Springtime in Emerging Markets
One of the most striking features so far of 2016 has been the relative strength of Emerging
Market (EM) currencies. This has happened over a period when other risky assets generallyplummeted.
What explains this relative strong performance? First, many EM currencies
were in cheap territory after being battered over the past two years since the tapering
discussion started in May 2014. Furthermore, after a turbulent start to the year, the worst
fears about a meltdown in China have abated and commodity prices have seen a recovery.
The G20 finance ministers and central bankers’ meeting in Shanghai, while not resulting in a grand growth plan, seems to have ensured closer coordination between the world’s biggest central banks, supporting global risk sentiment.
Will EM currencies continue to do well? They may well; at least as long the Fed maintains
its relatively dovish stance, which it signalled on Wednesday (16 March). In a way, the
combination of a relatively healthy growing US economy (ensuring demand for EM exports) and subdued wage growth (taking the pressure off the Fed to raise rates) may be the best of both worlds for EMs.
Commodities seems to be finding a stronger footing after a couple of difficult years. Oil
producing countries finally seem to be talking about cutting back on excessive production
with both OPEC and non-OPEC countries planning to meet next month and a relative
dovish FED is also helping. Furthermore, the Chinese construction sector is again showing
signs of life as housing starts are starting to rise. As the world’s second most important
commodity importer, a rebound in Chinese construction activity is good news to mining
EMs such as Brazil, Chile and South Africa.
So, are EMs out of the woods? For now yes, but there are certainly several that are still
struggling with the aftermath of the collapse in commodity prices amid weak political
situations (most notably Brazil and South Africa). In addition, Fed angst may well return in
the late summer if the steady improvement in the US economy continues. Therefore, EM
countries should probably enjoy the springtime while it lasts, as the future in uncertain.
Russia – dreaming of recovery
S&P: BB+ (negative)
4% in 2017
According to preliminary data, Russia’s GDP shrank 3.7% y/y in 2015 versus 0.6% y/y
growth in 2014. The path of economic contraction continues to slow. GDP shrank 2.5%
y/y In January 2016 versus a 3.5% y/y fall in December 2015. We expect the economy to
shrink 2.1% y/y in 2016 if the crude price stays at USD31/bl on average, while we would
expect expansion to happen if the oil price climbs to USD59/bl on average.
The supply-side indicators touched the bottom in Q3 15, while recovery prospects
remain very fragile, as the Brent oil price average YTD is still under USD35/bl.
However, Russia’s oil production hit its post-Soviet high, climbing to almost 11m
bpd. Seasonally adjusted data show that industrial production grew 0.3% m/m in January
2016, while construction shrank 1.5% m/m seasonally adjusted.
Growth in private consumption continued to be negative, as real disposable income is
shrinking, inflation is high and purchasing power for imported goods has fallen
significantly. Food inflation is decelerating due to the high base effect but weighs on
private consumers, with 9.2% y/y in January versus 14% y/y in December 2015.
FX and monetary policy outlook
Russia’s central bank (CBR) kept its key rate unchanged at 11.0% on 29 January in
line with our expectations and those of consensus. The main reasons given by the
central bank for holding rates were ‘another oil price slump’, high levels of consumer
price growth and a higher risk of accelerated inflation despite continuing disinflation.
We expect the CBR to stay on hold at its next meeting on 18 March 2016, while risks
for resuming monetary easing have increased on a higher oil price and stronger RUB,
which are subduing price growth further.
Inflation eased to 8.1% y/y in February, from 9.8% y/y in January, as prices already
included the RUB devaluation and the high base effect is weighing on the CPI. We
expect 2016 inflation to stay single digit, posting 8.1% y/y in December 2016.
The RUB continues to be the best play among oil producers on a
rising oil price. Yet, Russia’s currency has moved closer to its equilibrium levels, as
its strengthening has been subdued. We continue to be bullish on the RUB in the long
run, as the free float is protecting Russia’s current account surplus and economy
despite probably another year of a slump.
Potential upside risks to our macro outlook are a higher oil price, easier monetary
policy and expansionary fiscal policy before the parliamentary elections in the
autumn. Yet, we do not expect the revoking of sanctions. An escalation of geopolitical
issues and a tumbling oil price are downside risks to our GDP growth forecasts.
Turkey – solid growth, higher risks
S&P: BB+ (negative)
5.0% year-end 2016-17
Turkey’s positive economic surprises continued, as Q3 15 GDP expanded 4.0% y/y
versus 3.8% y/y a quarter earlier. Consensus expected a slowdown to 2.7% y/y. Early
2016 macro indicators have been supported by a weaker lira. We continue to expect
growth to slow to 2.7% y/y in 2016, as tight monetary policy continues and foreign
trade is suffering from the geopolitical situation.
Industrial production continued its solid expansion, posting 5.6% y/y growth in January
versus a 4.6% y/y (revised) increase a month earlier. The strongest growth is in both
durable and non-durable consumer goods production, especially pharma products. Yet,
local consumer confidence has begun deteriorating, which is likely to weigh on private
consumption, partly subduing industrial production growth.
The current account balance switched into negative territory despite low oil prices, as
exports to Russia fell. We continue to see downside risks to the current account
development, as we expect Russia’s economic sanctions to weigh on USD45bn of
bilateral trade annually, hitting the Turkish tourism sector and agricultural exports.
FX and monetary policy outlook
Inflation decelerated to 8.8% y/y in February 2016, down from its 20-month high of
9.6% y/y a month earlier, as the lira weakness effect on prices eased. The Turkish
central bank kept its policy rate unchanged at 7.50% in February, in line with our
expectations and those of consensus. As the lira is climbing as a result of the dovish
Fed, we see the previous risk of an emergency rate hike decreasing significantly.
We expect the lira to get support in the short and medium term due to improvements
in global risk sentiment and rising appetite towards emerging market assets because of
the dovish Fed, ECB and Bank of Japan. We see a slight deterioration in the TRY spot
in the long run, due to rising oil prices and weaker exports, which we believe will add
to pressure on the current account deficit.
Uncertainty about Turkey’s cross-border military operations, current geopolitical risks and volatile FX inflows could fuel a deterioration in sentiment. Higher oil prices
would put renewed pressure on the current account. Further dovishness by major
central banks is a strong upside risk for our TRY forecasts. Geopolitical risks could
depress the Turkish economy on the back of Russia’s sanctions.
South Africa – messy politics, messy economic outlook
S&P: BBB- (negative)
Free float (freely convertible)
South Africa continues to struggle with the aftermath of the collapse in commodity
prices. Real GDP growth fell to 0.6% y/y in Q4 15, the slowest pace in 18 years (apart
from the brief recession in 2008) given weak domestic demand and net exports (due
to declining exports and higher imports). Consumer confidence is extremely weak,
although retail sales and private consumption have so far been relatively resilient. We
think that private consumption will start to weaken at a faster rate and expect real
GDP growth to slow to 0.9% in 2016 and only recover slowly to 1.5% in 2017. On a
more positive note, the higher gold prices is improving South Africa’s terms of trade.
The uncertainty about the future of finance minister Gordhan adds to concerns about
the future policy direction of South Africa. The row between the finance minister and
the tax agency and the police lately, raises questions about how much backing the
finance minister has from President Zuma and to what extent the finance minister can
deliver on fiscal consolidation and the structural reforms needed to prevent a
downgrade of South Africa to junk.
Monetary policy outlook
The SARB faces a delicate task in containing inflation pressures amid an economy
that could be heading into recession. The SARB increased its benchmark repo rate to
7% on 17 March given the rise in headline inflation above the upper end of the
inflation target range due to food price pressures and a passthrough from the weaker
Rand. Going forward, we think that a relative stable ZAR and slag in the economy
could reduce inflation pressures in the economy. Hence, we expect the SARB to
remain on hold for the time being and to monitor inflationary developments before
changing the policy rate again.
Despite domestic uncertainty and weak global risk sentiment, the ZAR has
strengthened against the US dollar (since mid-January, the ZAR has strengthened by
7%). The political uncertainty and potential rating downgrade will weigh on the ZAR
in our view over the next months but may be neutralised by the impact of a more
dovish FED and higher commodity prices. Over the medium term, we see ZAR
strengthening, as the ZAR is fundamentally undervalued after years of weakening. As
a result we forecast the USD/ZAR to trade slightly around 15.30 in 3-6M and then
strengthen somewhat to 15.00 in 12M. However, we caution the outlook is very
uncertain given political risks.