Emerging Market Monitor - Inflation in Central & Eastern Europe
March 2018
Patrick Zweifel, Chief Economist, Nikolay Markov, Senior Economist
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Inflation across emerging markets is at multi-decade lows. But one region is bucking the overall trend: Central & Eastern Europe. What does it mean for investors?
First, some global observations about inflation. Average inflation across emerging markets has fallen to 2.9%, a level not seen since the 1970s, and this is good news for holders of hard currency debt.
FIG. 1 inflation in EMerging markets
Source: Pictet Asset Management, CEIC, Datastream, February 2018. *Based on 30 EM consumer prices indices, GDP weighted.
As Fig. 2 below shows, the inflation differential between developed and emerging markets and EM hard currency yield spreads appear closely linked. Even if inflation is expected to pick up modestly in emerging markets, we believe it will rise less than in developed markets, and this supports a further narrowing in emerging hard currency debt spreads.
Fig. 2 - INflation differential
Source: Pictet Asset Management, CEIC, Datastream, January 2018
The exception to the rule...
As mentioned, one cluster of countries bucking the falling inflation trend is the Central and Eastern Europe (CEE) markets of the Czech Republic, Hungary, Poland and Romania. This is mainly because of wage growth, which has ticked up in all four countries.
Fig. 3 - Nominal wage growth in the CEE region
Source: Pictet Asset Management, CEIC, Datastream, February 2018
The four markets in the CEE region account for over a trillion dollars of GDP and around 80 million people. Poland is the region’s powerhouse accounting for half of GDP and half of the population. The richest market in terms of GDP per capita is the Czech Republic.
fig. 4 -THE CEE REGION AT A GLANCE
Population, dependency ratios, unemployment and GDP per capita
Source: Pictet Asset Management, CEIC, Datastream
The charts below show two key drivers of wage increases in these four economies: record-low unemployment and increasing minimum wages.
Figs. 5a & 5b -
Left chart - Central Eastern Europe unemployment rates (%) Right chart - Central Eastern Europe minimum nominal monthly wages (EUR)
Source: Pictet Asset Management, CEIC, Datastream, February 2018
You can depend on us...
Wage pressure could continue to build in the CEE region as ageing populations and rising life expectancy cause the dependency ratio of non-working to working people to rise across all markets. As Fig. 6 shows this is especially the case for the Czech Republic.
FIg. 6 - RISING Dependency ratios
Dependency ratio is the percentage of population outside of working age: 0-14 year, 65 years +
Source: Pictet Asset Management, CEIC, Datastream, January 2018
Central banks behind the curve
What does this mean for debt investors? Although rising wage growth in the CEE is a sign of strong economic conditions, the risk of central banks falling behind the curve is a threat for the region’s local currency debt.
Overall CEE central banks have been slow to react to inflation. Poland and Hungary in particular have not started the tightening yet. The Czech National Bank was first to hike rates after the removal of the EUR/CZK floor in April 2017.
FIG. 7 - TWIN PEAKS - ROMANIA MOST AT RISK
Romania's current account and fiscal balance (% GDP)
Source: Pictet Asset Management, CEIC, Datastream. Current account January 2017, fiscal balance January 2018.
Although the Bank of Romania began hiking rates in February 2018, we believe the country is the most at risk. As Fig 7 shows it is the only market in the region with a ‘twin deficit’ – trade and current account - which is deteriorating. We believe this increases the pressure on CPI inflation through an expected depreciation of the currency, in addition to the rising domestic inflationary pressures. We expect a more rapid pace of rate increases in the year ahead.
THE VIEW FROM OUR EMERGING MARKET EQUITY TEAM
By Christopher Bannon, Senior Investment Manager
Christmas decorations in Vaci Street, Budapest, Hungary
Backing the consumer boom
The CEE region is booming. In our view this is best captured through stocks exposed to consumption and credit, such as banks and consumer companies backed up by strong fundamentals.
Valuations here look reasonable, trading at a slight discount to western European markets. In addition, we believe that forward expectations do reflect strong macro growth dynamics.
Fig 8. Upside in Consumer and financials
Change to 2019 net income expectations
Source: Bloomberg, March 2018
As Fig. 8 shows, both financial services and consumer sectors have seen their earnings forecasts upgraded quite consistently over the past year.
Despite the overall positive trend, the market has been paying greater attention to company fundamentals and rewarding those with the strongest growth prospects. In our view, the increasing dispersion of returns between the market's winners and losers is creating a fertile ground for stock pickers.
MARKET WATCH
MARKET WATCH DATA
28.02.2018
Source: Datastream, Bloomberg, data as at 28.02.2018 and in USD. Equity indices are quoted on a net dividend reinvested basis; bond and commodity indices are quoted on a total return basis. The currency rates evolution is treated as a performance calculation based on FX rates.
Nikolay Markov joined Pictet Asset Management in 2013 as an Economist in the Fixed Income department.
Before joining Pictet, he was working in the Monetary Policy Analysis Unit of the Swiss National Bank where he performed research on monetary policy rules for Switzerland. Prior to working at the Swiss National Bank he was a teaching and research assistant at the University of Geneva and participated in international academic conferences.
Nikolay holds a PhD in Economics from the University of Geneva and obtained a PhD program certificate from the Swiss National Bank doctoral institute in Gerzensee.
About
Christopher Bannon
About
Christopher Bannon
Christopher Bannon joined Pictet Asset Management in 2007 and is a Senior Investment Manager in the Emerging Markets Equities team, specialising in Emerging Europe and Russia.
Christopher joined Pictet in 2007, initially as a risk manager before moving across to the Emerging Equities Research team in 2011 specialising in the energy sector across global emerging markets. Christopher started his career in 2005 with Citigroup, where he spent 18 months on the corporate actions desk.
Christopher graduated from Trinity College Dublin with a BA (Hons) in Mathematics and Philosophy and he holds an MSc in Finance (graduated with Distinction) from Imperial College London. He is also a Chartered Financial Analyst (CFA) charterholder.
About
Patrick Zweifel
About
Patrick Zweifel
Patrick Zweifel joined Pictet in 1997. He is Chief Economist at Pictet Asset Management. Before assuming his current position in 2009, he was head of the “Macro Research Team” at Pictet Private Wealth Management. In particular, he had economic research responsibility for emerging markets and Japan, and for the development of quantitative models on major asset classes, primarily foreign exchange models. Before joining Pictet he was a research assistant in econometrics and monetary theory and worked on international research projects for the World Bank and the European Union. He holds a PhD in econometrics from the University of Lausanne.
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