ING Forex Update

8/3/2019 ING Forex Update

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ING PPP survey January 2012

1

ING PPP survey

A look at FX valuations in the real worldMexico and Poland remain cheap

Several times a year, INGs global team of economists goes shopping for a similar basket

of goods and services to measure relative currency valuations. INGs Purchasing Power

Parity (PPP) index is similar to The Economistmagazines famous Mac-PPP index, which

is based on a single item a McDonalds Big Mac. Both measure long-term equilibrium

exchange rates based on relative price levels around the world.

Measures of fair currency values derived from Real Effective Exchange Rates merely

adjust an exchange rates long-term average for inflation differentials between countries.

PPP analysis is based on absolute prices, rather than rates of change of price indices,

which brings it closer to the real world of things people shop for. It asks how many

baskets of similar items Big Macs for the Mac-PPP and baskets of goods for the ING

PPP can be bought with a fixed amount of money, 100 for the ING PPP. By

calculating how many shopping baskets 100 will buy, we get a measure of which

countries currencies are cheap or expensive.

Our shopping basket includes 25 products and services. Within food, we price beverages,

proteins, fresh fruit and vegetables, and staples like sugar and spaghetti. The likes of

shampoo, washing powder and magazines feature in the non-consumables category. 95

octane gasoline or its closest variant is used for energy prices, while cinema and subway

tickets are used in our services category.

Fig 1 Purchasing Power How ma ny shopping basket s does 100 buy?

0.6

0.7

0.8

0.9

1.0

1.1

1.2

1.3

Mexico

Poland

Bul

garia

Hun

gary

Chi

na

Ukr

aine

Rom

ania

India

South

Afri

ca

Cze

chRep

Rus

sia

Slo

vakia

Philip

pine

s

Indo

nesia

Kaz

akhs

tan

Brazil

Turk

ey

Sin

gapo

re

Arg

entin

a

South

Korea

Spain US UK

Hon

gK

ong

Basketspurchased

per100

Mar-11 End-11

Cheap

Expensive

High per capita income

EM average

Note: Indonesia, Singapore and South Korea have been added to the survey, so no historical survey data isavailable

Source: ING

The shopping expedition in this exercise was conducted towards the end of 2011 and we

compared the outcomes with the prior survey undertaken in March 2011 (and results

published 13 April 2011). The biggest movers in Figure 1 were in the Mexican peso andthe Eastern European and Former Soviet Republic currencies, which became cheaper,

and the Ukrainian hryvnia and four Asian currencies, the Chinese renminbi, the Hong

Kong dollar, the Indian rupee and the Philippine peso, which became more expensive.

FINANCIAL MARKETS RESEARCH

research.ing.com SEE THE DISCLOSURES APPENDIX FOR IMPORTANT DISCLOSURES & ANALYST CERTIFICATION

FX24 January 2012

Chris TurnerHead of FX Strategy

London +44 20 7767 [email protected]

Tim CondonSingapore +65 6232 6020

[email protected]

ING basel ine forecas ts ,12m c hange (%)

Versus

USD

Versus

EUR

UK 12 10

Hungary 11 9

Poland 6 4

Czech Rep 5 3

Turkey 4 2

China 3 1

Romania 3 1

Brazil 3 1

Kazakhstan 2 0

Philippines 2 0

Eurozone 2 0

Bulgaria 2 0India 1 -1

Russia 0 -2

US 0 -2

Hong Kong 0 -2

Mexico -1 -3

Ukraine -2 -3

South Africa -10 -12

Argentina -12 -13

For ING forecast levels, see INGEconomic Forecasts, 11 January 2012

Source: ING


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Between-period changes in a currency are driven by the relation between changes in the

price of the commodity basket local inflation and a currencys exchange value against

the euro. If a currency depreciates in line with local inflation, there would be no change in

its PPP value. If it depreciates by more than inflation, its PPP value would get cheaper

and vice versa.

High inflation explains why the Indian rupee, the Hong Kong dollar and the Ukrainian

hryvnia became more expensive in 2011. Large depreciations explain why the Eastern

European currencies and the Mexican peso became cheaper.

The behaviour of the euro, our base currency, also matters. For example, in March 2011,

EUR/USD was trading above 1.40 compared with the sub-1.30 levels that we are seeing

early this year. The euros depreciation means USD-linked currencies will be more

expensive today than last March, even if prices of all goods in the basket are unchanged.

We think this effect, as much as high inflation, explains the big moves in the Chinese

renminbi and the Philippine peso depicted in Figure 1.

By product, the decline in fresh vegetable prices helped subdue prices in much of EMEA

(food has the largest weight, 32%, in our shopping basket). INGs EMEA analysts are

fearful that we will not see a repeat of food-driven disinflation in 2012.

We outline the core views derived from our PPP model, but note these are just additions

to the views expressed by our economists in other publications and we are not attempting

to replace them. Indeed, while the PPP analysis may suggest a buy or sell, local short-

term factors may imply the opposite. Please consider investments taking both the PPP

model and our country views into account.

Looking at how currencies stacked up at the end of 2011, Mexico was the cheapest EM

currency, a position it also held earlier in the year, but Eastern European currencies

dominate the cheap end of our scale thanks to subdued price changes in local baskets

(relative to other countries) and depreciations of their currencies against the euro.

The Singapore dollar and the Korean won, new entrants on our list, are at the expensive

end, with Korea expensive even relative to developed markets (the US and the UK in our

example). Their expensiveness squares with our intuition both countries feel

expensive and it will be interesting to track them to test the intuition. Beyond these new

Asian entrants, Brazil and Turkey are expensive despite depreciating by 11% and 18%,

respectively, against the dollar in 2011 (year-end to year-end) as their central banks

embarked on easing cycles. The Central Bank of Turkey is stoutly resisting further TRY

weakness, having widened the policy corridor and hiked short-term rates to near 12%.

There may be greater depreciation potential in the BRL given INGs forecast of another

200bp of policy rate cuts this year.

Whats cheap/rich to EM/regional averages?We also look at whats rich/cheap compared to benchmarks such as regional averages,

EM as a whole, Spain and the US (see Figure 2). Rich/cheap assessments versus

regional averages may be useful to fund managers with dedicated positions in the region

(eg, against equity or bond benchmarks), with a view to running overweight or

underweight positions.

We have historically used Spain as a benchmark because as a convergence country in

the Eurozone with a high per capita income, it is a country to which EMEA in particular

might aspire. However, Spains 7-8% of GDP current account deficits in 2007-09 suggest

that the country was overvalued, perhaps by as much as 20-30% against Germany. Thus

the implied EM FX appreciation from our PPP survey to catch up with Spain is excessive.

Spain is no longer a role model.


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Using regional averages as the benchmark, our PPP survey suggests PLN may be as

much as 25-35% under-valued against the EUR. This harks back to the distant days of

July 2008, when EUR/PLN was trading 3.20. And in the EMEA world, EUR/TRY could,

over the medium to long term, trade substantially higher were market conditions and

policy action to allow it. In Asia, our PPP measure suggests the Chinese renminbi may

be anywhere between 10% and 30% under-valued against the dollar, higher than the 3%

to 23% indicated by the IMF in its 2011 Article IV consultation report. Our PPP analysis

suggests there is scope for USD/MXN trading below 10. However, Julys presidential

elections may deter investors from aggressively increasing MXN exposure until political

uncertainty is resolved.

Fig 2 ING3Pi impl ied exchange ra tes

Implied ING3Pi rate Implied ING3Pi rate

Exchange rate

vs

Regional avg

as benchmark

EM as

benchmark

Spain as

benchmark

Exchange rate

vs US$

Regional avg

as benchmark

EM as

benchmark

US as

benchmark

(lc/) (lc/) (lc/) (lc/) (lc/US$) (lc/US$) (lc/US$) (lc/US$)

Emerging Europe

Bulgaria 1.96 1.65 1.57 1.43 1.53 1.30 1.23 0.96Czech Republic 25.4 27.1 25.7 23.4 19.9 21.2 20.1 15.7

Hungary 310 287 271 247 242 224 213 166

Kazakhstan 189 229 217 197 148 180 170 133

Poland 4.40 3.37 3.19 2.90 3.45 2.64 2.50 1.95

Romania 4.33 4.30 4.07 3.70 3.39 3.37 3.19 2.49

Russia 40.5 43.2 40.9 37.2 31.7 33.8 32.0 25.0

Slovakia 1.00 1.07 1.02 0.92 1.28 1.37 1.30 1.01

South Africa 10.26 10.87 10.30 9.37 8.03 8.51 8.06 6.28

Turkey 2.36 2.99 2.83 2.57 1.85 2.34 2.21 1.73

Ukraine 10.22 9.66 9.15 8.32 8.00 7.56 7.17 5.59

Latin America

Argentina 5.51 7.14 6.80 6.19 4.31 5.59 5.33 4.15

Brazil 2.27 2.85 2.72 2.47 1.78 2.23 2.13 1.66

Mexico 17.31 12.10 11.53 10.49 13.55 9.47 9.03 7.04

Asia

China 8.06 6.39 7.13 6.49 6.31 5.00 5.58 4.35

Hong Kong 9.93 12.89 14.39 13.09 7.77 10.08 11.26 8.78

India 65.8 56.8 63.4 57.6 51.4 44.4 49.5 38.6

Indonesia 11,735 11,957 13,355 12,146 9,075 9,247 10,328 8,051

Philippines 55.9 53.7 60.0 54.5 43.7 42.0 46.9 36.6

Singapore 1.65 1.77 1.97 1.79 1.29 1.38 1.54 1.20

South Korea 1,468 1,722 1,923 1,749 1,148 1,346 1,504 1,172

Prices as at 17 January 2012

Source: ING

In Figure 3, we rank the results of our survey against standard valuation metrics for

currencies derived from balance of payments measures of cold money the current

account balance plus foreign direct investment (FDI) in relation to GDP. Abundant cold

money inflows indicate a fundamental argument for currency appreciation. Thisperspective undermines the PPP findings that the SGD is expensive. Alternatively, a

large current account deficit and meagre FDI inflows (ie, a current account deficit funded

largely by hot money) indicates vulnerability in times of financial market stress, eg,

Turkey.


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Fig 3 FDI + C/A as % of GDP, 2011 F and 201 2F (in ord er of ING PPP valuat ion)

-10

-8

-6

-4

-2

0

2

46

8

10

12

14

Mexic

o

Polan

d

Bulga

ria

Hungary

China

Ukraine

Roma

niaIndia

SouthA

frica

CzechR

ep.

Russia

Slovakia

Philip

pines

Indonesia

Kazakh

stan

Brazil

Turke

y

Singap

ore

Argentina

South

Korea

Spain US UK

% of GDP

FDI + C/A (% of GDP) 2011 FDI + C/A (% of GDP) 2012

Appreciation pressure

Depreciation pressure

Source: National sources, ING forecasts

Looking at per capita GDP, our PPP survey reinforces the message that the MXN looks

cheap; it is a relatively wealthy economy with a cheap real exchange rate (see Figure 4).

Poland also appears cheap. We also show the average three-month rates that we expect

to be available in each of our surveyed countries in 2012. At the cheap end of the

spectrum, Hungary offers high rates and abundant cold money inflows. Were it not for an

uncertain political environment, the HUF could start to receive a little more support if the

global environment improves. The expensive TRY and BRL are temporarily supported by

high local rates.

Fig 4 Per capi t a GDP in 2011F and 2012F (US$) ( in order of ING PPP valuat ion)

0

5000

10000

15000

20000

25000

Mexico

Poland

Bulga

ria

Hungary

China

Ukraine

Roma

niaIndia

SouthAfrica

CzechRep.

Russia

Slovakia

Philip

pines

Indonesia

Kazakh

stanBrazil

Turkey

Singap

ore

Argentina

South

Korea Sp

ain US UK

Hong

Kong

Per capita GDP US$ 2011 Per capita GDP US$ 2012

Above the line= cheap

Below the line= expensive

(Capped at US$25,000)

Source: National sources


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Fig 5 Three-month average int erest rat es (%), 2012F (in order of ING PPP valuat ion)

0

2

4

6

8

10

12

14

16

18

20

Mexico

Polan

d

Bulga

ria

Hung

ary

China

Ukraine

Romania

India

CzechR

ep.

Russia

Slovakia

Philip

pines

Indonesia

Kazakh

stan

Brazil

Turke

y

Singap

ore

Argentina

SouthK

orea US UK

Hong

Kong

3m average interest rates 2012

These currencies are cheap High rates in key EM countries support expensive currencies

Source: National sources, ING forecasts (Chinese rates seven-day repo)

Over the life of our shopping survey, there has been a tendency for PPP exchange rates

for EM and developed markets to converge (see Figure 6). In early 2004, our 100 would

buy over 1.3 baskets of goods, using the EM average. It currently buys just 0.88 of a

basket.

Fig 6 Histor ical ING 3Pi variat ions

0.65

0.75

0.85

0.95

1.05

1.15

1.25

Jan-04

Jun-04

Oct-0

4

Mar-05

Sep-05

Jan-06

Jun-06

Nov-0

6

Mar-07

Aug-07

Jan-08

Jun-08

Nov-0

8

Mar-0

9

Aug-09

Jan-10

Jun-10

Nov-1

0

Mar-1

1

End-11

EM average US Spain

Basketspurchased

per

100

Source: ING


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Fig 7 Relat ive compet i t i veness vs the US s ince 2003 wi t h US rebased to 1 .0

0.8

1.0

1.2

1.4

1.61.8

2.0

2.2

2.4

Jan-03

Jun-03

Jan-04

Jun-04

Oct-0

4

Mar

-05

Sep-05

Feb-

06

Jun-06

Nov-0

6

Mar

-07

Aug-07

Jan-08

Jun-08

Nov-0

8

Mar

-09

Aug-09

Jan-10

Jun-10

Nov-1

0

Mar

-11

End-11

South Africa Turkey Brazil Mexico China

Twice as cheap as US

Below 1.0 = more expensive than US

Source: ING

Fig 8 Convergence currenc ies valuat ions in ING PPP survey

0.6

0.8

1

1.2

1.4

1.6

1.8

3Q00

1Q01

2Q01

4Q01

2Q02

3Q02

Jan-03

Jun-03

Jan-04

Jun-04

Oct-0

4

Mar-05

Sep-05

Feb-

06

Jun-06

Nov-0

6

Mar-07

Aug-07

Jan-08

Jun-08

Nov-0

8

Mar-0

9

Aug-09

Jan-10

Jun-10

Nov-1

0

Mar-1

1

End-11

Basketspurchased

per100

Czech Republic Hungary Poland Spain

Romania Turkey Ukraine Russia

Cheap

Expensive

Source: ING

Fig 9 EM pol icy rates Marc h, June and Decem ber 2012 forec asts

0

2

4

6

8

10

12

Mexico

Polan

d

Hungary

China

Ukraine

Roma

niaIndia

CzechR

ep.

Russia

Slovakia

Philip

pines

Indonesia

Kazakh

stan

Brazil

Turke

y

SouthK

orea US UK

EM policy rate end March 2012 EM policy rate end June 2012 EM policy rate end Dec 2012

4.50

7.25 7.00

5.50

0.75

7.75

4.00

7.50

5.75

3.25

0.00-0.25

4.003.50

7.75

0.75

5.00

9.00

0.50

Source: ING


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EM currency valuations are converging with those in the developed world. On a

relative basis, the currencies of Mexico and Poland look as though they have room

for appreciation/convergence. Turkey, Brazil and Korea have converged.

[email protected]


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Disclosures AppendixANAL YST CERTIFICATION

The analyst(s) who prepared this report hereby certifies that the views expressed in this report accurately reflect his/her

personal views about the subject securities or issuers and no part of his/her compensation was, is, or will be directly or

indirectly related to the inclusion of specific recommendations or views in this report.

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