Emerging Markets Briefer Geopolitics and deflation

Transcription

1 Investment Research General Market Conditions 20 August 2014 Emerging Briefer Geopolitics and deflation Over the past month, a number of emerging market currencies have come under renewed pressure. This is particularly the case in Central and Eastern Europe, where currencies such as the Polish zloty and the Czech koruna have had a stormy month. Renewed concerns over the geopolitical situation in Ukraine and, in particular, fear of an outright Russian invasion of Ukraine are adding to the worries in the markets. Furthermore, the newly introduced sanctions against Russia and the Russian counteraction have spooked investors. The Russian counter-sanctions, especially the sanctions on imports of certain food and agricultural products, have unnerved investors and it is clear to us that these sanctions are having a negative impact on, for example, Polish exports to Russia. These sanctions have also raised concerns about deflation in Central and Eastern Europe, as European food exporters are now dumping their products in Europe rather than exporting them to Russia. This is likely to put further downward pressure on prices, particularly in Central and Eastern Europe. Poland, Hungary, Romania and Bulgaria already have deflation and the Czech Republic is inching closer. Naturally, this has increased market expectations and rightly so in our view of monetary easing across Central and Eastern Europe. Hence, in our view, it is becoming more and more likely the Polish central bank will cut interest rates to curb deflationary pressure and we believe the Hungarian central bank is likely to continue its ongoing rate cutting cycle. Furthermore, we consider it is becoming increasingly likely that the Czech central bank will lift the floor under EUR/CZK to fight deflation. In our view, the increased likelihood of monetary easing across CEE will continue to put depreciation pressure on the CEE currencies over the next three to six months but more than is currently priced by the markets. We believe this will be even more important than the renewed geopolitical tension, although this risk should not be ignored. Contents Poland... 2 Czech Republic... 3 Hungary... 4 Romania... 5 Baltics... 6 Russia... 7 Ukraine... 8 Kazakhstan... 9 Turkey South Africa Brazil Mexico China Indonesia India Forecasts vs forwards Monetary policy calendar. 21 However, it is not all bad. It should be noted that the recovery continued in the US, the UK economy is also doing better and better and finally there are clear signs that the Chinese economy is moving out of the soft spot. All this should be generally supportive for risk sentiment and the emerging markets in general. On the back of this, in our view, it is also likely the Latin American and emerging Asian currencies and markets in general will outperform the CEE markets at least in the near term. Chief Analyst Lars Christensen larch@danskebank.dk Important disclosures and certifications are contained from page 23 of this report.

2 Poland The latest GDP data shows that growth seems to be picking up faster than we previously expected, but the escalating Ukrainian crisis clearly had downward risk on Polish growth. We expect real GDP growth of 3.6% y/y in 2014 and 3.6% in We still expect private consumption and investments to be the main drag on growth this year. Given the expected weakness in private demand, external balances should improve somewhat (and have been doing so recently). Monetary policy outlook While Polish growth seems to be picking up, inflation remains very subdued and there is a risk of outright deflation in the coming months in Poland. The continued very low inflation could very well push the Polish central bank (NBP) in a slightly more dovish direction and a rate cut now seems increasingly likely. Hence, we expect the NBP to lower its key policy rate by 25bp to 2.25% at its September Monetary Policy Council meeting and to deliver an addition rate cut later in the autumn, bringing down the key policy rate to 2.0% by the end of FX outlook The zloty has been under significant pressure recently on the back of the re-escalation in the Ukrainian crisis and momentum clearly remains very negative. Furthermore, downside risks to growth and inflation have clearly increased and that is likely to keep the zloty under pressure. Therefore, we do not see any near-term rebound. Polish economy faces deflation Some slowdown in Q2 14 PLN S&P: A- (stable) Free float (freely convertible) 2.5% +/-1pp Macro forecasts GDP (% y/y) GDP deflator (% y/y) CPI (% y/y) Private consumption (% y/y) Fixed investments (% y/y) Unemployment (%) Current account (% of GDP) Source: Macrobond, Danske Bank Interest rate forecast National Bank of Poland (NBP) Policy rate 2.50 Next meeting 03 September 2014 Next change - 25bp September, 2014 End Source: Macrobond Source: Macrobond EUR/PLN 18-Aug M M M USD/PLN 18-Aug M M M Source: Macrobond, Danske Bank 2 20 August

3 Czech Republic Czech Q1 GDP was revised up to 2.5% y/y. Growth was driven by investments but also domestic demand contributed more than expected. We expect the Czech economy to continue its recovery with average 2014 GDP growth of 2.4% y/y, 3.1% y/y in 2015 and 3.2% y/y in The Czech central bank (CNB) revised up its GDP growth forecast to 2.9% in 2014 (2.6% previously). In 2015, the CNB forecasts GDP growth of 3.0% (unchanged). However, the Russia sanctions clearly represent downside risk to the Czech economy. Inflation remains well below the central bank s official inflation target of 2%. Despite inflation in July coming out higher than expected, increasing to 0.5% y/y, up from June s 0.0% y/y, it is expected to fall again in the autumn. Furthermore, the risks to inflation are squeezed on the downside given very lower imported inflation on the back of very low inflation elsewhere in Europe. The Czech central bank expects inflation to return to the 2% inflation target in Q3 15. Overall, the latest economic indicators keep pointing to further economic recovery. PMI in July increased to 56.5 up from 54.8 and is one of the highest in the CEE region. Industrial production for June was 8.1% y/y and retail sales accelerated to 8.2% y/y. Monetary policy outlook In line with expectations, the CNB left its key policy rate at a technical zero of 0.05% and also kept the Czech koruna cap near 27/EUR at its July monetary policy setting meeting. Even though there was no change in monetary policy, the statement from the CNB following the announcement was perceived by the markets as dovish with the Czech koruna since losing around 1% against the euro. As the discussion about a possible lift of the koruna cap has strengthened, the market seems to have begun pricing in further CNB action. Given that inflation will increase only slowly and due to lower imported inflation given very low inflation elsewhere in Europe, downside risks to the Czech economy from Russian sanctions means that the likelihood of the CNB lifting the EUR/CZK floor is fairly high, especially on the medium-term horizon. FX outlook The Czech koruna has lost around 1% against the EUR following the monetary policy setting meeting at the end of July, as the possibility of the CNB lifting the floor has increased. Even though the CNB says that the weaker koruna cap is not currently justified and stronger deflationary risks would be needed, the pressure on the CNB to deliver additional monetary easing and lift the EUR/CZK floor higher has increased. This is on the back of the increasing deflationary risks in other European countries (with Poland very close to deflation and Hungary already in deflation) but also from the downside risk to the economy from the Russian sanctions. We have therefore decided to revised our CZK forecast in a more negative direction. We now expect the EUR/CZK at 28.2, 28.5 and 28.5 in three, six and 12 months. CZK S&P: AA- (stable) Free float (freely convertible) 2% +/-1pp Macro forecasts Interest rate forecast GDP (% y/y) GDP deflator (% y/y) CPI (% y/y) Private consumption (% y/y) Fixed investments (% y/y) Unemployment (%) Current account (% of GDP) Policy rate Czech National Bank (CNB) 0.05 Next meeting 25 Sep 2014 Next change - Unchanged 2014 End EUR/CZK 18-Aug M M M USD/CZK 18-Aug M M M August

4 Hungary Growth is clearly picking up in Hungary and after years of stagnation, it is becoming one of the fastest growth economies in central and eastern Europe. However, both structural problems and weak domestic demand are continuing to weigh on economic activity. We now expect a higher pick-up in growth to 3.5% y/y in 2014 up from 1.2% y/y in We expect growth to remain at 3.5% y/y in Hungary has seen a substantial improvement in external balances in recent years. The improvement in external balances partly reflects the continued improvement in Hungarian public finances but also still weak domestic demand. This by far is the most positive element in the Hungarian economy. Continued high political risk and very unorthodox economic policy, on the other hand, continue to weigh significantly on Hungary s long-term growth perspectives. Monetary policy outlook The Hungarian central bank (MNB) has initiated a policy of baby-step rate cuts. Further monetary easing is justified as there is actually now deflation in Hungary (despite higher growth) and there is certainly a risk of further deflation in coming months. However, rates have now come down to the point where the MNB might start to worry that the stability of the HUF is jeopardised. Furthermore, higher GDP growth might also turn the MNB slightly less dovish. FX outlook We continue to believe that Hungary s fairly strong external position is likely to be supportive for the HUF in the medium term as will the increasingly stronger recovery in growth. As a consequence, the HUF could even strengthen moderately against the EUR on a 12-month horizon, while the short-term outlook is likely to be dependent on the general emerging markets outlook as well as developments in the Russian- Ukrainian conflict. The biggest risks to the HUF remain the political uncertainty and the Hungarian government once again taking a misstep in economic policy. HUF S&P: BB (stable) Free float (freely convertible) 3% (medium term) Macro forecasts Interest rate forecast GDP (% y/y) GDP deflator (% y/y) CPI (% y/y) Private consumption (% y/y) Fixed investments (% y/y) Unemployment (%) Current account (% of GDP) Policy rate Hungarian Central Bank (MNB) 2.10 Next meeting 26 Aug 2014 Next change - 10 bp August, 2014 End Deflation Source: Macrobond Financial Growth is picking up further Source: Macrobond Financial EUR/HUF 18-Aug M M M USD/HUF 18-Aug M M M August

5 Romania The Romanian economy performed relatively well in 2013 with GDP growth of 3.3% y/y. Still, Q1 14 GDP growth was decent at 3.8% y/y. However, preliminary Q2 GDP numbers surprised well on the downside, showing growth of only 1.2% y/y and contracting by 1.0% q/q. On the back of the low reading in Q2, we cut our GDP forecast down to 2.7% y/y for 2014 (3.8% y/y previously). Next year, we expect GDP growth of 3.3% y/y. Inflation has dropped considerably over the past year. Despite inflation having increase to 1.0% y/y in July, up from 0.7% y/y in June, it remains well below the central bank s official inflation target of 2.5%. We expect inflation to average 1.8% y/y in The risks to the inflation outlook are on the downside. Economic indicators continues to be decent. Retail sales in June accelerated by 10.3% y/y, up from 10.1% y/y in May. Industrial production is expected to be 11.5% y/y. The current account deficit has narrowed considerably over the past two years. Looking ahead, we expect the current account deficit to remain sustainable. We expect a deficit of 2.2% of GDP in 2014 and 2.0% of GDP in Monetary policy outlook In line with our expectations cut the Romanian central bank (NBR) the key policy rate by 25bp to 3.25% at its monetary policy setting meeting in early August. Furthermore, at the press conference the NBR Governor Isarescu clearly left the door open for further monetary policy easing. Given the increasing downside risks to inflation not only in Romania but overall in Europe, it is likely that the NBR will ease monetary policy further this year. We expect at least one more 25bp rate cut this year. FX outlook Due to Romania s improved external imbalances, the leu has become more resilient to external shocks. However, this did not protect the leu completely when the geopolitical risks in Ukraine intensified and all CEE currencies came under immediate pressure including the RON. We have become slightly less upbeat on the leu going forward, as it seems that the economic recovery is losing some momentum. That said, we are not more negative compared with market pricing. RON S&P: BBB- (stable) Free float (freely convertible) 2014: 2.5% +/-1pp Macro forecasts Interest rate forecast GDP (% y/y) GDP deflator (% y/y) CPI (% y/y) Private consumption (% y/y) Fixed investments (% y/y) Unemployment (%) Current account (% of GDP) National Bank of Romania (NBR) Policy rate Next meeting Sep 2014 Next change - H2, 2014 End EUR/RON 18-Aug M M M USD/RON 18-Aug M M M August

6 Baltics Overall comment: the escalation in geopolitical tension with regard to the situation in Ukraine is likely to have a significant negative impact on Baltic growth. Furthermore, a further escalation in geopolitical tension could hurt the general investor perception of the Baltic States. Estonian macro outlook The Estonian economy slowed significantly in 2013 and underperformed the other two Baltic economies in terms of growth performance. In particular, the weak growth of Estonia s trading partners, such as Finland, has been weighing on growth. We expect some pickup in Estonia but, given the overall lacklustre European growth, we expect this to be slow. We expect Estonian GDP growth to pick up moderately from 2013, to 1.5% y/y in 2014 and further to 1.8% y/y in Latvian macro outlook The recovery in the Latvian economy continues with GDP growth around 3-4% y/y but the Ukraine-Russia conflict is clearly a downside risk to Latvian growth. Latvia joined the euro area on 1 January. We do not expect a major short-term impact as Latvia has effectively been shadowing ECB monetary policy for years as a consequence of the peg to the euro. However, it is also clear that the performance of the Latvian economy is now linked completely to that of the euro area. Inflation came down significantly in 2013 and we are likely to see outright deflation in Latvia during some of We expect inflation to pick up only slowly in coming years. Lithuanian macro outlook Lithuania has not joined the euro area yet but looks set to fulfil the Maastricht criteria soon. The economy continues to recover and growth remains among the fastest in Europe. However, the output gap has not yet been fully closed following the sharp fall in economic activity in We still expect Lithuanian growth to pick up. The biggest near-term risk to growth is the expected sharp slowdown in Russia, as it is one of Lithuania s main trading partners. As in Latvia, inflation in Lithuania fell significantly in Given the continued decline in global commodity prices and continued slack in the Lithuanian economy, we expect inflation to remain quite subdued in 2014 and Baltics macro forecast Estonia Latvia Lithuania Year GDP (% y/y) GDP deflator (% y/y) CPI (% y/y) Private consumption (% y/y) Fixed investments (% y/y) Unemploy ment (%) Current account (% of GDP) EEK S&P: AA- (stable) Currency: EUR since 1 January 2011 LVL S&P: A- (stable) Currency: EUR since 1 January 2014 LTL S&P: A- (stable) Currency board, ERM2 member (freely convertible) None, due to fixed exchange rate 6 20 August

7 Russia Economic growth in Russia has slowed further, posting 0.8% y/y growth in Q2 14 compared with 0.9% y/y in Q1 14. Our 2014 GDP forecast remains -0.3% y/y due to a surge in geopolitical risks, which have introduced both supply- and demand-side shocks: extreme acceleration in capital outflows in H1 14 and continuing monetary tightening. Fixed investment growth is still disappointing: it increased just 0.5% y/y in June, falling for the first five months of Construction improved 1.2% y/y in June, staying negative in H1 14 despite strong residential construction data: 30.2% y/y growth in H1 14. As supply-side shocks and tightening monetary policy are set to have a further negative impact on fixed investments in , we see some upside risks in arising from giant state projects such as the gas line deal with China and plans to invest additionally into infrastructure. Unemployment remains under 5%, posting 4.9% in June. Yet, private consumption expansion is slowing down at an alarming rate on high interest rates and a weakened rouble: retail sales expanded 0.7% y/y in June and 2.7% y/y in H1 14. Russia s credit rating was downgraded by S&P to BBB- with a negative outlook on 25 April 2014 as geopolitical and economic risks continue to weigh. We do not exclude further downgrade to the junk level as sanctions are weighing on sentiment. FX and monetary policy outlook The Russian central bank surprisingly hiked its main rates by 50bp on 25 July 2014 to curb accelerating inflation and support the RUB. We do not expect Bank Rossii to lower the key rate in coming months. The next rate decision is due to be published on 12 September. We expect rates to be unchanged. We believe that a 50bp rate hike is possible in H2 14 if CPI accelerates further on the food import ban. We raise our CPI forecast for December 2014 by 6bp to 6.8% y/y. Bank Rossii has made another firm step towards a free floating currency in On 18 August, the rouble s trading band against the dual currency basket was widened by two roubles to nine roubles. This is the first widening in two years. The central bank is abolishing FX interventions within the range, aiming to complete the shift to free float by the end of Risk factors The main risks continue to be geopolitical. However, we reiterate that the geopolitical risks are underestimated by the markets. As the oil price has fallen almost 10% since June 2014, heading to USD100/bbl, we see the oil price risk rising on levels lower than USD100/bbl. Bank Rossii s monetary tightening is another large risk. A rapid devaluation of RUB could prompt more radical measures such as capital control, although we see this as less probable under the new governor of Bank Rossii than under the previous team. We see possible escalation in sanctions war as a significant downside risk to our 2014 GDP forecast. RUB S&P: BBB- (negative) Managed peg versus dual currency basket 45% EUR and 55% USD (freely convertible) 5% in 2014, 4.5% in 2015 (December-on-December basis) Macro forecasts Interest rate forecast GDP (% y/y) GDP deflator (% y/y) CPI (% y/y) Private consumption (% y/y) Fixed investments (% y/y) Unemployment (%) Current account (% of GDP) Bank of Russia (CBR) Policy rate Next meeting Sep 2014 Next change - Unchanged 2014 End EUR/RUB 18-Aug M M M USD/RUB 18-Aug M M M August

8 Ukraine The escalation of the political situation and continued fighting in Ukraine is weighing dramatically on the Ukrainian economy. The economy continues to shrink further, falling 4.7% y/y in Q2 14, according to preliminary data, versus a 1.1% y/y decrease in Q1 14. As military operations by the Ukrainian army in the country s eastern parts to quash action by federalisation and independence movements are putting the future of the IMF programme at risk, private consumption growth has turned negative and Ukraine is introducing economic sanctions against Russia, we cut our 2014 GDP forecast from -5% y/y to -8% y/y. UAH S&P: CCC (negative) Managed peg versus USD The decline in industrial production continued in July, posting a 12.1% y/y decline from a 5% y/y fall a month earlier. Mining and manufacturing shrank 12.7% y/y in July. As the major unrest and military operations are concentrated on Ukraine s most industrialised regions, industrial production will be hit heavily in The industrial production in Ukraine will be hit further on the absence of gas supplies from Russia, as Ukraine is leaving Gazprom bills unpaid. In January-July 2014, retail sales growth hit negative territory for the first time since April Utility services prices are set to significantly reduce consumer purchasing power. FX and monetary policy outlook Inflation continues to accelerate on the weak UAH, reaching 12.6% y/y in July versus 12% y/y a month earlier. Ukraine s foreign reserves saw an improvement in May as the country got the first tranche from the IMF. Yet, the reserves are heading down again. In August 2014, UAH has hit an all-time low against the USD at We still expect USD/UAH to hit this year as there are insufficient FX reserves to provide enough support. However, IMF financing may mitigate the path of devaluation. Risk factors An escalation of the geopolitical situation and difficulties with debt servicing are the major economic risks in the current environment. Private consumption set to dive in 2014 Industrial and agricultural production EUR/UAH 18-Aug M M M USD/UAH 18-Aug M M M August

9 Kazakhstan Kazakh economic growth slightly improved to 3.9% y/y in Q2 14 versus 3.8% y/y in Q1 14, according to preliminary data. Agriculture, the production of services and construction were still growing, but industrial production shrank 0.4% y/y. Global uncertainty among EM markets and China s slowdown are also weighing on the Kazakh economy. Kazakhstan s credit rating outlook was lowered to negative from stable by rating agency Standard & Poor s on 13 June, as the outlook for economic growth is worsening together with effectiveness of monetary policy. KZT S&P: BBB+ (negative) Corridor versus USD Real wage expansion continues, posting 6% y/y in June versus 6% y/y a month earlier. However, the growth trend can be easily interrupted due to devaluated KZT and accelerating inflation. We expect CPI to increase to 8% y/y in Inflation eased a notch in July to 6.9% y/y versus 7% y/y a month earlier. Low unemployment prevailed throughout 2013 and early 2014, rising to 5.1% in July and supporting the private consumption outlook for FX and monetary policy outlook In early August, KZT saw additional pressure as households and corporations ran into FX on devaluation expectations. Some banks even had to halt currency exchanges for a while. Yet, expectations were curbed by the National Bank of Kazakhstan (NBK), which intervened aggressively in the FX market, worsening available liquidity. Additional verbal interventions were made to support the KZT. The artificiallysupported KZT, which has gained 0.85% since early August, implies we may see more of a squeeze in liquidity. As inflation has accelerated on the devaluated KZT and the economic performance is relatively good, we do not exclude monetary policy tightening in 2014 to keep inflationary pressure down and support the KZT. Risk factors Kazakhstan remains dependent on its resource sector and oil exports. Accelerating inflation and weak global demand for commodities, especially by China, could cool Kazakh economic growth further. EUR/KZT 18-Aug M M M USD/KZT 18-Aug M M M Kazakhstan and Russia are big trade partners. A slowdown in the Russian economy would weigh on Kazakh exports, the KZT and the economy. GDP and inflation Industrial production growth 9 20 August

10 Turkey The Turkish economy has been showing quite clear signs of slowing over the past couple of years; however, recently the macroeconomic news flow has been less encouraging. We expect 2.7% y/y real GDP growth in 2014 and 2.9% y/y in The continued high inflation (8.4% y/y in 2014) and the large current account deficit continue to be a problem from a fundamental perspective. Monetary policy outlook Turkish inflation expectations have risen sharply on the back of the significant sell-off in the lira and this was undoubtedly, in our view, one of the main drivers behind the central bank of Turkey s (TCMB) emergency rate hike at the end of January. Recently higher food prices have pushed Turkish inflation up further. That said, inflation has probably peaked and recently the TCMB has changed course and has initiated a rate cutting cycle cutting its key policy rate by 50bp at the latest monetary policy meeting. The TCMB is likely to remain under political pressure to cut rates even more despite the elevated level of inflation. FX outlook Continued fairly high inflation and a large current account deficit are likely to continue to weigh on the lira over the longer term. However, these imbalances are to a large extent already reflected in the lira and the lira continues to trade at what we consider to be fairly cheap levels from a fundamental perspective. Furthermore, high Turkish interest rates are likely to provide some support for the lira. Overall we see a gradual depreciation of the lira, but we are slightly less negative than markets in general. Growth likely to slow down Current account deficit remains wide TRY S&P: BB+ (negative) Free-float (freely convertible) 5.0% year-end 2014 Macro forecasts Interest rate forecasts GDP (% y/y) GDP deflator (% y/y) CPI (% y/y) Private consumption (% y/y) Fixed investments (% y/y) Unemployment (%) Current account (% of GDP) C.B. of the Republic of Turkey (TCMB) Policy rate 8.25 Next meeting 27 Aug 2014 Next change -50bp H2, 2014 End Source: Macrobond Source: Macrobond EUR/TRY 18-Aug M M M USD/TRY 18-Aug M M M August

11 South Africa The South African economy has been hard hit by the prolonged strikes in the platinum sector. This was reflected in very weak Q1 GDP, which showed growth of 1.6% y/y (down from 2.0% y/y in Q4 13) but a contraction of 0.6% q/q from 3.8% growth in Q4 13. On the back of that weak reading, we have revised our GDP forecast to 1.9% y/y for this year and to 2.3% y/y in The South African central bank (SARB) revised its GDP forecast down again to 1.7% (versus 2.1% previously). In 2015, the SARB expects GDP growth of 2.9% (versus 3.1% previously). Inflation in June came out lower than expected and remained unchanged at 6.6% y/y in June versus May. Looking ahead, we expect inflation to drop somewhat in coming months but it will remain above the upper end of the inflation target range of 3-6%. The SARB forecasts average inflation of 6.3% in 2014 and 5.9% in The current account deficit in Q1 14 improved somewhat, narrowing to 4.5% of GDP. However, given the protracted strikes in platinum sectors, which negatively affected exports, the current account deficit is likely to widen somewhat in Q2 again. Overall, we do not expect the current account deficit to improve this year. The large current account deficit makes the South African economy vulnerable to external shocks. Q2 14 unemployment surprised slightly on the upside when it increased to 25.5%, up from 25.2% in Q1. Given that the economy remains very weak, we do not expect any major improvement in the labour market. Monetary policy outlook At its MPC meeting in July, the South African central bank decided to hike by 25bp, bringing the key policy rate up to 5.75%. The move was not completely expected but also did not come as total surprise as the central bank has indicated many times that the next move would be up and also a smaller increase such as 25bp would be meaningful. Given that inflation continues to run above the 3-6% inflation target, we still expect the SARB to continue its monetary tightening but we expect only a moderate rate increase of 25bp given the ongoing weakness in the economy. The timing of the next rate hike highly depends on inflation development but also on the exchange rate. FX outlook Our outlook for the rand has changed in a somewhat more positive direction versus our previous forecast, especially on the short- to medium-term horizon. Given that Chinese growth is stabilising and the UK economy is doing better, this should be supportive for the rand. We are therefore more positive on the three- and six-month horizons versus our previous forecast and market pricing. On the 12-month horizon, we remain bearish on the rand given the fundamental overvaluation on the back of the large external imbalances. ZAR S&P: BBB (stable) Free float (Freely convertible) 3%-6% Macro forecasts Interest rate forecast South African Reserve Bank (SARB) Policy rate Next meeting 18 Sep 2014 Next change +25bp H2, 2014 End GDP (% y/y) GDP deflator (% y/y) CPI (% y/y) Private consumption (% y/y) Fixed investments (% y/y) Unemployment (%) Current account (% of GDP) EUR/ZAR 18-Aug M M M USD/ZAR 18-Aug M M M August

12 Brazil The Brazilian economy remained weak. Q1 14 GDP expanded by 1.91% y/y, down from the revised 2.2% y/y in Q4 13. Q2 is likely to show a further slowdown. We expect the Brazilian economy to remain weak and to operate well below its potential over the next three years. We expect GDP growth to average 0.8% in 2014, 1.5% in 2015 and 2.2% in Manufacturing PMI continues to disappoint and remained below the critical 50 in July at Industrial production remains well in the red, falling by 6.9% y/y in June, down from -3.4% y/y in May. Retail sales remain weak, pointing to continued weakness in private demand. Retail sales for June came out at 0.8% y/y, down from 4.7% y/y in May. The situation in the labour market remains fairly stable with the unemployment rate at around 5%. Hence, unemployment remains fairly low and anchored. IPCA inflation in July inched further up to 6.51% y/y from 6.41% y/y in June. Hence, inflation hovers slightly above the upper end of the official inflation tolerance band of 4.5%,+/-2 percentage points. We have lowered our inflation forecast somewhat and we now expect it to average 6.2% y/y in 2014 and 6.8% y/y in Monetary policy outlook The Brazilian central bank (BCB) stayed on hold and kept the Selic rate at 11% at its monetary policy committee (Copom) meeting in July. The Minutes were more or less balanced and the BCB expect inflation converge towards the inflation target during Given that inflation will remain elevated there is no scope for any monetary easing. It is likely that the BCB stays on hold for reminder of the year. FX outlook and risk factors Global risk sentiment remains highly dependent on the incoming economic data from the large economies but also on the lingering geopolitical concerns. The Brazilian real has recently been under some pressure as Chinese economic data has been mixed, with the first rate hike by the Fed moving closer and oil prices declining. We have revised our forecast for BRL in a more negative direction as the economy remains very weak, oil prices are declining and the global recovery is uncertain. BRL S&P: BBB- (stable) Free float (non-convertible) 4.5% +/- 2% points Macro forecasts Interest rate forecasts Central Bank of Brazil (BCB) Policy rate Next meeting Sep 2014 Next change - Unchanged 2014 End GDP (% y/y) GDP deflator (% y/y) CPI (% y/y) Private consumption (% y/y) Fixed investments (% y/y) Unemployment (%) Current account (% of GDP) n/a EUR/BRL 18-Aug M M M USD/BRL 18-Aug M M M August

13 Mexico Q1 14 GDP came out slightly lower than expected with GDP expanding by 1.8% y/y, up from 0.7% y/y in Q4 13. Given the ongoing continued weakness in the economy, it is likely that Q2 GDP could show even weaker economic activity versus Q1. We expect the Mexican economy to recover somewhat this year; however, the recovery is likely to be milder than we previously expected. We expect the economy to expand 2.7% y/y in 2014, 3.8% y/y in 2015 and 3.8% y/y in Manufacturing PMI in July remained above the critical level at 51.5, slightly down from 51.8 in June. Industrial production data remains in the black but still rather weak. Industrial production advanced by 2.0% y/y in June, up from 1.6% y/y in May. Retail sales also remain weak and volatile, suggesting that private consumption remains soft. In May, retail sales advanced by 1.6% y/y, up from -0.4% y/y in April. Unemployment remains fairly contained at just below 5%. Monetary policy outlook Consumer prices accelerated further in July, to 4.07% y/y, up from 3.75% y/y in June. Hence, inflation is currently outside the target range of 3.0% +/-1pp. We expect inflation to average 3.8% y/y in 2014 and 3.9% y/y in After the unexpected 50bp rate cut in June, which brought the key policy rate to 3.00%, the Mexican central bank, Banco de Mexico, left interest rates unchanged at its monetary policy setting in July. Minutes from July s meeting suggest that the Banco de Mexico will stay on hold for some time to come. Indeed, inflation is elevated and inched above the inflation target. Therefore, the central bank does not have much room for further easing. We expect the Banco de Mexico to stay on hold for the reminder of the year. FX outlook The MXN gained somewhat recently, having been under some pressure at the start of August. This was due to sentiment towards emerging markets turning sour on the back of stronger US data and an increasing likelihood that the Fed will hike sooner than later. As long as risk sentiment stays favourable, the MNX should remain fairly stable. On the other hand, we do not expect the MNX to come under appreciation pressure going forward. However, we are somewhat more positive on the MXN compared with market pricing. Growth still remains weak Inflation rises above the target MXN S&P: BBB (positive) Free float (freely convertible) 3.0% +/- 1% point Macro forecasts Interest rate forecast GDP (% y/y) GDP deflator (% y/y) CPI (% y/y) Private consumption (% y/y) Fixed investments (% y/y) Unemployment (%) Current account (% of GDP) n/a Bank of Mexico (Banxico) Policy rate Next meeting Sep 2014 Next change - Unchanged 2014 End EUR/MXN 18-Aug M M M USD/MXN 18-Aug M M M Source: Macrobond Source: Macrobond August

14 China Growth has started to improve on the back of moderate fiscal and monetary easing. Stronger exports to developed markets have also added to growth recently. We expect growth to lose some momentum in late 2014 as the impact from the mini-fiscal stimulus earlier this year starts to wane. We expect China s manufacturing PMIs to peak in September/October slightly above 52. Inflation remains below 2.5% y/y and is therefore substantially below the government s 3.5% critical threshold for inflation. This leaves room to ease both fiscal and monetary policy if needed and reduces the downside risk to growth. The biggest downside risk for China is that the government s bid to deleverage the Chinese economy could turn into a severe credit crunch. In the short term, particularly the weakness in the property market is a concern. Monetary policy outlook Financial conditions have so far eased modestly in 2014 after a substantial tightening in 2013 even though the leading interest rates have so far been left unchanged. The Peoples Bank of China (PBoC) has mainly eased monetary policy through a larger injection of liquidity through its open market operations, a targeted cut in the reserve requirement ratio for primarily smaller banks and a broader base for base for calculating deposits in the loan-to-deposit cut. We do not expect the PBoC to cut its leading lending rate, although it cannot be completely ruled out in light of the current weakness in the property market. FX outlook The CNY initially weakened after the PBoC widened the daily trading band in March for USD/CNY to +/-2% from +/-1% previously. In our view, PBoC is not targeting a major depreciation of CNY to support growth, but is mainly attempting to stem speculative capital inflows into China by creating more two-way volatility in the exchange rate. The wider trading band should be regarded as another step towards a floating exchange rate and a convertible currency. Current account surplus is above 2% of GDP and continued gains in market share on global export markets suggest that the CNY is still slightly undervalued, in our view. Hence, we believe the CNY remains on a moderate appreciation path in the medium term. With the economy expected to recover moderately in H2 14, we expect CNY to resume a moderate appreciation path supported by a slightly higher trade balance surplus. CNY has resumed appreciation path Trade balance surplus is again increasing CNY S&P: AA- (stable) Crawling USD peg 3.5% for 2014 Interest rate forecast People's Bank of China (PBOC) Policy rate Next meeting 6.00 Not announced Next change - Unchanged 2014 End EUR/CNY 18-Aug M M M USD/CNY 18-Aug M M M Source: Macrobond, Danske Bank Source:, Macrobond Source: Macrobond, Danske Bank August

15 Indonesia The Indonesian economy has been balancing close to overheating in recent years and the current account has deteriorated markedly since In Q2 14, the current account was close to 4% of GDP. Growth has continued to slow moderately and in Q2 14 reached just 5.1% y/y. Growth is expected to improve moderately in H2 14 as the negative impact from last year s cut in fuel subsidies wanes. Inflation in July dropped markedly to 4.5% y/y from 6.7% y/y largely because the base impact from the cut in fuel subsidies in July 2013 disappeared due to the weaker IDR and a cut in subsidies on gasoline and diesel. A slight appreciation in the IDR so far this year has also added to downward pressure on inflation. Monetary policy outlook The Bank of Indonesia (BI) hiked interest rates aggressively in 2013 in the wake of the plunge in the IDR and the jump in inflation after energy subsidies were cut. With inflation now back within BI s % target range, a rate cut is possible later this year, particularly if growth continues to disappoint. However, with the Fed expected to start raising interest rates in H1 15, there will only be limited room to cut interest rates in Indonesia. FX outlook Joko Widodo, the presidential candidate of the main opposition party PDI-P, appears to have narrowly won the presidential election July 2014 although the outcome is being contested by his main opponent Prabowo Subianto. Widodo is regarded as the most reform-minded candidate, so this outcome has been positive for INR. However, PDI-P performed poorly in connection with the April parliament election and hence it will be dependent on the support of other parties in the parliament. In policy terms, we expect Indonesia to continue its slide towards a more nationalistic and populist policy, with a negative impact on foreign direct investment and competitiveness. Following its plunge in 2013, the IDR no longer looks substantially overvalued. However, because of foreign investors large share in Indonesian government bonds, Indonesia is particularly sensitive to Fed tapering and interest rate hikes. In addition, Indonesia s balance of payments could be affected by the lack of policy adjustments in 2014 and a push in a more protectionist direction. We still see moderate depreciation of the IDR on a 12-month horizon. CA deficit leaves Indonesia vulnerable Growth continues to slow IDR S&P: BB+ (stable) Free float % for 2014 Interest rate forecast Policy rate Next meeting 11 Sep 2014 Next change - 25 bp Q End Bank Indonesia (BI) 7.50 EUR/IDR 18-Aug M M M USD/IDR 18-Aug M M M Source: Macrobond, Danske Bank Source: Macrobond Source: Macrobond August

16 India GDP growth has slowed markedly to less than 5% after double-digit growth just before the global financial crisis started in The slowdown has been driven by both monetary tightening and a slowdown in India s potential growth as the pace of economic reforms has slowed. India s current account has also improved markedly to about 1% of GDP in Q2 14, from more than 5% of GDP in H2 13. The general election concluded in May gave main opposition party BJP an outright majority in the Lower House. Hence, it appears that India will get a relatively strong government which will again lead to accelerated economic reforms. In 2014, GDP growth is likely to remain subdued slightly below 5%. With inflation gradually under control and external balances substantially improved, India now appears well positioned for a recovery in 2015 and Monetary policy outlook The new Reserve Bank of India s (RBI) governor Raghuram Rajan has attempted to signal an increasingly independent monetary policy and, among other things, RBI is planning to move gradually towards a pure inflation target using traditional CPI instead of currently wholesale prices. A report commissioned by the RBI recommends the inflation target for CPI should eventually be 4% +/-2%., With CPI inflation currently about 8% y/y this is very ambitious. Hence, a possible new inflation target suggests a more hawkish RBI and it now looks less likely that the RBI will cut its leading interest sooner than Q4 14 and possible not until FX outlook INR has appreciated markedly in recent months and we expect the appreciation to continue in the short term. The main drivers are 1) a marked improvement in the current account, 2) possible acceleration in economic reforms under a strong new BJP-led government, 3) credible/hawkish central bank and 4) dovish central banks in the developed countries. In 2015, gradual monetary tightening in the US should gradually start to weigh on INR. However, because the Indian money and bond market is relatively closed, India should also be less sensitive to higher interest rates in the US than other emerging markets, so major depreciation unlikely. External balances have improved markedly Deleveraging in India will soon come to an end INR S&P: BBB- (negative) Free float 5% medium term Interest rate forecast Reserve Bank of India (RBI) Policy rate Next meeting Sep 2014 Next change - 25 bp Q End EUR/INR 18-Aug M M M USD/INR 18-Aug M M M Source: Macrobond, Danske Bank Source: Macrobond, Danske Bank Source: Macrobond, Danske Bank August

17 Core major EUR USD JPY EUR USD DKK SEK NOK 18-Aug M M M Aug M M M Aug M M M Wider CEE PLN HUF CZK RON EUR USD DKK SEK NOK 18-Aug M M M Aug M M M Aug M M M Aug M M M Baltics LTL EUR USD DKK SEK NOK 18-Aug M M M August

18 CIS RUB UAH KZT EUR USD DKK SEK NOK 18-Aug M M M Aug M N/A 46.7 N/A 40.8 N/A +6M N/A 47.2 N/A 41.2 N/A +12M N/A 46.9 N/A 41.3 N/A 18-Aug M M M MEA TRY ZAR ILS EGP EUR USD DKK SEK NOK 18-Aug M M M Aug M M M Aug M M M Aug M M M Latin America BRL MXN EUR USD DKK SEK NOK 18-Aug M M M Aug M M M August

19 Emerging markets Asia CNY KRW THB SGD HKD MYR PHP IDR INR TWD EUR USD DKK SEK NOK 18-Aug M M M Aug M M M Aug M M M Aug M M M Aug M M M Aug M M M Aug M N/A N/A N/A N/A N/A +6M N/A N/A N/A N/A N/A +12M N/A N/A N/A N/A N/A 18-Aug M M M Aug M M M Aug M M M August