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Emerging Markets Research

March 2014

The Emerging Markets Quarterly

Tactical opportunities amid shifting winds

PLEASE REFER TO THE LAST PAGE FOR ANALYST CERTIFICATION(S) AND IMPORTANT DISCLOSURES.

Barclays | The Emerging Markets Quarterly

CONTENTS
Overview
Tactical opportunities amid shifting winds ........................................................................... 3
Growth in EM remains generally weak and China faces formidable challenges. Yet we view
these as manageable and expect a continuing gradual adjustment, rather than an EM crisis.
We believe cheaper valuations, lighter positioning, higher EM policy rates and ongoing
external adjustments argue against treating EM assets as a clear short. While far from calling
for any broad-based recovery in EM assets, we do see a number of opportunities for tactical
long and short positions to take advantage of the varying economic and political prospects in
EM countries.
Trade summary .....................................................................................................................................23
EM credit portfolio ................................................................................................................................26

Macro Outlooks
Asia: Shaken, stirred but not disturbed................................................................................ 27
Weather disruptions have temporarily reversed north Asias export-led outperformance. But
we expect growth in north Asia to re-accelerate in Q2, and attention to refocus on shrinking
output gaps, which will renew expectations for rate normalisation especially for
economies more synchronised to the US. While external risks have turned the corner in the
south, political cycles in Indonesia and India, coupled with signs of drought in southeast
Asia, could constrain domestic demand.
Emerging Europe, Middle East and North Africa: Growth and inflation divergence ........ 32
Regional growth has divergent trends: Central Europe is accelerating, Russia and Turkey are
slowing and MENA is broadly stable. A divergence in inflation has also occurred: it is stuck
above targets in Russia and Turkey and is well below targets in Central Europe. C/A balances
are improving across the region. Russia-Ukraine tensions remain a major political risk.
Sub-Saharan Africa: Positive growth outlook despite challenges ..................................... 36
Sub-Saharan Africa is expected to continue to show strong economic growth, though the
regions large twin deficits are also gaining less positive attention. Its FX markets are on the
back foot, complicating the outlook for monetary policy. In the country section of this
Emerging Markets Quarterly, we provide more detailed views on six countries in Sub
Saharan Africa, namely Ghana, Kenya, Mozambique, Nigeria, South Africa, and Zambia. For
further coverage, please also see the recently published Africa Markets Guide 2014, with
coverage of 20 economies across the continent.
Latin America: The productivity challenge .......................................................................... 41
With the exception of Venezuela and Mexico, growth expectations are gradually stabilizing
in LatAm. As the region enters a period of slower growth, the challenge for policymakers is
how to compensate for lower terms of trade, which should start to erode domestic demand.
We believe the new wave of growth will come through productivity enhancing reforms, and
Mexico is taking the lead.
EM political heat map...........................................................................................................................45

25 March 2014

Barclays | The Emerging Markets Quarterly

Country Outlooks
Emerging Asia
China: Growth recovery in a volatile market ....................................................................................48
Hong Kong: Burgeoning credit exposure to mainland China .......................................................52
India: All eyes on elections ..................................................................................................................55
Indonesia: The Jokowi effect ...............................................................................................................59
Korea: Regaining vitality ......................................................................................................................63
Malaysia: Biased to raise rates ............................................................................................................67
Philippines: BSP getting ready to pull the trigger ............................................................................71
Singapore: A tale of two halves ..........................................................................................................75
Taiwan: Still in growth support mode ...............................................................................................79
Thailand: Uncertainty set to continue ...............................................................................................83
Emerging Europe, Middle East and Africa
Egypt: Realism takes hold....................................................................................................................87
Ghana: Testing the boundaries ......................................................................................................91
Gulf States: Trouble within ..................................................................................................................95
Hungary: Recovery boosts Fidesz ......................................................................................................99
Iraq: Politics delay 2014 budget law ............................................................................................... 103
Kenya: Making headway despite challenges................................................................................. 107
Lebanon: With or without you......................................................................................................... 110
Morocco: Challenges resurface as growth slows......................................................................... 114
Mozambique: Fiscal gap set to widen ............................................................................................ 118
Nigeria: Undermined by uncertainties............................................................................................ 121
Poland: Smooth sailing ..................................................................................................................... 125
Romania: On track as political noise intensifies ........................................................................... 129
Russia: Vulnerable giant ................................................................................................................... 132
South Africa: Challenging year ahead ............................................................................................ 137
Turkey: In search of a new equilibrium.......................................................................................... 142
Ukraine: Tighten your belts .............................................................................................................. 146
Zambia: Copper price jitters likely to be short lived..................................................................... 152
Latin America
Argentina: A heterodox stabilization plan ..................................................................................... 154
Brazil: Looking more like a glass half-full....................................................................................... 159
Central America and the Caribbean: New governments, same challenges............................. 163
Chile: Curb your pessimism ............................................................................................................. 167
Colombia: Re-election and recovery on track............................................................................... 172
Mexico: The long and winding road to faster growth ................................................................. 176
Peru: Keep an eye on inflation ......................................................................................................... 180
Uruguay: BCU to refocus on inflation; uneventful primaries ............................................................ 183
Venezuela: Survival instinct or structural change ........................................................................ 186
Overview of key economic and financial indicators .................................................................... 190
Global forecasts (1): GDP and inflation ......................................................................................... 191
Global forecasts (2): External and government balances........................................................... 192
Official interest rates and forecasts ................................................................................................ 193
FX forecasts and forwards ............................................................................................................... 194
25 March 2014

Barclays | The Emerging Markets Quarterly

OVERVIEW

Tactical opportunities amid shifting winds


Christian Keller
+44 (0)20 7773 2031
christian.keller@barclays.com
Koon Chow
+44 (0)20 7773 7572
koon.chow@barclays.com

Growth in EM remains generally weak and China faces formidable challenges. Yet we view
these as manageable and expect a continuing gradual adjustment, rather than an EM crisis.
We believe cheaper valuations, lighter positioning, higher EM policy rates and ongoing
external adjustments argue against treating EM assets as a clear short. While far from calling
for any broad-based recovery in EM assets, we do see a number of opportunities for tactical
long and short positions to take advantage of the varying economic and political prospects in
EM countries.

FX: Go long high-yielding currencies where C/A adjustments are advanced, growth
momentum has stabilized, and policy credibility has improved (INR, BRL and IDR). Remain
cautious where adjustment is slow and political risk high (short ZAR, TRY and RUB).

Rates: Buy bonds of our favoured high yielders, picking spots where risk premia are
highest relative to policy rate expectations (5y India, 10y Indonesia and 3y Brazil). Pay
rates where growth is picking up and inflation or premia are low (Poland and Korea).

Credit: Rotate from Russia into Brazil and Indonesia in sovereign and corporate credit.
We see opportunities in high-yielding LatAm corporate credits in particular. We remain
positive on Venezuela, which we express in a relative value trade recommendation
against Ukraine. In China, we prefer core versus non-core SOEs.

Return to differentiation theme


China data, not Fed tapering,
weighed on EM in January

EM assets had a difficult start to the year. Although the earlier-than-expected Fed tapering
in December had a relatively benign impact on the US Treasury market, EM assets sold off in
the correlated manner typical of risk-off periods. Investor concerns about EM shifted from
tapering effects to weakness in China data. Deterioration in EM sentiment was further
exacerbated by continuing negative headlines from various EM markets, particularly in
EEMEA, related to political tensions and event risk. This initially went against our
differentiation theme for 2014, which we had set out in early December (Emerging
Markets Quarterly: Differentiation continues, 10 December 2013).

FIGURE 1
EM assets had a tough start, but have improved since February
Total returns index

(May 2013 = 100)


102
101
100
99
98
97
96
95
94
93
92
Jun-13
Aug-13
Oct-13
EM FX

EM LC bonds

Source: Bloomberg, Barclays Research

25 March 2014

Increasing
differentiation in 2014

FIGURE 2
EEMEA has suffered, largely on (geo)political events
3

YTD total returns at index level, %

2
1
0
-1
-2
-3
-4
Dec-13

Feb-14
EM HC bonds

Credit

Local bonds
EEMEA

LatAm

FX
EM Asia

Source: Bloomberg, Barclays Research

Barclays | The Emerging Markets Quarterly


with a turnaround in
February

This has since changed, however. EM asset performance has improved since February and
correlation has dropped, creating a better backdrop for differentiation in asset performance.
The three developments we highlighted as crucial for EM asset performance in 2014 remain
the same: 1) Fed policy for capital flows; 2) global recovery to support the EM
adjustment process; and 3) China growth for commodity prices and general EM
sentiment. However, the order has reversed: since December, markets have grown much
more concerned about China and less concerned about Fed tapering.

China has taken centre stage

US Treasury market conditions have been more supportive for EM than many anticipated
(10yr UST yields have averaged 2.77%YTD), and growth data out of the euro area have
remained encouraging. In contrast, in China, growth indicators have disappointed while signs
of stress in the financial system have increased. This has triggered sharp falls in Chinasensitive commodity prices, raising concerns about growth in EM more generally and leading
to further capital outflows from EM. Thus, developments in China have taken centre stage.
At the same time, EM economies have continued to adjust as a consequence of depreciated
currencies and higher interest rates. Growth should remain slow, as increased net export
contributions cannot offset the slowdown in domestic demand. External imbalances are
adjusting as a result, albeit with different speeds. Importantly, these economic developments
are overlaid with elevated political risks in many EM countries, as important elections
approach and/or parts of the population voice their dissatisfaction with existing regimes.

EM growth remains soft while


economies adjust

Macro and valuation shifts


help differentiation in EM

Amid this macroeconomic and political diversity, we believe differentiation should take hold
albeit with different themes than a few months ago. Cheaper valuations, lighter foreign
positioning and higher EM policy rates weigh against seeing EM assets as a clear short, in our
view. Although we are far from calling a broad-based recovery in EM assets, we see a number
of opportunities for tactical long and short positions to take advantage of the changing
economic and political prospects among EM countries. Before we discuss these, we explain
what we consider the key macro drivers of our strategy view.

US and Europe on track

The global growth recovery remains broadly intact, and our forecast for global growth to
accelerate modestly to 3.4% in 2014 is unchanged. However, growth performance in the G3
economies has been uneven, and we have made further downward growth revisions to a
number of EM economies. US growth data for Q4 2013 were stronger than we expected,
suggesting somewhat better momentum for growth going into 2014. Although weather

EM still weak amid modest global recovery

FIGURE 3
Outflows have continued
40

FIGURE 4
despite a supportive US Treasury market backdrop

USD bn

100d rolling correl.

%
3.5

30
20

1.0

3.0

10
0

0.5

2.5
0.0

-10
-20

2.0

-30

1.5

-0.5

Equity
LC Bonds
Source: EPFR global, Barclays Research

25 March 2014

HC Bonds
BC Bonds

Feb-14

Dec-13

Oct-13

Aug-13

Jun-13

Apr-13

Feb-13

Dec-12

Oct-12

Aug-12

Jun-12

Apr-12

Feb-12

-40
1.0
Aug-11

-1.0
Feb-12

Aug-12

UST 10y
Correl. to EM credit, RHS

Feb-13

Aug-13

Feb-14

Correl. to EM local, RHS

Source: Bloomberg, Barclays Research

Barclays | The Emerging Markets Quarterly


effects led to sharp swings in higher-frequency data in recent months, the US economy
seems on track for around 2.7% growth in 2014. In contrast, Japans Q4 growth
disappointed significantly, which, together with developments so far in 2014, has caused us
to lower our annual growth forecast for Japan in 2014 to just 1.0%. In the euro area, activity
data has, on average, surprised to the upside. Notably, domestic demand, driven by stronger
investment, looks set to make larger contributions to growth in coming quarters. This has
allowed us to make small upward revisions in our growth forecasts for 2014 and 2015 (to
1.3% and 1.5%, respectively). In aggregate, this has meant a slight upward revision of our
growth expectation for advanced markets to 2.1%.

but growth disappoints in


China and Japan

FIGURE 5
Barclays growth, inflation and current account forecasts
Real GDP

Inflation

Current account

(% annual change)

(% annual change)

(% GDP)

Barclays

Barclays

Barclays

vs. prev. EMQ

vs. consensus

2014

2014

2012

2013

2014

2015

2015

2015

2012

2013

2014

2015

2012

2013

2014

2015

Global

3.1

2.9

3.4

3.8

0.0

0.0

-0.1

-0.1

2.8

2.6

3.0

3.1

-0.1

0.0

0.3

0.3

US

2.8

1.9

2.7

2.6

0.3

0.0

-0.1

-0.5

2.1

1.5

1.8

2.1

-2.7

-2.3

-2.0

-2.0

Japan

1.4

1.5

1.0

1.2

-0.5

-0.1

-0.4

-0.1

-0.1

0.4

2.8

2.3

1.0

0.7

0.1

0.3

Euro area

-0.6

-0.4

1.3

1.5

0.2

0.1

0.2

0.1

2.5

1.4

0.9

1.1

1.4

1.7

2.5

2.4

Advanced

1.4

1.2

2.1

2.1

0.1

0.0

0.0

-0.2

1.9

1.3

1.6

1.8

-0.6

-0.3

0.0

-0.1

Emerging

5.0

4.8

4.7

5.4

-0.2

0.1

-0.1

0.0

4.6

4.9

5.4

5.3

0.7

0.5

0.8

0.9

Brazil

1.0

2.3

1.9

2.4

0.1

-0.2

0.1

0.3

5.4

6.2

5.9

5.9

-2.4

-3.7

-3.3

-2.5

Mexico

3.9

1.1

3.0

3.8

-0.7

0.0

0.0

-0.2

4.1

3.8

3.8

3.7

-1.2

-1.8

-2.7

-2.2

China

7.7

7.7

7.2

7.4

0.0

0.0

-0.2

0.1

2.6

2.6

2.7

3.5

2.3

2.0

1.9

2.0

India

6.7

4.5

4.7

5.6

0.0

0.0

-0.7

-1.2

9.0

7.4

5.9

5.4

-4.2

-4.8

-2.1

-2.5

S. Korea

2.0

2.8

4.1

4.2

-0.1

0.0

0.6

0.5

2.2

1.3

2.0

2.3

4.3

5.9

4.9

4.4

Indonesia

6.3

5.8

5.3

5.6

0.3

0.4

-0.1

-0.2

4.0

6.4

6.2

5.3

-2.8

-3.3

-2.5

-1.9

Poland

2.1

1.6

3.1

3.5

0.2

0.0

0.1

0.0

3.6

1.0

1.1

2.0

-3.5

-1.3

-1.2

-1.1

Russia

3.4

1.3

0.7

1.4

-1.9

-0.7

-0.6

-0.7

5.1

6.8

6.7

5.7

3.6

1.5

2.7

3.9

Turkey

2.2

3.9

2.2

3.5

-1.1

-0.7

0.0

-0.3

8.9

7.5

8.1

6.9

-6.2

-7.8

-5.7

-6.0

S. Africa

2.5

1.9

2.2

2.8

-0.5

-0.4

-0.4

-0.5

5.7

5.8

6.4

6.0

-5.2

-5.8

-5.8

-5.3

Note: 1. Consensus forecasts are as of March 2014 for G10 and EM Asia countries, as of February for LatAm and EEMEA countries. 2. Both Barclays and consensus
forecasts for India are for FY. WPI is reported for India. Source: Consensus Economics, Barclays Research

FIGURE 6
Gap between DM and EM momentum has widened further

56

Manufacturing PMI (SA, >50 = Expansion)

EM Asia

56

LatAm

EEMEA

54

54

52

52

50

50

48

48

Source: Haver Analytics, Barclays Research

25 March 2014

EM

2013-Dec

2014-Jan

Mexico

Brazil

Poland

Turkey

Feb-14

S. Africa

Global

Feb-13

Russia

Feb-12

Indonesia

Feb-11

S. Korea

46

India

46
Feb-10

PMI: Manufacturing (SA, 50+= Expansion)

China

58

FIGURE 7
mainly driven by weakness in China, Russia and Brazil

2014-Feb

Source: Haver Analytics, Barclays Research

Barclays | The Emerging Markets Quarterly


Downward revisions in Mexico,
Turkey and Russia

In Brazil, recent upside data


surprises suggest growth has
stabilised

Outside China, EM Asia


performed surprisingly well

In contrast, we have lowered our aggregate forecast for EM economies further, to 4.7% (from
5.0%). In Latin America, Mexico was the main downward revision (to 3%), as disappointing
Q4 data suggested slower momentum going into 2014 than we had expected. Turmoil in
Venezuela now makes us forecast a GDP contraction there. Most recent indicators from Brazil
suggest some stabilization and we have left our already weak forecast (1.9%) unchanged. The
main revisions were in EEMEA, where growth momentum continues to diverge: while the
smaller, open CE economies continue to recover along with the euro area, the outlook for
Russia, Turkey and South Africa has deteriorated since the last EMQ. We slashed our Russia
forecast on the back of disappointing data even before its involvement in the Ukraine crisis.
Economic sanctions by the West could drive Russia into recession. In Turkey, increased
domestic tensions since our last forecast in early December have hurt confidence, which,
along with sharp emergency interest rate hikes should weaken growth significantly. South
Africa continues to be burdened by political and labour tensions and weak commodity prices.
Growth performance in EM Asia (ex-China) has been somewhat better than expected: the
manufacturing exports-oriented economies (Korea, Taiwan) have continued to do well, as
expected. At the same time, some of the economies hitherto considered more fragile, such
as Indonesia and India, have performed slightly better than expected, allowing for modest
upward revisions. However, weak growth indicators from China cast a shadow over the
regional outlook and, indeed, over the global economy. Although we have left our 7.2%
annual growth forecast for China unchanged, a likely very weak Q1 growth number could
add risk to this forecast (see below).

Core central banks remain supportive


Forward guidance helped
stabilize the UST market

although Fed surprises


remain a risk for H2

BoJ and ECB to remain dovish,


given inflation outlooks

Fed policy remains crucial for the outlook for capital flows into EM. Although the Feds
tapering started earlier than expected, the accompanying communication has helped to
keep 10y yields anchored and the yield curve steep. Our reading of Fed communication,
combined with our forecasts of a moderate growth recovery and rising core inflation
(mainly in H2), suggests to us a steady pace of tapering (with a final $15bn taper in October
2014) and a first rate hike in June 2015. The key risk to this forecast could be a strongerthan-expected US recovery, accompanied by rising inflation in H2. In such an event, the
Treasury curve could adjust more abruptly we already forecast 10y yields to reach 3.5%
by end-2014 likely putting EM markets under renewed pressure.
In contrast, the BoJ and ECB are more likely to ease. We expect the BoJ to lower its GDP and CPI
forecasts in its semi-annual Outlook Report at end-April and to ease policy further at its mid-

FIGURE 8
Chinas slowdown raises questions about CNY appreciation
135
130

1.2

560

1.1

540

1.0
125

0.9

120

0.8
0.7

115
110
Feb-11

Feb-12

Feb-13

Feb-14

China: Real Effective Exchange Rate Index (2000=100)


China: Real Gross Value Added (SA, 3MMA, m/m, % )
Source: Haver Analytics, Barclays Research

25 March 2014

FIGURE 9
and has created fear in China-sensitive commodity markets

520
500
480

0.6

460

0.5

440
Mar-13

Jun-13

Sep-13

Dec-13

Mar-14

S&P GSCI Copper Index (Dec-30-76=100)


Source: Haver Analytics, Barclays Research

Barclays | The Emerging Markets Quarterly


July meetings. For the ECB, we recently removed our earlier forecast for policy rate cuts from
the baseline scenario, as cyclical data, financial conditions and even labour markets in the euro
area have improved. However, inflation remains significantly below the ECBs target (we
forecast <1% in 2014), which not only implies the risk of slipping into outright deflation, but
also creates a burden for the euro area economies in need of continued debt deleveraging.
Thus, the risk that the ECB could be forced to ease further remains tangible. Such easing by
the ECB and/or the BoJ would be unlikely to offset the adverse effect that tighter Fed policy, or
market expectations thereof, could have on EM. However, on balance, core market central
banks do not seem to be the main threat to EM assets, at least not for the coming quarter.

Chinas challenges significant but manageable


Weak data challenge the 7.5%
growth target

Uncertainty about China has become a major risk to the global recovery. Weak activity data
since December, coupled with the countrys first onshore bond default and CNY weakness,
have raised new fears of a hard landing in China. With IP and fixed asset investment
momentum notably lower, property investment and starts down, and retail sales growing at
their slowest pace in nine years, we estimate that Chinas economy slowed sharply at the start
of 2014, to a sequential pace of c.5%, compared with our earlier estimate of 6.6%. At the recent
National Peoples Congress, the government set its annual 2014 growth target at around
7.5%, which would require a significant uptick in sequential growth for the rest of the year.

China challenges are


formidable...

We still believe that the Chinese authorities have the means and the will to implement policies
to buttress growth in coming quarters. However, in contrast to 2009, todays total public and
private debt ratio of over 200% (compared with 135% at end-2008) limits the scope to do this
via credit-financed investment. Indeed, allowing selective defaults in onshore corporate bonds
and trust products signals policymakers determination to deal with moral hazard and
excesses in domestic credit markets. Policy responses will thus have to strike a balance
between supporting growth without further fuelling imbalances (eg, a property price bubble).

but authorities still have the


ability and determination to
manage them
Looser monetary policy
controlled defaults
and public investment

The easing of monetary policy in recent weeks, including earlier-than-expected widening of


the CNY band to create two-way volatility, was such a step, in our view: increased liquidity
helps banks to deal with the potential fallout from defaults, while the FX move seems
designed to curb hot-money-fuelled carry trades. Importantly, it also suggests that
policymakers view current CNY valuations as close to equilibrium, following a longer period
of real appreciation, and current account surplus that has narrowed to around 2% of GDP.

FIGURE 10
Where domestic credit growth was high, it is now slowing

2.5%

m/m,
6mma

FIGURE 11
External deficits are adjusting, albeit at different speeds
(trade balance, seasonally adjusted)
USD bn

2.0%

USD bn

-6

-8
-10

1.5%

-12
1

Source: Bloomberg, Haver Analytics,

25 March 2014

BRL
INR, RHS

IDR
TRY, RHS

Jan-14

Oct-13

Jul-13

Apr-13

Jan-13

Oct-12

Jul-12

Apr-12

Jul-13
Jan-14
SA
Turkey

Jan-12

Jan-13
Brazil
Russia

-18

Oct-11

Jul-12
India
Indo

-1

Jul-11

0.0%
Jan-12

-16

Apr-11

0.5%

-14

Jan-11

1.0%

ZAR

Source: National Statistics, Barclays Research

Barclays | The Emerging Markets Quarterly


We expect the CNY to stay weak, before eventually returning to a mild appreciation trend.
Furthermore, the government is likely to start planned public investment projects (housing,
infrastructure) and further open the service sectors to private capital to buttress growth in
coming quarters.
Calibrating these policy responses will not be without challenges and will likely keep
markets nervous. The sharp drops in commodity prices and pressure on EM assets
whenever China data have disappointed in recent months demonstrate this. However, our
analysis of the challenges, eg, potential defaults of trust products, suggests the magnitude
should be manageable (eg, Asia Themes: Financing Chinain (orderly) default we trust; 10
March 2014). Moreover, policymakers alertness to these challenges, their control over the
systemically relevant financial institutions and the still robust public debt dynamics, work in
favour of successful policy responses.

EM economies are adjusting at different speeds


Large interest rate hikes in key
EM since last May

Since the prospect of Fed tapering emerged in May 2013, EMs with C/A deficits and large
external financing needs have been under particular pressure. They have experienced the
sharpest currency depreciation, creating pass-through into inflation and pressure on FXleveraged balance sheets. Some central banks reacted early with decisive policy adjustments
(India); others tried to delay but were ultimately forced by markets into hikes (Turkey). The
necessary external adjustments also occurred at different speeds, depending on the extent of
real effective exchange rate adjustments and on the momentum of domestic credit markets
and the composition of export and imports in specific countries.

Narrowing of external
deficits

Indias C/A adjusted rapidly due to an administrative measure that curbed gold imports, but
also on a surge in its goods and service exports. Indonesias C/A deficit also narrowed
significantly in Q4, helped by the front-loading of mineral ore exports ahead of the January
ban, but also by increased manufacturing exports, especially to the US and Japan. In Turkey
and South Africa the deficits remained stubbornly high, but have more recently shown signs
of adjustment. We expect this to continue in Turkey in coming months as imports slow
further and exports to Europe pick up. In contrast, South Africas need for infrastructurerelated imports, and its commodity-heavy exports, also affected by supply-side disruptions,
seem set to stand in the way of a more pronounced adjustment. The C/A in Brazil is
expected to show more adjustment in Q2, as import demand slows further.

rapidly in India
some in Indonesia
less in Turkey and South
Africa thus far

FIGURE 12
Inflation has converged and we see it staying relatively tame
6%

Inflation (% y/y), simple average

5%

4%

3%

2%
Dec 10

Dec 11

Dec 12

LatAm (excl. Veni & Argy)

Dec 13

Dec 14

EM Asia

Source: National Statistics Sources, Haver Analytics, Barclays Research

25 March 2014

EEMEA

FIGURE 13
If sustained, the recent rise in agricultural prices could pose
a risk
90%
% y/y
80%
70%
60%
50%
40%
30%
20%
10%
0%
-10%
-20%
-30%
-40%
-50%
Mar-10
Mar-11

Mar-12

SPGS Agri Index

Mar-13

Mar-14

WB EM Food index

Source: Haver Analytics, Barclays Research

Barclays | The Emerging Markets Quarterly


Most of the monetary policy
tightening in EM seems over

Overall, we expect this adjustment process through slower growth and weaker currencies to
continue, avoiding the EM crisis that some observers fear. Most monetary policy rate
adjustments are probably over the hikes in the C/A deficit countries as well as the significant
cuts in Central Europe, where low inflation had kept real rates high. We expect South Africa
and Russia to hike further this year. Both started tightening late and their real rates are low and
their currencies remain vulnerable. We expect a final 25bp hike from Brazil in April and then a
pause until more hikes in 2015. Turkey will likely try to avoid additional hikes, but could be
forced by the market in case of political turmoil and higher-than-expected inflation.

Some potential risk to inflation


from food prices

One risk to our relatively benign inflation outlook for EM in general could be the recent surge in
global agricultural prices. Food has a larger share in EM CPI baskets, which implies large
exposure to global food prices as well as potentially poor local harvests due to many extreme
weather conditions this winter. However, other non-agricultural commodity prices have
behaved more favourably and global trends seem to support a moderate inflation outlook.

China and the Fed remain key


risks to EM adjustment process

A bigger risk to our view of a continuing gradual EM adjustment is a hard landing in China,
possibly combined with a faster-than-expected secular increase in US inflation in H2. Such a
combination would result in falling global trade, particularly of key EM commodity exports,
and turn capital flows away from EMs. This could more seriously derail the EM adjustment
process, including by forcing central banks into additional interest rate hikes in response to
capital outflows and currency pressures.

Elevated (geo)political risks


Political risks are likely to remain more elevated than usual in the coming months. As discussed
in our publication, Global EM Political Risk: The heat is on (6 March 2014), important elections
loom in Turkey, India, Indonesia and South Africa. Turkeys local elections on 30 March are
widely viewed as a popular referendum on Prime Minister Erdogan amid an escalation of
domestic tensions, which have cast doubt on the countrys democratic institutions. It is unclear
whether any of the election scenarios can restore political stability in Turkey in the short term.
Meanwhile, Indias elections, set to start on 7 April, look more promising in this regard, as polls
suggest the BJP-led NDA coalition is likely to gain a majority. Investors are hopeful that this could
result in a reform-oriented government. However, the usual event risk around such events and
the uncertainty around the eventual result remain. In Indonesia, the confirmation of the most
popular candidate Jokowi as the presidential candidate for the opposition PDI-P is a positive
development for markets. The focus will now turn to his policy platform, which, based on his
current policy initiatives and plans for Jakarta, we believe will be market friendly. However,
legislation needs to pass through the parliament, so consensus building will remain important.

FIGURE 14
Currencies and interest rates adjusted in real terms
%, chg.

FIGURE 15
Policy rates were hiked where needed, we expect little more
bps, chg.

-18

600

-16
-14
-12
-10
-8
-6
-2
0

400

100

300

-100

0
BRL

INR

IDR

Real Rate (bps, chg.) - RHS


Source: Barclays Research

25 March 2014

ZAR

TRY

REER (% chg.)

400
300

100

Changes in policy rate (bp)

500

500

200

-4

600

200
0
-200
-300

Turkey
Brazil
Indonesia
Russia
India
S.Africa
Malaysia
Philippines
China
Czech R
Colombia
Korea
Peru
Thailand
Israel
Chile
Mexico
Egypt
Poland
Romania
Hungary

Elections in Turkey, India,


Indonesia and SA in Q2

Since May 2013

Remainder of 2014F

Current real policy rate

Sources, Haver Analytics, Barclays Research

Barclays | The Emerging Markets Quarterly


Ongoing turmoil in Thailand
and Venezuela; Brazil elections
likely centre stage after the
June World Cup

In South Africa, the latest opinion poll from IPSOS suggests another clear African National
Congress victory (at the national level) in the 7 May election, despite an intensification of
protests over poor service delivery and slow socio-economic transformation. The elections
in Brazil are not gaining much attention yet, as the focus is firmly on the World Cup soccer
tournament, to be hosted by Brazil in June. However, protests last summer suggest that this
could change once the games are over and elections approach. In other countries, domestic
tensions have flared without any elections scheduled. Venezuela and Thailand have
continued to experience mass public protests and unrest that have affected economic
management and led to further deterioration in economic conditions.

Russias involvement in Crimea


has many political and
economic repercussions

More worrying from a global perspective, Russias involvement in Crimea has significantly
complicated Ukraines situation and initiated geopolitical tensions that could create
repercussions well beyond the two countries. We believe that even without an escalation of
sanctions, the already weak Russian economy will be hurt by the adverse confidence effects
already visible in recent weeks. If sanctions were to seriously disrupt trade flows between the
West and Russia, possibly even including Europes gas imports from Russia, this could not only
drive Russia into recession but also create risk for the euro areas still fragile recovery.
Geopolitical events are difficult to trade from an investor perspective, but they cannot be
ignored, as the sell-offs in Russia-related assets, including the DAX, have shown. We
caution against assuming that the tension between the West and Russia will blow over
quickly. We think the recent history of such events (eg, the Georgia conflict in 2008) may
not be the best guide, as the conflict in Ukraine has already become more complex and the
risk of escalation is higher.

EM capital flows in perspective


Retail investors continue to pull out of EM mutual funds, both equities and bonds. However, the amount they are still able to extract appears
low, in our view. According to EPFR global data, the cumulative amount left by retail-type investors in all EM-dedicated bond funds (using
January 2009 as a starting point) is only USD12bn. Retail investors have already taken out USD22bn more than they had put into EPFRtracked EM equity mutual funds since January 2009. The big question is whether institutional investors will exit from EM in a more
meaningful way. They have sold some of their EM bonds and equities, but the amounts have been modest compared with the volume of
sales by retail investors. We think the risk of a large-scale institutional exit is low because their overall EM exposure was a relatively small
share of their investments to start with. The EM share of institutional investors portfolios may have actually shrunk in the past eight months
due a combination of EM redemptions, inflows to DM equities and bonds, and relative valuation shifts. Unless there is a major structural reassessment of EM and an increase in concerns over EM fundamentals, we think a significant increase in withdrawals by global institutional
investors from EM mutual funds is unlikely.
The size of global institutional investors assets under management is cUSD91tn (theCityUK estimate for end-2013), compares to global
foreign holdings of EM portfolio assets of cUSD 4tn (USD1.6tn for equities and USD0.6bn for local bonds in foreign hands plus the total
outstanding of USD0.5bn sovereign Eurobonds and USD1.5tn in corporate Eurobonds). EM probably represents no more than 4.6% of assets
under management in institutional investor portfolios.

Two key concerns and their impact on flows: China and Russia
We see two main sources of concern for investors currently, which could have contagion effects for other EM markets: the growth slowdown
in China; and the political tensions between Russia and the West (over Ukraine/Crimea). Both are important given the size of the Chinese and
Russian economies and the size of their markets in global portfolios. Therefore, fundamental developments in both and changes in perceived
riskiness in equities and bonds of these markets could have a significant spillover effect on other EMs.
However, the type of the spillover/contagion is likely to vary. We view the slowdown in China as temporary, although until there is clarity on
the countercyclical measures used to address this slowdown, investors may be nervous about the impact of the slowdown on both Asian
economies and commodity-producing economies. This contagion may weigh particularly on equity markets where foreign investors have a
heavy exposure. The Korean and Brazilian equity markets are probably at the apex of these concerns and may be most vulnerable to
contagion effects, in our view. Conversely, a China recovery into the remainder of the year (as per our baseline scenario) could lead to equity
inflows to these markets.
The spillover from political tension between Russia and the West likely works through a different avenue in terms of flows. The tensions are
likely to hurt Russian growth and Russian markets. But the economic spillover to other markets else may be limited apart from Baltic states
and some central European economies. If we do not face a scenario of generally elevated oil prices (because of these tensions), then the
problems that weigh on Russian markets might actually support other benchmark EM bond markets. We may see a re-allocation out of
Russian equities and bonds into other EM benchmarks. We have already seen some anecdotal evidence of this in both local and hard
currency bonds.

25 March 2014

10

Barclays | The Emerging Markets Quarterly

FIGURE 16
Institutional investors are holding onto EM bond funds
70

FIGURE 17
but appear to be losing confidence in EM equity funds
200

Cumulative flows to EM bond


funds, USD bn

60

EM: USD bn, cumulative


flows to equity funds

150

50
40

100

30
50

20
10

0
-10
Jan-09

Jan-10

Jan-12

Jan-11
Bond inst.

Jan-13

-50
Jan-09

Jan-14

Jan-10

Jan-11

Jan-12

Equity inst.

Bond retl.

Jan-13

Jan-14

Equity retl.

Source: EPFR global, Barclays Research

Source: EPFR global, Barclays Research

FIGURE 18
Investor concern heightened over Chinese growth

FIGURE 19
Value of total foreign equity holdings higher in non-Asian
markets, with the exception of Korea

2008

Source: EPFR Global, Haver Analytics

Source: National Statistics sources, Barclays Research

FIGURE 20
EM local bonds enjoying better total foreign inflows

FIGURE 21
which may be more evenly distributed among the high
yielders, avoiding Russia for now

USD mn

Total stock of foreign holdings of


local bonds

USD bn

20,000

140

15,000

120

Hungary

Poland

Turkey

Malaysia

SA

Latest

Thailand

Asian equity fund flows

India

Russia

Brazil

Korea

Sep-13

Mar-14

Sep-12

Mar-13

Mar-12

Total stock of foreign holdings of


local equities

400
350
300
250
200
150
100
50
0

Indonesia

China PMI Manuf.

Sep-11

Sep-10

Mar-11

Sep-09

Mar-10

Sep-08

Mar-09

Sep-07

Mar-08

Sep-06

Mar-07

100

10,000

80

5,000

60

40
20

Pol

Bra

*Not available for Brazil and Poland. ** Not available for Brazil, Poland, Mexico.
Source: National Statistics Sources, Barclays Research

25 March 2014

Latest

Thailand

SA

Russia

Turkey

Korea

Poland

Brazil

Mexico

Mar-14**

Feb-14*

Jan-14

Tur

Hungary

SA

Dec-13

Nov-13

Oct-13

Sep-13

Indo

Indonesia

Hun

Malaysia

Mex

Aug-13

Jul-13

-5,000

India

Mar-06

USD bn
10
8
6
4
2
0
-2
-4
-6
-8
-10
-12

Mexico

USD bn

Index
60
58
56
54
52
50
48
46
44
42
40

2008

Source: National Statistics sources, Barclays Research

11

Barclays | The Emerging Markets Quarterly

FIGURE 22
Barclays global survey shows that investors still keen to buy
equities *
50%
40%

FIGURE 23
particularly in the US and the euro area

40%

Which asset class do you


think will provide the
best return in the next
three months?

What region will likely outperform


in equities over the next three months?

30%

30%
20%

20%
10%
0%

10%

Commodities

Credit

Emerging
Markets

Equities

Short-end,
Long-end,
high-quality high-quality

0%

Europe

US

Europe exUK

UK

Japan

Pacific ex- Emerging


Japan
Markets

Note: *March 2014 Global Macro Survey. Source: Barclays Research

Source: Barclays Research

FIGURE 24
Investors are nervous over developments in China

FIGURE 25
and attitudes towards the CNY have changed

35%
30%

40%

What is the most important


risk of financial markets over
the next 12 months?

What do you think will be the PBoCs


inclination towards CNY in 2014?

30%

25%
20%

20%

15%
10%
5%
0%

10%
Worsening
Fed
euro
stimulus
tensions reduction

DeWeak
DM
Geoanchoring growth
growth
political
inflation
in China deterioration develop
expectations
/EM
ments

Other

0%

Weaken it further to Weaken it further to


support growth
allow two-way
volatility

Tolerate strength
again to allow
rebalancing

Stable CNY in 2014

Source: Barclays Research

Source: Barclays Research

FIGURE 26
Investors relaxed about Russia/Ukraine political risks

FIGURE 27
Some expectations for a more reflationary global backdrop

60%

What do you think about the recent escalation


of geopolitical risks in Ukraine/Russia?

40%

50%

What is your favourite commodity


to hold in the next the six months?

30%

40%
30%

20%

20%
10%

10%
0%

It will only have


short-term market
implications

Source: Barclays Research

25 March 2014

It will affect risk


appetite for
several weeks
but will then be
forgotten

It will spill over to other EM


markets

0%

Gold / precious
metals

Oil / other energy


products

Base metals

Agricultural
commodities

Source: Barclays Research

12

Barclays | The Emerging Markets Quarterly

FIGURE 28
Heat map of EM fundamental vulnerabilities to a sudden stop in capital flows
Macro and financial (im)balances
External balance

Foreign positioning and gross reserve cushion

Chg. in ext.
debt since
FX reserves /
2007 (% GDP) ext. debt (%)

Foreign holding
of local bonds
(%)

FX reserves/
foreign holdings
of local bonds

Banking system leverage

Fiscal balance
Primary
balance (%
GDP)

Govt.
debt (%
GDP)

C/A + FDI
(% GDP)

External
debt (%
GDP)

2013F

2013F

2013F

2013F

>2, <-3

<30, >65

<1, >10

>100, <50

<20 >30

>-1, <-3

<40, >60

<0, >10

<3, >18

Turkey

-6.7

46

12

30

27

Russia

1.2

34

70

24

219

0.9

35

-5

1734

-0.2

10

S. Africa

-5.0

38

13

30

33

117

Poland

-1.3

68

13

28

34

150

-0.9

46

-1.7

58

Hungary

4.4

114

11

25

46

187

1.4

81

Romania

0.7

68

18

34

24

562

-0.7

39

27

114

-1

Ukraine

-6.5

81

25

14

3819

-2.3

42

29

171

24

Last

Chg. in govt. Chg. in domestic


debt since
credit since 2007
2007 (% GDP)
(% GDP)

Banking
LTD ratio
(%)

Monetary policy

Ratings

Chg. in LTD
since 2007
(%)

Inflation,
3m avg.
(y/y %)

Real
Rating better or
policy
worse since
rates (%)
Jan 2007

Outlook by
Moodys, S&P
and Fitch

<80, >100

<0, >19

<3.5, >9

>2, <0.5

23

109

31

7.7

1.1

Better

S/N/S

15

120

-2

6.3

0.8

Worse

S/N/N

18

-6

96

5.7

-0.4

Worse

N/N/S

13

14

110

12

0.6

1.8

Unchanged

S/S/S

14

-11

109

-21

0.2

2.6

Worse

N/N/S

1.2

2.5

Unchanged

N/P/S

0.7

5.3

Worse

N/N/N

Last

Heat Map
criteria

>300, <150

Pos, Neg

EEMEA

Nigeria

9.2

0.9

522

15

611

-1.6

20

13

57

-15

7.9

4.1

Unchanged

S/-/S

Ghana

-5.7

27

13

51

23

193

-4.8

55

25

67

-18

13.8

4.0

Worse

N/N/S

Serbia

-2.3

83

31

54

n/a

n/a

-2.3

64

29

21

126

25

2.6

6.9

Unchanged

S/N/S

EEMEA avg.*

-0.9

44.3

8.6

75

25

-0.4

29

13

112

5.4

1.4

India

-2.0

24

62

1704

-3.8

64

-2

116

8.2

0.8

Unchanged

S/N/S

Korea

4.0

34

79

15

591

0.5

37

64

-3

1.1

1.5

Better

S/S/S

Taiwan

8.7

29

286

n/a

n/a

-3.2

37

13

60

-5

0.4

1.9

Unchanged

S/S/S

Indonesia

-1.4

30

34

34

269

-0.8

30

-9

11

94

25

8.0

-0.3

Better

S/S/S

Philippines

3.5

22

-11

128

n/a

n/a

0.6

54

-4

82

-6

4.1

-0.6

Better

P/S/S

Thailand

-1.2

36

123

18

833

-2.2

47

32

111

16

1.9

0.0

Unchanged

S/S/S

Malaysia

2.5

37

123

30

280

-1.7

55

17

29

81

3.4

-0.5

Unchanged

P/S/N

n/a

3.8

108

22

70

106

32

1.1

-0.3

Unchanged

S/S/S

-1.6

51

13.9

92.7

4.8

0.6

Asia

Singapore

29.2

418

-77

22

n/a

Asia avg.*

2.3

48.5

-0.3

89

12

LatAm
Brazil

-0.8

14

117

15

320

1.9

68

21

134

28

5.7

5.1

Better

S/S/S

Mexico

0.2

30

11

47

37

123

-0.4

38

131

-10

4.2

-0.7

Better

S/S/S

Chile

1.0

45

14

34

118

-0.5

13

120

3.1

0.8

Better

S/S/S

Peru

-0.4

31

0.4

98

57

11

1.5

21

-8

100

3.2

0.2

Better

P/S/S
P/S/S

Colombia

0.1

23

51

910

0.7

32

90

-6

2.1

0.9

Better

Argentina

-0.9

29

-18

21

50

-2.2

43

-12

90

61

33

-13.6

Worse

S/N/N

Venezuela

5.4

47

27

21

n/a

n/a

-10.7

70

37

49

-9

56.5

n/a

Worse

P/S/S

LatAm avg.*

0.0

24.1

5.7

76

23

0.0

52

12.5

118.9

15

10.4

1.0

EM avg.*

0.6

39.1

4.4

80

20

-0.7

44

13.1

107.3

6.9

1.0

Note: Rating is median/composite rating of Moodys/Fitch/S&P. * Reflects liabilities of the financial sector. Source: National statistics offices, Barclays Research

25 March 2014

13

Barclays | The Emerging Markets Quarterly

FX strategy: Opportunities among high yielders


The losses in EM FX have worsened, with the Barclays GEMS index losing 1.9% YTD
following a 0.4% decline in Q4 2013. Index level returns mask considerable differences, with
both depreciation (-9% RUB, -8% for ARS and CLP) and appreciation (+8% IDR, +2% for INR
and THB) during the quarter. This is not unusual per se and reflects idiosyncratic political,
terms-of-trade and policy shifts. Differentiation is at work, which we view as a positive
development from the perspective of encouraging fundamentally-driven asset selection.
Argentina devalued its currency, while negative political risks and worsening terms of trade
have weighed on the RUB. In contrast, the IDR and INR have benefited from an improvement
in the policies of the two countries as well as further signs of narrowing in their current
account deficits.

Koon Chow
koon.chow@barclays.com
Durukal Gun
durukal.gun@barclays.com
Mike Keenan
mike.keenan@barclays.com
Hamish Pepper
hamish.pepper@barclays.com

The soft patch in US data meant that the USD was kept in a range against the EUR. We see
more upside potential in the USD later this year, but a range trading environment in Q2
versus the EUR would be broadly helpful for EM FX, in our view. The stability of US dollar
and US rates could pull investors into carry trades in EM, where yields are high or, at the
very least, make investors more reluctant to short those currencies.

Valuations and carry more


attractive now

The attractive FX valuations in some places have been carried forward. Our BEER valuation
models show only a handful of currencies remain overvalued, including the RUB, CNY and
HUF. In the alternative FEER estimates (Figure 30), only the TRY appears (moderately)
overvalued. This provides a helpful backdrop for currencies, particularly where a
fundamental inflection point has been passed and where yields are high.

Manufacturing upswing failed


to provide a lift

On a negative note, the growth trends in some of the major EM economies has been
disappointing in Q1 (including China). Moreover, our expectation that stronger global
manufacturing would pull up EM manufacturing activity has not generally played out. In the
December Emerging Markets Quarterly, we wrote that we anticipated the manufacturing
sector in Poland, Mexico, Korea and India to do particularly well. We thought this would
filter through to exports, manufacturing data and overall GDP growth and would indirectly
provide support for these countries currencies by attracting equity portfolio inflows.
The reality was that there was no marked pick-up in activity in these countries in the first
quarter (Korean IP disappointed), and their equities markets continued to slide with no
obvious increase in foreign appetite (a simple average of the Polish, Mexican, Korean and

FIGURE 29
1.9% YTD drop in GEMS masks divergent performance

FIGURE 30
EM currencies, with few exceptions, are general cheap
% Misval.

% chg.*
8

20

10

2
0

-10

-2

-20

-4

-30

-6

Note: * versus USD (or EUR for CE currencies) Source: Bloomberg

25 March 2014

BEER misval.

RUB

HUF

CNY

TRY

PLN

BRL

THB

MXN

MYR

KRW

IDR

INR

THB

BRL

MYR

CZK

SGD

MXN

Q4 2013

IDR

ZAR
YTD

KRW

TWD

PLN

CNY

TRY

ZAR

HUF

RUB

-10

INR

-40

-8

Misval. External balance assessment

Note: External balance assessment approach of the IMF. Source: Barclays


Research

14

Barclays | The Emerging Markets Quarterly


Indian equity markets fell 3.1%, as opposed to the MSCIs 4.6% drop). The China and US
growth disappointment was likely partly to blame, but with little visibility on when this will
turn around, we think the theme of manufacturing boosting some names may need to be
tamed, at least for Q2.
We recommend investors position in EM FX along the lines of the following themes, which
take into account the lessons of Q1:

Buy INR, BRL and IDR. We recommend being long the high-yielding currencies where
the macroeconomic rebalancing (the narrowing of the C/A deficit) is advanced and the
central bank has taken steps to prevent an overshoot depreciation that could otherwise
be triggered by FX hedging demand or worsening inflation. We recommend being long
INR, BRL and IDR, all of which appear to have passed an inflection point on the C/A and
have high yields. They have the added positives of receding political risk (India and
Indonesia) and a backdrop of central bank steps that have made FX hedging by
corporates less expensive (persistent, albeit a lower pace of swaps intervention in Brazil
and an improvement in the NDF fixing protocol in Indonesia). We believe the blend of
currency valuations and high rates risk premia is particularly persuasive on Brazil where
the real risk premia provides more than 430bps pa of compensation against the risk of
real depreciation for the next 10 years. We expect most of the returns on INR, BRL and
IDR to be from carry as the central banks in these countries are likely to use further spot
appreciation to rebuild FX reserves.

Short RUB, ZAR and TRY. Investors should be defensive on currencies where political
fallout could still be significant. Chief here, in our view, is the RUB, where the
developments in Ukraine/Crimea have increased the external cost of funding for Russia,
potentially weighing on growth and leading to more private capital outflows. We
recommend being short RUB. We continue to recommend being short TRY and ZAR,
and view the political risks for these markets to be on a lower scale compared to
Russia, although they are unlikely to ease this side of the local elections in Turkey (30
March) and the general elections in South Africa (7 May). Turkey is starting to see its
C/A deficit narrow, unlike South Africa. We think the adjustment is likely to come at an
uncertain price on growth and inflation, which could weigh on both currencies.

FIGURE 31
Manufacturing currencies have stopped outperforming
110

FIGURE 32
Brazil offers greatest real and nominal FX premium
FX misvaluation versus real rates
20%

Index of total returns

105

10%

100

0%
-10%

95

-20%
90

-30%

85
Mar-13

-40%
Jun-13

Sep-13

Dec-13

Mar-14

EM manuf.-oriented FX (PLN, HUF, MXN, KRW, MYR)


EM high yield FX basket (BRL, INR, RUB, TRY, ZAR)
Source: Barclays Research

25 March 2014

SA

Russia*

India

FX misvaluation (BEER)
10y real rates

Turkey Mexico Poland

Brazil

Risk adjusted 10y real rates**

*We assume real rates based on long-term inflation. ** 10y linker CDS US
TIIPs. Source: Bloomberg, Barclays Research

15

Barclays | The Emerging Markets Quarterly

Position for more volatility in EM Asian currencies but not necessarily a turn in trend.
The PBoC announced that effective from 17 March it would widen the trading band on
USDCNY to +/-2% from +/-1%. This is similar to April-July 2012, when a similar
widening of the fluctuation band together with a backdrop of China cyclical weakness
contributed to CNY depreciation and some contagion to other Asian currencies. There
may be some repeat of this in the coming month/quarter, with CNY weakness (we look
for 6.20 in one month versus USD) as well as heightened volatility on CNY. There is a
possibility of this spilling over to EM Asian currencies; the THB, KRW, MYR were the
most affected in April-July 2012. We do not anticipate a change in the CNY trend we
still expect gradual medium-term appreciation but warn of temporary contagion.

Play monetary policy divergences through currencies. We recommend being long


MYR/short THB. We think there is likely to be further significant divergence in monetary
policy from Q2 until the end of the year, and we see an opportunity to position long in
countries where rates are being normalized because of the cyclical upswing (against
being short, where the reverse is true). Our view on the growth and inflation outlook is
behind our forecast for the start of Malaysia rate hikes in Q2, while, conversely, the
central bank in Thailand is likely to remain dovish as political risks weigh on an already
weak economy. The Philippines, Poland and Korea are also potential long-side
candidates for playing monetary policy divergence, as we think rate hikes in these
countries are likely in the next 6-12 months due to the strength of the business cycle.
However, we remain neutral PLN and KRW as we believe regional contagion risks could
hold them back. We believe the problems in Russia and Ukraine could trigger some
hedging-related selling of PLN given that the economy would be negatively impacted by
gas stoppages from Russia while, at the same time, PLN is one of the most liquid
currencies in EM Europe. The KRW will likely struggle to appreciate if the JPY, as we
expect, depreciates further. MXN has been one of our favoured structural longs, but
with growth slow to recover, we prefer to buy into dips, ie, around the 13.40 level.

FIGURE 33
RUB: Intense capital outflows even before political risks
increased
USD bn

Large
outflows/mixed
intervention

20
15
10
5
0
-5
-10
-15
-20

FIGURE 34
CNY: Similar to 2012, when band widened during a slow
cyclical period and renminbi fell

Large outflows/
rising FX-sales
intervention

6.50
6.45
6.40

Band widening
to 2%

6.35
6.30
6.25
6.20
6.15

FX intervention
Source: CBR, Barclays Research

25 March 2014

Net private capital flows

Feb-14

Aug-13

Feb-13

Aug-12

Feb-12

Aug-11

Feb-11

Aug-10

Feb-10

Aug-09

Feb-09

6.10

Band widening to
1% in April 2012

6.05
6.00
Sep-11
Mar-12
Sep-12
USD/CNY spot
Lower trading bound

Mar-13
Sep-13
Mar-14
USD/CNY fixing
Upper trading bound

Source: Barclays Research

16

Barclays | The Emerging Markets Quarterly

EM local currency rates: High premia


Rohit Arora
rohit.arora@barclays.com
Koon Chow
koon.chow@barclays.com
Donato Guarino
donato.guarino@barclays.com
Mike Keenan
mike.keenan@barclays.com

Breathing room from stable


UST

The key theme in EM rates in Q1 was an increased differentiation. In Q1, the Barclays EM
local index returned 0.15% at the index level, compared to -0.23% in Q4 2013. FX
contributed -0.16%, while carry and yield compression added a further 0.3%. Although the
broad returns are flat YTD, the performance distribution has a high dispersion, particularly
within vulnerable countries with large current account deficits (India, Indonesia, Turkey,
South Africa, and Brazil).
USTs stabilization, policy actions, and nascent signs of turnaround in current account
deficits. A number of developments have enabled this to happen, and we think it will have a
lasting impact in continuing to facilitate differentiation. UST yields have corrected lower and
have been broadly range trading since January. This, in conjunction with lower cross asset
market volatility, has put investor focus squarely on idiosyncratic EM issues and
developments. There have also been a number of monetary policy shocks, with large
interest rate hikes in Turkey (550bps for the repo rate on 28 January), Russia (150bps on 3
March), and a surprise hike in South Africa (50bps on 29 January). Current account deficit
countries appear to have reached an inflection point in their deficits, in our view, so that
even with the continuing paucity of portfolio capital outflows, the pressures on currencies
and monetary policy is reduced.
We look for range trading in US Treasuries and then re-trending higher in H2. As we break
into new higher territory, we may see the sensitivity of EM yields to the US increase again.
Our baseline scenario is still for 10y UST yields to end the year at 3.50% from the current
2.80%, as the tightening labour market in the US and a re-acceleration of growth from the
recent spell of cold weather pushes up core inflation and leads to a re-pricing of US rates.
For now, however, we think there is some breathing space.
We recommend positioning in EM rates along the lines of a number of key themes, some of
which we expect to have a longer shelf life than others:

We recommend longs (Brazil, India and Indo.) where there are generous rates premia
and where the current account adjustments could be a catalyst for a re-assessment
by investors. Our favoured candidates are the Brazil 3y, the India 5y and Indonesia 10y
nominal bonds. Among the current account deficit countries, we believe these three
have the best combination of factors to pull down yields and to stabilize the exchange
rates. Brazil, India and Indonesia (alongside Turkey and South Africa) have suffered
FIGURE 35
Differentiation trend intensified in EM local currency
bonds
9.0%
8.0%
7.0%

FIGURE 36
particularly among the vulnerable EM countries
YTD returns
%
15

Rising dispersion in the high


yielders quarterly
performance (EM indices)

10

6.0%

5.0%

4.0%

-5

3.0%

-10

2.0%

-15

1.0%

-20

0.0%
Mar-12

Sep-12

Source: Barclays Research

25 March 2014

Mar-13

Sep-13

Mar-14
Source: Barclays Research

17

Barclays | The Emerging Markets Quarterly


capital outflows since May 2013, which triggered significant currency depreciation and
monetary tightening to meet the risk of rising inflation. A natural part of this adjustment
is that GDP growth slows and the C/A deficit narrows. However, this adjustment does
not necessarily mean that rates can become a receive once the current account
adjusts, because the inflation tail may still be long and significant. Moreover, slower
growth carries with it some fiscal challenges. However in the case of Brazil, India and
Indonesia, we have been positively surprised on a number of these issues. Brazils
inflation has been easing, suggesting limited FX pass. Despite this, the BCB has
continued to hike rates, which appears to have boosted the credibility of the central
bank. Inflation appears to be starting to turn around/lower in India and Indonesia, and
growth has, surprisingly, been firm.

UST range trading should contain the volatility of local rates markets, providing an
opportunity for carry trades. In this vein, we recommend being long Mexico Mbono 42
and Thai 7y bonds FX hedged. We believe Mexico is a particularly strong candidate for
this theme as the overreaction of local yields to last years backup in US Treasuries has
not been fully reversed. The domestic cyclical and structural backdrop is also supportive
of a lower and flatter yield curve, in our view: growth is recovering slowly, inflation
remains muted, and the implementation of last years reforms appears positive for
Mexicos long-term fiscal outlook, which could pull down long-tenor yields. The Thai
rates curve is one of the steepest in EM Asia, but a cyclical recovery seems a long way in
the distance given the ongoing political uncertainty in the country, which continues to
weigh on growth. We see the most gains from accreting carry roll-down in both Mexico
and Thailand, but do not rule out a further bull-steepening in the latter, as we think rate
cuts still possible in Thailand.

Position in select locations of the output gaps and a normalisation of monetary


policy. We recommending paying Poland 1y1y IRS, Korea 5y5y NDIRS and keeping
watch for opportunities to pay Malaysia rates. We consider these economies to have
some the strongest cyclical upswings in EM currency, with strong exports dovetailing
with improving domestic demand. Although inflation is rising only gradually (and, in the
case of Malaysia, due to administered price increases), we think the shrinking economic
output gaps means that inflation could trend up more quickly into late 2014.

FIGURE 37
Yields in C/A deficit countries are diverging

INR

The current deficit yields have


ceased moving together

ZAR

TRY

BRL

Mar-14

Dec-13

Sep-13

Jun-13

Mar-13

Dec-12

IDR

Source: Bloomberg, Barclays Research

25 March 2014

Country
India

Sep-12

Jun-12

Mar-12

%, 5yr bond yields


14
13
12
11
10
9
8
7
6
5
4

FIGURE 38
with the restoration of pre-QE yield levels supporting
India, Brazil, SA and Indonesia
10yr Real,%

Avg. real Rate Precris levels*

Current - Avg.

2.7

1.2

144

Brazil

6.6

6.7

-3

SA

1.8

1.9

-9

Thailand

1.8

2.1

-22

Turkey

3.7

4.4

-70

Poland

2.2

3.1

-93

Indonesia

1.5

2.6

-111

Korea

1.5

2.8

-136

Mexico

2.4

3.9

-148

US

0.5

2.7

-225

Note: *Based on linkers as of 17 March 2014. We use inflation and nominal


bonds for Indonesia and India. Source: Bloomberg, Barclays Research

18

Barclays | The Emerging Markets Quarterly


Our baseline scenario is for Malaysia to hike rates in Q2, Korea to follow in Q3, and
Poland in Q1 2015. In Malaysia, we view the tightening expectations as fairly priced.
However, in Korea, the nascent recovery in the housing sector supports our view that
the pass-through from the recovery in exports into domestic demand is occurring
slowly, reviving consumer confidence. Unless there is a severe bout of global risk
aversion (driven by geopolitical concerns), and if Koreas domestic economy keeps
growing at a modest pace, we think there is very limited room for yields to decline and
recommend paying 5y5y NDIRS. The rates markets in Poland, Korea and Malaysia
appear to be pricing in some gradual monetary policy tightening in the next 6-12
months but with a slower pace of normalisation than in past cycles.

Short or paid in markets where policy makers are battling large capital outflows
(Hungary and Russia). These provide attractive tail-risk shorts in EM rates and are
hedges against our rates carry trade recommendations. Hungary (we recommend
paying 5y) and Russia (we recommend a duration neutral 2s5s flattener) are the best
candidates for this, in our view, because they are suffering from significant capital
outflows. This is weighing on their respective exchange rates, which likely has negative
implications for both inflation and corporate balance sheets. Hungary is still in an easing
cycle, which makes the back end of its curve more vulnerable than the front. In Russia, a
bear-flattener seems superior to outright payers because growth is likely to be
depressed in the foreseeable future, which would anchor long end yields.

FIGURE 39
Growth recoveries in Malaysia, Korea and Poland will bring
rate hike risks onto the radar
Pct. pt.

1y1y - Policy Rate (bp)

Real GDP growth minus 10y average growth

8%

FIGURE 40
and the rates premia will need to adjust

400
300

4%

200

0%

100

-4%

-8%

-100

Korea

Malaysia

Source: Haver Analytics, Barclays Research

25 March 2014

Poland

Current

ILS

IDR

KRW

INR

THB

USD

PLN

AUD

MYR

TRY

MXN

HUF

COP

BRL

ZAR

-200

RUB

Dec-13

Dec-12

Dec-11

Dec-10

Dec-09

Dec-08

Dec-07

Dec-06

-12%

May 2013

Source: Bloomberg, Barclays Research

19

Barclays | The Emerging Markets Quarterly

Sovereign and corporate credit: Regional rotations


Andreas Kolbe
andreas.kolbe@barclays.com
Aziz Sunderji
aziz.sunderji@barclays.com
Donato Guarino
donato.guarino@barclays.com
Bruno Rovai
bruno.rovai@barclays.com
Avanti Save
avanti.save@barclays.com
Krishna Hegde
krishna.hegde@barclays.com

Geopolitical and China


headwinds

but DM credit performance


should help contain EM
spreads

Compared with other EM asset classes, EM sovereign and corporate credit has been
relatively resilient at the index level (Figure 34). From a total return perspective, EM credit
has been helped by the retracement in US Treasury yields (benefiting longer-duration
sovereigns in particular), but we note that even from a spread/excess return perspective,
both EM sovereign and corporate credit performance at the respective Barclays index level
has been close to flat year-to-date. Issuance, though roughly in line with prior years, has
fallen behind our expectations for supply this year (Figure 42). This is particularly the case
for EEMEA corporates, indicating that supply in EM remains largely sized to demand:
relatively light supply from EEMEA coincides with the regions underperformance (YTD total
return of 0.4% at the aggregate index level, comprising both corporates and sovereigns),
versus LatAm (2.1% YTD total return) and Asia (2.7% YTD total return).
For Q2, we expect political and geopolitical concerns to remain an important driver of volatility,
with the Russia-Ukraine conflict likely to lead to a structural re-pricing wider of Russia credit.
China-related concerns (growth, trust product defaults, onshore bond defaults, the rise in
USDCNY fixing and spot CNY and CNH and their implications for FX product exposures) are
also likely to remain on investors minds. These developments have some specific consequences
for our recommendations on Chinese credits, which we outline below, but are also likely to have
broader adverse effects on sentiment towards EM credit as a whole.
On a more positive note, however, we do not expect US Treasuries to be a significant
headwind. While rates volatility at the short-end could lead to some flattening of credit
curves, EM spread sensitivity to UST yields has subsided and, with upward pressure on UST
yields likely to accelerate only in H2, we think UST yields are unlikely to be a dominant topic
in Q2. Moreover, and perhaps most importantly, EM seems to be anchored by the
comparison to DM. We think the strong performance of DM credit should help EM spreads
stay contained, at least for those parts of EM that are not directly affected by adverse
political developments (Figure 43).
On balance, we think that EM spreads are likely to move sideways on aggregate over the
next quarter, but with generally heightened volatility as well as differentiation among credits
and regions. We recommend positioning along the following lines:

FIGURE 41
EM credit at index level has outperformed other EM asset
classes YTD, but with sharp regional divergences
3.0

350

Total return, YTD, %

2.0
1.0
0.0
-1.0
-2.0
-3.0
-4.0
-5.0

EEMEA: 0.4%
LatAm: 2.1%
EM Asia: 2.7%

30%

250

25%

200

20%

150

15%

100

10%

50

5%
0%
EM hard-ccy
EM hard-ccy
EM USD
sovereigns (gross) sovereigns (net*) corporates (gross)

-7.0
EM local
gov.

EM FX

EM equities

Note: Based on Barclays EM USD sovereign, EM USD corp/quasi, EM local gov.


bond, GEMS and MSCI EM indices. As of 15-March. Source: Barclays Research

25 March 2014

35%

USD bn

300

-6.0
EM USD sov. EM USD
corp/quasi

FIGURE 42
However, issuance has fallen behind schedule, particularly
for EEMEA corporates

2014 YTD
2014 full-year forecast
YTD in % of full-year forecast (RHS)
Note: *net of interest payments and redemptions. As of 15-March. Source:
Bloomberg, Barclays Research

20

Barclays | The Emerging Markets Quarterly

Re-allocate from Russia into Brazil, Indonesia. The risk of prolonged RussianWestern tensions following the Russia-Ukraine conflict and the threat of further
sanctions against Russian individuals and businesses remain clear negatives for
Russian credit, in our view. The muted growth outlook and the adverse implications
for capital flows could also put downward pressure on Russias ratings in the
medium term, in our view. Although Russia has underperformed meaningfully
already as positions are adjusting to the recent developments, we think this is a
structural shift higher in spreads that is likely to extend further. While broader riskoff from the Russia-Ukraine developments is a possible scenario, we think that
substitution effects may support other parts of EM. In particular, we have become
positive on Brazil: despite the recent one-notch downgrade from S&P to BBB- (which
was largely priced in), the outlook has been moved to stable. Combined with positive
signals on the fiscal front, better-than-expected growth data and still-attractive
valuations against peers, this leads us to lift the sovereign to tactically overweight.
We also suggest expressing the Russia/Brazil theme in corporates/quasi-sovereigns
(switching from Gazprom into Petrobras, for example, or going long BANBRA T1
bonds outright). We also think that Indonesia should benefit from some reallocations from Russia perceived improvements in economic data have triggered a
turnaround in sentiment and the upcoming maturities of offshore bonds provide a
good technical backdrop for issuance from quasi-sovereigns, in our view.

Ukraine versus LatAm HY sovereigns long PDVSA 17Ns, short Ukraine 17Ns.
We reiterate our overweight recommendation on Venezuela. The central bank has
finally published the exchange agreement that sets the (more flexible) rules for the
new FX market (SICAD II). There are still issues to be clarified, but the FX market
changes could significantly reduce Venezuelas economic distortions and
imbalances, which we think should be very supportive for Venezuela/PDVSA debt.
The outlook for Ukraine, however, still looks challenging. Swift financial aid from
the West and the apparent commitment of the new Ukrainian government to an
IMF-led reform path are positive, in our view, but implementation risks to any
reform programme, not least in light of the threat of retaliatory measures from
Russia, are likely to re-ignite concerns that a debt rescheduling/restructuring may
become unavoidable at some stage. We suggest being long the PDVSA 17N,
against being short the (high cash-price) Ukraine 17N. We also remain

FIGURE 43
Russia has been the underperformer but Brazil and Global
EM credit are also at record-cheap levels vs US credit
2.5
2.3

FIGURE 44
EM sovereign spread versus rating likely different
trajectories for Russia and Brazil
EM USD Sov Index OAS
300

Spread ratio

Tur

Rus

2.1

250

1.9
1.7
1.5
1.3

Ind

Soaf

200

Pan

150

1.1

Pol

0.9
0.7
May-10 Dec-10 Jul-11

100

Feb-12 Sep-12 Apr-13 Oct-13

Russia BBB/US BBB


EM BBB/US BBB
Source: Barclays Research

25 March 2014

Brazil BBB/US BBB

Mex

Mly

Rom
Bra
Col

Phil

Per

50
A-

BBB+

BBB

BBB-

Note: Average rating of S&P/Moodys/Fitch. Source: Bloomberg, Barclays


Research

21

Barclays | The Emerging Markets Quarterly


constructive on Argentina credit. The recent developments suggest that Argentina
has changed its attitude and is now willing to preserve its FX reserves rather than
artificially boost growth.

25 March 2014

Chinese credit buy China CDS, stick to core (CNOOC) versus non-core SOEs:
We recommend using the China sovereign CDS to hedge against concerns around
further CNY depreciation or increased stress in onshore funding. In cash bonds we
recommend an overweight stance on core SOEs (such as CNOOC) while
underweighting non-core SOEs and financials. We recently turned neutral (from
previous overweight) on the Chinese investment grade property companies. We
think high grade issuers hybrid bonds offer better volatility-adjusted returns
compared to Chinese SOEs and we recommend switching into HUWHY 6% perps
(issued in 2012).

Select longs in smaller, higher-yielding EM sovereigns and corporates with


limited linkages/correlations to the Russia/Ukraine conflict. We recommend an
overweight stance in Sri Lanka and think that the ongoing weakness in Zambia
may have created an opportunity to turn less bearish, as our commodity
colleagues think the recent concerns around copper prices are overdone (and
should be partly compensated by higher production in Zambia) and relative
valuations versus other SSA credits now look appealing, in our view. Despite recent
outperformance, we see value in select GCC credits - such as DARALA 15s/16s.

We also think a number of high yielding LatAm credits stand to benefit from
idiosyncratic developments. In particular, we recommend Colombian energy
producer Pacific Rubiales; we view Pacific Rubiales as a solid credit with an
impressive operational track record. We view PRECN a potential rising star; we
think an upgrade (from the current Ba2/BB+/BB+) is possible in late 2014 or 2015.
We also recommend Pan-LatAm telecoms company Digicel; although the
companys fundamental profile appears stable, the long thesis here is primarily
based on valuations: we think DLLTD looks unusually cheap compared to global
comps in, for example, the US HY communications index. We also recommend
Brazilian sugar producers USJ and Tonon, which we believe are attractive if sugar
prices are able to maintain gains in the 17 range, and present some upside
potential if sugar prices rise beyond that level. Finally, we recommend Brazilian
beef producer Marfrig following a strong 4Q13 performance, which came in ahead
of company guidance and our expectations. We see scope for spreads to compress
a further 100bp.

22

Barclays | The Emerging Markets Quarterly

TRADE SUMMARY
Country

Rates

Credit

Foreign Exchange

Emerging Asia
China

Easier liquidity, lower rates. The PBoC


sounded less hawkish in its February policy
report, stating that it would maintain
appropriate levels of liquidity and create a
stable monetary-financial environment. The
outlook for fixed income markets has
changed in favour of receivers/long bonds.

We recommend an underweight stance


on Chinese financials and non-core SOEs.
We prefer core SOEs.

India

Receive 5y OIS, buy 5y bonds (above 9%).


Indias policy adjustments and increased
differentiation within EM have put INR assets
in a sweet spot. Bonds so far have struggled
to follow through; however, given the
momentum in INR, we think the path for
least resistance for yields is lower.

We recommend a neutral stance on India


credit, as we believe spreads provide very
little buffer for any surprise on the
elections.

Short USDINR targeting 59.0 ( stop loss at


62.50): Positive INR momentum will likely
continue in the near term, due to a narrowing
current account deficit, softer inflation,
enhanced policy credibility and strong capital
inflows.

Indonesia

Stay neutral IndoGBs, for now: We believe


policy and market price adjustments in
Indonesia have been sufficient. However, we
think a lot of optimism is priced in: 10y yields
have rallied from 9% to 8%, foreign inflows
have been strong at ~USD2.5bn vis--vis
USD4.4bn in 2013. At current levels, we do
not find the risk-reward to be overweight
asymmetric.

We recommend buying long-end bonds


(INDON44/43) and the quasi-sovereigns
that have lagged the sovereign (ie,
Pertamina and PLN).

Short USDIDR 12m NDF targeting 11,200 (stop


loss: 12500; strike: 12300): We believe Jokowis
confirmation is a significant positive for the IDR
against a backdrop of reduced vulnerabilities.
We also expect the upcoming change to an
onshore (JISDOR) NDF fix on 28 March to
improve NDF market liquidity and support
investment into Indonesian equities and local
currency bonds by giving investors a better
instrument to hedge these exposures.

Korea

Pay 5y5y NDIRS, underweight duration.


We recommend an overweight stance on
There are nascent signs of recovery in
Korea credit
domestic demand. However, so far, rates
markets have focused on global growth
uncertainties. However, we think those
expectations could be disappointed.
Moreover, the favourable technical factors in
February (eg, strong demand from insurance
companies) are receding.

Malaysia

Overweight cash, neutral duration. We think


IRS are fairly pricing in monetary policy
tightening risks. In fact, market pricing of
~65bp of tightening in the next two years
exceeds our view of a 50bp policy tightening
in 2014 and a pause thereafter. However,
given the probability of an overshoot and EM
contagion risks, we remain neutral.

Philippines

Long MYRTHB targeting 10.19 (stop loss: 9.75;


spot ref: 9.83): Strong growth momentum,
recovering commodity prices, continued
current account surpluses and likely central
bank rate hikes bode well for MYR appreciation.
In Thailand, continuing political uncertainty, a
dovish BoT and modest economic growth are
likely to encourage further capital outflows and
weigh on the THB over the next three months.
Along the curve, prefer the PHILIP 21s,
24s and 34s.

Singapore Receive SGD 3y2y vs USD. We recommend


being long SGD rates vs US rates in a rising
yield environment. The 2% FX 'carry', in the
form of SGDNEER upward slope, makes SGS
look relatively attractive and is a key reason
for our spread tightener view. Indeed, SGD
rates were lower than USD rates prior to H2
11 in a higher rate environment.
Thailand

Buy 7y ThaiGBs, fX hedged: Deteriorating


growth, low inflation, lower supply and the
Thai curves relative steepness to the region
still warrant an overweight duration stance,
which should also counter any potential
uptick in global bond yields. We recommend
the 7y sector in ThaiGBs, given the steepness
of the curve. We recommend hedging FX
risk, owing to a prolonged political stand-off.

25 March 2014

We recommend buying protection and


funding via Philippines or Malaysia to
hedge headline risks from political
uncertainty and potential credit ratings
pressure

Long MYRTHB targeting 10.19 (stop loss: 9.75;


spot ref: 9.83): Strong growth momentum,
recovering commodity prices, continued
current account surpluses and likely central
bank rate hikes bode well for MYR appreciation.
In Thailand, continuing political uncertainty, a
dovish BoT and modest economic growth are
likely to encourage further capital outflows and
weigh on the THB over the next three months

23

Barclays | The Emerging Markets Quarterly


Country

Rates

Credit

Foreign Exchange

Latin America
Argentina

Brazil

We remain constructive on Argentina


credit, which we keep as an overweight in
our portfolio, given positive policy steps,
potential catalysts in the financial agenda,
and valuations. We recommend the very
short end of the curve, since it is inverted.
In particular, we favour the Boden15;
while it trades tighter than the Bonar17, it
is more immune to supply risk and still
trading at a sizable pickup relative to the
long-end bonds.
Brazil local rates offer generous risk premia,
despite the inflation challenges. We think
the current account adjustment can serve as
a catalyst to stabilize the exchange rate and
pull down the yield curve. Given the shape
of the yield curve, we think the 3y point
offers the most attractive carry/roll-down;
therefore, we recommend buying NTN-F 17s
for real money and receiving DI Jan17 for
leveraged investors.

Despite the recent one-notch downgrade


from S&P to BBB- (which was largely
priced in), the outlook has been moved
to stable. Combined with positive signals
on the fiscal front, better-than-expected
growth data and still-attractive valuations
against peers, this leads us to lift to
tactically overweight.

Colombia

We recommend going long Colombia


2044s, switching from the 2023s. With
our expectation of a smooth political
transition against a backdrop of continued
strong economic fundamentals, we think
valuations at the long end of Colombias
bond curve have become attractive. At
portfolio level, we remain overweight.

Peru

We move the credit to neutral after the


outperformance; we think the risks are
asymmetric. To express our defensive
view, we recommend positioning on the
belly of the curve (PE25s).

Mexico

We reiterate our recommendation to be long


Mbono42s despite the recent rally.
Valuations remain attractive: the Mexico
bond/swap curve is one of the steepest in
EM, hinting that it has overreacted to US
Treasury movements. We would express our
monetary policy outlook by entering either a
1y1y TIIE receiver or a 2y TIIE receiver.

Venezuela

25 March 2014

Further possible rating upgrades are


already priced in; therefore, we remain
neutral at portfolio levels. We think the
belly of the Mexico curve is particularly
rich versus Brazil and recommend a long
BR25 short MX23 switch.

We still like the BRL on tactical grounds and


recommend being short USDBRL (target 2.29,
stop 2.42). While we expect a weaker BRL in
the longer run, we believe that the BCB will
continue to use its large balance sheet to
prevent a sell-off of the currency, at least
until the election.

Structurally long but warn of range trading over


the coming quarter due to the absence of clear
triggers for an MXN rally.

We reiterate our overweight


recommendation. The central bank has
finally published an exchange agreement
that sets the (more flexible) rules for the
new FX market (SICAD II).This could
reduce Venezuelas economic distortions
and imbalances significantly, which
should be supportive for
Venezuela/PDVSA debt. Since both bond
curves are inverted, we suggest being long
the PDVSA17N and the VE16s.

24

Barclays | The Emerging Markets Quarterly


Country

Rates

Credit

Foreign Exchange

EEMEA
Hungary

We are underweight HGB, given our currency Remain overweight USD bonds. With
issuance needs for 2014 largely met and
view and the low HGB yields.
economic fundamentals improving, we
see value in Hungary 41s in particular.
Switch from Croatia/Serbia.

MENA

We are moderately negative HUF and


recommend using levels of about 310 per EUR
to accumulate EUR.

Long select GCC higher-yielding credits:


DUBAIH 17s (DHCOG), MAF perps,
DARALA 16s, value in the Qatar sovereign
and the DP World long end. Take some
profits on Morocco ahead of likely new
issuance, re-allocate into Egypt 40s,
Lebanon. Hold on to Iraq 28s.
Neutral PLN.

Poland

We recommend being underweight. Avoid


POLGBs including and longer than the
Apr16s. We look for foreign selling to
increase, due to the low yield levels and the
low premium for a cyclical and an inflation,
albeit gentle, upswing.

Romania

Moderate overweight ROMGB Jul17. The


NBR has a strong control over the exchange
rate and the local yields are close to those on
HGB. We think that the Romania local market
will draw most of the inflows to CEE local
bonds because of this.

Take profits in USD paper, some value left Short EUR/RON: The RON is likely to rise on
in EUR bonds. With further supply and
foreign investor bond re-weighting flows.
an approaching election period, we do not
think Romania has significant room for
spread tightening. Some value remains in
EUR-denominated bonds, which continue
to trade wide to USD.

Russia

Underweight. Reduce duration and lower


cash exposure to OFZ. Foreign ownership
levels are greatest on the OFZs maturing on
and after March 2018. We view those as
most prone to pressure and volatility. The
15s, 16s and 17s offer a relatively better
safe haven, and we recommend switching
into these instruments. 2s5s flattener is
attractive.

Underweight. The risk of prolonged


Russian-Western tensions and the threat
of further sanctions remain clear negatives
for Russian credit, in our view, across the
sovereign, corporates and banks. Among
corporates, we remain most skeptical of
Gazprom and Rosneft, while we suggest
maintaining exposure to MTS and Norilsk
Nickel.

We recommend being short the RUB against


the USD, as the scale of portfolio outflows,
associated with the high level of political
tension, could easily drive depreciation beyond
the 0.8% per month priced in by the market.

South
Africa

The curve is likely to bear flatten again, with a


weaker ZAR and higher US Treasury yields
lifting short-end rates faster than back-end
ones.

Remain Underweight SOAF credit; current


levels offer an attractive opportunity to
reset shorts by via 5y CDS (buy 5y CDS
protection).

Short ZAR against USD. A structural current


account deficit, heightened socio-political
tensions, fractious labour markets, and the
lingering possibility of another credit rating
downgrade are likely to weigh on the ZAR.

SubSaharan
Africa

Long shorter-dated rates in Nigeria.

Buy Zambia 22s. The ongoing weakness


of Zambia credit has created an
opportunity to turn less bearish. A
potential stabilisation of copper prices,
signs of fiscal consolidation and the
possibility of re-engaging with the IMF
could all be positive catalysts.

Long NGN via NDFs.

Turkey

Buy Apr20 linkers. Breakevens are relatively


low compared with the long-term inflation
trends and the inflation coupon will likely be
high in the coming quarter.

Stay neutral, prefer 5-10y sector on the


cash curve. Political uncertainties are
offset by strong fiscal dynamics and
possible positive re-allocations flows from
Russia in an EEMEA portfolio context.

Short the TRY against the USD due to external


funding pressures and a reactive stance by the
CBT (towards inflation and depreciation
pressures).

Ukraine

Stick to short-dated bonds (Ukr 14s,


Nafto), remain underweight longer-dated
ones. We think that the likelihood is
relatively high that a default in the short
term will be avoided. Longer-term
economic challenges and political risks
make us reluctant to turn more positive on
longer-dated bonds. Short Ukraine 17s vs
long PDVSA 17Ns.

Source: Barclays Research

25 March 2014

25

Barclays | The Emerging Markets Quarterly

EM CREDIT PORTFOLIO
OAS (bp)

OAD

31-Dec-13 21-Mar-14 3mF

Weights (%)

Total Returns (%)

Benchmark Model Tactical bias

1w

Q1 14 QTD 2014 YTD

Bonds we recommend
3m F

Buying

EM Portfolio

312

334

331

7.2

100

100

0.3

1.8

1.8

0.3

Arg, Ven, Ukr

887

1048

1046

5.1

12.1

13.6

over

2.2

-1.3

-1.3

1.0

Other

216

221

220

7.4

87.9

86.4

neutral

0.0

2.2

2.2

0.2

EM Asia

228

204

198

8.0

15

16

neutral

-0.1

4.2

4.2

0.3

Philippines

129

126

126

9.1

5.8

5.4

under

-0.2

3.6

3.6

0.4

PHILIP '21s, '24s, '34s

Indonesia

264

231

221

7.6

7.9

8.2

neutral

0.0

4.6

4.6

1.4

INDON '43s, '44s

Sri Lanka

406

321

306

5.4

1.0

1.5

over

0.2

7.7

7.7

1.8

SRILAN '19s, '22s

Vietnam

303

240

240

3.5

0.4

0.5

neutral

0.3

3.6

3.6

0.7

Mongolia

527

590

590

5.4

0.3

0.3

neutral

0.0

-1.0

-1.0

1.6

EEMEA

269

305

315

6.1

45

43

under

0.5

1.0

1.0

0.1

Turkey

311

302

302

7.6

10.1

10.2

neutral

-0.5

3.4

3.4

0.8

5-10y sector

Russia

187

288

313

5.7

10.0

9.0

under

0.8

-3.6

-3.6

-0.6

Qatar

101

94

89

7.0

3.8

4.2

over

0.3

2.6

2.6

0.6

Poland

117

109

109

5.6

3.7

2.8

under

-0.1

2.1

2.1

0.4

Lebanon

395

376

376

4.7

4.3

4.2

neutral

0.3

2.7

2.7

1.1

Ukraine

725

1055

1130

3.8

2.9

2.3

under

4.6

-4.6

-4.6

-0.1

Ukraine '14s

Hungary

269

268

248

6.5

3.5

3.7

over

0.1

2.9

2.9

2.1

Hungary '41s

South Africa

221

208

228

7.1

2.3

1.6

under

0.3

3.3

3.3

-0.8

Selling

30y sector
Russia '22s, '23s, '42s, '43s

Qatar '40s, '42s

Qatar '20, '22s


Poland EUR
Ukraine '16s, '16Ns, '17s, '17Ns
Hungary EUR
SOAF '41s

Lithuania

146

154

154

5.4

1.5

1.5

neutral

0.2

1.7

1.7

0.5

Croatia

308

284

284

5.4

2.2

2.2

neutral

0.3

3.5

3.5

0.9

Croatia '19s, '20s

Egypt

454

356

336

6.8

0.3

0.4

over

0.8

8.8

8.8

2.4

Egypt '40s

Latvia

149

137

137

4.5

0.6

0.6

neutral

0.1

1.6

1.6

0.4

Latin America

364

387

375

8.1

38

41

over

0.2

1.8

1.8

0.5

Brazil

178

181

166

8.0

7.7

8.3

over

0.4

2.4

2.4

1.7

BR25

BR41

Mexico

127

134

129

9.7

9.0

8.7

neutral

-1.0

2.5

2.5

0.8

MX44

MX23

Venezuela

1070

1174

1144

5.4

5.8

6.8

over

0.5

-0.9

-0.9

4.8

PDVSA17N

Argentina

740

830

810

5.5

3.4

4.5

over

3.0

0.9

0.9

3.3

G17, Boden 15

USD Par

Colombia

153

165

155

8.8

4.2

5.0

over

-0.3

2.0

2.0

1.3

CO44

CO19

Peru

145

149

144

10.0

2.5

2.5

neutral

0.1

3.0

3.0

0.9

PE33

Panama

191

194

199

9.6

2.0

1.7

under

-0.1

3.6

3.6

0.1

PA36

Uruguay

191

194

199

10.2

1.5

1.5

neutral

0.2

3.6

3.6

0.0

UY25

El Salvador

365

440

420

8.0

1.0

1.0

neutral

0.6

-1.6

-1.6

2.9

ElSalv25s
DR18

Dominican Republic

374

349

369

5.9

0.7

0.5

under

-0.1

3.1

3.1

-0.1

Rest of Index

331

373

352

4.9

1.4

0.9

under

-0.4

1.7

1.7

0.2

UY36

Source: Barclays Research

25 March 2014

26

Barclays | The Emerging Markets Quarterly

MACRO OUTLOOK: ASIA

Shaken, stirred but not disturbed


David Fernandez
+65 6308 3518
david.fernandez@barclays.com
Wai Ho Leong
+65 6308 3292
waiho.leong@barclays.com
Rahul Bajoria
+65 6308 3511
rahul.bajoria@barclays.com

Weather disruptions have temporarily reversed north Asias export-led outperformance.


But we expect growth in north Asia to re-accelerate in Q2, and attention to refocus on
shrinking output gaps, which will renew expectations for rate normalisation especially
for economies more synchronised to the US. While external risks have turned the corner
in the south, political cycles in Indonesia and India, coupled with signs of drought in
southeast Asia, could constrain domestic demand.
We maintain our 2014 growth forecast for EM Asia at 6.1% (2013 and 2012: 6.1%), but
expect growth to be weak in Q1 2014, on the back of slower-than-expected growth in China
and India, as well as in export-oriented Korea and Taiwan. While we expect momentum to
rebound from Q2, these downward revisions are balanced out by an upward revision to
Indonesias growth forecast. For 2015, we forecast a minor acceleration in regional growth,
to 6.6% (previously 6.5%), led by China (7.4% in 2015, up from 7.2% in 2014) and India
(6.4% in 2015, up from 5.3% in 2014). We expect the pick-up to be driven by stronger
export demand from China and likely post-election pickups in private investment in India
and southeast Asia.

1. Weather-related disruptions shake the north, but recovery trend intact


External growth momentum
has stalled on aberrant
weather in the US and Europe

The north-south divide we identified in Q3 13 has reversed in Q1 2014 temporarily. North


Asian economies have seen a slow start to the year in terms of export performance, mainly
due to weather disruptions in the US. Indeed, the airport closures in the US had a
disproportionate impact, as electronic shipments from north Asia are usually transported by
air. After the polar vortex storms in December, the winter storm pax at start of 2014
brought more flight cancellations, which resulted in the US transport freight index dropping
by 2.7% m/m in January, its biggest decline in two years.

But Q2 14 should see an


improvement in shipments,
and better growth

Another data point indicating that the disruption to the recovery is temporary is the
semiconductor equipment book-to-bill ratio provided by the Semiconductor Industry
Association (SIA). The ratio remained firmly above the 1.0x waterline for the past five
months, which indicates that global semiconductor equipment bookings continued to
exceed billings, despite the weather-related disruptions in the US. Given that this index

FIGURE 1
Asian exports pause amid poor weather conditions

FIGURE 2
Weakness in the CNY affected market sentiment

100

6.50

80

6.45

60

6.40

40

6.35

20

6.30

6.25

-20

6.20

-40

6.15

Port strike

Weather
-60
disrupts
GFC
momentum
-80
Feb-02
Feb-05
Feb-08
Feb-11
Feb-14
Port of Long Beach: inbound containers (% 3m/3m, saar)
North Asia exports (% 3m/3m, saar)
Source: CEIC, Haver Analytics, Barclays Research

25 March 2014

6.10

Band widening
to 2%

Band widening to
1% in April 2012

6.05
6.00
Sep-11
Mar-12
Sep-12
USD/CNY spot
Lower trading bound

Mar-13
Sep-13
Mar-14
USD/CNY fixing
Upper trading bound

Source: Bloomberg, Barclays Research

27

Barclays | The Emerging Markets Quarterly


tends to lead production, we think this indicates that the global electronics cycle will keep
north Asian export momentum supported in the coming months. Other catalysts on the
horizon include the launch of the Samsung Galaxy S5 (from April), which could trigger other
manufacturers to bring forward launches of competing products this year.
China has seen a slower start
to the year, but we maintain
our 7.2% growth forecast

Exacerbating the growth fears for the north Asia economies has been the volatility in Chinas
capital markets. A weak start to 2014 for Chinas economy accentuated depreciation fears
for the CNY, as well as the impact of a potential hard landing. While we do not discount
event risks, we see Chinas slowdown as largely the result of policies to trim excess capacity
in some industries (steel, for example) and clamp down on corruption. While we have
revised lower our Q1 2014 growth forecast, we expect stronger growth from Q2 as the
focus of policy turns towards sustaining growth above 7% this year. We also expect Chinas
consumption growth to hold up better in 2014, and this should eventually work as a
tailwind for the north Asian economies, which are well placed to tap the Chinese consumer
given their strong distribution networks and product brand premiums.

South recovers in Q1, but growth differentials will widen again from Q2
Reduction in vulnerabilities
have led to an improvement in
sentiment in India and
Indonesia

On the other hand, south Asia, where exports are less correlated with global demand, has
benefitted from improved sentiment, as selling pressure in FX and capital markets stabilised
in Q1. PMI readings in these economies have also picked up, as vulnerabilities eased,
monetary policy settings were not tightened further, and fears of a deep slowdown abated.
While domestic demand slowed further in Q4 13 in the south, we expect only a moderate
pick-up in 2014, and one that will not be uniform across these economies. We expect
domestic growth across most of south Asia to be tepid, on a continued softening in demand
growth in economies such as India, Indonesia and Thailand. While the Philippines and
Malaysia have continued to perform well, we think they may face headwinds from fiscal
(Malaysia) and monetary tightening (Malaysia and the Philippines) in coming quarters.
Moreover, a recent period of dry weather in Asean stoked drought fears, driving up prices of
some commodities, which could benefit countries such as Malaysia and Indonesia in Q2, as
they offload palm oil inventories at higher prices.

FIGURE 3
South Asia PMIs are outperforming north Asia

FIGURE 4
Equity market performance has improved in south Asia

65

110

60

105

55

100

50

95

45

90

40

85

35
Feb-06

Feb-08
Feb-10
South Asia

Feb-12
North Asia

Note: North Asia = China, Korea, Taiwan.


South Asia = India, Philippines, Indonesia, Thailand, Malaysia.
Source: Haver Analytics, Barclays Research

25 March 2014

Feb-14

100 = 1 May

80
May-13

Jul-13

Sep-13
North Asia

Nov-13

Jan-14

Mar-14

Asean

Note: Excludes India and China. North Asia = Korea, Taiwan.


South Asia = Philippines, Indonesia, Thailand, Malaysia.
Source: Haver Analytics, Barclays Research

28

Barclays | The Emerging Markets Quarterly

2. Vulnerabilities reduced, but contagion risks need to be addressed


Falling current account deficits
have aided a recovery in asset
prices across south Asia

Since the previous edition of the EMQ, external balances in Asia have improved markedly.
This decline in external financing requirements has led to a sharp rebound in asset prices in
the vulnerable countries, especially India and Indonesia. Economies such as Malaysia, which
had also been affected by contagion fears, have also seen improvements in sentiment, as
improved risk perception has supported asset prices amid better economic data. For the
south as a whole, we estimate that the current account balance turned positive in Q4,
predominantly on the back of larger surpluses in Malaysia and Thailand, and also helped by
sharp reductions in current account deficits in India and Indonesia.

Drought fears have triggered


positive terms of trade shocks
for Malaysia and Indonesia

Resource exporters in south Asia have seen improvements in their terms of trade. Higher
soft commodity prices should act as a tail wind in the adjustment process of their current
account deficits. But given high inventories, we expect the impact on inflation and growth to
lag by about three months. In particular, we expect Malaysia and Thailand to see an increase
in their current account surpluses on higher rice and palm oil prices. Indonesia, too, has
seen a large improvement in its current account deficit, on the back of weaker domestic
growth, frontloading of mineral exports ahead of the January ban on ore exports and
improved manufacturing exports, especially to the US and Japan. India remains the
frontrunner in the deficit adjustment process. We forecast its current account will register a
deficit of 2.1% of GDP in FY13-14, expanding marginally to 2.4% in FY14-15.

North Asia continues to enjoy a


large external surplus

External balances remain supportive in north Asia. Despite a decline in trade surpluses in
Q1, we expect current account balances for the north Asian economies to move in line with
global demand. Indeed, we forecast Koreas current account surplus will total USD65.5bn
(4.9% of GDP) in 2014 and Taiwans USD51bn (10% of GDP). While Asean markets have
seen a return of portfolio capital, equity markets in Taiwan and, to a certain extent, Korea
have remained solid. The regulatory regime to deal with market volatility has also been
strengthened. Apart from the Chiang Mai Initiative's Multilateralisation (CMIM) mechanism,
several bilateral arrangements have been made between countries in south Asia and Japan
and China in past year, which give the south a stronger buffer for periods of stress.

Soft commodity prices some support for current accounts

North Asia: Large current account surpluses to continue

FIGURE 5
South Asias current account balances have improved
12%

( Current account balance, % GDP )

FIGURE 6
Soft commodity prices have outperformed industrial metals
125

8%

120

6%

115
110

4%

105

2%

100

0%

95

-2%

90
85

-4%
-6%
Dec-05

Dec-07
North Asia

Dec-09

Dec-11

Dec-13

South Asia

Note: North Asia = China, Korea, Taiwan. South Asia = India, Philippines,
Indonesia, Thailand, Malaysia. Source: Haver Analytics, Barclays Research

25 March 2014

Price Index (2013=100)

130

10%

80
Mar-13

Sep-13
Palm Oil

Coal

Mar-14
Copper

Source: Bloomberg, Barclays Research

29

Barclays | The Emerging Markets Quarterly

What does this mean for monetary policy?


Output gaps are closing,
monetary normalisation cycle
to begin

Overall, we expect the economies of north Asia to outperform those in the south, as the former
continue to benefit from stronger global demand in 2014. This has implications for output gaps,
which have been closing. While this is already evident in the more industrialised north Asia, it is
also happening in a number of the export-oriented economies in south Asia. We think the
Philippines output gap turned positive in H2 13 and we expect output gaps to close in Malaysia
(in H1), Korea (H2), Taiwan (H2) and Singapore (H2). For India and Indonesia, despite a more
sanguine outlook for growth, we expect these economies to remain laggards in this regard.

FIGURE 7
Growth synchronisation with global GDP will close output gaps, push countries into monetary policy normalisation
Country

Correlation to Initial shock


global growth after (quarters) Comments

Trade openness
(% of GDP)

Singapore

74.4%

0-1

Singapore is one of the most open economies in the world

394%

Taiwan

73.6%

0-1

Leading producer of semiconductors; less-diversified economy than its peers

140%

Malaysia

65.7%

0-2

Reasonably diversified, but high trade openness raises leverage to global cycles

162%

Philippines

57.3%

0-2

Electronics a large share of trade, but increasingly dependent on services

Korea

49.6%

0-2

Well diversified, with a high brand premium

102%

Thailand

41.5%

1-2

Reasonably diversified and exports food, automobiles and petrochemicals

149%

India

29.1%

1-2

Trade openness rising, but domestic demand remains key for GDP growth

55%

China

23.1%

1-2

Domestic demand will be a larger share of economy

49%

Indonesia

16.5%

1-2

Aside from commodities, manufacturing sector is not export oriented

48%

71%

Source: CEIC, Barclays Research

Growth synchronization will


eventually lead to monetary
policy synchronizationWe
expect rate hikes in Malaysia,
the Philippines, Taiwan and
Korea in 2014

Positive output gaps have significant implications for monetary policy. We expect policy
rates to be hiked in Korea, Malaysia, the Philippines and Taiwan in 2014. According to our
estimates, their output gaps have improved materially, and monetary stances now appear
accommodative given rising inflation. This will add more pressure on central banks to hike
rates, especially against the backdrop of the Federal Reserve revising its own assessment of
rate hikes in the US. Indeed, we think the Feds own forecast of rates going to 2.25% by the
end of 2016 may prompt central banks in Asia with positive output gaps to hike preemptively, to avoid having to match the pace of the Fed hikes in 2015. We expect more
market attention on policy synchronisation in the coming months. Inflation is also picking

FIGURE 8
Weather is dry and warmer, pushing up commodity prices
30

FIGURE 9
Output gaps across the region are closing
0.3

La Nina (cool & wet)

20

0.2

10

0.1
0.0

-0.1

-10

-0.2

-20
-30
Mar-06

El Nino (warm & dry)


Mar-08

Mar-10

Mar-12

Southern Oscillation index (30 dma)


Source: Australia BOM, Barclays Research

25 March 2014

Mar-14

-0.3
Dec-10

Dec-11
Dec-12
Dec-13
Dec-14
Dec-15
EM Asia GDP index Deviation from trend (%)
Asia ex China GDP index Deviation from trend (%)
Asia ex China, India GDP index Deviation from trend (%)

Source: Haver Analytics, Barclays research

30

Barclays | The Emerging Markets Quarterly


up in these economies, another factor likely to drive rate hikes in the next 2-3 quarters.
Recent rises in inflation have partly been driven by administered price increases or weatherrelated shocks, but we see signs of demand-driven inflation also starting to emerge.
India and Indonesia are
unlikely to raise rates further

On the other hand, we think India and Indonesia have finished their rate hiking cycles, as
policy credibility amid Fed tapering has been restored and their currencies have stabilised.
Inflation remains high, but recent downside surprises provide some comfort for maintaining
the status quo in policy rates.

Elections a looming risk in Q2

The balance of political risk remains against south Asia, in our view. Major economies such
as India and Indonesia have elections scheduled for Q2 14. So far, this has not weighed on
local asset prices, but we sense that higher risks could start being priced in once the
electoral campaigning officially begins.

Indias sixteenth general


election to be held from 7 April
to 12 May. Polls put the BJP led
NDA in the lead

In India, voting in the national election will begin on 7 April and will be conducted in nine
stages, with final results on 16 May. The latest opinion polls indicate Narendra Modis BJP as
the leading contender to form the next government (see the India chapter for more details).
While the parties have yet to announce detailed economic agendas, the BJP has indicated its
preference to prioritise the infrastructure, power generation and manufacturing sectors,
along with the implementation of a goods and service tax, and measures to increase FDI as
easy wins to boost growth momentum. However, political uncertainty is unlikely to ease
before mid Q2 2014.

With Jokowis nomination in


Indonesia, the focus now turns
towards his policy platform

Indonesias parliamentary elections are slated for April and the presidential election for July.
The recent confirmation of Joko Widodo (Jokowi) as the presidential candidate for
Indonesian Democratic Party of Struggle (PDI-P) is a positive development for markets. His
lead in polls indicates that he could win the presidential race. The focus will now turn to his
policy platform, which, based on his current policy initiatives and plans for Jakarta, we
believe will be market friendly. However, legislation needs to pass through the parliament,
so consensus building will remain important.

Political risks in Thailand


remain high

Thailand is another country where considerable political unrest has had a negative bearing
on growth, and the central bank appears forced into a rate cutting cycle, despite rising
inflation, albeit moderate. We think Thailands political unrest could continue in Q2, and
may lead to downward growth revisions in coming months. Apart from these three
economies, we think in the rest of EM Asia, political conditions will likely remain benign.

3. Political dynamics Perceived political risks rising in the south

FIGURE 10
Political risks will likely peak in Q2 2014, with elections in India and Indonesia
Current focus

Upcoming key dates / Outlook

Growth implications

The political uncertainty looks set to


continue. The standoff has entered its
fifth month. Next event to watch is a
verdict from anti-corruption bureau on
the rice pledging scheme.

Current situation raises the vulnerability


of Thailand. Growth is suffering on
account of weakness in private
consumption and slower tourist arrivals.

Countries experiencing political instability


Thailand

Anti-government protests continue


Thailands Constitutional Court annulled
the 2 February elections

Countries with elections in next 3-6 months


India

Indonesia

General elections the largest democratic Voting will take place in nine phases,
Ahead of the elections, the government
exercise in history, with 814mn people
beginning 7 April and ending 12 May. The has not made a major push for reforms.
eligible to vote
results will be declared on 16 May.
Economic agenda of the respective
parties are not yet fully clear.
Legislative elections on 9 April;
Polls put Jakarta Governor Jokowi as the Growth typically sees a boost prepresidential elections on 9 July
frontrunner in presidential election race. elections. Focus shifting to policy
Consensus building to remain important platforms of different political parties.
due to a likely fragmented parliament

Source: Barclays Research

25 March 2014

31

Barclays | The Emerging Markets Quarterly

MACRO OUTLOOK: EEMENA

Growth and inflation divergence


Daniel Hewitt
+44 (0)20 3134 3522
daniel.hewitt@barclays.com
Eldar Vakhitov
+44 (0)20 7773 2192
eldar.vakhitov@barclays.com

Regional growth headed in


different directions

Regional growth has divergent trends: Central Europe is accelerating, Russia and Turkey
are slowing and MENA is broadly stable. A divergence in inflation has also occurred: it is
stuck above targets in Russia and Turkey and is well below targets in Central Europe.
C/A balances are improving across the region. Russia-Ukraine tensions remain a major
political risk.
Growth trends in the region are diverging. Russia and Turkey, the two largest economies,
find their growth retreating from relatively high levels. Based on an expected slowdown in
domestic demand, we have cut our growth forecasts for both countries. However, neither is
likely to fall into recession, assuming economic sanctions on Russia remain benign. In
Central Europe, the economies are in the early stages of recovery, and we expect a further
pick-up in growth in 2014 and 2015. In the Middle East, growth is picking up in oilexporting countries and is roughly stable at a moderate level in Israel.

Russia growth likely to


decelerate further this year

In Russia, even before the conflict with Ukraine started, growth had undergone a change in
momentum. In 2013, it decelerated by 2pp to 1.3% due to declines in domestic demand.
Private investment declined due to a drop in corporate profits, and public investment fell
due to completion of large projects in 2012. A deceleration in consumption is under way as
the squeeze in corporate profits is slowing wage increases and bank lending to households
decelerates from unsustainably high levels. We expect further growth deceleration to 0.7%
in 2014.

Recession can be avoided


provided economic sanctions
remain mild

In Russia, tightening of monetary policy will hold back both investment and consumption,
with the latter to be adversely affected by lower private sector wage increases and a freeze
in public wages. Export revenue will be limited by lower global oil prices. Furthermore,
investor sentiment will be adversely affected by the Russia-Ukraine conflict. Russias
annexation of Crimea led the EU and US to enact mild sanctions. In our main scenario, we
expect the sanctions to be intensified gradually, but a political solution to be found that
avoids serious economic sanctions. However, in the event the latter are introduced, they
would likely push the Russias economy into recession. Even prolonged uncertainty will
likely have a damaging effect on the Russian economy and cause ripple effects elsewhere.
On RUB depreciation, we expect it to have a positive effect on growth; however, it will be
FIGURE 1
Growth likely to improve in Central Europe, but decline in Russia and Turkey
6
5

Central Europe

Real GDP (% y/y)


Other
CIS
South Eastern
Europe
Europe

MENA

3
2
1
0
-1

2014F Barclays

Morocco

Egypt

UAE

S. Arabia

Russia

Israel

Turkey

Serbia

Croatia

Romania

Hungary

Poland

Czech R.

2013 Barclays

Ukraine

-4%

-2

2015F Barclays

Note: Arrows denote changes of 0.2pp or more since December EMQ. Source: Haver Analytics, Barclays Research

25 March 2014

32

Barclays | The Emerging Markets Quarterly


more visible in 2015 as exporters and importers adjust their behaviour. Along with an
expected increase in oil prices and higher government spending, this should help growth
recover to 1.4% in 2015.
Turkeys growth to slow,
but remain relatively high

In Turkey, a rotation from consumption-led to export-led growth will lead to slower growth
and a gradual narrowing of its high C/A deficit. Subdued capital flows into EM are forcing this
adjustment after growth had been driven by foreign-funded credit growth for some time. A
marked increase in domestic tensions ahead of the local elections in end-March and the
presidential elections this summer has weighed on business confidence, and a resolution to
the political conflict is not in sight. Large external financing needs and FX mismatches on
corporate balance sheets leave Turkey vulnerable and could trigger the need for further rate
hikes in event of significant TRY depreciation. Against this backdrop, we expect growth to
moderate to 2.2% in 2014 from estimated 3.9% y/y in 2013.

CE growth likely to accelerate


further in 2014-15

Growth in Central Europe (CE) improved in 2013, bringing these economies out of
recession/slowdown. Several factors will likely support growth acceleration in 2014-15. The
recovery was sparked by a pick-up in exports, primarily to core euro area, where we expect
further moderate growth improvements during 2014-15. In a second stage, domestic
demand is picking up, with consumption rising on base effects, improvement in labour
market conditions, stronger consumer confidence and, last but not least, less fiscal drag.
Some early signs of investment recovery are starting to emerge, although existing excess
capacity will likely delay a full investment surge until later in the recovery cycle. Given very
low inflation across the region, monetary policy should stay expansionary with policy rates
at or near all-time lows. The only slight negative effect in 2014 may come from lower
agricultural growth, after a strong harvest in 2013.

Growth should remain relatively


stable in the Middle East

In the Middle East, aggregate demand is relatively stable, albeit with significant intraregional differences between oil exporters and oil importers. Growth in Saudi Arabia and the
UAE should accelerate, supported by government spending and higher credit growth. In
Egypt, growth disappointed in H2 13 on the back of heightened political volatility, and we
downgrade our forecasts for 2014 and 2015. Israel has managed to maintain growth at
about 2.5-3%. While this is below medium-term potential and appears to be receding
slightly, it is still decent by global standards.

Inflation also diverging


Regional inflation trends are also divergent, but in the opposite directions. Russia and
Turkey inflation is high and above target; in CE and Israel, it is low and below target.
FIGURE 2
CE exports surge while Russia exports stagnate
40%

FIGURE 3
Credit growth still high in Russia and Turkey, low in CE

Goods exports (USD, % y/y)

35%

Private sector credit growth (% y/y)


45%

30%
35%

25%
20%

25%

15%
10%

15%

5%
5%

0%
-5%
-10%
Jan-11

Jan-12
Russia

Jan-13
Turkey

Source: Haver Analytics, Barclays Research

25 March 2014

Jan-14
CEE-4

-5%
Jan-10
Russia

Jan-11

Jan-12

Turkey

Israel

Jan-13

Jan-14

CEE-4 (wght avg)

Source: Haver Analytics, Barclays Research

33

Barclays | The Emerging Markets Quarterly


Russia inflation remains well
above the target

In Russia, in contrast to CBR expectations, inflation has not declined sufficiently towards the
target and, with heavy RUB depreciation (in excess of 10% year-to-date), it will likely shift
higher. We have increased our inflation forecasts to 6.7% y/y at end-2014 and 5.1% at end2015, both well above the targets (5% and 4.5%, respectively). The CBR is transitioning to
inflation targeting (implying RUB flexibility), a five-year process that was set to be
completed at end-2014. However, the exchange rate pressure has set this process back.

forcing the CBR to keep


policy rates at elevated levels

In early March, the CBR increased its FX intervention levels and raised its policy rate 150bp
to 7.0% in an effort to stabilize the RUB. Subsequently, the CBR has kept the higher rates
unchanged and indicated they would have to stay high. The measures appear to have
helped stabilize the RUB. However, we think that further pressure on the RUB will force
another 100bp rate increase in Q2. Rates will likely remain elevated throughout 2014 as the
CBR tries to lean against inflation pass-through.

Turkeys inflation rising


on TRY weakness

In Turkey, the inflation outlook remains challenging, with exchange rate pass-through
driving core inflation higher and raising uncertainties surrounding food prices. TRY
weakness will likely push inflation higher with a lag, and food prices could surge due to the
relatively dry winter, leading to historically low water reservoir levels. In addition, there is a
risk of potential post-election adjustments to energy prices (~10% hike would add about
0.5pp to headline inflation). In our opinion, inflation could surpass 9% around mid-year
before moderating to 8.3% y/y for end-2014 and 6.7% for end-2015, both well above the
5% target.
In CE and Israel, the low inflation environment persists with inflation mostly below targets
and continuing to surprise on the downside in recent quarters. The main factor holding
inflation down is falling domestic energy prices (averaging -2.8% y/y in February). After
previous rapid increases, global oil prices have been within a relatively narrow range (Brent
at $100-120 per barrel) for the past three years with a slight downward drift. Local factors
are also in place: eg, Hungary lowered administrated energy prices as a pre-election ploy,
and Israel started to benefit from lower-cost offshore natural gas production. Food inflation
has been moderating due to lower global food prices and is negative in Hungary and
Romania, where the 2013 harvest was particularly strong. Core inflation has decelerated due
to low wage pressures and weak domestic demand. Policy rates are near or at all-time lows
only Hungary is likely to deliver additional small rate cuts. Meanwhile, rate hikes are not on
the horizon, with inflation mostly well below target ranges. Rate hikes will probably be
delayed until inflation starts to rise again and heads towards the middle of target ranges.

Inflation remains low in


CEE and Israel, mostly
below target ranges

Rate hikes likely delayed

FIGURE 4
Inflation high in Russia and Turkey, and low in CE and Israel
12%

FIGURE 5
Limited room for monetary policy easing, except Hungary
8%

CPI (% y/y)

7%

10%

Policy rate (%)


Inflation (% y/y), latest
Inflation target/range (%), 2014

6%

8%

5%

6%

4%
3%

4%

2%

2%

1%

Source: Haver Analytics, Barclays Research

25 March 2014

Czech R.

Israel

Poland

CEE-3 avg

Hungary

Romania
Israel

Feb-14

Romania

Feb-13

Russia

Russia
Turkey

0%
Feb-12

Turkey

0%
Feb-11

Source: Haver Analytics, Barclays Research

34

Barclays | The Emerging Markets Quarterly

C/A improvements
Improving C/A balances in
the region

Since the previous EMQ, we have improved our forecasts for Russia and Turkeys C/A
balances. In Russia, we expect RUB depreciation to cause a turnaround in trend, leading to
increases in the C/A surplus in 2014 and 2015. In Turkey, rotation away from consumptionled growth, currency depreciation, and better external demand will help C/A adjustment. In
other countries, C/A improvements are expected to continue. Strong exports should lead to
rising surpluses in Hungary and Israel and narrowing deficits in Poland, Romania, and Czech
Republic, releasing these countries from previous heavy reliance on external financing.

Russia-Ukrainian uncertainties dominate


Risks from further economic
sanctions on Russia that could
harm economic growth in
the region

The uproar over the Russia-Ukraine tensions and annexation of Crimea presents serious
economic risks. So far the EU and US have introduced only mild sanctions that will have little
economic impact. Russia, the US and the EU are clearly trying to find a diplomatic solution
that will avoid heavy sanctions and violence. It remains to be seen how successful they will
be. While we expect sanctions to be upgraded gradually, our main scenario is that they will
not be intensified to the point of having a serious impact on the Russian economy. But the
risk of hardening of sanctions at some point is not negligible, and this would likely push
Russias economy into recession and directly damage growth prospects of the euro area,
given significant economic linkages between the two. This would have knock-on effects on
world growth and damage CE growth prospects in particular.

March local elections in Turkey

In Turkey, the 30 March local elections have effectively turned into a referendum on Erdogan,
and the AKP and the results will determine Erdogans strategy for the presidential election in
August. We do not expect a new political equilibrium to be achieved, leaving investors with a
high level of political uncertainty, at least until the presidential elections in August.
Central Europe politics are relatively stable, confined to regional/local issues. According to
polls, Hungary parliamentary elections on 6 April will likely result in the re-election of the
government of PM Orban, which could retain its super-majority. Czech Republic has a new
three-party government in place led by the socialist but supported by right-centre parties. In
Romania, the ruling coalition split, but PM Ponta managed to form a new majority and
reiterated its commitment to the IMF programme. However, the coalition split raises
uncertainty ahead of the presidential elections in November.

Current account (% GDP)

12%

6%

-2

4%

-4

2%

-6

0%
Feb-14

-8

4%

2%
Feb-10

Feb-11

Feb-12

Feb-13

EEMENA CPI

EEMENA core

Food CPI

Energy CPI

Source: National statistical offices, Haver Analytics, Barclays Research

25 March 2014

Russia

3%

2012

2013

2014F

2015F

Turkey

8%

Poland

5%

Hungary

10%

Romania

EEMENA CPI (unweighted average, % y/y)

Israel

6%

FIGURE 7
Current account balances likely to improve further

Czech R.

FIGURE 6
Downward inflation from energy and food

Source: Haver Analytics, Barclays Research

35

Barclays | The Emerging Markets Quarterly

MACRO OUTLOOK: SUB-SAHARAN AFRICA

Positive growth outlook despite challenges


Sub-Saharan Africa is expected to continue to show strong economic growth, though
the regions large twin deficits are also gaining less positive attention. Its FX markets are
on the back foot, complicating the outlook for monetary policy. In the country section of
this Emerging Markets Quarterly, we provide more detailed views on six countries in
Sub Saharan Africa, namely Ghana, Kenya, Mozambique, Nigeria, South Africa, and
Zambia. For further coverage, please also see the recently published Africa Markets
Guide 2014, with coverage of 20 economies across the continent.

Jeff Gable
+27 11 895 5368
jeff.gable@barclays.com
Ridle Markus
+27 11 895 5374
ridle.markus@barclays.com

SSA growth outlook still a highlight

Peter Worthington

The broad story on economic growth remains a positive one for the 131 countries under
coverage in Sub Saharan Africa. We see weighted GDP growth at 5.0% y/y in 2014, above
the average of 4.6% in 2013. The 2014 figure is 0.2pp lower than our forecast in the last
EMQ. The figures apparent resilience is less about the rotation of global growth back to
developed markets, and more to do with a combination of the SSA region's multi-year focus
on infrastructure build-out, fresh investment in the resource sector in several countries, and,
less helpfully for the medium term perhaps, fiscal slippage in several important markets.
Commodity prices do look more challenging now than in 2013, particularly for countries
with a high exposure to precious and base metals. However, so far the lagged realisation of
past investment commitments has generally boosted economic growth in the region, but
raises questions about future investment commitments a for 2015 and beyond.

+27 21 927 6525


peter.worthington@barclays.com

We have trimmed our growth


projection for South Africa

Within the major economies, we have lowered our GDP growth estimates for South Africa
by a few tenths as the strike in the platinum sector looks likely to be a very long one. A brief
period of rolling blackouts in early March served to remind us just how critically tight the
electricity supply situation remains until new generation capacity is brought online (around
year-end), and an expectation of gradual monetary tightening weighs on our previous
estimates. We now look for the economy to grow by 2.2% this year, only slightly higher
than 2013. In Nigeria, the main driver of the economy remains the non-oil sector, and we
expect a similar story for 2014 (with, perhaps, some additional pre-election spending boost
in the later stages of the year). Coming off a very strong end of 2013 (real GDP rose by 7.7%
y/y in Q4), average growth of 6.8% this year is likely.

FIGURE 1
Economic growth remains firm in several countries
9

FIGURE 2
Commodity exposure in SSA
AO

8.1

6.9

6.8

6.7

6.1
5.5

5.0

5
4

2.2

3
2
1
0
MZ

TZ

NG

ZM

Mar'14 forecast

GH
Dec'13

Source: Official offices, IMF Barclays Research

KE

SSA*

Sep'13

SA

Oil
Gold
Platinum
Diamonds
Copper
Cobalt
Aluminium
Chrome
Coal
Iron ore
Cocoa
Timber
Tea
Fish
Canned tuna
Cane sugar
Coffee

BW

GH

KE

MU

MZ

x
x

SA

SC

x
x
x

x
x

TZ

UG ZM

x
x
x
x

x
x
x

x
x
x
x

x
x

x
x

Source: Official offices, Barclays Research


1

The thirteen countries that make up our SSA aggregate are Angola, Botswana, Ghana, Kenya, Mauritius,
Mozambique, Namibia, Nigeria, Seychelles, South Africa, Tanzania, Uganda and Zambia

25 March 2014

36

Barclays | The Emerging Markets Quarterly


Growth prospects upbeat for
East Africa, Zambia and
Mozambique in 2014

In East Africa, growth in Kenya and Tanzania is expected to accelerate this year, to 5.5% y/y
and 6.9% y/y, respectively, thanks to investment in infrastructure (transport in Kenya's case,
and a combination of transport and gas and electricity in Tanzania). Uganda's outlook will
be boosted by expected improvement in domestic demand, and we see growth accelerating
to 6%. Further south, fresh copper mine capacity should help offset the negative impact of
lower copper prices on Zambia this year and allow the economy to still grow by more than
6%, whilst Mozambique's infrastructure spend (and, perhaps, some pre-election spending
too) should lead to another above-7% growth rate there.

Revised GDP methodologies in


Nigeria and Zambia expected
to have a significant impact on
the size of their respective
economies

For the sake of completeness, it is also worth noting that both Zambia and Nigeria are
expected to restate their National Accounts in the near term, updating base years and
accounting methodologies. Delayed many times already, when the restatements are finally
published, the result is likely to be a 25% or more increase in the level of measured GDP, thus
altering significantly any typical GDP ratios (and possibly making Nigeria the continent's
largest economy).

Outside South Africa and


Ghana, the inflation outlook for
the remainder of the region
remains broadly favourable

Inflation, monetary policy and the FX challenge


Inflation, outside South Africa and Ghana, is broadly favourable across the region, at least
when measured against inflation targets and guidance that tend to be higher than global
peers. Food prices will need to be watched closely, given shifts in global soft commodity
prices and variations in country-specific agricultural conditions, whilst FX pass-through
could also play a spoiling role in several of the economies in which currencies have been
under pressure. But largely we see these as risks rather than baseline views.

FIGURE 3
Monetary policy developments and outlook
Current (%)

Last move (bp)

Cummulative ch.
since Jan-13 (bp)

Next move
expected

Angola

9.25

25 Nov13

-100

2015

Potential further easing given record low inflation


and FX stability

Botswana

7.50

10 Dec 13 (-50)

-200

2015

Early tightening, higher rates in SA, administered


price increases

Ghana

18.00

6 Feb 14 (+200)

+300

Apr-14

Further tightening, FX depreciation, further utility


price increases

Kenya

8.50

7 May 13

-250

2015

Mauritius

4.65

17 Jun 13 (-25)

-25

Apr-14

Mozambique

8.25

16 Oct 13 (-50)

-125

2015

Early tightening, food price pressures due to


floods, interruption to growth trajectory could see
low rates for longer

Nigeria

12.00

10 Oct 11 (+275)

2015

Further tightening, FX pressures, excess liquidity

South Africa

5.50

28 Jan 14 (50)

50

Mar-14

Further tightening, FX pressures on inflation

Uganda

11.50

3 Nov 13 (-50)

-50

2015

Early tightening, food price pressures, low


inflation could see neutral stance for longer

Zambia

10.25

28 Feb 14 (+50)

100

Apr-14

Country

2014 monetary policy outlook and concerns

Early tightening, food price pressures due to


drought
Tightening, continued rise in inflation

Further tightening, FX pressures

Source: Official offices, Barclays Research

In South Africa, exchange rate


depreciation is likely to push
inflation out of its target range,
eliciting a modest tightening
cycle from the SARB
25 March 2014

For South Africa, we see inflation breaching the 6% upper target soon, and for that breach to
be fairly long-lived, but at a peak of about 7% in our base case, we expect the breach to be
modest by historical standards. The rand could play a major spoiling role in these forecasts,
however. The monetary policy call in South Africa is a tricky one, as a generally weak
economic outlook meets with an inevitable (if delayed) FX pass-through and a central bank
37

Barclays | The Emerging Markets Quarterly


that will look to navigate the thankless task of balancing up the risks of damage to the
medium-term inflation outlook (and expectations) versus the domestic economys sensitivity
to a fragile household balance sheet. Following January's 50bp rate hike, we foresee another
100bp delivered in the next few MPCs, taking the policy rate to 6.5% before year-end.
We expect an unchanged
policy rate in Nigeria, though
Ghana may hike further

Nigeria's inflation fell to 8% by end-2013, from which we expect a gradual increase back to
about 10% in H2 as the currency effects and these FX pressures have shifted the bias in our
policy rate forecast towards further tightening, though our base case remains for rates to be
on hold at 12.00%. We will learn more when the new governor takes office in June. Ghana
faces greater challenges, with the cedi having depreciated more than 25% in the last 12
months and the market still struggling to find a comfortable level. In addition to FX
depreciation, removal of fuel subsidies in 2013, increased utility tariffs and higher VAT at
the start of 2014 have led headline inflation to reach 14% y/y, and we believe risks lean to
the upside. Ghana's central bank hiked by 200bp in February, taking the policy rate to 18%,
but with FX pressures unabated and market yields already well into the 20s, we think
another 100bp in rate hikes is likely and the risk is for even more.

Monetary policy tightening


likely in Zambia, while East
African countries may keep
policy rates unchanged over
the medium term

Zambia's currency has also been under extreme pressure and we believe further monetary
policy tightening is probable. In East Africa, we see Kenya (8.50%) and Uganda (11.50%) on
hold as inflation (and FX) pressures look manageable. In the region's smaller markets, we
also see the potential for a tightening of policy, with Botswana likely to move modestly
higher should the gap with South African rates rise further, and Mauritius' MPC signalling a
willingness to tweak rates higher to help contain inflation expectation.

Sub Saharan Africa external accounts remain a vulnerability


If the combination of generally strong GDP growth and fairly high domestic interest rates
look like an attractive combination, Sub Saharan Africa's twin deficits do not, and it is this
factor that helps explain the current unfavourable market sentiment. Import demand looks
resilient despite the FX moves as most countries are committed to large infrastructure
programs, which show little sensitivity to the exchange rate, and the same can be said for
energy imports across the region. On the export side, the decline in commodity prices is
definitely being felt, with precious metal exporting countries (Ghana, Tanzania and South
Africa) particularly exposed to profitability-related mining volume declines as well as the
pure price effect on exports. Idiosyncratic factors (oil output disruptions in Nigeria, delays to
gas production in Ghana, platinum sector strikes in South Africa) pull in the same direction.
Across our sample, there are more countries with 10% of GDP or greater current account
deficits than those with deficits of smaller than 3%, and only three countries (Angola,
Botswana and Nigeria) run surpluses.

Imports are likely to remain


strong across the continent
amid focus on expanding
infrastructure

FIGURE 4
CA balances remain wide

FIGURE 5
Several SSA currencies are on the back foot

10

10

5
0

-5

-5

-10

-10

-15

-15

-20

-20
-43

CA balance (2013E, % GDP)


Source: Official offices, Barclays Research

25 March 2014

2014F

Performance against USD (% ch. YTD)

MUR

UGX

AOA

TZS

KES

NGN

SCR

MZN

BWP

NAD

ZMW

GHS

Nig

Ang

Bot

Zam

Nam

SA

Mau

Uga

Ken

Gha

-30
Tan

Moz

-25

-25

1-year

Source: Reuters, Barclays Research

38

Barclays | The Emerging Markets Quarterly


Before we sound too alarmist, it is worth noting that only in Nigeria, Ghana and Zambia are
FX reserves under downward pressure, so Sub Saharan Africa is not facing a funding crisis
nor is the market forcing a sharp macro correction. The nature of important parts of the
import bill in many of the countries means that they enjoy an important amount of self
financing (this is particularly true for infrastructure and resource sector investment). But it is
also easy to understand why many countries in the region are increasingly drawn to credit
markets for financing.

Fiscal outlook tests market and rating agencies patience


Public finances are under
pressure

Beyond the external account discussion, the second uneasy fact is that public finance in
Sub-Saharan Africa is generally more stretched in 2014. In the west, we expect that preelection spending could add 1-2 points to Nigeria's fiscal deficit this year (taking it to 3.1%
of GDP), Ghana looks to have suffered another year of fiscal slippage in 2013, and higher
domestic interest rates will further complicate the outlook this year. In East Africa, big
pushes on infrastructure in all of the economies, along with some politically driven spending
(the rolling out in mid-2013 of a devolved government in Kenya, and pre-election spending
in Mozambique) are expected to press deficits higher this year, whilst in Southern Africa
Zambia's government is coming to grips with the impact of last year's large rises in public
sector salaries. South Africa's 4% of GDP deficit may seem modest in this company, but at
BBB its peer-group is more global, and the country's very slow deficit consolidation is
testing the patience of the rating agencies, and, at times, investors.

Several countries are seeking


external financing

Perhaps unsurprisingly, many countries in the region have tabled plans to seek out financing
from external markets in 2014 for the fiscal shortfalls and to ease the burden on domestic
markets. Nigeria, Ghana, Kenya, Tanzania, Zambia, Cote dIvoire and South Africa are all
eyeing hard currency issuance. That may place more focus on the country's credit ratings at
a time when, faced with this environment of pressurised public finance and external
accounts, the view from global credit rating agencies has turned less sanguine for SSA
countries in the last six months. Over that period Ghana, Zambia, Uganda and Mozambique
have had their sovereign rating cut by one notch by at least one of the big three agencies,
with several others, including South Africa, under negative outlook. This may mean a more
tepid response from global credit markets to SSA issuers in 2013 as opposed to the very
warm welcome received in 2012 and 2013.

FIGURE 6
Fiscal deterioration in several markets

FIGURE 7
Upside risks to inflation

18

16

-2

14

-4

12

-6

10

-8

-10

Fiscal balance (2013E, % GDP)


Source: Official offices, IMF, Barclays Research

25 March 2014

2014F

Gha

Zam

Ken

Tan

Moz

SA

Mau

Nam

Nig

Uga

Bot

Ang

-12

4
Jan-06

Jan-08

Jan-10

Jan-12

Jan-14

SSA average inflation*


Source: Official offices, Barclays Research

39

Barclays | The Emerging Markets Quarterly

Update on politics and security


Elections in South Africa on
7 May seem likely to return the
ANC with a reduced majority
at the national level

The headline event will be the 7 May general election in South Africa. The latest IPSOS poll,
as reported in the local press on 23 March, suggests that the governing African National
Congress (ANC) should secure another clear majority at the national level, with the declared
support of 66% of voters, close to its share in the 2009 election (please see Global EM
political outlook: The heat is on, 6 March 2014). While some opposition parties appear to be
gaining support, others appear to be losing it. The current official opposition, the
Democratic Alliance (DA), seems likely to continue the trend increase in its vote witnessed
since the 1994 election (the DA took 16% of the vote in 2009) with the IPSOS poll putting
its support at around 22%. Meanwhile, the new Economic Freedom Fighters, which targets
the disenfranchised and the poor with a nationalist/populist program, could also have an
important impact. Notably, however, the poll was conducted before the publication of the
Public Protectors report on the improper use of state funds to upgrade President Zumas
private residence. This may exacerbate the growing discontent in some circles of traditional
ANC supporters with the current ANC leadership, but just how much of this unhappiness
will be converted into votes for the opposition or simply lower voter turnout will only be
known on the day. Some slippage in votes for the ruling party may also result from the
apparent split of the largest organised labour federation, COSATU, which has traditionally
aided the ANC at election time with strong logistical and funding support.

No great policy shifts expected,


but some movement at the
margins is possible depending
on the exact electoral outcome

At this stage there is little evidence to suggest that the ANC is about to discard the National
Development Plan as the key driver of medium-term policy and so we do not, as a baseline,
expect this much-covered election to be a major macro or market driver for South Africa.
However, the exact dispersion of the votes and the conclusions that politicians and the
government draw from the result could serve to tweak the next administrations policy at
the margins. Appointments to key economic ministries and to the Deputy Presidency will
provide tangible clues as to the next governments policy inclinations.

Mozambiques political outlook


has improved somewhat,
though we expect increased
tension in Nigeria ahead of the
2015 elections

Elsewhere in the region, Mozambique will hold elections in October, and Tanzania and Nigeria
are the notable elections for next year. The outlook has improved for a smooth election
process in Mozambique, as the ruling party and leading opposition have found common
ground on some issues relating to election law. This raises hopes that the sporadic and lowintensity violent political confrontation that re-emerged late last year could again abate. In
Tanzania, efforts are ongoing to confirm a new constitution, but despite the sharp divisions on
the issue we do not expect any domestic security challenge. In contrast, political tensions in
Nigeria have increased as splits within the ruling party continue to widen, the early removal of
the central bank governor continues to make headlines, and the violent action against civilians
by terrorist group Boko Haram look to have entered a more intense phase.

25 March 2014

40

Barclays | The Emerging Markets Quarterly

MACRO OUTLOOK: LATAM

The productivity challenge


With the exception of Venezuela and Mexico, growth expectations are gradually
stabilizing in LatAm. As the region enters a period of slower growth, the challenge for
policymakers is how to compensate for lower terms of trade, which should start to erode
domestic demand. We believe the new wave of growth will come through productivity
enhancing reforms, and Mexico is taking the lead.

Alejandro Grisanti
+1 212 412 5982
alejandro.grisanti@barclays.com
Marcelo Salomon
+1 212 412 5717

Growth prospects are beginning to stabilize in a portion of Latin America. While the worst
appears to be behind us, with the exception of Mexico and Venezuela, we forecast growth
for the region for 2014 and 2015 at or below potential. Challenges to the breadth and the
speed of the next recovery phase are great, especially as consumption may not remain the
engine of growth. Productivity-led growth, with stronger investment flows and a supportive
reform agenda, is critical for a new leg of sustained growth acceleration in the region.

marcelo.salomon@barclays.com

Other than in Mexico and


Argentina, growth
expectations are stabilizing in
LatAm

Mexican growth continued to disappoint at the end of 2013. Q4 real GDP printed a weak 0.2%
q/q, putting last years growth rate at a modest 1.1%, or the lowest since the strong 4.7%
contraction in 2009. This has led us to revise our 2014 forecast down to 3.0% from 3.7% (see
Mexico GDP: The economy hit the brakes, dampening the 2014 outlook, February 21, 2014),
raising the question of how much of the slowdown is cyclical and how much is structural.
We still believe that much of the slowdown is cyclical, and the stimulative monetary/fiscal
policy mix this year, along with a strong industrial production rebound in the US as of Q2, will
help return growth to higher levels. However, it also stresses the point that the reforms will
help push growth to a structurally higher level, but this will only happen in the longer term.
Secondary laws regulating the constitutional reforms approved last year are the biggest
political challenge in 2014, and a stronger pipeline of FDI is likely to start building only after
2015. Banxicos intention to stay on hold should be validated by a well-behaved inflation rate
that is likely to fall back below 4.0% in March as the effect of the tax hikes prove short lived.

The largest downward growth


revision in the region is in
Venezuela

The largest growth revision we are making this quarter is for Venezuela. Large popular
protests against the steep deterioration of economic conditions reflect political and
economic mismanagement, which has led to a strong increase in inflation and restrictions in
the access to foreign currency. The latter has directly influenced the scarcity of
consumption goods. A strong repressive stand against these popular movements only adds
to the negative sentiment and could ultimately lead to a stronger slowdown of the

FIGURE 1
Barclays real GDP growth forecasts vs consensus

FIGURE 2
Outlook for policy rates in LatAm

Barclays vs. consensus


GDP

Country

Current

Next

2013

2014

2015

Brazil

10.75

Apr 14 (+25)

10.00

11.00

12.00

Chile

4.00

Beyond 2015

4.50

4.00

4.00

Colombia

3.25

Jul 14 (+25)

3.25

4.75

5.00

2013

2014

2015

2013

2014

2015

LatAm

2.2

2.1

3.5

-0.4

-0.4

0.5

Argentina

3.1

-1.5

4.4

-0.7

-1.7

3.3

Brazil

2.3

1.9

2.4

0.1

-0.1

0.1

Mexico

3.50

Mar 15 (+25)

3.50

3.50

4.50

Chile

4.2

4.2

4.7

0.2

0.3

0.4

Peru

4.00

Beyond Q4 14

4.00

4.00

5.00

Colombia

4.2

4.8

4.5

0.1

0.2

-0.1

Mexico

1.1

3.0

3.8

-0.1

-0.4

-0.2

Peru

5.0

5.1

5.7

0.0

-0.4

0.0

Venezuela

1.1

-1.8

2.5

-0.4

-0.8

1.3

Source: Consensus forecasts, Barclays Research

25 March 2014

Source: Bloomberg, Barclays Research

41

Barclays | The Emerging Markets Quarterly


economy. While part of the solution to the crisis is a reform of the exchange system, which
the government has already presented, the expected devaluation of the Bolivar should have
a contractionary effect on consumption.
we now expect depressed
consumption and investments
to drag real GDP down by
-1.8% this year

We believe the announcement of the new FX system, Sicad II, is a move in the right direction
and could alleviate the scarcity problem that has been disrupting the supply chain and push
growth to a better level. However, this is a story for the second half of 2014. New
investment in the oil sector could also be a factor that supports growth, but operational and
managerial problems still seem to be affecting progress in these projects; therefore, we do
not expect this to make a significant contribution to GDP until next year. We are revising our
growth forecasts down to -1.8% this year and +2.5% in 2015, from 0.3% and 3.0%,
respectively. But despite the political and economic noise, we remain of the view that
Venezuelas capacity and willingness to pay its external obligations remain unscathed.

News out of Brazil has been


more encouraging; we
maintain our current growth
forecast of 1.9% for 2014

The news out of Brazil has been more encouraging. After Q4 2013 real GDP growth
surprised on the upside, higher frequency data for January (IP and retail sales) helped dispel
fears that Brazil could be moving into a recession. 2014 growth expectations have been on a
steep downward trend since late 2013, falling from 2.30% in the last Focus Consensus
Survey of 2013 to finally stabilize at 1.7% in the first week of March this year. The better
growth numbers also prevented us from downgrading our 1.9% growth forecast for 2014,
but the trade-off between growth and inflation in Brazil is getting worse. Better news on the
growth side, along with the governments new 1.9% GDP primary surplus target, has eased
market concerns of an imminent sovereign ratings downgrade. While we are skeptical that
the government will deliver such a high primary fiscal surplus, especially in an election year,
we agree that the better growth outlook and signs that the government is attempting to
prevent the ratings downgrade have changed the mood.

Repressed regulated prices and


more tightening in 2015 makes
the growth-inflation trade-off
worst in Brazil

However, the medium- and longer-term challenges to reignite growth without pressuring
inflation in Brazil have been growing. The next president-elect will have to unwind repressed
regulated prices (delayed gasoline, public transportation and utility price hikes to name a
few) as well as past tax incentives in order to reorganize the fiscal accounts. Hence, the
government will need to tighten the policy mix even further in 2015 (we expect an
additional 100bp of rate hikes, lifting the Selic rate to 12%, and the primary surplus to rise
to 1.7% of GDP in 2015, from 1.3% in 2014) to bring inflation down to 5.6% revised up
from 5.4%. We also expect real GDP to recover next year, but only to a modest 2.4%.

FIGURE 3
Terms of trade moderating after 2011

220

FIGURE 4
Future growth will rely on productivity, which remains a
challenge across most of the region

Argentina
Brazil
Chile
Colombia
Mexico
Peru

200
180
160

6.0%
5.0%

Chile

4.0%
3.0%

140

2.0%

120

Argentina

Peru

Colombia

Venezuela Brazil

1.0%

100
80
2000

GDP Per Capita


Growth (Avg p/y)

2002

2004

Source: Haver, Barclays Research

25 March 2014

2006

2008

2010

2012

Mexico
0.0%
-2.0% -1.5% -1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 2.0%
TFP Gap with US (- below US/ + above US; avg per year)
Source: Conference Board, Barclays Research

42

Barclays | The Emerging Markets Quarterly


Finally, on the monetary policy front, we now expect the Brazilian BCB to deliver a final 25bp
hike in the Selic rate in April, lifting the target rate to 11%, and keep it there throughout the
rest of the year. Meanwhile, we also tweak our rate forecast for Peru slightly: only easing
policy with reserve requirements, instead of cutting rates in the short run.

Productivity is the next frontier for growth in LatAm


Terms of trade have been
moving south in LatAm since
2011

Over the 10 year period ending in 2011, the strong terms of trade (ToT) expansion (Figure
3) has helped lift income and growth across most of the LatAm Region. Countries like Chile,
Peru and Argentina experienced an average terms of trade growth rate of 5% or more per
year (Chiles ToT expanded by 10% on average per year). These are smaller than the
whopping 21% observed in Venezuela, but meaningfully higher than 1% observed in
Mexico. Colombia and Brazil, while also benefitting from the commodity boom, saw more
modest expansions (4% and 2%, respectively). But this has changed since 2011: across the
region ToT have stabilized or have been moving down.

eroding an important driver


of domestic demand growth

We believe that this has been one of the main drivers behind the slowdown of both current
and potential growth in the region. Normalization of monetary policy in the US, boosting the
cost of foreign funding and provoking a strong upward movement in local yields across EM
amplified the cyclical slowdown. But policymakers across the region will have a very large
challenge ahead to compensate for the reversal of fortunes that that lack of ToT tailwinds
will have for the region.
Figure 4 plots the average growth rate in which the gap between productivity growth in
LatAm economies and the US widened or contracted versus each countrys average percapita growth rate in the 2000-2013 period. The strong positive correlation between
productivity growth and per-capita growth is very clear. Moreover, with the exception of
Peru, the region appears to be parked in a bad equilibrium, where low productivity has
probably prevented growth from accelerating in a more consistent manner. When we cross
this data with our estimated pace of income growth coming from the surge in terms of
trade between 2001 and 2012, the discrepancies are even bigger. Venezuela and Chile were
the largest beneficiaries, and while growth in the latter has moved up, productivity has
consistently underperformed that of the US. While average income growth rates in Peru,
Colombia, Argentina and Brazil were clustered at similar levels, only the first was able to
move toward a better growth-productivity equilibrium.

FIGURE 5
Average yearly income growth generated from ToT expansion (%, 2001-2012)
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
Venezuela

Chile*

Colombia

Peru

Argentina

Brazil

Mexico

LatAm
Note: Chile (2001-2010) Source:

25 March 2014

Haver, Barclays Research

43

Barclays | The Emerging Markets Quarterly


that we believe needs to be
offset by an agenda of
productivity-enhancing
measures

An agenda of productivity-enhancing reforms needs to be adopted across the region. This has
been the story in Mexico since last year, and we believe that the legislative component of the
reforms (approving secondary regulation of the constitutional changes of 2013) will set the
stage for an increase in investment and productivity over the longer term. While Peru stands in
a privileged place, the sense of urgency is much higher in Brazil, Argentina and Venezuela.

Politics
Energy rationing and public
demonstrations ahead of the
World cup could challenge
President Dilmas strong
support for re-election in Brazil

While the majority of Brazilian voters will only focus on politics and the October presidential
elections after the World Cup (June-July 2014), President Dilma is holding on to a very strong
lead. According to the latest Datafolha polls (February 19 and 20) her vote intentions stabilized
at 47%, which means if the elections were held today she would be re-elected in the first
round. However, a lot could happen between now and October. We believe two critical issues
could start to erode her political support this quarter. The first and more important risk is the
looming energy crisis that could impose a rationing program similar to that in 2001. Very dry
weather conditions and record low levels of water reservoirs have impaired the hydro-energy
production grid in Brazil. While some is being supplied by fuel-led plants (despite the much
higher cost), the system is working very close to full capacity and if it doesnt rain soon the
government may be forced to start rationing the supply of energy. The second could be new
public demonstrations during the World Cup. While Brazil winning the world cup should give
her candidacy a shot in the arm, that is a story for the next quarter.

In Colombia, President
Santoss re-election remains
the most likely scenario, but it
is not clear if this would
happen in the first or second
round.

Although it is strange to have a boring election in Latin America, we believe that the risks of
political noise amid the run-up to the 25 May presidential election in Colombia are contained.
Although a recent poll by Datexco has shown a rise in the prospects of the Green Party
candidate, Enrique Penaloza, and a possible victory for him in the second round, that still
seems an uphill road. He lacks a strong political machine to move the voters and has not built
a consensus among the left. Therefore, we believe President Santos re-election remains the
most likely scenario, given his leading position in other pools such as Ipsos-Napoleon Franco.
At this junction, it seems just a matter of whether this happens in the first or second round.

In Mexico, the political parties


will be focused on the
discussion and eventual
approval of secondary
legislation

As we have mentioned before, in Mexico the political parties will be focused on the
discussion and eventual approval of secondary legislation for the telecommunications,
competition, political and energy reforms. The federal government is designing these new
laws that will likely be submitted to Congress in the coming weeks. We believe that the risks
of their not passing pass are low, as the government party requires only a simple majority
for approval. Furthermore, opposition parties PAN and PRD face internal disputes to renew
their leadership, which reduces their ability to control their respective congressional groups.

Argentina has moved towards


the center, while Venezuela
remains highly polarized

Of Venezuela and Argentina, we are more constructive on the latter. Public opinion in
Argentina has moved towards the center as the public looks for more moderate political
leaders and someone who has better relations with the international market. This transition in
the political arena will likely act as an anchor of expectations that will support the Argentine
assets. On the other hand, in Venezuela, public opinion remains highly polarized and although
the level of demonstrations has diminished, we still believe that sky-rocketing scarcity and
inflation will maintain a very volatile political framework. We expect, sooner rather than later,
the opposition to start negotiations with the government with likely improvements in the
institutional framework, such as a more balanced national electoral council.

25 March 2014

44

Barclays | The Emerging Markets Quarterly

POLITICAL HEAT MAP


Societal Stability Events (SSE)* and elections calendar for emerging market countries
* Events that threaten societal stability including political expression events, politically motivated attacks, disruptive state acts, political power reconfigurations and mass movements of people.
Shading of cells refers to degree of political risks attached to electoral milestone:

high

protests or strikes terrorist attacks civil strife


J
EM Asia
India
Indonesia
Korea
Taiwan
Thailand
EM Europe
Czech Republic
Hungary
Israel
Lithuania
Poland
Romania
Russia
Serbia
Slovenia
Turkey
Ukraine
MENA
Bahrain
Egypt
Iraq
Lebanon
Morocco
Tunisia
Saudi Arabia
SSA
Cte divoire
Mozambique
Namibia
Nigeria
South Africa
Latin America
Argentina
Brazil
Chile
Colombia
Costa Rica
Dominican Republic
El Salvador
Mexico
Panama
Uruguay
Venezuela

2013
S

moderate

low

P - Presidential, G - General/Parliamentary, L - Local.


2014

L, G
G

L, G

2015
J

P
L
L

G
G (6)
P
P
L
P
L

P, G

G (16)
G
L (30)

P*

G*

P (25)

G*
P*

G*

G (30)
P (25)

G*
G*

P*
L
P

G, P (15)

P, G

P, G (14)

G (7)
L, G

P, G
P, G, L
P, G
G(9)
G

P(25)
P(6)
G (25)

P(9)

G
G
G(4)
P, G

L
G

Source: National governments, Barclays Research. Note: * tentative/ subject to change.

25 March 2014

45

Barclays | The Emerging Markets Quarterly

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25 March 2014

46

Barclays | The Emerging Markets Quarterly

Country outlooks

25 March 2014

47

Barclays | The Emerging Markets Quarterly

EMERGING ASIA: CHINA

Growth recovery in a volatile market


We lower our Q1 GDP forecast to 7.3% y/y but maintain our 7.2% full-year forecast. We
expect a recovery in growth momentum in Q2 on a quick start of investment projects,
further deregulation and SOE reforms. We expect more volatile financial markets with
more defaults and bankruptcies, a weak CNY, and the PBoC maintaining easier liquidity.

Economics
Jian Chang
+852 2903 2654
jian.chang@barclays.com

Key recommendations
Rates: Easier liquidity, lower rates. The PBoC sounded less hawkish in its February

Rates Strategy
Rohit Arora

monetary policy report, stating that it would maintain appropriate levels of liquidity and
create a stable monetary-financial environment. The outlook for fixed income markets
has changed in favour of receivers/long bonds. We think low inflation and slower GDP
growth provide further support for such a stance, would be biased to receive on spikes.

+65 6308 2092


rohit.arora3@barclays.com
FX Strategy
Hamish Pepper

FX: We think the recent CNY depreciation and widening of the USDCNY trading band is

+65 6308 2220

designed to discourage one-way CNY appreciation expectations and moderate the pace
of capital inflows and FX reserve accumulation, rather than support exports. We expect
further near-term CNY depreciation on weakness in economic activity and continued
concerns about domestic financial sector risks. However, further upside in USDCNY is
likely to be limited due to significant currency weakness year-to-date. Further out, the
PBoC will likely favour modest CNY appreciation, albeit at a slower pace than in recent
years, as growth momentum picks up in H2 and trade surpluses return.

hamish.pepper@barclays.com

While the Lunar New Year


effects brought some
distortions, the start of 2014
was challenging

There was no shortage of bad news for the Chinese economy at the start of 2014. While the
Lunar New Year makes it difficult to assess underlying strength, manufacturing PMIs fell for
a third consecutive month to an eight-month low in March. Average Jan-Feb activity data
missed expectations by a wide margin, confirming a significant slowdown in Q1. In the
financial markets, after a near default of a trust product in January, March saw the first
onshore corporate bond default. The sharp depreciation of the CNY over Feb-Mar also
triggered sell-offs in commodities and worries of a property bubble burst.

We expect a marked
slowdown in Q1, followed by a
pick-up in q/q momentum

We lower our Q1 GDP forecast to 7.3% y/y but maintain our 7.2% full-year forecast. This
implies a marked slowdown in sequential momentum to about 5% q/q saar (Figure 1). We
expect the government to implement a more proactive fiscal policy and accelerate planned
investment projects to prevent growth from sliding further and to achieve its around 7.5%

FIGURE 1
We expect a recovery after the sharp deceleration in Q1
20
18
16
14

GDP, %q/q saar


F'cast
GDP, %y/y
IP, %3m/3m saar (RHS)

12

FIGURE 2
FAI growth slowed across all three major components
30

% y/y YTD
40

25

35

20
15

10
8
6
4
2
0
Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14
Source: Haver Analytics, CEIC, Barclays Research

25 March 2014

10
5
0
-5

30
25
20
15
10
5
0
-5
Jan-10

Jan-11
Manufacturing

Jan-12
Jan-13
Jan-14
Infrastructure
Real estate

Source: CEIC, Barclays Research

48

Barclays | The Emerging Markets Quarterly


growth target for 2014. Meanwhile, the PBoC will likely maintain easier liquidity conditions
throughout H1 and, following the recent widening of the trading band, we expect CNY to
stay weak in the near term. These views underpin our forecast of a recovery in q/q
momentum for the rest of the year (see China: Stimulus underway? 24 March 2014).
We think the weak data
highlight the challenge to
balance reform and growth

In our view, the weaker-than-expected Jan-Feb activity data highlight the governments
challenge to push for reforms while maintaining stable growth. We have argued that
reforms tend to slow growth in the near term before any longer-term benefits are felt. Since
December, the government has shown more commitment to cutting overcapacity and
controlling pollution, including measures like closing down factories. It has released new
local government performance evaluation criteria, downplayed the importance of GDP
growth and added environment standards and debt levels to the top of the priorities list.
These changes are curbing the investment enthusiasm of local governments. The ongoing
anti-graft campaign was broadened with more austerity measures to cut public spending
and a strict ban on gift-giving, which contributed to a deceleration in Jan-Feb holiday sales.

Negative impact from reforms


has led to a sharper-thanexpected slowdown in
economic activity and demand

Reflecting the above, IP growth fell to a 5-year low of 8.6% y/y over Jan-Feb, from 9.7% in
December and 10% in Q4. In sectors with overcapacity issues, such as steel, aluminium, and
cement, production slowed markedly. Fixed asset investment growth also decelerated to its
slowest pace since December 2002, at 17.9% y/y ytd, led by the manufacturing sector
(Figure 2). We estimate that infrastructure investment growth also slowed to 18.8% y/y
(Dec: 21.1%). Retail sales growth fell to a 9-year low of 11.8%, though in real terms it was
more stable. Soft external demand was also not helpful (Figure 3). For details, see China:
Weak Jan-Feb data highlight the challenge to balance reform and growth, 13 March 2014.

The weakness in consumption


reflects a cooling housing
market that deserves attention

The housing market also shows increasing signs of weakness, which is weighing on
investment and consumption. Property sales were flat over Jan-Feb, down from +17.3% in
2013 (Figure 4). Property starts fell by 27.4% y/y, and 3mma growth of -2.8% was a 9month low. The cooling housing market led to slow Jan-Feb sales of furniture, construction
materials and household appliance (Figure 5). Amid slowing sales and house price inflation,
some developers are facing financing difficulties, including bankruptcies. The CNYs recent
sharp deprecation has added to concerns about a potential bursting of the property bubble.
While the risks are real, we are not expecting a disorderly adjustment in the housing market.

We look for a more proactive


fiscal policy with more central
government-led investment

Looking ahead, we expect the government to accelerate the start of investment projects to
stabilise growth. The government targets a budget deficit of CNY1.35trn in 2014 (2.2% of
GDP), compared with the 1.9% deficit in 2013. Premier Li said in March that reasonable
investment growth is needed in 2014. Leveraging private investment, the central

FIGURE 3
Weaker external demand has not helped
%3m/3m, saar
80
60
40
20
0
-20
-40
-60
-80
Feb-08 Feb-09
Exports

% y/y 3mma

35
30
25
20
15
10
5
0
-5
-10
-15
-20
Feb-10 Feb-11 Feb-12 Feb-13 Feb-14
US ISM: New orders less inventories (RHS)

Source: Haver Analytics, CEIC, Barclays Research

25 March 2014

FIGURE 4
Waning growth in property sales and starts
100
80
60
40
20
0
-20
Feb-09

Feb-10

Feb-11
Feb-12
Feb-13
All buildings: floor space started
All buildings: floor space sold

Feb-14

Source: Bloomberg, Barclays Research

49

Barclays | The Emerging Markets Quarterly


government will focus on social housing, rural infrastructure, major irrigation and water
conservancy projects, railways in the central and western regions, public utilities and
environmental protection. We believe weak growth will increase the incentive to push for
deregulation and SOE reforms to unleash new growth drivers (see Report). In the property
market, we expect increasing land and housing supply to be a priority in first-tier and some
second-tier cities. The government plan to renovate shanty towns of 4.7mn units, a 57%
y/y increase and involving an estimated CNY1trn investment, will also lend support.
We look for more but selective
defaults. That said, the
government operates on
bottom-line thinking and still
has capacity to take action

We continue to expect more but selective defaults, further exposure of financial risks, and
greater financial market volatility in Q2 (see China: Implications of a first onshore corporate
bond default, 5 March 2014). We think recent events show the governments recognition of
the need to reduce moral hazard and excessive risk taking. But we believe the likelihood of
a financial meltdown remains small. Debt repayment pressures in a slowing and highly
leveraged economy certainly present risks, but Chinas government operates on a bottomline basis. It has committed to monitor and prevent systemic and regional financial risks.
The government would assess the investor base and potential impact before allowing more
defaults to occur. Debt rollovers or extensions will continue. While the chance of policy
mistakes is high, Chinas financial system is not fully-market based and the government still
has capacity to take action. Bank runs or capital flight remain unlikely, in our opinion.

We expect easier liquidity


conditions in H1 and do not
rule out RRR cuts

We expect the PBoC to maintain easier liquidity conditions in H1, keeping interbank interest
rates low, ie, 7d repo rates at 3-4% (Figures 6, 7). This should help to prevent a liquidity
crisis, reduce shadow bank lending, promote bond financing, and lower average financing
costs. In our view, the PBoC shifted to a more neutral stance in January, in contrast to Q4
2013 (see China PBoC Watch: Less hawkish, more flexible, 12 February 2014). In February,
the PBoC also pledged to ensure appropriate liquidity and a stable monetary and financial
environment. RRR cuts are likely in the event of significant capital outflows or to avoid a
liquidity crisis after a credit event. Interest rate cuts are likely if growth disappoints further in
Q2. Well-contained inflation and slower property price rises provide room for an easing bias.

We look for weaker CNY in the


near term given a marked shift
in market expectations

On 17 March, the PBoC widened the USDCNY trading band to 2% from 1%, a move that
highlights its determination to proceed with its long-held currency reform and convertibility
agenda, in our view. The PBoC reiterated that two-way currency volatilities will be a norm
and it will (gradually) exit from the day-to-day FX intervention. We think the main purpose
of the PBoC guiding the CNY weaker in mid-end February was to create two-way
expectations to deter speculative capital inflows and prevent an over-valued currency, and
not to actively use the currency to boost exports or growth. Increased uncertainty on the

FIGURE 5
Property sales and housing-related retail sales
% y/y
60

FIGURE 6
PBoC has ensured ample liquidity in the interbank market
% y/y

Property related retail sales

110

Residential property sold (RHS) 90

50

7-day repo rate


Overnight repo
7-day repo rate (monthly average)

11

70

40

50

30

30
20

10

10

-10

0
-10
Feb-08

%
13

-30
Feb-09

Feb-10

Source: CEIC, Barclays Research

25 March 2014

Feb-11

Feb-12

Feb-13

-50
Feb-14

9
7
5
3
1
Mar-13

Jun-13

Sep-13

Dec-13

Mar-14

Source: CEIC, Barclays Research

50

Barclays | The Emerging Markets Quarterly


CNY outlook, concerns about Chinas growth and financial risks, together with reduced
onshore-offshore interest rate differentials, however, point to smaller inflows and
depreciation pressures (see China: PBoC widens USDCNY trading band, 16 March 2014).
FIGURE 7
Borrowing costs down from recent peak
9

FIGURE 8
CNY weakness continued amid a band widening

6.50
6.45

Expected return on WMP (1y)


Bill Rediscount Rate (6m)
Corporate bond yield (AAA, 5y)
Treasury bond yield (10y)

8
7

6.40

Band widening
to 2%

6.35
6.30
6.25

6.20
6.15

6.10
6.05

4
3
Feb-11

Band widening to
1% in April 2012

Aug-11

Feb-12

Aug-12

Feb-13

Aug-13

6.00
Sep-11
Mar-12
Sep-12
USD/CNY spot
Lower trading bound

Feb-14

Source: Wind, Barclays Research

Mar-13
Sep-13
Mar-14
USD/CNY fixing
Upper trading bound

Source: Bloomberg, Barclays Research

FIGURE 9
China macroeconomic forecasts
2010

2011

2012

2013

2014F

2015F

Real GDP (% y/y)

10.4

9.3

7.7

7.7

7.2

7.4

Domestic demand contribution (pp)

10.0

9.7

7.9

8.0

7.2

7.2

Final consumption (% y/y)

9.2

10.9

8.6

7.8

7.1

7.2

Gross capital formation (% y/y)

12.0

9.5

7.7

8.9

7.9

7.7

Activity

External demand contribution (pp)

0.4

-0.4

-0.2

-0.3

0.0

0.2

Nominal exports (% y/y)

31.3

20.3

7.9

7.9

8.3

8.8

Nominal imports (% y/y)

38.8

24.9

4.3

7.3

8.5

8.8

Nominal GDP (USD bn)

5,943

7,336

8,242

9,264

10,261

11,707

238

136

193

189

199

229

External sector
Current account (USD bn)
CA (% GDP)

4.0

1.9

2.3

2.0

1.9

2.0

Customs trade balance (USD bn)

182

155

230

260

278

302

106

116

112

118

125

141

Utilised FDI (USD bn)


Gross external debt (USD bn)

549

695

737

839

899

967

International reserves (USD bn)

2847

3181

3312

3821

3920

4050

Public sector
Public sector balance (% GDP)

-1.7

-1.1

-1.7

-1.9

-2.2

-2.1

Central government debt (% GDP)

16.8

15.2

14.9

15.3

15.7

16.0

Prices
CPI (% Dec/Dec)

4.6

4.1

2.5

2.5

3.5

3.5

FX (USD/CNY, eop)

6.59

6.32

6.23

6.06

6.07

5.95

1y ago

Last

Q1 14F

Q2 14F

Q3 14F

Q4 14F

Real GDP (% y/y)

7.7

7.7

7.3

7.2

7.1

7.2

CPI (% y/y, eop)

2.1

2.5

2.5

2.5

2.7

3.5

FX (USD/CNY, eop)

6.21

6.06

6.20

6.15

6.08

6.07

Monetary policy benchmark rate (%, eop)

6.00

6.00

6.00

6.00

6.00

6.00

Source: CEIC, Barclays Research

25 March 2014

51

Barclays | The Emerging Markets Quarterly

EMERGING ASIA: HONG KONG

Burgeoning credit exposure to mainland China


Hong Kongs surging credit exposure to mainland China points to asset-quality and
finance risks amid Chinas slowing economy, though these risks should be manageable.
We forecast 2014 GDP growth of 3.4%, with more downward pressure on property prices.

Jian Chang
+852 2903 2654
jian.chang@barclays.com

Hong Kong has been the hub of credit supply to mainland Chinese corporations and
individuals in recent years. As of September 2013, the Hong Kong banking systems gross
credit exposure to mainland China had jumped by 32% y/y to HKD3.5trn, equivalent to 21%
of total banking sector assets (Figure 1). This is more than four times the HKD0.86trn at
end-2008. This data includes Hong Kongs direct and indirect, on- and off-balance-sheet
exposure to China-related non-bank counterparties.

Jerry Peng
+852 2903 3291
jerry.peng@barclays.com

Hong Kongs credit exposure to


mainland China has surged

On a net basis, Hong Kong had net claims of HKD2.3trn on mainland banks and non-bank
sectors as of end-2013. This is a marked increase from the HKD0.58trn at end-2010 and
-HKD0.15trn in 2009. The increase in net claims has been driven by rapid expansion of the
asset side of the banking sector balance sheet, while liabilities to China have risen much
more modestly (Figure 2). Since a majority of the transactions are conducted through banks
rather than directly with mainland non-bank entities, the credit expansion is recorded as
claims on mainland banks, though ultimately it reflects exposure to non-bank sectors.

Low interest rates, tight


onshore liquidity and the rising
CNY fuelled the surge

It is not a surprise that Hong Kong has been a net supplier of credit to China since 2010. A
combination of factors low interest rates in Hong Kong since the Fed launched QE in
November 2009, tight liquidity conditions in the mainland, particularly in 2010-11 and H2
2013, and continued expectations of CNY appreciation (except for 2012) has driven the
surge. In the last six months of 2013, there was a steady rise in onshore funding costs, and
the CNY appreciated rapidly from September.

leading to increased
arbitrage activity

These factors created sizeable onshore-offshore interest rate and exchange rate arbitrage
opportunities. Borrowing in HKD or USD and depositing the funds in higher yielding mainland
investment products has been a popular carry trade. Moreover, Chinese corporates have a
strong incentive to raise funds offshore, while Hong Kong banks have a strong incentive to
hold more interbank assets in the mainland. Capital inflows in the guise of trade finance have
been prevalent. For example, Hong Kongs bank loan data show trade finance surged by
44%y/y in 2013, with its share rising to 9.1% from 5.2% in 2009 (Figure 3).

FIGURE 1
Rising exposure to mainland China

FIGURE 2
Hong Kongs claims on and liabilities to mainland China
%
25

HKD trn
4.0
3.5
3.0

HK banking sector non-bank China exposure


As % of banking sector assets (RHS)

3.5

20

3.0

Claims on Banks

Claims on non-banks

Liabilities to banks

Liabilities to non-banks

2.5

2.5

15

2.0
10

1.5

2.0
1.5
1.0
0.5
0.0

1.0

0.5
0.0
Sep-07

HKD trn
4.0

-0.5
-1.0

Sep-08

Sep-09

Source: CEIC, Barclays Research

25 March 2014

Sep-10

Sep-11

Sep-12

0
Sep-13

-1.5
Dec-07

Dec-08

Dec-09

Dec-10

Dec-11

Dec-12

Dec-13

Source: CEIC, Barclays Research

52

Barclays | The Emerging Markets Quarterly


Robust CNH bond issuance at
the start of the year

The strong financing demand from mainland borrowers is also reflected in robust CNH bond
issuance. In the first two and a half months of this year, CNH bond issuance has totalled a
record CNY191bn, already more than half the CNY383bn for all of 2013 (Figure 4). Chinese
companies account for 84.5% of the issuance YTD, up from 79% in H1 2013.

Sizeable mainland exposure


points to potential asset
quality risks for the Hong Kong
banking system

This sizable mainland credit exposure in the facing of rising China credit defaults and a
decelerating economy pose significant risk to the banking system in Hong Kong. Our equity
bank analysts expect more NPLs for Hong Kongs banking system in 2014. Overall, however,
we think the risks remain manageable. Bank lending to mainland customers is mostly backed
by guarantees or collateralised. The Hong Kong Monetary Authoritys macro stress testing in
September 2013 suggests that the banking sector should be able to withstand severe macro
shocks, similar to those experienced during the Asian financial crisis. Meanwhile, we note
that recent sharp depreciation of the CNH and increased volatility, easier onshore liquidity
and Fed tapering are likely to dampen arbitrage activity and excessive risk taking.

Risks to housing prices remain


to the downside

Hong Kongs property market has been subdued since the government announced stricter
demand-curbing measures in February 2013 (see CNH Markets: Facing competition, 19
March 2013). Transactions have stayed at multi-year lows of 4,000-5,000 units per month
since Q2 13. Property prices ended 2013 with the slowest pace of increase since 2009, at
8%, and they have been flat since last summer (Figure 5). We think the government is
unlikely to relax the tightening measures. The budget report estimates total land supply of
20,000 residential flats this year, up from 18,000 in 2013. The government is committed to
increasing housing supply to 470,000 units in the coming 10 years. Overall, we believe the
risks to property prices remain to the downside amid steady Fed tapering. At the March
FOMC meeting, the Fed quickened the expected pace of its rate hike cycle. The median
forecast of the fed funds rate rose by 25bp, to 1.0%, at the end of 2015.

We expect GDP growth to pick


up to 3.4% in 2014

We forecast Hong Kong GDP growth of 3.4% y/y in 2014, up from 2.9% in 2013. Growth in
Q4 13 was stronger than expected (3.0% y/y), supported by a rebound in private
consumption. Investment remained weak while trade growth accelerated on improved
demand from advanced economies. In 2014, we expect continued weakness in the property
market to weigh on private consumption growth (Figure 6). Investment growth is likely to pick
up, driven by the rollout of public infrastructure projects, such as the airport expansion and
major railway upgrade projects. The government expects the economy to grow 3-4% in 2014
on the back of an improved global environment. The 2014 budget report also emphasised
fiscal sustainability in view of the ageing population and shrinking labour force.

FIGURE 3
Hong Kong loan growth breakdown

FIGURE 4
CNH bond issuance has accelerated
CNY bn

%y/y
100

Loans for use in HK


Loans for use outside HK
Trade finance

80

80
70
60

60

50

40

40

20

30

20
10

-20
-40
Jan-08

CNH bond issuance

0
Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14
Jan-09

Jan-10

Source: CEIC, Barclays Research

25 March 2014

Jan-11

Jan-12

Jan-13

Jan-14

Mar
MTD

Source: Bloomberg, Barclays Research

53

Barclays | The Emerging Markets Quarterly

FIGURE 5
Subdued housing transactions and flat property prices
20

thousand units

Index (1999=100)

FIGURE 6
Weak property market likely to weigh on consumption

18

240

16

220

14

Property price (%y/y)

30
20

200

12

180

10

10

160

140

6
4

120

100

0
-10

0
80
Jul-06
Jan-08
Jul-09
Jan-11
Jul-12
Jan-14
House price index (RHS)
Residential transaction volume
Source: CEIC, Barclays Research

Retail sales (%y/y)

40

260

-20
Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14
Source: CEIC, Barclays Research

FIGURE 7
Hong Kong macroeconomic forecasts
2010

2011

2012

2013

2014F

2015F

Real GDP (% y/y)

6.8

4.8

1.5

2.9

3.4

3.8

Domestic demand contribution (pp)

6.7

5.9

3.8

3.9

4.6

4.5

6.1

8.4

4.1

4.2

3.4

4.0

Investment/GFCF (% y/y)

7.7

10.2

6.8

3.3

7.9

6.0

Net exports contribution (pp)

-0.2

-1.4

-2.2

-0.9

-1.2

-0.6

Exports (% y/y)

16.8

3.9

1.9

6.5

6.7

6.5

Imports (% y/y)

17.4

4.6

2.9

6.9

7.2

6.7

229

249

263

274

288

309
12.6

Activity

Private consumption (% y/y)

GDP (USD bn)


External sector
Current account (USD bn)

16.0

13.8

4.1

5.6

9.5

CA (% GDP)

7.0

5.6

1.6

2.1

3.3

4.1

Goods Trade balance (USD bn)

3.3

-7.5

-18.9

-26.2

-28.2

-29.9

Net FDI (USD bn)

-15.7

0.2

-13.2

-14.9

-12.9

-12.9

Other net inflows (USD bn)

12.5

-3.4

29.0

17.4

14.2

14.2

Gross external debt (USD bn)

879

985

1031

1166

1280

1408

International reserves (USD bn)

269

285

317

311

322

335

Public sector balance (% GDP, FY)

4.1

3.8

3.2

0.6

1.0

1.0

Gross public debt (% GDP)

0.6

0.6

0.5

0.5

0.5

0.5

Public sector

Prices
CPI (% Dec/Dec)

2.9

5.7

3.8

4.3

3.7

4.4

FX (USD/HKD, eop)

7.78

7.77

7.75

7.75

7.77

7.77

1y ago

Last

Q1 14F

Q2 14F

Q3 14F

Q4 14F

Real GDP (% y/y)

2.9

3.0

3.2

3.3

3.6

3.6

CPI (% y/y, eop)

3.6

4.3

4.4

4.3

3.9

3.7

FX (USD/HKD, eop)

7.76

7.75

7.77

7.77

7.77

7.77

Discount window base rate (%, eop)

0.5

0.5

0.5

0.5

0.5

0.5

Source: Barclays Research

25 March 2014

54

Barclays | The Emerging Markets Quarterly

EMERGING ASIA: INDIA

All eyes on elections


Market performance has followed improving fundamentals, but the focus now shifts to
elections, which will take place over April-May. Opinion polls suggest the BJP-led
opposition is consolidating its gains, though it is still short of a full majority. The RBI has
maintained tight monetary policy despite the recent normalisation in inflation. The INR
has appreciated on the improving current account and policy initiatives. Growth
remains weak, but we think the green shoots of recovery are emerging.

Economics
Siddhartha Sanyal
+91 22 6719 6177
siddhartha.sanyal@barclays.com
Rahul Bajoria
+65 6308 3511

Key recommendations
Rates: Receive 5y OIS. Indias policy adjustments and an ongoing differentiation within

rahul.bajoria@barclays.com

emerging markets have put Indian assets in a sweet spot. But the rates market so far has
struggled to follow-through amid pessimism in the onshore market. But given the
strong momentum, we think the near-term path of least resistance for yields is lower,
and we recommend tactically initiating a 5y OIS receiver. However, if there is uncertainty
ahead of the election results in May, we think 1s5s flatteners may offer a better riskreward and would look for opportunities to convert receivers into flatteners.

Rates Strategy
Rohit Arora
+65 6308 2092
rohit.arora3@barclays.com
FX Strategy

FX: Positive INR momentum will likely continue in the near term, on the back of a

Hamish Pepper

narrowing current account deficit, softer inflation, enhanced policy credibility and strong
capital inflows. Moreover, lower vulnerabilities given continued undervaluation, make
the INR one of our favoured high-yield EM currencies. As such, we recommend being
short USDINR targeting 59.0 (1m; stop loss at 62.50). The general election remains a risk
and further out, an expected stronger USD will likely limit INR appreciation.

+65 6308 2220


hamish.pepper@barclays.com

Political outcome remains critical; BJP seems to be leading the pack


The countdown has begun for Indias sixteenth general election (7 April 12 May), which
will be critical for the economy as well as for financial markets. Most opinion polls suggest
the leading opposition party, the BJP, is the frontrunner to form the next government. For
the first time since April 2013, the BJP-led NDA coalition is not only leading the incumbent
UPA but also the consolidated tally of all smaller and regional parties, according to recent
opinion polls. But with nearly two months to go before the votes are counted, changes in
political dynamics cannot be ruled out. Moreover, the electoral mandate in India has been
fragmented since 1989. Indeed, while the BJP is leading in opinion polls, it would still have to
ally with smaller regional parties to form a government.

Opinion polls suggest the


BJP-led coalition is the
frontrunner to form the
next government

FIGURE 1
BJPs projected vote share has risen significantly relative to
previous elections
40

Seats

Vote share
(%)

35

FIGURE 2
Opinion polls confirm lead of the BJP-led coalition (NDA)

Simple majority: 272

300
250

30

200

25

150

20

100

15

50
0

INC

BJP

Note: E expectation for 2014 polls. Source: CSDS,CEIP, Barclays Research

25 March 2014

Feb 2014E

2014E

2013E

2009

2004

1999

1998

1996

1991

10

NDA

UPA

Source: CSDS, Cvoter, Nielsen, Hansa Research, Barclays Research

55

Barclays | The Emerging Markets Quarterly


BJP indicates that it would
prioritise infrastructure
investments, power
generation, the manufacturing
sector, implementation of a
goods and service tax, and
measures to boost FDI

The progress of the two larger parties in acquiring new alliance partners has been limited.
The momentum of the new political party, AAP, has slowed, with opinion polls showing
subdued national support for the anti-corruption party. The economic agendas of the key
parties have yet to be fully detailed. However, the BJP has indicated its preference to
prioritise infrastructure, power generation and the manufacturing sector, along with
implementing a goods and service tax and measures to increase FDI as ways to boost
growth momentum (see Inside India: The game of thrones, 4 March 2014).

Current account deficit cut


rapidly and likely to stay within
comfortable levels in FY 14-15

The rupee (INR) has strengthened significantly since September 2013. The slew of measures
by the Reserve Bank of India (RBI), including policies designed to attract near-term capital
flows (see India: Rajans roadmap to confidence, 5 September 2013), have been markedly
beneficial. Inflows due to these unconventional measures have totalled nearly USD35bn.
More fundamentally, Indias current account deficit, has improved rapidly since mid-2013.
We estimate the current account deficit will be USD38bn in FY 13-14 (2.1% of GDP) and
USD50bn in FY 14-15 (2.4% of GDP), markedly lower than the USD88bn (4.8% of GDP)
deficit in FY 12-13. The improvement has been driven by stronger exports (both
merchandise and services), much lower gold imports, softer non-oil/non-gold imports, and
steady remittances. INR weakness and government efforts to curb various imports, on top
of sluggish domestic demand, have also helped in the rapid adjustment.

The INR heavily outperformed


EM peers; pre-election INR rally
will likely continue

The INR has also recovered, gaining more than 10% against the USD since early September
and reversing a large part of its ~20% fall over June-August. The INR has also outperformed
a basket of its EM peers by more than 1100bp since early September, which has reversed a
similar magnitude of underperformance in the previous three months (Figure 4). We remain
sanguine on INR fundamentals, but think the election results will have strong influence on
the trajectory of the currency (see India: Pre-election INR rally to continue, 11 March 2014).

Capital inflows, in the absence


of any major disappointment in
the election, will likely remain
supportive

Capital inflows, such as foreign direct investment (FDI), remain supportive (USD21.5bn during
April 2013-January 2014). Investment flows from foreign institutional investors (FIIs) into
equities have remained steady as well (USD11.6bn FYTD). FII investment in Indian debt has
seen large swings outflows of USD10.3bn during April-December, followed by more than
USD6bn of inflows since January. On balance, we expect an overall balance of payments
surplus in FY 14-15, in the absence of any major disappointment in the elections.

Current account deficit improving quickly; INR outperforming EM peers

FIGURE 3
Current account deficit a rapid turnaround

FIGURE 4
INR has outperformed EM peer currencies since September,
after underperforming previously

130

125

-5

120

-10

115

-15
-20

110

-25

105

-30
-35
May-11
Apr-12
Mar-13
Jan-14
Dec-14
Barclays tracking estimate of current account deficit (USD bn)
Current account: existing forecast (USDbn)
Source: Haver Analytics, Barclays Research

25 March 2014

100
95
Jan-13

Apr-13
INR

Aug-13

Nov-13

Mar-14

Average of MXN, RUB, ZAR, IDR, TRY and BRL

Source: Bloomberg, Barclays Research

56

Barclays | The Emerging Markets Quarterly

Inflation surprises lower; we expect the RBI to stay on hold near term
Inflation prints softer;
we think core inflationary
pressures are low

Inflation has been volatile but is now moving lower. After a late-2013 upsurge, largely
reflecting food (eg, vegetables) price spikes, inflation prints have normalised this year as
wholesale (WPI) and retail (CPI) inflation were 4.7% and 8.1% y/y, respectively, in February
2014 (Jan WPI: 5.1% and Jan CPI: 8.8%). Core inflation also remains soft: core WPI and CPI
were 3.2% and 7.9% y/y, respectively, in February. We think that weak growth momentum,
large spare capacity in the manufacturing sector, a lack of pricing power within industry,
and the recent stability in INR should limit upside pressure on core inflation. This view also
takes into account the possibility of some more upticks from adverse base effects.

RBI set to stay on hold in April,


while post-election
developments and the new
governments economic
policies will likely have a
material influence on monetary
policy in H2 2014

Even with tepid growth and softening inflation, the RBI is unlikely to lose its focus on
managing inflation expectations. The central bank surprised with a 25bp hike in the repo
rate to 8% at its policy meeting in January. It also shows an inclination to adopt the
recommendations of the Dr. Urjit Patel committee on monetary policy framework, which
expects CPI inflation to be close to 8% by January 2015. As such, the RBI has indicated that
rates are appropriate now, but CPI inflation and inflation expectations will need to be
lowered over time to generate sustainable growth. On balance, we expect the RBI to stay on
hold in the coming months, while post-election developments and the new governments
economic policies will likely have a considerable influence on monetary policy in H2 2014.

Growth recovery still weak, but with early indications of green shoots
Growth is still weak, but
headwinds are easing

Growth momentum remains weak, but we see some emerging green shoots of recovery.
Real GDP growth came in at 4.7% y/y in Q4 13, and we forecast growth of above 5% in
2014. We think the headwinds buffeting India are easing at the margin, as bottlenecks in
key industries such as power generation, mining and the financial sector are being cleared.
While this may not be a conclusive signal of stronger activity just yet, we think these
improvements could facilitate a growth recovery in FY 14-15. This is supported by improved
exports and PMIs as well. We maintain our FY 13-14 GDP forecast at 4.7% and expect
growth to improve to 5.6% in FY14-15. Following the elections, if business confidence
improves, growth could turn stronger, as key industries start to regain momentum. Growth,
however, will continue to face challenges from the RBIs tight monetary policy stance, which
along with restrained spending capacity could act as a constraint if the new government
remains committed to achieving the current fiscal deficit target of 4.1% of GDP.

FIGURE 5
Subdued capacity utilisation suggests benign core
inflationary pressures

FIGURE 6
Repo rate towards upper end of historical range despite
weak growth prospects

20

10

10

8
6

-10

-20

-30
-40
Dec-05

11

-2
-4
Dec-07
Dec-09
Dec-11
Dec-13
Level of Cap Utilization: Net Response (%, 1Q lead)
Core WPI (% y/y, RHS)

Source: RBI, Haver Analytics, Barclays Research

25 March 2014

3
Mar-09

Jun-10
MSF Rate

Sep-11
Repo Rate

Dec-12

Mar-14

Reverse Repo Rate

Source: RBI, Haver Analytics, Barclays Research

57

Barclays | The Emerging Markets Quarterly


FIGURE 7
Intermediate goods production bodes well for
manufacturing

FIGURE 8
Recovering PMIs hint at a modest uptick
65

10

60

55

50

-2

45

%, y/y

14

-6
Jan-10

Jan-11

Jan-12

Jan-13

Jan-14

40
Feb-06

Feb-08

Feb-10
Feb-12
Composite PMI
Manufacturing PMI
Services PMI

Intermediate goods (6mma)


IP: Manufacturing (6mma)
Source: GoI, Haver Analytics, Barclays Research

Feb-14

Source: GoI, Haver Analytics, Barclays Research

FIGURE 9
India macroeconomic forecasts
FY 10-11

FY 11-12

FY 12-13

FY 13-14F

FY 14-15F

FY 15-16F

Real GDP (% y/y)

9.3

6.2

4.6

4.7

5.6

6.4

Domestic demand contribution (pp)

11.9

7.4

4.6

3.7

6.6

7.7

Private consumption (% y/y)

8.6

8.6

4.7

3.2

5.9

6.6

Fixed capital investment (% y/y)

14.0

8.0

0.8

0.4

5.3

6.8

Net exports contribution (pp)

-0.3

-2.7

-1.0

1.1

-1.3

-1.7

Exports (% y/y)

19.7

14.9

5.2

9.0

11.0

11.0

Activity

Imports (% y/y)

15.8

20.8

6.8

3.3

12.2

13.0

GDP (USD bn)

1713

1874

1850

1851

2049

2197

-47.9

-78.2

-87.8

-38.2

-50.0

-53.8

External sector
Current account ($bn)
CA (% GDP)

-2.8

-4.2

-4.7

-2.1

-2.4

-2.4

-127.2

-189.7

-195.7

-150.1

-165.7

-180

Net FDI ($bn)

9.4

22.1

19.8

23.7

25.0

27

Other net inflows ($bn)

52.6

45.7

69.5

27.5

42.2

50

Gross external debt ($bn)

306

345

390

430

450

455

International reserves ($bn)

305

294

293

300

315

330

Public sector balance (% GDP)

-8.1

-8.1

-7.4

-7.2

-7.0

-7.0

Gross public debt (% GDP)

66.0

65.6

64.5

63.5

61.0

61.0

WPI (% Mar/Mar)

9.7

7.7

5.7

5.7

5.5

5.6

CPI (% Mar/Mar)

10.0

9.4

10.4

8.3

7.6

7.0

Trade balance ($bn)

Public sector

Prices

FX, eop

44.6

50.9

54.4

59.0

61.0

63.0

1y ago

Last

Q1 14F

Q2 14F

Q3 14F

Q4 14F

Real GDP (% y/y)

4.8

4.7

4.8

5.4

5.2

5.6

WPI (% y/y, eop)

5.7

6.4

5.7

5.9

5.0

5.0

CPI (% y/y, eop)

10.4

9.9

8.3

7.2

6.0

6.3

FX (domestic currency/USD, eop)

54.4

61.9

59.0

61.0

61.0

61.0

Repo rate (%, eop)

7.50

7.75

8.00

8.00

7.75

7.50

Note: Fiscal year runs from 1 April to 31 March. Source: GoI, RBI, Bloomberg, Barclays Research

25 March 2014

58

Barclays | The Emerging Markets Quarterly

EMERGING ASIA: INDONESIA

The Jokowi effect


Economics
Prakriti Sofat
+65 6308 3201
prakriti.sofat@barclays.com
Rates Strategy
Rohit Arora
+65 6308 2092
rohit.arora3@barclays.com
FX Strategy
Hamish Pepper
+65 6308 2220
hamish.pepper@barclays.com
Credit Strategy
Avanti Save
+65 6308 3116
avanti.save@barclays.com

Jokowis confirmation in the presidential race is a positive development for investors.


Focus will now turn to his policy platform which we believe will be market friendly. With
polls indicating he could win, the potential for reform could support a change to a
positive outlook from S&P before year-end. On monetary policy, we expect BI to keep
rates unchanged but maintain a tight bias. Barring EM stress or fuel price related
inflation spike, we believe the next move from BI will be easing, but only in H1 2015.

Key recommendations
FX: Constructive IDR: We recommend being short 12m USDIDR NDF (strike: 12,300,
target: 11,200, stop: 12,500). We believe Jokowis confirmation is positive for the IDR
against a backdrop of reduced vulnerabilities. We also expect the upcoming change to an
onshore (JISDOR) NDF fix on 28 March to improve NDF market liquidity and support
portfolio inflows by giving investors a better instrument to hedge FX risk. However, in the
near term, the IDR rally may be capped as BI manages it relative to a basket to maintain
export competitiveness and reduce the gap between gross and net FX reserves.

Rates: Stay neutral IndoGBs, for now. We believe policy and price adjustments in
Indonesia have been sufficient, which in an environment of increased differentiation
within EM makes Indonesian assets look attractive. However, at current levels, we think
a lot of optimism is priced, and we do not find the risk-reward to be overweight
asymmetric. In fact, Indonesias improving fundamentals have been getting priced since
late January 10y bond yields have rallied from 9% to 8%, and foreign inflows have
been a significant ~USD2.5bn, compared with USD4.4bn in 2013 as a whole. Moreover,
global risks remain high. Although our bias is to move overweight (if economic data do
not disappoint and yields rise above 8.5%), we do not recommend chasing the rally at
current levels and remain comfortable with our neutral stance.

Credit: Our current stance on the credit is neutral. That said, we see Jokowis candidacy
as a positive. We have pointed to two potential triggers to increase exposure: 1) an early
announcement of Jokowi as a presidential candidate; and 2) stable (or at least more
than USD100bn) foreign reserves for March (due in early April). We may review our
FIGURE 1
Investment some signs of hope from terms of trade
20

FIGURE 2
Current account: Sharp turnaround in non-oil & gas goods
balance
15

12

10

10

-5

-4

15

-10
0

-15

-5

-20
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
ID: Investment (% y/y)

Source: Haver Analytics, Barclays Research

25 March 2014

ToT % y/y lagged 3qtrs (RHS)

USD bn

-8
-12
04

05

06

07

Goods - oil & gas


Services
Transfers
Source: CEIC, Barclays Research

08

09

10

11

12

13

Goods - non- oil & gas


Incomes
Current account

59

Barclays | The Emerging Markets Quarterly


stance when we get more clarity on March foreign reserves. Our overall constructive
stance is driven by an improving macro backdrop and favourable demand/supply
technicals, given USD2.95bn of maturities in March-May. We recommend buying longend bonds (INDON44/43) and the quasi-sovereigns that have lagged the sovereign (ie,
Pertamina and PLN). Finally, we think Indonesias relative attractiveness would decline if
the credit outperforms BBB peers such as Russia or Turkey, compressing to 80-100bp
inside these peers (compared with 69bp versus Turkey currently).

Politics: Jokowi confirmation removes election uncertainty


Jokowis candidacy
confirmed

and polls indicate he could


win the presidential election
Focus to turn to Jokowis policy
platform - we expect a market
friendly bias
but consensus building will
remain important to pass
legislation

On 14 March, the Indonesian Democratic Party of Struggle (PDI-P) announced that


Governor of Jakarta Joko Widodo Jokowi would be its candidate for the presidential
election. The announcement takes away uncertainty on whether Jokowi would participate in
the presidential election and is a positive development for markets, in our view. Opinion
polls indicate that he is the most popular candidate to be president, and suggest that he
could win the first round of the presidential race in July with no need for a second vote.
In our opinion, the focus will now turn to Jokowis policy platform. The governor has been
relatively reticent on national policies so far, with his focus remaining squarely on Jakarta.
We believe that his overall policy bias is likely to be market friendly, supporting investor
confidence. For example, in a recent interview Jokowi had said that he will take tax
collection online in Jakarta to tackle widespread evasion and remains focused on improving
infrastructure (Bloomberg). While increasing infrastructure spending would be positive for
the medium-term growth outlook, investors may worry about a potential increase in bond
issuance. Ultimately, legislation needs to pass through the parliament, which means
consensus building will remain important. We also think that Jokowi would need a strong
vice president to help with the execution of policy (see Indonesia: Higher political risk
premium needed, 5 March 2014). Current polls suggest that a Jokowi-Jusuf Kalla
combination would be the most popular president-vice president ticket.

IDR: Finally turning constructive


Jokowi confirmation positive
for IDR against a backdrop of
improved macro credibility
framework over the last 6-9
months

We believe Jokowis confirmation is positive news for the IDR in the context of a significant
reduction in Indonesias vulnerabilities over the past 6-9 months: increased policy credibility
(rate hikes plus concerns on two-tier market being addressed), the sharp reduction in the
current account deficit, moderating inflation and rising FX reserves. The upcoming change
in benchmark for IDR NDFs is another positive development that should support portfolio
inflows by giving investors a better instrument to hedge FX risk (see Indonesia: IDR NDFs
revamp A positive development, 19 February 2014).

However, near-term
appreciation will likely be
limited, given BIs bias to keep
IDR REER competitive and
rebuild FX reserves

However, the sharp year-to-date strengthening in the IDR, BIs focus on keeping IDR REER
competitive to manage the current account deficit and a bias to rebuild FX reserves to
reduce the gap between gross and net reserves will likely limit the extent of any further
rally. We forecast USDIDR at 11,400 in 1m and 3m. Upside risks to our forecast emanate
from a larger trade deficit, driven by the mineral ore export ban and concerns about EM on
account of weakness in Chinese activity and the Russia-Ukraine stand-off. Over the
medium term, we expect USDIDR gradually to drift lower to 11,300 in 6m and 11,200 in
12m as the current account adjustment process continues and more clarity on the new
governments policy agenda emerges. However, a strong dollar environment will tend to
cap the extent of appreciation.

25 March 2014

60

Barclays | The Emerging Markets Quarterly

Bank Indonesia: Staying on the sidelines with a tight bias


Policy focus remains on
current account deficit
management
barring EM stress or fuel
price related inflation spike, we
believe next move will be
easing

We expect Bank Indonesia to keep policy rates unchanged through 2014 (BI: 7.5% and
FASBI: 5.75%) as it lets the 175bp of hikes undertaken last year pass through to the real
economy amid a better-behaved FX market. However, we believe BI will maintain its tight
bias to support investor confidence, with a policy focus remaining squarely on current
account deficit management and ensuring within-target inflation. Barring renewed market
stress on account of EM concerns or inflation spike driven by an upwards adjustment to
administered prices, we believe the next move from BI would be easing, but only in H1 15.

Bank NIMs remain under


pressure, leading to tightening
financial conditions

Policy rate hikes continue to pass through to the real economy, with a time lag of 6-9
months. Working capital interest rates rose 80bp, to 12.2%, in January, compared with
11.4% in June 2013. There has been some stabilisation in deposit rates, with the 1m time
deposit rate holding at 7.9% in January, unchanged from December. It has, however, risen
230bp since June 2013 when it was 5.6%. It is worth noting that some of the smaller banks
are offering rates as high as 10-12% for large deposits. Overall net interest rate margins
remain under pressure, making banks more cautious in their lending activities.

Improving growth/inflation trade-off


Revising up 2014 GDP forecast
30bp, to 5.3%, and 2015
forecast 40bp, to 5.6%

We continue to expect economic growth to soften in 2014, given tightening credit


conditions. However, we are revising up our GDP forecast 30bp, to 5.3% y/y, equally
distributed to investment, net exports and consumption. Support should come from some
improvement in terms of trade and external demand. Further, consumption is being helped
by the rally in the equity market and IDR strength. BIs growth forecast despite the 30bp
downward revision in March is still more upbeat at 5.5-5.9%. We are also adjusting our
2015 growth forecast up 40bp, to 5.6% y/y, in line with expected stronger external demand
and some pick up in investment.

Revising down 2014 inflation


60bp, to 5.4%, but maintaining
2015 at 5.5%

We are revising down our year-end 2014 inflation forecast 60bp to 5.4% y/y (BI target: 3.55.5%). This is on account of: 1) a change in base year to 2012 from 2007, which shaves off
20-30bp; 2) a downside surprise in February inflation relative to our forecast; and 3) the
rupiah strengthening by nearly 8% year-to-date. If the government increases fuel prices by
roughly a third, we estimate this would boost inflation by 250-270bp. The central banks
reaction function will depend on second-round effects; however, under the new governor,
we believe the willingness to hike is higher to ensure that inflation expectations remain
anchored. We maintain our 2015 year-end inflation forecast of 5.5%.

Current account adjustment underway


Revising 2014 C/A deficit lower
by 20bp to 2.5% of GDP and
2015 by 10bp to 1.9% of GDP

Indonesias current account deficit improved significantly in Q4 down to 2% of GDP from


a peak of 4.4% of GDP in Q2. The turnaround has been driven by a sharp improvement in
the non-oil & gas goods balance, supported by front-loading of mineral ore exports ahead of
the January ban and increased manufacturing exports, especially to US and Japan. While the
mineral ore ban is fully effective for nickel and bauxite, copper exports can continue (see
Asia Themes: Indonesia: Mineral ore export ban a cross asset view, 15 January). However,
Freeport Indonesia has cut copper production as it remains in talks with the government
about progressive taxes that it believes breach existing contracts (Reuters). On the positive
side, manufactured exports continue to improve, with BI stating that machinery &
mechanical equipment, pharmaceuticals and metal-based products surged in January. We
are revising down our 2014 current account deficit forecast by 20bp to 2.5% of GDP (BI:
under 3%) and 2015 by 10bp to 1.9% of GDP (BI: 2%), supported by external demand.

We expect BI to absorb dollars


to increase buffer

FX reserves rose nearly USD6bn to USD102.7bn in February from their recent low in
November. The build-up is supported by trade and portfolio flows, but also FX swap/dollar
term deposit accretion. Indonesias import cover ratio is 6.6 months, and short-term

25 March 2014

61

Barclays | The Emerging Markets Quarterly


external debt was USD56bn as of end-January, with the coverage ratio remaining below 2x.
We continue to expect BI to absorb dollars to increase the buffer.

Budget deficit: Upward revision likely; possibility of a fuel price hike?


Target fiscal deficit to be
revised higher, to 2.2% of GDP,
suggesting IDR50trn of
additional issuance

We expect the government to revise its 2014 fiscal deficit target higher by 50bp, to 2.2% of
GDP, as it adjusts its macro assumptions. We raise our forecast by 20bp to 2.1%, slightly
better than the target on our assumption of capex under-spending. Year-to-date, the
government has completed over 41% of its gross issuance target of IDR370.4trn. However,
a higher deficit would imply IDR50trn of additional issuance, which could weigh on markets.
We expect the budget revision to come through in Q2, likely May.

Fuel price hike 50:50

As for a fuel price hike, the government has the authority to adjust prices and does not need
approval from parliament. While the political cycle makes it challenging, President
Yudhoyono does not have much to lose if he hikes fuel prices, given that he cannot run in
the presidential race. We think it is 50:50 whether hikes will materialise. In terms of timing,
we think they would likely be after the parliamentary but before the presidential elections.
The 2014 budget allocates IDR210.7trn for fuel subsidies up from IDR199.9trn last year.

FIGURE 3
Indonesia macroeconomic forecasts
2010

2011

2012

2013

2014F

2015F

Real GDP (% y/y)

6.2

6.5

6.3

5.8

5.3

5.6

Domestic demand contribution (pp)

4.8

5.3

7.1

4.6

3.8

4.2

Private consumption (% y/y)

4.7

4.7

5.3

5.3

5.3

5.2

Fixed capital investment (% y/y)

8.5

8.3

9.7

4.7

4.5

4.8

Activity

Net exports contribution (pp)

0.9

1.5

-1.6

2.1

1.7

1.2

Exports (% y/y)

15.3

13.6

2.0

5.3

5.4

5.5

Imports (% y/y)

17.3

13.3

6.7

1.2

2.5

4.0

GDP (USD bn)

710

846

874

864

885

1002

5.1

1.7

-24.4

-28.5

-21.7

-18.6

External sector
Current account (USD bn)
CA (% GDP)

0.7

0.2

-2.8

-3.3

-2.5

-1.9

Trade balance (USD bn)

30.6

34.8

8.6

6.2

6.9

7.1

Net FDI (USD bn)

11.1

11.5

13.7

14.8

10.0

12.0

Other net inflows (USD bn)

15.5

2.0

11.1

7.9

6.0

10.3

Gross external debt (USD bn)

202

225

252

264

281

298

International reserves (USD bn)

96.2

110.1

112.8

99.4

103.5

107.2

Public sector balance (% GDP)

-0.7

-1.1

-1.8

-2.3

-2.1

-2.0

Primary balance (% GDP)

0.6

0.1

-0.6

-1.1

-1.0

-0.9

Gross public debt (% GDP)

25.9

24.1

23.7

27.0

24.0

23.1

Public sector

Prices
CPI (% Dec/Dec)
FX, eop
Real GDP (% y/y)
CPI (% y/y, eop)
FX (domestic currency/USD, eop)
Overnight policy rate (%, eop)

7.0

3.8

3.7

8.1

5.4

5.5

8,991

9,068

9,670

12,189

11,300

11,000

1y ago

Last

Q1 14F

Q2 14F

Q3 14F

Q4 14F

6.0

5.7

5.4

5.2

5.2

5.5

5.0

8.1

7.2

6.8

5.3

5.4

9,719

12,189

11,400

11,400

11,300

11,300

5.75

7.50

7.50

7.50

7.50

7.50

Source: CEIC, Barclays Research

25 March 2014

62

Barclays | The Emerging Markets Quarterly

EMERGING ASIA: KOREA

Regaining vitality
The more convincing revival of domestic demand is finally giving the Park administration
the space to pursue structural policies to lift trend growth and reinvigorate the services
economy. This should add to the safe-haven appeal of Korean assets and the growth
momentum generated by rising consumer confidence and property prices.

Economics
Wai Ho Leong
+65 6308 3292
waiho.leong@barclays.com

Key recommendations
Rates: Pay 5y5y NDIRS, underweight duration. There are nascent signs of a recovery in

Bill Diviney
+65 6308 3607

domestic demand. However, so far, rates markets have focused on global growth
uncertainties. We think those expectations could be disappointed. Moreover, the
favourable technical factors observed in February (eg, strong demand from insurance
companies) are receding, in our view.

bill.diviney@barclays.com
Rates Strategy
Rohit Arora

FX: Continued concern about the strength of Chinese and US economic activity, as well

+65 6308 2092

as recent CNY weakness, is likely to limit near-term KRW appreciation. Further out, a
likely pickup in domestic demand bodes well for a return of inflows to Korean equities,
and we think there is room for the KRW to reverse some of its year-to-date
underperformance (-2.0% against the USD), in the context of low vulnerability and a
pickup in global manufacturing activity.

rohit.arora3@barclays.com
FX Strategy
Hamish Pepper
+65 6308 2220
hamish.pepper@barclays.com

We expect growth momentum


to be soft in Q1, but
reaccelerate in Q2

But the quality of growth is


improving and broadening to
domestic demand

Due to a weaker start to exports, we now expect Q1 GDP to grow at a slightly slower pace
of 0.9% q/q sa (previously: 1%; Q4: 0.9%), but to re-accelerate to 1.2% (previously: 1.1%)
in Q2. There is no change to our full-year forecasts for 4.1% (Bank of Korea: 3.8%) in 2014
and 4.2% in 2015. One silver lining is the strength of the recovery in the EU (where weather
was normal), which enabled Korean exports to average 0.6% y/y growth in January and
February (January-February US shipments: -8.1%; EU: +17.7%). We look for momentum to
recover more meaningfully from March, as air freight to the US normalises after a record
number of airport closures. Looking ahead, the launch of the Samsung smart phone the
Galaxy S5 (ahead of the likely release of a competing Apple model) is expected to be a
factor of support for electronics production and shipments from Q2.
Another factor of support is the growing sense that growth is broadening out into domestic
demand, particularly consumption. The Bank of Koreas (BoK) consumer sentiment index,
which rose to 107 in November from 99 at end-2012, rose further to 108 in February
helped by a steady increase in wages and a sustained recovery in house prices (Korea
Property market bottoms out, aiding the recovery in domestic demand, 7 November 2013).

FIGURE 1
Business confidence plays catch-up with US ISM

FIGURE 2
Shipbuilders could make more deliveries in 2014

80

30

60

25
20

40

Daewoo's shipbuilding backlog


(number of vessels)

180

15

20

10

5
0

-20

160

-10
Feb-09

Feb-10

Feb-11

Feb-12

Feb-13

-15
Feb-14

IP (% 3m/3m saar)
US ISM New Orders - Inventories (3mma, RHS)
Source: Haver Analytics, Barclays Research

25 March 2014

USD bn

60
55
50
45

140

-5

-40
-60
Feb-08

200

120
100
Nov-11
Aug-12
May-13
Daewoo's shipbuilding backlog (# vessels)

40
35
30
Feb-14
USD bn

Source: Bloomberg, Barclays Research

63

Barclays | The Emerging Markets Quarterly


Shift in policy emphasis to
long-term structural reforms

More importantly, in our view, the more stable growth outlook has allowed government policy
to refocus its attention on dealing with structural challenges to offset the effects of an aging
population and to grow the economy out of its household debt burden. Aimed also at creating
more jobs for women and the young, the three-year economic innovation plan announced on
25 February will focus first on revitalising five key services industries: healthcare, education,
tourism, finance and software. Our sense from onshore meetings in March was that the
government is moving more quickly and cohesively than usual. To speed things up, the
Ministry of Strategy and Finance (MOSF) is now forming inter-ministry taskforces for each of
the five industries each led by a minister and drawing advice from private sector experts
that will report with actionable strategies by end-Q2. Even so, the Park administrations ability
to implement these recommendations will likely depend on the Saenuri partys performance in
the 4 June local elections. Although technically not a mid-term test, a poor showing by the
ruling party could galvanise the opposition to resist the passage of the bills in the National
Assembly more strongly. This is less likely, however, as long as President Parks popularity
rating continues to hold up above 60% in recent opinion polls. 2

Shipbuilding revival should


support exports

We expect exports to continue to hold up well, despite concerns of a more abrupt slowdown
in China. One factor is the recovery in shipbuilding. Korean shipbuilders, the largest in the
world in gross tonnage, reported substantial increases in new orders in 2013, benefiting from
a drive towards fuel efficiency and increasing demand for energy exploration platforms. For
instance, Samsung Heavy, the worlds second-largest shipbuilder, received more than
USD13bn in orders in 2013 (2012: USD9.6bn). It is currently building a 600,000-ton floating
LNG processing platform for Shell the worlds first and a vessel worth an estimated USD6bn.

Current account surplus


continuing its record-breaking
streak

With shipbuilders stepping up vessel deliveries this year, Koreas current account surplus is
not likely to narrow too much from last year. Indeed, the current account surplus was
USD3.6bn in January 2014 a new record for January despite the weaker JPY, timing of
Lunar New Year holidays and disruptions to air freight to the US due to poor weather. To us,
this affirms the rising global brand premium of Korean exports. Coupled with a steady
improvement in the foreign earnings of Korean civil engineering firms, we recently
upgraded our 2014 current account surplus projection to 4.9% of GDP (USD65.5bn) and
adjusted our 2015 current account forecast to 4.4% or USD64bn (from USD47.6bn). The
trend in corporate foreign cash holdings, which continues to reach new highs, reflects this,
in our view. For instance, foreign-currency deposits held by Korean companies (or
exporters) rose 54% y/y to USD47.4bn at end-February 2014 and this is limiting the ability
of USDKRW to grind higher during bouts of risk aversion.

FIGURE 3
Apartment buying has picked up, even at the height of winter

FIGURE 4
Prices bottoming, but is it time to buy rather than rent?

200

120

150

110

100

100

50

90

80

-50

70

-100
Feb-09

Feb-10

Feb-11

Feb-12

Apartment transactions, % y/y


Source: CEIC, Barclays Research

Feb-14

Seoul, % y/y

60
Feb-04

Feb-06

Feb-08

Feb-10

House purchase price in Gangnam

Feb-12

Feb-14
Jeonse

Source: CEIC, Barclays Research


2

25 March 2014

Feb-13

Index, Mar2013 = 100

Parks One-Year Scorecard: Could Do Better, Wall Street Journal, 24 February 2014

64

Barclays | The Emerging Markets Quarterly


House prices bottomed in July,
and the recovery is broad
based but gradual

Some of the current account surplus is being channelled into asset markets. The housing
recovery that began in July 2013 has continued to gather pace. According to data compiled
by Kookmin Bank, national home prices accelerated in February, up 0.15% m/m on a
seasonally adjusted basis, the eighth straight monthly increase (January: +0.18%; December:
+0.19%). More homes were bought and sold in February this year than in the same month
since statistics began in 2006. According to the Ministry of Land, Infrastructure and
Transport, home transaction volumes totalled 78,798 units in February, up 66.6% y/y and up
34% m/m an indication that it is not typical for apartment buying to occur during the cold
winter months. The recovery also appears to be broader based this time, led initially by price
increases outside of Seoul from June. However, more recently, even Seoul prices have picked
up. The Seoul metropolitan area, home to 21% of Koreas 50mn people and a main driver of
house price appreciation in the past, showed the first m/m increase in prices in 26 months in
October. Indeed, prices in some of the more fashionable Seoul districts have started to
stabilise. In Gangnam, house prices increased 0.12% m/m on a seasonally adjusted basis in
February, the third straight monthly rise (January: +0.04%; December: +0.10%).

Rise in inflation should lead to


incrementally more hawkish
tone to BoK statements

Meanwhile, inflation should turn incrementally less benign. From a 1% average in JanuaryFebruary, we expect headline inflation to hit 2% by end-Q2 and re-enter the BoKs target
range by end-Q3 (2.6%), led by base effects, the removal of subsidies for school meals and
the gradual re-emergence of demand-side pressures. With growth now broadening into
domestic demand, supported by the governments shift towards structural reforms (see
Korea: A clear structural reform agenda to offset ageing demographics, 28 February 2014),
we expect the BoK to adopt an incrementally more hawkish tone in its policy statements.

Comments by BoK governor


nominee Lee Ju Yeol are
supportive of our view of policy
normalisation in late Q3

Following the recent nomination of Lee Ju Yeol as candidate for the BoK governorship,
inflation is likely to become a bigger focus of market attention, with policy becoming more
data dependent (see Korea: BoK governor nominee announcement supportive of our H2
normalisation call, 3 March 2014). In a submission ahead of his 19 March Parliamentary
committee hearing, Mr Lee argued that the economy needed to prepare for the eventuality
of higher interest rates in the interests of maintaining price stability. To us, these
comments are consistent with the tone at recent BoK MPC meetings. With growth
continuing to broaden into domestic demand, and policy shifting decisively towards
structural reforms and away from short-term monetary and fiscal boosters, we maintain our
view that the BoK will begin normalising interest rates in H2 14 probably from late Q3,
when we expect Koreas negative output gap to have closed.

FIGURE 5
Continued strong current account surplus

FIGURE 6
supporting gains in the (still below fair value) KRW

Current Account Balance, year-to-date (USD bn)

80

120

70

110

60

100

50
40

90

30

80

20

70

10

60

0
-10
Jan Feb Mar Apr May Jun
2008
2011
Source:

Jul Aug Sep Oct Nov Dec


2009
2012

Haver Analytics , Barclays Research

25 March 2014

2010
2013

50
Mar-94

Mar-98
KRW REER

Mar-02

Mar-06

Std Dev Bands

Mar-10

Mar-14
20-year avg

Source: Haver Analytics, Barclays Research

65

Barclays | The Emerging Markets Quarterly

FIGURE 7
Inflation likely to pick up in 2014
5.0

FIGURE 8
catching up with well-anchored inflation expectations

contribution to CPI (% y/y)

6.0
Forecast

4.0

5.0
4.0

3.0

3.0

2.0

2.0

1.0

1.0
0.0
-1.0
Dec-10

0.0
Feb-08
Dec-11

Food

Dec-12

Energy

Dec-13

Services

Dec-14
Goods

Source: Haver Analytics, Barclays Research

Feb-09

Feb-10

Feb-11

Inflation Expectations
CPI inflation (% y/y)

Feb-12

Feb-14

Feb-13

BoK Policy Rate

Source: Haver Analytics, Barclays Research

FIGURE 9
Korea macroeconomic forecasts
2010

2011

2012

2013

2014F

2015F

Real GDP (% y/y)

6.3

3.7

2.0

2.8

4.1

4.2

Domestic demand contribution (pp)

5.7

1.9

1.0

2.1

3.6

3.8

Private consumption (% y/y)

4.4

2.4

1.7

1.9

2.8

3.1

Fixed capital investment (% y/y)

5.8

-1.0

-1.7

3.8

8.1

7.7

Net exports contribution (pp)

0.1

1.9

1.1

0.7

0.8

0.5

Exports (% y/y)

14.7

9.1

4.2

4.3

6.5

7.3

Activity

Imports (% y/y)

17.3

6.1

2.5

3.5

6.1

7.9

GDP (USD bn)

1,015

1,115

1,128

1,202

1,325

1,444
64.3

External sector
Current account (USD bn)

29.4

26.1

48.1

70.7

65.5

CA (% GDP)

2.9

2.3

4.3

5.9

4.9

4.4

Trade balance (USD bn)

40.1

31.7

39.8

60.7

52.9

47.9

Net FDI (USD bn)

-22.2

-16.4

-18.9

-15.5

-15.0

-15.0

Other net inflows (USD bn)

21.9

3.6

-19.3

-33.8

2.0

12.0

Gross external debt (USD bn)

360

399

409

407

418

428

International reserves (USD bn)

292

306

327

346

373

404

Public sector
Public sector balance (% GDP)

1.4

1.5

1.5

1.6

2.0

2.5

Excluding social security funds (% GDP)

-1.6

-1.6

-2.1

-2.0

-1.0

-0.5

Gross public debt (% GDP)

32.8

31.2

35.4

36.6

35.8

35.4

Prices
CPI (% Dec/Dec)

3.0

4.2

1.4

1.1

3.0

2.1

1,139

1,153

1,071

1,055

1,050

1,025

1y ago

Last

Q1 14F

Q2 14F

Q3 14F

Q4 14F

Real GDP (% y/y)

1.5

3.9

4.1

4.1

4.1

4.0

CPI (% y/y, eop)

1.5

1.1

1.3

1.9

2.6

3.0

1112

1055

1070

1060

1050

1050

FX (USD/domestic currency, eop)

FX (USD/domestic currency, eop)


Policy rate (%, eop)

2.75

2.50

2.50

2.50

2.75

2.75

3m CD rate (%, eop)

2.81

2.65

2.65

2.65

2.65

2.90

Source: Barclays Research

25 March 2014

66

Barclays | The Emerging Markets Quarterly

EMERGING ASIA: MALAYSIA

Biased to raise rates


Growth momentum remains robust but inflationary pressures are rising. BNM expects
domestic demand to soften marginally, but is biased to tighten monetary policy. We
expect the central bank to hike rates by 50bp by end-2014.

Economics
Rahul Bajoria
+65 6308 3511
rahul.bajoria@barclays.com

Key recommendations
Rates: Overweight cash, neutral duration on MGS: We think IRS is fairly pricing in

Rates Strategy

monetary policy tightening risks. In fact, market pricing of c65bp of tightening in the
next two years exceeds our view of a 50bp policy tightening in 2014 and a pause
thereafter. However, given the possibility of an overshoot and EM contagion risks
(through the channel of high foreign ownership of bonds), we remain neutral. We would
look for opportunities to reduce duration and enter payers.

Rohit Arora
+65 6308 2092
rohit.arora3@barclays.com
FX Strategy
Hamish Pepper

FX: Strong growth momentum, recovering commodity prices, continued current

+65 6308 2220

account surpluses and likely BNM rate hikes bode well for MYR appreciation against the
USD, in our view. While continued cautious global sentiment is a downside risk for the
high-beta MYR, we do not expect this environment to persist and recommend being
long MYR against the THB (target: 10.19; stop: 9.75; spot ref: 9.83), where the BoT is
likely to remain dovish as political uncertainty weighs on an already weak economy.

hamish.pepper@barclays.com

We expect growth momentum


to remain resilient in 2014

Growth drivers are firming up in Malaysia, according to the incoming real sector indicators.
In recent months, momentum in the manufacturing and industrial sectors has improved,
and export growth has also perked up. Private investment activity has shown a steady
increase, while major catalytic projects under the Economic Transformation Programme
(ETP) have continued to contribute positively to growth momentum. Q4 13 GDP expanded
5.1% y/y, on strong investment spending, and despite the large fiscal consolidation. As a
result, GDP ex-government rose to an 11-quarter high (Figure 2). Domestic demand
moderated, largely on account of this fiscal consolidation, but remains the key driver of
economic growth. In 2014, we expect the rebound to continue on stronger global growth
and off a low base. Indeed, we think the tailwinds of improving external demand, positive
terms of trade shock through higher palm oil prices, and resilient domestic demand are
likely to keep growth above 5% this year. The biggest headwind for growth that we see is

FIGURE 1
Private spending likely to play a larger role in 2014

FIGURE 2
Domestic demand resilient, amid low unemployment

15

16
14
12
10
8
6
4
2
0
-2
-4
Dec-03

10
5
0
-5
-10
Jun-06

Dec-07

Jun-09

GDP
Source: CEIC, Barclays Research

25 March 2014

Dec-10

Jun-12

Dec-13

2.6

3.1

3.6

4.1
Dec-05

Dec-07

Dec-09

Dec-11

Dec-13

Domestic demand (% y/y)


unemployment (%, inverted, RHS)

GDP ex government (% y/y)


Source: CEIC, Barclays Research

67

Barclays | The Emerging Markets Quarterly


from the fiscal consolidation outlined in the 2014 budget, and the deteriorating weather,
which can affect sentiment. Even then, we expect the output gap to turn positive by the
middle of 2014.
BNM has indicated concerns
over sustainability of domestic
demand

The key concern for policymakers appears to be the sustainability of private consumption
amid administered price hikes. There have been a few initial signs that consumption
momentum is slowing down, and consumer sentiment indices show that private
consumption may moderate at the margin. So far, auto sales have slowed and consumer
credit growth has also moderated, although the latter may be more a reflection of macro
prudential measures to curb personal loans than actual slowing demand for loans.

BNM forecasts 2014 growth of


4.5-5.5%, but expects higher
domestic growth relative to its
earlier projection for 2014

BNM is forecasting growth of 4.5-5.5% for 2014, which is a wider range than the Finance
Ministrys forecast of 5-5.5% growth made in October 2013. The drag appears to be coming
from net exports, due to a disproportionately large upgrade in import growth relative to
exports. At the same time, the central bank has revised its assessment of domestic growth
for 2014 to 6.9% from its forecast of 5.9% in October 2013. We maintain our forecast of
5.4% real GDP growth in 2014 and see upside risks to the official BNM forecast, given the
global economic backdrop has improved, unemployment levels remain low, and BNM
expects wage growth to remain high. In fact, manufacturing wage growth has been rising,
and should continue to support private consumption growth, in our view. At the same time,
private investment growth has been robust. The sharp increase in capital imports in the past
three months, complemented by ongoing project investments through the mass rapid transit
system in Kuala Lumpur, petrochemicals projects in southern Malaysia and road projects in
eastern Malaysia, have kept activity levels elevated.

BNM has expressed concerns


over inflation expectations

However, we think BNMs key focus is likely to be on managing inflation expectations.


Inflation has been rising on the back of fuel and electricity tariff hikes, while real interest
rates have turned negative, and are likely to remain so for some time, in our view. Inflation
rose to 3.5% in February, a 32-month high, and we expect it to stay above 3% for most of
2014 and 2015. Indeed, we forecast inflation to be close to 4% by the middle of 2014, as we
see a pass-through from higher fuel prices into inflation. While the central bank appears
comfortable with inflation risks, indicating that price rises are currently cost-push in nature,
at the annual report press conference BNM Governor Zeti said: higher cost-push inflation
could lead to inflation expectations becoming unanchored and could in turn lead to wage
growth that is not consistent with productivity growth. There are also signs of a rise in

FIGURE 3
Wage growth remains robust in Malaysia, supporting private
consumption
20

FIGURE 4
Inflationary pressures becoming more generalised
3.8
3.3

15

2.8
2.3

10

1.8
1.3

0.8

0.3

-5
Mar-09 Dec-09

Oct-10

Aug-11

Jun-12

Mar-13

Manufacturing wages (% y/y, 3mma)


Source: Haver Analytics, CEIC, Barclays Research

25 March 2014

Jan-14

-0.2
Nov-11

Aug-12
May-13
Feb-14
Supply side inflation (PP contribution to CPI)
Demand driven inflation

Source: Haver Analytics, CEIC, Barclays Research

68

Barclays | The Emerging Markets Quarterly


demand-driven inflation. Indeed, with higher housing costs, pass-through of electricity
prices in services and strong disposable incomes, demand-driven inflation which accounts
for more than 70% of the inflation basket has risen to a two-year high, and is likely to
continue to rise in 2H 2014. This is despite increases in highway tolls and transport costs in
urban areas being put on the backburner, due to recent protests against the cost of living.
We see upside risks to our
3.2% inflation forecast in 2014

We maintain our CPI inflation forecast of 3.2% for 2014, but see upside risks to this figure.
This would be the highest level since 2008, followed by even higher inflation in 2015, once
the goods and services tax (GST) is imposed. The inflation growth dynamics continue to have
implications for monetary policy, in our view. As real rates will remain negative for longer, the
central bank is evaluating its options to hike rates. Already, BNM has a modestly hawkish bias,
and as more signs of demand-side price pressures emerge, we see it possibly turning more
hawkish. We expect the central bank to hike rates in Q2 14, followed by another hike in Q3,
although the latter is likely to be contingent on BNMs assessment of inflation in 1H 14.

Fiscal policy consolidation


continues smoothly

Fiscal policy has been an area of success for the government. Following on from the 2014
budget in October, the government reduced its fiscal deficit to 3.9% of GDP, overshooting
the consolidation target of 4.0% for 2013. For 2014, the government is targeting to reduce
the countrys fiscal deficit to 3.5% of GDP. It will also implement a goods and service tax
(GST) at 6% from 1 April 2015. According to the Ministry of Finance, the move to boost
revenues is in order to achieve a 3% deficit target in 2015. We expect this, accompanied by
accrual accounting practice from 2016, to lead to better outcome budgeting, and support
the fiscal target of a balanced budget by 2020.

MYR has been volatile, but


terms of trade turning positive

BNM appears to have been comfortable allowing the MYR to move in line with the market, and
broadly in line with fundamentals. The current account balance is starting to stabilise, and we
think it could be marginally higher in 2014, especially given the positive terms of trade. Due to dry
weather and concerns of a drought, the price of palm oil, which comprises of 12% of Malaysias
exports in 2013, has risen sharply so far this year, and is up c15% since 1 February. While this
could stoke inflation concerns, it does have a positive impact on Malaysias current account.
Indeed, the trade surplus has started to recover, and we expect the surplus to rise y/y in the
coming months, supported by better external demand. Looking ahead, we expect Malaysias
current account surplus to be around USD12.1bn in 2014, or 3.7% of GDP. Capital flows, on the
other hand, are likely to be negative, on a smaller global liquidity pool and tapering concerns, as
well as structural diversification by institutional investors in Malaysia.

FIGURE 5
We expect two 25bp rate hikes in 2014

FIGURE 6
Palm oil prices have risen recently given declining stocks

4,300

3,800

3,300

1200
1600
2000

2,800

-2

2400

2,300

-4
-6
Oct-05 Dec-06 Feb-08 Apr-09 Jun-10 Aug-11 Oct-12 Dec-13
Policy rate (%, RHS)
Source: CEIC, Barclays Research

25 March 2014

Real policy rate (%)

1,800
Mar-09

Jun-10

Sep-11

Dec-12

2800
Mar-14

Palm oil price (MYR/ton)


Stock of palm oil (ton, inverse, RHS)
Source: CEIC, Barclays Research

69

Barclays | The Emerging Markets Quarterly


FIGURE 7
Current account likely to remain in check in 2014

FIGURE 8
Fiscal deficit consolidation looks on track
0

20
18

Forecast

16

-1
-2

14

-3

12

-4

10

-5

-6

-7

-8

2
Dec-08

2001

Mar-10

Jun-11

Sep-12

Dec-13

2003

2005

Mar-15

Current a/c balance (% of GDP, 4q rolling sum)


Source: CEIC, Barclays Research

2007

2009

2011

2013

2015F

Primary balance (% of GDP)


Debt service charges (% of GDP)
Fiscal balance (% of GDP)
Source: CEIC, Barclays Research

FIGURE 9
Malaysia macroeconomic forecasts
2010

2011

2012

2013

2014F

2015F

Real GDP (% y/y)

7.4

5.1

5.6

4.7

5.4

5.3

Domestic demand contribution (pp)

9.1

5.8

9.8

6.6

6.5

6.9

Private consumption (% y/y)

6.9

6.8

7.7

7.6

6.8

7.0

Fixed capital investment (% y/y)

11.9

6.2

19.9

8.2

7.5

9.3

Net exports contribution (pp)

-1.7

-0.7

-4.2

-2.0

-1.0

-1.5

Exports (% y/y)

11.1

4.6

-0.1

-0.3

3.8

3.0

Imports (% y/y)

15.6

6.1

4.7

1.9

5.3

5.0

GDP (USD bn)

248

289

305

312

328

364

Current account (USD bn)

27.0

33.5

18.6

11.7

12.1

11.0

CA (% GDP)

10.9

11.6

6.1

3.8

3.7

3.0

Trade balance (USD bn)

42.3

49.6

40.7

32.5

32.7

28.0

Net FDI (USD bn)

-4.5

-3.0

-7.1

-1.4

-1.9

-3.0

Other net inflows (USD bn)

-1.5

10.7

-0.4

-3.2

-6.7

-2.0

Gross external debt (USD bn)

82.4

93.2

99.9

115.0

110.0

115.0

International reserves (USD bn)

106.5

133.6

139.7

134.9

133.0

136.0

Public sector balance (% GDP)

-5.6

-4.8

-4.5

-3.9

-3.5

-3.0

Primary balance (% of GDP)

-3.5

-2.8

-2.4

-1.7

-1.3

-0.9

Gross public debt (% GDP)

51.1

51.6

53.3

54.8

54.0

52.5

Activity

External sector

Public sector

Prices
CPI (% Dec/Dec)

2.1

3.0

1.2

3.2

3.0

3.5

FX (eop)

3.08

3.16

3.06

3.25

3.20

3.15

1y ago

Last

Q1 14F

Q2 14F

Q3 14F

Q4 14F

4.1

5.1

5.3

5.3

5.7

5.4

Real GDP (% y/y)


CPI (% y/y, eop)

1.6

3.2

3.1

3.5

2.9

3.0

FX (domestic currency/USD, eop)

3.11

3.25

3.26

3.24

3.20

3.20

Overnight policy rate (%, eop)

3.00

3.00

3.00

3.25

3.50

3.50

Source: Haver Analytics, CEIC, Bloomberg, Barclays Research

25 March 2014

70

Barclays | The Emerging Markets Quarterly

EMERGING ASIA: PHILIPPINES

BSP getting ready to pull the trigger


Economics
Prakriti Sofat
+65 6308 3201
prakriti.sofat@barclays.com

We expect the central bank to hike the policy rate by 50bp to anchor inflation
expectations and allay investor concerns. We also believe liquidity management
measures are likely. Although the President is focused on infrastructure projects, we
think broader reform momentum is fading.

Key recommendations
FX: Increased BSP hawkishness is supportive of the PHP; however, the central banks

Credit Strategy
Avanti Save
+65 6308 3116
avanti.save@barclays.com
FX Strategy

willingness to accept appreciation is limited. We believe the central bank prefers the PHP
to move broadly in line with other currencies in the region. Further, we believe that
reform as a catalyst for peso strength is fading.

Credit: We recommend an underweight on dollar bonds (ROPs) because current spreads

Hamish Pepper
+65 6308 2220
hamish.pepper@barclays.com

are much tighter than the EM sovereign benchmark and we expect spreads to remain
rangebound in Q2. For 2014, we expect modest spread compression, as global investors
recognise both ample onshore liquidity conditions and the improving balance sheet of the
Philippines. Across the curve, we like the PHILIP 21, 24 and 34.

BSP: Higher rates and liquidity management measures ahead


BSP bias to move preemptively

we expect 25bp hikes in Q2


and Q3 taking policy rate to 4%

Bangko Sentral ng Pilipinas turned hawkish in its February meeting, stating that it still had
room to hold policy rates, though noting that the scope was narrowing, which, in our
opinion, indicated its strong commitment to inflation management. Governor Tetangco said
recently that pre-emptive action can be less disruptive and that markets should prepare for
higher global rates. We expect the reverse repo rate to be raised by 50bp to 4%, split equally
between Q2 and Q3 to ensure inflation expectations remain anchored. With the BSP more
watchful on liquidity, we also believe that measures such as hikes in the SDA rate or
potentially in reserve requirement ratios (RRR) are likely in the May policy meeting, with
some risk of an adjustment on the 27 March meeting.

FIGURE 1
Positive output gap creating pressure on underlying inflation
2.5

ppts

% y/y

2.0

FIGURE 2
SDA balances have fallen as banks comply with BSPs policy
limiting trust department access
2,500

PHP bn

1.5

1.0
0.5

0.0

-0.5

-1.0

2,000
1,500
1,000

-1.5

-2.0
-2.5

0
01 02 03 04 05 06 07 08 09 10 11 12 13 14 15
Output gap 4qtr avg

Source: CEIC, Barclays Research

25 March 2014

Core inflation (RHS)

500
0
07

08

12

13

Reverse repurchase agreements

09

10

11

SDAs

14

Source: CEIC, Barclays Research

71

Barclays | The Emerging Markets Quarterly


SDA is the effective policy rate

Given the limited stock of bonds with the BSP, the impact of changes in the reverse repo
rate is limited. With overall systemic liquidity being flush, we believe that the effective
monetary policy rate is the SDA rate (special deposit account) as reflected in overnight
interbank rates trading close to the SDA rate. Therefore, we believe that SDA rate hikes at
least 50bp in the coming 3-6 months are key for monetary policy tightening to impact
market interest rates.

BSP's increased concern on


liquidity; we do not rule out
RRR hikes

In recent commentary, Governor Tetangco said that the BSP is watchful of liquidity
increases, a marked change from a comment he made in mid-February: liquidity rise not
worrisome (Bloomberg). Nearly PHP500bn has left SDA accounts since the central bank
limited access by trust departments to the SDA facility, which has resulted in a sharp
increase in broad money aggregates. While Deputy Governor Guinigundo maintained in
early March that strong liquidity is temporary, we think the central bank now acknowledges
the risks this level of liquidity could pose. As such, we believe a RRR hike would be the most
cost effective way to absorb excess liquidity, given that the BSP no longer pays any interest
on reserves. Further, adjustments to RRR levels tend to be directly passed onto end
consumers, so they have a limited impact on NIMs, while at the same time ensuring that
lending interest rates trend higher to manage credit growth.

Positive output gap, rising


underlying inflationary
pressures

We estimate that the spare capacity in the economy has been shrinking given the solid
growth over the past two years 6.8% in 2012 and 7.2% in 2013. On a 4-quarter moving
average basis, we think the output gap turned positive in H2 2013 and we expect it to rise
further, which would increase underlying inflationary pressures. We forecast GDP growth of
6.5% in both 2014 and 2015. We continue to forecast inflation will average 4.3% in 2014
(BSP: 4.3%, 2013: 3%), which is above the mid-point of the 3-5% inflation target range. In
2015, the inflation target range is being lowered to 2-4% and we forecast inflation will
average 3.5% (BSP: 3.3%), which again is above the mid-point of the target range.

Peso: Limited appreciation despite BSP hawkishness


BSP hawkishness supportive of
peso

After rallying by 2.2% in early February on positive global risk sentiment, the peso has
stalled given: (i) concerns around under-reporting of imports, which may be overstating the
strength of the trade account; and (ii) investor concern that the central bank may be falling
behind the curve. We believe the issue of under-reporting of imports is not new and should
be seen in the context of structural under-reporting of remittances. In our opinion, the
increased hawkishness of the central bank since the February meeting is positive for its

but limited central bank


willingness to accept
appreciation
FIGURE 3
SDA rate is the effective policy rate
10

FIGURE 4
Real estate credit growth remains strong

Repo

% y/y, 3mma

Reverse repo

o/n rate

% y/y, 3mma

Production
Real estate
Total

SDA rate

Manufacturing
Consumer
Wholesale retail (RHS)

40

30

50

20

40

10

30

20

-10

10

6
5
4
3
2
1
05

06

07

08

09

Source: Haver Analytics, Barclays Research

25 March 2014

10

11

12

13

14

-20

60

0
10

11

12

13

14

Source: CEIC, Barclays Research

72

Barclays | The Emerging Markets Quarterly


credibility and the peso. However, the BSPs appetite to allow too much appreciation is
limited, and its preference is for the peso to move broadly in line with regional currencies. In
recent comments, Governor Tetangco has said that the central bank will maintain a
strategic presence in the market. As such we are revising our 1-month USD/PHP forecast to
44.50 (45 earlier) and keeping our 3-month forecast at 44. Further out, we believe that
reform as a catalyst for peso strength is fading amid a strong dollar environment. We
maintain our 6-month forecast at 44 but revise our 12-month forecast to 44 (43 earlier).

Fiscal: Focus on consolidation and reducing external debt


We revise down our 2014 fiscal
deficit forecast by 40bp to
2.1% of GDP

The 2013 fiscal deficit was PHP164.1bn (1.4% of GDP), much below the governments
target of PHP238bn (2% of GDP), reflecting slow disbursals. The government is targeting a
deficit of PHP266.2bn (2% of GDP) in 2014. While there may be slippage on reconstruction
efforts, under-spending remains a problem, though officials have indicated that spending on
pre-procurement will accelerate. Nevertheless, we revise down our 2014 fiscal deficit
forecast by 40bp to 2.1% of GDP. In 2015-16, the government is targeting fiscal deficits of
2% of GDP (2015: PHP285.3bn and 2016: PHP322bn), which should keep the public debtto-GDP ratio on an improving trajectory.

President is focused on
infrastructure projects

President Aquino remains focused on increasing infrastructure spending, as highlighted by


the 2014-16 budget plans - infrastructure spending for 2014 is targeted at PHP404bn (3.1%
of GDP), PHP587bn in 2015 (4% of GDP) and PHP824bn in 2016 (5% of GDP), up from an
average of 2.1% of GDP over the past decade. If these spending plans materialise, we think
they could have a positive impact on the Philippines potential GDP growth rate. But we
believe broader reform momentum may be fading. For example the tax incentive
rationalisation bill remains stuck, given differing views of the department of finance and
ministry of trade and industry. President Aquino has around one year before the approach
of the 2016 elections increases political uncertainty he cannot run for another term.

but reform momentum may


be fading

Philippines to maintain a
presence in dollar market
but supply to be contained

The sovereign remains focused on funding locally and reducing its external debt. In 2013,
the Philippines issued only USD500mn of new money alongside a debt buyback tender. We
think another buyback of long-end RoP paper is likely in Q4 14, with new money issuance
up to a maximum USD500mn. Note, in 2012 the Philippines raised USD1.5bn from external
funding. For 2015, we believe the sovereigns bias will be to maintain a presence in the
offshore market to ensure liquidity and investor interest but we believe that supply will
remain very contained, likely around USD1bn.

Growth: Domestic demand to remain the driver


We maintain our 2014-15
growth forecasts of 6.5%

25 March 2014

The Philippines economy has weathered the impact of Typhoon Haiyan well with GDP
only slowing to 6.5% y/y in Q4 from 6.9% in Q3 and 7.7% in H1. Note, H2 growth was
expected to moderate as mid-term election-related spending faded. We maintain our 2014
growth forecast of 6.5% (government target: 6.5-7.5%) as reconstruction efforts get
underway, although there is likely to be a continued drag from trade, services and
agriculture. Budget secretary Florencio Abad has indicated that the government will spend
PHP120bn on reconstruction, with PHP30bn released over January-February. We believe
consumption and investment will remain the key drivers of economic growth. We also
maintain our 2015 growth forecast at 6.5%.

73

Barclays | The Emerging Markets Quarterly


FIGURE 5
Philippines macroeconomic forecasts
2010

2011

2012

2013

2014F

2015F

Real GDP (% y/y)

7.6

3.6

6.8

7.2

6.5

6.5

Domestic demand contribution (pp)

8.2

4.5

5.2

8.2

7.5

6.9

Private consumption (% y/y)

3.4

5.7

6.6

5.6

6.1

5.9

Fixed capital investment (% y/y)

19.1

-2.0

10.4

11.7

11.5

9.0

Net exports contribution (pp)

-0.6

-0.9

1.6

-1.7

-0.5

-0.5

Exports (% y/y)

21.0

-2.8

8.9

0.8

4.5

5.0

Imports (% y/y)

22.5

-1.0

5.3

4.3

5.5

6.0

GDP (USD bn)

200

224

251

271

290

323

Current account (USD bn)

8.7

7.0

7.1

10.6

9.3

8.7

CA (% GDP)

4.3

3.1

2.8

3.9

3.2

2.7

-13.3

-17.0

-15.2

-14.6

-17.5

-19.2

Net FDI (USD bn)

0.6

1.3

1.0

1.6

1.8

2.1

Other net inflows (USD bn)

6.6

4.3

5.2

-2.8

-3.4

-2.6

Gross external debt (USD bn)

60.0

60.4

60.3

59.1

60.8

63.3

International reserves (USD bn)

62.4

75.3

83.8

83.2

87.1

91.9

Public sector balance (% GDP)

-3.5

-2.0

-2.3

-1.4

-2.1

-2.0

Primary balance (% GDP)

-0.2

0.8

0.7

1.4

0.5

0.4

Gross public debt (% GDP)

58.5

56.9

56.2

52.9

49.8

47.2

CPI (% Dec/Dec)

3.6

4.2

3.0

4.1

3.3

3.8

FX, eop

43.9

43.9

41.2

44.4

44.0

43.5

1y ago

Last

Q1 14F

Q2 14F

Q3 14F

Q4 14F

Real GDP (% y/y)

7.7

6.5

5.8

6.7

6.6

6.9

CPI (% y/y, eop)

3.2

4.1

4.1

4.6

4.2

3.3

FX (domestic currency/USD, eop)

40.9

44.40

44.50

44.00

44.0

44.0

Overnight policy rate (%, eop)

3.50

3.50

3.50

3.75

4.00

4.00

Activity

External sector

Trade balance (USD bn)

Public sector

Prices

Source: Barclays Research

25 March 2014

74

Barclays | The Emerging Markets Quarterly

EMERGING ASIA: SINGAPORE

A tale of two halves


We do not expect growth to accelerate in 2014. While the export sector is likely to be on
a stronger footing this year, the cooling of home prices could precipitate a decline in
sentiment-sensitive activity. With the rise in unit labour costs now tempered slightly by
government measures to share wage increases with employers, the stance of monetary
policy is unlikely to be changed in the upcoming April meeting.

Economics
Wai Ho Leong
+65 6308 3292
waiho.leong@barclays.com
Bill Diviney

Key recommendations
FX: Gradual NEER depreciation: The SGD NEER has recently been trading around the

+65 6308 3607


bill.diviney@barclays.com

Hamish Pepper

midpoint of our estimate of the 2% band. Given our expectations of slower economic
growth, a dovish MAS and a strengthening USD, we forecast the SGD NEER to drift
gradually lower towards 100bp below the midpoint of the band over the next 12 months.

+65 6308 2220

Rates: Receive SGD 3y2y vs USD. We recommend receiving SGD rates versus US rates

FX Strategy

hamish.pepper@barclays.com

in a rising-yield environment as a medium-term trade. The 2% FX carry, in the form of


SGD NEER appreciation, makes SGS look relatively attractive and is a key reason for our
spread-tightener view. Indeed, SGD rates were lower than USD rates prior to H2 11,
when interest rates were higher.

Rates Strategy
Rohit Arora
+65 6308 2092

We expect the Monetary Authority of Singapore (MAS) to maintain its gradual and modest
appreciation stance for the SGD NEER in its April Monetary Policy Statement (date not set;
likely 14 April). We expect the slope of the SGD NEER band to be kept at 2% (our estimate)
with no change in the midpoint or width of the policy band (currently 2%, we estimate).
However, the tone of the statement is likely to be slightly dovish, extending the cautious tone
in October 2013. We highlight five reasons for the bar for further tightening to be higher now.

rohit.arora3@barclays.com

We expect no change to the


SGD NEER policy band, but the
central banks tone is likely to
be slightly dovish
More tolerance of supply-sideinduced rise in core inflation

First, our sense is that the authorities may be willing to tolerate a higher rate of core
inflation. Our baseline assumption is for core inflation to rise from 2.2% in January 2014 to
between 2.5% and 3% in H2 before rolling down from Q1 15. The role of monetary policy
is to temper, but not fully offset inflation. The central bank may not be uncomfortable if
core inflation ranges between 2% and 3%. Increasingly, rising wages are seen as a catalyst
to change firms behaviour, encouraging companies to innovate, invest in capital equipment
and reduce their reliance on low-paid foreign workers. This adjustment is crucial for the
economy to move towards innovative and knowledge-intensive activity.

FIGURE 1
Singapore PMI recovery lagging the global improvement
58

FIGURE 2
Sentiment-sensitive activity to be a larger drag on growth
250

PMI

Private Residential prices, 4Q98 = 100


Landed

56
210

54
52

Non-landed

170

50
130

48
46
Feb-10

Feb-11
Manufacturing

Feb-12

Electronics

Source: Haver Analytics, Barclays Research

25 March 2014

Feb-13

Feb-14
Global

90
Dec-93

Dec-97

Dec-01

Dec-05

Dec-09

Dec-13

Source: Haver Analytics, Barclays Research

75

Barclays | The Emerging Markets Quarterly


Growth to slow, on longer lag
from strengthening global
demand, weaker domestic
demand

Second, while we continue to forecast a recovery in external demand, we expect Singapores


growth to slow to 3.5% in 2014 from 4.1% in 2013. We believe Singapore is still highly
leveraged to the global business cycle, but the transmission lags are likely longer than in the
past. We attribute this to three factors: 1) its electronics sector is not plugged into the
smartphone business; 2) rather, Singapore is plugged into the US investment and capacity
expansion cycle, which lags the US consumer cycle; and 3) the city-state is unable to raise
its labour force participation rate further, given it is already very high at 67% (2013).
Another reason we believe growth will slow is that domestic demand may weaken slightly
as the real estate market and sentiment-sensitive activity cools further.

Unit wage cost growth to be


contained, in line with recent
trends

Third, unit labour costs are not likely to rise as much as before, but rather to continue along
the flat trajectory that started Q3 13. Since the introduction of the SGD3.6bn Wage Credit
Scheme in 2013, the government shares the wage rise increments for low-income workers.
This has reduced the costs borne by manufacturers and has slowed ULC growth.
Meanwhile, productivity growth is falling short of the governments target of 2-3%, growing
just 1.1% in 2013, and productivity remains below its 2011 peak. In the coming years,
government efforts will focus on laggard services sectors, including hospitality and
construction, among an initial shortlist of 18 industries.

Weaker SGD appreciation


potential on aging
demographics, higher social
spending

Fourth, we think aging will temper the potential appreciation of the SGD, by pushing up
social expenditures. Indeed, the governments emphasis on healthcare spending is rising, as
was spotlighted in the recent budget (see Singapore: Budget 2014: Staying the course, 13
February 2014). With healthcare costs likely to rise substantially in the coming years, the
structural fiscal surplus will narrow, requiring the government to seek new sources of tax
revenue, most likely from wealth and asset taxes. The continuing emphasis on prudential
controls will also reduce the appeal of SGD assets to overseas buyers. On real estate, some
of the cooling measures could be relaxed if needed, although in terms of timing, it is likely
too soon for this at present. While the scope of the measures were recently relaxed to
exempt homebuyers seeking to refinance their mortgages, the total debt servicing ratio
(TDSR) ceiling introduced by MAS on 29 June 2013 is unlikely to be relaxed.

Growth to decelerate in 2014,


as slower services growth
offsets a lagged pass-through
from stronger global demand

We expect growth to be a tale of two halves in 2014. We think Singapore will continue to
benefit from the recovery in demand in the US and Europe, albeit with a lag given Singapores
place as a swing producer in the electronics supply chain. However, we expect sentimentsensitive activity to be weaker given the subdued outlook for the property market.

FIGURE 3
Manufacturing and services drove the acceleration in H2
25

FIGURE 4
but electronics exports recovery has lagged IP growth
120

pp contribution to GDP (% y/y)

3m/3m saar

3m/3m saar

100

20

150

80

15

60

10

40

20

100
50
0

-20

-5

-50

-40

-10
Dec-07

Dec-08

Manufacturing

Dec-09

Dec-10

Construction

Source: Haver Analytics, Barclays Research

25 March 2014

Dec-11

Dec-12

Services

Dec-13

Others

200

-60
-100
Feb-08 Feb-09 Feb-10 Feb-11 Feb-12 Feb-13 Feb-14
Electronics NODX, SA

Electronics IP (SA, RHS)

Source: Haver Analytics, Barclays Research

76

Barclays | The Emerging Markets Quarterly


Growth was surprisingly strong
in Q4

Growth is not likely to accelerate in 2014. GDP was revised sharply higher for Q4 13 in the
second estimate, from -2.7% q/q saar in the advanced estimate to +6.1%. We expected a
sizable upward revision for Q4 given the surge in industrial production and net exports in
December, but the second estimate showed upward revisions across industries, particularly
services. Growth in services was led by the wholesale/retail segments and a sharp rebound
in financial services, which offset a deceleration in domestic demand. Overall, we continue
to look for growth of 3.5% in 2014 a slowdown from 2013s 4.1% with the lagged passthrough from stronger external demand offset by weaker domestic demand.

but has weakened in Q1,


notwithstanding signs of a
pickup in manufacturing

Activity weakened at the beginning of the year, however. Exports contracted in January,
following the surprise surge towards the end of 2013. Aside from Lunar New Year
distortions, which also affected Koreas and Taiwans exports, poor weather in the US likely
affected electronics shipments, and this has been evident in comparatively stronger export
growth to Europe. Manufacturing activity in Singapore has already shown signs of an
upturn. The manufacturing PMI continued to edge higher in February, lagging the
improvement in global PMIs. Meanwhile, despite the weakness in headline IP and exports in
January, momentum on a 3m/3m basis has improved. As the production of hard-disk drives
resumes in Thailand, and given that the launch season for electronics products starts in
March, we expect Singapores electronics sector to finally start contributing to growth in
Q2. Stronger activity in the biomedical and transport engineering industries from new
capacity will also provide a boost to growth this year.

MAS likely to look through


supply-side driven rise in core
inflation

Meanwhile, headline inflation has continued to edge lower, even as core has crept higher.
The main drag on headline inflation has been private transportation costs, due largely to the
high year-earlier base for CoE (car ownership license) prices, following the governments
curb on car loans in 2013. Conversely, the MASs core CPI measure which excludes this
volatile driver of the headline CPI, as well as accommodation costs has picked up in recent
months, rising to 2.2% in January (Dec: 2.0%), the highest since October 2012. However,
the rise in core inflation has been driven mainly by the supply side increases to hospital
charges and school fees, and higher food prices. Compounding the latter was the higher
cost of raw food prices trucked in from Malaysia, after diesel prices in Malaysia were raised
by more than 11% last September. The regions recent drought poses additional upside
risks to food inflation. However, there are still few signs of demand-pull inflationary
pressures, and with inflation expectations remaining well anchored, the MAS is likely to look
through the recent rise in core inflation.

FIGURE 5
Inflation to bottom in Q1, gradually picking up in 2014
8

pp contribution to CPI (% y/y)

FIGURE 6
Supply-side cost pressures have shown signs of easing
130

125

120
115

110

0
-2
Feb-09

Unit labour costs, 4qma, 2005 = 100

105

Feb-10
Feb-11
Feb-12
Feb-13
Feb-14
Core Items ex-Food
Food
Non-Core Items (Pte Rd Trpt and Accommodation)

Source: Haver Analytics, Barclays Research

25 March 2014

100
95
Dec-03

Dec-05

Dec-07

Dec-09

Dec-11

Dec-13

Source: Haver Analytics, Barclays Research

77

Barclays | The Emerging Markets Quarterly


FIGURE 7
We expect no changes to MASs SGD NEER policy in 2014

FIGURE 8
Output gap to close only gradually

105
103
101
99
97
95
93
91
89
87
85
Aug-08 Aug-09 Aug-10 Aug-11 Aug-12 Aug-13 Aug-14
Barclays SGD NEER (100 = first week of April 2013)
SGD NEER spot and forwards
Forecast band (2% slope, +/-2% width)

Output gap (%) and major SGD NEER policy changes

Neutral

Forecast

4
2
0
-2

Modest
appreciation

-4
-6

Recentered
downwards

-8
Dec-00

Source: Barclays Research

Zero
appreciation

Dec-03

Dec-06

Modest
appreciation

Dec-09

Dec-12

Dec-15

Source: Barclays Research

FIGURE 9
Singapore macroeconomic forecasts
2010

2011

2012

2013

2014F

2015F

15.1

6.0

1.9

4.1

3.5

3.4

Activity
Real GDP (% y/y)
Domestic demand contribution (pp)
Private consumption (% y/y)
Fixed capital investment (% y/y)

6.6

4.9

6.0

1.2

2.6

2.2

6.4

4.4

4.1

2.7

2.3

2.5

6.4

6.0

8.7

-2.6

7.8

5.5

9.5

1.3

-4.4

2.2

1.2

1.0

Exports (% y/y)

18.3

3.0

1.4

3.6

3.6

3.8

Imports (% y/y)

16.1

2.8

4.0

3.0

3.5

3.9

234

272

284

295

307

324

58.9

63.3

49.4

54.4

50.7

46.9

Net exports contribution (pp)

GDP (USD bn)


External sector
Current account (USD bn)
Current account (% GDP)

25.3

23.2

17.4

18.4

16.5

14.5

Trade balance (USD bn)

65.4

70.8

62.8

67.8

59.6

57.0

Net FDI (USD bn)

21.7

26.9

47.5

36.8

28.3

25.1

Other net inflows (USD bn)

-41.3

-75.6

-69.2

-75.8

-59.8

-58.9

Gross external debt (USD bn)*

1043

1088

1176

1130

1154

1174

International reserves (USD bn)

226

238

259

273

286

295

Public sector
Public sector balance (% GDP)

0.3

1.2

1.1

1.1

-0.3

0.4

Gross public debt (% GDP) #

101

103

108

105

104

102

Prices
CPI (% Dec/Dec)

4.6

5.5

4.3

1.5

2.2

2.2

USD/SGD (eop)

1.29

1.30

1.22

1.27

1.27

1.28

1y ago

Last

Q1 14F

Q2 14F

Q3 14F

Q4 14F

Real GDP (% y/y)

0.6

5.5

5.1

2.7

3.0

3.2

CPI (% y/y, eop)

3.5

1.5

1.0

2.7

2.2

2.2

USD/SGD (eop)

1.24

1.27

1.27

1.28

1.27

1.27

Note: *Singapores large gross external debt mainly reflects liabilities of the financial sector a situation typical for a regional financial centre. #Singapores large
domestic public debt is not related to fiscal funding (the government generally runs surpluses), but is for development of the domestic debt market and to meet the
investment needs of the pension fund. All proceeds are invested by the sovereign wealth funds and the MAS. Source: Haver Analytics, Barclays Research

25 March 2014

78

Barclays | The Emerging Markets Quarterly

EMERGING ASIA: TAIWAN

Still in growth support mode


Economics
Wai Ho Leong
+65 6308 3292
waiho.leong@barclays.com
FX Strategy
Hamish Pepper
+65 6308 2220
hamish.pepper@barclays.com

The Central Bank of China (Taiwan) is expected to provide support for growth, which is
currently led by a narrowly centred recovery in exports. Adding to concern is the delay in
passing key economic bills through Parliament, which could stall a recent drive to attract
FDI. Meanwhile, the structural boost the economy is gradually receiving from tourism
and the onshore CNY business will likely drive domestic demand and asset prices.

Key recommendations
FX: Continued market perception that recent CNY weakness will negatively affect
proximity currencies in north Asia is likely to weigh on the TWD. Further ahead, export
growth is likely to pick up, but currency appreciation is likely to be limited by still-low
economic growth and benign inflation, in an environment of broad USD strength.

Even though Q4 was strong,


the central bank is still
stepping up liquidity support
for the economy

Our sense is that the growth outlook remains a source of concern, despite an export-led
acceleration in momentum to 1.8% q/q sa in Q4 (Q3: 0.1% q/q). One factor is that Taiwan
is more highly leveraged to the global electronics cycle, particularly to the ailing PC supply
chain, and more correlated to the G3. Another factor is that export growth continues to be
narrowly based on semiconductors in the first two months, while PCs, petrochemicals,
mobile phones, machinery and panel shipments remained weak. As a result, we expect Q1
GDP to moderate more sharply, to 0.7% q/q (from 1.8% q/q). Exports grew in the first two
months, on average, but just barely (+0.4% y/y; Dec: 1.2%; Nov: 3.4%; Oct: 0.7%),
hampered by weather-related disruptions to air freight shipments to the US. Reflecting
these concerns and the lunar new year holidays, the Central Bank of China (Taiwan)
boosted excess reserves in the banking system to a four-year high of TWD53bn/day in
January (Q4 average: TWD32.8bn; 2012: TWD17.1bn; TWD5-7bn when growth is above
trend), and the highest monthly level of liquidity support since October 2009 (TWD65.9bn).

We are still comfortable with


our 4% forecast this year

That said, we are comfortable with our above-consensus 2014 GDP forecast of 4%
(government: 2.82%) on account of two factors. First, we continue to expect the recoveries
in the US and Europe to support a pickup in exports from March, with an increase in
equipment investment in the US in particular likely to drive growth. Second is the fasterthan-expected development of the CNY capital market in Taiwan, prompting rapid growth in
financial services (lending and underwriting). Since 25 November, when Taiwans Financial

FIGURE 1
An investment-driven growth model shapes up
12

FIGURE 2
An electronics-led recovery

pp contribution to GDP growth

40

10
8
6

4.0% 4.5%

IP (% 3m/3m saar)

Electronics IP (% 3m/3m saar)

80

30

60

20

40

10

20

2.1%

2
0
-2
-4

Forecast

-6
2007 2008 2009 2010 2011 2012 2013 2014f 2015f
Consumption
Change in Inventories
Source: Haver Analytics, Barclays Research

25 March 2014

Capital Formation
Net Exports

-10
-20
Feb-11

-20

Aug-11
IP

Feb-12

Aug-12

Feb-13

Aug-13

-40
Feb-14

Electronic parts IP (RHS)

Source: Haver Analytics, Barclays Research

79

Barclays | The Emerging Markets Quarterly


Supervisory Commission allowed Chinese enterprises to issue CNY-denominated Formosa
bonds in Taiwan, Chinese banks have issued TWD6.7bn of such bonds in Taiwan, prompting a
review of the TWD10bn annual cap. This follows strong growth in CNY deposits in Taiwan
since the launch on 6 February, with deposits topping CNY247bn by end-February 2014
(roughly 3.9% of total deposits), up 35% since the start of the year. CNY loans have also
surged to CNY14.2bn, more than double the level of outstanding loans a year ago.
The FEPZ framework is a
comprehensive drive to
compete for FDI

A third factor that should support growth in 2014 is structural: an ambitious drive to attract
FDI into Taiwan, spearheaded by the National Development Council (NDC; formerly known
as the CEPD). The NDC plans to offer tax incentives in eight free economic pilot zones
(FEPZs). This is also targeted at Taiwanese firms based overseas, particularly in China. In
2013, Taiwan approved more than USD8bn of foreign investments, mainly from Taiwanese
firms in China. With the FEPZ strategy and tax incentives, we estimate it could secure
another USD8bn in FDI commitments in 2014. When realised, we estimate these
investments could lift trend growth 0.2pp on an annual flow basis. Over time, this should
narrow Taiwans structural net FDI deficit, reversing the drag from the overall financial
account on its balance of payments. We believe this sets the stage for domestic demand to
become a more important growth driver in 2014, which we expect to contribute 3pp to our
4% forecast (2013: 1.5pp of 2.1%). One concern, however, is the delay in the passage of a
bill to enable the tax incentives for the FEPZs in the legislature. However, our sense is that
the bill will be passed before the end of the current parliament session, which ends on 18
June. This would pave the way for the formal launch of the FEPZs in Q2.

Political deadlock in
Parliament could constrain
Taiwans FTA strategy

Meanwhile, the KMT-led government is having greater difficulty ratifying the services chapter
of the Economic Cooperation Framework Agreement (ECFA inked with China in June 2013)
in the current sitting of Parliament. With local elections looming in November, the risk is that
the government may defer the ratification to next year if this is stalled beyond the current
session. Delay could put at risk Taiwan's FTA ambitions: the Trans-Pacific Partnership, the
Regional Comprehensive Economic Partnership (Asean plus six) agreements and other
bilateral agreements. The president warned on 13 March that delays could hurt Taiwans
credibility in the international community. A saving grace for the country is that it is making
progress on expanding the early harvest ECFA agreement on goods trade with China to
continue to include critical export items such as chemicals and machinery which account for
13.5% of Taiwans exports. For these items, it has lost competitiveness in the Chinese market,
as Asean exporters pay no tariffs (while a 6.5% duty applies to Taiwan).

FIGURE 3

FIGURE 4

Mainland Chinese visitor arrivals likely to top 3mn in 2014

Services balance: From structural negative to structural positive

3.5

Mainland visitors, mn

9,500
7,500
5,500
3,500
1,500
-500
-2,500
-4,500
-6,500
-8,500
Dec-01 Dec-03 Dec-05 Dec-07 Dec-09 Dec-11 Dec-13

3
2.5
2
1.5
1
0.5
0
Jan

Mar
2009

May
2010

Source: CEIC, Barclays Research

25 March 2014

Jul
2011

Sep
2012

Nov
2013

Travel
Transport
Services balance, USDmn 4Q rolling sum
Source: CEIC, Barclays Research

80

Barclays | The Emerging Markets Quarterly


Cross-Strait ties continue to
pay strong dividends for the
services economy

The evolution of cross-Strait ties, which has awakened Taiwans services economy, has
entered a more exciting phase. In February, China and Taiwan held their highest-level talks
since the start of cross-Straits ties in 2008, resulting in an agreement to open
representative offices in each others countries. Chinese media (China Daily) described the
summit as a promising new starting point. We believe this could usher in a period of more
rapid progress on the economic integration agenda that started in 2009.

Tourism from the mainland


adds USD6bn to the current
account surplus each year

Another sign of deepening ties is tourism, which is already adding USD6bn to the current
account surplus each year. A hotel and retail boom is underway, due to the influx of 2.87mn
mainland Chinese tourists in 2013. Taiwan is planning to expand the number of Chinese
cities where residents are eligible to apply for individual travel to Taiwan, beyond the current
26. We expect 20% of the projected 3mn mainland visitors to Taiwan in 2014 to be
individual travellers, up from 7% in 2012. According to the tourism bureau, Taiwan will raise
the daily limit for independent Chinese visitors to 4,000/day from 3,000/day. These visitors
are of higher quality, as they are more likely to spend more on a per person per day basis. In
our view, this will help maintain our current account surplus projection for 2014 at a solid
10% of GDP (2013: 11%), reinforcing the safe-haven appeal of Taiwanese assets.

We expect resurgent hiring


and low inflation to bolster
consumer confidence

All of this is also pointing to stronger consumption in 2014. First, there are indications that
employment is picking up, particularly in the services economy, which should sustain
further improvement in consumer confidence. The employment opportunity sub-index of
the consumer confidence index jumped to a 20-month high in February 2014 (to 109.75),
up from end-2013 (106.2) and the low of 104.70 in June 2013. Second, inflation is low. We
continue to expect inflation to remain muted at 0.9% in 2014 (2013: 0.8%), but for prices to
rise at a slightly faster pace in 2015 (1.8%).

Real estate demand remains


strong; more steps may be
taken to boost housing
affordability

Moreover, the stronger services economy continues to stoke property prices, in our view.
Prices rose for the tenth successive quarter in Q4 13, by 2.7% q/q sa, re-accelerating from
the pace in Q3 (1.9%; Q2: 6%). Since the low in December 2008, home prices have risen
89% as of December 2013. Construction activity is also being sustained at a higher level.
Despite the weaker economy, housing building permits jumped 37% y/y, to 129,307 units,
in 2013. We expect prices and transaction volumes to rise further, following the passage of
an amendment to the luxury tax on 12 March that allows the finance ministry to grant
exemptions on a caseby-case basis. Another potential source of upside is more decisive
measures to boost home affordability, particularly for first-time mass market buyers. This
could come ahead of the local elections in November this year.

FIGURE 5
Strong upturn in residential house prices is underway
320

Index, March 2001 = 100

FIGURE 6
but not enough to drive demand-side inflation yet
4

pp contribution to CPI (% y/y)

3
270

KMT came to power;


begins cross-Strait
economic integration

2
1

220

0
-1

170

120
Dec-05

-2
-3
Feb-09
Dec-07

Dec-09

Home prices, sa
Source: Haver Analytics, Barclays Research

25 March 2014

Dec-11

Dec-13

Feb-10
Food

Feb-11
Energy

Feb-12

Feb-13

Feb-14

Other goods and services

New Taipei City, sa


Source: Haver Analytics, Barclays Research

81

Barclays | The Emerging Markets Quarterly

FIGURE 7
Employment conditions are improving again

FIGURE 8
TWD REER well below 18-year average: Little downside risk

115

4.5

100

4.0
3.5

85

3.0

70

2.5

55
40
25
Feb-04

Feb-06

Feb-08

Feb-10

Feb-12

1 Std Dev
120
110
Average

2.0

100

1.5

90

1.0
Feb-14

Employment opportunity sub-index 6 mths ahead


CBC Discount Rate (%, RHS)

KMT
returned
to power,
Mainland
tourism
boost

130

1 Std Dev

80
Mar-96 Mar-99 Mar-02 Mar-05 Mar-08 Mar-11 Mar-14
Barclays TWD REER, Jan 2005 =100

Source: Haver Analytics, Barclays Research

Source: Bloomberg, Barclays Research

FIGURE 9
Taiwan macroeconomic forecasts
2010

2011

2012

2013

2014F

2015F

Real GDP (% y/y)

10.8

4.2

1.5

2.1

4.0

4.5

Domestic demand contribution (pp)

8.1

0.6

0.2

1.4

3.1

3.4

Private consumption (% y/y)

4.0

3.1

1.6

1.8

2.9

2.9

Fixed capital investment (% y/y)

21.1

-2.3

-4.0

3.4

9.5

9.6

Net exports contribution (pp)

2.7

3.6

1.3

0.6

1.0

1.1

Exports (% y/y)

25.6

4.5

0.1

3.8

6.2

5.9

Imports (% y/y)

27.7

-0.5

-2.2

4.0

6.6

6.0

GDP (USD bn)

428

465

475

488

507

549

39.9

41.7

50.7

50.8

50.9

50.0

Activity

External sector
Current account (USD bn)
CA (% GDP)

9.3

9.0

10.7

10.4

10.0

9.0

Trade balance (USD bn)

26.5

28.3

31.6

30.5

32.9

32.2

Net FDI (USD bn)

-9.1

-14.7

-9.9

-11.2

-6.5

-2.5

Other net inflows (USD bn)

8.7

-17.3

-21.7

-25.7

-24.0

-24.0

Gross external debt (USD bn)

102

123

131

142

149

156

International reserves (USD bn)

382

386

403

402

421

444

Public sector
Public sector balance (% GDP)

-3.3

-2.2

-2.5

-2.0

-1.0

-1.0

Gross public debt (% GDP)

33.5

34.8

35.6

35.8

35.5

34.4

Prices
CPI (% Dec/Dec)
FX, eop

Real GDP (% y/y)


CPI (% y/y, eop)

1.2

2.0

1.6

0.3

1.5

1.6

30.37

30.29

29.14

29.95

30.00

28.75

1y ago

Last

Q1 14F

Q2 14F

Q3 14F

Q4 14F

1.4

2.9

3.6

3.9

4.7

3.8

1.4

0.3

1.4

0.7

0.1

1.5

FX (domestic currency/USD, eop)

29.88

29.95

30.50

30.00

30.00

30.00

Base rate (%, eop)

1.875

1.875

1.875

1.875

2.000

2.125

Overnight rate (%, eop)

0.386

0.388

0.385

0.385

0.485

0.585

Source: Barclays Research

25 March 2014

82

Barclays | The Emerging Markets Quarterly

EMERGING ASIA: THAILAND

Uncertainty set to continue


Economics
Rahul Bajoria
+65 6308 3511
rahul.bajoria@barclays.com

The political uncertainty in Thailand looks set to continue despite a recent easing in
tensions. The standoff between the protesters and caretaker government of Yingluck
Shinawatra has entered its fifth month. Growth is suffering on account of weakness in
domestic demand. We recently lowered our 2014 growth forecast to 3.0%.

Key recommendations
Rates: Long duration in 7y, short cash: Thai bonds have rallied significantly since

Rates Strategy
Rohit Arora
+65 6308 2092
rohit.arora3@barclays.com
FX Strategy
Hamish Pepper

December 2013, and we see the momentum continuing. In our view, deteriorating
growth, low inflation, lower supply and the Thai curves relative steepness to the region
still warrant an overweight duration stance, which should also counter any potential
uptick in global bond yields. We recommend the 7y sector in ThaiGBs given the
steepness of the curve. We recommend hedging FX risk.

FX: Continuing uncertainty, a dovish BoT and slow economic growth are likely to

+65 6308 2220


hamish.pepper@barclays.com
Credit Strategy
Avanti Save

encourage further capital outflows and weigh on the THB over the next three months.
We recommend being long MYRTHB (target: 10.19; stop: 9.75; spot ref: 9.83) on
account of growth, policy rate, terms of trade and current account differentials.

Credit: Political uncertainty is affecting both growth and business sentiment. We think a

+65 6308 3116


avanti.save@barclays.com

Ongoing political protests are


having a significant impact on
growth

prolonged political deadlock, softer growth and a rising fiscal burden could lead to a
Negative Outlook for the sovereign rating. Thai CDS has outperformed in recent weeks
retracing towards 27bp over Malaysia from the high ~40bp area in January. We think this
an attractive opportunity to buy Thai CDS against Malaysia or the Philippines.
The economy was already struggling at the end of 2013, and the political protests have
exacerbated this weakness. High household debt, external risks on account of Fed tapering
and weak production are constraining growth. Once the political protests started in
November 2013, tourism, which was the only sector performing well, also started to see
significant declines, and arrivals are now contracting on a momentum basis. As a result,
GDP drive has also been lost, and we recently cut our 2014 growth forecast to 3.0%, from
4.3% previously. This is now in line with the central banks forecast, though it recently said
that further revisions may be required, as the political situation does not bode well for
growth in 1H 2014 (see BoT warns of slump in GDP growth, Bangkok Post, 1 March 2014).

FIGURE 1
Private consumption has softened considerably
15

FIGURE 2
Tourist arrivals have started slowing down
50

10

40

30
20

10

-5

-10

-10
-20

-15
-20
Dec-95 Dec-98 Dec-01 Dec-04 Dec-07 Dec-10 Dec-13
GDP: Private consumption (% y/y)
Source: CEIC, Barclays Research

25 March 2014

-30
-40
Feb-08

Feb-09

Feb-10

Feb-11

Feb-12

Feb-13

Feb-14

Visitors arrival (% 3m/3m, saar)


Source: CEIC, Barclays Research

83

Barclays | The Emerging Markets Quarterly


We expect weaker growth on account of softer private consumption, which fell sharply in
Q4 2013, and has fallen to levels not seen since the 1997-98 Asian financial crisis. We
believe the loss in consumer and business sentiment could exacerbate the weakness in
private consumption, as the tourist market may take some time to recover to normal levels,
in line with past trends, once the protests subside. Indeed, consumer confidence has
declined below levels not seen since the 2008 global financial crisis. And with fiscal
spending, which was already shrinking, taking a backseat as well, the only strong driver of
growth in 2014 is likely to come from a pick up in external demand.
Inflation has been low, but has risen recently on the back of weather related disruptions. Dry
weather in large parts of North and North East Thailand has exacerbated price pressures,
and has led to increases in food prices. Even so, 12-month forward price expectations
appear manageable, and have been on a downward trend in the past eight months. Indeed,
with inflation expectations at a 42-month low, core inflation should remain benign in the
coming months, allowing the Bank of Thailand to keep an accommodative policy stance.
BoT expected to keep an
accommodative policy stance

The Bank of Thailand cut the policy rate by 25bp to 2.00% in a very close call at its 12
March meeting. The move was largely to support sagging business and consumer
confidence. With falling inflation expectations, there was room for a rate cut. However, the
positive impact of a rate cut on growth may be limited, as private credit growth has
continued to lose momentum despite several interest rate cuts over the past year. Given the
close nature of voting patterns in recent MPC meetings, we think that the threshold for
further rate cuts has increased considerably. We expect future decisions to be driven by
three things: 1) inflation expectations; 2) the balance of risks to growth (which remain to
the downside); and 3) financial stability risks, which have eased given falling credit growth.

THB expected to remain under


pressure

Given the political turbulence, we see room for underperformance by the THB, which will
also be driven by swings in global risk sentiment. And with the support from a large current
account surplus having disappeared, we think a renewed bout of risk aversion could trigger
another round of THB weakness. On the current account, we expect the small deficit in
2013 to turn into a small surplus in 2014, as weak domestic growth, low capital import
demand and some recovery in service sector revenues support a stronger current account
balance in 2H 2014. However, outflows through the capital account may continue, as Fed
tapering-related risks, the weak growth backdrop and low interest rates are unlikely to
attract incremental inflows in the near term. While we do not believe credit risks have
escalated materially, as noted by recent statements from Moodys and S&P, any further
escalation in the political protests may lead us to reconsider this view.

FIGURE 3
Consumer confidence is falling

FIGURE 4
Recent policy decisions have been very close

84
82

3.75%

3.50%

80

78

76

2.75%
2.50%

72

2.25%

70
Feb-08

Feb-10

Feb-12

TH: Consumer Confidence Index


Source: Bank of Thailand, CEIC, Barclays Research

25 March 2014

3.00%

74

68
Feb-06

3.25%

Feb-14

0
Jan-11

2.00%
Aug-11

May-12

Nov-12

MPC: votes in favour


MPC: absent

Jul-13

1.75%
Mar-14

MPC: votes against


rate (%, RHS)

Source: Bank of Thailand, CEIC, Barclays Research

84

Barclays | The Emerging Markets Quarterly

Protests enter a fifth month


Protests enter fifth month

The anti-government protests in Thailand, which began in response to the governments


attempt to pass amnesty legislation in November 2013, have entered a fifth month. Former
interior minister Suthep Thaugsuban is leading the protests, which at times have paralysed
government services. In response, Prime Minister Yingluck Shinawatra dissolved parliament
in December and called an election in February. The main opposition Democrat Party
boycotted the election. The People's Democratic Reform Committee (PDRC), a self styled
group advocating electoral reforms, also opposed the election and called instead for an
unelected peoples council to undertake electoral reforms. When the government did not
yield, the PDRC organised a mass movement in January to disrupt voting. The government
imposed a state of emergency prior to the election (recently lifted). While the election went
ahead smoothly in most parts, in Bangkok polling was disrupted. The final voter turnout
was 47.7%, down from 75% in 2011. On 21 March, Thailands Constitutional Court decided
to annul the elections, paving the way for new elections to be held, most likely in late Q2.
The opposition has indicated it will not participate in an election if it is not free and fair.

Uncertainty may prevail for longer


Elections likely to be completed
by the end of April

There are three key areas of dispute between the government and protesters. The first is
around the legitimacy of the February election. The PDRC insists that the caretaker Prime
Minister should quit. The Constitutional Court has now scrapped the February poll results;
therefore, new elections need to be held. However, it is unclear when these will be
conducted and whether the opposition will participate (see, Thailand: Elections annulled,
uncertainty prolonged, 21 March 2014).

Governments constrained
ability to borrow has halted
payments to farmers under the
rice-pledging scheme

The second issue is around the rice-pledging scheme. As the current administration is a
caretaker government, the finance ministry is constitutionally prevented from borrowing
money to pay for the rice-pledging scheme. While this is mostly a cash flow issue (most tax
collections come in H2 of the fiscal year, running October to September), the governments
struggle to bolster its finances has prompted protests by farmers demanding payment
(outstanding amount is around THB130bn, or USD4bn). The cancellation by China of a
large order for Thai rice has compounded the governments financial difficulties.3

Allegations of corruption in the


rice-pledging scheme are
being investigated by NACC

The third is an enquiry into allegations of corruption in the rice-pledging scheme against the
government, which is being led by the National Anti-Corruption Commission (NACC). If
charges are laid, caretaker Prime Minister Yingluck could be impeached.4
FIGURE 5
Thailand has been resilient to multiple disruptive events in the past decade
60
50

Military Coup

40

Airport
seizure

Red shirt protests Floods

30

Forecast

20
10
0
-10
-20
-30
-40
Sep 05

Japan earthquake
Oct 07

Nov 09

Dec 11

PDRC
protests

Jan 14

GDP (% q/q, saar)


Source: CEIC, Barclays Research
3
4

25 March 2014

see China cancels deal to buy Thai rice due to graft probe: Thai minister, Reuters, 4 February 2014
see NACC reveals timeline for PM's indictment, NNBT, 3 March 2014

85

Barclays | The Emerging Markets Quarterly

FIGURE 6
Rising household debt constrains impact of monetary policy

FIGURE 7
Credit growth has slowed despite rate cuts
20

85
80

5.0

15

75
70

4.0

10

65

3.0
5

60
55
45
40
Sep-04

2.0

50

-5
Mar-05
Mar-06

Sep-07

Mar-09

Sep-10

Mar-12

Sep-13

Sep-06 Mar-08

1.0
Sep-12 Mar-14

Sep-09 Mar-11

Private credit (% 3m/3m saar)

Policy rate (%, RHS)

Loans to households (% of GDP)


Source: Bank of Thailand, CEIC, Barclays Research

Source: Bank of Thailand, CEIC, Barclays Research

FIGURE 8
Thailand macroeconomic forecasts
2010

2011

2012

2013

2014F

2015F

Real GDP (% y/y)

7.8

0.1

6.5

2.9

3.0

4.0

Domestic demand contribution (pp)

8.4

0.8

7.8

1.1

1.8

3.7

Private consumption (% y/y)

4.8

1.3

6.7

0.2

2.5

4.0

Fixed capital investment (% y/y)

9.4

3.3

13.2

-1.9

4.9

5.5

Net exports contribution (pp)

-0.5

-0.7

-1.4

1.7

1.5

0.3

Exports (% y/y)

14.7

9.5

3.1

4.2

5.6

4.5

Imports (% y/y)

21.5

13.7

6.2

2.3

4.5

5.2

GDP (USD bn)

319

346

366

384

389

413

10.0

4.1

-1.5

-2.8

2.4

2.0
0.5

Activity

External sector
Current account (USD bn)
CA (% GDP)

3.1

1.2

-0.4

-0.7

0.6

Trade balance (USD bn)

29.8

17.0

6.0

6.4

6.1

5.0

Net FDI (USD bn)

4.5

5.0

-2.0

1.4

-3.0

-3.0

Other net inflows (USD bn)

20.6

-5.6

16.3

1.9

4.0

3.0

Gross external debt (USD bn)

96.5

106.5

133.3

139.8

143.0

145.0

International reserves (USD bn)

172

175

182

167

168

167

Public sector
Public sector balance (% GDP)*

-0.8

-2.7

-2.8

-2.5

-2.2

-1.5

Gross public debt (% GDP)

42.4

40.3

44.0

45.7

46.3

47.0

3.1

3.5

3.6

1.7

2.4

2.5

Prices
CPI (% Dec/Dec)
FX, eop
Real GDP (% y/y)

30.1

31.2

30.6

32.7

32.0

32.0

1y ago

Last

Q1 14F

Q2 14F

Q3 14F

Q4 14F

5.4

0.6

1.8

2.9

3.7

3.8

CPI (% y/y, eop)

2.7

1.7

2.1

2.5

2.7

2.4

FX (domestic currency/USD, eop)

29.3

32.7

32.5

33.0

32.5

32.5

Overnight policy rate (%, eop)

2.5

2.3

2.0

2.0

2.0

2.0

Note: * Indicates fiscal year projection (October to September). # indicates only the central government deficit, does not include emergency decree-related shortfall.
Source: Barclays Research

25 March 2014

86

Barclays | The Emerging Markets Quarterly

EEMEA: EGYPT

Realism takes hold


As Egypt braces for presidential elections in May, polls show Field Marshal Abdel Fattah AlSisi as having the most popular support, but Hamdeen Sabbahi is a credible contender.
Growth continues to disappoint, but a fiscal stimulus of 3% of GDP could reverse the
dynamics by year-end. We downgraded our growth and fiscal deficit forecasts to 2.2% y/y
and 11.7% of GDP respectively, but expect GCC financial support to continue until end 2014.

Economics
Alia Moubayed
+44 (0)20 3134 1120
alia.moubayed@barclays.com
FX Strategy

Key recommendations
FX: Tactically positive. Disbursements of financial support from Kuwait, Saudi Arabia

Koon Chow
+44 (0)20 7773 7572

and the UAE (GCC-3) are likely to keep the EGP stable, at least until a legitimately elected
government is in place, as expected, in Q3 2014. We think this provides a good
opportunity to buy 3m (10.27%) and 6m (10.59%) T-bills to earn carry, although some
bureaucratic hurdles may slow the transaction process.

koon.chow@barclays.com
Credit Strategy
Andreas Kolbe
+44 (0)20 3134 3134

Credit: Extend duration into Egypt 40s. We lifted Egypt credit to overweight in our

andreas.kolbe@barclays.com

December 2013 Emerging Markets Quarterly based on the improved financing outlook.
Although the fiscal outlook has somewhat deteriorated since then and Egypt spreads
have tightened meaningfully recently, we think some value remains, particularly in Egypt
40s. With the financing backstop from the GCC remaining in place, we think Egypts
diversification appeal in a broader EM credit context and the steepness of the spread
curve will attract further investor demand (Figure 1).

Protests escalate ahead of presidential elections


Field Marshall Al Sisi is
expected to announce his
presidential bid soon

Over the coming few months, Egyptians will go to the polls at least twice to elect a new
president and Parliament, expected in mid-May and late July, respectively. As we noted in
Global EM political outlook: Egypt, Field Marshal Al-Sisi could announce his candidacy at any
time after he resigns from his defence minister post. A recent poll indicates that popular
support for his presidential bid stands at about 54.7%, significantly ahead of other
candidates. Another survey conducted by the Egyptian Centre for Public Opinion Research
(Baseera) in late February says that just over half of the respondents would vote for him,
while 45% said they were undecided as to whom they would vote for (Figure 2). While polls

FIGURE 1
Egypts spread curve has steepened meaningfully we see
value particularly in Egypt 40s
900

150

Z-sprd, bp

800

100

700

50

600

500

-50

400

-100

300

-150

200
Oct-11

-200
Apr-12
Egypt 40s

Oct-12

Egypt 20s

Source: Bloomberg, Barclays Research

25 March 2014

Apr-13

Oct-13
slope (40s-20s), RHS

FIGURE 2
Field Marshal Abdel Fattah Al-Sisi has the most support but
many remain undecided
%
60

Who will you vote for if the presidential elections were


to be held tomorrow?

50
40

45

51

30
20
10

0
Did not
decide

Abd ElHamdeen
Fatah Al-Sisi Sabbahi

0.3

0.3

Abd
ElMonem
Aboul
Fotouh

Am r
Moussa

Source: Egyptian Centre for Public Opinion Research (February 2014)

87

Barclays | The Emerging Markets Quarterly


indicate a higher probability for Al-Sisi to win, Hamdeen Sabbahis track record and ability to
attract young, secular liberals, as well as some of the Islamists vote, should not be
underestimated, in our view.
The key test for Egypts administration is to ensure fair and free presidential elections and
lay a stable path towards broad-based participation in the parliamentary elections. So far,
however, efforts at national reconciliation have failed and security risks remain high. The
war against terror continues in Sinai, with recent attacks targeting police, army posts and
tourist attractions. At the same time, pro-MB protestors continue to mobilise in universities,
highlighting the divide and socio-political malaise, which continues to undermine efforts
aimed at restoring political stability.

Protests and volatile security


continue to undermine the
path to political stability

Growth disappoints, but fiscal stimulus should help the recovery


Growth in H1 FY 13/14 did not
exceed 1.2% y/y

We revised our FY 13/14


growth to 2.2% y/y

With an uncertain political outlook, heightened security volatility and severe energy
shortages, economic activity remained lacklustre. Q4 13 GDP registered only 1.4% y/y,
compared with 2.2% y/y in Q4 12, reflecting the persistent contraction in investment
growth and a slowdown in consumption and exports (Figure 3). PMI in January and
February remained at just 50, while tourism and exports growth stayed negative (Figure 4).
The weak activity indicators led the government to revise its growth forecasts to 2.0-2.5% in
FY 13/14, down from its official target of 3.5% announced by the outgoing cabinet. With no
major improvement in investment expected over the coming three months, we think that
growth in H1 14 (H2 FY 13/14) is unlikely to rebound significantly and, thus, we revised our
growth forecast down from 3.1% to 2.2% in FY 13/14.
Having said that, and given its emphasis on investment, the fiscal stimulus announced last
October and recently in January should have its impact felt on growth starting in Q3 14 (Q1
FY14/15). Out of EGP29.7bn stimulus approved in October, almost 53% was allocated to
investments (settlement of arrears to contactors, national housing, and drinking water and
sanitation programs). The package approved in January allocated almost EGP18bn, or 45% of
the total, to investment projects (housing and basic infrastructure, as well as contributions to
the Suez Canal Development Project) (Figure 5). Finally, the recently announced initiative from
the CBE to provide financing through the banks of up to EGP10bn for low and middle income
housing should boost residential investment further and support growth.

FIGURE 4
PMI remains below 50 in the first two months of 2014

-6
Q4 07

Q4 08

Q4 09

Q4 10

Q4 11

Q4 12

Q4 13

Feb-14

25

Dec-13

-4

Oct-13

30

Jun-13

-2

Aug-13

35

Feb-13

Oct-12

40

Dec-12

Jun-12

45

Output
New export orders

Aug-12

50

Apr-12

Feb-12

55

Jun-11

PMI
New orders
Employment

Aug-11

60

Apr-11

10

Apr-13

% y/y

Oct-11

FIGURE 3
H1 FY13/14 growth at 1.2% y/y was lower than expected;
we thus revise our growth forecast the FY to 2.2% y/y

Dec-11

Fiscal stimulus and CBE


housing finance initiative
should support growth

GDP growth (% y/y)


Source: Haver Analytics, Barclays Research

25 March 2014

Source:

Haver Analytics , Barclays Research

88

Barclays | The Emerging Markets Quarterly

Fiscal performance: realism takes hold


Domestic revenue
performance remains weak,
increasing Egypts reliance on
foreign grants

With growth in the first half of 2014-15 below target, we have also revised our fiscal
forecasts. Revenue performance remains weak on the tax and non-tax sides compared with
rising spending, confirming Egypts growing reliance on external grants. Tax revenues
increased only 7.1% y/y during the first seven months of the fiscal year, compared with a
35.4% y/y increase last year, reflecting the slowdown in economic activity. On the other
hand, spending continued to rise, though at a slower 15.4% y/y, compared with 29.8% y/y
in the same period last year. As such, the overall and primary deficit reached 5.9% and 1.5%
of GDP, respectively, during the first seven months of this fiscal year. The composition of
spending, however, is starting to shift. While wage growth maintained its pace from last
year (21% y/y), growth in debt service obligations slowed sharply, reflecting the reduction
in local debt yields over the past months. Moreover, growth of spending on subsidies fell to
10.7% y/y, compared with 50% y/y during the same period last year.

Spending increases pushed the


deficit to almost 6% of GDP in
seven months

Overall deficit could reach


11.7% of GDP this FY

While we had accounted for some slippage in fiscal performance, the above developments
merit a slight upwards revision of our deficit forecasts from 11.5 to 11.7% of GDP. The new
minister of finance recently announced that the FY 13-14 deficit is likely to hover at 11-12%
y/y, almost 1ppt of GDP higher than the target under the outgoing government. The minister
also indicated that the government is aiming to reduce the deficit to 10-10.5% percent in
FY14-15, hinting at the possible introduction of a one-off 5% income tax, the introduction of a
VAT and the implementation of a property tax, along with a bolder approach to the energy
subsidy rationalisation. After all, the authorities are aware of the need to accelerate fiscal
consolidation notably after the elections period, given the anticipated phase-out of GCC
support by year end.

But we expect bolder steps


towards fiscal consolidation

GCC-3 support reconfirmed


Egypt has received around
USD12bn of GCC support since
July 13

Egypts fiscal and external position will continue to be backstopped in the short term by the
disbursement of GCC funds and the supply of petroleum products (Egypt: Financing outlook
positive post-referendum). Following disbursements of over USD12bn during July 13 to
February 14, the GCC-3 countries pledged to supply Egypt with fuel until end-2014, which
adds to another USD5bn of financial disbursements still expected over the coming six
months (Figure 6). At the same time, the UAE announced recently the funding of a project
to build more than 1mn housing units over five years, which is valued at USD40bn and to be
implemented by the Dubai-based Arabtec in conjunction with the Egyptian armed forces. In

And more is expected in the


form of investment

FIGURE 5
The fiscal stimulus packages should support a growth
rebound in H2 14, given the emphasis on investment
EGP bn
35

First package

FIGURE 6
Disbursements of GCC aid has helped stabilise the
currency and shore up reserves (July 2013-February 2014)*
USD bn

Second package

30
25

15.9

20
15
10
5
0

Source:

10
2.6

0.8
Wages and Goods and
salaries
services

1.4
6.2

Subsidies Investments

Ministry of Finance, Barclays Research

25 March 2014

15.8

6.6
4.3
Net
acquisition
of financial
assets

20
18
16
14
12
10
8
6
4
2
0

17.9
12.7
8 8.0
3

Interest free
deposit at
CBE

4.0 3.7
1.0

Grants

2.9
0.0

Energy
products

Pledged

Project
related
devpt.
Spending

Total

Disbursed

Note: *Barclays estimates for Jan-Feb 2014. Source: Ministry of Finance, Barclays
Research

89

Barclays | The Emerging Markets Quarterly


the coming months the shift from budget support to more investment-related flows, both
public and private, coming from the Gulf States could expand in scope, in view of supporting
the fragile recovery while focusing on addressing socio-economic concerns. This should help
the central bank stabilise the EGP in the short to medium term in order to fend off inflationary
pressures, which we expect to heighten as a growth recovery picks up in H2 14.
Post elections, an IMF-GCC
supported program may be
explored

Beyond Q4 14, once a new government is in place and legitimately supported by a new
Parliament, there could be a rapprochement with the IMF with the aim possibly of securing
an IMF-GCC supported program, which is much needed to ease liquidity and encourage
portfolio investment flows back into the country. The countrys large external financing
needs, which we estimate at about USD16.2bn in FY 14/15 make this imperative (Egypt
Quarterly Outlook: Positive momentum).

FIGURE 7
Egypt macroeconomic forecasts
2009/10

2010/11

2011/12

2012/13

2013/14F 2014/15F

5.1

1.8

2.2

2.1

2.2

3.7

Activity
Real GDP (% y/y)
Domestic Demand Contribution (pp)

5.0

3.9

6.3

1.1

1.7

3.0

Private Consumption (% y/y)

4.1

5.5

5.9

2.8

2.3

3.0

Fixed Capital Investment (% y/y)

7.8

-5.6

0.7

-7.8

-3.0

2.0

0.2

-1.7

-3.0

1.0

0.5

0.7

-3.0

1.3

-2.3

4.1

4.5

8.0

Net Exports Contribution (pp)


Exports (% y/y)
Imports (% y/y)
GDP (USD bn)

-3.2

8.4

10.8

-1.1

1.0

3.0

218.9

235.9

262.6

271.7

277.0

318.4

-4.3

-6.1

-10.1

-5.6

-6.0

-6.7

External Sector
Current Account (USD bn)
CA (% GDP)

-1.97

-2.6

-3.9

-2.1

-2.2

-2.1

Trade Balance (USD bn)

-25.1

-27.1

-34.1

-31.5

-33.3

-35.2

Net FDI (USD bn)

5.8

1.2

3.7

3.0

3.0

4.5

Other Net Inflows (USD bn)

-4.1

-2.7

2.6

5.5

6.0

3.0

Gross External Debt (USD bn)

33.7

34.9

34.4

43.2

54.5

62.4

Gross External Debt (% GDP)

15.4

14.8

13.1

15.9

19.7

19.6

International Reserves (USD bn, excl gold)

32.8

23.5

12.2

11.6

13.1

15.8

-8.1

-10.1

-10.6

-13.7

-11.7

-11.0

-2.1

-3.9

-4.0

-5.3

-2.9

-2.5

73.2

76.6

78.9

89.2

90.8

92.4

CPI (% June/June)

10.1

11.8

7.2

9.8

10.4

11.1

FX, eop (june)

5.70

5.96

6.06

7.02

6.97

6.88

1y ago

Last

Q1 14F

Q2 14F

Q3 14F

Q4 14F

2.2

1.0

2.0

2.3

2.8

3.4

Public Sector
Public Sector Balance (% GDP)
Primary Balance (% GDP)
Gross Public Debt (% GDP)*- Gen Gvt
Prices

Real GDP (y/y)

7.6

9.8

10.3

10.4

10.5

10.8

Exchange Rate (eop)

CPI (% y/y, eop)

6..80

6.96

6.96

6.97

6.90

6.88

Monetary Policy Benchmark Rate (%, eop)

9.75

8.25

8.25

8.25

8.25

8.25

Note: *Consolidated domestic debt of the Budget sector, NIB, and SIF. This level of compilation entails the deduction of Budget Sector borrowings from NIB, MOF
securities held by the SIF and NIB, the SIF bonds, and NIB borrowings from SIF. Source: IMF, Haver Analytics, Egyptian Ministry of Finance, CBE, Barclays Research

25 March 2014

90

Barclays | The Emerging Markets Quarterly

EEMEA: GHANA

Testing the boundaries


Ghanas economy is looking increasingly vulnerable as the currency sell-off continues in
2014, while financing costs have risen. Thus far, a clear strategy to address macroeconomic
imbalances is still lacking. Meanwhile, rising inflation suggests further monetary policy
tightening is likely.

Economics, Rates Strategy


Ridle Markus
+27 11 895 5374
ridle.markus@barclays.com

Key recommendations
Credit: Remain underweight, better value in Zambia. Ghanas credit metrics show little

Dumisani Ngwenya
+27 11 895 5346

sign of improvement as the countrys fiscal and external imbalances increasingly fuel
concerns about debt sustainability. Ghanas intent to seek additional non-concessional
market financing in international markets may also weigh on investor appetite in
secondary markets. Spreads have underperformed SSA peers meaningfully, and investor
positioning has likely been defensive in credit. However, international investor exposure
in Ghana local markets at least partially offsets this, and we think a significant
turnaround in policy would be required for sentiment to turn more positive again. We
see better value in other high-yielding SSA sovereigns, particularly Zambia.

dumisani.ngwenya@barclays
.com
Credit Strategy
Andreas Kolbe
+44 (0)20 3134 3134
andreas.kolbe@barclays.com

Rates and FX: We maintain a bearish view on the cedi (GHS). Depreciation pressures have
persisted into 2014, with the cedi weakening a further 7% after depreciating 20% in 2013.
Heightened USD demand means that recent regulatory changes have had limited effect on
easing pressures on the currency. Fundamental factors are unfavourable, with the current
account deficit expected to remain in double digits this year (-12.3% of GDP in 2013). We
believe weak fundamentals will continue to weigh on the currency despite tighter
monetary policy. On balance, we project the cedi to weaken further to about 2.90/USD by
year-end. Following the 200bp increase in the policy rate in February 2014, market yields
reversed their easing trend, which lasted for most of H2 2013. At the short end of the
curve, the 91-day yield has increased 395bp since the end of 2013, while the first bond
auction for 2014 saw the 3y yield jump to 23%. Our view that further policy tightening is
probable, along with ongoing fiscal challenges, suggests further upside potential to yields.
We continue to expect yields to peak above 25% in the months ahead, while the country
remains susceptible to a large foreign sell-off in local bonds.

FIGURE 1
Ghanaian yields have spiked in recent months

FIGURE 2
Fiscal deficit at risk of being missed again in 2014
0

24

-2

22
20

-4

18

-6

16

-8

14

-10

12

-12

10
8
Jan-10

-14
Jan-11
Policy rate (%)

Jan-12
91-day

Source: Official offices, IMF, Barclays Research

25 March 2014

Jan-13

Jan-14

1 Year Note

2008

2009

2010

2011

2012 2013F 2014F 2015F

Fiscal balance (inclu. grants, % GDP)


Source: BoG, Barclays Research

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Barclays | The Emerging Markets Quarterly

Fiscal and external concerns unresolved


Urgent action needed to
stabilize public finances

A former minister of state at the finance ministry, Dr Osei, noted recently that the current
wage bill is unsustainable, proposing that the government defer further payment of the
single spine salary (SSS) and retrench some public sector workers. Finance Minister
Terkper disagreed, however, noting that since the migration to the SSS was substantially
completed, the government cannot go back to previous systems. Finance Minister Terkper
is awaiting a report on the wage issues before taking action, while the government
proposed a moratorium on wage increases in the most recent budget. The reality is that
more urgent action is needed to address the countrys large fiscal deficit, which was 10.2%
of GDP in 2013. While Finance Minister Terkper is under pressure to show some fiscal
consolidation, we fear that some of the measures taken to improve revenue collection and
contain spending (eg, by reducing various subsidies) may not be adequate to stabilise
public finances. The 2014 budget shows a 17.7% y/y increase in fiscal spending, and the
fiscal deficit target remains a large 8.5% of GDP. The governments problem is not just the
issue of the size of the fiscal deficit, but also its history of being missed to the upside; the
credibility of governments policies will be weakened further if fiscal slippages continue.

Fiscal outlook not promising


with risk of further slippage

On 26 February, the IMF released a statement on Ghana that said In the absence of further
measures, the mission sees the fiscal deficit target of 8.5% of GDP at risk. The IMF called
for urgent measures to address macroeconomic imbalances, adding that, despite recent
measures, additional fiscal savings are required to address short-term vulnerabilities,
contain rising public debt and reduce interest rates. We share the IMFs views that the
deficit target is at risk of being missed again, particularly as we believe that revenue targets
appear ambitious in the current environment (the 2014 budget assumes a 25% y/y increase
in revenues) and that it may be very difficult to contain wage increases when inflation
continues to rise. Coupled with the risk of overruns on the wage bill, the continuing increase
in bond yields suggests that interest costs may once again be a major contributor to the
deficit target being missed.

Further questions on debt


sustainability though IMF
remains positive

Meanwhile, the debt situation remains challenging: we estimate that debt may have been
c.55% of GDP by end-2013 (last official print: 52% of GDP at the end of September 2013).
Sustained large fiscal deficits and the countrys appetite for debt to expand infrastructure
mean that questions about debt sustainability are becoming more frequent among market
commentators. In a paper released in mid-2013, the IMF noted that the countrys debt risk
has risen yet remains moderate. That said, this is contingent on fiscal consolidation being
realised as planned and continues beyond the medium term.

FIGURE 3
Rising debt levels becoming a concern

FIGURE 4
Current account deficit a significant source of vulnerability

70

60

-2

50

-4

40

-6

30

-8

20

-10

10

-12
-14

0
2008

2009

2010

2011

External debt (% GDP)


Source: IMF, MoFEP, Barclays Research

25 March 2014

2012

2013F 2014F 2015F

2008

2009

2010

Domestic debt

2011

2012 2013F 2014F 2015F

CA balance (% GDP)
Source: BoG, Barclays Research

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Barclays | The Emerging Markets Quarterly


Only marginal improvement in
current account deficit
expected in 2014

The large fiscal deficit is also largely responsible for the persistently large, double-digit
current account deficit. In Ghana: Under pressure, December 2013, we highlight the plight
of the gold sector in 2013, which saw production decline 4% y/y and gold earnings 13% as
lower prices contributed to the sectors woes. The outlook for the sector is uncertain, with a
number of mining companies having announced plans to retrench workers and scale back
production. In 2013, gold and cocoa export receipts declined USD1.3bn. The outlook for the
cocoa sector remains upbeat, though the sharp run-up in cocoa prices over the past twelve
months is also unlikely to continue (+43.6% y/y), in our view. Furthermore, Tullow Oil
announced in January that it is scaling back oil production amid delays on gas processing,
with production projected to average 100,000bpd in 2014, on par with last years levels. As
such, oil revenues may be flat in 2014 unless oil prices move substantially higher (our
Barclays commodities team expects oil prices to remain flat in 2014). In contrast to the
somewhat uncertain outlook for exports, we believe that imports are likely to remain strong
despite the weaker exchange rate, driven by the importation of capital and consumer
goods. Against this backdrop, we project a current account deficit of 12% of GDP, only
marginally better than the 12.3% recorded in 2013. The current account deficit is likely to
be financed through still-strong FDI and Eurobond proceeds, while the government is also
looking at additional loans.
The increased risk has acted the countrys sovereign ratings negatively. In October 2013,
Fitch Ratings downgraded Ghanas sovereign rating to B from B+ with the outlook stable.
The downgrade was mainly a result of the governments failure to fully implement fiscal
consolidation, and the countrys external vulnerability also increasing. In December, S&P
revised its outlook for Ghana lower from stable to negative and warned that it may lower
the countrys rating (B) over the next 12 to 18 months due to the weakening fiscal and
external profiles.

Economic growth increasingly at risk


Economic growth slipped in
2013 with outlook for 2014
only marginally better

Following sharply weaker growth in Q3 2013, overall growth in 2013 appeared to have
declined sharply to 5.7% (our estimate) from 7.9% in 2012. Official data from Q3 show
economic growth slowed to 0.3% y/y, compared with 6.7% and 6.1% in Q1 and Q2,
respectively. The decline in Q3 was largely attributed to the industry sector (-11.8% y/y
versus +2.5% in Q2) following a contraction in the mining subsector. The struggling gold
sector saw production decline, while oil production was also cut back. While the agriculture
sector continued its decline as well (-3.8% versus -3.9% in Q2), the services sector

FIGURE 5
GDP growth has weakened significantly in Q3 13, dragging
overall growth for 2013 lower
20

FIGURE 6
Upside risks to inflation suggest further policy rate hikes in Q2
22

18

20

16
14

18

12

16

10

14

12

10

2
0
2010

2011

2012
Real GDP (% y/y)

Source: GSS, Barclays Research

25 March 2014

2013

6
Jan-07

Jan-09
Policy Rate (%)

Jan-11

Jan-13
CPI (% y/y)

Source: BoG, GSS, Barclays Research

93

Barclays | The Emerging Markets Quarterly


continued to expand, albeit at a slower pace (6.7% y/y from 9.2% in Q2). The outlook for
2014 is only marginally better as we believe that weaker gold and oil production may weigh
on overall growth. Moreover, economic growth may be dampened further by the increasing
cost of living amid rising inflation and tighter monetary policy. The continued focus on
expanding infrastructure and improved agriculture output is likely to provide some impetus
to growth in 2014, which we project at 6.1%.
At least another 100bp rate
hike likely in Q2 2014 as
inflation is set to rise further

The outlook for monetary policy is also somewhat uncertain as rising inflation remains a
problem for the Bank of Ghana, despite initial confidence that it could contain inflation. The
depreciation in the cedi (nearly 26% against the USD over the past twelve months), subsidy
reductions and rising food prices remain negative effects. Headline inflation rose further to
14.0% y/y in February, from 13.8% in the preceding month, with food inflation (43.6% of
basket) and utilities inflation underpinning the increase. In addition to food (+7.5% y/y in
February) and utilities inflation (+38.9%), transport inflation (+26.8%) is also rising, with
further increases expected given the currencys woes. Overall, the non-food component
increased 19% y/y in February, compared with 14.2% in September 2013. The medium- to
long-term outlook for inflation deteriorated amid continuing exchange rate depreciation and
likely further increases in fuel and utilities prices. Our projections indicate that inflation may
move above 15% in the near term, well outside the Bank of Ghanas year-end target of 9.5%
and its band of +-2pp. As such, we believe that another 100bp is likely to contain inflation
pressures in the short to medium term. This is in addition to likely further FX regulations.

FIGURE 7
Ghana macroeconomic forecasts
2010

2011

2012

2013F

2014F

2015F

Real GDP (% y/y)

8.0

15.0

7.9

5.7

6.1

6.6

GDP (USD bn)

32.2

39.6

40.7

41.6

40.8

45.0

Current account balance (% GDP)

-8.2

-9.0

-12.1

-12.3

-12.0

-11.1

Official reserves

4.7

5.5

5.3

5.6

6.1

3.7

3.2

3.0

3.1

3.2

Activity

External sector

Months of imports
Public sector
Fiscal balance (% GDP)

-6.5

-4.1

-11.8

-10.2

-9.0

-7.5

Total public debt (% GDP)

46.3

43.7

47.0

54.9

63.7

62.9

8.6

8.6

8.8

13.5

12.8

9.6

Prices
CPI (% Dec/Dec)
USD/GHS (eop)

CPI (% y/y, eop)

1.47

1.55

1.88

2.38

2.90

3.50

Q3 13

Q4 13

Q1 13F

Q2 14F

Q3 14F

Q4 14F

11.9

13.5

15.1

15.1

14.9

12.8

USD/GHS (eop)

2.18

2.38

2.65

2.75

2.80

2.90

Policy rate (%,eop)

16.00

16.00

18.00

19.00

19.00

18.50

Source: BoG, MoFEP, GSS, IMF, Reuters, Barclays Research

25 March 2014

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Barclays | The Emerging Markets Quarterly

EEMEA: GULF STATES

Trouble within
The spat between Qatar on the one hand and Saudi Arabia, UAE and Bahrain on the other is
unlikely to be resolved soon, but nor is it likely to have an immediate major economic effect
on the parties. However, the isolation of Qatar and escalation of rhetoric do not bode well for
investment sentiment and raise questions about the GCC as a political and economic bloc.
Abu Dhabis rollover of USD20bn of debt has reduced significantly Dubais refinancing risk.

Economics
Alia Moubayed
+44 (0)20 3134 1120
alia.moubayed@barclays.com
Credit Strategy
Andreas Kolbe
+44 (0)20 3134 3134
andreas.kolbe@barclays.com
Bayina Bashtaeva
+44 20 7773 7428
bayina.bashtaeva@barclays.com

Credit: Long DUBAIH 17s (DHCOG), MAF perps, DARALA 16s, value in Qatar long-end.
While an escalation of the recent tensions between Qatar and Saudi Arabia, UAE and Bahrain
(GCC-3) is not our base case, risks for the GCC credit space, particularly Qatar, could rise if the
recent developments lead to a re-adjustment of cross-border holdings of securities. However,
from a fundamental stand point, we note that Qatari corporates RasGas, Nakilat and Ooredoo
(Qtel) do not operate in any of the three countries. Moreover, the GCC credit space should
remain relatively well supported by local liquidity and limited linkages to other EM regions that
have been at the centre of recent investor concerns (Russia/Ukraine in particular). Hence, we
continue to see value in select higher-yielding credits in the region, such as DUBAIH 17s
(DHCOG), MAF perps or DARALA 16s, as well as the Qatar sovereign long-end, given the
persistent steepness of the Qatari spread curve (Figure 1).

Intra-GCC tension risks Qatars isolation


Tension between Qatar and its
neighbours reflects a deep
divide on strategic issues

In an unprecedented development in the history of the GCC, Saudi Arabia, UAE and Bahrain
withdrew their ambassadors from Qatar after relations between them soured on account of
various controversial issues (see Saudi Arabia, UAE and Bahrain withdraw ambassadors from
Qatar, 5 March 2014). The GCC-3 wanted Qatar to put an end to its interference in their internal
affairs, to stop sheltering Muslim Brotherhood figures who rally against them, and cease support
for the group in Egypt and other parts of the Middle East. We do not think Qatar will escalate
beyond its defiant response that its foreign policy is non-negotiable. This stance, however,
as well as the insistence of Saudi Arabia and UAE on specific measures such as closing AlJazeera media outlets and restricting movements in the GCC of MB-affiliated activists,
indicates that intra-GCC relations are severely compromised and that the divide runs deep
on strategic issues, notably GCC foreign and security policy.

FIGURE 1
Qatars spread curve remains among the steepest in EEMEA
140

10s30s Z-sprd slope, bp

FIGURE 2
Qatars trade with its neighbors is not significant, but
political and economic isolation could hurt sentiment
16

120

Qatar's trade with GCC and Iran


(2012, share of total)

14.2

14

100

12

80

10

60

40

20

0
Mar-13

7.8
5.2

4.3

May-13

Jul-13

Sep-13

Qatar (42s vs 23 sukuk)


SOAF
Morocco
Source: Bloomberg, Barclays Research

25 March 2014

Nov-13
Turkey
Russia
Hungary

Jan-14

4.7
0.8

0
GCC-3*

UAE

1.7

0.1

0.6

0.3

Saudi Bahrain Oman


Arabia

Share of total imports

0.8 0.6

0.2 0.0

Kuwait

Iran

Share of total exports

Note: GCC-3 refers to Saudi Arabia, UAE and Bahrain. Source:


Barclays Research

Haver Analytics,

95

Barclays | The Emerging Markets Quarterly


Qatars trade with GCC-3 is
about 5.7% of its GDP

Qatars trade with its neighbours is in fact not significant (as is intra-GCC trade in general)
and amounted only to c. USD11bn in 2012, or less than 5.7% of Qatars GDP. The GCC-3
countries account for 14.2% and 5.2%, respectively, of Qatars imports and exports, with
the UAE being the largest trade partner, on account of gas imports from Qatar through the
Dolphin pipeline (Figure 2). Recent threats by Saudi Arabia to block or restrict access to its
air space for Qatari flag-carrying aircraft, or to block Qatars land and sea borders, would
certainly impose material costs to its national airline and severely restrict Qatars ability to
import goods, particularly food. If tensions were to escalate in that direction, however, to
involve economic sanctions or border closures, the UAE could be negatively affected by any
potential retaliatory decision by Qatar regarding gas supply through the Dolphin Energy
pipeline owned by Mubadala. The latter carries about 2bn cubic feet of gas per day from
Qatar to the UAE and Oman, which represents about 4.3% of total Qatari exports and
roughly 30% of the UAE's gas needs, we estimate. While we do not think that interrupting
gas flows is an option, the Qatari government could opt to impose higher royalties or taxes
on UAE counterparts, but we believe this is unlikely at this stage.

Any escalation could result in


greater rapprochement
between Qatar and Iran

We would expect Kuwait to play a role in mediating some solution in the short term but,
given the deep divide, this may not yield results. Should Qatar choose to escalate this
situation by retaliating, we think it will find itself increasingly isolated, which could open the
door for Iran to accelerate the planned rapprochement following recent bilateral visits and
announced intentions to deepen trade and economic relations between the two parties, to
the dislike of other neighbours and GCC partners.

Dubai refinancing risks continue to abate


Abu Dhabi rolled over Dubais
USD20bn debt on more
favourable terms

Away from the intra-GCC infighting, Dubais outlook continues to strengthen. In line with
our expectations, an agreement was signed between Abu Dhabis Department of Finance,
UAEs Central Bank and the Dubai government to refinance Dubais USD20bn debt, which
the emirate borrowed in 2009 to fend off a financial crisis. The roll-over comprises a
USD10bn, five-year loan which was offered to Dubai by the Abu Dhabi government through
two state-owned banks, and USD10bn of five-year bonds that Dubai issued to the UAE
central bank. The agreement extended Dubais debt maturity by another five years at a cost
of 1%, below the 4% charge in 2009. Therefore, Dubais remaining maturities for 2014
should not exceed USD5bn, of which USD1.25bn is for the Dubai government and
USD1.4bn for Borse Dubai which we expect to be refinanced through a combination of
issuance, repayments and restructuring. Thus, we expect Dubais debt to remain around 4041% of GDP over the coming 12-18 months (Figure 3).

FIGURE 3
Dubais debt to GDP is likely to stabilize in the short term, as
refinancing risks have abated
Dubai's government debt

45

60

40

50

35

40

30

30

25

20

20

10

15

0
2008 2009 2010 2011 2012 2013 f 2014 f 2015 f
Govt debt (USD bn)

Source: Haver Analytics, Barclays Research

25 March 2014

Govt debt (% GDP, RHS)

FIGURE 4
Credit growth acceleration should help support growth
amidst expected slowdown in government spending
% y/y
30
25
20
15
10
5
0
UAE

Kuwait

Saudi
Arabia
2011

Qatar
2012

Bahrain

Oman

2013

Source: Haver Analytics, Barclays Research

96

Barclays | The Emerging Markets Quarterly


helping to ease Dubais
refinancing risks considerably

Support from Abu Dhabi should help ease Dubais refinancing risks and give the emirate
enough room for manoeuvre to deal with its financial obligations and sovereign debt
maturing at the level of its Government Related Entities (GREs), while reducing sovereign
risks considerably. The reduction in borrowing costs from 4 to 1 percent could result in
fiscal savings of about USD600mn annually for the Dubai government, In addition, the
announced IPO of the shopping mall and retail unit of Emaar, through which the latter
expects to raise about USD2.5bn, could benefit the sovereign from the upstreaming of
dividends should Emaar decide to redistribute some of the proceeds to shareholders.
Investment Corporation of Dubai (ICD), a quasi-government entity under the auspices of
the Dubai department of finance, owns c.29% of Emaars shares.

Slowdown in government spending to follow


GCC spending growth in Saudi
Arabia and Kuwait is slowing
down

Unlike previous years, much of the expected growth in the non-hydrocarbon sector is unlikely
to be driven by government led fiscal stimulus. The 2014 budget in Saudi Arabia reflected the
announcement made last December by the Saudi Minister of Finance about the need to curb the
rate of spending increases over the coming year, in light of expected downward pressures on
production and prices in the global oil markets. Accordingly, the budget stipulates a rise of only
4% y/y in spending compared to 2013, the lowest projected increase since 2003. With an
expected revenue target of around SAR1.1trn, we anticipate the fiscal surplus to shrink further in
2014 to around 5.1% of GDP down from 7.4% in 2013. The same pattern of fiscal consolidation
is also observed in Kuwait, where the new FY 2014/15 budget, due to enter into force at the
beginning of April, projects spending growth to decelerate to around 4% y/y, compared with an
average growth rate of around 15% last FY. Further, across the region, and notably in Kuwait and
Oman, governments have announced a review of their subsidies systems, which highlights
growing concerns about the need to create savings though subsidy reforms.

but credit growth is


gathering pace, notably in UAE

While government spending is likely to slow and its contribution to growth fall in the years to
come, credit growth will remain robust as investment sentiment improves and project
implementation picks up, notably in the UAE ,in our view. Here, average credit growth reached
7.1% y/y in 2013, its fastest pace since Q4 09, compared with an average of 2.7% in 2012,
while in Kuwait, it reached 7.25% y/y in 2013, compared with only 2.8% y/y a year earlier.
Credit growth in Saudi Arabia, however, decelerated from a peak of 16.4% y/y in 2012 to
around 12.5% y/y in 2013 and 12.3% in January 2014, while private sector credit growth in
Qatar slowed sharply in 2013, though remains elevated at about 12% y/y (Figure 4). Much of
this healthy credit expansion reflects the improvements in bank liquidity in 2013 and
translated into continued improvements in PMI in Saudi Arabia and UAE (Figure 5).

FIGURE 5
Saudi Arabia and UAE PMI point to continued expansion of
economic activity
65

FIGURE 6
Bahrains growth remains moderate
8

Composite PMI (50+= expansion)

(% y/y)

60

4
2

55

50

-2
-4

Saudi Arabia
Source:

Haver Analytics, Barclays Research

25 March 2014

UAE

Nov-13

Aug-13

May-13

Feb-13

Nov-12

Aug-12

May-12

Feb-12

Nov-11

Aug-11

May-11

Feb-11

Nov-10

45

-6
Sep-11

Jan-12

May-12

Non-financial

Sep-12

Jan-13

Financial

May-13

Sep-13

Real GDP

Source: Haver Analytics, Barclays Research

97

Barclays | The Emerging Markets Quarterly

Bahrains outlook continues to be volatile


The political outlook in Bahrain
worsened in Q1 14

In Bahrain, however, the political situation remains volatile and has worsened during Q1 14,
notably around the third anniversary of the 2011 uprising. After two rounds of national
reconciliation talks between the opposition and the government, the parties failed to make
any headway on a settlement between the ruling Al-Khalifa family and the majority Shiite
population. The killing of three Bahraini police in March aggravated the situation and stalled
the political process, while the decision by the authorities to toughen jail sentences for
offending the King compounded the problems.

but the economy is largely


shielded and growth should
reach 4.3% y/y

The spill-over of this turbulence into economic activity is, however, likely to remain limited.
Real GDP growth in Q3 13 expanded by 4.6% y/y with support coming almost equally from
both the oil and non-oil sectors, bringing growth for the year to date to 4.7% (Figure 6), in
line with our GDP growth estimate for 2013 of 4.3%.

FIGURE 7
GCC macroeconomic forecasts
Real GDP (% y/y)

Hydrocarbon GDP (% y/y)

2011

2012

2013 E

2014 F

2015 F

2011

2012

2013 E

2014 F

2015 F

GCC

8.1

5.8

4.0

4.2

4.3

10.5

5.5

1.0

0.0

-0.4

Saudi Arabia

8.6

5.8

3.8

4.0

4.1

11.0

5.7

-0.6

-1.2

-1.5

UAE

3.9

4.4

4.5

5.1

5.5

6.6

6.3

4.1

3.1

2.3

Kuwait

10.2

8.3

3.0

2.6

2.5

15.0

11.9

1.0

0.0

-0.5

Qatar

13.0

6.2

5.3

5.1

5.2

15.7

1.7

0.6

0.2

0.0

Oman

4.5

5.0

4.2

3.9

3.9

2.4

3.4

4.1

1.7

1.5

Bahrain

2.1

3.4

4.3

4.0

4.2

3.4

-8.5

15.1

2.8

2.0

Non-hydrocarbon GDP (% y/y)

Inflation (Avg. % y/y)

2011

2012

2013 E

2014 F

2015 F

2011

2012

2013 E

2014 F

GCC

6.7

5.8

5.5

5.6

5.8

3.2

2.4

2.9

3.4

3.4

Saudi Arabia

8.0

5.8

5.0

5.3

5.5

3.9

2.9

3.5

3.8

3.6

UAE

2.6

3.5

4.8

5.4

6.3

0.9

0.7

1.1

2.3

2.6

Kuwait

3.3

4.0

4.6

4.5

4.3

4.7

2.9

2.5

3.2

3.5

Qatar

10.8

10.0

9.4

8.3

7.9

1.9

1.9

3.1

3.8

3.9

Oman

5.8

5.8

5.7

5.3

5.5

4.0

2.9

2.1

2.2

2.6

Bahrain

1.7

6.6

3.7

4.0

4.2

-0.4

2.8

3.3

3.3

3.1

Current account balance (%GDP)

Fiscal Balance (% GDP)

2011

2012

2013 E

2014 F

2015F

2011

2012

2013 E

2014 F

2015 F

GCC

23.5

24.2

22.4

21.2

20.0

11.2

13.8

9.8

8.1

7.4

Saudi Arabia

23.7

23.2

20.1

18.5

16.7

11.6

14.0

7.4

5.1

4.5

UAE

14.6

17.3

16.1

15.8

15.5

4.1

8.6

8.5

8.3

8.0

Kuwait

41.8

43.2

42.1

40.6

39.4

30.8

32.5

32.9

30.6

29.0

Qatar

30.3

32.0

30.1

28.7

27.4

7.7

11.8

9.5

8.9

8.3

Oman

12.8

10.4

9.9

8.8

7.6

6.3

5.7

4.8

3.8

3.2

Bahrain

11.2

7.3

12.8

11.5

10.9

-0.3

-2.0

-4.4

-4.8

-5.0

Note: *Kuwait and Qatar fiscal year (FY) starts 1 April until 31 March.
Source: National ministries of finance and central banks, IMF, Haver Analytics, Barclays Research

25 March 2014

98

Barclays | The Emerging Markets Quarterly

EEMEA: HUNGARY

Recovery boosts Fidesz


Economics
Daniel Hewitt
+44 (0)20 3134 3522
daniel.hewitt@barclays.com
Local Markets Strategy

Hungarys growth recovery has boosted Fideszs re-election prospects. Other economic
fundamentals have also improved, with inflation lower, the current account surplus
growing, and the fiscal deficit securely below 3% of GDP, allowing a rise in capital
spending. Yet private sector investment remains weak, possibly limiting the durability of
the recovery. Loose monetary policy has made the HUF increasingly vulnerable.

Key recommendations
FX: We are moderately negative on the HUF and recommend using levels of about 310

Koon Chow
+44 (0)20 7773 7572

per EUR to accumulate EUR. Policy rates are near historic lows and HUF liquidity is
ample, which is a source of outflow pressure to repay external loans (the stock of
maturing CHF mortgages is 10% of GDP with 10-15y maturity) and from foreigner
selling of HGBs. The 3% GDP current account surplus provides some offset.

koon.chow@barclays.com
Durukal Gun
+44 (0)20 3134 6279
durukal.gun@barclays.com

Rates: We are underweight HGB, given our currency view and the low HGB yields.
After the spread between EM average and HGB yields reached a multiyear wide in
January, foreigner outflows accelerated. The belly of the HGB curve is probably the most
exposed to re-pricing, as the front end has the anchor of dovish monetary policy and the
back end is the anchor of our relatively positive credit view. Nov20 HGB is the most
vulnerable HGB, given high foreign ownership.

Credit Strategy
Andreas Kolbe
+44 (0)20 3134 3134
andreas.kolbe@barclays.com

Credit: Remain overweight. Hungary credit has likely been a consensus long for many
investors, given the fundamental improvements and the countrys close linkages to the
euro area recovery. Overweight investor positioning and the recent new supply have likely
contributed to the tightening momentum having stalled. However, with Hungarys
issuance needs in international markets now largely met for 2014, we continue to think
that Hungary credit offers value. Given the relatively steep curve versus most EEMEA
peers, we see value in Hungary $41s in particular and also reiterate our recommendation
to switch into Hungary from Serbia and Croatia.

FIGURE 1
Hungary yields decline below EM average
%

Yields
cross/inflows
slow

12
11
10

FIGURE 2
Growth slowly reviving on exports and investments
HUF bn

120

130

2008 = 100

5500
5000

120
110
110

4500

4000

100

100

3500

7
6

3000

2500

4
Mar-09

Mar-10

Mar-11

EM local govt. yields


Foreign HGB holdings, RHS
Source: Bloomberg, Barclays Research

25 March 2014

Mar-12

Mar-13

HGB 5y yields

2000
Mar-14

90
90
80
80
70
Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13
GDP

Priv.Cons.

Imports

Invest. (RHS)

Exports

Source: Central Statistical Office, Haver Analytics

99

Barclays | The Emerging Markets Quarterly

Fideszs unorthodox economic policy initiatives to continue


Increased state management
of the economy

Fidesz is apparently on the verge of another election victory and polls indicate it could retain
its super majority. We expect more unorthodox policies in the second term of this
government. PM Orban has reiterated his intentions, including increasing Hungarian
ownership of the banking system to 50%, presumably through buying out loss-making
foreign-owned banks (due to high taxes and NPLs). Another goal is to lower energy prices
for businesses also (to US levels) with energy supplied by non-profit companies (again
through buying out loss-making foreign-owned companies, a process that has already
begun). The Russia-financed building of two new nuclear generators is an important element
of ensuring energy supply, but is not likely to help lower energy costs. Land reform, reindustrialisation, full employment, and demographic planning are other goals PM Orban
mentioned. We think Fidesz will continue to be proactive in increasing government control of
economic sectors, but at the same time try to encourage export-oriented FDI inflows, though
its success has been limited (net FDI has been negative in 2013). A new FX mortgage bail-out
scheme is expected after the election. The central banks Funding for Growth Scheme (FGS)
lending to small enterprises, government job creation, and EU-financed public capital
investments are important elements of the growth strategy.

Improving growth
Growth recovery may prove to
be fragile

Growth recovered in 2013 to 1.2% from the 2012 recession (-1.7%) and we expect it to
increase 2.2% in 2014 and 2.6% in 2015 (Figure 2). The relatively mild trajectory reflects our
view that the recovery is somewhat fragile, overly dependent on government stimulus, rather
than strong underlying market trends (Figure 3). In 2013, growth was helped by a low base
from 2012 (in particular in Q4 13, when real GDP accelerated to 2.7% y/y), the strong
agricultural harvest, less fiscal tightening, and considerable monetary policy loosening. The
strong increase in investment of 16.5% y/y in 2013 reflected almost entirely public sector
projects funded by increased EU transfers (transport, public administration, public utilities, and
energy investment spending were up over 50%). Private sector investment appears to have
stalled, as overall bank loans to businesses continued to fall (Figure 4), notwithstanding cheap
NBH funding to small businesses (FGS). It remained particularly weak in sectors that have
been subject to heavy taxation and regulation (finance & insurance, communication, and real
estate) and FDI net inflows have stagnated. On the plus side, industrial production has been
bolstered by exports-oriented car production (volumes up 21% in 2013), and recently
announced production increases by Mercedes and Audi ensure further gains in 2014.

FIGURE 3
Evidence that growth recovery is underway
20
15
10
5
0
-5
-10
-15
-20
-25
-30
Jan-09

FIGURE 4
Overall bank credit to businesses still declining
20%

Jan-10

Jan-11

Jan-12

Jan-13

Jan-14

40%
35%
15%
30%
25%
10%
20%
15%
5%
10%
5%
0%
0%
-5%
-5%
-10%
-15%
-10%
-20%
Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14
Total MFI corporate loans (const ex. rate, % y/y, LHS)
HUF MFI corporate loans (% y/y, RHS)
FX corporate loans (const. ex rate, % y/y, RHS)

IP (% y/y, SWDA)
Hungary: Retail Sales Volume (WDA, Y/Y % Chg)
Source:

Central Statistical Office, Haver Analytics

25 March 2014

Source:

Central Statistical Office, Haver Analytics

100

Barclays | The Emerging Markets Quarterly

Inflation bottoming at low levels


Very mild inflation pressures

Headline inflation was just 0.1% y/y in February, compared with a 3% target. It was affected
by government administrative price cuts in energy and utilities that lowered inflation 2-2.5pp.
In the opposite direction, increased tobacco, alcohol and financial transaction taxes raised
prices 1-1.5pp. This leaves underlying inflation at 1-1.5%. Also, food prices are falling (-0.4%
y/y) due to the very strong 2013 harvest following the poor 2012 one (when food inflation
peaked at 8% y/y). A measure suggested by NBH research that abstracts from all these effects
is core inflation excluding indirect tax effects, which was up 1.6% y/y in February. We expect
inflation to pick up in the second half of this year, reaching 2% at end-2014. This is due
primarily to powerful base effects as most electricity and utility price cuts fall out of the base
(in H2 13, overall inflation declined -1.0pp) and normalisation of food prices. An important
factor will be the 2014 agricultural harvest; we are assuming an average harvest, in contrast to
the excellent one in 2013. Admittedly, there are still downside risks to inflation from light
domestic demand and low global commodity price pressures.

Excessively loose monetary


policy

Even so, this still leaves inflation far below the 3% target and underlying real rates at about
1%. However, in our view, monetary policy has become excessively accommodative for the
circumstances. The NBH has lowered its policy rate continuously for the past 20 months,
appears likely to lower it to at least 2.5% and may not stop there. At the same time, it has
been increasing liquidity in the system through its FGS. This has caused M1 money supply
growth to increase to over 20% y/y (Figure 5), and bank holdings of 2-week NBH securities
increased to about HUF4,900bn at end-December. This excess liquidity has made the HUF
vulnerable to a market sell-off, in our view. Indeed, the HUF has sold off about 5% this year
(Figure 6). Further rate cuts and FGS lending could lead to further weakness. At this point,
the NBH has become so focused on promoting growth that it no longer seems as concerned
about a HUF sell-off. Thus, we see further HUF downside risk.

Current account surplus helping offset capital outflows


Current account surplus rising
on stronger trade surplus

The current account surplus has been increasing steadily, reaching 3.1% of GDP in 2013,
compared with 1% in 2012. The deepening of the trade surplus has been the main factor,
more due to low imports than strength in exports. Rising car exports have been the main plus
factor while food, fuel, and energy import costs were flat. An increase in EU transfers also
supplemented the current account surplus. In addition, unlike in other countries, income
payments fell. We think further slight strengthening of the current account surplus will occur
during 2014-15.

FIGURE 5
High money supply increase puts risk on the HUF and inflation
12

25

10

20
15

10

0
Inflation target

2
0
Feb-08

Feb-09

Feb-10

Feb-11

Feb-12

Feb-13

-5
-10
Feb-14

Headline CPI (% y/y)

Core CPI (% y/y)

NBH base rate (%)

M1 (% y/y, RHS)

Source: Central Statistical Office, Haver Analytics

25 March 2014

FIGURE 6
Currency weakness as rates stay low
10

320

310

300

290

280

270

4
Mar-12

Jul-12

Nov-12 Mar-13

5y T-bond (%)

Jul-13

260
Nov-13 Mar-14

EURHUF (RHS)

Source: Bloomberg

101

Barclays | The Emerging Markets Quarterly


Withdrawal of foreign investors
from HUF securities offset by
global bond sales

Balance of payments financing has dropped considerably. FDI inflows have fallen sharply, to
near zero. Portfolio financing has dropped as foreign investors have decreased holdings of
HGB, reducing their share to about 36% from a peak of 44% at end-2012. This has been
offset by large global bond sales. Furthermore, bank outflows moderated somewhat, as
banks have already withdrawn so much capital.

Government financing made easy


Deficit is steady, capital
spending increasing

Global bond and retail sales


provide abundant financing

The fiscal deficit is well contained below 3% of GDP; thus, EC conditions are satisfied. With
greater revenue collection because of tax increases on banking and energy, as well as a
pickup in growth, the government was able to raise its capital spending considerably (up
25% in 2013), reversing decreases in previous years. Government bond financing has
increasingly been geared towards retail investors, where net financing surged to 3.5bn in
2013. This easily absorbed the outflows of foreign holdings (1.5bn over the past nine
months). In addition, AKK (the government debt agency) has re-entered the global bond
markets with issuance of USD2bn in November 2013 and an additional USD3bn in Q1 14
(following USD4bn in Q1 13).

FIGURE 7
Hungary macroeconomic forecasts
2010

2011

2012

2013

2014F

2015F

1.0

1.6

-1.7

1.2

2.2

2.6

0.0

-0.8

-3.5

0.6

0.7

1.8

Activity
Real GDP (% y/y)
Domestic demand contribution (pp)
Private consumption (% y/y)

-3.0

0.4

-1.6

0.2

1.4

1.9

Fixed capital investment (% y/y)

-8.5

-5.9

-3.7

5.9

6.1

5.0

Net exports contribution (pp)

1.1

2.4

1.8

0.6

1.5

0.8

Exports (% y/y)

11.3

8.4

1.7

5.3

6.3

6.1

Imports (% y/y)

10.9

6.4

-0.1

5.3

5.5

6.1

128

138

125

130

137

144

0.3

0.6

1.3

4.0

4.9

4.9

CA (% GDP)

0.2

0.5

1.0

3.1

3.5

3.4

Trade balance (goods and serv., USD bn)

3.2

4.3

4.6

6.4

7.7

8.3

GDP (USD bn)


External sector
Current account (USD bn)

Net FDI (USD bn)


Gross external debt (USD bn)
International reserves (USD bn)

1.1

0.8

2.6

-0.4

-0.6

-0.5

185.3

172.1

163.7

141.6

145.4

141.1

45.0

48.9

44.7

37.7

35.7

34.7

-4.4

4.1

-2.2

-2.4

-2.9

-2.9

Public sector
Public Sector Balance (% GDP)
Primary Balance (% GDP)

-0.3

8.4

2.3

2.4

1.9

1.9

82.4

82.2

79.9

79.4

79.1

77.4

CPI (% Dec/Dec)

4.7

4.1

5.0

0.4

2.0

2.1

EUR/HUF, eop

279

311.1

291

297

315

320

1y ago

Last

Q1 14F

Q2 14F

Q3 14F

Q4 14F

-0.8

2.7

2.1

2.5

2.2

2.2

Gross Public Debt (% GDP)


Prices

Real GDP (y/y)


CPI (% y/y, eop)
Exchange Rate (eop)
NBH policy rate (%, eop)
Market implied 3m Bubor

2.2

0.1

0.2

0.4

1.0

2.0

304.3

310

314

315

315

315

5.8

2.7

2.6

2.5

2.5

2.5

2.78

2.66

3.50

4.01

Source: Central Statistical Office, National Bank of Hungary, Ministry of Finance, Haver Analytics, Barclays Research

25 March 2014

102

Barclays | The Emerging Markets Quarterly

EEMEA: IRAQ

Politics delay 2014 budget law


Violence in Iraq has continued unabated and the elections on 30 April could add to this
volatility amid expectations of major changes in political alliances. Passing the 2014
budget will require addressing the stand-off between Erbil and Baghdad over KRG oil
exports. We think the surge in production is a positive surprise, but the 4.1 mb/d target
looks too optimistic and we expect further erosion in Iraqs fiscal buffers in 2014.

Economics
Alia Moubayed
+44 (0)20 3134 1120
alia.moubayed@barclays.com
Commodities

Key recommendations
Credit: Election-related uncertainties may make market participants hesitant to add to

Helima L. Croft
+1 212 526 0764
helima.croft@barclays.com
Christopher Louney
+1 212 526 6721
christopher.louney@barclays.com

positions in Iraq 28s at present. Also, given the deteriorating fiscal position, a new
eurobond issue later this year is a possibility. That said, we think Iraqi spreads are generous
based on the countrys credit metrics. Given Iraqs diversification potential and aboveaverage yield in a Global EM Credit context, we recommend holding on to positions and
suggest seeking renewed buying opportunities when election-related risks dissipate.

Violence in Anbar and across Iraq continues

Michael Cohen
+1 212 526 3606
michael.d.cohen@barclays.com
Credit Strategy
Andreas Kolbe
+44 (0)20 3134 3134
andreas.kolbe@barclays.com

The confrontation in Anbar has


taken a turn for the worse

Violence in Iraq has intensified since our previous EM Quarterly (Iraq Quarterly Outlook:
Realism taking hold), as Iraqi forces raided the home of Ahmed Al-Alwani, a controversial
Sunni MP from Ramadi, and cleared the main Sunni protest camp in Anbar province in late
December. Anbar, home to the countrys Sunni community, was the epicentre for the armed
resistance to the American occupation of Iraq and has remained so for opposition to Prime
Minister Malikis government. These moves set off violent demonstrations, and the Islamic
State of Iraq and Al Sham (ISIS) capitalised on the chaos in the regions two largest cities
and seized control of Fallujah and Ramadi earlier this year, the first time Iraqs Al Qaeda
affiliate had captured Iraqi territory since the US troop withdrawal in 2011 (Iraq: Things Fall
Apart, 6 January 2014).
The instability in Anbar comes on the heels of a particularly violent year in the country.
According to the United Nations, 8,868 people were killed in attacks in 2013, the highest
yearly death toll since the conclusion of the civil war in 2008. Nearly 8,000 of the fatalities
were civilians, with the vast majority coming from the countrys Shiite community. The
death toll YTD for 2014 has reached more than 2,688 (Figure 1).

Adding to Iraqs violent record

FIGURE 1
Alarming uptick in violence in Iraq (number of casualties)
1,200

FIGURE 2
2010 electoral alliances could drastically change on 30 April
(% of seats in Parliament)

Monthly total

1,000

Kurdistan
Alliance
13%

800

Iraq
National
Movement
(Iraqiyya)
28%

600
400

National
Iraqi
Alliance
22%

200
0
Jan-08

Jul-09

Jan-11

Jul-12

Source: UNAMI, Iraq Body Count Project, BBC, Barclays Research

25 March 2014

State of Law
Coalition
27%

Jan-14
Source: Iraqi Parliament, Barclays Research

103

Barclays | The Emerging Markets Quarterly

April elections likely to see major shifts in political alliances


A repeat of the 2010 elections
on 30 April could raise political
risks significantly

The upcoming April elections could add to the volatility. In many respects, the 2010
elections helped steer Iraq onto its current negative political and security trajectory. Prime
Minister Maliki has been heavily criticized for allegedly waging a political campaign against
rival Sunni politicians in the run-up to, and aftermath of, the controversial 2010 polls. His
opponents have also accused him of failing to honour the terms of the power-sharing
agreement that allowed him to secure a second term in office even though his coalition did
not win the most seats in parliament. If the April polls are similar to the 2010 election, it
could push Iraq closer to the brink of another civil war (Geopolitical Update: A cold front).

But political alliances are


shifting

However, pre-election political dynamics suggest that many of the 2010 alliances could
change drastically (Figure 2). On the one hand, the main bloc of Al Iraqiyya (Iraq National
Movement) is disintegrating and three alliances (mostly Sunni) will be competing in the next
elections: the United bloc, headed by Osama al-Nujaifi, the current speaker of the house; the
Iraqi Front for National Dialogue, headed by current Deputy Prime Minister Saleh al-Mutlaq,
and the National Iraqiya bloc led by the former head of the Iraqiya bloc, Ayad Allawi, a secular
Shiaa. On the other hand, Shiite parties allied in the current governing coalition led by PM
Maliki, the State of Law Coalition, seem to have fallen apart, while the Shiite cleric, Muqtada alSadr recently announced his decision to retire from politics and quit the National Iraqi Alliance.
Finally, how the Kurdish parties will decide to ally themselves with other contenders, amid the
ongoing negotiations between Baghdad and Erbil over the exports of the Kurdistan Regional
Government (KRG) oil, remains unclear.

2014 budget law highlights the persistent divide over KRGs oil exports
The budget 2014 has yet to be
approved

Indeed, Iraqs 2014 budget continues to be delayed, partly because of objections from the
Kurdistani Alliance (KA) in Parliament. The KA is objecting to the fact that the KRG has yet to
receive the 17% share of budget revenues for which it is eligible by law in return for the sale of
its oil exports. Kurdish parliamentarians, among others, are also questioning the assumptions
on which the 2014 budget law is based. The proposed 2014 budget targets spending of
IDQ164.5trn (USD141bn), 16.4% more than in the 2013 budget. Budgeted revenues, on the
other hand, are estimated at about IDQ139.6trn (USD 119.7bn) based on the assumption that
Iraq will sell 3.4mn bpd in 2014, compared with the 3.1mn bpd in 2013 (Figure 3). The budget
also assumes that 400,000 bpd should be exported by the KRG, compared with 250,000 bpd
registered in 2013, something that the KA and other Kurdish parties contest. Finally, the draft
law stipulates that all Iraqi oil revenues, including from Kurdistans oil sales, should be

FIGURE 3
2014 budget could result in further fiscal outlook deterioration
% GDP

$/barrel

20

-15

Deficit (% GDP)
Source:

Oil price (RHS, Brent, $/b)

IMF, Haver Analytics, Barclays Research

25 March 2014

2015f

-10

2014f

40

2013e

-5

2012

60

2011

2010

80

2009

2008

100

2007

10

2006

120

2005

15

FIGURE 4
Oil production hit its highest levels in many years
mbpd
4.0

3.5

3.0

2.5

2.0
Feb-08

Feb-10

Feb-12

Feb-14

Source: MEES, Haver Analytics, Barclays Research

104

Barclays | The Emerging Markets Quarterly


deposited in the Development Funds of Iraq (DFI) in the US and be sold through the State
Owned Marketing Organization (SOMO). While the KRGs PM offered on 20 March to send
100,000 bpd of Kurdish oil through SOMO as of 1 April 2014, in an attempt to appease
Baghdads authorities, we remain sceptical about further progress on the general framework
agreement on the management of the hydrocarbon sector,
KRGs exports remain caught in
the political crossfire

In fact, prospects for Kurdistans autonomous oil exports remain caught in the political
crossfire between Baghdad and Erbil (KRG). In January 2012, Erbil halted its exports via the
Baghdad-controlled Kirkuk-Ceyhan pipeline because of disputes over payments to
contractors and revenues from past oil sales. As a result, Baghdad has been receiving less
than half of the 175 kb/d due from the KRG. Since then, Erbil has trucked close to 65 kb/d
to Turkey for export through the Mediterranean port of Mersin. According to MEES, crude
exports are also being channelled through Iran at a rate of 30-40 kb/d. Remaining volumes
have been refined at the KRGs 100 kb/d Kar refinery and other topping plants.

Failure to agree on revenue


sharing arrangements will only
undermine budget targets

The limits on export outlets have also constrained the expansion of production from
Kurdistan. Genels recently completed Khurmala-Fishkabur pipeline linking with a branch
of the Kirkuk Ceyhan network offers an opportunity for incremental exports. The 40-inch
pipeline (with a capacity of 300 kb/d, though there have been KRG claims of 400 kb/d) is
being tested now but has commissioning problems. As storage at Ceyhan and production
capacity in the KRG mount, the KRGs offer may help re-start the stalled negotiations. The
sides remain at odds, however, on revenue sharing and the marketing of KRG oil, which
could undermine budget targets. That said, the KRGs offer indicates that an agreement
over the budget in the next few days will, in our view, depend on whether PM Maliki is able
to extract a political dividend from the Kurds through a potential electoral deal that is much
needed ahead of the 30 April elections.

Recent oil production surge notwithstanding, risks to macro outlook persist


Iraq oil production and exports
surged to highest levels

The deteriorating security situation notwithstanding, Iraqs oil production surged by


530,000 bpd in February to a 35-year high of 3.62m b/d (Figure 4). Iraqi exports jumped by
about 500,000 b/d (20% y/y) due to progress in relieving infrastructure bottlenecks in the
south and favourable weather. Loadings from Basrah indicate 2.5 mb/d of exports have
been sustained through the first week of March. A new central metering platform allowed
the two 900 kb/d single point mooring (SPM) facilities to operate concurrently. A third SPM
is planned by the middle of the year, but additional storage facilities are still required for
these levels to be maintained once new production comes online.

FIGURE 5
Drawdown of DFI balances was significant during 2013
USD bn

USD bn

25
20
15
10
5
0
Nov-08

FIGURE 6
Iraq FX reserves stood at USD67bn at end August 2013

Nov-09

Nov-10

Nov-11

Nov-12

Nov-13

DFI balance (USD bn, eop)


Source: Committee of financial experts, Haver Analytics, Barclays Research

25 March 2014

70
65
60
55
50
45
40
35
30
25
20
Aug-07 Aug-08 Aug-09 Aug-10 Aug-11 Aug-12 Aug-13
FX reserves (excl gold, USD bn)
Source: IMF, Haver Analytics, Barclays Research

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Downside risks to production
and exports are nonnegligible
rendering the 4.1 production
target optimistic

Fiscal performance is unlikely


to improve in 2014

While exports have the potential to stay near record levels, downside production risks
remain acute. Disruptions to the Kirkuk-Ceyhan line continue, and the security situation in
Anbar province has the potential to spread. Without adequate storage capacity, production
growth will be delayed, making the 4.1 mb/d production target announced by the
government overly optimistic, in our view. As such, and cognizant of the recent
improvements, we raise our average yearly production 2014 forecasts to 3.5 mbpd only
from 3.3 mbpd, and 2014 real GDP forecasts from 5.8 to 7.6% y/y respectively, while
recognizing upside risks to this forecast (Figure 7).
The above notwithstanding, we think the rise in production is unlikely to translate into any
major improvement Iraqs fiscal outlook. While we maintain our projected average oil price
per barrel for 2014 at USD 104.5, this is barely above our estimated fiscal oil breakeven price
for Iraq. Moreover, available data highlight an erosion of balances of the Development Fund
of Iraq (DFI) from USD18.05bn at end-2012 to USD10.8bn, their lowest level since February
2010 (Figure 5), a reflection of a deteriorating fiscal performance in 2013, owing to higher
military spending and most likely expansion in spending for electoral purposes. We think
that our estimate of a 0.8% of GDP surplus was not achieved in 2013, although budget
execution data have yet to be published. Given the current political landscape and PM
Malikis attempt to secure a third term, such patterns of fiscal underperformance are likely
to persist in 2014 if the budget is passed as proposed. We therefore reduce our fiscal
balance forecasts to almost zero, from 0.5% of GDP previously and would not be surprised
by further drawdowns on DFI balances.

FIGURE 7
Iraq macroeconomic forecasts
2010

2011

2012

2013E

2014F

2015F

Real GDP (% y/y)

5.857

8.582

8.4

4.9

7.6

7.8

Nominal GDP (USD bn)

135.5

180.6

212.5

225.4

246.2

267.5

Oil production (mbpd)

2.4

2.7

3.0

3.1

3.5

3.8

C/A balance (% GDP)

3.0

12.5

7.0

2.1

3.6

4.2

External debt (USD, bn)*

60.9

61.0

60.2

57.8

28.4

29.0

External debt (%, GDP)*

44.9

33.8

28.3

25.6

11.5

10.8

Gross FX reserves (USD bn, excluding gold)

50.4

60.7

68.7

70.3

73.8

75.7

Activity

External sector

Public sector
Overall fiscal balance (% GDP)

-4.3

4.9

4.0

0.5

0.1

-0.2

Gross public debt (% of GDP)*

52.2

40.2

34.1

28.7

14.5

12.3

2.4

5.6

6.1

1.9

4.5

4.8

1170

1170

1166

1166

1166

1166

Prices
CPI (% y/y, period average)
Exchange rate (USD/Dinar, end of .period)

Note: *Assumes a debt reduction in 2014 by non-Paris Club official creditors, comparable to the Paris Club agreement.
Source: Central Bank of Iraq, IMF, Haver Analytics, Barclays Research

25 March 2014

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Barclays | The Emerging Markets Quarterly

EEMEA: KENYA

Making headway despite challenges


Economics, Rates, FX strategy
Ridle Markus
+27 11 895 5374
ridle.markus@barclays.com

Kenyas economy continues to strengthen despite numerous challenges, including stilllarge twin deficits. Inflation has been brought under control and monetary policy is
likely to remain unchanged in H1. The infrastructure bond continues to offer
opportunities, while the Eurobond issuance is planned for the current fiscal year.

Key recommendations
Rates and FX: Although opportunities remain limited in the local market, we believe that

Dumisani Ngwenya
+27 11 895 5346

the tax-exempt Kenya infrastructure bond continues to offer value. Yields in the
infrastructure bond are currently at 11.9% and have moved only marginally lower since
Q4 13 as the relatively stable inflation environment has led to an unchanged monetary
policy stance. We expect monetary policy to remain unchanged in H1 amid a positive
inflation outlook, which, in turn, results from a stable FX outlook. Despite twin deficits,
KES has not suffered the selling witnessed in some other parts of the region, in part
because the CBK has been effective in its FX management, but also because Kenya had
few of the portfolio inflows in recent years that have become more difficult to maintain
in a less EM friendly global environment. We expect that the KES can remain well
anchored in the months ahead, particularly should the country launch its maiden
Eurobond as planned in the current fiscal year. Over the longer term we do project
modest shilling weakness, and forecast an end-year rate of 90/USD.

dumisani.ngwenya@barclays.com

Economic momentum edging upwards


Economic growth driven by
electricity, trade, construction
and services sectors

Economic growth is estimated to have been 4.6% in 2013, which is flat from the 2012
outcome. Although final quarter data for 2013 is still outstanding, growth appears to have
been underpinned by strong performances in the electricity, trade, construction and
financial services sectors, while agriculture also recorded solid growth despite weatherrelated and productivity challenges. Within agriculture, the 2013 experience was mixed with
tea, vegetable and sugar cane production having recorded strong performances during the
year while coffee production declined. The hotels and restaurant sector declined sharply
(c.10% y/y in the first three quarters of 2013) as security concerns had a negative effect.
Following the fire at Jomo Kenyatta International Airport in August 2013, the Westgate Mall
attack in September may have further weighed on the sector in Q4 13.

FIGURE 1
Policy rate likely to remain unchanged in 2014

FIGURE 2
FX reserves continue to increase, which bodes well for FX
6.5

22

6.0
17

5.5

12

5.0
4.5

4.0
2

3.5
3.0

-3
2010

2011
Policy rate (%)

Source: CBK, Barclays Research

25 March 2014

2012

2013

CPI (% y/y)

2014
182-Tbill yield (%)

Jun-12
Dec-12
Usable FX reserves (USDbn)

Jun-13
Dec-13
Months of imports

Statutory level
Source: CBK, Barclays Research

107

Barclays | The Emerging Markets Quarterly


Real GDP expected to expand
by 5.5% in 2014 on improved
exports, ongoing infrastructure
and accommodative monetary
policy

The outlook for 2014 is more upbeat: during our visit to Kenya in February, the CBK
indicated that it expects growth of c.5% in 2014, somewhat below our estimate of 5.5%. We
look forward to improved weather conditions and anticipated improved demand from key
export markets to provide support to the agriculture sector. Along with the anticipated
improved external sector performance, the ongoing focus on expanding infrastructure and
the accommodative monetary policy environment will lend further support to growth.
Downside risks include the security environment and the countrys narrow export base
(predominantly agricultural), while volatile weather conditions and global growth (if it
disappoints) remain key threats.

Monetary policy likely to remain unchanged in H1


With a stable inflation outlook
over the medium term, we
expect monetary policy to
remain unchanged during this
time

The stable currency has underpinned the favourable inflation environment after peaking
at 8.3% y/y in September, lower food inflation has helped the overall moderation in inflation
to 6.9% in February 2014. The MPC remains unperturbed by credit growth of around 20%
y/y (January 2014), which it sees as still non-inflationary, while it also views fiscal policy as
consistent with the monetary policy objectives. Our projections indicate a stable inflation
trajectory near 7% over the medium term, which is still within the medium-term target of
5% and +-2.5pp around this level. As such, we do not expect any policy rate adjustment in
the remainder of H1. Upside risks to inflation (and thereby monetary policy rate) include a
sharp rise in fiscal spending and volatile weather conditions, which may affect food supply.

Twin deficits remain sources of vulnerability


Current account deficit, despite
narrowing in 2013 (% GDP),
may rise again in 2014 to
10.5% of GDP

Despite hopes of improved demand for exports in 2014, the external sector remains
vulnerable. While there has been a decline in the current account deficit to an estimated
8.1% of GDP in 2013 from 10.5% in 2012, some key sectors remain exposed. These include
agriculture and manufacturing, with coffee exports sharply lower. Export data for the twelve
months to October 2013 show a 4% y/y decline, while imports rose 1% amid still-strong
imports of manufactured goods and capital goods. We expect the current account deficit to
rise to 10.5% of GDP in 2014 in the wake of continued strong capital goods imports.

Devolution is putting upside


pressure on fiscal spending

On the fiscal side, uncertainties particularly in terms of its eventual cost about the rollout of the devolved system of government remain. Effective implementation of devolution
was a key precondition to its success, though a lack of clarity on respective roles of the
national and country governments, lack of supportive legal framework, power struggles
among governors and the national assembly, overspending and lack of skills at the country

FIGURE 3
Devolution putting upside pressure on fiscal deficit
0
-1
-2
-3

FIGURE 4
CA deficit to remain wide amid large imports
60

50

-2

40

-4
-5

30

-4
-6
-8

-6

20

-7
-8
-9
-10
FY2007

FY2009

FY2011

FY2013

Fiscal balance (% GDP, rhs)


Source: Kenyan National Treasury, Barclays Research

25 March 2014

FY2015

Public debt (% GDP)

-10

10

-12

-14
2006

2008

2010

2012

2014F

Current account balance (% GDP)


Source: CBK, Barclays Research

108

Barclays | The Emerging Markets Quarterly


level are just some of the challenges of the new system. The exercise has been costly, with
nearly a quarter of total central government revenue being spent on devolution.
Nonetheless, during our recent visit to Kenya, the central government acknowledged the
initial problems but seems to be dealing with them in the appropriate manner. Separately,
the national assembly recently proposed reining in the powers of county governors in an
effort to make them more accountable.
The fiscal deficit has been
revised upwards to 8.7% of
GDP for FY2013-14 as a result
of the cost of devolution

Ultimately, we believe that the system of devolved government is likely to be costly should
systems to ensure accountability fail. This could, in view of the IMF, derail fiscal discipline and
erode the recent success toward gradual consolidation leaving lower buffers to deal with
adverse shocks. Major spending pressures emanating from devolution have caused
authorities to adjust the deficit for FY2013-14 upwards to 8.7% of GDP from the initial 7.9%.
Still, we believe upside risk remains to the FY2013-4 deficit target. The government is
considering the Eurobond, domestic borrowing and multilateral support to finance the deficit.

Kenya likely to seek IMF


program to provide BoP and
budget support

Positively, we believe that Kenyan authorities may seek another Extended Credit Facility
(ECF) program from the IMF to replace the one that had come to an end in December 2013.
The previous ECF was intended to provide balance of payments assistance and budgetary
support.
In terms of longer-term risks, we believe that the ICC case against Kenyas President and
Deputy President is unlikely to have any effect on local markets in the medium term. The
trial against President Kenyatta has been postponed indefinitely from the 5 February 2014
date, while that of Deputy President Ruto will continue. There has been increased pressure
from the African Union for the cases to be withdrawn, while the withdrawal of witnesses
has also been hampering the cases. As such, we see any risk pertaining to these cases as
limited over the medium term.

FIGURE 5
Kenya macroeconomic forecasts
2010

2011

2012

2013F

2014F

2015F

Real GDP (% y/y)

5.8

4.4

4.6

4.6

5.5

6.1

GDP (USD bn)

32.2

34.1

40.9

44.0

47.9

52.7

Current account balance (% GDP)

-7.8

-9.8

-10.5

-8.1

-10.5

-11.8

Gross reserves (USD bn)

4.0

4.2

5.7

6.1

7.0

3.9

3.7

4.3

4.1

4.2

-7.2

-5.0

-5.6

-6.8

-8.7

-6.0

48.1

54.2

49.6

51.7

53.7

53.3

Activity

External Sector

Months of imports
Public sector
Fiscal balance (% GDP)1
1

Public Debt (% GDP)


Prices
CPI (% Dec/Dec)

4.5

18.9

3.2

7.2

7.5

7.2

USD/KES, eop

80.75

85.07

86.00

86.31

90.00

93.50

Q3 13

Q4 13

Q1 14

Q2 14F

Q3 14F

Q4 14F

CPI (% y/y, eop)

8.3

7.2

6.8

6.9

5.8

7.5

USD/KES (eop)

86.40

86.31

86.60

87.20

88.50

90.00

8.50

8.50

8.50

8.50

8.50

8.50

Policy rate (%, eop)

Note1: Fiscal year ending. Source: IMF, CBK, IHS-Global Insight, Barclays Research

25 March 2014

109

Barclays | The Emerging Markets Quarterly

EEMEA: LEBANON

With or without you


Economics
Alia Moubayed
+44 (0)20 3134 1120
alia.moubayed@barclays.com
Credit Strategy

Lebanons new government faces daunting socio-economic and security problems. Any
efforts to revive growth or reverse the deterioration in public finances are likely to be
constrained. We think the uncertain outlook at the institutional level due to electoral
milestones will leave this and future governments with limited opportunity to improve
economic conditions during 2014.

Key recommendations
Credit: Lift to neutral. Although the political and economic backdrop does not seem

Andreas Kolbe
+44 (0)20 3134 3134
andreas.kolbe@barclays.com

conducive for increasing allocations to Lebanon credit, we think that relative valuations
in the non-GCC MENA region should attract demand. Morocco and Egypt have
outperformed in particular and for investors seeking to take some profits, we think
Lebanon may be an adequate, higher-yielding alternative, with spreads anchored by
local ownership and the resulting low correlation to global drivers of EM credit
(Figure 1).

A new government in place: Does it matter?


New government wins vote of
confidence

A few days before the looming constitutional deadline, Lebanons deeply divided political
factions agreed to form a new government; on 20 March, Parliament voted by
overwhelming majority to grant a vote of confidence. Unlike similar political crises in 2007
and 2009, in which some form of compromise was reached, the agreement took place
without addressing the fundamental differences between the two opposing camps March
8 and March 14. Namely, Hezbollah is still fighting with the Assad regime forces against the
rebels. At the same time, several elements of the March 14 coalition maintain their strong
ties with regional powers that have been supporting various Syrian rebel factions. The deal
over the new government was achieved only after the Saudis and the Iranians put
significant pressure on their respective allies, amid a severe escalation in security threats.

Preventing a security collapse


it its utmost priority

Indeed, the security situation remains very fragile and could deteriorate further. The recent
battle of Yabroud in Syria (near the Lebanese border), in which Hezbollah played a key role
in securing victory over the Syrian rebels, looks set to renew the violence while raising

FIGURE 1
Based on valuations versus regional peers, Lebanon screens
as increasingly attractive
950

54

Z-sprd, bp

850

Composite PMI (50=expansion)

52

750

50

650

48

550
450

46

350

44

250
150
Feb-13

FIGURE 2
Economic activity weakens further

42

May-13

Aug-13

Feb-14

Lebanon 21s

Morocco 22s

Bahrain 20s

Egypt 20s

Source: Bloomberg, Barclays Research

25 March 2014

Nov-13

40
Jan-13 Mar-13 May-13

Jul-13

Egypt

Sep-13 Nov-13 Jan-14


Lebanon

Source: Haver Analytics, Barclays Research

110

Barclays | The Emerging Markets Quarterly


sectarian tensions between Sunnis and Shiites locally, notably in Northern Lebanon and in
the Bekaa region. Over the past year, the multiple security threats and the absence of a
functioning government in which all political factions were represented have also
challenged the ability of the Lebanese Armed Forces (LAF) to preserve law and order. The
ongoing deep societal divide and continued rise in the number of Syrian refugees have
further contributed to the troubled landscape. As such, the utmost priority of the incoming
government will be to reassert the states authority by providing the needed political
backing for security institutions to fulfil their roles not an easy task given the battle raging
in the neighbouring country.
This government should also
prevent a scenario of
institutional void

Expect more changes in


government before year-end

A coalition government can also prevent a possible scenario of an institutional void at the
executive branch level. Over the next few weeks the Lebanese are faced with a choice between
forging a consensus over who will be put forward to be the next president, or letting deep
divisions and geopolitical power plays lead the country into vacuum at the presidential level,
similar to 2007. According to the constitution, the Parliament will become a voting assembly
as of 25 March, and must elect a president no later than 25 May 2014. Should this not happen,
the current government would assume all powers of the executive branch according to Art 62.
Alternatively, a newly elected president will nominate a new prime minister and form a new
government by June. In either scenario, however, yet another new government should be
formed after Parliamentary elections in November. This uncertain outlook at the institutional
level due to electoral milestones will leave this and future governments limited opportunity to
improve economic conditions during 2014, in our view.

Economic activity continues to weaken


Lebanon PMI remains
below 50
Weakening retail trade and
tourism

With sharp contraction in


exports

The uncertain political outlook and deteriorating situation in Syria continue to weigh on
Lebanons economic activity, as reflected in the January and February PMI prints (43.2 and
45.8, respectively). Tourism sector indicators point to a significant slowdown, with hotel
occupancy rates during January 2014 falling to 36% compared with 50% in January 2013. A
recent study conducted by Beiruts Traders Association showed Lebanons retail trade has
fallen a cumulative 35% over the past two years, a clear consequence of the political
instability the country has been facing.
Notable also is the stagnation in imports, which confirms the severe weakening in domestic
demand, as well as the sharp fall in export growth since April 2013, resulting in a contraction
in exports by 12.2% y/y, the first time since 1997 (Figure 3). This contraction is largely

FIGURE 3
Exports fell by 12.2% y/y for the first time since 1997 while
imports kept stagnant reflecting weak domestic demand
% y/y

FIGURE 4
BoP deficit shrank in 2013, on improvements in non-goods
related current and financial flows

40

USD bn
25

30

15

20

10

20

10

-5
-10

-10

-15
-20

-20

2006 2007 2008 2009


BoP balance
Non-goods net inflows

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Exports (% y/y)
Source: Haver Analytics, Barclays Research

25 March 2014

Imports (% y/y)
Source:

2010 2011 2012 2013


Goods trade balance

Haver Analytics, Barclays Research

111

Barclays | The Emerging Markets Quarterly


explained by the sharp fall in jewellery exports, which topped the list of exporting industries
and accounted for more than 30% of total exports over the period 2010-2012. Given the
above, we do not expect growth dynamics to improve significantly during 2014 and we
maintain our GDP growth forecast at about 1.5% y/y. With political risk remaining elevated
and expectations that there could be one, if not two, changes in government by year-end, we
do not expect any reforms to be enacted or initiatives to be put in place to revive growth.

Further deterioration in debt dynamics is expected


Delay in fiscal reforms due to
government changes will
worsen debt dynamics

Total public debt stood at


146% of GDP at end 2013
Deficit financing increasingly
reliant on bank liquidity

Deposit growth at 6.8% y/y

The composition of the current government and the likelihood of stalled reforms in light of
expected changes in administrations do not augur well for a reversal in deteriorating public
finances. As we highlighted previously (Lebanon Quarterly Outlook: Further institutional
void is looming), public debt dynamics continued to worsen in 2013 with total public debt
increasing by 8.3% y/y compared with 5.9% y/y in 2012, and the debt to GDP ratio
reaching 145.9% compared with 139.5% a year earlier. Total 2013 revenues remained
almost flat, while expenditures rose by 2.5% y/y. As such, the overall fiscal deficit widened
8.0% y/y, reaching 9.3% of GDP, up from 9.0% last year. The widening primary fiscal deficit
is significant in that it more than doubled, registering 0.4% of GDP in 2013 and further
pressured debt dynamics.
In the absence of fiscal reforms, we expect the deficit to continue to widen during 2014 as
the burden of Syrian refugees increases and stagnation of economic activity undermines
revenue generation. Financing the deficit is likely to remain highly reliant on ample domestic
liquidity in the local banking system. In addition to an estimated USD4.8bn deficit we
forecast for 2014, banks will also roll over another USD3.4bn of maturing Eurobonds
(USD1.9bn of principal and USD1.4bn of coupon). After all, they continue to benefit from a
sustained flow of private sector deposits, which grew at an annual average of 6.75% in 2013
compared with 6.84% y/y. That, along with the recent slowdown of credit for the private
sector (9.7% y/y in 2013 versus 10.6% y/y in 2012) should keep the loans to deposit ratio
of the banking system below 40%.

FIGURE 5
Fiscal deficit grew wider reaching 9.7% of GDP in 2013

% GDP

% GDP
6
4
2
0
-2
-4
-6
-8
-10
-12
-14
-16
2003

95
90
85
80
75
70
65
60
55
2005

2007

Primary deficit (% GDP)


Source:

FIGURE 6
Gross public debt rose sharply to 145.9% of GDP at end
2013, as both local and FX denominated debt edged up

Haver Analytics, Barclays Research

25 March 2014

2009

2011

2013

50
2003

Fiscal deficit (% GDP)

2005

2007

2009

FX denominated
Source:

2011

2013

LC denominated

Haver Analytics, Barclays Research

112

Barclays | The Emerging Markets Quarterly


FIGURE 7
Lebanon macroeconomic forecasts
2011

2012

2013E

2014F

2015F

1.5

1.5

1.5

1.5

2.5

Activity
Real GDP (% y/y)
CPI (% average)

5.0

6.6

5.6

4.5

4.1

GDP (USD bn)

39.0

41.3

43.5

45.5

47.8

1,507.5

1,507.5

1,507.5

1,507.5

1,508.5

FX, eop
External sector
Current account (USD bn)
Current account (% GDP)
Net FDI (USD bn)
Gross external debt (% of GDP)1
Gross international reserves (USD bn)2

-4.8

-6.7

-6.9

-7.0

-7.1

-12.4

-16.2

-15.8

-15.5

-14.9

3.4

1.1

0.5

0.4

0.5

173.8

174.8

175.9

174.7

174.9

33.7

37.2

36.7

35.3

34.1

Public sector3
Public sector balance (% GDP)
Primary balance (including grants) (% GDP)
Gross public debt (% GDP)

-6.1

-9.0

-9.3

-10.5

-10.9

4.3

-0.2

-0.4

-1.0

-2.0

137.5

139.5

145.9

153.9

157.0

Note: 1 Includes all banking deposits held by non-residents, including estimated deposits of Lebanese nationals living abroad but classified as residents. 2 Total gross
reserves excluding gold. The national valuation of the latter amounts to about USD11.1bn as at end-2013. 3 Public finance data presentation was modified to account
for a consolidated presentation of fiscal data, which includes capital expenditures executed by the Council for Reconstruction and Development.
Source: Haver Analytics, IMF, Ministry of Finance, Banque du Liban, Barclays Research

25 March 2014

113

Barclays | The Emerging Markets Quarterly

EEMEA: MOROCCO

Challenges resurface as growth slows


We expect growth to slow from 4.4% y/y in 2013, but a rebound in manufacturing exports
and robust domestic demand should keep it at 3.8% y/y in 2014. The narrowing of
external and fiscal deficits seen in 2013 continues but may prove more difficult in 2014.
Renewal of the IMFs USD6.2bn Precautionary Liquidity Line (PLL) is not yet confirmed,
but the authorities will likely leverage the PLLs support and issue a new bond soon.

Economics
Alia Moubayed
+44 (0)20 3134 1120
alia.moubayed@barclays.com
Credit Strategy

Key recommendations
Credit: While we are not turning fundamentally bearish on Morocco, we think that the

Andreas Kolbe
+44 (0)20 3134 3134

recent outperformance in a broader EEMEA credit context and the possibility of nearterm supply justify reducing positions in Morocco credit. Within the non-GCC MENA
region, we think Lebanon could provide a temporary carry-enhancing alternative, until
new opportunities in the primary market emerge.

andreas.kolbe@barclays.com

Non-agricultural growth led by high value-added manufacturing exports


Moroccos 2013 growth was
4.4% y/y, compared with 2.7%
y/y in 2012

Moroccos GDP growth accelerated in Q4 13 to 4.8% y/y, closing the year at 4.4% y/y average
annual growth, below our forecast of 4.8% y/y, but significantly higher than the 2.7% y/y in
2012. This came as a result of a sharp expansion in agricultural output (20.1% y/y), coincident
with a slowdown in non-agricultural output (2.1% y/y/ vs. 4.4% in 2012) (Figure 1).
Since the beginning of this year, indicators have demonstrated continued strengthening
of non-agricultural output supported by improvements in external demand (notably
from the EU). Non-phosphate related exports registered 7.6% y/y growth, led by newly
developing manufacturing sectors (e.g. automobile, aeronautics), with high valueadded content that should gradually benefit from the pick-up in the global recovery,
particularly the EU. Domestic demand is also benefiting from low inflation, an
improvement in agricultural income due to a good harvest, steady increases in public
sector wages and a quasi-stabilization of unemployment levels. The latter rose only
slightly, to 9.2%, in 2013, up from 9% in 2012, driven primarily by youth
unemployment, which increased to 19.3% from 18.6% in 2012 (Figure 2) and remains a
key challenge for the country. In addition, FDI, public investment and banking credit to
capital goods/projects remain supportive of domestic demand. Therefore, we maintain

Rebound in manufacturing
exports and signs of strong
domestic demand bode well
for non-agricultural growth

FIGURE 1
Growth in 2013 driven by the non-agricultural sector

35

% y/y

% y/y

FIGURE 2
The unemployment rate stabilized in 2013, but increased
among the youth and in urban areas
6

25

15

-5

-15

-25

0
2007

2009

2011

Agric. GDP (%, y/y)


GDP (RHS, % y/y)
Source: Haver Analytics, Barclays Research

25 March 2014

2013

2015f

Non-Agric GDP (%, y/y)

25

20

Unemployment rate (%)


18.6

19.3

15
10

16.4 16.3
13.4

14

9.0 9.2

4.0 3.8

4.0 4.5

Rural

With univ. Without


degree
univ
degree

0
Total

Youth
(15-24)

Urban
2012

2013

Source: Haut Commissariat au Plan, Barclays Research

114

Barclays | The Emerging Markets Quarterly


our GDP growth forecast at 3.8% y/y higher than the Bank Al-Maghribs forecast of
3.2% y/y, but lower than the IMFs (4% y/y), and we look for non-agricultural growth
to reach 3.7% y/y in 2014.

The 2013 improvements in the external position will be hard to replicate


2013 CAD narrowed close to
7.4% of GDP

Moroccos CA deficit (CAD) narrowed significantly in 2013, judging by preliminary annual


balance of payments data. While the trade deficit narrowed slightly (-3.2% y/y) over the
past year, remittances remained stagnant, and most improvement in the current account
may have come from a combination of reduction in the income balance deficit, along with a
small improvement in the services surplus and disbursements of official grants. Thereby, the
CAD narrowed significantly to 7.4% of GDP, down from 9.7% of GDP in 2012 (Figure 3).
Improvements in net FDI flows were also significant in 2013, as they rose by 23.2% y/y. In
addition, external borrowing and support from regional (notably GCC) and international
partners helped bolster FX reserves by almost USD1.4bn to reach USD18.4bn at endDecember (excl. gold), the equivalent of almost four months of imports (Figure 5).
In the first two months of the year, the trade balance widened by 4.7% y/y, but largely due
to a tripling of wheat imports. Export growth, on the other hand, registered 2.8% y/y,
mainly due to a sharp drop in phosphate and its derivatives by 18.1% y/y. Excluding the
latter, however, exports rose by 7.6% y/y, benefiting from a remarkable 43.7% y/y increase
in exports of cars as well as growth in exports of electronics (12.2% y/y) and
pharmaceuticals (29.5% y/y), confirming the positive spill-over of the global economic
recovery on manufacturing exports (Figure 4). Non-goods financial flows, however, were
weak: while tourism receipts stagnated, remittances registered a small decline of 3.3% y/y.
The drop in net FDI flows by 60.1% y/y reflects the exceptional FDI operations in the agrofood sectors realized in February 2013. Excluding the latter, net FDI flows rose by 18.6% y/y
during the first two months of 2014. Thus, we expect the CAD in 2014 to narrow only to
about 6.5% of GDP in 2014, helped by relative stability in the trade deficit, against
improvement in the services balance and higher transfers, notably given the recent
disbursements of GCC support of around USD1.2bn. Further reduction in the current
account will be hard to realise, in our view.

Car and electronics exports


rebounded in 2014

And net FDI inflows remain


strong, though slowing down

We forecast the CAD to narrow


to 6.5% of GDP in 2014

That said, in an attempt to encourage capital flows into Morocco, the countrys foreignexchange regulator (Office des Changes-OC) declared that individuals and non-exporting
companies can now open foreign-exchange bank accounts. The relaxation of foreign
FIGURE 3
Moroccos CA deficit narrowed significantly in 2013

FIGURE 4
High value added manufacturing exports contributed the
most to export growth

CAB (% GDP)

% GDP

Contribution to export growth (Jan-Feb, ppt)

6
4

Phosphate

Textile & leather

Aeronautical

-2
-4

Pharmaceutical Ind.

-6
-8
-10
2014f

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

-12

-3.4
-0.5
-0.1
0.1

Agriculture-Agrofood

0.5

Electronics

0.5

Cars/Vehicles

6.7
-6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8

Source: Haver Analytics, Barclays Research

25 March 2014

Source: Ministry of Economy and Finance, Barclays Research

115

Barclays | The Emerging Markets Quarterly


exchange controls, though gradual, is a step in the right direction, in our view, and should help
gradually attract foreign capital. Another decision aimed at encouraging capital repatriation
was taken by the OC, offering one year of amnesty to individuals and companies in Morocco
who repatriate assets, cash and property illegally acquired abroad.

Awaiting a decision on the IMFs PLL


It is unclear whether Morocco
will renew the IMF PLL once it
expires next August

Either way, we still expect


Morocco to issue before
August

Against the backdrop of the relatively large CAD, the key question in the coming few months is
whether Morocco and the IMF can agree to renew the USD6.2bn Precautionary Liquidity Line
(PLL) due to expire in August 2014. The PLL served Morocco well in terms of anchoring
expectations for reforms and providing insurance against external shocks during periods of
weak growth and volatile commodities markets. In its recently published third review under the
PLL, and despite highlighting some areas of underperformance in terms of weaker-thanexpected fiscal and external positions, the IMF appeared broadly satisfied with the
governments reform program, and stated that Morocco continued to meet the PLL criteria. In
principle, Morocco can draw upon the facility any time and use it to support its external
financing needs, something it has not done so far. Instead it sees the PLL as precautionary, and
has used it as a credit enhancer, preferring to access capital markets to finance itself over the
past 18 months. Whether or not the PLL is extended, this strategy is unlikely to change and we
think the government will opt to go to the markets and issue up to USD1bn, leveraging the
PLLs support prior to August.

A bolder move on subsidy reform is needed to reduce the deficit further


Fiscal deficit in 2013 reached
5.4% of GDP down from 7.6%
of GDP in 2012

Moroccos fiscal deficit registered 5.4% of GDP during 2013, in line with our expectations,
narrowing from 7.6% of GDP in 2012. The reduction in the deficit came mainly as a result of
an almost 2 percentage point of GDP reduction in subsidies, after the latter expanded at a
double digit growth rate over the past two years (Figure 6). This was possible through
adjusting the prices and quantities of subsidized products, and indexing prices of three
subsidized energy products to world prices. We expect subsidy reduction to continue in
2014 (the budget targets another 1pp of GDP), and the authorities have already taken
measures to remove subsidies on gasoline and industrial fuel not used for electricity
generation and to reduce the per-unit subsidy on diesel in January.

Besides subsidy reforms,


wages and pension reforms
are needed

Having said that, we maintain our view that the deficit target of 4.9% will be difficult to
achieve, given the growth slowdown and the limited progress on much-needed wage and
pension reforms. After all, Morocco has one of the highest levels of wage to GDP ratios
(11%) compared to regional peers. Moreover, the main public pension fund (the Caisse

FIGURE 5
FX reserves are rising in line with the PLL targets

FIGURE 6
The fiscal deficit closed at 5.4% of GP, in line with our forecasts
% GDP
6

USD bn
24
23
22
21
20
19
18
17
16
15
14

4
2
0
-2
-4

Feb-09
May-09
Aug-09
Nov-09
Feb-10
May-10
Aug-10
Nov-10
Feb-11
May-11
Aug-11
Nov-11
Feb-12
May-12
Aug-12
Nov-12
Feb-13
May-13
Aug-13
Nov-13
Feb-14

-6

FX reserves (USD bn)


Source:

Haver Analytics, Barclays Research

25 March 2014

-8
2005 2006 2007 2008 2009 2010 2011 2012 2013
Overall balance (% GDP)

Primary Balance (% GDP)

Source: Haver Analytics, Barclays Research

116

Barclays | The Emerging Markets Quarterly


Marocaine de Retraites) is expected to run into a deficit starting in 2014 and to exhaust its
reserves by 2021 if no reforms are undertaken. However, as we have indicated previously
(Morocco 2014 budget: An ambitious plan, 3 December 2013), the 2014 budget plans to
introduce parametric reforms to address the structural CRM deficit. While this is a step in
the right direction, we remain concerned about how fast the government will be able to
take action on that front.
FIGURE 7
Morocco - Select macroeconomic forecasts
2010

2011

2012

2013

2014F

2015F

Real GDP (% y/y)

3.7

2.7

4.4

3.8

4.1

GDP (USD bn)

90.7

99.2

96.0

106.0

111.5

118.6

Current account (USD bn)

-3.7

-8.1

-9.6

-7.9

-7.2

-6.5

Current account (% GDP)

-4.1

-8.1

-10.0

-7.5

-6.5

-5.5

Trade balance (USD bn)

18

22.8

22

20.4

19.8

20.1

Net FDI (USD bn)

1.6

2.4

2.3

3.0

3.3

3.6

Activity

External sector

Gross external debt (USD bn)

26.9

31.5

33.3

39.5

44.0

47.5

Gross external debt (% GDP)

29.7

31.7

34.7

37.3

39.5

40.0

Gross international reserves (USD bn)

22.6

19.5

16.4

18.4

19.2

20.5

-4.7

-6.7

-7.6

-5.4

-5.3

-4.8

Public sector
Public sector balance (% GDP)
Primary balance (% of GDP)

-2.4

-3.7

-4.8

-3.2

-2.9

-2.4

Gross public debt (% GDP)*

51.3

54.4

60.2

62

63.1

63.9

0.9

1.3

1.9

2.5

2.6

8.40

8.07

8.60

8.38

8.50

8.52

Prices
CPI (% Dec/Dec)
FX (eop)
* General Government Source: Haver Analytics, Barclays Research

25 March 2014

117

Barclays | The Emerging Markets Quarterly

EEMEA: MOZAMBIQUE

Fiscal gap set to widen


Economics
Ridle Markus
+27 11 895 5374
ridle.markus@barclays.com
Dumisani Ngwenya

Mozambiques fiscal deficit is set to widen markedly in 2014, although unspent capital
gains tax revenues from 2013 should partly offset the planned rise in expenditures.
Future fiscal consolidation will be essential for maintaining a stable debt path.
Nevertheless, economic prospects remain bright, with real GDP estimated at more than
7% for this year and beyond.

Key recommendations
Credit: Better value in Zambia. Questions have intensified regarding Mozambiques

+27 11 895 5346


dumisani.ngwenya@

fiscal management and investment priorities amid an expansionary budget financed


by one-off revenue windfalls and the continued lack of transparency about the
EMATUM financing and management. Steps have been taken to incorporate the
government guarantee into the fiscal framework, as advised by the IMF. However, the
risks to donor relations, to the credibility of public investment management, and to
Mozambiques debt path as well as political risk ahead of the October elections make
the outlook for MEMATU 20s cloudier than current spreads levels and the countrys
upbeat long-term economic prospects would suggest. Given MEMATUs solid
performance versus Ghana, we recently suggested taking profits on our long-standing
buy MEMATU/sell Ghana recommendation. With uncertainties in Mozambique
intensifying, we see better value in Zambia than in MEMATU at present.

barclays.com
Credit Strategy
Andreas Kolbe
+44 (0)20 3134 3134
andreas.kolbe@barclays.com

Fiscal metrics to weaken in 2014


This years budget deficit is
expected to be more than
twice that of 2013, as a
percent of GDP

Our recent trip to Mozambique affirmed our view of a likely marked deterioration in
Mozambiques fiscal balances this year. Although the budget deficit was contained at about
4% of GDP in 2013, it is expected to be more than double this year, in light of an expanded
wage bill and capital expenditure. Unspent 2013 capital gains tax revenues are expected to
offset the increased spending, but the trajectory in the deficit is unsustainable, given that
these revenue flows are one-off. The IMFs release (14 March), following its second review
of the Policy Support Instrument visit, indicated that the fiscal deficit could reach 9.5% of
GDP in 2014, taking into account an expected further 2.9% of GDP in a one-off windfall
revenue. The Fund urged authorities to begin a gradual fiscal adjustment in 2015, including

FIGURE 1
Divergence in recent rating agency action in 2013-2014
BB/Ba2

FIGURE 2
Fiscal deficit to widen sharply in 2014
0
-1
-2

Fitch
upgrade
July2013

BB-/Ba3

-3
-4
-5

B+/B1

-6

S&P revises
outlook neg

-7

B/B2

-8
S&P
downgrade

B-/B3
2010

2011

Moody's (B1)
Source: Bloomberg, Barclays Research

25 March 2014

2012
S&P (B)

2013

2014

Fitch (B+)

-9
-10
2007 2008 2009 2010 2011 2012 2013 2014F 2015F
Fiscal balance (% GDP)
Source: IMF, Barclays Research

118

Barclays | The Emerging Markets Quarterly


reducing the wage bill towards the authorities medium-term target of 8-9% of GDP from a
projected 11% of GDP in 2014. Financing the deficit is expected to be largely from external
sources. Domestic financing of about 3% of GDP includes a 2pp of GDP drawdown of
deposits from the 2013 capital gains tax. Potential slippage ahead of the October 2014
elections and uncertainty regarding donor inflows pose risks to the fiscal outlook. The
expected widening of the fiscal deficit comes amid already high public debt of about 44% of
GDP in 2013.

Economic growth momentum upbeat


Looking for economic growth
of more than 8% in 2014

Amid fiscal expansion, economic growth is likely to remain firm in 2014. We project real GDP
growth to reach an eight-year high of 8.1% y/y, up from an estimated 7.1% in 2013. Although
susceptible to adverse weather patterns, agriculture (23% of GDP) is expected to remain a key
pillar of growth. Flooding has been less severe this year, after the worst floods in more than 12
years were seen in early 2013. In the mining sector, logistical constraints continue to hinder
growth in coal output and exports. Production at Vales Moatize mine was roughly flat at
3.8mn tonnes in 2013, although a ramp-up in output is expected over the medium term as
transport and port bottlenecks are alleviated. Port capacity at Beira (via the Sena railway) and
Nacala (Nacala rail way) is set to be upgraded, with operation of a 18mn tonne per annum
(Mtpa) capacity Nacala railway and port expected to begin in 2015. Current capacity of the
Sena railway of 6.5 mtpa is planned to be trebled in the next two years.

Upgrading the transport


infrastructure is set to boost
coal exports in the medium
term while the development of
the LNG sector is ongoing

The upgrading of transport infrastructure would boost coal output and exports considerably
as capacity at the Moatize mine stands at 11mn tonnes (the mines Phase 2 development is
expected to double production to 22mn tonnes by 2017). Production at the Moatize mine is
in addition to Rio Tintos Benga mine while further exploration is ongoing. With progress in
improving rail and port infrastructure, coal is likely to surpass aluminum as Mozambiques
largest export in the next 2-3 years. Stoppages of shipments, associated with flooding
and/or security concerns, as observed in 2013, are the main risk to this outlook. Meanwhile,
development of the natural gas sector is ongoing with Mozambique expected to be among
the worlds largest exporters of LNG by the turn of the decade. Against this backdrop, the
overall growth of the mining sector is likely to remain firm in the medium term, after
averaging above 25% y/y in 2013.
Monetary policy is also likely to remain growth-supportive, with inflation (2.3% y/y in
February) expected to remain contained. Headline inflation continued to ease through H2
13 into this year, underpinned by decline in food prices and relative stability of the MZN.

FIGURE 3
Inflation close to historical lows

FIGURE 4
FDI to remain firm

18

50

16

40
30

14

20

12

10

10

-10

-20

-30

-40

0
Jan-08

-50

Jan-09

Jan-10

SLF rate, %
Source: INE, Barclays Research

25 March 2014

Jan-11

Jan-12

SDF rate, %

Jan-13

Jan-14

CPI (% y/y)

2006 2007 2008E 2009 2010 2011 2012 2013 2014F


CA balance (% GDP)

FDI (% GDP)

Source: IMF, Barclays Research

119

Barclays | The Emerging Markets Quarterly


Subject to our expectation of a marginal depreciation in the MZN over the rest of 2014, we
believe headline inflation will end the year within the 6% target. Despite this outlook, we
expect the Bank of Mozambique to remain on hold through the next quarter, after
substantial rate cuts in the current cycle.
Current account deficit likely to
remain elevated in 2014,
although sufficiently financed
by FDI

In the external accounts, we expect the current account deficit to remain elevated (43% of
GDP) because of strong FDI-related imports (currently mostly consisting of service imports).
With coal gaining visibility in the export basket and aluminum accounting for the largest
share of exports (c. 31%), export revenues are vulnerable to a sharp drop in global
commodity prices. FDI was about USD6bn in 2013 (c. 43% of GDP) and is expected to
remain near this level in the medium term. Given that the large current account deficit is
linked to imports that are FDI-financed, it poses limited risk of a disorderly depreciation in
the MZN in the months ahead.

Political noise ahead of the October general elections


Frelimo and Renamo resumed
talks in January after
heightened tensions in 2013

On the political front, the resumption of talks between the ruling Frelimo Party and the
Renamo Party from late January 2014 signals a positive development. Tensions between the
two parties escalated in 2013, with Renamo stating in October that it is pulling out of the
peace accord that ended the 16-year civil war in 1992. Amid heightened tensions last year,
Renamo did not participate in the November 2013 local government election, thereby losing
all its municipal representation. The latest talks have led to agreement on changes on the
composition of the National Electoral Commission (CNE), which was a key deadlock issue
between the parties. Frelimo and Renamo have also recently expressed a common will for
peace (Reuters, 4 March).

Political volatilities to persist


ahead of the elections

Although the Frelimo Party won all but four of the 53 municipal assemblies, the elections
significantly changed the political landscape, with the MDM gaining popularity, particularly
in the main cities. The MDM will be a major challenger to Renamos current position as the
party with the second most seats in the Frelimo-dominated parliament. Ahead of the
October elections, Frelimos Central Committee in early March voted for Defence Minister
Nyusi to be the partys presidential candidate in the upcoming elections, with President
Guebuza currently serving his final term. Though there appears to be recent improvement in
the political climate, we believe political noise is likely to persist ahead of the elections.
Security challenges remain, particularly in the Sofala region where there has been
intermittent fighting of Renamo-aligned militants with the army.

FIGURE 5
Mozambique macroeconomic forecasts
2010

2011

2012

2013

2014F

2015F

Real GDP (% y/y)

7.1

7.3

7.2

7.1

8.1

8.2

GDP (USD bn)

9.3

12.5

14.4

15.1

16.5

18.5

-11.7

-23.9

-44.7

-43.0

-43.8

-42.2

2.1

2.4

2.8

3.1

3.6

Current account balance (% GDP)


Gross reserves (USD bn)
Months of imports
Fiscal balance (% GDP)

4.2

3.0

3.9

3.1

3.3

-4.3

-5.3

-4.1

-4.6

-9.5

-8.3
49.3

Total public debt (% GDP)

45.8

39.6

41.9

44.3

46.9

CPI1 (% Dec/Dec)

16.6

5.5

2.2

2.9

4.8

6.4

USD/MZN (eop)

32.58

27.31

29.75

30.08

32.00

32.80

Q1 13

Q4 13

Q1 14F

Q2 14F

Q3 14F

Q4 14F

CPI (% y/y, eop)

4.3

2.9

2.6

2.6

4.2

4.8

USD/MZN (eop)

30.10

30.08

31.95

31.72

31.90

32.00

Policy rate2 (%,eop)

9.50

8.25

8.25

8.25

8.25

8.25

Note 1 Maputo CPI (used for policy purposes), 2) Standing lending facility rate (SLF) Source: IMF, BoM, INE, Barclays Research

25 March 2014

120

Barclays | The Emerging Markets Quarterly

EEMEA: NIGERIA

Undermined by uncertainties
Nigerias economy continues to expand at a solid pace despite a deteriorating security
situation, increased political disputes, mounting governance concerns and management
changes at the central bank. Although inflation has been stable, deteriorating investor
sentiment resulting in a weaker naira suggests imminent monetary policy tightening.
Yields on the 1y T-bill have risen further in recent months.

Economics, Rates, FX Strategy


Ridle Markus
+27 11 895 5374
ridle.markus@barclays.com
Dumisani Ngwenya

Key recommendations

+27 11 895 5346

Credit: As a credit benefitting from higher energy prices and largely uncorrelated to the
recent geopolitical developments concerning Russia/Ukraine, Nigeria spreads have seen
some support. However, Nigeria has underperformed most regional peers such as Angola or
Gabon, which we think is justified given the political and economic uncertainties and
pressures Nigeria faces ahead of the 2015 presidential elections and the likely eurobond
supply from Nigeria this year. We continue to think that better investment opportunities
may again arise in Nigeria local markets (see below) or elsewhere in the SSA credit space.

dumisani.ngwenya@
barclays.com
Credit Strategy
Andreas Kolbe
+44 (0)20 3134 3134
andreas.kolbe@barclays.com

Rates and FX: Nigerian yields remain among the highest in the region with the yield on the
1-year T-bill trading above 15%. The rise comes amid a deteriorating macro backdrop, as
increased political noise and the suspension of Central Bank of Nigeria (CBN) Governor
Sanusi caused considerable uncertainty with regard to policy direction. Moreover, the neardepletion of fiscal buffers and the expectation of higher fiscal spending ahead of the 2015
elections cloud the outlook further. The mounting uncertainties have resulted in
deteriorating investor sentiment, which is reflected in increased demand for FX, putting the
naira under considerable pressure. Attempts by the CBN to intervene on a daily basis may
have narrowed the daily trading range to USD164-166, but it has also resulted in FX
reserves falling to below USD40bn (from USD49bn in early 2013), raising questions of how
much longer the Bank will be able to support the naira. With an increasing risk of larger
capital outflows, we believe that the naira may soon be devalued. At the same time, amid
additional policy tightening to drain liquidity, we believe yields may rise further and we
therefore recommend waiting for better entry levels in local rates until conditions stabilise.

FIGURE 1
Nigerian yields higher across the curve (%)

FIGURE 2
Official USDNGN rate versus interbank (spot) rate

16

170

15

160

Devaluations of naira

Another devaluation
coming?

150

14

140

13

130

12

120

11

110

10

100
Jan-08

3m

6m

1y
Mar-13

3y

5y
Sep-13

Source: CBN, Bloomberg, Barclays Research

25 March 2014

7y

10y
Mar-14

20y

Jan-09

Jan-10

Jan-11

CBN Official rate (USDNGN)

Jan-12

Jan-13

Jan-14

Spot USDNGN

Source: CBN, Reuters, Barclays Research

121

Barclays | The Emerging Markets Quarterly

Deteriorating risk environment naira-negative


Challenges persist, resulting in
policy reforms being neglected

Nigerias challenges have not abated since the publication of our previous Emerging
Markets Quarterly. Security challenges persist; political disputes are ongoing; allegations of
mismanagement and waste within the government continue; and monetary policy concerns
have intensified following the suspension of CBN Governor Sanusi. Policy reforms have also
been neglected as the executive appears too distracted by other events in the economy.

We expect the security


situation to continue to
deteriorate in 2014

The security situation in the north of the country appears to have worsened. President
Jonathan has, however, replaced the Ministers of Defence and Police in search of new
strategies to defend against Boko Haram. We fear that ethno-religious tensions may stretch
security forces further, particularly when campaigning starts for the February 2015
elections. President Jonathans likely participation in this election is expected to add to
tensions. At the end of February, Nigerias Independent Electoral Committee warned
politicians not to start their election campaigns early to avoid overheating the political
environment (campaigns are officially set to start 16 November 2014, ahead of the 14
February 2015 elections).

Sanusis suspension has seen


pressure on naira increase

Although the political environment has heated up, with more ruling PDP members crossing
over to the opposition APC in January, the spotlight in recent weeks has been the
suspension of (former) CBN Governor Sanusi at the end of February for alleged financial
recklessness and misconduct. Sanusi, who indicated he will not return even if his
suspension is lifted, was replaced by Deputy Governor Dr. Sarah Alade. Meanwhile,
President Jonathan nominated the Managing Director of Zenith Bank, Mr Godwin Emifiele,
as successor to Sanusi. Mr Emifiele, once confirmed, will take up his position in June. The
increased policy uncertainty continues to be felt in the currency market as demand for FX
has risen despite attempts by both Dr Alade and Finance Minister Okonjo-Iweala to calm
markets. Pressure on the currency has been exacerbated by Sanusis suspension.

We believe a devaluation of the


naira is imminent

The former governors removal is just one of many events that appeared to have dented
investor confidence in Nigeria as this coincided with Fed tapering and the flight of capital
out of riskier EM markets. Pressures persist despite the CBN intervening daily in recent
weeks to maintain a stable currency, and we believe that a devaluation of the naira parity is
likely. FX supply totalled USD7.7bn in the first two months of 2014, compared with
USD2.7bn in the corresponding period in 2013.

FIGURE 3
Fiscal risks are to the upside given upcoming election

FIGURE 4
FX reserves continue to fall
50

45

-1

40

-1

35
30

-2

25

-2
-3
-3

20

Pre-election
years (elections
held early in
following year)

15
10
5

-4
2005

2007

2009

2011

2013

2015F

0
Jan-11

25 March 2014

Jan-12

Jul-12

Jan-13

Jul-13

Jan-14

FX reserves (USDbn)

Fiscal balance (% GDP)


Source: IMF, FMF, Barclays Research

Jul-11

Source: CBN

122

Barclays | The Emerging Markets Quarterly


We believe that Sanusis suspension brought forward the risk of devaluation as the former
governor resisted devaluing the naira. Given continued pressure on the naira and continued
depletion of FX reserves, we expect the CBN to move the central point of the official rate to
165/USD during the remainder of H1 2014.

Fiscal risk persist despite low budget deficit


Federal government remains
committed to fiscal
consolidation

Finance Minister Okonjo-Iweala released her 2014 Budget proposal in January, which is
based on oil production of 2.39mbpd (down from 2.5mbpd assumed for 2013), a
benchmark oil price of USD77.50/bl, projected average GDP growth of 6.75%, and an
average exchange rate of N160/USD. The fiscal deficit is expected to increase marginally, to
1.9% of GDP from the estimated deficit of 1.85% in 2013, showing the federal
governments continued commitment to fiscal prudence.

though we remain concerned


about low fiscal buffers, with the
ECA close to depletion

However, despite the apparent fiscal prudence, the biggest threat remains the low fiscal
buffers, in our view. The excess crude account balance stood at USD2.5bn in January,
compared with USD11.5bn at the end of 2012. Government revenue (and the economy
overall) remains vulnerable to lower oil prices and production disruptions as close to 80% of
revenues originate from the oil sector. Furthermore, we believe the 2015 elections add
considerable upside risk to the 2014 deficit target, which would be finalised should a
supplementary budget be passed. Before his suspension, former Governor Sanusi supported
the maintenance of tight monetary policy in anticipation of an increase in fiscal spending that
may affect inflation negatively. Our estimates point to a fiscal deficit of c.3% of GDP in 2014.

Monetary policy rate likely to


remain on hold until new
governor arrives

In our opinion, three things will drive monetary policy. Current inflation (7.7% y/y in
February versus a policy rate of 12%) might alone argue for easing monetary policy, but the
threat of a fiscal overshoot (and its related impact on inflation) and the sustained pressure
on the naira suggest otherwise. Rather, we expect policy rates to remain on hold in the
coming months, with the acting governor using open market operations, FX regulations and
other measures to drain excess liquidity, and for the policy rate decision to be left until after
the new governor arrives in June 2014.
Even as monetary policy is expected to remain tight, we believe considerable risk remains
that the inflation target of 6-9% is missed. Should the currency be devalued as we expect, it
would put further upside pressure on the inflation outlook, with our estimates (excluding
the effect of a devaluation) pointing to year-end inflation of 10.4% y/y, driven largely by
food and utilities inflation.

FIGURE 5
GDP expected to remain strong in 2014, albeit marginally
lower
8
7

FIGURE 6
Monetary policy rate expected to remain unchanged, though
we expect other instruments to be used to drain liquidity
16

Average

14

12

5
4

10

1
0
2005

2007

2009

2011

Real GDP (% y/y)


Source: CBN, Barclays Research

25 March 2014

2013

2015F

4
Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14
Monetary policy rate (%)

CPI (% y/y)

Source: NBS, CBN, Barclays Research

123

Barclays | The Emerging Markets Quarterly


Economic momentum is likely
to be maintained despite
challenging conditions

Looking at economic growth, we expect growth momentum to be maintained in 2014 amid


a still-supportive policy environment. The non-oil sector was once again the key driver in
2013, expanding 8.7% y/y in Q4 to push overall growth for the quarter to 7.7% and 6.9%
for the year as a whole. Growth was largely driven by trade, services and agriculture, with
the latter sector benefitting from favourable weather conditions. We project overall growth
of 6.8% in 2014, down only marginally from the previous year, with trade and services
expected to underpin growth. The outlook for agriculture is somewhat clouded by the
increasing security concerns in the northern states. Likewise, the outlook for the oil sector is
also somewhat uncertain given continued shutdowns of pipelines in the Delta as a result of
oil theft. Nonetheless, somewhat better production levels in 2014 are likely after repairs to
key pipelines. The appointment of new Defence and Police ministers and the replacements
of army chiefs bring hope of improved security in the oil producing region. Even so, with
import growth likely to remain strong, we project the current account surplus to decline to
4.6% of GDP from c.8% in 2013.
Meanwhile, the National Bureau of Statistics has once again postponed the rebased GDP
estimates to 31 March (from 10 December 2013) given continued delays over the past
two years, the risk of further delays cannot be excluded.

FIGURE 7
Nigeria macroeconomic forecasts1
2010

2011

2012

2013F

2014F

2015F

Real GDP (% y/y)

8.0

7.4

6.6

6.9

6.8

7.0

GDP (USD bn)

226

243

255

277

309

348

Current account balance (% GDP)

5.9

3.6

8.0

8.2

4.6

5.3

Gross reserves (USD bn)

32.3

32.6

43.8

42.9

37.8

45.5

Months of imports

8.9

6.6

10.7

10.0

7.4

7.9

-3.3

-1.9

-2.3

-2.0

-3.1

-2.3

Fiscal balance (% GDP)


Total public debt (% GDP)

17.8

18.4

19.0

19.7

21.2

21.2

CPI (% Dec/Dec)

11.8

10.3

12.0

8.0

10.4

9.2

USD/NGN (eop)

150

154

159

160

172

176

Q3 13

Q4 13

Q1 14

Q2 14F

Q3 14F

Q4 14F

8.0

8.0

8.4

8.8

9.9

10.4

CPI (% y/y, eop)


USD/NGN (eop)
Policy rate (%,eop)

162

160

165

168

170

172

12.00

12.00

12.00

12.00

12.00

12.00

Note: 1) New GDP estimates are expected on 31 March 2014.


Source: CBN, MoF, NBS, IMF, Reuters, Barclays Research

25 March 2014

124

Barclays | The Emerging Markets Quarterly

EEMEA: POLAND

Smooth sailing
Growth is accelerating, with considerable upside potential. With inflation far below the
target, we expect hikes to be delayed until Q1 15. The current account continues its
uninterrupted improvement as trade flips into surplus; however, external financing has
dried up. With growth recovering, it should be easier to reduce fiscal deficits.

Economics
Daniel Hewitt
+44 (0)20 3134 3522
daniel.hewitt@barclays.com

Key recommendations
FX: We close our bullish PLN trades (against both EUR and HUF). The risk-reward for

Local Markets Strategy


Koon Chow

longs does not seem particularly attractive right now as the positive factors that we had
expected to drive appreciation have not worked. While manufacturing production,
exports and overall GDP growth have done as expected, they have not helped to
strengthen the PLN. Monetary tightening is our trigger for an appreciation but seems
more likely to be a theme for late 2014.

+44 (0)20 7773 7572


koon.chow@barclays.com
Durukal Gun
+44 (0)20 3134 6279
durukal.gun@barclays.com

Rates: The 2-3 year nominal yield curve does not offer, in our view, sufficient risk premia
for an eventual turn in the monetary policy cycle. We look for an upward adjustment in
yields here, which is likely to percolate along the entire yield curve. 2y swaps are closer
to fair territory at about 3.5% and 10y at 4.5% (compared with 3.0% and 4.10%
currently, respectively). We recommend cash-based investors switch into the
benchmark bonds including and shorter than the Apr 16s. For levered investors, we
recommend paying 1y1y IRS, which is currently only 70bp above the policy rate (the low
of the trading range since monetary policy went on hold in July 2013).

Growth takes off


Economy on a solid recovery
path led by exports

Growth is on a steady upward trajectory since Q2 13, and we expect it to accelerate steadily
(Figure 2). Overall, we expect growth to double to 3.1% in 2014 and accelerate in 2015 to
3.5%, a slight improvement from our previous forecasts. Net exports have led the growth
recovery. While exports have expanded (led by cars and other manufactured goods) helped
by the EU recovery, most of the gains have resulted from low imports caused by a 12% y/y
decline in imports of fuels and other crude materials.

FIGURE 1
Bond and swaps likely to adjust higher, led by 2y
%

2.0

0-160bp range for


1y1y-policy

8
7
6
5
4
3
2
1
0
-1
-2

FIGURE 2
Growth upswing in full bloom

130-230bp

60-150bp

(% q/q, SA)

1.5
1.0

2
1

0.0

0
-1

Source: Haver Analytics, Barclays Research

25 March 2014

1y1y - policy

Mar-14

Mar-13

Mar-12

Mar-11

Mar-10

Mar-09

Mar-08

Mar-07

Mar-06

Mar-05

-0.5

Policy

4
3

0.5

PLN 1y1y

-2

-1.0
Dec-09

Dec-10

Dec-11

Dec-12

-3
Dec-13

GDP

Consumption

Investment (RHS)

Exports of G & S (RHS)

Source: GUS, Haver Analytics

125

Barclays | The Emerging Markets Quarterly


Consumption gaining,
providing additional boost

The second leg of the economic recovery is well underway with consumption starting to rise
(Figure 3). We envisage further upside potential for consumption as household real incomes
are rising, causing gains in retail sales. In particular, car sales have shot up in the past few
months. Consumer confidence has improved consistently since Q1 13.

Investments offer
upside potential

Investment is starting to show signs of recovery. Industrial production is increasing and


producer confidence has improved. However, given considerable spare capacity left in the
economy (according to NBP estimates and others), and since the excess capacity will not
disappear until next year, this will likely delay the last leg of the growth upswing. However, a
boost to investment may come from a pick-up in EU transfers expected in 2014-15 as the
new EC budget (2014-20) starts and simultaneously Poland uses up funding from the
previous budget (Figure 4).

Inflation still in low gear, monetary policy on hold


Inflation remains below
the target, but is set to
increase gradually

CPI inflation was 0.7% y/y in February and has remained below the 1.5-3.5% target for over
a year. We think inflation has hit bottom and will accelerate gradually from Q3 14 onward
and rise to 1.3% at end-2014 and 2.3% at end-2015. The decline in inflation represented a
convergence of different disinflationary factors that we think will begin to dissipate. Food
inflation halved due to global food price declines (Poland had an average harvest in 2013,
unlike record harvests in Romania and Hungary). Lower global energy prices contributed to
declines in energy and transport costs. Service inflation declined because of milder wage
increases due to the 2013 economic slowdown. In addition, education costs declined
because of cuts in kindergarten fees, while competition and technology advances brought
communications costs lower.

NBP refrains from excessively


lowering its policy rate

The National Bank of Poland (NBP) is in a strong position because it refrained from lowering
its policy rate excessively, stopping at 2.5%. While this is a record low for Poland, inflation
also hit record lows recently, so real rates remains quite high. With the economy on a
recovery path, there is little reason for the NBP to consider further cuts, even if the ECB were
to cut. The NBP has kept M2 and M3 money supply under control, both rising only 6% y/y
and decelerating, contributing to the low inflation environment; thus, there is no liquidity
overhang in Poland (unlike Hungary and Russia). Part of this is apparently due to Polands
concern to keep the PLN stable, particularly when the government took over open pension
fund (OFZ) assets. Government transfers of FX deposits from the NBP to the Development
Bank (BGK), which are then sold into the market along with EU transfers, has led to a slight
decline in NBP reserves and lower money supply.

NBP keeps money supply


under control

FIGURE 3
With real incomes rising, consumption is gaining

FIGURE 4
EU transfers declined following high levels in 2012

15

14

20

100

Transfers from EU to government


(current plus capital accounts)

80

15

60

13
10

3
12

11

1
0
Feb-10

10
Feb-11

Feb-12

Wage (% y/y, LHS)


Unemployment (%, RHS))
Source: GUS, Haver Analytics

25 March 2014

Feb-13
CPI (% y/y)

Feb-14

40

Peak Nov '12


5

0
Dec-06

20

May-08

Oct-09

Mar-11

Aug-12

0
Jan-14

EU transfers to government (EURbn, 12m rolling)


NBP FX assets (EURbn, RHS)
Source: National Bank of Poland, BGK, Haver Analytics

126

Barclays | The Emerging Markets Quarterly


NBP likely to begin raising rate
in 2015 by a cumulative 100bp

We expect the NBP to keep its policy rate on hold at 2.5% throughout 2014 and only raise
rates in Q1 15. This is in line with NBP forward guidance to keep rates unchanged until at
least the end of September and considered possibly extending this until end-2014.
Furthermore, Governor Belka emphasized that this is a promise the NBP takes very seriously.
We forecast inflation pushing through into the lower end of the 1.5-2.0% target in Q1 15,
which means the real rate will drop below 1.0%, probably a tipping point for the NBP.
Furthermore, we expect inflation to surpass 2% by end-2015. We think gradual rate hikes of
25bp per quarter will be in place until end-2015 when it reaches 3.5%. Ideally, inflation will
settle at about 2.5%, the middle of the target. From there, monetary policy would become
data-dependent.

Current account deficit shrinks


as balance of payments
inflows disappear

Perhaps the most positive macro development over past two years has been the shrinking
of the current account deficit by two-thirds to just -1.3% of GDP in 2013. The trade account
has gone from a deficit to a slight surplus. Much of the improvement is from declines in fuel
imports as export growth has been modest. However, given the weak global environment,
Poland has been able to increase its share of export markets. We think the improvements
have come to an end because the economic recovery will push imports higher. In our view,
the current account deficit will settle at about 1% of GDP. External financing has almost
completely dried up. Net FDI shrivelled to zero in 2013 and has been negative this year.
Portfolio inflows have turned slightly negative as foreign investors decrease their holdings of
government bonds. The main source of external financing is EU transfers (capital account)
and IFI loans.

Trade surplus leads to improved current account

Fiscal policy and pensions


Fiscal deficit being cut to 3%
of GDP in 2015 to meet
EU requirements

Fiscal adjustment discussions have been dominated by the government taking over half of
OFE pension assets. In fact, the government has carried out significant other fiscal
adjustments, bringing its deficit down by 3.5pp of GDP between 2010 to 2013 by freezing
wages and cutting other expenditures. The takeover of OFE assets and reduced OFE
payments have given fiscal accounts an important boost. Government payments to OFE
peaked at about 1.6% of GDP in 2010 and will shrink to about 0.5% of GDP in 2014 and less
in 2015. Another 0.5pp is saved in decreased interest payments on outstanding bonds. On
the other hand, with the adoption of ESA2010 rules, ongoing transfers from the OFE to the
budget will no longer count as revenue. After reaching about 4.4% of GDP in 2013, we
expect the deficit to improve to about 3.8% of GDP in 2014 (under ESA2010, OFE transfers

FIGURE 5
Inflation remains well below the target

FIGURE 6
Current account improves as trade surplus develops

12

40

10

30

Inflation target
(LHS)

-1

-2

-2
Feb-09

Feb-10

CPI (% y/y)

Feb-11

Feb-12

Repo rate (%)

Source: National Bank of Poland, GUS, Haver Analytics

25 March 2014

Feb-13

-4
Feb-14

PPI (% y/y, RHS)

EUR bn.

12m rolling

20
10
0
-10
-20
-30
07

08

09

10

11

12

13

14

C/A balance

Capital Acct (EU Trans.)

Trade Balance

Fin. acct. + Errors & omm.

Source: National Bank of Poland, Haver Analytics

127

Barclays | The Emerging Markets Quarterly

OFE takeover eases


governments adjustment
burden

do not count as government revenue, otherwise there would be a substantial surplus of


about 4.5% of GDP). Then, as per EC forecasts, Poland will need to implement measures of
0.5-1.0% of GDP to lower the deficit to the agreed 3%-of-GDP target in 2015 to graduate
from the excessive deficit procedure. Even though 2015 is an election year (presidential and
parliamentary), we think the government will try to satisfy the requirement, in part due to
embarrassment over the pension takeover. Debt levels have declined to about 50% of GDP
and could ease further if the government reaches its deficit targets as growth rises. The
government has lowered its fiscal responsibility thresholds to 43% and 48% of GDP, while
retaining unchanged the more stringent thresholds of 55% and 60% (the latter of which is
in the constitution).

FIGURE 7
Poland macroeconomic forecasts
2010

2011

2012

2013

2014F

2015F

3.9

4.6

2.1

1.6

3.1

3.5

4.6

4.2

1.1

0.7

1.8

3.0

Private consumption (% y/y)

3.1

2.7

1.0

1.0

2.7

4.1

Fixed capital investment (% y/y)

10.5

9.8

-5.0

-4.2

-1.8

1.6

Activity
Real GDP (% y/y)
Domestic demand contribution (pp)

Net exports contribution (pp)

-0.7

0.4

0.9

0.9

1.3

0.4

Exports (% y/y)

12.2

8.4

3.3

5.0

7.4

8.2

Imports (% y/y)

13.8

5.8

-1.8

1.9

4.5

7.9

469

516

489

516

539

570

-24.3

-26.0

-18.7

-7.2

-6.6

-6.7

GDP (USD bn)


External sector
Current account (USD bn)
CA (% GDP)

-5.2

-5.1

-3.5

-1.3

-1.2

-1.1

Trade balance (goods and serv., USD bn)

-11.7

-14.3

-6.9

2.8

3.8

4.0
0.9

Net FDI (USD bn)

7.0

12.3

5.2

0.3

0.7

Other net inflows (USD bn)

32.6

16.7

23.1

7.4

7.6

7.6

Gross external debt (USD bn)

317

323

366

380

386

392

94

98

109

106

106

106

-7.9

-5.0

-3.9

-4.4

-3.8

-3.0

-5.4

-2.6

-1.3

-1.7

-1.7

-1.0

54.9

56.2

55.6

57.6

50.7

49.8

International reserves (USD bn)


Public sector
Public sector balance (% GDP)
Primary balance (% GDP)
Gross public debt (% GDP)
Prices
CPI (% Dec/Dec)

3.1

4.6

2.4

0.7

1.3

2.3

EUR/PLN,

4.00

4.48

4.09

4.18

4.10

4.10

1y ago

Last

Q1 14F

Q2 14F

Q3 14F

Q4 14F

Real GDP (y/y)

0.8

2.7

2.8

3.0

3.1

3.1

CPI (% y/y, eop)

1.0

0.7

0.9

0.9

0.6

1.3
4.10

eop

Exchange rate (eop)

4.16

4.15

4.14

4.12

4.11

NBP policy rate (%, eop)

3.25

2.50

2.50

2.50

2.50

2.50

2.67

2.71

2.73

2.73

WIBOR 3m rate (%,eop)


Source: GUS, National Bank of Poland, Ministry of Finance, Haver Analytics, Barclays Research

25 March 2014

128

Barclays | The Emerging Markets Quarterly

EEMEA: ROMANIA

On track as political noise intensifies


Economics
Eldar Vakhitov
+44 (0)20 7773 2192
eldar.vakhitov@barclays.com
Local Markets Strategy
Koon Chow
+44 (0)20 7773 7572

Following the ruling coalition split, Prime Minister Ponta formed a new majority government,
gathering support from smaller parties. The new government reiterated its commitment to
the IMF programme. However, the coalition split increases political uncertainty ahead of the
presidential elections in November. Meanwhile, economic growth surprised on the upside,
while the current account deficit seems to have stabilized.

Key recommendations
Credit: Take some profits, some value still in EUR paper. Romania credit has continued
to perform well over the past quarter (albeit underperforming higher-yielding CEE
peers). Romanias macroeconomic performance justifies this, in our view. However, with
further issuance likely and the election period approaching, we do not think Romania
has significant room for further outperformance at current spread levels. Some value
remains in EUR-denominated bonds which, contrary to patterns across most other CEE
credits, continue to trade outside USD bonds in spread terms.

koon.chow@barclays.com
Credit Strategy
Andreas Kolbe
+44 (0)20 3134 3134
andreas.kolbe@barclays.com

FX/Rates: We recommend a small overweight on ROMGB, offsetting the defensive


positions that investors should have on POLGB and HGBs. RON benefits from strong
exports, which have already helped to narrow the C/A deficit significantly, but also has
an advantage over PLN and HUF, because the central bank remains committed to a
broadly stable exchange rate. For leveraged investors, we recommend paying local rates
into further dips. Short-term FX implied yields are low, considering the high probability
that inflation could return to 3% by the end of this year.
PM Ponta formed a new
majority government after the
ruling coalition split

In February, the ruling coalition split as the two main parties, PSD led by PM Ponta and PNL
led by Crin Antonescu, could not agree on a government reshuffle proposed by the PNL.
Notably, the split was not caused by the differences in parties ideologies (PSD is centre-left
and PNL is centre-right), but by the failure to agree on particular ministerial candidates, as
PNL tried to increase its influence within the government. Following the split, PM Ponta
managed to put together a new majority (supported by about 60% of MPs), having
gathered support from the minorities parties and non-affiliated MPs. The new government
already confirmed that it will remain committed to the IMF programme. However, the
coalition split will add to political uncertainty ahead of the presidential elections in

FIGURE 1
ROMGB safe haven
%
10
9
8
7
6
5
4
3
2
1
0
Jul-12

FIGURE 2
Growth accelerated partly due to household consumption
ROMGB: similar yielding as
peers but with lower FX vol.

2%

% q/q, SA

1%

0%

Jan-13
ROMGB 5y
Romanian FX vol.

Source: Bloomberg, Barclays Research

25 March 2014

Jul-13

Jan-14
CE 5y avg.
CE avg. FX vol.

-1%
Dec-10

Dec-11
Real GDP

Dec-12

Dec-13

Household consumption

Source: National Institute of Statistics and Economic Research, Haver Analytics

129

Barclays | The Emerging Markets Quarterly


November. PM Ponta could easily withdraw his support for Antonescu as the joint
presidential candidate, and may either run for the presidency himself or find another
candidate. A recent INSCOP poll suggests Ponta has about 38% support, should he decide
to run for presidency, while Antonescu would get 25% support. Another consequence of
the coalition split is that it now will be harder to agree on planned constitutional changes
which were discussed to limit the powers of the president.
Growth surprised on the
upside, led by agriculture and
industry

Growth surprised significantly on the upside in Q4 13, accelerating to 5.2% y/y (1.5% SA q/q).
This brought annual GDP growth to 3.5% in 2013, one of the highest growth rates in Europe.
Growth in Q4 and in 2013 as a whole was driven almost exclusively by agriculture and
industry that contributed 1.7pp each to the annual figure. Exports at 13% y/y continued to
shine in Q4, being led by food and cars, but with broad-based improvement in almost all
categories. Q4 was also marked by a notable improvement in household consumption, which
accelerated to 3.2% y/y (Figure 2). The negative surprise came from fixed investment, which
contracted by 11% y/y in Q4 and 5.6% y/y in 2013 as a whole. This year, we expect a further
recovery in private consumption to make a significant contribution to growth. Exports should
also improve further, helped by continued recovery in the euro area. However, the effect of
agriculture (assuming an average harvest) on growth will likely be negative this year after a
very high base in 2013. Thus, we expect headline growth to fall to 2.7% in 2014. Excluding
agriculture, we expect growth to accelerate further this year.

Inflation remains low, but the


rate cutting cycle is likely over

Inflation declined further in the winter months, reaching 1% y/y in February. Food deflation
continued at -2% y/y due to an excellent harvest and a VAT rate cut on bread products. Energy
inflation dived in recent months as large energy price hikes were not repeated this year, while
services inflation started to pick up. Inflation may be close to bottoming out, but favourable base
effect will likely keep it near historical lows in the coming months. By the end of the summer, the
base effects will fall out and the new agricultural season will likely lead to higher food inflation
(given a very good harvest in 2013). Together with improving domestic demand, this should
result in higher inflation, which we expect to reach 3.8% by the end of 2014. Meanwhile, the rate
cutting cycle is likely over, with the policy rate at 3.5% being described as well-positioned now
by the governor. The central bank also expressed its satisfaction that monetary policy loosening
finally transmitted into lower lending rates. Private sector lending growth slightly improved in
recent months, but remains marginally positive for RON-denominated loans and negative for FXdenominated ones. The NBR indicated that a reduction in the reserve requirements was needed
to stimulate bank lending and "will proceed at a moderate pace to gradually bring them in line
with European levels." Essentially, this would be another form of monetary loosening, so we

FIGURE 3
Inflation at historical lows, but the cutting cycle is likely over

EUR bn, 12m rolling

21

12%
10%
8%
6%
4%
Inflation
target

2%
0%
-2%
Feb-10

Feb-11

Feb-12
Food CPI (% y/y)

Feb-13

25 March 2014

15

12

-3

-1

-6

-2

Feb-14

NBR policy rate (%)

National Institute of Statistics and Economic Research, Haver Analytics

18

-9
Jan-08

CPI (% y/y)
Source:

FIGURE 4
Current account deficit has stabilized

Source:

Jan-09

Jan-10

Jan-11

Jan-12

Jan-13

-3
Jan-14

Reserves decline (RHS)

Current account deficit

FDI+capital transfers

Other investments

National Institute of Statistics and Economic Research, Haver Analytics

130

Barclays | The Emerging Markets Quarterly


expect the NBR to proceed cautiously with its plan, which could weaken the currency. The RON
has been under depreciation pressures since the beginning of the year, mainly due to the EMwide sell-off, forcing the central bank to intervene heavily at end-January. On a positive note, the
RON seems to have weathered relatively well the political noise in recent months.
Current account deficit
stabilized and will likely
increase in 2014 on recovering
imports

The current account deficit declined to 1.1% of GDP in 2013 (from 4.4% in 2012), driven by
strong exports. In Q4, the deficit was mainly caused by lower direct investment income, which
was offset by higher EU transfers. Overall, the trade and current account trends seem to have
stabilized in recent months, and we see little room for further improvement. Goods exports
continue to expand at robust rates, but imports have also started to pick up in recent months.
We expect this trend to strengthen as consumer demand has started recovering. This will
likely lead to a small widening of the current account deficit in 2014-15. Meanwhile, the
financial account remains in deficit as the government and the central bank continue to
make their regular repayments to the IMF (c.EUR1.4bn per quarter). On a positive note, net
FDI picked up significantly in recent months. NBR reserves declined somewhat recently, but
overall remained at adequate levels (about seven months of imports).

IMF programme is back on


track

The pre-cautionary IMF programme was resumed in February as President Basescu finally
agreed to sign the IMF's letter of intent, paving the way for the completion of the IMF
review. We point out that the programme had been suspended due to the dispute between
the government and the president over a fuel tax in the 2014 budget. The fuel tax will now
be introduced in April, with a three-month delay compared to the government's initial plan.
This delay is expected to be compensated for by additional expenditure cuts, to bring the
budget deficit to 2.2% of GDP in 2014. The budget deficit target for 2013 of 2.5% of GDP
was met. The IMF positively assessed the current progress of the precautionary programme,
mentioning that four out of five performance criteria had been met (only the reduction of
SOE arrears target was missed) and the privatisation programme was on schedule. Recently
though, the government decided to postpone the privatisation of the utility company
Oltenia, which was initially planned for H1. While the IMF programme is precautionary and
does not expect the withdrawal of funds, investors will likely find more comfort from the
programme's resumption, which will increase their confidence in the government's fiscal
credibility and reform path, especially given the current volatility in the markets.

FIGURE 5
Romania macroeconomic forecasts
2010

2011

2012

2013

2014F

2015F

Activity
Real GDP (% y/y)

-1.0

2.2

0.4

3.5

2.7

2.9

GDP (USD bn)

166

183

170

190

201

212

External Sector
Current Account (USD bn)

-7.3

-8.2

-7.5

-2.0

-3.4

-5.1

-4.4
-9.5
2.9
123.8
43.3

-4.5
-9.8
2.5
128.1
42.9

-4.4
-8.0
2.9
130.5
41.2

-1.1
-4.4
3.4
128.4
44.9

-1.7
-5.5
3.0
126.1
42.0

-2.4
-7.0
3.5
123.3
42.5

Public Sector
Public Sector Balance (% GDP, ESA95)
Primary Balance (% GDP)

-6.8
-5.3

-5.6
-3.9

-3.0
-1.2

-2.5
-0.7

-2.4
-0.6

-2.0
-0.2

Gross Public Debt (% GDP)

30.5

34.7

37.9

38.5

38.5

38.0

CA (% GDP)
Trade Balance (USD bn)
Net FDI (USD bn)
Gross External Debt (USD bn)
International Reserves (USD bn)

Prices
CPI (% Dec/Dec)

8.0

3.1

5.0

1.6

3.8

3.9

EUR/RON, eop
Policy rate (%, eop)

4.28
6.25

4.32
6.00

4.43
5.25

4.43
4.00

4.40
3.50

4.40
4.25

Source: National Institute of Statistics and Economic Research, National Bank of Romania, Ministry of Public Finance, Haver Analytics, Barclays Research

25 March 2014

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EEMEA: RUSSIA

Vulnerable giant
Russias economy has entered a negative spiral. We expect growth to decelerate further
this year due to continued weakness in investment and slowing consumption. This
process was already underway before the tensions with Ukraine, but is intensified by the
recent deterioration of relations with the West. Inflation remains above the target,
pushed up by continued RUB depreciation. The Bank of Russia hiked rates and will likely
need to implement further monetary tightening. RUB weakness should help reverse the
current account deterioration, but this may be offset by larger capital outflows.

Economics
Daniel Hewitt
+44 (0)20 3134 3522
daniel.hewitt@barclays.com
Eldar Vakhitov
+44 (0)20 7773 2192
eldar.vakhitov@barclays.com

Key recommendations
FX: We recommend being short the RUB against the EUR-USD basket as the scale of

Local Markets Strategy

portfolio outflows, associated with the high level of political tensions, could easily drive
depreciation beyond the 0.8% per month priced in by the market. We see most of the
pressure in the upcoming quarter and the Bank of Russia (CBR) could realistically be
called to intervene with USD20-25bn per month. Given the CBRs FX intervention
mechanism accommodates a 5 kopeck depreciation for every USD1.5bn of intervention,
this would translate to a 1.6-2.0% monthly depreciation of the RUB versus the basket.

Koon Chow
+44 (0)20 7773 7572
koon.chow@barclays.com
Durukal Gun
+44 (0)20 3134 6279
durukal.gun@barclays.com

Rates: We recommend reducing duration and lowering cash exposure to OFZ, as


elevated FX and rate hike risks weigh on valuations. Foreign ownership levels are
greatest for the OFZs maturing on and after March 2018. We view those as most prone
to pressure and volatility. The 15s, 16s and 17s offer a relatively better safe haven, and
we recommend switching into these instruments. For leveraged investors, the very high
levels of price volatility are a barrier for new positions but flatteners in 2s5s are attractive
if trading conditions improve and prices are still at -55bp. This is similar to Turkey and
below South Africa, but arguably the Russia curve could become more inverted as RUB
FX pressures (and the pressure on policy rates) are greater.

Credit Strategy
Andreas Kolbe
+44 (0)20 3134 3134
andreas.kolbe@barclays.com

Credit: The risk of prolonged Russian-Western tensions and the threat of further
sanctions against individuals and businesses remain clear negatives for Russian credit,
in our view, across the sovereign, corporates and banks. The adverse economic
developments could also put downward pressures on Russias ratings in the medium
term. Even though Russian spreads have underperformed meaningfully already as
FIGURE 1
Not hard to depreciate faster than the forwards

FIGURE 2
Consumption is likely to continue decelerating
15

Basket/RUB

Spot and fwds


$20bn pcm intervention
Source: Bloomberg, Barclays Research

25 March 2014

Jan-15

Apr-14

Jul-13

Oct-12

Jan-12

Apr-11

Jul-10

Oct-09

Jan-09

50
48
46
44
42
40
38
36
34
32
30

$5bn pcm intervention


$25bn pcm intervention

% y/y

% y/y

45

10

30

15

-5
Feb-10

Feb-11

Retail sales

Feb-12
Real wages

Feb-13

-15
Feb-14

Household credit (RHS)

Source: Rosstat, Haver Analytics, Barclays Research

132

Barclays | The Emerging Markets Quarterly


positions adjust to the recent developments, we think this is a structural shift higher in
spreads. We have downgraded Russia sovereign credit to underweight. Among
corporates, we remain most sceptical of Gazprom and Rosneft, while we suggest
maintaining exposure to MTS and Norilsk Nickel.

Weakening consumption and investment weigh on growth


Growth is likely to ease further
in 2014 on lower private
consumption

With growth having decelerated in 2012-13, we forecast a further easing to 0.7% in 2014
from 1.3% in 2013. Private consumption was the main engine behind economic growth in
the past few years, fuelled by double-digit real wage growth and record credit expansion.
However, these high levels are no longer sustainable. With profits falling, we expect slower
increases in private sector wages, along with lower public wage hikes, to weigh on private
consumption (Figure 2). In addition, household credit will likely decelerate further given the
tightening of monetary policy, tighter credit standards, the continuing clean-up of the
banking system and lower credit demand.

and weak investment

The decline in investment spending since mid-2012 has been another reason for slowing
growth. The decline is attributable to lower enterprise profitability (Figure 3) and an overall
weak business climate. Similarly to consumption, private investment will likely suffer further
from tighter monetary policy and the strengthening of bank prudential regulations. In
addition, sizeable investment projects mostly completed in 2012 (Nord Stream, Sochi 2014
Olympics) have not yet been replaced by new projects. The prospects for a near-term
turnaround in investment appear bleak. We expect investment spending to be lower in
selected sectors (eg, steel, rail) and stagnant elsewhere: lower revenue in certain sectors is a
major factor behind the decreases. In addition, the governments decision to freeze utility
tariffs paid by enterprises and lower the rate of tariff increases paid by households could
also have a negative effect. Overall, though, we expect the decline in public investment to be
smaller this year, due to an already low base from 2013.

High dependence on
energy makes Russias
economy vulnerable

Russias growth is vulnerable due to its high dependency on energy exports and lack of
diversification. The high level of growth during 1999-2012 (about 5% per annum,
notwithstanding the 2008-09 recession) was made possible by large increases in global
energy prices (up 4.2% per annum on average), to a lesser extent increases in Russias
energy production (particularly oil), and use of spare capacity (employment increased 20%
as unemployment halved). Even though massive outflows of capital occurred, Russias
current account surpluses were sufficient to handle these without harming growth.
However, this era appears to be over, as global energy prices are expected to remain

FIGURE 3
Declining profitability leads to falling investment spending
% y/y
30
20

RUBbn
5000

14

4000

12

3000
2000

10

1000

0
-1000

-10

-2000
-3000

-20

-4000

-30
-5000
2006 2007 2008 2009 2010 2011 2012 2013 2014
Investment

Corporate profits change (RHS)

Source: Rosstat, Haver Analytics, Barclays Research

25 March 2014

FIGURE 4
Monetary policy tightening was necessary

10
8
6
End-2014
inflation target

4
2
Mar-09

Mar-10
CPI (% y/y)

Mar-11

Mar-12

Mar-13

Mar-14

One-week auction repo (%)

Source: CBR, Haver Analytics, Barclays Research

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Barclays | The Emerging Markets Quarterly


roughly flat this year, albeit relatively high. Furthermore, Russias energy production appears
to be near full capacity and the limited new investment makes significant near-term
improvement unlikely. Efforts are underway to improve the business climate, encourage
more capital to stay in Russia and to attract new FDI to promote economic diversification.
Privatization and market liberalisation could have important effects. Furthermore, the recent
RUB depreciation could provide a strong incentive to decrease imports, contributing to the
diversification of production in Russia, and could improve export performance.

Robust fiscal situation could help


Fiscal accounts to improve on
RUB depreciation and higherthan-budgeted oil prices

Russia still enjoys a strong fiscal position. Government debt hovers at just 11% of GDP and
the budget deficit at 0.5% of GDP in 2013 was lower than the 0.8% planned. The 2014
budget foresees a deficit of 0.5% GDP (RUB389bn), though the Ministry of Finance (MinFin)
already indicated that the actual turnout could well avoid a deficit altogether. The budget is
based on an average oil price of USD101/bbl and USD/RUB at 33. If the average oil price
stays at the current ~USD107/bbl and the USD/RUB averages 37 (ie, c.12% depreciation),
this would bring the budget about RUB400bn and RUB700bn, respectively, in additional
revenue. The exchange rate matters, as oil tax receipts are tied to the oil price in USD and
represent about 50% of the total budget revenues. These additional funds provide the
necessary fiscal space for counter-cyclical policies to stimulate growth. In line with the
budget, gross internal debt issuance is planned at RUB809bn this year. However, the MinFin
has already indicated that it is likely to reduce this amount (and might also cancel external
issuance initially planned at USD7bn for this year), given current market volatility and extra
revenues from higher oil prices and depreciation.

Fiscal stimulus possible


but would take time

Thus, one key question is to what extent the Russian government will use its fiscal space to
actively support growth. After having stressed fiscal conservatism until now, the government
may not want to be seen as being in emergency mode. Thus, any counteracting measures
such as increases in government wages or expansion in public investments will likely be backloaded to the second half of the year, with a relatively limited effect on 2014 growth.
Furthermore, other than productive infrastructure investments, measures to just boost wages
and pensions further would raise concerns about future fiscal dynamics, as well as the
competitiveness of the economy outside of the resource extraction sectors.

but Ukraine conflict adds downside risks


Tensions with Ukraine harm
investor sentiment

In addition to the economic challenges already underway before the conflict with Ukraine,
the ongoing tensions with the West could cause a lasting deterioration in investor sentiment

FIGURE 5
Liquidity overhang leads to pressures on the RUB

FIGURE 6
as the C/A surplus declined and capital outflows increased
30%

200

60

20%

160

-160

30

10%

120

-120

0%

80

-80

-10%

40

-40

90

USDbn

-30
-60
Mar-10

Mar-11

Mar-12

CBR FX interv (12m rolling)


M2 (% y/y, RHS)
Source: CBR, Haver Analytics, Barclays Research

25 March 2014

Mar-13

-20%
Mar-14

CBR repo outstanding

0
Dec-08

-200

USD bn, 12m rolling

Dec-09
C/A balance

Dec-10

Dec-11

Dec-12

0
Dec-13

Net private capital flow (RHS)

Source: CBR, Haver Analytics, Barclays Research

134

Barclays | The Emerging Markets Quarterly


towards Russia. The associated increase in external and local funding costs will hurt
domestic demand. In economic terms, Crimeas annexation by Russia represents more of a
cost than an acquisition. Crimea does not have any substantial industry and its gross
regional product comprises just 0.2% of Russian GDP. According to unofficial estimates, it
could cost the Russian budget about RUB90bn per year (excluding one-off infrastructure
investments) just to bring the standard of living in this relatively poor region in line with the
Russian standard of living. In response to Russias actions, the EU and the US reduced
cooperation with Russia and imposed visa bans and asset freezes on specified individuals.
The EU and the US have also discussed imposing more general economic sanctions,
including trade sanctions and asset freezes for selected economic entities. We believe it may
prove difficult for the Western countries to agree upon a severe set of sanctions, given the
threat of retaliatory sanctions by Russia and the fact that Europe continues to depend on
Russian gas exports (covering 34% of European consumption). However, investor
sentiment towards Russia, its business relations abroad and, more generally, its integration
into the global economic system will likely be adversely affected.

Monetary policy tightening on RUB depreciation


RUB depreciation and inflation
pressures lead to monetary
policy tightening

The CBR tightened monetary policy at an emergency meeting on 3 March, deciding to


increase its main policy rate 150bp, to 7.0%. It also increased its cumulative daily FX
intervention needed to shift the exchange rate band by RUB0.05, to USD1.5bn from
USD350mn, effectively reducing RUB flexibility. While the sharp depreciation pressure
spurred by tensions with Ukraine was the immediate cause of the abrupt monetary policy
tightening, we think this would have been needed in any case (Figure 4). Since April 2013,
net daily transactions of the CBR have been only FX purchases to defend the RUB.
Nevertheless, money supply growth remained elevated (12.5% y/y in January) as the CBR
continued to increase its repo allocations (Figure 5). The RUB depreciated by about 10%
since the beginning of 2014, becoming one of the worst-performing currencies in the world
during this period. With a pass-through coefficient estimated at 10-15%, this would add 11.5pp to inflation upfront (barring a reverse appreciation of the RUB, which we consider
unlikely). Even if the RUB stabilizes, the 2014 inflation target will almost certainly be missed:
we predict inflation will reach 6.7% at end-2014. In the absence of significant depreciation
in 2015, we think it could decline to 5.1% at end-2015, still above the 4.5% target, thus
requiring the CBR to maintain high interest rates, in our view. We think it will have to raise
its policy rate one more time, by 100bp, to 8.0% in Q2, to contain RUB depreciation
pressures, with a risk that intensification of political tensions could force further increases.

Better current account versus worse capital flow outlook


Current account deterioration
set to reverse

The current account underwent a sharp deterioration since the beginning of 2012 that has
brought the surplus down from USD97bn in 2011 to only USD33bn in 2013. The trade
surplus decline accounts for about half of the deterioration, while services and income
accounts split the other half. From our point of view, this was an indication that monetary
policy was too loose with the RUB over-valued. We think the RUB depreciation is just what is
needed to correct the current account drainage. In our estimates, a 10% RUB depreciation
increases the current account surplus by about 0.7% of GDP. We expect a virtual reversal of
the negative external trends in 2014 and quick increases in the trade surplus as imports
become more expensive and exports become cheaper (they should also remain supported
by stable and high oil prices). Imports of services (mostly tourism) are also likely to fall.
Potential economic sanctions could harm the current account, but given the high share of
oil and gas (about 65%) in total exports and Europes difficulty in reducing dependence on
them in the short term, we do not foresee a significant effect of the sanctions at this stage.

Capital flight could intensify


due to sanctions

More importantly, however, additional sanctions could increase the already high capital
flight. Net private capital outflows were about USD15bn per quarter in 2013, according to
official CBR data. We are forecasting on the basis of recent flow trends and the experience

25 March 2014

135

Barclays | The Emerging Markets Quarterly


during the political charged period of end 2011/early 2012 outflows of USD25bn per
quarter in 2014. This should translate to a drop in reserves of about USD50bn. However,
with harsher US and EU sanctions, the outflows could rise further former Russian Finance
Minister Alexei Kudrin estimated USD50bn per quarter. Such outflows would easily offset
the gains on the current account, leaving the BoP in negative territory and, hence, putting
continued pressure on official reserves and/or the exchange rate.
FIGURE 7
Russia macroeconomic forecasts
2010

2011

2012

2013

2014F

2015F

4.3

4.3

3.4

1.3

0.7

1.4

6.2

8.4

5.2

0.8

0.4

1.4

Activity
Real GDP (% y/y)
Domestic demand contribution (pp)
Private consumption (% y/y)

5.4

6.3

6.8

5.4

2.7

2.0

Fixed capital investment (% y/y)

26.6

26.4

7.4

-9.0

-2.1

1.4

-1.9

-4.1

-1.8

0.6

0.3

0.0

7.1

0.3

1.3

4.3

1.7

1.8

Net exports contribution (pp)


Exports (% y/y)
Imports (% y/y)
GDP (USD bn)

25.2

21.1

9.6

3.1

0.9

2.3

1525

1899

2012

2102

1907

1920

67.5

97.3

72.0

33.0

53.6

77.5

External sector
Current account (USD bn)
CA (% GDP)
Trade balance (goods and serv., USD bn)
Net FDI (USD bn)

4.4

5.1

3.6

1.5

2.8

4.0

120.9

163.4

145.8

119.6

149.9

184.3

-9.4

-11.8

1.8

-7.8

-15.0

-10.0

Other net inflows (USD bn)

-12.0

-64.5

-23.0

-32.6

-60.0

-30.0

Gross external debt (USD bn)

488.9

538.9

636.4

732.0

768.6

807.0

International reserves (USD bn)

479.4

498.6

537.6

509.6

460.0

479.0

-3.9

0.7

-0.1

-0.5

0.1

-0.5

-3.7

0.9

0.3

-0.2

0.4

-0.2

8.4

8.6

10.8

11.2

10.8

10.8

Public sector
Public sector balance (% GDP)
Primary balance (% GDP)
Gross public debt (% GDP)
Prices
CPI (% Dec/Dec)

8.8

6.1

6.6

6.5

6.7

5.1

USD/RUB (eop)

30.5

32.2

30.4

32.9

39.5

41.0

Brent oil price (avg)

Real GDP (% y/y)

80

111

112

109

106

108

1y ago

Last

Q1 14F

Q2 14F

Q3 14F

Q4 14F

1.6

1.3

1.1

0.9

0.7

0.1

CPI (% y/y, eop)

7.0

6.2

6.5

6.8

7.1

6.7

USD/RUB (eop)

31.1

36.1

36.5

38.0

39.0

39.5

CBR policy rate (1 week repo, %, eop)

5.50

7.00

FX RUB OIS 3m implied yield (%, eop)

7.00

8.00

8.00

8.00

8.30

8.20

7.30

7.20

Source: Rosstat, CBR, Ministry of Finance, Haver Analytics, Barclays Research

25 March 2014

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Barclays | The Emerging Markets Quarterly

EEMEA: SOUTH AFRICA

Challenging year ahead


Economics
Peter Worthington
+27 21 927 6525
peter.worthington@barclays.com
Miyelani Maluleke
+27 11 895 5655
miyelani.maluleke@barclays.com
FX and FI Strategy
Mike Keenan
+27 11 895 5513
mike.keenan@barclays.com
Credit Strategy
Andreas Kolbe
+44 (0)20 3134 3134
andreas.kolbe@barclays.com

South Africa is experiencing tepid growth as a result of weak domestic demand and a variety
of supply-side issues. The likely inflationary consequences of the rands depreciation
motivated the SARB to hike 50bp in January and we think another 100bp of tightening could
be forthcoming this year. The big current account deficit looks likely to narrow but at a
sluggish pace. A continued deterioration in fiscal metrics could elicit a rating downgrade
later this year, unless the 7 May election generates positive policy surprises.

Key recommendations
FX: We do not expect the ZAR to sustain its recent recovery over the coming quarter.
We think it will still reach R12.00/USD later this year. A structural current account
deficit, heightened socio-political tensions, fractious labour markets, the lingering
possibility of another credit rating downgrade and the prospect of broad-based USD
strength form the basis of our bearish ZAR view. Consequently, we continue to
recommend that participants fade ZAR rallies; we still have the ZAR and the TRY as our
preferred EM shorts in relation to the USD over the coming months.

Rates: The curve is likely to bear flatten again, with a weaker ZAR and higher US
Treasury yields lifting short end rates faster than back end ones. We still regard the belly
of the curve as the most vulnerable during bouts of global risk aversion, because that is
the area of the curve where foreign ownership is greatest. We would also expect bonds
to outperform swaps in a risk-off environment. Swaps are vulnerable to fresh corporate
fixing activity as a result of higher policy rates and renewable energy hedging activity.
Although the risk to inflation remains to the upside, we think that linkers are already
trading at a significant premium to nominals.

Credit: Stay underweight, buy 5y CDS protection. South Africa credit has indirectly
benefitted from the Russia-Ukraine crisis, as investors have re-allocated from Russia and
higher gold prices have supported sentiment. This, coupled with defensive positioning,
has helped South Africa credit to outperform. We do not think, however, that the
outperformance is justified fundamentally and, hence, believe that current valuations
offer an attractive entry level to reset shorts.

GDP growth likely to come in just over 2% this year


Most components of domestic
demand are quite subdued

25 March 2014

The domestic demand environment is very subdued with private household consumption
forecast at just 2.2% this year. Rising inflation and rate hikes should eat into consumers real
disposable income and spending. Furthermore, lending to households has slowed sharply.
One big question mark for the household consumption outlook is the employment
situation. Two separate quarterly surveys paint rather divergent pictures. A householdbased survey suggests South Africa is experiencing reasonable job growth with
employment back at pre-crisis levels while an enterprise-based survey points to very
anaemic employment trends. We think employment creation is likely to be quite
pedestrian. Nonetheless, the last retail sales number for January was unexpectedly robust
after two prior strong prints, so there could be some upside risk to our consumption
forecast if this is sustained. Fiscal restraint should limit the growth of government
consumption (2.1%), while weak business confidence continues to curb private investment
spend (3.5%).

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Infrastructure constraints and labour unrest are big drags on growth


Various supply-side issues are
also negatively affecting the
growth outlook, with fractious
labour markets and capacity
constraints in infrastructure
(especially electricity
generation) the most
important

Wide-ranging infrastructure constraints, especially electricity shortages, are negatively affecting


growth. Eskom has trimmed power supply to large industrial customers several times in the
year-to-date, and in early March it was forced to implement the first episode of load-shedding
(rationing) since 2008. The exceptionally tight electricity supply situation is likely to continue for
the rest of the year until the first 800 MW unit of the Medupi power project is connected to the
grid. Labour market instability is also weighing on growth, as shown, for example, by the
platinum sector strike, which is in its eighth week with no end in sight. Moreover, heavy rains in
the northeast part of the country now threaten to move to a drag on agricultural output from a
boost. Clearly, the rands depreciation should deliver a modest growth stimulus to import
competing manufacturing industries and other exchange rate sensitive sectors such as tourism.
Upside risks to the growth outlook may come from a pick-up in global demand, particularly in
Europe, or a reform-friendly election result. A potential intensification of labour unrest or a
sharp slowdown in China seems to be the main downside risks.

CPI inflation set to breach the target range sometime in Q2


Over the past couple of years, there has been remarkably little pass-through from rand
depreciation to inflation, but we expect it to show up in a modest way in the coming CPI
releases. We forecast headline CPI inflation to breach the 6% target in May and to hit a peak
of about 7.0% by year-end. We think core CPI inflation will grind steadily higher throughout
the year to peak at about 6.1% by year-end. Food price inflation is a particular upside risk,
given the upward momentum in grains prices and the end of downward pressure on meat
prices from drought-related herd culling. However, like the SARB, we have to acknowledge
considerable uncertainties about the inflation trajectory. Not only is the rands future
trajectory uncertain, but also the quantum of pass-through that should eventually
materialize in the CPI is highly unclear. The SARB assume a 20% pass-through coefficient in
its forecast (which has a trajectory roughly similar to ours) but recognizes, as do we, that
the weakness of domestic demand means that pass-through may be quite limited in this
cycle. The SARB has recently spoken out to dampen market expectations of aggressive
tightening. On balance, we expect another 100bp of tightening from the SARB this year, but
the exact timing of this is uncertain and highly data dependent.

Current account deficit to narrow very gradually


The small merchandise trade surpluses in November and December suggested that perhaps the
rand was finally starting to narrow South Africas external deficits, but the trade balance swung
FIGURE 1
Divergent pictures on job creation

FIGURE 2
Power rationing in early March could be repeated
%

q/q change in thousands


400
350
300
250
200
150
100
50
0
-50
-100
-150
Mar-11

Sep-11

Mar-12
QES

Sep-12
QLFS

Source: Statistics South Africa, Barclays Research

25 March 2014

Mar-13

Sep-13

Capacity reserve margin


18
16
14
12
10
8
6
4
2
0
-2
Load-shedding trigger
-4
01-Jan 11-Jan 21-Jan 31-Jan 10-Feb 20-Feb 02-Mar
Source: Eskom, Barclays Research

138

Barclays | The Emerging Markets Quarterly


deep into the red in January again, and we do not anticipate any rapid recovery. There will likely
be some modest improvement in the trade balance of those goods for which there are
domestically produced alternatives to imports (eg, autos, textiles, plastics, and chemicals).
Various reports from businesses indicate that this expenditure switching is starting to take place
but it is not manifesting in a major way in either the production or the trade data yet. However,
export volumes are unlikely to pick up much given capacity constraints in railways and ports and
supply-side shocks. Moreover, prices for South Africas key commodity and basic metals exports
could remain under downward pressure. In the meantime, essential imports of crude oil and
capital equipment for the public infrastructure program will continue unabated. Transnet, for
example, recently signed a R50bn deal for 1,064 locomotives, and although the deal has strong
localization elements, it will have a big import component as well. We think there will be some
improvement in net services balance, stemming mainly from the tourism boom, but other
invisible outflows (like the current transfers to other countries in the customs union, worth more
than 1% of GDP per annum) should remain elevated. We expect the current account, which
narrowed to 5.1% of GDP in Q4 (seasonally adjusted) from 6.4% in Q3 to widen again in Q1 14,
in part because of supply-side shocks (such as the power outage at Richards Bay coal terminal
in February, which cost R2bn in lost exports), the ongoing platinum sector strike, and the
retooling of some car manufacturing facilities. We expect the deficit to narrow gradually over
2014 but to average the year at about 5.8% of GDP, unchanged from 2013. In 2015, once the
capacity constraints begin to ease (allowing greater production and exports of bulk mineral
commodities), the current account deficit should narrow further. It will also help to reduce some
categories of imports, such as the diesel fuel for Eskoms Open Cycle Gas Turbines (OCGTs).
Recently Eskom revised its estimated cost (mainly diesel) to run OCGTs to about R10bn (or 0.3%
of GDP) in the current financial year from the budgeted R2bn. OCGTs are being used pretty
much continuously, rather than just during peak demand times.

2014/15 Budget basically held the line on spending but


The twin counterpart to the large external deficit is of course South Africas large fiscal
deficit. The 2014/15 Budget in late February contained both good and bad news. Positively,
the National Treasury reported that a robust revenue performance meant that the
consolidated budget deficit the current fiscal year is likely to come in at about 4.0% of GDP,
compared with the original target of 4.5% and the midyear revision to 4.2%. In addition, the
government is sticking to its commitment to limit the growth of real noninterest
expenditure to 2% and to treat previously announced spending targets as hard ceilings.
FIGURE 3
Trade balance back in the red in January

FIGURE 4
Public indebtedness is on an upward trend
Rbn
20

% y/y 3mma
40
30

15

20

10

10

% of GDP

2013/14 Budget

51

MTBPS October 2013

46

2014/15 Budget

41

0
-10

-5

-20

-10

-30

-15

-40

-20
2011

2012

2013

Trade balance (rhs)

Exports (lhs)

Source: South Africa Revenue Services, Barclays Research

25 March 2014

2014
Imports (lhs)

36
31
26
21
03/04

05/06

07/08

09/10

11/12

13/14

15/16

Source: National Treasury, Barclays Research

139

Barclays | The Emerging Markets Quarterly


However, we are a little uncomfortable with the continued gradualist approach to deficit
reduction. The 2014/15 Budget targets a consolidated fiscal deficit of 4.0% of GDP
unchanged from the estimated outcome for 2013/14 and projects only a modest
narrowing thereafter, to 2.8% of GDP by FY 2016/17, despite a forecast recovery in real
economic growth to 3.5% in 2016. In our opinion, fiscal consolidation remains rather
vulnerable to downside growth shocks. In the meantime, rating agencies are concerned
about the deterioration in South Africas fiscal metrics, including the steady rise in
government debt to GDP, which makes South Africa vulnerable to possible rating
downgrades towards the end of the year. Thus, a more active approach to fiscal
consolidation would seem desirable, but given the governments reluctance to cut
expenditures, we believe such an approach is only likely to come with new revenue
measures in the next budget in February 2015.

elections on 7 May could nudge policy settings in either direction


The country is due to hold national and provincial elections on 7 May. The latest IPSOS poll,
as reported in the local press on 23 March, suggests that the governing African National
Congress (ANC) should secure another clear majority at the national level, with the declared
support of 66% of the voters, close to its share in the 2009 election. While some opposition
parties appear to be gaining support, others appear to be losing it. The current official
opposition, the Democratic Alliance (DA), seems likely to continue the trend increase in its
vote witnessed since the 1994 election (the DA took 16% of the vote in 2009) with the
IPSOS poll putting its support at around 22%. Meanwhile, the new Economic Freedom
Fighters, which targets the disenfranchised and the poor with a nationalist/populist
program, could also have an important impact. Notably, however, the poll was conducted
before the publication of the Public Protectors report on the improper use of state funds to
upgrade President Zumas private residence. How the votes actually array and what
messages politicians and policy makers draw from the electorates judgement may have
subtle but important economic consequences (see Global EM political outlook: South Africa,
6 March). The devil is in the detail here, but the exact detail is highly difficult to predict at
this stage. A reform-friendly election outcome, in our view, would be the ANC losing more
support to the opposition Democratic Alliance rather than the populist/nationalist
Economic Freedom Fighters, such that it is galvanized into growth-boosting labour market
reforms and faster implementation of the National Development Plan, rather than panicked
into greater spending or more administrative interference in the economy. Investors should
watch the appointments to the Deputy Presidency and the key economic ministries after
the elections for signs of the next administrations inclinations.

25 March 2014

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Barclays | The Emerging Markets Quarterly


FIGURE 5
South Africa macroeconomic outlook
2010

2011

2012

2013

2014F

2015F

Real GDP (% y/y)

3.1

3.6

2.5

1.9

2.2

2.8

Domestic demand contribution (pp)

Activity

4.0

4.8

4.2

2.4

2.4

3.3

Private consumption (% y/y)

4.4

4.9

3.5

2.6

2.2

2.7

Fixed capital investment (% y/y)

-2.1

4.2

4.4

4.7

3.6

3.8

-0.9

-1.2

-1.7

-0.5

-0.3

-0.5

Net exports contribution (pp)


Exports (% y/y)

9.0

6.8

0.4

4.2

7.7

6.5

Imports (% y/y)

11.0

10.0

6.0

4.7

6.8

6.4

360.8

405.3

381.5

350.8

318.8

350.7

GDP (US$bn)
External sector
Current account (US$bn)

-7.2

-9.41

-20.0

-20.3

-18.5

-18.6

CA (% GDP)

-2.0

-2.3

-5.2

-5.8

-5.8

-5.3

Trade balance (US$bn)

-6.8

-6.5

-4.8

-7.6

-6.9

-6.6

3.7

4.5

1.6

2.6

3.5

3.8

Net FDI (US$bn)


Other net inflows (US$bn)

-1.9

5.7

13.1

5.6

8.2

-3.9

Gross external debt (US$bn)

27.4

31.4

38.3

Gross international reserves (US$bn)

39.7

54.9

52.5

53.9

53.8

56.1

CPI (% Dec/Dec)

3.5

6.1

5.7

5.4

7.0

5.5

CPI (% average)

4.3

5.0

5.7

5.8

6.4

6.0

Exchange rate (USDZAR, eop)

6.63

8.09

8.48

10.49

11.87

11.07

Exchange rate (USDZAR, period average)

7.32

7.26

8.21

9.65

11.52

11.43

2009-10

2010-11

2011-12

2012-13

2013-14

2014-15

-5.4

-4.3

-3.7

-4.3

-4.0

-4.0

-2.1

-1.5

-1.0

-1.3

-0.9

-0.8

32.7

36

39.8

42.7

45.8

46.9

Prices

Public sector
Budget balance (% GDP)
Primary balance (% GDP)
Total govt debt (% GDP)

1y ago

Last

Q114F

Q214F

Q314F

Q414F

Real GDP (% y/y)

2.3

3.8

2.1

2.1

2.3

2.4

CPI (% y/y, eop)

5.3

4.9

5.9

6.9

6.7

7.1

Exchange rate (eop)

9.23

10.52

11.00

11.70

12.00

11.83

Monetary policy benchmark rate (%, eop)

5.0

5.5

6.0

6.0

6.5

6.5

Source: SARB, National Treasury, Statistics South Africa, Barclays Research

25 March 2014

141

Barclays | The Emerging Markets Quarterly

EEMEA: TURKEY

In search of a new equilibrium


Domestic tensions have risen further and the local elections (30 March) are unlikely to
provide closure. Uncertainty is likely to remain high, at least until the presidential
elections in August. Growth is moderating and could weaken further if political
uncertainty prevails. The external deficit should narrow, but the external financing
needs remain high, and inflation risks are to the upside as well. This leaves the TRY
vulnerable, while credit remains more shielded by the still-sound fiscal position.

Economics
Durukal Gun
+44 (0)20 3134 6279
durukal.gun@barclays.com
Christian Keller
+44 (0)20 7773 2031

Key recommendations
FX: The TRY does still not look cheap, based on our valuation models, and political risks are

christian.keller@barclays.com

elevated. The now higher carry and adjusting current account are not sufficient to offset
this, in our view. Prolonged domestic tension could further deter investment prospects and
the growth outlook. Hence, we remain tactically bearish on the TRY ahead of the elections.

Local Market Strategy


Koon Chow
+44 (0)20 7773 7572
koon.chow@barclays.com

Rates: We neutralize our bearish view on local rates, as monetary policy has significantly
adjusted and the economy is slowing (in the previous quarterly, we recommended paying
2y and a 2s10s cross-CCS flattener). We recommend being long Apr20 linkers FX hedged.
This has good risk-reward, ie, small positive carry and the opportunity for a good payout if
annual CPI surges above 9% in the next 3-6 months. Apr20s offer 3.7% real yield,
implying a 6.8% breakeven (vs. nominal 20s and 21s bonds). The rate hike risk to the
bond trade is modest, given that real yields did not react to the aggressive hike in January.

Durukal Gun
+44 (0)20 3134 6279
durukal.gun@barclays.com
Credit Strategy
Andreas Kolbe

Credit: We retain a neutral stance on Turkey credit, which has not adjusted as

+44 (0)20 3134 3134

aggressively as local markets, and political uncertainties and slower growth may weigh
on investor sentiment. However, credit spreads are anchored by Turkeys strong fiscal
position and declining public debt ratios and, given the recent developments in Russia,
could benefit from portfolio re-allocation flows within EEMEA. On balance, we retain a
neutral stance, favouring the 5-10y sector of the sovereign cash curve from a relative
value perspective.

andreas.kolbe@barclays.com

FIGURE 1
TRY still slightly overvalued

ZAR

INR
Jan-13

Source: Barclays Research

25 March 2014

IDR

BRL
Mar-14

TRY

Nominal bonds

Linker bonds

Apr-23

-40

Apr-22

Apr-14

-30

Apr-21

-20

Apr-20

-10

Apr-19

Apr-18

10

Apr-17

20

Apr-16

%
12
11
10
9
8
7
6
5
4
3
2

% deviation from BEER


(+ overvaluation / - undervaluation)

Apr-15

30

FIGURE 2
Value in linkers, with inflation risks priced as short-lived

Breakevens

Source: Haver Analytics, Treasury, Barclays Research

142

Barclays | The Emerging Markets Quarterly

Political uncertainty adds to challenges for growth


As we discussed in our recent macro update Turkey: Rotating to a Slower Growth, the less
favourable capital flow environment for EMs is forcing the Turkish economy to rotate from
consumption-led growth to more export-driven, slower growth. The effect from the less
favourable external funding environment is exacerbated by the increase in domestic political
tensions, the large emergency rate hikes in January, and FX mismatches on corporate
balance sheets. This has made the growth outlook more challenging. We now forecast GDP
growth to moderate to 2.2% y/y in 2014 from an estimated 3.9% y/y in 2013. We see the
risks to our forecast skewed on the downside, in light of the risk for a prolonged period of
political instability even after the local elections (on 30 March).

Rotation away from


consumption-led growth

The slowdown in growth should support the external adjustment. The January current account
balance suggests that this adjustment has already begun, and we expect it to become more
visible into Q2 14. Monetary tightening and additional macro-prudential measures (effective
since February) have led to a moderation in consumer credit (current run rate of ~7, vs. the
2007-13 average of 26%), which would slow imports further in the next couple of months.
Conversely, export growth should be lifted by stronger external demand, particularly from the
euro area, and by the lagged effect of currency weakness. Thus, we forecast the current account
deficit to shrink to about USD43bn in 2014 (5.7% of GDP), from USD65bn in 2013 (c. 7.8% of
GDP). Some particular effects, such as the declining gold trade (reverting to its historical norms
of USD3-4bn per annum from USD12bn last year) would also be supportive of the adjustment.
On the flip side, a potential rise in oil prices in the event of further escalation of geopolitical risks
may create some headwinds for the current account adjustment. As a rule of thumb, a USD
10/bbl change in the average oil price leads to a USD4-5bn change (negative or positive) in the
annual current account balance. Despite shrinking current account deficit, Turkeys external
funding needs remain high at about USD206bn, or 25% of GDP, which includes USD163bn
external debt due in the next 12 months in addition to the current account deficit.

Current account to narrow to


5-6% of GDP (from close to
8%)

... implying external financing


needs to remain high

CBT more focused on inflation but will try to remain on hold


CBT was forced into large
emergency hikes in January

January was a tough period for the central bank (CBT). Negative sentiment towards EM in
general and negative headlines about domestic tensions in Turkey left the TRY under
immense pressure. Initially, the CBT refrained from using interest deference by introducing a
new virtual rate, which was followed by a direct intervention in the FX market (the first
since 2012). However, this could not prevent the TRY from depreciating sharply, and the
CBT was eventually forced to hike all of its policy rates significantly (1w repo and O/N
lending rates by 550bp and 425bp, respectively) at an emergency MPC meeting in late

FIGURE 3
Consumer credit significantly slowed

FIGURE 4
which helps current account adjustment as well
USD bn

2014
Source: BRSA, Barclays Research

25 March 2014

2013

2007-2013 (average)

Jul-13

Jan-14

Jul-12

Jan-13

Jan-12

Jul-11

Jul-10

Jan-11

Jul-09

Jan-10

Dec-14

Nov-14

Oct-14

Sep-14

Aug-14

Jul-14

Jun-14

May-14

Apr-14

Mar-14

Feb-14

Jan-14

Jul-08

10

Jan-09

15

Jan-08

20

Jul-07

25

Jul-06

30

Jan-07

35

Jan-06

1
0
-1
-2
-3
-4
-5
-6
-7
-8

40

C/A Balance (SA, 3mma)


C/A Balance (SA, ex-gold 3mma)
Source: Haver Analytics, Barclays Research

143

Barclays | The Emerging Markets Quarterly


January. The operational framework was also simplified, with 1w repo becoming the
primary funding rate. However, this shift towards a more orthodox framework came only
after numerous switches of the policy framework within a few months. It is, thus, likely to
take some time for the CBT to re-establish its credibility.
FX pass-through and potential
weather-related pressure on
food prices

CBT now focused on


inflation

but will likely try to resist


another round of hikes
instead tightening liquidity
to deal with temporary TRY
pressure

The inflation outlook remains challenging. Exchange rate pass through is driving core
inflation higher, and food price volatility continues to pose additional upside risk, in our
view. Although the headline inflation rate remained roughly flat in February, core inflation
surged to 8.4% y/y; rent and restaurant inflation continued their upward trend. TRY
weakness has yet to show its full impact on inflation in coming months, and the relatively
dry winter so far (i.e. historically low water reservoir levels) has increased the risk for higher
food prices, in our view. Considering also the risks of potential adjustments to energy prices
post elections (~10% hike would add around 0.5pp to headline inflation), we think inflation
could surpass 9% y/y in Q2 14 before moderating towards 8% y/y by year-end.
The CBT has recently emphasised the need to control inflation, signalling that the tight
monetary policy stance will be maintained until medium-term inflation expectations are in
line with the target. The latest CBT expectation survey shows inflation expectations
continued to deteriorate (2014 inflation expected at 8% y/y, 12m ahead inflation at 7.3%
y/y), which is clearly above CBTs revised year-end forecast of 6.6% and 5%. However, the
CBT is likely to try to avoid additional rate hikes, in our view, and may tolerate temporary
spikes in inflation. Instead, additional hikes would be triggered only by renewed episodes of
strong sustained TRY pressure. Our baseline is for the one-week repo rate to be unchanged
at 10%. In case of temporary pressure on TRY, eg, in the wake of election results, the CBT
could adjust the composition of the liquidity provision to push the effective CBT funding rate
higher (ie, towards the O/N lending rate, which is 12%), and let the overnight market rate
rise all the way to the late liquidity window of 15% by tightening liquidity. Only if that were
to fail would further hikes in the repo rate be considered, in our view.

Local elections unlikely to bring a new equilibrium


The key forthcoming event is the local elections on 30 March, which is in effect a popular
referendum on PM Erdogan and the AKP. The outcome should then also set the stage for
Erdogans strategy for the presidential election in August. In our base-case scenario (see
Turkey Elections Primer), a new political equilibrium is unlikely to be achieved after the local
elections, leaving investors with an uncertain backdrop, at least until the presidential elections.

FIGURE 5
TRY stabilized after significant hike in January

FIGURE 6
Politics works against TRY via FX deposit channel

45

1.35

40

1.55

35

1.75

30

1.95

25

2.15

20

2.35

1.90

45%

1.70
1.50

100

1.30

1.10

Mar-05
Sep-05
Mar-06
Sep-06
Mar-07
Sep-07
Mar-08
Sep-08
Mar-09
Sep-09
Mar-10
Sep-10
Mar-11
Sep-11
Mar-12
Sep-12
Mar-13
Sep-13
Mar-14

200

cumulative rate hike


Source: CBT, Haver Analytics, Barclays Research

25 March 2014

USDTRY

USD Deposits (in USD) - Retail

Feb-13
Aug-13

27%

2.10

Feb-12
Aug-12

24%

Feb-14

2.30

Feb-11
Aug-11

16%

500
300

50

Feb-10
Aug-10

600

18%

Feb-09
Aug-09

CBT lowered policy rate


during global financial crises

USD bn

Feb-08
Aug-08

700

400

2.50

USDTRY
Inverted
1.15

USDTRY

Feb-07
Aug-07

bp

Feb-06
Aug-06

Local elections unlikely to


provide closure to tensions

USDTRY

Source: CBT, Haver, Barclays Research

144

Barclays | The Emerging Markets Quarterly

Heightened political tensions


could work against the TRY
through the FX deposit
channel

The prolonged political uncertainty not only poses a downside risk to growth, but also works
against the currency through the FX deposit channel. As we discussed in Turkey: Local FX
deposits in Turkish banks, since mid-2013, households have stopped being contrarian
investors in the TRY and instead have bought FX (mainly USD) during periods of TRY
depreciation. The CBTs initial unwillingness to defend the TRY more forcefully and heightened
domestic political tensions likely played a role. The recording of local FX swap transactions of
residents also partially explains the upward trend in FX deposits. However, ultimately, this
phenomenon also reflects the continued demand for TRY hedging from investors.

FIGURE 7
Turkey macroeconomic forecasts
2010

2011

2012

2013F

2014F

2015F

9.2

8.8

2.2

3.9

2.2

3.5

13.5

9.9

-1.8

5.8

0.9

2.7

6.7

7.7

-0.6

4.6

1.6

2.5

30.5

18.0

-2.7

4.3

0.8

2.8

-4.4

-1.1

4.1

-1.9

1.3

0.8

Exports (% y/y)

3.4

7.9

16.7

0.9

4.2

5.0

Imports (% y/y)

20.7

10.7

-0.3

7.5

-0.8

1.9

732

775

788

822

761

830

Activity
Real GDP (% y/y) 1/
Domestic Demand Contribution (pp)
Private Consumption (% y/y)
Gross

Fixed Capital formation (% y/y)

Net Exports Contribution (pp)

GDP (USD bn)


External Sector
Current Account (USD bn)

-45

-75

-49

-65

-43

-50

CA (% GDP)

-6.2

-9.7

-6.2

-7.9

-5.7

-6.0

Trade Balance (USD bn)

-56

-89

-65

-80

-53

-62

Net FDI (USD bn)

7.6

13.8

9.2

9.8

8.0

9.0

Gross External Debt (USD bn)

292

304

339

376

365

380

International Reserves (USD bn)

81

79

100

111

115

120

General Govt Balance (% GDP)

-3.6

-1.4

-2.1

-1.2

-2.2

-2.1

Primary Balance (% GDP)

0.7

1.8

0.8

0.9

0.8

0.9

General Govt Debt (EU def. % GDP)

42.3

39.1

36.2

35.3

34.9

34.2

CPI (% Dec/Dec)

6.4

10.5

6.2

7.4

8.3

6.7

USD/TRY,

1.54

1.92

1.78

2.15

2.35

2.40

1y ago

Last

14 Q1

14 Q2

14 Q3

14 Q4

Public Sector

Prices
eop

Real GDP (y/y)

1.4 (4Q12)

3.6*

2.5

2.1

1.8

2.4

CPI (% y/y, eop)

6.2

7.9

8.0

8.1

8.0

8.3

Exchange Rate (eop)

1.78

2.24

2.25

2.30

2.35

2.35

One-week repo rate (%, eop)

5.50

10.00

10.00

10.00

10.00

10.00

11.74

11.51

11.30

11.13

11.15

Market implied 3m rate (%, eop)


Source: CBT, Treasury, Haver Analytics, Barclays Research, *4Q13 estimate

25 March 2014

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EEMEA: UKRAINE

Tighten your belts


Economics
Eldar Vakhitov
+44 (0)20 7773 2192
eldar.vakhitov@barclays.com
Credit Strategy
Andreas Kolbe
+44 (0)20 3134 3134
andreas.kolbe@barclays.com

A diverse, European choice


government

External and fiscal balances remain under pressure as the economy dived into recession,
exacerbated by the ongoing conflict with Russia, which annexed the Crimea. To save the
country from default, the new government urgently needs to secure an agreement with
the IMF. However, we do not think public debt is on an unsustainable path and assign
the highest likelihood to a no default scenario, at least in the near term.

Key recommendations
Credit: Stick to short-dated bonds. Short Ukraine 17Ns versus long PDVSA 17Ns. We
think that the likelihood is relatively high that a default in the short term will be avoided.
While such a scenario should be supportive for Ukraine credit in the near term, the
longer-term economic challenges and political risks make us reluctant to turn more
positive on longer-dated bonds. On a relative value basis, among global EM highyielding sovereigns, we prefer Venezuela over Ukraine and suggest expressing this view
by going short the (high cash price) Ukraine 17Ns, versus long PDVSA 17Ns.
Following mass and violent protests, President Yanukovich was ousted in February. The
opposition formed a new government led by Arseniy Yatsenyuk, leader of the Fatherland
Party in parliament and close ally of Yulia Tymoshenko. The new Cabinet is a diverse one and
includes representatives of the protest movement. The appointment of ministers in charge of
the economic block looks encouraging: the Minister of Finance has held various posts in the
previous governments, and the Minister of Economy is a liberal technocrat with strong
management experience. Three main opposition parties (Fatherland Party, UDAR Party and
the nationalist Svoboda Party), together with smaller groups and independent deputies,
formed a European choice coalition in parliament comprising 250 deputies (out of 450 in
total). Importantly, the nomination of the government and the PM Yatsenyuk himself
received significantly larger support, of 331 and 371 parliamentary deputies, respectively.
The UDAR Party refused to be included in the government, yet supported it.

FIGURE 1
Petr Poroshenko is leading in the latest poll
25

Potential presidential candidates' ratings (%)

20

FIGURE 2
Violent protests, conflict with Russia and fiscal tightening
will return the economy to recession this year
20

% y/y

15

15

10

10

-5
-10
Feb-10
GDP

Source: SOCIS

25 March 2014

% y/y, 3mma

Feb-11
IP

Feb-12

Feb-13

Retail trade

50
45
40
35
30
25
20
15
10
5
0
-5
-10
-15
-20
-25

Feb-14
Exports (USD), RHS

Source: Haver Analytics, Barclays Research

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Petr Poroshenko leading the
polls ahead of 25 May
presidential elections

Early presidential elections have been brought forward to 25 May (from March 2015). The
political turmoil has significantly changed the presidential elections landscape (for more
detail, please see Global EM Political Outlook: Ukraine, 6 March 2014). The only recent
available poll by SOCIS suggests a significant increase in the rating of Petr Poroshenko, an
experienced politician and billionaire businessman who claimed to be one of the sponsors of
the mass protests. The two other main candidates are Vitali Klitschko (leader of the UDAR
Party) and former PM Yulia Tymoshenko (leader of the Fatherland Party). We expect a closerun contest between these three candidates (Figure 1). Ousted President Yanukovich is now
facing criminal charges and will not be able to run: with the Party of Regions popularity
having slumped during the protests, we do not expect its candidate to be a frontrunner.

Presidential elections unlikely


to lead to significant policy
shifts

In February, the parliament approved a return to the 2004 constitution, which was one of the
main issues in the disputes with Yanukovich. The new constitution limits the powers of the
president and enlarges those of the government and parliament. Given this return and the
fact that all main presidential candidates are viewed as pro-Western, we do not expect the
presidential elections to cause a major shift in policy direction. However, political noise may
naturally increase closer to the election date, also given the ideological differences between
the opposition parties (eg, Fatherland and UDAR are centre-right parties, Svoboda is radicalright, and Solidarnost is centre-left).

The recent civil strife will push


Ukraine back into recession
this year, amplified by sizeable
fiscal consolidation

The economy finished last year on a positive note, with GDP growth surprisingly accelerating,
after three quarters of contraction, to 3.3% y/y in Q4 (Figure 2). As in previous quarters,
growth was driven by private consumption but this time it got some support from slower
rates of contraction in investment and exports, as well as favourable base effect. The growth
spike in Q4 allowed real GDP to stay flat for 2013 as a whole. However, this positive trend is
bound to be short-lived. Prolonged civil clashes throughout the country at the beginning of
2014 have led to the wide-spread economic paralysis and severely worsened the growth
outlook. While it is difficult to estimate the exact impact, the economic effect of the Orange
revolution in 2004 can provide some guidance. Less prolonged and violent protests
(compared to the recent ones) at end-2004 contributed to sharp growth deceleration from
12% in 2004 to 3% in 2005 (which was amplified, though, by lower steel price growth). All
growth components are likely to deteriorate significantly this year. Consumption will take a
major hit as the new government plans to enact severe fiscal consolidation measures,
including massive across-the-board expenditure cuts and a large hike in gas tariffs. The
latter, together with sharp UAH devaluation (Figure 3), will likely push inflation close to
double digits after a prolonged deflation period. Ongoing conflict with Russia and its military

FIGURE 3
UAH devaluation is comparable to that during 2008-09 crisis
11

FIGURE 4
Twin deficits will undergo a sizeable adjustment this year
12%

USD/UAH

10%

10

8%
6%

4%
2%

0%

-2%

-6%

-4%
-8%

5
4
Mar-08

4Q rolling, % GDP

-10%
Dec-04

Mar-09

Mar-10

Mar-11

Source: Bloomberg, Barclays Research

25 March 2014

Mar-12

Mar-13

Mar-14

Dec-06

Dec-08

C/A balance

Dec-10

Dec-12

Dec-14

Budget balance

Source: Haver Analytics, Barclays Research

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intervention in Crimea are already having a detrimental effect on the economy, leading to a
sharp deterioration in business confidence and capital flight. Furthermore, Russia is the main
trading partner, getting 25% of total Ukrainian exports, which are already suffering due to
(unofficial) trade restrictions imposed by Russia. Given all of the above, we expect 4-5% of
GDP contraction this year and signs of a recovery trend emerging only in late 2015. Crimeas
secession amounts to an additional 3% of GDP loss. However, it should be noted that Crimea
is a relatively poor region with GDP per capita of about 70% of the countrys average, and
without any significant industry. It has about 2mn population (c.4% of the total in Ukraine),
but accounts only for 1.5% of exports.

The Crimea secession will


result in a c.3% loss in
Ukraines nominal GDP

The C/A deficit remains


substantial, but we expect it to
adjust to c.5% of GDP this year

Significant external imbalances raise concerns about financing. The current account deficit
widened to USD16bn (8.8% of GDP) in 2013. Gas imports are about 15% of the total imports
(c.8% of GDP), and Russias decision to withdraw the gas price discount starting from Q2 is a
significant negative. The discount lasted only one quarter, and the savings were relatively
modest at c.USD0.5bn. According to Ukrainian government officials, the gas price is expected
to increase to about USD380/bcm in April (from USD269/bcm in Q1). In the extreme
scenario of a significant escalation of the conflict, Russia could increase the price even further
to USD450-500bcm, which would have a detrimental effect on the current account and the
wider economy. On the positive side, in February the central bank abandoned its exchange
rate peg as the first step towards meeting the IMF requirements. The UAH has experienced
sharp swings since then, but we expect the average devaluation to be about 25-30% this
year. This should help to reduce non-gas imports (by about 15-20%), which will also take a
hit from significantly lower consumption. Exports trends are harder to gauge due to several
counteracting effects. Positive effects should come from UAH devaluation and the EUs
decision to remove excises for Ukrainian exports (25% of which go to the EU). Recovering
global prices for food (about 20% of total exports) should also help. However, these effects
will likely be more than offset by falling steel prices (25% of total exports), the deep recession
implying lower production, and significantly lower exports to Russia given the ongoing
tensions. Overall, we expect the C/A deficit to fall significantly, driven by import contraction,
to about USD8bn (about 5% of GDP) in 2014 and to adjust further in 2015 (Figure 4).

A total of USD12bn in financial


assistance seems needed this
year to stabilise reserves

We estimate total external financing needs of about USD60bn until the year-end (Figure 7).
Those of the government (including Naftogaz) constitute c.USD8.5bn. FX reserves declined
to USD15.5bn at end-February. Conflict with Russia will likely damage investor sentiment,
leading to a significant reduction in FDI and portfolio flows this year. Corporate debt rollover
ratios have been high historically (as most of it reflects the returning capital flight), and

FIGURE 5
The NBU has partially monetized the deficit
40

USD bn

FIGURE 6
Public debt is sustainable even under adverse scenarios

Holdings of government securities

80

35

70

30
25

60

20

50

15

40

10

30

5
0
Jan-09

Public debt (% GDP) - fiscal


adjustment scenarios

Optimistic
Baseline
Adverse

20
Jan-10

Jan-11

Jan-12

NBU
Source: NBU, Haver Analytics, Barclays Research

25 March 2014

Jan-13

Banks

Jan-14

10
2006

2008

2010

2012

2014

2016

2018

Source: IMF, Haver Analytics, Barclays Research

148

Barclays | The Emerging Markets Quarterly


bank debt repayments are comparatively small and largely owed to parent banks. However,
even assuming the 80-100% rollover of the private sector external debt and the significant
reduction in the C/A deficit, our analysis suggests about USD12bn of external assistance is
needed this year just to keep the FX reserves close to their current level (which is very low at
less than three months of imports). The bulk of assistance is expected to be provided by the
IMF, with contributions from the EU, EBRD, EIB, World Bank, the US and potentially Japan.
Bank recapitalisation needs
could also arise

Similarly to the rest of the economy, the Ukrainian banks are facing tough times as the
banking system is plagued by legacy NPLs, which are close to 40% of total loans. Additionally
UAH depreciation is likely to further put pressure on asset quality (capital adequacy ratio
declined to 15.8% in March). The banks are facing liquidity pressures as deposit flight has
exceeded 8% since the beginning of the year, and was above 5% in February alone (with
roughly the same pace in UAH and FX deposits). The NBU provided extensive liquidity to
banks and responded with different restrictions to preserve financial stability, including limits
on FX deposit withdrawals and purchases. Nevertheless, some banks could need
recapitalisation in the coming years: according to IIF estimates, state-owned banks recap
needs could reach up to USD2bn (1% of GDP). In an adverse scenario, banking system recap
needs could reach USD5bn, in case private bank owners do not participate in the recap.

Sizeable expenditure-side fiscal


consolidation is needed

The fiscal situation is also challenging. The central government budget deficit reached 4.4%
of GDP in 2013 (excluding a Naftogaz deficit of about 1% of GDP). With fiscal reserves
depleted, the NBU has had to partially monetise the deficit (Figure 5), which has likely
contributed to UAH depreciation pressures. In cooperation with the IMF, the government is
currently working on a fiscal consolidation programme to cut the deficit to 2.5-2.8% of GDP
in 2014. Revenues will dive this year due to the recession: in January/February they already
declined by 4% y/y, while the government estimates the decline for 2014 as a whole could
reach 15%. In order to cut the deficit, this would imply sharp across-the-board expenditure
cuts, as well as an increase in household gas tariffs (the current plan foresees a 40% increase
in April and further increases later in the year), which has been resisted by the Yanukovich
government since 2011. The effective gas subsidies have also been widely associated with
related corruption, which the new government seems determined to tackle. Given the
unstable political backdrop and already poor economic situation, we expect the fiscal
consolidation to be tilted towards cuts in spending on investment and government goods &
services, rather than harsh social benefits cuts. In this regard, the secession of Crimea should
be marginally positive for Ukraines finances, as this region is a net recipient of the
governments funding. In contrast, any escalation of the unrest in Eastern Ukraine would be a
significant negative, given these heavily industrialised regions have GDP per capita above the
country average and are significant net contributors to the budget.

IMF programme will be the


vital anchor to fiscal
consolidation

Overall, the Ukrainian government has little room for manoeuvre as the IMF deal is vital to
save the country from default, so we expect the government to accept the IMF requirements
and ensure their implementation, at least in the near term. The negotiations with the IMF are
expected to finish next week, with the swift approval of the programme by an IMF board to
follow and the first tranche of financial assistance expected to be disbursed by end-March or
early April. According to the government, it will likely be a two to three-year IMF programme
with the total size of about USD15bn. The EU will also participate, with the amount of about
EUR1.6bn to be disbursed in three tranches this year (as part out of a multi-annual package
of up to EUR11bn in cooperation with EBRD and EIB). In addition, the US extended USD1bn
of credit guarantees to Ukraine. Russia indicated it could participate as well, though this is
becoming increasingly unlikely given the ongoing conflict between Russia and Ukraine.

Public debt is not on an


unsustainable path, however,
according to our analysis

All that said, we do not think Ukraine finds itself in an insolvent situation. The problem lies in
FX liquidity rather than debt sustainability, in our view. At end-2013, public debt reached
43% of GDP, about half of which is denominated in FX. Crimeas secession reduces nominal

25 March 2014

149

Barclays | The Emerging Markets Quarterly


GDP by about 3% which would increase public debt to GDP ratio. In our base case scenario,
which foresees fiscal consolidation of 2-3pp of GDP in 2014-2016, an output decline of 4%
and 30% UAH depreciation (since end-2013), public debt is expected to reach 55% of GDP in
2014. A modest growth recovery and about 10% further depreciation in 2015 will see public
debt peaking at 62% of GDP. Even the adverse scenario of an extended recession (output
decline of 8% in 2014 and 2% in 2015), sharp UAH depreciation (50% in 2014 and 20% in
2015) and bank recap worth 3% of GDP in 2014-16 would lead to public debt peaking at
77% of GDP. We assume that the government will proceed with fiscal consolidation, but
even some slippages in this respect would not derail the stabilisation of public debt, provided
growth resumes in 2015-16. Our conclusion is that even realistically most adverse economic
scenarios should not lead to public debt turning to an unsustainable path (Figure 6).

Default: unnecessary and rather unlikely


Possible near-term scenarios:
No default the most likely one,
in our view

While an ultimate decision on any forced debt re-scheduling will likely have a political element
and is hence hard to completely anticipate, we believe that weighing the arguments for and
against a forced default results in a strong case for remaining current on all external debt.
From an economic perspective, the costs of a default are hard to estimate with certainty and
this uncertainty alone should outweigh the relatively limited financial costs of avoiding the
default to commercial creditors. Hence, we assign the highest likelihood to a no default
scenario, followed by some potential voluntary exchange initiatives of selected issues (possibly
Naftogaz). The more disruptive scenarios have a lower likelihood, in our view. A mandatory
debt re-profiling/maturity extension could be a consideration. Assuming that such a debt reprofiling would extend maturities to 10-15 years, with a 7.5% annual coupon (close to the
average coupon Ukraine is paying on its commercial external debt at present), and assuming
an exit yield around 11% (marginally above the current yield at the long-end of Ukraines USD
curve), cheapest-to-deliver (CTD) recovery values could be in the 70-80 region, we think.
Naturally, mandatory notional haircuts would lead to lower recovery values. Finally, we note
that the political situation remains fluid and any further escalation of the Russian-Ukrainian
conflict may make a purely economic assessment of the default risks obsolete. While this is
not our base case scenario, a disorderly default scenario, eg, driven by a civil strife/violent
conflict situation in Eastern Ukraine, cannot be fully ruled out at this stage. Please refer to
Ukraine sovereign credit: Default Unnecessary and rather unlikely, 20 March 2014, for a
more detailed discussion on possible near-term debt scenarios and a summary of Ukraines
sovereign and sovereign-guaranteed international bonds.

FIGURE 7
Ukraines external market maturity profile maturities
concentrated from September 2015 to 2017

FIGURE 8
Eurobond interest payments are relatively low and
manageable, in our view
USD mn

Eurobond interest payments

5.0

2,500

Eurobond principal payments

4.0

2,000

USD bn

IMF payments

3.0

1,500

2.0

1,000

1.0

500

Note: Principal only. Source: Bloomberg, Barclays Research

25 March 2014

Dec-14

Nov-14

Oct-14

Sep-14

Aug-14

Jul-14

Jun-14

May-14

2023

UkrInf

Apr-14

Nafto

2022

2021

2020

2019

2018

2017

2016

Q4 15

Q3 15

Q2 15

Ukraine sov. (Russian bailout)

0
Mar-14

Ukraine sov.

Q1 15

Q4 14

Q3 14

Q2 14

Q1 14

0.0

Source: Bloomberg, Barclays Research

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FIGURE 9
Estimated external financing needs and sources: Mar-Dec 2014
External financing needs (USD bn)
1. Government (including NBU)
Short term (original maturity <12 months)
Long and medium term falling due in Mar-Dec 2014

Rollover
8.5

12.2

144%

0.0
8.5

Available financing sources (USD bn)


1. Government (including NBU)

0.0
12.2

144%

IMF- Government

1.5

7.0

Potential IMF, World Bank financing needed

IMF- NBU

1.2

2.1

EU financing

Other

1.5

1.3

EBRD*

Eurobonds (incl. Naftogaz)

2.6

0.8

EIB*

Naftogaz arrears to Gazprom

1.7

1.0

US loan guarantees

10.8

9.3

2. Financial sector

3.7

80%

2.9

Long and medium term falling due in Mar-Dec 2014

7.1

90%

3. Nonfinancial corporates and quasis

36.5

2. Financial sector
Short term (original maturity <12 months)

Short-term (original maturity <12 months)

Trade credits

25.3

6.4
39.0

110%

27.8

100%

11.3

3. Nonfinancial corporates and quasis

19.1

Long and medium term falling due in Mar-Dec 2014

11.3

4. External debt falling due in next 10 months (1+2+3)

55.7

60.5

4. Available through rollover (1+2+3)

5. C/A deficit (Mar-Dec 2014; forecast)

6.7

1.9

5. FDI (net)

0.0

6. Other portfolio flows (net; excl. eurobonds)

62.4

7. External financing available (4+5+6)

0.0

Use of reserves

15.5

Memo: Reserves at end-2014

6. External financing needs (4+5)


Memo: Reserves at end-Feb 2014

62.4
15.5

Source: NBU, IMF, Bloomberg, Barclays Research. *Based on the proportional distribution of announced multiannual packages.

FIGURE 10
Ukraine macroeconomic forecasts
2010

2011

2012

2013

2014F

2015F

Real GDP (% y/y)

4.1

5.2

0.3

0.0

-4.0

0.5

GDP (USD bn)

136

163

177

182

142

145

Activity

External sector
Current account (USD bn)

-3.0

-10.2

-14.3

-16.1

-8.0

-3.5

CA (% GDP)

-2.2

-6.1

-8.5

-8.8

-5.4

-2.4

Trade balance (USD bn)

-8.4

-16.3

-19.5

-19.6

-10.2

-6.3

5.8

7.0

6.6

3.3

1.9

2.5

Gross external debt (USD bn)

117.3

126.2

135.1

142.5

149.3

159.0

International reserves (USD bn)

34.6

31.8

24.5

18.4

17.5

20.0

Public sector balance (% GDP)

-5.9

-1.7

-3.6

-4.4

-3.0

-2.5

Gross public debt (% GDP)

39.5

34.9

36.3

41.2

54.8

60.3

CPI (% Dec/Dec)

9.1

4.6

-0.2

0.3

12.0

7.0

UAH / USD, eop

8.0

8.0

8.1

8.2

10.5

11.0

Net FDI (USD bn)

Public sector

Prices

Source: Ukrstat, NBU, Finance Ministry, Haver Analytics, Barclays Research

25 March 2014

151

Barclays | The Emerging Markets Quarterly

EEMEA: ZAMBIA

Copper price jitters likely to be short lived


We believe the economy will be resilient to the current volatility in copper prices, and
output is set to rise later this year. We expect economic growth of more than 6% this
year, even as monetary policy remains tight to help combat rising inflation.

Economics, Rate, FX Strategy


Ridle Markus
+27 11 895 5374
ridle.markus@barclays.com

Key recommendations
Credit: We think the ongoing weakness and underperformance of Zambia credit has

Dumisani Ngwenya

created an opportunity to turn less bearish. A potential stabilisation of copper prices,


signs of fiscal consolidation and the possibility of re-engaging with the IMF on a new
programme could all be positive catalysts. While expected new eurobond supply could
cap investor interest in the secondary market in the near term, we think Zambia 22s
are attractive in the regional and global EM credit contexts at current levels.

+27 11 895 5346


dumisani.ngwenya@barclays.com
Credit Strategy
Andreas Kolbe
+44 (0)20 3134 3134

Rates and FX: Pressures on the ZMW heightened in recent weeks, as it depreciated to a

andreas.kolbe@barclays.com

record weak point above 6.40/USD. This was despite tighter monetary policy via a 50bp
hike in the policy rate at the end of February and a 6pp increase in the statutory reserve
ratio (effective 10 March). Following the recent sharp depreciation, the revocation of
Statutory Instruments No. 33 and No. 55 by the government on 21 March has boosted
the ZMW. Incorporating this development, we expect further tightening measures by the
authorities and a recovery in copper prices to lead the ZMW to trade in a narrower range
over the rest of the year. Nevertheless, we project the currency to end the year weaker at
about 6.20/USD. In rates, we believe upward pressure on yields will continue into Q2,
amid tight monetary policy. Despite yields above 15%, we remain cautious, given the
depreciation risk beyond our current forecasts.

Copper price slide dents sentiment, at least in the near term


Copper prices expected to
recover

The recent sharp fall in copper prices has brought to the fore a key vulnerability of the
Zambian economy. Weak activity data from China saw copper prices fall 12% from their
year-to-date high, reaching their lowest level since 2010. This price action reignited
concerns about domestic growth, specifically the possibility of a sustained decline. In our
view, this is unlikely to be the case. Our commodities team projects prices to recover in the
quarter ahead, while Chinas economic growth is expected to improve over the rest of 2014.

FIGURE 1
Zambia 2022s attractive after sustained underperformance
versus most SSA peers, in our view

1,000

Ghana 17s

Zambia 22s

Senegal 21s

Angola 19s

CIV 32s

MEMATU 20s

Source: Bloomberg, Barclays Research

25 March 2014

2015F

Q214F

6000
Jan-14

6500

600
Jul-13

650
Oct-13

7000

Jan-13

7500

700

Apr-13

8000

750

Jul-12

800

Oct-12

250
Feb-13 Apr-13 Jun-13 Aug-13 Oct-13 Dec-13 Feb-14

8500

Jan-12

350

9000

850

Apr-12

450

9500

900

Jul-11

550

950

Oct-11

650

10000

Jan-11

Z-sprd

Apr-11

750

FIGURE 2
Copper production higher despite lower prices

Copper production (12m rolling, '000 tonnes)


Copper price (USD/ton, rhs)
Source: In-Net Bridge, BoZ, Barclays Research

152

Barclays | The Emerging Markets Quarterly


Though mining costs vary, Mining Minister Yaluma noted recently that mines would be
threatened should copper prices fall to USD5,000/ton and below (Bloomberg, 14 March).
Within the domestic economy, new projects coming on stream and mine expansion
continue to boost production. Bank of Zambia data show copper production grew 21% y/y
to 915k tonnes in January-November 2013 despite lower average prices, while annual
output is expected to reach 1.5 million by end-2016. Increasing production will cushion the
effect of lower copper prices, with the current account balance likely to return a small deficit
in 2014 (Barclays: -1.8% of GDP) despite firm import growth.

Economic growth outlook favourable


Economic growth expected to
remain above 6% in 2014

Barring a downside risk scenario in which copper prices fail to recover and even decline
further, we believe Zambias economic growth is likely to be more than 6% this year.
Though weather-dependent, we expect agriculture to continue to provide sustenance for
growth in addition to increased copper production. Infrastructure development will also
provide impetus with several energy sector projects in the pipeline. Power constraints will
be eased with 500MW in additional capacity expected to be commissioned in the next 18
months, providing a significant boost to current capacity of about 2000MW. The ongoing
revision of GDP means that growth rates and economic estimates will change in upcoming
quarters, also affecting fiscal and external balance metrics.

Weaker ZMW and wage


increases key risks to the
inflation outlook

Amid expected firm growth and rising inflation, we believe further monetary tightening is
possible in the next quarter. While base effects may support disinflation in H2, we continue
to see upside risks to the BoZs 6.5% end-2014 inflation target (Barclays end-2014 forecast:
7.7% y/y), amid recent FX depreciation and large public wage increases in 2013. Given tight
monetary policy, credit growth (12.7% y/y at end-2013, from 39.2% a year before) is likely
to remain relatively subdued.

Risks to 6.2% fiscal deficit


target for 2014 remain

Despite the favourable growth outlook, recent fiscal deterioration and the weaker external
position keeps Zambia at risk for a negative rating action in the next quarter (please see our
assessment in the previous Emerging Markets Quarterly). Announcements are expected from
Moodys (30 May; B1 stable) and S&P (B+ negative) in the upcoming months. After the onenotch downgrade last October, Fitch affirmed its B (stable) rating on Zambia on 21 March.
The significantly larger public wage bill suggests further fiscal slippage is possible (from 2013),
particularly should revenues disappoint, despite the two-year freeze in public wages and
subsidy reforms implemented in 2013 (which have freed some fiscal space).

FIGURE 3
Zambia macroeconomic forecasts
2010

2011F

2012

2013E

2014F

2015F

Real GDP (% y/y)

7.6

6.8

7.3

6.0

6.7

7.0

GDP (USD bn)

16.2

19.2

20.6

22.3

23.2

25.2

Current account balance (% GDP)

7.1

3.7

0.1

-1.5

-1.8

2.3

Gross reserves (USD bn)

2.1

2.3

3.1

2.7

2.9

Months of imports

3.0

3.2

4.1

3.0

3.0

Fiscal balance (% GDP)

-3.0

-2.2

-3.3

-7.5

-7.0

-6.5

Total public debt (% GDP)

25.8

27.2

32.4

35.2

37.5

39.3

CPI (% Dec/Dec)

7.9

7.2

7.3

7.1

7.7

6.9

USD/ZMW (eop)

4.80

5.12

5.15

5.51

6.20

6.52

Q1 13

Q4 13

Q1 14F

Q2 14F

Q3 14F

Q4 14F

CPI (% y/y, eop)

6.6

7.1

7.8

7.6

7.7

7.7

USD/ZMW (eop)

5.37

5.51

5.92

6.01

6.11

6.20

Policy rate (%,eop)

9.25

9.75

10.25

10.75

10.75

10.75

Source: BoZ, IMF, Reuters, Barclays Research

25 March 2014

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LATAM: ARGENTINA

A heterodox stabilization plan


Economics
Sebastian Vargas
+1 212 412 6823
sebastian.vargas@barclays.com
Credit Strategy
Donato Guarino
+1 212 412 5564
donato.guarino@barclays.com

A heterodox stabilization plan is apparently being pursued, a positive change to our


expectations about domestic policies. Income policies such as wage-price controls will be a
crucial aspect of stabilization, as is the nominal exchange rate that will be used as a nominal
anchor. However, the success will depend on the fiscal adjustment. We also now expect
advances with the Paris Club and holdouts. We remain overweight.

Key recommendations
Strategy: We remain constructive on Argentina credit, which we keep as an overweight
in our portfolio, given positive policy steps, potential catalysts in the financial agenda,
and valuations. We recommend the very short end of the curve, since it is inverted. In
particular, we favour the Boden15; while it trades tighter than the Bonar17, it is more
immune to supply risk and still trading at a sizable pickup relative to the long-end bonds.
For investors who cannot take on Argentina local law risk, the less liquid G17 is our pick.
We think that the ARS will be used as a nominal anchor and that the depreciation will be
gradual, but we sense risks are high for long peso positions in NDF.

The authorities are apparently


pursuing a heterodox
stabilization plan: income
policies, opportunistic fiscal
adjustment and monetary
tightening; no inflation
objective has been announced

In Argentina: Policy supports valuations, December 10 2013, we confirmed our constructive


expectations of the direction of policy and raised the credit to overweight. We argued that the
major shifts in policy would be the approach to creditors and foreign investment in energy and
mining but that domestic policies would remain mostly unchanged. This was based on the
authorities need to contain the reserves drain but would be limited by social unrest and lower
popularity as inflation and a weaker labor market kicked in. We now think that they will also
pursue changes in domestic policies. Therefore, we now think that the economic plan is
becoming more consistent, increasingly looking like a heterodox stabilization plan with a
(more or less) pegged exchange rate, wage-price controls to coordinate the inflation process
(the release of a new CPI will help), fiscal control and tighter money. The program comes at a
time of good soybean prices and production; this should support reserves in the second
quarter. That said, the second half of the year is more challenging for reserves, as the
seasonality of exports will fade, but we do not expect a reserves downdraft in 2014. In sum, by
July, we expect better policies and more or less the same fundamentals as in January 2014.

We think external funding is


part of the plan: ICSID
arbitrations settlements,
Repsol, Paris Cluband
holdouts?

The more significant update to our views is that we expect negotiations with holdouts to
materialize within the Kirchner administration; we had expected Argentina to negotiate after
litigation avenues were exhausted. We now think that the main question is when the
settlement is likely to happen and that the authorities will avoid default of exchange bonds.
The days of financial isolation are over. According to our forecasts (Figure 1), Argentina
needs to access markets rapidly if the authorities want to avoid a serious effect on the
economy and the associated political costs. Moreover, we think that the authorities might
prefer not to wait for the Supreme Court decision, even if the Solicitor General pushes
forward the expected litigation timeline. Entering 2015 without access to markets would
leave the economy, the president and investors too vulnerable to Brazil, uncertain terms of
trade shocks and the weather whims of La Nia. In this respect, on March 18, Cabinet Chief
Capitanich mentioned to the National Broadcasting Service advances in negotiations with
Paris Club and holdouts . This is the first time the authorities put out in the public domain
that a negotiated settlement with holdouts is within the feasible set of options. Capitanichs
pragmatism is a step forward and supports our constructive views on more recent policies.

Financing needs require


market access down the line

Federal financing needs are manageable but a combination of fiscal adjustment and market
access is required. Federal financing can be split between hard currency (Figure 1) and peso
(Figure 2) needs. The former is related to hard currency debt service and GDP warrants, net

25 March 2014

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The time of paying debt with


reserves is over

of public sector holdings. Our calculations show that these stand at a manageable $6.6bn in
2014. This includes the Paris Club $2bn down-payment in 2014 and $1.5bn in cash per year
thereafter. It also includes net financing from multilaterals of $500mn and no GDP warrant
payment in December 2014. In 2015, even under the optimistic assumption that Argentina
settles with holdouts and issues a global bond for $5bn, the treasury would have to issue to
the central bank a note for $8.5bn 5. Therefore, it should not be a surprise if the authorities
move fast to engage with markets, else anxiety will build as forward-looking investors focus
on hard currency financing needs, particularly after taking into account interest due to debt
issued to settle with the International Centre for Settlement of Investment Disputes (ICSID),
Repsol and the Paris Club expected payment schedule. The time of paying debt with
reserves is almost over.
FIGURE 1
Hard currency financing needs 2014-20
USD bn
1. Hard currency bond debt service*
2. GDP warrants
3. In the hands of the public sector**

2014 2015 2016 2017 2018 2019 2020


6.0

13.6

17.3

15.3

12.2

9.8

2.8

2.8

2.8

2.8

16.2
2.8

-0.9

-1.2

-10.4

-3.2

-4.2

-0.9

-6.9

4. Multilaterals amortizations

2.4

2.3

2.2

2.0

1.8

1.5

1.4

5. Multilaterals rollover and disbursements

-2.9

-2.8

-4.2

-5.0

-5.3

-5.0

-4.9

6. Paris Club***

2.0

1.5

1.5

1.5

1.5

1.5

-5.0

-9.2

-13.4 -8.8

-9.7

-8.5

6.6

8.5

7. Federal global issuance + swaps


8. Net financing USD needs: use of reserves

Note: Financial isolation is not a viable plan. *includes interests on rollover debt ** estimates *** assumes that after
the $2bn down-payment, installments are made in cash, not bonds. The provinces face low payments in 2014, and we
assume market access for them in or before 2015 of about $1.8bn. Source: Barclays Research

FIGURE 2
Peso financing needs 2014-20
USD bn
1. Primary deficit

2014 2015 2016 2017 2018 2019 2020


9.9

6.4

7.2

4.8

2.8

0.6

-1.5

3.0

3.0

3.0

3.0

2. Provinces gap

3.0

3.0

3.0

3. Local currency bond debt service*

11.8

8.8

11.0 11.9 15.6 16.6 17.1

4. Swaps + public sector rollover + new peso bonds**

-14.3 -12.5 -18.8 -18.8 -20.4 -18.6 -15.8

5. Central bank: Profit transfers***

-6.5

0.0

2.0

3.0

2.0

1.0

0.0

6. Central bank: "Adelantos transitorios" ****

-3.8

-5.7

-4.4

-3.8

-3.1

-2.7

-2.8

7. Net financing ARS needs/new peso bond issues

0.0

0.0

0.0

0.0

0.0

0.0

0.0

8. Total monetary financing, % of GDP

2.8

1.6

0.7

0.3

0.3

0.5

0.8

9. Total monetary financing, % of money base in t-1

23.2 14.6

6.9

2.6

3.6

5.6

9.0

Memo item

Note *includes interests on rollover debt ** in January 2014, a number of locals swapped ARS Bonar 2014. We expect
the authorities to start issuing peso-denominated paper to roll over peso paper due, and issue additional paper if
needed. *** Amount the treasury needs to give back (in 2016) to the central bank to maintain a decent level of net
worth. **** limited by the central bank charter. Source: Barclays Research

The financial agenda is unlikely


to be reversed at this stage

Moreover, we think that the authorities are too invested in tapping the markets. It would be
unreasonable to increase hard currency needs with ICSID, Repsol, and the Paris Club, paying
the political cost of reporting high inflation, without reaping the benefits of tapping markets
and reducing financing costs for YPF and provinces and lowering the pressure on currency
markets. We think that the chances that the process is reverted are extremely low.
Therefore, progress in the agenda will act as an important market catalyst.

The effect on reserves, however, would be less, given that part of 2015 debt services are held domestically, as
balance of payments data suggest.

25 March 2014

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Barclays | The Emerging Markets Quarterly


Peso financing needs can be
absorbed by the central bank
balance sheet, but not for
long

Reducing peso financing needs is more complicated than negotiating with holdouts because it
hits the pockets of voters, union leaders, and social movements; affects territorial political
support and aids the political opposition. The peso financing needs comprise the primary
fiscal deficit, the peso debt service, and the peso financing needs of the provincial and
municipal governments. These are financed through central bank profits and adelantos
transitorios, or money printing. The problem here, connected with the issues discussed above,
is that the reserves dynamics are the flip side of monetary conditions. Excess money supply
means too many pesos chasing too few dollars. It drains reserves and puts pressure on the
official and parallel market premium, as well as inflation. Therefore, the central bank faces a
constraint when financing the treasury, although it can technically print as many pesos as it
likes to pay for these6. The January reserves crisis is evidence that the central bank is close to
the point where printing too much hurts central bank reserves.

given the increase in the cost


of servicing Lebacs

The central bank can always sterilize excess money printed to finance the treasurys peso
financing needs (by issuing Lebacs). This would be equivalent, in practice, to transfer peso debt
from the treasurys balance sheet to the central banks. But there is also a constraint to this
process, given the concomitant crowding out of private sector credit and, over time, the
increase in the quasi-fiscal deficit of the central bank. The central bank needs to pay interest for
Lebacs. The higher the Lebac interest rates, the shorter the time before the central bank starts
running quasi-fiscal deficits. Today, the central bank runs a surplus, but this could rapidly turn
into a deficit if Lebac rates remain at 30% for more than a year. This implies that sterilization at
high interest rates is not a process that can be ran for a sustained time and that, sooner rather
than later, the fiscal deficit must be tackled. This likely explains the hurry of the authorities to
move on with painful subsidy cuts, even with inflation at a cumulative 7.2% YTD in February.

Subsidies and non-essential


spending should be reduced in
real terms

This leads us to assume that the authorities will embark on a sizable fiscal adjustment that
takes the peso primary deficit to $10bn in 2014 (from $12bn in 2013) and to $6.4bn in
2015. We assume that the adjustment will happen in 2H (reducing the effect on 2014)
given the need to stabilize inflation in the next few quarters (tariff increases hit inflation)
and pass the union wage negotiation season that is mostly accomplished in the first half of
the year. Peso debt payments of close to $12bn are assumed to be easily rolled over (held
by local banks and public sector) and that the federal government issues peso domestic
debt to local banks and Anses for about $2.6bn. In addition, the aggregate provincial
financing needs are assumed to be $3bn. Assuming central bank profit transfers of $6.5bn
(same as in 2013) and adelantos transitorios of about $4bn, this would mean that money
printing to finance the treasury would amount to 2.8% of GDP and contribute a 23pp
increase in base money in 2014 if it is not sterilized by the central bank.
Is this amount of money printing low enough not to put pressure on exchange rate markets
and reserves? It is impossible to predict 7. But we do know that the central bank balance sheet
has room to stabilize exchange rate markets if needed. Assume, for instance, that the money
growth rate that stabilizes the exchange rate markets is 20% in 2014, a significantly lower
pace than nominal income. This would mean the central banks Lebac stock would increase
90% in 2014, or close to ARS100bn, given the 2.8pp of monetary financing mentioned above.
We think that such an increase is manageable (temporarily) for the central bank. For example,
from December 2014 to March 7, the stock of Lebacs has increased ARS43bn, or 40%. This
supports our view that the authorities have room to manoeuvre to contain the reserves bleed
if it becomes pressing again in the quarters to come.

The central bank charter does not allow printing any amount of pesos. In our forecasts, we respect these charter
constraints to finance the treasury.
7
This involves predicting demand for money in a changing and uncertain environment. Real money demand should
fall with lower activity and increasing depreciation/inflation expectations. However, should prices stabilize, it could
compensate for this effect from the effect on real income.

25 March 2014

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Barclays | The Emerging Markets Quarterly


A real depreciation of the peso
is highly unlikely, given the lack
of economic slack

This means that the nominal


exchange rate should not
depreciate sharply again

Therefore, we see the authorities pursuing a heterodox stabilization plan that involves
(politically opportunistic) fiscal tightening of subsidies and non-essential capex spending
but most of the heavy lifting put on the central banks shoulders in 2014. To reduce the
effect of this on the economy, the authorities could pursue a combination of price-wage
controls and opening up external financing. Where does this logic leave us in terms of the
peso outlook? In our opinion, the January depreciation has proven that with full
employment and unanchored inflation expectations, seeking a real exchange rate
depreciation is fruitless: it brings nominal instability, labor unrest and a potential shortening
of contracts. Instead of obtaining the desired results, it leaves the real exchange rate at its
original level. Under this logic, we think that the authorities will use the peso as a nominal
anchor and a critical part of their income policies and pursue a gradual depreciation path
that will mean that the peso will depreciate below inflation. Pressures in the parallel
exchange market will depend, ultimately, on policy consistency.
The authorities have not stated an explicit objective in terms of inflation, but we think it is
close to 30% in 2014. The authorities are focused in combating inflation inertia. Their efforts
to reach agreements with friendly unions (~ 30%) and Secretary Costas work on price
controls (precios cuidados) and coordination between sectors are important policy elements
to reaching this goal. The new CPI will certainly help in such coordination efforts. Coordination
is needed because to protect their margins, firms are reluctant to contain prices if they have no
assurance that competitors, unions and inputs in the production chain, will do the same.
However, Secretary Costas efforts will fail to deliver permanent results unless there is success
on the fiscal side of the policy equation the Achilles heel of past failed stabilization plans. The
increase in economic slack will likely help the authorities in the next quarters, as well as the
nominal stability of the peso. Therefore, we think inflation will not spiral.

Argentina will have to pick its


poison: IMF conditionality or
holdouts?

In past times, such a stabilization plan would include IMF financial support at the political
cost of the strings attached to financing, or "IMF conditionality". In the current state of
affairs, we think the authorities will not approach the Fund seeking for financing. Instead,
they are likely leaning toward negotiating with creditors including holdouts to get muchneeded hard currency to reduce the effect on growth and reserves during the transition to
2015 presidential elections. However, we think that the authorities could reluctantly
entertain an IMF Art 4 consultation should Paris Club creditor nations make it a nonnegotiable condition for a debt restructuring.

FIGURE 3
Argentina assets had a volatile performance in Q1
%

FIGURE 4
Argentina USD-denominated curve remains inverted

USD/ARS
8.5

100
98

8.0

96
7.5

94

7.0

90

6.5

88
86
Dec-13

Jan-14

EF106106 Corp
Source: Barclays Research

25 March 2014

Feb-14

Mar-14

Bonar 17

1250
1150
1050

92

84
Nov-13

(bp)
1350

Current

08-Jan-14

G17
G17
Boden15
Bonar 17

950

Discount

850

6.0

750

5.5

650
0.50

Discount
Par

Boden 15
Par
2.50

USD/ARS (RHS)

4.50
6.50
Modified Duration

8.50

10.50

Source: Barclays Research

157

Barclays | The Emerging Markets Quarterly

FIGURE 5
Argentina macroeconomic forecasts
2007

2008

2009

2010

2011

2012

2013E

2014F

2015F

Activity
Real GDP (% y/y)

8.5

2.4

-4.1

7.9

5.0

-0.4

3.1

-1.5

4.4

Domestic demand contribution (pp)

9.7

4.1

-6.1

10.2

7.1

-0.3

4.1

-2.7

5.3

Fixed capital investment (% y/y)

13.6

9.1

-10.2

21.2

16.6

-4.9

5.0

-4.3

10.4

-1.2

-1.7

1.9

-2.3

-2.2

0.0

-1.0

1.1

-0.9
3.4

Net exports contribution (pp)


Exports (% y/y)

9.1

1.2

-6.4

14.6

4.3

-6.6

1.3

1.0

Imports (% y/y)

20.5

14.1

-19.0

34.0

17.8

-5.2

7.1

-5.9

8.2

261

327

307

369

433

432

461

363

350

12.5

16.9

11.8

14.1

9.0

7.3

-2.8

6.1

-0.2

GDP (USD bn)


External Sector
Trade balance minus interests cash (USD bn, cash)
as a % of GDP

4.8

5.2

3.8

3.8

2.1

1.7

-0.6

1.7

-0.1

Trade balance (USD bn), FOB

11.1

13.0

17.0

11.8

10.0

12.0

9.0

9.1

2.1

-16.7

-10.2

-9.9

-14.9

-10.4

-9.9

-9.2

-11.2

124.6

124.9

116.4

128.6

135.0

141.8

148.9

156.3

164.2

46.2

46.4

48.0

52.2

46.4

43.3

30.6

27.5

16.1

Public sector balance (% GDP) **

0.0

0.9

-2.6

-1.8

-2.8

-3.3

-4.8

-4.6

-3.2

Primary balance (% GDP) **

2.1

2.6

-0.4

-0.3

-0.9

-1.5

-3.2

-3.1

-2.1

56.0

47.1

49.0

45.2

41.4

45.7

53.6

52.1

50.6

Other net inflows (USD bn)


Gross external debt (USD bn)
International reserves (USD bn)
Public Sector

Gross public debt (% GDP)


Prices
CPI (% Dec/Dec) *

25.7

21.8

15.0

26.9

21.8

27.0

27.3

39.0

38.4

CPI (% average) *

18.6

27.0

14.1

23.6

23.7

24.0

26.9

37.4

38.2

Exchange rate (ARS/USD, eop)

3.15

3.45

3.80

3.98

4.30

4.92

6.32

9.67

13.12

Exchange rate (period average)

3.12

3.16

3.73

3.91

4.13

4.55

5.48

8.52

11.56

Q2 12

Q3 12

Q4 12

Q1 13

Q2 13

Q3 13

Q4 13F

Q1 14F

Q2 14F

-2.8

-1.2

-0.5

0.2

6.4

3.4

2.2

-0.5

-2.5

Real GDP (y/y)


CPI (% y/y, eop)

23.1

24.5

26.1

28.0

26.2

26.4

27.0

33.2

37.7

Exchange Rate (dom currency/USD, eop)

4.53

4.70

4.92

5.08

5.33

5.74

6.32

7.87

8.48

Badlar Rate (%, average)

12.0

13.8

15.2

14.9

15.8

17.7

19.4

24.2

24.7

Source: Central Bank, Anses, Mecon, Barclays Research

25 March 2014

158

Barclays | The Emerging Markets Quarterly

LATAM: BRAZIL

Looking more like a glass half-full


Economics
Marcelo Salomon
+1 212 412 5717
marcelo.salomon@barclays.com
Bruno Rovai
+ 55 11 3757 7772
bruno.rovai@barclays.com

We believe the combination of better growth in early 2014 and a slightly more marketfriendly government has reduced some of the pessimism about the outlook of the Brazilian
economy. We remain sceptical that the government will deliver the 1.9% GDP fiscal primary
surplus target and are not surprised by the S&P rating downgrade of the sovereign. The
agency outlook moved back to stable, which should give a breather to overall mood and
allow the markets to enjoy the carry trade, at least until the World Cup in June.

Key recommendations
Credit: Despite the one-notch downgrade from S&P to BBB- (largely priced in), the outlook
has been moved to stable. Combined with positive signals on the fiscal front, better-thanexpected growth data and still-attractive valuations against peers, this led us to lift the
sovereign to tactically overweight in our portfolio. We believe the belly of the curve (new
BR 2025s) is the most attractive. For leveraged investors, we express our view by selling
Brazil and buying Colombia/Mexico 5y CDS.

Rates and Credit Strategy


Donato Guarino
+1 212 412 5564
donato.guarino@barclays.com
FX Strategy

FX: We still like the BRL on tactical grounds and recommend being short USDBRL (ref.

Sebastin Brown

2.37, target 2.29, stop 2.42). While we do expect a weaker BRL in the longer run, we
believe that the BCB will continue to use its large balance sheet to prevent a sell-off of
the currency, at least until the election. Recent inflationary pressures, together with the
need for slightly looser monetary policy in the face of more austere fiscal policy, only
increase the BCBs incentives to keep the BRL under control. The limited potential for a
sell-off, relatively low vol, and the currencys high FX-implied yield make short USDBRL
positions attractive in the 1-3m horizon.

+1 212 412 6721


sebastian.brown@barclays.com

Rates: Brazil local rates offer generous risk premia, despite the inflation challenges. We
think the current account adjustment can serve as a catalyst to stabilize exchange rate and
pull down the yield curve. Currently, the DI curve is pricing almost 300bp in hikes over the
next two years, which seems excessive. While the receiving trade has been extremely
volatile relative to other EM local rates, the risk-reward profile is extremely high. Given the
shape of the yield curve, we think the 3y point offers the most attractive carry/roll-down;
therefore, we recommend buying NTN-F 17s for real money and receiving DI Jan17 for
leveraged investors.
FIGURE 1
Brazil spreads are attractive relative to its peers
(bp)

FIGURE 2
Consumption and net exports are the main source of growth
in 2014
pp, contr.
10

120

100

6
80

60

40

20
May 13

-2
Aug 13

Brazil - Mexico 5yr CDS


Source: Bloomberg, Barclays Research

25 March 2014

Nov 13

Feb 14

Brazil - Colombia 5yr CDS

-4
2007 2008 2009 2010 2011 2012 2013 2014F 2015F
C

Net Exp

Real GDP

Source: IBGE, Barclays Research

159

Barclays | The Emerging Markets Quarterly

Growth changes everything


Weak growth data have
contaminated the mood for the
past two years, but we believe
sentiment is now changing

It was at the end of 2011 when Q3 real GDP for that year started to surprise on the downside
in Brazil, the government embarked on what we called a fear of slowdown strategy (see the
Brazil chapter in The Emerging Market Quarterly: A Glass Half Full Take a Sip, 6 December
2011) and investors started to question Brazils bullish investment growth story. Heavy
government interventionism, in a frustrated attempt to re-stimulate growth and control
inflation, added fuel to the fire and led to a strong negative sentiment with Brazil. After the
resulting S&P downgrade, which was largely priced in, and move of the outlook back to
stable, the mood is starting to change again, and we believe positive growth surprises have
a lot to do with this.

There were upside surprises in


the GDP report and other highfrequency indicators for early
2014, helped by a change in
the governments approach

Q4 13 real GDP growth surprised on the upside, which, along with better-than-expected
activity indicators in January 2014, dispelled concerns that the economy could be entering a
technical recession. Other factors helped to set a more positive stage: the government
announced a 1.9% of GDP primary fiscal surplus target for this year, which is the same level
as in 2013 and should interrupt the fiscal splurge that eroded 1.2 pp of GDP from the 3.1%
surplus level in 2011; is extending the monetary policy tightening; and is adopting a slightly
more market-friendly speech.

We do not believe the


government will achieve the
new primary fiscal surplus
target, but we reckon it
brought a positive mood

These factors, however, were not enough to prevent a downgrade, as S&P moved the longterm Brazil rating to BBB-. Weak growth prospects for the next couple of years, fiscal
deterioration and lack of economic policy credibility are the reasons, according to the
agency. We share the view that the government will not deliver the 1.9% primary fiscal
surplus this year, as we reiterate our 1.3% forecast. At the same time, with this event largely
priced in, we believe that the bearishness with Brazil could now take a breather, as the focus
moves to the World Cup in mid-year. Moreover, with the temperature rising in other parts of
the EM universe, Brazilian fundamentals, which are behind the investment-grade level, may
start to look a little brighter than those of others high yielders, which should give markets
some breathing space, at least in the coming months.

The current account deficit improvement remains critical


Weak trade balance data led
us to revise our current
account deficit forecast

A critical point that helps support the improving sentiment in Brazil is the expected
contraction of the current account deficit. Even though we revised higher our 2014 year-end
current account deficit forecast to 3.3% from 3.0% of GDP, we remain more optimistic than
the consensus. According to the latest BCB Focus consensus survey, markets expect an
even milder improvement this year (current account deficit of 3.5% of GDP), with further

FIGURE 3
Current account deficit set to improve by Q2 14

FIGURE 4
Iron ore price decline is a risk to 2014 export growth
USD/ton

USD bn,
12mth sum
-55

170
Forecast

160

-60

150
-65

140

-70

130

-75

120

-80

110

-85
Jan-13

May-13

Sep-13

Source: BCB, Barclays Research

25 March 2014

Jan-14

May-14

Sep-14

100
Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14
Source: Bloomberg, Barclays Research

160

Barclays | The Emerging Markets Quarterly


gains pushed back to 2015 (Barclays forecast: 2.5%; consensus: 3.2% of GDP). At the end
of last year, we were expecting the combination of a weaker BRL, stronger global demand
and slower domestic activity to have a positive effect on the trade balance in the beginning
of this year. However, the disappointing trade performance in the first two months of 2014
suggests that most of the improvement on the current account front will have to come
from lower import demand, as exports may pitch in very little.
Risks to exports continue to
rise, as Argentina adjusts the
exchange rate and iron ore
prices continues to decline

The Argentine crisis is clearly bad news for Brazilian industrial exports. Argentina is Brazils thirdlargest trade partner; hence, the peso devaluation and slump in economic activity pose threats
to Brazilian industrial exports. For example, the transportation/industrial complex, which
represents 11% of total exports, depends strongly on Argentine demand, as more than onethird of exports of this sector goes to Argentina. Commodity prices, specifically iron ore,
represent another source of risk to export performance. Iron ore exports represent 13% of the
total, and the 25% y/y price decline already registered by mid-March (Figure 4) indicates that
further weakness in Chinese growth could have a larger effect on Brazilian export performance.

Despite risks, we still see the


current account deficit
improving by Q2 14

That said, we expect exports to inch up 1.9% this year, and the bulk of the trade balance
improvement (USD14.7bn forecast for this year, vs. USD2.6bn in 2013) should come from a
3.1% contraction in imports. The inflection point of the current account balance (12 months
rolling, Figure 3) appears already to have happened in March and should gain more traction
between Q2 and Q3 14. Despite the sluggish improvement, 85% of the current account gap
continues to be financed by net FDI, which is clearly good news for the BRL.

Electoral cycle could interfere on regulated price adjustments


Climate adverse changes are
pressuring food inflation on the
upside

The trade-off between growth and inflation should continue to deteriorate over the medium
run as the government unwinds repressed regulated prices and eliminates tax exemptions.
In the short run, adverse weather conditions should add to the inflationary concerns.
Wholesale price indices are already capturing this trend. The February IGP-DI index
surprised on the upside, printing at 0.85% m/m, against the 0.65% consensus expectation,
led primarily by spikes in agricultural producer prices. Daily surveys also point to higher
inflation figures, with food inflation hovering above 1% throughout March. While there is
normally some lag between wholesale prices swings and consumer price movements, the
pass-through of non-industrialized food inflation is swifter and could pressure inflation
indices in the short run.

FIGURE 5
Net debt should increase this year, as we reiterate our
primary fiscal surplus forecast

FIGURE 6
Regulated price increases prevent IPCA softness, despite
floating prices slight relief

% GDP

% y/y

3.5
3.0
Forecast

2.5
2.0
1.5

1.0
Jan-11 Aug-11 Mar-12 Oct-12 May-13 Dec-13 Jul-14
Primary surplus
Source:

BCB, Barclays Research

25 March 2014

40

9.0

39

8.0

38

7.0

37

6.0

36

5.0

35

4.0

34

3.0

33

2.0

32

1.0

31

Forecast

0.0
Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14

Net debt (RHS)

Regulates Prices
Source:

Floating Prices

IPCA

IBGE, Barclays Research

161

Barclays | The Emerging Markets Quarterly


Adjustments on regulated
prices are also expected for
this year, but the electoral
cycle could change this

Some of the regulated price adjustment has already taken place this year, but there is still a
lot to be dealt with that could be left to 2015. In our 6% IPCA forecast for this year, pencilled
in are hikes in transportation prices, as bus fares were hiked in Rio de Janeiro in February
and at least two more cities are considering raising them after the elections; a 5% increase
in gasoline prices; and a 7.5% gain in electricity prices. This means that regulated prices will
rise nearly 4.5% this year, from a very depressed 1.5% in 2013. However, all of these hikes
depend on the electoral prospects: if floating prices move up more than we expect, the
government may leave regulated price adjustments for 2015. And if all of the BRL12bn in
new subsidies to the energy sector, announced on 14 March, is finally transferred into
higher consumer utility prices, our 5.6% 2015 IPCA forecast would rise at least an additional
60bp. Hence, despite the depressed domestic demand, inflation is likely to remain close to
the upper, rather than mid-, point of the inflation target.

FIGURE 7
Brazil macroeconomic forecasts
2010

2011

2012

2013

2014F

2015F

Real GDP (% y/y)

7.5

2.7

1.0

2.3

1.9

2.4

Domestic demand contribution (pp)

10.2

3.6

1.0

3.2

0.5

2.2

Private consumption (% y/y)

6.9

4.1

3.2

2.3

2.0

2.1

Fixed capital investment (% y/y)

21.3

4.7

-4.0

6.3

0.9

2.5

Net exports contribution (pp)

-2.7

-0.8

0.0

-0.9

1.4

0.2

Exports (% y/y)

11.5

4.5

0.5

2.5

7.6

3.8

Imports (% y/y)

35.8

9.7

0.2

8.4

-3.2

1.7

GDP (USD bn)

2144

2477

2237

2217

2167

2248

Current account (USD bn)

-47.3

-52.5

-54.2

-81.4

-70.8

-56.8

CA (% GDP)

-2.2

-2.1

-2.4

-3.7

-3.3

-2.5

Trade balance (USD bn)

20.1

29.8

19.4

2.6

14.7

27.2

Net FDI (USD bn)

36.9

67.7

68.1

67.5

60.0

52.0

Activity

External sector

Other net inflows (USD bn)

61.9

43.1

3.8

6.6

9.0

13.0

Gross external debt (USD bn)

256.8

298.2

312.9

312.0

304.3

308.2

International reserves (USD bn)

288.6

352.0

373.1

358.8

359.0

369.2

-2.5

-2.6

-2.5

-3.3

-3.9

-3.5

Public sector
Public sector balance (% GDP)
Primary balance (% GDP)

2.7

3.1

2.4

1.9

1.3

1.7

Gross public debt (% GDP)

53.4

54.2

58.8

57.2

58.1

58.6

Net public debt (% GDP)

39.1

36.4

35.3

33.8

35.3

36.1

CPI (% Dec/Dec)

5.9

6.5

5.8

5.9

6.0

5.6

CPI (% average)

5.0

6.6

5.4

6.2

5.9

5.9

Exchange rate (BRL/USD, eop)

1.66

1.87

2.05

2.36

2.45

2.60

Exchange rate (period average)

1.76

1.67

1.96

2.18

2.41

2.52

1y ago

Last

Q1 14F

Q2 14F

Q3 14F

Q4 14F

Real GDP ( % y/y)

1.8

2.2

2.3

1.1

2.2

2.1

CPI (% y/y, eop)

5.8

5.8

5.7

5.7

6.1

6.0

Exchange rate (BRL/USD, eop)

2.05

2.33

2.35

2.40

2.45

2.45

Monetary policy benchmark rate (%, eop)

7.25

9.50

11.00

11.00

11.00

11.00

--

--

--

10.99

11.37

11.89

Prices

Market implied benchmark rate (%,eop)


Source: Barclays Research

25 March 2014

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Barclays | The Emerging Markets Quarterly

LATAM: CENTRAL AMERICA AND THE CARIBBEAN

New governments, same challenges


Economics
Alejandro Arreaza
+1 212 412 3021
alejandro.arreaza@barclays.com
Alejandro Grisanti
+1 212 412 5982
alejandro.grisanti@barclays.com
Credit Strategy
Donato Guarino
+1 212 412 5564
donato.guarino@barclays.com

New authorities need to move


quickly to tackle fiscal
imbalances

Leaving behind the electoral uncertainty, Central American authorities still face
challenging political hurdles to implementing fiscal consolidation. Risks of radicalization
in El Salvador seem contained, opportunities to build consensus in Costa Rica appear to
have opened, and in Panama, delays in the canal works and the deferral of public works
payments will require a more restrictive fiscal policy.

Key recommendations
Credit: During the election process, El Salvador spreads have repriced wider relative to
the Dominican Republic. While we think the uncertainty is higher, the risk of
radicalization is limited, in our view. Therefore, we recommend that investors tactically
switch out of the DOMREP 2021s into the ELSALV 2023s. At a portfolio level, we express
our view by leaving our stance on El Salvador at neutral and on the Dominican Republic
at underweight.
Elections have been center stage in most Central American countries (CAC) over the past
months; however, electoral uncertainty has steadily declined, and the main question
remains how the new authorities will tackle challenging fiscal conditions, particularly in the
context of tighter global monetary conditions, which could make it more difficult to finance
CAC deficits. In order to limit further deterioration in fundamentals, the new governments
will have to move rapidly from the ballot box to building consensus and implementing
measures that bring fiscal consolidation.
El Salvador elected Salvador Sanchez Ceren as its new president. His very narrow winning
margin is likely to maintain a high level of polarization and could increase political noise.
However, we believe economic and political constraints should limit the risk of radicalization
of the new administration, which has been the markets main concern. Costa Rica will hold
a run-off election on April 6, but the ruling partys candidate, Johnny Araya, withdrew his
candidacy, clearing the path for Luis Guillermo Solis to become president. In our view, this
increases the chances of building a consensus to pass needed fiscal reforms, although we
expect some deterioration in the public accounts in the short term. Panama will hold
general elections on May 4. Although the various opinion polls show different margins, the
government candidate, Jos Domingo Arias, remains ahead. Still, his lead may not imply

FIGURE 1
El Salvador spreads underperformed during the election
process, creating a tactical opportunity, in our view

FIGURE 2
Close win likely to maintain high polarization (%)

Spread (bp)
550
500
450
400
350
300
250
Feb 12

Aug 12

Feb 13

El Salv 23
Source: Barclays Research

25 March 2014

Aug 13

Feb 14

DomRep 21
Source: TSE

163

Barclays | The Emerging Markets Quarterly


policy continuity, as a larger deficit, the deferral of payments for infrastructure projects and
lower-than-expected fiscal revenues will require a more restrictive fiscal policy.

El Salvador: Radicalization risks contained


Surprisingly close victory for
Sanchez Cern

Surprisingly, the run-off in El Salvador was very tight, with both candidates claiming victory.
Although polls showed a large advantage for Salvador Sanchez Cern, the candidate of the
leftist FMLN, the countrys electoral court (TSE) declared him the winner with just 50.1% of
the vote, compared with 49.9% for Norman Quijano of the center-right ARENA (Figure 2).
Mr. Quijano is contesting the result and has taken his case to the Supreme Court. This
shows a highly polarized society that will find it difficult to build a consensus to overcome
the challenges facing the country. However, we also believe that the room for radicalization,
which has been the markets biggest concern in the event of a Sanchez Cern victory, is
limited. As we wrote in Global EM political outlook: Central America and the Caribbean,
March 6, 2014, Mr. Sanchez Cern will most likely face constraints that limit the potential
for policy change.

Economic and political


constraints may contain risks
of radicalization

The country faces a difficult economic situation. Despite improvements on the fiscal front,
the government still has substantial financing needs, given the high concentration of shortterm domestic debt, which amounts to approximately USD0.6bn. This will force the new
government to seek financing. It will have to consider looking for a new agreement with the
IMF and/or trying to place a long-term bond in the international market. After the inability
of El Salvador to extend the previous standby agreement with the IMF, we expect intense
negotiations if the government seeks a new one. The key point is a possible increase in the
VAT, which the government has resisted. An agreement might be possible by earmarking
the revenues from the tax increase for social expenditures in health and education.
Nonetheless, the negotiations will likely be protracted, which means the government is
likely place a bond in the market before year-end. This funding need requires the new
administration to maintain a moderate position.
A political constraint for the new government is legislative elections that will be held next year.
With the electorate divided in half, radicalization could shift swing voters to the opposition and
cause the government to lose control of the legislature. The FMLN seems to have a long-term
goal of retaining power; as such, we believe it is likely to pursue gradual reforms, rather than
radical shifts, to ensure its projects sustainability. Radicalization could lead to deterioration in
the countrys economic situation, which has been registering very low growth due to a lack of
investment, thus jeopardizing its position. Nonetheless, even if policies are not radicalized,
rising polarization could increase political noise, negatively affecting investment in a country
whose main problem has been its inability to grow at a faster rate.

Despite efforts, still on an


unsustainable fiscal path

Despite the contained political risks, we continue to see El Salvadors debt dynamics moving
in an unsustainable trend. There have been significant fiscal efforts to reduce the public
sector deficit; however, we estimate that it will remain at about 4.0% of GDP. Even if the
government is able to pass fiscal reforms, we expect the measures to result in slower
growth, or even a recession, making debt stabilization unlikely in the next two years. We
estimate the public sector debt/GDP ratio will exceed 65.0% of GDP by 2015, which leaves
the country in a vulnerable position, particularly considering the changes in the global
environment, which imply less liquidity and higher financing costs.

Costa Rica: A chance to build consensus


Solis has a clear path to
become president

25 March 2014

Luis Guillermo Solis of the Citizen Action Party (PAC) was supposed to face Johnny Araya of
the ruling Partido de la Liberacin Nacional (PLN) on April 6. The momentum that Mr. Solis
showed in the final stretch of the first round and Mr. Arayas weak performance made Mr.
Solis the favorite in the run-off election. This was confirmed by a CIEP poll published in early
March that showed Mr. Solis with 64.4% support, compared with 20.9% for Mr. Araya, an
164

Barclays | The Emerging Markets Quarterly


advantage of 43.5pp. Soliss strong lead triggered Arayas surprise withdrawal from the
race. Even if the constitutional rules require that the election be held, the withdrawal cleared
the path for Mr. Solis to become president.
Arayas resignation opens the
possibility of an alliance to
approve fiscal reform

Mr. Arayas withdrawal could also mean that additional friction between the political parties
can be avoided, which would make it easier for the new administration to reach
agreements. Nonetheless, Februarys election left a more fragmented Legislative Assembly
(Figure 3). The leftist Frente Amplio (FA), which had just 1 of the 57 seats in the Assembly,
won 9 seats. Mr. Arayas PLN remains the main political force in the legislature, with 18
seats, but that is down from 24 in the previous legislature. Mr. Soliss PAC will have 13
seats, the libertarian movement 3 and the Social Christian Unity (PUSC) 9. The more
fragmented Legislative Assembly could cause further delays to the reform agenda. Mr.
Soliss initial move was to try to build an alliance with the FA and PUSC, rather than with the
PLN. However, Mr. Arayas withdrawal also introduces the possibility that PLN legislators
could support a legislative proposal that the government might present for the good of the
country. He said they will adopt a responsible opposition.
Mr. Solis has proposed postponing reform for two years in order to try to look for a more
efficient use of public resources and reduce tax evasion. Still, the impact of his proposal is
limited, considering that the government is legally required to increase expenditures for
education to 8.0% of GDP, and more that 60% of the government budget is committed to
salaries and interest payments. However, his advisers are conscious of the necessity of reform.
They say they just want to avoid ending up like previous administrations, trapped in
congressional negotiations and legal discussions. In that sense, the possibility of an alliance that
includes the PLN and reaches at least 38 of the 57 assembly seats opens the possibility of fasttracking the reform and preventing further deterioration of Costa Ricas fundamentals.

Even in a best-case scenario,


we expect the fiscal deficit to
increase in 2014

Despite the improved chances of building consensus, it seems difficult to avoid further
deterioration in the fiscal accounts, at least in 2014. It is important to take into account that in
Costa Rica there is no re-election for legislators. Therefore, all members of the legislative
assembly will be new, which implies that they will need time to reach an agreement. In that
sense, we estimate that the fiscal deficit will reach 6.0% of GDP in 2014, and in order to finance
it, we believe the government will need to issue another USD1.0bn of bonds after the elections.
We believe the first signals the administration sends will be critical. If it does not provide a clear
sign that it is tackling the fiscal imbalance in the short term, the credit is likely to be downgraded
by Moodys, the only rating agency that rates the sovereign investment grade.

FIGURE 3
El Salvador needs to extend debt maturity

FIGURE 4
Costa Ricas fragmented Legislative Assembly

1.2

60

1.0

50

0.8

40

0.6

6
1

30

11

0.4

5
3

6
9

9
9
13

20

0.2

24

10

External
Source: TSE, Barclays Research

25 March 2014

Letes

2040

2038

2036

2034

2032

2030

2028

2026

2024

2022

2020

2018

2016

2014

0.0

18

0
Current LA
PLN

PAC

New LA
FA

PUSC

ML

Others

Source: TSE, Barclays Research

165

Barclays | The Emerging Markets Quarterly

Panama: Continuity with change


The presidential race in Panama has tightened; however, Jos Domingo Arias, the ruling
partys candidate, remains the favorite. According to a Ditcher and Neira poll, Mr. Arias has
36% support, followed by Juan Carlos Navarro from the Revolutionary Democratic Party (PRD)
with 32%. Nonetheless, even if Arias wins the election, he may need to make to changes to
the fiscal policies of President Martinelli. The government has been awarding infrastructure
projects using a format under which the winner of the contract has to raise the funding for the
project and the government does not pays until the conclusion of the project. This has
resulted in accumulated liabilities of approximately USD2.2bn (5.4% of GDP) that the
government will have to pay over the next five years.

Even if the ruling partys


candidate wins, changes to
fiscal policy may be needed

In absence of fiscal tightening,


there will be deterioration in
fundamentals

This, along with a reduction in government revenues due to the delay in the expansion of the
Panama Canal, will require the next government to cut investment or issue more debt in the
near term, in our view. Passing fiscal reforms are necessary over the medium term in order to
able to continue to reduce the indebtedness level. Growth will not be enough to continue to
lower Panamas debt/GDP ratio. Considering the partial paralyzation of work on the canals
expansion, the conclusion of this project next year and possible future fiscal tightening, we
expect GDP growth to moderate towards 6.5% from an average of 9.0% over the past seven
years. We believe that further downward pressures on growth are contained, considering that
a large portion of demand is satisfied by imported goods and services, which reduces the
multiplier effect of public spending. Nonetheless, in absence of fiscal tightening, we could start
to see deterioration of the fundamentals of the credit, with the debt increasing from 40.0% of
GDP to more than 45.0% of GDP over the next two years.

FIGURE 5
Costa Ricas high financing needs (% GDP)

FIGURE 6
Tighter race, but Arias retains the lead in Panama (%)

12

40

10

36

38
34

32
30

28

26
24

22

0
2013E

2014F

Primary Deficit

2015F

Interest Payments

2016F
Amortization

20
01-Nov-13

01-Dec-13
Arias

01-Feb-14

01-Jan-14
Navarro

Varela

Source: BCCR, Barclays Research

25 March 2014

166

Barclays | The Emerging Markets Quarterly

LATAM: CHILE

Curb your pessimism


Economics
Marcelo Salomon
+1 212 412 5717
marcelo.salomon@barclays.com
FX Strategy
Sebastin Brown

Weak Q4 13 data lead us to see downside risks to our growth forecasts. Internal
demand, the foundation of Chiles past resilience, is now declining as investments dry
up. However, we see reasons to avoid an overly pessimistic outlook: the weaker CLP
should improve the trade balance and curb current account risks, which, together with
this years robust expansion of fiscal spending, are likely to push growth back into line
with its 4.5% potential by 2015.

Key recommendations

+1 212 412 6721


sebastian.brown@barclays.com
Credit Strategy
Bruno Rovai
+ 55 11 3757 7772
bruno.rovai@barclays.com

FX: We believe the USDCLP should converge to close to 555-560 towards the end of the
year. While the volatility of the cross is high and there are no clear triggers for a sustained
rally of the peso, we recommend building long CLP positions when the USDCLP goes
above 575 and taking profits whenever the cross dips below 550 as fiscal spending limits
the upside potential of the cross. Funding with PEN could be attractive, as the Nuevo Sol
should continue to exhibit low volatility.

Domestic demand: The decline of Chiles main growth driver

Weak growth during Q4 13


surprised investors due to the
prominent role of plummeting
investment

thus, if internal demand is to


continue to be the driver of
growth, it will be crucial for
consumption to remain
dynamic

The slowdown of the economy during 2013 became a matter of widespread consensus in
April last year when the growth rate of the IMACEC fell to a 21-month low, reaching only
3.1% y/y saar. The debates among analysts and investors quickly shifted from whether the
resiliency of internal demand could continue to isolate growth from a weakening global
context to the extent to which the growth would suffer and the BCChs likely policy answer.
But even in that context of unanimous bearishness, most analysts did not expect the
economy to perform as poorly as it did in Q4 13: GDP expanded only 2.7% y/y, driven by a
12.3% y/y contraction of investment. While falling inventories during Q2 and Q3 were the
main drag on investment, that is no longer the case. During Q4 13 investment was mainly
driven by a 28.5% y/y decline of purchases of machinery and (Figure 1).
GDP growth reached only 4.1% during 2013. And the 12.6pp, 8.7pp, and 6.7pp
contributions of internal demand to real growth in 2010, 2011, and 2012, respectively, are
useful data if one wants to gauge the real weakness of internals demand 3.4pp contribution
over 2013. The Chilean economys internal demand-based growth resiliency seems to be
quickly vanishing and will now depend on the dynamics of consumption alone: its

FIGURE 1
Weak Q4 13 data driven by sharp contraction of investments
pp

FIGURE 2
Consumer confidence correction likely to hurt retail sales
25%

20

130
125

20%

15

120

15%

10

115
110

10%

105

5%

100
95

0%

-5

90

-5%

-10
Mar-10

Dec-10

Sep-11

FAI
Net exports
Private consump.
Source: BCCh, Barclays Research

25 March 2014

Jun-12

Mar-13

Dec-13

Governm. consump.
Inventories
GDP growth (% y/y)

85
Q1
06

Q1
07

Q1
08

Q1
09

Q1
10

Q1
11

Q1
12

Q1
13

Real retail sales growth (y/y)


Consumer confidence index (RHS March '03 =1)
Source: BCCh, Universidad de Chile, Barclays Research

167

Barclays | The Emerging Markets Quarterly


contribution to growth last year reached 4.0pp, which bested the overall role internal
demand played on GDP growth the first time since 2009.
The sharp investment
slowdown will eventually take
a toll on the labor market and,
thus, consumption

Consumption has continued expanding in part because of the resilience of the labor market. Yet
the sharp decline of investments will sooner or later translate into higher unemployment and.
Therefore, less disposable income and weaker consumer confidence should lead to softer
consumption (Figure 2). In fact, we expect consumption to grow by 4.1% during 2014, which is
well below the last years 5.6% expansion. High frequency data released this year has generally
surprised on the downside and is therefore in line with our relatively pessimistic outlook.

Strikes and policy uncertainty: even further downward pressures on growth


Politically driven events such
as a port workers strike and
the uncertainty regarding a
potential tax reform are
domestic drags on growth as
well

Tangible economic forces associated with a global decline of the investment cycle in
commodities play an important role in the relatively grim state of the Chilean economy. Yet
they are not the only elements holding economic expansion back, as political events seem to
be curtailing activity as well. In particular, the dismal prints of the IMACEC early this year
would have not been as negative if it had not been for the 22-day strike by Chilean port
workers last January, which directly limited copper exports during the month.
Michelle Bachelet has already been inaugurated as Chiles new president, but some of the
uncertainty that pushed up volatility in financial markets around last Decembers election
has not yet dissipated. In particular, the fears of a reform that will entail a higher effective
taxation of retained earnings could be holding investments back. While there are few details
yet available about the governments preferred changes to the tax code, the uncertainty and
pessimism associated with these changes are unlikely to fade unless the government
quickly announces a full-fledged tax reform proposal.

Tapering, currency depreciation, and the current account: From risks to


adjustment facilitators
A few months ago, the widening current account deficit in an environment of high financial
market volatility, associated with fears that an early stop of the Feds QE3 program could
trigger several sudden stops to flows into EM economies, was among the biggest concerns
of policymakers and investors.
In the case of Chile, the lack of glaring currency mismatches and the floating exchange rate
regime greatly limited the risks associated with the issues mentioned above, at least in
theory. The relatively few positive surprises among economic data released this year could
be in part attributed to a weaker CLP. The stronger-than-expected performance of
FIGURE 3
Current account mainly funded by FDI
20
15

FIGURE 4
Inflationary pressures still subdued

Cumulative net flows over


4q (bn of USD)

Forecast

4.5

10

4.0

3.5

3.0

-5

2.5

-10

2.0

-15

1.5

-20
Q4
09

Q2
10

Q4
10

Q2
11

Reserves and Derivatives


Portfolio
Financial Account
Source: BCCh, Barclays Research

25 March 2014

Q4
11

Q2
12
Other
FDI

Q4
12

Q2
13

Q4
13

1.0
0.5
2011

2012
CPI (% y/y)
Core CPI (% y/y)

2013

2014
Inflation target
Inflation target bounds

Source: BCCh, Barclays Research

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Barclays | The Emerging Markets Quarterly


The CLP appears oversold, but
it will help growth to converge
towards the potential while
keeping external vulnerabilities
contained

exporters during Q4 13 and Q1 14 and the improvement of Chiles current account position
associated with it should serve as reminder of the benefits of a floating exchange rate
regime. We believe the weaker CLP is likely to play an important role in allowing growth to
bounce back from 4.0% to levels closer to 4.5% towards 2015. We estimate Chiles potential
GDP growth to be closer to 4.5% than to 4.0%.

External funding conditions


remain relatively stable

The combination of lower appetite for EM financial assets and the BCChs expansionary
monetary policy has resulted in a strong sell-off of the CLP, well beyond what our fair value
models could account for on the basis of commodity prices and interest rate and inflation
differentials. On the other hand, Chilean yields have fallen, not only because of the interest
rate cuts but also because of the limited supply of government paper issued so far. The
combination of these elements has not resulted in a significant increase of financing costs
for the Chilean economy.

as the current account is still


mostly FDI-funded and likely to
quickly narrow as the CLP
weakens

At the same time, the relative weakness of investments and improving prospects for Chilean
exports as the CLP depreciates will likely result in a quick narrowing of the current account
deficit towards levels closer to 2.0% of GDP by 2015, which should all but eliminate the
current account position from the list of main risks to Chiles economy. And while a
withdrawal of liquidity from EM assets is likely also to put pressure on Chilean financial
markets, the current account continues to be financed mainly by FDI (Figure 3); thus, the
scope for speculative flows to threaten financial stability is fairly limited, especially if the CLP
continues to sell off.

Inflation and monetary policy: Steady


The sell-off of the CLP has not yet resulted in significant pass-through of higher USD prices into
domestic inflation. We estimate the pass-through of the exchange rate to domestic inflation to
be about10%; that is, a 100bp depreciation of the CLP is associated with a 10bp increase of the
domestic inflation rate. While far from harmless, our the estimate implies that pesos year-todate 7.7% depreciation relative to the USD is likely to result in a 0.8pp inflation hike.
Our inflation expectations are for price growth to converge towards the 3.0% the BCCh
targets, as rising energy prices are likely to be in part offset by the softer growth of
consumption associated with our expectation of unemployment rising later this year. At
current levels, inflation is not yet a major concern for policymakers (Figure 4). In sum, we do
not expect inflation to become worrisome enough to prevent the BCCh from moving the TPM
below 4.0% if consumption data continue to disappoint. In our view, one of the main reasons
the BCCh did not begin easing in Q3 13, even though a decline in investment was evident by
then, was the risk of a wider current account deficit. But with a weaker CLP and faltering
consumption growth the risks to the current account position of further monetary easing are
relatively low, which in our view further tilts the balance of risks towards a more dovish BCCh.
In the absence of new data that show that consumption is in fact weakening, we still expect
the BCCh to keep the TPM on hold at 4.0% the rest of the year, although the risks are clearly
to the downside.

Fiscal policy: Lower revenues could cap the CLPs depreciation


Lower copper prices are likely to dampen fiscal revenues significantly as Codelcos income
and the tax revenue the government can extract from private mining companies both fall as
base metals get cheaper. On the other hand, because commodities are traded in USD and
mining firms face CLP-denominated costs, a depreciation of the peso somewhat limits the
erosion of public funding.
Yet to the extent the government needs extra funding, the increase of interest rates is likely
to keep the government from covering its funding needs fully by issuing debt. Instead, the
government would at least in part cover its funding gap by liquidating USD-denominated
25 March 2014

169

Barclays | The Emerging Markets Quarterly


assets parked off-shore to then fund CLP-denominated public expenditures. The larger the
share of the governments funding gap that is covered by asset sales, the greater the CLPpositive effect of declining fiscal revenues.
In addition to fiscal funding-related issues likely to be CLP-positive, fiscal spending is also
likely to support the currency. In particular, we are likely to see government spending
growing faster in 2014 than it has in recent years.
Because fiscal spending in Chile is set to meet structurally adjusted targets a lower
exchange rate does have an impact of the fiscal goal. In particular, fiscal spending for 2014
was set assuming a USDCLP rate of 522. Thus a weaker exchange rate mechanically
increases structurally adjusted revenues and allows for higher government spending. Also,
the 4.0% growth of fiscal spending during 2013 fell well below the 5.9% expansion of public
spending authorized in the budget for the year. Because of base effects, planned fiscal
spending in 2014 will entail an expansion of public expenditures of 6%.
In sum, although we do expect a relatively weaker rate of economic growth during 2014, we
are relatively moderate in our pessimism as both monetary policy and fiscal policy in Chile are
both designed to be unambiguously counter-cyclical. In addition of supportive institutional
features, we believe the weaker exchange rate will have important pro-growth consequences
as it should result in an improvement of the trade balance and more positive risk sentiment as
risks associated to the current account abate. Finally, the below-budget fiscal spending during
2013 should result in a strong expansion of public consumption during 2014 that is likely to
entail a contribution to GDP growth of about 0.5pp over the course of the year. Thus, we
believe that when it comes to Chile, only mild pessimism is in justified.

25 March 2014

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Barclays | The Emerging Markets Quarterly

FIGURE 5
Chile macroeconomic forecasts
2010

2011

2012

2013

2014F

2015F

5.8

5.8

5.4

4.1

4.2

4.7

Domestic demand contribution (pp)

13.5

9.9

7.1

3.5

3.2

5.2

Private consumption (% y/y)

10.8

8.9

6.0

5.6

4.1

4.4

Fixed capital investment (% y/y)

12.2

14.4

12.2

0.4

4.4

6.3

-7.7

-4.1

-1.7

0.6

1.1

-0.5

Activity
Real GDP (% y/y)

Net exports contribution (pp)


Exports (% y/y)

2.3

5.5

1.1

4.3

5.7

4.6

Imports (% y/y)

25.9

15.6

5.0

2.2

2.4

5.3

217.7

251.5

266.5

277.2

272.8

289.1

GDP (USD bn)


External Sector
Current account (USD bn)

3.6

-3.1

-9.1

-9.5

-8.2

-6.1

CA (% GDP)

1.6

-1.2

-3.4

-3.4

-3.0

-2.1

Trade balance (USD bn)

15.7

11.0

2.5

2.1

3.9

6.4

Net FDI (USD bn)

6.1

5.5

8.5

10.0

9.0

9.0

Other net inflows (USD bn)

-4.0

17.5

-1.4

-0.5

-0.8

-2.9

Gross external debt (USD bn)

84.1

98.6

116.7

130.7

146.4

164.0

International reserves (USD bn)

27.9

42.0

41.6

40.2

40.2

40.2

-0.4

1.5

0.6

0.4

-0.9

-0.5

Public Sector
Central government balance (% GDP)

0.1

1.9

1.2

0.7

-0.6

-0.2

Gross central govt. debt (% GDP)

Primary balance (% GDP)

8.6

11.1

12.0

11.5

12.4

12.9

Net central govt. debt (% GDP)

-7.0

-8.6

-9.2

-9.6

-8.7

-8.2

CPI (% Dec/Dec)

3.0

4.4

1.5

3.0

3.0

3.0

CPI (% average)

1.4

3.3

3.0

1.8

3.0

3.0

Exchange rate (dom currency/USD, eop)

468

520

479

525

555

545

Exchange rate (period average)

510

483

486

495

540

550

1y ago

Last

Q1 14F

Q2 14F

Q3 14F

Q4 14F

4.9

2.7

3.4

4.1

4.5

4.9

Prices

Real GDP (y/y)


CPI (% y/y, eop)

1.6

3.0

3.4

3.9

3.5

2.6

Exchange rate (dom currency/USD, eop)

471

572

570

560

560

555

Monetary policy benchmark rate (%, eop)

5.00

4.00

4.00

4.00

4.00

4.00

Source: Barclays Research

25 March 2014

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Barclays | The Emerging Markets Quarterly

LATAM: COLOMBIA

Re-election and recovery on track


Unusually for a Latin American election, the risks of political noise in the run-up to
Colombias presidential election in May appear very limited. Opinion polls suggest
President Juan Manuel Santos is likely to be re-elected. Meanwhile, the growth recovery
remains on track. The normalization of interest rates should add support to the COP.

Economics
Alejandro Arreaza
+1 212 412 3021
alejandro.arreaza@barclays.com

Key recommendations
Credit: We recommend that investors go long Colombia 2044s, switching from the

Alejandro Grisanti
+1 212 412 5982

2023s. Supply at the long end earlier this year and, political developments more recently,
have likely driven the underperformance of Colombia credit relative to its Latin American
peers (Peru, in particular) and caused the spread curve to steepen. Given our relatively
benign view of US Treasury yields in the near term and our expectation of a smooth
political transition against a backdrop of continued strong economic fundamentals, we
think valuations at the long end of Colombias bond curve have become attractive. We
expect the spread curve to flatten. At portfolio level, we remain overweight.

alejandro.grisanti@barclays.com
Credit Strategy
Donato Guarino
+1 212 412 5564
donato.guarino@barclays.com

Can Santos win in the first round?


Few surprises in the run-up to
the presidential election

There have been few surprises in the run-up to the 25 May presidential elections in
Colombia. In the absence of a strong contender, President Santos remains the clear favorite.
The main question is whether he will be able to win in the first round or require a run-off.
The only unexpected event in the campaign so far has been the Conservative Party decision
not to support President Santoss re-election. Nonetheless, with a fragmented Conservative
Party and a candidate that still lacks support, this decision has not altered the picture.

Santos is clearly ahead of the


main candidates

Although it is strange to have an uneventful election in Latin America, we believe that the risks
of political noise in the run up to the election are very limited. According to the last poll by
Ipsos Napoleon Franco, a large portion of the electorate (47%) is still undecided. Nonetheless,
President Santos has maintained a clear lead over the other candidates. According to the poll,
Santos received 28% of support, more than three times that of the second candidate, Oscar
Ivan Zuluaga, with just 8%. Next was Enrique Penaloza (5%) of the Green party, the leftist
Clara Lopez (4%) and the conservative Marta Lucia Ramirez (3%). Moreover, in the event of a
second round, President Santos has a large advantage over the other contenders. Only one

FIGURE 1
Colombia: Long end has been underperforming similar lowbeta LatAm credits

30

10s30s (bp)
80
70
60
50
40

FIGURE 2
President Santos maintains lead in opinion polls (%)

Col 23-44

25

Mex 23-44
Mex 23-44
Per 25-50 Bra 25-41

20
15

Indo 22-42

30

10

Tur 25-40

20

SOAF 25-41

10

0
Nov-13

0
Ru 23-43

-10
-20
100

150

Source: Barclays Research

25 March 2014

200

10yr

250

300

Dec-13
Juan Manuel Santos
Enrique Penalosa
Marta Lucia Ramirez

350
Source:

Jan-14

Feb-14

Mar-14

Oscar Ivan Zuluaga


Clara Lopez

Registraduria Nacional

172

Barclays | The Emerging Markets Quarterly


poll (Datexco) shows Enrique Penaloza gaining momentum, with 17.1% of support and
beating President Santos in a run-off (40.4% versus 37.1%). However, the same poll projected
a similar scenario in 2010, showing the Green candidate Antanas Mockus beating Santos; the
poll proved to have overestimated the vote from young people in urban areas. Moreover, even
if other polls were to confirm Penalozas gains, victory still looks like an uphill battle for him. He
lacks a strong political machine, has not been able to build the consensus and gain
confidence among the left parties and his partys presence at various levels of government,
particularly the Congress, are small, and he would likely struggle to build alliances, which
would make a government led by him likely to be perceived as unviable.
Although Santoss support is relatively low for an incumbent, he has the potential to boost
his electoral appeal. Indeed, the presidents approval rating improved by 6pp in February,
recovering from the term lows reached last year. Improved economic activity is also likely to
favor his campaign as should the prospect of reaching a peace agreement, which is clearly
at the center of the political debate. Additionally, even if the conservative party does not
support Santos, he has managed to maintain the support of most of the conservative
members of Congress and ministers, which still ensures him part of the conservative vote.
Finally, Santos recently chose the current Minister of Housing, German Vargas Lleras, as his
vice president candidate, who has an even higher approval rating and could reinforce his
candidacy. All this makes Santos not only the favorite to win the election, but also likely to
avoid a run-off, as the previously mentioned poll suggests.
Despite facing a more
fragmented Congress,
Santos and his allies
maintain their majority

In a first test of his re-election bid, Santos performed relatively well at the 9 March
parliamentary elections. These were marked by the emergence of a stronger opposition to
President Santoss government, which had until then enjoyed almost total control of the
legislature. This opposition will be led by former President Alvaro Uribe, whose Democratic
Center Party obtained 19 of the 100 seats in the Senate. Nonetheless, Santos and his allies
still control the majority of the seats. Santoss U Party got 21 seats, the liberals 17, the
conservatives 19 (15 of which have not expressed their support for the Conservative
presidential candidate, suggesting they are likely to support Santos), and Radical Change
nine seats. This tally means more than 50% of the seats are aligned with the Santos
administration. In addition, the Green party and the leftist Polo Democratico got five seats
each. Although these last two parties are not part of Santos coalition, they do support the
peace process that the government has been promoting. Therefore, even if Santos will need
to negotiate more and face stronger debates, he will likely have the support for the
legislative agenda that a potential peace agreement with the guerrillas might require.

FIGURE 3
Leading indicators show sustained growth recovery

FIGURE 4
Stagnant oil production caps growth

20

25%

15

20%

10

15%

10%

5%

-5

0%

-10
2008

2009

2010

GDP (LHS)
Source: Haver,

Barclays Research

25 March 2014

2011
IP

2012

2013

Retail Sales

-5%
Jan-10

75
70
65
60
55
50
45
40
35
30
Sep-10 May-11 Jan-12

Sep-12 May-13 Jan-14

Oil produc growth y/y (3months moving avg)


Rig count (RHS)
Source: Bloomberg, Barclays Research

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Barclays | The Emerging Markets Quarterly

The recovery remains on track


The chances of growth going
far beyond potential remain
very limited

Colombias economic activity recovery appears to have consolidated, with stabilization of


GDP growth supporting our view that it is unlikely to significantly exceed potential. GDP
expanded 4.9% y/y in Q4 2013, in line with our expectation (5.0%) and slightly above the
market consensus (4.7%). In 2013, GDP expanded 4.3%, slightly above our forecast of
4.2%, thanks to a revision of previous quarters. The expansion was supported by strong
household and government consumption (4.9% y/y and 6.1% y/y). Investment, meanwhile,
decelerated from 11.3% in Q3 to 8.0% in Q4 on a sharp contraction in building construction
(-2.0% y/y in Q4 vs 20.4% in Q3). An expected recovery in exports was partly offset by a
rise in imports, minimizing the contribution from net exports.
We expect this dynamic to continue. Oil production has stabilized at about 1.0mn b/d,
which also limits the exports contribution to growth. On the supply side, we continue to
think the lack of discovering new reserves in the oil sector limits potential upside for growth.
Moreover, the industrial sector continues to show some improvements but still registers low
growth, which makes it unlikely to add dynamism to the economy. These considerations
lead us to confirm our 2014 growth forecasts at 4.8%.

The main risk for inflation is


the pass-through of the recent
depreciation of the COP

Inflation, meanwhile, remains low (2.32% y/y), with no evidence of demand pressures.
However, prices have been accelerating as expected, with inflation converging toward the
center of the target. Nonetheless, the main increases have come from food and energy
prices, while core inflation excluding these components remains stable at 2.70%.This still
gives Banrep the space to remain on hold until mid-year. The bank has so far maintained a
cautious tone, and without a widening of the output gap we do not think demand pressures
in the short term could trigger an early start to interest rate normalization. We continue to
expect the tightening cycle to start in July, bringing the reference rate to 4.75% by year-end
and 5.0% next year. The main risk that we see for inflation in the short run is the passthrough of the recent depreciation of the COP, which has been bigger than we expected.
However, we see possible a stabilization of the exchange rate in the coming months.

Interest rate normalization


should support the COP

The normalization of interest rates should add support to the COP, which seems to have
weakened excessively in recent months on global factors. Moreover, even if Banrep could keep
the option of intervening in the FX market, in practice it might reduce or even stop dollar
purchases. Historically the bank has been of the opinion that there is no significant deviation
of the real exchange rate and that the accumulation of reserves implies a high cost.

FIGURE 5
Growth stabilizing (%)

FIGURE 6
Less intervention and higher rates should reduce pressures
on the COP

800

700

600

-2

200

-4

100

-6

2
Q1-10

Q4-10

Q3-11

Investment Contrib

Q2-12

Q1-13

25 March 2014

Barclays Research

2,000
1,950

500
400

1,900

300

0
Jan-12

Net exports Contrib

1,850
1,800
1,750
Jun-12

Nov-12

Apr-13

Sep-13

Feb-14

m/m International Reserves var. (USD mn)

GDP growth (RHS)


Source: Haver, DANE,

2,050

Exchange rate (COP/USD, avg, RHS)


Source: Haver,

Barclays Research

174

Barclays | The Emerging Markets Quarterly


FIGURE 7
Colombia macroeconomic forecasts
2010

2011

2012

2013

2014F

2015F

4.0

6.6

4.2

4.3

4.8

4.4

Activity
Real GDP (% y/y)
Domestic demand contribution (pp)

5.3

9.0

5.6

5.0

5.5

5.5

Private consumption (% y/y)

5.0

5.9

4.7

4.5

4.7

4.4

Gross fixed capital formation (% y/y)

4.9

18.7

7.6

4.9

7.1

7.5

-2.1

-2.8

-1.4

-0.4

-0.9

-1.1

Exports (% y/y)

1.3

12.9

5.4

1.9

4.0

5.5

Imports (% y/y)

10.8

21.2

9.1

2.6

6.0

7.3

287

336

369

376

377

411

-8.8

-9.6

-11.9

-12.0

-13.7

-14.3

-3.1

-2.9

-3.2

-3.2

-3.6

-3.5

Net exports contribution (pp)

GDP (USD bn)


External sector
Current account (USD bn)
CA (% GDP)

2.4

6.1

4.9

3.1

1.5

1.2

Net FDI (USD bn)

Trade balance (USD bn)

-0.1

5.1

15.9

13.0

12.0

12.5

Other net inflows (USD bn)

12.0

8.0

1.2

5.2

3.2

2.8

Gross external debt (USD bn)

64.7

75.9

80.5

86.5

95.2

104.7

International reserves (USD bn)

28.5

32.3

37.5

43.6

45.1

46.1

Non-financial public sector balance (% GDP)

-3.3

-1.8

0.4

-1.4

-1.2

-0.9

Central government balance (% GDP)

-3.9

-2.8

-2.3

-2.4

-2.2

-2.1

-1.1

-0.2

0.5

0.3

0.5

0.5

46.2

42.9

40.6

39.7

38.2

35.7

37.2

34.5

33.4

34.4

32.1

30.3

3.2

3.7

2.4

1.9

3.3

3.0

Public sector

Central primary balance (% GDP)


Gross Non-financial public sector debt (% GDP)
Gross central government debt (%GDP)
Prices
CPI (% Dec/Dec)
CPI (% average)

2.3

3.4

3.1

2.0

2.8

3.2

Exchange rate (dom currency/USD, eop)

1914

1930

1820

1929

2000

2000

Exchange rate (period average)

1899

1848

1800

1869

2020

2000

1y ago

Q413

Q1 14

Q2 14

Q3 14

Q4 14

Real GDP (y/y)

2.6

4.9

5.1

4.5

4.8

5.1

CPI (% y/y, eop)

1.9

1.9

2.4

2.6

2.7

2.7

1822

1930

1990

2000

2000

2000

3.25

3.25

3.25

3.25

4.00

4.75

Exchange rate (dom currency/USD, eop)


Monetary policy benchmark rate (%, eop)
Source: DANE, Banrep, Ministry of Finance, Haver, Barclays Research

25 March 2014

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Barclays | The Emerging Markets Quarterly

LATAM: MEXICO

The long and winding road to faster growth


The Mexican government is defining the roadmap for the long reform implementation
process while the economy still shows signs of weakness. However, a strong recovery in
the US in 2014 should support export growth and Mexicos economy should expand
3.0% y/y. Inflation will likely remain under control, allowing Banxico to stay on hold for
the rest of the year.

Economics
Marco Oviedo
+52 55 5241 3331
marco.oviedo@barclays.com
FX Strategy

Key recommendations

Donato Guarino
+1 212 412 5564

Rates: We reiterate our recommendation to be long Mbono42s despite the recent rally.
Valuations remain attractive: the Mexico bond/swap curve is one of the steepest in EM,
hinting that it has overreacted to US Treasury movements. In addition, limited pressure on
the inflation front and still-anaemic growth should be fertile ground for building
long/receiver positions. Our core rate market view is that the pressure on US Treasuries is
likely to be seen only in H2, which should reduce headwinds over the next quarter.
Leveraged investors should express this view via flattening the long end of the curves.
Finally, we would express our monetary policy outlook by entering either a 1y1y TIIE
receiver or a 2y TIIE receiver.

Credit: Mexico bonds/CDS spreads have outperformed other low-beta credit over the
past six months. Since the reform agenda has progressed, it appears that further possible
rating upgrades are already priced in at current levels (Moodys moved the credit to A3
this quarter). Technicals also suggest a more cautious bias since the supply outlook
remains challenging for the credit and recent weakness of other lG credits in EMEA has
accelerated demand for Mexican bonds. Overall, we prefer to remain neutral for now as
there is a lack of short-term catalysts to drive outperformance. We recommend buying
Mexico 5y CDS against Brazil. For real money, we think the belly of the Mexico curve is
particularly rich versus Brazil and recommend a long BR25 short MX23 switch.

FX: A dearth of clear triggers for an MXN rally over the next three months and an
economy that, although weak, still seems promising relative to other EM countries lead us
to recommend an MXN-neutral approach to the upcoming quarter. While the MXN has
performed relatively well compared with the rest of EM FX, our expectation of mild peso

donato.guarino@barclays.com
Rates and Credit Strategy
Sebastin Brown
+1 212 412 6721
sebastian.brown@barclays.com

FIGURE 1
EM sovereign spread versus rating: Mexico spreads already
priced-in a eventual upgrade to A- from Fitch and S&P
EM USD Sov Index OAS
300

Rus
Tur

250
Soaf

200

Ind

Bra

Rom

150
Mex
upgr

100
50

Col

Mex

Phil

5.5

6
4

BBB

2.6

25 March 2014

4.7 4.5

2.5

0.8

0.7

BBB-

-2.7

-4
Mar-12

Source: Barclays Research

3.9

3.7

-2

Pol
BBB+

Forecast

% q/q saar
8
6.6

0.2

Per
Pan

A-

FIGURE 2
The economy should pick up moderately with external
demand

Sep-12

Mar-13

Sep-13

Mar-14

Sep-14

Source: INEGI, Barclays Research

176

Barclays | The Emerging Markets Quarterly


appreciation against the USD failed to materialize. From a valuation perspective, the MXN
looks fair, although we see some value on the long-end government bond curve. We
believe that until US economic data are positive long enough to produce noticeable
spillover effects in Mexico, the MXN is unlikely to rally. Thus, while the potential of an
MXN sell-off seems relatively narrow, we believe that in the short run, currencies such as
the BRL and INR offer a similarly limited downside with a much better carry.

Defining implementation
Recent developments in
telecoms signal the
governments strong
commitment to reform
implementation

After passing constitutional changes, the government continues to design secondary


legislation and reform implementation. The government has mentioned that this year it will
focus on the telecommunications, competition, political and energy reforms. Implementation
should take several quarters. In particular, there have been the first steps in the
telecommunications front: the new regulatory agency, the Federal Telecommunications
Institute (IFT), has declared Televisa and America Movil dominant companies in the
broadcasting and telecommunications sectors, respectively. This means these companies
have more than 50% of the market share in their respective sectors. The reform is that the IFT
should impose 180 regulatory measures to enhance competition in these two sectors. For
example, these companies will have to share infrastructure with other operators and will face
restrictions regarding charging fees and exclusivity for broadcasting. In our view, this
development signals that the government is serious about implementation and that it will not
protect vested interests.

Energy reform implementation


will take most of 2014 and the
first half of 2015

In that sense, we expect the government to submit secondary legislation for


telecommunications and political reform during April. In particular, the secondary laws for the
energy sector should be submitted after the telecommunications and political legislation.
Nevertheless, according to the transitory articles of the Constitution that were approved in
December, the laws must be approved by April 20. The government will likely submit a
legislative package that has been previously discussed with the opposition so it could move
through the legislative process more quickly than usual. In addition, only a simple majority is
needed to pass the package. We believe the political risks of not passing this secondary
legislation are low because both the National Action Party (PAN) and the Revolutionary
Democratic Party (PRD) currently face internal disputes to renew their leadership, which
reduces their ability to control their respective congressional groups. Overall, we believe that
implementation of the energy reform will take most of 2014 and the first half of 2015. In that
sense, the first auctioned contract for oil or gas might materialize during H2 2015, and the first
inflows of investment in the energy sector might not be deployed until 2016.

FIGURE 3
and the output gap remaining negative

FIGURE 4
Inflation should remain within Banxicos target interval
% q/q saar

% of GDP
4

Forecast

10.0
5.0

0.0

-2
-5.0

-4
-6

-10.0

-8
Mar-03 Mar-05 Mar-07 Mar-09 Mar-11 Mar-13

-15.0

Fiscal reform effect


Forecast

4.5
Ceiling
4.0
3.5
3.0
Target

2.5

Output gap
Source: INEGI, Barclays Research

25 March 2014

% y/y
5.0

GDP growth

2.0
Dec-12

Jun-13

Dec-13

Jun-14

Dec-14

Jun-15

Dec-15

Source: INEGI, Barclays Research

177

Barclays | The Emerging Markets Quarterly

Relying on the external push due to domestic weakness


Even though the economy is implementing structural reform, GDP has performed very
poorly in the past six quarters, which was particularly surprising in Q4 13. Accordingly, we
recently downgraded our annual GDP growth forecast for 2014 to 3.0% from 3.7%
previously (see Mexico GDP: The economy hit the brakes, dampening 2014 outlook,
February 21, 2014). We believe the reforms will accelerate the pace of growth in the coming
years, but the road ahead is still bumpy: the construction sector remains depressed,
manufacturing is dependent on the still-uncertain external environment, and fiscal policy
might have negative effects via higher taxes before the spending impulse starts to kick in.
There might still be some weakness during Q1 14, particularly on the domestic side. Overall,
we estimate the economy will expand 3.0% y/y in 2014 if GDP accelerates slightly in Q1 14
and consolidates its pace through Q2.
We believe that as US
manufacturing accelerates
during the year, Mexican
exports will push industrial
activities, leading to the
consolidation of growth

In terms of external factors, our US economists forecast that US GDP will expand 2.7% y/y
in 2014, consistent with industrial production growing close to 3.8% y/y. High frequency
data suggest that US manufacturing growth was soft in January, but this slowdown is
probably temporary. In particular, Mexico manufacturing exports declined 1.8% m/m sa,
consistent with the 0.8% m/m sa contraction in the US manufacturing sector. Nevertheless,
US manufacturing improved during February and it will likely continue expanding in March
so we expect Mexican exports to expand 3.5% 3m/3m saar in Q1, pushing industrial
production in Mexico to 3.1% 3m/3m saar. If in fact US manufacturing accelerates to 5%
3m/3m saar in H2 14, exports would also accelerate to 5.3% 3m/3m saar in Q3 and Q4,
leading to the consolidation of growth.

The depression of the


construction sector suggests its
recovery is not near and the
short-term outlook of
investment is not very promising

Domestic demand has been persistently weak. Fixed investments declined 1.8% in 2013,
with the construction sector contracting 4.9% y/y in 2013, while machinery and equipment
investment increased 5.4% y/y. The construction outlook remains uncertain as it remains
depressed, even though public investment actually accelerated in H2 13 to 4% y/y in 2013.
Moreover, the short-term outlook for investment is not very promising. First, the new fiscal
framework does not allow the immediate deduction of investment, raising its cost for firms.
The higher tax burden will also reduce the availability of cash balances for investment.
Finally, the higher fiscal deficit might consume an important amount of domestic saving,
reducing funding resources for investment. Only a boost in optimism from the reform
implementation outlook will give investment an additional push this year, combined with an
effective public spending implementation.

The economy should expand


3.8% y/y in 2015 as public
investment accelerates and the
reform implementation
process is clarified

Private consumption will be harmed by the higher tax burden, especially during Q1 14. This
has been evident in the consumer confidence index, which fell 16% in January, and in the
stagnation of the retailing sector. Nevertheless, we expect consumption to expand 3.5% y/y
as higher public spending should translate into stronger retail sales and employment,
supporting overall consumption dynamics. For 2015, we continue to believe GDP will be
3.8% y/y, as fiscal spending, particularly in the public sector, will have a full effect on the
economy. Furthermore, the construction sector should have recovered by then, while
investment should accelerate with positive developments in the reform implementation.

Large output gap, controlled inflation


With the size of the output gap,
inflation will likely be under
control and within Banxicos
target interval

25 March 2014

In terms of inflation, since the economy is likely to continue growing below potential, core
inflation will likely remain subdued. We estimate that the output gap is currently 2% of GDP.
The tax effects on inflation were proven to be short-lived and lower than expected. The oneoff effect was observed in the first fortnight of January, and in the second half of the month,
inflation did not show signs of contamination or persistence. We believe that inflation will
return to below 4% in March and it will begin to decline for the rest of H1 14 with very
limited non-core pressures. If in fact the economy accelerates in H2 14, then so would

178

Barclays | The Emerging Markets Quarterly


inflation to close the year at 3.8% y/y, with core inflation at 3.4%. In 2015, we expect core
inflation to accelerate to 3.7% and headline inflation to close the year at 3.7%.

Neutral for the foreseeable future and into 2015


Growth acceleration under
controlled inflation implies
central bank neutrality for the
rest of the year

Banxico is also expecting annual inflation to begin to decline. This will be confirmed with the
March and April prints. Accordingly, our macroeconomic outlook suggests Banxico will
remain on hold for the rest of the year and possibly start rising rates until March 2015 as
core inflation accelerates. However, if economic activity starts to disappoint, central bank
communications will be more focused on growth with a more dovish tone. In fact, weakerthan-expected growth in 2014 would likely delay central bank intentions to increase rates in
2015. Moreover, we believe the board would feel uncomfortable implementing additional
rate cuts this year since it would imply short-term negative real rates, something that seems
to be a concern given high market volatility. Nevertheless, if the deterioration of economic
activity deepens, we cannot discard a reaction.

FIGURE 5
Mexico macroeconomic forecasts
2009

2010

2011

2012

2013F

2014F

2015F

Activity
Real GDP (% y/y)

-4.7

5.1

4.0

3.9

1.1

3.0

3.8

Private Consumption (% y/y)

-6.5

5.3

4.9

4.7

2.4

3.1

3.5

Fixed Capital Investment (% y/y)

-9.3

1.3

7.9

4.6

-1.8

0.9

5.1

Net Exports Contribution (pp)

2.0

0.0

0.0

0.2

0.2

0.2

-0.2

Exports (% y/y)

-11.8

20.5

8.2

5.9

2.0

5.0

5.6

Imports (% y/y)

-17.6

20.5

8.0

5.4

1.3

4.3

6.4

GDP (USD bn)

889

1,048

1,164

1,186

1,276

1,332

1,444

GDP (MXN bn)

12,094

13,282

14,531

15,588

16,380

17,512

18,814

External Sector
Current Account (USD bn)

-8.1

-3.6

-12.3

-14.8

-22.3

-36.1

-31.6

CA (% GDP)

-0.9

-0.3

-1.1

-1.2

-1.8

-2.7

-2.2

Trade Balance (USD bn)

-4.9

-2.9

-1.3

0.2

-0.7

-13.4

-6.1

7.5

8.0

10.4

-5.2

25.2

20.0

20.0

Net FDI (USD bn)

8.4

36.0

39.8

56.3

33.6

44.5

31.5

Gross External Debt (USD bn)

Other Net Inflows (USD bn)

195.0

247.9

282.1

346.8

380.3

424.8

456.3

International Reserves (USD bn)

90.9

113.6

142.5

163.6

176.6

191.4

197.6

PS traditional balance (headline % GDP)

-2.3

-2.8

-2.4

-2.6

-2.3

-3.5

-3.1

PS primary balance (% GDP)

-0.1

-0.9

-0.6

-0.6

-0.4

-1.5

-1.1

PSBR (% GDP)

-2.6

-3.4

-2.7

-3.2

-3.0

-4.1

-3.7

Gross Public Debt (% GDP)

34.3

33.5

34.9

35.3

37.6

39.0

39.3

Public Sector

Net Public Debt (% GDP)

31.4

31.7

33.4

34.3

36.3

38.3

38.6

Historical Balance of PSBR (% GDP)

36.2

36.2

37.5

37.8

39.7

43.1

43.0

CPI (% Dec/Dec)

3.6

4.4

3.8

3.6

4.0

3.8

3.7

CPI (% average)

5.3

4.2

3.4

4.1

3.8

3.8

3.7

Exchange Rate (dom currency/USD, eop)

13.09

12.34

13.94

12.85

13.04

12.95

13.14

Exchange Rate (period average)

13.60

12.67

12.48

13.15

12.84

13.15

13.03

Prices

1y ago

Last

Q1 14F

Q2 14F

Q3 14F

Q414F

Q1 15F

Real GDP (y/y)

0.6

0.7

1.0

3.1

3.3

4.3

4.5

CPI (% y/y, eop)

4.3

4.2

3.9

3.5

3.8

3.8

3.5

Exchange Rate (dom currency/USD, eop)

12.33

13.25

13.25

13.20

13.10

12.95

12.97

Monetary Policy Benchmark Rate (%, eop)

4.00

3.50

3.50

3.50

3.50

3.50

3.75

Source: Barclays Research

25 March 2014

179

Barclays | The Emerging Markets Quarterly

LATAM: PERU

Keep an eye on inflation


Economics
Alejandro Arreaza
+1 212 412 3021
alejandro.arreaza@barclays.com

Despite the persistence of relatively low growth, inflation has been surprising to the
upside. A possible decline in potential growth could lead to demand pressures, despite
moderate growth. Nonetheless, continued FX stability as a result of central bank
intervention should help to contain inflation in the short term.

Key recommendations
Credit: After Perus recent outperformance, we move it to neutral from overweight in

Alejandro Grisanti
+1 212 412 5982
alejandro.grisanti@barclays.com
Credit Strategy
Donato Guarino
+1 212 412 5564
donato.guarino@barclays.com

our credit portfolio. We think the risks are asymmetric at current levels: while the
slowdown in growth is largely priced in, a weaker external position and inflation
pressures could move the market down, and given the tight valuation, we prefer to take
profits. To express our defensive view, we recommend positioning on the belly of the
curve since it is flat relative to similar LatAm credits.

Inflation risks, despite moderate growth


Although economic activity has been below the Central Bank of Reserves of Perus forecasts
(eg, in June the BCRP expected 6.1% growth in 2013 and reduced this to 5.5 in September)
the upside inflation surprise has prevented it from providing additional monetary stimulus
and is likely to continue to do so. Although we expect growth to remain below 5.0% during
the first half of 2014, we still expect inflation to remain above the upper bound of the target,
declining to 2.6% by year-end. We do not expect this to trigger interest rates hikes yet;
however, we do expect the bank to start the normalization of interest rates in early 2015.

Growth unlikely to pick up in


the first half of the year

GDP growth closed 2013 in line with our expectations, with 5.0% growth, and got off to a
weaker start in 2014, printing a 4.2% expansion in January (in line with our forecast of 4.1%,
but below the consensus estimate of 4.9%). Although statistical factors, including more
working days in February and March, could support stronger growth in the months ahead,
we do not see a source for an acceleration of growth above 5.0% in the first half of the year.
This is because of an expected weak contribution from private investment and a negative
shock in terms of trade given the fall in metal prices, particularly for copper. In the second
half of the year, we continue to expect a better performance when new production from
mining projects enters the market, potentially boosting growth via exports.

FIGURE 1
Peru credit has been outperforming its peers; we think there
is limited room to compress

FIGURE 2
Inflation acceleration likely to prevent further monetary
stimulus (%)

(bp)

4.5

35

4.0

25

3.5

15

3.0

2.5

-5
-15

2.0

-25

1.5

-35

1.0
Jan-10

-45
Apr 12

Oct 12

Apr 13

Oct 13

Peru 37s-Colombia41s
Peru 50s - Colombia 41s
Source: Barclays Research

25 March 2014

Oct-10

Jul-11

Apr-12

Jan-13

Oct-13

Ex- Food & Energy

Headline Inf

Target center

Target ceilling

Reference rate
Source: BCRP, Barclays Research

180

Barclays | The Emerging Markets Quarterly


BCRP expected to be more
cautious with inflation

Despite weaker internal demand, inflation has not moderated, reaching 3.78% in February
vs a target range of 3.0% +/-1pp. Part of this increase has been driven by supply factors,
with recent increases in electricity and fuel prices. Nonetheless, inflation excluding food and
energy, the key indicator tracked by the BCRP, has escalated to the upper bound of the
inflation target (Figure 2). In the past three years, the BRCP has not tightened monetary
policy even when headline inflation has been above the upper bound of the target. Actually,
it has been loosening policy, reducing reserve requirements, and last November it surprised
the markets by cutting interest rates. However, although inflation excluding food and
energy has remained close to the center of the target since 2011, it could move above the
target range. We expect the BCRP to be more cautious.

Normalization of interest rates


in early 2015 could be
necessary

Given the weaker demand, we expect inflation to moderate in the coming months, which
could give the BCRP space to remain on hold. Nonetheless, we see a risk that potential
growth in Peru has been declining in the past couple of years; therefore, as GDP growth
recovers in the second half of 2014 and the beginning of 2015, Peru might start to see some
demand pressure on prices (Figure 3) even if growth remains moderate (5.5-6.0%). In that
case, inflation will likely resist converging toward the center of the target range. This has
caused us to increase our CPI forecast for the end of 2014 to 2.6% from 2.3% and we think
the BCRP might need to start normalizing interest rates in early 2015.

Continued BCRP intervention


likely to keep the PEN stable.

The BCRP could still have another tool to contain inflation: the exchange rate. So far, the
BRCP has been able to maintain the PEN very stable for nearly nine months by selling dollars
in the FX market (Figure 4). Although we were expecting the BCRP to let the currency
depreciate in order to contain the deterioration of the current account, it has given no signal
of a change in its strategy. Peru has the largest FX reserves in Latin America, accounting for
approximately 30% of its GDP. Therefore, it has the capacity to continue to do so for some
time, keeping its currency relatively stable around USD/PEN1.82.

FX intervention could help to contain inflation

The stability of the currency could have several implications, including containing the
inflation of tradable goods. The strongest acceleration in prices in recent months has been
in tradable inflation, which has increased from 1.32% in May 2013 to 3.02% in February
2014. This partly reflects the pass-through of the 7.1% depreciation of the currency in mid2013. However, if the BCRP continues to keep the PEN stable, this pressure is likely to be
contained in the short term.

FIGURE 3
Possible demand pressures in the horizon (%)

FIGURE 4
FX intervention stabilizing the PEN

5.0

7.0

400

2.85

4.0

6.0

200

2.80

5.0

3.0
2.0

4.0

1.0

3.0

0.0

2.0

-1.0

1.0

-2.0
-3.0

0.0
I-08

I-09

I-10

I-11

I-12

Output Gap(LHS)

Source: INEI, Barclays Research

25 March 2014

I-13

I-14

I-15

2.75
2.70

-200

2.65

-400

2.60

-600
-800
2Jan13

2.55
2.50
1Apr13

25Jun13

23Sep13

19Dec13

FX Intervention (mn USD, LHS)

Inflation

Exchange rate (USD/PEN)


Source: BCRP,

Barclays Research

181

Barclays | The Emerging Markets Quarterly


The cost of the FX stability would be the persistence of a relatively large current account
deficit above 4.0% of GDP. Although the 2013 balance was better than expected, given a
decline in profits paid to non-residents, the continuity of the depreciation of the currency
should spur imports as the economy recovers, limiting the improvement in the current
account coming from the increase in export volumes. Nonetheless, Peru still covers most of
this deficit with FDI as a large portion of the profits received by non-residents are reinvested
in the country. This continues to provide a stable source of funding for Peru

FIGURE 5
Peru macroeconomic forecasts
2010

2011

2012

2013

2014F

2015F

Activity
Real GDP (% y/y)

8.8

6.9

6.3

5.0

5.1

5.7

Private Consumption (% y/y)

6.2

5.8

5.8

5.2

5.2

5.5

Private Fixed Capital Investment (% y/y)

22.1

11.4

13.5

3.9

0.8

6.8

Exports (% y/y)

1.3

8.8

5.9

1.0

8.1

10.4

Imports (% y/y)

24.0

9.8

10.4

5.1

3.0

10.2

155.2

176.3

197.2

211.1

217.7

236.6

-3.8

-3.3

-6.5

-10.2

-9.9

-9.7

CA (% GDP)

-2.4

-1.9

-3.3

-4.8

-4.6

-4.1

Trade Balance (USD bn)

6.8

9.3

5.1

-0.4

0.6

0.8

GDP (USD bn)


External sector
Current Account (USD bn)

Net FDI (USD bn)

8.2

8.1

12.3

10.0

8.0

8.9

Gross External Debt (USD bn)

40.5

48.0

58.8

60.3

61.8

60.8

International Reserves (USD bn)

44.1

48.8

64.0

66.8

65.5

63.7

Public Sector Balance (% GDP)

-0.5

2.0

2.1

0.8

0.3

0.8

Primary Balance (% GDP)

0.6

3.0

3.1

1.9

1.2

1.6

25.2

24.0

23.2

21.4

21.2

19.0

2.3

4.7

2.6

2.9

2.6

2.6

Public sector

Gross Public Debt (% GDP)


Prices
CPI (% Dec/Dec)
FX (PEN per USD, eop)

2.80

2.73

2.60

2.80

2.85

2.82

1y ago

Last

Q1 14F

Q2 14F

Q314F

Q414F

Real GDP (y/y)

4.7

5.1

4.6

4.9

5.3

5.7

CPI (% y/y, eop)

2.59

2.86

3.33

2.97

2.19

2.61

Exchange Rate (PEN per USD, eop)

2.59

2.80

2.81

2.81

2.83

2.85

Monetary Policy Benchmark Rate (%, eop)

4.25

4.00

4.00

4.00

4.00

4.00

Source: BCRP, INEI, Ministry of Finance, Haver, Barclays Research

25 March 2014

182

Barclays | The Emerging Markets Quarterly

LATAM: URUGUAY

BCU to refocus on inflation; uneventful primaries


Economics
Sebastian Vargas
+1 212 412 6823
sebastian.vargas@barclays.com
Credit
Donato Guarino
+1 212 412 5564
donato.guarino@barclays.com

The inflation surge in January and February will likely shift the central banks attention
back to inflation, supporting the peso. Fiscal policy will likely be unhelpful in this regard
in an election year. Junes presidential primaries should have little market effect.

Key recommendations
Credit: Positive externality from geopolitical conflicts has increased flows to low-beta
LatAm credit. Uruguay has benefited from these flows, especially at the long end
(UY36s), which has outperformed. The bond curve is extremely flat relative to other low
beta credits in LatAm; therefore, we prefer the 10yr part of the curve (UY 25s).

Central bank attention set to switch to inflation; supporting the peso


Inflation surprise should bring
tighter monetary policy

In our view the objective of Uruguays central bank (BCU) is not merely low inflation. Based
on its past behavior, the BCU cares strongly about competitiveness, inflation and
employment, as well as keeping real wages in positive territory. As a result, the central
banks priorities change over time, complicating communication with markets.
We think recent inflation dynamics, coupled with a more comfortable real exchange rate
and less pressing capital inflows, will shift the central banks attention to inflation in the
months ahead. Uruguayan inflation surprised in January and February, climbing to 9.8% y/y
(1.7% m/m). Cumulative inflation in the first two months of the year was 4.1pp, versus 2.9pp
in the same period of 2013. A renewed focus on inflation should bring tighter monetary
policies and support the peso in the short run. We expect the peso to reach 23.5 by year-end.

Fiscal policy unlikely to be helpful in an election year


Elections will likely delay any
fiscal tightening

Central bank efforts to contain inflation and real appreciation of the peso have historically
received little help from the fiscal side. The main problems for the fiscal authorities, we
think, are the budgets high indexation portion and the unwillingness to hit real wages and
pensions. We expect this tension between fiscal and monetary policy to increase in an
election year, putting more pressure on monetary policy to clamp down on inflation. Figure
2 depicts real interest rates and the real change in the primary balance. The chart shows
that the primary surplus has been contracting, indicating that fiscal efforts have not been
significant to fight inflation. In contrast, note that the recent central bank policies has had
the effect of increasing real deposit interests rates (and volatility). This would be in line with
our view that the recent high inflation prints and a more comfortable real exchange will
likely mean a tighter monetary policy in the quarters ahead. We think inflation will come
back to about 8% by the end of 2014.

Productivity boost needed


We believe a productivity
growth agenda is needed

From a longer-term perspective, low productivity growth remains the main economic
challenge. This relates to stubborn inflation and to the future path of adjustment of the
current account deficit. The authorities avoid cooling the economy to fight inflation because
they feel those growth rates are too low. This reluctance to cool down the economy in turn
dents competitiveness unless the economy is able to move to higher output per worker.
Long-term reforms in the labor market, taxation, and deeper reforms in education are likely
needed to address productivity growth issues and help to reduce inflation and maintain
growth at acceptable levels.
The productivity problem also sheds light on the future adjustment path of the current
account deficit. Unless productivity increases, the current account adjustment will mean
subpar growth, precisely what the authorities are refusing to accept in the fight against

25 March 2014

183

Barclays | The Emerging Markets Quarterly


inflation. Although part of the current account deficit is explained by investment that will
increase productivity down the line, the sustained increase in real wages is also contributing
to short-term excess demand that is reflected in a high current account deficit and will not
boost productivity. Reforms that boost productivity growth might have to wait until after
presidential elections. In the meantime, the country has accumulated a solid position of
external assets that could cushion a potential reversal in capital inflows.

Unsupportive Brazil and Argentina


Events in Brazil and
Argentina hurt Uruguays
2014 growth outlook

That said, the shorter-term growth outlook is not bright. External shocks stemming from
disappointing growth in Brazil and Argentina will take a toll on Uruguays growth. Moreover,
the depreciation of the official and unofficial Argentine peso, as well as measures taken in
Argentina to make spending abroad more expensive, will likely have a negative effect on the
tourism sector. On the positive side, the development of several FDI-funded investments
will contribute to investment growth. However, the main source of growth in 2014 will
remain consumer spending as real wage growth, and high employment should maintain
consumer demand at high levels. We expect growth at 3% in 2014 and 3.2% in 2015.

Primary elections on June 1: Likely to be uneventful for markets


Uruguay is to vote in primary presidential elections in June 1. The primaries would normally
have been held on the last Sunday of June, but because of the World Cup were moved to the
first Sunday in June. The winners of the primaries will compete for the presidency in October
2014. The main parties are Frente Amplio (FA), Partido Nacional (PN), Partido Colorado
(PC) and Partido Independiente (PI). We do not expect this to be a significant market event.
However, the reduction in the number of candidates in the primaries and the focus of the
candidates on the national audience may help investors to build a picture of the candidates
political programs and potential economic measures.

FIGURE 1
Uruguay long end has benefited from the positive externality
of geopolitical risk; the curve looks flat
(bp)

x 10000

80

FIGURE 2
Fiscal and monetary policy divergence

70
60
50

2.5

5.0

2.0

4.0

1.5

3.0

1.0

2.0

0.5

1.0

0.0

0.0

-0.5

-1.0

30

-1.0

-2.0

20

-1.5

-3.0

10

-2.0

-4.0

40

0
Mar 13

-2.5
Jun 13

Sep 13

PE 50 - PE 25
Source: Bloomberg, Barclays Research

25 March 2014

Dec 13
UY 36 - UY 25

Mar 14

-5.0
Feb 12

Aug 12

Feb 13

Aug 13

Real 12m change in primary balance (base =Jan '11)


Real deposit interest rate (RHS)
Source: BCU, Barclays Research Note: Negative numbers in the (real) change of
primary balance shows that policies are loser than a year before. Last data point:
January.

184

Barclays | The Emerging Markets Quarterly


FIGURE 3
Uruguay macroeconomic forecasts
2007

2008F

2009

2010

2011

2012

2013E

2014F

2015F

Real GDP (% y/y), RHS

6.5

7.2

2.2

8.9

6.5

4.2

3.6

3.0

3.2

Domestic Demand Contribution


(pp)

6.9

12.3

-2.4

11.3

9.2

8.6

5.1

4.6

4.8

Activity

Private Consumption (% y/y)

7.1

9.1

-1.6

13.7

8.9

6.9

4.2

4.1

4.4

Fixed Capital Investment (% y/y)

9.3

19.3

-5.7

13.3

5.5

19.4

6.4

4.7

4.7

Net Exports Contribution (pp)

-0.4

-5.1

4.7

-2.4

-2.6

-4.5

-1.4

-1.5

-1.6

Exports (% y/y)

4.8

8.5

4.2

7.8

6.3

1.6

1.1

3.0

3.0

Imports (% y/y)

5.9

24.4

-9.3

14.8

13.4

13.6

4.5

6.0

6.0

23.4

30.5

30.3

38.9

46.6

49.4

53.8

56.5

62.5

-0.2

-1.7

-0.4

-0.7

-1.4

-2.7

-2.7

-1.8

-2.1

CA (% GDP)

-0.9

-5.7

-1.3

-1.9

-2.9

-5.4

-5.0

-3.1

-3.3

Trade Balance (USD bn) ( FOB)

GDP (USD bn)


External Sector
Current Account (USD bn)

-0.5

-1.7

-0.5

-0.5

-1.4

-2.4

-1.4

-1.8

-2.1

Net FDI (USD bn)

1.2

2.1

1.5

2.3

2.5

2.8

2.9

3.0

3.0

Other Net Inflows (USD bn)

1.3

3.9

2.0

0.4

4.0

6.0

5.8

3.8

3.8

Gross External Debt (USD bn)

12.2

12.0

14.1

14.6

15.1

15.6

16.1

16.6

17.1

International Reserves (USD bn)

4.1

6.3

8.0

7.7

10.3

13.6

16.7

18.7

20.5

Public Sector Balance (% GDP)

0.0

-1.6

-1.7

-1.1

-0.9

-2.8

-2.3

-2.1

-1.9

Primary Balance (% GDP)

3.6

1.4

1.2

1.9

2.0

-0.2

0.3

0.5

0.6

Gross Public Debt (% GDP)

58.1

44.9

56.8

44.0

40.0

40.7

40.2

40.9

39.4

Net Public Debt (% GDP)

41.2

27.1

36.9

32.4

30.3

31.6

31.8

32.9

32.2

CPI (% average)

8.1

7.9

7.1

6.7

8.1

8.1

8.6

9.4

8.5

FX (UYU per USD, eop)

21.5

24.4

19.5

19.9

20.0

19.2

21.5

23.5

23.9

Exchange Rate (period average)

22.0

23.3

20.3

20.0

19.3

20.3

20.4

23.2

23.9

Q4 12

Q1 13

Q2 13

Q3 13

Q4 13

Q1 14

Q2 14

Q3 14

Q4 14

5.0

4.0

5.6

2.1

3.0

2.4

3.2

3.2

3.2

Public Sector

Prices

Real GDP (y/y)


CPI (% y/y, average)
Exchange Rate (UYU/USD, eop)

8.5

8.7

8.1

8.9

8.6

9.5

9.7

9.4

9.2

19.18

18.85

20.55

21.85

21.50

22.91

23.39

23.40

23.50

Source: BCU, Barclays Research

25 March 2014

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LATAM: VENEZUELA

Survival instinct or structural change


Economics
Alejandro Arreaza
+1 212 412 3021
alejandro.arreaza@barclays.com
Alejandro Grisanti
+1 212 412 5982
alejandro.grisanti@barclays.com
Credit Strategy
Donato Guarino
+1 212 412 5564
donato.guarino@barclays.com

New FX market rules finally out

In action in the decision-making process could have high economic costs: a contraction in
the economy of 1.8%, inflation of 59.5%, and a fiscal deficit of 7.2% of GDP. But there are
some signals of change, such as a more flexible exchange rate system and the possibility
of changing general subsidies for localized ones.

Key recommendations
We reiterate our overweight recommendation on Venezuela. The central bank has
finally published an exchange agreement that sets the (more flexible) rules for the new
FX market (SICAD II). There are still issues to be clarified, but the FX market changes
could reduce Venezuelas economic distortions and imbalances significantly, which
should be supportive for Venezuela/PDVSA debt. Since both bond curves are inverted, we
suggest being long the PDVSA17N and the VE16s.

Moving in the right direction


The Central Bank of Venezuela (BCV) published an exchange agreement that sets the rules
for the new FX market (SICAD II). The rules seem to establish a flexible exchange market.
We maintain our opinion that this change in the FX market could reduce the fiscal deficit
(significantly), monetization needs, and the scarcity of non-priority goods, since it improves
the productive sectors access to dollars, creates incentives for exporters because they are
allowed to sell part of their revenues in the new market, and close the pervasive gap
between the different exchange rate markets. Implementation of this new FX market
should be supportive for Venezuela/PDVSA debt.
The published rules allow public and private entities to participate in a system managed by
the BCV and the Ministry of Finance. It could function with cash and bonds on a daily basis.
Banks and financial institutions operating in the new market will not be allowed to bid on or
accept short positions, which could, in principle, contain speculative demand.

Neither ceiling nor bands in the


new market

25 March 2014

Even if the rules allow the BCV to intervene and set limits and conditions to direct the market,
authorities have stated explicitly that they will not use a ceiling or bands to constrain the
exchange rate. Intervention seems to be limited to selling dollars at any time at a price set to
direct the FX rate to a specific level. In that sense, the public entities, as suppliers of this
market, could set the offer and closing prices, but the highest bid would be allocated the
dollars. This would direct dollars to the sectors willing to pay more, thus reducing the marginal
pressure in the non-official market. Moreover, if new supply comes in at a weaker rate, the
government would have greater capacity to sterilize excess liquidity and encourage
convergence between the official and non-official exchange rates. Authorities have said that
their goal is to stabilize the new FX rate at VEB/USD 50.0-60.0. In our opinion, a stronger rate,
even below 40, could be reached in the short to medium term. We also expect that in the
longer term, the government will migrate priority goods (foods, medicine, housing, and
education) from Cadivi/Sincoex to Sicad I and unify all non-priority goods at the Sicad II. We
view this as a significant change that could improve fiscal accounts and the countrys external
position. But the new systems probability of success will depend on the end of fiscal
monetization and some moderation on the fiscal front. If the government is not able to
improve fiscal accounts and continues to monetize the deficit, it may not be able to avoid a
strong devaluation in this new market, which could lead to its closure.

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Important improvement in the capacity to pay


Venezuela will suffer a 95%
increase in USD value, to
VEB/USD 16.0, which
represents a 49% devaluation

In an economy such as Venezuelas, with significant gaps among the different exchange
rates, it is very important to calculate the weighted average exchange rate for the economy,
for the private sector, and for the amount of USD the public sector is expected to sell to the
private sector. The latter category is needed to measure the fiscal effect of the devaluation.
The various calculations are shown in Figure 1. Venezuela, including the private and public
sectors and the non-official market, transacted USD69.7bn at a weighted average exchange
rate of VEB/USD 8.2 in 2013. For 2014, we expect a similar amount of transactions, but
given the difference of dollars sold in each market, the dollar will increase its value by 95%,
to VEB/USD 16.0, which represents a 49% devaluation.
FIGURE 1
Weighted average exchange rate by sector
2013

2014

USD

VEB/USD

USD

VEB/USD

CADIVI/SINCOEX

28.9

6.3

12.0

6.3

SITME/SICAD I

2.4

11.3

SICAD II

7.4

14.0

11.6

42.0

Public imports

34.3

6.3

31.7

6.3

Non-official market

4.1

35.7

4.5

46.0

Average FX for the economy

69.7

8.2

67.2

16.0

Average FX for the private sector

35.4

10.0

35.5

24.6

Average FX for fiscal gain

31.3

6.7

31.0

21.5

Source: Barclays Research

The private sector will suffer a


higher devaluation of 59%

To calculate the average exchange rate for the private sector, we subtract from the previous
amount all public sector transactions, which represent almost half of the total transactions.
For the private sector, we expected a similar dollar supply in 2014 as received in 2013
(about USD35.5bn), but at a completely different exchange rate. In fact, the weighted
average exchange rate would increase 145%, from VEB/USD 10.0 in 2013 to VEB/USD 24.6
in 2014. This movement represents a devaluation of 59%.

Devaluation will increase the


income of the public sector by
VEB459.2bn, or 12pp of GDP

If we separate the transactions that do not involve the public sector, which for simplicity we
call the non-official market, from the private sector transactions, we should be able to
calculate the fiscal gains. In 2013, authorities sold almost USD28.9bn at the cadivi rate, and
given all the changes and delays in SITME and SICAD, they sold just USD2.4bn at the SICAD I
rate. The weighted average exchange rate at which authorities sold dollars to the private
sector was just VEB/USD 6.7. Given the change in weights and the importance we assign to
Sicad II, we expect the new exchange rate to be VEB/USD 21.5, a devaluation of 69%,
representing a 222% increase in the price of the dollar. Given that we expect the public sector
to sell almost the same amount of dollars at a very important weaker rate, the effect on the
public sector accounts should be VEB459.2bn, or 12.0pp of GDP. Unfortunately, given the
fiscal voracity that authorities have shown, we expect a reduction of the fiscal deficit of 9pp of
GDP, ending at 7.2pp of GDP without taking into consideration additional measures.

Markets are not pricing additional measures


Authorities are trying to
substitute general subsidies for
focalized ones

25 March 2014

We believe the government is in the middle of trying to transform general subsidies into
focalized ones. President Maduro recently announced a debit card, the Secure Supply Card.
Use of the card will be optional and it will have different benefits, with the government
denying that it is intended to limit food purchases. We believe that through this card, the
government will distribute the subsidies to the poorest sector of the population so that it
can adjust the prices of priority goods, such as food and medicine, and increase the
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Barclays | The Emerging Markets Quarterly


domestic price of gasoline. Moving from generalized subsidies to focalized ones should
produce important efficiencies that will help fiscal accounts. Moreover, the adjusted
domestic price of gasoline, already announced by authorities several times in the past three
months, should also improve the cash flow of PDVSA. We expect the price of gasoline to be
adjusted to VEB2.0 per liter in July, improving PDVSA accounts by VEB41.8bn this year, or
1.1pp of GDP, and doubling the amount for 2015.

The economy likely to get worse before it starts to improve


Uncertainty about leadership and a fragmented government are leading to inaction, with
high economic costs: inflation at 57% and scarcity at 28%. The negative news for the
government is that the scarcity of dollars in the past six months has depleted inventories in
too many sectors, and we are of the opinion that scarcity will get worse before it starts to
improve. The likely best scenario is for the authorities to start the new exchange rate system
today, allowing the currency to fluctuate and intervening aggressively to correct the
important sub-valuation of the currency in the actual non-official market. In this case, the
private sector (basically the non-priority sectors) would be able to receive dollars at a
weaker rate in order to increase inventories. For the priority sectors, the government needs
to increase the flow of hard currency through Cencoex and Sicad I, which have been
reduced drastically due to the closing of Cadivi and the creation of a new entity (remember
the beginning of the Cadivi era in 2003) in the past four months. Scarcity could continue
even in this best-case scenario, given that the private sector will need time to increase
inventories to raise the supply of goods and services in Q3. A question mark in this bestcase scenario is how the private sector will be able to reflect the higher cost due to the
devaluation in prices and the new law of fair prices..
Even in this best-case scenario, the Venezuelan economy will likely contract about 1.8% this
year, maintaining high inflation at 59.5% and, without taking into account the possibility of
an increase in the price of gasoline, an elevated fiscal deficit of 7.2%. In this scenario, the
opposition will likely continue to focus on economic issues in order to chip away at
Maduros popularity until the government is forced to negotiate. Improvements in the
institutional framework, a more balanced national electoral council, and/or negotiated
appointments of the general attorney, the ombudsman, the supreme court, etc. would be
important victories for the opposition one year before the election of the National Assembly.
It is difficult to predict whether the protests will stop, remain the same, or heat up, but in
our opinion, the economic turmoil will keep volatility and uncertainty high.
In our opinion, institutional improvements are possible, given that this poor economic
performance is already reflected in public opinion. According to Datanalisis, 74.3% of
Venezuelans have a negative opinion of the countrys situation, the lowest approval rate in
the past 10 years. Moreover, when Venezuelans were asked to evaluate President Maduros
efforts to solve their largest problems, 74.1% had a negative opinion of his attempts to fight
scarcity, 75.6% disapproved of his performance against inflation, 75.9% cited negative
views about his attempts to reduce unemployment, and more than 80% were disappointed
by his approach to improving security. An important point is that 45-60% of the chavistas
have a negative evaluation of President Maduros performance in those areas, compared
with 85-90% of the ni-ni (non-aligned voters) and 99% of the opposition. If the
opposition continues to stresses economics as the central message of its political actions, a
continued deterioration of Maduros popularity and a greater probability of institutional
improvements are possible.

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FIGURE 2
Venezuela macroeconomic forecasts
2010

2011

2012

2013F

2014F

2015F

-1.5

4.2

5.6

1.1

-1.8

2.5

Oil GDP (% y/y)

0.1

0.6

1.4

0.4

0.5

4.9

Non-Oil GDP (% y/y)

-1.8

4.5

5.8

1.4

-2.3

2.1

Consumption (% y/y)

-1.9

4.4

6.9

3.6

-1.3

3.1

Fixed Capital Investment (% y/y)

-4.1

4.4

23.3

-5.6

-5.4

3.1

Exports (% y/y)

-14.0

4.7

1.6

-5.0

-1.2

4.6

Imports (% y/y)

-5.5

15.4

24.4

-7.3

-6.6

5.6

223.3

265.9

318.1

239.5

209.7

268.1

Oil Price (Brent, USD/bl.)

78.0

112.0

113.0

108.7

106.0

108.0

Current Account (USD bn)

12.1

24.4

11.0

10.0

15.0

18.6

Activity
Real GDP (% y/y)

GDP (USD bn)


External Sector

CA (% GDP)

5.4

9.2

3.5

4.2

7.1

6.9

Trade Balance (USD bn)

27.1

46.0

38.0

35.0

38.8

40.5

Gross External Debt (USD bn)

73.9

97.2

100.4

102.5

107.9

110.8

International Reserves (USD bn)

30.3

29.9

29.9

21.5

20.5

21.2

Public Sector + Cuasi-fiscal Balance (% GDP)

-12.2

-11.6

-19.6

-16.2

-7.2

-8.9

Public Sector Balance (% GDP)

-10.3

-11.6

-16.6

-13.5

-6.2

-8.4

-8.5

-9.4

-13.7

-10.4

-3.6

-6.1

43.1

48.2

50.8

63.8

70.0

56.9

Public Sector

Primary Balance (% GDP)


Gross Public Debt (% GDP)*
Net Public Debt (% GDP)

7.0

8.4

11.6

21.6

32.2

22.5

External debt service/Oil exports (%)**

16.5

16.6

14.5

21.0

25.7

25.6

CPI (% Dec/Dec)

27.2

28.5

20.1

56.2

59.5

40.8

Offc Exchange Rate (VEF/USD, eop)

4.30

4.30

4.30

6.30

6.30

6.30

Avg Weighted Exch Rate (VEF/USD)

4.49

5.11

5.16

9.75

18.23

20.54

1y ago

Last

13Q4F

14Q1F

14Q2F

14Q3F

Prices

Real GDP (y/y)

5.5

1.1

0.1

-0.3

-3.5

-2.5

Offc Exchange Rate (VEF/USD, eop)

4.30

6.30

6.30

6.30

6.30

6.30

* Includes central government, PDVSA and Chinese Fund estimated using the average weighted exchange rate. ** Includes Chinese Fund repayments
Source: MF, BCV, INE, Haver, Barclays Research

25 March 2014

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OVERVIEW OF KEY ECONOMIC AND FINANCIAL INDICATORS

PR China

GDP at
PPP

(20032013)

2013
population

(USD bn)

(mn)

9,264

1,361

6,808

9,828

15.4

274

38,056

52,687

0.4

Taiwan

2013
GDP

Real GDP

2013
GDP

Hong Kong, SAR

2013
GDP

2013
Share
of world

(USD pc) (PPP pc)

growth

2013
2014
Inflation Inflation
Target
Inflation Target

Sovereign credit
rating

(20032013)

(%)

(%)

10.2

2.9

3.5

3.5

Aa3

AA-

A+

4.4

2.1

Aa1

AAA

AA+
A+

Moodys S&P Fitch

2013
2013
Gross Gross
2013 External Public
Reserves Debt
Debt
(USD
bn)

2013
Saving
Rate

2013
Openness
((X+M)/GDP)

(%
GDP)

(%
GDP)

(%
GDP)

3,821

35

51

45

311

414

29

467

488

23

20,855

39,580

1.1

3.9

1.2

Aa3

AA-u

402

29

36

30

118

1,863

1,202

1,550

3,991

5.7

7.7

6.6

Baa3

BBB- BBB-

294

23

64

31

55

Indonesia

864

250

3,455

5,182

1.5

5.7

7.1

Baa3

BB+

BBB-

99

31

27

31

42

Malaysia

312

29

10,638

17,526

0.6

5.1

2.4

A3

A-

A-

135

37

55

31

157

Philippines

271

100

2,719

4,660

0.5

5.4

4.5

3-5%

3-5%

Baa3

BBB- BBB-

83

22

53

21

43

Singapore

295

54,630

62,428

0.4

6.1

2.5

Aa