The impact of global market volatility

on the EBRD region

CSE and OCE September 02, 2015

KEY RECENT DEVELOPMENTS

IN CHINA AND COMMODITY MARKETS

Emerging markets growth

has been decelerating since 2009

3

Sources: IMF WEO, EBRD REP, weighted averages.

4

Recently growing concerns about slowdown

in China - despite continued 7% growth

• Exports growth has been decelerating markedly

• Weaker PMI index (manufacturing orders) in July-August

Source: National Sources, IMF, authors’ calculations.

5

China has moved towards (somewhat) more

flexible exchange rate on 11 Aug 2015

• This resulted in a 3% depreciation against the US dollar, in contrast with long-term appreciation trend

• IMF is currently reviewing possible addition of yuan to SDR basket of currencies from 2016 (which would likely require China’s forex markets to “mature”)

Source: Bloomberg

100

105

110

115

120

125

130

Dec

-06

Apr-

07

Aug-

07

Dec

-07

Apr-

08

Aug-

08

Dec

-08

Apr-

09

Aug-

09

Dec

-09

Apr-

10

Aug-

10

Dec

-10

Apr-

11

Aug-

11

Dec

-11

Apr-

12

Aug-

12

Dec

-12

Apr-

13

Aug-

13

Dec

-13

Apr-

14

Aug-

14

Dec

-14

Apr-

15

Aug-

15

USD per 1 RMBIndex: 31 Dec 2006 = 100

6

Correction in China’s stock market sparked

global sell-off on 24 Aug

Shanghai Stock Exchange index lost 8.5 per cent on 24 Aug and 7.6 per cent on Aug 25

Overall, China’s stock market has dropped 39% since its peak from June 12th, yet

remains more than 40% up on a year ago

Source: Bloomberg

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

5,500

01-Sep-12 01-Sep-13 01-Sep-14 01-Sep-15

Shanghai Stock Exchange Index

ca. 40 % downsince the peak

peaked on June 12at 5,166

7

Global equities lost ground; emerging markets,

already under pressure, additionally impacted

Source: Bloomberg

• EM pressures over the last few months reflect expectations of the US monetary tightening

8

Interest rate hike announcement by FED on 17

September 2015 now seen as less likely

0

500

1000

1500

2000

2500

3000

3500

4000

4500A

ug-0

7

De

c-0

7

Ap

r-0

8

Au

g-0

8

De

c-0

8

Ap

r-0

9

Au

g-0

9

De

c-0

9

Ap

r-1

0

Au

g-1

0

De

c-1

0

Ap

r-1

1

Au

g-1

1

De

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1

Ap

r-1

2

Au

g-1

2

De

c-1

2

Ap

r-1

3

Au

g-1

3

De

c-1

3

Ap

r-1

4

Au

g-1

4

De

c-1

4

Ap

r-1

5

Au

g-1

5

Tota

l a

sse

ts, U

S$

bil

lio

n

Source: Fed; ECB

FED

ECB

Start of tapering

Fed starts QE1

Fed announces "tapering" of QE3

End of QE3

End of QE2

Start of QE2

End of QE1

Start of QE3

ECB provides€489 billion via LTRO with a maturity of 3 years

€530 billion allocated with 3 year LTRO

ECB starts purchasing"weaker" states' bonds

ECB starts QE

• But overall tightening in the US still expected

Current operational indicators: refineries` maintenance period is approaching; storages are at record level; long-lead projects still coming online

Supply growth: High supply by Saudi Arabia and other OPEC; US producers more resilient than expected

Demand slowdown: China’s demand growth is expected to slow down for the first time

Iran deal: Iran’s oil supply is expected to gradually return to pre-sanction levels

9

On Aug 24th Brent oil declined to

US$ 43 per barrel

Source: Bloomberg

Spillovers to the EBRD region

11

Lower oil prices: gains spread, losses heavily

concentrated

-50

-40

-30

-20

-10

0

10

20

Turk

men

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Aze

rbai

jan

Kaz

akh

stan

Ru

ssia

Bel

aru

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Alb

ania

Esto

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Egyp

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Ukr

ain

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Ro

man

ia

Tun

isia

FYR

Mac

edo

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Po

lan

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Slo

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Mo

nte

neg

ro

Bu

lgar

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Tajik

ista

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Latv

ia

Cro

atia

Slo

vak

Rep

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Serb

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Geo

rgia

Hu

nga

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Turk

ey

Cyp

rus

Lith

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Mo

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Mo

ngo

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Mo

rocc

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Kyr

gyz

Rep

.

Per

cen

t o

f G

DP

Net oil imports 2013

Source: IMF World Economic Outlook

• Major commodity exporters are most immediately affected

12

Capital outflows intensified in the second

quarter of 2015

• Based on EPFR monthly mutual fund flows -- similar trends in balance of

payments data (available with a long lag)

Source: EPFR

-0.6

-0.5

-0.4

-0.3

-0.2

-0.1

0

0.1

0.2

Hu

nga

ry

Po

lan

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Ro

man

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Turk

ey

Ukr

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Ru

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Kaz

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Ne

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infl

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DP

, an

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Q1 2015

Q2 2015

13

Downward pressures on currencies

Source: Bloomberg

14

High stock of total forex debt

means vulnerability to capital outflows

• If economies with high forex exposure adjust via exchange rate depreciation, burden of

debt service rises significantly

Source: National authorities, BIS, World Bank, IMF and EBRD Staff Calculations.

Total debt denominated in foreign currency comprises public, household and corporate debt, both domestic and external.

15

A number of countries with high forex debt

already experienced significant depreciations

Source: Bloomberg, National authorities, BIS, World Bank, IMF and EBRD Staff Calculations.

Total debt denominated in foreign currency comprises public, household and corporate debt, both domestic and external.

Regional developments and

vulnerabilities

Concluding remarks

Sell-off in China sparked increased global volatility; Emerging markets negatively

impacted

At the same time, the Fed interest rate hike is now widely expected to happen later

In the EBRD region, commodity exporters have been the most immediately affected • Rouble weakened further in Russia,

• Kazakhstan floated tenge on 20 August in anticipation of low oil prices

This may add to the pressure on currencies in the EEC region and Central Asia,

given countries’ strong trade, investment and financial sector linkages with Russia

Other countries are vulnerable to increased volatility of capital flows into emerging

markets

Turkey’s economy is particularly vulnerable • In Turkey, the situation is compounded by political uncertainty

• Large current account deficits (around 6 per cent of GDP last year) financed by non-FDI portfolio inflows,

substantial refinancing needs and significant external corporate debt denominated in US dollars

Markets in CESEE have shown some increase in volatility in recent days; are likely to

be further affected by increased global volatility 17

Turkey

Turkish economy was already squeezed by expected US monetary tightening, rising regional

geopolitical tensions, elevated domestic political uncertainty and domestic security issues

Amidst this environment, news from China additionally affected Turkish markets last Monday:

Equity market weakened, as BIST 100 index declined 2% on Monday, carrying total losses since the beginning of the year to 15.7%

CDS rose to 295 from 280 last week and 175 at the turn of the year

Lira weakened 0.4% against the USD and 3.7% against the Euro on Monday, bringing total losses since the turn of the year to 26% for USD and 20% for Euro

Direct impact of Chinese slowdown on Turkish trade will likely be limited, as China makes up only 1.8% share of Turkish exports

Low oil prices will benefit Turkey, but the effect will likely be dominated by deteriorating investors’ sentiment towards emerging markets

Given large current account deficits (around 6 per cent of GDP last year) financed by non-FDI inflows, large refinancing needs (around US$ 220 billion annually) and external corporate debt denominated in US dollars, Turkey’s economy is particularly exposed to emerging market capital outflows. However, public debt remains low at around 33 per cent of GDP and banking sector well capitalized and with low NPLs, providing some buffers for reaction

18

Russia

Rouble is now trading above 70 to the dollar (and shortly touched 75),

and recession is deepening: lower rouble may help exports and partially offset lower budgetary oil receipts

Our forecast of -4.5% growth in 2015 and -1.8% in 2016 still looking valid

The recently revised “conservative” forecast of the Ministry of Economic Development also includes continuing recession (-3.7 per cent in 2015 and -0.9 per cent in 2016) in case of sustained low oil prices (50 US$ in 2015 and 40 US$ in 2016).

Overall reforms have stalled, with negative consequences for long-term growth prospects.

Capital outflows in H1 below last year’s levels but still substantial.

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Central Asia/Kazakhstan

On August 20th, Kazakhstan switched from the exchange rate regime with peg to the US dollar, to a floating exchange rate regime with inflation targeting

The switch was expected, however, the timing has been brought forward considerably, reflecting government’s/NBK’s view of the expected further decline in oil price (and to a much lesser extent deterioration of other external factors)

Tenge is now trading at around 235 USD/KZT or around 20% below the exchange rate prior to introduction of the floating rate regime

Weaker Tenge will support exporters, particularly oil and other commodity producers, as well as alleviate some of the pressure that domestic producers face from Russian competitors

Our current forecast of 1.5% growth in 2015 and 2.0% in 2016 remain broadly valid, however, there are significant downside risks to growth if the oil price further weakens

Inflation can be expected to increase, but from very low levels, and it is projected to reach 6% in 2015, although precise outcome depends on the scope and effectiveness of government’s announced anti-inflationary price control measures

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EEC/Ukraine

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Ukraine:

• GDP fell by 17.2% and 14.7% year-on-year in the first and second quarters of 2015. Some sequential month-on-month metrics indicate that the economy may have bottomed out in the middle of the year. Given the scale of the contraction in the first half and the ongoing fighting in Ukraine’s East, we see realization of significant downside risks to our GDP growth forecast for Ukraine in 2015

• On August 26, 2015, Ukraine and Bondholders’ Committee signed indicative term sheet with respect to the debt operation (20% reduction in nominal principal value, 4-year maturity extension, coupon increase from c7.2% p.a. to 7.75% p.a., GDP linked warrants in 2021-2040). Formal launch of the Exchange Offer expected no later than September 15

• Ukraine is broadly on track with structural benchmarks and prior actions under the IMF programme

• Removal of capital controls is likely to be incremental, stretching into 2016 EEC

• Currencies in the EEC region have been under pressure, including due to trade,

investment and financial sector linkages with Russia and oil price adjustment. Country-specific economic trends / vulnerabilities depend on inherited domestic and external imbalances, existence of fiscal space and buffers, stability of financial sector and past record of structural reforms

SEMED

22

Limited direct effects from China – sign that countries in SEMED have not diversified much to other markets.

Lower oil prices is directly beneficial, but important negative indirect effects, through likely drop in FDI to oil sector, and drop in support from GCC countries which are facing fiscal pressures themselves.

• Lower oil prices, better external demand from US the

eurozone and economic reforms support growth

Security and geopolitical risks remain high

CEB and SEE

• Limited direct trade or financial linkages with China. Currency

depreciation versus EUR as yet limited

• As other emerging markets gain competitiveness from depreciation CEB will need to maintain export market shares through further quality upgrades

• CEB economies play increasingly important role in ‘global value chains’ managed by western European investors, but with China and other emerging markets as ultimate source of demand

• A sustained emerging markets downturn would likely discourage further FDI, and relocation of more sophisticated production stages into the CEB economies

• Trade links between China and SEE are low but growing (e.g. Kosovo exports significant amounts of scrap metal to China)

• Lower oil imports largely beneficial (Albania is an exception – effect is approximately neutral)

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