Emerging Markets Strategist - HSBC · 2014-02-12 · Figure A1. US swap 1y1y suggests expectations of late hikes have been priced out Source: Bloomberg These risks remain on the radar

Disclosures and Disclaimer This report must be read with the disclosures and analyst

certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it

Emerging MarketsStrategist2014 outlook: Baby steps on shaky ground

Global Emerging MarketsMulti-asset strategy

January 2014

Stronger EM growth in 2014 might not be enough to generate strong appetite for EM assets

Market volatility should stay high, but low positive returns across asset classes are likely

Risks come from higher US rates and the constraints on policy of a heavy election calendar

By Pablo Goldberg and the Emerging Markets Research team

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Global Emerging Markets Multi-asset strategy 20 January 2014

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HSBC’s Emerging Markets Strategist identifies the best trading opportunities across asset classes, building on our teams’

analysis across all EM regions. Find below our key calls for emerging markets for 2014, encompassing external and local

debt, EM corporate credit, foreign exchange, and equities.

Last year proved to be a rude awakening for investors in the emerging markets as risks facing the asset class quickly rotated

A repeat of the 2013 scare cannot be ruled out, but we expect a slow healing in 2014 and recommend investors take baby

steps as the ground remains very shaky

We believe investment success in 2014 will be about avoiding the EM pitfalls rather than trying to time changes in US

monetary policy

Fundamentals within EM might continue to diverge and we are concerned about the limitations imposed to economic

policy by a heavy election calendar at a time when flexibility is most needed

Investors should be watchful of political risk: all the so called Fragile Five countries --Brazil, Turkey, India, Indonesia,

and South Africa-- will face elections this year, Thailand and Ukraine could see more popular protests, and unorthodox

policies could lead to more capital flight in Argentina and Venezuela

EM assets should perform better than they did in 2013: volatility should stay high, but positive returns, while low, are likely

Our base case is for returns around 5% in external debt, where we favor the high grade sector

We expect local debt markets to face the biggest headwinds among the EM asset classes, as currency volatility discourages

inflows; still, we see potential for 4-6% returns in local currency terms thanks to the carry

We forecast 7% increase for the MSCI EM, or 10% once dividends are accounted for

With a calmer global backdrop, inflows to EM funds should return, yet at a much more moderate pace than in the past

We expect EM GDP growth to accelerate to 4.9% in 2014 versus an estimated 4.5% in 2013

We see growth accelerating in Mexico, the CEE, Taiwan, Thailand, South Africa, and Morocco, while China (to 7.4%),

Turkey, Venezuela, Argentina, Philippines, Pakistan, and Indonesia are expected to decelerate.

We expect EM to contribute 75% of total global growth, a powerful argument to stay invested in EM

Where inflation is low monetary conditions are likely to remain accommodative and FX depreciation will continue to act

as a buffer to external shocks

In countries where inflation is high –India, South Africa, Indonesia, Brazil and Turkey—the ability of policymakers to

support the economy is severely constrained; for the last two we expect rate hikes during 2014

We acknowledge the contribution of Jessica Wu and Amrita Pal to this report; Ms. Pal is employed by a non-US affiliate of

HSBC Securities (USA) Inc., and is not registered/ qualified pursuant to FINRA regulations.

Emerging markets in 2014

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Emerging markets in 2014 1

Baby steps on shaky ground 4 2014: A slow healing 4 Another 2013? Unlikely 4 Avoiding pitfalls, for low, yet positive returns 6 Investors needed 7 Politics to the forefront 8 The strong to get stronger, while the weak might not 9 Inflation determines room for manoeuvre 12 Monetary policy to stay loose, with a tightening bias in Asia 12 Beware of EM vulnerabilities 14 How to position for the potential 2014 risks 16 Ratings to show greater divergence in 2014 18 2014 key ratings watch list 19

EM funds flows: A long way back to recovery 22 Should I stay or should I go? 22 What will it take for flows to recover? 23 The risks of a 2013 repeat 24 Flows to local debt markets to be particularly weak 24 Focus on the stronger countries 25

2014 asset class outlooks 27

EXD: Value has returned 28 Outlook and drivers for 2014 28 Scenarios and risks 29 Strategies and top trades 30 Supply-and-demand dynamics 31

Local debt: Carry attractive, hostage to FX 32 Outlook and drivers for 2014 32 Scenarios and risks 33 Strategies to begin the year 34 Supply in the local markets 36

EM FX: Focus more on local factors 39 Outlook and drivers for 2014 39 ‘Balance of payments’ stories 39 FX Policies 40 Politics 40 ‘Valuation’ opportunities 41 Strategies to start the year 41

Equities: Cheap, unloved, but not straightforward 43 Outlook and drivers for 2014 43 Scenarios and risks 44 Strategies to begin the year 46

EM Corporates in 2014 47 Asia 47 CEEMEA 48 Latin America 49

2014 regional economic outlooks 51

Asia in 2014 52 Steady at best 52 Less shiny growth 53 Low inflation except in India and Indonesia 54 Tightening cycle in sight? 55 2014: The year of reforms in China 55

Latin America in 2014 56 Inching forward 56 Weak and uneven recovery 57 Rising or sticky inflation in the Atlantic, lower in the Pacific 58 Tightening vs. easing 58

CEEMEA in 2014 60 Politics, politics everywhere 60 Growth still too slow for comfort 61 Inflation broadly in check 62 Diverging policy measures 63

The Middle East and North Africa in 2014 64 Another year of contrasts 64 Still spending its way up 64 Inflation risks rising in GCC 66 Subsidy spending key 66 FX policies to stay stable 67

Multi-asset strategy summary 69

Macroeonomic forecasts 77 Macroeconomic Forecasts 78 EM FX Forecasts 79

Disclosure appendix 82

Disclaimer 84

Contents

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2014: A slow healing

After an extremely difficult year, both in terms

of returns and outflows from emerging

markets, investors wonder when it will be time

to go back to EM. Last year proved to be a rude

awakening for investors as risks quickly rotated

from disappointing economic activity in the

developed markets (DM) and risk aversion shocks

to financial tightening for exactly the opposite

reasons. While a repeat of the 2013 scare cannot

be ruled out, we expect a slow healing in 2014;

thus we recommend investors take baby steps

as the ground remains very shaky.

The reflow of capital toward developed

markets and a slowdown in China have left the

emerging markets more exposed. Below the

liquidity veil, there was a strong undercurrent of

diverging domestic fundamentals; a divergence

that is likely to continue in 2014. To identify EM

weaknesses and strengths, we use proprietary

HSBC indicators and valuation tools.

We believe investors will only slowly come

back to the asset class, and recommend a

defensive stance at the start of 2014. Stronger

appetite for EM risk requires a further recovery in

economic momentum and less uncertainty about

the future of US rates. We use HSBC’s Growth

and Inflation Trackers, and PMIs, to test the

temperature of economic variables.

We believe outperformance will come from

avoiding domestic hiccups rather than trying

to guess the direction of external variables. We

believe UST will recover from here, but views

around the markets have never been so

widespread. We use our recently enhanced HSBC

EM Vulnerabilities framework to test the

resilience of different emerging countries to a still

challenging global environment.

Should conditions deviate from our moderately

constructive case for EM in 2014, we identify

which EM countries would fare best under

alternative scenarios, including a China hard

landing and faster removal of QE.

Another 2013? Unlikely

While a repeat of 2013 cannot be ruled out, we

believe last year’s scare took place thanks to a

combination of very specific conditions. First,

there was the sudden and unexpected change in

investors’ perception of the direction of US

monetary policy. Consider that it was only a

Baby steps on shaky ground

Stronger EM growth in 2014 might not be enough to generate strong appetite

for EM assets; we expect markets to heal slowly

Market volatility should stay high, but low positive returns across EM asset

classes are likely

Risks come from higher US rates and domestic vulnerabilities in key EM

countries, heightened by policy constraints due to a heavy election calendar

Pablo Goldberg Global Head of EM ResearchHSBC Securities (USA) Inc.+1 212 525 [email protected]

Bertrand Delgado EM StrategistHSBC Securities (USA) Inc.+1 212 525 [email protected]

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month before Fed Chairman Bernanke suggested

the possibility of ‘tapering’ quantitative easing

(QE) last May that investors were discussing the

implications of QE-infinity and a potential strong

interest of Japanese investors for foreign assets.

Second, a deterioration of economic data in China

raised concerns about policy makers’ willingness

and ability to reflate the economy. This combined

shock hit the market at a time when positioning

was stretched, with EM investors too long in

terms of duration, mostly currency unhedged, and

increasingly drawn to illiquid trades following

many years of a strong hunt for yield.

Table A1. Emerging markets assets started 2014 with mixed performance following a turbulent 2013

YTD 2013 2012 2011 2010

EM EXD 0.6% -5.3% 17.4% 7.3% 12.2% EM IG 0.4% -8.0% 14.5% 9.9% 9.6% EM B-BB 0.9% -4.2% 25.3% 5.2% 18.2% EM Corporates 0.7% -1.3% 18.1% 4.2% 14.7% US HY 0.3% -0.3% 13.7% 8.4% 11.4% US IG 0.5% 7.1% 10.8% 3.8% 13.4% EM LCY bonds (in USD) -0.8% -9.0% 16.8% -1.8% 15.7% EM LCY bonds (in LCY) 0.3% -0.3% 13.7% 8.4% 11.4% EM Short-term rates 0.2% 3.8% 3.7% 2.7% 3.1% EM EQUITIES -2.8% -5.0% 15.1% -20.4% 16.4% S&P 500 -0.1% 29.6% 13.4% 0.0% 12.8% EM FX -1.1% -3.5% 7.9% -6.1% 7.7%

Source: Bloomberg, Datastream, HSBC

Such a ‘perfect storm’ caused a rapid and

violent reversal of appetite for EM risk,

bringing back memories of those times when

sudden stops of capital flows led to financial crisis

in the region. According to EPFR data, around

USD100bn left EM fixed income and equity

dedicated funds between May and December

2013, more than reversing the USD49bn that

came in during January to April of the same year.

Figure A1. US swap 1y1y suggests expectations of late hikes have been priced out

Source: Bloomberg

These risks remain on the radar screen for

2014, but the surprise factor has diminished.

With the Bank of Japan is still in easing mode and

the European Central Bank potentially providing

more stimuli, global liquidity remains plentiful

despite the start of US tapering. Global liquidity is

likely to remain plentiful.

The potential for higher US rates, particularly

if they are the result of a sudden adjustment,

remain an important force, depressing the

appetite for EM risk, however. A recent

steepening of the front end of the US swap curve

shows balanced risks between a more dovish Fed

and an early un-anchoring of US rates should

economic activity outperform expectations. This

compares with a market that was more dovish

prior to the December FOMC meeting (Figure

A1). With the market fully pricing in forward

guidance, there is little room for error if the data

become stronger. Such a tight scenario is likely to

keep weighing on EM investors’ mind and

discourage strong inflows.

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Avoiding pitfalls, for low, yet positive returns

We believe investment success in 2014 will

come from avoiding the bad stories, rather

than from trying to time the gyration of US

rates. Picking quality and emphasizing relative

value appears the way to go. Tighter external

financial conditions have emphasized

differentiation within EM, with the strong getting

stronger and the weak getting weaker.

Local factors are likely to gain dominance.

Weakening external financing has exposed

fragilities in the EM fabric. Structural reforms are

only taking place in a few places, and more will

be needed to avoid below-trend growth. Where

possible, the policy of choice for adjustment has

been currency depreciation; however, in countries

where the ability to float currencies is constrained

by high inflation rates (e.g. Brazil, India,

Indonesia, Turkey, Argentina), interest rates will

have to stay high and economic growth will likely

suffer. Furthermore, a heavy election calendar,

particularly in the case of those countries grouped

in the so-called ‘Fragile Five’ --Brazil, Turkey,

India, Indonesia, and South Africa--, is likely to

reduce policy makers’ room for manoeuvre at a

time when flexibility is most needed to deal with

external shocks.

We expect low, yet positive, returns from

emerging markets assets in 2014, while market

volatility should stay high. Performance year-to-

date has been mixed, with hard currency debt

returning 0.6% so far, local bonds returns up

0.3%, but dragged down to negative territory by a

depreciation in EM currencies. Emerging equities

are also down by almost 3%, with losses very

much across the board (Table A1).

We expect hard currency denominated bonds

to return around 5% this year, as spreads could

tighten further. We recommend investors focus on

the high grade sector, as high yield sovereign

names present idiosyncratic and very difficult-to-

predict risks at this point.

We expect 4-6% returns from the local

markets, supported by the carry. We see index

yields going slightly higher, while EM FX

depreciation could shave off another 0.3% to

returns in USD, according to HSBC FX Strategy

forecasts. Currency volatility, which we expect to

stay high, continues to be a major drag on appetite

for local bonds, as it contributes with 75% of the

benchmark local currency bond total return index

when measured in USD. Local debt presents, in

our view, an inferior risk-reward to hard currency

debt, we estimate.

We expect the MSCI EM equity index to rise

by about 7% during 2014, and total returns of

10% once dividends are included. EM trades at

a discount on price-to-book to developed markets.

Consensus is for 12% EPS growth this year, thus

our modest return expectations could be met even

if earnings disappoint again, as long as multiples

do not contract further.

We recommend investors:

Retain a conservative approach at the start

of 2014

Emphasize hard over local currency

Add overall exposure to emerging markets

hard currency debt as valuations better

accommodate for the existing risks.

Focus on the high grade sector debt due to its

superior Sharpe ratio (see External Debt

section on page 28). We favor Colombia,

GCC, Indonesia, Mexico, and South Africa

versus Turkey, Brazil, and Malaysia.

Remain short duration and selectively hedging

currency exposure in the local markets (see

Local Markets section page 32). We receive in

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Colombia and Mexico, and are paying in India,

Singapore, Malaysia, Turkey, and in the China

front end. We like the belly in Philippines,

Poland, and Uruguay inflation linkers.

Stay neutral in EM equities, as cheaper

valuations compensate somewhat for lost

earnings momentum.

Concentrate mostly in relative value trades in

EM FX and maintain strategic hedges. Some

EM central banks, while aiming at keeping

volatility at bay, have displayed a bias towards

currency depreciation (see the EM FX section

on page 39). We see room for appreciation in

MXN, CNY, ILS, PEN vs USD; we favor PLN

vs EUR and HUF, KRW vs THB, SGD vs

MYR, MXN vs CLP, and TWD vs PHP; we

are negative UAH, VEF, TRY, ARS vs USD.

Favor stocks in the structurally strong EMs

and those that have made progress in tackling

problems (see EM Equities section on

page 43). We like Taiwan, Philippines, Peru,

Mexico, Indonesia and Malaysia, and

underweight Colombia, India, South Africa,

and China.

Investors needed

Key to our return expectations is tied to

foreign investors abandoning their current

sceptical attitude towards EM; however, our

Capital Flows Indicator (CFI) suggests this is

not the case yet. In Capital Inflows into EM

(August 2013) we analyzed the motives behind

and the characteristic of investors’ appetite for

emerging markets assets and we created the CFI

to better monitor the direction of capital. We

divided these motives between pull and push

factors. While the first refer to those local

attributes that generated attention for EM, the

latter involve the reasons why investors were

‘forced’ to leave the developed markets. Among

the latter are QE and the risk of a euro breakup.

In contrast to previous cycles, this time around,

the more rapid the deterioration of push

factors –due to better DM performance--, the

weaker the pull factors become. In fact, appetite

for EM risk is so sensitive to higher US rates, that

EM returns present a negative correlation to

positive US economic surprises (see Emerging

Markets Strategist: When good news is bad news,

24 November 2013).

EM-dedicated funds continue to see outflows

for the most part, particularly from retail

investors (Table A2). Appetite for EM assets

should return only slowly, as there does not

appear to be an immediate catalyst to bring money

back. However, we still expect moderate, yet

positive, flows for the year, following outflows in

2013. This should come from what we expect to

be an only gradual adjustment in US monetary

conditions, accelerating EM growth, still-decent

fundamentals in many economies, and cheaper

relative valuations for EM assets.

Appetite for external debt is likely to recover

fastest, followed by equities, while local debt is

likely to face more resilient headwinds.

Emerging market central banks, while looking to

reduce currency volatility, are happy to see

currencies depreciate. External imbalances may

slowly start to correct, but more economic and

financial adjustments might be needed.

Table A2. EM-dedicated funds saw heavy outflows in 2013

EM Equities EM FI External debt Local debt USDbn % AUM USDbn % AUM USDbn % AUM USDbn % AUM

2009 84.2 19.1 8.3 8.3 3.2 6.9 2.6 5.0 2010 103.6 14.3 55.7 60.8 15.0 30.7 31.1 119.9 2011 -38.1 -4.2 17.1 10.0 0.7 0.8 14.8 22.2 2012 46.5 5.3 57.0 26.4 36.5 42.4 15.3 16.1 2013 -26.7 -2.4 -25.1 -6.7 -19.2 -11.4 -5.5 -3.2 Jan-April 23.3 2.3 26.1 8.2 4.2 3.0 17.7 13.6 May-Dec -50.0 -4.6 -51.2 -13.8 -23.3 -14.0 -23.2 -14.7 YTD -2.6 -0.3 -0.8 -0.4 -0.4 -0.4 -0.4 -0.4

Source: EPFR

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A pickup in EM growth alone might not be

enough to generate a strong appetite for EM

assets for now. Fundamental momentum

continues to favor DM over EM for the time

being; our more constructive outlook for the year

might take some time to get traction. HSBC

Surprise Indices point towards upwards

momentum for economic activity and downward

momentum for inflation in the US (long-term) and

Europe (short and medium term), which should

continue to attract the attention of investors.

What will it take for investors to come back?

A return of investors to the asset class requires an

improvement of EM’s risk-reward profile and

more clarity on the direction of rates in the US.

On the positive side, EM now offers cheaper

relative and absolute valuations in the context of

still ample global liquidity. This is true for hard

currency bonds and equities to a large extent.

Local curves are too steep, and EM central banks

are likely to stay in an accommodative mode

(see EM Funds Flow on page 22).

Politics to the forefront

Investors should keep an eye on political risk in

EM during 2014. Some of the countries that have

been under scrutiny have entered political cycles

that may constrain their ability to adequately

respond to the new macroeconomic challenges.

All the so-called “fragile five” countries will face

elections this year. Turkey will face local

elections in March and presidential in August.

Brazil will also face presidential elections in

October, while South Africans and Indonesians

(April), and Indians (May) should go to the polls

to renew their parliaments (Table A3).

In Turkey, a corruption investigation led to further

pressure on the currency. In Brazil, concerns

about the fiscal accounts, high inflation, and lack

of reforms may lead to a credit ratings downgrade

during 2014. While President Dilma Rouseff

remains the favorite in the polls to win another

term in office according to the polls, necessary

adjustments could be delayed.

In Thailand, parliamentary elections will take

place on 2 February. Still, anti-government

protests will still go on as the ultimate objective is

to force the resignation of Prime Minister

Yingluck. With no end in sight for the political

turmoil, downward pressure will remain on Thai

financial markets.

Table A3. Emerging Markets 2014 elections calendar

Month Day Presidential Elections

Legislative/ Parliamentary Elections

Feb-14 02 El Salvador-1st Rd Costa Rica

Costa Rica Thailand

Mar-14 09 El Salvador-2ndRd Colombia 15 Slovakia 1st Rd29 Slovakia 2nd Rd

Apr-14 TBC Hungary South Africa

05 Afghanistan09 Indonesia 30 Iraq

May-14 TBC Lebanon India 04 Panama Panama 11 Lithuania 1st Rd25 Lithuania 2nd Rd

Colombia Jul-14 09 IndonesiaAug-14 TBC TurkeyOct-14 05 Brazil

Bolivia Brazil Bolivia

26 Uruguay-1st Rd Uruguay Nov-14 TBC Romania

30 Uruguay-2nd Rd

Source: IFES Election Guide, The Atlantic, The National Democratic Institute

Although without elections in the short term,

political events in Ukraine, Argentina, and

Venezuela are also key. In Ukraine, the

opposition has demonstrated against the

governments’ decision to snub a European Union

integration pact last November, and the monies

raised from an agreement with Russia could be

used for current spending, suggesting such aid

might be only a short term fix. In Argentina and

Venezuela, restrictions to buy FX and high

inflation fuel by money printing are leading to

capital flight and a rapid deterioration in the

foreign reserves position.

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The strong to get stronger, while the weak might not

HSBC Economics forecasts EM growth of

4.9% in 2014, up from 4.5% last year. Yet this

acceleration will have two characteristics: it is

likely to be moderate and uneven among

countries. Figure A2 compares our 2014 forecasts

versus our 2013 estimates, and shows the

acceleration for this year would come mostly from

Mexico, Taiwan, Thailand, and CEE. On the other

hand, we expect significant deceleration in

Argentina and Venezuela, as well as in Turkey

and the Philippines (Figure A2).

HSBC Growth Tracker suggests the EM

growth scare is behind us (see Figure A3).

Growth appears to have bottomed in the first

quarter of last year, with conditions improving

thereafter. Yet, it also shows the recovery is

happening at a below-trend pace in many places.

We expect this performance to continue into

2014. HSBC PMI indicators suggest some

deceleration might be taking place as we enter

2014, however (see Figure A5). Still, close to

80% of the EM countries covered by our PMI

indices are above the 50-threshold level.

Key to the performance of EM is what happens

in China, as the region has become more

integrated with the second-largest economy of the

world. Should China slow down significantly, EM

will suffer (see page 14). We expect China to

grow around 7.4% in 2014, which is enough for

the rest to accelerate (see Asia Economics

Quarterly, Q1 2014 for more). However, current

account deficits (e.g. Turkey, South Africa, Chile,

Colombia, Brazil, India, and Indonesia) in many

large EM economies may put a ceiling on growth

as the markets are more averse to financing

countries with imbalances.

Figure A2. EM growth to accelerate but divergence to prevail

Source: HSBC

'14 vs '13

Country 2013f 2014f 2013f 2014f

Developed 1.1 1.8 1.3 1.6US 1.8 2.3 1.5 1.7Eurozone -0.4 0.8 1.4 1.0Germany 0.6 1.7 1.6 1.7Japan 1.7 1.3 0.3 2.3Emerging 4.5 4.9 5.5 5.7Asia-Pacific 4.3 4.2 2.6 3.3China 7.7 7.4 2.6 2.7Hong Kong 2.9 3.7 4.2 4.2India 4.6 5.3 9.5 7.2Indonesia 5.6 5.0 7.0 5.6Malaysia 4.6 5.2 2.1 2.4Philippines 6.8 5.9 2.9 4.2South Korea 2.7 3.2 1.2 2.6Singapore 3.7 3.8 2.4 3.1Sri Lanka 6.8 7.2 6.9 6.9Taiwan 1.7 2.8 0.9 1.9Thailand 2.8 4.4 2.2 2.6Vietnam 5.4 5.6 6.6 7.9LatAm 2.0 3.0 8.7 10.0Argentina 2.5 1.0 25.1 27.4Brazil 2.2 2.2 6.2 6.0Chile 4.3 4.3 2.0 2.8Colombia 4.0 4.5 2.0 2.4Mexico 1.3 4.1 3.7 4.0Panama 7.5 6.3 4.1 3.5Peru 5.0 5.6 2.9 2.1Uruguay 3.5 3.5 9.1 8.1Venezuela 1.3 -1.7 53.0 59.4CEEMEA 2.0 2.5 5.2 4.7Czech Rep. -1.4 1.9 1.4 1.1Estonia 1.5 2.5 3.2 2.8Hungary 1.0 2.1 1.7 1.3Israel 3.3 3.3 1.6 1.6Kazakhstan 6.0 6.2 5.8 4.9Latvia 4.0 4.0 0.0 1.2Lithuania 3.0 3.5 1.0 1.1Poland 1.4 3.0 1.0 1.8Romania 2.8 2.4 4.0 1.8Russia 1.5 2.0 6.8 5.6South Africa 1.8 2.6 5.8 5.7Turkey 3.9 2.2 7.5 7.4Ukraine -1.0 0.0 -0.3 2.1MENA 4.0 4.1 3.7 5.3Algeria 2.7 2.7 0.8 2.5Bahrain 3.5 2.8 3.5 3.0Egypt 2.2 2.6 10.3 8.6Kuwait 3.7 3.1 1.8 4.0Jordan 3.0 3.3 6.8 6.5Lebanon 0.1 1.3 1.0 1.7Morocco 2.8 3.6 1.0 3.0Oman 4.8 4.0 0.5 3.0Pakistan 3.6 2.5 9.2 12.0Qatar 6.5 6.5 3.0 5.6Saudi Arabia 3.8 4.0 3.3 5.0UAE 4.5 5.0 1.6 4.5

GDP growth (%) Inflation (%)

-4 -2 0 2 4

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Figure A3. HSBC Growth Tracker

Figure A4. HSBC Inflation Tracker

Figure A5. EM PMI Heatmap

Source: HSBC, Bloomberg, Markit

Dec 13 Nov 13 Oct 13 Sep 13 Dec 13 Nov 13 Oct 13 Sep 13 Dec 13 Nov 13 Oct 13 Sep 13 Dec 13 Nov 13 Oct 13 Sep 13 Dec 13 Nov 13 Oct 13 Sep 13

Brazil 50.5 49.7 50.2 49.9 51.5 50.8 51.6 50.6 51.3 54.0 58.9 57.5 50.7 49.3 49.9 49.6 49.7 49.2 49.0 49.3 BrazilMexico 52.6 51.9 50.2 50.0 52.7 51.5 49.4 50.0 49.9 50.0 49.5 49.8 54.3 53.4 51.3 50.3 50.5 50.8 49.1 50.4 MexicoChina 50.5 50.8 50.9 50.2 51.4 52.2 51.1 50.2 49.9 50.3 50.4 51.3 51.6 51.7 51.5 50.8 48.7 48.9 50.4 48.8 ChinaHongkong 51.2 52.1 50.1 50.0 52.1 53.5 50.5 50.6 50.3 51.0 50.7 52.2 53.0 54.0 50.0 50.3 48.0 48.2 48.1 48.2 HongkongIndia 50.7 51.3 49.6 49.6 51.3 51.5 48.6 49.6 51.8 51.9 55.3 51.1 51.3 51.9 48.9 49.6 50.8 50.5 50.6 49.7 IndiaIndonesia 50.9 50.3 50.9 50.2 50.2 49.0 51.8 50.3 55.4 57.0 62.9 64.8 52.0 52.2 51.3 49.5 50.0 49.2 49.7 49.7 IndonesiaSingapore 49.7 50.8 51.2 50.5 49.5 51.0 52.4 52.1 50.3 51.7 52.2 51.0 51.6 51.2 50.1 SingaporeSouth Korea 50.8 50.4 50.2 49.7 51.3 50.2 50.6 49.8 49.4 49.7 48.2 50.5 50.7 50.1 50.7 49.8 50.8 51.5 49.5 50.3 South KoreaTaiwan 55.2 53.4 53.0 52.0 58.8 55.2 53.9 52.7 48.0 48.3 48.0 48.1 58.2 55.2 54.4 52.1 51.6 52.3 51.9 52.5 TaiwanVietnam 51.8 50.3 51.5 51.5 52.6 52.0 51.2 49.8 49.0 50.5 51.2 49.3 52.5 48.8 53.1 52.4 53.6 51.8 51.5 53.8 VietnamCzech Republic 54.7 55.4 54.5 53.4 57.0 59.0 56.9 55.9 54.6 51.1 50.4 48.9 55.9 57.1 53.8 53.6 53.3 53.0 54.4 51.5 Czech RepublicHungary 50.2 52.6 51.0 54.5 HungaryIsrael 46.6 44.9 51.4 51.8 49.7 40.1 40.0 44.3 IsraelPoland 53.2 54.4 53.4 53.1 53.6 56.9 55.4 55.8 48.2 48.8 47.2 48.2 54.9 57.2 55.1 53.1 53.4 52.8 52.9 53.5 PolandRussia 48.8 49.4 51.8 49.4 50.6 50.9 54.9 50.7 52.7 52.7 51.1 52.2 49.8 50.6 54.7 50.4 45.8 47.1 48.6 46.2 RussiaSaudi Arabia 58.7 57.1 56.7 58.7 61.6 59.4 58.2 60.9 51.2 50.5 50.4 50.8 67.5 63.9 64.7 68.8 52.7 52.0 51.5 52.5 Saudi ArabiaSouth Africa 52.4 50.7 50.0 54.0 52.6 48.1 54.8 52.4 54.2 55.4 51.6 50.6 49.4 50.8 49.4 49.5 South AfricaTurkey 53.5 55.0 53.3 54.0 54.5 56.7 52.7 55.6 53.5 54.4 54.7 56.2 54.7 57.1 53.2 54.9 53.2 53.7 54.9 53.7 TurkeyUAE 57.4 58.1 56.3 56.6 60.1 59.7 56.4 57.9 51.8 48.7 49.0 50.3 65.2 66.9 64.6 65.0 52.8 53.6 52.7 53.4 UAEEgypt 52.0 52.5 49.5 44.7 54.7 54.0 50.5 42.1 49.7 50.3 48.4 49.5 54.0 54.7 49.3 41.7 48.7 49.0 49.0 46.5 Egypt

** for HK, SAU, UAE, EGY- Whole Economy

EmploymentOutput prices New ordersPMI-M Output

Above 50 & Rising Above 50 & Falling Below 50 & Rising Below 50 and Falling

11


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Growth in EM will continue to depend mostly

on domestic demand; however, the acceleration

would come from an improvement in the

contribution of net trade. This is the case in

Asia, where net trade should contribute to about

1pp to total growth, from an almost zero

contribution in 2013. In the case of Latin

America, while still negative, net exports should

be less of a drag than in 2013 (Figure A7). EM

new export orders PMI, a good leading indicator

for actual exports, has been consistently above the

50-mark during the last six month. Figure A8

attributes such improvement to a pickup in

activity in China, which now combines with the

ongoing improvement in demand from DM.

Private consumption while still the most

powerful source of GDP expansion, is expected

to provide less of a contribution than last year,

in particular for CEEMEA and Latin America.

The contribution of investment should continue to

be quite uneven across regions. It would again be

the largest in Asia, growing slightly from 2013. In

Latin America, we expect the contribution of

investment to growth to stay unchanged, while we

see it accelerating in CEEMEA, yet still for a

total contribution of less than half than in the

other regions.

Figure A7. LatAm to grow on consumption, Asia on investment and net exports

Figure A8: EM exports recover on China and developed markets growth pick up

Source: HSBC Source: Markit, HSBC

Figure A6. Emerging markets to contribute 85% of world’s growth, most of it coming out of Asia

Source: HSBC

42

44

46

48

50

52

54

56

58

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2010 2011 2012 2013

DM output PMI China output PMIResidual EM new export orders (rhs)

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

China Rest of Asia Latam EMEA DM World growth, % yoy

pp contribution to growth

Forecast

12


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We expect EM to continue to be the main force

behind the expansion of the global economy,

which is a powerful argument to stay invested

in EM. While its share of contribution to GDP

should decrease from last year due to the

acceleration expected in DM, we see EM still

carrying two-thirds of world growth. The main

contribution still comes from Asia (close to 60%),

with China providing around 1.2pp, or 40% of

total global growth. Latin America and CEEMEA

should contribute with about 5%. While

developed markets are accelerating, investors

should continue to look to participate in the fastest

growing areas of the world (Figure A6).

Inflation determines room for manoeuvre

Far from being a concern, inflation has surprised

to the downside in most of the emerging countries

during 2013. Figure A9 shows that year-end

inflation fell within the bands targeted by most of

local central banks. Interestingly, inflation ended

below the lower bound for four (Poland, Colombia,

Korea, and Hungary) of the 16 emerging countries

that explicitly target inflation, and above the upper

end only in two cases (Indonesia and Turkey).

HSBC Inflation Tracker shows that following a two-

year long disinflationary period, consumer prices

regained some traction in the emerging markets

during the second half of last year (Figure A4).

Yet inflation remains a big concern in places

without explicit targets, like Venezuela and

Argentina, and the fragile five countries. High

inflation in Brazil, South Africa, India and the

already mentioned Indonesia and Turkey,

constrained policy makers from loosening

monetary policy despite weak growth (SoAf), and

forced them to tighten financial conditions

(everywhere else) in 2013.

We see few inflation pressures building across

the board in the region for 2014, yet those

under pressure in 2013 should see little relief.

Output gaps are not expecting to exercise

significant upward pull on inflation in general and

commodity futures suggest disinflationary forces

could continue. Inflation, on the other hand, might

see some upward pressure from past and

potentially future currency depreciation. This

could be the case of those countries that saw

important currency weakness, like India, Turkey,

Indonesia, South Africa, Czech Republic, Chile,

and Peru, according to our inflation

pressure model.

Monetary policy to stay loose, with a tightening bias in Asia

A benign inflation outlook for most should

allow for monetary policy to remain loose.

HSBC Economics is forecasting some tightening

bias to start in the second half of the year, in

particular in Asia. In Latin America, we might see

some belated easing in Peru, Chile and Uruguay,

while Brazil is likely to pause its tightening cycle

soon and wait until after the presidential elections

to continue hiking rates. Colombia might begin its

own tightening cycle late in the year, we believe.

Figure A9. 2014 inflation to stay within targets, except in Turkey and Hungary

Source: HSBC

0

1

2

3

4

5

6

7

8

IL CZ PO BR CL CO ZA TH KR MX HU PE PH ID RO TR

Target 2013E 2014F

%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%

13


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In CEEMEA, we still believe Turkey will be

forced to increase interest rates to both fight

inflation and currency depreciation during the first

quarter of the year by about 175bp. In CEE,

Hungary, Poland, and Romania are likely to stay

on hold and wait until 2015 to begin a process of

monetary normalization. On the other hand,

Russia may finally cut rates late in the year.

Contrary to Turkey, we believe India and

Indonesia will not be forced into more rate

hikes this year, with the exception of one early

25bp adjustment in the former. We expect South

Africa to remain on hold (Figure A10).

The risk is for less rather than more action.

Contrary to initial expectations, the shocks of 2013

led to a divergent monetary stance. Those seeing little

inflation and ample room to let currencies depreciate

ended up cutting rates, while those facing high

inflation and/or weak external balance sheets were

forced to increase rates. For those that cut in 2013, the

current level of rates suggests there is not that much

room left for conventional policy should growth

conditions falter. Alternatively, a process of rates

normalization would likely come pari passu a broad

recovery of economic conditions (Figure A11).

Figure A11. PMI-based Taylor Rule shows EM CB on hold

Source: HSBC

Figure A10. Policy rates forecasts (%)

Source: HSBC

-20

-15

-10

-5

0

5

10

2007 2008 2009 2010 2011 2012 2013

Policy rates change PMI Model

Tighter

Looser

Country 2012 2013 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15

Brazil 7.25 10.00 10.75 10.75 10.75 10.75 11.25 12.25 12.25 11.75

Chile 5.00 4.50 4.25 4.25 4.25 4.25 4.25 4.25 4.75 5.00

Colombia 4.25 3.25 3.25 3.25 3.25 4.00 4.25 4.50 4.75 5.00

Mex ico 4.50 3.50 3.50 3.50 3.50 3.50 4.00 4.00 4.00 4.00

Peru 4.25 4.00 3.75 3.50 3.50 3.50 3.75 3.75 4.00 4.00

Uruguay 9.00 15.00 14.00 13.00 13.00 13.00

China 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00

Hong Kong 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50

India 8.00 7.75 8.00 8.00 8.00 8.00 8.00 8.00 8.00 8.00

Indonesia 5.75 7.50 7.50 7.50 7.50 7.50 7.50 7.50 7.50 7.50

Korea 2.75 2.50 2.50 2.50 2.75 3.00 3.25 3.50 3.75 3.75

Malay sia 3.00 3.00 3.00 3.25 3.50 3.50 3.50 3.50 3.50 3.50

Philippines 3.50 3.50 3.50 3.50 3.75 4.00 4.00 4.00 4.00 4.00

Singapore 0.38 0.20 0.30 0.30 0.30 0.30 0.30 0.30 0.30 0.30

Sri Lanka 9.50 8.50 7.50 7.50 7.50 7.50 8.00 8.00 8.50 8.50

Taiw an 1.875 1.875 1.875 1.875 2.000 2.125 2.250 2.375 2.375 2.375

Thailand 2.75 2.25 2.25 2.25 2.50 3.00 3.00 3.00 3.00 3.00

Vietnam 7.00 5.50 5.50 6.00 7.00 7.00 7.00 7.00 7.00 7.00

Czech 0.05 0.05 0.05 0.05 0.05 0.05 0.05 0.05 0.05 0.05

Hungary 5.75 3.00 2.75 2.75 2.75 2.75 3.00 3.25 3.50 3.50

Poland 4.25 2.50 2.50 2.50 2.50 2.50 2.75 3.00 3.25 3.25

Romania 5.25 4.00 3.75 3.75 3.75 3.75 4.00 4.00 4.25 4.25

Russia 5.50 5.50 5.50 5.50 5.50 5.25 5.25 5.25 5.25 5.00

South Africa 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.50

Turkey 9.00 7.75 9.50 9.50 9.50 9.50 9.50 9.50 9.50 9.50

14


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Beware of EM vulnerabilities

EM economies are now more exposed and

investors could become more broadly risk

averse in case of further deterioration in some

benchmark countries like Brazil, Turkey,

and/or India. Chinese growth and ample liquidity

have been external lifesavers and drivers of

growth for the emerging markets. With those

tailwinds reduced, investors have become less

tolerant of macroeconomic imbalances in EM,

which were more easily overlooked when the

ample liquidity safety net was supressing risk

(Figure A12).

In a recent publication, we enhanced our

HSBC EM Vulnerability Index to help identify

the more vulnerable and the more resilient

countries in EM. Our indicator consists of six

components reflecting growth, solvency, and

liquidity risks. (See Emerging Markets

Vulnerability, 18 December 2013) (Figure A13).

The Index shows Asia appears the best

positioned, and CEEMEA the most disperse

across the ranking. Latin America shows two very

weak countries (Argentina and Venezuela), and

the rest are in the middle of the pack. At the

country level, Venezuela appears as the weakest

of them all, followed by Ukraine, Turkey, and

Pakistan by a small margin. Venezuela’s

weakness comes from its sensitivity to the

performance of the global economy through the

price of oil, and its weak reserves position.

Ukraine remains very sensitive to changes in the

outlook for the eurozone, and has a very large and

short-term debt position. The recent agreements

with Russia should come as a great help to

alleviate some of these concerns. In the case of

Pakistan, while its coverage of short-term debt is

strong and the country is not heavily commodity-

dependant, it carries a large debt load and has a

weak current account position.

We are growing increasingly cautious about

Turkey. While the country benefits from a low

level of public debt, its ranking is dragged down

in our index by a large current account deficit,

low reserves with respect to short-term debt, and

high external debt over exports. Turkey is quite

sensitive to negative changes in the global

economy. On 7 January 2014, HSBC Economics

downgraded Turkey’s growth to 2.2% for 2014

and cut our TRY forecasts to 2.1 by year end.

Argentina appears also vulnerable due to a weak

reserves position and high debt-to-GDP ratio, in

particular when considering that the country has

very restricted access to alternative financing.

On the resilient side is the Philippines. It ranks

very strongly overall, with the exception of public

debt-over-GDP, where it appears in the weaker half.

It is followed by Singapore, which while quite

sensitive to the global economy, is a commodity

importer, and carries the largest current account

surplus of them all. China, ranking well across all

indicators, ranks at third place among the least

vulnerable countries, according to our index. Taiwan

and Korea follow among the winners. Taiwan ranks

strongly everywhere but has a high sensitivity to a

slowdown in the global economy, while Korea is

solid across the board.

It is interesting to see Russia at the top half of

vulnerability, dragged down by its vulnerability to

negative shocks in commodity prices. Among the

‘Fragile Five’, Indonesia is the best-ranked,

supported by a low level of public debt and little

sensitivity to shocks to the global economy.

Remember that Indonesia was one of the few EM

countries that did not experience a recession in

2009. South Africa is a close second, showing a

large current account deficit, but keeping a

relatively strong external balance sheet. India

comes next (although there has been some

improvement already), followed by Brazil, which

is last among this group. India and Brazil show a

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=MNrKvlQM4G&n=398678.PDF


https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=xfeBUssmiA&n=399710.PDF



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poor current account reading, with Brazil showing

larger commodity dependence. Should commodity

prices actually start going higher, Brazil will look

stronger than India. This suggests Brazil’s

problems are more domestic than external, linked

more to a flows story than its stocks. While the

balance sheet of the country remains solid,

investors appears to have lost confidence that

policy makers will take the right decisions to

promote growth and contain inflation.

Mexico is in the middle of the pack. Its long term

outlook has been bolstered by a series of

structural reforms, including the opening of the

energy sector to the private sector. The country

shows a below average foreign reserves coverage

of short term debt. However, this appears less

crucial given its ability to float its currency and to

attract FDI on the back of the energy reform

just approved.

Figure A12. Emerging markets external and fiscal positions j- 2014 forecasts

Source: HSBC

Figure A13. HSBC EM Vulnerability Index

Source: HSBC

CN

HK

IN

ID

MYPH

SGKR

LK

TW

THVN

AR

BR

MX

VE

RU

TR

PO

ZA

CZ HU

EG

IL

SAUAE

RO

KZCO

CL

-14

-12

-10

-8

-6

-4

-2

0

2

4

6

8

10

-8 -6 -4 -2 0 2 4 6 8 10 12 14 16 18 20

Budg

et b

alan

ce (%

GD

P)

Current a/c balance (% GDP)

16


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How to position for the potential 2014 risks

We use our HSBC EM Vulnerability Index to

rank the different EM countries in the context

of some alternative scenarios, which we

presented in the Top 2014 Risks report by

Stephen King and Fredrik Nerbrand. These are not

part of our base case for 2014, but may have a

profound impact on EM. The six scenarios are: Fed

is forced to increase QE, Fed tapers without a

strong recovery, China hard landing, EM current

account crisis, successful eurozone rebalancing,

and large commodity price declines.

Figure A14 takes a bird’s eye view to see how

countries cluster across bad scenarios for stress

testing. Two Latin America countries, Argentina

and Venezuela, appear to be quite sensitive to all

risks. Turkey and Ukraine, given that they are

commodity importers, improve if commodity

prices suffer a decline. The graph also highlights

the vulnerability of Chile to a bad commodity

price shock, as it stays in the middle of the pack in

any other case. China, Korea, The Philippines,

Thailand, and Taiwan appear quite resilient at the

least vulnerable side of the spectrum. Others

combine good and bad outcomes, with its stress

test range being quite wide (Figure A14).

Each scenario brings winners and losers. When

thinking about asset pricing, investors should

remember that while shocks may come from the

same direction, countries will react differently,

which suggests an emphasis on differentiation

and the need to adopt a more flexible

cross-asset approach.

For example, in the case of the EM current

account crisis or the Fed tapering without growth

scenarios, we expect a reduction of foreign

financing, to which EM countries will have to

adjust with varying combinations of FX

depreciation or a reduction in domestic demand.

Therefore, while in some countries a given

negative shock will suggest a short FX position, in

another the most advisable route may be to play

on the credit or equity market.

The most efficient asset selection to play each

scenario would result from a combination of

the overall and relative impact of the risks on

each country, but also on the way the country

Figure A14. Looking across bad scenarios

Source: HSBC

0

5

10

15

20

25

30

Arge

ntin

a

Braz

il

Chi

le

Chi

na

Col

ombi

a

Cze

ch R

epub

lic

Egyp

t

Hon

g Ko

ng

Hun

gary

Indi

a

Indo

nesi

a

Isra

el

Kaza

khst

an

Kore

a

Mal

aysi

a

Mex

ico

Paki

stan

Philip

pine

s

Pola

nd

Rus

sia

Sing

apor

e

Sout

h Af

rica

Taiw

an

Thai

land

Turk

ey

Ukr

aine

Vene

zuel

a

Viet

nam

MO

RE

----

Vuln

erab

ility

-----

LESS

Large commodity price decline Fed is forced to increase QE Fed tapers wthout strong recovery

China hard landing EM current account crisis


https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=a0DFUWMsmR&n=397636.PDF

17


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adjusts to each particular shock. In those

countries where policymakers face fewer

restrictions to let their currencies float more

freely, interest rates could rally. This was the case

last year in Mexico, Chile, Thailand, Hungary,

and Israel. Conversely, in countries where

inflation pressures are higher to start with,

monetary policy might have to be tightened even

when global liquidity is getting scarcer. We have

seen this before in places like Brazil, Turkey,

Indonesia, and India.

Table A4 shows how to position in each scenario

according to HSBC EM Strategists. These

recommendations can be played as relative value,

or outright, depending on the direction provided

by the general market.

Table A4. What to buy, what to sell in each scenario

Hard currency bonds Local rates EM FX EM Equities

Fed is forced to increase QE Market direction Bullish Bullish Bullish MixedOutperform Turkey, South Africa, Indonesia,

Mexico, Brazil Turkey, South Africa, Singapore,

Indonesia, Mexico, Brazil ZAR, TRY, RUB, MYR, IDR, MXN, PEN, CLP, COP, BRL

India, Indonesia, Turkey, South Africa, Brazil, Nigeria and Kenya

Underperform Poland, Czech Rep, Korea Czech Rep., Korea CZK, TWD, PHP, ARS Korea, Taiwan and China

Fed tapers without a strong recovery Market direction Bearish Bearish Bearish BearishOutperform Hungary, Romania, Korea Poland, Czech Rep., Philippines PLN, ILS, RMB, TWD, PEN GCC, China, Taiwan and KoreaUnderperform Turkey, South Africa, Indonesia<

Mexico Turkey, India, Malaysia, Mexico,

Peru, Brazil, Colombia TRY, ZAR, MYR, INR, MXN,

COP, CLP, BRL, ARS India, Indonesia, Turkey, South Africa,

Brazil and Mexico

China hard landing Market direction Bearish Mixed Bearish BearishOutperform

Hungary, Romania, India, Mexico Poland, Czech Rep., Hong Kong,

Mexico PLN, CZK, RMB, SGD Mexico, CE3 and Greece

Underperform South Africa, Russia, China, Peru, Colombia, Panama

South Africa, Russia, Malaysia, Indonesia, Peru, Colombia

ZAR, RUB, KRW, MYR, MXN, BRL, CLP, COP, ARS China, Russia, Brazil and South Africa

EM current-account crisis Market direction Mixed Mixed Bearish BearishOutperform Hungary, Romania, Korea, Mexico,

Peru Poland, Czech Rep., Korea,

Philippines, Mexico, Peru PLN, RMB, SGD China, Korea, Russia and Taiwan

Underperform Turkey, South Africa, Indonesia, Chile, Brazil

Turkey, South Africa, Indonesia, India, Brazil

TRY, ZAR, INR, IDR, BRL, PEN, CLP, COP

India, Indonesia, Turkey, South Africa and Brazil

Large commodities price decline Market direction Mixed Bullish Mixed MixedOutperform Turkey, Indonesia, India, Mexico,

Panama Turkey, Poland, Indonesia, India,

Mexico TRY, INR, PHP Turkey, China and India

Underperform Russia, South Africa, Indonesia, Peru, Venezuela, Argentina

Russia, Malaysia, Peru ZAR, RUB, MYR, CLP, COP,

BRL, ARS, MXN GCC, Russia, South Africa and Brazil

Source: HSBC EM FX, Fixed Income and Equity Strategy teams

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Ratings to show greater divergence in 2014

2013 has been a testing year for EM with

countries in economic imbalances facing most

challenges in credit profile. Among the 68

countries that broadly encompass the EM world,

more countries suffered negative rating actions

than positive (Figure A15). Some major EM

countries like Hungary, South Africa, Argentina,

Brazil, Egypt, South Africa, Indonesia, Ukraine

and Venezuela were downgraded or received

outlook cuts.

Thanks to the downgrades of 2013, the number of

countries below investment grade is now higher

than those with investment grade, something that

had not occurred even briefly since 2009, and

more structurally since 2006 (Figure A16). In fact

the average credit rating of EM (not market

weighted) has returned to sub-investment grade as

of September 2013. Tunisia and Croatia lost their

investment grade ratings last year, while

Philippines and Turkey reached migrated to

investment grade.

With growth expected at 4.9% this year,

average ratings for the asset class should tend

to stabilize (Figure A15). However, what is true

for the aggregate might not be for the individual

countries. HSBC Economics and Strategy expects

several major countries to be upgraded next year

including Indonesia, Romania, Peru, Mexico, and

Colombia. On the other hand, we expect Brazil

and Venezuela to be downgraded while India and

Thailand may see outlook cuts.

Figure A15: Net upgrade across EM: Credit rating upgrades (+) minus downgrades (-)

Figure A16: Distribution between investment- and non-investment grade

Source: S&P, Moody's, Fitch, HSBC Source: S&P, Moody's, Fitch, HSBC

2

3

4

5

6

7

8

9

-6

-4

-2

0

2

4

6

8

02 03 04 05 06 07 08 09 10 11 12 13 14

%

EM GDP Growth (rhs) Positive - negative rating actions

Positive vs negative rating actions

0%

10%

20%

30%

40%

50%

60%

02 03 04 05 06 07 08 09 10 11 12 13

Investment Grade Non-Investment Grade

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2014 key ratings watch list

Potential positive rating actions

Indonesia (BB+ sta/ Baa3 sta/ BBB- sta)

HSBC expects Indonesia to be upgraded to BBB-

by S&P in 2H14. We believe the S&P’s use of

per-capita GDP as the key reason for keeping the

rating at sub-investment grade is hard to

comprehend, given the per-capita GDP of the

Philippines, rated investment grade by S&P, is

about USD1,000 lower. On the other hand, the

concerns of the country’s reliance on foreign

currency borrowing can be eased if the

government focuses on reducing bureaucratic

interference (especially in the oil and gas sector),

raising labor market flexibility, removing

impediments to land acquisition and reversing the

export ban on metal ores.

Hungary (BB neg/ Ba1 neg/ BB+ sta)

HSBC Economics sees a chance for an outlook

change from negative to stable from

Moody's/S&P in recognition of good fiscal

performance in 2013 and pickup in growth

provided no policy disappointments (e.g. in the

banking sector related to a new support scheme

for FX mortgage holders).

Romania (BB+ pos / Baa3 neg/ BBB- sta)

HSBC expects S&P to upgrade Romania this year

while there is a probability for Moody’s to cut

outlook to negative. S&P has Romania's BB+

rating on a positive outlook and could upgrade it

this year. This will be just a catching up with

Moody's and Fitch who rate Romania at

investment grade already. IMF agreement and

prudent fiscal policy support the upgrade.

However, potential political noise in the run-up to

the end-2014 presidential election together with

limited growth pick-up will likely hold in place

negative outlook for Moody's rating.

Kazakhstan (BBB+ sta/ Baa2 pos/ BBB+ sta)

HSBC Economics believes that Kazakhstan could

be upgraded to Baa1 Stable by Moody’s in 2Q14,

since the Kashagan oil field Phase 1 capacity is

expected to continue moving closer to its peak,

adding to strong economic fundamentals of

Kazakhstan.

Latvia (BBB+ pos/ Baa2 pos/ BBB+ sta)

Moody's is likely to catch up with S&P and Fitch

and upgrade Latvia to Baa1Stable in 2Q14 on the

country's eurozone accession on 1 January 2014.

Belarus (B- sta/ B3 neg/ BB- sta)

HSBC Economics expects that S&P will probably

revert back to a positive outlook in 2Q14 amid the

recently approved roadmap for structural reforms

that can smooth macroeconomic imbalances at

least partially. In addition, Belarus will enjoy the

USD4bn revenue windfall in 2015 as Russia

seems to be ready to stop collecting revenues

from Belarus’s export duty on oil products.

Lithuania (BBB pos/ Baa1 sta/ BBB+ sta)

HSBC Economics expects S&P to upgrade the

country to BBB+ Positive in 1Q14. Lithuania is

on track to fulfil all the Maastricht criteria to join

the eurozone in 2015. So the country is expected

to follow the same rating pattern as its regional

peer Latvia.

Colombia (BBB sta/ Baa3 pos/ BBB sta)

HSBC Economics expects the upgrading process

in 2013 to continue in 2H14 once growth

consolidates even though excess fiscal spending is

a source of downwards risk. We maintain our base

scenario as at least one additional notch upgrade

as from 2Q 2014.

Peru (BBB+ sta/ Baa2 pos/ BBB+ sta)

HSBC expects it is likely for Moody's to upgrade

Peru to Baa1 in 2014 as outlook is already

positive and its rating is 1 notch below Fitch and

S&P. We expect that a positive outlook could

trigger upgrades in 2015 once exports begin

recuperating steadily on the back of higher

mining exports.

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Mexico (BBB+ sta/ Baa1 sta/ BBB+ sta)

HSBC Economics believes that Moody's may

upgrade Mexico one notch to A3 at in 2H14. The

fundamental reason is that in addition to a solid

macroeconomic framework, the structural reform

drive has been successful and has generated

positive expectations on investment and economic

growth. The timing depends on three factors:

1) the closing of the energy reform with the

approval of secondary laws in 1H14; 2) the need

to have an intermediate step by changing to

positive from the current stable outlook before

granting the upgrade to A3; 3) how the

implementation and expectations evolve with

respect to the fiscal and energy reforms.

Potential negative rating actions

Thailand (BBB+ sta/ Baa1 sta/ BBB+ sta)

HSBC expects the BBB+ rating to be maintained

while the outlook is likely to be cut to negative in

2014. Weakening fiscal and external indicators

going forward will make it difficult, for the

government to achieve its goal of a balance

central government budget by 2017 and keeping

the public debt below 50% of GDP. Moreover, a

less friendly political environment as the political

tension continues and is unlikely to be resolved in

a constructive manner any time soon adds extra

downward pressure on the country’s

rating profile.

Ratings shown correspond to S&P/Moody’s/Fitch

India (BBB- neg/ Baa3 sta/ BBB- sta)

HSBC Asia credit team expects India’s rating is

likely to remain BBB-, but outlook could be

lowered to negative by Moody's and Fitch in

2H14. In 1H14, the government and the Reserve

Bank of India (RBI) are likely to focus on short-

term actions to ensure macro stabilization rather

than bold initiatives to revive the economy, or put

it on a lower inflationary but faster growth

pathway. The reason is that, with the need to hold

general elections before May 2014, the Congress-

led United Progressive Alliance lacks the time and

support to push forward with structural reforms

that might hurt near-term economic performance.

Brazil (BBB neg / Baa2 sta/ BBB sta)

HSBC Economics thinks there is a high

probability of a downgrade to BBB- in 2014 in

1H14 due to fiscal deterioration and weak

recovery. The World Cup will probably not

provide as much stimulus to growth as had until

recently been expected.

Venezuela (B- neg/ Caa1 neg/ B+ neg)

HSBC Economics expects further downgrades

starting in 1Q14 particularly if authorities fail to

put together an aggressive fiscal adjustment and

currency devaluation to rein in inflation and the

consistent drainage of FX savings.

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Table A5. Open trade ideas (as of 16 January 2014)*

*Buy PLN-HUF and Turkey payer as of 1/20/2014

Source: HSBC

Country Trade idea Entry date Entry price Last* Target Stop

Turkey /South Africa Buy 5y TURK-SOAF CDS spread 1/8/2014 30bp 26bp 85bp 0bp

Colombia/Peru Buy CO May -24 short PE '25 12/13/2013 21bp 22bp -10bp 40bp

Brazil/Mex ico Buy Brazil sell Mex ico 5y CDS 10/10/2013 43bp 101bp 120bp 75bp

Turkey Long 2025 short 2023 8/1/2013 60bp 60bp 20bp 85bp

Venezuela Buy Venz '31 short PdVSA '35 7/29/2013 0bp -25bp 80bp -50bp

Brazil/Pemex Buy Pemex 19 v s short Brazil Jan-19 2/14/2013 90bp 33bp 25bp 75bp

Turkey * Pay TRY 2y fw d1y X-ccy sw ap 1/20/2014 9.40% 9.40% 10.00% 9.00%

China Pay 1y CNY IRS 1/15/2014 4.92% 5.02% 5.50% 4.75%

India Pay 2y INR OIS 1/15/2014 7.97% 8.00% 8.35% 7.80%

Thailand/Malay sia 2s5s THB flattener v s MYR steepener 1/15/2014 29bp 29bp 0bp 40bp

Mex ico Receiv e 2y TIIE 1/13/2014 4.36% 4.37% 4.15% 4.50%

Poland PLN 5y IRS 1/9/2014 3.74% 3.63% 3.30% 3.95%

China CNY NDIRS 2s5s steepener 12/4/2013 20bp 20bp 60bp 0bp

China/Australia Pay CNY receiv e AUD 3y IRS 12/4/2013 139bp 192bp 230bp 190bp

India INR OIS 1s2s steepner 12/4/2013 -21bp -26bp 5bp -35bp

Thailand/Malay sia Receiv e THB pay MYR 1y IRS 12/4/2013 116bp 133bp 160bp 120bp

Taiw an/Singapore Receiv e TWD pay SGD 5y IRS 12/4/2013 14bp 29bp 35bp 5bp

Singapore Pay SGD 2y IRS 12/4/2013 0.46% 0.57% 0.65% 0.35%

South Korea KTB 3 12/16 v s 3.375 9/23 steepener 12/4/2013 69bp 75bp 100bp 50bp

Malay sia Pay MYR 1y 1y IRS 12/4/2013 3.55% 3.60% 3.80% 3.40%

Indonesia Buy IndoGB 8.375 3/34 12/4/2013 9.10% 8.90% 8.90% 9.05%

China Pay SHIBOR receiv e Repo 5y NDIRS 11/20/2013 37bp 52bp 80bp 20bp

Colombia Receiv e 1y IBR 11/14/2013 3.55% 3.47% 3.25% 3.75%

Brazil Receiv e Jan '15 DI 11/14/2013 10.78% 10.94% 10.25% 11.15%

South Korea KRW IRS 1s3s steepener 11/13/2013 22bp 26bp 35bp 10bp

Thailand Buy ThaiGB 3.875 6/19 pay 5y IRS 11/13/2013 -29bp -34bp 0bp -35bp

Uruguay Buy Global UI '18 10/10/2013 3.18% 2.90% 2.50% 3.65%

Mex ico TIIE 5s10s flattener 10/10/2013 133bp 142bp 90bp 160bp

Poland/Hungary * Buy PLN-HUF 1/20/2014 72.50 72.50 74.50 71.5

China Pay 1y 2y USD-CNH FX forw ard points spread 1/9/2014 590pts 590pts 900pts 500pts

Mex ico/Chile Long MXN-CLP 3mth NDF 1/15/2014 40.27 40.05 41.90 39.60

Israel Long USD-ILS 10/31/2013 3.52 3.48 3.65 3.45

South Africa Short USD-ZAR 11/20/2013 10.13 10.36 9.68 10.36

Poland/Hungary Short PLN-HUF 10/15/2013 70.65 72.00 68.00 72.00

Czech Receiv e 5y fw d5y IRS 10/29/2013 2.67% 2.84% 2.35% 2.90%

Poland PLN 1s2s flattener 10/14/2013 33bp 27.5bp 5bp 50bp

Mex ico Receiv e 1y 1y TIIE 11/14/2013 4.45% 4.65% 4.20% 4.65%

Chile Pay 1y CLP x Camara 11/14/2013 4.21% 4.31% 4.60% 4.00%

Panama Buy '29 sell '26 10/10/2013 55bp 86bp 30bp 68bp

Rates

FX

Closed since last EM Strategist publication on 24 November 2013

Credit

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EM funds flows will likely remain subdued

in 2014, while selectivity should intensify

We expect Equities and EXD funds to be

better supported than LCD

Un-anchoring of the short end of the UST

yield curve and China’s hard landing are

the main downside risks

Should I stay or should I go?

We expect portfolio flows into EM to pick up

slowly, yet stay subdued in 2014, while not

dismissing the potential for bouts of outflows. The

global setting remains tough and there are no instant

catalysts bringing investors back to the asset class.

Following a sharp drop in 2Q-3Q13 net

portfolio flows into the emerging markets

rebounded modestly by end-2013, yet

momentum remains unimpressive into the new

year. IMF or official country net portfolio flows

data up to 2Q2013 shows that net flows into EM

dropped sharply to USD46bn in 2Q13 (equities:

-USD12bn and bonds: USD58.1bn) from

USD97bn in 1Q13 (equities: USD36.1bn and

bonds: USD61bn) and USD117bn average per

quarter in 2H12 (equities: USD45.1bn and bonds:

USD72bn). Things got worse in Q3, when flows

marked a post-crisis low of USD5bn. With little

official data available, our HSBC Capital Flows

Indicator (CFI) suggests a modest rebound to

USD12bn in 4Q13, lifted by flows into equities.

EPFR Global data show a year of two halves.

After seeing the second largest net inflows into EM

funds on record in 2012 (USD103bn), mostly

institutional, they experienced a reversal in 2013

(-USD52bn or 50% of net inflows in 2012), chiefly

retail. EM bond funds losses amounted to USD25bn

or 44%, led by EXD USD19bn (52%) while LCD

funds only lost USD6bn (34%) (Table A6). EM

institutional bond funds added USD2bn, mainly into

EM funds flows: A long way back to recovery

Figure A17. Net portfolio flows to EM Figure A18. EM fund flows momentum (z-scores)

Source: EPFR Global, HSBC Source: EPFR Global, HSBC

Bertrand Delgado EM Strategist HSBC Securities (USA) Inc. +1 212 525 0745 [email protected]

-150

-100

-50

0

50

100

150

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

EM Total Actual EM Total Fitted

-3

-2

-1

0

1

2

2008 2009 2010 2011 2012 2013 2014

EM Equities EXD LCD

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LCD funds, but retail lost USD27bn, particularly

from EXD. EM equities lost USD27bn (58%) on

withdrawals from retail funds.

We highlight that net inflows into EM funds in

the January-April 2013 period were quite

strong (USD50bn), particularly into institutional

funds, compared to the same period in 2012

(USD44.1bn), highlighting not only buoyant

support for EM, mainly into equities and LCD,

but also the potential for a new record in 2013.

By May, however, things changed radically.

While in 2013 net outflows from EM funds

amounted to 50% of net inflows in 2012,

redemptions in the May-December period reached

USD100bn, largely from retail funds, reversing

USD50bn in gains between Jan–April, when

institutional funds added USD18bn. In the May to

December period, EXD and LCD funds lost

USD23bn each, with retail losses the more

dominant among EXD funds but institutional

outflows more severe from LCD funds. This is a

sharp reversal when compared to the Jan-April

period when EXD and LCD funds grabbed

USD4bn and USD18bn, respectively, with heavy

institutional support for LCD funds. EM equity

funds lost USD50bn in May-December, mostly

retail funds, after grabbing USD23bn in early

2013, mainly institutional funds (Table A6)

What will it take for flows to recover?

A comeback of investors to the asset class

would require progress of the EM risk-reward

outlook. While there has been some advancement

on the valuation front – EM asset classes have

cheapened considerably to their DM counterparts-

the relative risk profile picture remains biased

against EM on two counts. First, investors

continue to see upside potential for DM, mainly

the US and Europe, which could be a double

whammy to flows as stronger growth would put

upward pressure on global rates and weaken EM

currencies. Flows into EM debt continue to be

highly correlated to the outlook for US rates and

EM FX and related volatilities (Figure A21).

Second, investors remain concerned about EM

growth, politics, and large current account

financing in some key emerging countries.

In light of the methodology we established in

our Capital Flows into EM piece, it will take

some improvement in the outlook of both push

and pull factors to revitalize flows into EM. On

the former, it is about getting more clarity that

rates in the US will move up only slowly or go

back down. On “pull factors”, it depends whether

China growth momentum is maintained and that

politics not get too much in the way of needed

structural adjustments across EM.

Figure A19. Cumulative flows (% AUM) into DM and EM funds

Figure A20. EM has become cheaper to DM alternatives

Source: EPFR Global, HSBC Source: HSBC

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-5

0

5

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15

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25

2007 2008 2009 2010 2011 2012 2013 2014-25

0

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50

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100

EM (RHS) DM

% AUM

0

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2

3

4

5

6

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0

200

400

600

800

2009 2010 2011 2012 2013 2014

EM vs Spain EM vs DM P/E (rhs)

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Cheaper valuations along with the long term

EM growth outlook and portfolio

diversification are EM’s best line of defence at

the moment. EM assets massively

underperformed in 2013, and valuations are

suggesting they are starting to look cheap versus

their DM counterparts. Figure A20 shows the

spread between EM CDX and Spain 5y CDS has

widened by 400bp in the last 18 months, having

moved back to positive since the middle of last

year. Alternatively, EM stocks versus S&P500

forward looking P/Es differentials are back to

their levels of 2006.

The risks of a 2013 repeat

Another round of soft capital inflows or

outright outflows cannot be ruled out in 2014,

as momentum remains fragile. Indeed, EPFR

data still show weak momentum and persistent net

outflows by end-2013 and early 2014, in line with

poor asset performance and a less friendly global

backdrop, mainly in the bond market. Weekly

funds flows and market dynamics for January

2014 shows that this trend continues.

Strong inflows over the course of the last few

years suggest there could be a potential wall of

money to come out from EM, but we disagree

with this view. First, we do not expect a significant

reduction of global liquidity, with the BoJ and the

BOE still in easing mode and the US Fed not

expected to raise rates quickly. Second, while

dynamics will likely show differential improvements

in favor of DM over EM, the latter continues to

represent the lion share of global growth and

fundamentals overall continue to make EM attractive

for the long-term. Lastly, as explained before,

relative valuations have become more attractive.

That is, a repeat of 2013 would need a significant

risk aversion shock, which is not part of our base

case (for a discussion of tail risks see page 16).

The risk of higher US rates remains a key

factor, depressing the appetite for EM risk,

however. With the market fully pricing forward

guidance, there is little room for error if data

comes in stronger. Such a tight scenario is likely

to keep weighing on EM investors’ minds and

discourage strong inflows.

Flows to local debt markets to be particularly weak

We expect inflows to concentrate on hard

currency bond funds over local. Weaker technical

positions and still volatile currencies, coupled

with potentially more hawkish EM central banks,

are important headwinds to local debt funds. Total

outflows from EM-dedicated funds in 2013

reached 24% of inflows in 2013 and 8% of those

Figure A21. EXD fund flows and UST volatility (Move Index) Figure A22. 2013 redemptions as % of 2012 and 2009-12 total net inflows

Source: EPFR Global, Bloomberg Source: EPFR Global, HSBC

0

50

100

150

200

250-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2007 2008 2009 2010 2011 2012 2013 2014

MOVE Index 4wma flows to EXD funds

Index% AUM

-70%

-60%

-50%

-40%

-30%

-20%

-10%

0%

EM EQ EM FI EXD LCD Total

% of 2012 inflows % of 2009-2012 inflows

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-40

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0

20

40

60

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

LatAm Total Actual LatAm Total Fitted

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-40

-20

0

20

40

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

CEEMEA Total Actual CEEMEA Total Fitted

in 2009-2012. In the case of bonds, these numbers

are 32% and 13% yet with strong differences

between hard and local currency funds. In the case

of the former, 2013 outflows represented 45% and

30% of previous inflows, while in the case of

local funds they were only 13% and 3%.

Table A6. Funds flows by investors’ type (USDbn)

_ EM EQ __ _ EM FI __ __ EXD ___ __ LCD ___ Inst Retail Inst Retail Inst Retail Inst Retail

2009 42.4 42.3 1.6 8.0 0.1 3.7 0.7 2.1 2010 73.5 31.6 25.0 30.5 4.2 10.7 16.6 14.4 2011 -1.8 -34.5 17.2 0.1 1.9 -1.2 13.5 1.5 2012 65.8 -18.9 36.8 20.1 16.7 20.0 17.0 -1.7 2013 15.7 -41.5 2.2 -27.2 -0.5 -18.4 0.1 -5.7 Jan-April 23.3 0.0 15.4 10.7 1.0 3.2 12.6 5.1 May-Dec -7.6 -41.5 -13.1 -37.9 -1.6 -21.6 -12.5 -10.8 YTD -1.4 -1.2 0.3 -1.2 0.2 -0.7 -0.1 -0.3

Source: EPFR

We note also that outflows from hard currency

bond funds were led by retail, which most likely

migrated towards developed market equities.

Outflows from local currency bond funds show a

larger share of outflows by institutional funds,

suggesting a broader reassessment of the asset

class is taking place.

We expect inflows into EM equities to remain

resilient on the back of valuations and less

comparable inflows than in previous years. Key

here is the recovery of margins, which are being

squeezed by higher wages. In the case of equities,

2013 redemptions accounted for 14% and 3% of

2012 and post crisis net inflows, respectively.

Focus on the stronger countries

At the country level, using actual data through

2Q13 and our CFI afterwards, India, and South

Africa signal a recovery in 2H13, led by equities,

after a strong drop in 2Q13. Russia points to

persistent outflows in 2H2103. Looking at China,

Turkey, and Indonesia actual numbers up to

3Q13, and Brazil up to November, China shows

softer inflows in 3Q13 compare to 2Q13, yet, we

expect a rebound in 4Q13, led by equities. Turkey

points out major ease in inflows in 3Q13

(USD700m) from 2Q13 (USD8.6bn) driven by a

sharp drop in flows into bonds and constant losses

from equities, but we see a comeback in 4Q13, led

by stable gains in bonds and rebound in equities

Yet, politics might prove challenging. In

Indonesia, there were softer inflows in 3Q13

(USD2.5bn) from 2Q13 (USD3.2bn), led by

stubborn losses from equities and softer inflows

into bonds. We see Indonesia posting outright

outflows in 4Q13 from equities and bonds. On

Brazil, after strong gains in 3Q13 (USD18.4bn),

there are outflows so far in 4Q13 (-USD500m).

Figure A23. Actual BOP portfolio flows and HSBC Capital Flows Indicator (USDbn)

Source: EPFR Global, Datastream, Bloomberg, HSBC

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2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

AxJ Total Actual AxJ Total Fitted

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2014 asset class outlooks

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We expect 2014 total returns around 5%

EM high-grade credits attractive

Differentiation is likely to be the key theme

Outlook and drivers for 2014

We expect EXD to deliver mid-single digit total

returns (carry plus capital gain/loss) in 2014,

reversing a 5.3% loss in 2013. With QE tapering

now underway, the performance of EM debt will

remain hostage to the gyrations of US Treasuries.

However, HSBC’s constructive outlook on US

bonds should support our view that volatility in

the debt market could recede and appetite for EM

assets could resume. Carry should be the main

driver of returns, as the index yield has increased

by c140bp from the beginning of 2013.

EM hard currency bonds appear in a good

position to outperform other fixed income asset

classes. As presented in The 2014 HSBC View

(9 January, 2014), our expectation for EM EXD

beats those for the global All Gov Index (4.3%),

Bunds (1.5%), Gilts (3.8%), European high-grade

(2.0%), and High Yield (4.0%)

Contrary to what happened last year, we see

room for spread compression of about 15-25bp.

At around 285bp over UST, EM high grade

spreads (66% of the benchmark index) appear to

be close to 50bp wider to a model based on

financial variables. However, a strong

differentiation has to be made between the high

grade and the high yield sectors of the asset class.

While high grade credits’ external repayment

capacity has stayed strong for the most part, high

yielders have seen a significant deterioration in

reserve positions, which suggests idiosyncratic

risk remains ample. Credit ratings (see section

below) present more downside than upside risk.

Yet in most key places, prices accommodate for

ratings cuts.

The EM high grade sector appears cheap, as its

spread has widened significantly versus its

comparable US counterpart. While both have

historically traded flat in spread terms since 2005,

EXD: Value has returned

Victor Fu EM StrategistHSBC Securities (USA) Inc.+ 1 212 525 [email protected]

Gordian Kemen Head, LatAm FI ResearchHSBC Securities (USA) Inc.+ 1 212 525 [email protected]

Alejandro Martinez-Cruz LatAm FI StrategistHSBC Mexico SA+52 55 5721 [email protected]

Di Luo, CFA CEEMEA FI StrategistHSBC Bank Plc+44 20 [email protected]

Dilip Shahani Head of Asia-Pacific ResearchThe Hong Kong and ShanghaiBanking Corporation Limited +852 2822 [email protected]

Devendran Mahendran Senior Credit Research AnalystThe Hongkong and ShanghaiBanking Corporation Limited + 852 2822 [email protected]

Figure B1. EM EXD IG cheap to model

Model based on simple regression against VIX, MOVE, UST10yr and UST slope

Source: HSBC, Datastream

Figure B2. EM EXD and US corporate spreads

Source: Datastream, HSBC

150

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450

550

650

750

850

07 08 09 10 11 12 13 14

Actual Model EM EXD

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2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

EM spread EM inv grade spreadUS corp inv grade EM-US corp inv grade spread diff

https://www.research.hsbc.com/R/20/5gBFW64W3ePg

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this margin has broadened to c80bp since May

2013. While some deterioration in EM

fundamentals explains this divergence, the most

important force has been the temporary

breakdown in the long-term negative relationship

between EM EXD spread and UST yield (see a

discussion of this phenomenon in Emerging

Markets Strategist: When good news is bad news,

24 November 2013). As depicted in Figure B3, the EM EXD investment

grade index spread had usually moved in an

opposite direction to the UST 10-year yield until

May 2013, when it followed the latter higher until

the FOMC’s decision to delay the QE tapering in

September 2013. This, in our view, reflected

investors’ aversion to uncertainty about the timing

of tapering. Now that the Fed has provided more

clarity, it could be expected that the long-term EM

EXD spread-UST yield relationship and EM-US

corporate spread equilibrium could be restored

gradually. In fact, it can be seen that the EM index

spread did not join the run-up of the UST 10-year

yield since November 2013.

Scenarios and risks We expect 2014 total return for EXD around 5%.

A likely range could be 4.5- 5.5%. As in previous

years, we construct total return scenarios for EM

EXD with US Treasury yields and appetite for EM

risk as variables to watch (see Table B1). We color

code the scenarios to reflect probabilities. This

should be complemented by the findings presented

in Emerging Market Vulnerability: How to position

for the risks of 2014 by Pablo Goldberg et al., which

provides a cross-country analysis of vulnerability

rankings in the context of different risk scenarios.

Table B1. 2014 EXD return scenarios

Note: Calculation is done as of 31-Dec-13 with UST at 3.03% and EM EXD spread at 313bp. Color coding means probability increases as color moves from white to red. 1: We assume that the current level of our proprietary risk aversion index decreases by one-half standard deviation, stays the same, or increases between 1 and 2 (shock) standard deviations. A standard deviation is measured with respect to our index over the entire sampling period since January 2001. Note: We estimate the historical relationship via multivariate OLS regression of the form:

where Spd denotes the EM index spread, UST the 10y UST yield, and MRAI our proprietary risk aversion index. We use weekly average changes for all the variables. Based on our analysis, we find that the index spread exhibits a higher sensitivity to UST when UST is lower than 3.63% than otherwise and that the spread moves more rapidly when MRAI is greater than 0.35(risk-averse) than otherwise. To model these effects, we use two dummy variables, d1 and d2, which take a value of 1 or 0 based on the two states of UST and those of MRAI. Source: HSBC

Figure B3. EM investment grade spread and UST 10y yield

Source: Datastream

UST Risk aversion shock Decreases Constant IncreasesAccident US economic growth dissapoints

Spread Δ:129bp Spread Δ:67bp Spread Δ:34bp Spread Δ:17bp

Exp. Return:-0.5% Exp. Return:4.1% Exp. Return:6.6% Exp. Return:8.0%

Taper without growthSpread Δ:96bp Spread Δ:33bp Spread Δ:0bp Spread Δ:-17bp


Tapers bring outflows Tapering acceleratesSpread Δ:79bp Spread Δ:17bp Spread Δ:-17bp Spread Δ:-34bp


Spread Δ:45bp Spread Δ:-17bp Spread Δ:-51bp Spread Δ:-67bp


Probability

High Low

Appetite for EM

-50bp

+75bp

+0bp

+25bp

Strong US recovery lifts EM

Fed takes it easy

0

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2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

EM inv grade spread UST 10y yield

tttttt MRAIdUSTdMRAIUSTSpd εβββββ +Δ+Δ+Δ+Δ+=Δ 2413210

https://www.research.hsbc.com/R/20/wpyLSmKs0C3s

https://www.research.hsbc.com/R/20/wpyLSmKs0C3s

https://www.research.hsbc.com/R/20/Jm8etSms0C3s

https://www.research.hsbc.com/R/20/Jm8etSms0C3s

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HSBC FI Strategy holds a constructive view on

US Treasuries, thus the most likely scenarios do not

expect a repetition of the challenging environment

seen in 2013. Should the Fed “take it easy”, as

suggested after the last FOMC meeting, EM EXD

could see some spread tightening and middle-single

digit returns. This would be the case also if the US

10-year yield increases by about 25bp, and as long

as appetite for EM does not suffer another blow.

The risk to our base case scenario comes first

from an acceleration of tapering due to faster US

growth. In this case, appetite for EM should suffer,

but not as much as last year, when investors reacted

violently to the Fed’s change of paradigm from a

very weak technical position. Small, but still

positive, returns are possible in this case.

Second is a (less likely) repetition of 2013, with

higher US rates leading to further capital

outflows from EM. Similar to last year, we

believe credit differentiation will play a crucial if

not more important role, with those countries able

to float their currencies (e.g. Mexico, Colombia,

and Korea) outperforming those that would need

to use reserves or hike interest rates to prevent too

much currency adjustment (e.g. Brazil, Turkey,

and India). Total returns are likely to be negative,

yet not as bad as in 2013.

Consider the case in which the Fed continues

with QE tapering but US growth falters. In this

low-probability scenario, appetite for EM is likely

to decrease and spreads of EXD to widen. We

expect still positive, yet close to zero, returns for

EM hard currency debt in this scenario.

Strategies and top trades

Latin America

In LatAm, our key convictions remain our

underweight in Brazil’s external debt and our

overweight in Mexico. For both countries, we

expect rating action as early as this year, and we

disagree with the notion that Brazil’s spreads are

fully priced for a downgrade, while Mexico’s

already price in the full upside of the recently

passed reforms and a potential upgrade. In fact,

we have recently raised the target on our

recommendation to buy 5y CDS protection in

Brazil versus Mexico.

We shifted Panama from overweight to neutral.

We remain overweight Colombia and expect

global bonds in Colombia to outperform some of

its peers, as is already reflected in the CDS market

(buy Colombia ‘24s and sell Peru ‘25s).

In Venezuela, for the first time in many years,

investors are looking at debt serviceability as a

tail risk. We expect that the country can manage

its debt payments at least until 2017, but it is clear

that without meaningful adjustments its

fundamentals will continue to deteriorate. If such

adjustments are not introduced soon, we will need

to revise our credit view on Venezuela’s external

debt (currently at neutral-weight).

Argentina appears at the beginning of a multi-

year re-rating process. The possibility of political

change after the 2015 presidential election and

some signs of policy pragmatism under way has

shifted our view on fixed income to be more

constructive. However, recent price action

suggests that further upside is limited, especially

in NY-law bonds, which are still at risk given the

pending legal case against the holdouts. We

recommend buying local law USD bonds instead.

For a more detailed discussion, please read LatAm

FI: Catch carry if you can, 15 December 2013.

CEEMEA

In CEEMEA, we continue to envisage the under-

performance of the Turkish sovereign spreads.

As the political uncertainties will linger

throughout the election year, external debt still

needs to factor in more risk premium. Moreover,

the central bank’s reluctance to resort to rate hikes

only diverts the pressure to external debt, given

the continued reserve depletion via FX sales.

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Elevated external debt service (both public and

private sector) also weighs on the credit. On the

other hand, we expect South Africa credit to

gradually recover and outperform Turkey. On the

balance of payments front, there are tentative

signs of improvement in the trade account and

more rebalancing is possible (albeit gradual).

External borrowing stands out as one of the

lowest with little rollover risk. We recommend

buying Turkey 5y CDS protection against

South Africa.

In CIS, we advocate neutral weight on Russian

credit: the continued capital outflow and

deteriorating current account surplus point to

lacklustre performances. In Ukraine, despite the

near-term solution with Russia's bailout package,

it's premature to turn positive fundamentally. We

continue to argue for an underweight.

In CEE, we see limited value, and particularly

believe the out-performance of Hungarian

sovereign credit has run its course.

For more details, please see CEEMEA

Opportunities: Less miserable, 2 December 2013.

Asia

We believe the bulk of the Asian credit market re-

pricing was completed in 2013, but there are no

compelling catalysts to start a new credit

compression cycle in 1H14. China needs to be

watched because of its increasing reliance on debt to

drive growth. We fear the implementation of the

ambitious domestic reform agenda could throw up

some surprises in 2014. From both a fundamental

and technical perspective, we might have a

corrective phase towards late 1Q14. So, whilst the

ADBI and AHBI-Corp spreads offer value around

current levels, unexpected event risks could push

spreads out to 350bps and 750bps, respectively.

This would be an opportunity to buy if investors

have a 12-month horizon. For alpha performance,

we like exposure to sub-investment grade Chinese

property issuers and particular single-B names on an

opportunistic basis. Otherwise, we prefer beaten

down Indian private sector banks to government-

owned entities and Indonesian sovereign and quasi-

sovereign issuers.

For more details, please read Asia’s Bond Markets

– The View, December 2013 / January 2014.

Supply-and-demand dynamics

We expect the total supply of hard-currency

sovereign bonds around USD81bn, and

redemptions and coupon payments in 2014 for

the amount of USD90bn. This figure comes from

55 EM sovereigns and seven quasi-sovereigns. Of

the total amount, 52% are coupon payments and

48% redemptions. The schedule is heavily

concentrated at two ends of the year in January

(USD12bn), February (USD10bn), and October

(USD11bn).

By region, CEEMEA leads the reflows,

accounting for 44%, followed by LatAm (38%)

and Asia (18%). In LatAm, Venezuela and

PdVSA combined have the largest reflows of over

USD10bn, followed by Mexico and Pemex, with a

combined total of USD8bn. In CEEMEA, Poland

and Turkey each have almost the same reflows

of USD7bn.

Figure B4. EM EXD redemptions and coupons, 2014

Note: Included are 55 EM countries plus the seven largest quasi-sovereign countries

Source: HSBC, Bloomberg

0

2

4

6

8

10

12

14

16

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

LATAM EMEA ASIA

USD bn

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We expect a 4-6% total return from local

markets in 2014, with FX potentially

taking 0.3% from USD returns

Carry should be the main component of

the return; UST impact diminishing; FX

to stabilize

LatAm curves offer value in front end; we

like Polish curve and ZAR long end; we

remain a payer in Turkey, China & India


We expect EM local market debt (LMD) to

generate total returns (carry plus capital

gain/loss) between 4-6% in local currency

terms in 2014, with FX potentially removing

around 0.3% from USD returns. 2013 showed

one of the worst returns for this asset class, down

9% in USD-terms. While coupons contributed

north of 6.2pp to last year’s returns, this was

eroded by yields widening, and FX depreciation

of 8.7% sent overall returns deep to negative

territory when measured in USD-terms.

Our above-consensus forecast for the asset class

comes on the back of the following drivers.

High carry: Following last year’s sell-off,

the carry of the asset class has increased by

27bp in aggregated approximately, with the

index yield now close to 7%.

Small negative duration return: We expect

the duration component to shave off 1% in

2014. We see the aggregate yield of a local

currency index composed of 5yr government

bonds of major EM countries increasing by

about 25bp during the year should UST10yr

stay constant at around 3%, or staying around

the current levels if US long rates decline.

EM central banks’ accommodative stance:

We expect monetary policy to remain

accommodative during the year across EM, with

some chance of a broader tightening cycle

developing in Asia in the latter part of the year.

Inflation is expected to pick up, but only

slightly, staying within the targets of the

respective central banks for the most part.

Turkey and India are exceptions. There, we

expect monetary policy to be tightened. The

short-end of selective local yield curves thus

could have a potential to rally after the sell-off

in 2013. According to our EM Central Bank

Monitor, in the next 12 months, local rate curves

Local debt: Carry attractive, hostage to FX

Victor Fu EM StrategistHSBC Securities (USA) Inc.+ 1 212 525 [email protected]

Gordian Kemen Head, LatAm FI ResearchHSBC Securities (USA) Inc.+ 1 212 525 [email protected]

Alejandro Martinez-Cruz LatAm FI StrategistHSBC Mexico SA+52 55 5721 [email protected]

André de Silva, CFA Head, Asia-Pacific Rates Research The Hongkong and ShanghaiBanking Corporation Limited + 852 2822 [email protected]

Di Luo, CFA CEEMEA FI StrategistHSBC Bank Plc+44 20 [email protected]

Figure B5: 2014 5yr expected USD returns for a 3% UST10yr

Source: HSBC Forecasts

-10%

-5%

0%

5%

10%

15%

CL RU HU TH COTW CZ CN KR MA PD ID BZ IL PH SG TU PE IN SA MX

Coupon return Duration return FX return USD return

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in South Africa, Brazil, and Mexico are pricing

in excess hikes, while those curves in Turkey

and India are implying unwarranted cuts. EM FX stability. Following a turbulent 2013,

we expect EM FX to be more stable during the

year. According to HSBC FX Strategy

forecasts, an index-weight basket of EM

currencies could take 0.3% from the index total

returns when measured in USD. Importantly,

FX performance may display a big dispersion

across countries. HSBC forecasts ZAR to

appreciate, same as MXN. On the other hand,

we expect BRL and RUB to depreciate from

their levels at the beginning of the year.

Scenarios and risks

We construct a list of scenarios for the local

markets index return in USD-terms, by shifting

the two key drivers: the index yield and EM FX

performance. Based on the forecasts by HSBC FI

and FX Strategy, our base-case scenario is for a

slight aggregate increase in yields for the index,

accompanied by slight depreciation of local

currencies from current levels. This results in our

point forecast of 4-6% return in USD-terms.

Table B2. Local markets total return scenarios

Source: HSBC

Our constructive outlook for 2014 is not

without risks:

Local markets remains very sensitive to

UST moves: Both directly and indirectly

through FX, the long-end of local rates would

suffer if there is another sell-off in US rates.

Having said that, our PCA-based swap curve

fair value model shows that most EM curves

are steep (see Figure B6). Such results

suggests there is room for EM curves to

accommodate further steepening in the US

curve given that the model incorporates the

slope of the US curve as a factor. In

particular, CEE curves such as Hungary and

Poland are poised to flatten given their strong

ties with a still-dovish ECB. In LatAm,

Mexico and Colombia offer value on their

sound fundamentals. The only exception is

the Turkey XCCY curve, which has flattened

significantly with the front-end suffering

from concerns regarding potential monetary

tightening.

Fund flows and FX volatility: Foreign

investors’ appetite for local markets is being

reassessed following QE tapering and a

pickup in EM FX volatility. Inflows are not

likely to return to the levels seen in previous

years. With foreign participation having

increased dramatically over the last years,

further deterioration in FX fundamentals

could lead to more outflows. Local markets

carry-to-FX vol. has reduced from early last

year, and is now below the historical average

since 2007 for most countries, with the

exception of Brazil, Korea, India, and Russia.

Higher implied FX vol. may move investors

to demand higher local returns, putting a floor

on local yields.

50 25 0 -25 -50

-5.0% -0.5% 0.7% 1.9% 3.1% 4.4%

-2.5% 2.0% 3.2% 4.4% 5.6% 6.9%

0.0% 4.5% 5.7% 6.9% 8.1% 9.4%

2.5% 7.0% 8.2% 9.4% 10.6% 11.9%

5.0% 9.5% 10.7% 11.9% 13.1% 14.4%

High Low

Yield change (bp)

FX re

turn

Probability

Figure B6. EM swap curves too steep relative to our model


-100

-50

0

50

100

150

200

250

300

TR IL CO PE KR TW TH CL IN CZ MY ZA PL HU MX BR2s10s mkt 2s10s fitted Latest 5/8/2013

Steep to flat

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Figure B7. Carry-to-FX vol. generally below historical avg.

Source: HSBC

We compare our forecasted returns in light of

the presented risks across EM via a scorecard

in Figure B8. Its top panel looks at valuation

metrics, while the bottom focusses on risks. The

scorecard ranks EM countries on a cross-country

basis according to each metric and risk. Let’s use

Brazil as an example. Brazil has the largest

monetary policy gap (12-month ahead implied

policy rate – HSBC forecast), best carry and

roll-down profile, and steepest IRS curve slope

relative to the fair value. It also presents low

foreign participation in its local market. On the

other hand, inflation is way above the centre point

of its targeted band, and its sensitivity to moves in

UST is relatively high. On the positive side as

well, this curve presents the higher ratio between

carry and implied FX vol.

Strategies to begin the year

Latin America

In LatAm, we focus on finding pockets of value in

local markets mostly in shorter-duration trades for

now. With the exception of Brazil and Colombia,

we do not expect any hikes in the region in 2014.

In fact, Peru is expected to cut its policy rate and

Chile and Mexico have both eased only recently.

In all cases, implied forward rates are pricing in

significantly more hawkish scenarios. This should

leave the front end of local curves as relatively

safe places to receive rates. Strategically, we

would like to revise that stance and extend

duration if the external environment (US

Treasuries, in particular) allows. Here, Mexico

and Colombia remain our top strategic picks.

In Brazil, we receive Jan ’15 DI given our view

that the implied tightening cycle appears

excessive. In Mexico, we maintain our 5s/10s

flattener as a bullish relative-value trade with

long-end exposure. We also see value in the front-

end of the TIIE swap curve as the curve is pricing

in premature hikes in 2014 vs. our forecast of no

hikes. We express this view by receiving 2y TIIE.

In Colombia, our receiver in 1y IBR swaps has

benefitted from the de-pricing of a steep hiking

cycle next year. In Uruguay, inflation continues to

deteriorate and policy uncertainty regarding the

Figure B8. EM local market scorecards/1

1/ This is an EM variation and extension of an original work done by Gordian Kemen et. al., October 2013

Expected return: return based on a 1y return projections given our yield forecasts for 5y rates; monetary policy gap: Cross country Z-score of difference between 12m implied rate and HSBC forecast; carry and roll-down: cross country Z-score of 6m carry and roll-down of 5y rate; foreign ownership: Cross country Z-score of foreign ownership; IRS slope: Historical Z-score of difference between 2s10s IRS slope market and fair values; Beta (6m) to US rate: Beta of 5y local rate w.r.t. US rate; FX vol adjusted carry: Historical Z-score of residual of 3m FX implied vol regressed w.r.t. G7 & EM vol (hist) and Historical and cross-country Z-score of FX vol-adjusted carry (5y IRS/3mo FX implied vol (x-country); Inflation: Z-score of Difference between current CPI and the target.


BZ CL CO MX PE CZ HU IL PL TU SA IN MY KR TWExpected return 1.94 -0.61 -0.36 0.61 1.04 -0.09 -1.11 -0.42 0.18 -0.79 1.38 1.16 -0.78 -1.18 -0.98Monetary policy gap 1.66 -0.42 -0.15 0.73 0.91 0.04 -0.02 0.07 -0.16 -2.73 1.28 -0.63 -0.21 -0.34 -0.03Carry and roll-down 2.73 -0.86 0.75 0.27 -- -0.38 -0.42 -0.21 -0.10 -0.37 1.21 -1.19 -0.48 -0.28 -0.67IRS slope 2.38 0.02 0.21 1.52 0.00 1.54 1.78 0.39 1.47 0.09 0.86 1.27 1.20 0.24 1.22Foreign participation 1.93 0.00 2.99 1.99 1.31 0.00 -4.49 0.00 -3.20 2.45 0.91 0.96 1.62 0.92 0.00Inflation -0.96 0.04 0.80 -0.65 -0.57 0.47 1.55 0.12 0.04 -1.67 -0.53 0.04 0.04 1.40 0.04Beta (6m) to US rate -3.15 0.37 0.31 -0.33 -0.04 0.68 0.57 0.55 0.59 -1.13 -0.28 0.38 0.51 0.36 0.62FX vol adjusted carry (hist) 0.71 -0.22 0.18 0.34 -- 0.02 -1.19 -0.86 1.67 0.32 1.48 1.96 0.46 0.69 1.18FX vol adjusted carry (x country) 2.08 0.00 0.19 -0.15 --- -1.56 -0.65 -1.05 -0.54 1.16 -0.05 1.54 0.05 -0.25 -0.76

Inferior Superior

Valu

atio

nRi

sks

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effectiveness of new monetary policy remains.

Under this scenario, we remain long Global UI ‘18s,

for the second-highest expected return in the region.

Figure B9. HSBC forecast vs. implied policy rate moves


Asia

There are several key determinants that are set to

dominate Asia’s rates markets in 2014 aside from

the external influence of US Treasury yields and

Fed tapering. Weak external trade positions that

were a particular focal point last summer are

likely to linger, and there is likely to be additional

attention on countries with high fiscal deficits as

economic growth becomes more challenging. EM

policy responses to the threat of rising inflation

and the global interest rate outlook after the Fed

tapers will be crucial for Asia.

In China, funding conditions have already begun

to tighten due to tax payments as well as the

approach of the Lunar New Year. So far, the

PBoC has been largely absent in injecting

liquidity. Beyond these seasonal money market

squeezes, higher rates are likely to be tolerated as

a tool to deleverage the economy and stem credit

expansion. Whilst the latest GDP print of 7.7%

for Q4 2013 indicates that China growth is

moderating, it would take the order of around 7%

GDP to stall the normalization of money markets

and rate liberalization. HSBC FI Research

therefore takes advantage of the recent downward

retracement in front-end rates to pay 1yr NDIRS,

targeting 5.50%.

National elections in India by mid-April and the

presidential election in Indonesia in July 2014 are

two key events to watch. For both countries, there

will still be additional scrutiny on balance of

payments with a better chance of a sustained

improvement in Indonesia.

Malaysia’s fiscal position will also be carefully

monitored as the net revenue contribution from

the introduction of the goods and services tax

(GST) is not due until April 2015. Public debt as a

percentage of GDP at 53.5% for Malaysia is

already the highest amongst single-A rated EM

sovereigns. This is even before accounting for

large contingent liabilities, which are estimated by

the IMF at around 10% of GDP. To improve

finances, a further reduction in fuel subsidies is

likely in 2014. Also, the central bank is expected

to hike rates to tackle inflation pressure. We thus

recommend paying MYR-THB 1y IRS spread

as we anticipate a rate cut in Thailand in the first

half of the year.

India remains the most vulnerable local

government bond market, given election

uncertainty and the currency’s greater sensitivity

to Fed tapering. In H1 2014, the central bank is

expected to remain hawkish on elevated inflation.

In the near term, however, a continued easing in

the liquidity situation should lead to a steepening

of the OIS curve. We express this view by a 1s2s

INR OIS steepener.

International exposure to the Philippine local bond

market has scope to grow, given its full investment

grade status and in the event of greater liquidity and

other market/tax reforms. Capital gains for the local

government bond market may be difficult, though,

with front-end yields already close to record lows.

However, currency volatility may be more

contained than for peers. We recommend buying

5y RPGB for attractive carry.

The Korean bond market demonstrated its safe-

harbor characteristics during the summer 2013

-100

-50

0

50

100

150

200

ZA BR MX PL HU CZ IL TW CO MY CL KW IN TR

12m-ahead HSBC projected move 12m-ahead implied move

PayReceive

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with continued bond inflows and exchange rate

stability, as well as its deep and liquid market.

Even though household debt remains high and

bonds show a strong correlation with US

Treasuries, there are other supportive factors for

Korea, such as the sizeable trade surplus, fiscal

surplus, and an economy that benefits

significantly from improving activity in major

developed countries.

CEEMEA

In 2014, performance within the CEEMEA region

is set to diverge even further, based on individual

countries’ credit qualities. On the positive side,

we find value in receiving the belly of the Polish

IRS curve or 2018 POLGB. Poland has

underperformed CEEMEA peers like Hungary

and Russia as well as peripheral Europe, with

foreign ownership declining the most. However,

Poland's solid sovereign credit metrics (favorable

debt dynamics and healthy BoP dynamics)

justifies little credit risk premium. Also, the

benign inflation-growth mix also argues against

imminent normalisation. We recommend

receiving 5y IRS.

On the other side of the spectrum, we retain

bearish/payer bias on Turkish rates. Not only

will the inflation trajectory deteriorate, but also

the political uncertainties and elevated current

account deficit argue for front-end concentrated

credit risk premium. We Pay TRY 2yfwd1y X-

ccy swap outright.

For South Africa, we seek tactical bullish

opportunities in the very front-end and the very

long-end of the curve. The front-end is pricing in

excessive hikes (c90bp for this year) and the ultra-

long end bonds are better anchored by the

domestic investor base.

We hold a mildly bearish stance on Russian

duration due to a deteriorating macro combination

and low FX hedged yield.

For a more detailed discussion, please read LatAm

FI: Catch carry if you can, 15 December 2013,

Time for TEA: Trades, Events & Analysis,

6 December 2013, and CEEMEA Opportunities:

Less miserable, 2 December 2013.

Supply in the local markets

In Brazil, gross issuance could increase by about

38% based on HSBC’s assumptions for the

primary fiscal balance and debt service this year.

2014 is an election year; the Treasury is typically

more aggressive in its debt issuance in election

years to build up a liquidity cushion. There

could be a significant front-loading of local

debt issuance.

Mexico could increase net domestic debt issuance

by 33% in 2014, equivalent to 0.6% of GDP, to

finance the expected rising public sector deficit to

1.5% of GDP in 2014 from 0.4% in 2013. We

believe the Treasury will mostly issue in the front

end and the belly of the curve to mitigate the

impact of higher supply.

In Chile, we expect net issuance to increase from

CLP1.1trn to CLP2.0trn due to an increasing

fiscal deficit while gross issuance is likely to fall

slightly due to a longer maturity profile of the

local debt. We expect the government to increase

duration and the proportion of fixed-rate and

inflation-linked issuance in 2014.

We expect Argentina’s total gross issuance to

reach USD7.5bn, a 7.1% increase over last year,

with net issuance remaining flat in USD-terms.

The government could tap the local fixed income

market for all bond issuance in 2014. We believe

the majority of issuance will be short-term paper.

In Colombia, gross issuance is expected to

increase by 0.3% in 2014 with net issuance

remaining flat. Domestic debt issuance is likely to

be concentrated in the front end and belly of the

yield curve (75% of total TES issuance).



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Uruguay’s gross issuance is expected to be 66%

lower in 2014 than 2013 due to a significant

reduction in the amortization calendar (52%). We

believe that most of the local issuance is likely to

be concentrated in the front end of the curve.

In Peru, a lighter amortization calendar in 2014

will help reduce gross issuance by around 30%.

We estimate a reduction of c21% in net issuance

in 2014. The government likely will try to

increase the proportion of short-term bonds.

The issuance plan remains daunting in China.

Gross issuance in China is expected to jump by over

10% due to large refinancing needs. In the offshore

market, government bond gross issuance will likely

be increased to RMB28bn from RMB23bn in 2013,

largely to refinance the redemptions.

Thailand offers the most positive supply outlook

in the region. The Ministry of Finance (MoF)

plans to issue THB440bn of government bonds in

FY13/14 (October 2013 to September 2014), 26%

less than in FY12/13. The reason for the lower

supply is the delay in the passage of the

infrastructure bill.

Indian bond supply is set to surge higher in

FY14/15. Assuming a fiscal deficit of 4.7% and

nominal GDP growth of 10% in FY14/15, gross

issuance is expected to rise by 14% to INR6.6trn in

FY14/15 from the budgeted INR5.8trn in FY13/14.

In Malaysia, we expect issuance to decline this year

by 13%. Issuance is likely to be front-loaded to the

first half of the year and supply pressures are likely

to be most evident in Q1. Gross supply is estimated

to be the highest in Q1 at MYR23.5bn.

In Indonesia, the high gross issuance target likely to

be a challenge. Gross government bond issuance is

estimated to jump by 12% in 2014 and this may be a

daunting task given the reduced appetite for high-

beta emerging market assets. Korea is likely to

increase issuance by 10% this year with a focus on

long-dated bond supply, which could place

steepening pressure on the KTB curve.

Taiwan’s gross issuance this year could remain

unchanged with net issuance dropping 20% due to

large redemptions. The government will not issue

15yr bonds. Instead, the number of 10yr bond

auctions has been increased from four to six.

South Africa faces onerous net issuance pressure

with its long duration issuance profile to stay. Net

issuance is expected to decrease by 8% in 2014

and issuance pressure is likely concentrated on the

10-20yr tenors.

Turkey is the largest issuer of local currency

bonds in CEEMEA. Even though gross issuance

is projected to decline (due to a lower redemption

profile compared with 2013), net issuance will

rise by c25%. Also, a likely worsening budget

deficit could imply higher gross issuance risk.

Poland managed to start the year with a solid pre-

financing ratio of c25%. In 2014, we expect gross

and net issuances to decline 29% and 25%,

respectively, on the country’s improving fiscal

account. In Israel, we forecast a decline in local

net issuance in 2014 by ILS6bn. The budget

balance has outperformed in 2013 with net

savings of ILS12bn carried over to this year as

source of pre-financing.

Czech Republic is expected to step up local

currency net issuance significantly by over 200%

in 2014, largely due to a strategy to finance part of

the upcoming redemption of two EUR-

denominated bonds. Romania plans to reduce its

net issuance by c68% on a better outlook of the

fiscal account.

For more details, please see 2014 Latin America

debt supply, 9 January 2014, Asia-Pacific Supply

Synopsis, 7 January 2014, and.CEEMEA Bond

Supply 2014, 6 January 2014.

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Table B3. Estimated gross and net issuance of EM local government bonds

________ 2014e issuance target _________ _________ 2013a issuance ___________ _______________Change _______________ Gross issuance Net issuance Gross issuance Net issuance Gross issuance Net issuance

Argentina*** USD7.5bn USD2.5bn USD7.0bn USD2.5bn 7% 0%Brazil BRL619bn BRL137bn BRL 450bn -BRL 100bn 38% 237%Chile*^ CLP3.0trn CLP2.0trn CLP3.7trn CLP1.1trn -19% 82%Colombia COP30.5trn COP12.2trn COP30.4trn COP12.3trn 0.3% -0.2%Mexico MXN1.56trn MXN0.57trn MXN1.25trn MXN0.43trn 25% 33%Peru PEN2.65bn PEN2.33bn PEN3.76bn PEN2.97bn -30% -22%Uruguay UYU5.7bn UYU2.1bn UYU16.7bn UYU9.3bn -66% -78% Czech Republic CZK185bn CZK120bn CZK146bn CZK 38bn 27% 218%Hungary** n.a n.a HUF1799bn HUF364bn n.a n.aIsrael ILS76bn ILS14bn ILS 88bn ILS20bn -14% -29%Poland PLN91bn PLN34bn PLN129bn PLN45bn -29% -25%Russia RUB 794bn RUB 309bn RUB 829bn RUB 365bn -4% -15%South Africa* ZAR171bn ZAR138bn ZAR171bn ZAR150bn 0% -8%Turkey TRY135bn TRY17bn TRY141bn TRY13bn -5% 25% China offshore CNY28bn CNY16bn CNY23bn CNY16bn 22% 0%China onshore CNY2.1trn CNY1.3trn CNY1.9trn CNY1.1trn 11% 18%Hong Kong HKD56bn HKD33bn HKD30bn HKD23bn 87% 43%India* INR6.6trn INR5.1trn INR5.8trn INR4.7trn 14% 9%Indonesia IDR362trn IDR205trn IDR323trn IDR224trn 12% -8%Korea KRW97.5trn KRW38.2trn KRW88.5trn KRW37.9trn 10% 1%Malaysia MYR87bn MYR36bn MYR101bn MYR42bn -13% -14%Singapore SGD17-19bn SGD2-4bn SGD14.8bn SGD3.4bn 22% -12%Taiwan TWD640bn TWD235bn TWD642bn TWD292bn 0% -20%Thailand* THB440bn THB197bn THB593bn THB380bn -26% -48%

*2014 refers to October 2013 - September 2014 for Thailand, 2015 refers to April 2014 - March 2015 for India; South Africa estimates based on fiscal year (Apr-Mar). ** Hungary is yet to report its 2014 debt management strategy. *** Does not include local USD bonds or loans from BCRA and Banco Nacion. Does include issuance to ANSES. *^ Chile includes central bank bonds

Source: Finance ministries and central banks, HSBC estimates.

Table B4. Estimated tenor distributions

_2014e issuance target by tenors (%)_ Remarks <=5yr 5-10yr 10-20yr 20yr+

Argentina** 90% 10% 0% 0% Most issuance will be short-term for monetary regulation purposes Brazil 50% 30% 10% 10% Goal to increase the average duration and replace short-term debt with NTN-B and NTN-F bondsChile*^ 25% 40% 20% 15% The Treasury will continue to focus on issuing fixed-rate and inflation-linked bonds Colombia 36% 39% 26% 0% Efforts to increase foreign holdings to continue. Issuance concentrated in front end and bellyMexico 87% 7% 2% 4% Treasury to reduce impact of higher supply in 2014, focusing on front end and belly of curvePeru 10% 25% 50% 15% Issuance strategy to increase relative size of short-term bondsUruguay 80% 20% 0% 0% Strategy to continue to focus on reducing hard-currency debt

Czech Rep. 20% 36% 44% 0% The ministry indicates a lengthening of the yield curve to occur in 2014; likely to improve liquidity at long-endHungary 54% 37% 0% 9% Despite a fall in debt redemptions in 2014, total financing requirements remain elevated Israel 54% 37% 0% 9% Fiscal consolidation likely to lead to a reduction in net issuancePoland 76% 17% 7% 0% Supply dynamics remain favorable with 25% of the 2014 borrowing requirement pre-financedSouth Africa 0% 14% 35% 51% Long duration issuance profile here to stay; switch auctions to put further pressure on 10-20yr tenorsTurkey 48% 52% 0% 0% Expect net issuance to rise; Treasury looks to extend debt maturity depending on external conditions

China onshore 60% 30% 5% 5% High gross supply due to larger fiscal deficit and bond redemptionsChina offshore 80% 15% 2.5% 2.5% Gross issuance to remain small as China MoF is not dependent on offshore market as funding source,

benchmark curve unlikely to be lengthened further from 30-year Hong Kong 85% 15% - - Higher bond supply in 5-year segmentIndia* 0% 20% 60% 20% Bond supply to surge higher in 2014Indonesia 40% 20% 35% 5% Larger short-dated supply to cater to investors’ cautious approach in emerging markets Korea 48% 32% 9% 11% Increase in total KTB issuance; higher long-dated bond supply is likely Malaysia 37% 43% 11% 8% Relatively higher supply in 1Q 2014Singapore 57% 27% 8% 8% More favorable supply condition in 2H 2014; No issue of 30-year benchmark Taiwan 30% 30% 20% 20% More frequent 10-year auctions as the 15-year bond will not be issued in 2014 Thailand* 33% 23% 17% 27% Proportion of long-dated issues rises as supply of 3- and 5-year bonds is stopped

*2014 refers to October 2013 to September 2014 for Thailand, 2015 refers to April 2014 to March 2015 for India. ** Argentina does not include local USD bonds or bonds issued to settle claims *^ Chile includes central bank bonds Source: Finance ministries and central banks, HSBC estimates.

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Investors will have to be selective in 2014

QE tapering still relevant to flows, but

local factors are becoming more important

We favor North Asian currencies over

ASEANs, the MXN and the PEN in

LatAm, and the HUF and the PLN in CEE


While certain broad market themes may still

prevail, notably the path of Fed QE tapering

and its influence on capital flows, we believe

that across the EM space, currencies will move

more independently than during last year.

Country-specific factors should become more

dominant. Even last year, with the anticipation of

QE tapering, we saw divergent performances

within EM, and even within regions (Figure B10).

Many Asian currencies were stuck in a rut in

2013 and this will likely be the case in 2014,

too. Challenges for a number of Asian currencies

will become more apparent. For instance, lower

growth potential, weakening current accounts,

lower portfolio inflows, signs of overvaluation for

some currencies, and low yields for others do.

Latin American currencies underperformed

other regions in the ‘new’ global cycle of lower

commodity prices and rising rates. We argue

that depreciation should be less pronounced in

2014. Valuations are much improved and we see

no reasons for a severe currency crisis in the

region. For EMEA, as elsewhere, we think that

the country-specific factors will play a dominant

role in 2014. We see EM FX driven by: 1) balance

of payment stories, 2) FX policy, and 3) politics.

‘Balance of payments’ stories

While many EM countries will continue to see

their current accounts remain in deficit in 2014,

not all will necessarily see their currencies suffer

as a result. For some, such as many LatAm

countries, the deterioration seen in recent years

has largely come to an end, and improvements

will begin to be seen in 2014. Also, currencies

have already adjusted, and this will help the

improvement in the deficits next year. The PEN

and CLP in LatAm still remain vulnerable to

weak current account positions, but in both cases

we do not anticipate funding issues. Of the two,

we are less positive on the CLP, looking for

modest nominal weakness in 2014 vs the USD.

Figure B10. Current account deficits and FX performance

Source: Bloomberg, HSBC

BZ

CLCO

MXHUPL

RU

ZATK

CN

IN

ID

KR

MY PH

TWTH

-25

-20

-15

-10

-5

0

5

-10 -5 0 5 10

Current account (as % of GDP)

2013 performance (%)

EM FX: Focus more on local factors

Clyde Wardle LatAm FX StrategistHSBC Securities (USA) Inc.+1 212 525 [email protected]

Paul Mackel Head, Asia FX ResearchThe Hong Kong and ShanghaiBanking Corporation Limited +852 2996 [email protected]

Murat Toprak EMEA FX StrategistHSBC Bank plc+44 20 7991 [email protected]

Marjorie Hernandez LatAm FX StrategistHSBC Securities (USA) Inc.+1 212 525 [email protected]

Ju Wang Asia FX StrategistThe Hong Kong and ShanghaiBanking Corporation Limited +852 2822 [email protected]

Dominic Bunning Associate, FX StrategistThe Hong Kong and ShanghaiBanking Corporation Limited +852 2822 [email protected]

40


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We expect North Asian currencies to hold up

better than the rest of the region. Stronger

external balances and slower leveraging trend

should see the KRW and TWD face less volatility.

We are most cautious on the IDR, THB, MYR,

and INR, which in general have more challenging

BoP and IIP positions.

A cyclical economic improvement combined

with a solid external position will be supportive

for PLN and HUF. A small current account

surplus in a context of persistent and structural

capital outflows will continue to weigh on the

RUB, particularly in a context of very weak

economic growth and sticky inflation. The RUB

has weakened significantly during the EM sell-off

in H2 2013 and we believe that the adjustment is

likely to carry on in 2014.

FX Policies

As ever, investors should be mindful of official

policy towards currencies. Most central banks in

Asia have been buying USD as of late, bolstering

reserves buffers and resisting local currency

strength (see Asian FX Policy Dashboard,

13 December). Asian CBs last year showed a

propensity to stabilize their markets and reduce

volatility, rather than target particular levels. This

is true elsewhere too, with Peru and Brazil’s

central banks regularly intervening in LatAm,

though with USD sales in recent months.

In EMEA, we saw the Czech National Bank

finally step into the fray last November, selling

the CZK to induce a sharp downward correction

for the koruna. Israel’s central bank will likely

continue its resistance to further ILS strength. The

Israeli economy is growing below trend and

export performance is weak, partly because of ILS

strength. In fact, we believe the BoI may adopt a

more aggressive intervention policy aiming at

weakening the ILS if the economic growth

disappoints and inflation stays persistently low.

Overall, we see USD-ILS trending towards 3.60

in the coming months.

In China, we believe bold FX reforms are needed

to reduce the one-sided appreciation pressures on

the CNY and create greater CNY volatility. RMB

internationalisation will accelerate in 2014,

suggesting the path towards currency

convertibility will quicken too. For China, we see

USD-CNY ending 2014 at 5.98. Inflow pressures

that support the CNY are expected to remain

stubbornly strong, helped by interest rate

liberalization and an increasing policy willingness

to adapt to market forces.

Politics

The macro and political backdrop has led to a

vicious circle for the TRY. Political risk has to

be priced in by the TRY not only in the short-term

but also in the long term. The constant re-pricing

of the Turkish political risk in the absence of

sufficient monetary policy response has made the

TRY downward spiral self-sustaining. We revised

our USD-TRY forecast significantly higher. We

now see USD-TRY rising to 2.30 in Q1 and

ending 2014 at 2.10 compared to 1.90, previously.

Presidential elections in Brazil (Oct), Colombia

(May), and Uruguay (Oct) are likely to

influence sentiment. Of these, Brazil’s election

offers the most room for two way risk. Yet,

markets are expecting a continuation of policies

and prefer to play this defensively. Any changes

to this scenario (i.e. a narrowing of the President’s

lead in polls or hints of a more market-friendly

agenda), leave room for a stronger BRL. In Chile,

too, the transition of power will be closely

followed as leading candidate Bachelet’s populist

re-election campaign could bring about important

changes for investors. In Mexico, attention will

shift from the approval phase to the

implementation phase of the reforms. For the

MXN, what is most relevant is the scope of FDI

as a result of these reforms.

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=rI185ERcb7&n=398270.PDF

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‘Valuation’ opportunities

There is no strong domestic reason for further

ZAR depreciation. Beyond the potential

implications of a broad-based USD strength, there

is little domestic macro reason for a further

depreciation as we believe that FX has already

adjusted. The ZAR is the cheapest currency in the

EM space as measured against the 10-year

average REER (Figure B11). We expect a

stabilization in the medium-term with the

materialization of the so-called “J-curve”.

In CEE, the PLN does not show any valuation

issues. The NBH meeting on 21 January is pivotal

for the HUF. Consensus expects a 10bp cut, but

we forecast 15bp. In Poland, the central bank’s

stance is moving in the opposite direction. This

gives room for a Long PLN-HUF position.

Meanwhile, for the shekel, while the macro

fundamentals are still ILS-supportive, we

consider that the valuation is no longer

compelling. The real effective exchange rate has

risen substantially in 2013 and no longer shows

misalignment with important macro variables like

the current account balance or terms of trade

momentum. Meanwhile, as we discuss in the next

section the BoI is unlikely to let the ILS

strengthen much further.

Cheap valuations are also one of the reasons we

are more positive on the MXN. Indeed, the MXN

remains the only LatAm currency that is cheaper

than its 10-year average REER (see Figure B11).

In Asia, the PHP and SGD, while still

fundamentally sound, should face gradual

depreciation pressures after Q1 given their rich

valuations and relatively low yield.

Strategies to start the year

LatAm

As market conditions are likely to remain

challenging, we argue in favor of distinguishing

between strategic and tactical trading strategies.

For the fundamental trades, we like cross-country

picks and recommend the following crosses:

Buy MXN-BRL: 2014 could see Mexico

upgraded and Brazil downgraded

Buy COP-CLP: Based on COP’s lower

vulnerabilities, rate hike potential and

momentum in portfolio inflows

Buy PEN-UYU: Based on central bank

action to support PEN and UYU ties to

depreciating BRL

Figure B11: EM valuations, based on distance to average and peak 10 year REERs

Source: BIS, HSBC

-40%

-30%

-20%

-10%

0%

10%

20%

30%

Braz

il

Chi

le

Col

ombi

a

Mex

ico

Peru

Chi

na

Hon

g Ko

ng

Indo

nesi

a

Indi

a

Kore

a

Mal

aysi

a

Philip

pine

s

Sing

apor

e

Thai

land

Taiw

an

Cze

ch R

ep.

Hun

gary

Isra

el

Pola

nd

Rom

ania

Rus

sia

Turk

ey

S. A

frica

Distance from 10 year avg Distance from 10 year peak

-------- LatAm -------- ------------------------- Asia ------------------------- ----------------- EMEA -----------------

42


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We like the following conditional trades:

Sell USD-LatAm FX on weaker US data

and/or a more-dovish-than-expected pace of

Fed tapering

Buy USD versus PEN and CLP on a fall of

metal prices

Sell USD-BRL if President Rousseff’s lead in

the polls shrinks ahead of the October elections

Buy USD-BRL on Brazil credit downgrade

risk rising

Sell USD-MXN on spikes caused by external

risk aversion

Asia

Long INR-IDR: while the INR is mainly

suffering from a large trade deficit, the IDR is

being hurt by a widening income account

deficit. While the RBI has been trying to curb

the INR’s volatility, BI has allowed the IDR

to adjust weaker. Valuation also suggests the

INR is still more undervalued than the IDR.

Short AUD-CNH: as China rebalances,

growth will depend less on exports and

investment, suggesting greater policy

tolerance of a stronger FX. Meanwhile

interest rate liberalization means higher rates,

supporting the RMB. The AUD is a big loser

from China’s economic transition as demand

for commodities slows.

Short THB-KRW: the KRW should

continue to enjoy a hefty current account

surplus and significantly lower domestic and

external leverage. The THB is more

vulnerable to further outflows, as FX cover

has fallen sharply due to a rapid build-up of

external debt and a weakening current

account position. Political tensions may add

downward pressure on the THB. The KRW

also continues to look cheaper than the THB

on long term valuation metrics.

Long SGD-MYR: The SGD should

outperform ASEAN currencies given the

MAS’s tightening stance as well as Singapore’s

stronger BOP profile. The MYR faces

headwinds from a thinning current account

surplus, high foreign exposure in the local debt

market, the threat of higher inflation and

elevated fiscal burden. As the BNM is one of

the least interventionist central banks in Asia,

we expect the MYR to remain volatile with a

depreciation bias.

Long TWD-PHP: We see TWD among the

more resilient Asian currencies, supported by

a 2013 near record surplus across all

categories. TWD is also still the most

undervalued in Asia on various REER

metrics. Although resistant FX policy and

negative implied interest rates are hurdles to

be long the currency, being short the PHP

negates some of these risks, which it is likely

to be stifled by expensive valuation, resistant

FX policy and negative carry.

EMEA

Long USD-RUB: the RUB has never been

included in the “fragile” group of currencies

(e.g. TRY and ZAR), thanks to Russia’s

current account surplus. Yet, the RUB

weakened during the sell-off in 2H13 and we

believe that the adjustment is likely to extend

to 2014. A small current account surplus in a

context of persistent and structural capital

outflows will continue to pressure the RUB,

particularly given very weak growth and

sticky inflation. The diminished involvement

of the central bank in the FX market and a

likely further widening of the RUB trading

band should weigh on the currency.

Long PLN-HUF: we recommend

PLN-HUF to benefit from divergent

monetary policy.

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GEMs equities - cheap and unloved, but

not straightforward

Our best country ideas are in markets with

strong macro positions – Taiwan, Mexico,

and the Gulf

But a number of small markets also stand

out – Greece, Egypt, Peru, and selective

ASEAN markets


A starting point from which to approach GEMs

equities is that they are cheap and unloved. These

attributes have the potential to become important in

an environment where US equities, in particular,

have had a very strong run and valuations are less

compelling. Of course, there are differences between

sectors, but in aggregate, this observation holds true.

However, there are important constraints on

performance, which points to a need for

inventiveness. We have been asked frequently

whether we should expect performance to be

differentiated or correlated. The data suggest that

it is quite likely that if EM move, they are rather

likely to move as a bloc. In the near term, it is not

very clear that this will happen. The data continue

to suggest that the probability of investors

achieving a strong performance increases with the

extent to which they make use of off-benchmark

positions and small markets.

Clearly, this also highlights a need for nimbleness,

since if EM does begin to move, it may be

necessary to shift quickly back on-benchmark and

re-position in the larger markets.

Equities: Cheap, unloved, but not straightforward

John Lomax* Head of Global Emerging Market Equity Strategy HSBC Bank plc+44 20 7992 [email protected]

*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations

Figure B12. 12M-forward PE of EM relative to DM Figure B13. 12M-forward PB and RoE of EM relative to DM

Source: MSCI, IBES, Thomson Reuters DataStream, HSBC Source: MSCI, IBES, Thomson Reuters DataStream, HSBC

0.40

0.50

0.60

0.70

0.80

0.90

1.00

1.10

1.20

Jan-91 Jan-95 Jan-99 Jan-03 Jan-07 Jan-11

Av g.

Av g. + 2 Stdev .

Av g. - 2 Stdev .

0.60

0.70

0.80

0.90

1.00

1.10

1.20

1.30

Jan-06 Jan-08 Jan-10 Jan-12 Jan-14

PB

RoE

RoE of EM is just atpar with that of DM while the P/B of EM is at a 30% discount to DM.

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We see EM equities driven by:

Valuations are low relative to DM at least in

the context of the last 10 years. This is clear

whether one looks at forward earnings

multiples or the price to book/RoE mix. Even

on macro measures like ‘stock market

capitalization-to-GDP ratio’, EMs look cheap

compared with DMs.

Earnings revisions appear to be less of a

drag on EM than was the case through H1 last

year. It seems that some of the pressure is

coming off EM corporate margins as EM

economies slow.

Positioning is light, as global funds are now

heavily underweight EM equities and

liquidity outflows from EM funds stand in

stark contrast to inflows into their DM peers.

Against this background it’s quite hard to

argue that there is excess enthusiasm for EM.

High correlation between EMs. The

dispersion of returns within EM is low

relative to historical standards. Unless there is

a sharp deterioration in the international

environment (e.g. US bond yields spike

sharply higher), the asset class may tend to

move as a bloc.

Scenarios and risks

We forecast a 7% increase in the MSCI EM

index, for a total return of 10% including

dividends during 2014. Consensus expectations

for EPS points towards 12% growth, thus our

expected price gains are possible even if there is

some disappointing earnings, as long as multiples

remains unchanged (Table B5).

Risks comes from a rather intense election

calendar across the GEM universe this year,

particularly so in the current account deficit

countries. There are general elections in South

Africa (April), parliamentary and presidential

elections in Indonesia (April and July,

respectively), parliamentary elections in Hungary

(May), presidential elections in Colombia (May),

and general elections in India (May). In addition

there are municipal and presidential elections in

Figure B14. Global funds remain underweight on EMs Figure B15. Cumulative flows (% of AuM) into equity funds

Source: EPFR Global, MSCI, Thomson Reuters DataStream, HSBC calculations Source: EPFR Global, HSBC

Figure B16. EM dispersion is very low to its own history

Notes:*calculated as the standard dev of cross country returns for a given month

Source: MSCI, Thomson Reuters DataStream, HSBC calculations

5%

7%

9%

11%

13%

15%

Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13

EM Weight in Global portfoliosEM weight in MSCI ACWI

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13EM DM

0%

5%

10%

15%

20%

25%

Jan-97 Jan-01 Jan-05 Jan-09 Jan-13

Dispersion of monthly returns across the EM countries

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Turkey (March and August respectively) and

presidential elections in Brazil (October).

All of these may yield positive or negative

surprises. In most cases, all that can be usefully

said is that a lot of potential political risk seems to

be quite heavily priced in. However, especially in

Brazil (neutral) and India (underweight), our

regional strategists believe that the political

environment has additional scope to limit the

market outlook.

We believe the past few years have seen a

structural decline in profitability across much

of the EM region. Margins have contracted due to

increasing competition and rising labor costs and

this has led ROEs to fall. This takes some of the

gloss off the region’s attractive valuations.

Table B5. 2014 MSCI EM total return scenarios

Source: HSBC

Table B6. GEMs consensus valuations

______________ PE (x) _____________ __________ EPS growth (%) _________ PEG ratio Consensus EPS 2013e 2014e 2015e 2013e 2014e 2015e 2014e 3M change

Czech Republic 9.7 11.0 11.8 -6.9 -11.7 -6.6 -1.7 -1.8 Hungary 11.2 9.4 8.2 -18.9 19.7 15.0 0.6 -6.4 Poland 13.1 12.7 11.6 -23.4 2.8 9.9 1.3 0.3 Egypt 13.8 8.8 7.5 -19.3 57.1 17.0 0.5 -9.4 Russia 4.6 4.7 4.8 -2.8 -2.2 -1.7 -2.8 0.3 South Africa 16.2 14.3 12.9 2.3 13.5 10.5 1.4 -0.1 Greece 11.8 16.7 18.8 4.5 -6.2 51.0 0.3 5.4 Turkey 9.4 8.7 7.3 7.0 8.1 18.0 0.5 -0.3 EM cons plays in DM* 21.2 17.3 15.0 37.1 41.3 16.5 1.0 1.1 CEEMEA 8.5 8.2 7.9 -3.1 3.4 4.4 1.9 -0.1 China 9.5 8.7 7.8 11.3 9.2 11.7 0.7 0.4 India 16.3 13.8 12.0 8.7 18.2 14.9 0.9 -0.2 Indonesia 14.0 12.6 11.0 1.7 11.9 14.1 0.9 -1.4 Korea 10.4 8.5 7.7 7.6 22.4 10.1 0.8 -2.6 Malaysia 16.9 15.6 14.2 -1.0 8.1 9.7 1.6 -0.4 Philippines 18.8 17.5 15.2 7.6 7.6 15.6 1.1 0.1 Taiwan 15.4 14.4 12.9 33.2 6.9 11.2 1.3 -1.8 Thailand 12.1 10.7 9.6 12.7 12.8 11.7 0.9 -2.0 EM Asia 11.6 10.3 9.2 11.7 13.6 11.4 0.9 -1.1 Brazil 11.6 9.9 8.8 11.6 17.4 11.8 0.8 -0.1 Chile 18.0 14.5 12.4 3.8 24.0 17.1 0.8 -2.3 Colombia 16.0 14.2 12.2 -10.3 12.5 8.2 1.7 -1.1 Mexico 20.3 17.7 15.6 -5.1 15.1 13.4 1.3 -2.2 Peru 14.2 12.0 10.3 -29.8 17.9 17.2 0.7 -5.2 LatAm 13.8 11.8 10.5 4.7 16.7 12.3 1.0 -0.7 GEMs 11.3 10.1 9.1 6.9 11.8 10.1 1.0 -0.8 Developed 16.4 14.8 13.3 6.5 10.5 11.0 1.3 -1.2

Note: Equal-weighted basket of Sabmiller, Richemont N, Jeronimo Martins and Erste Group Bank, used to measure the performance of our off-benchmark exposure to EM consumer Source: MSCI, IBES, Thomson Reuters DataStream, HSBC

To 2008 low PE

of 8.6x Down to x10.6

Unchanged at

x11.5 Up to x12.3

To post 2000 avg

PE of 12.9x

Recession -5% -34% -15% -5% 1% 6%

No growth 0% -29% -10% 0% 6% 11%

Similar to 2013 7% -22% -3% 7% 13% 18%

Consensus 12% -18% 2% 12% 18% 23%

Above consensus 15% -14% 5% 15% 21% 26%

High Low

P/E Contraction / expansion scenarios (as at end of 2014)

Probability

EPS Growth

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In our view, the market continues to attach too

high a probability to a Chinese hard landing –

and during the course of the year, this is likely to

be progressively priced out of associated countries

and sectors. However, we are far from sure that

Chinese equities themselves are the best way to

play Chinese macroeconomic stabilization (we are

underweight). We think this has better chances of

getting traction elsewhere. In particular, it should

support the GEMs material sector but also, to

some extent, derived country plays on China such

as Russia and Brazil (both rated neutral).

Strategies to begin the year

In our view, the most compelling GEMs country

ideas are in some of those countries with the

strongest macro support and some small markets.

We define the former in terms of relatively low

external risk, improving domestic growth and

support from the global cycle. On both US

monetary policy and in some respects China

(although not with regard to Chinese equities),

which have been durable impediments to the EM

equity outlook, we think the clouds are lifting

although the position remains far from clear. In

this category, our regional strategy teams would

particularly highlight Taiwan, Mexico, and the

Gulf. In terms of small markets, we would

particularly highlight selected ASEAN countries,

Greece, Egypt, and Peru.

By sector, among the large markets, we suggest

the following exposures. In Taiwan (overweight),

we see technology stocks with structural growth

drivers as likely to outperform, as their valuation is

more reasonable than non-technology stocks and

their fundamental growth will depend less on the

volatile product market. In Mexico (overweight),

energy reforms could potentially boost private and

public investment, increase employment and raise

GDP growth above 4%. We see industrials, building

materials, and infrastructure builders as the main

beneficiaries. In the Gulf (off-benchmark), we favor

both domestic demand and petrochemical themes.

Table B7. HSBC EM country portfolio

CurrentRecommendation

Previous Recommendation

MSCI benchmark weight (%)

HSBC weight (%)

CEEMEA Neutral 18.1 18.1 Czech Republic Neutral 0.2 0.2 Egypt Overweight 0.2 1.0 Greece Overweight 0.5 1.5 Hungary Neutral 0.3 0.3 Poland Underweight 1.7 0.8 Russia Neutral 6.1 6.1 South Africa Underweight 7.5 4.5 Turkey Overweight 1.6 2.8 DM plays on CEEMEA consumer* Off Benchmark - 1.0 EM Asia Underweight 62.8 59.3 China Underweight Neutral 19.7 17.0 India Underweight 6.4 4.0 Indonesia Overweight 2.2 3.2 Korea Neutral Overweight 15.9 15.9 Malaysia Overweight Neutral 3.9 4.2 Philippines Overweight Neutral 0.9 1.2 Taiwan Overweight 11.7 13.0 Thailand Underweight 2.2 0.8 Latin America Overweight 19.2 19.6 Brazil Neutral 10.7 10.7 Mexico Overweight 5.5 6.7 Chile Underweight 1.6 0.8 Colombia Underweight 1.1 0.8 Peru Overweight 0.4 0.6 Frontier Markets Off Benchmark - 3.0

Note:*We would like to implement this through Austrian banks and dual-listed stocks in South Africa. | Weights may not sum to 100% because of rounding | Source: MSCI, Thomson Reuters DataStream, HSBC estimates

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Issuance to remain robust on higher

demand in Asia

Favorable operating environment will

support ME corporates and banks

Macro backdrops likely to make or break

corporate bond performance in LatAm

Asia We believe the bulk of the Asian credit

re-pricing is over in 2014 but see no positive

catalysts to start a new credit compression

trend in 1H14. Deleveraging and reforms should

be favorably rewarded this year, while

unsustainable credit growth should receive a

negative response from the market.

Sector-wise, the property sector is still our top

pick. Balance sheet liquidity of developers

remains adequate in 2014, despite active land

acquisitions in 2013. In the ASEAN property

sector, we are more positive on the credit stories

of the Philippine property conglomerates than

their Indonesian peers. Away from the property

space, we prefer companies with stable cash flows

and credit profiles, such as in the utilities, oil and

gas, telecom, and internet sectors. Meanwhile,

industries which had oversupply issues would

continue to face challenges in 2014. We would

focus on companies with low production costs,

positive free cash flows, and deleveraging

strategies. Those would outperform on a relative

basis against average industry peers.

We also prefer beaten down Indian private sector

banks to government-owned entities as well as

Indonesian quasi-sovereign issuers such as

Pertamina and PLN. These quasi-sovereign issuers

trade cheap to relative value versus the sovereign,

especially at the back end of the credit curve.

Asian issuance remains robust on higher

demand. We expect Chinese corporates to

continue to dominate the 2014 primary issuance,

where we could see USD83-95bn gross issuance

on the corporate front. The US dollar market will

be attractive to Chinese issuers as financing costs

are still expected to be lower than in the onshore

financial markets. These issuers are unlikely to be

dissuaded by the still unquantifiable implication

of potential Fed tapering for the US term rate

structure. Besides, another consideration is that

the redemption schedule for Asian bonds should

be much heavier in the coming years.

The disinflationary pressures in Asia ex-Japan are

not obvious, but nominal GDP growth is declining

relative to real GDP and mirrors weakening

pricing power for firms. Disinflation is not yet an

obvious trend as growth rates remain largely

healthy, but signs of it are evident in select

economies in Asia, which appear to be under

different stages of disinflation.

From a banking sector perspective, by overlaying

the inflation/deflation debate with the

leverage/deleveraging cycle, one can lead to some

interesting conclusions. The two subjects are

anecdotally linked but it is not clear what the

nature of the relationship is and what the eventual

EM Corporates in 2014

Sarah Leshner LatAm Corporate Credit AnalystHSBC Securities (USA) Inc+1 212 525 [email protected]

Devendran Mahendran Senior Analyst, Sovereigns and Financial Institutions The Hongkong and Shanghai Banking Corporation Limited +852 2822 [email protected]

Philip Wickham Director, Corporate Credit Research The Hongkong and Shanghai Banking Corporation Limited, Singapore Branch +65 6658 [email protected]

Keith Chan Director, Corporate Credit ResearchThe Hongkong and Shanghai Banking Corporation Limited +852 2822 [email protected]

Sean Glickenhaus AnalystHSBC Securities (USA) Inc+1 212 525 [email protected]

Pavel Simacek AnalystHSBC Bank plc+44 20 7992 [email protected]

Raffaele Semonella AnalystHSBC Bank Middle East+ 971 442 36 [email protected]

Reza-ul Karim AnalystHSBC bank plc+44 20 7992 [email protected]

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outcomes will be. The outcome is also dependent

on the maturity of the economy and how heavily

indebted the country is.

There are different stages of disinflationary

pressures affecting some banking sectors in

Asia. The first is that of a low interest rate

environment in a relatively mature economy

which is putting pressure on banks’ interest

margins. This is evident in the more mature

economies of Korea, Singapore, Malaysia,

and Thailand.

Countries like India and Indonesia, on the

other hand, have low levels of indebtedness and

relatively higher inflation rates. While it is not

good for savers, it is beneficial to banks as

inflation, accompanied by growth, melts away

debt levels and can improve debt service

over time.

In China, the concerns remain more or less the

same as last year in that credit growth in the

financial system is too strong, at 23% y-o-y as at

June 2013, and the leverage as measured by

credit/GDP is now very high, estimated at 198%.

The absolute amount of credit outstanding as at

June 2013 was RMB106.7trn (USD17.6trn),

representing a RMB19trn (USD3.1trn) increase

from a year earlier.

In 2013, however, funding pressures have become

more acute with visible strains in the interbank

market, as shown by the upward shift in China’s

government bond curve.

We think the authorities are generally taking a

neutral stance by neither injecting nor

withdrawing liquidity through PBOC

operations and are willing to tolerate higher

market-based rates. While this has not yet slowed

credit growth, higher market-based rates should

bring about a more moderate pace of credit

expansion, particularly in the shadow banking

sector. This could coincide with higher levels of

underlying non-performing loans (NPLs) as the

authorities look to restructure industries with

over-capacity and local government debt.

CEEMEA Our CEEMEA research universe consists of a

broad variety of banks and corporations

operating in a wide number of markets and

industries. We actively cover financial

institutions in the Commonwealth of Independent

States (the CIS), Turkey, and the Middle East; oil

and gas companies in Russia and Kazakhstan;

metals and mining companies in Russia; as well as

a broadly diversified array of corporates in

Bahrain, Kuwait, Qatar, the UAE, and

Saudi Arabia.

The future performance and fortunes of corporates

and banks in our research universe are driven by

very different factors but one unifying theme for

them would be the state of the global and

respective national economies where they operate.

Middle Eastern corporates and banks benefit

from a positive macroeconomic backdrop. For

the corporates, we expect the average leverage to

stabilize and the liquidity profile to remain solid.

Large refinancing requirements will result in a

busy primary market and total hard currency

supply from the corporates could potentially reach

USD12bn.

Qatari and UAE banks will continue to benefit

from strong growth in their domestic markets.

In Qatar, lending activities have been advancing

rapidly for a number of years. This trend is

unlikely to abate with real private sector credit

growth projected to reach 14% in 2014. In the

UAE, private sector credit growth is projected at

9.5% in 2014.

Turkish economic growth is likely to lose

momentum in 2014, which will weigh

negatively on the business prospects of local

banks. With economic activity expected to slow

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down in 2014, demand for banking services and

credits is also set to weaken. Our macroeconomic

team projects GDP growth in Turkey to drop to

2.2% in 2014, down from a projected 3.9% in

2013. We expect the aggregate loan portfolio of

Turkish banks to advance by around 12-15% in

2014. The most dynamically growing segments

should be loans to individuals and to small- and

medium-sized enterprises.

Despite the focus on higher-yielding market

segments, we expect the profitability of Turkish

banks to come under pressure in the near to

medium term with bottom line performance likely

to be impacted by falling net interest margins and

trading income and growing operating expenses.

In order to overcome the negative margin

pressures many banks, and not only in Turkey,

will likely seek to strengthen their positions in

business segments offering higher margins. e.g.

retail business and lending to small and medium-

size enterprises (SMEs). These market segments

offer potentially higher profitability but at the

same time represent a higher risk and a possible

threat to asset quality.

We also expect political developments in the

country to remain a key driver of volatility for the

banks’ publicly traded debt.

Lending growth in Russia is likely to remain

quite high. In the CIS, we expect the performance

of Russian banks to remain sound throughout

2014, albeit somewhat constrained by the

weakening operating environment and

thinning capitalization.

The lending operations represent the main

component driving the profitability of Russian

banks and we project their loan portfolios to

increase by 15-20% in volume terms in

2013/2014. Loans were up by 13.0% in the first

nine months of 2013.

Corporate lending is slowing as a result of

weakening industrial output and companies’

reluctance to invest in their future growth. Many

corporates have adopted a defensive business

strategy and are hoarding cash reserves. Corporate

behavior is likely to change only if companies’

management teams become more confident about

future prospects, and the level of predictability

and stability increases.

Russian oil and gas companies are expected to

intensify their green field activities while the

weak operating environment and adverse pricing

conditions will continue to weigh on the

performance of Russian metals and

mining companies.

Latin America As we come off a rather tricky year with most

EM corporate indices underperforming in

2013, we believe that industry and issuer

selection has become ever more important,

coupled with picking the right sovereign

backdrop. Below we highlight why we think

certain factors will help drive the selection

process, and how to make the right calls.

Macro backdrops likely to make or break

corporate bond performance. We see important

and varied impacts from macro developments

expected throughout Latin America in 2014.

Specifically, we have an eye on economic

forecasts, foreign exchange movements, and

government intervention affecting key industries

for issuers. In the run-up to the 2014 Brazilian

presidential election, we believe that supporting

the private sector is unlikely to be a priority. Our

fixed income team noted a bearish sentiment

among local investors in a recent trip to the

region, with the risk of a credit rating downgrade

very much on the market’s mind. Similarly, GDP

growth in Mexico disappointed most economist

and analysts last year, reflecting both domestic

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weakness and the close link to a lacklustre US.

Slower-than-expected government spending hurt

construction and related industries but is likely to

pick up in 2014 and beyond. Mexican GDP is also

forecast to rebound strongly in 2014.

Domestically-oriented corporates, as well as those

in industries affected by government decisions

(e.g, Petrobras, energy, and petrochemicals in

Mexico) and/or dependent on government

spending (construction, infrastructure in Mexico)

will be particularly impacted by GDP growth. We

also believe that deteriorating economic

conditions are likely to strike lower-quality issuers

harder, given their lack of (or lower) cushion for

absorbing slower growth.

A weak BRL will likely be supportive for

exporters, much as we saw in 2Q13 and 3Q13.

Our strategists expect the BRL to continue

depreciating, which will help industries like protein

and pulp but will present challenge for those

companies with a mismatch of currencies such as the

airlines and sugar and ethanol producers. Similar to

the economic slowdown, we believe that the fact that

these industries maintain high leverage and low

liquidity cushions makes them particularly

disadvantaged. In contrast, the rating agencies

include telecom companies among those with the

most significant mismatch of currencies but we note

that most of the telecom companies we cover are

investment grade and have sophisticated methods for

hedging this exposure.

The rating agencies also identified other sectors

as already struggling as a result of less

favorable economic conditions; these include

housing, construction, and metals. We would

add petrochemicals and building materials.

Transportation, auto suppliers, utilities, and

conglomerates are included in the raters’ list of

industries that “remain highly correlated with

general economic conditions in the region

and abroad.”

We do not expect a spate of defaults in 2014 of

the same magnitude as we saw in 2013 given

that maturities have generally been extended and

sufficient buffers exist in the near-term for a

greater proportion of LatAm corporates to meet

debt obligations this year as compared to 2013.

Balance sheets are healthy, but with

negative-biased momentum. However, the joint

possibilities of lower cash flows and less access to

refinancing could mean liquidity ratios worsening,

even slightly.

We note that the credit rating agencies have had a

slightly negative bias for the region’s corporate

issuers in 2012-2013 and we expect that to

continue in 2014. High-yield corporates in

particular had more negative activity than positive

during the past year, according to Fitch, and we

find some of the most attractive opportunities to

be credits that buck this trend, especially for those

on the cusp between IG and HY.

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2014 regional economic outlooks

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Growth will likely tread sideways across

the region overall, slowing in China and

Japan, and be disappointing in much of the

rest of Asia

Exports to the West, even if improving, will

not boost local growth enough to offset the

drag from rising funding costs amid

high debt

Focus will be on structural reforms, with

elections in Indonesia, India and – possibly

- in Thailand adding to wider

policy uncertainty

Steady at best

Asia’s economies appear to have lost their

stride. After years of heady growth, and a

remarkable rebound after the global financial

crisis of 2008-2009, the pace has slowed into a

disappointing rhythm. Yet, we believe a stumble

is not in sight as many fear, with sufficient

momentum left to see the region through another

solid year. Liquidity, too, is ample enough to

sustain growth for the time being, even if the

Federal Reserve started to “yank the leash.” This,

then, opens an opportunity for Asian officials to

tidy up. Structural reforms, whether in China,

India, Japan, or ASEAN, are now needed to

restore growth to its former vibrancy. These will

not deliver prompt results and require

perseverance. However, when implemented, Asia

should once again march with confidence as the

most dynamic region in the world.

One lesson of 2013 was that Asia’s exposure to

global financial volatility has increased over

the years. A sharp rise in US interest rates

weighed on credit growth and economic activity

more broadly. Especially vulnerable proved India

and Indonesia, where current account deficits

require a steady stream of capital inflows to

maintain stability. Should Fed tapering and US

economic strength sharply push up funding costs

again this year, growth would likely slow further

Asia in 2014

Frederic Neumann Co-Head, Asian EconomicsThe Hongkong and Shanghai Banking Corporation Limited +852 2822 [email protected]

Qu Hongbin Co-Head, Asian EconomicsThe Hongkong and Shanghai Banking Corporation Limited +852 2822 [email protected]

Table C1. Asia – Key forecasts

GDP Inflation Policy rate FX Current account (% GDP) Fiscal account (% GDP) 2013e 2014f 2015f 2013e 2014f 2015f 2013e 2014f 2015f 2013e 2014f 2015f 2013e 2014f 2015f 2013e 2014f 2015f

China 7.7 7.4 7.7 2.6 2.7 3.1 6.00 6.00 6.00 6.08 5.98 5.90 2.3 2.6 2.7 -2.1 -1.9 -1.9Hong Kong 2.9 3.7 4.0 4.2 4.2 4.2 0.50 0.50 0.50 7.8 7.8 7.8 4.9 6.5 8.4 2.4 1.4 1.0India 4.6 5.3 6.3 9.5 7.2 7.8 8.00 8.00 8.00 61.0 62.0 64.0 -2.9 -3.0 -3.0 -5.1 -4.7 -4.3Indonesia 5.6 5.0 6.0 7.0 5.6 4.9 7.50 7.50 7.50 12189 12500 12500 -3.7 -2.8 0.4 -2.4 -1.8 -1.5Korea 2.7 3.2 3.4 1.2 2.6 3.0 2.50 3.00 3.75 1050 1025 1000 5.1 4.4 4.4 1.0 2.0 2.9Malaysia 4.6 5.2 5.0 2.1 2.4 2.0 3.00 3.50 3.50 3.24 3.33 3.35 3.3 6.0 7.7 -4.0 -3.5 -3.0Philippines 6.8 5.9 6.1 2.9 4.0 4.2 3.50 4.00 4.00 43.8 45.2 45.4 3.3 2.9 2.3 -2.7 -3.3 -3.6Singapore 3.7 3.8 4.3 2.4 3.1 3.1 0.20 0.30 0.30 1.24 1.25 1.26 17.3 17.8 18.3 1.5 1.5 1.4Sri Lanka 6.8 7.2 6.8 6.9 6.9 8.0 8.50 8.00 8.50 130.9 130.0 130.0 -5.0 -5.9 -5.7 -6.0 -5.5 -5.0Taiwan 1.7 2.8 3.4 0.9 1.9 1.6 1.88 2.13 2.38 29.5 29.1 29.0 10.5 8.8 6.7 -1.5 -1.3 -1.2Thailand 2.8 4.4 5.2 2.2 2.6 3.8 2.25 3.00 3.00 32.4 34.0 34.5 -1.9 0.6 4.1 -2.1 -3.1 -3.5Vietnam 5.4 5.6 5.8 6.6 7.9 8.2 5.50 7.00 7.00 21250 21100 21100 1.8 2.0 0.7 -2.6 -2.3 -2.3Japan 1.9 1.3 1.3 0.3 2.2 1.5 0.05 0.05 0.05 99.0 94.0 94.0 1.0 1.1 1.6 -9.7 -7.0 -5.9

Source: CEIC, HSBC forecasts

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in EM Asia, with stronger exports not sufficiently

offsetting the drag from higher interest rates.

Yet, there are reasons to remain a little more

optimistic for 2014. The region looks in robust

enough shape to withstand at least a gradual rise

in dollar funding costs. First, Asia’s most battered

economies last year, India and Indonesia, have

raised policy rates and seen a gradual improvement

in their current account positions, even if this is

more marked in the former than the latter and has

come at the cost of growth.

Second, and this applies to emerging Asia more

broadly, quantitative easing by the Bank of

Japan will increasingly make itself felt. This

should at least partly offset the impact of Fed

tapering, with ASEAN standing to benefit the

most. Here, lending by Japanese banks will likely

play the most critical role, with 2013 already

seeing a surge in flows to the region in the form of

direct investment and loans. M&A deals, with

Japanese firms targeting ASEAN companies, hit a

record last year.

One big risk for Asia in 2014, paradoxically, is

therefore that US growth surprises sharply on the

upside, requiring accelerated tapering: the benefits

of faster exports, if they indeed materialize, would

likely be more than offset by the drag of higher

interest rates.

Less shiny growth

It is tempting to think that growth across

emerging Asia is set to accelerate. The US

economy, after all, seems to be on the mend.

Europe has turned a corner and Japan is still

buoyed by a generous stimulus. Exports may thus

improve. Moreover, officials in China and other

markets are making reassuring noises about

structural reforms. Will 2014 shape up to be

another blockbuster year in Asia? Will growth

accelerate to accustomed speed?

We believe the answer is: unlikely. A number of

structural headwinds are weighing on the region.

Rising debt, slowing gains in productivity, and

falling competitiveness mean that growth in

emerging Asia will likely stay subdued. True,

fears over a bigger stumble are equally misplaced.

Tapering by the Federal Reserve will likely not

trigger a nasty bout of deleveraging in Asia this

year as many sceptics have argued. For this, the

Bank of Japan is still too determined to supply

liquidity in buckets and local financial systems

remain resilient enough to shake off at least a

gradual rise in dollar rates. Even the spike in

volatility across the region last summer didn’t

lead to a 1997-style bust as many had feared.

With growth steady, for now, the focus will thus

be on structural reforms.

Figure C1. Japanese bank lending to ASEAN rising (USDbn)

Source: Bank of Japan, HSBC; NB: 2013: annualized through 3Q, ASEAN 5: Indonesia, Thailand, Malaysia, the Philippines and Singapore, ASEAN-4: minus Singapore

Figure C2. Manufacturing strength in G3 yet to spilled into emerging Asia

Source: Markit, HSBC

0

20

40

60

80

100

120

140

160

ASEAN-5 (USDbn) ASEAN-4 (USDbn)30

35

40

45

50

55

60

2006 2007 2008 2009 2010 2011 2012 2013G3 Output PMI EM Asia output PMI

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China likely ended 2013 on a firm footing, and

we expect growth of around 7.4% in 2014.

Activity could read stronger, at about 7.5-7.6%

for H1 2014 before some moderation in the

second half of the year, reflecting the impact of

the base effect. Investment should remain the

main driver, supported by infrastructure

investment which expanded by over 20% y-o-y in

the first 11 months of 2013. We expect

infrastructure investment to find support from:

1) changes to the investment and financing system

that would encourage private investors to

participate in infrastructure projects (e.g.

railways) and 2) more local governments will be

allowed to issue municipal bonds to support

ongoing projects and key infrastructure projects.

India faces a crucial year as well; we expect

growth at 5.3% for this fiscal year. A new

government will need to press on with reforms,

while the central bank maintains a tight rein to

finally throttle inflation. Fiscal spending, too, may

need to be cut further to meet ambitious targets

and equally pushy expectations among investors.

The good news is that the current account deficit

has narrowed sharply, giving the country a

cushion against possibly rising rates elsewhere.

Korea has seen its economy pull up in recent

months as well. Exports are doing better, so far

withstanding the impact of a weaker JPY. Faster

US growth may have a more positive impact here

than elsewhere, with the exception of Taiwan,

which is feeling an early lift as well. Still, China

now matters more for both than the US, so their

recovery should prove more muted than in

the past.

In Indonesia, we expect growth to remain

subdued by past standards as well. Elections are

looming, which could lead, finally, to more policy

action. In Thailand, politics will dominate as

well, with gridlock weighing more and more on

growth. Malaysia and the Philippines, by

contrast, appear more stable, with growth

chugging along, if not exactly at the desired pace.

Low inflation except in India and Indonesia

With growth thus more likely going sideways

for now, the good news is that inflation will

stay in the comfort range of central banks. In

fact, the latest PMIs show another easing of input

and output price pressures of late (Figure C4).

With commodity prices expected to remain stable,

including food, which matters greatly for Asian

CPI baskets, and capacity utilization measures

showing considerable slack, a spike in inflation

appears unlikely for the time being.

Figure C3. Inflation still sticky in India and Indonesia (% y-o-y)

Source: CEIC, HSBC

Figure C4. Little price pressure in Asia

Source: Markit, HSBC

-2

0

2

4

6

8

10

12

14

08 09 10 11 12 13Indonesia CPI India CPI India WPI

35

40

45

50

55

60

65

70

75

2005 2006 2007 2008 2009 2010 2011 2012 2013

EM Asia output price PMI EM Asia input price PMI

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Again, two exceptions are India and Indonesia.

In those two countries, price pressures have

proven a lot stickier than elsewhere. This

reflects, in part, the drop in exchange rates, which

raised the cost of imports. In addition, both

governments took steps in 2013 to cut energy

subsidies, which temporarily pushed up headline

readings as well. While the current account

position has improved faster in India than in

Indonesia, the opposite is true for inflation, which

shows signs of stabilization in the latter but not

yet the former. Unless price pressures in both

economies ease soon, rate hikes may be needed.

Tightening cycle in sight?

Expect few moves in policy rates in EM Asia

this year. With the exception of India and

Indonesia, central banks are in a more comfortable

position and likely to hold rates for quite a while.

In Malaysia, further subsidy cuts could also coax

the central bank into a hike to anchor inflation

expectations, but the planned fiscal consolidation,

by retarding growth, renders the case less pressing.

Meanwhile, in Thailand, continued political

turmoil leaves the bias towards further easing. But

the drop in the currency has already done much of

the work for the BoT.

2014: The year of reforms in China

Following the Third Plenum at which a bold

master reform plan was rolled out, December’s

Central Economic Work Conference pledged

to speed up financial, taxation, and other

reforms while maintaining a positive growth

trend in 2014. We expect more concrete reform

measures to be announced by central and local

governments in the coming quarters, including:

Financial reform: further steps towards interest

rate and capital account liberalization. We expect

the negotiable certificates of deposit could be

expanded from banks to businesses and a deposit

insurance scheme could be introduced in the

coming months. A further increase in the upper

limit of deposit rates (now x1.1 against the

benchmark) is also likely in the coming quarters.

Fiscal reforms: We believe the central

government will start to take more responsibilities

while local governments will get a bigger share of

tax revenues. We also expect local government

municipal bond issuance to be expanded and

Beijing could start compiling a detailed

government balance sheet.

Deregulation: We expect progress in lowering

the entry barrier for private enterprises in service

sectors, such as railways, urban public transport,

healthcare and elderly care, as well as

environmental protection and financial services.

Pricing reform, including letting the market

dictate the price of natural gas and reforming the

water pricing system with extra fees charged for

industrial sectors and a tiered pricing mechanism.

Hukou and one-child policy reforms: Further

relaxation of the hukou residency permit policy

should take place in some small and medium

sized cities. We believe more provincial

authorities will allow couples to have a second

baby if one of the parents is an only child.

Figure C5. FAI growth led by infrastructure

Source: CEIC, HSBC

-10

0

10

20

30

40

50

60

-10

0

10

20

30

40

50

60

05 06 07 08 09 10 11 12 13

(%yr, 3mma)(%yr, 3mma)

Total FAI PropertyManufacturing Infrastructure

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2014 should see a weak and uneven

recovery and countries with higher

inflation may struggle to boost growth

Mexico GDP to grow 4.1%, Brazil seen

lagging at 2.2%, Argentina down to 1%,

good growth seen in the Andean countries

Brazil seen ending its tightening cycle soon,

most other banks either in easing or steady

monetary policy modes.

Inching forward

As we head into 2014, activity in many LatAm

countries is gradually recovering. Yet, the pace

of the rebound will likely be weak and far from

even. Indeed, we see the splits we identified a

year ago – between the fast-growing countries on

the Pacific coast and the slower-growth countries

on the Atlantic – as still relevant. The key factors

holding back the recovery in some countries, and

allowing it to go ahead full throttle in others, also

have not changed much.

While we have seen rising current account deficits

acting as a brake on growth in 2013, inflation –

more specifically, the inflation-growth trade-off –

remains the main dividing factor between the two

groups of countries in Latin America.

An adverse trade-off limits the ability of countries

to float their currencies, delaying current account

adjustments and thus holding back growth. This

is especially so in countries where a higher degree of

dollarization persists, such as Argentina, Uruguay,

and Venezuela. High inflation also limits

governments’ capacity to support a stronger rebound

with the help of policy easing.

We expect on a marginal policy response.

Pressures resulting from tighter external financing

conditions have recently pushed the governments

of these lower-growth countries into applying

marginal corrections to some of their policies. We

believe their efforts may have only a limited

impact, as they may be restricted by two factors:

politics and inflation.

Latin America in 2014

Table C2. Latin America – Key forecasts

______ GDP _______ _____ Inflation ______ ____ Policy rate _____ _______ FX _________ Current accnt (% GDP) Fiscal accnt (% GDP) 2013e 2014f 2015f 2013e 2014f 2015f 2013e 2014f 2015f 2013 2014f 2015f 2013e 2014f 2015f 2013e 2014f 2015f

Argentina 2.5 1.0 1.5 26.3 27.5 26.0 20 23 23 6.5 8.5 11.0 -0.8 -0.7 -0.7 -2.7 -2.3 -2.0Brazil 2.2 2.2 1.2 5.7 6.3 5.8 10 10.75 11.75 2.36 2.50 2.60 -3.4 -3.2 -3.0 -3.2 -3.7 -3.0Chile 4.3 4.3 4.5 2.6 3.0 3.0 4.5 4.25 5.0 525 545 550 -3.6 -3.9 -4.6 -0.8 -1.0 -1.2Colombia 4.2 4.7 4.5 1.9 2.9 3.0 3.25 4.0 5.0 1932 1,960 2,000 -3.9 -4.2 -3.3 -1.2 -1.2 -1.0Mexico 1.3 4.1 3.8 3.7 3.9 3.2 3.5 3.5 4.0 13.1 12.6 12.6 -1.2 -1.3 -1.4 -2.9 -4.1 -3.2Panama 7.5 6.3 6.5 4.1 3.5 3.2 1.1 1.1 1.2 1.0 1.0 1.0 -8.0 -7.7 -7.3 -3.7 -3.5 -3.5Peru 5 5.6 6.1 2.9 2.1 2.5 4.0 3.5 4.0 2.80 2.75 2.75 -5.4 -5.3 -3.9 0.5 -0.4 0.2Uruguay 3.5 3.5 3.8 9.1 8.1 7.5 15.0 13.0 13.0 21.5 22.8 23.5 -5.4 -2.8 -2.3 -1.4 -1.3 -0.7Venezuela 1.3 -1.7 1.5 53.0 59.4 35.3 18.9 20.1 15.3 6.3 15.0 15.0 4.3 7.4 5.2 -14.3 -8.1 -4.4

Source: Central banks, finance and economy ministries, Comptroller General's Office of the Republic of Panama, national statistics institutes, HSBC

* Average of consumer price indices from provincial statistical institutes used since 2007 for Argentina.

** For Panama, the values denote the deposit rate; for Argentina, the 1-month wholesale market rate; for Uruguay, the overnight inter-bank rate; and for Venezuela, the average lending rate informed by the Central Bank

Andre Loes Chief Economist, Latin AmericaHSBC Bank Brasil S.A. – Banco Multiplo +55 11 3371 [email protected]

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The first one is looming elections. Brazil has

general elections in October this year, while

Argentina will hold presidential elections in

2H2015. While in the Argentine case this may

seem far away, the deterioration of the economic

environment is putting pressure on the

government. This window of opportunity for

corrections provided by a year with no elections

may be used sparingly, as too much pain in the

current year could lessen electoral support down

the road.

Another limitation for deeper adjustments is

related to the short-term inflationary impact of

reducing price misalignments in these

economies. We refer to electricity prices in

Argentina, fuel in Venezuela, as well as the real

FX rate in Argentina, Brazil, Uruguay, and

Venezuela. The relative appreciation of these

currencies is illustrated by Figure C6.

Figures C6. Real Effective Exchange Rate (Dec 2004 = 100)

Source: Global Economic Monitor, HSBC estimates for Argentina

While closing these gaps can pave the way for a

significant reduction of fiscal and external

imbalances currently unfolding in some of these

countries, we believe the short term effect of these

corrections is inflationary.

Weak and uneven recovery

Latin America is finally recovering from a

bottom reached during the 2H2013. Yet, we

expect the recovery to be a mild one, with average

regional growth for 2014 forecast at 2.9%,

compared to 2.4% in 2013. Growth is also going to

remain uneven among countries, as highlighted in

the previous section, and illustrated by Table C3.

Table C3: A comparison of our growth forecasts – those published in our October LatAm quarterly report and the latest

2013f 2014f Q4 2013 Latest Q4 2013 Latest

Lat Am 2.3 ▲2.4 2.9 2.9 ARG 2.5 2.5 1.0 1.0 BRA 1.9 ▲2.2 2.2 2.2 CHI 4.5 ▼4.3 4.5 ▼ 4.3 COL 3.8 ▲4.2 4.5 ▲ 4.7 MEX 1.7 ▼1.3 4.1 4.1 PAN 7.0 ▲7.5 6.6 ▼ 6.3 PER 5.1 ▼5.0 5.6 5.6 URU 3.5 3.5 3.5 3.5 VEN 1.3 1.3 0.7 ▼-1.7

Source: HSBC forecasts

Mexico is the bright spot, with growth expected to

reach 4.1% in 2014. Regarding external

influences, all indications suggest that the US

economy is accelerating. On the domestic front,

the government has sped up policy easing in order

to encourage a cyclical recovery, the impact of

which is already showing up in recent high-

frequency activity indicators. Beyond the 50bp

rate cut applied by Banxico during H2 2013, we

note the material fiscal easing budgeted for 2014,

c1.5% of GDP. Last but not least, reforms

approved over the last 12 months will gradually

materialize into higher growth.

Colombia (4.7%) and Peru (5.6%) should also

observe a rebound in activity in 2014. This is

helped by policy easing – mostly monetary in

Colombia, mostly fiscal in Peru – as well as, in

the Peruvian case, an increase in copper

production, which starts to accelerate in 2014.

Chile is more a story of a permanent reduction of

potential GDP growth, following a weakening of

its competitiveness in the mining business at the

margin, but still with quite decent growth

(at 4.3%). The small economies of Uruguay and

– especially – Panama should still grow at

reasonable rates (3.5% and 6.5%, respectively).

80

100

120

140

160

180

200

220

Dec-04 Jan-06 Feb-07 Mar-08 Apr-09 May-10 Jun-11 Jul-12 Aug-13Argentina Portugal Russian FederationUnited States Brazil ChileColombia Mexico PeruUruguay China Germany

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When we turn to Brazil, growth should stay at the

same level of last year, at 2.2%. While

government spending may be supportive to

growth – as typically happens in electoral years –

private consumption as well as investment is

likely to grow modestly, as both business and

consumer confidence should remain subdued

ahead of October elections. In the case of

consumption, rising inflation (see next section)

represents another headwind.

The growth outlook is worse in Argentina and

Venezuela, as stronger imbalances need to be

corrected. In Argentina, pressured by the loss of

reserves, the government has been speeding up

the pace of depreciation, as well as tightening

some FX controls. The result should be a

convergence to very low growth, at 1.0% in 2014.

In Venezuela, the sheer size of imbalances is

most visible in the FX market, where the recently

observed parallel rate of VEF60/USD was a

significant premium over the official

VEF6.30/USD FX rate. The necessary

rebalancing will imply a devaluation of the

official FX rate to VEF 15.0/USD (138%), as well

as adding a larger number of activities to the

alternative SICAD USD auction mechanism1,

which would imply an even stronger depreciation.

As strong currency depreciations typically lead to

growth contractions in Venezuela, we are

forecasting -1.7% GDP for the current year.

Rising or sticky inflation in the Atlantic, lower in the Pacific

Inflation should remain low and contained in

most countries following explicit inflation

targets. Nevertheless, in Brazil and Uruguay, we

may observe relatively large headline inflation

1 See Venezuela: A weaker currency is not enough to

bridge the external and fiscal gaps, 24 December 2013

gaps – expected at 1.8% and 3.1% for the 2014

year-end, respectively. In Brazil, this will

represent an acceleration of inflation vis-à-vis

2013. Moreover, core inflation items such as

services have been among the main drivers of the

inflation dynamic in these countries.

But the inflationary problems of Brazil and

Uruguay are quite modest when compared to

the situation in Argentina and Venezuela,

where inflation is accelerating despite already-

high levels. This is specially the case in

Venezuela. The huge premium of the parallel over

the official FX rate has combined with deep

scarcities in order to generate a rapid acceleration

of inflation in 2013, as shown on Figure C7.

Figure C7. Headline CPI in LatAm high inflation countries (%)

Source: Reuters DataStream and HSBC

Tightening vs. easing

Tightening, even when easing would appear to

be needed, is the fate of countries showing an

adverse trade-off between inflation and

growth. Despite only a modest expansion of

activity, countries like Brazil and Uruguay have

been obliged to tighten monetary policy in order

to contain the escalation of inflation. Figures C8

and C9 compare the evolution of this trade-off in

two groups of Latin American countries.

In Brazil, we believe the central bank is

unlikely to extend the tightening cycle beyond

15202530354045505560

Jan-11 Sep-11 May-12 Jan-13 Sep-13

ARG VEN

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=TFuijYCdD6&n=399114.PDF

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=TFuijYCdD6&n=399114.PDF

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the end-February meeting, despite the

persistence of a relevant inflation gap.

In Uruguay – which recently changed its

monetary policy regime to one based on the

control of monetary aggregates –policy has also

turned tighter. Authorities have said that, filtered

of seasonal and irregular components, the

announced targets for monetary aggregates imply

lower money supply growth. The interbank

lending rate has generally been higher under the

new scheme than when it was the target of

monetary policy.

Table C4: Policy rates – quarterly (% p.a.)

2013 ______________ 2014 ________________ Q4 Q1f Q2f Q3f Q4f

Brazil 10.00 10.75 10.75 10.75 10.75 Chile 4.50 4.25 4.25 4.25 4.25 Colombia 3.25 3.25 3.25 3.25 4.00 Mexico 3.50 3.50 3.50 3.50 3.50 Peru 4.00 3.75 3.50 3.50 3.50 Uruguay* 15.00 14.00 13.00 13.00 13.00

Source: Central banks, Finance and Economy Ministries, National Statistics Institutes, HSBC

* for Uruguay, the overnight inter-bank rate

The mostly improving trade-off between inflation

and growth in the Pacific countries – see Figure

C9 – allow these countries to move in the opposite

direction, i.e., a more relaxed monetary policy.

While this easing trend already occurred in

Colombia and Mexico – where we believe

monetary conditions are either loose or just

adequate – in Chile and Peru we are still set to see

additional easing, as illustrated by Table C4.

In Mexico, we believe Banxico will keep the

Fondeo rate unchanged at 3.5% in 2014, owing

to the transitory nature of tax reform. We do not

expect inflation pressures coming from the

demand side as output gap will remain negative in

2014. Although we expect a temporary pick-up on

inflation during 1H14 to 4.6%, we see inflation

coming down to 3.9% at the end of the year. The

first hike should come in 1Q15, when we expect a

50bp tightening to 4.0%.

Overall, the region should stay more on the easing

side, after Brazil likely interrupts its tightening

cycle early this year.

Figure C8. Growth-inflation trade-off in the Atlantic countries (average 2009-2011 in red; average 2012-2014f in black)

Figure C9. Growth-inflation trade-off in the Pacific countries (average 2009-2011 in red; average 2012-2014f in black)

Source: Thomson Reuters Datastream, HSBC forecasts Source: Thomson Reuters Datastream, HSBC forecasts

ARG

BRA URU

VEN

05

101520253035404550

-0.5 1.0 2.5 4.0 5.5 7.0

Infla

tion

(% y

-o-y

)

GDP grow th (%)

PERCOL

CHI

MEX

PAN

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

0.0 2.0 4.0 6.0 8.0 10.0In

flatio

n (%

y-o

-y)

GDP grow th (%)

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CEEMEA is facing a difficult year in 2014

Politics are set to dominate the domestic

agenda, especially in Turkey, South Africa,

and Ukraine

The external backdrop continues to pose

challenges for those economies dependent

on foreign financing

Politics, politics everywhere

Politics and election outcomes will help to

define the fortunes of a number of CEEMEA

countries in 2014. These developments will be

particularly crucial in Turkey, South Africa, and

Ukraine, all of which have large current account

deficits and have been under market pressure. On

the next page, we list the crowded election cycle

faced by the region over the 2014-2015 period,

and which come amid a backdrop of slow growth.

Rising political uncertainty is probably the last

thing that EM investors would like to deal with

as the external liquidity backdrop remains

challenging following the US Fed’s tapering

decision in December. We are fairly cautious

when it comes to growth momentum and

normalization of monetary policy in the

developed economies. However, the external

financing conditions are tightening for economies

dependent on foreign savings such as Turkey,

South Africa, and Ukraine. As such, political

complications could raise the risk premium

further and keep local markets under pressure.

CEEMEA in 2014

Table C5. CEEMEA - Key forecasts

______ GDP _______ _____ Inflation ______ ____ Policy rate _____ _______ FX _________ Current accnt (% GDP) Fiscal accnt (% GDP) 2013e 2014f 2015f 2013e 2014f 2015f 2013e 2014f 2015f 2013e 2014f 2015f 2013e 2014f 2015f 2013e 2014f 2015f

Belarus 1.0 2.0 3.0 18.5 15.7 16.5 23.50 15.00 20.00 9,510 10,500 11,000 -8.7 -7.8 -3.3 -0.5 -1.0 0.5Czech Rep.1 -1.4 1.9 1.7 1.4 1.1 2.4 0.05 0.05 0.05 27.0 27.0 26.0 -1.1 -0.5 -0.9 -2.5 -2.9 -3.0Estonia2 1.5 2.5 3.0 3.2 2.8 2.5 0.25 0.25 0.25 1.38 1.28 1.25 -0.5 0.5 0.5 -0.2 -0.5 -0.5Hungary1 1.0 2.1 1.6 1.7 1.3 3.0 3.00 2.75 3.50 300 290 290 3.1 2.4 2.4 -2.4 -3.0 -2.9Israel 3.3 3.3 3.4 1.6 1.6 2.2 1.00 1.25 1.75 3.60 3.50 3.50 1.4 2.0 2.1 -3.1 -2.8 -2.5Kazakhstan 6.0 6.2 7.0 5.8 4.9 5.5 5.00 5.00 5.00 159 160 162 -1.7 -2.1 -2.3 -2.8 -1.8 -1.8Latvia3 4.0 4.0 4.0 0.0 1.2 2.0 0.25 0.25 0.25 1.38 1.28 1.25 -1.5 -2.0 -2.5 -1.5 -1.0 -1.0Lithuania3 3.0 3.5 4.0 1.0 1.1 2.0 0.75 0.25 0.25 2.50 2.78 1.25 -0.5 -1.0 -1.5 -3.0 -2.5 -2.0Nigeria 6.6 7.0 6.2 8.0 8.7 9.5 12.00 12.00 12.00 160 159 162 6.9 5.7 4.3 -2.8 -2.4 -3.2Poland1 1.4 3.0 3.3 1.0 1.8 2.2 2.50 2.50 3.25 4.2 3.9 3.9 -1.5 -1.6 -2.5 -4.4 4.6 -3.0Romania1 2.8 2.4 2.4 4.0 1.8 2.9 4.00 3.75 4.25 4.5 4.3 4.3 -0.6 -0.9 -1.2 -2.5 -2.2 -1.8Russia 1.5 2.0 2.0 6.8 5.8 4.8 5.50 5.25 5.00 32.9 35.2 37.3 1.6 1.5 1.4 0.0 0.7 -0.3Serbia1 2.2 1.0 2.0 7.9 4.1 4.8 9.50 8.50 8.50 115 120 125 -4.6 -3.7 -4.1 -5.6 -5.5 -5.0South Africa 1.8 2.6 3.1 5.8 5.7 5.5 5.00 5.00 5.50 10.6 10.4 10.0 -6.1 -6.0 -5.7 -4.2 -4.3 -4.3Turkey 3.9 2.2 4.1 7.5 7.4 6.8 7.75 9.50 8.50 2.2 2.1 2.0 -7.3 -6.3 -6.5 -1.2 -2.2 -2.2Ukraine -1.0 0.0 -3.5 -0.3 2.1 9.2 7.50 7.00 7.00 8.3 8.9 11.0 -9.2 -8.7 -1.6 -5.0 -4.9 -1.8

1 FX forecasts vs. EUR

2 EUR and ECB policy rate forecasts

3 Latvia switched to the euro on 1 January 2014, EUR FX rate and ECB policy rate forecast from 2014; In our baseline scenario Lithuania switches to the euro on 1 January 2015, EUR and ECB policy rate forecast from 2015

Source: HSBC

Dr. Murat Ulgen Chief Economist, Central & Eastern Europe and Sub-Saharan Africa HSBC Bank plc+44 20 7991 [email protected]

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Growth still too slow for comfort

In line with our eurozone and global economic

outlook, GDP growth will likely accelerate across

Central & Eastern Europe (CEE) in 2014, but

the recovery is too slow for comfort. We estimate

narrowing, but not complete closures, of the

negative output gaps across the CEE in the next

couple of years. The spill over from weak growth

momentum in the eurozone, as we foresee in 2015,

will likely lead to stabilization and in some cases

even a correction lower of GDP growth next year

after an expected improvement in 2014.

The 2012-13 growth slowdown in CEE was down

to two factors: slower exports growth and fiscal

austerity. From 2014 on, less-to-no austerity will

mean better growth. Exports have already picked up

Table C6. CEEMEA faces a crowded election cycle over 2014-15 period

Greece Greece will closely follow the European Parliament elections in May. A strong showing by Eurosceptic parties could fuel domestic political unrest and lead, in an extreme scenario, to snap elections if the ruling coalition – struggling already with a very slim majority – were to face further departures or lose a potential “no confidence motion”. Needless to say, any renewed political disturbance in Greece could rekindle worries about the future of its troika programme and the integrity of the eurozone, as in 2012.

European Parliament

The elections for the European Parliament will be held in all member states of the European Union (EU) between 22 and 25 May 2014, as decided unanimously by the council of the European Union. It will be the eighth Europe-wide election since the first direct elections in 1979. Elections for the 751 Members of Parliament take place every five years.

Hungary Hungary will hold regular parliamentary elections in Q2 2014. Latest opinion polls show Fidesz as a clear leader in the election race. It could win a 50% majority but it is unlikely to repeat the 2010 success of securing a two-thirds majority based on the polls. There are a large percentage of voters that remain undecided or unwilling to vote (over 40%). The government’s policies towards the banking sector will be at the heart of election campaigning.

Latvia The next parliamentary elections in Latvia are scheduled for October 2014. With a year of elections ahead, the November Riga supermarket tragedy is likely to be a central focus of political campaigning. The position of the current center-right coalition (‘Unity’, ‘National Alliance’ and the ‘Reform Party’) is shaky following the tragedy, with former Prime Minister Valdis Dombrovskis taking political responsibility and resigning shortly after. The pro-Russian Harmony Centre (the largest party in the Parliament, yet not in the coalition) may gain popularity from anti-austerity circles after Latvia’s experience during the global crisis.

Nigeria In Nigeria, investors will first focus on the replacement of the successful Central Bank of Nigeria Governor, Lamido Sanusi, when his term expires in June. Governor Sanusi overhauled the banking system in 2008-09 and managed to break the back of inflation, bringing it persistently to single digit after a long period of prudent monetary policy. Nigeria will also go to the polls in early 2015 to elect its next president. The incumbent President Jonathan appears to be willing to run again, which has stirred unrest within his ruling People’s Democratic Party (PDP). According to an unwritten rule, the presidency rotates two terms between the predominantly Muslim North and largely Christian South of the county. President Jonathan hails from the South. He won elections in April 2011, but actually took office after the demise of the then President Umaru Yar’Adua from the North when he was the Deputy President.

Poland In Poland, the ruling Civic Platform (PO) and the Polish People's Party (PSL) will have been in power for eight years by the time of Q4 2015 elections. Prime Minister Donald Tusk was the first one to be re-elected in 2011 for a second term in the post-1989 history. But the popularity of the government has waned since the 2011 elections. Since Q2 2013 the Civic Platform has been lagging in public opinion polls behind the opposition Law and Justice (PiS) party.

Romania The cohabitation pact between the two rivals, the ruling Social Liberal Union (USL) and President Traian Besescu, is likely to be tested during this election campaign, the first time since an impeachment referendum for the president tabled by the government in summer 2012. Opinion polls in December show PM Ponta as the second-most trusted statesman behind National Bank of Romania (NBR) Governor Isarescu and ahead of the current president Basescu with Crin Antonescu only in the fourth place.

South Africa South Africa will hold its fifth democratic elections between April and July 2014. The ruling African National Congress (ANC) won almost 66% of the vote in the previous 2009 elections and is widely expected to retain a large majority given its considerable support base, according to the latest opinion polls. Hence, the incumbent President Jacob Zuma is expected to return for a second five-year term following his re-election as ANC’s leader (president) in the December 2012 party caucus. However, based on the polls again, the size of the ANC’s majority could narrow as a result of the weak performance of the economy, high levels of unemployment (especially youth), poverty and inequality, service delivery failures and rising perceptions of corruption. These are likely to be the focal issues for the election.

Serbia Regular parliamentary elections are not due before 2016 but there is a heightened risk of early elections. Both Deputy PM Aleksandar Vucic and PM Ivica Dacic have publicly contemplated such a solution. According to opinion polls, the Serbian Progressive Party (SNS) led by Vucic could win a majority if early elections were to be held. In contrast, SNS’s current coalition partner, the Socialist Party of Serbia (SPS), led by PM Ivica Dacic, scores poorly in the opinion polls. Early elections could be positive if they were to result in a single party, and thus more stable, government with a strong mandate for reform. The current uncertainty is negative though and could weigh on progress of the planned reforms. The government plans to speed up privatisation, reform the bankruptcy law and the public enterprises law but these are likely to trigger significant lay-offs.

Turkey Turkey will have three elections within the next 15 months. Municipal elections will take place on 30 March 2014. President Gul’s term will end on 28 August 2014, which means that presidential elections must be held sometime in the 60 days before then. Finally, general elections are scheduled for June 2015. There is considerable uncertainty regarding the outcome of the election cycle because of two reasons: 1) the ongoing investigation into alleged corruption, which appears to involve people with close ties to the current government and has already led to a major Cabinet reshuffle; and 2) whether Prime Minister Erdogan chooses to run for President in 2014, which could impact both the timing and the results of general elections in 2015.

Ukraine The first round of the next Ukrainian presidential elections is scheduled for 26 February 2015. Currently none of the potential candidates is likely to obtain anabsolute majority in the first round. Therefore, it is likely the incumbent President Victor Yanukovych and one of Ukraine’s three main opposition leaders will contest a run-off second ballot. Recent public opinion polls give the incumbent president very little chance of success in the second election round. At this point, Vitaly Klychko, the leader of UDAR (the ‘Punch’) party, and leaders of the Batkivschina (‘Fatherland’) party appear to have a higher chance of winning the presidential elections.

Source: HSBC, national sources

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towards the end of 2013 -as the region is

piggybacking on the eurozone recovery- and should

continue to expand in 2014. After that, growth rates

will, at best, consolidate in 2015. The relatively

muted recovery, compared to the size of negative

output gaps, will keep inflation within targets.

In Turkey, we have revised down our 2014

growth forecast to 2.2% from 3.1% on the back

of rising political uncertainty and tighter

external/domestic financial conditions. In South

Africa, we expect some gradual improvement in

growth this year to 2.6% from an estimated 1.8%

as the sharply weaker currency should support

exports at a time when the key export markets are

also doing better. Russia is stuck with a paltry

2.0% growth pace. Both the cyclical and structural

story looks weak.

Inflation broadly in check

End-2013 inflation was particularly low on

one-off factors like energy price cuts in Hungary,

a reduction in the communication tariff in Poland,

lower food prices in Romania, and fuel prices

deflation across CEE. As these impacts fade

throughout 2014, inflation is likely to start

climbing higher, though without breaching central

bank targets.

One potential exception is Romania. Inflation risks

are more unpredictable here given the high share of

food in the consumption basket (c37%). Also, we

forecast that the output gap will close at the fastest

pace in Romania. We also see heightened inflation

risks in Hungary. Here, historically, inflation

expectations have not been strongly anchored and

the growth recovery last year and in 2014 rests on

stimulus for domestic demand.

In Russia, thanks to weak activity and prudent

monetary policy, inflation is broadly in check.

Central Bank of Russia (CBR) moves ahead with

its plans of inflation targeting and complete

liberalization of exchange rate by end-2014.

The fragile or shaky part of our universe, in

particular Turkey and South Africa, have both

embraced sharp currency weakness throughout

last year. The depreciation of the real effective

exchange rate (REER) was larger in South Africa

due to its relatively lower inflation (Figure C10).

In Turkey, we revised up our 2014 average

inflation forecast to 7.4% from 6.6% due to the

currency pass-through from the weaker Lira,

sizable tax and excise increases in January as well

as expected hikes in electricity and natural gas

tariffs after sharp rise in in the cost base of

the utilities.

Figure C10. Sharp adjustment lower in TRY and ZAR Figure C11. Turkey’s high inflation blunts the sharp rate rise

85

90

95

100

105

85

90

95

100

105

Jan-13 Mar-13 May-13 Jul-13 Sep-13

Real effective exchange rates

HUF TRY PLN ZAR

Jan 13=100 Jan 13=100

-300

-200

-100

0

100

200

300

-300

-200

-100

0

100

200

300

Jan-13 Mar-13 May-13 Jul-13 Sep-13

Real interest rate based on short rates

Hungary Poland

Turkey South Africa

bp bp

Source: HSBC, Bloomberg Source: HSBC, Bloomberg

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Similarly, despite a much sharper increase in the

short-end money market rates in Turkey

compared to South, the rise in Turkish inflation

from 6.2% at end-2012 to 7.4% in December

2013 (with a peak of 8.8% in July) sort of blunts

the increase in real interest rates (Figure C11).

South Africa’s inflation was contained in a

narrower range throughout 2013. As a matter of

fact, it fell from 5.7% in December 2012 to 5.3%

in November 2013.

Diverging policy measures In CEE, inflation within central bank target

ranges should support policy interest rates that

are lower for longer and we do not except a turn

to policy tightening before 2015. Romania is the

exception, and we expect the NBR to start

tightening very loose liquidity conditions in H2

2014 but via open market operations, while policy

rate hikes will likely be added only in 2015.

Economies with large external deficits also tend to

have a poor competitive position (Figure C12).

However, it would be unrealistic to expect

sweeping and unpopular structural reforms in the

midst of an election cycle. Hence, countries with a

need for further macroeconomic rebalancing will

likely leave it to market forces unless

policymakers choose to take other steps on

monetary, fiscal, and macro-prudential measures.

In Turkey’s case, we continue to argue for

higher real interest rates, while our FX Strategy

team has actually revised weaker its Lira forecasts

for two reasons; 1) the emergence of substantive

political risk not only in the short term but also in

the long term and 2) The lack of immediate

response by the Central Bank of Turkey (CBRT).

In the case of South Africa, we do not see the

need for higher rates this year and expect the

currency to be the adjustment mechanism. But

this would not remove the need for a major

overhaul of the labor market that again is difficult

to foresee in an election year. Similarly, continued

hefty public sector investments will unlikely slow

sharply when political sensitivities are high. As

such, the rebalancing will likely take long, leaving

the wide current account deficit narrowing only

gradually. In a similar manner, our FX Strategy

team has revised its Rand forecasts weaker, too.

The case with Ukraine is more interesting given

Russia’s helping hand in the near-term that may

help the country muddle-through this year. The

risk is that Russian funds could be used for social

spending in Ukraine ahead of 2015 presidential

elections, leaving the country’s debt problem

unresolved. Similarly, the presidential elections

will probably keep delaying what is necessary for

macroeconomic stability, at the very least

currency reform (a more flexible exchange rate)

and a fiscal overhaul including the finances of

public sector companies.

In sum, politics is set to trump economics.

Figure C12. ULC-based REER is a comprehensive indicator of competitiveness

60

80

100

120

140

60

80

100

120

140

03 04 05 06 07 08 09 10 11 12 13

ULC-based REER

South Africa TurkeyHungary RomaniaPoland Czech Rep

Index, 2007Q1=100Index, 2007Q1=100

Source: HSBC estimates, national sources

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2014 looks set to be another good year for

MENA's oil exporters…

… most of which retain the means and the

motive to stimulate growth through

expansionary oil-funded spending

For the Arab Spring states, we still see

recovery as a 2015 story, not a 2014 one

Another year of contrasts

2014 will see a continuation of 2013’s trends for

the MENA region, with the contrast in

performance between the oil exporters and oil

importers remaining stark. Oil-funded

expansionary spending in the Gulf will continue

to feed through to solid rates of growth, while the

region remains, on aggregate, one of fiscal and

current account surplus.

In the non-oil exporting parts of the region,

2014 performance is likely to be an

improvement on 2013, but growth rates will

remain below potential, and below pre-Arab

Spring trend rates. Much will depend on political

progress, particularly for post-revolution Egypt

and Tunisia, while severe political turmoil will

stand in the way of growth for Libya, Syria, Iraq

and, to a lesser extent, Lebanon.

Still spending its way up

We are forecasting a solid aggregate growth

rate of 4.0% in 2014 for the MENA region,

driven by the oil-rich Gulf Cooperation Council

(GCC) region, which will grow by 4.4%. The top

performers in this group over the last few years

have been Saudi Arabia and Qatar, which have

seen strong non-oil sector expansion driven by

energy-fuelled spending. Both have the ability to

The Middle East and North Africa in 2014

Table C7. MENA – Key forecasts

______ GDP _______ _____ Inflation ______ ____ Policy rate _____ _______ FX _________ Current accnt (% GDP) Fiscal accnt (% GDP) 2013e 2014f 2015f 2013e 2014f 2015f 2013e 2014f 2015f 2013e 2014f 2015f 2013e 2014f 2015f 2013e 2014f 2015f

Algeria 2.7 2.7 1.1 3.0 2.5 2.5 4.00 4.00 4.00 77.3 78.3 78.7 3.6 0.8 -2.2 -3.4 -4.9 -6.5Bahrain 3.5 2.8 2.3 3.5 3.0 3.0 2.25 2.25 2.25 0.4 0.4 0.4 11.0 9.6 8.5 -2.5 -4.6 -5.4Egypt1 2.2 2.6 4.2 10.3 8.6 8.6 9.75 8.25 8.25 7.0 7.0 7.4 -2.1 -1.8 -2.3 -13.9 -12.4 -11.6Iraq 6.7 6.9 5.3 3.0 3.5 4.5 5.50 5.50 5.50 1165 1165 1165 13.8 11.3 9.5 3.7 1.4 -0.7Jordan 3.0 3.3 3.2 6.8 6.5 6.0 4.50 4.25 4.25 0.7 0.7 0.7 -20.1 -19.8 -18.9 -11.7 -10.8 -10.3Kuwait 3.7 3.1 3.1 1.8 4.0 4.4 2.00 2.00 2.00 0.3 0.3 0.3 58.9 56.5 54.9 26.3 24.0 19.8Lebanon 0.1 1.3 2.5 1.0 1.7 3.0 10.00 10.00 10.00 1508 1508 1508 -23.6 -22.9 -22.9 -9.1 -9.8 -10.1Morocco 2.8 3.6 4.1 1.0 3.0 3.5 3.00 3.00 3.00 8.2 8.6 8.9 -12.1 -10.8 -10.3 -6.4 -5.6 -4.3Oman 4.8 4.0 3.4 0.5 3.0 3.0 1.00 1.00 1.00 0.4 0.4 0.4 12.9 9.8 7.7 14.4 10.1 7.9Pakistan1 3.6 2.5 3.1 9.2 12.0 12.0 9.00 10.50 10.50 99.5 110.0 114.0 -2.8 -3.3 -3.9 -8.9 -8.3 -8.0Qatar 6.5 6.5 6.4 3.0 5.6 6.4 0.75 0.75 0.75 3.6 3.6 3.6 28.8 21.7 16.0 10.8 9.4 6.7KSA 3.8 4.0 3.9 3.3 5.0 5.4 0.25 0.25 0.25 3.7 3.7 3.7 18.7 13.1 8.4 7.2 4.1 2.0Tunisia 3.1 4.0 4.8 6.0 4.5 4.8 4.00 4.00 4.50 1.5 1.6 1.6 -10.6 -9.6 -6.6 -7.9 -7.7 -6.4UAE 4.5 5.0 5.1 1.6 4.5 6.5 1.00 1.00 1.00 3.7 3.7 3.7 13.7 6.3 1.4 10.8 6.4 3.1

Source: HSBC

Simon Williams Chief Economist, MENAHSBC Bank Middle East Limited+9714 423 [email protected]

Liz Martins Senior EconomistHSBC Bank Middle East Limited+9714 423 [email protected]

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maintain fiscal stimulus, with oil and gas revenues

at record levels. Both also have the motive to keep

this spending going, even in the event of a dip in

energy prices: Saudi Arabia’s need to address

demographic challenges and Qatar’s commitment

to hosting the 2022 World Cup will both ensure

broad policy continuity for 2014. We see Qatar at

the top of the table (6.5%) while we forecast

Saudi Arabia’s economy will expand by 4.0%.

Moving up the rankings in 2014, however, is the

UAE, which will see the second highest rate of

growth in the GCC this year, building on the 2013

recovery we highlighted in last year’s outlook.

The UAE’s growth story is different to those of its

neighbours. Driven by neither fiscal stimulus nor

bank lending – which is only now beginning to

recover – it relies instead on external and

domestic demand for, primarily, the services-

orientated economy of Dubai. This is supported

by a lack of real competition – Dubai’s

infrastructure, business and leisure environment is

unrivalled in the Middle East – and its status as

“safe haven” in the region. Dubai’s consistent

stability has made it the beneficiary of capital that

has been withdrawn from other, more turbulent

markets. This has fed through to a very strong

pick-up in real estate and construction, which we

see continuing through 2014.

At the bottom of the table, Bahrain and Kuwait

will continue to be held back by politics. In

Bahrain’s case, ongoing instability and sporadic

violence – as well as much lower oil revenues

Figure C13. The GCC will continue to outperform its oil importers by some margin in 2014…

Figure C14. … with the UAE and Qatar being the outperformers for 2014

Source: National statistics authorities, HSBC forecasts Source: National statistics authorities, HSBC forecasts

Figure C15. MENA’s non-oil states will continue to underperform relative to GCC counterparts

Figure C16. Project spending is a growth driver across the GCC

Source: HSBC Forecasts Source: MEED Projects

0

2

4

6

8

2010 2011 2012 2013e 2014f

Real GDP growth (% )

Non oil producers GCC MENA

0

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4

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6

7

Algeria Bahrain Kuwait SaudiArabia

Oman GCC UAE Qatar

Real GDP growth (%), 2014

0.00.51.01.52.02.53.03.54.04.5

Lebanon Egypt1 Non-oilaggregate

Jordan Morocco Tunisia

Real GDP growth (%), 2014

0

200

400

600

800

1000

1200

Bahrain Oman Kuwait Qatar UAE Saudi

Projects planned or underw ay (USDbn)

Oct-11 Oct-12 Oct-13

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than its neighbours – will weigh on growth, as it

has for the last three years. In Kuwait, it is not a

lack of cash, but a lack of policymaking

dynamism, which is holding back growth and

investment. We see little indication at this stage

that this will change in 2014.

For MENA’s non-oil states, growth will

continue to be constrained by political risk. The

biggest economy in this group, Egypt, will see

better growth this year – we are forecasting 3% on

average over 2013/14, which includes the

turbulent last six months of 2013, rising to 4.2%

for 2014/15. However, the growth comes from a

very low base.

Outside of Egypt, Tunisia is something of a

bright spot – we forecast growth of 4.0%, on the

back of apparent political progress – and

Morocco should also have a better year.

However, with the Syria conflict looking no

closer to a resolution than at the beginning of

2014 than it was at the beginning of 2013,

regional political risk will weigh heavily on

Lebanon and Jordan. Both will continue to

suffer from declining tourist arrivals, low

consumer confidence, and flat or

contracting investment.

Inflation risks rising in GCC

We think inflation will finally start to pick up

in the GCC, following some years in which this

has been contained – indeed has surprised on the

low side. Most at risk, in our view, are the UAE –

already seeing double-digit rental price growth –

Saudi Arabia, and Qatar. All are seeing strong

domestic demand conditions, loose fiscal policy

and robust population and credit growth.

Outside of the Gulf, Egypt is most at risk of

inflation. Apart from a severe lack of hard

currency, which restricts imports, potential for

further EGP depreciation, especially on the

parallel market, will weigh on prices. Traditional

supply side bottlenecks, particularly in the food

and drink segment, will also be exacerbated by the

ongoing political instability and weak activity

levels. Risks to our 9% y-o-y forecast for end-year

CPI are to the upside. Elsewhere, weak activity

and credit growth will keep pressures more or less

subdued, although any subsidy reform (see below)

poses upside risk.

Subsidy spending key

Perhaps the single biggest economic policy

issue for MENA as a whole in 2014 will be that

of subsidies. The region spends more on energy

subsidies than any other – nearly USD250bn in

2011, according to the IMF. The degree to which

Figure C17. The issue of subsidies will be on the table in 2014…

Figure C18. …. particularly for those states running big budget deficits

Source: IMF Source: National statistical authorities, HSBC forecasts

0

50

100

150

200

250

MENA EmergingAsia

CIS, CEE Lat Am Sub-Sahara

Advancedecon

Energy subsidies (2011 USD, bn)

-16-14-12-10-8-6-4-20

2006

2007

2008

2009

2010

2011

2012

2013e

2014f

Egypt Tunisia

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governments can afford this high level of

spending, however, varies significantly.

For the big deficit countries the policy is

clearly unsustainable – Egypt (14% of GDP),

Jordan (11%), Lebanon (9%), Morocco (8%) and

Tunisia (8%). Jordan, Morocco, and Tunisia have

IMF programmes to abide by, and the former two

have already begun steps to raise domestic

energy prices.

In the middle of the table are the less wealthy

of the oil exporters: Algeria and Bahrain are

already running fiscal deficits, while Iraq, Oman,

and Saudi Arabia are heading that way (though

not, according to our projections, in 2014). For

these states, subsidy reform may well be an

increasingly prominent issue over 2014. The

Bahraini and Omani governments have already

hinted that they are considering reforms.

Beyond the issue of subsidies, we see challenges

for UAE policymakers in particular, not to

generate growth, but to manage its pace. We have

already seen some evidence of this, with macro-

prudential measures targeting the real estate and

banking sectors emerging over the last year or so,

in a bid to prevent a credit bubble.

FX policies to stay stable

Nearly all MENA currencies manage their FX

to some degree. We expect the currency pegs

operated by the Gulf to sustain, backed by a long

historical track record, sizeable current account

surpluses (18% of GDP on aggregate in 2014) and

large net external asset positions.

The next category is that of the currency pegs

with less solid external positions to support them.

These are either straight USD (Jordan and

Lebanon), or euro-heavy basket pegs (Morocco

and Tunisia). Although these arrangements have

been subject to varying degrees of pressure in

recent years, we have no immediate concerns

about their viability for now.

The Egyptian pound is still subject to heavy

capital and exchange rate controls, following

the severe deterioration of financial conditions in

the aftermath of the 2011 revolution. We think the

central bank will continue to manage the

currency, perhaps allowing some mild

depreciation, but leaving restrictions in place at

least until the completion of the political transition

and election process. With ongoing political

uncertainty and still heavy external pressures,

though, the risk to this outlook is that of a bigger

and less orderly decline in EGP.

Figure C19. For Egypt, the political turmoil of recent years has taken a heavy toll on the economy

Source: Markit Economics

Jul-11

Sep-11

Nov-11

Jan-12

Mar-12

May-12

Jul-12

Sep-12

Nov-12

Jan-13

Mar-13

May-13

Jul-13

Sep-13

Nov-13

PMI Index Output New Orders Employment

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Multi-asset strategy summary

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cTable D1: Summary of HSBC fixed income, FX, and equity views

Country External debt Local market debt and rates FX Equities

Argentina Neutral Negative Short vs. USD Overweight LatAm equities in 2014 Despite renewed optimism on the back of increased

hopes for political change in 2015 and the fact that a default no longer seems inevitable, we believe Argentina EXD has reached lofty levels and may correct, albeit on low volume, as we’ve seen just recently. Longer-term, we remain neutral as high carry offsets limited room for price appreciation, in our view.

Highly negative real rates as well as restrictions for foreigners in accessing non-USD-denominated bonds makes local-currency bonds unattractive, in our view. On the USD curve, however, we like Bonar ‘17s, as the bonds trade at a significant pickup (more than 300bp) over Boden ‘15s.

We revise our ARS forecasts for 2014 to 8.50/USD (from 7.8/USD) and for 2015 to 11.00/USD (from 9.0/USD). This implies an annual devaluation of 30%. We see the authorities targeting a stable real effective exchange rate but do not anticipate an FX or balance of payments crisis. Key risks are the possibility that the government may move towards a multiple FX regime and that FX reserves fall to worrisome levels.

Off-benchmark Overweight with 60% upside back to 5- year historic peak multiples. We see significant political optionality, with two years remaining under the current administration, and the equity markets being supported by the negative real rate and weaker FX environment. The market performed the best in LatAm in 2013.

Brazil Underweight Buy Brazil 5y CDS, Sell Mexico 5y CDS Receive Receive Jan ’15 DI Neutral Neutral LatAm equities in 2014

We remain underweight, as we see the balance of risks tilted towards the downside, since low growth and persistently high inflation may lead to more fiscal slippage. A one-notch downgrade appears priced in, but a negative outlook is not. We remain buyers of 5Y CDS protection in Brazil versus Mexico, and stay long Pemex ’19s vs short Brazil ‘19Ns.

Despite double digit yields, expected returns melt to the low-single digits in USD terms. Considering the likely persistence of high volatility this may not be too attractive, especially since fiscal and downgrade concerns remain. Receiving the front end, which is pricing in excessive monetary tightening, has better risk/reward than the long end, in our view.

We see the pace of depreciation in the BRL slowing down and are targeting a 2.50/USD rate for end-2014. We are less bearish on the BRL based on: a) the BRL’s overvaluation having largely corrected, b) a reduction in the current account deficit, c) the BCB’s continued intervention, d) higher yields, and e) more incentive to maintain a stable BRL in an election year. Fiscal slippage and ratings cuts are the key risks.

We are Neutral on Brazil. Current aggregate valuations are not cheap, earnings uncertainty is high and the political calendar heavy. We are OW global cyclicals, as global environment is positive (cheaper valuations, recovering DM, China growth, good commodity prices and outlook for a weaker BRL) and underweight domestic stocks (on high valuations; well-owned, and sluggish GDP growth).

Czech Rep. Neutral Neutral Neutral Neutral

Czech plans to partly fund EUR3bn of redemptions with Eurobond issuance of medium and long-term maturity in 2014. Whilst the strategy points to negative net issuance, Czech credit spreads will largely take their lead from eurozone sovereigns and we stay side-lined.

The supply side issuance of CZGBs is projected to rise in both gross and net terms with the largest increases coming at maturities exceeding 10 years. However given that debt and foreign positioning remain low in Czech, and rates are likely to outperform in an environment of Fed tapering and ECB dovishness, we believe that it is premature to turn negative on the curve.

At the beginning of November, the Czech central bank announced that it will intervene in the FX market to prevent EUR-CZK falling significantly below 27.00. It has been a success so far. The CNB’s communication seems to have convinced the market that the policy will be maintained for an extended period of time. Our macroeconomic scenario is consistent with the CNB maintaining EUR-CZK target at 27.00 for the whole 2014.

Macroeconomic conditions appear to be stabilising, but questions about sustainability remain. The equity market does not look very attractive, either. Although the market is under-owned (in relation both to other markets and its own history), we see few bottom-up opportunities. We stay neutral.

Chile Neutral Short vs MXN Buy MXN vs CLP 3m NDF Underweight LatAm equities in 2014

We remain less pessimistic than most on the back of the HSBC view of higher copper prices for 2014 and the growth recovery in China. A weaker currency should also help to improve terms of trade. Further marginal easing of monetary policy is expected, but not beyond what the market is already pricing in for 2014. We prefer being neutral duration and see limited value in inflation break-evens given their levels.

We have moved our end-2014 forecast for USD-CLP up to 545 from 510, previously. We have become less constructive on the CLP based on: a) lower copper prices and weaker terms of trade, b) tighter interest rate differentials, and c) political risks associated with possible tax changes under the new administration. A key factor will be the movement of copper prices. We like to hold short CLP positions vs the MXN.

We are underweight Chile, on negatives - multiple de-rating bear case continues, rising tax rates, increased market volatility, lower potential GDP growth, less pension fund support, lower cost of capital differentiation, and increased ex-Chile earnings. On positive side, central bank is easing rates and we are bullish on China and copper relative to consensus.

China Neutral Pay Pay CNY 1y NDIRS Long vs USD; Pay 1y2y USD CNH FX forward pts Underweight

In 2014, we will be watching for the implementation of economic reforms proposed at the Third Plenum. Nurturing private sector business development by reducing government intervention in the economy will be crucial. The economy would benefit from capacity reduction in various industries. On the monetary side, rapid debt-dependent growth must be kept in check to ensure financial sector stability.

Funding conditions have eased recently with the 7-day repo rate falling from 8.84% on 23 December to 4.04% on 14 January. Banks’ demand for funds is likely to rise in the 2H of January due to the seasonal tax payments and the Lunar New Year. Paying 1y NDIRS thus makes sense. Also, SHIBOR-based floating-rate CD issuance should surface this year, putting an upward pressure on the SHIBOR curve. We thus recommend paying SHIBOR-repo 5y IRS spread.

We see USD-CNY ending 2014 at 5.98. Inflow that supports the RMB should remain stubbornly strong, helped by interest rate liberalization and an increasing policy willingness to adapt to market forces. We trust bold FX reforms are needed to lower the one-sided appreciation pressures on the CNY and create greater RMB volatility. RMB internationalisation will accelerate in 2014, suggesting the path towards currency convertibility will quicken too.

We downgrade China to underweight. The reforms announced at the third plenum late last year were warmly welcomed by the market, but we don’t see any immediate growth catalyst as earnings visibility remain limited. Valuations ex-financial sector look expensive.

Source: HSBC

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=xuzMX0iDGL&n=394265.PDF

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=h7aDUd0CSE&n=398387.PDF



https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=E3K8q1yP6D&n=400761.PDF


https://www.research.hsbc.com/R/20/wNkpQ0x

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=vgpB32gZlV&n=399969.PDF

hhttps://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=V6ICtnWclm&n=400693.PDF

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cTable D1: Summary of HSBC fixed income, FX, and equity views


Colombia Overweight Buy Colombia ‘24s vs Peru ’25s Receive Receive 1y IBR Neutral Underweight LatAm equities in 2014 Colombia’s spreads look cheap compared to some of

its peers. We remain overweight Colombia and expect global bonds in Colombia to outperform some of its peers, as is already reflected in the CDS market. Strong fundamentals and relatively wide spreads support our view. We suggest buying Colombia ‘24s and selling Peru ‘25s.

Colombia’s local curve remains very steep, offering attractive carry and roll-down. The government will continue its efforts to increase foreign participation to 20%-25% from currently 7%. GDNs may be created targeted at foreign investors. We see value in receiving the front-end (1y IBR swaps), which can further benefit from a de-pricing of a steep implied hiking cycle.

We see a fairly balanced outlook for the COP in 2014 and are targeting 1960/USD by end-2014. While oil production has stopped rising and the current account has yet to show signs of contracting, on the capital account side both FDI and portfolio inflows continue to surprise on the upside. The latter in particular could receive another boost in 2014 with the launch of GDNs for Colombian bonds.

Colombia has been the most resilient market in LatAm in terms of earnings revision and price performance. The strong domestic investor base and uncorrelated returns make it a defensive place for investors to hide. We are underweight given the lack of attractively valued and liquid local equities, and some tail risks into the 2014 Presidential election. Valuations remain high for the small number of relevant equities.

Egypt Neutral Neutral Neutral Overweight

Yields on Egyptian bonds have trended steadily down since the ouster of President Morsi in July 2013 and subsequent receipt of around UD10bn in foreign aid flows. Bonds also found further support from an S&P upgrade in November 2013 (to B-). Against a backdrop of still weak public finances and ongoing political uncertainty, we see only limited scope for further upside.

The CBE cut rates by 50bp in December – the third consecutive cut since the removal of former President Morsi in July 2013. In conjunction with an uptick in inflation, this has taken real yields on Egyptian paper into negative territory, even without accounting for (highly possible) currency depreciation. As such, we see no value in the paper at this time.

While EGP is clearly more stable going into 2014 than it was going into 2013, we stay neutral on the EGP, with risks weighted to the downside. We do not see the central bank loosening its tight management of the currency before the completion of elections, but it may allow some further gentle depreciation. Still large backlogs of demand for US suggest downside pressures when controls are removed.

Political transition and clarification are the keys to future market performance. The ongoing restoration of political order is likely to release pent-up demand for both corporate and personal sector spending, which should increase confidence in current earnings projections and more than likely lead to earnings upgrades. In our view, it is worth staying overweight Egypt despite currency repatriation delays.

GCC Overweight Neutral Off-benchmark

GCC bonds still offer relatively good risk/reward profiles, with yields standing favourably with EM peers. Qatar and Abu Dhabi are well-placed due to their fiscal and current account surpluses and ample savings pools. Dubai and Bahrain are weaker due to limited oil revenues. After the recent rally that took Dubai's CDS to below 200bps, its lowest level since 2008, further gains may be limited.

We expect no change to the GCC's USD-pegged currencies, which are supported by strong current account surpluses and ample reserves. With inflation pressures low, there should be little discussion of a policy shift.

We can see particular reasons to be more cautious. Part of our reticence is down to valuation: after a very strong relative performance, there is simply much less valuation support than at the beginning of this year. Positive on Saudi Arabia and Oman, neutral on UAE, negative on Kuwait and Qatar.

Hong Kong Neutral Neutral Neutral Neutral

In the past year, Hong Kong authorities were able to cool the frothy residential property market, which was positive. On the negative side, public sentiment in Hong Kong towards the mainland has become less constructive over the course of 2013. This is a worrisome trend as Hong Kong’s long-term growth prospects are tied to greater integration with the mainland’s economy.

The belly of the HKD swap curve offers one of the best carry in the Asia-Pacific region. It will require a 17bp rise in 5y HKD swap in 3 months to offset the carry. UST yield consolidation should be favourable for HKD swap curve. In addition, the 5y HKD IRS has recently underperformed the same tenors of the USD and SGD swap curve by 10-12bp, making a 5y HKD IRS receiver attractive.

The HKD has dismissed concerns about its falling trade surplus and the impact of Fed tapering by trading persistently close to the stronger side of the band (i.e. 7.75).The HKD’s strength is also supported by a large positive net international investment position. We expect the Linked Exchange Rate System (often referred to as the USD-peg) to stay in place for the foreseeable future.

We upgrade HK to neutral from underweight. HK offers a more open economy and greater exposure to the US recovery. However, potential deleveraging and rich valuations make us more cautious on Hong Kong stocks.

Hungary Neutral Neutral Neutral Neutral

We have been overweight in REPHUN credit as amongst high yielders in CEEMEA the current account surplus has made the sovereign appear attractive. However, we believe that the recent outperformance may have run its course, and in the face of the government’s FX mortgage programme we downgrade sovereign credit to neutral

On a fundamental basis, Hungarian rates embed an attractive country specific risk premium as well as offering the highest real yields in the region. However, after the outperformance in the past two years and as we approach the end of rate cut cycle, the risk reward is no longer compelling and we stay neutral for now

The uncertainties surrounding the FX mortgages and the NBH loose monetary policy have weighed on the HUF. The Supreme Court said that FX mortgage contracts were valid, removing one of the most important risks for the HUF. However, the saga has not come to end yet as the government is expected to present a new plan in Q1 2014 to gradually phase out FX mortgages. Given the persistent uncertainties, we stay neutral for now.

The positive effect of the improving macro back drop is likely to be offset by strains on the corporate sector in the context of an already over-owned market. Uncertainties around FX mortgage reforms a major drag on the banks.

Source: HSBC




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Table D1: Summary of HSBC fixed income, FX, and equity views


India Neutral Overweight private banks Pay Pay 2y INR NDOIS, INR2-1y NDOIS steepener Long vs IDR Underweight In 2014, the government and the RBI are likely to

focus on short-term actions to ensure macro-stabilisation rather than bold initiatives to revive the economy. With the need to hold general elections before May 2014, the government lacks the time and support to enact deep reforms. Baa3/BBB- ratings will hold but negative outlook possible during the year.

We like paying 2yr INR OIS. Government securities (Gsecs) yields are likely to remain high at least 1H2014. Higher bond supply and a hawkish policy stance by the RBI are expected to keep 10-year yields in the 8.5-9.0% range. Better opportunities to establish a long position on Gsecs are expected in 2H2014. With inflation well above the RBI’s target, the central bank is expected to remain in a tightening mode.

The INR has staged an impressive turnaround since the summer sell-off as the result of a slew of emergency measures and the tightening of monetary policy. These measures helped to narrow the current account deficit and boost FX reserves. Despite a better INR performance in recent months, the currency remains challenged by a weak external balance and a capital account that is sensitive to broader risk appetite.

We remain underweight on India. The market is over-owned, valuations look expensive and earnings growth expectations at 18% for 2014 are too high. The general election, which will be held in May at the latest, adds uncertainty.

Indonesia Overweight Buy long-dated USD-debt Overweight Long IndoGB 8.375 3/34 Long NDF points steepener Overweight

While there is little chance of reform initiatives ahead of parliamentary and presidential elections in April and July 2014, we expect Indonesia’s sovereign rating to be upgraded to a BBB- by S&P given its favourable metrics compared to peers. Government and private sector’s reliance on foreign currency borrowing is a concern as it makes the country more vulnerable to currency volatility. We like Indonesia ’42 and’43.

Modest overweight as carry should negate likely FX losses. The 20yr benchmark is favoured as the curve should flatten on further monetary tightening. Current account deficit should narrow in 2014 with the CB and MoF making a concerted effort to announce reforms and monetary tightening (the mineral ore export ban should have a temporary negative impact). Gross issuance could jump 12% to in 2014, a daunting task given reduced appetite for high-beta EM assets.

The IDR suffered the most in 2013 even after BI tightened monetary policy and we remain cautious in 2014. The IDR's challenge boils down to a combination of an income deficit driven by equity dividends and bond coupon repatriation, persistent inflation due to subsidy removal, and thinning onshore FX liquidity. The legislative and Presidential elections in April and July respectively add further uncertainty.

We remain overweight Indonesia. While aggressive efforts to cool domestic demand have lowered growth, we appreciate government's efforts. We believe the market has now largely priced in slower growth, a weaker currency and escalating labor costs, and expect downgrades to taper off from here.

Israel Neutral Neutral Long vs. USD

Geopolitical risks will continue to be the key driver of Israeli credit in the near term. Whilst the sovereign credit metrics remain solid, the CDS in particular remains unattractive and we see no compelling case either way.

Fiscal savings in 2013 have enabled an improved supply outlook for ILGOVs this year, with net issuance projected to fall. Low foreign positioning and decent carry, particularly in the belly of the curve, also lends support to Israeli rates. Yet, as the spread against UST has tightened sharply last year, cheaper valuation is required before we build bullish positions again.

Macro fundamentals are supportive but on valuation basis, the ILS is no longer attractive. The Bank of Israel’s stance is neutral but the economy grows below potential and export performances are disappointing. Therefore, the BoI is likely to fight ILS appreciation. The BoI plans buying USD3.5bn in 2014 to offset the effect of gas production on the current account balance but additional discretionary buying are likely.

Korea Neutral Buy the quasi-sovereigns Pay KTB 3-10yr steepener Long vs THB Neutral

With regards to external profiles, a healthy current account surplus projected at 3.2% of GDP for 2014 and a high level of FX reserves amounting to over seven months of import coverage should sufficiently cushion the economy against external shocks. We believe the unpredictability of the North Korean regime remains a key factor, capping the South Korean sovereign rating at AA-/stable.

Bond and swap curves should steepen in 2014. The front-end of the curve is likely to benefit from an anticipated rate cut if weakness of JPY against KRW intensifies. Yet, prospects of an accelerating growth likely to push long-end rates higher. Possible increase in KTB supply, mainly at the 10yr sector could further steepen the curve. We recommend positioning for a 3-10yr KTB steepener.

The KRW ended 2013 as one of Asia's most resilient currencies, though policymakers are now becoming more concerned by FX strength. Weaker balance of payments seasonality in Q1 may lead to fairly dull performance in early 2014. But we remain constructive in 2014 as strong current account and the improvement in Korea's International Investment Position will help it weather tighter USD liquidity better than others.

We downgrade Korea to neutral from overweight. Korea’s current account surplus and exposure to a global cyclical recovery have led to funds flowing back, and pushing up the valuations. Funds have increased exposure to Korean equities in recent months. Earnings may surprise on the downside as well, given high consensus expectations at the start of the year.

Malaysia Underweight Sell MAYMK 3.25% '22-17c Pay 2s5s MYR steepener vs THB flattene, pay 1y1y Short vs SGD Overweight Malaysia’s household indebtedness (or the household

debt-to-GDP ratio) was the highest in the region at 81% in 2012 (from 60% in 2008), which makes it vulnerable to higher interest rates. Debt-fuelled government expenditure and private consumption have shaped Malaysia’s economic structure in recent years, masking the weakness in private investment activity. Expect negative rating outlooks in 2014.

We like paying 1yr1yr MYR IRS to position for limited rate hikes priced into the MYR IRS curve. High foreign participation is expected to expose bonds to external risks. Fiscal concerns should continue and a resolute effort to implement reforms introduced in the 2014 budget is crucial to strengthen the fiscal outlook. Separately, higher inflation owing to potential fuel price hikes could compel the BNM to hike rates in 2014.

The MYR saw an aggressive sell-off after the Fed announced tapering in December and remains sensitive to US Treasury yield movements. Although the current account deterioration has not been as bad as feared, income outflows remain persistent. As the BNM remains one of the least interventionist central banks in Asia, we expect the MYR to remain volatile with bias towards depreciation in 2014.

We upgrade Malaysia to overweight from neutral. We like Malaysia for its defensive qualities and high dividend yield. It also has domestic institutional fund support, which results in lower volatility as well as reasonable valuations. Importantly, the government is now dealing with fiscal imbalances, which will benefit the overall macro environment.

Source: HSBC


https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=V6ICtnWclm&n=400693.PDF













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Mexico Overweight Long Pemex ‘19s, short Brazil ‘19Ns Receive Receive 2y TIIE, 5s/10s flattener Long vs. CLP Buy MXN vs CLP 3m NDF Overweight LatAm equities in 2014 Mexico outperformed the low-beta bloc in the region in

2013 supported by the reform momentum. However, spreads are still c30bp wider this year and far from their all-time lows in 2007. Current levels as well as an expected pick-up in economic growth in Mexico should support spreads. We remain engaged in long Pemex ‘19s vs short Brazil ‘19s and Buy Brazil 5y CDS vs Mexico.

Going into 2014, we tread carefully and keep duration limited through front-end receivers (2y TIIE), as the market prices in a faster reversion of the easing cycle than we expect. In addition, we remain invested in the 5s/10s TIIE flattener to position for a potential rating upgrade.

We still like the MXN. The effects of Fed tapering and higher US rates will dissipate in our view and we believe that above 13.00 in USD-MXN the currency offers good value. Fundamentals are still sufficiently sound and our economists expect an above-consensus boost to growth, helped by a recovering US economy. We like to play long MXN positions vs the CLP.

We are overweight Mexico, contrarian to consensus underweight. We are expecting highest upside in Mexico, earnings expectations should recover on the back of the sharp forecast macro bounceback; there is room for currency appreciation; and multiples remain supported by the structural reform agenda. We focus on better value cyclical and industrial sectors versus more expensive defensive domestics.

Panama Neutral

We moved Panama back to neutral. We see two negative risks for 2014: (1) economic slowdown (2) deterioration in fiscal accounts due to increased pre-election spending. After the elections, we do not expect a significant change in economic policies. Bonds in the 15-year sector of the curve continue to trade cheap on the curve.

Peru Neutral Buy Colombia ‘24s vs Peru ’25s Receive Long vs. USD Overweight LatAm equities in 2014 We remain neutral on Peru EXD as valuations as

spreads trade very tight to its peers. We see risks roughly in balance: On the positive side, the country has strong policy firepower to mitigate economic slowdown. On the negative side, political scandals and low business confidence may affect investment. We expect Peru to underperform Colombia and find value in buying Colombia ‘24s vs selling Peru ‘25s.

HSBC Economics projects 50bp of monetary policy easing in 2014, which we expect to be supportive for short rates. The long end of the curve remains very sensitive to changes in US rates, with high foreign ownership exacerbating that risk. We expect the local curve steepen in 2014 and recommend long-end Soberanos only as a tactical play.

The PEN’s long term appreciation trend is likely over, but we still believe the currency will remain broadly stable over the medium term. Peru remains a strong growth story, with GDP growth expected to rise from 5.1% in 2013 to 5.6% next year. BCRP will maintain a vigilant presence both selling and buying USDs to maintain a stable PEN. As such, we see USD-PEN strengthening modestly to 2.75/USD by end-2014.

We remain overweight on Peru. Peru equities performed worst in 2013, on investor fears about the country’s commodity exposure and the weaker Sol. We are positive commodity prices, as well as the country’s positioning in the region, with the highest potential GDP and strongest policy flexibility. Focused on financials and infrastructure opportunities.

Philippines Neutral Overweight Buy 5yr RPGB Short vs TWD Overweight

We expect the Philippines will continue to pursue prudent economic policies based on HSBC Economics forecasts for 2014. We expect fiscal consolidation to focus on tax buoyancy. Further structural reforms are achievable, now President Aquino has greater control of both houses of Congress after the wins in the mid-term elections. Also, President Aquino’s high popularity level provides support the reform agenda.

While Philippine government bond yields look relatively low, a better FX outlook for 2014 should provide more incentive to buy Philippine bonds. We thus raise its portfolio stance to overweight from a modest overweight. Prospects of FX appreciation would also allow investors to extend duration. The 5yr RPGBs looks attractive, as its yield change since the beginning of November has been the highest.

The PHP was more resilient than its ASEAN peers in 2013, but did not outperform when remittances were higher as the BSP tended to step up its intervention to curb appreciation. Although the fundamentals support the PHP via healthy FX cover, the currency remains rich in terms of valuation and is low yielding; as such we do not expect significant outperformance.

We upgrade Philippines to overweight from neutral. The country continues to march ahead of its peers in terms of growth, clocking in near 7% growth rate. Remittances have provided strong support for the consumption growth story. Mutual funds have reduced their exposure in Philippines equities, There are also chances of earnings growth surprise.

Poland Neutral Receive Receive 5y IRS outright Long vs EUR Underweight

A strong balance of payments, improving fiscal dynamics and a solid supply outlook means Poland has some of the strongest credit metrics in EM. Indeed demand for the recent EUR2bn issue of 10yr Eurobond was strong and contributed towards total 2014 borrowing needs that are already 35% financed. However, much of this is reflected in the price and we see little value in Polish credit for now.

We consider Polish rates as the best candidate to take duration exposure. We have seen a risk premium restoration in recent months that does not reflect the country’s solid credit metrics, favourable supply outlook and benign macro outlook - which implies only a gradual tightening cycle. Our preferred trade to take advantage of this mispricing is to receive 5y IRS outright

The PLN remains the strong link of the region. The macro setting of a recovery in economic activity amid low inflation is PLN-supportive. The PLN is also less subtle to the potential consequence of Fed tapering. Poland benefits indeed from a low current account deficit. Finally, the orthodox approach of the central bank aiming at maintaining real positive policy rate is also PLN-positive.

We believe that valuations are expensive and bottom-up investment themes are hard to find. Pension funds are likely to create a drag, and macro recovery is too slow for comfort.

Source: HSBC


https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=2u6Dpex6f3&n=400225.PDF


https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=E3K8q1yP6D&n=400761.PDF




https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=T4aKtf0HqS&n=397355.PDF


https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=iJTAGk0wvs&n=400001.PDF

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Russia Neutral Underweight Neutral Neutral Russian sovereign credit has been a strong performer

over the last month. However, a deteriorating current account surplus and signs of continued capital outflow may restrain further gains particularly in light of the country’s high beta status. Consequently, we move to a neutral weighting.

The government faces a number of structural challenges in 2014. Continuing capital outflows and a deteriorating current account deficit are likely to put pressure on Russian rates. Notably the FX hedged yield is the smallest in CEEMEA indicating that investors will have little tolerance for currency volatility. Bearing this in mind and with the curve outperforming recently we argue for a reduction in OFZ weightings.

Seasonal improvement of the current account in 1Q14 will be strong enough to arrest the RUB’s weakening and bring about some RUB strength but it looks unlikely that the RUB will be able to credibly firm in the free-floating corridor of the currency band where the CBR does not intervene. The key downside risks for the RUB remain in 2-4Q14 when positive seasonality disappears.

The key potential catalysts are easy to list – valuation, strong external position and resilient Chinese growth. The impediments, however, are also rather strong – lack of structural reform, weak domestic cycle and a lack of bottom-up attraction. In addition, there is little reason to believe that the political discount on the Russian equity market will change over our investment horizon.

Singapore Neutral Neutral Pay2yr SGD IRS Long vs MYR Neutral

For 2014, the property market is set to remain a focus as the government looks to continue striking a balance between dampening speculative activity and supporting end-user demand. The other key challenges for the government are to close the rich-poor income gap, deal with an ageing population, and the population’s growing disaffection with foreign workers.

Paying 2yr SGD IRS remains the most favoured trade before a progressive rise in the 6-month swap offer rate (SOR) in early 2014. A higher SOR fixing is also expected to drive the term structure flatter in 2014. We estimate the gross issuance in 2014 to be SGD17-19bn, higher than SGD14.8bn in 2013, due to larger redemptions in 2014. Supply conditions will be more favorable in the second half of 2014.

The SGD performed better than many Asian currencies as the MAS chose to maintain the path of modest and gradual SGD NEER appreciation. The SGD's external balances remain among the best in Asia. For 2014 as a whole, the SGD will likely stay relatively better insulated given a strong current account and significant FDI inflows.

We remain neutral on Singapore. It offers a mix of well managed companies, a defensive market with realistic earnings expectations, reasonable valuations and high yield. However, monetary stance remain restrictive, and it faces foreign labour constraints post the new labor law.

S. Africa Overweight Buy 5y Turkey CDS v South Africa Tactically bullish Neutral Underweight

In the high beta space we prefer South African credit. The factors working in its favour include tentative signs of an improvement in the trade balance, total financing needs in 2014 that compare well against its peers and an improving credit ratings outlook. We express our view on an RV basis, selling 5y CDS protection versus Turkey.

The heavy issuance and switch auction profile the Treasury will undertake in 2014 indicates that investors must be careful when choosing SAGB tenors. We favor ultra-long bonds such as the R2048 that are supported by an under-invested local investor base. On the IRS curve, we continue to like the front-end, where we believe excessive hikes are priced in.

Beyond the potential implications of a broad-based USD strength, there is little domestic macro reason for a further depreciation as we believe that FX has already adjusted. We expect a stabilization in the medium-term with the materialization of the so-called “J-curve”.

Weak domestic macro and fundamentals still weigh on domestic demand plays, especially the consumer discretionary sector. While we are positive on the rand, we do not expect this to impede the performance for some parts of the material sector – in particular, we view PGM prices as unsustainably low and see the platinum sector as a leveraged exposure to this.

Taiwan Neutral Receive TWD-SGD5yr IRS spread Long vs PHP Overweight

We like receiving TWD-SGD 5yr IRS spread. The CBC might begin another round of rate hikes in 2014 given the steady economic growth. Yet, the CB would be less forceful in monetary tightening as inflation could head higher in 2014 due to electricity price hikes. A rise in long-end TWD rates should be much slower than regional peers and USD rates as the TWD-SGD spread tends to narrow when US rates are rising.

The TWD has been supported by its solid current account surplus reaching an all-time high in 2013. While fundamentals favour a strong TWD, one risk in 2014 is whether higher US yields will see increasing outward investments with potentially less FX hedging; FX policy swill also prevent aggressive appreciation.

We remain overweight on Taiwan. Economic growth has accelerated, as reflected in high frequency data. Corporate earnings expectations of 6.9% look a little low and may give positive surprises later. Further, the market is under-owned and offers attractive valuations. Will benefit from recovery in Asia tech cycle.

Thailand Neutral Receive 2s5s THB flattener vs MYR steepener Short vs KRW Underweight

Thailand’s economy is under a cloud of uncertainty, as domestic political tensions have re-emerged. The risk going into 2014 is that the civil unrest will escalate to a level that will disrupt the government’s ability to govern and discourage investments. What this means is that economic management will likely suffer in the near term, and there is no external buffer that the country can count on.

Market weight Thailand in 2014. The growth outlook might worsen by the political impasse. A rate cut is likely in Jan 22. In cash bonds, we favor short-dated bonds. FX losses due to political tensions should be offset by fixed-income gains, leaving total returns mainly flat in 1Q2014. On swaps, we like 2s5s IRS THB flattener vs MYR steepener on further monetary policy divergence between the two central banks.

The THB is in a weaker position given lower inflows and the build-up of external debt over the past few years, which have increased the THB's vulnerability to more volatile capital flows. Political pressures provide another point of concern for the THB. Sentiment is likely to remain cautious going into the 2 February election. The THB should trade with a weaker bias in 2014, especially with lingering political risks.

We remain underweight on Thailand. While the economy continues to struggle with the slowdown, political turmoil has intensified. Both consumer and business sentiment indices have slid. There is also a risk of negative earnings surprise as companies face frequent business disruptions. Earnings downgrades have kicked in which may push up the valuations.

Source: HSBC

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=T4aKtf0HqS&n=397355.PDF


https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=BsqNAKu0Ic&n=399873.PDF





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Turkey Underweight Buy 5y Turkey CDS v South Africa Pay Short vs USD Overweight Following the re-emergence of political uncertainty in

Turkey, we expect Turkish credit to continue to underperform as more risk premium needs to be factored in. The CBRT’s reluctance to raise rates will elevate pressures as FX reserves continue to be depleted. We recommend buying Turkey 5y CDS protection against South Africa.

More front-end risk premium is required, in the face of elevated political worries, inflationary risks, and the possibility of an eventual central bank tightening. Worsening supply dynamics and foreign outflows that have only just started offer little reassurance and we opt to retain our payer and bear flattener bias on the X-CCY swap curve. For cash bond curve, front-end bonds are the most vulnerable and should be avoided.

The macro and political backdrop has led to a vicious circle in the FX market. The constant re-pricing of the Turkish political risk in the absence of a monetary policy response from the central bank has made the TRY downward spiral self-sustaining. We revised our USD-TRY forecast significantly higher. We now see USD-TRY rising to 2.30 in Q1.

In our view, despite heightened political risk, this is not the time to sell Turkish equities – we stick with our relatively limited overweight position. The equity market is, in our view, cheap and currency risk has diminished in the sense that the exchange rate has depreciated.

Ukraine Underweight Neutral Short vs. USD

Following the recent political crisis caused by the failed EU negotiations, the Ukrainian government has faced increasing foreign exchange depletion. The Russian NWF has provided a near time solution by offering to buy USD15bn worth of Ukrainian debt. However, despite this, it is premature to turn positive as the political outlook remains mired in uncertainty.

We advise avoiding UAH-denominated rates product for unfavourable currency exposure and insufficient liquidity risk premium.

Unsustainable current account deficit prompted by negative terms-of-trade shock and the UAH appreciation to the pre-crisis level in real terms makes a strong case for the devaluation. However, the NBU will be capable to allow only gradual UAH depreciation as a bailout deal with Russia is set to replenish its international reserves.

Uruguay Neutral Receive Buy Global UI ‘18s Neutral

We believe the recent global bond underperformance vs peers could be a re-pricing of risk as Uruguay is, on average, one notch below its regional peers. We believe this year’s presidential elections will be neutral for bonds. The main headwind for global bonds will come from external factors, given a high sensitivity of Uruguayan bonds to US rates swings.

We continue to favor CPI-linked bonds as the inflation outlook and monetary policy management leaves a high degree of uncertainty. In particular, we remain long the Global UI’18s. We believe a victory of former President Tabare Vazquez in October’s presidential elections could bring a slightly more orthodox policy management with reduced inflation.

The main shift we see in the path of the UYU in the coming year is a recoupling with the BRL. This means the pace of UYU depreciation should moderate, in line with our BRL view. We expect USD-UYU to end 2014 at 22.75/USD for a 5.8% devaluation. An expected improvement in the current account deficit to -1.5% of GDP (from -3.0% of GDP in 2013) supports our call.

Venezuela Neutral Short vs USD

We resist the temptation of the highest carry currently available in the region and stay neutral. Uncertainty surrounding macro policies remains high. If a cohesive set of economic adjustment is initiated, we see significant upside. On the flipside, we expect volatility to remain high or even increase if such adjustments are delayed. Stay in the front end of the sovereign curve or low dollar bonds in the long end.

We now expect a devaluation of the official rate to 15/USD, the largest in recent history. The eye-popping acceleration of inflation in recent months to over 50% y-o-y, mounting scarcities, and the huge spread between the official 6.30/USD rate and the parallel market rate (currently trading around 60/USD), implies the need for a much larger FX adjustment than we were previously forecasting.

Vietnam Neutral Neutral Neutral

We expect Vietnam’s economic recovery will continue to be hesitant and uneven in 2014. The economy’s reliance on the external sector to drive growth, plus strong foreign direct investment inflows generating a balance of payment surplus, should be viewed positively from several perspectives. It will provide a much needed buffer against potential swings in speculative capital flows.

The current account has improved with the trade balance rebounding and deleveraging continuing to depress imports. We feel the worst is probably over for the VND but some caution is still warranted. The stability in the current account and inflation has a short track record and prudent monetary policy is required to keep them in check.

The economy is showing signs of improvement with expanding PMI. Vietnam will benefit from the Trans-Pacific Partnership Agreement (TPP). However, the country continues to struggle with the dual impact of an inefficient banking system and ailing state-owned enterprises (SOEs). Valuations are at a premium to the broader frontier market index, liquidity remains poor and declining ROE further adds to concerns.

Source: HSBC

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=BsqNAKu0Ic&n=399873.PDF


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Macroeconomic Forecasts Table E1. Summary of HSBC macroeconomic forecasts

______GDP______ ____Inflation____ ___Policy rate___ ______FX______ __Current account__ __Fiscal account__ 2013e 2014f 2015f 2013e 2014f 2015f 2013 2014f 2015f 2013 2014f 2015f 2013e 2014f 2015f 2013e 2014f 2015f

Argentina 2.5 1.0 1.5 26.3 27.5 26.0 20.00 23.00 23.00 6.50 8.50 11.00 -0.8 -0.7 -0.7 -2.7 -2.3 -2.0Brazil 2.2 2.2 1.2 5.7 6.3 5.8 10.00 10.75 11.75 2.35 2.50 2.60 -3.4 -3.2 -3.0 -3.2 -3.7 -3.0Chile 4.3 4.3 4.5 2.6 3.0 3.0 4.50 4.25 5.00 530 545 550 -3.6 -3.9 -4.6 -0.8 -1.0 -1.2China 7.7 7.4 7.7 2.6 2.7 3.1 6.00 6.00 6.00 6.08 5.98 5.90 2.3 2.6 2.7 -2.1 -1.9 -1.9Colombia 4.2 4.7 4.5 1.9 2.9 3.0 3.25 4.00 5.00 1,930 1,960 2,000 -3.9 -4.2 -3.3 -1.2 -1.2 -1.0Czech Republic* -1.4 1.9 1.7 1.4 1.1 2.4 0.05 0.05 0.05 27.0 27.0 26.0 -1.1 -0.5 -0.9 -2.5 -2.9 -3.0Egypt 2.2 2.6 4.2 10.3 8.6 8.6 9.75 8.25 8.25 6.95 6.80 6.80 -2.1 -1.8 -2.3 -13.9 -12.4 -11.6Hong Kong 2.9 3.7 4.0 4.2 4.2 4.2 0.50 0.50 0.50 7.80 7.80 7.80 4.9 6.5 8.4 2.4 1.4 1.0Hungary* 1.0 2.1 1.6 1.7 1.3 3.0 3.00 2.75 3.50 300 290 290 3.1 2.4 2.4 -2.4 -3.0 -2.9India1 4.6 5.3 6.3 9.5 7.2 7.8 7.75 8.25 8.25 61.0 62.0 64.0 -2.9 -3.0 -3.0 -5.1 -4.7 -4.3Indonesia 5.6 5.0 6.0 7.0 5.6 4.9 7.50 7.50 7.50 11,700 12,500 12,500 -3.7 -2.8 0.4 -2.4 -1.8 -1.5Israel 3.3 3.3 3.4 1.6 1.6 2.2 1.00 1.25 1.75 3.60 3.50 3.50 1.4 2.0 2.1 -3.1 -2.8 -2.5Korea 2.7 3.2 3.4 1.2 2.6 3.0 2.50 3.00 3.75 1,050 1,025 1,000 5.1 4.4 4.4 1.0 2.0 2.9Lebanon 0.1 1.3 2.5 1.0 1.7 3.0 10.00 10.00 10.00 1,507.5 1,507.5 1,507.5 -23.6 -22.9 -22.9 -9.1 -9.8 -10.1Malaysia 4.6 5.2 5.0 2.1 2.4 2.0 3.00 3.50 3.50 3.25 3.33 3.35 3.3 6.0 7.7 -4.0 -3.5 -3.0Mexico 1.3 4.1 3.8 3.7 3.9 3.2 3.50 3.50 4.00 13.00 12.60 12.60 -1.2 -1.3 -1.4 -2.9 -4.1 -3.2Panama 7.5 6.3 6.5 4.1 3.5 3.2 1.12 1.10 1.20 1.00 1.00 1.00 -8.0 -7.7 -7.3 -3.7 -3.5 -3.5Peru 5.0 5.6 6.1 2.9 2.1 2.5 4.00 3.50 4.00 2.80 2.75 2.75 -5.4 -5.3 -3.9 0.5 -0.4 0.2Philippines 6.8 5.9 6.1 2.9 4.2 4.3 3.50 4.00 4.00 44.1 45.2 45.4 3.3 2.9 2.3 -2.5 -2.8 -3.1Poland* 1.4 3.0 3.3 1.0 1.8 2.2 2.50 2.50 3.25 4.20 3.90 3.90 -1.5 -1.6 -2.5 -4.4 4.6 -3.0Russia 1.5 2.0 2.0 6.8 5.8 4.8 5.50 5.25 5.00 32.9 35.2 37.3 1.6 1.5 1.4 0.0 0.7 -0.3Singapore2 3.7 3.8 4.3 2.4 3.1 3.1 0.20 0.30 0.30 1.27 1.25 1.26 17.3 17.8 18.3 1.5 1.5 1.4South Africa 1.8 2.6 3.1 5.8 5.7 5.5 5.00 5.00 5.50 10.60 10.40 10.00 -6.1 -6.0 -5.7 -4.2 -4.3 -4.3Taiwan 1.7 2.8 3.4 0.9 1.9 1.6 1.875 2.125 2.375 29.8 29.1 29.0 10.5 8.8 6.7 -1.5 -1.3 -1.2Thailand 2.8 4.4 5.2 2.2 2.6 3.8 2.25 3.00 3.00 32.8 34.0 34.5 -1.9 0.7 4.3 -2.1 -3.1 -3.5Turkey 3.9 2.2 4.1 7.5 7.4 6.8 7.75 9.50 8.50 2.15 2.10 2.00 -7.3 -6.3 -6.5 -1.2 -2.2 -2.2UAE 4.5 5.0 5.1 1.6 4.5 6.5 1.00 1.00 1.00 3.67 3.67 3.67 13.7 6.3 1.4 10.8 6.4 3.1Ukraine -1.0 0.0 -3.5 -0.3 2.1 9.2 7.50 7.00 7.00 8.30 8.90 11.00 -9.2 -8.7 -1.6 -5.0 -4.9 -1.8Uruguay 3.5 3.5 3.8 9.1 8.1 7.5 15.00 13.00 13.00 21.5 22.8 23.5 -5.4 -2.8 -2.3 -1.4 -1.3 -0.7Venezuela 1.3 -1.7 1.5 53.0 59.4 35.3 18.90 20.10 15.30 6.30 15.00 15.00 4.3 7.4 5.2 -14.3 -8.1 -4.4Vietnam 5.4 5.6 5.8 6.6 7.9 8.2 5.50 7.00 7.00 21,036 21,100 21,100 1.8 2.0 0.7 -2.6 -2.3 -2.3

EM 4.5 4.9 5.2 5.5 5.7 6.1 DM 1.1 1.8 1.9 1.3 1.6 1.7 US 1.8 2.3 2.5 1.5 1.7 1.9 0-0.25 0-0.25 0-0.25 N/A N/A N/A -2.4 -2.1 -1.9 -4.1 -3.2 -2.3UK 1.4 2.6 2.7 2.6 2.4 2.4 0.50 0.50 0.50 1.66 1.50 1.47 -3.8 -2.3 -2.1 -5.6 -4.7 -3.9Eurozone -0.4 0.8 1.0 1.4 1.0 1.2 0.25 0.25 0.25 1.37 1.28 1.25 2.1 2.1 2.0 -3.2 -2.9 -2.8Japan 1.7 1.3 1.3 0.3 2.3 1.5 0-0.10 0-0.10 0-0.11 105 101 99 1.0 1.1 1.6 -9.8 -7.1 -5.9

Source: HSBC *FX forecasts vs EUR

Figure E1. GDP growth and contributions* Figure E2. 2013f GDP growth ranking (%) Figure E3. 2013f inflation ranking (%)

Source: HSBC, Bloomberg *Of each component to total growth Source: HSBC, Bloomberg Source: HSBC, Bloomberg

0

1

2

3

4

5

6

7

8

9

'13e '14f '15f '13e '14f '15f '13e '14f '15f

BRIC EM DM

Brazil Russia

India China

LatAm

CEEMEA

Asia ex-J

All

-2 0 2 4 6 8 10 12

Venezuela

Ukraine

Argentina

Lebanon

Czech Republic*

Peru

Vietnam

Philippines

Panama

China

BEST 5W

OR

ST 5

0 5 10 15 20 25 30 35 40 45 50 55 60 65

Venezuela

Argentina

Egypt

Uruguay

Vietnam

Ukraine

Taiwan

Poland*

Hungary*

Czech…

BEST 5W

OR

ST 5

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EM FX Forecasts Table E2. Summary of HSBC EM FX forecasts

2011 2012 2013 1Q14f 2Q14f 3Q14f 4Q14f 1Q15f 2Q15f 3Q15f 4Q15f

USD-ARS 4.31 4.92 6.52 7.00 7.50 8.00 8.50 9.20 9.80 10.50 11.00USD-BRL 1.86 2.05 2.36 2.35 2.40 2.45 2.50 2.52 2.55 2.58 2.60USD-CLP 520 478 525 530 535 540 545 550 550 550 550USD-CNY 6.30 6.23 6.05 6.04 6.02 6.00 5.98 5.96 5.94 5.92 5.90USD-COP 1,938 1,767 1,923 1,935 1,940 1,950 1,960 1,970 1,980 1,990 2,000EUR-CZK 25.6 25.1 27.0 27.0 27.0 27.0 27.0 26.8 26.5 26.0 26.0USD-EGP 6.03 6.36 6.95 6.80 6.80 6.80 6.80 6.80 6.80 6.80 6.80USD-HKD 7.80 7.75 7.80 7.80 7.80 7.80 7.80 7.80 7.80 7.80 7.80EUR-HUF 315 291 300 295 295 290 290 290 290 290 290USD-INR 53.1 55.0 61.8 59.0 60.0 61.0 62.0 63.0 64.0 64.0 64.0 USD-IDR 9,075 9,638 12,171 11,750 12,000 12,250 12,500 12,500 12,500 12,500 12,500USD-ILS 3.81 3.73 3.50 3.60 3.55 3.55 3.50 3.50 3.50 3.50 3.50USD-KRW 1,160 1,064 1,050 1,040 1,035 1,030 1,025 1,020 1,015 1,010 1,000USD-MYR 3.17 3.06 3.28 3.25 3.28 3.30 3.33 3.35 3.35 3.35 3.35USD-MXN 13.95 12.85 13.05 12.90 12.80 12.70 12.60 12.60 12.60 12.60 12.60USD-PEN 2.69 2.55 2.80 2.80 2.80 2.75 2.75 2.75 2.75 2.75 2.75USD-PHP 43.9 41.1 44.4 44.5 44.8 45.0 45.2 45.4 45.4 45.4 45.4EUR-PLN 4.47 4.07 4.20 4.10 4.00 4.00 3.90 3.90 3.90 3.90 3.90USD-SGD 1.30 1.22 1.26 1.23 1.24 1.24 1.25 1.25 1.26 1.26 1.26USD-ZAR 8.08 8.46 10.60 10.60 10.60 10.40 10.40 10.00 10.00 10.00 10.00USD-THB 31.6 30.6 32.8 33.0 33.3 33.6 34.0 34.3 34.5 34.5 34.5USD-TRY 1.89 1.78 2.15 2.30 2.20 2.15 2.10 2.15 2.15 2.00 2.00EUR-RON 4.327 4.44 4.5 4.4 4.35 4.3 4.3 4.3 4.3 4.3 4.3USD-RUB 32.2 30.5 32.9 33.5 34.7 34.8 35.2 36.1 37.6 37.1 37.3USD-TWD 30.3 29.0 29.8 29.4 29.3 29.2 29.1 29.0 29.0 29.0 29.0USD-UYU 19.90 19.18 21.13 21.75 22.00 22.50 22.75 22.90 23.10 23.30 23.50USD-VEF 4.30 4.30 6.30 15.00 15.00 15.00 15.00 15.00 15.00 15.00 15.00USD-VND 21,035 20,835 21,095 21,100 21,100 21,100 21,100 21,100 21,100 21,100 21,100

Select G10 2011 2012 2013 1Q14f 2Q14f 3Q14f 4Q14f 1Q15f 2Q15f 3Q15f 4Q15f

EUR-USD 1.30 1.32 1.37 1.35 1.33 1.30 1.28 1.25 1.25 1.25 1.25USD-JPY 77.0 86.0 105.0 106.0 103.0 103.0 101.0 99.0 99.0 99.0 99.0GBP-USD 1.55 1.63 1.66 1.65 1.61 1.55 1.50 1.47 1.47 1.47 1.47

Source: HSBC

Figure E4. Percentage change over the last four weeks (vs USD) Figure E5. Percentage change year-to-date (vs USD)

Source: HSBC, Bloomberg Note: Changes as of 16 Jan 2014 Source: HSBC, Bloomberg Note: Changes as of 16 Jan 2014

-8% -6% -4% -2% 0% 2%

ZARTWDTRYTHBRUBPLNPHPPENMYRMXNKRW

INRIDR

HUFCZKCOPCNYCLPBRL

-4% -3% -2% -1% 0% 1% 2%

ZARTWDTRYTHBRUBPLNPHPPENMYRMXNKRW

INRIDR

HUFCZKCOPCNYCLPBRL

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EM Central Bank Watcher Table E3. HSBC forecasted and market-implied policy rates

__________2014__________ Country Last 2014 2015 Jan Feb Mar Apr May Jun Risks

Brazil HSBC 10.50 10.75 11.75 +25 - = = - We expect the Central Bank to end the tightening cycle with a 25bp hike in February. The persistence of inflation or BRL weakness could lead the CB to extend or resume the tightening cycle further.

Market-implied +25 - +25 +25 -

Chile HSBC 4.50 4.25 5.00 = -25 = = = = We expect one cut from BCCh in Q1. Further cuts may take place if GDP decelerates more than expected and/or inflation expectations fall below target. Market-implied -24 +3 -6 -10 -4

China HSBC 6.00 6.00 6.00 = = = = = = PBoC is likely to keep rates steady given still sub-potential growth in 2014. Inflationary pressures remain modest. We expect monetary policy to remain status quo.

Colombia HSBC 3.25 4.00 5.00 = = = = = = We believe BanRep will keep rates at current depressed levels and only begin monetary policy normalization in 4Q14, as inflation is slowly picking-up. Market-implied +5 -2 -6 -6 +8 +23

Czech Rep. HSBC 0.05 0.05 0.05 = - = = = = The CNB has launched FX interventions as the next step in policy easing and these should prevail until 2015. Market-implied -2 -1 -1 +1

Hungary HSBC 3.00 2.75 3.50 -15 -10 = = = = CPI could turn negative in the first months of 2014. NBH Deputy governor pointed to 2.5% as a possible bottom for the policy rate. This is a downside risks to our 2.75% forecast. Market-implied -3 -11 -9 -8 0 0

India HSBC 7.75 8.25 8.25 = = +25 = = +25 With inflation risks still tilted to the upside, the RBI has to keep its inflation guards up and stand ready, if needed, to raise rates further to bring inflation under control. Market-implied +34 +22 -62 -28

Indonesia HSBC 7.50 7.50 7.50 = = = = = = BI now appears to be pausing after 175bp of rate hikes. But if a broad-based domestic slowdown does not emerge soon, the policy transmission mechanism may need strengthening.

Israel HSBC 1.00 1.25 1.75 = = = = = = Further easing unlikely with some improvement in growth in Q413 and a frothy housing market, unless of course global recovery stalls. First hike expected in 4Q14. Market-implied -8 -2 -1 1 1 1

Korea HSBC 2.50 3.00 3.75 = = = = = = The Bank of Korea has remained optimistic on the economic outlook. But the impact of additional JPY weakening on Korean exporters may pressure rates to stay low for longer. Market-implied -1 0 0 +1 +1

Malaysia HSBC 3.00 3.00 3.50 -- = -- = -- +25 In the coming months, elevated levels of household debt and rising inflation owing to subsidy rationalization might take precedence over growth, resulting in tightening in late 2Q 2014. Market-implied +10 +10 -2

Mexico HSBC 3.50 3.50 4.00 = = = = = = We expect Banxico to keep the policy rate on-hold at 3.5% throughout 2014 in spite of the expected rise in inflation due to its temporary nature related to tax increases. Market-implied -4 +6 +11 +5

Peru HSBC 4.00 3.50 4.00 = = -25 = = -25 We believe that with inflation converging to the mid-point of the targeted band, BCRP will have room to continue reducing rates and also to cut on reserve requirements.

Philippines HSBC 3.50 3.50 4.00 = = = = = = Inflation picked up in December and will likely accelerate in January due to a negative supply shock from the typhoon. We expect the BSP to hold rates steady to support growth.

Russia HSBC 5.50 5.25 5.00 = = = = = = The CBR made it clear that it considered long-term benefits of credibly lower inflation in the medium term to exceed the short-term costs of the economy running below its potential.

Poland HSBC 2.50 2.50 3.25 = = = = = = NBP committed to keeping policy rate unchanged until at least mid-2014. We believe rates will stay unchanged until 2015 as CPI will stay below CB’s 2.5% target though 2014. Market-implied 0 -1 1 0 -1

S. Africa HSBC 5.00 5.00 5.50 -- = -- = -- = Sluggish growth and benign core inflation likely to preclude rate hikes until the end of 2015. Market-implied +7 +24 +15Taiwan HSBC 1.875 1.875 2.125 = = = = = = Taiwan's high frequency data points towards economic stabilization in 4Q 2013. But as growth is

still below potential, the CBC will likely keep rates unchanged in 1H 2014. Market-implied +26 -15Thailand HSBC 2.50 2.50 3.00 -- = = -- = = Downside growth risks from politics may delay upward policy normalization, or even result in

further easing. But high household debt will limit the degree to which BOT can ease. Turkey HSBC 7.75 8.50 9.50 = +100 75 = = = The overnight lending rate is now the most relevant policy rate for Turkey. We expect

cumulative 175bp of tightening, but the precise timing will depend on Fed policy. Market-implied +187 +36 +20 +16 7 +6Vietnam HSBC 5.5 5.5 7.00 = = = = = +50 Inflation reached 6.0%y-o-y in December due to higher food and energy prices. With food prices

elevated and headline CPI likely to accelerate in January, we expect the SBV to remain vigilant.

Source: HSBC forecasts. Market implied rates are taken from HSBC Emerging Central Bank Monitor. (As of January 16, 2014) .

Figure E6. Implied 12-month forward policy rates vs HSBC Economics forecasts

Source: HSBC

-100

-50

0

50

100

150

200

ZA BR MX PL HU CZ IL TW CO MY CL KW IN TR

12m-ahead HSBC projected move 12m-ahead implied move

PayReceive

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Notes

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Disclosure appendix Analyst Certification The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Pablo Goldberg, Bertrand Delgado

Each analyst whose name appears as author of an individual section or individual sections of this report certifies that the views about the subject security(ies) or issuer(s) or any other views or forecasts expressed in the section(s) of which (s)he is author accurately reflect his/her personal views and that no part of his/her compensation was, is or will be directly or indirectly related to the specific recommendation(s) or view(s) contained therein: Andre de Silva, John Lomax, Clyde Wardle, Gordian Kemen, Marjorie Hernandez, Dilip Shahani, Murat Toprak, Di Luo, Victor Fu, Dominic Bunning, Devendran Mahendran, Sarah Leshner, Sean Glickenhaus, Paul Mackel, Murat Ulgen, Andre Loes, Simon Williams, Frederic Neumann, Raffaele Semonella, Philip Wickham, Keith Chan, Pavel Simacek, Reza-ul Karim, Elizabeth Martins, Hongbin Qu, Alejandro Martinez-Cruz, and Ju Wang

Important disclosures

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expected to underperform its required return by at least 5 percentage points over the next 12 months (or 10 percentage points for a stock classified as Volatile*). Stocks between these bands are classified as Neutral.

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As of 18 January 2014, the distribution of all ratings published is as follows: Overweight (Buy) 45% (34% of these provided with Investment Banking Services)

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EM Fixed Income Research Americas Gordian Kemen Head of Latin America Fixed Income Research +1 212 525 2593 [email protected]

Victor Fu EM Quantitative Strategist +1 212 525 4219 [email protected]

Alejandro Mártinez-Cruz +52 55 5721 2380 [email protected]

Asia André de Silva, CFA Head of Rates Research, Asia-Pacific +852 2822 2217 [email protected]

Pin-ru Tan +852 2822 4665 [email protected]

Himanshu Malik +852 3941 7006 [email protected]

Dayeon Hong +852 3941 7009 [email protected]

EMEA Di Luo +44 20 7991 6753 [email protected]

EM Currency Strategy Asia Paul Mackel Head of Asia FX Strategy +852 2996 6565 [email protected]

Dominic Bunning +852 2822 1672 [email protected]

Ju Wang +852 2822 4340 [email protected]

Americas Clyde Wardle +1 212 525 3345 [email protected]

Marjorie Hernandez +1 212 525 4109 [email protected]

CEEMEA Murat Toprak +44 20 7991 5415 [email protected]

EM Equity Strategy Herald Van Der Linde Deputy of Equity Research and Head of Equity Strategy, Asia-Pacific +852 2996 6575 [email protected]

Devendra Joshi +852 2996 6592 [email protected]

John Lomax Head of Global Emerging Market Equity Strategy +44 20 7992 3712 [email protected]

Wietse Nijenhuis +27 11 676 4218 [email protected]

Economics Latin America Andre Loes Chief Economist, Latin America +55 11 3371 8184 [email protected]

Javier Finkman Chief Economist, South America ex-Brazil +54 11 4344 8144 [email protected]

Sergio Martin Chief Economist, Mexico +52 55 5721 2164 [email protected]

Ramiro D Blazquez +54 11 4348 2616 [email protected]

Lorena Dominguez +52 55 5721 2172 [email protected]

Constantin Jancso +55 11 3371-8183 [email protected]

Priscila Godoy +55 11 3847 5190 [email protected]

Jorge Morgenstern +54 11 4130 9229 [email protected]

Emerging Europe, Middle East and Africa Murat Ulgen Chief Economist, Central & Eastern Europe, and sub-Saharan Africa + 44 20 7991 6782 [email protected]

Simon Williams Chief Economist, Middle East and North Africa +971 4 507 7614 [email protected]

Liz Martins +971 4 423 6928 [email protected]

Alexander Morozov +7 495 783 8855 [email protected]

Melis Metiner +90 212 376 4618 [email protected]

David Faulkner +27 11 676 4569 [email protected]

Agata Urbanska-Giner +44 20 7992 2774 [email protected]

Asia Pacific Qu Hongbin Managing Director, Co-head Asian Economics Research and Chief Economist Greater China +852 2822 2025 [email protected]

Frederic Neumann Managing Director, Co-head Asian Economics Research +852 2822 4556 [email protected]

Leif Eskesen Chief Economist, India & ASEAN +65 6658 8962 [email protected]

Paul Bloxham Chief Economist, Australia and New Zealand +61 2925 52635 [email protected]

Trinh Nguyen +852 2996 6975 [email protected]

Ronald Man +852 2996 6743 [email protected]

GEMs Research Team Pablo Goldberg Head of Global Emerging Markets Research +1 212 525 8729 [email protected]

Bertrand Delgado EM Strategist +1 212 525 0745 [email protected]

mailto:[email protected]
















Pablo GoldbergGlobal Head of Emerging Markets ResearchHSBC Securities (USA) Inc.+1 212 525 [email protected]

Bertrand DelgadoFixed Income Strategist, Emerging MarketsHSBC Securities (USA) Inc.+1 212 525 [email protected]

Victor FuStrategistHSBC Securities (USA) Inc.+1 212 525 [email protected]

Di Luo, CFAFixed Income Strategist, EMEAHSBC Bank plc+44 20 7991 [email protected]

Gordian KemenHead, LatAm Fixed Income researchHSBC Securities (USA) Inc.+1 212 525 [email protected]

Andre de SilvaDeputy Head, Global Fixed Income StrategyThe Hongkong and Shanghai Banking Corporation Limited+852 2822 [email protected]

Dilip ShahaniHead of Global Research, Asia-PacificThe Hongkong and Shanghai Banking Corporation Limited+852 2822 [email protected]

Devendran Mahendran Senior Analyst, Sovereigns and Financial InstitutionsThe Hongkong and Shanghai Banking Corporation Limited+852 2822 [email protected]

Sarah LeshnerAnalystHSBC Securities (USA) Inc.+1 212 525 [email protected]

Raffaele SemonellaCredit Research AnalystHSBC Bank Middle East Ltd(0)20 7991 [email protected]

Murat ToprakFX Strategist, EMEAHSBC Bank plc+44 20 7991 [email protected]

Clyde WardleSenior FX Strategist, Emerging MarketsHSBC Securities (USA) Inc.+1 212 525 [email protected]

Marjorie HernandezFX Strategist, LatAmHSBC Securities (USA) Inc.+1 212 525 [email protected]

Simon WilliamsEconomistHSBC Bank Middle East Ltd+971 4 423 [email protected]

Murat UlgenChief Economist, Central & Eastern Europe and Sub-Saharan AfricaHSBC Bank plc+44 20 7991 [email protected]

Hongbin QuChief China Economist and Co-head, Asian Economics ResearchThe Hongkong and Shanghai Banking Corporation Limited+852 2822 [email protected]

Frederic NeumannCo-Head of Asian Economic ResearchThe Hongkong and Shanghai Banking Corporation Limited+852 2822 [email protected]

Andre LoesChief Economist, LatAmHSBC Bank Brasil S.A.+55 11 3371 [email protected]

John Lomax*GEMs Equity StrategistHSBC Bank plc+44 20 7992 [email protected]

Paul MackelHead of Asian Currency ResearchThe Hongkong and Shanghai Banking Corporation Limited+852 2966 [email protected]

*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations.

Issuer of report: HSBC Securities (USA) Inc.

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Emerging Markets Strategist - HSBC · 2014-02-12 · Figure A1. US swap 1y1y suggests expectations of late hikes have been priced out Source: Bloomberg These risks remain on the radar