elections by June 2015. The latest polls suggest that
the ruling AK Party would win in each case, though
who would assume the key positions of president and
prime minister appears less clear.
Support for AKP remains strong
Support for AKP (%)
56
54
52
50
48
Domestic liquidity conditions have been tightened
46
44
Overnight interbank rates, 5-day moving average (%)
8
42
40
7
38
36
Mar 2009
6
5
4
May 13
Feb 2010
Oct 2010
Sep 2011
Sep 2013
Source: Konsensus, Deutsche Bank
Jul 13
Source: Deutsche Bank
Deutsche Bank Securities Inc.
Sep 13
Nov 13
Prime Minister Erdoğan has vowed to respect his selfimposed three term limit, which would require him and
other senior members of the government to step down
at the end of the current parliament. Erdoğan has
designs on the presidency, which will be decided by a
popular vote for the first time this year. He has been
unable to change the constitution and create a more
powerful executive presidency; but we note he could
still use the popular mandate and some dormant
powers of the office to wield significant influence,
Page 135
5 December 2013
EM Monthly: Diverging Markets
especially if he is able to install a sympathetic
candidate as prime minister.
This is not a given. Support for Erdoğan still appears
strong, but he has faced increasing opposition from
various groups within the party. Moderates have
sought to distance themselves from his authoritarian
approach. Nationalists have objected to his overtures
towards Kurdish separatists. Tensions with followers of
the religious-social Gulen movement have been
growing. AKP deputies running up against their term
limits may also be amenable to a change in the party
statutes that would allow them to run for office again.
Erdoğan may therefore face a challenge for supremacy
within the AKP, most likely from Abdullah Gül, the
current President. He could either run for a second
presidential term or position himself to be the next
prime minister when Erdoğan resigns to run for the
presidency. The latter is more likely and something that
investors could find reassuring given Gül’s generally
more moderate and conciliatory tone, though the
overall approach to economic policy would probably
not differ much. It could, however, also herald a period
of uncomfortable power sharing between the two party
heavyweights if Erdoğan wins the presidency.
A likely alternative would be an Erdoğan presidency
with one of his supporters as prime minister, which
could lead to a further polarization of politics of the
kind that triggered the Gezi Park earlier this year.
Municipal elections in March would provide the first
signpost as to the likely outcomes. A weak showing by
the AKP, especially in the signature seat of Istanbul,
would weaken Erdoğan’s hand and increase the
likelihood of Gül replacing him as prime minister.
Turkey: Deutsche Bank Forecasts
2012 2013E
National Income
Nominal GDP (USD bn)
Population (mn)
GDP per capita (USD)
2014F
2015F
788.0
74.9
10523
817.1
75.8
10775
824.4
76.8
10736
863.2
77.8
11100
Real GDP (%)
Priv. consumption
Gov’t consumption
Gross capital formation
Exports
Imports
2.2
-0.6
6.1
-2.7
16.7
-0.3
3.7
4.1
6.1
3.0
3.4
7.2
3.4
1.5
5.0
2.8
7.9
3.3
4.4
3.4
4.0
3.7
8.4
5.3
Prices, Money and Banking
CPI (YoY%, eop)
CPI (YoY %, pavg)
Broad money (YoY%)
Bank credit (YoY%)
6.2
8.9
10.3
18.5
7.1
7.5
20.0
30.0
6.9
6.4
10.1
18.1
6.6
6.8
11.6
25.0
Fiscal Accounts (% of GDP)
Consolidated budget
Interest payments
Primary balance
-1.6
2.8
1.2
-2.3
3.0
0.7
-2.3
2.7
0.4
-2.3
2.5
0.2
External Accounts (USDbn)
Exports
Imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI
FX reserves
TRY/USD (eop)
163.2
228.6
-65.3
-8.3
-48.5
-6.2
9.0
99.9
1.79
162.4
240.3
-77.9
-9.5
-61.7
-7.5
7.1
110.0
2.03
169.3
241.2
-71.9
-8.7
-53.2
-6.5
9.8
115.0
2.15
178.9
250.4
-71.5
-8.3
-51.5
-6.0
10.3
120.0
2.30
36.2
25.4
10.8
42.8
337.5
29.9
36.0
25.6
10.4
46.2
377.8
30.3
34.9
24.9
10.0
49.7
409.9
30.0
33.6
23.6
10.0
51.0
440.3
30.0
2.5
9.2
3.0
9.4
3.6
9.5
4.6
9.5
Current
14Q1
4.50
8.75
7.50
10.1
2.06
14Q2
4.50
9.00
7.75
10.2
2.09
14Q4
4.50
9.00
7.75
10.2
2.15
Debt Indicators (% of GDP)
Robert Burgess, London, +44 20 7547 1930
Government debt
Domestic
External
Total external debt
in USD bn
Short term (% of total)
General (%)
Industrial production (YoY)
Unemployment (pavg)
Financial Markets (eop)
Repo rate
Overnight lending rate
Effective funding rate
10-year bond yield
TRY/USD
4.50
7.75
6.70
9.3
2.02
Source: Deutsche Bank, National Sources.
Page 136
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Ukraine
Caa1(negative)/B-(negative)/B(negative)
Moody’s/S&P/Fitch
„
Economic Outlook: Continued headwinds against
growth, most notably on the investment side, are
likely.
with the 3Q13 GDP down 1.5% yoy after -1.3% yoy in
2Q13 and -1.1% yoy in 1Q13 following -0.2% yoy in
2012.
„
Main Risks: A weak external position could be
exacerbated by uncertainty over the eventual
vector of Ukraine's trade integration.
The growth outlook for 2014 crucially depends on the
resolution of the political tensions that erupted in early
December of this year. In the case of a resolution that
opens up the possibility for receiving financial
assistance, we believe there might be some scope for
growth, albeit at a moderate pace. The possibility of
exchange rate weakness and budget constraints could
limit the expansion in household consumption. On the
other hand, there might be some support to growth
coming from the recovery in the EU and Russia –
Ukraine’s largest trading partners. In the base case we
expect the growth of the real sector to accelerate from
0.3% yoy in 2013 to 1.5% yoy in 2014 and 2.0% yoy in
2015.
Political uncertainty on the rise
In October, Ukraine’s economy continued to
experience significant pressure, with the slowdown
exacerbated by BoP difficulties, a decline in reserves
and increasing fiscal strains. Observing the difficulties
on the macro front, the Ukrainian government made a
sharp u-turn, postponing the signing of the association
agreement with the EU at the end of November,
leading to mass protests across the country. The
eruption of mass protests against the cancellation of
the deal imposes significant risks for the country,
potentially pushing it to the edge of political turmoil in
the near term. Given that, the current socially oriented
stance of the authorities (higher pensions, wages,
frozen gas tariffs, fixed exchange rate, etc) is unlikely to
change up to that point in a bid to protect votes. As a
result, the lack of structural reforms could lead to
further difficulties in budget implementation and state
debt refinancing.
In the real sector, Ukraine’s economic decline
continued to accelerate for a fifth consecutive month:
in October, industrial production decreased 4.9% yoy
after posting -5.6% yoy in September. The main drag
on IP growth was manufacturing, declining 9.8% yoy in
October. Within the manufacturing space, metallurgy’s
decline accelerated to -8.5% yoy from -5.9% yoy in
September; engineering continued to be weak, down
by 14.3% yoy in October vs. -16.2% yoy in September.
Mineral
extraction
gained
0.9%
yoy;
gas/water/electricity
supply
and
distribution
significantly accelerated to 8.9% yoy after 3.6% yoy
growth in September. In agriculture, the growth
significantly recovered to 9.9% yoy over 10M13,
benefiting from the base effects of the drought last
year. Construction continued to exhibit the same
weakness: -24.3% yoy in October vs. -24.9% yoy in
September.
On the consumer side, retail sales growth continued to
gradually slow to 9.5% yoy in 10M13 from 14.8% in
2M13, accompanied by a deceleration in real wages
growth to 5.7% yoy in October vs. 7.1% yoy in
September and 8.1% yoy in August. Overall, October
statistics continued the trend exhibited earlier this year
Deutsche Bank Securities Inc.
Regarding the monetary and exchange rate conditions,
consumer prices grew slightly mom in October: +0.4%
mom after returning to the inflationary zone from
deflation in July-August. On a yoy basis, deflation
continued in Ukraine (with a small break in July when
consumer prices stood still). In October, deflation stood
at 0.1% vs. -0.5% yoy in September and 0.4% yoy in
August. Monetary authorities maintained the discount
rate at 6.5%, while the National Bank continued to
keep the UAH/USD rate unchanged at 8.00. The
interbank rate climbed from UAH/USD8.17 to
UAHUSD8.24 over the month of October. Given the
expected recovery of the real sector, we project CPI to
move into positive territory to 2.8% yoy by December
2014 and to increase to 3.6% yoy by the end of 2015.
On the BoP front, Ukraine’s current account (CA) deficit
amounted to USD2.0bn in October, the same as
September, driven by the expanding deficit in goods TB
to USD2.5bn in September-October vs. USD2.0bn in
both July and August. Overall, facing the continuing
deterioration in the external sector conditions, the
National Bank of Ukraine continued to support the
fixed exchange rate. As a result, as of 1 November,
gross international reserves declined sharply by
USD1bn to USD20.6bn, contracting 5% yoy and 16%
YTD.
Given the reluctance of the authorities to allow for
sizeable exchange rate weakness, the fx is likely to be
depreciated gradually in the next year and we expect
the hryvnia to weaken to USD/UAH8.7 by December
2014 with the international reserves projected to
continue the fall to USD18bn by YE14. Given the
projected recovery in the EU and Russia, and
Page 137
5 December 2013
EM Monthly: Diverging Markets
improvement of trade terms with Russia, we expect the
CA deficit to improve from c.7.0% GDP to 5.4% GDP in
2014 and 4.8% GDP in 2015.
Ukraine: Deutsche Bank forecasts
2012
2013F
2014F
2015F
In terms of fiscal conditions, the state budget deficit,
which had stabilized, began to widen again in October
to UAH40bn, thus exceeding the 3.5% GDP level
(which compares to the budget target of 3.2% of GDP).
Meanwhile, direct public debt remained stable in
October at USD56.33bn, implying a 13% YTD increase,
driven by internal borrowings, which increased 26.6%
YTD to USD30.1bn as of the end of October on net
issuance of USD6.1bn of domestic bonds over 10M13.
Meanwhile, the external debt remains broadly stable,
both on a mom and YTD basis, at USD26.3bn.
National Income
Nominal GDP (USDbn)
Population (m)
GDP per capita (USD)
175.9
45.1
3 901
181.1
45.0
4 024
189.4
45.0
4 208
175.9
45.1
3 901
Real GDP (yoy %)
Priv. consumption
Govt consumption
Investment
Exports
Imports
0.2
11.7
2.2
0.9
-7.7
1.9
0.3
6.5
2.3
-5.4
-6.5
1.2
1.5
4.8
0.5
1.5
1.2
4.6
2.0
4.8
1.5
2.5
2.8
6.6
Given the political, trade and economic turmoil, the
authorities have not yet finalized their 2014 fiscal
projections. The most recent version guided for GDP
growth of 3.0% yoy, CPI growth of 8.0% yoy eop and
unemployment at 7.1-7.4%. Overall, revenues were
projected at UAH403bn, expenditure at UAH448bn
with the deficit at UAH45bn, leading to a deficit of
2.8% GDP. The direct public debt limit was set at 31%
GDP. Given our relatively conservative outlook for
growth in 2014, we expect the fiscal deficit to reach
4.5% of GDP leading the direct public debt from 32% of
GDP currently to 36% of GDP.
Prices, Money and Banking (eop)
CPI (YoY%) ann avg
0.5
Broad money
12
Credit
1.5
-0.4
18.0
6.6
1.4
16.0
8.0
2.9
14.0
10
Fiscal Accounts (% of GDP)
State budget balance
-2.5
Revenue
23.5
Expenditure
26.0
-4.0
22.1
26.1
-4.5
22.8
27.3
-4.2
23.6
27.8
External Accounts (USDbn)
Exports
69.8
Imports
90.2
Trade balance
-20.5
% of GDP
-11.6
Current account balance
-14.4
% of GDP
-8.2
FDI (net)
6.6
FX reserves (USDbn)
24.5
UAH/USD (eop)
8.1
71.4
92.6
-21.2
-12.0
-18.0
-10.2
4.3
21.6
8.4
75.6
90.3
-14.7
-8.1
-9.5
-7.5
4.5
18.0
8.7
78.8
92.1
-13.3
-7.0
-9.5
-7.0
4.2
15.0
9.0
Debt Indicators (% of GDP)
Government debt
Domestic
External
Total external debt
in USDbn
28.4
14.8
22.0
75.5
133.0
32.0
15.0
18.4
75.6
133.0
36.0
17.7
18.3
80.0
144.9
40.2
20.8
159.1
General (% pavg)
Industrial production (%)
YoY)
Unemployment
1.4
1.5
1.8
2.0
7.8
7.8
7.2
7.0
Financial Markets (eop)
Spot
1Q14
2Q14
4Q14
6.5
6.5
6.5
6.5
8.2
8.4
8.65
8.7
Yaroslav Lissovolik, Moscow, +7 495 933 9247
Artem Zaigrin, Moscow, +7 495 797 5274
Policy rate (refinancing
rate)
UAH/USD
19.4
84
Source: Source: Official statistics, Deutsche Bank Global Markets Research
Page 138
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Argentina
B3(stable)/CCC+ (negative)/CC(stable)
Moodys /S&P/ /Fitch
„
„
Economic outlook: A new cabinet and some
specific
measures
confirmed
the
binding
constraints of a new political reality and the
beginning of a leadership transition. This is
expected to improve the medium-term outlook for
the country. In the short term, the economy
remains lackluster, with inflation accelerating
slowly, driven by faster depreciation without a
nominal anchor. This path remains challenging,
pointing to a difficult 2014, economically and
politically. Some tighter capital controls and
incentive for capital repatriation might gain some
time, but a more fundamental policy change might
be necessary before CFK’s end of mandate in 2015.
Main risks: Continued exchange rate controls and
significant state intervention could continue to
block any potential recovery. Thus, stagflation
seems to be the most likely outlook. A negative US
Supreme Court take on the final ruling from the
Court of Appeals in mid 2014 could trigger a
default on international debt. In that event, the
economic and financial situations could deteriorate
markedly, reinforcing the need for policy changes.
New cabinet, old problems, some hope
A positive political decision
On Monday, November 18, President Cristina
Fernandez de Kirchner (CFK) reported her return to
office after her post-surgery recovery, although
anticipating a gradual incorporation. That same day,
the speaker of the government announced important
changes in the cabinet. These included the naming of
Chaco Governor Jorge Capitanich as new Chief of
Cabinet, Economic Vice Minister Axel Kicillof as the
new Economic Minister, Banco Nacion President Juan
Carlos Fabrega as the new Central Bank President, and
Economic Minister Hernan Lorenzino as the new
ambassador to the EU, with the responsibility to also
lead a newly created debt restructuring unit.
The cabinet change mostly signaled policy continuity,
at least in economic matters, and as such was
negatively perceived by market participants. However,
more importantly, the decision seems to have an even
bigger meaning politically, which is the potential
delegation of power to a popular governor that could
become a new candidate for the presidential race in
2015. The latter is critical because Capitanich is
believed to be a moderate and pragmatic Peronist
leader, with significant executive experience and
popular backing. Thus, such a choice could be
consistent with a President that is not only restrained
by her health, but also by the results of the last election.
Deutsche Bank Securities Inc.
Consistently, the President also decided to remove
Secretary of Commerce Guillermo Moreno and send
him to a new diplomatic position in Italy.
Time will tell whether the naming of the economic
members of the cabinet does represent a reinforcement
of extreme policy making. In our view, instead, this
could also reflect just a compromise, using the new
Economic Minister as a sign of strength, but at the
same time accepting the delegation of policy power to
the new Chief of Cabinet. It is worth noting that the
new Economic Minister worked for the new Chief of
Cabinet Capitanich on previous occasions in the
Ministry of Social Affairs and Congress few years ago.
Also, it is important to report that senior business
representatives in the utility sector, mostly controlled
and regulated by Kicillof, have recently suggested a
learning curve from the former Vice Minister; today
more informed about the real needs of the private
sector to at least survive. Thus, we are inclined to see
the recent news as a reason to hope for a government
that might have already accepted a different political
equilibrium in order to guarantee governing for the
remaining two years in power.
Obviously, the pending question remains the likely
economic policy measures to come. In his first press
conference, Mr. Capitanich suggested some marginal,
but relevant, policy changes to bring confidence and
predictability. The most important points included the
following: 1) the government will seek to maintain a
competitive FX using the current dirty floating regime,
somehow rejecting the possibility of dual currency
regime for now, and hinting at a faster pace of
depreciation; 2) it will also promote negotiation with
regional economies to assist producers; 3) it will better
administer foreign reserves, by directing funds to
productive inputs instead of luxury goods (explicitly
mentioning cars); 4) it will focus on getting more
external financing through multilateral and bilateral
sources, including specific plan of getting foreign funds
for infrastructure spending; 5) it will promote a
negotiated stance among companies and workers to
foster production without inflationary pressures; and 6)
it will prioritize investment.
The announcement of a preliminary agreement with
Repsol to define compensation for YPF expropriation
was the very first concrete positive measure from the
new cabinet. The confirmation of a much faster pace of
depreciation was another encouraging reaction to an
exigent reality. Likewise, a proposed tax increase in
luxury goods and credit card spending abroad was
aimed at dampening the desire to spend dollars.
Meanwhile, a potential reduction in subsidies to utilities
Page 139
5 December 2013
EM Monthly: Diverging Markets
seems to be in the pipeline to moderate fiscal needs.
All these initiatives, however, remain specific policy
measures that do not yet offer a comprehensive and
credible solution against inflation, declining reserves,
and
economic
stagnation.
Nevertheless,
the
combination of policy delegation and some minimal
correction in the economic course could be enough to
deter a major stress situation before October 2015. This
is essentially what is needed now that market
participants know there is a terminal condition that
guarantees a transition to better policy making as reelection is banned, the facto and jure.
Repsol’s agreement and beyond
On November 25, officials from the Ministry of
Economy reported a preliminary agreement with
Repsol regarding compensations for the expropriation
of 51% of YPF in early 2012. The decision was reached
by representatives of the Argentine, Mexican, and
Spanish governments, and part of Repsol’s
management as well as two of its major shareholders,
Pemex and Caixabank. A day later the management
board of Repsol “valued positively” the agreement. In a
communiqué to the press, Repsol anticipated that it
would hire an international bank to help the company
find a fair, efficient, and prompt resolution to the
negotiation. Spanish newspapers indicated that
sources of the company suggested Repsol would
receive USD5.0bn in sovereign bonds (10 years
maturity) and gold, but there was no official report on
the details.
The good news was partly overshadowed the same day
by another daily loss of international reserves at the
Central Bank of around USD100mn, accumulating a
more than USD1bn drain in the ten working days
elapsed since the new cabinet took office. This despite
dollar bond selling against pesos by the social security
administration
(ANSES).
On
current
trends,
international reserves could be well below USD30bn by
the end of the year, or more than USD13bn lower than
in December 2012. This steady pressure on the
exchange market and international reserves despite the
tight capital and trade controls is the main challenge
for the new authorities, at least in the short term.
As noted, the new cabinet did react to exchange rate
concerns by depreciating the peso at a much faster
pace than before. In the two weeks since November 18,
the peso depreciated by more than 3%, or roughly 75%
annualized. Similarly, a new 30-50% tax on luxury cars,
boats, and planes was proposed to Congress, and tax
advances on credit card uses abroad were increased
from 20% to 35%.
Furthermore, the new cabinet has continued to indicate
a more reasonable policy mix, including the
confirmation that this December there will not be yearend bonuses for pensions and/or salaries, and income
Page 140
taxes will also be applied to the 13th salary paid in
December (“aguinaldo”) despite strong pressure from
labor unions to except it like in June this year. In
addition, the Central Bank has let money base to
contract by not compensating for on-going reserves
and bond sales, contrasting radically with the practice
so far. Finally, four directors for the Central Bank board
were commissioned, partially favoring the new Central
Bank President. Out of the four new directors, Eduardo
Antonio Barbier and Cosme Juan Carlos Belmonte,
come from Banco Nacion and are aligned with the new
CB President Juan Carlos Fabrega. The other two,
Sebastian Aguilera and German Feldman, are
supported by Chief of Cabinet Capitanich and
Economic Minister Kicillof, respectively. Within the
economic team, Fabrega is the most likely to accept a
more traditional approach to monetary policy, against
Minister Kicillof, who does not seem to believe tighter
monetary conditions have any benefit.
The new economic authorities were able to
significantly cut the gap between the non-official
exchange rates and the official rate plus taxes. For
example, this Wednesday, the ARS closed at around
6.20, while the parallel market closed at 9.30 and the
blue chip swap closer to 8.4, both 7% stronger than
two weeks ago. This notwithstanding, the Central Bank
has continued to sell more than USD100mn of reserves
on a daily basis, while both the CB and the social
security administrator (ANSES) allegedly traded dollar
bonds against pesos in the market. Contraction of this
exchange rate gap could continue in the short term,
but for this to be sustainable, the government will have
to either tighten policies further and/or get significant
external financing before the summer starts and the
growing tourist demand outpaces the reduced export
supply of the season.
In rhetoric and actions, the new cabinet seems to be
simultaneously targeting the required fronts: the
internal adjustment and the external financing.
However, the government might still lack the
conviction to follow a significantly tighter fiscal and
monetary policy. One example is the planned reduction
of utility fares, many times abandoned in the past.
Another indicator could be the behavior of interest
rates, which have remained significantly negative in
real terms, mostly reflecting still abundant liquidity
around and lack of demand for pesos. A more
important signaling though is the lack of any explicit
target for inflation. Thus, in the government ad-hoc
adjustment, it could be very difficult to coordinate
expectations downwards, in particular with a faster
pace of currency depreciation, and strong labor unions
amid a divided political spectrum.
A full recognition of actual inflation could embody a
major step forward toward gaining macro-consistency.
This could actually be achieved with the launching
early next year of the new CPI constructed with the
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
IMF’s advice. A new and credible CPI adjusting CER
instruments could bring for the first time in years a
valid ARS alternative to hold foreign currency. This,
together with dollar-linked instruments, could slowly
equilibrate the demand for assets, softening gradually
the existing pressure in the exchange rate market.
Furthermore, this could also represent the starting path
for the lifting of some capital controls later on.
Otherwise, the lack of efficient means to protect asset
prices from inflation erosion would inevitably keep the
current bias in favor of dollar instruments despite the
controls. All this noted, and after many years of the
government neglecting inflation, we confess some
degree of skepticism in this regard.
On the external front, the compensation agreement
with Repsol re-affirmed a radical change initiated last
month, with the decision to pay USD500mn to five
international companies with favorable rulings in the
court for international settlements (ICSID). These
decisions are meaningful for an administration that had
been reluctant to accept even basic and reasonable
concessions to different interest groups, and could
eventually open the door for increasing foreign
investment interest in the country. However, the
continued drain in reserves, together with the
perception that a currency re-alignment is inevitable,
but will not be achieved immediate, is likely to remain a
strong deterrence against capital inflows for now.
Although the authorities seem to be overestimating the
short-term power of the Repsol deal, they also appear
to be seeking alternative financing sources. A plan to
use YPF to issue new debt seems a clear path in the
government new roadmap. Negotiating with Chinese
authorities to finance infrastructure projects is another
initiative, although tied to specific projects. Forcing
export trading companies to get USD2.0bn financing
from abroad by limiting their ability to get local funding
constitutes another source.
A more active dialogue with multilateral organizations
appears as another potential course of action, even
considering once again negotiating with the Paris Club.
The creation of a new debt unit under the lead of
former Ministry of Finance Lorenzino seems to support
such a policy decision. Thus, this could even be
extensive to holdouts. However, we still do not see the
government prepared to negotiate with holdouts prior
to any decision by the US Supreme Court, nor to
accept IMF article IV consultation to facilitate a rapid
Paris Club resolution. Thus, we might see new
insinuations of the authorities moving in the right
direction, but without achieving much.
Meanwhile, on November 18, the NY Court of Appeals
rejected Argentina’s last request for a full court revision
(en banc), and the Republic now has 90 days from that
date to file a new appeal to the Supreme Court of
Justice. Argentina’s last resort would take the whole
Deutsche Bank Securities Inc.
legal impasse at least up to March of next year, or
more likely the beginning of next summer.
Nevertheless, the final schedule still depends on the
Supreme Court decision. For example, a Supreme
Court request for the Solicitor General’s opinion, which
is rare but not uncommon in cases involving other
sovereign governments, could delay the whole process
another half a year or so.
Therefore, the government seems to be finally
responding to a challenging reality but with a number
of measures that have failed to constitute a consistent
and solid macroeconomic approach. Based on the
announcements so far, the main risk remains a
continued depletion of international reserves. A faster
depreciation rate is welcome, but works too slowly and
demands significant international reserves even if
accompanied by tighter fiscal and monetary policies,
which do not yet seem to be part of the policy tools of
this new cabinet. Furthermore, inflation management
unfortunately will remain a serious threat, without a
proper recognition of the problem, and a target
consistent with the other policy measures.
The 2014 outlook
As suggested above, next year’s outlook remains
challenging. Economic performance in the last few
months has re-affirmed the problems facing the
country’s economy, mainly the lack of growth drivers,
high inflation, distorted relative prices and a continued
dollar rationing. This was somehow evidenced by the
main activity indicators published by the official
statistical unit INDEC. For example, INDEC reported
that, on a seasonally adjusted basis, aggregate activity
did not grow in September. This notwithstanding,
activity expanded by 4.7% YoY, accumulating 5.4%
YoY so far this year. This reported performance is
expected to ease concerns that growth numbers could
be adjusted downwards markedly in the last part of the
year, although a YoY deceleration should be coming
ahead, as the strong harvest effect of 2Q13 is fading
and the end of the year starts to compare with the
stronger base in 2012. Notwithstanding, the official
growth number should be at least 4.5% this year,
although private sector estimates are suggesting half
that pace.
Furthermore, INDEC’s proxy of monthly industrial
activity was down 0.5% YoY in October, but recovered
by 1.4% seasonally adjusted from the level reached in
September this year. With this, the accumulated
industrial growth so far this year is just 0.9%. The trend
indicator calculated by the same INDEC reports a 0.2%
fall with respect to September this year. On the outlook,
the survey run by INDEC does not provide much
indication of a change.
Page 141
5 December 2013
EM Monthly: Diverging Markets
Argentina: Deutsche Bank forecasts
Growth proxies pointing toward slowdown
2012
20%
30%
15%
20%
10%
10%
5%
0%
-5%
-10%
-15%
National Income
Nominal GDP (USDbn)
Population (m)
GDP per capita (USD)
496
41.0
12,101
2013E
2014F
2015F
513
493
41.5
41.9
12,376 11,761
491
42.4
11,592
0%
EMAE, YoY 3m MA
IPI FIEL, YoY 3m MA
-10%
-20%
Tax Revenue (CPI adj), YoY 3M MA, rhs
-30%
-20%
Real GDP (YoY%)
Priv. consumption
Gov't consumption
Gross capital formation
Exports
Imports
1.2
4.6
6.7
-11.1
-5.6
-4.4
2.4
4.2
4.5
0.5
1.7
9.3
1.6
2.1
1.5
1.0
3.1
4.2
2.8
3.4
2.0
4.0
2.5
6.0
Prices, Money and Banking
CPI (YoY%, eop) (*)
CPI (YoY%, avg) (*)
Broad money (M2)
Bank credit (YoY%)
25.2
24.0
34.3
30.8
25.7
24.9
20.0
5.0
27.2
28.5
21.0
15.0
20.9
23.6
18.0
20.0
Fiscal Accounts (% of GDP)
Budget surplus
Gov't spending
Gov't revenue
Primary surplus
-3.5
32.8
29.3
-1.3
-3.6
33.9
30.4
-2.2
-3.8
33.1
29.3
-2.4
-3.6
31.8
28.2
-2.3
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) ARS/USD
80.9
68.5
12.4
2.5
-0.1
0.0
11.1
43.3
4.92
83.6
74.7
8.9
1.7
-6.0
-1.2
7.8
30.6
6.30
86.1
79.8
6.3
1.3
-8.1
-1.6
5.4
23.8
8.49
90.7
85.8
4.9
1.0
-9.6
-2.0
7.5
15.1
10.46
Debt Indicators (% of GDP)
Government debt
Domestic
External
Total external debt
in USD bn
Short-term (% of total)
18.6
5.4
13.2
28.4
140.9
36.9
18.0
6.2
11.8
26.5
135.8
38.3
18.5
6.1
12.4
27.7
136.5
38.1
18.5
6.9
11.6
27.0
132.6
39.2
General
Industrial production (YoY)
Unemployment (%)
-1.2
7.8
1.5
8.0
1.1
8.5
2.1
8.5
Source: INDEC. MECON, and Deutsche Bank
Tax collection in November also corroborated some
weakening activity. The Argentine tax administrator
(AFIP) reported that November tax collection reached
ARS73.585mn, showing a 21.3% YoY increase.
Individual tax performance varied, however, with VAT
collection advancing 30.5% YoY, while the tax on
banking credits and debits was up 32.9%, and gasoline
taxes reported a 43.3% YoY increase. On the contrary,
export taxes fell by 37% YoY and income taxes were
only up 10.8% on the year. It is worth recalling that
private sector estimates of consumer price inflation
suggest inflation is running at 24% YoY, which in turn
suggests that overall tax collection continues to fall in
real terms.
The main problem continues to be the steady drain on
international reserves, even despite the economic
slowdown. As discussed, this has multiple explanations,
but in particular, an increasing energy deficit. With the
help of a faster pace of depreciation, tighter controls
and some improved incentives for capital repatriation,
we estimate that reserves could be down to
approximately USD24bn by the end of 2014.
Unfortunately, the combination of loose fiscal policy
and faster depreciation pace represents a serious threat
to inflation stability, as the government is not willing to
use interest rates to anchor the economy in nominal
terms. Furthermore, this demand push faces increasing
supply constraints, either from the lack of imported
goods due to hard dollar rationing or the lack in
investments given uninspiring incentives to take on
business risk.
Thus, economic activity next year is likely to be
restrained on many fronts, hardly reaching 1.6%
growth, with increasing inflation and widening current
account and fiscal deficits. The outlook for 2015 is
expected to be improved by a more competitive
exchange rate and the proximity of a true political
change ahead of the 2015 presidential election.
Financial Markets (EOP)
Overnight rate
3-month Badlar
ARS/USD
Current 1Q2014 2Q2014 4Q2014
15.0
21.3
6.20
16.5
23.0
6.79
17.5
24.0
7.31
19.0
25.0
8.49
Source: DB Global Markets Research, National Sources
*Inflation reported by Congress
Gustavo Cañonero, New York, (212) 250 7530
Page 142
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Brazil
Baa2/BBB(neg)/BBB
Moody’s/S&P/Fitch
„
„
Economic outlook: Loose fiscal policy and high
inflation continue to put pressure on interest rates,
while the currency remains vulnerable to external
shocks due to Brazil’s current account deficit. In
2014, growth will depend to a large extent on the
government’s
ability
to
stimulate
private
investment through its concession program, amid
potential political noise generated by the elections.
Main risks: Although the government has removed
some capital controls and tightened monetary
policy, fiscal policy remains expansionary and
inflation remains high. A sudden stop in foreign
capital flows could lead to further currency
depreciation, higher interest rates, and even slower
growth.
2.3%, and government consumption rose 2.3%. The
agricultural sector fell 1.0%, the industry grew 1.9%,
and services expanded 2.2% YoY.
Brazil: GDP growth
200
1995=100
178
GDP
Investment
Consumption
156
134
112
90
GDP contracted by 0.5% QoQ in 3Q13, below the
market consensus forecast of -0.2% QoQ and our
forecast of 0.0% QoQ. The latest data incorporated
several revisions (especially a new methodology to
measure the services GDP) retroactive to 2012.
However, the revision to 2012 GDP growth was
surprisingly small (from 0.9% to 1.0%), considering that
President Dilma Rousseff had told the press that the
number would be revised to 1.5%. Moreover, although
2Q13 was revised to 1.8% QoQ from 1.5% QoQ, 1Q13
was cut to 0.0% QoQ from 0.6% QoQ. In 3Q13, as
expected, the deceleration in economic activity was led
by investment, which declined by 2.2% QoQ after
climbing 3.6% in 2Q13 and 4.2% in 1Q13, heavily
influenced by the demand for agricultural machines
(reflecting the good harvest) and transportation
equipment (boosted by the government’s subsidized
loans). Moreover, different from what happened in the
second quarter, the external sector had a negative
contribution to growth, as imports fell 0.1%, but
exports declined by 1.4% QoQ. Consumption, however,
was somewhat better than expected, probably due to
the government’s stimuli and expansionary fiscal
policy: government consumption rose by 1.2% QoQ,
while household consumption rose 1.0% QoQ. On the
supply side, the agricultural sector was responsible for
the GDP decline, as it fell 3.5% QoQ after posting very
strong growth in 1H13. The industrial and services
sectors had the same mediocre performance, growing
0.1% QoQ each. In the industrial sector, a 2.9% QoQ
increase in mining extraction (led by oil) offset a 0.4%
QoQ drop in manufacturing and a 0.3% QoQ decline in
construction. In the services sector, increases in
transportation and information services offset flat retail
sales and decline in financial and real estate services. In
the year-on-year comparison, GDP grew 2.2%, as
investment rose 7.3%, household consumption grew
Deutsche Bank Securities Inc.
Source: IBGE
We cut our GDP growth forecasts to 2.2% and 1.9% for
2013 and 2014, respectively. We still expect economic
activity to improve at the margin in 4Q13, in line with
some of the latest indicators, such as the 0.6% MoM
increase in industrial production in October. However,
even assuming 0.5% QoQ growth for 4Q13, we now
project GDP growth of only 2.2% for 2013 instead of
2.5%. The latest data also reduced the carryover for
2014, so we cut our GDP growth forecast for next year
to 1.9% from 2.1%. We expect household consumption
to decelerate further next year, growing 1.9% after
climbing an estimated 2.3% in 2013 (down from 3.2%
in 2012), mainly due to deceleration in labor income
growth (although slower population growth is helping
to keep unemployment at record low levels, we expect
a gradual increase in joblessness due to the slowdown
in job creation) and limitations to credit growth
imposed by high consumer leverage and rising interest
rates. We believe investment will be the key variable to
determine growth next year and we also expect it to
decelerate due to higher interest rates, slowdown in
subsidized lending, lower demand for transportation
equipment following this year’s surge, and especially
low business confidence due to inefficient economic
policies and uncertainty surrounding the 2014 elections.
The government is managing to move along with its
concessions program (the first pre-salt auction and the
latest airport auction were successful), but investments
related to these projects will probably not begin before
2H14. An additional complication next year will be the
World Cup, which could hurt economic activity by
reducing the number of working days. On the other
hand, the Brazilian economy could benefit from faster
Page 143
5 December 2013
EM Monthly: Diverging Markets
growth in US and China, as Deutsche Bank forecasts.
For 2015, we expect GDP growth to decelerate further
to 1.7%, as we believe fiscal policy will eventually be
adjusted and interest rates will probably rise further
after the elections to restrain inflation.
Brazil: Primary fiscal balance
4.5%
% of GDP
4.0%
3.5%
3.0%
2.5%
2.3
2.0%
1.5%
Target
1.0%
Primary surplus
0.5%
Adjusted surplus
1.4
0.7
0.0%
Source: BCB, Deutsche Bank
Expansionary fiscal policy continues to weigh on
Brazilian financial markets. The fiscal numbers were
worse than expected in September and October, mainly
reflecting aggressive federal spending. The public
sector’s consolidated primary fiscal surplus totaled
1.4% of GDP in the year to October, remaining
significantly below this year’s target of 2.3% of GDP.
Excluding extraordinary revenues and dividends from
state-owned enterprises, we estimate that the primary
surplus fell to just 0.7% of GDP. Although large
extraordinary revenues expected for November and
December (Libra, REFIS) will allow the federal
government to finish the year very close to its target,
states and municipalities are poised to fall short, so the
consolidated primary surplus this year will likely drop
below 2% of GDP for the first time since 1998 (we
forecast 1.8%). For 2014, the fiscal target is not clear at
all. The Budget Guideline Law (LDO) set a consolidated
primary surplus target of 3.2% of GDP, but also allowed
the government to deduct up to BRL67bn (1.3% of
GDP) from this target, which has led some government
officials to claim that the fiscal target is actually a band.
For 2014, the target would be something between
1.9% and 3.2% of GDP. The government has
announced that it plans to use BRL58bn (1.1% of GDP)
in deductions (slightly less than the BRL67bn allowed
by law), so the consolidated target would be 2.1% of
GDP. Nevertheless, the consolidated primary surplus of
2.1% of GDP assumes that states and municipalities
will deliver a primary surplus of 1.0% of GDP. Since the
budget law no longer requires the federal government
to make up for the local government’s shortfalls, the
lower bound for the consolidated primary surplus
target is actually 1.1% of GDP, and our forecast is 1.5%.
Public debt sustainability is at risk and Brazil’s
sovereign rating could be downgraded next year. Since
Page 144
interest rates remain quite high and the rate of return
on the government’s assets is low, Brazil will likely post
a nominal budget deficit above 3% of GDP this year.
Assuming potential GDP growth of 2.5% of GDP, the
current primary surplus is not high enough to stabilize
the net public debt-to-GDP ratio. Moreover, the
expansionary fiscal policy leads to higher interest rates
and crowds out private investment. While the
government has pledged to tighten fiscal policy and
moderate public bank lending, budget rigidity and the
political calendar preclude a rapid adjustment. The
slower the economy grows in 2014, the higher the
probability that a substantial fiscal adjustment will be
postponed until 2015. However, aside from temporary
adjustments, the next administration’s main challenge
will be to pass structural reforms that permanently
improve fiscal sustainability, addressing difficult issues
such as budget’s rigidity, generous retirement rules,
and the minimum wage adjustment rule. Unfortunately,
recent political trends do not support optimism about
such reforms and the next government may tackle the
problem by raising taxes instead of reining in spending.
Although inflation remains high, the Central Bank has
stressed that interest rates have risen significantly and
affect inflation slowly. The government finally
announced the much-awaited increase in fuel prices at
the end of November, but the 4% hike in refinery
gasoline prices was lower than we expected. It will
raise consumer fuel prices by approximately 2%,
adding just 10bps to the IPCA consumer price level
(instead of the 20bps we had assumed) this year. Thus,
we lowered our 2013 IPCA forecast slightly to 5.7%
from 5.8%. The small adjustment, however, has not
closed the gap between domestic and international
prices, so another increase will probably have to occur
next year, probably after the elections in October.
Therefore, we raised our 2014 IPCA forecast to 5.7%
from 5.6%. We do not expect the BCB to tighten
monetary policy aggressively enough to bring inflation
back to the 4.5% target, as it would be very costly in
terms of output loss. The COPOM raised the SELIC rate
by 50bps to 10.0% in November, but changed its
communiqué for the first time after four meetings. By
highlighting that the tightening cycle started in April
2013, the BCB hinted that the cycle might be coming to
an end, in line with our view that it will reduce the pace
of tightening to 25bp in January. Nevertheless, the
COPOM minutes repeated that the BCB will “remain
especially vigilant” to control inflation, thus keeping the
door open to raise interest rates further depending on
the upcoming data. Since we expect inflation to remain
quite high in January and February, it will be difficult
for the BCB to interrupt the cycle in January. Therefore,
we now forecast two additional 25bp hikes. We expect
the SELIC to climb to 10.50% and remain at this level
until the end of 2014. Given the pressure on the
currency and uncertainty related to domestic fiscal
policy and QE tapering in the US, we believe the risk
remains tilted toward higher rates. We still expect the
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
tightening cycle to be resumed in 2015, when the
SELIC will likely rise further to 11.50%.
Brazil: Deutsche Bank forecasts
The BRL has remained volatile, reflecting concerns
about fiscal policy and US monetary policy. After
trading below BRL2.20/USD in October, the currency
depreciated sharply in November, mainly reacting to
negative news on the fiscal front. The BCB is
proceeding with its intervention program (which aimed
to offer as much as USD100bn in FX swaps and dollar
repurchase lines by year-end) and we expect it to keep
on providing liquidity to the market in 2014, so as to
smooth currency movements. Although foreign direct
investment has remained roughly stable and foreign
portfolio investment has increased significantly this
year, the current account deficit has been on a rising
trend and Brazilian assets abroad have posted large
outflows. Consequently, the balance of payments
posted deficits in June, August, September and
October. In 2014, tighter monetary policy in the US
could hurt foreign capital flows to Brazil, at the same
time that locals could continue to keep on
accumulating assets offshore due to uncertainty about
domestic economic policies. Therefore, we believe a
weaker currency will be needed to reduce the current
account deficit in an environment where external
financing could become scarcer. In light of the
deterioration in the market perception about Brazil, we
raised our year-end forecasts to BRL2.35/USD from
BRL2.30/USD for 2013 and to BRL2.45/USD from
USD2.40/USD for 2014. We expect the weaker
exchange rate, moderate economic growth, and a
reduction in net oil imports to reduce the current
account deficit from an estimated USD79bn (3.6% of
GDP) this year to USD68bn (3.2% of GDP) in 2014.
National Income
Nominal GDP (USDbn)
Population (m)
GDP per capita (USD)
Brazil: Current account deficit and capital flows
90
USDbn, 12m
Current account deficit
FDI
70
Portfolio
50
30
10
-10
2012
Source: BCB
José Carlos de Faria, São Paulo, (5511) 2113-5185
2014F
2015F
2,253 2,204 2,157 2,196
199
201
203
204
11,306 10,969 10,645 10,752
Real GDP (YoY%)
Private consumption
Government consumption
Gross capital formation
Exports
Imports
0.9
3.2
3.3
-4.0
0.5
0.2
2.2
2.3
1.8
5.4
1.2
8.0
1.9
1.9
1.9
2.5
4.0
4.0
1.7
1.5
1.5
1.3
5.0
3.0
Prices, Money and Banking
CPI (YoY%, eop)
CPI (YoY%, avg)
Money base (YoY%)
Broad money (YoY%)
5.8
5.4
8.3
5.3
5.7
6.2
7.5
11.0
5.7
5.8
7.0
8.0
5.2
5.4
6.5
6.0
Fiscal Accounts (% of GDP)
Consolidated budget
Interest payments
Primary balance
-2.5
-4.9
2.4
-3.2
-5.0
1.8
-3.8
-5.3
1.5
-3.4
-5.4
2.0
External Accounts (USDbn)
Merchandise exports
Merchandise imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI
FX reserves (USDbn)
FX rate (eop) BRL/USD
242.6
223.2
19.4
0.9
-54.2
-2.4
65.3
378.6
2.04
241.0
239.0
2.0
0.1
-79.0
-3.6
65.0
378.6
2.35
254.0
240.0
14.0
0.6
-68.0
-3.2
60.0
373.6
2.45
270.0
253.0
17.0
0.8
-77.0
-3.5
70.0
371.6
2.55
Debt Indicators (% of GDP)
Government debt (gross)
Domestic
External
Total external debt
in USDbn
Short-term (% of total)
58.7
55.8
2.9
19.6
440.6
7.4
60.9
58.1
2.8
20.6
453.6
6.7
62.1
59.4
2.7
21.5
463.6
6.5
64.2
61.7
2.6
21.6
473.6
6.5
-2.7
5.5
2.0
5.4
2.5
5.8
2.0
6.3
Current
10.00
10.0
2.37
1Q14
10.50
10.6
2.35
2Q14
10.50
10.5
2.40
4Q14
10.50
10.5
2.45
General
Industrial production (YoY%)
Unemployment (%)
-30
2013
Financial Markets (EOP)
Selic overnight rate
3-month rate (%)
BRL/USD
Source: National Statistics, Deutsche Bank forecasts
Deutsche Bank Securities Inc.
Page 145
5 December 2013
EM Monthly: Diverging Markets
Chile
Aa3 (stable)/AA- (stable)/A+ (positive)
Moodys /S&P/ /Fitch
„
„
Economic outlook: Despite better-than-expected
retail and supermarket sales in recent weeks, we
expect
subdued investment
demand, low
employment growth, and weak external markets to
drive further deceleration in private consumption
growth. Investment contraction has markedly
affected manufacturing, reinforcing declining
business and consumer confidence, and extending
a more depressed investment cycle in the mining
sector. This notwithstanding, we forecast 4.2%
average growth next year (close to this year’s 4.3%
performance) with low inflation and a relatively
stable current account deficit.
Main risks: Downward surprises in China’s
economic growth can severely affect commodity
prices (particularly copper prices), which remain an
important determinant of GDP growth in Chile. The
partial undoing of the monetary stimulus in the
United States also represents a threat, as a disorder
adjustment in financial markets could bring
volatility and much higher financing costs. Locally,
further depression of business confidence ahead of
tax increases could exacerbate the decrease in the
internal impulse.
Decelerating smoothly
Mixed economic data to continue
Industrial production expanded by 2.1% YoY in October,
decelerating from the 2.9% YoY posted in September.
The annual average of expansion in the industrial
sector in 2013 is now running at 3.1%, compared with
3.5% in the same period of 2012. Among sectors,
mining grew by 6.0% YoY, mildly accelerating from the
5.4% YoY increase posted in the previous month. This
higher pace of growth was partly due to a base effect
as some factories were under maintenance or showing
irregular production capacity in 2012. Utilities rose by
3.1% YoY in the same month. Conversely,
manufacturing contracted by 3.2% YoY, recording an
annual decline for the third consecutive month. On the
demand side, retail sales advanced by 13.4% YoY,
accelerating from the expansion rate of 7.0% YoY in
September and returning to the levels seen in the
previous months. On average, retail sales have grown
by 10.2% this year. In addition, supermarket sales
advanced by 11.2% YoY, way above the 1.3% YoY
growth posted in the previous month
Aggregate economic activity advanced by 4.7% YoY in
the third quarter of the year; accumulating 4.5%
growth so far this year. On a seasonally adjusted basis,
GDP rose by 1.3% QoQ. Expenditure was mainly driven
by external demand, led by a 13.1% YoY increase in
Page 146
exports. Domestic demand, in turn, expanded by 0.4%
QoQ or 1.3% YoY, mainly boosted by consumption
which grew by 5.2% YoY, driven by a 5.3% YoY
increase in households’ expenditure on goods and
services. On the contrary, investment surprised
negatively and rose only by 3.2% YoY last quarter.
Meanwhile, unemployment rate for the moving quarter
August-October slightly increased to 5.8% from 5.7%,
ending two consecutive periods with the lowest
historical unemployment rate as per the new series.
This rate was the result of an increase in employment
of 1.2% YoY, slower than the increase in labor force.
The categories that contributed the most to
employment in twelve months were wholesale and
retail (97.72k) and real estate (45.65k). Conversely,
agriculture was the sector with the highest job
destruction (75.85k). Investment underperformance as
anticipated by weak business confidence is likely to
slowly negatively affect the labor market and labor
income in the months ahead.
Low inflation provides further room for rate cuts
The consumer price index increased by 0.1% MoM,
driving down the 12-month inflation to 1.5% YoY from
2.0% YoY in September. Accumulated inflation up to
October reached 2.0% YoY. The sector that contributed
the most to the increase in prices was food and
beverages, whose prices increased by 1.8% MoM
(2.8% YoY). In October, core inflation was 0.1% MoM,
taking this measure of annual inflation to 1.6%.
According to the base scenario of the latest Monetary
Policy Report (IPOM by its acronym in Spanish),
headline and core inflation are projected to end 2013 at
2.6% YoY and 1.7% YoY, respectively.
Such inflation performance has facilitated the Central
Bank’s recent decision to cut again its monetary policy
rate by 25bps to 4.5%. This was the second rate cut in
a row. According to the CB communiqué, domestic
economic activity has kept growing at a moderate pace
due to the slowdown of final demand, as confirmed by
the latest quarterly figures. In addition, the CB
statement acknowledged that the country has been
facing moderate inflation figures while market
expectations in 24 months have remained well
anchored to the official inflation target. Presenting the
last IPOM to the Senate, CB President Vergara stated
that future monetary policy decisions would be data
dependent, not anticipating any bias at this stage. This
notwithstanding, we believe the conditions are there
for at least another one or two additional rate cuts in
the months to come.
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Chile: Deutsche Bank forecasts
Policy rate decisions have reacted to inflation
2012
CPI (lhs)
4.5%
Policy Rate (rhs)
4.0%
3.5%
3.0%
5.50%
2.0%
1.5%
5.00%
GDP per capita (USD)
4.25%
1.0%
0.5%
Nov-11
May-12
Nov-12
May-13
Nominal GDP (USDbn)
Population (m)
4.50%
4.00%
Nov-13
Source: Deutsche Bank
2015F
National income
5.25%
4.75%
2.5%
2013F 2014F
Real GDP (YoY%)
268.2
286.0
291.4
17.4
17.6
17.7
310.4
17.9
15408 16287 16451
17373
5.6
4.3
4.2
4.5
Priv. consumption
6.1
5.0
5.2
5.4
Gov't consumption
4.2
4.1
3.9
4.0
12.3
5.7
4.5
7.0
Exports
1.9
4.0
3.3
5.9
Imports
9.7
5.6
4.5
6.5
CPI (YoY%, eop)
1.5
2.4
2.9
3.0
CPI (YoY%, avg)
3.0
1.7
2.8
3.0
Broad money (YoY%, eop)
7.6
8.3
10.1
8.0
13.5
12.5
11.7
10.0
Investment
Prices, money and banking
A challenging 2014 for Bachelet’s likely government
As expected, former President Michelle Bachelet won
the first-round presidential election of November 17th,
when her center-left coalition "Nueva Mayoria"
collected 46.7% of total votes. Evelyn Matthei, a former
Minister of the Piñera administration, was the runnerup, obtaining 25% of total votes. A second round will
take place on December 15th between the two
candidates, but all projections anticipate a second
mandate for Bachelet. Parliamentary elections gave
Bachelet's party 21 Senate seats, out of the 38 possible,
and 68 lower chamber seats out of 120. Thus, the
configuration of Parliament should give the new
government the simple majority needed to pass its tax
reform proposal. Likewise, the educational reform
envisaged by Bachelet would require some political
negotiation but it seems likely to be supported. The real
challenge for the new administration, in our view,
would be to promote its planned Constitutional reform,
as it requires the highest quorum (two-thirds of each
chamber). In addition, there is a fair amount of
disagreement among opposition parties regarding this
reform.
Credit (YoY%, eop)
Fiscal accounts (% of GDP)
Consolidated budget
bGovernment
l
spending
0.6
-0.9
-0.5
-0.4
21.4
23.4
23.2
24.5
Government revenues
21.9
22.4
22.7
24.1
Exports
78.3
78.5
78.4
87.8
Imports
74.9
76.0
78.0
82.7
Trade balance
3.4
2.5
0.4
5.1
% of GDP
1.3
0.9
0.1
1.6
-9.5
-10.0
-11.0
-9.8
External Accounts (USDbn)
Current account balance
% of GDP
FDI
FX reserves
FX rate (eop) USD/CLP
-3.5
-3.2
-3.8
-3.2
9.2
12.4
14.0
15.6
41.6
42.0
43.5
42.0
478.6
523.0
531.0
535.0
Debt indicators (% of GDP)
Based on current trends, GDP growth this year should
be around 4.3%. Based on the discussion above, we
project a slight deceleration in economic activity during
2014, mostly due to a gradual normalization in
domestic demand, and subdued external impulse. The
already weak consumption and investment figures so
far this year have contributed to reducing the current
account deficit, a key concern early this year ahead of
US monetary tapering. Thus, next year will likely show
a smooth deceleration without major adjustment risks.
Low inflation should remain the silver lining of such a
macro scenario. We expect inflation to stay below the
Central Bank’s 3% target until early 2015, when the
economy is expected to gain further steam,
accelerating to 4.5% growth.
Government debt
6.9
6.3
6.0
5.6
Domestic
4.5
4.3
4.5
4.2
External
2.3
2.0
1.5
1.4
43.9
41.3
40.6
38.2
117.8
118.0
118.2
118.5
18.6
14.1
14.5
14.5
3.0
3.1
4.0
4.1
6.5
6.0
6.0
6.0
Total external debt
in USDbn
Short-term (% of total)
General
Industrial production
(Y
Y%)
Unemployment
(%)
Financial markets (eop)
Overnight rate (%)
6-month rate (%)
USD/CLP
Current 1Q14
2Q14
4Q14
4.50
4.25
4.25
4.25
4.30
534.0
4.25
535.0
4.25
530.0
4.35
531.0
Source: DB Global Markets Research, National Sources
Gustavo Cañonero, New York, (212) 250 7530
Deutsche Bank Securities Inc.
Page 147
5 December 2013
EM Monthly: Diverging Markets
Colombia
Baa3 (stable)/BBB (stable) /BBB- (positive)
Moodys /S&P/ /Fitch
Domestic recovery to offset external risks
Accelerating activity despite fading external tailwinds
Economic activity slowed markedly in the first quarter
of 2013, partly reacting to the monetary policy
tightening during 2010-2011 and weaker external
demand. Consequently, the monetary easing that
began by end-2012 has only now started to accelerate
growth and close the output gap amid benign inflation
numbers. However, we do not expect a return to the
8% growth rate achieved in the third quarter of 2011,
given that the outlook for commodity prices and
external financing conditions is meaningfully worse
than that experienced in the last two years.
Industrial production remains subdued, partly due to a
significant slowdown in exports to Venezuela, which
are mostly composed of manufacturing goods. The
economic crisis in Venezuela has indeed taken a toll on
Colombian exports and the next year should also be
difficult for the sector. Representatives from the
manufacturing sector had also blamed appreciation
pressures for the decrease in competitiveness and
activity. This notwithstanding, the Central Bank
anticipated it will not continue with the reserve
Page 148
This above notwithstanding, the labor market has been
steadily creating jobs. Indeed, unemployment numbers
have decreased rapidly in the last three years and in
October the national rate reached 7.8%, the lowest
level since 1994 and a historical low with the current
methodology launched in 2002. This decrease in
unemployment amid stable inflation is a reaction to a
series of measures that have cut hiring costs, as the tax
reform enacted by end-2012 which has exerted an
effect on structural unemployment. We expect this
decrease to continue and the economy to achieve a
long-term level of unemployment around 7.0%. This
should also help foster consumption in the months
ahead.
Exports to Venezuela (12 months sum)
$4,500
$4,000
$3,500
$3,000
$2,500
$2,000
$1,500
$1,000
$500
Jul‐13
Apr‐13
Jan‐13
Jul‐12
Oct‐12
Jan‐12
Apr‐12
Jul‐11
Oct‐11
Jan‐11
Apr‐11
Oct‐10
Jul‐10
$0
Jan‐10
Main risks: The main local risk is over the extension
of the monetary stimulus, which could be
translated into accelerating inflation. A rupture of
the peace process would jeopardize political
stability and Santos’ re-election chances. The high
dependence of exports on oil and mining (around
60%) points to significant risk of falling commodity
prices. A sharp decrease in external liquidity
conditions, if accompanied by the fall in
commodity prices, would imply a rapid increase in
the current account deficit with deteriorating
financing sources.
accumulation program with pre-determined dollar
purchases.
Apr‐10
„
Economic outlook: After the slowdown in economic
activity and the subsequent monetary and fiscal
stimulus response from economic authorities in
2013, next year’s growth and inflation should
accelerate, with growth reaching potential and
inflation approaching above the middle of the
inflation range. We expect the Central Bank to keep
the current expansionary stance until 2Q14, when
it should start a tightening cycle after one year of
unchanged policy rate at an historically low level.
Global liquidity conditions and stabilization in FDI
could entail a slight depreciation of the currency.
The political agenda will be dominated by the
Presidential elections in May, when President
Santos is expected to be re-elected, and the peace
process with guerrilla groups continues.
USD m
„
Source: Deutsche Bank and Direction of Trade Statistics (DOTS)
Stable external and fiscal financing conditions
Even though next year’s commodity prices and external
financing conditions should not be as favorable as the
ones experienced in the last three years, the current
account deficit is projected to remain more than
covered by FDI flows, and financing needs from the
public sector are expected to decrease, in line with the
medium-term forecasts from the Ministry of Finance.
Central government financing sources
USD Millions
External
Bonds
Multilaterals
Domestic
TES
Auctions
Public Companies
Sources
2013
2014
$ 21,520.5
$ 22,040.6
$ 2,600
$ 4,880
$ 1,600
$ 2,928
$ 1,000
$ 1,952
$ 15,684
$ 15,676
$ 11,622
$ 4,054
$ 15,891
$ 15,885
$ 11,719
$ 4,167
Source: Deutsche Bank and Ministerio de Hacienda y Credito Publico
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
As the table above shows, the bulk of financing needs
for 2014 will be covered by the domestic market with a
manageable rollover of dollar-denominated debt that is
due to mature in 2014. The financing needs of the
government should not be affected significantly by
tighter external financing needs.
Colombia: Deutsche Bank forecasts
2012
Nominal GDP (USD bn)
Population (mn)
GDP per capita (USD)
Politics will dominate the agenda in 2014
The respective Congressional and Presidential elections
in March and May and the culmination of the peace
process with FARC will dominate the agenda in
Colombia in 2014. President Santos is expected to be
re-elected, although it’s not clear yet if he would need a
second round to obtain four more years. Former
President Uribe will most likely be the most voted
Senator in the March elections and his political
movement will fight, now from Congress, the
compromises agreed in the peace negotiations.
Real GDP (YoY%)
The political landscape that President Santos will face
in his re-election bid favors him given the power that
an incumbent has over politics in general and
bureaucracy in particular. Even though the President’s
popularity has decreased after a series of political
missteps in the last two years, the major political forces
are still expected to back Santos. The candidate from
the Uribista party, Oscar Ivan Zuluaga, has not been
able to obtain voter support in the most recent polls.
This notwithstanding, Santos will likely need a second
round to obtain the Presidency, in contrast with the
sweeping victories in the first round obtained by
President Uribe in 2002 and 2006. We note that the
uncertainty surrounding elections has implied
noticeable exchange volatility in the past and this time
might not be different. It is difficult to come up with a
rational explanation for these market movements, but
the chart below showing the three months of daily data
before the elections suggests they should not be
underestimated.
COP around presidential elections
112
110
2006
2010
March 1st = 100
108
2014F
2015F
376.5
382.9
46.0
47.0
8,185
8,146
402.0 431.2
47.0
48.0
8,553 8,984
4.2
4.0
4.3
4.5
Priv. consumption
4.4
4.3
4.4
4.6
Gov't consumption
5.1
5.0
5.2
5.0
Gross capital formation
5.7
5.6
6.2
8.0
Exports
5.3
4.0
3.5
3.2
Imports
8.0
7.0
6.5
6.0
CPI (YoY%, eop)
2.4
2.8
3.3
3.9
CPI (YoY%, avg)
3.2
2.6
3.1
3.6
Broad Money (YoY%, eop)
17.0
15.0
15.0
14.0
Bank Credit (YoY%, eop)
18.2
13.0
15.0
12.0
Prices, Money and Banking
Fiscal Accounts (% of GDP)
Consolidated budget balance
-2.3
-2.4
-2.3
-2.2
Interest payments
2.6
2.5
2.5
2.4
Primary Balance
0.3
0.1
0.2
0.2
Exports
60.6
69.0
75.0
78.3
Imports
55.0
69.0
76.0
81.5
5.6
0.0
-1.0
-3.2
External Accounts (USD bn)
Trade balance
% of GDP
Current account balance
% of GDP
FDI
1.5
0.0
-0.2
-0.7
-12.2
-9.8
-11.0
-12.9
-3.2
-2.6
-2.7
-3.0
15.7
15.0
14.5
15.0
FX reserves
37.5
42.0
44.0
46.0
COP/USD
1768
1950
2050
2100
Debt Indicators (% of GDP)
Central Government debt
36.1
35.0
35.5
34.0
Domestic
25.7
27.5
26.0
25.0
External
10.4
12.0
9.5
9.0
21.0
22.2
22.4
22.0
in USDbn
79.1
85.0
90.0
95.0
Short-term (% of total)
13.5
14.0
14.5
14.0
Total external debt
2002
2013F
National Income
106
General
104
Industrial production (YoY%)
2.4
-2.6
-1.5
2.0
102
Unemployment (%)
9.6
9.5
8.2
7.8
100
Financial Markets (eop)
98
96
Days
Current 1Q14
2Q14
4Q14
Overnight rate (%)
3.17
3.18
3.50
3-month rate (%)
COP/USD
3.18
3.20
3.55
3.75
3.80
1885
1980
2000
2050
Source: Deutsche Bank
Source: Deutsche Bank and Bloomberg.
Note: The first round of presidential elections are scheduled by law to take place the last Sunday of
May.COP/USD rate is rebased at 100 for March 1 in each of the years.
s
Gustavo Cañonero, New York, (212) 250 7530
Deutsche Bank Securities Inc.
Page 149
5 December 2013
EM Monthly: Diverging Markets
Mexico
Baa1 (stable)/BBB (positive)/BBB+ (stable)
Moody’s/S&P/Fitch
The economy in recovery and reforms
agenda nearly complete
Increased downside risks
With three quarters of economic activity indicators now
available for 2013, the prospects of recovery for the
Mexican economy are confirmed and it seems headed
to a 1.2%YoY GDP growth this year. GDP growth in the
third quarter came out above expectations at 1.3%YoY,
due to a strong expansion of services at 2.3%YoY.
Services offset a weak industrial activity, which fell
0.6%YoY in the third quarter. Nevertheless, despite a
Page 150
„
Manufacturing activity ended the quarter falling at
1.0%MoM in September, thus suggesting that it
may further decelerate. A source of risk is that
most of its expansion is concentrated in production
of automobiles and light trucks, while the other
components are growing more slowly. However,
we expect the production of vehicles to stay an
important engine for manufacturing in the coming
months. In fact, the trade deficit fell significantly in
October due partly to stronger exports of autos,
which grew 13.0%YoY
„
Contrary to expectations, construction activity had
not bottomed out yet in September, posting a fall
of 1.5%MoM
As the two major components of industrial production
performed below expectations, the risks for services
activity to follow suit and weaken overall growth is a
concern. In fact, the monthly Economic Activity Index
(IGAE) fell 0.4%MoM in September, thus suggesting
that the economy lost dynamism at the end of the
quarter.
Industrial production (Jan12=100)
Total
Construction
Manufacturing
Motor vehicles and parts
115
110
105
100
95
2013/09
2013/08
2013/07
2013/06
2013/05
2013/04
2013/03
2013/02
2013/01
2012/12
2012/11
2012/10
2012/09
2012/08
2012/07
2012/06
2012/05
2012/04
90
2012/03
Main risks: With the two main components of
industrial production underperforming, there is a
risk that services may decelerate in the coming
months and weaken overall activity. Besides,
private consumption may deteriorate further before
additional growth and more credit availability start
supporting it. So, the downside risks to our
economic outlook have increased with the latest
indicators. On the positive side, we anticipate that
the approval of the energy reform may extend good
expectations about Mexico and translate into
continued favorable market conditions in 2014.
This scenario is not free of obstacles but the
legislative process is moving forward fast enough.
In fact, such process has improved the reform
proposal itself by including oil exploration and
production schemes that may attract more
investment and boost overall activity in the energy
sector.
firmer expansion of overall economic activity in 3Q2013,
the composition of growth was disappointing and has
negative implications for the coming months:
2012/02
„
Economic outlook: Recent indicators show that
economic recovery is under way but it is weaker
than expected. Manufacturing activity decelerated
slightly at the end of 3Q2013 and its expansion is
sustained mainly by automobiles and light trucks.
Contrary to expectations, the latest data on
construction activity show that it has not bottomed
out yet, since building and infrastructure
development fell on a monthly basis in September.
Indicators on the demand side also suggest that
the rebound may be milder than anticipated, since
retail sales and consumer confidence are on a
downward trend. These indicators have prompted
negative revisions for growth in 2014. Nevertheless,
we maintain our view that even in absence of
extraordinary positive shocks, the bottoming out of
construction activity, a more vigorous recovery of
manufacturing in the US and the normalization of
government spending and investment in 2014, will
cause GDP growth to rebound next year. We
maintain our forecast for GDP growth in 2014 at
3.2%YoY.
2012/01
„
Source: INEGI
Recent indicators on the demand side also suggest that
the rebound may be milder than anticipated. Retail
sales fell more than expected in September, 0.4%MoM
and 4.0%YoY. Also, wholesales fell 2.7%MoM and
7.3%YoY, thus anticipating that retail sales are likely to
keep showing subpar readings in October. We
anticipate that weakness of private consumption will
continue, as consumer confidence dropped 1.5%MoM
in November, its fourth consecutive monthly fall.
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Some preliminary reports show that the retail sales
specials known as "Buen Fin" (Good Weekend) may
surprise positively on November data, but it is unlikely
to break the downward trend in retail sales as it may
have anticipated end-of-year households' purchases.
Private consumption (Jan12=100)
107
GDP growth forecasts (%YoY)
Retail sales
Consumer confidence
105
broad-based recovery of manufacturing in the US that
includes those activities highly correlated with Mexican
industrial production, and the normalization of
government spending and investment, GDP growth will
rebound in 2014 out of a base effect. Therefore, we
maintain our forecast for GDP growth in 2014 at
3.2%YoY.
4.5
103
4.0
101
3.5
3.0
99
2.5
97
2013
2.0
2014
Labor markets also remained weak in the third quarter
and reports showed mixed results. According to the
Quarterly Survey of Employment prepared by INEGI for
3Q2013, the unemployment rate was 5.2% of the
active population, up from 5.1% in 3Q2012 and the
highest since 2Q2011. On the other hand, population
on different types of informal jobs was 59.1% of
employed population, slightly down from 61.4% in
3Q2012 and the rate of underemployment (respondents
that answered that they would work more if allowed) is
8.5%, down from 8.7% in 3Q2013. Indicators for
October suggest that a slight improvement of the labor
market could be under way as seasonally adjusted data
showed a marginal drop in the unemployment rate.
As year-end approaches, weak indicators have stopped
affecting expected 2013 GDP growth and their
forward-looking implications are prompting revisions to
growth forecasts for next year. The latest Central Bank
survey showed a slight increase in average forecasts
for GDP growth in 2013, but a negative revision for
2014. Expected GDP growth for 2014 is now 3.3%,
down from 3.4% last month and from almost 4.0%
around mid-year. A similar result was reported by the
Banamex survey earlier in November, in which growth
prospects for 2013 remained virtually unchanged but
forecasts for 2014 were revised downwards. This
suggests that the market is probably more sensitive
now to negative indicators when forming medium-term
growth expectations.
Latest indicators have not changed our view that a
moderate a recovery is under way, but have increased
downside risks to our base scenario. Even in absence
of extraordinary positive shocks, the combination of
construction bottoming out in the coming months, a
Deutsche Bank Securities Inc.
2013/11
2013/10
2013/09
2013/08
2013/07
2013/06
2013/05
2013/04
2013/03
2013/02
2013/01
1.0
2012/12
Source: INEGI
1.5
2012/11
2013/11
2013/10
2013/09
2013/08
2013/07
2013/06
2013/05
2013/04
2013/03
2013/02
2013/01
2012/12
2012/11
2012/10
2012/09
2012/08
2012/07
2012/06
2012/05
2012/04
2012/03
2012/02
2012/01
95
Source: Banco de México
Inflation remained contained in 2013. The latest results
put annual headline CPI inflation at 3.5% and core
inflation at 2.4% in mid-November. Both readings are
well into the comfort zone of the Central Bank and we
anticipate that it will end the year at 3.7%, in line with
market expectations. According to the latest Banxico
survey, expected headline CPI annual inflation for yearend 2013 is 3.7%, up from 3.5% in the last survey, and
expected core inflation is now 2.7%, down from 2.8%.
Inflation expectations for 2014 also deteriorated slightly
with headline CPI forecasts at a 3.9% and core at 3.3%,
the former up from 3.8%. These results show that the
fiscal plan for 2014 has not prompted inflation
expectations for next year and that some of its
temporary effects on prices may be front-loaded into
2013.
Interestingly, expectations show that markets are
getting used to diverging headline and core inflation
readings, as public prices are keeping them apart. This
situation has important implications for the
government’s policy on controlled energy prices and
monetary policy. The path of energy prices, which is
determined by fiscal authorities, has an important
incidence on non-core inflation and creates a “floor”
for headline CPI inflation, which is the focal variable for
monetary policy by legal mandate. In our view, the
focus of the Central Bank on overall inflation rather
than core inflation has increased the credibility of
monetary policy. Nevertheless, the effect of public
prices on monetary policy through non-core inflation is
an issue that should be analyzed.
Page 151
5 December 2013
EM Monthly: Diverging Markets
Congress
made
minor
modifications
to
the
expenditures bill proposal and put the budget at
MXN$4,467bp pesos. The main points in the bill
passed are that the public deficit will run at 1.5% of
GDP, a new scheme of payments to unemployed
workers in the formal sector is created and a higher
spending in infrastructure development is targeted. It is
worth mentioning that the relationship between the
government and the right-wing PAN was damaged in
the discussion and approval of the revenues law (with
the left-wing PRD supporting it), but it was rebuilt
throughout the budget approval process, so the reform
agenda continued.
Inflation expectations for 2013 (%, Dec-Dec)
4.1
3.9
3.7
3.5
3.3
3.1
Headline CPI
Core
2.9
2.7
2013/11
2013/10
2013/09
2013/08
2013/07
2013/06
2013/05
2013/04
2013/03
2013/02
2013/01
2012/12
2012/11
2.5
Source: Banco de México
In late November, the Mexican Senate approved the
financial reform after the original proposal was passed
in the lower chamber back in September. The approved
bill has three main pillars to increase credit to the
private sector.
Inflation expectations for 2014 (%, Dec-Dec)
4.0
„
Strengthens the role of development banks by
allowing more flexibility in their operation and
relaxing its regulation to grant credit
„
Spurs competition among private financial
institutions by involving actively the newly created
Federal Antitrust Commission in their regulation,
rules out some practices that hinder competition
such as tied sales of financial services, creates
information disclosure entities to improve users’
access to market information, reduces switching
costs for users and promotes access to the stock
market by medium-sized companies
„
Modifies existing regulation to give private banks
more incentives to lend over holding alternative
assets, expedites the collateral recovery process on
non-performing loans and streamlines the
bankruptcy process for corporate borrowers
Headlin
e CPI
3.9
3.8
3.7
3.6
3.5
3.4
3.3
2013/11
2013/10
2013/09
2013/08
2013/07
2013/06
2013/05
2013/04
2013/03
2013/02
2013/01
2012/12
2012/11
3.2
Source: Banco de México
In this context, the Central Bank has mentioned
repeatedly since the last policy decision that a recovery
is under way, so further policy rate cuts are not
convenient. Particularly, it has been explicit that
additional rate cuts may not help economic activity and
put pressure on inflation, in turn. So we maintain our
call that Banxico will keep its policy rate unchanged at
3.5% in the December 6 meeting and stay there for
most of next year. We anticipate that as inflation
mounts in 2014 and approaches the upper limit of the
target range, the Central Bank will hike rates
preemptively in the last quarter.
Reforms agenda nearly complete
The process of legislative approvals in the
government’s agenda moved ahead in November and
now it is nearly over. After the fiscal plan for 2014 was
passed in October and the revenues of the Federal
Government were determined by law, the lower house
approved the budget for 2014, thus concluding the
process for the economic program.
Page 152
After credit has been growing slowly in the last years,
we believe that this bill may trigger lending, particularly
because of the increased room of maneuver granted to
development banks. However, we look forward to an
implementation of the new rules that do not displace
commercial banks from lending and maintains a sound
financial position for development banks.
The approval process of the electoral reform took place
in late November and early December, as a condition of
PAN to start the discussion of the energy bill. As it was
seen as a key element to unlock the energy reform, the
PRD dismissed the agreements on the electoral reform
and announced that it was leaving the “Pacto por
México”. PRD's announcement was expected, as we
did not see it supporting the energy constitutional
reform in any scenario, and signaled that PRI and PAN
were reaching agreements on the energy front
relatively fast.
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Allows re-election for Senate and lower chamber
members to serve up to 12 consecutive years, and
seeks to allow for re-election for mayors and statelevel legislators. No re-election for president was
included in the approved bill.
Passing the electoral bill was a major step towards the
energy reform. Nevertheless, two possible obstacles
loom. First, PAN has stated that the discussion and
approval of changes to the electoral system have to
take place in full before the energy bill is discussed.
Second, the left-wing PRD announced that it has
gathered 1.7 million signatures from citizens and asks
to stop the legislative process of the energy reform.
This request is based on Article 35 of the Mexican
Constitution, which says that a public consultation
should be called by Congress for relevant national
issues if at least 2% of all registered voters ask so (1.6
million). Even though there are differing legal
interpretations about what Congress should do next,
this formal request from PRD poses a threat to the
process. Above all, any legislative procedure that can
be disputed by the left on legal grounds will surely fuel
the array of protests that are widely expected to follow
the reform approval.
The expected positive impact of the energy reform has
improved
over
the
last
few
weeks.
First,
notwithstanding the possible obstacles mentioned
before, the energy reform is likely to be passed this
year and we anticipate that secondary legislation will
be processed relatively fast in 2014. Secondly, the
contents of the reform proposal itself have evolved
positively as discussions unfolded. Closing the gap
with the PAN concessions-based proposal, the PRI has
signaled repeatedly that it would support modifications
to its original project to include production-sharing
contracts and licenses for oil exploration and
production. Licenses could work as a good proxy to
concessions in terms of operability, without the
political costs of granting property of underground
resources to private companies.
The new framework of multiple schemes is a big
departure from the originally proposed profit-sharing
contracts. Such contracts may have been less
attractive to investors and conveyed more important
challenges for the design, approval and implementation
of secondary legislation. Even though the framework
based
on
profit-sharing
contracts
could
be
Deutsche Bank Securities Inc.
Top oil producers and their alternative schemes
10,427
•
•
S. Arabia
9,813
•
US
6,401
•
China
4,122
Canada
3,127
Iran
3,000
Iraq
2,918
Co u ntr y
Russia
Pro duction
Ser vice co nt ract s
„
Pr o fit sharing
The creation of a new National Electoral Institute
that substitutes the current federal authority but
not the electoral authorities at state-level
Pr o du ct io n shar ing
„
strengthened through an appropriate secondary
legislation and regulation, allowing companies to write
them as long-term assets, international investors have
more experience working with schemes based on
concessions and/or production-sharing contracts.
Approximately half of the crude oil production in the
world is conducted through concession-based
schemes, and another quarter rests on legal
arrangements that combine them with another
scheme. On the other hand, only Iran, Iraq and Angola,
out of the 20 top oil producers use profit-sharing
contracts.
Co ncessio ns
The Mexican Senate voted and passed in general terms
the election bill on December 4, which means that a
basic agreement has been reached on major issues and
now specific aspects are being discussed. As expected,
the two main points contained in the approved bill
were:
•
•
•
•
Kuwait
2,754
U.A.E.
2,653
Mexico
2,548
Venezuela
2,479
•
Nigeria
2,092
•
•
Brazil
2,061
•
•
Angola
1,756
•
•
Norway
1,618
•
Kazajistan
1,583
•
Libia
1,402
Argelia
1,165
•
UK
890
•
Qatar
741
•
•
•
R
R
•
•
•
•
•
Source: Deutsche Bank
By including production-sharing contracts and licenses
in the menu of available schemes for oil exploration
and production, the energy reform is likely to be deeper
and broader than the original proposal (the table above
shows the potential enhancements to the current legal
framework with the reform “R”). Deeper because
licenses and production sharing contracts can attract
more investment by granting companies more
operational control of their projects than profit-sharing
contracts and provide a clearer legal framework.
Broader
because
different
projects
can
be
Page 153
5 December 2013
EM Monthly: Diverging Markets
accommodated in the different schemes, depending on
their risk, investment requirements and technical
difficulty. A diverse menu of schemes may create
opportunities to investment not only in deep-water
wells and other high-risk projects, but also in mature
fields on a declining production path. Such flexibility
would be difficult to attain even in a scheme purely
based on concessions. We estimate that additional FDI
to the oil sector could be around USD$20bn or 1.5% of
GDP, up from our previous estimate of 1%.
FDI scenarios (% of GDP)
4.0
Mexico: Deutsche Bank Forecasts
2012
National Income
Nominal GDP (USD bn)
Population (m)
GDP per capita (USD)
2013F
2014F
2015F
1177
117
10063
1235
119
10380
1324
121
10946
1422
124
11464
3.8
4.6
2.4
5.5
4.2
6.0
1.2
4.0
2.2
0.0
1.5
2.0
3.2
4.3
3.3
4.2
3.3
4.5
3.6
4.6
5.0
4.6
3.7
5.0
Prices, Money and Banking
CPI (Dec YoY%)
CPI (avg %)
Broad Money
Credit
4.1
4.1
10.8
12.0
3.7
3.7
11.5
10.0
3.9
3.8
11.0
13.0
3.6
3.7
12.0
17.0
Fiscal Accounts (% of GDP)
Consolidated budget balance
Primary Balance
-2.6
-0.6
-2.9
-0.9
-4.0
-1.9
-3.6
-1.5
External Accounts (USD bn)
Exports
Imports
Trade Balance
% of GDP
Current Account Balance
% of GDP
FDI
FX Reserves
MXN/USD (eop)
371.4
371.2
0.2
0.0
-11.8
-1.0
15.4
163.5
13.0
377.0
378.6
-1.7
-0.1
-17.3
-1.4
13.0
186.5
12.9
389.4
395.7
-6.3
-0.6
-26.5
-2.0
18.0
205.0
12.5
403.8
415.4
-11.6
-0.8
-31.3
-2.2
26.0
225.0
12.4
Debt Indicators (% of GDP)
Government debt
Domestic
External
Total External Debt
in USD
Short term (% of total)
33.7
23.1
10.6
19.3
227.2
19.0
35.6
24.4
11.2
20.3
250.2
18.0
36.5
25.0
11.5
21.7
287.6
17.0
36.8
25.2
11.6
23.3
331.3
19.0
2.8
5.0
1.0
5.4
2.8
4.9
3.2
4.8
Current
1Q14
2Q14
4Q14
3.50
3.75
13.10
3.50
3.80
12.75
3.50
3.80
12.70
3.75
4.05
12.50
Real GDP (YoY%)
Priv. consumption
Gov't consumption
Investment
Exports
Imports
3.5
3.5
3.0
2.5
2.0
2.0
1.5
1.0
0.5
0.0
No reform
Reform
Source: Deutsche Bank
Moreover, we estimate that a broader legal scope able
to accommodate a wider diversity of projects may have
a bigger impact on production. Thus, we adjusted our
estimate for crude production under the reform
scenario from 3.5 to 4.0 million barrels per day.
Production scenarios (mbpd)
4.5
4.0
4.0
3.5
3.0
2.5
2.5
2.0
1.5
1.0
0.5
0.0
No reform
Reform
Source: Deutsche Bank
We expect that the reform agenda will be over with the
energy bill approval and that efforts in 2014 will be
directed to the implementation of the constitutional
changes of 2013, particularly by processing a robust
secondary legislation for all reforms.
General
Industrial Production
Unemployment
Financial Markets (end
i d)
Overnight
rate (%)
3-month rate (%)
MXN/USD
Source: DB Global Markets Research, National Sources
Alexis Milo, Mexico City, (52 55) 5201-8534
Page 154
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Peru
Baa2 (positive)/BBB+ (stable)/BBB (neutral)
Moodys /S&P/ /Fitch
„
Main risks: The widening of the current account
deficit, although currently financed by foreign
direct investment (FDI), constitutes a source of
vulnerability for the economy. A larger-thanexpected decrease in commodity prices and/or
Chinese growth, or the inability to meet copper
production targets from new projects would
endanger the financing of external accounts.
Domestically, the key risk is related to the decline
in President’s popularity, raising concern on
potential populist reactions as well as lack of
confidence translating into subdued investment
and consumption growth.
Domestic demand to drive recovery
Demand to offset confidence
Growth in economic activity decelerated significantly in
2013 from the high rates in 2012. Global and domestic
demand drove the move in 2013. Government
expenditure could be the only macro variable that may
contribute with higher numbers as compared to last
year. Private consumption growth should be around
5.0%, while gross fixed investment would grow a
meager 6.0%, both below 2013’s levels. After this year
fall in copper prices, exports are also likely to impact
growth numbers.
Even though lower copper and gold prices probably
started the deceleration in economic activity this year,
domestic demand reacted markedly. The following
figure shows how the decline in the expectations of
economic agents from the start of the year deepened
the fall in economic activity throughout the year.
Deutsche Bank Securities Inc.
Demand expectations and economic activity
9.0
68
8.0
66
7.0
64
6.0
62
5.0
60
4.0
58
3.0
GDP Growth
Jul‐13
Aug‐13
Jun‐13
Apr‐13
May‐13
Mar‐13
Jan‐13
Feb‐13
Dec‐12
Oct‐12
Nov‐12
Sep‐12
Jul‐12
Aug‐12
Jun‐12
52
Apr‐12
54
0.0
May‐12
56
1.0
Mar‐12
2.0
Jan‐12
Economic outlook: Growth in economic activity is
likely to accelerate after this year slowdown. We
expect domestic demand to react to the monetary
policy stimulus and make a larger contribution to
GDP growth. In addition, the direct and spillover
effects from the expected increase in copper
production will start helping growth by the end of
next year and the beginning of 2015.
Notwithstanding, the outlook for falling copper
prices will imply a widening in the current account
deficit in 2014. The decline in President Humala’s
popularity could be an obstacle to relative political
stability in the next couple of years. In 2014, the
political outlook should start to clear; but President
Humala is banned for the 2016 election by
constitution and his low popularity is also
preventing a potential candidacy of his wife.
Feb‐12
„
Demand expectations next 3 months
Source: Deutsche Bank and BCRP
The Central Bank of Peru decided to cut its reference
rate by 25bps in the November to stimulate domestic
demand, after more than two years of an unchanged
policy stance. However, it clarified that the decision to
lower the reference rate should not be interpreted as
the beginning of an easing cycle and that economic
activity would have to seriously deteriorate for them to
consider further cuts. Meanwhile, inflation exceeded
the target briefly due to temporary factors.
The main reason behind the reluctance to lower the
interest rate further is that economic authorities expect
a rebound in exports in the coming years, with spillover
effects to domestic demand components; specifically,
expectations are high regarding the starting operation
of the Las Bambas and Toromocho mining projects in
late 2014. The following table shows that copper
production will increase by close to 20% in 2015E,
constituting a large positive external shock to
economic activity.
Copper production expected to pick-up in 2015
Production (M Tn)
Annual Growth
2011
2012
2013e
2014e
2015e
1.20
-0.1%
1.29
6.9%
1.44
12.3%
1.42
-1.7%
1.70
19.7%
Source: Deutsche Bank Research forecasts
The current account deficit further widened in 2013,
pointing to reach 5.0% of GDP on average this year,
after a 6% peak during the third quarter. Declining
exports have been the main driver. This high external
deficit has been nevertheless covered by FDI inflows.
Furthermore, significant foreign exchange reserves
(around 30% of GDP) accumulated over the last few
years, also prevent any serious concern on external
Page 155
5 December 2013
EM Monthly: Diverging Markets
financing.
Nonetheless,
a
larger-than-expected
commodity shock could put pressure on the currency.
Peru: Deutsche Bank forecasts
De-dollarization allows for more FX-rate volatility
Significant dollarization of the Peruvian economy in
general, and of the financial system in particular,
explains the authorities active role in limiting exchange
rate volatility. Aside from achieving nominal stability,
monetary authorities have used the differential
between reserve requirements in local currency
deposits and dollar denominated deposits to reduce the
degree of dollarization by decreasing the former and
keeping the latter unchanged. This policy has been
effective (see figure below), and credit denominated in
local currency now exceeds credit in dollars. Going
forward, this change in regime will imply a lower
degree of intervention to curb volatility than before.
However, economic agents still have sizable exposures
to foreign currency, which precludes the Central Bank
from allowing major shifts in the exchange rate.
De-dollarization of financial sector continues
National Income
% of GDP
Credit, PEN denominated
Credit, USD denominated
25
20
15
10
Jun-13
Jun-12
Jun-11
Jun-10
Jun-09
Jun-08
Jun-07
Jun-06
Jun-05
Jun-04
Jun-03
Jun-02
Jun-01
0
Jun-00
5
Source: Deutsche Bank and BCRP
Political instability to be extended into 2014
After the 2011 elections, President Humala, a socialist
politician, surprised his fellow citizens and the financial
markets positively by changing his radical discourse
and engaging the private sector with a business
friendly attitude. Up to mid-2013, his government
enjoyed high popularity and talks of his wife
succeeding him also started, given that immediate reelection is not allowed in Peru. However, in the second
half of the year, poor policy decisions and political
scandals undermined the government’s popularity.
The reaction of the government after its fall in popular
support is an important variable to focus on during
2014. We do not expect any major policy or discourse
shift from Humala that could put at risk the market’s
confidence in the strength of the Peruvian economy.
Certainly, the government could extend cash transfers
programs that target the poor directly to try to regain
popularity. But such a policy shift alone would not
threaten macroeconomic stability as long macro
prudence is preserved, as expected.
Gustavo Cañonero, New York, (212) 250 7530
Page 156
2012
2013F
2014F
2015F
Nominal GDP (USDbn)
Population (mn)
GDP per capita (USD)
196.9
30.0
6,562
194.3
30.5
6,369
202.4
31.0
6,529
226.8
31.5
7,200
Real GDP (YoY%)
Priv. Consumption
Gov't consumption
Investment
Exports
Imports
6.3
6.5
8.0
11.0
14.0
23.0
5.2
5.0
8.5
6.0
10.0
12.0
6.0
6.0
8.0
9.0
10.5
15.0
6.5
6.2
7.0
9.5
12.0
15.0
Prices, Money and Banking
(YoY%)
CPI (YoY%)
2.7
CPI (avg%)
3.7
Broad money
16.5
Credit
16.0
3.0
2.5
15.0
15.0
2.5
2.7
16.0
15.5
2.7
2.9
16.0
17.0
Fiscal accounts, % of GDP
Balance
2.1
Interest payments
1.1
Primary surplus
3.2
1.0
0.7
1.7
0.6
0.9
1.5
0.5
0.8
1.3
External accounts (USDbn)
Exports
Imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI
FX reserves (USDbn)
FX rate PEN/USD (eop)
45.2
39.8
5.4
2.7
-6.1
-3.1
12.2
64.1
2.55
52.0
46.0
6.0
3.1
-9.7
-5.0
11.0
74.0
2.80
57.0
52.0
5.0
2.5
-11.1
-5.5
10.9
80.0
2.92
62.0
55.0
7.0
3.1
-10.2
-4.5
12.5
78.0
2.85
Debt Indicators (% of GDP)
Government debt
23.4
Domestic
9.8
External
13.6
Total external debt
24.8
in USDbn
48.8
Short-term (% of total)
15.1
23.7
10.0
13.7
27.2
52.9
14.8
23.0
10.4
12.7
27.7
56.0
14.5
21.0
9.5
11.6
27.6
62.6
15.0
General
Industrial prod (%)
Unemployment (%)
9.0
6.8
10.0
6.9
11.0
6.8
10.3
6.9
Current 1Q20142Q20144Q2014
Policy rate (interbank o/n) 4.00
4.00
4.00
4.50
3-month rate
4.90
4.90
5.00
5.00
PEN/USD
2.81
2.85
2.89
2.92
Source: DB Global Markets Research, National Sources
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Venezuela
B2 (negative)/B (negative)/B+ (negative)
Moody’s/S&P/Fitch
„
Economic outlook: The economic situation
worsened in 2013 due to the unsustainable mix of
expansionary fiscal and monetary policies, a rigid
exchange rate and capital controls, and nonincreasing oil revenues. In 2014, the policy mix will
remain unchanged, although a slight moderation in
expenditure and money creation during a nonelection year will likely decrease the speed of
deterioration. Even after this expected weakening
in public and external accounts, the amortization
schedule for the government and PDVSA remains
sustainable in the short term, but economic
performance will remain lackluster.
„
Main risks: The vulnerability of the economy to a
negative oil price shock will be at its highest next
year as the country will face less favorable external
financing conditions due to domestic, as well as
external factors. The extensive use of domestic
credit to finance government spending has ignited
an inflationary spiral that so far has only been
addressed with the extension of price controls. This
situation could get out of control before the
necessary measures are taken, threatening a
delicate economic and political equilibrium.
From bad to worse
Economic deterioration is accelerating
In 2014, the outlook for the Venezuelan economy will
be determined by the ability of the economic
authorities to adjust fiscal, monetary, and external
accounts. Otherwise, the government will be facing
binding constraints exemplified by decreasing oil prices
and unfavorable external financing conditions. Even
though the political situation will not likely add an extra
constraint next year lacking elections, the excesses in
economic policy taken in the first six months of
President Maduro’s term will have repercussions in the
coming year. In our opinion, economic performance
will continue to deteriorate, but would eventually
stabilize the worsening of external accounts, absent
any major shock in oil prices.
After the uncertainty surrounding Chavez’s illness,
death, and the surprisingly close electoral results in the
April presidential elections, President Maduro opted to
harden the speech and actions against the private
sector to solidify his position as the leader of the
“Bolivarian Revolution”. Expansionary fiscal policy had
been a constant feature during the years of President
Chavez leadership, but was mostly financed by
increasing oil revenues. Nowadays, with stable or
declining revenues, such policy stance brings a
worsening of the economic imbalances.
Deutsche Bank Securities Inc.
In order to cover the shortfall in the fiscal accounts
amid increasing spending requirements, economic
authorities reacted by boosting the pace of fiscal deficit
financed directly by the Central Bank. The result was a
rapid acceleration in money and credit growth, as well
as inflation. A larger increase in the demand for hard
currency and capital flight, deterioration in FX reserves,
and stagnation in economic activity were the inevitable
consequences. The authorities tried to resolve the
situation by blocking the access to hard currency from
the private sector, but the measure ended up rationing
access to imported goods, limiting intermediate
products, and increasing the differential between the
official and the black market rate.
As the figure below shows, money and credit growth
have accelerated in the past twelve months. The ratio
of M2 to foreign exchange reserves in the Central
Bank, one potential reference for the “market clearing”
exchange rate, is running around 50 VEF per USD. The
result of this growing imbalance fueled capital flight as
the demand for foreign currency and imported goods at
the official exchange rate skyrocketed, gradually
eroding foreign exchange reserves and subsequently
the net foreign asset position of the public sector.
Monetary and credit expansion
80%
M2 YoY growth
Credit YoY growth
70%
60%
50%
40%
30%
20%
10%
0%
Source: Deutsche Bank and BCV
Sources of imbalances are yet to be addressed
Instead of addressing the sources of domestic and
external imbalances that fostered capital flight from the
private sector, economic authorities have chosen to
fight the symptoms of the current economic malaise.
Thus instead of introducing another devaluation of the
official exchange rate and/or a tightening of fiscal and
monetary policies, the government imposed further
controls. Specifically, it further restrained dollar access
for the private sector, including imports. During the
Page 157
5 December 2013
EM Monthly: Diverging Markets
third quarter of 2013, the current account surplus
increased from an average of USD1.2bn in the previous
four quarters to USD4.1bn, explained mostly by a
decrease in imports of the same magnitude. However,
this broad measure has negatively impacted economic
activity as importers cannot access inputs of
production, fueling inflation and scarcity as a large part
of Venezuelan consumer goods are imported.
immediate result would be a sharp recession
accompanied with a fall in private consumption,
investment, and inflation, amid a gradual restoration of
external accounts. Therefore, it is unlikely that
government would embark fully on this kind of
adjustment; partly because of ideology, but partly
because of the high political cost these measures could
represent.
Capital flight and net foreign assets accumulation
Instead, a more likely path will be for the economic
authorities to keep financing government spending
domestically with money creation and further
devaluation, albeit at a slower pace. This, at best, could
stabilize inflation around current levels. We also expect
a new exchange rate regime to be launched in January,
with a sizable 50% devaluation, although not enough to
restore the equilibrium in the external sector. Thus,
hard currency rationing will remain inevitable. It is also
likely that the government will keep increasing its role
in economic activity, taking care of an even larger
share of imports (already running at around 45% of
total imports for 2013). More importantly, to ease the
effects of high inflation, scarcity, and falling economic
activity, the government will likely try to establish
mechanisms that target its voter base more efficiently,
including the combination of subsidized goods and
price controls.
NFA (Public Sector)
NFA (Private Sector)
140
120
USD bn
100
80
60
40
20
0
Source: Deutsche Bank and IMF-IFS
Similarly, to tackle the rampant inflation, the
government has expanded price controls to sectors
such as automotives, electronics, commercial rents,
food, and pharmaceuticals, among others A credible
enforcement was introduced as the National Assembly
voted in favor of granting President Maduro
extraordinary powers. Using those powers, President
Maduro has promised to penalize those who infringe
the price controls.
The coming municipal elections this December 8 are
part of the reason behind the government hesitation to
better address internal and external imbalances.
Nonetheless, the government has not been able to
campaign as in past elections launching massive
spending projects given the tighter budgetary
constraints nowadays. Instead, price controls and the
increased
rhetoric
against
private
sector
representatives have been used as a tool to gain
popularity.
Between a rock and a hard place
Next year will probably be one of the hardest in the last
decade for the Venezuelan economy. The rapid
deterioration in economic conditions during 2013 have
roots in the volatile political situation experienced
during the year. However, whether some stabilization
of the political regime could anticipate a change of
direction is hard to say, as ideology constitutes a main
driver force behind the authorities’ decisions. If the
authorities were to make a u-turn in economic policy
and reign in monetary and fiscal expansion, along with
a flexibilization of the exchange rate regime, the
Page 158
Official and black market rate differential widens
VEF
60
50
40
30
20
10
-
Black market exchange rate
Official exchange rate
Source: Deutsche Bank and Ecoanalitica
The limit of this unsustainable economic policy mix will
be determined by the government’s ability to balance a
necessary internal adjustment and the damage it could
cause in its popularity. Direct intervention in the
logistics and private sector economic plans will
continue to be used to achieve the satisfaction of the
government political base amid budget constraints.
Countless corruption scandals and the inability to run
nationalized
industries
efficiently,
evidenced
throughout the years of the current regime, do not
augur much hope for this strategy, thus extending the
gradual but steady deterioration of the Venezuelan
economy.
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Worsening, but manageable external financing needs
The amortization schedule for 2014, as pictured below,
is going to be aggravated by the tightening of external
financial conditions. This notwithstanding, we expect
the government and PDVSA to be able to access
international markets to refinance their maturing debt.
Venezuela: Deutsche Bank Forecasts
2012
National Income
Nominal GDP (USD bn)
Population (mn)
GDP per capita (USD)
2013E
2014F
2015F
381
430
329
358
30
31
31
31
12,918 14,111 10,621 11,543
External debt amortization (including PDVSA)
16
14
12
USD bn
10
8
6
4
2
0
2013
2014
2015
Principal
2016
2017
Interest
Real GDP (YoY%)
Priv. consumption
Gov't consumption
Investment
Exports
Imports
5.6
7.0
6.3
23.3
1.6
24.4
1.5
5.0
2.7
1.0
3.0
7.0
0.5
3.5
3.0
2.5
2.8
8.0
3.5
5.0
7.0
8.0
4.0
10.0
Prices, Money and Banking
CPI (YoY%, eop)
CPI (YoY%, avg)
Broad Money (YoY%, eop)
Credit (YoY%, eop)
20.1
23.8
60.1
49.0
50.0
40.0
65.0
55.0
45.0
47.5
50.0
45.0
40.0
43.0
62.0
50.0
Fiscal Accounts (% of GDP)
Consolidated budget
Interest payments
Primary Balance
-18.0
2.5
-15.5
-14.3
2.8
-11.5
-11.5
3.5
-8.0
-13.5
3.5
-10.0
External Accounts (USDbn)
Exports
Imports
Trade balance
% of GDP
Current account balance
% of GDP
FDI
FX reserves
VEF/USD
98.0
58.0
40.0
10.5
14.0
3.7
0.0
29.9
4.30
92.0
55.0
37.0
8.6
7.2
1.7
0.0
21.7
6.30
95.0
50.0
45.0
13.7
14.0
4.3
1.0
25.0
12.0
98.0
60.0
38.0
10.6
15.0
4.2
1.5
30.0
16.0
Debt Indicators (% of GDP)
Government debt
Domestic
External
Total external debt
in USDbn
Debt Service (USD bn)
37.9
15.6
22.4
25.8
98.4
8.6
35.4
15.5
19.9
23.1
99.6
13.0
43.7
17.5
26.2
30.6
100.9
14.0
46.3
22.0
24.3
28.5
101.8
13.7
2.4
8.0
1.0
8.3
2.0
8.5
2.5
8.0
Current
20.6
14.5
6.30
1Q14
25.0
15.5
10.00
2Q14
25.0
15.5
10.00
4Q14
25.0
17.0
12.00
Source: Deutsche Bank and Ecoanalitica
In our opinion, losing access to international capital
markets would gravely endanger the political stability
of the government, given the nature of the Venezuelan
economy. Currently, a large part of consumer and
investment (mostly oil related) goods are imported.
Furthermore, Venezuela’s most important and
profitable activity (oil) is capital intensive and cannot
succeed without access to international markets. This
explains the willingness to continue honoring external
debt even during the last 14 years of the Chavista
regime. True, the ability to pay is linked to the liquidity
of the government’s external assets and appears to
have been further compromised during 2013. However,
the government is expected to embark in different
renegotiations with its closest partners in order to
mollify the existing financing constraints.
Thus, it is likely that further issuance would be replaced
by direct funding with PDVSA’s partners in an attempt
to finance capital expenditure and obtain an increase in
oil production and revenues. A softening of the terms
on the private-public partnership agreements to
develop new projects should also be a part of the
economic strategy for next year.
In sum, the Venezuelan economy is getting closer and
closer to the edge of sustainability. Likewise, its
dependence on the fate of oil prices is at its maximum
due to the growing imbalances in the external as well
as the domestic sector. This, therefore, anticipates a
new challenging economic and political year ahead,
with 2014 likely to be as convulsed and daring as the
already volatile 2013 performance. In addition, next
year’s policy outcome will condition the economy, but
more important politics in the years ahead.
General (%)
Industrial production
Unemployment
Financial Markets (eop)
Overnight rate (%)
3-month rate (%)
VEF/USD
(*) Includes PDVSA external debt
Source: DB Global Markets Research, National Sources
Gustavo Cañonero, New York, (212) 250-7530
Deutsche Bank Securities Inc.
Page 159
5 December 2013
EM Monthly: Diverging Markets
Theme Pieces
November 2013
„
„
„
„
„
„
China: Economic Benefits of TPP Entry
EM Rates: Trading Pre-Taper Anxiety
Chile's Presidential Election from a Regional
Perspective
Inflation Drivers in EMEA
The Mystery of Russia's Deteriorating Current
Account Balance
Charting Malaysia's BoP Position
October 2013
„
„
„
„
„
„
EM Allocation: Strategic vs. Tactical
Sovereign Credit - Fundamentals Re-pricing and
Credit Differentiation
Balance of Payment Sensitivities in Latin America
Towards free trade across the Pacific
Outlook and Implications of Mexico´s Fiscal and
Energy Reforms
Greece: GGBs and Warrant, updated and term
structure of risk
September 2013
„
„
„
„
„
Emerging Value in Sovereign Credit
Brazil: External Adjustment and FX Intervention
Latin America: Challenged by US Tapering and Time
Decay
Russian Growth: a View from the Regions
Poland – A Deeper Look at Pension Reform
July 2013
„
„
„
Foreign Ownership of EMEA Government Debt: an
Update
Introducing EM Sovereign Credit Valuation Snapshot
India: Battling Vulnerability
June 2013
„
„
„
„
„
„
Capital Flows to EM: Ample but (Mostly) Not
Alarming
EMEA Gov’t Debt: Who Holds it (and Will They Keep
It)?
EM Credit: Coping with the End of Easy Money
EM Rates: Restoring Value
LatAm FX: Roadmap to USD Strength and Weakness
Brazil: QE Tapering Requires Plan B
May 2013
„
„
„
„
„
EM: Boundaries to QE Hype
Analyzing the Inflation Bonus from Elusive Growth
Venezuela: Time to Take a More Defensive Position
Breakeven Oil Prices
Greece: GDP Warrants Revisited
Page 160
April 2013
„
„
„
EM Growth : Unevenly Elusive
Brazil: Is CDS Overbought?
EM Rates: At an Inflection Point
March 2013
„
„
„
„
„
„
Inflation Targeting: What Target?
Mexico: Reforms Are Drawing Nigh
Venezuela – Chavismo, The Sequel
Ukraine Muddles Through, For Now
Argentina: The Sense Of A Legal Ending
Revisiting Market-Implied Credit Quality
February 2013
„
„
„
„
„
Ranking Policy Weapons for Currency Wars
Looking for Convergence Opportunities in QuasiSovereigns
Idiosyncratic Sources of Value in Local Rates
A Closer Look at Swap Spreads in EMEA
India's potentially significant cash transfer plan
January 2013
„
„
„
„
RV Themes in Sovereign Credit: Retracing Basis and
Slope
Venezuela: Chavismo Without Chavez
Recent Inflation Surprises and Monetary Stances in
EM
Revisiting the sensitivity of EMEA to the G2
December 2012
„
„
„
„
„
„
Rates in 2013: The Cliff and Beyond
FX in 2013: Gaining Ground
Sovereign Credit in 2013: Less Gas in the Tank
On the Likelihood of EM Diminishing Economic
Performance
EM Performance: Growth and Asset Rebalancing
EM Vulnerability Monitor
November 2012
„
„
„
Argentina: Pricing Litigation
EM Options: Gliding Over the Cliff
South Africa: Short-Term Gain, Long-Term Pain
October 2012
„
„
„
„
„
„
Stress Testing EM External Resilience
EM Rates: Analyzing Sensitivity to US Rates
Sovereign Credit: Retracing Basis and Slope
EMFX: Switching to Low Volatility
Venezuela: Chavez Still Unbeatable
Greece: GGB RV – It’s Not About the Yield
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
Contacts
Name
Title
Telephone
Email
Location
EMERGING MARKETS
Balston, Marc
Regional Head, EMEA
44 20 754 71484
marc.balston@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
Jiang, Hongtao
Spencer, Michael
Ortiz, Nellie
LATIN AMERICA
Armenta, Armando
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
Head of EM Corporates
1 212 250 7568
denis.parisien@db.com
New York
Senior Economist, Mexico
525552018534
alexis.milo@db.com
Mexico
EM Strategist
1 212 250 5932
assaf.shtauber@db.com
New York
Burgess, Robert
Head of Economics, EMEA
44 20 754 71930
robert.burgess@db.com
London
Grady, Caroline
Senior Economist
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 Economist/Strategist
44 20 754 58774
lionel.melin@db.com
London
EMEA Rates Strategist
44 20 754 74241
siddharth.kapoor@db.com
London
EMEA Sovereign Credit Strategist
44 20 754 51382
winnie.kong@db.com
London
Senior Economist
27 11 775 7267
danelee.masia@db.com
Johannesburg
Singapore
Faria, Jose Carlos
Marone, Guilherme
Parisien, Denis
Milo, Alexis
Shtauber, Assaf
EMERGING EUROPE, MIDDLE EAST, AFRICA
Gullberg, Henrik
Kalani, Gautam
Melin, Lionel
Kapoor, Siddharth
Kong, Winnie
Masia, Danelee
ASIA
Baig, Taimur
Head of Economics, Asia
65 642 38681
taimur.baig@db.com
Das, Kaushik
Economist, India, Pakistan, Sri Lanka
91 22 71584909
kaushik.das@db.com
Mumbai
65 6423 5261 diana.del-rosario@db.com
Singapore
65 6423 6973
Singapore
Del-Rosario, Diana
Economist, Malaysia Philippines
Goel, Sameer
Head of Asia Rates & FX Research
Kalbande, Swapnil
Rates Strategist
Kojodjojo, Perry
Lee, Juliana
FX Strategist
Senior Economist, India, Pakistan, Sri Lanka
Li, Lin
Liu, Linan
Ma, Jun
Sachdeva, Mallika
Seong, Ki Yong
Deutsche Bank Securities Inc.
sameer.goel@db.com
65 6423 5925 swapnil.kalbande@db.com
Singapore
852 2203 6153
perry.kojodjojo@db.com
Hong Kong
852 2203 8312
juliana.lee@db.com
Hong Kong
Economist, China, Hong Kong
852 2203 6187
lin.li@db.com
Hong Kong
Rates Strategist
852 2203 8709
linan.liu@db.com
Hong Kong
Chief Economist, Greater China
852 2203 8308
jun.ma@db.com
Hong Kong
FX Strategist
Rates Strategist
65 6423 8947 mallika.sachdeva@db.com
852 2203 5932
kiyong.seong@db.com
Singapore
Hong Kong
Page 161
5 December 2013
EM Monthly: Diverging Markets
Policy Rate Forecast
Projected Policy Rates in Emerging Markets
Policy Rate Forecasts
Current policy rate
Q4-2013
Q1-2014
Q2-2014
Q4-2014
Q4-2015
Emerging Europe, Middle East & Africa
Czech
0.05
0.05
0.05
0.05
0.05
0.50
Hungary
3.20 ↓
3.00 ↓
2.70 ↓
2.70 ↓
2.70 ↓
3.75
Israel
1.00
1.00
1.25
1.50
2.00
3.00
Kazakhstan
5.50
5.50
5.50
5.50
5.50
5.50
Poland
2.50
2.50
2.50
2.50
3.50
4.50
Romania
4.00
4.00
3.50
3.50
3.50
3.50
Russia
5.50
5.50 ↑
5.25
5.25 ↑
5.25 ↑
5.25
South Africa
5.00
5.00
5.00
5.00
5.00
6.50
Turkey
7.75
7.75
8.75
9.00
9.00
9.00
Ukraine
6.50
6.50
6.50
6.50
6.50
6.50
China
3.00
3.00
3.00
3.00 ↓
3.25
3.25
India
7.75
7.75
7.75
7.75
7.00
7.50
Indonesia
7.50 ↑
7.50
8.00 ↑
8.00 ↑
7.50 ↑
7.00
Korea
2.50
2.50
2.50
2.50
2.50
3.50
Malaysia
3.00
3.00
3.25 ↑
3.50 ↑
3.50
4.00
Asia (ex-Japan)
Philippines
Taiwan
3.50 ↓
3.50
3.50
1.875
1.875
1.875
3.50 ↓
1.875
4.00 ↓
4.50
1.875 ↓
2.325
Thailand
2.25 ↓
2.25
2.00
2.00 ↓
3.00
Vietnam
7.00
7.00
7.00
7.00
7.00 ↓
10.00
Brazil
10.00 ↑
10.00
10.50 ↑
10.50 ↑
10.50 ↑
11.50
Chile
4.50 ↓
4.50
4.25
4.25
4.25
4.50
Colombia
3.25
3.25
3.25 ↓
3.75
4.00
4.75
Mexico
3.50
3.50
3.50
3.50
3.75
4.00
Peru
4.00 ↓
4.00 ↓
4.00 ↓
4.25 ↓
4.50 ↓
4.75
3.00
Latin America
↑/↓ Indicates increase/decrease in level compared to previous EM Monthly publication; a blank indicates no change
For Turkey, we have switched to showing the overnight lending rate rather than the one-week repo rate as the more meaningful indicator of the p
Source: Deutsche Bank
Page 162
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
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
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 163
5 December 2013
EM Monthly: Diverging Markets
Regulatory Disclosures
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.
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.
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
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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.
Page 164
Deutsche Bank Securities Inc.
5 December 2013
EM Monthly: Diverging Markets
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 165
David Folkerts-Landau
Group Chief Economist
Member of the Group Executive Committee
Guy Ashton
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
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Global Disclaimer
Emerging markets investments (or shorter-term transactions) involve significant risk and volatility and may not be suitable for everyone. Readers must make their own investing and trading decisions using their own
independent advisors as they believe necessary and based upon their specific objectives and financial situation. When doing so, readers should be sure to make their own assessment of risks inherent to emerging
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