a changing global environment facing emerging markets · 2011. 10. 28. · 2 the wheels of risk are...

Deutsche BankJune 2011

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208-6300. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1

A Changing Global Environment

Facing Emerging Markets

Fernando Losada

[email protected]

1

Global economic outlook

Source: DB Global Markets Research (May 2011)

GDP

growth (%)

CPI

inflation

(%)

2009 2010 2011F 2012F 2009 2010 2011F 2012F

Global -1.2 4.9 4.0 4.4 5.4 3.6 4.1 3.6

G7 -3.5 2.8 2.0 2.9 3.2 1.5 2.6 1.9

US -2.6 2.9 3.2 3.9 3.8 1.6 3.0 2.6

Japan -5.2 4.0 -2.1 1.9 1.4 -0.7 0.5 -0.5

Euroland -4.1 1.8 1.5 1.5 3.3 1.6 2.5 1.9

EM Asia (ex-Japan) 5.7 9.6 8.0 7.6 6.5 5.2 4.6 4.3

China 9.1 10.3 9.4 8.6 5.9 4.6 4.0 3.3

EMEA -4.7 4.3 4.3 4.7 11.1 6.5 6.7 6.3

LatAm -2.7 6.1 4.3 4.1 10.0 8.8 8.9 8.5

Argentina -3.1 9.2 6.9 3.3 14.8 25.2 27.1 28.8

Brazil -0.2 7.5 3.6 4.4 5.9 4.9 6.4 5.2

Colombia 0.2 4.3 5.0 5.4 7.7 3.2 3.5 3.5

Mexico -6.5 5.5 4.4 3.9 6.5 4.4 3.5 3.5

Peru 0.9 8.8 7.0 6.5 0.3 2.1 3.1 2.6

Venezuela -2.9 -1.4 2.0 2.3 26.9 27.2 25.0 25.0

2

The wheels of risk are turning

• Global macroeconomic environment is

changing near term in three ways:

– Concerns about US double dip have faded. Gradually,

focus is turning to timing of withdrawal of monetary stimulus

and sustainability of fiscal stance.

– Europe is becoming less of a driver for global markets.

European policy makers likely to avoid extreme scenario of

uncontrolled default and/or Eurozone breakup.

– EM economies have turned from being a source of

disinflation to becoming a medium term source of inflation.

3

The wheels of risk are turning – bonds and equity

• While we continue to believe that US interest rates will

eventually have to increase, Fed core members

(Bernanke, Yellen, Dudley) are still dovish.

• Inflation is edging upwards on the back of fuel prices.

• However, the combination of the negative output gap

closing at a slow pace, very high unemployment and

the housing sector still in trouble suggests no hikes

are imminent.

• Outlook for US and EU equity markets is moderately

positive on the back of attractive valuations, while

valuations across EM look somewhat stretched.

4

The wheels of risk are turning - FX

• We expect the dollar to be weak against other

central currencies over the medium term, as

the Fed will remain one of the most dovish

central banks.

• We see room for Asia FX appreciation, but we

favor countries with high external growth beta

and C/A surpluses versus economies led by

domestic demand growth with C/A deficits.

5

Oil – A renewed challenge

• Energy price-induced slowdown of the global

economy is a justified concern.

• Every US recession since 1973 has been preceded or

coincided with a sharp oil price increase.

• Two important differences exist nowadays relative to

the 1970s, however:

– Monetary policy is extremely accommodative, allowing the

economy to better absorb an oil price shock.

– The energy share of the economy is lower than before;

household energy consumption currently at 9% of GDP versus

17% in the early 1970s.

6

Some simple US oil arithmetic

• WTI prices at USD100/barrel are consistent with retail

gasoline prices in the US at USD3.40/gallon.

• Every dollar increase in WTI price results in a

USD0.026 increase in gasoline prices, i.e. WTI price

should increase by USD38/barrel for gasoline prices

to rise by USD1/gallon.

• A USD1/gallon increase in gasoline prices leads to a

USD140bn “tax” on personal consumption per year.

• WTI prices averaged USD79.40/barrel in 2010. WTI at

USD110/barrel would offset the positive boost from

the payroll tax reduction announced at the end of last

year.

7

Impact of oil prices on PCE

WTI price (USD/barrel) Retail gasoline

(USD/gallon)

“Energy tax” on personal

consumer expenditure (USDbn)

2010 79.43 2.84 67

2011 90.00 3.15 49

95.00 3.28 66

100.00 3.41 84

105.00 3.54 102

110.00 3.67 120

115.00 3.80 138

120.00 3.93 156

125.00 4.06 174

150.00 4.72 263

8

Oil spike: Winners and losers

• In general, EM fares better than DM during oil

spikes.

• In previous oil crises, increases of USD10/barrel

were associated with drops of 0.4% in DM growth

and 0.2% in EM growth.

• In the EM universe, countries likely to benefit

from higher oil prices include Colombia,

Kazakhstan, Russia and Venezuela.

• Countries such as Hungary, Israel, Turkey and

Ukraine will probably be net losers.

9

Government debt

0

20

40

60

80

100

120

2006 2007 2008 2009 2010 2014

% of GDP

0

20

40

60

80

100

120

% of GDP

Advanced Countries

Developing countries

Forecast

Source: IMF WEO, DB Global Markets Research

Over the medium term, OECD countries face a potential debt overhang

-6 -4 -2 0 +2 +4 +6

Required primary balance in order to stabilise debt/GDP in 2010

EM Countries

Advanced

Economies

EM debt dynamics compares favorably with developed world Advanced economies have a tougher fiscal challenge ahead

• EM’s fairly loose fiscal stances look tight vis a vis DM.

• Less indebted EM should grow faster, continuing to attract capital.

• But complacency in EM may hurt later on…

10

IMF 2003 WEO warned about public debt crises in EM!

Source: IMF WEO

11

But now EM debt outlook looks relatively strong

Adjustment needed to stabilize public debt ratios

Source: IMF, Haver, DB Global Markets Research

-15

-10

-5

0

+5

+10

+15

Gre

ece

Hun

gary

Irel

and

UK

Japa

nE

gypt

Por

tuga

lR

oman

iaP

olan

dP

akis

tan

Fran

ceU

krai

neIta

lyC

z. R

ep.

Mal

aysi

aU

SA

Vie

tnam

Spa

inC

olom

bia

Mex

ico

Indi

aA

ustr

iaG

erm

any

Bel

gium

Chi

naN

ethe

rland

sTu

rkey

Bra

zil

Phi

lippi

nes

Thai

land

Taiw

anIn

done

sia

Isra

elS

. Afr

ica

Sw

itzer

land

Ven

ezue

laA

ustr

alia

Arg

entin

aN

ew Z

eala

ndS

wed

enC

anad

aS

inga

pore

Kore

aD

enm

ark

Finl

and

Rus

sia

Chi

le

Range of primary balance 2005-09

Required Primary Balance

Primary Balance, % of GDP

12

Fiscal effort in developed countries will have to be substantial over the next few years

IMF projections of public sector debt/GDP ratios: High and

increasing in developed countries, low and stable in LatAm

0

50

100

150

200

250

2009

2014

Source: DB Global Markets Research

13

EM economies enjoy structural advantages

Population age is also favoring EM outlook


0

10

20

30

40

50

60

70

80

90

1950 1959 1968 1977 1986 1995 2004 2013 2022 2031 2040 2049

EM

Industrial

Dependency Ratios

EM‟s growth differential vs advanced economies

-2

-1

0

1

2

3

4

5

6

7

1980 1983 1986 1989 1992 1995 1998 2001 2004 2007

Growth differential EM vs Industrial Countries

Avg differential per decade

Growth differential EM vs Industrial Countries (pp)

14

EM economies have achieved policy improvements

EM ratings indicate improvement in fundamentals


Credit model predictions based on our forecasts

BBB+

BBB

BBB-

BB+

BB

BB-

B+

B

99 00 01 02 03 04 05 06 07 08 09 10

Asia

Latin America

EMEA

15


Degrees of mean reversion in EM currencies

0

5

10

15

20

25

30

35

40

45

50

Brazil Mexico Russia Turkey

1995-2004

2005-2010

REER Half Life (in months)

The ultimate proof of improvement: lower measures of market risk

EMFC volatility

11%

25%

29%

11%

29%28%

7% 7%

24%

13%

10%

6%

0%

5%

10%

15%

20%

25%

30%

35%

Bra Mex Rus Tur

FX

Activity

Commodity

16

LatAm FX valuation: Real Effective Exchange Rates(Jan 2005=100)

Source: Global Market Research, IIF

17

EM financial markets have significant room for further development


Such a gap is even bigger in

Latin America

EM has less than half the financial depth of

developed countries

18

LatAm: Commodity blessing this time around


-15

-10

-5

0

5

10

15

20

25

30

35

KZ

T

RU

B

ZA

R

UA

H

EG

P

PLN

HU

F

TR

Y

RO

N

CZ

K

ILS

SK

K

MY

R

IDR

TH

B

CN

Y

INR

PK

R

PH

P

HK

D

KR

W

VE

B

CLP

EC

U

AR

S

CO

P

PE

N

BR

L

MX

N

Energy Metals Food

EMEA Asia LatAm

Net commodity export by country (% of GDP)

19

EM: Rebalancing challenge I


Net savings by region (% of world GDP) Investment by region (% of world GDP)

-1.50

-1.00

-0.50

0.00

0.50

1.00

1.50

ADVANCED EMEA EMASIA MEAST LATAM

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

20.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

EMEA EMASIA MEAST LATAM ADVANCED (lhs)

20

EM: Rebalancing challenge II


FDI to emerging markets (% of world GDP)

0,00%

0,05%

0,10%

0,15%

0,20%

0,25%

0,30%

EMEA EMASIA LATAM

-4,00

-3,00

-2,00

-1,00

0,00

1,00

2,00

3,00

4,00

5,00

2004 2005 2006 2007 2008 2009

LATAM EMEA EM ASIA

Primary balances (% of each regional GDP)

21

EM Monetary Policy: Differentiated sensitivity to EU shock

Source: DB Global Market Research

22

EM Rates are sensitive to global drivers

2Y Rates

Activity CPI Policy Rate CDS 10Y US Rate

BRL 63 57 59 26 43

CLP 14 17 29 0 35

MXN 4 28 56 15 51

COP 2 0 94 10 19

PEN 5 10 81 0 37

HUF 3 0 52 56 49

PLN 6 49 26 15 24

CZK 0 6 95 0 26

ZAR 2 5 59 11 86

TRY 3 58 54 38 64

ILS 16 18 43 0 81

10Y Rates

Activity CPI Policy Rate CDS 10Y US Rate

BRL 44 53 37 52 56

CLP 9 12 0 0 26

MXN 10 40 16 51 53

COP 1 0 44 66 20

PEN 2 41 0 0 57

HUF 1 0 18 49 48

PLN 6 32 6 18 8

CZK 0 6 55 0 26

ZAR 0 1 53 42 84

TRY 4 46 17 53 64

ILS 35 28 8 0 62

NOTE: Shocks of 100 bp for each of the variables

referred to (activity measured in YoY terms)


Rates sensitivities to macro drivers

23Source: DB Global Markets Research

Existing trade links (% of GDP)

EM: Chinese sensitivity

ASIA

0

5

10

15

20

25

30

Taiw

an

South

Kore

a

Philippin

es

Thaila

nd

Mala

ysia

Sin

gapore

Indonesia

India

X to China

M from China

LATAM

0

5

10

15

20

25

30

Peru

Chile

Bra

zil

Arg

entina

Venezuela

Colo

mbia

Mexic

o

X to China

M from China

EMEA

0

5

10

15

20

25

30

Kazakhasta

n

South

Afr

ica

Russia

Isra

el

United A

rab

Em

irate

s

Ukra

ine

Turk

ey

Hungary

Slo

vakia

Pola

nd

Czech

Republic

Rom

ania

X to China

M from China

24

The banking contagion channel to EM

Spain Portugal Greece

Total as share of

Total Credit to

Private Sector

LatAm 367 8 0 27%

AR 14 0 0 34%

BR 147 8 0 20%

CL 54 0 0 43%

CO 12 0 0 19%

MX 129 0 0 36%

PE 11 0 0 24%

EMEA 10 17 35 4%

Asia 5 0 0 0%


Regional loan exposure (USD bn)

25

IMF medium term forecasts sums it up: LATAM is expected to regain the

4% growth path after having the milder 2009 recession and the stronger

2010 recovery, only behind non-Japan Asia and Middle East

Source: IMF

26

Latin America:

Economic Outlook

27

Growth is slowing down but still remains robust

GDP growth

Current account balances

Inflation

LATAM forecasts

(% yoy unless stated) 2009 2010E 2011F 2012F

Real GDP growth -2.5 6.1 4.3 4.2

Priv. consumption -0.3 5.7 5.1 4.5

Investment -9.5 13.8 7.4 5.9

Inflation 6.2 8.3 8.4 8.0

Exports, USD bn 609.8 776.8 890.7 942.4

Imports, USD bn 534.9 703.8 813.2 897.2

Industrial production -7.6 7.4 4.9 4.6

Unemployment (%) 7.8 6.8 6.6 6.5

Fiscal bal. (% of GDP) -3.0 -2.4 -2.2 -2.1

CA bal. (% of GDP) -0.4 -0.9 -1.1 -1.7

-8

-6

-4

-2

0

2

4

6

8

10

ARG BRA CHI COL MEX PEN VEN

% YoY 2009 2010 2011 2012

25.027.1 25.028.8

-2

0

2

4

6

8

10

12

14

16

18


% YoY 2009 2010 2011 2012

-5

-4

-3

-2

-1

0

1

2

3

4

5


2009 2010 2011 2012% GDP


28

Argentina: Nervousness on the rise

Growth has remained strong, hovering around 9%, but policies are certainly unsustainable as state intervention prevents investment.

In the absence of stronger investment, expansionary policies simply push inflation up.

The government will have to eventually abandon the current policy setup as the exchange rate can not be the only tool to maintain stable (although very high) inflation. The peso is not yet overvalued but the pace of appreciation is too fast.

29

Argentina: Election and beyond

The outcome of the coming presidential election will determine the future policy path. Currently, the most likely scenario is re-election.

This could be positive if moderation is achieved. Otherwise, another round of massive capital flight is likely to occur, becoming the market-driven adjustment mechanism.

Fundamentals are strong but somewhat “for the wrong reasons”. Nonetheless, a marginal improvement in policies could make Argentina a solid performer for years.

30

Brazil: Lower growth, higher inflation?

• The real economy is on a deceleration phase and

will most likely grow below potential this year.

• Inflation expectations deteriorated sharply since

4Q10 but appear to have stabilized now, although

at relatively high levels.

• The Central Bank has made it clear that it will

tighten monetary policy at a slow, gradual pace,

complementing the hikes with „macro prudential‟

measures.

• The currency has appreciated the most among

EM peers but flows are still supportive.

31

Brazil: Necessary adjustment, sooner or later

• Annual inflation surpassed the ceiling of the band

in April for the first time since July 2005. Although

we expect it to decline towards year-end, it will

remain above the medium term 4.5% target for the

foreseeable future.

• Protracted high inflation is to impose political

costs on President Rouseff, which in turn could

elicit a more energetic policy response, although

probably not this year.

• Credit origination is decelerating after last year‟s

macro prudential measures, although slowly.

32

Chile: Less exciting but still exemplary

The pace of economic activity moderated during the last quarter but we

expect it will accelerate again in the coming months helped by the

consolidation of a global recovery path. The economy is vulnerable to

oil price shocks and energy bottlenecks, so developments there will

affect performance.

Inflationary pressures are becoming more evident amid a closing output

gap and a tight labor market. This notwithstanding, we project inflation

to be back within the CB range during 2012.

We expect the Central Bank to continue hiking interest rates although

conditioned to the tightening pace in the US. Intervention rates could go

up to 5.75%-6.00% within the next twelve months but the final position

will depend on global rates.

CLP has been trading in the low part of the expected range on the back

of strong domestic growth, elevated copper prices, and the expected

increase of rates differentials. Additionally, the CB seems to be less

worried about appreciation now. Volatile commodity prices, however,

remain a serious risk.

33

Colombia: A successful convergence play

• Recovery in economic activity picking up speed.

• Negative output gap to close during 2H11.

• Inflationary pressures building up on the back of

recovering domestic demand coupled with supply

side shock since 4Q10.

• BanRep on the initial phase of monetary tightening

cycle.

• Average annual headline inflation likely to increase

vis a vis 2010, although remaining within the upper

part of the target band.

• Colombia within a new “inflation regime”, with

equilibrium rates near target levels.

34

Colombia: A successful convergence play

• BanRep to normalize monetary policy gradually until

reaching short term real interest rates of some 250bp.

• BanRep to act slowly and preemptively amid global

market uncertainty.

• We expect target repo rate at 4.75% by Dec 2011, with

another 125bp worth of hikes in 2012.

• MinFin worried about currency appreciation, daily

dollar purchase strategy to continue along with dollar

deposits abroad.

• Chances are good for COP curve flattening, as

BanRep engages in tightening exercise and fears of

substantial inflation in the medium term recede.

35

Mexico: Recovery under way

• Initial phase of the recovery was led by exports.

• Growth is now more balanced, with exports,

domestic consumption and investment becoming

significant contributors.

• Negative output gap likely to close down during

2H11.

• GDP to grow by more than 4% this year. But is

that growth pace sustainable?

36

Mexico: Ties to the US

• Industrial production cycles closely related.

• Full commercial and financial integration of both

economies, with well over 80% of Mexican

exports sold in US markets.

• Gradual recovery in US economic activity

currently benefiting Mexico.

• Questions remain about the sustainability of the

US recovery and the possible convergence

towards lower average GDP growth rates.

• Comparative advantage points to energy complex

but constitutional barriers prevent private

participation in the sector.

37

Mexico: Inflation and interest rates

• After a spike during 4Q10, annual inflation has

edged downwards and it appears to be under

control.

• The current environment of high commodity prices,

however, poses challenges to the sustained

convergence towards medium term target levels.

• In addition, domestic demand is no longer

depressed, thus contributing to fuel inflation at the

margin.

• Banxico will probably stay on the sidelines this

year, but it remains vigilant and ready to hike since

the beginning of 2012.

38

Mexico: Currency dynamics

• The exchange rate suffered during 2008-09 as a

result of the deterioration in the US economic

outlook.

• MXN recovered gradually with the stabilization and

eventual improvement of expectations about US

growth.

• MXN currently responding to robust foreign capital

flows and more stable global outlook.

• Appreciation pressures to continue, so Banxico

unlikely to be able to reverse the trend. Policy

actions likely to be geared towards reducing

volatility and slowing down pace of appreciation.

39

Peru: Among the region‟s top growth performers

• We expect a very soft deceleration in the growth

pace, towards potential levels, during 2011-12.

• Average growth performance 2010-2012 likely to

remain at the top of LatAm.

• Inflation to remain well behaved (at or below

3%), on the back of expansion of productive

capacity and conservative monetary policy.

• PEN to remain well supported by financial and

especially strategic foreign investment. We

expect it to be near 2.70/USD by year-end.

40

Peru: The region‟s top growth performer

• The real economy is still operating above

potential, which suggests that Central Bank will

continue tightening the policy rate through year-

end and beyond.

• We expect target policy rate at 4.75% by Dec

2011, with further hikes in 2012 likely.

• Central Bank to continue intervening in the FX

market to avoid stronger currency appreciation.

• PEN curve to flatten both because of increase in

short end and compression in long end post

presidential elections, assuming expectations of

no change in policy regime.

41

Venezuela: Slow recovery amid high oil prices

• The real economy has been recovering since 2H10,

although at a slow pace. We expect GDP to expand by

at least 2% this year.

• Inflation is to remain at the highest levels in the

region, along with Argentina, because of supply

bottlenecks and very active fiscal spending.

• With oil prices hovering around USD100/barrel, the

current account surplus is likely to be at least

USD20bn this year.

• The robust supply of dollars from the trade account

suggests the authorities will fuel the demand for

imports via Cadivi and Sitme to reduce shortages,

especially ahead of next year‟s election.

42

Venezuela: Presidential election

• President Chavez still holds the upper hand to

win reelection next year.

• His popularity suffered last year but has been

recovering in 2011, because of the robust fiscal

transfers and the public approval of the handling

of the flooding emergency.

• The opposition is to do a good election if it lines

up behind a coalition candidate, although it is still

early to determine whether there will be such a

unanimous choice.

43

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Aside from within this report, important conflict disclosures can also be found at https://gm.db.com/equities under the “Disclosures Lookup” and “Legal” tabs.

Investors are strongly encouraged to review this information before investing. Gustavo Cañonero and Fernando Losada

2. Short-Term Trade Ideas

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Risks to Fixed Income Positions

Macroeconomic fluctuations often account for most of the risks associated with exposures to instruments that promise to pay fixed or variable interest rates. For

an investor that is long fixed rate instruments (thus receiving these cash flows), increases in interest rates naturally lift the discount factors applied to the

expected cash flows and thus cause a loss. The longer the maturity of a certain cash flow and the higher the move in the discount factor, the higher will be the

loss. Upside surprises in inflation, fiscal funding needs, and FX depreciation rates are among the most common adverse macroeconomic shocks to receivers. But

counterparty exposure, issuer creditworthiness, client segmentation, regulation (including changes in assets holding limits for different types of investors),

changes in tax policies, currency convertibility (which may constrain currency conversion, repatriation of profits and/or the liquidation of positions), and

settlement issues related to local clearing houses are also important risk factors to be considered. The sensitivity of fixed income instruments to macroeconomic

shocks may be mitigated by indexing the contracted cash flows to inflation, to FX depreciation, or to specified interest rates – these are common in emerging

markets. It is important to note that the index fixings may -- by construction -- lag or mis-measure the actual move in the underlying variables they are intended to

track. The choice of the proper fixing (or metric) is particularly important in swaps markets, where floating coupon rates (i.e., coupons indexed to a typically short-

dated interest rate reference index) are exchanged for fixed coupons. It is also important to acknowledge that funding in a currency that differs from the currency

in which the coupons to be received are denominated carries FX risk. Naturally, options on swaps (swaptions) also bear the risks typical to options in addition to

the risks related to rates movements.

44

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a changing global environment facing emerging markets · 2011. 10. 28. · 2 the wheels of risk are...

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