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Emerging Markets Briefer (II)



Brazil – political troubles amid a deep recession

Credit rating:
S&P: BB+ (negative)
Currency regime:
Free float (non-convertible)
Inflation target:
4.5% +/- 2% points

Macro outlook
Brazil is experiencing its deepest recession since the 1930s as real GDP declined by
6% y/y in Q4 15. At the same time, a widespread corruption scandal is paralysing the
political system, preventing action to stem the rapid rise in the public debt burden.
The domestic economy is under tremendous pressure with the service PMI slumping
to 37 in February. Although the fall in consumer confidence has levelled out, it
remains at depressed levels amid rising unemployment and a sharp fall in real wages.
We expect a further fall in investment and private consumption over the coming
quarters. Furthermore, we expect government spending to be a drag on GDP growth.
However, net exports should contribute positively, especially as we expect iron ore
demand from China to recover as its construction sector rebounds. Overall we project
below-consensus real GDP growth of -3.8% and -1% in 2016-17 (consensus -3.4%
and 1%, respectively).

Monetary policy outlook
The Brazilian central bank (BCB) kept its leading Selic rate constant at 14.25% at the
policy meeting in March. As we expected, inflation pressures have started to ease
with the stabilisation in BRL and increasing slack in the economy. Hence, although
we expect some further weakening of the BRL, we think inflation could fall further in
the next months. Hence we think there is a good chance that the policy rate could be
lowered 25bp at the next meeting at the end of April.

FX outlook
 The BRL has remained surprisingly strong vis-à-vis the USD since September thanks
to the sharp rise in iron ore prices and market optimism about a downfall of the
Roussef government giving way to a more reform-friendly government. However, we
are sceptical that Roussef will easily step down in the near term (at least not before
the Olympic Games over the summer), which will weigh on BRL. Hence we expect a
weakening of the USD/BRL on 3M to 4.10, but then expect it to strengthen to 3.9 in
6M and 3.8 in 12M given potential upside from the Roussef administration stepping
down, increasing commodity demand from China and the BRL being somewhat


China – calm restored in Chinese markets

Credit rating:
S&P: AA- (stable)
Currency regime:
Managed exchange rate versus USD
Inflation target:
3.0% for 2016

Macro outlook
The Chinese economy slowed to 6.8% y/y in Q4 driven by weaker activity in the
industry and construction sector. The service sector grew robustly above 10%. Chinese
activity has been hurt by weak foreign demand and a sharp slowing in the construction
sector due to a big oversupply of houses. Meanwhile, private consumption has continued
to grow at a decent clip of around 8% y/y.
Looking ahead, we see tentative signs of a gradual recovery in the construction sector as home sales have been boosted by stimulus measures and housing oversupply is gradually
coming down. Infrastructure investment is supported by fiscal stimulus and consumption
and service sector growth is expected to remain strong. The Chinese government’s
growth target for 2016 is 6½-7%. Our forecast for GDP growth is 6.7% and 6.6% for
2016 and 2017.
China is facing several challenges from a strong increase in debt over the past few years.
Non-performing loans are on the rise – partly related to the sharp slowdown in
construction hitting developers and the steel and cement industry. China will need to slow
down the build-up of debt sooner or later, but for now we believe the government has the
tools to deal with the debt and recapitalisation of the banks should avoid a banking crisis.
As construction recovers, the rise in non-performing loans should stabilise. China still has
a big current account surplus of 3% of GDP and is still gaining market shares in global
export markets.

Monetary policy outlook
The People’s Bank of China (PBoC) currently has a clear easing bias and cut the reserve
requirement ratio (RRR) in Q1 by 50bp. We look for a further decline of the RRR of 50-
100bp this year and additional rate cuts of 50bp over the next six months. The lower
interest rates will give further stimulus to housing and ease the burden on companies.

FX outlook
China saw significant CNY selling pressure in January but managed to stabilise
outflows by pushing up offshore (CNH) money market rates through intervention.
Since then markets have calmed down. We do not believe China will devalue as the
markets have feared. Instead, we expect a continued gradual weakening versus the
USD as China eases further and the Fed raises rates. We look for a gradual weakening
towards 6.85 +12M versus the USD, a depreciation of around 5%.


India – still the bright spot

Credit rating:
S&P: BBB- (stable)
Currency regime:
Free float
Inflation target:
4% by end-2017

Macro outlook
India is one of the few bright spots in the Emerging Markets universe. While growth
has slowed a bit lately, it is still robust at around 7%. India is benefiting from the
lower oil price while improving external and domestic balances have left room to ease
both fiscal and monetary policy. India also has a relatively strong government that at
least to some degree has speeded up structural economic reforms, although not as
much as hoped for.
India’s GDP growth is likely to be above 7% in the coming years and exceed China’s
growth as there is still plenty of low-hanging fruit to be picked – in contrast with
India’s current account deficit has declined markedly to less than 2% of GDP and
should decline further due to the sharp decline in the crude oil price. We no longer
regard India as among the ‘fragile’ emerging markets as imbalances have been
reduced markedly over the past two years.

Monetary policy outlook
Reserve Bank of India (RBI) in March last year moved from targeting wholesales
prices to targeting consumer price inflation within 4% +/-2%. It is a gradual adjustment
and for Jan-2016 the target was below 6%. Inflation is currently at 5.2% and thus safely
below the target. The low inflation gave room for the RBI to cut interest rates at the end
of September last year by 50bp to 6.75%. This followed three cuts of 25bp since
December last 2014. We expect RBI to keep rates unchanged, although further cuts
cannot be ruled out to underpin growth.

FX outlook
In line with other emerging market currencies, the INR will remain under pressure
against the USD, in our view, but it is no longer one of the fragile EM currencies. The
current account has improved substantially and India is benefiting from the low oil
price. A credible central bank is also boosting confidence in the Indian economy. In
2016, gradual monetary tightening in the US and continued depreciation of the CNY
could weigh further on the INR and we look for a further depreciation of around 5%
in 12M.


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