EM Quarterly Outlook-Fundamentals and Markets Diverge

Emerging markets outlook

Emerging Markets FX

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


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

Fundamentals and markets diverge

Emerging markets analysis — July 8, 2014

Economic growth decelerated during the spring in most of the emerging markets we follow. In the short term the Chinese economy has stabilized at the same time that its political transition toward more balanced, sustainable growth means that China has downshifted to a slower growth path. Investment is the weakest since late 2001. We are seeing the effects of China’s lower demand on its major trade partners such as Brazil and South Korea. Exports are generally weak, even for countries with undervalued currencies. The decline in the Purchasing Managers Index (PMI) in recent months confirms this. Despite slow economic activity, emerging market currencies have been strong since the beginning of February.

The driver, again, is the big interest rate differential between several emerging currencies and currencies in the West. This situation appears to be continuing this summer. Deflation impulses are strong in the developed world and trouble many central banks. The European Central Bank (ECB) has signaled that another stimulus is in the works. The US is in the process of tapering the Federal Reserve’s (Fed) bond buying, but monetary signals are still dovish. With a zero interest rate policy continuing in the West and Japan, global capital once again is blindly flowing into emerging markets. As a whole, we see currency developments in emerging markets as a balance between weak

fundamentals and high global liquidity. As a result, we are neutral to most emerging currencies this summer. We see the biggest risk as being on the negative side, however, especially if US economic data continue to surprise on the upside and expectations as to the timing of an initial interest rate hike by the Fed are pushed forward.

We have a negative view of the Russian ruble. The economy is weak and turbulence in Ukraine continues. The threat of economic sanctions from the West persists. In India, the nearly six- week-long election concluded with a major victory for the BJP and its leader, Narendra Modi. The party won a majority in the lower house of parliament and is now beginning the arduous process of instituting reforms to promote growth. Political conditions are the best in some time, because of which we have maintained our positive view of the rupee since last autumn. Brazil is struggling with weaker growth, high inflation and dual deficits (budget and current account), a challenge leading up to the presidential election this autumn.

We remain positive on the US dollar vs. the euro on the back of increasing growth differences . Fed and ECB are also at different stages regarding monetary policy, where ECB is expected to ease more whereas Fed’s next step is to hike rate.

FX/FI research — Swedbank Large Corporates & Institutions Page 2 of 8


Forecast EUR/RUB in 3 months 48.28 (today 45.69) Forecast EUR/PLN in 3 months 4.15 (today 4.14)

Currency forecast vs. the euroCurrency forecast vs. the euro

We remain neutral to the zloty going forward. The Polish economy is strong, but appears to be losing momentum in the months ahead. Due to weak inflation pressures, short-term interest rates will remain low for some time with the risk of further rate cuts, as highlighted by central bank governor Marek Belka.

Growth in Poland has been driven by strong domestic demand this year. The Polish economy grew by 3.4% in the first quarter at an annual rate. The contribution from domestic demand was 2.9%, with investment accounting for most of the increase. Weaker exports to Russia and Ukraine were more than offset by higher exports to Western Europe. The downside risks associated with the crisis between Russia and Ukraine seem to have diminished slightly after the recent conciliation between Russia and Ukraine. The situation for households has gradually improved since the beginning of 2013. Real wages rose by 3.5% at an annual rate in March, the strongest growth since early 2009. The low interest rate level has also reduced interest expenses for households. These factors have raised consumer confidence to the highest level since 2010. This is reflected in strong retail sales, which rose by 8.9% at an annual rate in April. Industrial activity, on the other hand, has slowed and the PMI has fallen for four consecutive months to the lowest level in 12 months. The inflation rate was only 0.2% in May, putting it below the central bank’s lower tolerance limit of 1.5% since February 2013. We therefore expect the central bank to maintain its benchmark rate at 2.5% for the rest of the year.

PolandStrong recovery

Low short-term rates

RussiaHigh short term rates

Weak growth and risk of sanctions

The ruble is supported by high short-term rates and political successes domestically. The situation in Ukraine, on the other hand, is far from resolved and we have long been negative to the ruble on structural grounds against the backdrop of the negative business climate and weak investment.

The ruble has appreciated significantly in the last quarter. Russia’s tone vis-à-vis Ukraine was less aggressive leading up to the Ukrainian presidential election and President Vladimir Putin seems to be trying to avoid economic sanctions from the US and EU. The election was held without major incident, with Petro Poroshenko as the winner, but the conflict is far from resolved and turmoil in the region is likely to continue. In May Russia signed a 30-year deal to supply gas to China, a major political success for Putin at home, although the details of the agreement haven’t been made public. Polls show that confidence in Putin has further increased and is now the highest in over five years. The economy is struggling with stagflation. GDP growth was 0.9% on an annual basis during the first quarter. The inflation rate of 7.6% is the highest since autumn 2011, reducing the purchasing power of households, as reflected by retail sales, which are the weakest in over four years. Households are also being weighed down by higher loan rates. The central bank raised the benchmark rate by 50 bps at its April meeting and the governor of the central bank, Elvira Nabiullina, announced that interest rates won’t be cut until the central bank is convinced that the inflation target of 4% is within reach.



Forecast EUR/TRY in 3 months 2.95 (today 2.89) Forecast EUR/ZAR in 3months 14.90 (today 14.57)


After trending downward for about three years, the South African rand is now undervalued in terms of its real effective exchange rate. This hasn’t had an appreciable effect on economic activity, however. Due to weak growth, the problems in the mining industry and South Africa’s lower credit rating, we are maintaining our negative view of the rand.

Pressure on the lira decreased significantly during the spring thanks to continued expansive monetary policy in the West, a smaller current account deficit and a generally positive climate in the financial markets. We are negative to the Turkish currency heading into the presidential election in August, but the lira has support as long as the Fed doesn’t tighten monetary policy.

Tensions in the mining industry and lower demand from China have hurt South Africa’s economy in the last two years. GDP rose by 1.6% on an annual basis in the first quarter. The PMI has fallen substantially and hit 46.6 in June, largely due to the heavy spring rains, which damaged the country’s coal-fired electricity generation and disrupted manufacturing. Exports fell during the spring and grew only 1.5% on an annual rate in April, resulting in a record-high trade deficit on a rolling annual basis. China’s lower demand for commodities has dealt a stiff blow to South Africa’s exports, since China is its main export destination. Furthermore, growth is being weighed down by weak household spending and sluggish investment activity. Consumer confidence has declined, partly due to rising interest rates. Credit growth has continuously fallen since late 2012 and rose by 4.6% on an annual basis in April, the lowest rate since 2010. Inflation accelerated in May to 6.8% (highest since 2009), hurting retail sales, which gained a modest 1.6% on an annual basis by in April. The current account deficit has shrunk in the last year but still remains a major market risk, as evidenced by S&P’s downgrade of South Africa’s credit rating to BBB-.

Economic growth in Turkey has been surprisingly stable in the last year considering the turbulence in the financial markets. GDP grew during the first quarter by 4.3% at an annual rate, in line with average growth for the last four quarters. However, we expect weaker growth going forward. The PMI has trended downward since March and fell significantly in June to 48.8. In contrast, the inflation rate has increased every month in 2014 and in May consumer prices increased by 9.6% compared to the same month one year ago. In spite of this, the central bank has cut the benchmark rate on two occasions by a total of 125 bps to 8.75% since a major rate hike in January. Because of the high inflation, the real interest rate is now negative. Actions by the government continue to undermine confidence in Turkish monetary policy and the central bank’s independence, especially ahead of the presidential election in August. For its part, the central bank feels that monetary policy is tight, since it expects lower inflation going forward. They also point out the improvement in the trade balance. The current account deficit has shrunk, largely due to very weak imports, which fell by 10.3%, while exports rose by 3.6% on an annual basis in May.

South AfricaLow exchange rate

Lower credit ratings and weak external balance

TurkeyHigh short-term rates

Low political confidence



Forecast EUR/MXN in 3 months 17.29 (today 17.67) Forecast EUR/BRL in 3 months 3.06 (today 3.03)


We are positive long-term to the Mexican peso based on these growth-oriented reforms and stronger demand from the US. In the short term the peso is being weighed down by weaker terms of trade and less interest rate support after the unexpected rate cut by the central bank. We therefore remain neutral to the peso against the dollar, which, given our dollar outlook, means a stronger peso against the euro.

GDP rose by 1.8% on an annual basis in the first quarter, pointing to a revival in the Mexican economy after five quarters of below-average growth. Industrial production has recovered this year after seeing negative annual growth for much of 2013. The second quarter has begun on a positive note. Auto production accelerated during the spring after a weak period in 2013 and in May reached a new peak of over 300 million cars on an annual basis. The latest signals from purchasing managers in June were a disappointment, however, with the PMI falling from 52.6 to 50.3. Mexico’s central bank surprised the market by cutting its benchmark rate by 50 bps to a record-low 3% on June 6. The decision was made against a backdrop of weaker first-quarter growth compared with the central bank’s forecast from its May inflation report. Retail sales have been weak since new taxes on consumer goods were introduced at the beginning of the year. The recent improvement in consumer confidence may be a signal, however, that the negative impact of the tax hikes is tapering off.

The Brazilian real has been the biggest gainer among the emerging currencies we follow despite the economy’s weak performance. Sluggish growth, a large current account deficit and loose budget policy are negative factors for the real. They are partly offset by continued currency interventions from the central bank. As a whole, we expect the real to be slightly weaker this summer.

The Brazilian real has strengthened in the last quarter. The main reasons are high interest rates, the central bank’s currency interventions and the zero interest rate policy in the US. The fundamentals have worsened during the same period, with growth continuing to disappoint. The economy grew only 1.9% on an annual basis in the first quarter. Exports have continued to decline, reporting a negative annual growth rate in the last three months. As a result, the current account deficit has again swelled. Manufacturing shrunk by 5.8% at an annual rate in April and the outlook is gloomy based on the latest signals from purchasing managers. The June PMI fell to 48.7. Inflation is stuck at high levels despite rate hikes by the central bank totaling 375 bps in the last 12 months. We expect tight monetary policy to continue, since consumer prices rose by 6.4% at an annual rate in May, just below the central bank’s upper tolerance limit of 6.5%. Lending rates have risen from 34% at the beginning of 2013 to 42.5%. The high inflation rate and high interest rates are a challenge for already strained households. The situation in the labor market is weak and consumer confidence has dropped precipitously to levels last seen during the financial crisis in 2009.

BrazilHigh policy rate and central bank interventions

Weak growth and dual deficits

MexicoGrowth-oriented reforms on the way

Weak growth



Forecast EUR/IDR in 3 months 15827 (today 15860) Forecast EUR/KRW in 3 months 1369.90 (today 1376.00)


We feel that the risk of a correction in the won has risen after its significant appreciation in recent months. We are now seeing more signs that the strong won has begun to impede growth. We expect the won to weaken slightly against the dollar before then trading sideways in the next quarter. The forecast vis-à-vis the euro is neutral.

The Indonesian rupiah has depreciated in recent months ahead of the presidential election on 9 July. The favorite, Joko Widodo, has seen his lead shrink against former general Prabowo Subianto, according to the latest polls. There is also considerable uncertainty what kind of policies will be put into place. We are neutral to the currency leading up to the election.

The South Korean won has appreciated by over 11% measured as the real effective exchange rate in the last 12 months. The reason for the increase is South Korea’s strong fundamentals, including a current account surplus of over 6% of GDP. On the downside, the strong won has hurt South Korea competitively and has now begun to impact economic data. Growth was certainly strong during the first quarter, with GDP rising by 3.9%. Manufacturing, on the other hand, has seen little or no growth in the last two years and fell by 0.7% at an annual rate in May. The PMI fell in June till 48.4, suggesting continued weakness in industrial production in the months ahead. The strong won also means very low inflation pressures. Consumer prices rose by 1.7% at an annual rate in June. As a result, inflation has stayed below the central bank’s lower tolerance limit of 2% in the last 20 months. We therefore expect it to leave the benchmark rate unchanged for the rest of the year. One factor that could reduce the pressure on the won is if the ongoing talks with China pave the way for direct trade between the won and yuan. China is South Korea’s biggest trade partner and around 90% of trade between them is in US dollar.

Economic growth in Indonesia has gradually slowed since 2011 and rose by 5.2% in the first quarter. This is the lowest growth rate since the third quarter of 2009. Manufacturing has recovered slightly since bottoming out last December, but exports fell by 8.1% at an annual rate in May. As a result, the rupiah has not given Indonesia enough of a competitive boost to rouse exports, despite that the currency has weakened over 16% against the dollar in the last 12 months. On the other hand, the latest PMI shows a significantly improved outlook for manufacturing. The PMI rose in June to a new record level of 52.7. Inflation has declined slightly after peaking at 8.1% in January and was 6.7% in June. Prices at the wholesale level are even stronger, rising by 11.7% at an annual rate in April, the highest inflation rate since 2008. We therefore expect the central bank to maintain its benchmark rate at 7.5% to ensure they have inflation under control. Currency reserves have been partly restored since the turbulence last summer and total around USD 100bn, equivalent to the value of 6.4 months of imports. The current account deficit is a risk, however, if capital markets should falter again.

South KoreaLarge reserves and strong current account

Weak economic momentum

IndonesiaStrong PMI and hopes of new policies after election

Weak growth and high inflation



Forecast EUR/INR in 3 months 78.47 (today 81.15) Forecast EUR/CNY in 3 months 8.23 (today 8.43)


Economic data in China have continued to point to a slowdown in activity in recent months. GDP rose by 7.4% at an annual rate in the first quarter. Investment is the weakest since the end of 2001. Falling steel prices indicate that investment demand remains low. Steel prices have dropped about 15% this year alone. Growth in retail and industrial production is the weakest since the financial crisis in 2008-2009. Exports, in contrast, turned higher during the spring and rose by 7% at an annual rate in May. Moreover, the latest PMI shows that the slowdown has leveled off. Over a three-month period ending in June the PMI rose to 51.0 with the support of the latest fiscal stimulus. Real estate activity has slowed in 2014 and prices of new homes rose by 5.6% at an annual rate in May, down from 9.9% in December 2013. Surveys suggest falling confidence in the property market. Credit growth was 17.8% at an annual rate in May, a significant decline from levels of around 25% twelve months ago. Credit growth in the banking sector is relatively stable, which means that most of the changes have been in the shadow banking sector. In general, the Chinese economy seems to be developing in line with the political shift toward lower structural growth.

India’s nearly six-week-long election concluded with a major victory for the Hindu nationalist party BJP and its leader Narendra Modi. The party has secured its own majority in the lower house of parliament and is now beginning the painstaking process of instituting growth-oriented reforms. The latest proposals for greater openness, predictability and an improved business climate are important steps on the road to increasing investor confidence. The challenges are great and we don’t expect any rapid changes. The trade balance has steadily improved in the last year largely thanks to weak imports, but lately with increased support from stronger export growth. In the process, the current account balance has rapidly improved compared with a year ago. The deficit has shrunk from around 5% to about 1.7% of GDP. The manufacturing growth rate has fluctuated around zero since late 2011, but accelerated in April, rising by 3.4 on an annual basis. Signals from purchasing managers point to a continued modest improvement in industrial production. Economic growth is still low. GDP grew by 4.6% at an annual rate in the first quarter, the average growth rate since mid-2012. The central bank’s hard-line policies have quickly reduced the inflation rate from double digits in 2013 to 8.3% in May.

The yuan has fallen about 2.4% against the US dollar and by 1.0% against the euro. We expect the yuan to strengthen in the medium term, but see continued fluctuations going forward to counter new speculative flows. We are positive to the yuan against the euro given that we anticipate a stronger dollar.

The rupee has performed strongly since hitting bottom last autumn, but is still low measured in terms of its real effective exchange rate. Political conditions in India are the best in some time. Because of this, coupled with a smaller current account deficit and a high short-term interest rate, we are maintaining our positive view of the rupee from last autumn.

ChinaNew reforms facilitate more sustainable growth

Weaker yuan allowed to reduce speculative flows

IndiaNew government and stronger trade balance

Weak domestic consumption



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EM Quarterly Outlook-Fundamentals and Markets Diverge