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Emerging Markets

Emerging Markets Monitor

Emerging Markets Monitor

October 2017

Patrick Zweifel, Chief Economist

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

01

What caught our eye

Total debt in emerging markets has risen strongly since the 2008 financial crisis to reach a high of 186% of GDP in Q1 2017. It is corporate sector debt in particular that has driven the increase, accounting for over half of the total.

 
Total debt by main region

% GDP

 total debt by region
Source: Pictet Asset Management, BIS, CEIC, Datastream, Q1 2017. *Weighted average of 21 developed markets; **Weighted average of 19 emerging markets.
 
Whilst the overall percentage of EM debt-to-GDP is much lower than that of developed markets, history shows the rate of change matters more than the absolute level. Which prompts us to ask: after such a surge in debt and with tighter US monetary policy imminent, are emerging markets heading for a debt driven crisis?

Mind the (China) gap

We use a methodology from the Bank for International Settlements (BIS) to identify the long-term trend of the debt-to-GDP ratio. Subtracting this long-term ratio from the current debt-to-GDP ratio gives the excess debt of a market (also called the debt gap). The chart below shows the debt gap* of leading emerging markets.

Emerging private debt gap by markets 
(Q1 2017, % GDP)
 
 em debt gap
Source: Pictet Asset Management, BIS, CEIC, Datastream as at Q1 2017. *The debt gap here is based on private debt, namely household plus corporate debt.

A debt gap above 10% is a level beyond which the risk of financial crisis rises significantly. Fortunately almost all major emerging markets are below this threshold, especially compared to five years ago.

The only exception is China, where we do not expect a major crisis (read our article).

Watch out for the 'CADs'

Excess debt becomes an even bigger problem if it needs to be financed externally, i.e. if a country has a current account deficit (CAD).

Looking back in the chart below at the 2013 taper tantrum—a key episode for emerging market assets—5-year swap rates for emerging CAD countries (the green line) sold off in line with the US 10 year bond yields, selling off even further through early 2014.

By contrast, current account surplus countries (CAS) saw their swap rates remain far more resilient and stay inside the US 10 year yield, with a spread increase of only around 50bps.

The same trend was seen in the currency markets over this period, with CAD currencies depreciating by an average of 15%, but CAS countries by only 3%.

MIXED FORTUNES IN THE 2013 TAPER tantrum

EM CAD & CAS swap rates & US 10 year bond yield (2013-2014)

em CAD and CAS swap
Source: Pictet Asset Management, BIS, CEIC, Datastream, data from January 2013 to June 2014. CAD EM countries include: India, Indonesia, Brazil, Chile, Czech Republic Mexico, Poland, South Africa, Turkey. CAS countries  include China, South Korea, Malaysia, Philippines, Singapore, Taiwan, Hungary, Russia.
 

Are things different now?

Comparing the current state of CAD emerging markets with 2013 reveals a broad based improvement in fundamentals, making them we believe less vulnerable to an increase in US yields.
 
Then anD now...

Average of key current account deficit emerging markets in 2013 and 2017

table
Based on seven countries: Mexico and Poland and the so-called 'Fragile Five' (India, Indonesia, Brazil, South Africa & Turkey). Sources: BIS, CEIC & Datastream.
 

There are exceptions, notably Turkey which still has a high current account deficit (5.3% of GDP) and high inflation rate (>10% y/y).

Overall though, we do not believe the emerging market complex is heading for a major correction as US yields continue to rise.

Related macroeconomic data for CAD emerging markets

selected Current account deficit emerging markets

As at 30/09/2017

MacroData
Source: Pictet Asset Management, BIS, CEIC, Datastream

02

In focus: Russia

By Nikolay Markov, Senior Economist

We see some early evidence of a broadening recovery in Russia.
Moscow
Moscow skyline

Top of the class

As the chart below shows, Russia has the lowest general government debt in the emerging markets space. The flip side however is that total investment has been low, preventing Russia from diversifying away from its energy sector.

General government debt-to-GDP ratio: major emerging economies 

% GDP

 debt to GDP
Source: Pictet Asset Management, CEIC, Datastream, data to end 2016

Return of the bear...

Russia scores third in our proprietary country risk index, ranking  well in terms of economic environment, public finances, external financing and external strength (read more about how we compile our country risk index).
Country risk index ranking (CRI): all components
country risk
Source: Pictet Asset Management, CEIC, Datastream, data to June 2017. *Ranking based on 18 indicators in 6 dimensions: 1) economic environment 2) public finance 3) private finance 4) external financing 5) external strength 6) governance score.

The good scoring comes mainly from low inflation, low public debt and short-term external debt, as well as a rebound in FX reserves. This is being supported by a credible commitment by the Bank of Russia to bring down inflation while supporting the economic recovery. 

Meanwhile, the private sector, both households and corporates, has substantially de-leveraged over the past years.

A broadening recovery?

There is some early evidence of a broadening economic recovery in Russia, driven by new car sales, construction, labour market conditions, manufacturing sentiment, and a recovery in oil prices.

This points to solid GDP growth of 1.7% for 2017  based on our leading indicator (the grey line). However we believe this remains far below the growth potential of the Russian economy (dotted line).

Russian GDP & Leading index growth
GDP right axis / Leading Index left axis
russia leading and GDP

Source: Pictet Asset Management, CEIC, Datastream, GDP data to May 2017, leading data to August 2017. Our proprietary Russian leading indicator is computed using ten most relevant advanced indicators of the business cycle in Russia.

From a structural perspective, Russia’s main drawback is the lack of reforms to rebalance the economy from dependence on energy exports towards manufacturing and services. 

We believe this will weigh on potential GDP growth in the medium to long-term. Investing in technological innovation could significantly boost Russian potential GDP growth in the long-run and should become a top priority for the government.

The main risks in the near term are geopolitical, in particular conflicts in Ukraine and Syria, and also, of course, the risk of a negative oil-price shock. 

03

Our EM equity team's view

By Christopher Bannon, Senior Investment Manager

Waiting for a Russian consumer revival

Russian economic fundamentals remain very strong despite one of the highest real interest rates in the emerging world, currently at ~5%. It seems a question of when, not if, the long term 10-year yield will adjust downwards to reflect the lower inflation regime.
Russian Inflation and 10 year bond rate
russia rate and inflation

Source: Bloomberg, September 2017

Look to food retail

We think Russia’s strengthening economy bodes well for domestic consumer and real estate names. 

We particularly like food retailers where forecasted profits are close to an all time high with a still-improving trend and valuations are very compelling – see chart below.  Additionally, the industry is consolidating around market leaders.

 
PE Ratio of Leading  food retailers in russia

Forecast earnings for next 12 months

russia retailers
Source: Bloomberg and Pictet Asset Management analysis, September 2017

04

EM health check

Still room for further growth in EM economic activity...

Our proprietary leading indicator rebounded to 5.3% y/y in August, still pointing towards a pace of growth of 4.7%1, which was actually exceeded in Q2 realised GDP growth of 4.8%.

Despite lukewarm sentiment, growth in EM industrial production has reached its highest level (5.4%) since mid-2013. Meanwhile, our aggregated EM PMI survey increased to 51.7, a level not seen since May 2011 and which is associated with an industrial production growth greater than 6%. 

 
EM leading indicator & GDP (left) / EM PMI & industrial production (right)
em lead and IP

Source: Pictet Asset Management, CEIC, Datastream. 
Left chart: EM leading indicator data from January 2011 to August 2017. EM GDP data from January 2011 to June 2017. *Our proprietary EM leading indicator is a GDP-weighted average of 240 economic indicators across 24 countries. ** GDP-weighted average of 30 countries real GDP. Right chart: EM PMI data from January 2011 to September 2017. EM industrial production data from January 2011 to August 2017.  * 24 Manufacturing PMIs GDP-weighted. ** 31 industrial production GDP-weighted.
[1] Based on historical statistical relationship between these two variables.

05

Key market data

KEY MARKET DATA
As at 30/09/201
MarketData30.09.2017
Source: Datastream, Bloomberg, data as at 30/09/2017 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.