Download pdf - Emerging markets outlook, October 2014

8/10/2019 Emerging markets outlook, October 2014

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Emerging markets outlook

Emerging Markets FX

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


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

Weak growth, stronger dollar and geopolitical concerns

Emerging markets analysis October 13, 2014

The appreciation of the US dollar, concerns about higher interest

rates in the US and signs of weaker growth in China in particular

have placed pressure on emerging market currencies. Further

stimulus from the ECB hasnt helped to ease these concerns.We expect the pressure on most emerging market currencies

to continue this fall with the market again focused on weak

underlying fundamentals, including slow growth, imbalances and

geopolitical concerns.

Economic development in Chinahas been broadly disappointing

despite a major stimulus from the government. Housing pricesare falling throughout the country and industrial production

has lost momentum. Low demand from China means that

commodity prices will continue to trend downward. Moreover,

the protests in Hong Kong have raised concerns about socialconict on the mainland. This, together with continued unrest

in Russia and Ukraine and growing expectations of interestrate hikes in the US, has turned sentiment on several emergingmarket currencies bearish. This summer capital owed almost

without hesitation to currencies with high short-term interest

rates given the expectations of further stimulus from the ECB.

Since September growth concerns have spread to the eurozones

biggest countries. In the process, the focus and concern has

shifted to weaker growth and the effects of a stronger dollar.

Except for the nancial crisis in 2009, economic growth in Braziland South Africais the lowest in over 10 years.

A stronger dollar is mainly hurting currencies with large fundingneeds in dollar. This includes Turkey, South Africa, Brazil andIndonesia. We expect the weak trend for emerging marketcurrencies to continue this fall despite that several currencies

are signicantly oversold. The biggest risk for our negative

outlook is if the pressure on emerging market currencies is met

with substantial rate hikes, as happened in January. Another,

though less likely, possibility is that China decides to stimulateits economy even more than before.

We are still positive to Indias and Chinas currenciesversusthe euro, however. Partly this is because we expect a stronger

dollar. We feel that the rupee is less vulnerable to higher USrates thanks to a rapid improvement in Indias external balance

and better condence in policy makers. The dollar has the

support of a steadily improving US economy and expectations

of rate hikes starting next year. At the same time growth is

surprising on the downside in the eurozones big countries, and

the ECB is under major pressure to increase its stimulus. As a

whole, relative growth and relative monetary policy both favor

the dollar against the euro.


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Forecast EUR/RUB in 3 months 51.05 (today 51.02) Forecast EUR/PL N in 3 months 4.30 (today 4.19)

Currency forecast vs. the euroCurrency forecast vs. the euro

The Polish zloty has traded this year within a narrow range

against the euro and appreciated against the euro. We expect

the zloty to be slightly more vulnerable for the remainder

of the year. The effects of the crisis in Russia and Ukraine,

together with lower demand from the eurozone, are impeding

growth. Our forecast is that the zloty will weaken slightly

against the euro as the central bank cuts the benchmark rate.

The Polish economy has lost steam. While GDP grew by 3.3%

in the second quarter, economic data since then have been

disappointing. The economy has been driven by domestic

demand, mainly strong investment growth. Industrial

production has lost momentum and rose by only 1.4% at an

annual rate in August, compared with a growth rate of 7.5%

in April. The anemic numbers in recent months are rooted in

weaker exports owing to the recent slowdown in the eurozone,

especially in Germany. Poland is highly dependent on Germany,

where it sends 25% of its exports. The crisis in Russia and

Ukraine has almost certainly affected activity as well. It seems

that this weakness will continue through the rest of the year.

The purchasing managers index has collapsed from 55.9 in

February and stayed below the 50 mark for the last three

months. The ination rate has been negative since July, which

pressured the central bank to cut its benchmark rate by 50bpto 2.0% at its meeting in the beginning of October. We expect

the central bank to cut at least another 25bp during this fall.

On the positive side, low ination is strengthening household

purchasing power, which, along with job growth, is partly

offset ting the slowdown in manufacturing.

Poland

Strong household purchasing power

Low short-term rates

Russia

High short term rates

Weak growth and isolation

We expect the ruble to continue to weaken against the dollar.

Due to the high interest rate level in Russia, we anticipate a

gradual decline. The risk is that it will be bigger and faster if

Russia is slapped with further sanctions or if the central bank

introduces capital controls to stop capital outows. We have a

neutral view on the ruble against the euro as we see a stronger

dollar ahead.

The Russian ruble has continued to weaken to a new low

against the dollar. The crisis between Russia and Ukraine

has stabilized somewhat, with reports of troop pullbacks by

both sides. On the other hand, the EU decided on additional

sanctions against Russian ofcials in early September. Russia

countered with a bill that allows it to seize foreign assets in

Russian territory and by retaliating against several Western

companies operating in the country. Russia is also demanding

that the trade agreement between Ukraine and the EU be

ripped up and renegotiated. We expect political tension to

continue between Russia and the West for the foreseeable

future and economic activity in Russia to remain weak. The

credit channel from the West is practically closed, which means

that already weak investment activity will slow even further.

Households have been the driving force in the economy, but

high ination is reducing their purchasing power. The centralbank unexpectedly raised its benchmark rate at the end of July

by 50bp to 8%. Rates are now their highest since 2009, which

is slowing credit growth and consumer spending, as reected

in new car sales, which fell 26% at an annual rate in August.


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Forecast EUR/ TRY in 3 months 2.89 (today 2.89) Forecast EUR/Z AR in 3months 14.15 (today 14.07)


Though it is historically low in terms of its real effective

exchange rate, we remain negative to the rand against the

dollar due to South Africas persistent underlying problems

with slow growth, a large current account decit and falling

commodity prices. We have a neutral view of the rand against

the euro.

After a stable period this summer, the lira has weakened. It is

still among the currencies that are highly sensitive to tighter

global liquidity. The current account balance has improved, but

nancing of the decit is short-term. We remain negative to

the lira against the dollar and neutral against the euro.

A long list of negative stories about the South African

economy now includes mining strikes, which are cutting into

metal exports at the same time that the electricity shortages

are leading to higher oil imports. This has caused a record-

high trade decit. As a result, the current account decit

remains at about 6% of GDP. Growth is low, ination is high

and structural problems in the labor market persist. GDP

grew by only 1% in the second quarter, the lowest rate since

the nancial crisis. In 2000-2008 the growth rate averaged

about 4%. The purchasing managers index has stayed below

the 50 mark, indicating continued weakness in manufacturing.

After trending downward since 2011, the rand is weak in both

nominal terms and measured by its real effective exchange

rate. In spite of this, there isnt much in the economic data

that suggests the rand is undervalued. Exports are falling and

a weak commodity market has hurt terms of trade. Domestic

demand is also low, as evidenced by weak retail sales andimports. The ination rate has stayed above the central banks

upper tolerance level of 6% for most of 2014 and in August

reached 6.4%. The central bank has raised its benchmark rate

twice this year to 5.75%, and we expect further rate hikes.

Turkish growth slowed in the second quarter. GDP rose by 2.0%

on an annual basis, compared with an annual growth rate of

4.7% in the rst quarter. The drop-off is due to lower domestic

demand, including a 3.5% annual decline in investments.

Growth is being sustained by a trade surplus driven by lower

imports as well as strong exports. The trade balance has

gradually improved during the year, helping to reduce the

current account decit from about 9% of GDP to about 6.5%.

While the decit has shrunk, the economy remains vulnerable

to global risks, and the decit is still being funded with short-

term debt. The ination rate remained stubbornly high at 9.5%

in August, far exceeding the central banks tolerance level.

That didnt stop it from cutting the repo rate in several steps

this year to 8.25%. After the latest cut, real interest rates are

negative. The central bank considers monetary conditions to

be tight, but with real interest rates negative it continuesto undermine condence in its monetary policy. Domestic

demand is weak and may be in need of stimulus, but to secure

long-term funding for the current account decit the central

bank will have to increase condence in its economic policies.

South Africa

Low exchange rate

Weak external balance and low growth

Turkey

High short-term rates

Vulnerable to escalating risk in the nancial markets


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Forecast EUR/MXN in 3 months 16.48 (today 17.05) Forecast EUR/BRL in 3 months 3.14 (today 3.07)


The Mexican peso has appreciated signicantly against the

euro in 2014, which is partly because the euro has been weak

against the dollar. We like the peso for fundamental reasons.

While we see short-term downside risks against the backdrop

of expectations of rate hikes in the US, we are positive to the

peso against the euro through the end of the year.

Mexicos slow economic development continued during the

second quarter, with GDP growth of 1.6% on an annual

basis. As a result, growth has trended below average (about

2.5%) since early 2013. The slow growth is due to weakness

in manufacturing outside automaking, weak activity in the

construction sector and sluggish domestic demand. Domestic

demand, especially consumer spending, has stood still due to

weak consumer condence, which hasnt recovered from a

big drop in 2013. Retail sales growth has uctuated around

zero on an annual basis since the beginning of 2013. Auto

production, on the other hand, has accelerated again after

a period of stagnation in 2013. Industrial production saw

negative growth numbers for much of 2013, but rose by 2%

in July at an annual rate. The manufacturing PMI has risen and

the latest reading of 52.7 is evidence of improved optimism in

the industrial sector. The ination rate has uctuated aroundthe central banks upper tolerance level on 4%. On the other

hand, we dont expect any rate hikes in this year. The economy

is not strong enough and the central bank unexpectedly cut its

benchmark rate in June to 3% when it was worried about the

weak economic activity.

The Brazilian economy is facing stagation and is in need of

structural reforms. The election outcome will be important

and the challenges are huge, but we dont expect any rapid

changes in policy. Moreover, the global environment isnt

helping, with falling commodity prices and a strong dollar. We

are retaining a negative outlook on the real.

The rst round of the presidential election produced asurprising result which suggest a very tight race. The outcome

in the second round will be decisive to the investment climateand the nancial markets in Brazil going forward. Regardlessof whether President Dilma Rousseff or opposition leaderAcio Neves wins the election, political and structuralreforms are needed to restore investors condence. Brazilis underinvested and in need of long-term capital to nanceinfrastructure investments. The Brazilian economy is veryweak. GDP fell by 0.8% at an annual rate during the secondquarter and industrial production has trended lower throughmuch of 2014, falling in August by 5.4% at an annual rate.Household consumption rose during the second quarter by1.2% at an annual rate, the slowest growth rate since 2004.The balance of trade has stabilized, mostly thanks to weakimports, with exports continuing to languish. The currentaccount decit corresponds to about 3.5% of GDP, makingthe Brazilian economy vulnerable to lower dollar liquidity. Theination rate remains high despite the economic slowdownand several rate hikes. This year alone the central bank hasraised interest rates three times by a total of 100bp to 11%.This underscores the need for structural reforms to reducebottlenecks in the economy.

Brazil

High policy rate

Weak growth and dual decits

Mexico

Growth-promoting reforms on the way

Weak growth


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Forecast EUR/IDR in 3 months 15498 (today 15478) Forecast EUR/KRW in 3 months 1340.70 (today 1353.69)


The South Korean won lost some of its strength in September.

The strong dollar and growth concerns in China overshadowed

the large current account surplus. We expect the won to

weaken against the dollar as the dollar strengthens and

economic data from China are weak. We believe the won will

strergthen to the euro.

The Indonesian rupiah has several factors in its favor if the

nancial markets risk appetite zzles, including well-stocked

currency reserves, a low historic valuation and a high short-

term interest rate. But because of falling commodity prices

and lower expectations from the new government, we have a

negative outlook on the rupiah against the dollar and a neutral

view against the euro.

The won has been the strongest performer among the

emerging market currencies we monitor in the last 12 months,

appreciating by about 7.2% against the euro. South Korea

has strong fundamentals, with one of the highest current

account surpluses in the world. On the other hand, Chinas

slowdown is beginning to impact economic growth. GDP grew

by 3.5% in the second quarter, down compared with the rst

quarter, when the economy grew by 3.9%. China is South

Koreas largest trade partner, accounting for about 25% of

its exports. Exports to China have slowed on an annual basis

since May, but not only due to lower demand. Competition in

consumer electronics has increased as well, with new Asian

manufacturers of mobile phones with similar functions at

a lower price. Manufacturing sentiment is weak. This can be

seen in the September PMI, which fell to 48.8 from 50.3 in

August. The ination rate was 1.4% in August. On the whole,ination has stayed below the central banks lower tolerance

level since the end of 2012. Thats why it wasnt surprising

that the central bank cut its benchmark rate in August to

2.25%. We cant rule out another rate cut this fall.

Hopes of policy changes grew after Joko Widowo was elected

Indonesias president in July. These hopes were dashed fairly

quickly, however, when parliament decided to end direct

elections of local ofcials. This is a major setback for the

new government and an indication of the difculties it faces.

Uncertainty is now very high whether Widowo will succeed in

introducing much-needed infrastructure investments. At the

same time economic development is weak. Falling commodity

prices are having a big impact on the Indonesian economy.

Commodities account for about 40% of total exports and

18% of GDP. The large part of exports is to Asia, where

demand is weak. GDP rose by 5.1% at an annual rate in the

second quarter, the weakest growth since 2009. Ination rose

signicantly in 2013 but has been cut in half in 2014 and in

September was 4.5%. On the other hand, ination remains

high at the wholesale level, where prices are rising by doubledigits. The central bank has therefore kept i ts benchmark rate

unchanged at 7.5% for the entire year. The current account

decit has shrunk slightly and corresponded to 3.2% of GDP in

the second quarter, compared with a low of 3.8% in the third

quarter of 2013, but remains a risk to the economy.

South Korea

Large reserves and strong external balance

Weak momentum in the economy

Indonesia

Low valuation and high short-term rates

Setback for new government


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Forecast EUR/INR in 3 months 73.80 (today 77.69) Forecast EUR/CNY in 3 months 7.50 (today 7.77)


The Chinese economy is now showing signs of weakness ona broad basis. House prices fell in August in 67 of 70 large

cities. The government has stimulated the economy this yearto counteract weakness in the real estate market by reducingreserve requirements for selected banks and increasinginfrastructure investments. The impact of these stimulusmeasures has been short-lived, however. Industrial productiongrew in August by the weakest annual level since 2009 andinvestment growth during the same month was the lowestsince 2002. Metal prices have continued to fall and steelprices in China have now been cut in half compared with thelevel at the beginning of 2011. We feel that China will have toght hard to reach its growth target of 7.5% for 2014 unlesscredit growth accelerates, which isnt politically desirable. Weexpect GDP for the year to be 7.3%, but with a risk of a lowergrowth rate. On the positive side, and of political signicance,9.7 million new jobs have been created in 2014 despite theslowdown, which means that the government can acceptgrowth slightly below its target. This means that plannedstructural reforms will have to be put off to the future. Thesituation in the housing market poses the biggest risk forthe economy at this point, since a chaotic deceleration couldlead to bankruptcies among construction companies and havenegative consequences for the banking system.

The rupee has appreciated 6.6% against the euro in the last12 months. Including the interest rate component, the total

return is about 16.6%. The biggest reason for this increase isthe expectations that the new government will turn aroundthe countrys economic slide in recent years. GDP grew by5.7% in the second quarter, which was stronger than expectedbut still far from the growth levels of earlier years and rightafter the nancial crisis. The current account decit hasrapidly shrunk. The decit was about 1% as a share of GDP inthe second quarter, compared with about 5% in early 2013.Industrial production slowed during the summer months, butthe purchasing managers index has risen from a low of 48.5in August 2013 to 51.0 in September, indicating that theslowdown in manufacturing is temporary. The ination ratehas been reduced signicantly since Raghuram Rajan tookover as governor of the central bank in fall 2013. On an annualbasis, consumer prices rose by 7.8% and prices at the wholesalelevel by only 3.7% in August. During the period 2012-2013the increases were often around 10% for consumer prices.The central bank has kept the benchmark rate unchanged at8% since a 25bp hike in January. We expect the restrictivemonetary policy to strengthen condence in the inationtarget of 8% by January 2015.

Because of the strong dollar trend and weaker growth inChina, we expect the yuan to pause its steady appreciationagainst the dollar. In the slightly longer term we see the yuanrising against the dollar by about 3% at an annual rate. We alsosee a stronger yuan against the euro given our positive view

of the dollar.

Despite appreciating signicantly this year, the rupee is stillbelow its average real effective exchange rate. The rupeeis less vulnerable today should concerns arise over higherinterest rates in the US thanks to an improved external balanceand stronger condence in policy makers. Falling commodity

prices are positive for India, since oil accounts for a third of itstotal imports. We remain positive on the rupee.

China

Stimulus to mitigate propert y price decline

Economy weak on broad basis

India

Rapid improvement in the current account

Slight slowdown in manufacturing


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