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Emerging Markets

Emerging Markets Monitor

December 2017

Patrick Zweifel, Chief Economist

Pictet Asset Management’s monthly selection of the key charts and data trends to watch in emerging markets. 

01

Which countries are most at risk from rising global rates?

Will tighter global rates cool the 'CATS'?

This month we focus on one of the main risks facing emerging markets over the next year: higher interest rates. In particular, we look at which emerging markets are likely to be most vulnerable and why. For this we use our proprietary 12 risk factor model, the output of which is presented below. 

WhicH EMerging marketS ARE Most vulnerable to rising global RATES?

Fig. 1: Emerging countries scorecard: vulnerability to higher global rates (based on 12 risk factors)

ranking-table.jpg
Source: Pictet Asset Management analysis of market sources, Q4 2017


Encouragingly the largest emerging markets are among the least vulnerable: India, Russia and China. Even Brazil, the final member of the BRIC club, is in the second quartile. 

At the bottom of the table however we see a grouping of four reasonably large markets in terms of GDP: Chile, Argentina, Turkey and South Africa: the CATS. Let's look at the prospects for each.

i) Chile: on the rebound?

Chile’s poor ranking is surprising given its mature economy, solid political governance and overall good fundamentals. A key weakness appears to be external debt (61.3% of GDP), the highest among Latin American countries that we follow. The good news is only a small part of this external debt is short-term, 6.0% of GDP.

A short-term problem

Fig. 2: Chile's external debt, maturity breakdown (% GDP)

Fig 2 chile chart debt.png
Source: Pictet Asset Management, CEIC, Datastream, Q3 2017
 

We believe however a range of factors alleviate the risks in Chile:

  • The local interest rate and inflation are currently low. 
  • The currency is stable and the risks of a substantial depreciation are very limited.
  • Finally, Chile appears to be at a turning point in the business cycle after suffering from lower commodity prices in the past years.

ii) Don't cry for me Argentina...

The main components of Argentina’s low ranking are its fiscal balance, its current account, and its low score in foreign currency reserves.

Elected in late 2015, the government of Mauricio Macri is tackling all three.

Plans to tackle the fiscal deficit have centred on hiking public transit and utility prices. This plan will take a while but we believe sweeping victories in October's mid-term elections has provided them with more leverage to implement reforms. 

Fixing a hole

Fig. 3: Argentina's fiscal balance (% of GDP)

Fig 3 argentina fiscal balance.png
Source: Pictet Asset Management, CEIC, Datastream, Q2 2017
 
The liberalisation of trade has contributed to widen the current account deficit in spite of rising exports. From 2019, however, we believe the current account should start improving.

Meanwhile, the lifting of currency controls has led to doubling of foreign currency reserves between Q4 2015 from USD 24.5bn (equivalent to 4.1 months of imports) to USD 44.6bn by Q3 2017 (equivalent to 7.9 months of imports). While low by EM standards, reserves should continue to improve given the brighter outlook for exports and foreign investment.

The economy is recovering, but inflation is still too high

The economic backdrop is also encouraging. Argentina’s economy is recovering after last year’s recession (see chart below). Growth is increasingly driven by private consumption and investment. Moody’s and S&P raised the sovereign rating to B2 and B+ respectively, both with a stable outlook.

One negative remains inflation, which is still high and persistent, harming consumption. Inflation should go down, but we believe the ambitious target of 8% to 12% next year is out of reach. 
EnCOUrAGING TREND...

Fig. 4: Argentina's real GDP growth and leading indicator growth

Fig 4 argentina GDP lead indicator.png
Source: Pictet Asset Management, CEIC, Datastream, Q3 2017. *Mixed forecasting: non-accelerating inflation growth of output, HP filtering, working-age population.

iii) Turkey: handle with care

Absolute bottom of our ranking is Turkey, which is very likely to be challenged by an environment of policy normalisation. That said, Turkey's leading indicator is signalling a solid pace of recovery. Improvements in foreign demand, in particular from the EU and Russia, have boosted the manufacturing sector, although domestic demand is still struggling to gain momentum. 
SIGNS OF LIFE
Fig. 5: Turkey industrial production growth & PMI survey
Fig 5 Turkey IP and Manufacturing.png
Source: Pictet Asset Management, CEIC, Datastream, Q3 2017. Threshold line is for PMI.

Inflation - a growing problem

We believe the main risk in Turkey is inflation given the recent significant depreciation of the currency and further acceleration in headline and core inflation. Expectations are de-anchored reflecting a lack of credibility in monetary policy. The Central Bank of Turkey looks poised to further raise the late liquidity rate in December to contain the inflation surge.
INFLATION Surging out of control?
Fig. 6: Turkey's headline CPI, food & non-food inflation
Fig 6 Turkey inflation.png
Source: Pictet Asset Management, CEIC, Datastream, Q3 2017

iv) Crunch time for South Africa?

Finally, South Africa is another market that we are not surprised to see near the bottom of the ranking. Political risk remains a key issue under the discredited leadership of President Jacob Zuma. An inflexion point might be nearing however.

This week’s conference of the ruling ANC party saw the selection of deputy president Cyril Ramaphosa as new leader of the party, narrowly beating Nkosazana Dlamini-Zuma (Zuma’s ex wife). In the immediate aftermath of this announcement the South African rand rallied against the US dollar .

As the charts below demonstrate, the main risk for South Africa is on public finances given the large fiscal deficit and rising public debt. 

BASKET CASE?
LEFT CHART: Fig. 7A: South Africa's general government fiscal balance to GDP ratio
RIGHT CHART: Fig. 7B: South Africa's general government debt to GDP ratio & legal limits
Fig 7 South Africa fiscal balance and public debt.png
Source: Pictet Asset Management, CEIC, Datastream, Bloomberg, Q2 2017

Looking for silver linings, the rebound in commodity prices is providing some support. The current account is improving led by the rising trade surplus. This should contain the rand depreciation & help secure foreign capital inflows.

In conclusion: look at the business cycle

Finally, the momentum of each market's business cycle - positive or negative - will also have an impact on how well they are able to weather rising global rates. It will also affect how quickly they can improve their underlying risk factor scores.

In the chart below we plot each of  the ‘CATS’ in our Pictet Regime Indicator, which tracks where different regions are in the business cycle, and shows the asset classes most in favour in each growth/inflation regime.

TRACKING THE CATS
Fig. 8: Positioning of Chile, Argentina, Turkey and South Africa vs business cycle
diagram9.jpg
Source: Pictet Asset Management, December 2017

To summarise:

  • In Chile we expect growth to improve, although not substantially, and inflation should remain low.
  • Argentina should see growth improve, and whilst inflation will fall it will remain very high.
  • South Africa's low growth prospects might improve marginally depending on the direction of the political transition.
  • Turkey's growth looks likely to slow somewhat and inflation remain high.
EM Monitor

02

Our EM equity team's view

By Kiran Nandra, Senior Product Specialist

In terms of our EM equity team's exposure to the 'CATS' we are currently underweight South Africa, Argentina and Chile. Meanwhile in Turkey we are  currently neutral with our exposures restricted to specific names within the banking space. 

Although from a top-down perspective Turkey's growth momentum is decent, we are cautious on the current account deficit and possible weaker fiscal performance. That said, the Turkish banking sector appears to have benefited from the introduction earlier this year of the Credit Guarantee Fund, which helped bolster lending rates and top lines. It remains to be seen how long term this effect proves, especially when we turn to the deposit side and how banks intend to fund this lending. 

Mind the GAP
Fig. 9: Percentage of banking sector loans in non-domestic currencies (selected EMs)
Fig 9 em equity team chart on turkey.png
Source: Deutsche Bank, 30 October 2017
As the chart above shows, Turkish banks have one of the highest levels of foreign currency funding as a percentage of their overall balance sheet among EM peers. The potential for a mismatch is there and this is something investors need take into consideration when selecting Turkish banking stocks.
 

03

Market watch

KEY MARKET DATA

30/11/2017

market data_301117.png
Source: Datastream, Bloomberg, data as at 30/11/2017 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.