Directional EMEA Economics - ING WB · Directional EMEA Economics ... [email protected] Mihai Tantaru Romania +40 21 209 1290 [email protected] Dmitry Polevoy Russia +7 495 771

SEE THE DISCLOSURES APPENDIX FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONresearch.ing.com

FINANCIAL MARKETS RESEARCH

April 2013

EMEA Economics and Strategy TeamSee details at end of report

Directional EMEA EconomicsWho to tango with?

Bulgaria

Croatia

Czech Republic

Hungary

Israel

Kazakhstan

Poland

Romania

Russia

Serbia

South Africa

Turkey

Ukraine

1

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Directional EMEA Economics April 2013

1

Contents

Summary 1

Quarterly Outlook 5

EMEA Capital Markets Outlook 19

EM: Who to tango with? 29

Reassessing EMU entry for the CEE 46

Countries 59 Bulgaria ............................................................................................................................60 Croatia .............................................................................................................................62 Czech Republic ................................................................................................................64 Hungary............................................................................................................................68 Israel ................................................................................................................................72 Kazakhstan ......................................................................................................................74 Poland..............................................................................................................................76 Romania...........................................................................................................................80 Russia ..............................................................................................................................84 Serbia...............................................................................................................................88 South Africa......................................................................................................................90 Turkey ..............................................................................................................................94 Ukraine.............................................................................................................................98

Disclosures Appendix 101

EMEA Economics and

Strategy Team

Dorothee Gasser London +44 20 7767 6023 [email protected]

Mateusz Szczurek Poland +48 22 820 4698 [email protected]

Gustavo Rangel London +44 20 7767 6561 [email protected]

David Spegel New York +1 646 424 6464 [email protected]

Gergely Urmossy Hungary +36 1 235 8757 [email protected]

Rafal Benecki Poland +48 22 820 4696 [email protected]

Grzegorz Ogonek Poland +48 22 820 4608 [email protected]

Vlad Muscalu Romania +40 21 209 1393 [email protected]

Mihai Tantaru Romania +40 21 209 1290 [email protected]

Dmitry Polevoy Russia +7 495 771 7994 [email protected]

Egor Fedorov Russia +7 495 755 5480 [email protected]

Sengül Dağdeviren Turkey +90 212 329 0752 [email protected]

Muhammet Mercan Turkey +90 212 329 0751 [email protected]

Ömer Zeybek Turkey +90 212 329 0753 [email protected] Cover photograph courtesy of istockphoto.com Publication date 22 April 2013


1

Summary

2013 is increasingly looking like a repeat of 2012. The Eurozone economy remains stuck

in a recession. New bailouts and bail-ins continue in the EMU. The US economy is

getting visibly better, but fiscal headwinds continue to threaten the recovery. Central

banks are accelerating quantitative easing (or catching up with peers), while emerging

market debt markets are rallying as capital flows pour in. Though external refinancing

risks have far from disappeared in the EMEA region, the easy Eurobond placements in

1Q13 suggest that another annual contraction in foreign loans should be comfortably

compensated for by portfolio inflows, chiefly to bonds in CEE.

A direct consequence of this backdrop in the region can be seen in bond yields hitting

fresh lows. However, with Czech 10yr yields now at 1.65%, Polish at 3.3% and Romanian

and Hungarian both at 5.4%, and with easy access to cash inflows from foreigners, the

temptation is growing for governments to halt the fiscal-tightening wave experienced

since 2010. It is also enabling policy-makers to revisit traditional growth-boosting policies,

to the great relief of the soon-to-be-voting masses.

As the Eurozone now enters a triple-dip recession (our Global Economics Team projects

a -0.6% print for this year), the original EMU/CEE GDP slump is hitting previously resilient

Poland and Russia. We revise our Russian growth forecast to 2.8% this year, on slower

exports and investment prospects. Yet, on the other side of the Bosphorus, the sun is

noticeably brighter, with Turkey and Israel confirming their relative resilience.

While Eurozone challenges continue to hang as a Damocles sword on any wider

European recovery and the Chinese growth engine loses steam, 2014 still holds the

promise of a US recovery and evidence of outperformance in some Emerging Markets

(Latam or, as mentioned above, Turkey and Israel). This means there should be room for

EMEA to grasp some external support for GDP. But from where? And who in EMEA will

be best positioned, given their traditional trade ties, to capture the world’s demand growth

in 2013 and 2014?

This is the theme we address in this new version of Directional Economics. As the EMEA

region faces a heavy electoral schedule, political imperatives are set to reignite

international trade ‘courtship’. Having faced the GDP-slump for a few years now, and

having exhausted conventional fiscal possibilities, EMEA politicians need new partners

beyond their national boundaries to get “some” extra economic growth.

The “Who to Tango with” section of this report attempts to identify the main countries set

to contribute most to household consumption growth in the next two years. By

investigating corresponding trade ties, it seeks to establish which EMEA countries can

hope for the largest export contribution to growth this year and the next. It also identifies

which will struggle further.

We reassess the benefits of CEE joining the EMU in a second section. Given core

members’ loss of credibility in recent years, and the persistent contagion risks in the EMU

periphery, the appeal of the Club has receded. This is all the more so since the promise

of cheap and stable financing for new members within the EMU has proven overrated.

Latvia and Lithuania may prove to be the only ones joining the Euro area in this decade.

Dorothee Gasser-Chateauvieux, London (44 20) 7767 6023

Mateusz Szczurek, Warsaw (48 22) 820 4698


2

Country Summary : CE4

Czech Republic

Hungary

Eventual recovery in activity is going to be a prolonged affair,dependent on Eurozone stabilisation. For a change, we expect fiscalpolicy to become supportive for growth from mid-2013 onwards, notleast because of the general elections due in 1H14. Apart from theEMU outlook, the risks for growth include the tight debt thresholds inthe fiscal responsibility bill and high participation in the second pillarof the pension system, which could further increase savings. While the seventh-running quarter of the recession is likely to keep CZKweak and official rate expectations anchored at zero, we see 12x15FRAs pricing in no rate change, arguing that this rate is too low. We expect €/CZK to drift above 26.0, still allowing the CNB to abstainfrom actual interventions this quarter.

HUF recovered from above 300 to the 290-300 trading range once the uncertainties around the new NBH leadership and its possible programmes subsided. With Mr. Matolcsy appointed as the new governor, the MPC’s rate cut cycle did not stop, and the key rate was reduced to 5.00% in February. NBH’s Funding for Growth Scheme (FGS) could hardly be called aggressive, but the plans to reduce access to two-week central bank bills has potential to weaken the HUF, or at least shield it from appreciating in line with further bond inflows. While we expect Hungary’s recession to end in 2013, private deleveraging and slow EU growth will keep growth close to zero despite promising signs in industrial output.

Poland

Romania

While Poland should avoid near-zero growth in 1Q13, the case forrecovery in the next quarters remains weak. CPI should remainbelow the MPC target in 2013 and 1H14. The MPC is in 'wait and see’ mode but we expect further easing through 25bp cuts in Juneand July (to 2.75%). MinFin should avoid growth-damaging tightening to meet the deficit target of 3.5% of GDP: it can revise thecentral deficit up or utilise transfers from OFE capital. There is moreto do on the monetary policy side, as real rates - even after 50bps in cuts - should remain the highest in EM. This should attract portfolio capital, despite some cyclical fiscal slippage. Overvaluation of PLNbonds could be halted if yields pick up on core markets or if the MPCcredibly announce the end of the easing cycle.

Romania’s eurobonds have performed strongly in recent months. 5Y CDS spreads compressed to 215, after averaging slightly more than 350 in 2012. While reaching a third consecutive IMF deal remains our base-case scenario, this is probability less likely. The alternative might put some temporary pressure on Romania’s tradable debt, and future developments will depend on the fiscal line chosen by the executive. With the government continuing to talk about fiscal easing (cutting employer social security contributions, cutting VAT for bread and eventually all food items), we attach a reasonable probability to a scenario of fiscal experiments that could limit potential dips in popularity. While recent GDP growth revisions increase the chances of a ratings upgrade, for now a downgrade looks more likely.

Country Summary : other Central & Eastern Europe

Bulgaria

Croatia

Tens of thousands of Bulgarians took to the streets in February in a protest sparked by high utility bills and fuelled by poverty. This led the government to resign and brought forward general elections by about two months to 12 May. The good news is that this increase inpolitical uncertainty has not been reflected in available economic data, so our forecasts have not seen significant changes. The badnews, however, is that polls suggest the elections will not bring aclear winner, limiting the chances for a speedy formation of a new government. The risk of fiscal slippage has increased along withsocial tension. The Socialists’ plan to return to progressive taxationwould probably put the largest pressure on public finances.

HRK continued its weakening trend in 1Q13, with depressed domestic and foreign demand requiring an environment that discourages imports. While the near-term hurdles in the EU accession process were cleared, the economy’s outlook worsened. The two downgrades by Moody’s and S&P left Fitch as the only agency keeping Croatia’s BBB- rating. On the positive side, Croatia retains decent access to external funding. It recently placedUS$1.5bn in 10Y bonds, the first since April 2012. The issue alone covers a quarter of its gross 2013 issuance needs. We expect a continuation of the weakening of the HRK, on sub-average growth and increased pre-EU entry spending in 2Q13.

Serbia

2012 real GDP growth disappointed, down 2% on a poor harvest.2013 should see a return to positive territory, but our 1.1% forecastmakes officials’ 2% look optimistic. Their 3.6% targeted GDP budgetgap will likely be missed, while the CA gap should stay flat at 10% ofGDP, despite a boost in car exports. The government’s commitmentto restructuring has proven commendable so far, and the benignglobal liquidity backdrop has allowed for easing of financingpressures in 1Q13. Unfortunately, this also means stickier FX debtlevels and a less likely compliance with IMF conditions in the short term (with an IMF mission in May). But officials seem committed tonegotiations, as with Kosovo, despite recent bumps and cosinesswith Russia.


3

Country Summary : CIS

Russia

Kazakhstan

1Q13 economic weakness has forced us to cut our 2013 GDP call to2.8%, which still looks more optimistic than MinEco’s updated call of2.4%. However, the CPI forecast remains mostly unchanged atmarginally below 6%, with some upside risk in 2014. Thus, we thinkour call for a 25-50bp key CBR rate cut looks balanced in terms ofGDP and inflation risks. RUB had been doing well before early April’ssell-off, and we expect it to weaken further by year-end on a deteriorating BoP outlook and other domestic factors. Room for lowerpolicy rates and attractive OFZ position vs CEE/BRICS peers flagsthat there might be some extra yield compression in OFZ bonds. Key risks are lower rate cuts, a weaker fiscal outlook (vs MinFin’s -0.6%/GDP) and FX risk.

Higher GDP growth than in many DM/EM peers does not imply many changes in the macro story. Due to longer delays in 4Q12 data releases (eg, final GDP, 1Q13 BoP), we mostly stick to earlier GDPforecasts, with some adjustments to key items. We still keep a slightly below-consensus view on GDP, but now see a somewhat better 2H13 inflation profile. This will be beneficial for consumption. Despite the 3% of GDP budget gap, the fiscal profile is secured by the National Oil Fund (NOF), prudent budget planning and a rise in oil export duty. We however note that this looks as unwinding the effect of the 2009-1H10 duty abolition. The main concern is worsening BoP, which puts KZT at risk, barring a renewed commodity price rally.

Ukraine

We resume our Ukraine macroeconomic coverage with a 1.6% YoYGDP call for 2013 (vs 0.2% in 2012), with 1H13 likely to remainrecessionary. UAH devaluation pressure has slightly abated thanks toa calmer political scene post 4Q12 elections, appetite for Ukrainianrisk (both sovereign and corporate) and further hopes of an IMF deal.The mission completed the next round of talks in early April, flagging‘good progress’. Though tail-risks of the deal not going through stillexist, our base case scenario is for the deal to happen in late 2Q13-early 3Q13. The remaining BoP risks, FX reserves at 3-4 months of imports, and limited chance of lower gas price from Russia all call fora weaker UAH as a bare minimum requirement for the deal.

Country Summary : other EMEA

Israel

Turkey

Israel is on course to deliver a solid 3.5% YoY growth in 2013, liftedby the external accounts. The demand side should remain subdued,with heightened prospects of higher fiscal constraints. The latter point,alongside a benign inflation backdrop in 2Q13, should allow the BoI tocut the base rate against a rallying ILS (on a solid current accountprofile), though the window is small and limited to this quarter. DirectFX purchase and verbal signals are thus likely to be intervention toolsof choice in the short term. The fiscal accounts will remain the weakpoint of the country this year and budget noise is likely to increaseuntil August. The new government is settling in, but the alliance isparticularly fragile on the Palestinian issue.

Turkey’s 2012 soft landing, with 2.2% GDP growth, turned out to be faster than expected. That said, bringing along significantly neededexternal rebalancing, it was certainly supportive of sustainability. Last year, the C/A deficit fell from 9.7% to 6.0% relative to GDP, as the non-energy balance turned from a 3.6% deficit into a 0.7% surplus. The expected stabilisation in the C/A deficit at 6.5-7.0% of GDP as growth picks up towards a 5% potential rate this year will support Turkey’s rating outlook. We still expect an investment grade (IG) rating by 3Q13. Inflation and global liquidity will be the key drivers of volatility. We think all policy will be geared towards 4% GDP growth in 2013, while the CBT continues to keep interest rates low, watching out for REER and loan growth, and building up reserves.

South Africa

The South Africa macro mix is not likely to look better in 2Q13. Thefunding of the CA gap is set to be even tighter; as the trade balancedeteriorates further. Inflation should break the 6% threshold earlierthan the SARB anticipated in its last statement, and social noisecould be re-ignited during the wages negotiation season. Unless theauthorities come up with a ground-breaking action plan – a low probability in our view – local assets are likely to underperform EMpeers with overhanging risks of a rating downgrade. Still, it is not alldoom and gloom. Industrial production should show signs of revival and BRICS institutionalisation could offer credible anchors for SA inthe mid term.


4

ING Main Macroeconomic Forecasts

Real GDP (% YoY) Exchange rate (quarterly is eop, annual is avg)

1Q13E 2Q13F 3Q13F 4Q13F 2013F 2014F 1Q13E 2Q13F 3Q13F 4Q13F 2013F 2014F

Bulgaria 0.5 1.4 0.9 1.1 1.0 1.7 EURBGN 1.96 1.96 1.96 1.96 1.96 1.96

Croatia -3.2 -1.6 -0.7 -0.2 -1.4 1.0 EURHRK 7.59 7.66 7.60 7.60 7.59 7.61

Czech Rep -1.2 -0.3 1.3 1.5 0.1 2.1 EURCZK 25.76 26.30 26.50 25.70 26.07 25.10

Israel 2.6 3.5 4.3 3.7 3.5 4.7 USDILS 3.60 3.65 3.70 3.75 3.69 3.70

Hungary -0.8 0.1 0.8 1.0 0.3 1.3 EURHUF 304.3 290.0 295.0 295.0 295.6 292.0

Kazakhstan 4.0 4.1 6.6 5.8 5.3 5.8 USDKZT 150.9 152.1 152.5 152.5 151.5 152.8

Poland 0.7 1.0 1.3 1.8 1.2 2.6 EURPLN 4.18 4.16 4.20 4.10 4.17 4.13

Romania 0.7 0.7 2.2 2.1 1.6 2.0 EURRON 4.42 4.40 4.35 4.30 4.39 4.31

Russia 1.3 2.2 3.0 4.1 2.8 3.5 USDRUB 31.06 31.30 31.90 33.00 31.56 33.10

Turkey 3.2 4.4 5.0 5.3 4.5 5.0 USDTRY 1.81 1.80 1.84 1.90 1.82 1.90

Serbia -0.8 1.2 1.4 2.3 1.1 3.2 EURRSD 111.31 112.50 113.00 113.00 112.36 111.61

South Africa 2.4 2.8 2.5 2.7 2.6 3.0 USDZAR 9.23 9.25 9.00 9.10 9.08 9.05

Ukraine -1.1 -2.0 3.6 6.0 1.6 3.0 USDUAH 8.12 8.80 9.00 9.30 8.67 9.55

Eurozone -1.0 -0.8 -0.7 0.1 -0.6 0.9 EURUSD 1.28 1.28 1.25 1.20 1.27 1.22

US 1.8 1.7 1.5 2.2 1.6 2.4

CPI (%YoY) (quarterly is eop, annual is avg) CB rates (%, eop)

1Q13E 2Q13F 3Q13F 4Q13F 2013F 2014F 1Q13E 2Q13F 3Q13F 4Q13F 2013F 2014F

Bulgaria 3.6 4.0 2.2 2.9 3.3 3.4 Bulgaria n/a n/a n/a n/a n/a n/a

Croatia 4.9 4.3 2.9 2.5 3.7 2.3 Croatia 6.00 6.00 6.00 6.00 6.00 6.00

Czech Rep 1.7 1.7 1.9 1.8 1.8 1.8 Czech Rep 0.05 0.05 0.05 0.05 0.25 1.00

Israel 1.4 1.0 1.9 3.2 1.9 2.5 Israel 1.75 1.50 1.50 1.75 1.75 3.00

Hungary 2.7 3.3 2.6 2.8 3.0 3.2 Hungary 5.00 4.25 4.25 4.25 4.25 4.50

Kazakhstan 6.8 6.3 6.1 5.7 6.3 5.8 Kazakhstan 5.50 5.50 5.50 5.50 5.50 5.50

Poland 1.0 0.8 1.4 1.8 1.3 2.1 Poland 3.25 3.00 2.75 2.75 2.75 3.00

Romania 5.3 5.8 4.4 4.6 5.4 4.0 Romania 5.25 5.25 5.25 5.25 5.25 5.25

Russia 7.0 6.2 5.8 5.7 6.1 6.0 Russia 5.50 5.25 5.00 5.00 5.00 5.00

Turkey 7.3 7.8 6.9 6.5 7.1 5.9 Turkey 5.00 5.00 5.00 5.25 5.25 5.50

Serbia 12.5 6.9 2.0 4.6 7.3 6.5 Serbia 11.75 11.75 10.25 9.50 9.50 8.50

South Africa 5.7 6.1 6.5 6.5 6.2 5.5 South Africa 5.00 5.00 5.00 5.00 5.00 4.00

Ukraine -0.8 -0.3 2.5 6.7 3.4 6.8 Ukraine 7.50 7.50 7.50 7.50 7.50 7.00

Eurozone 1.8 1.7 1.6 1.7 1.7 1.7 Eurozone 0.75 0.75 0.75 0.75 0.75 0.75

US 1.5 1.8 1.6 1.6 1.6 1.8 US 0.00 0.00 0.00 0.00 0.00 0.00

Source: National sources, Bloomberg, Reuters, ING estimates


5

Quarterly Outlook

The stance of monetary stimulus in EM Exogenous pressures on CPI to ease further Over the quarter ahead, global food price pressures should remain broadly benign for

EM. Various lags in transmission would also argue for heightened food disinflation in local

CPI in 2Q13 versus 1Q13. However, weaker EM currencies versus the USD over 1H13

could still spoil the party – particularly for South Africa.

Fig 1 Reuters CRB and market forecast (ppt)

Fig 2 Reuters CRB and market forecast (% YoY)

200

300

400

500

600

700

800

CRB foodstuffs CRB generic f'cast based on BBG

consensus median

-40

-30

-20

-10

0

10

20

30

40

50

60CRB foodstuffs CRB generic

f'cast based on BBG

consensus median

Source: Bloomberg, ING estimates – CRB: Continuous commodities index Source: Bloomberg, ING estimates

Fig 3 Brent oil price (US$ per barrel)

60

70

80

90

100

110

120

130

Forwards ING

forecast

Source: Bloomberg, EcoWin, ING estimates

On the food prices front, the combination of stronger local currency and a higher

weightage in the CPI suggest that Romania would experience the largest disinflation

drive from exogenous factors in 1H13. At the opposite end of the spectrum, South Africa

would be one of the few still experimenting positive food inflation contributions over the

semester. This poses the additional risk of second-round effects, for a country where core

CPI is already close to the Central Bank tolerance threshold.

Global food and oil price

pressures should be broadly

benign in 2Q13

Romania to benefit most from

global food disinflation…


6

Fig 4 Estimation of exposure to global food price pressures

CRB foodstuff sub-index %ch 1Q13/4Q12 (lc)

CRB foodstuff sub-index%ch 2Q13/1Q13 (lc)

Food weight in CPI (%)

Impact over 1H13 CPI (ppt)

Romania -10.0 3.5 32.0 -1.0Israel -9.0 -1.9 16.8 -0.9Russia -7.5 2.4 27.9 -0.7Turkey -6.0 1.1 24.1 -0.6Poland -6.2 3.4 20.1 -0.3Czech R. -5.7 4.1 17.7 -0.1Hungary -2.9 3.3 20.1 0.0South Africa -4.5 8.4 14.2 0.3

Source: National sources, EcoWin, ING estimates

On the oil prices front, our rough estimate (arguably, fuel does not account for the full

transport weight in the CPI, but energy costs also depend on oil), suggests Israel’s CPI

would benefit the most from the developments in global oil prices and the local currency

rate versus the USD.

Fig 5 Estimation of exposure to global oil prices pressures

CRB foodstuff sub-index %ch 1Q13/4Q12 (lc)

CRB foodstuff sub-index%ch 2Q13/1Q13 (lc)

Transport weight in CPI (%)

Impact over 1H13 CPI (ppt)

Israel -5.3 -5.9 16.2 -0.9Romania -6.4 -1.4 12.4 -0.5Turkey -2.3 -3.0 18 -0.5Russia -3.9 -1.8 13.7 -0.4Poland -2.5 -1.5 10.7 -0.2Czech R. -1.9 -0.8 12.4 -0.2Hungary 0.9 -1.6 15.6 -0.1South Africa -0.7 4.0 16.4 0.3


Figure 6 presents a summary of both our estimates for 1H13 food and oil prices and the

expected impact on the main CEEMEA CPI. According to the latter, Israel and Romania’s

CPIs will face the strongest ‘exogenous’ price pressure recession. South Africa on the

other hand, appears to be the clear loser.

Fig 6 Exogenous price pressures: winners/losers over 1H13

Israel

Romania

Turkey

Russia

Poland

Czech R.

Hungary

South Africa

-1.4

-1.2

-1

-0.8

-0.6

-0.4

-0.2

0

0.2

0.4

-1.0 -0.8 -0.6 -0.4 -0.2 0.0 0.2 0.4

Transport component impact

Fo

od com

ponent im

pact


Domestic demand – more gloomers still than early bloomers Group 1: Central European countries have broadly disappointed markets and officials on

the private consumption front and high frequency data is still showing that the balance of

risks on the recovery lies on the soft side.

…and Israel to benefit the

most from fuel disinflation

South Africa to benefit the

least from the softer

commodities backdrop


7

Fig 7 Central Europe retail sales (3m-mav, % YoY)

Fig 8 …and other EMs doing better (3m-mav, % YoY)

-30

-20

-10

0

10

20

30

Czech R. Croatia Hungary

Poland Romania Bulgaria

Serbia

-30

-20

-10

0

10

20

30

40

Russia Ukraine South A.

Kazakhstan Israel

Romania and Bulgaria are ex vehicles

Source: National sources, EcoWin

Kazakhstan is volume

Source: National sources, EcoWin

Consumers in Central Europe seem rather depressed (see Figure 7) with real retail sales

growth still in the red – only Hungary retail sales data in the region seem to have offered

an uptick recently. The protracted support offered by the authorities to disposable income

(vs utility price cuts, wage hikes) may be filtering through – but the question that remains

to be answered is whether these costly policies will have a long-lasting impact.

Fig 9 Real wage growth in Central Europe (% YoY)

-15

-10

-5

0

5

10

15

20

25

Poland Hungary (estimates) Czech R. (estimates)

Croatia Bulgaria Romania


Real wage developments in CE3 (Poland, Hungary and Czech Republic,) continue to

point to subdued household consumption in the months ahead. Only Polish wages

recently turned positive, after a year of nil-growth, thanks to the spectacular collapse of

inflation from 3.7% in September 2012 to 1% in March 2013. This low inflation will provide

some support to consumer spending power, but the higher household savings rate should

prevent an immediate translation into stronger demand.

Group 2: Peripheral countries (Turkey, Baltics, CIS ex Ukraine) seem to be doing better

for different reasons. The time might soon come for a shift back from growth-support to

inflation re-targeting at the Central Bank level. Admittedly, this should not be the case in

the short-term for Russia, but we see upside risks building for 2014’s local CPI outlook.

CEE consumers the most

depressed

CEE peripheries are doing

better


8

Fig 10 Core CPI: the lower tier (% YoY)

Fig 11 Core CPI: the higher tier (% YoY)

-4-202468

1012141618202224

Jan

03

Oct 03

Jul 0

4

Apr 0

5

Jan

06

Oct 06

Jul 0

7

Apr 0

8

Jan

09

Oct 09

Jul 1

0

Apr 1

1

Jan

12

Oct 12

Bulgaria Czech R.Poland UkraineIsrael Romania

-4-202468

101214161820

Jan

03

Oct 03

Jul 0

4

Apr 0

5

Jan

06

Oct 06

Jul 0

7

Apr 0

8

Jan

09

Oct 09

Jul 1

0

Apr 1

1

Jan

12

Oct 12

Croatia HungarySouth A. KazakhstanRussia Turkey

Source: EcoWin Source: EcoWin

Core CPI measures suggest that Central Europe’s disinflation remains broadly intact in

1Q13. In ‘peripheral’ countries however, core inflation measures are all on the upside,

except for Turkey. But for the latter, the disinflation trend that started in 2H11 seems to

have levelled off in recent months.

Fig 12 Private sector credit growth (% YoY)

-20

0

20

40

60

80

100

120

Russia Turkey Kazakhstan South A. Poland


Another common factor for the peripheral countries is the relative robustness of private

sector credit growth relative to the CE4 (where household credit growth in particular is

below 5% YoY since 2H12). The case of Turkey is of particular interest for 2Q13, given

the recent acceleration in private sector credit growth – and its combination with sticky

core CPI, raising concerns of late at the Central Bank level. Russia could also be a

candidate for inflation ‘trouble’ down the line, while the markets currently focus on the CPI

sharp disinflation outlook and possibility of a rate cut. Indeed, core CPI seems sticky,

while credit growth is expanding at a robust 20% pace and real wages are still growing at

5% YoY at the end of 1Q13 (in spite of having halved this growth vs 1Q12)

Group 3: Some are slipping deeper into an un-virtuous cycle (South Africa, Ukraine) of

higher inflation (on the back of fiscal constraint, with administrative price hikes, electoral

pledges on public wage hikes, coupled with high exogenous price pressure filtering),

struggling domestic demand and balance of payment troubles.

Core CPI pressures

rebuilding at the periphery…

…as private credit growth

gains momentum

Ukraine and South Africa are

facing the hardest mix


9

The end of proactive reflating via policy rates is nearer, but the FX channel may still offer some ammunition The protracted actions of Central Banks in CEEMEA to support growth in the face of a

triple recession risk in the Eurozone, which blossomed in 1Q13, may face a soft

realignment:

• As nominal/real rates are low, room for further easing has shrunk. This goes even

beyond the debate on deficiencies in credit transmission mechanism, Draghi style.

Fig 13 Markets’ discounting of rate action vs ING’s views (updated 15 Apr 2013)

1*4 FRAs ING 3*6 FRAs ING

Poland -14 0 -32 -50Hungary -24 -25 -73 -75Czech R. -3 0 -6 0Russia -20 0 -40 -25Israel 2 0 -8 -25Turkey -15 0 -11 0South Africa -1 0 -1 0

Source: Bloomberg, ING

• FX interventionism is likely to re-emerge more forcefully in 2Q13, allowing for a dual

mandate of easing monetary conditions (when the interest rates tool grips) and

providing a growth lift via the export channel. With the markets yet to digest April’s

Japan QE shock, US risks of tighter labour markets (potentially reigniting the debate

on QE gradual removal) and lingering Eurozone systemic risks, trade-weighted

emerging market currencies are set to appreciate, putting competitiveness at risk.

That said, not all countries are equal in the face of FX reserve accumulation on

sterilisation costs.

Fig 14 EMEA forex intervention risk in 2Q13

Intervention risk

Direction bias Main tool

exp 2Q NTW %ch vs 1Q13

Poland Low Weaker Rate cut, measured verbal jawboning -0.7Hungary Medium Stronger Verbal jawboning +0.2Czech Republic Medium Weaker Verbal so far, direct FX a possibility +3.9Romania Medium Weaker Indirect FX +0.3Russia Low Weaker Verbal jawboning -0.5Ukraine Low - - -3.4Turkey High Weaker Rate cut/measured, gradual rate cut +2.0 (real)South Africa Medium Stronger Verbal jawboning -2Israel Strong Weaker Direct FX/rate cut +2

Source: ING estimates – NTW=nominal trade weighted exchange rate (+ is appreciation)

• The ‘third-wayers’ should continue to test their experiments. At one end of the

spectrum is Turkey, with its sophisticated ‘stabilisers’ strictly framed in the monetary

sphere (inflation/financial flows). At the other end, we have Hungary and its NBH

policy intrusion (inflation/credit stock). We do not see a change of paradigm in 2Q13

on these alternatives. However, we would remark only on one thing for the medium

term: Turkey’s technical tool has been heralded by the markets, but its increased

complication may be eating away investors’ ability to read the CBT. Meanwhile,

Hungary’s MNB has been widely feared to shift to unorthodoxy. Yet so far, the new

monetary policy bias has proven fairly pragmatic – it is the legal framework, tax

policies, and centrally-decreed price changes that are raising eyebrows.

Room for rate cuts is smaller

in 2Q13 …

…but monetary easing via

the FX channel is still an

option

Turkey and Hungary will

continue with their alternative

options


10

Those who have not showed reform efforts will suffer The strong pro-cyclical stringency imposed on the fiscal sphere in the aftermath of the

2008 crisis and the prolonged downturn has heightened emerging markets’ fiscal

idiosyncrasies. At this juncture, the fiscal subject will remain a key 2Q13 theme, though

its impact on local-asset EM prices is far from unilaterally transitive still.

Rating downgrade risks From a direct angle, four years after the onset of the downturn, and with the possibility of

a macro stabilisation – though at a low level – on the cards, there is now a bit more room

for rating agencies to take a step back and assess the ‘pragmatism’ of emerging markets’

country-cyclical strategies (versus so far normalising mostly developed markets ratings, in

tandem with an ex-post reassessment of risks). To sum it up: it is time to check whether

the rise in EM public debt over the past years is now relayed by a thoughtful willingness

to reverse the trend.

Fig 15 1Q13 main EMEA rating actions

Country Agency Date Action taken

Lithuania Fitch 05-Apr Upgrade Turkey S&P 27-Mar Upgrade Hungary S&P 21-Mar Outlook downgrade Egypt Moody’s 21-Mar Downgrade Latvia Moody’s 15-Mar Upgrade Thailand Fitch 08-Mar Upgrade Tunisia Moody’s 28-Feb Downgrade Tunisia S&P 19-Feb Downgrade Slovenia S&P 12-Feb Downgrade Croatia Moodys 01-Feb Downgrade South Africa Fitch 10-Jan Downgrade Ukraine S&P 7-Dec Downgrade Ukraine Moody’s 5-Dec Downgrade

Source: Bloomberg

In our view, the ‘bad pupils’ could face the music again this quarter. South Africa (S&P) is

at risk, but Hungary might be spared by the reasonably conservative NBH measures

package.

At the other end of the spectrum, Moody’s could upgrade Turkey to investment grade on

both the local and foreign long-term debt front. But we believe at this stage it is more

likely to happen in 2H13 rather than in 2Q13.

IMF deals far from certain for 2Q13 Those EM countries struggling amidst a hard combination of constrained fiscal

manoeuvres and high external financing have made little progress in 1Q13 to alleviate

their woes. At this stage, most EM countries still seem reluctant to embark on the

politically costly measures, even with the IMF nuancing its calls for tighter fiscal policy.

Other ‘intrusions’ on the domestic tax, deregulation, or privatisation policies are equally

touchy with elections looming.

• Ukraine: Has not unilaterally taken the IMF route yet, and is trying to play the Russian

option again – mulling a joint-venture with Gazprom on a gas pipeline lease (which

would in turn lower import prices and help the budget). We continue to believe a deal

should be struck on this, but is probably more likely in 3Q13. We thus might get some

more noise from tensing relationships between Ukraine, Russia and the EU in the

near term.

• Romania: The last IMF mission to visit Romania left in January, after agreeing to

extend the ongoing arrangement from March to June due to a lack of progress. While

there is still time for adjustments, and we believe the extension of the SBA will be

Rating actions could

intensify in 2Q13

South Africa and Hungary are

still facing downgrade risks

IMF deals are still slow to

progress


11

agreed on, market participants may soon start pricing in growing chances of an end to

the streak of IMF arrangements.

• Serbia: The case of an IMF deal is still alive, though Serbian authorities have

attempted recently to secure funding elsewhere (ex UAE) – Russia could also offer an

alternative, as it tries to secure new export markets for gas. Whether the Cyprus story

has dented its investment project in the region however has yet to be established…

• Hungary: With the new NBH Governor on board since February, the prospects of an

IMF deal have virtually disappeared for the year. So far the government seems

perfectly able to finance its domestic and foreign financing needs on its own.

• Egypt: The country’s economic situation has worsened dramatically over 1Q13, and

yet the authorities rejected an emergency loan in March. Talks are still ongoing for a

standby US$4.8bn, but negotiations are set to be burdened by the political backdrop

(new parliamentary elections date yet to be agreed on).

IMF negotiations should thus remain protracted and lengthy in 2Q13. But more generally,

it is interesting to note the emergence of an alternative option – a BRICs bank – as hinted

upon at the BRICs summit in Durban. However, its implementation still remains beyond a

six-month horizon at best: after a new meeting agreed for September in parallel to the

G20 in Russia.

Eurozone: the ‘sub-beta’ risk is not dead Another ramification of the fiscal theme in emerging markets in 2Q13 is the persistence of

the Eurozone debt risk. This is particularly relevant for the Central and Eastern region

non-EU member assets, as it kills any further (if possible) convergence trade play and it

further erodes the EMU attractiveness.

Admittedly, the direct reaction to the Eurozone’s ‘sub-beta risk’ highly depends on the

country in distress and the nature of the distress. In the case of Cyprus, the limited CE4

exposure in terms of net FDI to Cyprus offered protection – as opposed to Ukraine and

Russia (for a relative analysis on this issue, please refer to Mateuz Szczurek’s Cyprus and CEE: channels of contagion, 4 April 2013, and Dmitry Polevoy’s RUB: unlikely to avoid Cyprus risk, 20 March 2013). Also, the mid-term effect of the crisis has been

reallocated in the portfolio, from distressed EMU into higher quality CEE. Liquidity coming

out of Japan will reinforce this trend, given the Japanese experience with the CEE

markets.

With various level of pertinence, Slovenia, Malta, and Luxembourg have all been

heralded by the markets as the next ‘sub-beta’ risks. But the bulk of the core EMU –

namely Italy, Spain and France – are the bigger contenders in our view to bring long-

lasting and wider Eurozone debt stress systemic risk still this year.

The core markets backdrop to support EM assets still Core markets view (by Rob Carnell, ING’s Chief International Economist) Our G3 economists feel that the latest bout of Eurozone jitters suggests that not only has

Europe made little progress in the years since the onset of the global financial crisis, but

in some senses has gone backwards.

ING’s Eurozone forecasts are now for further deterioration in activity this year compared

to last, and more weakness in 2014. The lessons of aggressive fiscal austerity under

near-zero interest rates seem to have been learned by the OECD and IMF, but not the

European Commission, or in particular, the politicians of Germany and other core

European countries.

Some things never seem to

change in the developed

market universe

The outlook for the Eurozone

remains extremely

challenged…

Eurozone persistent debt

troubles challenge still the

convergence play

A BRICs bank as an

alternative to the IMF?

http://pull.xmr3.com/p/172-172966-FBD9/42420717/2013030409552335_E.pdf�

http://pull.xmr3.com/p/172-172966-FBD9/42420717/2013030409552335_E.pdf�

http://pull.xmr3.com/p/252-172966-AA90/11465247/2013022015002750_E.pdf�

http://pull.xmr3.com/p/252-172966-AA90/11465247/2013022015002750_E.pdf�


12

Self-destructive contractionary fiscal policy continues in many countries, with little to show

for it in terms of deficit improvements, and against a backdrop of a rising mountain of

public debt and collapsing activity.

If there is a change, it is that having sat on their hands for much of the early part of the

crisis, European politicians are now beginning to interfere, evoking fond memories of their

earlier inaction. The Cyprus bail-out/bail-in debacle is a good case in point, with the

integrity of bank deposit guarantee schemes across the single currency region looking

threatened. Attempts at damage limitation may have plugged the potential for a

resumption of capital flight from peripheral Eurozone banks, but having let the genie out

of the bottle once, lingering fears will remain.

Moreover, the hopes that a banking union across the Eurozone would help stem both

capital flight risks and break the pernicious link between bank solvency and sovereign

debt seem utterly out of reach now. Re-capitalisation is seen as a distinctly ‘national’

problem by today’s politicians.

Fig 16 Eurozone bank deposits (€m)

Fig 17 Liquidity from US Fed and BoJ

65

70

75

80

85

90

95

100

105

110

115

120

Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12

FRNLDEITIEESGRCYP

Jun-2010 = 100

0

0.5

1

1.5

2

2.5

3

3.5

4

-50000

0

50000

100000

150000

200000

11 12 13 14 15

US

JPN

10Y US Treasury

$mn

F'casts

0

0.5

1

1.5

2

2.5

3

3.5

4

-50000

0

50000

100000

150000

200000

11 12 13 14 15

US

JPN

10Y US Treasury

$mn

F'casts

Source: ECB Source: ING

If there is any silver lining, it is that in some countries, as unemployment continues to

mount throughout the Eurozone, the democratic backlash against austerity is

strengthening. The rejection of traditional party politics at the Italian elections in February

are a case in point, and Italy is to embark on some modest fiscal stimulus this year, whilst

France and Spain also seem to be giving up on previous deficit reduction plans.

Is this progress? Does it make the future of the Eurozone look stronger? Many will think

not. And though our house forecasts assume a gradual return to something approaching

normality over the next few years, scope for a future intensification of the Eurozone crisis

may have its roots in the political actions taken over the last few months.

As ever, the story is a somewhat happier one across the Atlantic…though here, the effect

of public spending ‘sequestration’ or spending cuts – the result of US political dysfunction

– and tax rises, are set to undermine what had been a very bright start to the year. Until

now, the US had avoided the Eurozone’s penchant for chasing deficit reduction targets.

But recent soft data suggests that these lessons are only ever learned the hard way.

But though the current set of fiscal measures are likely to dampen growth, they are one-

offs, and a strong housing and corporate sector will likely lift the economy again before

the end of the year, after a new, lower counterfactual for GDP is reached.

The recent debate over the future of QE in the US has centred on the likelihood of a

scaling back of its current US$85bn-per-month asset purchases. But the intensity of that

Progress towards a lasting

solution to the Eurozone

crisis remains perilous

…and politics are adding a

new, unwelcome dimension

The US outlook is

considerably brighter…as

usual…

…though there are some

mounting fiscal headwinds

here too


13

debate is likely to diminish over the coming months as activity softens, and will not pick

up again until later in the year.

Our best guess is that QE remains at US$85bn per month until 4Q13, at which point it will

be cut to about US$40-50bn per month, with the cuts evenly spread between MBS and

Treasury debt. Further, downscaling is likely in 2014, bringing incremental QE to an end

by 2Q14.

But where the US is scaling back, Japan is scaling up. A massive expansion of the BoJ’s

QE scheme, with a targeted doubling of base money over two years and expansion of

purchases across the maturity spectrum of the JGB market, has led to further JPY

weakness, and bolsters an already stimulatory fiscal backdrop – despite their 240+%

GDP debt ratio.

This is a refreshing change to the austerity being practised in the Eurozone. Along with

the resulting much weaker JPY, the outlook for Japanese growth has picked up

considerably. And whilst a new 2% inflation target seems optimistic, an end to deflation

for a time is looking more plausible.

The combination of a resumption of the Eurozone crisis, short-term US weakness, and

massively enhanced Japanese QE means a broad spectrum of support for bonds at the

longer end of the yield curve, though in Europe, mainly in the “core”.

Even with the US downscaling QE by the end of this year, and ending it by mid-2014,

total QE-derived liquidity will be at highly elevated levels over the next twelve months,

and even over a longer time horizon, remain at decent levels.

This only leaves the question of whether the source of QE matters (if for example, money

managers in the two regions had different geographical biases). Falling US QE and a

resumption of growth should lead to slowly rising Treasury yields over the second half of

this year.

But with global liquidity remaining ample, this is likely to be a subdued increase, ending

the year only slightly above recent March highs. Such increases in Treasury yields should

provide some support for the dollar, in particular against the JPY, though also against the

EUR. The search for yield will likely support EM as well as some of the higher yielding

G-3 alternatives – Scandi, and $-Bloc for example, though they may well lean against

increased flows with easier rates policy.

[email protected]

Against this backdrop of ample G3 liquidity, the risk appetite should remain broadly in the

positive this quarter – with relatively low core yields offering a cap to EM’s longer-dated

yields.

However, risk appetite volatility could increase as a few bumps build on the road. First,

the markets are still likely to gyrate on the US QE removal timing. Second, Japan QE

shock is now behind and digested – it is now time for views on the matter to consolidate.

But even if the Fed scales

back on QE this year, the BoJ

is picking up the liquidity

slack…

…and an ample liquidity

environment looks likely for

the foreseeable future

Risks may be thus on

markets consolidating the

Japanese QE shock

mailto:[email protected]�


14

Fig 18 ING risk appetite index (1m-average, ppt of SD)

-2.5

-2

-1.5

-1

-0.5

0

0.5

1

1.5

2

2.5

Mar

-95

Aug

-95

Jan-

96

Jun-

96

Nov

-96

Apr

-97

Sep

-97

Feb

-98

Jul-9

8

Dec

-98

May

-99

Oct

-99

Mar

-00

Aug

-00

Jan-

01

Jun-

01

Nov

-01

Apr

-02

Sep

-02

Feb

-03

Jul-0

3

Dec

-03

May

-04

Oct

-04

Mar

-05

Aug

-05

Jan-

06

Jun-

06

Nov

-06

Apr

-07

Sep

-07

Feb

-08

Jul-0

8

Dec

-08

May

-09

Oct

-09

Mar

-10

Aug

-10

Jan-

11

Jun-

11

Nov

-11

Apr

-12

Sep

-12

Feb

-13

Risk appetite

Risk aversion

Normalised index of ‘risk’ indicators: CHF volatility, Gold, 2-10Y US spread, US equity vs corporate spreads, EM equities, US small cap vs big cap, DJ defensive vs S&P500

Source: EcoWin, ING estimates

Fig 19 Risk appetite index over the past 9m (ppt of SD)

Fig 20 EM FX returns vs US%, 1 Jan-13/19 Apr-13

-1

-0.8

-0.6

-0.4

-0.2

0

0.2

Jun-

12

Jul-1

2

Aug

-12

Sep

-12

Oct

-12

No

v-1

2

De

c-1

2

Jan-

13

Feb

-13

Mar

-13

Apr

-13

Risk appetite

Risk aversion see EM fx performance over the period on Fig 6.

-10 -5 0 5 10

ZAR

CZK

COP

HUF

RUB

PLN

TRY

RON

BRL

ILS

MXN

Total return (%) Spot return (%)

Source: EcoWin, ING estimates Source: Bloomberg

Will the great bear-steepening ever come? Amidst broad-based downward revisions on local growth and extension/reactivation of

monetary easing, markets have struggled to find macro-story driven direction on the local

curves in 1Q13.

Yields in CEEMEA edged broadly lower across the board (Figure 21), with Poland and

Hungary outperforming peers. The latter benefitted indeed from significant monetary

easing action, with both the NBP and NBH delivering over the quarter a total of 100bp

cuts.

In 1Q13, CEEMEA local

government yields broadly

edged lower


15

Fig 21 CEEMEA 10Y benchmarks change (actual vs 1 Jan 2013)

Fig 22 Policy rate change over 1Q13 (bp)

0

1

2

3

4

5

6

7

8

-60

-50

-40

-30

-20

-10

0

10

20

Poland -10Y

Hungary- 10Y

CzechR. - 10Y

Russia -10Y

Turkey -10Y

SthAfrica -

10Y

Israel -10Y

Chge (bp) Actual yield (%, rhs)

-120

-100

-80

-60

-40

-20

0

Poland Hungary CzechR.

Russia Turkey SthAfrica

Israel

1Q13 2Q13F

Source: Bloomberg, ING estimates Source: Bloomberg

Looking ahead in 2Q13, we see room for another 25bp cut in Poland and 75bp cut in

Hungary, with another 25bp likely in Poland before their easing cycle ends during the

summer. Israel should also deliver a 25bp monetary easing (in May or June), but chiefly

for the purpose of mitigating bullish pressures on the Shekel.

Following a string of disappointing investment dynamics data (justifying our downward

revision for the country’s 2013 GDP to 2.8% YoY), we now expect the Russian Central

Bank to deliver a 25bp-cut in late 2Q13. Though we admit the risks on this call are biased

towards 50bp, we maintain the view that the CPI outlook does not argue for a deeper

easing cycle at this stage.

In terms of carry attractiveness, Ukraine remains at the top of the list in real terms, with

Hungary and Poland. The latter should climb to second position this quarter: a feature

that should allow expectations of monetary easing looking forward well anchored in the

markets (or at least easily reactivable). Serbia should also see its real carry attractiveness

recover significantly over the quarter, thanks essentially to strong base effects on the CPI

reading. That said, some caution is to be exerted here, considering the risks of potential

additional administrative prices hikes.

Fig 23 CEEMEA, US and Eurozone real rates (level-CPI eop)

-4

-2

0

2

4

6

8

10

Ukrain

e

Hunga

ry

Poland

Croat

iaIsr

ael

Roman

ia

South

Afri

ca

Serbia

Euroz

one

Kazak

hsta

n

Russia US

Czech

Rep

Turke

y

1Q13 2Q13F


Cuts of 75bp in Hungary and

25bp in Poland, Israel and

Russia are in the pipeline for

2Q13

Ukraine and Poland are the

most attractive in terms of

real carry


16

At the lower end of the spectrum, Turkey stands out. The negative carry would in theory

argue for a hawkish Central Bank stance. But the sophisticated mechanism on the policy

rates front in the country would also recommend exerting caution when analysing the real

carry measure. If anything, the negative print suggests dedication at the CBT level to

mitigate ‘hot money’ inflows.

Looking at intracurve swap dynamics over 1Q13, the picture is not unidirectional.

Steepening pressures were perceivable broadly across the board until mid-February, but

have proved more erratic since then. All in all, most curves appeared at the end of 1Q13

marginally steeper (by 10bp on average, with the exception of the Czech Republic –

where 2-10Y gained 60bp).

Now including early April market actions, the steepening ‘outperformers’ in the CEEMEA

region proved to be Turkey and Hungary, where both Central Banks appear the most

protracted on a monetary easing bias (as opposed to reactive, as in the case of Poland),

though for different reasons.

Fig 24 2-10Y IRS spread CEEMEA (rebased 100 = 1 Jan 2013)

80

90

100

110

120

130

140

150

160

170

180

1 Jan 10 Jan 19 Jan 28 Jan 6 Feb 15 Feb 24 Feb 5 Mar 14 Mar 23 Mar 1 Apr 10 Apr 19 Apr

POLAND CZECH HUNGARY SOUTH A.

ISRAEL TURKEY EU US

Source: Bloomberg

Looking ahead in 2Q13, we expect dynamics broadly similar to 1Q13 to prevail, namely:

• Core rates richness should continue to anchor medium/long-term maturities. In

particular, our Global Economics team continue to expect the critical 2% threshold on

Treasuries to be cleared (sustainably) in 3Q13.

• Further monetary easing should allow for relative resilience of front-end maturities.

However, this driver should be less strong than in 1Q13 considering the smaller scope

of monetary easing yet to be delivered.

This backdrop should continue to challenge the bet of a broad-based bear steepening on

CEEMEA curves. The case for bear-flattening is hard to make as well given the low

growth backdrop. Accordingly, we would expect further alternation of bull

flattening/steepening during the quarter, but probably with higher frequency than in 1Q13.

In terms of sensitivity, we noted in 1Q13 a rise in the 5Y government bonds spread vs

implied EUR/local currency 3m-rates in the CEE region (Figure 25) – which suggests a

weaker correlation between local rates and FX in recent months. This is most striking for

Romania. These dynamics suggest that liquidity – in particular – has been a key driver in

local curves over the quarter, whether fuelled by the benign core market rate backdrop or

technical local features (index inclusion).

And Turkey is the least,

owing to the dedication of the

CBT to mitigate hot money

flows

Hungary and Turkey’s swap

curves have steepened most

in 1Q13

But broad-based steepening

dynamics in CEEMEA are

likely to continue struggling

in 2Q13

CEE local rates sensitivity to

FX has weakened in 1Q13


17

Implied rates and the shape of the local government curve point to the highest correlation

between bonds and FX in Poland and Russia, with Romania, Hungary and the Czech

Republic offering 100-160bp FX-hedged returns. The end of the easing cycle could

normalise the short-end of the Polish curve, eventually, but it is unlikely to happen before

July.

Fig 25 5yr local currency treasury bonds spread over implied €/lc 3M rates

-80

20

120

220

320

420

520

9/11 10/11 11/11 12/11 1/12 2/12 3/12 4/12 5/12 6/12 7/12 8/12 9/12 10/12 11/12 12/12 1/13 2/13 3/13 4/13

PL CZ HU RO RU

Source: Thomson Reuters

Though we believe the liquidity factor will remain important in 2Q13, it should be slightly

weaker than in 1Q13, as: (1) the ‘index inclusion’ factor should disappear; and (2) the

debate on the core markets’ QE could tilt back towards the ‘end’ theme rather than the

‘more’ theme (Japan QE shock is behind also).

South Africa and Romania index inclusions in 4Q12 and 1Q13 are indeed behind us, and

so far, no new EM addition has been mulled over. In relative terms, this feature should

weigh particularly on SA assets.

Russia’s case is a bit more complicated: the OFZ clearing validation in 1Q13 has either

not yet fully materialised owing to administrative bottlenecks, or the pre-event inflows

have triggered the ‘sell-the facts’ dynamic. Still, the new OFZ status should gradually filter

into flows, offering more support for the local curve during the quarter.

Conclusion

All in all, 2Q13 should be seeing a broad gradual bottoming out of rates in CEEMEA

and steepening bull trends could face additional bumps, constrained further by a

benign backdrop in core markets. The liquidity-boosted events of 4Q12-1Q13 are

also behind us, and with no others on the horizon, some bull-drive in local curves is

ebbing away. In the region, we remain bullish on the belly of the Hungarian curve and

Russian long-dated papers (10Y OFZ). We also favour steepeners in Poland and

spread compression in Croatia vs Bund.

Poland and Russia’s curve

remains the most correlated

to FX vs CEEMEA peers

The liquidity factor should be

less compelling in 2Q13 vs

1Q13


18

ING EM FX and local rates views summary Country Foreign exchange Local rates

Poland Weak activity data, the risk of deeper rate cuts and an upward revision

of the fiscal gap call for a weaker PLN. But global liquidity may keep it

in the 4.10-4.15/€ range as real rates in Poland are the highest in the

region. NBP would likely react if it breaches 4.00.

Our models show that 5Y IRS’s in PLN are the most overpriced in the

7 largest EM rates markets. Upside risks on the budget gap coupled

with another 25-50bp rate cut on expected weak activity readings for

2Q13 argue for positioning on 2-10Y IRS steepening in our view.

Hungary The central bank’s new programme is very likely to result in an upward

shift in implied HUF rates. But the dedication of the NBH to lower

policy rates remains and the markets’ gyration on its easing scope

could still bring about volatile exchange rate movements in 2Q13.

We see the 3-10 year spread of c.140bp as too wide, taking into

account that the market’s expectation about the end of the rate cut

cycle is quite extreme and the Japanese QE may generate demand

for the long end of the curve. We thus expect a flattening below 100bp

on the aforementioned tenors.

Czech Republic

The active CNB FX policy has been talked about to death by the board

members, however, and the risk of an immediate action has subsided. We expect the interventions to remain verbal with €/CZK in the CNB

comfort range of 25.5-26.0/€, but the breach of 26.0/€ is possible on

low hedging costs.

High EMU liquidity will keep the Czech curve supported in the near

term, but we are growing increasingly sceptical on the levels. Czech

bonds cannot be treated as safe haven assets – or a proxy for Bunds

– for liquidity reasons, and a drop below 1.7% on 10 years is

excessive.

Romania Most domestic signs point to a weakening RON in 2Q13, in particular

the change at the SBA in June, consolidation post bond index inclusion

and FX intervention. This justifies our buy EUR/RON on dips

recommendation with a 2-3 month horizon and a target of 4.50. Our

year-end forecast, however, stands at 4.30.

Slowing debt supply and a more dovish NBR should allow 3-5Y

ROGB yields to push lower. Though we do not expect the NBR to cut

rates, it is likely to allow short-term rates to drift well below the key

rate when turning into a net debtor position, a change that looks to be

on the near-term radar.

Bulgaria n/a A delay in forming a new government is probably largely expected, so

the biggest threat for Bulgarian assets is in our view post-election

fiscal easing.

Croatia We expect a continuation of the weakening of the HRK vs the EUR on

sub-average growth and increased pre-EU entry spending in 2Q13.

Compared to its troubled neighbour Slovenia, the new EU entrant has

enough flexibility in surviving the economic slowdown. We prefer FX-

denominated instruments though, given the attractiveness of the FX

depreciation route to recovery.

Serbia In spite of the relatively better CA financing backdrop in 2013 vs 2012

and the authorities’ commitment to keep talks open with the EU and

IMF, we expect the NBS to ensure the RSD will remain competitive in

trade-weighted terms to help recovery this year. This should mitigate

outright long RSD position attractiveness despite the carry.

While inflation prints for 1Q13 should remain elevated, strong base

effects of well behaved global food prices should bring the CPI into

the NBH target by year end. Significant easing prospects for 2H13

render 2Q13 a good time to fish for an attractive long T-bills position

entry.

Russia We see risks of further unwinding of RUB-longs on worsening growth

and expectations of looser monetary policy, more limited OFZ flows, an

all-time strong RUB in REER terms, and the MinFin plans to buy FX for

the Reserve Fund directly on the market in 2H13.

Despite the RUB weakening and worse 2013 budget performance risks,

we like 10Y OFZ 26211, as it still offers one of the highest nominal yields,

and a real yield at par with the best in the region.

Ukraine A deal with the IMF remains our best case scenario, despite evidence

in 1Q13 that Ukraine would first try a Russian option to lower import

prices. As the IMF is likely to promote a gradual UAH adjustment, our

best guess now is for a gradual c.15% annually (to start with) once the

deal is sealed.

n/a

Kazakhstan The C/A surplus looks weak due to stable exports vs rising imports;

and FDIs are insufficient to offset the Oil Fund-driven gap in portfolio

flows. Accordingly, the KZT is set to weaken by 2013-end vs the USD.

The CPI peaked in Feb-12 at 7% and is heading to 5.5% by year-end

on retreating food prices and benign non-food CPI. We don’t see the

need for the NBK to touch the official rate at 5.5%, also in particular

as the banking system continues its self-rebalancing

Turkey The CBT will continue to mitigate capital flow pressures in 2Q13 to

ensure real TRY competitiveness. This, plus the upside risk on inflation

increases the risk of a higher nominal weakening for the TRY vs 50:50

EUR:USD FX basket vs the current 2.07 level.

Due to the CBT’s TRY REER focus, the chance of a policy rate cut in

the near term has increased notably. However, we think the fall in

yields will not turn into a sustainable downtrend, and we envisage the

benchmark rate remaining close to the 6.0% level in 2Q13.

South Africa The recent ZAR rally was essential core-markets driven and technical.

The fundamental picture for the currency remains soft, with 1Q13 CA

financing still tight, a rating downgrade and social noise risks. Levels

around 9.10 are good opportunities to buy USD:ZAR on dips.

The local curve flattened drastically in recent sessions on ZAR

movements. The inflation outlook for the quarter could further feed

this trend, though a correction in the Rand level (weaker than 8.90-

9.00 vs USD) will act as a cap. 2Q13 should all in all be a time to

position for 2H13’s steepening outlook.

Israel The strong external position of Israel should continue to underpin

strength for the ILS. But an active BoI at the 3.60 level to start with,

with FX reserves ammunition and a possible rate cut will act as a

buffer this quarter. This, combined with a stronger USD story should

hold the USD:ILS mostly in range in 2Q13.

A potential rate cut in May should anchor front-end rates. Given the

latest re-flattening on core markets view realignment, we see good

entry points for re-steepening on 2-10Y ILGB in the short-term. In the

medium-term, the overall curve direction is up, with bear-flattening

looming for 2H13 on a rapid reflation.

Source: ING


19

EMEA Capital Markets Outlook

EM external financing requirement in 2013 Needs rising, capital inflows slowing, but a comfortable coverage Over 2012, EM’s US$2.03tr external financing needs were amply met by net capital flows

that amounted to US$3.18tr, allowing EM reserves to grow by a record US$1.15tr. The

bulk of external capital reliance remains ST debt, virtually all of which lies in the banking

sector. This highlights the close tie of EM’s external vulnerability with the financial sector

and particularly with ST debt flows. External bond issuance amounted to an all-time

record US$487.24bn, with syndicated loans of US$532.4bn and other loans of US$319bn

providing substantial flows.

Fig 26 External financing analysis (US$bn)

2009 2010 2011 2012 2013F 2014F

External financing gap Current account balance 514.99 560.63 594.28 464.82 213.65 132.07M&LT loans/bonds due (599.43) (587.23) (673.27) (745.7) (788.96) (806.05)ST debt roll (1,465.89) (1,188.93) (1,494.79) (1,749.63) (1,802.24) (1,906.03)Total external financing needs (1,550.33) (1,215.54) (1,573.79) (2,030.50) (2,377.55) (2,580.00)

Sources of funds ST borrowing 1,188.93 1,494.79 1,743.64 1,998.04 1,995.07 2,091.86EM bond issuance 272.78 344.26 312.6 487.24 409.29 425Syndicated and official loans/credits 318.59 257.58 618.55 851.69 564.49 565.04FDI inward 462.9 546.58 800.87 771.94 804.79 872.52FDI outward (238.82) (267.14) (369.2) (438.97) (524.23) (473.91)Portfolio inward (net of debt) 172 221.46 (2.08) 289.11 196.98 228.45Portfolio outward (123.62) (213.74) (125.12) (238.57) (289.63) (287.64)Other capital flows 100.34 (500.57) (697.56) (540.3) (472.74) (307.54)Total capital flows 2,153.11 1,883.23 2,281.69 3,180.18 2,684.02 3,113.78

Change in reserves 602.79 667.7 707.91 1,149.69 306.47 533.78Reserves 6,671.89 7,513.69 7,973.26 9,122.94 9,429.42 9,963.20

Source: ING

So far in 2013, EM external bond issuance has totalled US$172bn, and we expect a further

US$237bn for the remainder of the year. Signs of slowing syndicated lending and likely lower

official loans should lower the total 2013 contribution of bonds and loans to fund the EM

external gap to US$974bn. Consequently, in total, we anticipate more moderate capital flows

of US$2.68tr, in line with somewhat slower EM growth. This will still prove ample to cover the

US$2.38tr external gap, allowing EM reserves to grow by a more modest US$306bn.

Fig 27 EM external financing needs and capital flows (US$bn)

Fig 28 Composition of EM capital flows (US$bn)

-1,500

-1,000

-500

0

500

1,000

1,500

2009

2010

2011

2012

2013

f

2014

f

-4,000

-3,000

-2,000

-1,000

0

1,000

2,000

3,000

4,000

Net capital flows (rhs) Current account balance (rhs)

M&LT loans/bonds due (rhs) ST debt roll (rhs)

YoY change of reserves (lhs)

-2,000

-1,000

0

1,000

2,000

3,000

4,000

5,000

2009 2010 2011 2012 2013f 2014f

ST borrowing M&LT bond/loan issuanceFDI inward FDI outwardPortfolio inward Portfolio outwardOther capital flows

Source: National sources and ING Source: National sources and ING

The bulk of external capital

reliance remains ST debt,

highlighting the potential

vulnerability of country risk

to the banking sector

For an exhaustive analysis,

please refer to our 19 April

2013 Emerging Markets Bi-

Weekly, Capital trends and foreign investment flight risk analysis

http://pull.xmr3.com/p/187-172966-1F7F/79526019/2013031915474916_E.pdf�




20

Still, some risks are evident. Looking at these risks on a regional basis reveals that EM

Europe still presents the highest external refinancing risk by far (Figure 29), with the

external gap at 154% of available reserves. An examination of the regional external

financing gap by category (Figure 30) shows that while less risky ST debt rollover

requirements are high for EM Europe, other external financing pressures from the current

account to loans and bonds are also relatively higher than for other regions. Despite

lingering EM European problems, overall EM risks continue to appear manageable this

year and in 2014, with the external gap just 23.54% of reserves for 2013F and rising

slightly to 27.6% in 2014F.

A mitigating factor within EM Europe is that most of the CEE countries are well advanced

in their sovereign issuance programmes, reducing refinancing risk. What is more, the CA

refinancing estimates for many EU new member states are skewed upwards, thanks to a

structural capital account surplus linked with EU transfers, running between 0.5% and

2.5% of GDP.

Fig 29 2013F external financing requirement relative to available FX reserves and GDP by region (%)

-180

-160

-140

-120

-100

-80

-60

-40

-20

0

20

40

EM Total Latam China Asia ex-China EM Europe CIS Middle East Africa

External gap versus GDP External gap vs reserves

Source: ING

Fig 30 Breakdown of 2013F external financing requirement by category versus reserves (%)

-160

-140

-120

-100

-80

-60

-40

-20

0

20

40

EM Total Latam China Asia ex-China EM Europe CIS Middle East Africa

Current account $m M&LT debt due ST debt

While ST debt rollover risks have proven less of a risk, for EM Europe, other components of the external funding gap are still very high, especially for loan and bond rolls.

Source: ING

Portfolio flows pick up to mitigate other capital inflows moderation/contraction In our Emerging Markets Universe report of 24 January 2011 and subsequent updates, we

revealed a detailed picture of the underlying capital structure of EM and the participation of

foreign investors. While the stock of loans and other investment contracted US$677bn

Yet, some external financing

requirement risks persist in

EM Europe


21

(10%) in 2012, this was fortunately more than offset by FDI and portfolio growth. However,

if direct investment rose most in absolute terms, up US$728bn (8.7%), portfolio investment

grew more on a percentage basis, up 21% YoY, to US$5.33tr.

Fig 31 4Q12 capital structure of EM markets (US$tr)

Fig 32 4Q12 foreign ownership of EM assets

0

5

10

15

20

25

EM Investment abroad (EM assets) Foreign investment in EM (EMliabilities)

Direct investment Equity portfolio Debt/MM portfolioOther investment Reserves GCC estMissing data

Direct investment

47%

Loans (incl ST loans)15%

Trade credits4%

Debt/MM portfolio

12%Equity

portfolio16%

Other liabilities

1%

Currency deposits

5%

US$9.06tr

US$3.11tr

US$2.22tr

US$2.88tr

US$724n

US$1.05tr

"Other investment"

81 EM countries

Source: Domestic sources and ING

81 EM countries

Source: Domestic sources and ING

Admittedly, the share of portfolio flows remains relatively small in EM – just 28% (from

24% in 2011) of foreign-owned EM assets total (Figure 32). The bulk remains more stable

direct investment. This limits EM exposure to capital flight risks in absolute terms. Still, in

relative terms, portfolio flows have historically presented significant risks in light of the

very small window of opportunity offered by EM’s 19% market share of portfolio

securities, as seen in Figure 33.

Fig 33 Global portfolio equity and debt securities supply at end-4Q12

EM local bonds7%

EM equity11%

EU bonds20%

EU equity6%

US bonds23%

US equity12%

EM external bonds1%

Other devl equity3%

Japan equity3%

Japan bonds11%

Other devl bonds3%

US$17.18tr

US$34.4trUS$29tr

US$8.23tr

US$16tr

US$4.6tr

US$15.55tr

US$2.2trUS$11tr

US$4.35tr

US markets continue to represent thelargest single segment of global FM

securities supply.

Although growing nominally, on a relative market share basis, EM securities markets actually shrank versus DM.

Source: National exchanges and ING data

We anticipate that portfolio flows to EM are likely to increase slightly to around US$200bn

this year as investors continue to search for diversification benefits and capitalise on the

better (if slower this year) growth of EM versus DM.

But rising portfolio flows could hold risks for EM It is worth highlighting that relative to EM GDP, the outstanding foreign portfolio stock

(bond and equity) increased by 2.47ppt (to 18.48%) in 2012 versus end-2011. However,

relative to EM FX reserves, it increased by a 6.74ppt increase from 55% in 2011 to 62%

by 4Q12. As seen later in Figure 34, this is above the 10-year median of 54%, which

suggests that while the threat is not similar to 2006/07, the risk posed by rising foreign

investment is rising.


22

The relative rise of foreign portfolio holdings suggests that the ability of EM to withstand

the damaging FX and economic effects of foreign capital flight deteriorated somewhat

over 2012, although, admittedly, conditions have not returned to the worst of the pre-

crisis period.

Fig 34 Foreign investor portfolio debt and equity investments

408 553 464 704 982 1,2201,739

2,891

1,6622,389

3,1162,673

3,046 2,790 2,823 3,114

540731

528635

776667

855

1,131

1,005

1,183

1,5371,694

1,9251,888 2,081

2,221

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

1997

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

1Q12

2Q12

3Q12

4Q12

20

25

30

35

40

45

50

55

60

EM equity holdings US$bn (lhs) EM debt holdings US$bn (lhs) Debt versus equity % (rhs)

…They have since been on an upward trend, revealing the rising preference of investors for bonds.

Foreign investor equity and debt portfolio positions have surpassed pre-crisis 2007 levels. What is also interesting is that after debt vs equity holdings declined over the 2000-2007 period...

Source: Domestic sources and ING estimates

Who is most exposed to portfolio flight risk? The highest foreign portfolio to GDP ratio: Hungary Observing only the nominal foreign portfolio liability picture may give investors the wrong

impression of risk. On this basis, Russia (US$207bn), South Africa, Poland and Turkey

(each close to US$150bn) stand out.

However, scaling portfolio holdings by GDP presents a better picture of the relative

importance foreign investors play in an economy (dots in Figure 35), and here only

Poland looks exposed, with 31% of GDP foreign portfolio capital outstanding. The

remaining three regional heavyweights rank far behind, with the Russian number at a

mere 10% of GDP. Hungary is particularly high on the list, with foreign investor portfolio

holdings accounting for 48% of GDP.

Fig 35 Foreign portfolio nominal holdings (lhs) and relative to GDP % (rhs)

48

3531 30 29 29

18 18

11 11 10 10 10 10 10 96

31 1 0

5

10

15

20

25

30

35

40

45

50

0

50,000

100,000

150,000

200,000

250,000

nominal (US$bn, lhs) % of GDP (rhs)

See 19 April 2013 Emerging Markets Biweekly Report for underlying country numbers Source: ING

Russia, South Africa, Poland

and Turkey attracted the

largest portfolio inflows in

nominal terms, but Hungary’s

exposure is the biggest

relative to size of economy


23

The highest share of foreign portfolio holding to total outstanding: Baltics, Hungary, Ukraine (bonds/equities combined) Figure 36 and 37 show which countries’ securities markets are most heavily owned by

foreign investors. Economies without a sizeable investor demand base might find their

financial markets – and the cost of funding in domestic markets – more at the whim of

foreign investors.

Of course, the sensitivity of an EM economy and exchange rates to foreign capital flight is

not entirely related to foreigner’s total ownership of securities. Indeed, on this basis,

countries such as the Baltic States, Ukraine or Hungary would all appear to be the most

at risk, since foreign investors own a higher percentage of the underlying securities base

than the total for EM (ie, 18.73% for equities and 15.94 % for debt).

Fig 36 Bond holdings versus total outstanding (%)

Fig 37 Equity holdings versus total outstanding (%)

0

10

20

30

40

50

60

70

80

90

100

0

10

20

30

40

50

60

% of foreign ownership of bonds relative to outstanding external and local bond stock (sovereigns and corporates)

Source: ING estimates


However, in many cases, relative to the overall size of the economy or FX reserves cover

in the event of capital flight, the size of the securities markets may not be as large as for

other EMs. Consequently, relative to reserves, the risks presented by foreign ownership

of Ukraine’s debt and equity securities market actually slip down the risk scale (Figure 38)

and Hungary moves up the risk ranking.

Compared over time (Figure 39), foreign investor portfolio positions in all of EM do not

appear alarming when viewed versus EM reserves. That said, at 62% of reserves, they

are actually 8ppt higher than the 10-year median. Given that in 2010 the ratio was 55%,

the more recent trend suggests that risks are starting to rise. Admittedly, while there are

notable country exceptions, on the whole the outflow threat – while rising – is less severe

a risk than in the past.

In many cases, foreign

investors own a sizable

chunk of the EM securities

markets…

…But, in many cases, this is

mitigated by ample FX

reserves cover


24

Fig 38 10% financial portfolio flight versus FX reserves as of 4Q12 (%)

0

5

10

15

20

25

30

Bah

rain

S A

fric

a

Jam

aica

Mex

ico

Bra

zil

S K

orea

Hun

gary

Lith

uani

a

Hon

g K

ong

Indo

nesi

a

Pol

and

Tur

key

Chi

le

Cze

ch R

ep

Ven

ezue

la

Isra

el

Mal

aysi

a

UA

E

Col

ombi

a

Ukr

aine

Phi

lippi

nes

Dom

inic

an R

epub

lic

Arg

entin

a

Kaz

akhs

tan

Cro

atia

Indi

a

Nig

eria

Tha

iland

Sin

gapo

re

Per

u

Egy

pt

Pak

ista

n

Tai

wan

Qat

ar

Latv

ia

Rus

sia

Examining the potential threat of a debt and equity market pullout equivalent to 10% of foreign portfolio positions relative to available reserves to support the BoP position presents a realistic picture of potential BoP and FX risks.

In our January '11 assessment, Turkey had the fifth most "at risk" currency to potential capital flight relative to reserves. The country looks more comfortable now just behind Poland.8

9%

Lithuania, Turkey and Chile have moved down the risk scale from a year ago.

39

%


Fig 39 Foreign investor holdings of EM financial securities and EM reserves (US$bn)

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

1997

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

1Q12

2Q12

3Q12

4Q12

35%

40%

45%

50%

55%

60%

65%

70%

75%

80%

Foreign portfolio investment in EM (lhs) EM Reserves (lhs)

Foreign investor positions versus EM reserves % (rhs) 10Y median (rhs)

Relative to reserves, foreign investor equity and debt positions appear to offer less of a threat now than in 2006 and 2007.

However, over the course of 2012, the ratio increased and remains above the 10 year median. Admittedly, the ratio remains well below pre-crisis levels.

Source: ING

EM Europe: still a debt house It is interesting to note in Figure 40 that the asset class distribution (ie, debt versus

equity) in Asia continues to be weighted in favour of equities, whereas in Latam and EM

Europe/CIS the weight of debt is greater. In 2010, the relative weight of equities was

actually higher than debt in the case of Latam and EM Europe and was more pronounced

in Asia. This underscores the international investment trend that has increasingly been

moving in favour of holding bonds (Figure 42). Where in 2007 foreign bond holdings

accounted for just 27% of their EM positions, this has increased to 42% by 4Q12.


25

Fig 40 4Q12 foreign investor holdings in EM (US$tr)

Fig 41 Foreign EM portfolios vs EM and world GDP (%)

1.80

0.630.30 0.28 0.10

0.66

0.73

0.560.20

0.060.00

0.50

1.00

1.50

2.00

2.50

3.00

Asia Latam EMEurope/CIS

ME&Africa Other

Portfolio equity Debt

It is interesting to note that the asset classdistribution in Asia is weighted in favour of

equities. Whereas in Latam and EM Europe/CISthe weight of debt is greater.

2

3

4

5

6

7

8

1997

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

1Q12

2Q12

3Q12

4Q12

10

12

14

16

18

20

22

24

26

Foreign debt&equity portfolio holdings % EM GDP (rhs)

Foreign debt&equity portfolio holdings % Global GDP (lhs)

EM crisis versus Developed crisis

“Other” corresponds to 96 mostly small frontier markets (eg, Cuba, Zambia, Syria and Mongolia)


Source: National sources and ING estimates

Fig 42 Foreign investor portfolio debt and equity investments

408 553 464 704 982 1,2201,739

2,891

1,6622,389

3,1162,673

3,046 2,790 2,823 3,114

540731

528635

776667

855

1,131

1,005

1,183

1,5371,694

1,9251,888 2,081

2,221

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

1997

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

1Q12

2Q12

3Q12

4Q12

20

25

30

35

40

45

50

55

60

EM equity holdings US$bn (lhs) EM debt holdings US$bn (lhs) Debt versus equity % (rhs)

…They have since been on an upward trend, revealing the rising preference of investors for bonds.

Foreign investor equity and debt portfolio positions have surpassed pre-crisis 2007 levels. What is also interesting is that after debt vs equity holdings declined over the 2000-2007 period...


Of course, this in part reflects the fact that in many cases EM equity markets have yet to

fully recover to pre-crisis levels, which favours the EM bond weightings (given that bond

prices are far less elastic than equities to financial market shocks). EM equities have

seen a poor 1H13 so far with Poland’s WIG index down 8.7%, the Shanghai Composite

down 1.08% and Bovespa down a significant 12.22%. So it may be some time before

security price effects help the relative dynamic of foreign investors’ relative equity versus

debt. Meanwhile, local EM bonds have benefited from capital upside tied to monetary

easing (as compared with 2007 levels) as well as positive US Treasury effects for

external dollar-denominated bonds where the UST10Y yield dropped 330bp between

2Q07 and 4Q12, which is equivalent to an over 21% price gain for the EMBI Global, or

about 40% of EM bond returns over the past five years. The rally of US Treasuries more

recently is likely to further boost this dynamic relative to EM equities.

Figure 43 shows where foreign portfolio values have seen the best expansion in the

EMEA region. Globally, Hong Kong, Mexico, South Korea, Brazil, Turkey and Poland are

at the front of the line. At the end of the line are Russia, Hungary and Bulgaria, which

have seen foreign portfolios shrink.

...However, admittedly,

market effects have played a

significant factor in the

observed trend


26

Fig 43 2012 YoY foreign debt and equity portfolio changes US$bn and % YoY (Incl flows, FX and market effects)

64%44%

23%

66%

212%

76% 78% 77%56%

109%91%

28% 36%15%

0%14%

-11% -17%

-43%

-11% -6%

-50%

0%

50%

100%

150%

200%

250%

-20

-10

0

10

20

30

40

50

60T

urke

y

Pol

and

S A

fric

a

Cze

ch R

ep

Kaz

akhs

tan

Lith

uani

a

Rom

ania

Cro

atia

Egy

pt

Ser

bia

Latv

ia

Leba

non

Geo

rgia

Est

onia

Isra

el

Mol

dova

Alg

eria

Mor

occo

Bul

garia

Hun

gary

Rus

sia

US$m % YoY

For foreign equity and debt portfolio positions only. See 19 April 2013 Emerging Markets Biweekly report for full list of countries.

Source: ING estimates (estimates based on flow, change in FX and portfolio asset price changes)

EM external bond issuance trends: robust 1Q13 issuances alleviate concerns over foreign loans contraction Throughout 2012, we expressed the concern that while EM bond issuance seemed

sufficient to offset the sharp drop in loans (Figure 44), should bond market sentiment sour,

EM might face refunding risks and capital flight if redemptions exceed issuance levels.

However, although there was a visible US$677bn (10% YoY) drop in loans and other

investments, and it was not fully offset by the US$364bn of net external bond issuance,

there was nevertheless more than a sufficient offset thanks to other forms of capital:

US$728bn (8.7% YoY) extra FDI and US$210bn of portfolio investment (net of debt).

Fig 44 Global EM bond issuance and net new investment flow analysis (US$bn)

Conventional bonds Non-conventional

placements New debt

Grand total Amortisations

Interest payments

Called bonds

Restr debt

Stock of debt

Net new investment in EM ext debt

Sovs Corps

Total Eurobond issuance

Sover eign

Corp PPs&E

MTNs Corp

conver fr

restr issuance Sovs Corps Sovs Corps Sovs Corpsretired

(all corp) change Sovs Corps

Total new inv

Jan 19.64 25.50 45.14 0.40 0.88 0.28 0.00 46.70 4.42 1.82 5.77 3.51 0.00 0.32 0.00 40.14 9.84 21.02 30.86Feb 5.31 34.38 39.69 0.70 4.00 0.55 0.00 44.95 5.31 4.72 3.54 2.29 0.00 0.73 0.00 34.19 (2.84) 31.20 28.36Mar 11.50 29.55 41.05 1.10 1.62 0.36 0.00 44.13 3.59 5.00 4.75 2.98 0.00 1.00 0.00 34.53 4.26 22.54 26.80Apr 9.21 20.76 29.97 0.00 1.63 0.42 0.00 32.02 2.49 5.88 3.40 4.02 0.00 2.30 0.00 21.35 3.32 10.61 13.93May 2.47 14.42 16.89 0.00 8.03 0.00 0.00 24.93 5.02 6.11 2.69 3.62 0.14 3.25 0.00 10.55 (5.39) 9.48 4.09Jun 6.89 16.11 23.00 3.10 2.63 0.05 0.00 28.78 3.03 7.04 3.15 3.10 0.14 2.22 0.00 16.49 3.68 6.42 10.10Jul 8.75 34.50 43.25 0.23 3.37 0.05 0.00 46.89 4.23 4.80 5.15 3.68 0.00 1.15 0.00 36.71 (0.40) 28.28 27.88Aug 1.32 11.02 12.34 0.66 2.59 0.25 0.00 15.85 3.01 3.19 2.15 1.99 0.42 1.62 0.00 8.04 (3.59) 7.07 3.48Sep 12.51 45.39 57.89 0.18 3.55 0.33 0.00 61.95 1.47 4.79 3.98 3.02 0.75 0.20 0.00 55.49 6.49 41.25 47.73Oct 11.57 41.53 53.10 0.50 2.92 0.92 0.00 57.43 2.32 4.22 3.08 3.98 3.05 3.15 0.00 47.75 3.61 34.03 37.64Nov 16.54 38.77 55.31 2.94 2.00 0.46 0.00 60.71 2.80 9.72 1.91 3.66 1.63 0.50 0.00 47.69 13.14 27.36 40.50Dec 4.03 15.32 19.34 0.00 3.26 0.30 0.00 22.90 1.361 8.09 1.44 1.65 1.06 2.22 0.00 11.23 0.16 6.91 7.082012 totals

109.74 327.24 436.98 9.82 36.49 3.95 0.00 487.24 39.06 65.37 41.01 37.50 7.19 18.66 0.00 364.16 32.30 246.16 278.46

2013 Jan 11.62 50.66 62.28 0.00 2.55 0.00 0.00 64.83 4.42 1.82 5.77 3.51 0.00 0.32 0.00 58.27 1.43 47.56 48.99Feb 13.37 17.47 30.84 0.36 1.84 0.50 0.00 33.54 5.31 4.72 3.54 2.29 0.00 0.73 0.00 22.78 4.88 12.07 16.95Mar 3.45 36.02 39.48 0.00 0.79 0.30 0.00 40.57 3.59 5.00 4.75 2.98 0.00 1.00 0.00 30.98 (4.89) 28.14 23.25Apr 10.09 23.36 33.44 0.00 0.00 0.00 0.00 33.44 3.59 5.00 4.75 2.98 0.00 2.30 0.00 22.55 1.75 13.07 14.822013 totals

38.53 127.50 166.03 0.36 5.18 0.80 0.00 172.38 16.92 16.54 18.81 11.76 0.00 4.35 0.00 134.57 3.16 100.84 104.01

1Q10 33.87 41.13 75.00 0.39 2.67 1.68 4.09 83.81 13.89 17.57 11.53 8.08 0.00 4.55 5.10 0.00 8.84 14.27 23.111Q11 26.39 66.47 92.86 2.96 6.07 2.77 0.00 104.66 13.32 11.54 14.06 8.78 0.00 2.47 0.00 77.32 1.97 52.51 54.481Q12 36.45 89.43 125.88 2.20 6.51 1.19 0.00 135.78 13.33 11.54 14.06 8.78 0.00 2.05 0.00 108.86 11.27 74.76 86.031Q13 24.99 75.09 100.08 0.36 5.18 0.80 0.00 106.42 13.33 11.54 14.06 8.78 0.00 2.05 0.00 79.51 (2.04) 58.71 56.67

*Issuance through 18 April. ‘Sovereign’ for Republics, states and municipals. Quasi-sovereign corporate amounts are in ‘Corporate’ numbers. ‘PP’ = Private placements; ‘EMTN’ = Euro Medium Term Notes

Source: Dealogic, BondRadar and ING

Fortunately, contraction of

foreign loans has been more

than offset by a rise of bond

and other forms of capital

funding


27

It is significant that EM bond issuance remains robust, with US$172.4bn of conventional

and non-conventional bonds placed with investors (Figure 44). This, along with continued

evidence of other portfolio and capital flows alleviates some of our concern tied to bank

loan uncertainties and presents a supportive first month for the remainder of 2013.

Indeed YTD issuance has already surpassed the US$167.8bn placed in the full January-

April 2012 period, setting a new all-time issuance record.

But speculative placements are on the rise That said, the level of speculative grade placements has increased to 42%, the highest

since 2Q11. While on one hand, this could be considered as a positive sign as HY

issuance had previously been well below the historical median of 35% (Figure 46), on the

other hand, it indicates that speculative “hot-money” flows may be on the rise in the bond

market as investors stretch for additional yield. One quarter is too short a time frame to

argue definitively that we are ushering in a period of speculative bubble building.

Furthermore, it is worth highlighting that “speculative conditions” were notable for six

consecutive quarters in 2006-2Q07 before the “bubble” finally burst.

In the YTD period (to 18 April), there has been US$104bn worth of net new investment

into EM external bonds. This is also above the US$99.96bn received in the same period

of 2012. The money helped the EM bond market grow by a net US$134.57bn. The bulk of

the new money has been channelled into EM corporate bonds (US$100.84bn new

investment), with sovereigns barely treading water, with just US$3.16bn of inflows.

Fig 45 Quarterly EM loan and bond issuance (US$bn)

Fig 46 EM external bond issuance

0

50

100

150

200

250

1Q06

2Q06

3Q06

4Q06

1Q07

2Q07

3Q07

4Q07

1Q08

2Q08

3Q08

4Q08

1Q09

2Q09

3Q09

4Q09

1Q10

2Q10

3Q10

4Q10

1Q11

2Q11

3Q11

4Q11

1Q12

2Q12

3Q12

4Q12

1Q13

EM Bond issuance Loan issuance

The rise of EM external bond issuance has not fully offset the drop of loan issuance.

42%

41%

49%54%

66%50%

44%

52%23%

28%

43%29%

13%

9%36%

30%35%

31%

17%

44%

39%

11%

15%

28%17%

36%

-20

0

20

40

60

80

100

120

1Q06

3Q06

1Q07

3Q07

1Q08

3Q08

1Q09

3Q09

1Q10

3Q10

1Q11

3Q11

1Q12

3Q12

1Q13

100

200

300

400

500

600

700

800

Post-restructured issuance Retired non-performing

Retired/put/called performing High Grade

Spec Grade EMBIG-Div spread (rhs)

The issuance market has started to show signs of some "froth".

Speculative

Source: ING Includes sovereigns and corporates

Source: ING

EM external bonds remain a small market, with ample room to grow The record levels of net new investment may partly reflect crossover investment from

troubled European bond markets as investors seek alternative debt markets. However,

EM external bonds represent just 2% of global marketable bonds, while local bonds (over

half of which may not be tapped by foreign investors due to capital controls) represent

only a further 7%. This means that EM bonds provide investors a tiny 13% window in the

global investible debt universe (Figure 48). Our analysis last year showed a slightly larger

15% window for EM bonds, which means that the pace of growth for non-EM bond

markets has been greater.

The fact that EM economies have been growing more rapidly than DM economies and

now account a third of global GDP (on a nominal basis) underscores the relative level of

capital markets development. Fortunately, it also means that EM has room to grow,

particularly if it is fuelled by stable crossover investment. After all, bond investors have

YTD bond issuance has

already surpassed January-

April 2012 levels…

There has been US$104bn

worth of net new investment

into EM bond markets this

year. This is also a record sum

EM bond’s tiny 13% window

in the global marketplace

presents opportunities as

well as risks, such as

overinflated asset prices

… However, the level of

speculative bond placements

is now above historical

norms, although it is too

early to make a judgement

whether or not increased hot-

money flows will persist

EM bonds account for only

19% of world GDP, whereas

DM bonds account for 121%


28

been increasing relative exposure to DM, not EM, over 1994-2009. And despite some

declines of DM debt versus global GDP, this has mostly been due to the effect of EM’s

strong contribution to global growth. This has still left DM bond markets representing

121% of global GDP versus less than 19% for EM at end-2012 (Figure 47). That said,

there is the additional risk that excessive demand chasing relatively scarce supply might

eventually lead to inflated prices.

The new bond issuance has helped reverse the decline of EM bonds outstanding versus

EM GDP ratio, notable back in 2008. Although there was a slight increase of EM

bonds/GDP in 2012 (46.4%) versus 2011 (44.5%), the ratio remains below the pre-crisis

peak of 48.7% and still significantly lower than DM marketable bonds to GDP ratio of

204% for 2012. Consequently, while DMs are still highly levered to debt capital markets, it

can be said the EMs are actually still relatively under-levered to DCM, despite new

records being set on the issuance front.

Fig 47 EM and DM bonds versus global GDP (%)

Fig 48 Global cash bond supply at end-4Q12

0

20

40

60

80

100

120

140

160

180

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2Q12

4Q12

Developed marketable bonds to Global GDP (lhs)

Total EM bonds (local & external) vs Global GDP (rhs)

EM's share of the global bond market is a mere 18.84% of global GDP. For developed markets, although there has been some sign of deleveraging versus the global economy, it is 121%.

EM external bonds

2%

EM local bonds11%

EU bonds30%

Japan bonds17%

Other devl bonds

5%

US bonds35%

US$11r

US$29tr

US$16tr

US$34.4tr

US$4.6tr

US$2.2tr

Source: ING Source: National sources and ING

Conclusions for EM Europe In the EM universe, EM Europe stands out as the region with high refinancing needs

relative to reserves. This has to do with current account deficits, and medium- and long-

term debt due. However, large upfront issuance structural capital account surplus related

to EU funds could mitigate much of the risks for most of the CEE economies in 2013. Still,

Ukraine and Belarus do display high 2013 re-financing risk, with funding requirements at

close to 300% of reserves.

For EM overall, we do not see 2013 and 2014 as problematic in terms of refinancing.

That said, growing EM Europe exposure to hot capital flows warrants increasing

attention, despite the improvements that we are witnessing on the fiscal front. Hungary

(47%), Israel (35%) and Poland (31%) are dealing with the highest share of portfolio

capital outstanding relative to GDP.

[email protected]

…Furthermore, on the basis

of respective GDP (ie, not

world GDP), EMs are even

more under-levered than DMs

to debt capital markets



29

EM: Who to tango with?

One of the key themes this year is whether the US economy will overcome fiscal

headwinds – bringing forward the prospects of a local QE ending. But is this a story for

this year or the next? Is it time for emerging markets (EM) to look back to the West to

capture some externally driven growth? And how far West is ‘west enough’? Will/can the

BRIC countries continue to offer a buffer to EM exports squeeze, should recession in the

Eurozone persist and/or a US rebound not materialise?

With a number of elections in the pipeline in CEEMEA for 2014, and a broad-based

backdrop of slowing domestic demand, a more forceful approach (whether actions or

words) from politicians is to be expected on economic policies. And this, at the external

level, is likely to translate into new efforts to orientate/promote trade ties.

It’s time to pick partners.

Fig 49 Political agenda in CEEMEA 2013-14

Presidential Parliamentary Other

Poland May-14 - EU Parliament Hungary May-14 May-14 - EU Parliament Czech R. 2Q14 May-14 - EU Parliament Romania 4Q14 May-14 - EU Parliament Bulgaria May-13 May-14 - EU Parliament Croatia May-13 - Local authorities Turkey 2Q14 2Q14 -Local authorities South Africa 2Q14 2Q14

Source: National sources

At this stage, with the Eurozone falling further into a triple-dip recession, Central and

Eastern Europe seems the least likely to grab some externally-driven growth. This is yet

another element weakening the case for an EMU anchoring, a feature we investigate

later in this publication (please refer to Mateusz Szczurek’s article, ‘Reassessing EMU

entry for the CEE’, pg 46).

The prospects of a stronger-than-anticipated US recovery would at first sight offer LATAM

and developing Asia the strongest export-pull for growth vs EM peers. But this could be a

misconception. What if the US recovery challenged traditional trade ties with EM?

Last but not least, if the US and the Eurozone both fail to gain any traction this year, can

BRIC (continue to) mitigate the core markets squeeze in trade flows? Has the train more

steam to run on? Or are we on the brink of a faster DM/EM re-coupling?

Before investigating further any of these questions, it is worth going back to basics and

try to assess first – quantitatively – where we think export growth will come from this year

and next. This, is in our view critical to establish whether or not the BRIC alternative as

import absorber of the past 3 years is still a valid option, or not.

Where will export growth come from? A lot has been written in the past decade about the transfer of the engine for world growth

from Advanced Economies (AE) to Emerging Markets economies (EM). In 2007, for the

first time, EM economies overtook AE in their growth contribution to world real GDP

growth – with Developing Asia (mostly China, and to a lesser extent India) leading the

pack. Since then, the AE seem to have conceded defeat…

EM growth has been

significantly faster than

advanced economies since

2007

More protracted action to

boost external growth is

ahead given the hefty

political agenda for CEEMEA


30

Fig 50 World real GDP YoY growth contributors

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

CEE CIS Developing Asia Latam

Mena Sub-Saharan Africa Advanced economies Emerging markets

Source: IMF, ING estimates

But does this mean that Emerging Market consumers have overtaken their advanced-

economy counterparts? So far, the data suggests not, at least, not yet.

Figure 51 shows that since 2002, roughly 50% of nominal GDP growth worldwide was

attributable to household consumption. And although emerging market consumption has

been playing catch-up ever since the 80s-90s, since 2002, they have on average ‘only’

contributed to 35% of nominal world household consumption growth (Figure 52).

Fig 51 World household consumption contribution to GDP growth (YoY, nominal)

Fig 52 Main regions’ contribution to world household consumption growth (YoY, nominal)

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

2013

Remaining contributor (net exports, investment etc…)

Houseshold consumption contribution to nominal GDP growth

ING estimates for 2012-2014

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

2013

Advanced economies Emerging markets

ING estimates for 2012-2014

Source: IMF, IFS, ING estimates Source: IMF, IFS, ING estimates

The same message comes out of analysis of world import data, which shows that over

the 2002-11 period, emerging market imports contributed to “only” 39%, on average, of

global import growth (in nominal terms).

But EM internal demand only

contributed to 35% of world

household consumption

growth over 2002-12


31

Fig 53 Contributions from main regions to world import growth

-20

-15

-10

-5

0

5

10

15

20

25

198

1

198

2

198

3

198

4

198

5

198

6

198

7

198

8

198

9

199

0

199

1

199

2

199

3

199

4

199

5

199

6

199

7

199

8

199

9

200

0

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

201

0

201

1

Emerging markets economies imports contribution to world export growth (pt)

Advanced economies imports contribution to world export growth (pt)

Source: IMF DOTS, ING estimates

Taking all this into account, it seems fair to assert that even if emerging markets are still

not on par with advanced economies in their role as world import absorber, they have

certainly reached a size now where they can act as important buffers in a context of an

advanced-economy squeeze.

But what is valid as a group, hides a number of country specific differences. Who then is

a key “consumption” force within EM? And critically, which EM can effectively compete –

in size- with the key consumption poles in the advanced economies group?

But before going any further, we would like first to note some limitations to our study. Due

to data constraints, we limited our analysis to the relationship between household

consumption growth and import growth. Clearly, investment also plays a part in the import

component, but data were unfortunately not available for a broad-based analysis. This

bias underplays the significance of EM in our import-absorption capacity analysis: as it

has been well documented now that the import to production ratio for capital goods is

negatively correlated with economic development. However, since the GDP per capita of

the countries of our interest in the EM spectrum are significantly above the EM average

(with the noticeable exception of India, see Figure 54), this constraint should not distort

the overall picture significantly.

Fig 54 GDP per capita, main EM countries (2012, US$)

0

2000

4000

6000

8000

10000

12000

14000

16000

18000

20000

Source: IMF

EM internal demand is an

efficient buffer for advanced

economies’ slump, but not an

alternative, yet

Lack of data on investment

limits the scope of our study


32

Another risk of distortion in our analysis lies in the composition of consumption-related

imports. One could argue that EM countries might have their import absorption capacity

skewed by higher food/commodities needs. The line of argumentation would be that even

if a region in EM could be in absolute size as big an export destination as a DM region,

the sharp commodities intake makes it interesting, chiefly for commodities exporters. In

other words, EM import markets bear a higher risk of being “polarised” to specific

exporters.

On the food front, this argument may be worth it for low income countries, but not so

much our smaller asset “trading” EM world. Of course, disparities exist between

countries, but on average, the latter group’s food import share in their total import is

consistent with levels seen in developed countries, ie, in a 5-10% range. This is not the

case for African and MENA countries, which records level in the 15-20% range (Figure

55).

But the opposite case can be made for fuel – and the assumption that DM hold a stronger

fuel-import bias than EM. This is again not true for all EM: developing Asia in particular

has a fuel-import share in total imports higher than both the US and the Eurozone.

All in all, the commodities angle in EM/DM trade ties is worth mentioning, but would

probably need a separate report to investigate fully. We believe that the high GDP per

capita in our region of interest (“EM asset trading”) means that the distortions from

investment and soft commodities will not fundamentally alter the conclusions arising from

assessing import growth prospects via the household consumption channel.

Fig 55 % share of fuel, food and manufacture imports in total imports (2011)

Fuel Imports Food Imports Manufactures Imports

Main core countries United States 20.6 5.1 67.9Euro Area 17.2 9.0 65.9Japan 32.1 9.2 47.5Main EM regions BRIC 18.0 5.6 60.6Central & Eastern Europe 12.1 6.7 65.3CIS 6.1 11.8 72.5Developing Asia 21.2 5.4 55.8LATAM & Carribean 14.8 6.5 73.9MENA 5.7 15.9 68.0SUB-SAHARAN AFRICA 16.8 15.2 61.9Main EM countries of interest Poland 12.8 7.8 71.3Hungary 12.3 5.1 71.2Czech Republic 10.0 5.6 78.9Romania 11.4 7.4 74.3Bulgaria 23.0 9.3 53.3Croatia 21.8 10.9 63.2Turkey 8.5 4.5 60.6South Africa 21.4 6.1 63.7Ukraine 34.9 7.4 53.2Russia 1.8 12.3 74.9Kazakhstan 12.9 10.4 74.6China 16.8 4.6 56.6Brazil 18.6 4.5 71.9India 38.5 3.7 46.9

Source: IMF, World Development Indicators

Who is the strongest import absorber? This is an easy one. In absolute size, China’s household consumer market appears to be

a serious contender to the main advanced-economy players: at US$2.5tr, it ranks third

after the US and Japan. Brazil is not far off either, with a domestic household

consumption of US$1.5tr. The BRIC countries (Brazil, Russia, India, and China) offer an

Amidst EM, China is the

biggest household

consumption market

Can EM commodities

polarisation in imports skew

our study results?

Evidence do not point to a

clear EM/DM opposition on

food balances

But the case of fuel import is

more complicated


33

aggregate US$6tr household market: rivalling the US$7.4tr Eurozone, but not the US yet

(Figure 56).

The picture turns less positive when adjusted for population. As Figure 57 shows, the

BRIC countries are nowhere near the same league as the US. This is no surprise: simply

a reflection of lower income levels. But in a context of constrained global demand

(sentiment, indebtedness, slowing/declining disposable income etc.), it is worth asking

what commercial strategy for exports is more efficient: targeting a few of the rich, or a lot

of the poor? Ultimately it all depends on the type of goods exported.

Fig 56 Top household consumers in US$bn (2011)

Fig 57 Household consumption per head, US$ (2011)

0

2000

4000

6000

8000

10000

12000

Un

ited

Sta

tes

Eur

ozo

ne

BR

IC

Japa

n

Ch

ina

Ge

rman

y

Fra

nce

Bra

zil

Un

ited

Kin

gdo

m

0

5000

10000

15000

20000

25000

30000

35000

40000

Un

ited

Sta

tes

Eu

rozo

ne

BR

IC

Japa

n

Ch

ina

Ge

rman

y

Fra

nce

Bra

zil

Un

ited

Kin

gd

om

Source: IMF, IFS, ING estimates Source: IMF, IFS, ING estimates

Fig 58 Household consumption per head, main markets and regions US$ (2011)

0

5000

10000

15000

20000

25000

30000

35000

40000

Aus

tra

lia US

Japa

n

Ca

nad

a

UK

Eur

ozon

e

Oth

er A

E

CE

E

LAT

AM

ME

NA

CIS

BR

IC

Dev

elo

ppin

g A

sia

Sub

-sah

aran

Afr

ica

Source: IMF, IFS, EcoWin

Looking at the metrics (see Figure 59), and taking 2011 as a base, BRIC household

consumption growth needs to be 1.8 times higher than that of the US to provide the

global market with the same amount (in US$bn) of extra demand. This is not unrealistic:

our estimations suggest that BRIC household consumption grew by 8.2% YoY in 2012,

versus 3.1% YoY in the US.

Looking at 2013 household consumption prospects, the table below indicates that apart

from the US, only the BRIC countries can make a significant impact on global demand.

The BRIC region is the only one with a household consumption growth rate forecast

BRIC internal demand is a

competitor to the Eurozone’s,

but not the US’s yet

BRIC household

consumption growth needs

to be almost twice as high as

the US to compete with it


34

higher than the one implied by the multiplier (so providing the market with at least the

same increment in value as the US).

Fig 59 Nominal household consumption YoY growth (in US$ terms)

US Australia Canada UK Japan EurozoneOther

advanced BRIC CEE CISDeveloping

Asia LATAM MENA

Sub-Saharan

Africa

Multiplier (2011 base) 1.0 13.4 11.3 7.4 3.0 1.5 4.3 1.8 8.6 33.3 7.7 5.6 9.8 13.8

2012 estimated 3.1 4.8 1.9 2.4 1.2 (7.7) 0.9 8.2 (2.5) 11.0 7.5 5.4 13.5 5.0Implied by multiplier 41.7 35.2 22.9 9.4 4.5 13.4 5.5 26.6 103.4 24.0 17.5 30.5 42.82013 forecast 3.3 6.5 3.6 3.7 0.8 1.3 1.6 8.0 4.7 11.0 9.0 6.2 6.5 7.7Implied by multiplier 44.3 37.4 24.3 10.0 4.8 14.3 5.9 28.3 109.9 25.5 18.6 32.4 45.5

Source: IFS, IMF, ING estimates – Multiplier is US household consumption size divided by national household consumption size

According to our estimates, household consumption worldwide should reach US$42.6tr in

2013 and US$44.9tr in 2014 vs US$40.9tr in 2012. Of the extra US$4tr over the two

years, 31% is expected to be generated in the BRIC countries, vs 21% in the US (on

average).

Figure 60 shows the various regions/main country contributions to 2013 household

consumption increments – which should also have a bearing on exporters’ growth

prospects.

Fig 60 Contributions by region to 2013 and 2014 household consumption growth (forecasts in US$)

30.9

21.6

7.9 7.45.2 4.8 3.7 3.4 3.3 3.2 2.4 2.3 2.1 1.7

0

5

10

15

20

25

30

35

BR

IC US

De

velo

ppin

g A

sia

LAT

AM

Eur

ozon

e

ME

NA

Sub

-sah

ara

n A

fric

a

CE

E

UK

Aus

tra

lia

Oth

er a

dva

nced

econ

omie

s CIS

Ca

nada

Jap

an

%

2013F 2014F

Source: IFS, IMF, ING estimates

The charts below indicate that the countries likely to do the best at achieving export

growth are those exposed chiefly to both the US and BRICs, according to a comparison

of household consumption size/growth – and with a 59-41% split between the two regions

over the next two years.

Of course, actual performance will also critically depend on the export products involved,

in particular for energy exporters (see the fuel-import bias commented upon in the

previous section).

If household consumption in advanced economies were to deteriorate further in the year

ahead, which countries in EM will be the most vulnerable?

For 2013-14, we expect BRIC

to generate 31% of extra total

world household

consumption, vs 21% for the

US

Countries to extract most

growth from their exports will

have to approximate a 59-

41% US/BRIC destination mix


35

Fig 61 Household consumption annual increment (US$bn) – main contributors

Fig 62 Household consumption annual increment (US$bn) – other regions

-800-600-400-200

0200400600800

10001200

US Japan

BRIC other advanced

Developing Asia LATAM

Eurozone

ING f'cast

-300

-200

-100

0

100

200

300

Australia CanadaUK CEECIS MENASub-saharan Africa

ING f'cast

Source: IFS, IMF, EcoWin Source: IMF, IFS, EcoWin

EM export exposure to key regions Now that we have identified an ‘optimal’ export destination mix, it is time to look at the

various EM ties to the main export absorbers (region-wise).

Eurozone: doom and gloom? The case for the Eurozone as a trading partner has not been compelling over the past

couple of years. Given the persistent debt issue and poor confidence, we doubt this will

change in the coming two years. Accordingly, CE4 countries will struggle most to

generate growth from their external accounts relative to EM peers, as they are sending,

on average, 50% of their total exports to the Eurozone.

Fig 63 Main EM regions’ % of exports to the Eurozone (vs total exports, 2011)

0

10

20

30

40

50

60

CEE CIS DeveloppingAsia

LATAM &Carribean

MENA Sub-saharanAfrica

Source: IMF DOTS

The Czech Republic appears to be the most vulnerable on this front (vs Figure 64) of the

CE4 (Poland, Hungary, Czech Republic, and Romania), with Romania the least

vulnerable. The Baltic States are less exposed directly, owing to ties with Russia,

Sweden and the other CEE countries, while Turkey has more diversified export

destinations, with the highest rate of exports to the US versus CEE peers, and one of the

highest rates of exports to EM ex BRICs, also versus the same group.

Exposure to Eurozone points

to limited external drive

growth for CE4 vs EM peers

The Czech Republic is

particularly vulnerable,

Turkey should fare the best


36

Fig 64 CEE exports to Eurozone as % of total exports

Fig 65 CIS exports to Eurozone as % of total exports

0

10

20

30

40

50

60

70

80

Alb

ani

a

Cze

ch R

epub

lic

Bos

nia

Hu

ngar

y

Pol

an

d

Ro

ma

nia

Cro

atia

Mon

ten

egro

Mac

edo

nia

CE

E a

vg

Bul

gar

ia

Ser

bia

Lith

uan

ia

Tur

key

Latv

ia

0

10

20

30

40

50

60

70

80

Ge

orgi

a

Kyr

gyz

Rep

ublic

Uzb

ekis

tan

Taj

ikis

tan

Mol

dova

Ru

ssia

Ukr

ain

e

CIS

avg

Bel

aru

s

Arm

enia

Tur

kme

nis

tan

Aze

rba

ijan

Kaz

akh

sta

n

Source: IMF DOTS (2011) Source: IMF DOTS (2011)

CIS countries are, on average, less exposed to the Eurozone – but the high ratio in

Eurasia republics is distorted by the energy component. It is worth noting however, that

Kazakhstan exports have the smallest exposure to the Eurozone vs peers in the region.

For the remaining EM countries, one has to highlight the particular vulnerability of Tunisia

– which sends 70% of its exports to the Eurozone (ties inherited from its colonial past with

France).

Fig 66 EM exports to Eurozone (% total exports, 2011)

0

10

20

30

40

50

60

70

80

Source: IMF DOTS

The US: Be careful what you wish for… Across the pond, the outlook looks brighter for household consumption – though

admittedly the balance of risk for the latter is capped by US public spending sequestration

in the short-term. This should keep LATAM and developing Asia trade accounts on a

better footing than CEE and CIS: both regional groups export on average 39% and 15%,

respectively, of their total exports to the US.

North African country

exports are also set to

struggle

LATAM has the highest

exposure to the US vs EM

peers


37

Fig 67 EM main regions % of export (vs total) to the US (2011)

0

5

10

15

20

25

30

35

40

45

Central &Eastern Europe

CIS DeveloppingAsia

LATAM &Carribean

MENA Sub-saharanAfrica

Source: IMF DOTS

Looking at the breakdown by country in these two main groups, Mexico appears to be the

clear winner, with almost 80% of its exports sent to its neighbour – courtesy of the

NAFTA and energy trade agreements. For the rest of LATAM, the main countries of the

region send ‘only’ c.10% of their exports to the US (eg, Brazil and Chile, and Argentina

even less, with 5%). In comparison with LATAM peers, some countries in Asia have a

higher export share to the US (eg, China, India, Thailand, Vietnam, the Philippines,

Malaysia, and Indonesia).

Within Developing Asia, it is interesting to note that China is not at the top of the list, but

at 17%, it is still above the region’s average. Cambodia, Sri Lanka and Vietnam hold the

lead – and with the exception of Vietnam – export good types are chiefly of a

manufacturing nature (ie, clothes/footwear, electronics).

Fig 68 LATAM exports to the US (% total)

Fig 69 Developing Asia exports to the US (% total)

0

10

20

30

40

50

60

70

80

0

5

10

15

20

25

30

35

40

Source: IMF DOTS - 2011 Source: IMF DOTS - 2011

But Mexico distorts the

picture

Asian countries seem more

homogenously exposed to

the US


38

Fig 70 EM exports to US (% of total exports, 2011)

0

10

20

30

40

50

60

70

80

Source: IMF DOTS

On a medium-term basis however, key paradigm shifts in the US could alter trade ties

with its traditional export partners.

First paradigm: US energy dependency. Shale energy production is emerging in the

US and is more advanced than in any other shale endowed country to date.

In the case of shale gas, the US is on course to raise – according to the EIA – its current

33% shale production as a total of gas production to 50% by 2034 (ie +85%) (see also

Frack in the US, 27 June 2012 and In search for the holy shale, 13 January 2013). This

should raise total US gas production by 30% by then, and imply in particular significant

substitution effects versus traditional gas. This latter point would likely squeeze the US’s

main EM gas trading partners, namely: Algeria, Nigeria, Russia, Mexico, and Brazil

(Figure 71).

Fig 71 US gas import main partners (% of total imp.)

Fig 72 US crude import main partners (% total imp.)

0

10

20

30

40

50

60

70

80

90

Ca

nada

Alg

eria

Nig

eria

No

rwa

yR

uss

iaM

exic

oE

quat

oria

l Gu

ine

aB

razi

lLi

bya

Ne

the

rland

sB

elg

ium

Do

min

ican

Rep

.T

aiw

an

Per

uU

KT

rinid

ad &

TV

enez

uel

aG

erm

any

Sth

Kor

eaT

urke

yF

inla

nd

Fra

nce

Sin

gap

ore

Liquified petroleum gases Natural gas

0

5

10

15

20

25

Ca

nada

Sau

di A

rab

iaM

exic

oV

enez

uel

aIr

aqN

iger

iaC

olo

mbi

aK

uwai

tA

ngol

aB

razi

lE

cuad

or

Alg

eria

Ru

ssia

Ch

adLi

bya

Ga

bon

Equ

ator

ial G

uin

ea

Egy

ptC

ong

o (B

razz

avill

e)

Trin

idad

an

d T

oba

goA

zerb

aija

nA

rgen

tina

Un

ited

Kin

gdo

mT

haila

ndN

orw

ay

Om

anV

ietn

am

Source: US department of Commerce Source: US department of Commerce

What is good for gas is also good for oil. Already, the US has experienced a significant

increase in production since 2009, largely due to shale oil recovery (data on the subject

are not detailed unfortunately) as shown in Figure 73.

Key US paradigm shift

however might challenge US-

biased exporters in the

medium-term

Shale energy production

could redefine trade ties,

mostly for natural gas and

gas partners


39

Fig 73 US crude fields production (%YoY)

-15

-10

-5

0

5

10

15

20

1963

1965

1967

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

Source: EIA

Looking at the long-term outlook, however, the picture for oil is less clear than for gas, as

the US EIA assumes a broadly flat production in 2034 vs 2012 (in spite of a pick-up of 8%

in 2013, 5% in 2014, 2% for 2015 and 3% for 2016). The share of oil as an energy source

in the US is also set to continue dropping through to 2030 (from 35% in 2012 to 30% by

2030 according to BP). That said, those less upbeat projections for oil versus gas seem

pessimistic to us.

But beyond the uncertainties related to the US oil production outlook, if US production

continues to increase as a result of shale recovery, this would be bad news for MENA

(Saudi Arabia, Kuwait, Iraq, Algeria) but also for Mexico, Nigeria, Brazil and Russia

(Figure 72).

The second paradigm shift to impact EM exporters to the US in the medium term is the

manufacturing ‘renaissance’. On the back of lower energy prices, a lower labour cost

gap vs trade partners (particularly in EM), heightened FX/commodities volatility

(impacting transport prices) and legal/quality issues (compliance, reliability), the

temptation for the US to on-shore or re-shore manufacturing within its frontiers has

increased in recent years.

Since the recovery from the global financial crisis, growth in the US seems to be driven

mainly by goods-producing sectors (durable and non-durable) and not the services and

construction sector, in stark contrast to previous post-WWII growth slumps (see also Re-

industrial - revolution, 24 July 2012). Also, as well as national output, labour data shows

that manufacturing employment is also recovering faster than in previous recovery

episodes.

US oil production outlook is

not as rosy as gas

MENA crude exports could

struggle in the short-term still

US ‘reindustrialisation’ is the

new fashion

The current US recovery is

driven by goods-producing

sectors


40

Fig 74 This recession (real GDP)

Fig 75 Last recession (real GDP)

-400.0

-200.0

0.0

200.0

400.0

600.0

800.0

1,000.0

1,200.0

Jun-09 Jun-10 Jun-11

Durables non-durables Services Structures

-200.0

-100.0

0.0

100.0

200.0

300.0

400.0

500.0

600.0

700.0

800.0

Mar-01 Mar-02 Mar-03

Durables non-durables Services Structures

Source: BEA Source: BEA

Admittedly at this stage, there is still little evidence that the revival of the manufacturing

sector in the US is translating into an export boost – a feature that questions the

sustainability of this ‘re-manufacturing’ of the US economy in the long-term. Still, this new

dynamic suggests potential import substitution, which could hit EM exporters to the US.

As we mentioned before, one of the key rationales for the ‘re-industrialisation’ of the US is

the labour cost gap reduction between EM countries and the US. The cost advantage for

EM countries to produce labour-intensive goods for re-export to DM countries is

diminishing.

And this is certainly true of the US, where the growth of real wages has been in negative

territory for the past two years (Figure 76). A similar reasoning for the Eurozone is less

compelling, considering the growth pickup of real wages in the region over the same

period.

Fig 76 Real wages growth (% YoY)

Fig 77 The dangers of extrapolation, US vs Chinese wages

-10

-5

0

5

10

15

20

US China Germany

0

50000

100000

150000

200000

250000

China US

We are here2022

$

Source: EcoWin Source: EcoWin, ING estimates

The level of available data do not, unfortunately, allow for the identification of sectors

leading the way in this US manufacturing renaissance. But anecdotal investment

evidence (foreign and local) point to several industries:

• Steel/chemicals (plastics, rubber) due to the energy production boost

• Furniture/appliances in connection with high transport costs and quality issues

But no impact on US exports

is visible yet

The main rationale for the US

manufacturing renaissance is

closing the labour cost gap

with EM countries

Steel, chemicals, furniture

and appliances could be first

to face import substitution


41

This would put the following countries in a vulnerable position within EM: China, Mexico,

Brazil, Vietnam, Indonesia, Russia, South Africa, Malaysia, Thailand, and Turkey to name

a few significant partners in the product areas presented above.

It is still too early to anticipate a radical change in the US trade pattern. We find it hard at

this stage to envisage a reversal of robust trade ties – with East Asia in particular – based

on the “global value chains”.

BRICs to the rescue? Looking now at Emerging Markets and the countries that we expect to provide the largest

increment in household consumption over 2013-14 (aggregated), it is no surprise that, the

BRIC countries appear in the top 15. But it is worth noting the relative underperformance

of India in the ranking relative to its absolute size, as well as Kazakhstan’s

outperformance (again relative to its size) pointing to a possible over-heating.

At the other end of the spectrum, Ukraine and the CEE countries (Romania, Hungary)

look like the worst destinations for EM goods exports for the two years ahead.

Another point to make is that even if as a region the BRICs appear to be the main world

household consumption growth contributor, on average, over the next two years, the

aggregate value of the remaining EM countries is actually larger (with a 26.7% share in

overall world household consumption growth), mostly courtesy of Indonesia, Mexico, Iran,

Thailand, Malaysia, Nigeria, Chile and Columbia (in that order). All of these, except

Columbia, are expected to add more individually to world household consumption than

India over the next two years…

Fig 78 Main EM household consumption growth contributors (US$bn)

Fig 79 Worst EM household consumption growth contributors (US$bn)

0

100

200

300

400

500

600

700

800

900

1000

for 2013 and 2014

-30

-25

-20

-15

-10

-5

0

for 2013-2014

Source: IMF, ING estimates Source: IMF, ING estimates

To extract better export growth potential from BRIC markets, it thus seems a focus on

China, Russia and Brazil would likely pay more than a focus on India. In terms of

products, this suggests favouring exporters of manufactured goods (Russia and Brazil

have the highest manufacturing goods share in their total import compared to the

remaining BRICs, see Figure 55).

In terms of EM exposure to the BRICs, Africa seems to hold the top of the list, with Sub-

Saharan Africa sending 34% of its total exports to the region. MENA follows suit with a

20% ratio – with both pointing to a heavy energy/mineral/metal component in the trade

ties. Interestingly, developing Asia ranks last but one, with only 9% of its total exports

going to the BRICs (in spite of the neighbouring Chinese powerhouse).

But strong ‘trade ties’ will be

hard to break

BRIC countries lead the EM

pack as ‘import absorbers’,

but India seems to

underperform

CEE/CIS fare the worst

BRIC import absorption

should mostly favour EM

manufactured goods

exporters

Africa and MENA exports’

highest exposure to BRICs vs

EM is distorted by the

commodities component


42

Fig 80 EM exports to BRICs (% total exports, 2011)

Fig 81 EM exports to EM ex BRICs (% total exports, 2011)

0

5

10

15

20

25

0

5

10

15

20

25

30

35

40

45

Source: DOTS Source: DOTS

Who has the best export mix? Going back to our household consumption projections for 2013-14, we have established

that the best export destination mix to optimise external growth would be as follows:

Fig 82 Export optimal mix: main household consumption ‘incrementer’ over 2013-14 in % of total increment

Region Share in %

EM ex BRIC 26.7China 22.2US 21.3Advanced economies (ex US, Eurozone and Japan) 11.7Eurozone 6.0Russia 4.6Japan 3.6Brazil 3.1India 0.8Total 100.0


Those ratios applied for each EM country to the respective export-share of each region in

the country’s total gives us the following results in Figure 83 and 84.

On a regional perspective, it seems that LATAM is the best positioned – with its current

export destination mix – to grab most of the global household consumption growth

dynamic over 2013-14 versus EM peers. Central and Eastern Europe however, ranks last

owing to its relatively low exposure to the BRICs and the US (vs other EM), and their

higher exposure to the Eurozone.

LATAM as a region seems

the best positioned to

capitalise on household

consumption dynamics over

2013-14


43

Fig 83 Main EM region export mix vs world consumption outlook performance ranking (ppt)

0

2

4

6

8

10

12

14

16

18

20

LATAM &Carribean

CIS Sub-saharanAfrica

Developing Asia MENA Central &Eastern Europe

Rank = sum of the export shares per region weighed by this region’s share in world’s household consumption increment (2013-14)


Looking now at the breakdown by country, Mexico, India and Brazil are the countries that

should benefit most from the world household consumption growth pattern over 2013-14.

The outperformers within Europe are Russia and Turkey – though Russia’s picture is

distorted by its energy trade component.

A surprise for us is the relatively good performance of South Africa, in the top 10, of the

countries “optimal” exposure list. It appears SA’s high exposure to Emerging Markets (ex

BRIC) compensates for a relatively large exposure to the Eurozone. Accordingly, it would

not “need” a fundamental shift its trade destination to capture the best of the expected

recovery in global household consumption over 2013-2014. It is still worth highlighting,

however, the high commodities component in South Africa’s export mix.

Russia’s export mix also looks relatively good on paper. But again, as for South Africa,

the results have to be taken with a pinch of salt owing to the large energy component in

the country’s trade ties.

Fig 84 EM export mix per country, weighed by household consumption growth avg share (2013-14)

0

5

10

15

20

25

Source: IMF DOTS, ING estimates

Mexico, Brazil and India at

the top of the list


44

Looking now at the bottom of the list, Central Europe and Northern Africa appear to have

the worst export mix to capture world growth dynamics. Exposure to the Eurozone is the

main reason for this, but also relatively modest exposure to BRICs vs other EM (ex

BRIC).

Czech Republic and Poland in particular emerge as the worst performers vs the other

CEE countries – owing essentially to a lower exposure to EM ex BRICs vs CEE peers

(Figure 85). For the opposite reason, Turkey should be doing better than CEE peers –

though its overall ranking still puts it close to the average.

Of the peripheral CEE countries (Baltics, Balkans), Serbia seems to hold the better

position thanks to its higher exposure to Emerging Markets in general.

Fig 85 CEE regional exposure score board (ppt)

Fig 86 Main “CEE periphery” exposure score board (ppt)

0

2

4

6

8

10

12

US Eurozone Japan BRIC EM exBRIC

Advancedeconomies

ex G3

Poland Hungary Romania Czech R. Turkey

0

2

4

6

8

10

12

14

US Eurozone Japan BRIC EM exBRIC

Advancedeconomies

ex G3

Ukraine Serbia Lithuania Croatia Latvia

Export share by region, weighed by region's household consumption increment to the world's


Export share by region, weighed by region's household consumption increment to world's


It is also worth noting China’s relatively poor performance on this index – owing to its

export polarisation on advanced economies vs Asian peers in general, and India in

particular. As Figure 87 shows, the country has a much higher exposure to EM (ex

BRICs) than China’s – justifying the higher ranking in the overall country list.

Fig 87 Main Asian countries performance exposure score board (ppt)

0

2

4

6

8

10

12

14

US Eurozone Japan BRIC EM ex BRIC Advancedeconomies ex

G3

Indonesia China Malaysia Thailand India


CEE and Northern Africa

region will fare worst owing

to Eurozone exposure

Czech Republic and Poland

are most vulnerable


45

In this “performers”/”underperformer” analysis, a feature seems to be repeating itself:

exposure to non-BRIC countries appears to be a key factor in providing an extra “boost”

to export growth prospects for the next two years.

Figure 88 details the largest of those EM, ex-BRIC, per household consumption size

(average for 2013-14, ING estimates). Out of the list, we can already remove Poland –

where local consumption dynamics are poor, and Egypt – facing a potential financing

crisis amidst persisting political uncertainties. This leaves us with a few targets: Mexico,

Indonesia, Turkey, Iran, South Africa (to consider with caution though, considering the

large income distribution gap, rising unemployment and modest household consumption

momentum), and further down the line, Thailand, Nigeria, Malaysia and the Philippines.

Fig 88 2013-14 average estimated household consumption market (bn US$)

0

100

200

300

400

500

600

700

800


So it seems that rather than wooing the West – whether near or far – Emerging Markets

hoping to capture some household consumption momentum to boost their exports should

rather be courting the South…

In absolute terms, LATAM appears to have the best export profile to capitalise on

world household consumption dynamics over 2013-14. But of EM countries in focus

in this publication, South Africa, Turkey and Serbia lead the pack. CEE and Poland in

particular, will fare the worst – at both an absolute and relative level. The common

feature of the “best positioned” countries to “capture” the various household

consumption regional boosts in 2013-14 is a balance between the US, BRIC and

critically EM ex BRICs export exposure. Time to Tango with Mexico then?

[email protected]

Export exposure to non-BRIC

countries is likely to make a

difference in 2013-14



46

Reassessing EMU entry for the CEE

Weak demand in the Eurozone is just one factor that could make the non-EMU member

states rethink their drive towards the final stage of the EU integration – the membership in

the common currency area. Although all new member states are obliged by the EU treaty

to join the EMU, the EMU itself is changing before our eyes, and we can argue that the

past agreement was referring to a different construct. To begin with, the candidate

countries may wonder what are the rules of the game – what is required of the members

and what can they count on from their partners in the Eurozone. Cyprus capital controls

are one extreme example of such an unpredictable drift, but with each year of high

unemployment in the periphery, the social tensions in the recession-struck countries will

rise. This could potentially lead to further financial, economic and political turbulence in

the EMU – a powerful argument for the new member rates to wait for the final result.

In this section, we look at the arguments for and against the euro adoption in view of the

events of the past four years in the EMU. We argue that while the list of pros and cons of

the euro adoption has not really changed, the relative weights of the points have, tipping

the balance against Eurozone entry for the bigger new member states.

Fig 89 Pros and cons of the EMU adoption at a glance

Pros Cons

Elimination of FX risk premium Inappropriate interest rate (structural or cyclical) Macro stability and increased competitiveness Loss of FX, interest rates, bank regulations as shock absorbers

Lower interest rates Risk of an inappropriate entry exchange rate Financial market integration Asset price misalignments Increase in investments Conversion costs, one-off price jump International trade promotion via lower costs Maastricht criteria costs Political power within the EU Net costs of future member bailouts Gaining policy credibility of the ECB Freeing up FX reserves

Source: ING

The prime macroeconomic argument for the EMU membership, in our view, had been

linked with the ease and durability of access to external capital. This access is especially

important for the new member states (NMS) that are catching up, given their limited

domestic savings on one side, and low accumulated capital and the need for high

investments on the other. This broad argument encompasses the first five points on the

pros and cons list in Figure 89.

Cutting the FX risk premium: not a big deal anymore Elimination of the FX risk premium should make lower interest rates available to

business, households and governments. One measure of such a premium is the spread

between the local currency and the foreign currency treasury yield of a country

(Figure 90).

Weak economy, mounting

political tensions, uncertain

rules – is EMU still attractive?


47

Fig 90 Local currency versus Eurobond sov 10Yr spreads

Fig 91 1Yr €/lc cross-currency basis swap spread (mid and bid-offer spread)

-100

-50

0

50

100

150

200

250

300

Nov 12 Dec 12 Jan 13 Feb 13 Mar 13 Apr 13

RO 9yrs PL 9yrs HU 7yrs

HR 9yrs BG 10yrs CZ 8yrs

-180

-160

-140

-120

-100

-80

-60

-40

-20

0

HRK RON HUF CZK PLN

Source: Thomson Reuters Source: ICAP, Tullett Prebon

There is a substantial variation between these estimates across the CEE countries,

ranging from 172bp for Romania to -51bp for the Czech Republic. It is, to a large degree,

a function of national rates differential, as implied by the covered interest rate parity, but

also of relative liquidity considerations linked with the issuance strategy. An elimination of

the central bank rate differential would be equivalent to cutting the policy interest rate, a

subject covered further on. Cross-currency basis swap spreads (Figure 91) are perhaps a

better measure of pure FX risk premium, reflecting also the access to funding for the local

banking systems. Here, benefits of the EMU entry vary between 140bp (Croatia) and

13bp (Poland). At the onset of the global financial crises, these additional costs were by

an order of magnitude higher, but have since fallen to below pre-crisis levels in some

countries, thanks to the generous liquidity provisions by the ECB.

Another measure of the FX risk costs is linked with option pricing. Figure 92 shows the

cost (in percentages) of 3M ATM hedge, at the average volatility in the past two years.

These should be treated as the absolute upper bound of the FX risk costs – assuming

100% hedge, the importer/exporter cannot lose more than the amounts below, while it

can gain on the favourable FX movements.

Fig 92 Cost of hedging using 3M ATM €/lc option (% of local currency, average in the past two years)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

CZK RON PLN HUF

Source: ING

Funding in euro steadily

becomes cheaper relative to

local currency, as implied by

basis swaps

1.7-2.7% will secure full FX

hedge for the CE4


48

Gaining EMU credibility: is anyone still craving for it? The reduction in the cost of funding could also come via improved monetary and fiscal

policy credibility under the EMU. This argument gets weaker with every year of the EMU

crisis – the worry for the potential new EMU entrants might not only be the lack of policy

flexibility in the face of asymmetric shocks (we deal with that below), but also the risk of

misguided policies for the Eurozone as a whole, such as the ECB rate hike in April 2011.

Either because of perceived Eurozone-specific vulnerabilities or because of other reasons,

the cost of funding of CEE countries in euro is actually quite low relative to their ratings.

Padhraic Garvey, ING Global Head of Developed Markets Debt Strategy has been

analysing treasury yields in euro-denominated instruments relative to the sovereign ratings.

The natural relationship (worse rating – higher yield) seems to break down if we apply the

model estimated for the EMU to the ‘greater Europe’ universe. Yields in the Czech

Republic, Poland, Bulgaria, Romania, Hungary, Croatia and Turkey are too low relative to

ratings, judging by the relationship that works in the Eurozone (Figure 93). This points to too

low ratings and too low yields, or, as Padhraic Garvey suggests, much lower volatility of the

CEE Eurobond yields justifying lower returns (Figure 94). Whatever the reason, there

seems to be little evidence of EMU membership making euro funding substantially cheaper.

While Slovakia also belongs to the ‘low yield – not so low ratings’ group, Slovenia does not.

Fig 93 Sovereign bond yields (€, %): Actual and implied by ratings

Fig 94 Basis point volatility

0 2 4 6 8 10 12

Cyprus CCCGreece CCC

Slovenia A-Portugal BB+Hungary BB+Spain BBB+

Italy BBB+Croatia BB+

Romania BBB-Ireland BBB+

Turkey BBSlovakia ACzech A+

Bulgaria BBBPoland A-

Belgium AAFrance AA+Austria AAA

Netherlands AAAFinland AAA

Germany AAA

0 2 4 6 8 10 12 14

Predicted yield Market yield

0 100 200 300 400 500 600 700

CyprusGreece

SloveniaPortugal

ItalyHungary

SpainCroatiaIreland

BulgariaRomaniaGermany

AustriaFranceFinland

BelgiumNetherlands

TurkeyPoland

SlovakiaCzech

Implied yields are calculating using the regression estimated for EMU yield-rating relationship

Source: Bloomberg, ING estimates

Historical volatility multiplied by 10yr yields


Another example of the EMU membership potentially increasing the cost of funding is the

case of Denmark and Finland, countries similar in many respects and sharing the same

exchange rate thanks to the Danish FX regime. During periods of Eurozone stress,

Danish yields fell well below those of Finland, the former benefitting not only from

potentially more willing lenders of last resort, but also from the long-standing DKK

attachment to the DEM.

The key to cheaper funding during the crisis is not EMU membership, but indebtedness

mostly in own currency. EMU members are increasingly perceived as being indebted in

external currency over which they have limited influence.1 From this point of view, being

“important enough” for the fate of the Eurozone could prove to be a better indicator of stable

and cheap financing than having low debt and a responsible macroeconomic policy.

1 See Paul De Grauwe (2011): “Managing a Fragile Eurozone” (http://www.econ.kuleuven.be/ew/academic/intecon/Degrauwe/PDG-papers/Recently_published_articles/CESifo-Forum-Managing-Fragility-Eurozone.pdf)


49

Another argument for EMU entry is the benefit of financial integration for growth and

development. The arguments are the same as for free capital flows, which in principle

allow for better global allocation of capital, and force the ‘right policies’.

A quick look at the health of the Eurozone countries versus the CEE shows the latter

argument to be quite weak. Low inflation and similar fiscal policy has been pursued

almost regardless of EMU membership (Figures 95 and 96). Core inflation in the CEE

has been above the EMU average, but the performance, especially in the CE3, still

qualifies as price growth that does not serve to distort economic activity. While the

primary balance in the CEE countries has been worse than the EMU average in 2011, the

debt remains much lower.

Fig 95 Core inflation (% YoY, excluding energy and food)

Fig 96 2011 EU public debt and primary balance as % of GDP

0

1

2

3

4

5

6

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

EMU SP,IR,GR,PT CE3 CEE

-SPA

-UK

MAL

AUS

-IRE

-ROM-LIT

-POL-LAT

-BG-CZ

-SK

-SI

-CYP

-NED-FRA

-EMU-POR

-BE

-GRE

EST

LUX

SWE HUNGER

ITAFIN

-DEN

-10

-8

-6

-4

-2

0

2

0 50 100 150 200

Public debt as % of GDP

Primary balance, % of GDP

Source: Eurostat Source: Eurostat

Freeing reserve money? One benefit from inheriting ECB’s credibility is the freeing up of national central banks’ FX

reserves. The ECB charter states that FX reserves after paying towards the ECB capital

remain in the national central banks. While the transactions with the remaining balances

are subject to the ECB’s approval (especially when they concern large FX interventions),

they could, in principle, be transferred to the government, eg, for deficit financing or debt

repayment. For example, the potential Polish contribution to the ECB capital and reserves

would be €5.5bn, against €81.5bn in total NBP reserves, leaving some €76bn, 20% of

GDP available for debt repayment, future pensions or healthcare etc. The amounts for

other candidate countries are bigger – up to 33% of GDP for Hungary.

Fig 97 FX reserves at the disposal of national central banks after the EMU entry (% of GDP)

0

5

10

15

20

25

30

35

Poland Latvia Romania Croatia Bulgaria CzechRepublic

Hungary


EMU promotes financial

integration, which should

help in more efficient

allocation of capital…


50

A quick estimate of the actual value of such an operation is the spread between the

effective interest on reserves and the effective yield on government debt. The rate of return

on NBP FX reserves measured in foreign currency (to filter out exchange rate effects) in the

five years ending in 2011 was 3.98%. Poland paid 5.1% to service its debt in that period.

The 20% of GDP of netted out debt is thus worth some 0.23% of GDP per annum2. The

convergence in LT rates is likely to tighten this spread for the more credible sovereigns,

while the more exposed governments and national central banks might want to maintain a

higher level of reserves. So while the reduction of gross debt might be tempting, the net

effect of spending the reserves would for public finances would be almost negligible.

Further financial integration: are free capital flows beneficial? We consider the translation from financial market integration to higher economic growth (as

opposed to banking system growth) as an even more doubtful argument. The doubts are

not new – the scepticism regarding free capital flows was underlying the 1944 Bretton

Woods agreement. Figure 98 shows that the growth rate of per capita GDP 1982-1997 had

nothing to do with capital account openness. As the authors of the 2003 paper3 conclude, “if

financial integration has a positive effect on growth, there is as yet no clear and robust

empirical proof that the effect is quantitatively significant.”

Fig 98 Growth rate of per capita GDP 1982-1997 versus capital account openness

Growth is measured by growth in real per capita GDP. Conditioning variables are: initial income, initial schooling, average investment/GDP, political instability and regional dummies

Source: Prasad, Rogoff, Wei and Kose (2003)

A quick look at Spain’s performance before and after EMU entry (Figure 99) is also quite

disturbing. Total real growth was 48.3% in the 13 years preceding the EMU entry and

38.9% in the 13 years since. What is more, the period ‘after’ included a spectacular drop in

interest rates, a significant increase in capital flow volatility and a rapid deterioration of

external balance (Figure 100), linked with credit booms, wage growth and loss of

competitiveness. Even without the post-2008 recession, the macroeconomic gains are not

apparent, even if the EMU entry as any other form of financial market integration shifts

income within the country.

A similar argument can be made with regard to trade promotion. With trade as free as it is

within the EU, further easing of obstacles by Eurozone membership will contribute more to

income transfers within the EU than to eliminating deadweight losses and to promoting overall

GDP growth.

2 This assumes that the positive effect of gross debt reduction is equal to the negative effect of lower central bank reserves on the funding costs. 3 Prasad, Eswar, Kenneth Rogoff, Shang-Jin Wei, and M. Ayhan Kose (2003). “Effects of Financial Globalization on Developing Countries: Some Empirical Evidence.” IMF Occasional Paper #220

…but opening capital

accounts have been bringing

surprisingly little growth

benefits


51

Fig 99 Spanish real GDP, not SA, log scale

Fig 100 Spanish balance of payments (€bn, net)

10

100

1,000

1980 1983 1986 1989 1992 1995 1997 2000 2003 2006 2009 2012

48.3% real growth in 13 years before EMU

vs 38.9% in the 13 years after

10

100

1,000

1980 1983 1986 1989 1992 1995 1997 2000 2003 2006 2009 2012

48.3% real growth in 13 years before EMU

vs 38.9% in the 13 years after

-110

-60

-10

40

90

140

190

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Current and capital account Portfolio+FDI investments

EMU brings higher capital flow volatility

... along with the current account deficit

-110

-60

-10

40

90

140

190

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Current and capital account Portfolio+FDI investments

EMU brings higher capital flow volatility

... along with the current account deficit

Source: IMF IFS Source: EcoWin

The Cyprus debacle provides an additional twist to the argument justifying EMU entry on

the grounds of freer capital flows and business convenience. The recent bailout/bail-in

required the introduction of stricter capital controls than in Argentina in 2002, and the

controls still remained in place at the time of the publication.

Dealing with common interest rates Even with currency risk costs falling, interest rates in most of the non-EMU CEE countries

are above the Euribor. This is related to the independent monetary policy, the end of

which would forcibly cut the interbank rates to the Euribor level, allowing for cheaper

funding, higher investment and a faster catching-up process, without policy credibility loss

that could accompany such a cut in official rates without the EMU entry.

The first problem with this mechanism is that it seems to translate into cheaper funding

only when the “times are good.” As the ECB has mentioned many times, the interest rate

transmission is broken during the crisis, as businesses in the crisis-stricken Eurozone

countries face higher funding costs. Whether it is linked with banking system issues,

higher business risk in a recession or higher sovereign risk, it does not really matter – the

changes in relative interest rates are strengthening business cycle deviations.

The second problem with this mechanism is the risk of facing an inappropriate interest

rate with insufficient policy freedom to counterbalance it. This is the standard optimum

currency area (OCA) debate, not quite settled with respect to the original Eurozone. The

interest rate might be unsuitable for structural reasons (abundant labour, scarce capital),

or for cyclical reasons (booming periphery versus struggling core or vice versa).

The lack of interest or exchange rates as shock absorbers can be substituted with fiscal

policy, macro- or micro-prudential banking regulation, labour mobility, real wage flexibility

or intra-EMU transfers. The viability of each might need to be revaluated in light of the

past few years’ experience.

It is now apparent that fiscal policy freedom might require a much tighter fiscal policy

during the boom time in order to allow for a counter-cyclical fiscal loosening during the

slump. The fact that Ireland and Spain, considered paragons of fiscal responsibility, were

forced into deep austerity programmes during the private sector deleveraging is a case in

point. The contingent liabilities related to banking system vulnerabilities and externalities

of the EMU-wide fiscal tightening increase the fiscal needs in times of stress. The

necessary swings to major budget surpluses should be a substantial political challenge,

Cyprus capital controls are

lowering the convenience of

doing business, on top of

reduced policy flexibility

Common interest and

exchange rate policy requires

other flexibilities

3% of GDP deficit limit is too

restrictive in times of stress

and vastly inadequate during

booms

Canges in relative interest

rates are strengthening

business cycle deviations in

the EMU


52

but the near-term problem is related to the market and EU partner acceptance of a much

looser fiscal policy – difficult when faced with intra-EMU capital flight risk.

Counter-cyclical banking regulation is another method of taking away the punch bowl

in good times. It remains to be seen how much such regulations could vary within

countries when a common European regulator would take over. If anything, the risk of a

one-size-fits-all policy is heightened with the current plans.

Labour mobility will be the crucial way of venting off public frustration with 20%+

unemployment. The fact that Romania, Bulgaria and Croatia are not part of the common

labour pool is a severe obstacle for the sensibility of their EMU entry bid, in our view.

Similarly damaging are the service sector labour market restrictions in several countries

including Germany. The rise of anti-migration sentiment in the Netherlands, France, Italy

and the UK is another factor potentially dismantling the foundation of the Eurozone (but

then, so far, the calls for tighter labour market regulations have been restricted to the

countries experiencing recessions, so the cycle-equalising argument is not strong in this

case).

Real wage flexibility as a way of replacing the lacking nominal exchange rate adjustment

to balance of payments flows is a slow and painful process, because of nominal wage

rigidities and low in partner economies. The newest Eurostat numbers on hourly labour

costs (excluding public administration and agriculture) are shown in Figure 99. True,

Greece, Portugal and Ireland labour costs did grow less than the EMU average (the

difference is 19.4, 8.9, 8.3 and 0.7%, respectively), but for an adjustment process that

lasted for four years, it is not particularly impressive, given the initial competitiveness

adjustment needs at the onset of the crisis.

Fig 101 Hourly labour costs (€, %ch 2008-12), excluding agriculture and public administration

-15% -5% 5% 15% 25% 35% 45%

Bulgaria NorwaySwedenAustria

SlovakiaFinland

BelgiumLuxembour

Denmark FranceCyprus

GermanyEMUMalta

ItalyEU27Spain

EstoniaNetherlands

SloveniaRomania

UnitedLatvia

IrelandPortugal

LithuaniaPoland

HungaryCroatiaGreece

Bulgaria’s indicated wage cost growth of 42.3% most likely reflects minimum wage growth and under-reporting of total wages in 2008

Source: Eurostat

Transfers, or debt forgiveness, as a method of easing the imbalances are a thorny

enough issue within a single country; a long-lasting transfer stream of the W-E Germany,

or N-S Italy type needs a different Europe than we have now, as shown during the recent

2014-20 budget debate. The discussion was about less than 1% of the EU GDP, a

marginal amount compared with the recent bailout costs or the ESM capital allocations

(see below). While the support for the Eurozone remains high amongst German voters,

we expect bail-out fatigue to mount amongst core taxpayers as we get closer to the

German elections.

EMU cannot be an optimum

currency area without labour

mobility – this works against

Romania, Bulgaria and

Croatia entry

Wage adjustment is possible,

but slow

Large transfers need different

voters in donor countries


53

Compared with the EMU members stuck in a long-run recession, this tool is probably of

smaller importance for the EMU candidate countries that have lower debt and can still

influence their external balance via the appropriate choice of entry exchange rate.

The benefits of FX flexibility A loss of competitiveness and the related external imbalances caused by credit booms

and too-low interest rates – asymmetric shocks – might eventually require a correction

when financing dries out. While current account can be brought into balance with a

recession, as shown by a number of European countries, this is suboptimal. A better

option is to cut the reliance on external savings via real exchange adjustment, and a

nominal exchange rate is the quickest way to achieve it.

Employment loss, given the same CA gap, does tend to be somewhat lower for countries

experiencing real exchange depreciation (Figure 103), but the statistical significance of

the relationship is weak.

Fig 102 Pre- and post- adjustment CA (% of GDP, sorted by the 07-11 difference)

-24

-19

-14

-9

-4

1

6

Turke

y

Ukrain

e

Russia

Czech

Rep

ublic

Poland

Slovak

ia

Croat

ia

Hunga

ry

Roman

ia

Latvi

a

Bulgar

ia

2007 2011

Source: National sources

Such analysis ignores the fact that the initial CA gap itself might have been connected to

the exchange rate policy (see Figure 102, the highest starting-point CA gaps were seen

in fixed exchange rate countries). A regression of employment change in crisis versus the

openness of the economy, REER depreciation and the share of FX credit in GDP shows

the latter factors significantly influencing the job loss cost of the recent crisis (Figures 103

and 104).

It is worth noting that while nominal exchange rate depreciation can have dangerous side

effects for the domestic demand due to FX borrowing exposure, the real wage deflation

channel is effectively equally damaging, but more prolonged: income falls relative to the

value of the loans for a big part of the population.

Weaker exchange rate did

save jobs in CEE, but

statistical relationship after

controlling for the size of CA

is weak…

…but fixed exchange rates

might have contributed to the

external imbalances


54

Fig 103 Employment versus REER change (%)

Fig 104 Employment versus FX credit/GDP

Turkey

Ukraine

Russia

Poland

Czech

Slovakia

Croatia

HungaryRomania

Latvia

Bulgaria

-20.0

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

-25 -15 -5 5 15 25

RE

ER

app

reci

atio

n (%

, 20

07-2

011)

Employment change (%, 2007-2011)

Turkey

Ukraine

Poland

Czech

Croatia

HungaryRomania

Latvia

Bulgaria

0

10

20

30

40

50

60

70

80

90

100

-30 -20 -10 0 10 20

FX

den

omin

ated

deb

t/GD

P

Employment change (%, 2007-2011)

Source: IMF IFS Source: IMF, national sources

Another reason that creating varying responses of the economies in an environment of

falling CA deficits could be the lack of output diversification, making import substitution

difficult. If the majority of the industry is concentrated in, for example, the car

manufacturing sector, the short-term scope for real exchange rate-linked net export gains

is mostly limited by the external demand, and not costs.

Such peculiarities are difficult to catch in a small sample. Time series estimates for

individual countries point to a consistently high and negative translation of weaker growth

into CA improvement. The importance of real effective exchange rate (unit labour cost-

corrected measure has been used) is much more patchy. While the sign is right for most

countries, significance is marginal. In particular, annual 2000-11 data show Turkey,

Slovakia, the Czech Republic and Hungary external balances responding in a limited

fashion to the exchange rate swings. REER in Croatia, Romania, Poland and, in

particular, Ukraine, tends to coincide with CA swings, after controlling for GDP. This is

especially visible in the crisis years as shown in Figures 103, 104, 105 and 106.

Fig 105 REER and CA change in Poland

Fig 106 REER and CA change in Czech Republic

-4-3-2-101234-30

-25-20-15-10

-505

101520

REER (% YoY, rhs) CA (YoY diff, % of GDP)

-10

-5

0

5

10

15-3

-2

-1

0

1

2

3

4

5

CA (YoY diff, % of GDP) REER (% YoY, rhs)

Source: ING estimates, OECD Source: ING estimates, OECD

More diversified economies

stand to benefit more from

the REER adjustments

Poland, Romania and Croatia

enjoy bigger FX shock-

absorbing than the Czech

Republic or Hungary


55

Fig 107 REER and CA change in Romania

Fig 108 REER and CA change in Croatia

-6-4-202468101214-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0


-6

-4

-2

0

2

4

6-6

-4

-2

0

2

4

6


Source: EcoWin, ING estimates Source: EcoWin, ING estimates

The importance of the exchange rate as a shock absorber varies across the NMS. It

appears significant in Poland, Croatia or Romania, but for the Czech Republic or Hungary

the best that can be said is “significant yet small.”

Political factors versus costs of future bailouts A new argument for EMU entry is the political power to shape the European Union. The

Eurogroup meetings increasingly shape bank regulations, bailouts and fiscal rules that

have a direct or an indirect (eg, via parent banks) influence over the non-EMU

economies. Staying outside exposes the NMS to “regulation without representation.”

Another factor speaking for entry could be the deepening of the financial links via the

EMU entry as a geopolitical protection (similar to the arguments for hosting US troops or

ballistic missiles).

The political power in the EU is becoming increasingly linked (via the Lisbon treaty and

double majority voting in most areas starting from 2014) to population. So far, however,

the realities of the political power in EMU decision-making have been constantly

changing. This also applies to the "rules of the game" of the bail-outs. One example is the

contrast in the range of bailed-in investors in Ireland and in Cyprus. Another is the

German retreat from the idea of bank bail-outs separated from sovereign support. And

generally, we expect size and systemic importance, as well as internal political logic of

the creditor countries to have an important influence over the governance of the EMU.

What is more, population, along with its potential political influence also carries financial

responsibilities within the EMU. Article 29 of the statute of the ECB sets the key for

capital subscription along the following rules, which apply also to the ESM capital key.

The key for subscription of the ECB’s capital, fixed for the first time in 1998 when the

ESCB was established, shall be determined by assigning to each national central

bank a weighting in this key equal to the sum of:

50% of the share of its respective Member State in the population of the Union in the

penultimate year preceding the establishment of the ESCB;

50% of the share of its respective Member State in the gross domestic product at

market prices of the Union as recorded in the last five years preceding the

penultimate year before the establishment of the ESCB.

Figure 109 shows the hypothetical capital subscription of the new members, as a

percentage of GDP and in nominal terms calculated on the assumption that the country in

question is the only one joining. NMS with a lower GDP per capita would contribute a

disproportionally higher share of their income to the European Stability Mechanism. The

potential burden would have been much greater without the correction mechanism

Being ‘in’ might bring some

power over the shaping of

the EMU and the EU...

…but it does not come

cheap. ESM capital

subscription alone might

weigh by 7-10% of the CEE

GDP


56

benefitting the countries with GDP/capita below 75% of the EU average. The Czech

Republic and Slovenia are the only countries in the region that enjoy income above that

level (thus, the Czech Republic’s is the highest capital subscription to the ESM, as a

percentage of GDP).

The estimates of the banking union benefits and costs also do not favour the NMS

without systemically important banks (Figure 108), with bigger countries particularly

disadvantaged.

In short, any political clout that the new entrants would gain would be quite expensive if

new ESM rescue mechanisms were to be arranged in the future.

Fig 109 Hypothetical ESM capital subscription

Fig 110 Net effect for countries joining the banking union

0

2

4

6

8

10

12

Sweden UK

Slovak

ia

Latvi

a

Lithu

ania

Poland

Hunga

ry

Croat

ia

Roman

ia

Bulgar

ia

Czech

Rep

ublic

0

20

40

60

80

100

120

ESM % of GDP ESM €bn (RHS)

-7 -2 3 8 13

GermanyPoland

ItalyFrance

RomaniaGreeceAustria

BelgiumCzech Republic

HungaryBulgariaSlovakia

LithuaniaSlovenia

LatviaCyprus

DenmarkNetherlands

SwedenSpain

United Kingdom

Note: Assuming EMU expansion by only the particular country

Source: ING estimates based on Eurostat data

Note: Net effects sum up to zero, % of EU-total gains minus % of total costs

Source: Dirk Schoenmaker, Arjen Siegmann (2013) (http://papers.tinbergen.nl/discussionpapers/13026.pdf)

Internal politics Ultimately, the key factor on the NMS’ way to the EMU should prove to be local support

for the adoption of the euro. There is a puzzling disconnect between the public support

for the EMU and the trust in the ECB. Support for the common currency tends to be low

in the non-EMU members and high in the Eurozone (Figure 111). The candidate

countries that have more people declaring their support than opposition to the common

currency are Bulgaria, Romania, Croatia and (barely) Hungary. Opposition to the EMU is

high not only in the Czech Republic and Poland, but even in Latvia and Lithuania, both

close to join the EMU. At the same time, EMU members generally distrust the ECB, while

only in Hungary, Latvia and Croatia does such distrust prevail.


57

Fig 111 Support for the EMU

Fig 112 Do you trust the ECB?

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

EU27 BG CZ LV LT HU PL RO SK HR

For Against neither

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

EU27 BG CZ LV LT HU PL RO SK HR

Tend to trust Tend not to trust Neither

Source: Eurobarometer, spring 2012 wave Source: Eurobarometer, autumn 2012 wave

These results do influence the governments’ drive for EMU entry, as shown in Figure 113.

With the exception of Latvia and Lithuania, not a single candidate country has a firm date set

for joining the EMU. Firmer declarations are at most limited to "readiness to join", but often

the calendar is open ended, as in "not before".

Fig 113 Maastricht criteria check

HICP (%)

Public finance deficit (%)

Public debt (%)

ERM-II LT IR (%)

Latest political declaration

Reference 2.5 3 60 2 yrs 4.81

Bulgaria 2.5 1.0 19 No 4.03 Suspended indefinitely Czech Republic 2.9 5.2 46 No 2.44 Not to decide before 2014 elections Hungary 4.9 2.4 79 No 7.23 Not before 2020 (assuming unchanged gov)Latvia 1.6 1.5 42 May 05 4.00 Jan-14 Lithuania 2.8 3.2 41 Jun 04 4.53 Jan-15 Poland 3.0 3.5 56 No 4.61 Criteria in 2015, no date set Romania 3.9 2.9 38 No 6.43 Previous 2015 target to be pushed, or

completely removed Croatia 4.0 4.6 54 No 5.73

Source: Eurostat, national sources

Conclusions The past five years revealed a number of deficiencies in the functioning of the EMU, while

most of the CEE continued maturing as credible economies. The key benefits of the EMU

membership are either proving overrated (balance of payments stability, policy credibility

of an economic superpower) or come with undesirable side effects (easier access to

capital, lower interest rates). Even though the convenience in doing day-to-day business

outweighs the inflation and transition costs, the macroeconomic issues are show-

stoppers for bigger new member states.

The candidate countries without derogation can postpone entry indefinitely (legal criteria

can be missed for as long as the country wishes), so the timing is up to the candidate

country.

Maastricht criteria are not sufficient to ensure a smooth functioning within the Eurozone.

To deal with unsuitable interest rates, the candidate might want to:

• Wait for the natural interest rate to converge to the EU core.

• Ensure a better investment environment to channel demand to potential growth-

enhancing investments, not consumption or real estate. This could include industrial

or innovation policy and a shift away from labour costs as the key trade driver.

The balance of benefits has

shifted against the EMU entry

for bigger CEE economies…

…and anyone still

considering entry must be

prepared to deal with the

problems that hit the 2000s’

outperformers


58

• Devise and secure the right to use bank regulations allowing for cooling consumption

or real estate booms.

As a way of dealing with reduced policy flexibility, public finances in good times must be

sufficiently good to allow for a much looser policy in bad times.

While we learned more about the risks connected with the functioning of the EMU, the

knowledge and policy prescriptions could still be tested by the changing structure of the

EMU governance (banking union) or fresh bailouts. Slovakia showed there is little hope in

negotiating lower share in pan-EMU rescue costs for the new member states.

With uncertainties that large, the risk of post-crisis nominal appreciation of the floating

CEE currencies spoiling the entry terms is worth taking in our view.

The countries standing to benefit the most will tend to be richer, smaller, more open and

maintaining the currency board or fixed exchange rates anyway. Latvia and Lithuania

have been living with the currency board for years; they learned to count mostly on

themselves (and Swedish parent banks), and thanks to their tiny population, the potential

costs would be counterbalanced by easier access to ECB facilities. For Bulgaria, similarly

open and running the same exchange rate policy, the ESM costs are politically

prohibitive. The shifting cost-benefit balance is likely to leave the Czech Republic,

Hungary, Poland and Romania out of the EMU and with their own interest and exchange

rates for at least a decade.

The Baltic states are likely to

remain the only entrants in

2010s


59

Countries

Bulgaria Directional EMEA Economics April 2013

60

Bulgaria [email protected]

Forecast summary

Country strategy

4Q12 1Q13F 2Q13F 3Q13F 4Q13F 2013F 2014F

Real GDP (%YoY) 0.3 0.5 1.4 0.9 1.1 1.0 1.7HH consumption (%YoY) 0.5 1.5 2.0 1.7 3.4 2.2 2.5Fixed investment (%YoY) -1.0 0.5 0.0 -0.4 1.2 0.3 1.8CPI (%YoY)* 4.2 3.6 4.0 2.2 2.9 3.3 3.4Current account (% of GDP) -1.3 -2.1 -2.7 -0.6 -2.2 -2.2 -3.0FX res. import cover (mths) 6.6 6.3 6.0 6.1 5.9 5.9 5.8Policy interest rate (%)* n/a n/a n/a n/a n/a n/a n/a3-mth interest rate (%)* 1.36 1.23 1.50 1.60 1.60 1.50 1.703-year yield (%)* 1.85 1.55 1.90 2.00 2.10 1.80 2.2010-year yield (%)* 3.45 3.44 3.40 3.50 3.70 4.40 4.60USDBGN* 1.48 1.51 1.53 1.57 1.63 1.54 1.60EURBGN* 1.96 1.96 1.96 1.96 1.96 1.96 1.96

Tens of thousands of Bulgarians took to the streets in Feb in a protest sparked by high utility bills and fuelled by poverty, leading the government to resign and bringing forward general elections by about two months to 12 May. The good news is that this increase in political uncertainty has not been reflected in available economic data, so our forecasts have not seen significant changes. The bad news, however, is that polls suggest the elections will not bring aclear winner and this limits the chances for a speedy formation of a new government. The risks for fiscal slippages have increased along with social tension and the Socialists’ plan to return to progressive taxation would probably put the largest pressure on public finances.

*Quarterly data is eop, annual is avg. Source: National sources, ING estimates

Opinion polls - latest vs pre-protest outbreak (ppt)

The Socialist Party calls for return of progressive tax

18.619.7

5.0 5.23.0

22.6 22.1

1.2

7.34.8

0

5

10

15

20

25

GERB SocialistParty (BSP)

Attack MRF Bulgaria forthe Citizens

Mar Feb

The protests did not manage to spawn a fresh political construction and it was the far-right party, Attack, that saw its support increase by the largest margin (~2-3ppt). The former ruling party, GERB, is still leading the polls, but by a very thin margin (1-4ppt, depending on the poll) over the Socialist Party. Ex-PM and GERB leader said he plansto focus on increasing income and taming youth unemployment on top of his former priority: fiscal stability that awarded Bulgaria a good rating and helped lure investors. The Socialists talk about switching from the 10% flat income tax to progressive taxation (with the first two rates set at 0% and 10%). Such a system is significantly more lenient than the 20-24% rates in force before 2008 and sounds difficult to implement without visibly widening the budget deficit.

Source: Reuters, Gallup

GDP components (% YoY, real growth)

Economic sentiment jumped in 1Q13

-30

-20

-10

0

10

20

30

40

1Q082Q

083Q

084Q

081Q

092Q

093Q

094Q

091Q

102Q

103Q

104Q

101Q

112Q

113Q

114Q

111Q

122Q

123Q

124Q

12

-10-8-6-4-202468

Household consumption Fixed investments GDP (rhs)

Bulgaria narrowly avoided contraction in 4Q12, stagnating QoQ, and, in spite of the political uncertainty, business confidence saw the largest increase in 1Q13 since 2010. At the same time, industrial output is on track to report that 1Q13 was one of the strongest in the past couple of years, while the contraction in household credit is slowing, which led us to operate only a small revision to our growth projections although ING now expects Eurozone growth to contract by 0.6% in 2013, similar to 2012, but well worse than the 0% forecasted earlier this year. We now look for 1% growth in 2013 and 1.7% in 2014 (vs 1.2% and 2.1% previously) as external headwinds will be, to some extent, buffeted by the easier fiscal policy as the government targets 1.4% of GDP vs 0.5% in 2012.

Source: NSI, ING estimates

Economic Sentiment Indicator (quarterly change)

Progressive taxation – the biggest near-term threat

Domestic debt has corrected a good part of the negative price action that followed February’s events, with 10Y yields easing 30bp after a 70bp jump. A delay in forming a new government is probably largely expected, so the biggest threat looks like post-election fiscal easing. Pre-election easing does not seem like a risk and most telling is that gas prices were recently cut (for the second time in 2013) at the expense of private distributors and not the fiscal purse.

Trade recommendation

Entry date Entry level Exit level S/L

-15

-10

-5

0

5

10

Mar-0

8

Sep-08

Mar-0

9

Sep-09

Mar-1

0

Sep-10

Mar-1

1

Sep-11

Mar-1

2

Sep-12

Mar-1

3

- - - -

Source: DG ECFIN, ING estimates


Bulgaria Directional EMEA Economics April 2013

61

Bulgaria

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012E 2013F 2014F 2015F

Activity Real GDP (%YoY) 5.5 6.7 6.4 6.5 6.4 6.2 -5.5 0.4 1.8 0.8 1.0 1.7 2.8Private consumption (%YoY) 6.8 7.7 6.7 8.6 9.0 3.4 -7.6 0.1 1.5 2.6 2.2 2.5 2.9Government consumption (%YoY) 8.5 5.8 4.8 2.1 -1.6 -1.5 -4.9 -0.5 0.3 -0.4 2.5 2.3 2.0Investment (%YoY) 13.0 13.7 30.7 13.1 11.8 21.9 -17.6 -18.3 -6.5 0.8 0.3 1.8 2.7Industrial production (%YoY) 12.8 12.7 7.0 6.1 9.7 0.3 -18.2 2.3 5.7 -0.2 1.1 2.8 3.3Unemployment rate year-end (%) 13.7 12.0 10.1 9.0 6.9 5.6 6.8 10.2 11.3 12.3 12.3 11.0 10.2Nominal GDP (BGNbn) 36 40 45 52 60 69 68 71 75 78 81 85 91Nominal GDP (€bn) 18 20 23 26 31 35 35 36 39 40 41 44 47Nominal GDP (US$bn) 21 25 29 33 42 52 49 48 54 51 53 53 58GDP per capita (US$) 2,658 3,264 3,749 4,332 5,521 6,852 6,440 6,372 7,317 6,987 7,200 7,300 7,900Gross domestic saving (% of GDP) 10.8 11.3 12.5 14.6 14.4 17.0 20.5 21.0 21.9 20.1 22.4 23.0 23.2Lending to corporates/households (% of GDP) 25.3 33.8 39.6 43.1 60.6 69.8 73.3 71.9 69.5 69.4 65.0 63.8 63.3

Prices CPI (average %YoY) 2.3 6.2 5.0 7.3 8.4 12.3 2.8 2.4 4.2 3.0 3.3 3.4 3.3CPI (end-year %YoY) 5.6 4.0 6.5 6.5 12.5 7.8 0.6 4.5 2.8 4.2 2.9 3.3 3.5PPI (average %YoY) 5.4 7.2 8.0 12.3 7.7 10.6 -6.6 8.7 9.4 4.2 3.0 4.0 4.7Wage rates (%YoY, nominal) 6.3 6.0 9.5 9.6 20.6 22.7 13.3 9.7 8.7 8.7 7.0 6.0 6.4

Fiscal balance (% of GDP) Consolidated government balance (ESA 95) -0.4 1.9 1.0 1.9 1.2 1.7 -4.3 -3.1 -2.0 -0.8 -1.9 -1.5 -1.4Consolidated primary balance 1.8 3.8 2.7 3.2 2.3 2.6 -3.6 -2.5 -1.4 n/a n/a n/a n/aTotal public debt (ESA 95) 44.4 37.0 27.5 21.6 17.2 13.7 14.6 16.2 16.3 18.5 17.6 18.1 19.3

External balance Exports (€bn) 6.7 8.0 9.5 12.0 13.5 15.2 11.7 15.6 20.3 20.8 21.8 23.3 25.0Imports (€bn) 9.6 11.6 12.5 15.4 21.9 25.1 16.9 19.2 23.4 25.5 26.9 28.8 30.9Trade balance (€bn) -2.9 -3.6 -3.0 -3.4 -8.3 -9.9 -5.2 -3.7 -3.1 -4.7 -5.1 -5.5 -5.9Trade balance (% of GDP) -16.1 -17.9 -13.0 -12.9 -27.1 -27.9 -14.8 -10.2 -8.2 -11.8 -12.3 -12.6 -12.7Current account balance (€bn) -1.0 -1.3 -2.7 -4.6 -7.8 -8.2 -3.1 -0.5 0.0 -0.5 -0.9 -1.3 -1.7Current account balance (% of GDP) -5.3 -6.4 -11.6 -17.6 -25.2 -23.1 -8.9 -1.5 0.1 -1.3 -2.2 -3.0 -3.8Net FDI (€bn) 1.3 2.1 3.5 6.2 9.0 6.7 2.4 1.2 1.7 1.5 0.9 1.0 1.3Net FDI (% of GDP) 6.9 10.3 14.9 23.5 29.4 19.0 7.0 3.2 4.5 3.7 2.2 2.3 2.8Current account balance plus FDI (% of GDP) 1.6 3.8 3.3 5.9 4.2 -4.1 -1.9 1.7 4.6 2.4 0.0 -0.7 -1.0Foreign exchange reserves ex gold, (€bn) 5.0 6.4 6.8 8.3 11.2 11.9 11.9 11.6 11.8 13.9 13.1 13.8 14.1

Import cover (months of merchandise imports) 6.2 6.7 6.5 6.5 6.2 5.7 8.5 7.2 6.0 6.6 5.9 5.8 5.5

Debt indicators Gross external debt (€bn) 10.6 12.6 15.5 20.7 29.0 37.2 37.8 37.0 36.2 37.6 35.5 36.5 37.7Gross external debt (% of GDP) 58 62 67 78 94 105 108 103 94 95 86 84 81Gross external debt (% of exports) 160 157 164 172 215 245 323 238 179 181 163 157 151Total debt service (€bn) 1.3 2.6 6.0 5.6 6.9 7.3 7.4 7.4 6.9 6.9 6.5 6.9 7.3Total debt service (% of GDP) 7.3 12.9 25.9 21.1 22.5 20.5 21.1 20.5 17.8 17.4 15.8 15.8 15.7Total debt service (% of exports) 20.0 32.8 63.7 46.5 51.2 47.7 63.1 47.4 33.9 33.3 29.9 29.6 29.2

Interest & exchange rates Central bank key rate (%) year-end n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/aBroad money supply (avg, %YoY) 19.5 23.1 23.9 27.0 31.3 8.9 4.2 6.4 12.2 8.5 7.0 8.0 8.33-mth interest rate (Sofibor, avg %) 3.8 2.8 2.7 3.1 4.8 7.2 5.7 4.1 3.8 2.3 1.5 1.7 1.83-mth interest rate spread over Euribor (ppt) 147 66 53 -1 51 251 450 329 237 169 124 111 993-year yield (avg %) n/a n/a 3.4 3.8 4.5 5.2 5.4 4.5 3.6 2.6 1.8 2.2 2.210-year yield (avg %) 6.5 5.4 4.1 4.4 4.8 5.4 7.4 6.0 5.3 4.5 4.4 4.6 4.6Exchange rate (USDBGN) year-end 1.55 1.44 1.65 1.48 1.34 1.40 1.37 1.46 1.51 1.48 1.63 1.56 1.56Exchange rate (USDBGN) annual average 1.73 1.57 1.57 1.56 1.43 1.33 1.40 1.47 1.40 1.52 1.54 1.60 1.56Exchange rate (EURBGN) year-end 1.96 1.96 1.96 1.96 1.96 1.96 1.96 1.96 1.96 1.96 1.96 1.96 1.96Exchange rate (EURBGN) annual average 1.96 1.96 1.96 1.96 1.96 1.96 1.96 1.96 1.96 1.96 1.96 1.96 1.96

Source: National sources, ING estimates

Croatia Directional EMEA Economics April 2013

62

Croatia [email protected]

Forecast summary

Country strategy

4Q12 1Q13F 2Q13F 3Q13F 4Q13F 2013F 2014F

Real GDP (%YoY) -2.3 -3.2 -1.6 -0.7 -0.2 -1.4 1.0HH consumption (%YoY) -4.2 -4.8 -1.0 -1.6 0.5 -1.6 0.5Fixed investment (%YoY) -4.9 -5.1 -3.0 -2.1 -0.4 -2.6 0.3CPI (%YoY)* 4.7 4.9 4.3 2.9 2.5 3.7 2.3Current account (% of GDP) 0.1 0.3 -0.1 0.6 0.9 0.9 -0.7FX res. import cover (mths) 8.6 8.1 8.3 8.5 8.6 8.6 8.7Policy interest rate (%)* 6.00 6.00 6.00 6.00 6.00 6.00 6.003-mth interest rate (%)* 1.67 1.10 1.30 1.50 1.50 1.40 2.203-year yield (%)* 4.28 3.80 4.00 4.00 4.20 4.00 4.807-year yield (%)* 5.00 5.00 5.20 5.30 5.20 5.10 5.00USDHRK* 5.72 5.92 5.98 6.08 6.33 5.97 6.24EURHRK* 7.55 7.59 7.66 7.60 7.60 7.59 7.61

HRK continued its weakening trend in 1Q, as the depressed domestic and foreign demand requires an environment that discourages imports. While the near-term risks to the EU accession process were cleared, the economy’s outlook worsened. The two downgrades left Fitch as the only agency keeping Croatia’s BBB-rating. On the positive side, Croatia retains decent access to external funding, having managed to place US$1.5bn in 10Y bonds, for the first time since Apr 2012. The issue alone covers a quarter of its gross 2013 issuance needs. We expect a continuation of the weakening of the HRK on sub-average growth and increased pre-EU entry spending in 2Q.


€/HRK and CDS spreads (bp)

Welcome to the EU

150

200

250

300

350

400

450

500

550

Oct 08 Sep 09 Aug 10 Jun 11 May 12 Mar 13

7.1

7.2

7.3

7.4

7.5

7.6

7.7

5yr CDS (bp) €/HRK (RHS)

As expected, the EC confirmed in its last monitoring report that Croatia is ready to join the EU, triggering Belgian and Dutch ratification of the entry treaty, with Germany and Denmark likely to follow shortly. Slovenia, having been threatening to derail Croatia’s entry ratified the treaty, after a memorandum on the failed Ljubljanska Banka deposit claim dispute was signed.

Similarly to the case of Romania and Bulgaria, the EU entry will leave Croatia out of the Schengen zone. Moreover, the Netherlands and Germany opted to exclude Croats from their labour market for at least two years. This is particularly painful for Croatia, given the recession and its high unemployment.

Source: Reuters

Growth and its main components (ppt)

Internal and external demand headwinds

-10

-5

0

5

10

4Q07

2Q08

4Q08

2Q09

4Q09

2Q10

4Q10

2Q11

4Q11

2Q12

4Q12

2Q13

4Q13

Priv consumption Fixed inv

Net exports GDP (%)

The Croatian economy will not only be struggling with an ever-deepening consumption slump and sustained weak investments, but also with the wrong set of trading partners within the EU. With Italy expected to contract 1.3% and Slovenia around 2% this year, the outlook for Croatia’s recovery rests, to a large extent, on the public investment push, which we think will prove insufficient. Unemployment has been growing 1.5ppt YoY to 21.5% and real wages have fallen around 4% YoY, but we expect retail sales (which were poor in 1Q) to recover on a pre-EU spending spree experienced by many EU entrants. Still, we revise our 2013 growth forecast to -1.4%, with all main domestic demand components staying negative.


Eurobond spreads vs bunds

Policy flexibility to the rescue?

Croatia is distancing itself from its troubled neighbour, Slovenia, as the initial HC spread widening around the Cyprus crisis was reversed. 20.5% capital adequacy of the banking system, only 70% of GDP in private lending and 50% of GDP public debt, own currency and 7% of GDP FX debt, give the new EU entrant enough flexibility to withstand the slowdown. We prefer FX-denominated instruments though, given the attractiveness of the FX depreciation route to recovery.



250

325

400

475

550

625

700

Nov 11 Mar 12 Jun 12 Sep 12 Dec 12 Apr 13

Slovenia 01/21 Croatia 7/18

Buy Croatia 7/18 vs bund 19-Apr 372 290 405


Croatia Directional EMEA Economics April 2013

63

Croatia

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012E 2013F 2014F 2015F

Activity Real GDP (%YoY) 5.4 4.1 4.3 4.9 5.1 2.1 -6.9 -1.4 0.0 -2.0 -1.4 1.0 1.8Private consumption (%YoY) 3.9 4.2 4.1 3.2 6.4 1.4 -7.5 -1.3 0.2 -2.9 -1.6 0.5 1.7Government consumption (%YoY) 1.9 3.8 2.5 4.5 5.0 -0.3 0.5 -2.1 -0.6 -0.8 0.8 1.2 2.0Investment (%YoY) 24.5 5.3 4.9 11.5 7.3 8.7 -14.1 -14.9 -6.4 -4.6 -2.6 0.3 2.1Industrial production (%YoY) 3.5 4.4 2.9 4.0 5.4 0.1 -9.9 -2.2 -0.9 -5.0 0.5 2.0 3.0Unemployment rate year-end (%) n/a n/a n/a n/a 9.6 8.3 9.0 11.7 13.5 15.9 17.3 16.5 15.0Nominal GDP (HRKbn) 229 247 267 291 318 343 329 324 330 330 338 350 367Nominal GDP (€bn) 30 33 36 40 43 48 45 44 44 44 45 46 49Nominal GDP (US$bn) 34 41 45 50 59 70 62 59 62 56 57 56 61GDP per capita (US$) 6,729 7,340 8,014 8,842 9,656 10,585 9,974 9,905 9,906 9,805 9,953 10,272 10,881Gross domestic saving (% of GDP) 20.4 21.2 21.6 23.2 22.7 .23.6 22.4 22.2 21.9 21.9 22.0 21.0 21.0Lending to corporates/households (% of GDP) 45.7 48.1 53.0 60.2 63.3 67.4 70.6 74.9 76.8 72.1 73.0 74.5 75.6

Prices CPI (average %YoY) 1.8 2.1 3.3 3.2 2.9 6.1 2.4 1.0 2.3 3.4 3.7 2.3 3.0CPI (end-year %YoY) 1.7 2.7 3.6 2.0 5.8 2.9 1.9 1.8 2.1 4.7 2.5 2.0 3.3PPI (average %YoY) -0.1 0.3 -0.2 0.0 0.3 -0.1 -0.4 4.3 7.1 5.6 5.0 4.5 2.0Wage rates (%YoY, nominal) 5.9 5.9 4.9 5.2 5.2 7.0 2.6 0.6 1.5 1.0 1.0 2.9 3.5

Fiscal balance (% of GDP) Consolidated government balance (ESA 95) -4.5 -4.3 -4.0 -3.0 -2.5 -1.4 -4.1 -5.2 -5.5 -4.8 -4.0 -3.2 -3.0Consolidated primary balance -2.5 -2.2 -1.8 -1.0 -0.7 0.1 -2.4 -3.1 -3.2 -2.2 -1.3 -0.4 -0.2Total public debt (ESA 95) 40.9 43.2 43.7 35.5 32.9 28.9 35.3 42.2 46.7 51.5 54.3 55.7 56.1

External balance Exports (€bn) 5.6 6.6 7.2 8.4 9.0 9.6 7.5 8.9 9.6 9.6 9.8 10.1 11.5Imports (€bn) 12.5 13.3 14.7 16.8 18.8 20.8 15.2 15.1 16.3 16.2 15.7 15.9 16.2Trade balance (€bn) -7.0 -6.7 -7.5 -8.4 -9.8 -11.2 -7.7 -6.2 -6.7 -6.6 -5.9 -5.8 -4.7Trade balance (% of GDP) -23.0 -20.4 -20.9 -21.1 -22.7 -23.6 -17.2 -14.0 -15.1 -14.9 -13.2 -12.6 -9.7Current account balance (€bn) -1.8 -1.4 -1.9 -2.6 -3.2 -4.3 -2.3 -0.5 -0.4 0.0 0.4 -0.3 -1.0Current account balance (% of GDP) -6.0 -4.1 -5.3 -6.7 -7.3 -8.9 -5.1 -1.1 -0.9 0.1 0.9 -0.7 -2.1Net FDI (€bn) 1.7 0.7 1.3 2.6 3.5 3.3 1.5 0.4 1.1 1.1 2.0 2.2 1.0Net FDI (% of GDP) 5.5 2.0 3.5 6.4 8.0 6.9 3.4 1.0 2.4 2.4 4.5 4.8 2.1Current account balance plus FDI (% of GDP) -0.5 -2.1 -1.7 -0.2 0.7 -2.1 -1.7 -0.1 1.5 2.5 5.4 4.1 0.0Foreign exchange reserves ex gold, (€bn) 6.0 6.4 7.0 8.4 9.3 9.7 9.2 10.6 11.2 11.5 11.3 11.5 11.9Import cover (months of merchandise imports) 5.8 5.8 5.7 6.0 5.9 5.6 7.3 8.4 8.2 8.6 8.6 8.7 8.8


Interest & exchange rates Central bank key rate (%) year-end n/a n/a 3.7 3.5 3.6 5.3 6.0 6.0 6.0 6.0 6.0 6.0 6.0Broad money supply (avg, %YoY) 4.6 5.4 7.3 6.2 4.5 5.7 7.2 9.0 2.2 4.7 3.5 3.7 4.03-mth interest rate (Zibor, avg %) 5.4 7.3 6.2 4.5 5.6 7.2 8.9 2.4 3.2 3.4 1.4 2.2 3.03-mth interest rate spread over Euribor (ppt) 311 521 403 139 137 254 773 162 177 284 114 161 2193-year yield (avg %) n/a n/a n/a 4.5 4.4 5.9 7.9 5.5 5.6 5.8 4.0 4.8 4.37-year yield (avg %) n/a n/a n/a 4.6 5.2 5.9 7.9 6.4 7.2 6.4 5.1 5.0 4.9Exchange rate (USDHRK) year-end 6.1 5.7 6.2 5.6 5.0 5.2 5.1 5.5 5.8 5.7 6.4 6.1 6.0Exchange rate (USDHRK) annual average 6.7 6.0 5.9 5.8 5.4 4.9 5.3 5.5 5.3 5.8 6.0 6.2 6.0Exchange rate (EURHRK) year-end 7.65 7.67 7.38 7.35 7.33 7.32 7.31 7.39 7.53 7.55 7.64 7.57 7.50Exchange rate (EURHRK) annual average 7.56 7.50 7.40 7.32 7.34 7.22 7.34 7.29 7.43 7.52 7.59 7.61 7.54


Czech Republic Directional EMEA Economics April 2013

64

Czech Republic Next elections : Parliamentary / May-2014 (tentative)

Forecast summary

Country strategy

4Q12 1Q13F 2Q13F 3Q13F 4Q13F 2013F 2014F

Real GDP (%YoY) -1.7 -1.2 -0.3 1.3 1.5 0.1 2.1HH consumption (%YoY) -4.0 -3.8 -1.0 0.0 1.0 -0.9 2.0

Fixed investment (%YoY) -5.0 -3.0 -1.7 0.4 1.5 2.0 4.5

CPI (%YoY)* 2.4 1.7 1.7 1.9 1.8 1.8 1.8

Current account (% of GDP) -2.1 -1.4 -1.2 -1.3 -1.5 -2.0 -2.6

FX res. import cover (mths) 3.4 3.4 3.5 3.6 3.6 3.6 3.4

Policy interest rate (%)* 0.05 0.05 0.05 0.05 0.05 0.25 1.00

3-mth interest rate (%)* 0.50 0.50 0.50 0.50 0.55 0.50 0.88

2-year yield (%)* 0.50 0.50 0.50 0.80 0.90 0.68 1.20

10-year yield (%)* 2.00 1.86 1.75 1.80 2.00 2.10 2.37

USDCZK* 18.98 20.10 20.55 21.20 21.42 20.48 20.59

EURCZK* 25.05 25.76 26.30 26.50 25.70 26.07 25.10

Eventual recovery in activity is going to be a prolonged affair, dependent on Eurozone stabilisation. For a change, we expect fiscal policy to become supportive for growth from mid-2013 onwards, not least because of the general elections due in 1H14. Apart from the EMU outlook, the risks for growth are the tight debt thresholds in the fiscal responsibility bill, and high participation in the second pillar of the pension system, which could further increase savings. The seventh-running quarter of the recession is likely to keep CZK weak and official rate expectations anchored at zero, but we see 12x15 FRAs pricing in no rate change as it is too low. We expect €/CZK to drift above 26.0, still allowing the CNB to abstain from actual interventions this quarter.


Real GDP %YoY growth contributions

Macro digest

- 8- 6- 4- 2 0 2 4 6

1Q082Q

083Q

084Q

081Q

092Q

093Q

094Q

091Q

102Q

103Q

104Q

101Q

112Q

113Q

114Q

111Q

122Q

123Q

124Q

121Q

132Q

133Q

134Q

13

Private consumption Public consumptionFixed Investments InventoriesNet exports GDP

Source: Ecowin, ING forecasts

Cumulative budget balance (CZKm)

(200,000)

(150,000)

(100,000)

(50,000)

0

50,000

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2008 2009 20102011 2012 2013

Source: Ecowin

Inflation indices

-1012345678

Jun

03

Jul 0

4

Aug 0

5

Sep 0

6

Oct 07

Nov 0

8

Jan

10

Feb 1

1

Mar

12

Apr 1

3

Jun

14

Headline CPI Policy-relevant inflation

The Czech economy still remains firmly stuck in a recession, which, while shallower than in 2009, is already the longest since transformation. 1Q13 is likely to constitute the seventh quarter of the recession, as the promising signals from the PMI (jumping to 50 for a month) and a slow, yet steady acceleration of corporate lending failed to translate into better activity numbers.

There has been some improvement in the noisy WDA-adjusted industrial output numbers (down 2.8% YoY on average in the first two months of the year vs -5% in the 4Q), but the MoM gains probably arrived too late to ensure any meaningful improvement. Even more worryingly, new orders have been trending substantially lower, declining over 7% YoY (WDA) in Jan-Feb, twice the speed of the 4Q decline.

While it is impossible to argue that the Czech private sector is over-leveraged, the household savings rate will not provide the recovery impulse for the industrial sector – consumer loan growth is steadily slowing, continuing a process that started in 2007. That leaves external demand as a trigger for investments and overall recovery, but neither our current EMU forecasts, nor the near-term outlook for the CEE trading partners, spell a quick end to the recession. Apart from the negative WD effect this quarter, snowy spring weather might prove to be quite disruptive for the construction activity in March. Consequently, we revise our 2013 GDP forecasts substantially lower, in line with lower Eurozone growth and more sluggish activity in 1Q. Our 0.1% 2013 forecast and expectations of a recovery to 2.1% are more optimistic than the ones in the official CNB forecast.

Growth underperformance is the dark side of the fiscal tightening success. While the 2012 ESA95 deficit jumped from 3.25% to 4.38% of GDP, it actually represents a substantial austerity effort, as without one-off factors (eg, church restitution law and grants returned to the EU), the public finance deficit would be merely 1.9% of GDP. From the point of view of the good 2012 results, 2013 budget plans might turn out growth-supportive for a change. The official target of 2.9% is not only looser than the 2012 realisation, but, after 1Q results, it actually seems achievable. March’s cumulative budget surplus was matched only during the boom of 2006.

As elsewhere in the region, and consistently with the poor domestic demand, inflation has been falling below the central bank’s target, with the core CPI actually falling below the 1-3% CNB target range. We expect headline inflation to remain below 2% well into 2014, as the inflationary VAT hike effect will disappear by then.

Source: Ecowin, ING forecasts


65

New EU budget proposal

Not doing so well in the EU budget negotiatons

0

10

20

30

40

50

60

70

80

PL RO BG HU CZ0%

5%

10%

15%

20%

25%

30%

35%

40%

Cohesion 2007-2013 2014-2020Cohesion CAP as % of GDP (RHS)

The 2014-20 EU budget is not yet a done deal, as the European Parliament factions were quick to remind after a deal was struck. Most of the CEE governments were quick to hail the 8 February agreement as a success, although they were tellingly quoting different statistics to prove it. The Czech Republic government has the toughest job defending the deal before the public, as gross cohesion and structural funds are down by 23% in nominal terms. Including CAP, the proposal points to gross allocation of 19% of GDP, much below the 29-32% agreed for the other three CE4 countries. Per capita, the difference is much less striking. Because of fiscal austerity, corruption and administrative problems, the Czech Republic failed to benefit much from the current round of EU money.

Source: EU

Net savings by institutional sectors: everyone saves!

Introduction of second pillar dangerous for recovery?

-6

-4

-2

0

2

4

4Q07

1Q08

2Q08

3Q08

4Q08

1Q09

2Q09

3Q09

4Q09

1Q10

2Q10

3Q10

4Q10

1Q11

2Q11

3Q11

4Q11

1Q12

2Q12

3Q12

Corp+financial Households Government

The Czech Republic plunges on with the pension system reform following the backtracking on the second-pillar contributions in the neighbouring countries. We find the increase in retirement age in2011 to be far more important for the public finances than the latest reform introducing second-pillar private pension funds. By linking second-pillar participation with the additional 2% private contribution, the Czech system tries to avoid the problem of diverting a large part of the social security contribution to the private pension funds, leading to an unchanged total savings rate – the larger budget gap balanced theincreased private savings. But the increased household savings is the last thing the Czech economy needs six quarters into a recession.

Source: Czech statistical office

Budget reponsibility bill provisions (draft)

Fiscal responsibility law – higher thresholds necessary

Parameters – public debt

Between 40.0% and 45.0% of GDP



> 50.0% of GDP

• Explain to parliament

• Freeze at least 3% of expenditures of the approved state budget

• Proposal for a balanced or surplus state budget;

• Should ask for a vote in confidence in the lower house

Required

Government

Action

• Come up with a set of austerity measures

• Cut salaries of constitutional officials (president, MPs, judges)

• A balanced or surplus budgets of all state funds and regional governments

• Freeze salaries of public sector's employees

After dismissing the EU fiscal pact, the ruling Czech coalition voted its own fiscal responsibility bill. Similar to the Polish public finance law, it sets precautionary debt/GDP thresholds, the crossing of which would limit fiscal policy options. The thresholds proposed in the first reading are actually quite tight at 40% and 50%. The new constitutional law would require a two-thirds majority, which the coalition does not have. Also, key opposition party CSSD demands to join the EU fiscal pact and to relax the thresholds by 5 points to 45% and 55%. As the 2012 ESA95 debt reading was 45.76% of GDP, we do not see CSSD supporting the final reading of the bill without the higher thresholds. With official rates at zero, fiscal policy is going to be a tool of choice for the new government.

Source: CEE Market Watch

Voting preferences

Centre-left CSSD ahead in the 2014 elections race

0

5

10

15

20

25

30

Mar

10

May

10

Jul 1

0

Sep 1

0

Nov 1

0

Jan

11

Mar

11

May

11

Jul 1

1

Sep 1

1

Nov 1

1

Jan

12

Mar

12

May

12

Jul 1

2

Sep 1

2

Nov 1

2

Jan

13

Mar

13

ODS CSSD KSCMKDU-CSL TOP 09

Centre-left CSSD remains a clear leader in the 2014 elections race, although their support is projected to secure 40% of the lower house seats. Natural partner KDU-CSL is still below the 5% threshold, and communist KSCM is too extreme for a workable coalition; a minority CSSD government is thus the most likely outcome. The policy tack under the new management would encompass looser fiscal policy (see above), and possibly a more open approach towards the EMU entry. We doubt the latter shift would be decisive though, given the scepticism of the general public towards the EMU entry. 2014 will be a super-election year with the lower house, the European Parliament (likely to be staged together in May), one-third of senate and local government posts up for grabs.

Source: CVVM, CEE Market Watch #


66

Czech Republic FX / MONEY MARKETS / DEBT STRATEGY LC Ratings (M/S&P/F): A1/AA/AA-

FX – spot vs forward and INGF

FX / Money Markets Strategy

23.5

24.0

24.5

25.0

25.5

26.0

26.5

Apr 10 Oct 10 Apr 11 Oct 11 Apr 12 Oct 12 Apr 13 Oct 13 Apr 14

ING f'cast Mkt fwd


FRA curve: rates expected to stay at zero for years

The short-term official and money market rate outlook is as benign as it can be. CNB rates remain at 0.05%, while the central bank staff forecasts PRIBOR rates lower than the current level in 2H13. This would require negative official rates, or otherwise looser monetary policy, which, according to the CNB board members means FX interventions weakening the koruna. The active CNB FX policy has been talked about to death by the board members, however, and after €/CZK moved above 25.7/€, the risk of an immediate action has subsided. What is more, the latest board meeting minutes express concerns over the consumption-depressing impact of weaker CZK via food and commodity prices. A more decisive drop in food and fuel would strengthen the case for FX interventions in our view. The board also mentions “further discussion of the monetary policy options available for responding to current and future shocks”, perhaps alluding to a measure stimulating flagging household credit.

We expect the interventions to remain verbal, with €/CZK well above the CNB minimum acceptable of 25.5. We doubt an explicit FX intervention will happen, but with funding rates low, we see a risk of 26.0 being broken. Still, as the RUB remains at risk from looser policy and the aftershocks of the Cyprus crisis, we recommend closing the long RUB/CZK opened in the previous Quarterly.


Entry date Entry level Exit level S/L0.30

0.35

0.40

0.45

0.50

0.55

0.60

1x4

2x5

3x6

4x7

5x8

6x9

7x10

8x11

9x12

12x1

5

15x1

8

21x2

4

Close long RUB/CZK 28-Jan 0.632 0.648 0.621


Local curve (%)

Debt Strategy

0.0

0.5

1.0

1.5

2.0

3m 6m 2Y 10Y

Now -3 Months +3 Months


10yr yield vs 3M implied rate – CZ becoming attractive

The FRA market is pricing no change, or a slight decline to PRIBOR rates for another two years (second chart), which, considering the 0.05% official rate, makes paying the longest FRAs a safe bet – we assume fiscal policy will become more supportive for growth and inflation from 2014 onwards.

10Y Czech local currency treasury bonds reached yet another record, hitting 1.65% in. mid April. However, unlike Poland or Hungary, the spread to bunds remains above late January levels, indicating some resistance to strengthening. Unlike bunds, Czech bonds cannot be treated as safe haven assets – low public debt and above-average growth prospects compared to the EMU are unable to compensate for their limited liquidity. Although, near-term macro releases and high EMU liquidity should keep the Czech curve supported, we find further gains limited by the liquidity considerations. In any case, any inflows into the bond market would likely be FX hedged - our favoured entry mode would involve funding 5yr CZGB via basis swaps, allowing for an extra 35bp pickup, while avoiding the CZK FX risk.



100

200

300

400

500

600

700

Oct 11 Jan 12 Apr 12 Jul 12 Oct 12 Jan 13 Apr 13

HU (bps) CZ (bps)

Pay 12x15 CZK FRA 19-Apr 0.43 0.75 0.3


#


67

Czech Republic

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012E 2013F 2014F 2015F

Activity Real GDP (%YoY) 3.8 4.6 6.8 7.2 5.7 2.9 -4.5 2.5 1.9 -1.3 0.1 2.1 2.4Private consumption (%YoY) 5.3 3.1 3.0 4.4 4.1 3.0 0.2 1.0 0.7 -3.5 -0.9 2.0 2.8Government consumption (%YoY) 6.0 -3.3 1.6 -0.6 0.4 1.2 4.0 0.5 -2.5 -1.0 0.8 0.8 0.8Investment (%YoY) 0.6 2.8 6.1 5.9 13.2 4.0 -11.0 1.0 -0.7 -1.7 2.0 4.5 5.0Industrial production (%YoY) 1.6 10.4 3.9 8.3 10.6 -1.8 -13.2 8.6 6.1 -0.6 3.0 8.5 8.0Unemployment rate year-end (%) 10.3 9.5 8.9 7.7 6.0 6.0 7.1 7.4 6.8 7.4 8.8 8.0 7.6Nominal GDP (CZKbn) 2,688 2,925 3,114 3,357 3,667 3,846 3,759 3,800 3,841 3,843 3,962 4,100 4,273Nominal GDP (€bn) 84 92 105 118 132 154 142 151 156 153 152 163 182Nominal GDP (US$bn) 96 114 130 149 181 227 198 200 218 197 193 199 228GDP per capita (US$) 9,342 11,151 12,701 14,471 17,503 22,040 19,404 19,604 21,303 17,980 18,721 19,593 22,440Gross domestic saving (% of GDP) 25.8 27.9 29.2 30.8 32.5 31.3 27.9 28.0 28.6 29.2 30.6 29.2 28.0Lending to corporates/households (% of GDP) 24.7 26.4 30.1 34.7 39.6 44.2 51.6 51.6 53.9 55.3 55.1 56.0 57.3

Prices CPI (average %YoY) 0.1 2.7 1.9 2.5 2.8 6.3 1.0 1.5 1.9 3.6 1.8 1.8 2.3CPI (end-year %YoY) 1.0 2.8 2.2 1.7 5.4 3.6 1.0 2.3 2.4 2.4 1.8 2.2 2.3PPI (average %YoY) -0.3 5.7 3.0 1.6 4.1 4.5 -3.1 1.2 5.6 2.2 2.5 3.0 3.0Wage rates (%YoY, nominal) 5.8 6.3 5.0 6.6 7.2 8.3 4.0 1.9 2.2 2.7 2.8 3.3 4.5

Fiscal balance (% of GDP) Consolidated government balance (ESA 95) -6.7 -2.8 -3.2 -2.4 -0.7 -2.2 -5.8 -4.8 -3.3 -4.4 -3.2 -3.0 -3.0Consolidated primary balance -5.7 -1.8 -2.2 -1.3 0.4 -1.2 -4.6 -3.5 -1.7 -2.8 -1.4 -1.0 -0.8Total public debt (ESA 95) 28.6 28.9 28.4 28.3 27.9 28.7 34.2 37.8 40.8 45.8 48.1 49.3 50.1

External balance Exports (€bn) 43.1 54.1 57.8 68.1 77.6 84.9 71.0 86.1 99.6 105.0 108.4 116.0 127.6Imports (€bn) 45.2 54.5 56.2 66.0 75.9 83.8 67.7 84.0 95.8 101.0 103.8 111.7 124.2Trade balance (€bn) -2.2 -0.4 1.6 2.1 1.7 1.0 3.3 2.1 3.8 4.0 4.6 4.4 3.4Trade balance (% of GDP) -2.6 -0.5 1.6 1.8 1.3 0.7 2.3 1.4 2.4 2.6 3.1 2.7 1.9Current account balance (€bn) -5.0 -4.7 -1.0 -2.4 -5.7 -3.3 -3.4 -5.9 -4.5 -3.2 -3.0 -4.2 -4.8Current account balance (% of GDP) -6.0 -5.1 -1.0 -2.0 -4.3 -2.1 -2.4 -3.9 -2.9 -2.1 -2.0 -2.6 -2.6Net FDI (€bn) 1.7 3.2 9.4 3.2 6.5 1.5 1.4 3.8 3.0 4.5 4.0 5.3 5.3Net FDI (% of GDP) 2.0 3.5 9.0 2.7 4.9 1.0 1.0 2.5 1.9 2.9 2.6 3.2 2.9Current account balance plus FDI (% of GDP) -4.0 -1.6 8.0 0.7 0.6 -1.2 -1.4 -1.4 -0.9 0.9 0.7 0.7 0.3Foreign exchange reserves ex gold, (€bn) 23.6 22.7 23.6 24.8 25.2 24.9 29.5 31.6 30.8 28.4 31.0 32.0 33.0Import cover (months of merchandise imports) 6.3 5.0 5.0 4.5 4.0 3.6 5.2 4.5 3.9 3.4 3.6 3.4 3.2


Interest & exchange rates Central bank key rate (%) year-end (2W repo) 2.00 2.50 2.00 2.50 3.50 2.25 1.00 0.75 0.75 0.05 0.25 1.00 1.00Broad money supply (avg, %YoY) 6.90 4.40 8.00 9.90 13.20 6.60 4.30 3.34 5.20 3.40 6.40 9.00 9.003-mth interest rate (Pribor, avg %) 2.30 2.30 2.00 2.45 3.53 3.98 1.54 1.28 1.17 0.83 0.50 0.88 1.003-mth interest rate spread over Euribor (ppt) -3 19 -18 -63 -74 -66 32 46 -22 26 24 29 192-year yield (avg %) 2.47 3.02 2.33 2.94 3.80 4.09 2.60 3.10 1.52 0.91 0.68 1.20 2.6010-year yield (avg %) 4.12 4.82 3.54 3.80 4.30 4.66 4.71 3.87 3.59 2.69 2.10 2.37 3.40Exchange rate (USDCZK) year-end 25.75 22.47 24.50 20.84 18.25 19.27 18.49 18.72 19.93 18.98 21.42 19.12 18.40Exchange rate (USDCZK) annual average 28.12 25.64 23.94 22.55 20.25 16.97 18.97 19.00 17.66 19.50 20.48 20.59 18.76Exchange rate (EURCZK) year-end 32.41 30.47 29.01 27.50 26.62 26.93 26.47 25.04 25.80 25.05 25.70 23.90 23.00Exchange rate (EURCZK) annual average 31.84 31.90 29.79 28.34 27.75 24.96 26.45 25.20 24.59 25.07 26.07 25.10 23.45


Hungary Directional EMEA Economics April 2013

68

Hungary Next elections : Parliamentary/May 2014

Forecast summary

Country strategy

4Q12 1Q13F 2Q13F 3Q13F 4Q13F 2013F 2014F

Real GDP (%YoY) -2.7 -0.8 0.1 0.8 1.0 0.3 1.3HH consumption (%YoY) -1.4 -0.9 -0.1 0.8 1.4 0.4 1.1Fixed investment (%YoY) -5.6 -1.5 -3.0 -0.9 0.5 -1.1 0.7CPI (%YoY)* 5.0 2.7 3.3 2.6 2.8 3.0 3.2Current account (% of GDP) n/a n/a n/a n/a n/a 1.9 2.1FX res. import cover (mths) n/a n/a n/a n/a n/a 4.9 4.4Policy interest rate (%)* 5.75 5.00 4.25 4.25 4.25 4.25 4.503-mth interest rate (%)* 5.33 4.71 4.10 4.30 4.30 4.49 4.703-year yield (%)* 5.61 5.12 4.50 4.70 4.70 4.85 5.3010-year yield (%)* 6.11 6.27 5.50 5.40 5.80 5.78 6.20USDHUF* 220.8 237.4 226.6 236.0 245.8 232.2 239.6EURHUF* 291.3 304.3 290.0 295.0 295.0 295.6 292.0

HUF recovered from above 300 to the 290-300 trading range once the uncertainties around the new leadership of NBH and its possible programmes subsided. With Mr. Matolcsy appointed as the new governor, the MPC’s rate cut cycle did not stop, and the key rate was reduced to 5.00% in February. NBH’s Funding for Growth Scheme (FGS) could hardly be called aggressive, but the plans reduce access to two week central bank bills that have the potential to weaken the HUF, or at least shield it from appreciating in line with further bond inflows. We expect Hungary’s recession to end in 2013, but private deleveraging and slow EU growth will keep growth close to zero despite promising signs in industrial output.


Real GDP growth contributions

Macro digest

-8

-6

-4

-2

0

2

4

6

1Q04

3Q04

1Q05

3Q05

1Q06

3Q06

1Q07

3Q07

1Q08

3Q08

1Q09

3Q09

1Q10

3Q10

1Q11

3Q11

1Q12

3Q12

Agriculture Industry Construction

Services GDP (% YoY)


Inflation measures (% YoY)

0

2

4

6

8

10

Jan 06 Feb 07 Apr 08 May 09 Jul 10 Aug 11 Oct 12 Dec 13

CPI Core CPI

CPI adjusted for tax changes Inflation target

ING f'cast

Source: EcoWin, NBH, ING estimates

Consumption and wages dynamics

-10

-5

0

5

10

15

20

25

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Consumption (% YoY) Net real wage (% YoY, RHS)

Economic activity contracted in 2012, with GDP shrinking 1.7% YoY, according to unadjusted data by HCSO. Data adjusted for seasonal and calendar effects reflected a 1.8% YoY contraction. As elsewhere in Southern Europe, big declines were seen in the agricultural sector (-16.9% YoY) due to unfavourable weather conditions (ie, a drought during the summer) and the high base. Industrial production failed to reach the previous year’s level since car manufacturers reduced their output in late 2012, while Nokia and Flextronics closed their plants. Domestic demand remained subdued, and this was reflected by a decrease in final consumption (-1.7% YoY). Propensity to invest has been stuck on a downward path, and gross capital formation declined 11.7% YoY. The deceleration spilled over to trading dynamics, but growth in export volume was able to reach 2.0% YoY, while that of imports stagnated (0.2% YoY). The latest data shows that there could be room for a slow recovery this year since industrial output grew on a MoM basis in February for a second consecutive month (2.9% MoM in January and 0.3% MoM in February). PMI (55.7ppt) indicated expansion in manufacturing, which is in line with our forecast that GDP may grow 0.3% YoY due to a pick-up in industrial production and a rebound of external (mainly EU) conjuncture. The optimistic business climate needs to be treated with caution though, as Hungarian PMI has been above its CE3 peers throughout 2012 with little growth to show for it. Also, domestic demand is likely to remain weak this year.

After last year’s high CPI (average 5.7% YoY), there is substantial moderation this year. Inflation collapsed to 2.2% after the domestic utility cost cuts took effect in February, and we expect it to fluctuate below the 3% inflation target. Government officials stressed there should be further steps to utilities’ cost reduction 2H13, which could take effect in 3Q13, at the earliest, and could push the headline below the 2.5% YoY average. However, core inflation got stuck around 3.6% YoY in February, which reflected that without the 10% utility cost cut, CPI would have remained at around 3.3-3.5% YoY.

Given the low CPI, there may be real wage growth this year after a 3.5% YoY net real wage decrease in 2012. Net real wage growth finally moved into positive territory (0.2% YoY) in January, and this rate is expected to accelerate. Employment statistics remain gloomy since only the fostered work programme fuels them. The unemployment rate (for ages 15-64) reached 11.1% in Dec12-Feb13. Due to the government’s measures, the activity rate has been growing and has increased to 58%. The labour market should remain loose, and the unemployment rate is not expected to drop below 11%.



69

Activity: Monetary trend : Looser Fiscal trend: Looser David Nemeth

External debt redemption profile

Debt structure

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Jan

13

Feb 1

3

Mar

13

Apr 1

3

May

13

Jun

13

Jul 1

3

Aug 1

3

Sep 1

3

Oct 13

Nov 1

3

Dec 1

3

Jan

14

Feb 1

4

Mar

14

Apr 1

4

May

14

Jun

14

Jul 1

4

Aug 1

4

Sep 1

4

Oct 14

Nov 1

4

Dec 1

4

HGB REPHUN IMF loan

Paid back

Hungary has been facing heavy redemption in 2012-14 due to the repayment of EU and IMF loans. While the new IMF programme. Although the IMF agreement is now fully out of the picture, Hungary has no problem regarding financing. Debt Management Agency (AKK) issued USD3.25bn Rephun in February, which was enough tocover February and March repayment. AKK is focusing more on local currency refinancing in order to moderate the FC debt ratio from 40% to 30%. Additionally, HUF funding collapsed to within 10bp of the hard currency funding costs. The government still has huge reserves (around €6bn), which provide significant financing flexibility as they can cover funding needs until mid-2014.

Source: Bloomberg, AKK, ING estimates

Two-week bond stock vs base rate

New NBH leadership

0%

2%

4%

6%

8%

10%

12%

14%

Jan 08 Jan 09 Feb 10 Mar 11 Mar 12 Apr 13

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

NBH 2-week bond (stock, HUFbn, RHS) Base rate (%)

After Mr. Matolcsy was appointed the new NBH governor, he chose Mr. Balog as his deputy governor and Mr. Pleschinger as an external member. The Monetary Policy Council (MPC) consists of the governor, one deputy and five external members. Deputy Király stepped down in April before her mandate expired. Under the new management, NBH announced the Funding for Growth scheme, similar to the BoE’s FLS. The goal is to melt the SME sector’s huge stock of FX loans and to improve their investment willingness by giving them cheap HUF loans. The third leg of the plan is reducing the outstanding two-week NBH bills. The idea is to cut access to them for foreign investors, and to replace them with deposits surfaced. If implemented, it would be equivalent to a major cut in ST cash rates.

Source: NBH, ING estimates

Hungary’s foreign currency long-term credit rating

Credit ratings: negative feedback

0

1

2

3

4

5

6

Mar 08 Mar 09 Mar 10 Mar 11 Mar 12 Mar 13

0

1

2

3

4

5

6

Moody's (LHS) Standard & Poor's FITCH Ratings

BBB+

BBB

BBB-

BB+

BB

BB-

Baa3

Baa1

A2

Baa2

A3

Ba1

A-

Ba2

After a series of ratings changes (see chart), S&P affirmed Hungary’s BB rating for a change, but cut the outlook to negative. In the rating agency’s opinion, “the predictability and credibility of Hungary’s policy framework has continued to weaken”. The appointment of Mr Matolcsy as the NBH governor has raised concerns whether the central bank could remain independent of the government in the future. S&P frowns upon so-called “unorthodox” measures since they “could erode Hungary’s medium-term growth potential”. This is important because low growth keeps public debt at an elevated leveldespite the austerity efforts. The rating agency stressed that the probability of a downgrade is only 30%, but that the government needs to implement an investment-bolstering economic policy.

Source: NBH

Average of opinion polls in March 2013 (%)

Frozen political scene

Együtt 2014 (new party)

9%

Other1%DKP

2%

FIDESZ (governing party)

46%

MSZP (former governing party)

23%

LMP (green party)4%

Jobbik (far right-wing party)

15%

Last year, it seemed that the new party founded by former PM Bajnai could challenge the reigning Fidesz-led government in 2014. However, according to the latest polls, the left wing will have a difficult time reaching out to undecided voters and reactivating them. Mid-term municipal elections have been held in small towns, and in some, Fidesz candidates did not win. These small victories will fuel the opposition and keep them keen for the next cycle. The left-wing parties are competing with each other, and they will definitely not be able to defeat Fidesz unless they form a coalition. The campaign will definitely be harder for these parties, since the new electoral system allows Fidesz-appointees to regulate campaign ads aired or shown in any medium.

Source: Gallup, Tarki, Median, Szondaipsos, Szazadveg, Nezopont #


70

Hungary FX/MONEY MARKETS/DEBT STRATEGY LC Ratings (M/S&P/F): Ba1/BB/BBB-


FX/Money market strategy

250

260

270

280

290

300

310

320

330


ING f'cast Mkt fwd


HUF performance vs the PLN and CZK

The HUF has strengthened against the EUR since early April. On one hand, the massive easing programme started by the Bank of Japan has been fuelling positive sentiment in international financial markets, which has also affected the HUF. On the other hand, the Funding for Growth Scheme (FGS) introduced by the Matolcsy-led NBH has given markets hope that the MPC will not carry out aggressive monetary stimulus or implement unconventional monetary tools. The HUF has broken out of its weak 300-310 channel and returned to the stronger 290-300 trading range. The central bank intends to shrink the stock of money kept in two-week NBH bonds and participate more actively in the FX-swap market, which is very likely to result in a shift in implied HUF rates. It has to be underlined that the current Hungarian economic environment is still supported by relatively high interest rates, but that is challenged by the recent plans to cut access to cenbank bills, strengthening the divergence in 5y CDS and 10-year bond yields’ correlation divergence seen since end-2012. One explanation is that the continued rate cut cycle makes it less attractive for international investors. In our view, we are slowly approaching the stage when lower interest rates would generate uncertainty, which could result in excessive vulnerability of the national economy and hectic and volatile exchange rate movements.



-100

0

100

200

300

400

500

600

Jan

03

Dec 0

3

Nov 0

4

Oct 05

Sep 0

6

Sep 0

7

Aug 0

8

Jul 0

9

Jun

10

May

11

May

12

Apr 1

3

HUF PLN CZK

- - - -

Source: Bloomberg

Local curve (%)

Debt Strategy

3.5

4.0

4.5

5.0

5.5

6.0

6.5

3m 6m 3Y 10Y



Five-year CDS vs the EUR/HUF

With the NBH having started the rate cut cycle, the MPC eased monetary conditions for an eighth consecutive month (200bp) in March when the base interest rate reached 5.00%. The council took a more cautious stance this year, but is likely to continue this gradual rate-setting policy. According to its last statement in March, rate reduction should continue if inflationary processes remain moderate and uncertainties surrounding the financial markets fade. Markets priced further rate cuts as the key rate is expected to drop to 3.50% by the end of this year. In our opinion, this might prove to be too optimistic a forecast. MPC might turn increasingly cautious in the coming months. We revise our forecast, as we expect the MPC to reduce the key rate to the 4.25% level and pause there. Demand for HGBs deteriorated slightly in the past few months, although the bid-cover ratio remained above 2 in the whole period.

As the market has already (correctly) priced in much lower short-end cash and implied rates, we find the best way to play the news to buy 5yr HGB, hedged by a 3M FX swap, securing a 150bp spread. Any backing off from the original proposal would send the implied rates back higher, and if the NBH stays with its proposal, the bond market will still remain attractive, as the only viable vehicle for investing in HUF rates.



0

100

200

300

400

500

600

700

800

Jan 08 Nov 08 Oct 09 Aug 10 Jul 11 May 12 Apr 13

225

240

255

270

285

300

315

330

5-year CDS (LHS) EURHUF

Buy 5yr HGB 19-Apr 143bp 100bp 165bp

Source: Bloomberg

Financed with 3M €/HUF FX swap #


71

Hungary

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012E 2013F 2014F 2015F

Activity Real GDP (%YoY) 4.0 4.5 3.2 3.6 0.8 0.9 -6.8 1.3 1.7 -1.7 0.3 1.3 1.7Private consumption (%YoY) 8.0 2.0 2.6 1.9 -0.9 -0.2 -5.7 -2.7 0.1 -2.3 0.4 1.1 1.6Government consumption (%YoY) 4.0 -0.3 0.4 4.1 1.8 -0.2 2.6 1.1 -1.3 4.2 2.2 2.7 2.4Investment (%YoY) 1.5 7.2 4.5 -2.7 4.3 2.9 -11.0 -9.7 -5.4 -2.0 -1.1 0.7 1.5Industrial production (%YoY) 6.3 7.1 7.3 10.6 8.5 -0.5 -17.3 10.3 5.8 -1.3 2.3 5.5 7.2Unemployment rate year-end (%) 5.5 6.3 7.3 7.5 7.7 8.0 10.5 10.8 10.7 10.7 10.5 10.2 9.8Nominal GDP (HUFbn) 18,738 20,665 22,018 23,675 24,990 26,543 25,626 26,607 27,886 28,276 29,169 30,434 31,880Nominal GDP (€bn) 74 82 89 90 99 105 91 96 100 98 99 104 110Nominal GDP (US$bn) 84 102 110 113 136 154 127 128 139 126 126 127 137GDP per capita (US$) 7,287 8,112 8,790 8,894 9,879 10,513 9,115 9,664 10,000 9,807 9,954 10,517 11,104Gross domestic saving (% of GDP) 14.8 17.5 17.8 16.7 15.2 16.2 17.8 19.8 20.4 18.9 20.5 21.0 21.3Lending to corporates/households (% of GDP) 46.4 50.5 56.2 60.9 67.5 75.8 74.5 73.2 68.3 54.4 49.5 49.0 49.3

Prices CPI (average %YoY) 4.7 6.8 3.6 3.9 8.0 6.1 4.2 4.9 3.9 5.7 3.0 3.2 3.5CPI (end-year %YoY) 5.7 5.5 3.3 6.5 7.4 3.5 5.5 4.7 4.1 5.0 2.8 3.5 3.5PPI (average %YoY) 2.4 3.5 4.3 6.5 0.2 5.0 4.9 4.5 4.2 4.3 4.0 3.5 3.0Wage rates (%YoY, nominal) 12.3 6.5 8.7 8.2 8.1 7.7 0.5 1.5 5.2 4.7 3.2 3.5 3.4

Fiscal balance (% of GDP) Consolidated government balance (ESA 95) -7.2 -6.4 -7.8 -9.2 -4.9 -3.4 -4.6 -4.3 4.3 -1.9 -3.0 -3.3 -2.8Consolidated primary balance -2.2 -2.2 -3.2 -5.3 -0.8 0.8 0.5 0.6 7.6 1.5 1.1 0.2 0.3Total public debt (ESA 95) 58.1 59.4 61.8 65.6 65.7 72.6 79.8 81.8 80.4 79.2 78.0 76.5 75.8

External balance Exports (€bn) 38.4 44.5 49.7 58.4 67.8 72.1 57.4 69.0 75.2 76.6 81.2 86.9 92.1Imports (€bn) 41.3 47.6 52.2 60.8 68.5 73.3 55.0 65.8 71.9 72.4 76.4 81.8 86.7Trade balance (€bn) -2.9 -3.1 -2.5 -2.5 -0.7 -1.2 2.3 3.2 3.4 4.2 4.8 5.2 5.4Trade balance (% of GDP) -3.9 -3.8 -2.9 -2.7 -0.7 -1.2 2.6 3.3 3.4 4.3 4.9 4.9 4.9Current account balance (€bn) -6.6 -6.9 -6.0 -6.6 -7.2 -7.8 -0.2 1.0 0.9 1.5 1.9 2.2 2.4Current account balance (% of GDP) -8.9 -8.4 -6.8 -7.4 -7.3 -7.4 -0.2 1.1 0.9 1.5 1.9 2.1 2.2Net FDI (€bn) 0.4 2.7 4.4 2.3 0.2 2.7 0.1 0.7 0.1 2.2 1.0 1.5 1.8Net FDI (% of GDP) 0.6 3.3 5.0 2.6 0.2 2.6 0.1 0.8 0.1 2.2 1.0 1.4 1.6Current account balance plus FDI (% of GDP) -8.3 -5.1 -1.8 -4.8 -7.1 -4.8 -0.1 1.8 1.0 3.7 2.9 3.5 3.8Foreign exchange reserves ex gold, (€bn) 10.1 11.7 15.7 16.4 16.4 24.0 30.7 33.7 37.8 33.9 31.0 29.8 28.6Import cover (months of merchandise imports) 2.9 2.9 3.6 3.2 2.9 3.9 6.7 6.1 6.3 5.6 4.9 4.4 4.0


Interest & exchange rates Central bank key rate (%) year-end (2W repo) 12.50 9.50 6.00 8.00 7.50 10.00 6.25 5.75 7.00 5.75 4.25 4.50 5.00Broad money supply (avg, %YoY) 12.0 11.6 14.5 13.8 11.0 8.7 3.5 2.9 5.9 -3.4 4.5 4.9 5.03 -mth interest rate (Bubor, avg %) 8.5 11.0 6.7 7.0 7.6 8.9 8.2 5.4 6.1 6.7 4.5 4.7 4.83-mth interest rate spread over Euribor (ppt) 617 894 456 392 328 429 701 460 470 613 425 411 3993-year yield (avg %) 8.1 10.0 6.8 7.6 7.2 9.5 9.3 6.8 7.1 7.3 4.8 5.3 5.510-year yield (avg %) 7.0 8.2 6.6 7.1 6.7 8.3 9.1 7.4 7.7 7.7 5.8 6.2 5.9Exchange rate (USD/HUF) year-end 207.9 180.3 213.6 191.6 172.6 187.9 188.1 208.7 240.7 220.9 245.8 240.0 229.6Exchange rate (USD/HUF) annual average 224.3 202.7 199.6 210.4 183.6 172.1 202.3 207.9 201.1 225.1 232.2 239.6 232.0Exchange rate (EUR/HUF) year-end 261.7 244.4 252.9 252.9 251.8 262.7 269.2 279.1 311.6 291.5 295.0 300.0 287.0Exchange rate (EUR/HUF) annual average 254.0 252.2 248.3 264.3 251.7 253.2 282.2 275.8 279.9 289.4 295.5 292.0 290.0


Israel Directional EMEA Economics April 2013

72

Israel [email protected]

Forecast summary

Country strategy

4Q12 1Q13F 2Q13F 3Q13F 4Q13F 2013F 2014F

Real GDP (%YoY) 2.6 2.6 3.5 4.3 3.7 3.5 4.7HH consumption (%YoY) 2.6 4.0 3.6 3.3 2.1 3.3 2.9Fixed investment (%YoY) -4.6 4.9 4.0 6.6 0.0 3.9 5.7CPI (%YoY)* 1.6 1.4 1.0 1.9 3.2 1.9 2.5Current account (% of GDP) 1.2 -2.5 3.0 0.5 5.2 1.6 2.0FX res. import cover (mths) 12.8 13.4 13.4 14.2 12.6 12.6 11.8Policy interest rate (%)* 2.00 1.75 1.50 1.50 1.75 1.75 3.003-mth interest rate (%)* 1.69 1.67 1.50 1.52 1.80 1.59 2.842-year yield (%)* 1.77 1.98 2.00 2.12 2.30 2.08 3.0710-year yield (%)* 3.19 3.77 3.90 3.87 3.95 3.89 4.65USDILS* 3.73 3.60 3.65 3.70 3.75 3.69 3.70EURILS* 4.92 4.61 4.67 4.63 4.50 4.69 4.51

Israel is on course to deliver a solid 3.5% YoY growth in 2013, lifted by the external accounts. The demand side should remain subdued with heightened prospects of higher fiscal constraints. The latter point, alongside a benign inflation backdrop in 2Q13, should allow the BoI to cut the base rate against a rallying ILS (on solid current account profile), though the window is small and limited to this quarter. Direct FX purchase and verbal jawboning are thus likely to be intervention tools of choice in the short term. The fiscal accounts will remain the weak point of the country this year and budget noise is likely to increase until Aug. The new government is settling in, but the alliance is particularly fragile on the Palestinian issue.


Political parties

Political stability for now

Hadash3%

Meretz5%

Labour party13%

Shas9%

Likud-Beitenu25%

Yesh-Atid16%

Hatenua5%

National Democratic Assembly3%

HaBayit HaYehudi10%

Ra`am-Ta`al3%

United Torah Judaism6%

Kadima2%

A 68-member/120-strong coalition was struck mid-Mar by Likud-Beitenu (right-wing) Netanyahu with Yesh-Atid (center-left), HaBayit HaYehudi (far-right), Hatenua (centrist), clearing the path for the 2013 budget to be submitted to the Knesset by early August (deadline extended). The task for new FinMin (neophyte in the matter) Lapid is challenging, but his electoral bid and recent outings lies in the ‘tough’ public spending cut direction. He might face strong opposition though, particularly from unionists. We doubt the 3% budget deficit target will be achieved this year as a new policy direction is unlikely to invert the trend on only 25% of the fiscal year. One thing is sure: tax hikes are looming – the question is whether Lapid will have the political strength to do it sooner rather than later.

Source: Knesset, ING estimates

Real interest rate vs US and USDILS

BoI to gear up against ILS strength

-1,000

-500

0

500

1,000

Jan

96

Jan

97

Jan

98

Jan

99

Jan

00

Jan

01

Jan

02

Jan

03

Jan

04

Jan

05

Jan

06

Jan

07

Jan

08

Jan

09

Jan

10

Jan

11

Jan

12

Jan

13

3.0

3.5

4.0

4.5

5.0

5.5

Real interest rate spread vs the US (bps)USDILS (1m-avg, RHS, inverted)

BoI fx intervention

ING f’cast

The relative performance of the Israeli economy in the region, boosted this year by the kick-off of gas production in the Tamar field, and the robust external stance of the country, are a strong anchor for ILS strengthening this year. Exporters have already voiced their concerns as the USDILS approaches the critical 3.60 level. Given the current low inflationary backdrop, the BoI has a small window, we think, to deliver a rate cut (just one) – but Governor Fisher is likely to stay put until a clearer picture is offered on the budget front. We still have a 25bp cut pencilled in for May, just a month before Fisher departs. In the meantime, more aggressive verbal jawboning and direct FX interventions are on the cards. A change at the BoI head should, in our view, not bring too much noise this quarter.


Current account balances (12m-rolling, % GDP)

Potash Corp. still trying

Though rejected in November by the authorities, Canada Potash Corp. reaffirmed in Feb its intention to gain control of ICL Israel Chemical (of which it holds 14%, and which has a USD15bn market cap). Now that a government has been formed, the company may attempt to again convince PM Netanyahu. This is a potentially strong positive for the ILS in the mid-term.



-8-6-4-202468

Mar

97

Mar

98

Mar

99

Mar

00

Mar

01

Mar

02

Mar

03

Mar

04

Mar

05

Mar

06

Mar

07

Mar

08

Mar

09

Mar

10

Mar

11

Mar

12

Mar

13

Mar

14

Mar

15

Current account Trade ServicesIncome Transfers

ING f’cast

Long USD:ILS 16-Apr 3.61 3.80 3.50



Israel Directional EMEA Economics April 2013

73

Israel

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012E 2013F 2014F 2015F

Activity Real GDP (%YoY) 1.8 4.6 5.1 5.8 5.9 4.3 0.6 5.2 4.7 2.9 3.5 4.7 3.2Private consumption (%YoY) 0.1 5.1 3.4 5.1 8.3 1.6 2.1 4.9 4.3 2.6 3.3 2.9 2.2Government consumption (%YoY) -2.5 -1.8 1.8 3.1 3.5 1.9 2.0 3.1 2.8 3.0 3.0 5.0 2.5Investment (%YoY) -4.0 -0.2 3.5 11.7 12.5 4.4 -3.4 11.3 17.5 3.4 3.9 5.7 8.0Industrial production (%YoY) -0.4 7.3 4.2 8.8 5.5 6.8 -6.0 8.2 2.6 3.2 4.7 3.4 1.5Unemployment rate year-end (%) 10.9 10.0 8.8 7.9 6.8 6.4 7.2 6.4 5.4 6.9 6.7 6.6 6.8Nominal GDP (ILSbn) 539 567 600 647 683 723 766 814 872 928 996 1,066 1,143Nominal GDP (€bn) 105 102 108 116 121 137 140 164 175 188 212 237 236Nominal GDP (US$bn) 119 127 134 145 166 202 195 218 244 241 270 288 295GDP per capita (US$) 17,602 18,429 19,145 20,412 22,981 27,388 25,859 28,355 31,127 30,211 33,247 34,864 35,026Gross domestic saving (% of GDP) 14.8 16.3 18.0 19.1 18.4 20.4 19.3 20.0 20.6 20.7 21.0 21.9 22.5Lending to corporates/households (% of GDP) n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a

Prices CPI (average %YoY) 0.7 -0.4 1.3 2.1 0.5 4.6 3.3 2.7 3.5 1.7 1.9 2.5 3.5CPI (end-year %YoY) -1.9 1.2 2.4 -0.1 3.4 3.8 3.9 2.7 2.2 1.6 3.6 0.9 4.6PPI (average %YoY) 4.4 5.4 6.3 5.7 3.5 9.7 -6.2 4.0 7.8 4.3 3.6 2.5 2.7Wage rates (%YoY, nominal) -2.3 2.0 3.1 3.5 2.1 4.2 0.4 3.3 3.9 3.3 4.3 4.7 4.8

Fiscal balance (% of GDP) Consolidated government balance -5.8 -4.0 -2.4 -1.0 -0.2 -2.0 -5.0 -3.4 -3.3 -4.7 -5.0 -4.5 -3.7Consolidated primary balance 0.0 1.6 2.7 3.7 4.4 1.7 -1.3 0.1 0.2 -1.2 -1.6 -1.2 -0.5Total public debt 99.4 97.8 93.9 84.9 78.5 77.1 79.5 76.0 74.0 74.0 73.9 72.3 70.9

External balance Exports (US$bn) 30.4 36.9 40.4 43.9 50.8 58.1 46.8 56.4 64.2 61.5 67.5 73.7 75.0Imports (US$bn) 33.3 39.5 43.9 47.2 56.0 64.4 46.0 58.1 72.0 71.4 74.6 79.9 82.3Trade balance (US$bn) -2.9 -2.6 -3.5 -3.2 -5.2 -6.3 0.8 -1.7 -7.8 -9.9 -7.1 -6.1 -7.3Trade balance (% of GDP) -2.5 -2.0 -2.6 -2.2 -3.1 -3.1 0.4 -0.8 -3.2 -4.1 -2.6 -2.1 -2.5Current account balance (US$bn) 0.6 2.1 4.1 7.0 5.3 2.9 8.1 8.1 3.4 -0.2 4.4 5.7 3.7Current account balance (% of GDP) 0.5 1.7 3.1 4.8 3.2 1.4 4.1 3.7 1.4 -0.1 1.6 2.0 1.3Net FDI (US$bn) 1.2 -1.6 1.9 -0.2 0.2 3.7 2.7 -3.6 7.8 7.2 5.9 7.1 2.2Net FDI (% of GDP) 1.0 -1.3 1.4 -0.1 0.1 1.8 1.4 -1.6 3.2 3.0 2.2 2.5 0.8Current account balance plus FDI (% of GDP) 1.6 0.4 4.5 4.7 3.3 3.3 5.5 2.1 4.6 2.9 3.8 4.4 2.0Foreign exchange reserves ex gold, (US$bn) 26.1 27.0 27.9 29.0 28.6 42.7 60.6 71.3 74.7 75.9 78.6 78.7 78.7Import cover (months of merchandise imports) 9.4 8.2 7.6 7.4 6.1 8.0 15.8 14.7 12.5 12.8 12.6 11.8 11.5

Debt indicators Gross external debt (US$bn) 72.1 78.7 77.5 56.7 89.6 87.0 93.5 106.5 103.6 93.6 94.8 99.6 104.5Gross external debt (% of GDP) 61 62 58 39 54 43 48 49 42 39 35 35 35Gross external debt (% of exports) 237 213 192 129 176 150 200 189 161 152 141 135 139Total debt service (US$bn) 8.3 6.7 7.5 8.9 14.9 7.6 6.5 9.2 7.3 11.8 9.0 8.9 8.5Total debt service (% of GDP) 7.0 5.3 5.6 6.1 8.9 3.8 3.3 4.2 3.0 4.9 3.3 3.1 2.9Total debt service (% of exports) 27.4 18.2 18.6 20.3 29.3 13.1 13.8 16.4 11.4 19.2 13.3 12.1 11.3

Interest & exchange rates Central bank key rate (%) year-end (base rate) 5.20 3.90 4.50 5.00 4.00 2.50 1.00 2.00 2.75 2.00 1.75 3.00 3.75Broad money supply (avg, %YoY) 1.7 3.9 5.7 4.5 14.4 8.8 16.3 3.1 9.1 7.5 5.3 8.3 9.43-mth interest rate (Telbor, avg %) 7.6 4.6 4.1 5.5 4.4 4.0 1.3 1.8 2.9 2.2 1.6 2.8 3.63-mth interest rate spread over US$-Libor (ppt) 638 297 55 33 -86 105 60 146 260 181 127 232 2862-year yield (avg %) 7.0 5.0 5.0 5.9 4.8 4.5 2.8 2.8 3.5 2.3 2.1 3.1 3.510-year yield (avg %) 7.9 6.3 5.2 6.3 5.5 5.8 5.0 4.7 4.8 3.9 3.9 4.6 4.6Exchange rate (USDILS) year-end 4.39 4.32 4.60 4.21 3.85 3.78 3.79 3.52 3.81 3.73 3.75 3.75 4.00Exchange rate (USDILS) annual average 4.54 4.48 4.48 4.45 4.11 3.58 3.92 3.73 3.57 3.85 3.69 3.70 3.88Exchange rate (EURILS) year-end 5.52 5.85 5.45 5.56 5.62 5.28 5.42 4.71 4.93 4.92 4.50 4.69 5.00Exchange rate (EURILS) annual average 5.14 5.57 5.58 5.59 5.63 5.27 5.47 4.95 4.98 4.95 4.69 4.51 4.85


Kazakhstan Directional EMEA Economics April 2013

74

Kazakhstan [email protected]

Forecast summary

Country strategy

4Q12 1Q13F 2Q13F 3Q13F 4Q13F 2013F 2014F

Real GDP (%YoY) 5.0 4.0 4.1 6.6 5.8 5.3 5.8HH consumption (%YoY) 7.0 7.5 5.9 11.5 8.2 8.4 7.8Fixed investment (%YoY) 5.0 6.5 7.0 7.4 7.6 7.2 8.7CPI (%YoY)* 6.0 6.8 6.3 6.1 5.7 6.3 5.8Current account (% of GDP) 1.2 8.8 2.1 -2.1 -1.5 1.2 0.6FX res. import cover (mths) 5.6 5.7 5.5 5.2 5.0 5.0 4.6Policy interest rate (%)* 5.50 5.50 5.50 5.50 5.50 5.50 5.503-mth interest rate (%)* 4.50 3.50 3.70 4.30 5.00 4.13 4.50yield (%)* n/a n/a n/a n/a n/a n/a n/ayield (%)* n/a n/a n/a n/a n/a n/a n/aUSDKZT* 150.4 150.9 152.1 152.5 152.5 151.5 152.8EURKZT* 198.5 193.4 194.6 190.6 183.0 192.8 186.2

Higher GDP growth than in many DM/EM peers does not imply many changes in the macro story. Due to longer delays in 4Q12 data releases (eg, final GDP, 1Q13 BoP), we mostly stick to earlier GDPforecasts with some adjustments to key items. We still keep a slightly below-consensus view on GDP, but now see a somewhat better 2H13 inflation profile. This will be beneficial for consumption. Despite the 3% of GDP budget gap, the fiscal profile is secured by the National Oil Fund (NOF), prudent budget planning and a rise in oil export duty. We though note that this looks as unwinding the effect of the 2009-1H10 duty abolishment. The only concern is worsening BoP, which puts KZT at risk, barring a renewed commodity price rally.


GDP and key components (YoY)

Soft landing may soon turn to some recovery

-25%

-15%

-5%

5%

15%

25%

35%

Household consumption Fixed investment GDP

55%

GDP was 5% in 2012 vs INGF 4.8%. A 0.6ppt drag from the production sector was offset by net taxes, so services sector (still a high single-digit consumption story) was a key driver. IP growth rose from 0.5% in Dec-12 to 0.9% on better mining sector growth and despite slower manufac/utilities gains. With the base effect in the manufac. sector expected to be favourable in 2Q13, and still rising consumption/investments, we expect a stronger 2H13 pace. This is also supported by the 2.9% YoY gain in the Kazstat proxy (2.1% in Dec-12) and improving industry/trade sentiments. High base in incomes/consumption should constrain 1H13 GDP at c.4%, with low unemployment, slowing CPI, 20%+ retail lending, rising corp. profits and pro-growth state drive to flag growth recovery in 2H13 to c.6%.

Source: Kazakhstan Statistics Agency

Inflation and real interest MM rates (YoY)

CPI evolves as expected/NBK rates to remain flat

-10%

-5%

0%

5%

10%

15%

Jan 09 Jul 09 Jan 10 Aug 10 Feb 11 Aug 11 Mar 12 Sep 12 Apr 13

Headline CPIFood CPIReal interest rate (3m KazPrime vs 12m ahead CPI)

Inflation has evolved in line with our expectations. Near 4% YoY PPI print in 1Q13 was fuelled by an 18% YoY advance in utilities tariffs after early-year hikes, on the back of a benign trend in mining and manufacturing items. With an unchanged US$105-110/bbl oil price and better grains harvest expected, PPI should not pose a risk. CPI seems to have peaked in Feb 2012 to 7%, now heading to c.5.5% by year-end on retreating food prices (including via import channel) and benign non-food CPI. The latter should come from normalisation of private consumption, relatively stable KZT and decelerating growth in monetary aggregates reflecting somewhat reduced liquidity overhang in the banking sector. Thus, there is still no need to touch the official 5.5% rate as the banking system continues its self-rebalancing.

Source: Kazakhstan Statistics Agency

Current account vs FDI/portfolio investments (US$bn)

BoP on the brink of deficit/state hikes oil export duty

2H12 saw BoP at -US$5bn and a weakening KZT. Flat FX reserves in 1Q13 indicate it moved from red to zero. CA surplus looks weak due to stable exports vs rising imports and FDI is insufficient to offset the Oil Fund-driven gap in portfolio flows. So, KZT is set to weaken by end-2013. The fiscal gap was 3% of GDP, but the rise in export duty from US$40/t to US$60/t will improve the figure in 2013 and beyond. Yet, the NOF at US$60bn still keeps the overall fiscal backdrop benign.



-20-15-10

-505

101520

1Q07

3Q07

1Q08

3Q08

1Q09

3Q09

1Q10

3Q10

1Q11

3Q11

1Q12

3Q12

1Q13

Current account (4Q rolling)

Net FDI (4Q rolling)

Net portfolio investment (4Q rolling)

Rising Oil Fund assets drives the gap

Long USD/KZT 19-Apr 151.1 152.5 150.0

Source: Kazakhstan Statistics Agency, NBK


Kazakhstan Directional EMEA Economics April 2013

75

Kazakhstan

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012E 2013F 2014F 2015F

Activity Real GDP (%YoY) 9.3 9.6 9.7 10.7 8.9 3.3 1.2 7.3 7.5 5.0 5.3 5.8 6.0Private consumption (%YoY) 11.9 14.1 10.9 12.7 10.9 7.8 0.6 11.8 10.9 9.7 8.4 7.8 7.5Government consumption (%YoY) 8.9 10.6 10.8 7.3 14.0 2.6 1.0 2.7 11.3 8.8 4.0 4.6 4.5Investment (%YoY) 8.0 22.5 28.1 29.7 17.3 1.0 -0.8 3.8 3.9 3.9 7.2 8.7 9.0Industrial production (%YoY) 7.8 11.7 3.1 7.1 6.2 2.6 2.7 9.6 3.8 0.5 4.5 5.5 5.7Unemployment rate year-end (%) 8.8 8.6 8.2 7.8 7.3 6.7 6.6 5.8 5.4 5.3 5.1 5.0 4.9Nominal GDP (KZTbn) 4,612 5,870 7,591 10,214 12,850 16,053 17,008 21,816 27,334 30,074 32,461 35,939 40,000Nominal GDP (€bn) 27 35 46 65 77 91 83 112 134 157 168 193 210Nominal GDP (US$bn) 31 43 57 81 105 134 115 148 186 202 214 235 262GDP per capita (US$) 2,076 2,874 3,771 5,297 6,771 8,532 7,159 9,073 11,222 11,956 12,529 12,995 13,948Gross domestic saving (% of GDP) 34.3 34.9 38.9 44.1 43.8 46.3 41.0 43.8 46.6 43.0 39.6 38.2 37.0Lending to corporates/households (% of GDP) 21.2 25.3 34.1 45.9 56.5 46.5 44.9 34.8 31.8 33.0 34.5 36.3 39.1


Fiscal balance (% of GDP) Consolidated government balance 0.0 1.7 0.6 0.8 -1.7 -2.1 -2.9 -2.4 -2.1 -2.8 -1.8 -1.2 -0.9Consolidated primary balance 0.9 3.1 1.0 1.1 -1.4 -1.7 -2.5 -2.0 -1.7 -2.1 -1.1 -0.5 -0.3Total public debt 13.5 9.9 6.8 6.9 5.5 6.3 10.4 11.4 11.9 12.2 14.9 16.0 18.0

External balance Exports (US$bn) 13.2 20.6 28.3 38.8 48.4 72.0 43.9 61.4 87.5 92.1 89.7 93.8 98.6Imports (US$bn) 9.6 13.8 18.0 24.1 33.3 38.5 29.0 32.9 40.7 47.4 52.6 58.0 64.5Trade balance (US$bn) 3.7 6.8 10.3 14.7 15.1 33.5 15.0 28.5 46.8 44.7 37.1 35.8 34.1Trade balance (% of GDP) 11.9 15.7 18.1 18.1 14.4 25.1 13.0 19.2 25.1 22.2 17.3 15.2 13.0Current account balance (US$bn) -0.3 0.5 -0.5 -2.0 -8.3 6.3 -4.4 1.4 12.3 7.7 2.5 1.3 3.5Current account balance (% of GDP) -0.9 1.2 -0.8 -2.5 -7.9 4.7 -3.8 0.9 6.6 3.8 1.2 0.6 1.3Net FDI (US$bn) 2.2 5.4 2.1 6.7 8.0 14.8 10.7 3.7 9.2 12.4 7.9 9.2 13.0Net FDI (% of GDP) 7.1 12.5 3.7 8.3 7.6 11.1 9.2 2.5 4.9 6.1 3.7 3.9 5.0Current account balance plus FDI (% of GDP) 6.3 13.7 2.9 5.8 -0.3 15.8 5.5 3.4 11.5 10.0 4.9 4.5 6.3Foreign exchange reserves ex gold, (US$bn) 4.2 8.5 6.1 17.8 15.8 17.9 20.6 25.2 25.2 22.1 22.0 22.0 24.0Import cover (months of merchandise imports) 5.3 7.4 4.1 8.8 5.7 5.6 8.5 9.2 7.4 5.6 5.0 4.6 4.5


Interest & exchange rates Central bank key rate (%) year-end 7.00 7.00 8.00 9.00 11.00 10.00 7.00 7.75 7.50 5.50 5.50 5.50 5.50Broad money supply (avg, %YoY) 27.0 69.8 25.2 78.1 25.9 35.3 25.6 28.5 20.3 7.5 14.0 16.0 15.03-mth interest rate (KazPrime, avg %) 5.4 4.8 2.5 3.6 7.3 8.5 8.3 4.1 1.8 2.5 4.1 4.5 5.03-mth interest rate spread over US$-Libor (ppt) 419 318 -107 -165 196 561 761 372 144 207 380 398 429yield (avg %) n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/ayield (avg %) n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/aExchange rate (USDKZT) year-end 144.22 130.00 133.98 126.79 120.68 120.88 148.36 147.37 148.49 150.44 152.50 153.00 152.00Exchange rate (USDKZT) annual average 149.00 136.04 132.88 125.97 122.52 120.00 147.60 147.29 146.66 149.15 151.47 152.75 152.50Exchange rate (EURKZT) year-end 181.52 176.25 158.63 167.31 176.06 168.96 212.39 197.14 192.22 198.49 183.00 191.25 190.00Exchange rate (EURKZT) annual average 168.71 169.23 165.34 158.28 167.94 176.54 205.83 195.37 204.19 191.78 192.77 186.16 190.63Brent price, annual average (US$/bbl) 29 38 55 65 73 98 62 80 111 112 108 114 115


Poland Directional EMEA Economics April 2013

76

Poland Next elections : EU Parliament / June-2014

Forecast summary

Country strategy

4Q12 1Q13F 2Q13F 3Q13F 4Q13F 2013F 2014F

Real GDP (%YoY) 0.7 0.7 1.0 1.3 1.8 1.2 2.6HH consumption (%YoY) -0.2 -0.5 -0.3 0.7 1.1 0.2 2.0Fixed investment (%YoY) -4.1 -4.0 -4.0 -4.3 -4.5 -4.3 2.2CPI (%YoY)* 2.4 1.0 0.8 1.4 1.8 1.3 2.1Current account (% of GDP) -3.5 -3.1 -2.9 -2.7 -2.6 -2.6 -3.0FX res. import cover (mths) 6.0 6.7 6.5 6.5 6.5 6.9 6.6Policy interest rate (%)* 4.25 3.25 3.00 2.75 2.75 2.75 3.003-mth interest rate (%)* 4.11 3.39 3.02 3.02 3.02 3.22 3.122-year yield (%)* 3.12 3.15 2.68 3.06 3.16 3.07 3.6110-year yield (%)* 3.74 3.95 3.55 4.06 4.28 3.84 4.59USDPLN* 3.10 3.27 3.33 3.44 3.42 3.33 3.39EURPLN* 4.09 4.18 4.16 4.20 4.10 4.17 4.13

Poland should avoid near-zero growth in 1Q13, but the case for recovery in the next quarters remains weak, and CPI should remain below the MPC target in 2013 and 1H14. The MPC, having delivered a surprising 50bp-cut in March, is in a 'wait and see’ mode but we expect further easing from a 25bp cut in June and July (to 2.75%). MinFin should avoid growth-damaging tightening to meet the deficit at 3.5% of GDP: it can revise the central deficit up or utilise transfer from OFE capital. There is more to do on the monetary policy side, as real rates, even after 50bps cuts, should remain the highest in EM. This should attract portfolio capital, despite some cyclical fiscal slippage. Overvaluation of PLN bonds would be halted if yields pick up on core markets or if the MPC credibly announce the end of the easing cycle.

*Quarterly data is EOP, annual is avg. Source: National sources, ING estimates [email protected]

GDP components (% YoY, real)

Macro digest – stagnation scenario

-15%

-10%

-5%

0%

5%

10%

15%

20%

1Q08

2Q08

3Q08

4Q08

1Q09

2Q09

3Q09

4Q09

1Q10

2Q10

3Q10

4Q10

1Q11

2Q11

3Q11

4Q11

1Q12

2Q12

3Q12

4Q12

1Q13

2Q13

3Q13

4Q13

0%

1%

2%

3%

4%

5%

6%

7%

Household Consumption Fixed Investment GDP (RHS)

ING f'cast

Source: GUS, ING estimates

Industrial output and business confidence

-15

-10

-5

0

5

10

15

Nov 06 Aug 07 Jun 08 Apr 09 Feb 10 Dec 10 Oct 11 Aug 12 Jun 13

-35

-30

-25

-20

-15

-10

-5

0

Industrial output (3m-mav, %YoY, RHS)

Industry, EC confidence indicator (sa, LHS)

ING f'cast

Source: GUS, EC, ING estimates

Retail sales and wage bill

-10

-5

0

5

10

15

20

Jan-08 Mar-09 May-10 Jul-11 Sep-12 Dec-13

8

9

10

11

12

13

14

Retail sales (real, 3m-mav, %YoY)Wage bill (real, %YoY)Unemployment rate (SA, %, RHS)

ING f'cast

We stick to our sub-consensus GDP forecast for 2013, as we still don’t see any signs of a turning point in domestic demand, while the external orders increase was halted by a recent softening of business confidence in Eurozone and Germany. Admittedly, GDP should avoid close-to-zero growth in 1Q13, but the case for recovery in the next quarters remains weak. The leading manufacturing sector should remain in contraction territory in 2Q13 to the tune of -1.4% YoY vs -1.6% YoY in 1Q13, as the slight improvement in orders was offset by the inventories build-up. Public investments did not hit bottom, and their surprising revival in 4Q12 has disappeared in subsequent revisions. Private consumption is unlikely to contribute positively to GDP growth in 1H13. We also doubt it could reach its long-term average contribution of 2ppt in 2014. In 3Q12, there was a slight pick-up in the household savings rate after consumption smoothing brought it to almost zero in 1H12. The process of replenishing savings was quite intensive judging by the size of the deposits. However, we still doubt that consumption will rebound once the buffers are refilled. Our poll among retail clients revealed that 50% of them cut expenditures in 2H12 due to insufficient income, while less than 20% mentioned higher propensity to save as the main reason for lower spending. So it takes a true improvement on the income side for consumption recovery. It might improve in real terms thanks to the quick disinflation, but it is the job security issues (GDP may struggle to reach a labour market neutral pace of growth before 2015) and the little scope for wage hikes that may still keep spirits low in 2013. The Labour Ministry showed a more active approach, which can be read from an increase in employers’ registered job offers in Feb – 83k vs 61k a year ago. On the other hand, layoff plans in the private sector adjusted for seasonal factors pushed above the highs reached in post-Lehman 2009 (but not the record high from Dec-08). The Labour Ministry intervention has dampened the trend in the unemployment rate, but we have not seen any growth in demand for labour yet to make this a more long-lasting achievement. The most that can be done is to push on with a special law to lower labour hoarding costs. We upgrade GDP growth forecasts for 1H13, but this is offset by weaker expectations for 2H13. We see less steep GDP acceleration in 2014 due to sluggish domestic demand (especially consumption) and postponed Eurozone recovery. 2014 should bring GDP growth to 2.6% YoY, still below the break-even level of 3% for the Polish economy, which would trigger the labour market recovery. Thus, we don’t expect MinFin to provide additional tightening measures to meet its 3.5% deficit target. There is more to do on the monetary policy side, so easing expectations should remain in place even after the 50bp cut we expect.

Source: GUS, EC, ING estimates [email protected], [email protected]



mailto:grzegorz.ogonek@ingbank.�


77

Activity: Monetary trend : Looser Fiscal trend : Neutral [email protected]

[email protected]

CPI and NBP inflation target

The second round of monetary easing

0

1

2

3

4

5

6

Jan-07 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13

CPI (%YoY) Core CPI (%YoY) NBP target with +/-1% band

The MPC, having delivered a surprising 50bp cut in March, is in a ‘wait and see mode’, but we expect further easing: 25bp in June and 25bp in July (to 2.75%). Our sub-consensus view assumes CPI falling below the NBP projection in 2013, which has been highlighted as a prerequisite for further action. On the other hand, the withdrawal from the VAT cut makes CPI in 2014 higher than in the NBP projection. It gives MPC hawks an argument to postpone, but not prevent, further easing, as the lack of production recovery in 2Q13 and continued weak growth in the Eurozone bodes poorly for expected recovery in 2H13-2014. The bond market rally may result in further PLN strengthening in 2Q13 so the risk is skewed to the downside for our rates view.

Source: GUS, NBP, ING estimates [email protected]

Central budget deficit (% of the yearly plan)

Revise (central deficit) or not?

0%

20%

40%

60%

80%

100%


2013 YTD budget 2012 YTD budget

2011 YTD budget 2010 YTD budget

MinFin is deliberating whether to revise the deficit. The revenue shortfall could reach PLN18bn, but MinFin can offset that with higher dividends from public caps, PLN5.5bn of NBP profit or OFE (private pension funds) capital. It is trying to avoid growth-damaging fiscal tightening due to record weak domestic demand, but on the other hand, expects the excessive deficit procedure to be lifted by the EC, so it needs a credible fiscal path in April’s update of the Convergence Programme. The recent price rally in the local debt market shows that investors ignore the cyclical budget worsening due to a strong track record from 2011-12. So MinFin may finally decide to revise the deficit up. Also, rating agencies prefer more transparent solutions.

Source: MinFin [email protected]

Assets of OFE (private pension funds)

Pension system revision

Shares38%

Others1%

Treasury bond and bills

45%

Non-treasury debt instruments

11%

Bank securities and deposits

5%

The government is undergoing a (planned) review of the private pension funds (OFE). It should choose the payer of pensions fromthe OFE. The proposals that leaked to the press indicate that the capital of workers who are 10 years younger than the pension age would be gradually moved from OFE to ZUS (public social security institution). Assuming the flow will be spread over 10 years, in 2013 or 2014 ZUS (effectively budget) would get cash of PLN20bn, while the remaining PLN26bn would flow in over the next 10 years. In this case, OFE would avoid an equity sell-off to rebalance the portfolios, while on the other hand, PLN20bn would help with the central budget. Moody’s has stated that the operation would be credit-neutral.

Source: KNF [email protected]

Support for Euro adoption

Euro adoption – festina lente (make haste slowly)

20

30

40

50

60

Dec-09 Jun-10 Sep-11 Oct-12

For Against

NBP governor Marek Belka stated that Poland should ask the European Commission for an exemption from the EMU entry criterion regarding the exchange rate. His argument was that the depth of the Polish market makes keeping in the ERM-2 highly risky. No FX criterion could encourage a more active FX policy, up to a point of entry exchange rate manipulation. But we also see Marek Belka’s view in a broader context. There are two approaches in the government to the issue of euroadoption. Foreign affairs minister Radoslaw Sikorski promotes quick EMU entry, while MinFin Jacek Rostowski and Marek Belka are more pragmatic in setting additional internal criteria, making readiness to enter, not entry, the actual goal. Postponement and testing the EC’s resolve seem beneficial for Poland.

Source: Ipsos/MinFin [email protected], [email protected]#









78

Poland FX / MONEY MARKETS / DEBT STRATEGY LC Ratings (M/S&P/F): A2/A/A



3.8

3.9

4.0

4.1

4.2

4.3

4.4

4.5

4.6

Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14

ING f'cast Mkt fwd


CA deficit and adjusted with capital account (% of GDP)

Weak local activity data, a risk of deeper rate cuts and the upward revision of the fiscal deficit all call for yet another return towards 4.20/€. And yet this local story may become temporarily irrelevant – global factors facilitating yield hunting may keep PLN under appreciation pressure due to the fact that real rates in Poland are the highest in the region. €/PLN should stay between 4.10-4.15/€, depending on the scale of inflows to the bond market; just like in 2H12, foreign demand for bonds gave the zloty resistance to growth deterioration and monetary easing. PLN appreciation below 4.00/€ should be seen as a warning signal that the bubble in the Polish bond market is getting risky and this may force more aggressive MPC action. The 50bp-cut in March set a precedent and the Council is now significantly less cautious than it was before. On a 6-month horizon we assume temporary PLN weakening when core market yields inch up again, forcing PLN bonds into a temporary sell-off. But ultimately, higher yields in the Eurozone would be accompanied with a better growth outlook in Germany, which is PLN positive. The weakness of domestic demand caused trade gap rebalancing and the current account adjusted with the capital account should stay close to 1% of GDP, also preventing negative actions on the FX market.

[email protected], [email protected]



-7%

-6%

-5%

-4%

-3%

-2%

-1%

0%

Jan

03

Jan

04

Jan

05

Jan

06

Jan

07

Jan

08

Jan

09

Jan

10

Jan

11

Jan

12

Feb 1

3

CA CA + capital account

EU accession

- - - -

Source: NBP

Local curve (%)

Debt Strategy

2.5

3.0

3.5

4.0

4.5

3m 6m 2Y 10Y



PLN10Y IRS, EM10Y IRS, NBP rates (%)

The aggressive easing by the BoJ, the dovish ECB, and the US soft patch expected in 2Q13 all fuelled the new wave of yield hunting on EM bond markets that sent PLN yields 30-60bp below the historical lows reached in Dec-12. The PLN curve performed in line with the average movement in the seven-largest EM rates markets, but this adds to the strengthening of the PLN curve in the same magnitude experienced after the surprising 50bp cut in March. Thanks to these two factors, 2Y yields have dropped by 65bp since the beginning of March while the 10y have dropped by 50bp, which calls for technical correction. Again our models show that 5Y IRS’s in PLN are the most overpriced among the seven-largest EM rates markets. Foreign investors seem to be ignoring the long end negative fact that the central deficit reached 70% of the yearly plan after 1Q13 and the MinFin is trying to avoid revising the deficit upward with another fudging on OFE. We expect CPI to stay below 1% in 2Q13, and the lack of industrial production recovery in 2Q13 should again soften the MPC’s stance, so additional 50bp cuts to 2.75% are likely. The easing expectations could stay in place (FRA price cuts to 2.5%), as even after the cuts we expect real rates to remain among the highest in the EM space. The trigger for correction should come from a yield increase in core markets or a warning from rating agencies. We recommend setting 2Y vs 10Y steepener on the PLN bond curve.

[email protected]



5.5

6.0

6.5

7.0

7.5

8.0

8.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

Mar-11 Aug-11 Dec-11 Apr-12 Aug-12 Dec-12 Apr-13

NBP rate PL10Y IRS EM 10YIRS (rhs)

Sell 10Y Buy 2Y POLGB 10-Apr 59bp 75bp 45bp

Source: NBP, Reuters, ING





79

Poland

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012E 2013F 2014F 2015F

Activity Real GDP (%YoY) 3.9 5.3 3.6 6.2 6.8 5.1 1.7 3.9 4.5 1.9 1.2 2.6 3.0Private consumption (%YoY) 2.0 4.4 2.0 5.0 4.9 5.8 2.0 3.1 2.6 0.8 0.2 2.0 3.0Government consumption (%YoY) 4.9 3.1 5.2 6.1 3.6 7.4 2.0 4.2 -1.7 -0.2 0.7 1.1 0.2Investment (%YoY) -0.1 6.4 6.5 14.9 17.5 9.6 -1.1 -0.4 8.5 -0.9 -4.3 2.2 7.0Industrial production (%YoY) 8.6 13.1 4.1 12.0 9.4 3.0 -3.6 11.1 6.8 1.4 -0.6 3.3 3.6Unemployment rate year-end (%) 20.0 19.0 17.6 14.8 11.2 9.5 12.1 12.4 12.5 13.4 14.7 14.5 14.4Nominal GDP (PLNbn) 843 925 983 1,058 1,211 1,276 1,345 1,417 1,528 1,595 1,622 1,703 1,805Nominal GDP (€bn) 183 191 217 272 320 356 309 354 371 382 389 412 461Nominal GDP (US$bn) 207 237 270 342 438 524 431 469 516 491 487 502 576GDP per capita (US$) 5,419 6,242 7,143 9,106 11,724 14,017 11,547 12,620 13,867 13,214 13,117 13,541 15,539Gross domestic saving (% of GDP) 17.2 19.0 19.8 20.6 24.6 20.8 21.3 20.6 21.7 21.8 21.9 22.7 23.2Lending to corporates/households (% of GDP) 29.7 27.9 29.8 34.1 38.4 50.3 51.8 53.5 56.6 54.7 54.8 54.7 53.4

Prices CPI (average %YoY) 0.8 3.5 2.1 1.0 2.5 4.2 3.5 2.6 4.3 3.7 1.3 2.1 2.8CPI (end-year %YoY) 1.7 4.4 0.7 1.4 4.0 3.3 3.5 3.1 4.6 2.4 1.8 2.3 3.2PPI (average %YoY) 2.6 7.0 0.7 2.3 2.0 2.2 3.3 2.1 7.6 3.4 -0.2 2.8 2.6Wage rates (%YoY, nominal) 2.6 4.3 3.2 5.0 9.1 10.6 4.2 3.5 4.9 3.5 2.4 3.0 3.7

Fiscal balance (% of GDP) Consolidated government balance (ESA 95) -6.2 -5.4 -4.1 -3.6 -1.9 -3.7 -7.4 -7.9 -5.0 -3.9 -3.5 -3.0 -2.0Consolidated primary balance -3.2 -2.6 -1.3 -1.0 0.4 -1.5 -4.7 -5.0 -2.0 -0.5 -0.5 -0.1 0.1Total public debt (ESA 95) 47.1 45.7 47.1 47.7 45.0 47.1 50.9 54.8 56.2 55.6 57.4 57.0 54.9

External balance Exports (€bn) 53.8 65.8 77.6 93.4 105.9 120.9 101.8 125.0 139.3 143.0 154.2 170.7 198.1Imports (€bn) 58.9 70.7 80.1 99.2 119.7 141.8 107.2 133.9 149.4 148.6 154.8 173.8 205.7Trade balance (€bn) -5.1 -4.8 -2.5 -5.8 -13.8 -20.9 -5.4 -8.9 -10.1 -5.6 -2.0 -4.5 -9.1Trade balance (% of GDP) -2.8 -2.5 -1.2 -2.1 -4.3 -5.9 -1.8 -2.5 -2.7 -1.5 -0.5 -1.1 -2.0Current account balance (€bn) -4.9 -10.7 -5.9 -10.4 -19.2 -23.8 -12.2 -16.5 -15.9 -13.5 -10.0 -12.5 -15.8Current account balance (% of GDP) -2.7 -5.6 -2.7 -3.8 -6.0 -6.7 -3.9 -4.7 -4.3 -3.5 -2.6 -3.0 -3.4Net FDI (€bn) 3.8 9.5 5.5 8.6 13.2 7.1 6.0 2.5 6.6 2.5 5.9 7.0 8.5Net FDI (% of GDP) 2.1 5.0 2.6 3.2 4.1 2.0 1.9 0.7 1.8 0.9 1.5 1.7 1.8Current account balance plus FDI (% of GDP) -0.6 -0.7 -0.1 -0.7 -1.9 -4.7 -2.0 -3.9 -2.5 -2.9 -1.0 -1.3 -1.6Foreign exchange reserves ex gold, (€bn) 25.8 26.6 34.5 35.2 48.4 42.5 52.7 66.5 71.7 78.4 90.3 96.9 106.1Import cover (months of merchandise imports) 5.3 4.5 5.2 4.3 4.9 3.6 5.9 6.0 5.8 6.3 6.9 6.6 6.1


Interest & exchange rates Central bank key rate (%) year-end (1W repo) 5.25 6.50 4.50 4.00 5.00 5.00 3.50 3.50 4.50 4.25 2.75 3.00 3.75Broad money supply (avg, %YoY) 5.8 9.4 10.3 16.0 12.9 18.6 8.1 8.8 12.5 4.5 2.4 4.5 5.73-mth interest rate (Wibor, avg %) 8.8 5.7 6.2 4.2 4.8 6.3 4.3 3.9 4.6 4.9 3.2 3.1 3.73-mth interest rate spread over Euribor (ppt) 644 356 406 112 52 170 309 312 318 430 297 252 2922-year yield (avg %) 5.48 6.97 4.95 4.58 5.11 6.26 5.24 4.76 4.85 4.25 3.07 3.61 4.3710-year yield (avg %) 5.84 6.85 5.21 5.26 5.51 6.04 6.13 5.83 5.97 4.95 3.84 4.59 4.96Exchange rate (USDPLN) year-end 3.74 2.99 3.26 2.91 2.76 2.94 2.85 2.96 3.41 3.10 3.42 3.20 3.08Exchange rate (USDPLN) annual average 4.07 3.90 3.64 3.09 2.76 2.43 3.12 3.02 2.96 3.25 3.33 3.39 3.14Exchange rate (EURPLN) year-end 4.71 4.05 3.86 3.84 4.02 4.11 4.08 3.97 4.42 4.09 4.10 4.00 3.85Exchange rate (EURPLN) annual average 4.61 4.85 4.53 3.88 3.78 3.58 4.35 4.00 4.12 4.17 4.17 4.13 3.92


Romania Directional EMEA Economics April 2013

80

Romania Next elections : Presidential -4Q14

Forecast summary

Country strategy

4Q12 1Q13F 2Q13F 3Q13F 4Q13F 2013F 2014F

Real GDP (%YoY) 1.1 0.7 0.7 2.2 2.1 1.6 2.0HH consumption (%YoY) 1.1 1.4 1.2 1.9 1.2 0.6 1.4Fixed investment (%YoY) -4.2 -2.7 -0.5 1.7 5.3 1.6 7.8CPI (%YoY)* 5.0 5.3 5.8 4.4 4.6 5.4 4.0Current account (% of GDP) -3.6 -3.7 -3.6 -3.3 -3.1 -3.1 -3.3FX res. import cover (mths) 7.2 7.4 7.3 7.2 7.0 7.0 6.3Policy interest rate (%)* 5.25 5.25 5.25 5.25 5.25 5.25 5.253-mth interest rate (%)* 6.05 5.20 4.20 4.30 4.20 4.80 4.503-year yield (%)* 5.95 5.39 4.80 4.70 4.70 5.10 4.905-year yield (%)* 5.95 5.46 5.00 4.90 4.80 5.20 5.00USDRON* 3.36 3.44 3.44 3.48 3.58 3.45 3.54EURRON* 4.43 4.42 4.40 4.35 4.30 4.39 4.31

Romania’s eurobonds have performed strongly over the past couple of months as 5Y CDS compressed to 215 after averaging slightly more than 350 in 2012. Reaching a third consecutive IMF deal remains our base-case scenario, though it’s probability softened. The alternative might put some temporary pressure on Romania’s tradable debt, and future developments will depend on the fiscal line chosen by the executive. Since it continues to talk about fiscal easing plans (cutting social security contributions of employers, cutting VAT for bread and eventually all food items), we attach a non-negligible probability to this scenario of fiscal experiments that could limit potential dips in its popularity. Recent GDP growth revisions beef the chances for a ratings upgrade; for now, this looks more like a risk.


Contributions to GDP growth (ppt)

Macro digest

7.9 6.3 7.4

-6.6

-1.2

2.2 0.7

-8-6-4-202468

10

2006 2007 2008 2009 2010 2011 2012

Services Industry Construction

Agriculture Net taxes GDP growth

Source: INS, ING Estimates

Industrial output data - revised vs old (%YoY)

-5.5

0.0

5.65.5

-5.5

2.4

7.55.5

-8-6

-4-2

02

46

810

2009 2010 2011 2012

Industrial output previous data Industrial output new


Lending stalled in late 2012

-20

0

20

40

60

80

Jan 07 Jan 08 Jan 09 Jan 10 Jan 11 Jan 12 Jan 13

Local currency credit (%YoY)Local currency credit (%YoY, EUR terms)Lending growth index (%YoY, limits FX impact)

Greek ties and loud political scandals have plagued Romania in 2012 and, as such stress has visibly decreased, Romania can resume the long road of convergence. One of the brightest spot on the macro map is that 2012 GDP figures have been revised sharply higher, from 0.2% growth presented by flash data to 0.7% by the second revision, and that the poor harvest had a very strong negative contribution to last year’s growth (excluding agriculture, Romania’s growth in 2012 was 2.1%). This means that the underlying trend of economic activity is stronger than portrayed by previous data and this has led us to upgrade our GDP growth projections to 1.6% for 2013 (from 0.5% previously). Excluding agriculture, this would mean a deceleration to 0.9%, worse than 2012 or 2011.

Our growth forecasts upgrade is tempered by the fact that ING now believes the euro area will post a 0.6% contraction in 2013 vs flat growth expected at the release of the previous quarterly report. On a more positive note, Romania’s monthly indicators suggest that most sectors performed significantly better in 1Q13 than in 4Q12 in quarterly terms and this should lead to GDP growth acceleration. This would be an interesting feat since 4Q12 saw a relatively brawny 0.4% seasonally-adjusted quarterly GDP growth and Romania has not seen two consecutive quarters of growth for almost two years.

Unfortunately, a stronger start in 2013 does not look like the beginning of a strong trend, but rather a correction after a soft patch in 2H12. Beyond past trends and hopes for a stronger harvest, Romania’s picture is not particularly rosy. Inflation is set to outpace private sector wage growth and this would be a first since the beginning of the crisis. Lending remains depressed, posting a slight contraction in real terms. The lack of improvement in home markets where the mother institutions of Romania’s main banks operate suggests a local improvement is not on the near-term radar.

The negotiations for a new precautionary arrangement with the IMF should start in June, and given the authorities’ strong verbal commitment to a new deal, we would guess that a sudden end to the IMF relationships would surprise most market participants.

However, there are growing chances for such an outcome as some early deadlines agreed in the last letter of intent (leaked in the local press) have been apparently missed and the April 5% gas price hike was postponed. We have previously said that a partial completion of the targets agreed with the Fund should provide a favourable negotiation starting point and stick to this view, but the current lack of clear progress is worrying.

Source: NBR, ING estimates


81


Real wage growth (% YoY, 3m-mav)

Real wage growth in private sector nears decade low

-10

-5

0

5

10

15

20

Jan

02

Jan

03

Jan

04

Jan

05

Jan

06

Jan

07

Jan

08

Jan

09

Jan

10

Jan

11

Jan

12

Jan

13

Total Private sector

Private sector real wage growth has dropped to -3.3% in Jan and 2013 is on track to be the first year since the beginning of the crisis to post negative real growth. The government has awarded several pay hikes for civil servants, pushing their real wage growth beyond 10%. This is one of the fastest paces since 2009, but as past wage hikes suggest, this should not necessarily improve the consumption trend. The reparative hikes that followed the 2010 +25% wage cuts did not bring visibly stronger consumption as a good part of theincome increase looks to have been used to deleverage. Consumer sentiment corrected the bout of optimism seen last spring after the government change and the lack of game-changing actions by the policymakers should fuel more disappointment.

Source: Source: INS, ING Estimates

Inflation dynamics (%YoY)

Rate cut hopes are rising

0

1

2

3

4

5

6

7

Jan 12 Apr 12 Aug 12 Dec 12 Apr 13 Aug 13 Dec 13

CPI CORE3 NBR target

ING f'cast

The last rate-cutting cycle was cut short in May 2012 (after 100bp of cuts to 5.25%) as financial stability concerns overshadowed the weak growth picture. The twin threat of Greek concerns and domestic political uncertainties drove 5Y CDS towards 500 by June, but these have now turned; 5Y CDS is a touch below 215, and NBR finds the near-term inflation outlook favourable. This has allowed the NBR governor to say that the next rate move will be a cut, but wouldnot come soon as inflation expectations are elevated. We guess this is hinting towards 2H13, when volatile food price deflation should drive inflation lower. While keeping this risk scenario in mind, we stick to our view of no change for this year, as we currently believe 2013 will see another inflation target miss.


CDS vs treasury deposits (eop)

Striking a new IMF deal – a difficult mission

0

100

200

300

400

500

600

700

Dec-08 Dec-09 Dec-10 Dec-11 Dec-12

0

5

10

15

20

25

30

35

Treasury deposits (RONbn) CDS (bps, LHS)

The last IMF mission to visit Romania left in Jan after agreeing to extend the ongoing arrangement from Mar to Jun due to a lack of progress. The letter of intent picked up anonymously by the local press showed most of the corrective actions needed for a successful review were achievable, focusing on SOE reform and arrears reduction. Some actions were introduced with a delay (healthcare copayments started in Apr, not Mar), others are late (private management should have been installed by Mar for Romgaz and Hidroelectrica), while one action has been skipped (Apr should have brought a 5% corporate gas price increase). While there is still time for adjustments, market participants may soon start pricing in growing chances of an end to the streak of IMF arrangements.

Source: INS, Reuters, ING estimates

Current share of seats in parliament

The governing alliance: a difficult connection

38% 13% 11%

3%5%

30%

0%

10%

20%

30%

40%

50%

60%

70%

USL PDL PPDD UDRM Otherminorities

PSD

PNL

It is hard to see a government alliance spanning from centre-left to centre-right as a lasting construction. Being the two largest parties (together holding almost 70% of the MPs), this is still the best current option for a majority. With no political hurdle on the near-term radar (presidential elections will be organised probably in Dec 2014), the alliance still holds, but there are visibly growing rifts between the socialists and liberals. Their working relationships have been dented by what looks like minute issues – after the recent nomination by thesocialists leader (and PM) of the head of the National Anticorruption Directorate, the liberal leader said they could consider leaving the alliance. A more difficult test, like maybe failed talks with the Fund, could permanently split this unusual alliance.

Source: Chamber of Deputies, ING estimates #



82

Romania FX/MONEY MARKETS/DEBT STRATEGY LC Ratings (M/S&P/F): Baa3/BB+/BBB


FX/money markets strategy

4.0

4.1

4.2

4.3

4.4

4.5

4.6

4.7


ING f'cast Mkt fwd


Bond and money market yields spread (ppt)

Most domestic signs point to a weakening RON, but the current risk-friendly environment, interest rate differentials and traditional FX interventions constrain our bias to only buy EUR/RON on dips during the summer, with a 2 to 3-month trade horizon. Still, difficult negotiations for a successor for SBA, a persisting soft growth outlook, improving liquidity, a shaky political scene and ING’s house view of a firmer USD suggest the RON is biased to the soft side. Originally, the domestic debt index inclusion news in January converted us to optimists; justifying our forecast of the RON firming to 4.30/EUR by year-end, in what would be the first year of gains since 2007. But with most of the index inclusion hype behind us, and some of its impact curbed by FX interventions, downside risks to our RON view have increased somewhat. We now expect it could temporarily move close to 4.50/EUR during the summer. The June negotiations for a successor SBA look like the biggest hurdle, but early signs of reform fatigue could weigh on the RON before the summer. We reluctantly stick to the view that another deal will be reached and expect that the alternative could put some limited pressure on the RON as the improved investors’ perception visible in Romania’s CDS trajectory, helped by strong FX reserves and growing fiscal buffers, should limit large moves. A rating upgrade remains the largest positive risk, but its chances look limited by the unstable political scene.



4.50es

4.53 4.67 4.91

2.78

0.790.26

3.15

5.12

0

1

2

3

4

5

6

RO HU PL CZ

3M (spread vs EURIBOR) 5Y(spread vs 10Y DE)

- - - -

Source: Reuters, ING estimates

Local curve (%)

Debt strategy

3.8

4.3

4.8

5.3

5.8

3m 6m 3Y 5YNow -3 Months +3 Months


Share of non-resident RON debt holdings (%)

We missed the entry point in the domestic debt rally induced by the index inclusion of Jan, but the MinFin’s strong appetite for funding provided a correction and opportunity for us to highlight that the 3-5-year segment could move from 5.7-5.8% towards 5.3%. Apart from the index news, our call was mainly based on prospects of slowing debt supply. Now the 3-5Y trades 5.0-5.1% and this argument still holds: after 1Q13, the public debt managers had already covered almost 40% of projected financing needs. Moreover, since Feb, the NBR has turned visibly more dovish and the liquidity picture is on a much stronger improving trend than we had anticipated, making us bump our targets for the 3-5Y segment to 4.8%. For the moment, we do not think a rate cut is likely, believing the food-driven disinflation of 2H13 will be softer than the NBR projects, expecting it to miss the inflation target. Still, it may allow an easing of monetary conditions by allowing short-term rates to drift well below the key rate when the bank turns into a net debtor position, a change that looks to be on the near-term radar. The operations of the treasury are bound to improve the liquidity picture; it plans to finance the fiscal gap with both RON and FX funding, so liquidity injected by running a fiscal gap will be larger than the liquidity taken from the market through domestic net debt issuance.


Entry date Entry level Exit level S/L4

8

12

16

20

Sep 10 Dec 10 May 11 Sep 11 Jan 12 May 12 Sep 12 Jan 13

Long 3Y-5Y ROM GB 07-Feb 5.7% 4.8% 5.3%

Source: MinFin, ING estimates

#


83

W

Romania

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012E 2013F 2014F 2015F

Activity Real GDP (%YoY) 5.3 8.5 4.1 7.9 6.3 7.4 -6.6 -1.2 2.2 0.7 1.6 2.0 3.0Private consumption (%YoY) 8.3 15.8 10.0 12.9 12.0 9.2 -10.5 -0.2 1.2 0.9 0.6 1.4 1.6Government consumption (%YoY) 10.5 -9.9 2.2 -11.8 2.7 6.8 9.5 -13.6 0.3 2.3 2.5 1.2 1.5Investment (%YoY) 8.7 11.0 15.3 19.9 30.3 15.8 -28.0 -2.0 7.3 5.0 1.6 7.8 5.5Industrial production (%YoY) -0.8 1.5 -2.9 9.9 10.0 2.6 -5.4 4.8 7.6 2.8 3.4 4.5 6.0Unemployment rate year-end (%) 6.8 8.0 7.2 7.3 6.4 5.8 6.9 7.3 7.4 6.8 6.7 6.6 6.4Nominal GDP (RONbn) 197 247 289 345 416 515 501 524 557 587 620 670 730Nominal GDP (€bn) 53 61 80 98 125 140 118 124 131 132 141 155 170Nominal GDP (US$bn) 60 76 99 123 171 206 165 165 183 170 180 189 212GDP per capita (US$) 2,414 2,811 3,682 4,525 5,780 6,492 5,501 5,796 6,135 6,900 7,400 8,200 8,900Gross domestic saving (% of GDP) 14.5 14.7 13.1 14.4 17.1 18.2 19.3 19.8 21.6 21.9 23.8 23.2 22.7Lending to corporates/households (% of GDP) 15.3 16.6 20.7 26.8 35.6 38.5 39.9 40.0 40.1 38.4 35.7 34.0 35.5


Fiscal balance (% of GDP) Consolidated government balance (ESA 95) -1.5 -1.2 -1.2 -2.2 -2.9 -5.7 -9.0 -6.8 -5.6 -2.9 -3.0 -2.9 -2.7Consolidated primary balance 0.1 0.2 0.1 -1.4 -2.2 -5.0 -7.5 -5.3 -4.1 -1.1 -0.9 -1.0 -0.9Total public debt (ESA 95) 21.5 18.7 15.8 12.4 12.8 13.4 23.6 30.5 34.7 37.8 38.0 40.3 42.1

External balance Exports (€bn) 15.6 18.9 22.3 25.9 29.5 33.7 29.1 37.4 45.3 45.0 46.4 48.5 50.9Imports (€bn) 21.2 26.3 30.1 37.6 47.4 52.8 36.0 44.9 52.7 52.4 53.1 56.1 60.0Trade balance (€bn) -5.6 -7.3 -7.8 -11.8 -17.9 -19.1 -6.9 -7.6 -7.4 -7.3 -6.7 -7.6 -9.1Trade balance (% of GDP) -10.6 -12.0 -9.8 -12.0 -14.3 -13.7 -5.8 -6.1 -5.6 -5.5 -4.8 -4.9 -5.3Current account balance (€bn) -3.1 -5.1 -6.9 -10.2 -16.7 -16.2 -4.9 -5.5 -5.9 -5.0 -4.4 -5.1 -6.6Current account balance (% of GDP) -5.9 -8.4 -8.6 -10.4 -13.4 -11.6 -4.2 -4.4 -4.5 -3.8 -3.1 -3.3 -3.9Net FDI (€bn) 1.9 5.1 5.2 9.1 7.2 9.5 3.5 2.2 1.8 1.6 1.6 1.8 2.1Net FDI (% of GDP) 3.6 8.4 6.5 9.3 5.8 6.8 3.0 1.8 1.4 1.2 1.1 1.2 1.2Current account balance plus FDI (% of GDP) -2.3 0.0 -2.1 -1.1 -7.6 -4.8 -1.2 -2.6 -3.1 -2.6 -2.0 -2.1 -2.7Foreign exchange reserves ex gold, (€bn) 6.4 10.8 16.8 21.3 25.3 26.2 28.3 32.4 33.2 31.2 31.0 29.5 31.4Import cover (months of merchandise imports) 3.6 4.9 6.7 6.8 6.4 6.0 9.4 8.7 7.6 7.2 7.0 6.3 6.3


Interest & exchange rates Central bank key rate (%) year-end 21.25 17.00 7.50 8.75 7.50 10.25 8.00 6.25 6.00 5.25 5.25 5.25 5.25Broad money supply (avg, %YoY) 23.3 37.1 36.5 28.1 34.0 17.3 8.3 6.1 6.3 4.6 7.4 6.3 7.13-mth interest rate (Robor, avg %) 19.9 20.7 9.8 8.8 7.8 13.0 11.7 6.7 5.8 5.3 4.8 4.5 5.03-mth interest rate spread over Euribor (ppt) 1754 1863 766 569 351 840 1050 593 443 477 454 391 4193-year yield (avg %) 14.8 15.5 7.4 7.4 7.6 11.5 11.1 7.4 7.2 6.3 5.1 4.9 5.25-year yield (avg %) n/a n/a 7.3 8.1 7.5 10.6 10.8 7.3 7.3 6.5 5.2 5.0 5.3Exchange rate (USDRON) year-end 3.27 2.93 3.11 2.56 2.47 2.85 2.95 3.20 3.34 3.36 3.58 3.44 3.36Exchange rate (USDRON) annual average 3.32 3.26 2.91 2.81 2.43 2.50 3.04 3.17 3.04 3.47 3.45 3.54 3.44Exchange rate (EURRON) year-end 4.11 3.97 3.68 3.38 3.61 3.99 4.23 4.28 4.32 4.43 4.30 4.30 4.20Exchange rate (EURRON) annual average 3.76 4.05 3.62 3.52 3.34 3.68 4.24 4.21 4.24 4.46 4.39 4.31 4.30


Russia Directional EMEA Economics April 2013

84

Russia Next elections : Parliamentary / Dec-2016

Forecast summary

Country strategy

4Q12 1Q13F 2Q13F 3Q13F 4Q13F 2013F 2014F

Real GDP (%YoY) 2.1 1.3 2.2 3.0 4.1 2.8 3.5HH consumption (%YoY) 5.8 3.4 4.4 5.3 4.7 4.5 5.3Fixed investment (%YoY) 1.4 0.0 2.6 4.3 7.7 4.8 7.3CPI (%YoY)* 6.6 7.0 6.2 5.8 5.7 6.1 6.0Current account (% of GDP) 6.3 8.4 3.2 1.4 2.8 1.4 0.9FX res. import cover (mths) 17.4 16.9 16.5 16.0 15.3 15.3 14.1Policy interest rate (%)* 5.50 5.50 5.00 5.00 5.00 5.00 5.003-mth interest rate (%)* 7.47 7.13 7.20 7.00 6.90 7.00 6.732-year yield (%, zero-cpn)* 6.37 6.00 5.80 5.70 5.70 5.91 5.7010-year yield (%, zero-cpn)* 7.00 7.40 7.00 6.90 6.80 7.02 6.80USD/RUB* 30.53 31.06 31.30 31.90 33.00 31.56 33.10EUR/RUB* 40.27 39.81 40.06 39.88 39.60 40.16 40.34

1Q13 economic weakness has forced us to cut our 2013 GDP call to 2.8%, which still looks more optimistic than MinEco’s updated call of 2.4%. Still, the CPI forecast remains mostly unchanged at marginally below 6% with some upside risk in 2014. Thus, we think our call for a 25-50bp key CBR rate cut looks balanced in terms of GDP/inflation risks. RUB has been doing well before the sell-off since late March, and we expect it to weaken further by year-end on a deteriorating BoP outlook and some other domestic factors. Room for lower policy rates and anattractive OFZ position vs CEE/BRIC peers flags that there might be some extra yield compression in OFZ bonds. Key risks are lower rate cuts, a weaker fiscal outlook (vs MinFin’s -0.6%/GDP) and FX risk.


GDP and key components (YoY)

Macro digest

-22.5%

-15.0%

-7.5%

0.0%

7.5%

15.0%

22.5%

1Q082Q

083Q

084Q

081Q

092Q

093Q

094Q

091Q

102Q

103Q

104Q

101Q

112Q

113Q

114Q

111Q

122Q

123Q

124Q

12

-12%

-8%

-4%

0%

4%

8%

12%

Household consumption Fixed investment

GDP (RHS)

Source: Rosstat, ING

Industrial output, retail sale and investments (YoY)

-30%

-20%

-10%

0%

10%

20%

30%

40%

Jan 07 Nov 07 Oct 08 Aug 09 Jul 10 May 11 Apr 12 Feb 13

Retail sales Fixed capital investmentsIP total IP manufacturing


Unemployment and personal income indicators (YoY)

0%

2%

4%

6%

8%

10%-20%

-10%

0%

10%

20%

Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13

Real wage Real disp. income

Unemployment (inverted, rhs)

The GDP growth slowdown wasn’t a surprise, apart from the scale, atonly 1.1% YoY growth in 1Q13, reflecting dire investment and exports under more resilient private consumption. Still, GDP growth has bottomed out and is set to accelerate to c.2% in 2Q13 and to 3-3.5% in 2H13 on a better global outlook, a rebound in domestic demand and a somewhat stronger oil price from the current US$90/bbl levels. Still, we cut our 2013 call from 3.5% to 2.8% and from 3.8% to 3.5% in 2014.

The goods-producing sector is likely to remain only a small contributor to growth, as in 2012 (+0.5ppt vs 1.5-1.7ppt in 2010-11). A positive is that agriculture will likely reverse its -0.1ppt in 2012 to 0.1-0.2ppt this year due to a 25-30% rise in grains harvest. The mining sector will hardly add much on tight capacity constraints in oil and a poor gas export outlook. Manufacturing will likely follow tepid export deliveries and slower domestic demand (vs 2012). After a calendar/high base-driven fall in IP in 2M13, there was relief in Mar-13, but the outlook remains challenging, with the PMI and similar IEP poll flagging low output and demand ahead, tight inventory management under marginal staff adjustments and only subdued hunger for price hikes. Investment plans have become marginally positive after a recessionary 4Q12, which flags some growth ahead, but still well below average at 8% YoY in 2010-1H12. The latter would be a result of nearly flat profit growth in 2013, fragile demand, a falling role of bank loans in funding capex and limited room for an extra fiscal boost to investments. Recall that in 2012 of the 3.8% nominal capex growth of big & medium companies (70% of total) 5.3ppt and 0.5/0.6ppt was from own funds and bank/non-bank loans vs -0.5ppt from fiscal side and -2.1ppt from other sources. Thus, we cut our investment call from 6.4% to 4.8% in 2013, while still pencilling in a rebound to 7.3% in 2014 on a better macro story.

Private consumption still looks more secured on low unemployment, 25-30%YoY retail lending, a lower CPI in 2H13-1H14 and positive real wage growth. Yet, we see the latter at 4-4.5% in 2013 vs 8% due to lower private sector wage hikes (its adding to nominal wage growth was nearly flat at 10ppt since 2011, now falling to high single-digits) and an only 10-15% rise in public wages vs c.30% last year. Our moderate optimism is mostly backed by a healthier above-50 PMI services gauge and a 1Q13 rise in consumer confidence (-7 vs -8) across all key components including readiness to durable purchases.

Net exports will likely be a drag on growth again due to outperforming import growth vs exports. Another worry is zero-adding from public consumption, with only the positives of rising budget outlays seen via a pass-through of public wages/pension hikes to incomes. And this below-one public spending multiplier is the biggest task to address.



85

Activity: Monetary trend : Looser Fiscal trend : Looser [email protected]

Inflation and real interest MM rates (YoY)

Inflation will likely subside, but for how long?

-10%-5%0%5%

10%15%20%25%

Jan 07 Nov 07 Oct 08 Sep 09 Aug 10 Jul 11 Jun 12 May 13

Headline CPICore CPIFood CPIReal interest rate (3M vs 12M ahead CPI)

The CPI fell from 7.3% to 7.0% in Mar-13 on lower food/services inflation,with the core CPI down to 5.7%. Services CPI will remain at 7.5-8% on the July utilities tariffs hike. Under unchanged (vs Jul-12) rise in gas/heating, consumers’ electricity bill will add 12-15% with similar YoY gains for producers. This will only widen the gap between core manufacturers (2.5% since Jan-12) and oil, gasoline, and utilities inflation (15%, 4%, 6%), either forcing PPI hikes or killing profits (-17% YoY in Jan-13) or/and investments even under lower energy inflation ahead. The non-food/core CPI will likely be benign under low M2 and GDP growth. The key hope is on lower grains/food prices under the 25-30% rise in grains harvest, but we don’t envisage as sharp a drop as in 2010-11. So, we see CPI down to 5.7% in 2013 before up to 6.4% in 2014.

Source: Rosstat, CBR, Bloomberg


Capital flight still looks (ir)reversable

-60

-30

0

30

60

90

120

1Q07

3Q07

1Q08

3Q08

1Q09

3Q09

1Q10

3Q10

1Q11

3Q11

1Q12

3Q12

1Q13

4Q -rolling

-300

-250

-200

-150

-100

-50

0

Current accnt Net PI Net FDI Current accnt, non-energy (RHS)

US$28bn C/A surplus in 1Q13 was a plus for external balances, but still accompanied by a huge (and rising on a 4Q-basis) non-energy C/A gap at US$58bn. This is the first reminder of high RUB fragility. The second is owed to continuing capital flight (US$26bn vs US$8bn in 4Q13, US$54bn in 2012). The Rosneft/TNK-BP deal did distort the figure sharply, but US$9bn left the country via a “Doubtful deals” line, ie, as much as on avg. in 1Q11-4Q12. Assuming US$105-110/bbl Urals price, the C/A should reach US$7.5-10bn in 2Q13-3Q13. We have also downgraded our capital flight call from US$20-25bn to US$35-40bn on 1Q13 data, non-improving net FDI and limited upside in portfolio inflows. The Cyprus issue does not look like a game-changer, but still may add extra pain given its offshore status.

Source: CBR

Federal budget performance (% of GDP)

Fiscal story may see some headwinds from regions

-4%

-2%

0%

2%

4%


2013 YTD 2011 20122013 plan 2011 plan 2012 plan

1Q13 budget dynamics were similar to 1Q12, with a big gap in Feb and a correction in March (to -0.9%/GDP in 1Q13). Key reasonswere a faster spending pace (24.2% of annual plan vs 23.6% in 1Q12) but also slower non-oil & gas income growth on weaker GDP,personal income and corp. profits. The MinFin upgraded the federal budget gap call from -0.8%/GDP to -0.6% on new macro and oil assumptions (US$105/bbl oil vs US$97/bbl now). We see it close to -1.0%/GDP, complicating the MinFin’s task of seeking RUB500bn for extra outlay. This would argue for a bigger privatisation agenda. Another fiscal risk stems from the regional coffers facing weakening incomes/profits tax intake (50% of total revenues). If confirmed, this would imply a higher – but already stretched – federal budget transfer.

Source: MinFin, ING

What president should Putin be focused on?

More anti-corruption fight in the paternalistic country

Apr-06 Mar-08 Mar-12 Mar-13

GDP growth 73 59 59 53

Anti-corruption drive - 35 46 46

Establish order 55 43 42 42

Social equality, income growth 62 53 44 39

Compliance with law - 30 28 28

Science, education, culture 31 23 21 23

Crime control 39 28 23 23

Higher defence capability 24 14 19 20

Stonger geopolitical weight 19 16 18 15

Religious development 17 11 13 10

Personal freedom, democracy 13 10 12 9

Environment 16 10 7 7

Interethnic issues 12 8 8 6

Property right, economic freedom 7 5 7 5

There have always been strong calls for properly-working institutions in Russia and the importance of low corruption as a key factor for stronger growth (eg, zero public adding to GDP), low inflation (unfortunately, corruption is out of CBR’s control) and a more stable RUB (the corruption-driven item of capital flight looks huge). It seems the general populace is becoming more concerned about the issue, with corruption being set as a top-2 priority for Mr. Putin right after GDP growth. The third priority of establishing order is simply another representation. The state’s anti-corruption drive did firm up recently (top-level accusations, a law on foreign property/deposits ban for top-state employees). Well done! But it risks being just for show, as the importance of democracy & personal/economic freedom has not been fully recognised.

Source: Levada Centre polling agency #



86

Russia FX / MONEY MARKETS / DEBT STRATEGY LC Ratings (M/S&P/F): Baa1/BBB/BBB


FX / Money Markets Strategy

27

28

29

30

31

32

33

34


ING f'cast Mkt fwd

Source: Bloomberg, ING

Real RUB exchange rate vs imports (index, Dec-03=1)

It seems investors have been neutral-to-positive on the RUB since 4Q12 on the back of the OFZ rally and bets on supportive seasonality. But falling oil and a fragile risk appetite has recently seen the RUB underperforming major commodity/EM currencies. We see risks of further cuts/unwinding of RUB-longs ahead as: (1) RUB fundamental story will start deteriorating from 2Q13 onwards; (2) OFZ-driven inflow may be limited as the CBR saw foreign share in OFZs already at 20% vs sub-10% in 2012; (3) the RUB trades at all-time highs in REER terms; (4) the MinFin plans to buy FX for the Reserve Fund directly on the market in 2H13; (5) ING keeps its 1.20 year-end EUR/USD call; and (5) bets on front-loaded CBR rate cuts remain. Under Putin’s nominee Nabiullina, the CBR will continue to shift toward inflation targeting, but with an eye on growth. After Duma’s approval, she said current rates leave room for manoeuvre if GDP slows, unemployment rises and the state addresses the utilities tariff issue. She flagged that flexible RUB and CBR policy consistency are also worth pursuing, with an enhancement of the current refinancing tools being a priority (eg, floating-rate longer-term loans, FX-swap auctions, REPO basket). So, given all this and our updated GDP/CPI projections, we still expect 25-50bp key rate cuts from June at the earliest, even though chances for a first move as early as in May have risen. The current April tax period may also give a better entry point in a long USD/RUB trade from 31.30-31.50/USD levels.



1.01.11.21.31.41.51.61.71.81.92.0

Dec 0

3

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4

Oct 0

5

Sep 0

6

Aug 0

7

Jul 0

8

Jun

09

May

10

Apr 1

1

Mar

12

Mar

13

1.01.21.41.61.82.02.22.42.62.83.0

RUB/USD RUB/€

RUB effective Import, SA (RHS)

Stronger RUB

1.01.11.21.31.41.51.61.71.81.92.0

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3

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8

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09

May

10

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1

Mar

12

Mar

13

1.01.21.41.61.82.02.22.42.62.83.0

RUB/USD RUB/€

RUB effective Import, SA (RHS)

Stronger RUB

Long USD/RUB long 19-Apr 31.50 32.50 30.95

Source: Bloomberg, CBR, ING

Local curve (%)

Debt Strategy

5

6

7

8

3m 6m 2Y 10Y



Yields metrics on 10Y local sovereign bonds

We see room for further MM rate tightening in 2Q13 on technical factors. As the 3m-MosPrime rate lost its “prime” status after the exit of key foreign banks (ING is still in) and entry of a local name (with talks on inclusion of more locals), it added 15bp even despite stronger expectations of policy easing. As key MM-derivatives (eg FRA, IRS) are linked to the 3m-MosPrime, liquidity deteriorated for these instruments, increasing even the risk of manipulation (many local banks link actual corporate loan rates to 3M MosPrime). This newfeature of the MM markets act as a strong constraint to any trade recommendations – at least in the short-term. Also, FRAs already price in up to 50bp rate cuts by year-end. In OFZs, the curve has already flattened after a record steepening in late March-early April (2Y-14Y at120bp vs 140bp then). But we believe there might be room for further flattening as we approach 2H13. Indeed and relative to CEE/BRICS peers: (1) the 10Y yield at c.7% is still one of the most attractive in the region; (2) there is room for significant policy easing in Russia vs EM peers; (3) after the recent RUB weakening, the FX-unhedged yield vs the 50%/50% USD/EUR basket of c.6% lags behind only those in Mexico, Brazil and S.Africa, which all have 10%+ figures; and (4) with around 1.0-1.1% real yield (based on INGF for 2013 CPI) it looks comparable with Poland, Mexico, Romania and well above negative prints for Czech and Turkey. On the curve, we like 10Y OFZ 26211, but we look for better entry levels. Key risks are weak 2013 fiscal performance, lower-than-expected rate cuts and a much weaker RUB.



-4

0

4

8

12

16

Czech

China

Poland

Mex

ico

Roman

ia

Hunga

ry

S.Afri

ca

Russia

Turke

yIn

dia

Brazil

Real yield (2013 CPI)Nominal yieldFX-adj. yield (under INGF vs equal-weight USD&EUR basket)

Buy 10Y RFLB 23 19-Apr 6.87% 6.70% 7.11%

Source: Bloomberg, ING estimates.

#


87

Russia

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012E 2013F 2014F 2015F

Activity Real GDP (%YoY) 7.3 7.2 6.4 8.2 8.5 5.2 -7.8 4.5 4.3 3.4 2.8 3.5 3.2Private consumption (%YoY) 7.7 12.5 12.2 12.2 14.3 10.6 -5.1 5.5 6.4 6.8 4.5 5.3 5.0Government consumption (%YoY) 2.4 2.1 1.4 2.3 2.7 3.4 -0.6 -1.5 0.8 -0.2 0.1 0.5 0.5Investment (%YoY) 13.9 12.6 10.6 18.0 21.0 10.6 -14.4 5.9 10.2 6.0 4.8 7.3 7.0Industrial production (%YoY) 8.9 8.0 5.1 6.3 6.8 0.6 -9.3 8.2 4.7 2.6 2.0 2.6 2.5Unemployment rate year-end (%) 8.6 8.3 7.7 6.9 6.1 7.8 8.0 7.0 6.0 5.1 5.1 5.1 5.0Nominal GDP (RUBbn) 13,208 17,027 21,610 26,917 33,248 41,277 38,807 46,309 55,800 62,599 66,489 73,011 79,940Nominal GDP (€bn) 380 475 614 788 948 1129 876 1150 1363 1568 1656 1810 1903Nominal GDP (US$bn) 430 591 764 990 1300 1661 1222 1525 1898 2016 2107 2206 2379GDP per capita (US$) 2,978 4,110 5,337 6,954 9,153 11,695 8,547 10,670 13,284 14,071 14,734 15,447 16,673Gross domestic saving (% of GDP) 31.4 32.6 33.2 33.8 33.9 33.3 24.6 29.8 32.9 32.2 30.3 30.7 29.5Lending to corporates/households (% of GDP) 19.7 22.4 24.8 30.4 37.6 40.8 42.4 40.2 42.9 45.8 50.6 53.7 61.0


Fiscal balance (% of GDP) Consolidated government balance 1.3 4.5 8.1 8.4 6.0 4.9 -6.3 -3.4 1.5 0.4 -1.2 -1.0 -0.7Consolidated primary balance 3.1 5.8 9.2 9.1 6.6 5.3 -5.6 -2.9 2.8 1.0 -0.5 -0.2 0.0Total public debt 31.2 23.2 14.2 9.0 7.2 6.5 8.3 9.3 9.8 12.0 12.9 13.7 14.3

External balance Exports (US$) 135.9 183.2 243.8 303.6 354.4 471.6 303.4 400.6 522.0 529.3 519.2 546.4 565.2Imports (US$) 76.1 97.4 125.4 164.3 223.5 291.9 191.8 248.6 323.8 335.4 360.6 385.4 389.7Trade balance (US$) 59.9 85.8 118.4 139.3 130.9 179.7 111.6 152.0 198.2 193.8 158.6 161.0 175.5Trade balance (% of GDP) 13.9 14.5 15.5 14.1 10.1 10.8 9.1 10.0 10.4 9.6 7.5 7.3 7.4Current account balance (US$) 35.4 59.5 84.6 94.7 77.8 103.5 48.6 71.1 98.8 74.8 30.3 20.9 28.4Current account balance (% of GDP) 8.2 10.1 11.1 9.6 6.0 6.2 4.0 4.7 5.2 3.7 1.4 0.9 1.2Net FDI (US$) -1.7 1.5 -1.5 6.6 9.2 19.4 -7.2 -9.2 -11.8 0.4 -18.4 -2.8 1.5Net FDI (% of GDP) -0.4 0.3 -0.2 0.7 0.7 1.2 -0.6 -0.6 -0.6 0.0 -0.9 -0.1 0.1Current account balance plus FDI (% of GDP) 7.8 10.3 10.9 10.2 6.7 7.4 3.4 4.1 4.6 3.7 0.6 0.8 1.3Foreign exchange reserves ex gold, (US$) 73.2 120.8 175.9 295.6 465.9 412.5 416.7 443.0 454.0 486.6 459.3 453.9 468.5Import cover (months of merchandise imports) 11.5 14.9 16.8 21.6 25.0 17.0 26.1 21.4 16.8 17.4 15.3 14.1 14.4

Debt indicators Gross external debt (US$) 185.7 213.5 257.2 313.2 463.9 480.5 471.6 488.9 538.8 631.8 681.5 736.9 792.9Gross external debt (% of GDP) 43 36 34 32 36 29 39 32 28 31 32 33 33Gross external debt (% of exports) 137 117 105 103 131 102 155 122 103 119 131 135 140Total debt service (US$) 21.0 46.8 64.2 65.5 49.4 88.0 126.2 139.8 158.5 181.0 100.0 66.0 70.0Total debt service (% of GDP) 4.9 7.9 8.4 6.6 3.8 5.3 10.3 9.2 8.4 9.0 4.7 3.0 2.9Total debt service (% of exports) 15.4 25.5 26.3 21.6 13.9 18.7 41.6 34.9 30.4 34.2 19.3 12.1 12.4

Interest & exchange rates Central bank key rate (%) year-end (refi rate) n/a n/a n/a n/a n/a n/a 6.00 5.00 5.25 5.50 5.00 5.00 5.00Broad money supply (avg, %YoY) 51.0 35.8 38.6 48.8 47.5 1.7 16.3 28.5 21.5 15.0 16.0 15.0 15.03-mth interest rate (Mosprime, avg %) 5.4 3.6 4.9 5.2 5.6 11.1 11.5 4.1 5.5 7.1 7.0 6.7 6.63-mth interest rate spread over US$-Libor (ppt) 416 198 134 1 28 819 1083 372 516 672 668 620 5892-year yield (avg %, zero-coupon terms) 7.0 5.4 6.0 6.0 6.0 7.5 9.3 5.9 6.7 6.9 5.9 5.7 5.710-year yield (avg %, zero coupons terms) 8.7 7.2 7.8 6.7 6.5 7.6 11.2 7.6 8.6 8.2 7.0 6.8 6.7Exchange rate (USDRUB) year-end 29.24 27.72 28.74 26.33 24.54 29.38 30.24 30.54 32.14 30.53 33.00 33.50 33.90Exchange rate (USDRUB) annual average 30.68 28.81 28.30 27.18 25.58 24.85 31.77 30.37 29.41 31.06 31.56 33.10 33.60Exchange rate (EURRUB) year-end 36.80 37.58 34.03 34.74 35.80 41.07 43.30 40.85 41.60 40.27 39.60 41.88 42.38Exchange rate (EURRUB) annual average 34.74 35.83 35.21 34.15 35.06 36.56 44.30 40.28 40.94 39.93 40.16 40.34 42.00


Serbia Directional EMEA Economics April 2013

88

Serbia [email protected]

Forecast summary

Country strategy

4Q12 1Q13F 2Q13F 3Q13F 4Q13F 2013F 2014F

Real GDP (%YoY) -2.0 -0.8 1.2 1.4 2.3 1.1 3.2HH consumption (%YoY) -2.1 -2.7 -1.6 -0.3 1.3 -0.8 1.4Fixed investment (%YoY) -15.9 8.2 -1.7 15.4 21.1 10.7 20.2CPI (%YoY)* 12.2 12.5 6.9 2.0 4.6 7.3 6.5Current account (% of GDP) -8.5 -12.0 -6.9 -6.7 -14.8 -10.1 -8.9FX res. import cover (mths) 8.5 9.3 9.2 8.6 8.5 8.5 8.6Policy interest rate (%)* 11.25 11.75 11.75 10.25 9.50 9.50 8.503-mth interest rate (%)* 11.25 10.20 10.60 9.20 8.50 9.62 9.032-year yield (%)* 12.86 14.06 14.51 13.01 12.31 13.63 12.835-year yield (%)* n/a 15.07 15.57 14.07 13.37 14.48 13.89USDRSD* 85.11 86.84 87.89 90.40 94.17 88.28 91.58EURRSD* 112.30 111.31 112.50 113.00 113.00 112.36 111.61

2012 real GDP growth disappointed, down 2% on poor harvest. 2013 should see a return to positive territory, but our 1.1% forecast puts officials’ 2% on an optimistic foot. Their 3.6% GDP budget gap target will likely be a miss, while the CA gap should stay flat at 10% GDP despite a boost in car exports. But the government’s commitment to restructuring has proven commendable so far, and the benign global liquidity backdrop has allowed for easing of financing pressures in 1Q13. Unfortunately, this also means stickier FX debt levels and a less likely anchoring to the IMF in the short term (mission in May). But officials seem committed to negotiations, as with Kosovo, despite recent bumps and cosiness with Russia.


Fiscal dynamics (% of GDP)

Looking for cash, and getting some

-8

-6

-4

-2

0

2

4

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

0

10

20

30

40

50

60

70

Consolidated budget balance Primary balance

Public debt (RHS, inverted)

ING f'cast

Serbian authorities have launched a rather successful funding search in 1Q13, which lessens the imminence of an IMF deal. EBRD confirmed its intent to provide EUR625m by year-end and EIB announced EUR500m to FSA (FIAT JV). On the foreign government side, in its search to find new originators, Serbia secured a US$400m loan with the UAE, also raising interest for a 49% stake in struggling JAT Airways. Relationships with Russia warmed further, with a US$500m loan signed off to support the 2013 budget, on top of the Jan US$800m loan, and a gas contract (good news for FDIs, CPI). With US$1.5bn raised with Feb Eurobond, Serbia’s financing looks better in the short term, which is supportive for the RSD. But this will imply sticky debt levels for 2013 and maybe heightened FX risks in the mid term (vs US$ denomination).

Source: Serbia Ministry of Finance, ING estimates

CPI vs policy rate

Monetary standstill at last, but no easing yet

0

4

8

12

16

20

Jan

03

Jan

04

Jan

05

Jan

06

Jan

07

Jan

08

Jan

09

Jan

10

Jan

11

Jan

12

Jan

13

Jan

14

Jan

15

0

3

6

9

12

15

18

CPI (%, YoY) Policy rate (%, RHS)

ING f'cast

Inflation remained stubbornly high at the turn of the year, with CPI at 12.4% in Feb, on the back of adverse base effects, gas price hikes(+10.4% over Jan-Feb) and limited food disinflation. Further administrative prices hikes in the pipeline for 2Q13 (electricity, tobacco/alcohol) should keep inflation in double digits and thus the NBS in a wait-and-see mode, having halted a 9-month 225bp hiking cycle in Feb. But strong favourable base effects, a moderate nominal trade weighted RSD appreciation and benign global food prices environment should allow the CPI to dive down in 2H13 inside the 4% +/- 1.5% band and allow the NBS to act significantly in 2H13, given the lacklustre demand-pull pressures (negative real household consumption growth in 2013).


Current account and RSD

CA gap still large, but easier financing

In spite of the FIAT export boost and higher income balance, stronger import growth on rebounding consumption should keep the CA gap flat at 10% of GDP in 2013. Better FDI and portfolio entries, however, should ease structural pressures on the RSD. But given the fiscal stance and always potential political noise, it would be nice to have a stronger official commitment to FX reserves building.



-24-18-12-606

12182430

Dec 0

2

Dec 0

3

Dec 0

4

Dec 0

5

Dec 0

6

Dec 0

7

Dec 0

8

Dec 0

9

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0

Dec 1

1

Dec 1

2

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3

Dec 1

4

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5

-25

-20

-15

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0

Trade-weighted RSD (% YoY) CA (% of GDP, RHS)

ING f'cast

Buy 53W T-bills* 21-May <9.40% (mid) 8.50% 9.60%

Source: EcoWin, ING estimates *hedged


Serbia Directional EMEA Economics April 2013

89

Serbia

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012E 2013F 2014F 2015F

Activity Real GDP (%YoY) 2.6 9.2 5.4 3.6 5.3 3.8 -3.5 1.1 1.7 -1.9 1.1 3.2 4.1Private consumption (%YoY) n/a 7.4 6.5 5.9 7.8 6.9 -2.7 -1.0 -1.2 -2.0 -0.8 1.4 3.4Government consumption (%YoY) n/a -0.6 3.3 2.4 12.6 5.7 -1.8 0.4 1.0 1.9 -0.5 -0.1 1.4Investment (%YoY) n/a 24.8 3.3 18.0 31.5 10.3 -21.9 -6.1 8.0 -2.5 10.7 20.2 10.7Industrial production (%YoY) -2.9 6.5 0.6 4.3 4.4 1.7 -12.7 2.9 2.3 -3.3 2.0 3.0 2.9Unemployment rate year-end (%) 14.6 18.5 20.8 20.9 18.1 13.6 16.1 19.2 23.0 25.7 25.6 25.3 25.0Nominal GDP (RSDbn) 1,126 1,381 1,683 1,962 2,277 2,661 2,720 2,882 3,209 3,386 3,628 3,964 4,305Nominal GDP (€bn) 17 19 20 23 28 32 29 28 31 30 32 36 39Nominal GDP (US$bn) 20 24 25 29 39 48 40 37 44 39 41 43 49GDP per capita (US$) 2,624 3,163 3,370 3,978 5,317 6,546 5,533 5,086 6,103 5,135 5,393 5,649 6,371Gross domestic saving (% of GDP) 1.0 4.2 4.1 2.7 -0.6 -2.9 -3.8 -2.0 0.3 -0.3 1.5 3.4 4.4Lending to corporates/households (% of GDP) n/a 23.6 29.5 29.9 35.5 41.0 45.7 54.5 51.9 53.8 55.4 57.0 58.4


Fiscal balance (% of GDP) Consolidated government balance (ESA 95) n/a n/a 1.1 -1.5 -2.0 -2.6 -4.5 -4.7 -4.9 -6.4 -4.6 -3.6 -2.2Consolidated primary balance n/a n/a 2.2 0.1 -1.2 -2.0 -3.6 -3.5 -3.5 -4.4 -1.9 -0.9 0.1Total public debt (ESA 95) n/a n/a 50.8 40.0 31.1 26.8 34.4 44.7 47.6 61.4 64.8 61.4 55.7

External balance Exports (€bn) 2.9 3.3 4.0 5.1 6.4 7.4 6.0 7.4 8.4 8.8 9.9 11.5 13.5Imports (€bn) 6.5 8.5 8.3 10.1 13.5 15.9 11.1 12.2 13.8 14.3 15.6 17.6 20.2Trade balance (€bn) -3.5 -5.2 -4.3 -5.0 -7.1 -8.5 -5.1 -4.8 -5.3 -5.4 -5.7 -6.1 -6.7Trade balance (% of GDP) -20.4 -27.4 -21.2 -21.4 -24.8 -26.2 -17.7 -17.1 -16.9 -18.2 -17.8 -17.2 -17.1Current account balance (€bn) -1.3 -2.6 -1.8 -2.4 -5.1 -7.1 -2.1 -2.1 -2.9 -3.2 -3.2 -3.2 -3.4Current account balance (% of GDP) -7.8 -13.8 -8.8 -10.1 -17.7 -21.7 -7.2 -7.4 -9.1 -10.5 -10.1 -8.9 -8.6Net FDI (€bn) 1.2 0.8 1.3 3.3 1.8 1.8 1.4 0.9 1.8 0.2 0.6 0.9 1.3Net FDI (% of GDP) 6.9 4.1 6.2 14.3 6.4 5.6 4.7 3.1 5.8 0.8 1.9 2.5 3.3Current account balance plus FDI (% of GDP) -0.9 -9.7 -2.6 4.2 -11.4 -16.1 -2.5 -4.4 -3.3 -9.8 -8.2 -6.4 -5.3Foreign exchange reserves ex gold, (€bn) 2.7 3.0 4.7 8.8 9.4 7.9 10.3 9.6 11.5 10.1 11.1 12.6 14.4Import cover (months of merchandise imports) 4.9 4.2 6.9 10.5 8.4 6.0 11.1 9.4 10.0 8.5 8.5 8.6 8.5

Debt indicators Gross external debt (€bn) 10.9 9.5 12.2 14.2 17.1 21.1 22.5 23.8 24.1 25.7 26.2 26.6 27.9Gross external debt (% of GDP) 63 50 60 61 60 65 78 85 77 86 81 75 71Gross external debt (% of exports) 370 288 304 278 269 284 376 321 286 292 266 231 207Total debt service (€bn) n/a 0.8 1.4 2.3 3.0 3.5 3.3 3.4 4.1 4.3 4.7 5.4 5.9Total debt service (% of GDP) n/a 4.0 7.0 9.9 10.5 10.7 11.4 12.2 13.1 14.5 14.5 15.2 15.0Total debt service (% of exports) n/a 23.1 35.3 44.9 46.9 46.8 55.3 46.1 48.9 49.2 47.5 46.9 44.1

Interest & exchange rates Central bank key rate (%) year-end 10.63 15.46 15.46 14.00 10.00 17.75 9.50 11.50 9.75 11.25 9.50 8.50 8.00Broad money supply (avg, %YoY) 24.5 15.7 27.2 30.5 42.6 24.9 7.2 2.3 0.7 10.8 1.1 6.5 12.83-mth interest rate (t-bill, avg %) 18.2 21.3 17.2 13.5 6.5 4.9 13.1 10.4 12.4 12.0 9.6 9.0 7.63-mth interest rate spread over Euribor (ppt) 1587 1920 1503 1038 221 30 1188 958 1101 1143 937 844 6772-year yield (avg %) n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a 13.6 12.8 11.45-year yield (avg %) n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a 14.5 13.9 12.5Exchange rate (USDRSD) year-end 54.12 57.94 72.74 60.39 54.91 63.90 66.97 79.20 82.71 85.10 94.17 88.80 87.20Exchange rate (USDRSD) annual average 57.41 58.38 66.93 67.19 58.34 55.68 67.43 77.71 73.25 87.90 88.28 91.58 87.36Exchange rate (EURRSD) year-end 68.12 78.55 86.12 79.69 80.11 89.32 95.87 105.95 107.07 112.28 113.00 111.00 109.00Exchange rate (EURRSD) annual average 65.01 72.63 83.28 84.42 79.97 81.91 94.03 103.08 101.98 113.03 112.36 111.61 109.21


South Africa Directional EMEA Economics April 2013

90

South Africa Next elections : Presidential & Parliamentary / spring-2014

Forecast summary

Country strategy

4Q12 1Q13F 2Q13F 3Q13F 4Q13F 2013F 2014F

Real GDP (%YoY) 2.5 2.4 2.8 2.5 2.7 2.6 3.0HH consumption (%YoY) 3.9 3.0 2.8 3.0 3.4 3.1 4.1Fixed investment (%YoY) 4.7 4.2 6.6 3.0 6.2 5.0 5.6CPI (%YoY)* 5.6 5.7 6.1 6.5 6.5 6.2 5.5Current account (% of GDP) -6.0 -6.9 -6.6 -6.3 -6.6 -6.6 -6.2FX res. import cover (mths) 5.2 5.1 5.1 5.4 5.4 5.2 4.7Policy interest rate (%)* 5.00 5.00 5.00 5.00 5.00 5.00 4.003-mth interest rate (%)* 5.13 5.13 5.10 5.15 5.10 5.10 4.442-year yield (%)* 5.07 5.29 5.30 5.41 5.30 5.18 5.0410-year yield (%)* 6.79 6.82 6.67 6.88 7.40 7.08 7.19USDZAR* 8.45 9.23 9.25 9.00 9.10 9.08 9.05EURZAR* 11.15 11.83 11.84 11.25 10.92 11.56 11.03

The South Africa macro mix is not likely to look better in 2Q13. The funding of the CA gap is set to be even tighter; as the trade balance deteriorates further, inflation should break the 6% threshold earlier than the SARB anticipated in its last statement, and social noise could be re-ignited during the wages negotiation season. Unless the authorities come up with a ground-breaking action plan – a low probability in our view – local assets are likely to underperform EM peers with risks of a rating downgrade hanging like a Damocles sword. Still, it is not all doom and gloom. Industrial production should show signs of revival and BRICS institutionalisation could offer credible anchors for SA in the mid term.


Real GDP trend and employment

Macro digest ES

-4-202468

Mar

-04

Feb-0

5

Jan-

06

Dec-0

6

Nov-0

7

Oct-08

Sep-0

9

Aug-1

0

Jul-1

1

Jun-

12

May

-13

Apr-1

4

Mar

-15

-5

0

5

10

15

Actual real GDP (% YoY) Trend real GDP (% YoY)

Employment (% YoY, RHS)

ING f'cast


Real GDP growth contribution

-6-4-202468

1012

1Q06

3Q06

1Q07

3Q07

1Q08

3Q08

1Q09

3Q09

1Q10

3Q10

1Q11

3Q11

1Q12

3Q12

1Q13

3Q13

-4

-2

0

2

4

6

8

Household consumption Gv't consumptionInvestment ResidualNet Export GDP (% YoY, RHS)

ING f'cast


Budget dynamics, 12m-rolling

-8-6-4-20246

Mar

99

Mar

00

Mar

01

Mar

02

Feb 0

3

Feb 0

4

Feb 0

5

Feb 0

6

Jan

07

Jan

08

Jan

09

Dec 0

9

Dec 1

0

Dec 1

1

Dec 1

2

Nov 1

3

-10-50510152025

Debt services costs (% of GDP) Primary budget (% of GDP)

Revenues % (YoY, RHS) Expenditures (% YoY, RHS)

ING f'cast

Real GDP growth failed to impress in 4Q12, printing a modest 2.5% YoY from 2.3% YoY in 3Q12. Primary sectors (agriculture and mining) were the main drags, amputating 0.2ppt off real GDP YoY growth. This reflected mainly the impact of the strikes, which crippled production over 2H12. The secondary sector recorded 3% growth (from 2.3% YoY in 2Q13), pushed up almost exclusively by utilities, oil-related and transport equipment sectors. The tertiary sector consolidated vs 2Q12 at an uninspiring 2.4% YoY amidst lacklustre domestic demand. On the expenditures side, recovery of household consumption and investment was tepid, reflecting poor sentiment, a persistently high indebtedness ratio, and slowing real disposable income. Related high frequency data so far in 1Q13 did not suggest any significant change in patterns, pointing to a probably flat 1Q13 GDP reading. At this juncture, we consider the treasury’s 2.7% forecast for 2013 a tad optimistic, mainly on its investment and net balance assumptions (CA gap officially seen at 6.2% GDP vs our 6.6% GDP forecast).

The lack of impulse at the GDP growth level did not meet decisive policy actions in the FY13-14 budget statement. Arguably, the fiscal manoeuvre is extremely tight; though the FY12-13 national budget deficit might actually come in lower than discounted in the fiscal plan (set at 5.7% GDP), it will remain above the 5% mark. Officials pencilled in a 5.2% GDP gap in FY13-14, discounting a ZAR7bn income tax relief (vs ZAR9.5bn in FY12-13), but introduced in parallel a string of sin and green taxes hikes. Beyond the limited leeway to boost directly disposable income and private capex, the treasury did not provide more details on economic policy direction: the Youth wage subsidy, the financing of National Security & Retirement Fund and the National Insurance Fund financing, a new tax framework for the mining sector were all critical issues left un-tackled. Also, consolidation (or lack of) presented by the treasury still left the public net loan to GDP ratio climbing above the 40% mark by end-FY15-16, a threshold heralded by many rating agencies as decisive for action. We fear this backdrop of fiscal inertia could face a tougher environment in 2Q13. Not so much due to a risk of authorities yielding to drastically higher wage demand during the seasonal negotiation process (macro pragmatism remain well entrenched within the ANC), but due to a risk of rising social contestation and political infighting –especially with the presidential elections ahead – diverting the government from focusing on laying framework, such as the NDP, to tackle SA structural issues. Unionists, great losers of the ANC December conference, have expectedly emerged on a war-mongering mood in 1Q13 and could prove particularly disruptive.



91

Activity: Monetary trend : Looser Fiscal trend : Tighter [email protected]

SA trade balance main drivers: 2012 “perfect storm”

Little hope for improvement before mid-year

-12

-10

-8

-6

-4

-2

0

Jan

99

Jan

00

Jan

01

Jan

02

Jan

03

Jan

04

Jan

05

Jan

06

Jan

07

Jan

08

Jan

09

Jan

10

Jan

11

Jan

12

Jan

13

0

2

4

6

8

10

12

Manufacturing (% of GDP)

Metals (base and precious, % of GDP, RHS)

4Q12 CA sent shockwaves, with a 6% GDP deficit, from an upwardly revised 6.7% reading the previous quarter. Trade balance widened further, from a 2.5% GDP drag in 3Q12 to 2.8% GDP – burdened by the mining strikes impact. But beyond the ‘cyclical’ culprits on the export side (social noise, core markets weakness), SA trade dynamics are a concern due to the stickiness of its import intake –particularly against a backdrop of a prolonged sluggish domestic demand and weaker trade-weighted ZAR. Some argue a ‘J-curve’ effect implies a rapid import slowdown in the near term. We are not so optimistic considering the country’s critical infrastructure needs (and the electoral agenda). All in all, 2013 trade gap should widen further to 2.9% GDP on our USD/ZAR assumptions.


Portfolio flows funding: a short reprive in 1Q13

Financing should be even tighter in 1Q13

-120

-90

-60

-30

0

30

60

Mar

00

Mar

01

Mar

02

Mar

03

Mar

04

Mar

05

Mar

06

Mar

07

Mar

08

Mar

09

Mar

10

Mar

11

Mar

12

Mar

13

Net purchases of equities and bonds (bn ZAR)Net portfolio flows (bn ZAR)

4Q12 financial account was another bad news. Already structurally weak in the FDI field, SA recorded a 2.2% GDP net outflow in 4Q12, and a broadly nil reading for 2012. Net portfolio flows settled at 1.7% GDP in 2012, just at a tad above their 12-year average, but showed in 4Q12 signs of consolidating. Unsurprisingly, ‘other investments’ and ‘unrecorded transactions’ provided the bulk of the financing – so mostly short-term and versatile capital. This pattern should linger in 1Q13, but with a wider CA gap. Portfolio inflows data have so far this year pointed to a marginally better reading than 1Q13, but their outlook is challenged: limited perspective of lower local rates, higher core yields in 2H13 and rating downgrade risks, sluggish local growth and consolidating metal prices (weighing on stocks).

Source: SARB, EcoWin, ING estimates

BRICS FX reserves (US$bn)

BRICS Bank to the rescue?

0

500

1,000

1,500

2,000

2,500

3,000

3,500

China (Dec-12)

Russia (Feb)

Brazil (Mar)

India (Feb)

South Africa(Feb)

South Africa external weakness puts the recent BRICS Summit in Durban in the spotlight. A US$100bn pool of reserves was agreed to support BoP pressures – but no details filtered on who will contribute to what. With US$44bn of FX reserves at end-2012, South Africa compares poorly with its peers (vs chart) – the coming months until a new BRICS gathering in Sep will probably be determinant to define SA’s participation scale. That said, this US$100bn is an ‘a propos’ cushion for the country. But the Durban Summit failed to provide any clear details on the establishment of a New Development Bank deemed a South-South alternative to the IMF. It is a shame, as we deem it would be a credible anchor for SA to navigate through this challenging macro time.


South Africa ratings per agencies

The rating challenge

Rating Outlook Latest actionS&PLT local ccy A- negative 12/10/2012 Rating downgradeLT foreign ccy BBB+ negative 12/10/2012 Rating downgradeMoody'sLT local ccy Baa1 negative 27/09/2012 Rating downgradeLT foreign ccy Baa1 negative 27/09/2012 Rating downgradeFitchLT local ccy BBB+ stable 10/01/2013 Rating downgradeLT foreign ccy BBB stable 10/01/2013 Rating downgrade

The combination of a stressed external position and a strained fiscal backdrop is putting South Africa at risk of a rating downgrade in 2Q13. Admittedly, SA faced its share of action already in 3Q12, with Moody’s and S&P downgrading both local and foreign currency ratings, switching to Negative outlook. Fitch followed in January, but left its outlook Stable. Still, the persistent lack of clarity on economic policies (Gordhan’s FY13-14 budget failed on this front, in our view) and the ‘actionability’ of the National Development Plan pose the risk of another rating late 2Q13 (post wage negotiations round), early 4Q13. Anything later could be seen as disruptive with the political agenda. We mostly see risks for the local debt rating, with S&P still one notch above Moody’s and Fitch.

Source: EcoWin, ING estimates #



92

South Africa FX / MONEY MARKETS / DEBT STRATEGY LC Ratings (M/S&P/F): Baa1/A-/BBB+


FX/money markets strategy

6.5

7.0

7.5

8.0

8.5

9.0

9.5

10.0


ING f'cast Mkt fwd


Nominal trade weighted ZAR vs equities flows

The rand is likely to remain under pressure in 2Q13, owing to the persisting stress on the external accounts, risk of a downgrade, heightened equities outflows and potential noise surrounding the wage negotiations process. We have discounted a 9.20 end-of-quarter reading on this basis vs the USD, but risk of a slippage to 9.50 is material. At this level, we would expect the SARB to be more proactive to support the currency, mostly via verbal jawboning. Its ammunition package is indeed limited given the difficult CA gap financing need backdrop and the incumbent necessity to maintain an attractive carry without endangering already sluggish domestic demand. Also, sterilisation costs – and to some extent its FX reserves level (particularly if SA has to contribute to the BRICS FX reserves pool) remain a deterrent to direct intervention. Note that early April pullback of the USD/ZAR towards the 9.00 level has been mostly technical: a combination of EUR/USD trend reversal and hedges removal. A return to these levels in the short term could still materialise, provided strengthening of risk appetite, consolidating commodities, and a further halt in the EUR/USD downward trend (but not our base-case scenario). But as the difficult macro-mix of SA won’t show signs of improvement in 2Q13, the rand should remain on a back foot. We would thus take ZAR short-term rallies vs USD below 9.10 as a buy USD/ZAR on dips opportunity.



-40

-20

0

20

40

Mar

-00

Mar

-01

Mar

-02

Mar

-03

Mar

-04

Mar

-05

Mar

-06

Mar

-07

Mar

-08

Mar

-09

Mar

-10

Mar

-11

Mar

-12

Mar

-13

40

60

80

100

120

Non-resident net purchase of shares (bn ZAR)

Nominal trade-weighted ZAR index (pt, 1m-lag, RHS)

Long USDZAR 11-Apr 8.90 9.30 8.80


Local curve (%)

Debt Strategy

4.5

5.0

5.5

6.0

6.5

7.0

3m 6m 2Y 10Y



2-5Y swap vs CPI

Inflation has surprised on the upside in recent months, settling at 5.9% YoY in March. Adverse base effects, administrative price adjustments and a weaker ZAR are set to push the YoY CPI above the SARB 6% limit as soon as 2Q13 vs officials’ expectations for 3Q13. While we discount still room for a small rate cut (growth-support style) at the beginning of next year, the balance of risks on this call is admittedly skewed on the no-change side. In parallel, given the sluggish growth backdrop and the need to avoid foreign investor outflows (by triggering bond profit-taking in case of a rate hike, or equities profit-taking on tighter monetary conditions dampening the growth outlook), we doubt the SARB will take the chance to raise the repo rate when it readjusts its inflation projections.

This backdrop should keep front-end rates well locked over the quarter, with confirmation of poor inflation-related data feeding into bear-steepening on money market rates. On this inflation rationale, 2-5Y should develop a more pronounced flattening bias (as per the chart below) – but USD/ZAR downward consolidation will be key for this trend to gain any steam. Short-term, the 2-5Y should stabilise in the 60-70bp range. This should offer good entry levels to position for 2H13 steepening outlook on the aforementioned tenors.


Entry date Entry level Exit level S/L-150

-100

-50

0

50

100

150

200

May 97 Sep 99 Jan 02 May 04 Sep 06 Jan 09 May 11 Sep 13 Dec 15

0

2

4

6

8

10

12

14

2-5Y IRS spread (1m-avg, bps) CPI (% YoY, RHS, inverted)

ING f'cast

Rec 2Y Pay 5Y SA IRS 19-Apr 63bp 85bp 45bp


#


93

South Africa

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012E 2013F 2014F 2015F

Activity Real GDP (%YoY) 2.9 4.6 5.3 5.6 5.5 3.6 -1.5 3.1 3.5 2.5 2.6 3.0 3.6Private consumption (%YoY) 2.8 6.2 6.1 8.3 5.5 2.2 -1.6 4.4 4.8 3.5 3.1 4.1 4.5Government consumption (%YoY) 6.0 6.0 4.6 4.9 4.0 4.6 4.8 5.0 4.6 4.2 3.1 3.0 3.6Investment (%YoY) 10.2 12.9 11.0 12.1 14.0 13.0 -4.3 -2.0 4.5 5.7 5.0 5.6 6.6Industrial production (%YoY) -2.1 4.0 3.1 4.8 4.8 0.7 -12.5 4.9 2.5 2.2 3.9 3.2 3.6Unemployment rate year-end (%) 29.3 26.4 24.2 23.1 23.6 21.9 24.2 24.0 23.9 24.9 24.8 24.5 24.2Nominal GDP (ZARbn) 1,273 1,415 1,571 1,767 2,016 2,256 2,406 2,659 2,918 3,155 3,424 3,728 4,083Nominal GDP (€bn) 149 177 199 208 209 186 206 275 289 299 296 338 361Nominal GDP (US$bn) 169 221 248 262 287 274 287 364 403 385 377 412 452GDP per capita (US$) 3,667 4,713 5,212 5,460 5,925 5,649 5,895 7,340 8,070 7,663 7,465 8,131 8,871Gross domestic saving (% of GDP) 18.7 17.7 17.5 17.2 18.4 19.6 18.2 18.6 18.5 17.1 16.9 16.5 16.2Lending to corporates/households (% of GDP) n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a


Fiscal balance (% of GDP) Consolidated government balance -1.7 -3.2 -0.1 1.1 0.9 -0.1 -4.9 -4.4 -3.8 -3.5 -4.4 -4.3 -3.7Consolidated primary balance 2.0 0.2 3.2 4.1 3.6 2.4 -2.5 -2.0 -1.3 -0.8 -1.8 -1.8 -1.1Total public debt 37.0 35.8 34.6 32.4 28.3 27.8 31.3 35.8 39.6 42.3 44.0 44.7 44.8

External balance Exports (US$bn) 38.7 48.4 56.5 66.3 76.5 85.4 66.4 85.7 103.0 93.6 91.3 101.9 120.1Imports (US$bn) 35.2 48.6 56.8 70.6 81.7 89.7 66.1 82.0 100.7 102.8 102.3 113.5 132.4Trade balance (US$bn) 3.5 -0.2 -0.3 -4.3 -5.2 -4.3 0.3 3.7 2.3 -9.2 -10.9 -11.6 -12.4Trade balance (% of GDP) 2.1 -0.1 -0.1 -1.7 -1.8 -1.6 0.1 1.0 0.6 -2.4 -2.9 -2.8 -2.7Current account balance (US$bn) -1.7 -6.7 -8.6 -13.9 -20.0 -19.6 -11.6 -10.3 -13.6 -24.1 -24.9 -25.4 -26.3Current account balance (% of GDP) -1.0 -3.0 -3.5 -5.3 -7.0 -7.2 -4.0 -2.8 -3.4 -6.3 -6.6 -6.2 -5.8Net FDI (US$bn) 0.2 -0.6 5.7 -6.6 2.7 12.2 4.3 1.3 6.3 0.2 0.4 2.7 5.4Net FDI (% of GDP) 0.1 -0.3 2.3 -2.5 1.0 4.4 1.5 0.4 1.6 0.1 0.1 0.7 1.2Current account balance plus FDI (% of GDP) -0.9 -3.3 -1.2 -7.8 -6.0 -2.7 -2.5 -2.5 -1.8 -6.2 -6.5 -5.5 -4.6Foreign exchange reserves ex gold, (US$bn) 6.5 13.1 18.6 23.0 29.5 30.1 35.2 38.4 43.0 44.2 46.2 49.2 51.4Import cover (months of merchandise imports) 2.2 3.2 3.9 3.9 4.3 4.0 6.4 5.6 5.1 5.2 5.4 5.2 4.7


Interest & exchange rates Central bank key rate (%) year-end (repo rate) 8.00 7.50 7.00 9.00 11.00 11.50 7.00 5.50 5.50 5.00 5.00 4.00 4.00Broad money supply (avg, %YoY) 15.8 12.2 15.8 19.7 19.7 16.0 5.8 2.0 6.3 6.7 8.0 9.0 10.03-mth interest rate (Jibar, avg %) 8.4 7.2 7.2 7.2 10.3 7.3 8.2 6.5 5.6 5.4 5.1 4.4 4.33-mth interest rate spread over US$-Libor (ppt) 715 562 361 198 498 440 749 614 524 494 478 391 3592-year yield (avg %) 9.7 8.4 7.4 7.2 8.9 9.8 7.1 6.8 6.6 5.4 5.2 5.0 5.310-year yield (avg %) 9.6 9.6 8.1 8.0 8.1 9.1 8.7 8.4 8.2 7.4 7.1 7.2 7.5Exchange rate (USDZAR) year-end 6.68 5.64 6.31 6.99 6.84 9.44 7.39 6.60 8.07 8.45 9.10 8.85 9.00Exchange rate (USDZAR) annual average 7.52 6.41 6.35 6.75 7.03 8.25 8.38 7.30 7.25 8.20 9.08 9.05 9.04Exchange rate (EURZAR) year-end 8.40 7.65 7.47 9.22 9.98 13.20 10.58 8.83 10.44 11.15 10.92 11.06 11.25Exchange rate (EURZAR) annual average 8.52 7.98 7.90 8.48 9.63 12.13 11.68 9.68 10.09 10.54 11.56 11.03 11.30


Turkey Directional EMEA Economics April 2013

94

Turkey Next elections: Local and Presidential 2014/Parliamentary 2015

Forecast summary

Country strategy

4Q12 1Q13F 2Q13F 3Q13F 4Q13F 2013F 2014F

Real GDP (% YoY) 1.4 3.2 4.4 5.0 5.3 4.5 5.0HH consumption (% YoY) -0.8 3.0 4.0 5.0 5.0 4.3 5.0Fixed investment (% YoY) -3.8 2.3 7.6 8.3 8.9 6.8 9.2CPI (% YoY)* 6.2 7.3 7.8 6.9 6.5 7.1 5.9Current account (% of GDP) -6.0 -6.1 -6.4 -6.4 -6.6 -6.6 -6.9FX res. import cover (mths) 5.6 5.4 5.5 5.3 5.2 5.4 5.3Policy interest rate (%)* 5.50 5.00 5.00 5.00 5.25 5.25 5.503-mth interest rate (%)* 5.79 6.30 5.53 5.55 5.60 5.63 5.752-year yield (%)* 6.16 6.35 5.74 5.84 6.30 5.93 6.5210-year yield (%)* 6.66 7.13 6.70 7.30 7.70 7.03 7.90USD/TRY* 1.78 1.81 1.80 1.84 1.90 1.82 1.90EUR/TRY* 2.35 2.32 2.30 2.30 2.28 2.32 2.32

Turkey’s 2012 soft landing, with 2.2% GDP growth, turned out to be faster than expected; yet, bringing along significantly needed external rebalancing, it was certainly supportive of sustainability. Last year, the C/A deficit fell from 9.7% to 6.0% relative to GDP, as the non-energy balance turned from a 3.6% deficit into a 0.7% surplus. The expected stabilisation in the C/A deficit at 6.5-7.0% of GDP as growth picks up towards a 5% potential rate this year will support Turkey’s rating outlook. We still expect an investment grade (IG) rating by 3Q13. Inflation and global liquidity will be the key drivers of volatility. We think all policy will be geared towards 4% GDP growth in 2013, while the CBT continues to keep interest rates low, watching out for REER and loan growth, and building up reserves.

*Quarterly data is eop, annual is avg. Source: National sources, ING estimates [email protected]

CBT bias cannot be easily defined as hawkish or dovish

Macro digest

TOOLS Hike Cut

ROC Works against CAPITAL INFLOWS / Absorb FX liquidity

Works against CAPITAL OUTFLOWS / Release FX Liquidity

O/N Borrowing Rate

Works against CAPITAL OUTFLOWS / depreciation

Works against CAPITAL INFLOWS / appreciation

O/N lending Rate

Works against falling risk appetite / Tightening bias abroad (CAPITAL OUTFLOWS)

Works against rising risk appetite / Easing bias abroad (CAPITAL INFLOWS)

1-week repo policy rate

Structural - Works against RISING medium term INFLATION RISKS AND/OR LT depreciation pressure on TRY

Structural - Works against FALLING medium term INFLATION RISKS AND/OR LT appreciation pressure on TRY

RRR Works against INFLOWS & LOAN GROWTH

Works against OUTFLOWS & RISING GROWTH RISKS

Source: CBT, ING Bank

2012: Seeking sustainability/2013: Higher growth

-20

0

20

40

60

80

-10

-5

0

5

10

15

Real GDP (4Q-avg, eop, YoY %)

Inflows to real economy (4Q-rolling, excl. reserve acc., USD bn, RHS)

Capital inflows (4Q-rolling, USD bn, RHS)

Source: CBT, Turkstat, ING Bank

Inflation hardly a demand problem as rates mirror ROW’s

0

2

4

6

8

10

12

1Q10

2Q10

3Q10

4Q10

1Q11

2Q11

3Q11

4Q11

1Q12

2Q12

3Q12

4Q12

34567891011

Real GDP (4Q-avg, eop, YoY %)CBT's Effective Cost of Funding (avg, %, RHS)Inflation CPI (eop, % YoY, RHS)

On the verge of an IG rating that will bring more challenges regarding capital flow management in Turkey, the CBT’s well-earned credibility and policy mix since end-2010 remain a significant safeguard against volatility. With the energy deficit being a structural problem, usually tackled via increasing the share of renewable energy, the 2013 priority seems more related to achieving accelerating growth towards the 4% target. This attempts “to keep rates low in the economy” while seeking “balanced growth”, as often stated by the CBT governor.

Turkey’s growth outlook, with its savings deficiency, is mainly driven bycapital inflows. The capital flow and 12-month rolling GDP growth chart shows this quite well. However, the most interesting observation last year, especially in 2H12, was that stronger capital inflows did not stop the soft landing as growth continued to lose pace. Hence, although last year’s growth figure turned out to be weaker than expected, it was policy-driven and mostly related to an automatic mechanism named Reserve Option Mechanism that the CBT has used since mid-2012 to boost official reserves as short-term inflows strengthen. In other words, it was not the CBT’s rate policy but rather its reserve policy that had the most significant effect on growth in 2H12 as “capital inflows directed to real economy” continued to decline. This trend materialised while the CBT, with a more medium-to-long-term sustainability perspective, prioritised reserve coverage of short-term debt (external debt due in the following 12 months), pulling it successfully from 76.7% in May 2012 to 93.7% as of January 2013. Looking at 2013, though, a more relaxed reserve approach might be necessary to stimulate growth early in the year and is likely to be a challenge for CBT policy, especially if capital inflows continue to weigh more on the short term.

Regarding price stability, which has rarely been a problem related to excess demand (not recently at least), continuing slack in the economy remains a key source of volatility this year. Food and regulated price volatility is often the source, but with the TRY targeted to remain stable in real terms, core inflation inertia of around 5.5% is also a threshold to pass. We revise our inflation forecasts up slightly to 6.5% in 2013 and 5.7% in 2014. However, in the current flexible inflation-targeting framework, the CBT is likely to allow local rates mirror the rest of the world’s (ROW), as long as capital inflows remain strong to safeguard 4% GDP growth. A 25bp-cut in the structural one-week repo policy rate remains highly likely, and other tools are to be micromanaged. After an unexpected 50bp cut in the 1W-repo rate and a similar shift in the rates corridor in April, we think policy rates will remain stable in 2Q13 while other tools are to be micromanaged.

Source: CBT, Turkstat, ING Bank [email protected]




95


Unemployment vs NPLs

Unemployment rate on an uptrend recently

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

5.5%

8%9%

10%11%12%13%14%15%16%

Unemployment rate (sa, LHS) NPLs (RHS)

Due to the slowing growth performance and a rising labour force participation rate of 50.9%, in seasonally adjusted (SA) terms – an all-time high – the unemployment rate (SA), which dipped to 8.9% in mid-2012, the lowest figure since 2005, adopted an uptrend thereafter and reached 9.5% at end-2012, improving only slightly in Jan-13. It should decline gradually with the rebound in activity this year. Meanwhile, after bottoming out at 2.6% in 2011, the NPL ratio deteriorated slightly to 2.8% in 2012 and to 2.9% in March 2013, consistent with weak momentum. Almost half of the 2013 NPL rise so far came from consumer loans and CCs, but with no sign of immediate threats, hinting that NPLs have been manageable through recent economic cycles, the ratio is expected to weaken only moderately in 2013.

Source: Turkstat, BRSA, ING Bank [email protected]

C/A vs FDI (12m rolling - USDbn)

12M rolling C/A deficit set to rise

-20

0

20

40

60

80

100

Feb 0

8

Aug 0

8

Mar

09

Oct 09

Apr 1

0

Nov 1

0

Jun

11

Dec 1

1

Jul 1

2

Feb 1

3

Current account deficit Net FDI

Net Portfolio Investments

February C/A print signalled the end in the deficit’s shrinking trend that started in November 2011, reaching US$48.4bn in annual terms. The non-energy C/A surplus also ceased its recovery, dropping from a level close to May 2010 high. Both were attributable to a gradual pick-up in activity. Albeit still slow, the recent expansion in the trade deficit suggests that an inflection point has just been passed, with the 12m-rolling deficit re-widening on the back of improving domestic demand. On the financing side, short-term inflows dominated, fuelled in particular by rating upgrade prospects – but higher volatility has emerged recently on rising global uncertainty and CBT’s “defensive” strategy vs hot money. Overall, FX inflows have exceeded the C/A gap since last April, feeding into FX reserves.

Source: CBT, ING Bank [email protected]

Budget performance relative to GDP (%)

On track, but primary spending accelerates

-12-10-8-6-4-20246

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

Budget Balance Primary Balance

ING f'cast

The fiscal balance improvement that started in 4Q12 continued in 1Q13, on the back of a pick-up in tax revenues, along with arecovery in domestic demand and measures taken last year, as well as a substantial drop in the Treasury’s average cost of borrowing. This was despite accelerating non-interest expenditure (especially due to current transfers that constitute close to 50% of total primary spending). In the breakdown, revenue expansion seems healthy, offering a better revenue generation outlook for 2013, and a fall in interest expenditure continues to support year-end targets. Given comments from officials that expenditure will be curbed in the coming period, our deficit-to-GDP forecast of 2% still seems attainable.

Source: Ministry of Finance, ING Bank [email protected]

On the verge of an investment grade

Another upgrade expected in 2013

Moody's Standard & Poor's Fitch Ratings

A2 Poland, Slovakia A Slovakia A Israel

A3 Malaysia A- Poland, Malaysia A- Poland, Malaysia

Baa1 Russia, Thailand, Bahrain, Mexico, S.Africa

BBB+ Thailand, Kazakhstan BBB+ Kazakhstan, Thailand

Baa2 Kazakhstan, Brazil, Bulgaria

BBB Bulgaria, Russia, Bahrain, Mexico, Brazil, S.Africa, Latvia

BBB Brazil, Russia, Bahrain, Mexico, Spain, Latvia, S.Africa

Baa3 Romania, India, Latvia, Indonesia, Azerbaijan, Spain

BBB- India, Azerbaijan, Spain

BBB- TURKEY, Bulgaria, India, Azerbaijan, Romania, Indonesia

1 notch to IG 1 notch to IG At the IG

Ba1 TURKEY, Hungary, Philippines

BB+ TURKEY (TL rating upgraded to BBB),Romania, Indonesia, Philippines

BB+ Philippines, Hungary, Portugal

Ba2 Jordan BB Portugal, Hungary BB El Salvador

Ba3 Bangladesh, Portugal, Nigeria

BB- Bangladesh, Nigeria BB- Nigeria, Serbia

S&P upgraded Turkey’s sovereign rating to BB+ (one notch below anIG) and the LT local currency to BBB, with a stable outlook, driven by the rebalancing in the economy, with a strong fiscal performance and political developments on the Kurdish issue. Given the adjustment trend in the external balance, as well as continuing structural reform drive, IG by Basel standards (getting a minimum two sovereign IG ratings) in 2013, in the absence of a global turmoil, looks highly likely. On the political side, efforts on the Kurdish issue catch attention as a credit positive (eg, Moody’s commented that the “prospect of peace promises to boost investor confidence”, supporting regional trade/FDI/development, but constitutional overhaul and unrest in neighbouring countries remain risk factors.)

Source: ING Bank [email protected]#







96

Turkey FX/MONEY MARKETS/DEBT STRATEGY LC Ratings (M/S&P/F): Ba1/BBB/BBB



1.3

1.4

1.5

1.6

1.7

1.8

1.9

2.0


ING f'cast Mkt fwd

Source: Thomson Reuters, ING Bank

FX reserves at all-time highs

The CBT, still committed to supporting balanced growth by closely watching REER and lending expansion, certainly looked more worried about capital outflows at March MPC. But, in April, the bank switched back to a macro-prudential stance against capital inflows by cutting policy rate(s) by 50bp and adjusting further ROCs. Looking ahead in 2Q13, we believe this CBT will remain mostly focused on to capital inflows dynamics, particularly if markets volatility re-appears.

But the latest swift rate cut action by CBT was also indicative of concerns over downside risks to export growth, with softening commodity prices potentially dampening MENA imports. This suggests the CBT will remain alert to the real value of the TRY in the months ahead. Finally, with regards to lending expansion, the CBT believes sterilising excess inflows (via ROM) will cap loan growth. In other words: it will not allow domestic demand to recover too quickly – so as to mitigate the impact of weakening exports on the external balance. Overall, we expect the TRY to remain in a 2.05-2.07 channel against a 50:50 EUR:USD basket until 4Q13, given the CBT’s policy guidelines to reduce volatility in general. However, with higher inflation forecast and the CBT’s REER targeting, we revise our 50:50 EUR:USD FX basket call for end-2013 to 2.09.

[email protected]



57

67

77

87

97

107

Aug 1

0

Oct 10

Dec 1

0

Feb 1

1

Apr 1

1

Jun

11

Aug 1

1

Oct 11

Dec 1

1

Feb 1

2

Apr 1

2

Jun

12

Aug 1

2

Oct 12

Dec 1

2

Feb 1

3

Apr 1

3

1.6

1.7

1.8

1.9

2.0

2.1

2.2

2.3

CBT Official Reserves (US$ bn)50:50 EUR:USD Basket - RHS

- - - -

Source: Thomson Reuters, CBT, ING Bank

Local curve (%)

Debt strategy

5.0

5.5

6.0

6.5

7.0

3m 6m 2Y 10Y


Source: Thomson Reuters, CBT, ING Bank

Bond yields to converge to sustainable levels

The yield curve shifted upwards in March, but followed an entirely opposite pattern in April. The CBT Governor’s verbal intervention hinting at measured policy rate cuts if the REER exceeded the 120 threshold (exactly at this level in March), the consequent 50bp cut in all policy rates in April MPC, S&P’s recent upgrade and hopes for another by Moody’s, all created a strong risk appetite for TRY assets early 2Q13, paving the way for a broad-based downward shift in the local curve.

Not surprisingly, with steady inflation expectations, the CBT’s easing bias created a sharper reaction at the front-end of the curve. However, 2Y benchmark yields down from the 6.3-6.4% range at end-March to the c.5.50% level currently are overreacting to the CBT’s stance in our view: core inflation should cap the CBT rate cut window in the medium term. Accordingly, we believe if local yields could hold to below 6% in 2Q13, they should gradually return on an upward path in 2H13.

[email protected]



5

6

7

8

9

10

11

Jan

12

Mar

12

Apr 1

2

Jun

12

Jul 1

2

Sep 1

2

Oct 12

Nov 1

2

Jan

13

Feb 1

3

Apr 1

3

2Y benchmark (% cmp, bid close)10Y benchmark (% cmp, bid close)

- - - -

Source: Thomson Reuters, ING Bank

#




97

Turkey

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012E 2013F 2014F 2015F

Activity Real GDP (%YoY) 5.3 9.4 8.4 6.9 4.7 0.7 -4.8 9.2 8.8 2.2 4.5 5.0 5.0Private consumption (%YoY) 10.2 11.0 7.9 4.6 5.5 -0.3 -2.3 6.7 7.7 -0.7 4.3 5.0 5.0Government consumption (%YoY) -2.6 6.0 2.5 8.4 6.5 1.7 7.8 2.0 4.7 5.7 4.0 4.5 4.5Investment (%YoY) 14.2 28.4 17.4 13.3 3.1 -6.2 -19.0 30.5 18.0 -2.5 6.8 9.2 9.2Industrial production (%YoY) 8.8 9.7 5.4 7.7 6.9 -0.9 -10.4 12.4 9.7 2.5 4.4 5.3 5.5Unemployment rate year-end (%) 10.5 10.8 10.6 10.2 10.3 11.0 14.0 11.9 9.8 9.2 8.9 8.6 8.6Nominal GDP (TRYbn) 455 559 649 758 843 951 953 1,099 1,297 1,417 1,585 1,763 1,950Nominal GDP (€bn) 270 316 389 421 474 501 442 552 558 615 685 773 825Nominal GDP (US$bn) 305 390 481 526 649 742 617 732 774 786 871 928 1069GDP per capita (US$) 4,559 5,764 7,022 7,586 9,240 10,438 8,559 10,022 10,466 10,504 11,491 12,098 13,549Gross domestic saving (% of GDP) 15.1 15.7 15.4 15.9 15.1 16.3 13.0 13.7 12.1 14.8 14.7 15.2 16.0Lending to corporates/households (% of GDP) 14.6 17.8 24.1 28.9 33.9 38.7 41.2 47.9 52.7 56.1 58.0 60.0 62.0

Prices CPI (average %YoY) 25.3 10.6 8.2 9.6 8.8 10.4 6.3 8.6 6.5 8.9 7.1 5.9 5.3CPI (end-year %YoY) 18.4 9.3 7.7 9.7 8.4 10.1 6.5 6.4 10.4 6.2 6.5 5.7 5.3PPI (average %YoY) 25.6 11.1 5.9 9.3 6.3 12.7 1.2 8.5 11.1 6.1 4.0 4.6 4.6Wage rates (%YoY, nominal) 22.9 13.4 12.2 11.5 9.5 7.7 -1.9 15.8 14.9 9.0 7.0 6.0 6.0

Fiscal balance (% of GDP) Consolidated government balance -8.8 -5.2 -1.1 -0.6 -1.6 -1.8 -5.5 -3.6 -1.4 -2.0 -2.0 -2.1 -2.1Consolidated primary balance 4.0 4.9 6.0 5.4 4.1 3.5 0.1 0.8 1.9 1.4 1.8 1.8 1.8Total public debt 67.7 59.6 52.7 46.5 39.9 40.0 46.1 42.3 39.2 36.1 35.5 34.2 33.2

External balance Exports (US$bn) 52.4 68.5 78.4 93.6 115.4 140.8 109.6 120.9 143.4 163.3 168.5 181.3 203.8Imports (US$bn) 65.9 91.3 111.4 134.7 162.2 193.8 134.5 177.3 232.5 228.9 243.6 263.1 294.7Trade balance (US$bn) -13.5 -22.7 -33.1 -41.1 -46.9 -53.0 -24.9 -56.4 -89.1 -65.6 -75.1 -81.8 -90.8Trade balance (% of GDP) -4.4 -5.8 -6.9 -7.8 -7.2 -7.1 -4.0 -7.7 -11.5 -8.3 -8.6 -8.8 -8.5Current account balance (US$bn) -7.6 -14.2 -21.4 -31.8 -37.8 -40.4 -12.2 -45.4 -75.1 -46.9 -57.3 -63.9 -73.4Current account balance (% of GDP) -2.5 -3.6 -4.5 -6.0 -5.8 -5.4 -2.0 -6.2 -9.7 -6.0 -6.6 -6.9 -6.9Net FDI (US$bn) 1.2 2.0 9.0 19.3 19.9 17.2 7.1 7.6 13.7 8.3 12.0 15.0 15.0Net FDI (% of GDP) 0.4 0.5 1.9 3.7 3.1 2.3 1.2 1.0 1.8 1.1 1.4 1.6 1.4Current account balance plus FDI (% of GDP) -2.1 -3.1 -2.6 -2.4 -2.7 -3.1 -0.8 -5.2 -7.9 -4.9 -5.2 -5.3 -5.5Foreignexchange reserves ex gold, (US$bn) 33.6 36.0 50.5 60.9 73.3 71.0 70.7 80.7 78.5 100.2 105.0 118.0 130.0Import cover (months of merchandise imports) 6.1 4.7 5.4 5.4 5.4 4.4 6.3 5.5 4.0 5.3 5.2 5.2 5.3


Interest & exchange rates Central bank key rate (%) year-end (1W repo) 26.00 18.00 13.50 17.50 15.75 15.00 6.50 6.50 5.75 5.50 5.25 5.50 5.50Broad money supply (avg, %YoY) 32.2 35.1 40.1 23.4 15.4 27.5 12.9 19.0 11.5 10.3 13.0 12.9 12.33-mth interest rate (TRLibor, avg%) 37.7 22.7 15.1 16.6 17.3 17.6 10.2 7.4 8.5 8.7 5.6 5.7 5.73-mth interest rate spread over US$-Libor (ppt) 3,650 2,105 1,149 1,143 1,197 1,465 951 705 821 825 531 522 5032-year yield (avg %) n/a n/a n/a n/a 18.7 19.3 11.4 8.4 9.1 8.1 5.9 6.5 6.510-year yield (avg %) n/a n/a n/a n/a n/a n/a n/a 9.8 9.6 8.5 7.0 7.9 8.0Exchange rate (USDTRY) year-end 1.40 1.34 1.34 1.41 1.16 1.51 1.51 1.55 1.91 1.78 1.90 1.90 1.85Exchange rate (USDTRY) annual average 1.49 1.42 1.34 1.43 1.30 1.29 1.55 1.50 1.67 1.79 1.82 1.90 1.85Exchange rate (EURTRY) year-end 1.75 1.83 1.59 1.86 1.71 2.14 2.16 2.05 2.46 2.35 2.28 2.28 2.43Exchange rate (EURTRY) annual average 1.69 1.77 1.67 1.80 1.78 1.90 2.15 1.99 2.32 2.30 2.31 2.28 2.36


Ukraine Directional EMEA Economics April 2013

98

Ukraine [email protected]

Forecast summary

Country strategy

4Q12 1Q13F 2Q13F 3Q13F 4Q13F 2013F 2014F

Real GDP (%YoY) -2.5 -1.1 -2.0 3.6 6.0 1.6 3.0HH consumption (%YoY) 6.9 7.0 -0.5 0.5 4.0 2.8 5.0Fixed investment (%YoY) -7.5 -10.0 -13.5 8.0 6.3 -2.3 4.8CPI (%YoY)* -0.2 -0.8 -0.3 2.5 6.7 3.4 6.8Current account (% of GDP) -10.3 n/a n/a n/a n/a -7.7 -7.0FX res. import cover (mths) 3.0 2.8 2.5 2.3 2.2 2.2 2.2Policy interest rate (%)* 7.50 7.50 7.50 7.50 7.50 7.50 7.003-mth interest rate (%)* 24.75 10.25 10.88 12.85 11.39 12.21 12.003-year yield (%)* n/a n/a n/a n/a n/a n/a n/a8-year yield (%)* n/a n/a n/a n/a n/a n/a n/aUSDUAH* 8.04 8.12 8.80 9.00 9.30 8.67 9.55EURUAH* 10.61 10.56 11.26 11.25 11.16 11.03 11.64

We resume covering the Ukraine macro with a 1.6% YoY GDP call for 2013 (vs 0.2% in 2012), yet 1H13 will likely remain recessionary. UAH devaluation pressure has slightly abated thanks to a calmer political scene post 4Q12 elections, appetite for Ukrainian risk (both sovereign and corporate) and further hopes of an IMF deal. The mission completed the next round of talks early April, flagging ‘good progress’. Though tail-risks of the deal not going through still exist, our base case scenario is for the deal to happen in late 2Q13-early 3Q13. Indeed, the call for the deal is still loud, what with the remaining BoP risks, FX reserves at 3-4 months of imports, and limited chance of lower gas price from Russia as it would be too costly for EU-Ukraine relations. In all cases, the IMF would require a weaker UAH for its money.


GDP and key economic indicators (YoY)

Only sluggish growth ahead after a recessionary pace

-40%-30%-20%-10%

0%10%20%30%40%

1Q08

2Q08

3Q08

4Q08

1Q09

2Q09

3Q09

4Q09

1Q10

2Q10

3Q10

4Q10

1Q11

2Q11

3Q11

4Q11

1Q12

2Q12

3Q12

4Q12

1Q13

GDP Retail sales IP

Real wage Headline CPI

The technical recession in 3Q-4Q12 was an outlier in the EM universe. Despite solid consumption, destocking and a negative pass-through of faltering export demand weighed on GDP. The latter will likely continue in 1H13 with a better trend appearing later in 2013 and on. One factor to count on is better agricultural output this year, which took 1.3/0.3ppt off GDP in 3Q12/4Q12. The domestic story is likely to also show weaker momentum with moderating wages, higher CPI, shrinking lending and expected gradual FX devaluation. The planned two-year US$45-47bn public development programme might meet funding challenges at this stage. We see investments declining 2.3% in 2013. Fortunately, weaker UAH will eventually translate into better investment opportunities, which we see from 2014 onwards.

Source: Ukrstat


External imbalances remain…

-20-15-10-505

1015

1Q072Q

073Q

074Q

071Q

082Q

083Q

084Q

081Q

092Q

093Q

094Q

091Q

102Q

103Q

104Q

101Q

112Q

113Q

114Q

111Q

122Q

123Q

124Q

12

Current account (4Q-rolling)

Net FDI (4Q-rolling)

Net portfolio investment (4Q-rolling)

After swelling to 8.4%/GDP in 2012, the C/A deficit showed marginally improving dynamics in Jan/Feb-13 on the back of more resilient total exports (-0.6% YoY owing to still-expanding agricultural and chemicaldeliveries) and contracting imports in goods and services (-5% YoY). Metals & mining related exports saw a 12% YoY decline and a still-challenging outlook for global metals prices/demand will keep the items in a depressed mode. Despite weaker FDI, the financial account reached US$2.5bn in 1Q13 -well above the US$1.5bn from 4Q12 –thanks to external debt rollover for banks/non-financials and a US$1bn sovereign debt issue. Yet, even though 2013 may see a slightly lower C/A gap, the F/A will remain a hostage of the US$60bn payback in foreign debt, including US$7.6bn for the government and NBU.

Source: NBU

USDUAH – spot vs market forwards

…so the unknown is only the scale of UAH devaluation

BoP-related risks, together with a challenging fiscal outlook, means that the UAH needs to pursue its efforts to find external financing, so as to avoid a scenario of abrupt devaluation. As the IMF will likely promote a gradual UAH adjustment, our best guess is for a gradual c.15% annually (to start with) once the deal is sealed.



7.70

8.20

8.70

9.20

9.70

Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14

ING f'cast Mkt fwd

- - - -

Source: Bloomberg


Ukraine Directional EMEA Economics April 2013

99

Ukraine

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012E 2013F 2014F 2015F

Activity Real GDP (%YoY) 9.5 12.1 3.0 7.4 7.6 2.3 -14.8 4.1 5.2 0.2 1.6 3.0 4.0Private consumption (%YoY) 11.2 13.0 20.1 15.9 17.2 13.1 -14.9 7.1 15.7 11.7 2.8 5.0 4.7Government consumption (%YoY) 6.9 1.7 2.3 4.0 1.8 1.1 -2.4 4.0 -3.0 2.2 -1.5 1.0 1.5Investment (%YoY) 22.3 20.4 3.9 20.9 24.4 -1.2 -40.0 3.9 7.1 0.9 -2.3 4.8 5.4Industrial production (%YoY) 15.8 12.5 3.1 6.2 7.6 -5.2 -21.9 11.2 7.6 -1.8 2.7 2.5 3.6Unemployment rate year-end (%) 9.1 8.6 7.2 6.8 6.4 6.4 8.8 8.1 7.9 8.1 7.9 7.6 7.5Nominal GDP (UAHbn) 267 345 441 544 721 948 913 1,083 1,302 1,409 1,517 1,664 1,835Nominal GDP (€bn) 44 52 69 86 104 122 82 103 117 136 138 143 146Nominal GDP (US$bn) 50 65 86 108 143 180 115 136 163 175 175 174 183GDP per capita (US$) 1,053 1,372 1,836 2,310 3,078 3,901 2,500 2,980 3,571 3,843 3,860 3,857 4,054Gross domestic saving (% of GDP) 24.6 28.8 23.5 21.9 22.5 20.0 15.4 15.6 14.5 9.9 12.0 12.3 13.0Lending to corporates/households (% of GDP) 25.4 25.3 32.2 45.1 59.6 77.4 78.4 65.6 59.7 56.3 55.0 55.4 56.7

Prices CPI (average %YoY) 5.2 9.0 13.6 9.1 12.8 25.3 16.0 9.4 8.0 0.6 3.4 6.8 6.0CPI (end-year %YoY) 8.2 12.3 10.3 11.6 16.6 22.3 12.3 9.1 4.6 -0.2 7.0 6.5 5.5PPI (average %YoY) 7.7 20.3 17.0 9.7 20.3 35.5 7.2 20.9 19.0 3.7 2.7 5.0 7.0Wage rates (%YoY, nominal) 22.8 27.5 36.7 29.2 29.7 33.7 5.5 20.0 17.6 14.9 8.3 11.2 10.5

Fiscal balance (% of GDP) Consolidated government balance -0.2 -3.2 -1.8 -0.7 -1.1 -1.5 -4.1 -6.0 -1.8 -4.0 -3.2 -2.6 -2.5Consolidated primary balance n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/aTotal public debt 29.0 24.4 18.2 13.2 11.2 18.3 32.4 38.2 35.7 36.6 41.5 40.5 41.0

External balance Exports (US$bn) 23.1 32.7 34.3 38.4 49.2 67.7 40.4 52.2 69.4 69.8 72.0 76.5 85.0Imports (US$bn) 23.0 29.0 36.1 45.0 60.7 83.8 44.7 60.6 85.7 90.2 91.5 96.2 106.0Trade balance (US$bn) 0.1 3.7 -1.9 -6.7 -11.4 -16.1 -4.3 -8.4 -16.3 -20.4 -19.5 -19.7 -21.0Trade balance (% of GDP) 0.1 5.7 -2.2 -6.2 -8.0 -8.9 -3.7 -6.2 -10.0 -11.7 -11.1 -11.3 -11.5Current account balance (US$bn) 2.9 6.9 2.5 -1.6 -5.3 -12.8 -1.7 -3.0 -10.2 -14.4 -13.5 -12.2 -10.5Current account balance (% of GDP) 5.8 10.6 2.9 -1.5 -3.7 -7.1 -1.5 -2.2 -6.3 -8.4 -7.7 -7.0 -5.8Net FDI (US$bn) 1.4 1.7 7.5 5.7 9.2 10.0 4.6 5.8 7.0 6.6 8.0 8.2 8.5Net FDI (% of GDP) 2.8 2.6 8.7 5.3 6.5 5.6 4.0 4.2 4.3 3.8 4.6 4.7 4.7Current account balance plus FDI (% of GDP) 8.6 13.3 11.7 3.8 2.8 -1.5 2.5 2.0 -2.0 -4.5 -3.1 -2.3 -1.1Foreign exchange reserves ex gold, (US$bn) 6.9 9.3 19.1 21.8 32.0 30.8 25.6 33.5 30.4 22.7 17.0 17.5 18.0Import cover (months of merchandise imports) 3.6 3.8 6.3 5.8 6.3 4.4 6.9 6.6 4.3 3.0 2.2 2.2 2.0

Debt indicators Gross external debt (US$bn) 23.8 30.6 39.6 54.5 80.0 101.7 103.4 117.3 126.0 132.0 138.0 145.0 155.0Gross external debt (% of GDP) 47 47 46 51 56 56 90 86 77 76 79 83 85Gross external debt (% of exports) 103 94 116 142 162 150 256 225 182 189 192 190 182Total debt service (US$bn) 2.8 3.0 3.2 3.5 4.8 9.3 24.5 29.3 32.2 34.9 60.9 n/a n/aTotal debt service (% of GDP) 5.5 4.5 3.7 3.2 3.4 5.2 21.3 21.5 19.8 20.0 34.8 n/a n/aTotal debt service (% of exports) 11.9 9.0 9.3 9.1 9.7 13.7 60.6 56.1 46.4 50.0 84.6 n/a n/a

Interest & exchange rates Central bank key rate (%) year-end 7.00 9.00 9.50 8.50 8.00 12.00 10.25 7.75 7.75 7.50 7.50 7.00 7.00Broad money supply (avg, %YoY) 46.5 32.4 54.8 34.5 51.7 29.9 -5.5 23.1 14.2 13.1 10.5 13.0 14.03-mth interest rate (KievPrime, avg %) 15.5 17.6 13.4 13.4 9.8 18.1 21.7 10.2 11.6 20.4 12.2 12.0 12.03-mth interest rate spread over US$-Libor (ppt) 1,427 1,599 988 823 452 1,520 2,099 987 1,121 1,998 1,189 1,148 1,1293-year yield (avg %) n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a8-year yield (avg %) n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/aExchange rate (USDUAH) year-end 5.33 5.31 5.05 5.05 5.05 7.70 7.99 7.96 8.03 8.04 9.30 9.80 10.30Exchange rate (USDUAH) annual average 5.33 5.32 5.12 5.05 5.05 5.27 7.95 7.94 7.99 8.06 8.67 9.55 10.05Exchange rate (EURUAH) year-end 6.71 7.19 5.98 6.66 7.37 10.76 11.43 10.65 10.39 10.61 11.16 12.25 12.88Exchange rate (EURUAH) annual average 6.04 6.62 6.38 6.35 6.92 7.75 11.09 10.53 11.12 10.36 11.03 11.64 12.56



100

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Emerging Markets Title Telephone Email

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101

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FINANCIAL MARKETS RESEARCH

April 2013

EMEA Economics and Strategy TeamSee details at end of report

Directional EMEA EconomicsWho to tango with?

Bulgaria

Croatia

Czech Republic

Hungary

Israel

Kazakhstan

Poland

Romania

Russia

Serbia

South Africa

Turkey

Ukraine

1

AMSTERDAM BRUSSELS LONDON NEW YORK SINGAPORE Tel: 31 20 563 8955 Tel: 32 2 547 2111 Tel: 44 20 7767 1000 Tel: 1 646 424 6000 Tel: 65 6535 3688

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PragueTel: 420 257 474 111 Sao Paulo Tel: 55 11 4504 6000 SeoulTel: 82 2 317 1800 Shanghai Tel: 86 21 2020 2000 SofiaTel: 359 2 917 6400

TaipeiTel: 886 2 8729 7600 Tokyo Tel: 81 3 3217 0301 Warsaw Tel: 48 22 820 5018

Research offices: legal entity/address/primary securities regulatorAmsterdam ING Bank N.V., Foppingadreef 7, Amsterdam, Netherlands, 1102BD. Netherlands Authority for the Financial MarketsBrussels ING Belgium S.A./N.V., Avenue Marnix 24, Brussels, Belgium, B-1000. Financial Services and Market Authority (FSMA)Bucharest ING Bank N.V. Amsterdam - Bucharest Branch, 48 Lancu de Hunedoara Bd., 011745, Bucharest 1, Romania. Romanian National

Securities and Exchange Commission, Romanian National BankBudapest ING Bank N.V. Hungary Branch, Dozsa Gyorgy ut 84\B, H - 1068 Budapest, Hungary. Hungarian Financial Supervisory AuthorityIstanbul ING Bank A.S., ING Bank Headquarters, Resitpasa Mahallesi Eski Buyukdere Cad. No: 8, 34467 Sariyer, Istanbul , Turkey. Capital

Markets BoardLondon ING Bank N.V. London Branch, 60 London Wall, London EC2M 5TQ, United Kingdom. Authorised by the Dutch Central BankManila ING Bank N.V., Manila Branch, 20/F Tower One, Ayala Triangle, Ayala Avenue, 1226 Makati City, Philippines. Philippine Securities and

Exchange CommissionMilan ING Bank N.V. Milano, Via Paleocapa, 5, Milano, Italy, 20121. Commissione Nazionale per le Società e la BorsaMoscow ING BANK (EURASIA) ZAO, 36, Krasnoproletarskaya ulitsa, 127473 Moscow, Russia. Federal Financial Markets ServiceMumbai ING Vysya Bank Limited, Plot C-12, Block-G, 7th Floor, Bandra Kurla Complex, Bandra (E), Mumbai - 400 051, India. Securities and

Exchange Board of IndiaNew York ING Financial Markets LLC, 1325 Avenue of the Americas, New York, United States,10019. Securities and Exchange CommissionSingapore ING Bank N.V. Singapore Branch, 19/F Republic Plaza, 9 Raffles Place, #19-02, Singapore, 048619. Monetary Authority of SingaporeWarsaw ING Bank Slaski S.A, Plac Trzech Krzyzy, 10/14, Warsaw, Poland, 00-499. Polish Financial Supervision Authority

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