Emerging Market Outlook Getting Better May 2016

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1 Emerging Market Outlook Getting Better May 2016 MACRO REPORT Key Insights Monica Defend Head of Global Asset Allocation Research Alessia Berardi Senior Economist Global Asset Allocation Research Abhishek Gon Economist Global Asset Allocation Research Edited by Claudia Bertino Head of Financial Communication EM Macro Momentum: According to our analysis, EM Macro Momentum has significantly improved between March and April. From a regional perspective, EM Asia (ex-korea) has gained the most, while EEMEA (Eastern Europe, Middle East and Africa) has marginally improved. Latin America remains the area with the worst Macro Momentum. Is India rightly the darling of the markets? In Q1 2016, economic activity sharply picked up. The strength of the current rebound is in part due to a depressed situation in the recent past and we expect that the recovery in economic activity will proceed at a more moderate pace going forward. Stability conditions are good. Is Brazil impeachment a real game changer? We do not think that the impeachment per se is a game changer for Brazil. The Government-to-be is unlikely to bring about much needed structural changes. We believe that a new democratically elected Government could be a game changer, but we do not see that option on the horizon earlier than the officially fixed date of Can current policy tightening in South Africa avert rating downgrades? In our opinion, fiscal and monetary tightening is not enough to avert rating downgrades. President Zuma has discussed a series of policy measures, but details remain thin and there is a lack of a timetable to implement these changes. As seen in the past, NDP (National Development Plan) announcements have been poorly executed and at times contradictory. Will the current positive macro momentum in Turkey continue? Specific factors and measures (all Consumption related) are supporting economic growth in the country. We expect that momentum will remain positive in 2016, but fundamentals remain poor. EM Macro Pulse Source: Pioneer Investments, May 2,

2 EM Macro Momentum has been improving in most countries since the beginning of the year. Asia (ex-korea) is the region that has gained the most. Is EM Macro Momentum Finally Improving? According to our analysis, EM 1 Macro Momentum improved between March and April. While GDP projections have not risen materially since the beginning of the year, in Turkey and Russia they have stopped deteriorating over the last six months. Similarly, export dynamics are slowing their fall, if not marginally improving, thanks to a sharp increase in commodity prices since the beginning of the year. Moving into Q2 2016, inflation rates are generally projected to more closely approach Central Bank targets than previously expected, with the exceptions of Colombia, Hungary and Taiwan. From a regional perspective, EM Asia (ex-korea) has gained the most in terms of Macro Momentum. China keeps improving thanks to a clear pro-growth fiscal stance taken by the Government, while the Philippines has improved its inflation outlook and, as a consequence, domestic liquidity conditions. EEMEA has marginally improved its Macro Momentum with less negative exports in Russia together with lower inflation. South Africa has improved its current Macro Momentum thanks to lower inflation, but its outlook remains quite clouded in our view. Although improving on the back of the commodities rally, Latin American remains the area with the worst Macro Momentum. Since beginning of the year: Net improvement in Turkey, Indonesia, China, Poland, Hungary, Philippines, South Africa, Thailand and Taiwan Net deterioration in Czech Republic and Chile EM Macro Scorecard, Dynamics Since Beginning of 2016 (Apr vs Dec. 2015) Delta Index (April- January 2016) Worsening Improving Source: Ceic, Bloomberg, Pioneer Investments, as of April 27, The score measures the macroeconomic momentum among the EMs. The growth momentum has measured with the latest six months changes in GDP forecasts. Related to the demand side, we have the internal demand (Private consumption and Investments) and external demand (exports) as momentum measures and with respect their position versus their growth trend. Public finance momentum has measured with changes in government debt over one year and fiscal balance dynamics through the current fiscal year. The three month forward inflation expectations have measured versus the Central Banks target. Lastly, the gap between real policy rates and real GDP growth for next three months measures the liquidity conditions in each economy. 2

3 With regard to our External Vulnerability Index, Asia is the least vulnerable area within the EM universe, with India and China at the top of the rank. From this point, we expect some further improvement, even if halting, thanks to the fiscal lever that more countries than previously expected are keen to use in order to support their domestic economic conditions. With regard to our External Vulnerability Index, Asia is the least vulnerable area within the EM universe, with India and China at the top of the rank and all countries above the vulnerability threshold but for Malaysia. However, Malaysia is the country that has improved the most since January (increasing by 6 positions in the rank); all the metrics monitored have contributed to that improvement. Figure 2. EM External Vulnerability India China Russia Philippines Peru Korea Indonesia Brazil Mexico Thailand Taiwan Malaysia Poland Chile Czech Republic South Africa Colombia Hungary Turkey -10,0-5,0 0,0 5,0 10,0 Source: Ceic, Bloomberg, Central Banks, BIS, Pioneer Investments, as of April 27, Vulnerability Index takes into account: Current Account and Funding; External Debt and ST External Debt; Reserve Adequacy; Domestic variables. In India, the strength of the current rebound is due to a depressed situation in the recent past, and we expect that the recovery in economic activity will proceed at a more moderate pace going forward. Are the Fundamentals Positive Enough for India to Remain the Darling of the Market? India has never been rated all that negatively even when EM macro conditions were much worse than they appear now, and the outlook remains for modest improvement during After struggling in H (Calendar Year, CY going forward), according to information available so far for Q CY, economic activity has sharply picked up. Credit, Electricity Generation, Cement Production and Vehicle Sales are all variables growing at a faster rate compared to 2015 on average. The improvement in economic conditions is significant although not broadly spread, as there are sectors where volumes are still lagging such as Steel and Traffic Freight. In our opinion, the strength of the current rebound is due to a depressed situation in the recent past, and we expect that the recovery in economic activity will proceed at a more moderate pace going forward. 3

4 India Economic Activity Indicator Pick-up in Q ,80 2,60 2,40 2,20 % YoY 2,00 1,80 1,60 1,40 1,20 1,00 Sources: CEIC, Datastream, Pioneer Investments, as of April 27, Forecast for Q2-Q In terms of stability conditions, the situation is quite good. India has been successful in moving away from fragile five conditions, in which the country seemed trapped three years ago. Inflation has been the real surprise so far. Beginning of the year figures have been better than in our expectations, and we have revised down our Inflation forecasts for 2016 CY from 5.4% YoY to 5.0% YoY. Tame inflation has made it easier for the Reserve Bank of India (RBI) to further cut policy rates, as it did at the beginning of April. A benign inflation path together with a Government committed to fiscal consolidation has supported the RBI s monetary policy easing. Our analysis still calls for marginal easing with current policy rates close to fairly valued. However, in our opinion, risks on inflation are on the upside, as drought is at severe levels and if the Monsoon is similar to the last two years food prices (almost 50% of the basket) could jump up. With respect to stability conditions, our most recent External Vulnerability Indicator sees India at the top position, marginally better than China. Q figures in terms of Balance of Payments, External Debt, and Reserves Adequacy are mildly improved. This represents a long and successful journey from India s status as part of the fragile five at the time of the tapering announcement by US Federal Reserve Governor Bernanke in December Moreover, the Government has not become complacent with respect to fiscal consolidation, making a ratings downgrade on its debt unlikely. Although we do not expect that this year s regional elections will pose any risk to the ruling party, neither do we expect any implementation of big item reforms (i.e. Land Acquisition or Goods and Services Tax) soon. It would be a meaningful sign of progress to see the adoption of a Bankruptcy Code, a condition necessary if not sufficient to deal with distressed sectors. We do not think that the impeachment per se is a game changer for Brazil. The situation remains very tricky. Is Brazil Impeachment a Real Game Changer? On the 17th of April, the Brazilian Lower House voted to allow impeachment proceedings to go ahead, passing the same opportunity to vote along to the Upper House. Within the first half of May, the Upper House is expected to vote by simple majority. If a vote to proceed with impeachment passes, President Dilma Rousseff will be temporarily removed from her role until a final vote is held, likely by July In the meantime, Vice President Temer would assume the role of President. 2 India Coincident Economic Indicator built on a group of high frequency variables to assess the state of the economy in the current quarter. We take into consideration Production side, Credit, Electricity Generation, External Demand, Vehicle Sales, Fiscal and Freight Traffic. 4

5 If Rousseff is ultimately impeached, the most likely outcome is that Temer will keep the President role until new elections in Although there is some uncertainty related to the final outcome of the impasse, political debate currently focuses on who will join Temer s Government, in particular at the Ministry of Finance. As was clearly demonstrated last year, rating agencies have their eyes on the country s debt sustainability, and the selection of an effective and highly regarded Minister of Finance could bring at least some shortterm relief. We do not think that the impeachment per se is a game changer for Brazil. The Government-to-be is unlikely to bring about much needed structural changes for two main reasons: 1. It is unlikely to be strong enough to overcome political resistance and pass the painful measures necessary to address the current awful economic conditions. 2. Temer was on the side of the Rousseff Government as recently as one month ago. It s uncertain how committed to painful reforms the new Government will be. We believe that a new democratically elected Government could be a game changer, but we do not see that option on the horizon earlier than the officially fixed date of Economic conditions are still awful. Brazil GDP fell by 5.9% YoY in Q and it s expected to fall by 5.7% in Q Domestic economic activity is collapsing while some support is coming from the external side, food and commodity exports specifically. We expect to see some good inflation figures in the short term, opening the door to a possible easing intervention by Brazil s central bank. Inflation is going to decline mainly because of a base effect kicking in. The currency has come back to more reasonable levels, reducing pressure on inflation. Brazil National Accounts: Strong Recession 15,0% 10,0% 5,0% 0,0% -5,0% -10,0% Mar-97 Dec-97 Sep-98 Jun-99 Mar-00 Dec-00 Sep-01 Jun-02 Mar-03 Dec-03 Sep-04 Source: Central Bank do Brazil, Pioneer Investments, as of April 27, HH Consumption, G=Government Expenditure. GFCF=Gross Fixed Capital Formation. Jun-05 Can Current Policy Tightening in South Africa Avert Ratings Downgrades? In an environment with rising stagflationary pressure along with high economic imbalances, South Africa is on the brink of sub-investment grade status. It would take urgent policy actions to help correct imbalances and push growth to avert further Mar-06 Dec-06 Sep-07 HH Cons G GFCF Net Exports GDP Jun-08 Mar-09 Dec-09 Sep-10 Jun-11 Mar-12 Dec-12 Sep-13 Jun-14 Mar-15 Dec-15 5

6 downgrades in short run. In response to these challenges, there has been a shift in South Africa s policy approach over the last year. South Africa is on the brink of sub-investment grade status. In our opinion, fiscal and monetary tightening is not enough to avert a rating downgrade. Tighter fiscal policy has been adopted in order to stabilize the debt situation. The government is aiming to narrow the budget deficit, from 3.9% of GDP in FY15/16 to 2.4% of GDP in FY18/19, largely through tax increases and a slower pace of spending. However, rising public debt (doubled in last 8 years) and increasing debtservice cost requires more drastic adjustments. South Africa Fiscal Consolidation Path 0,0% -1,0% -2,0% -3,0% -4,0% 2015/16 R 2016/ / /19 MTBPS 2015 Budget 2016 Source: National Treasury, Pioneer Investments, as of April 27, MTBPS is medium term budget policy statements. Interest rates have been raised (125bps from July 2015) to stabilize inflation pressures within the target band of 3-6%. However, risks to inflation remain elevated due to further rand depreciation, drought driving up food prices and a hike in electricity tariffs. In our opinion, fiscal and monetary tightening is not enough to avert further ratings downgrades. That s why, in the president s state of the nation address, Zuma discussed a series of policy measures with respect to labor markets, state-owned enterprise reforms and greater participation by the private sector. Details remain thin and there is a lack of a timetable to implement these changes. As seen in the past, the National Development Plan announced to increase productivity levels and labor force participation has been poorly executed and at times contradictory. On the external front, South Africa appears vulnerable, with a Current Account Deficit at 5.1% of GDP and expected to deteriorate further in 2016 due to subdued external demand, falling mining production and an underlying weak level of competitiveness. Our External Vulnerability Index ranks South Africa among the most vulnerable countries. Beyond that, social pressures, elevated political risks from Zuma s deteriorating popularity as apparent rifts within the ruling African National Congress grow larger, and signs of institutional erosion also weigh on the sovereign rating. 6

7 Turkey: Can the Current Positive Macro Momentum be Maintained? Our economic indicators show strong growth momentum in Q At the end of last year, Households Consumption was strong and fueled by the ongoing refugee influx (3 million Syrian). Populist Government policies, such as a 30% minimum wage hike, will support consumption demand. We expect unbalanced Consumption-driven growth to continue in 2016 and GDP growth to remain around 2015 levels (4%). Exports are expected to rebound, mainly from EU demand (44% share in total Exports). The main risk to our base case scenario is from a fall in revenues in the tourism sector due to increasing geopolitical deterioration through the rest of the year. On the inflation side, increases in consumer prices declined to 7.5% YoY in March on the back of a fall in food prices and a rebound in the lira. However, Core Inflation remained sticky at 9.5% YoY. We expect lower inflation in Q2 partially due to the base effect and an even stronger currency, but demand side dynamics and volatile food prices will keep 2H16 Headline CPI elevated. Turkey Inflation Outlook (% YoY) 10,0 8,0 Inflation Forecast 6,0 4,0 2,0 0,0-2, Misc Goods & Services (4.0%) Restaurants & Hotels (6.3%) Education (2.2%) Recreation & Culture (3.1%) Communications (4.6%) Transport (16.2%) Health (2.4%) Source: Ceic, Pioneer Investments, as of April 27, Household Equip & Routine House Maintenance (7.4%) Housing, Water, Electricity, Gas & Other Fuels (16.4%) Clothing & Footwear (7.1%) Alcoholic Beverages and Tobacco (5.3%) Food & Non Alcoholic Beverages (25.2%) CBT Target 2015 CPI Headline Turkey s current positive momentum may be short-lived. In his first Monetary Policy Meeting, the new central bank governor Murat Cetinkaya continued with easing, cutting the overnight lending rate (upper band of the corridor) by 50bps to 10.0%. The late liquidity window lending rate was also reduced by 50bps, to 11.50%. The weighted average funding cost is expected to come down by another 30/40bps by the end of Q2. According to the Central Bank, the growth outlook is moderately improved and the inflation outlook appears more 7

8 benign than previously expected, thus it remains open to further cuts at coming meetings. However, it is important to highlight that further (politically induced) dovish policy moves could derail inflation from its medium-term target (5%). The risk is of a vicious cycle of low real policy rates leading to currency depreciation and higher inflation. To structurally lower the inflation rate towards 5%, a tighter monetary policy should be implemented in the medium-term. A 25bps rate hike by year-end is possible. A debate over constitutional reform will take center stage in coming months. Early elections are a key risk for later this year, as the majority AKP party is 13 votes short of the threshold necessary to amend the constitution against a backdrop of increasing discord within the party. Our External Vulnerability Index ranks Turkey at the bottom among the EMs due to high Debt and Current Account dynamics. Notwithstanding the recent improvement, to 4.5% from 5.2% in 2014, the Current Account Deficit is expected to deteriorate because of geopolitical headwinds that will lower tourism revenues in the second half of the year (June to September accounts for 75% of tourism revenues). Tourism revenues are already at record lows (-22%YoY) due to travel bans from Russia. On the positive side, ongoing negotiations on the EU Refugee Package could act as a cushion against deteriorating geopolitical headwinds, helping to maintain growth at current levels in Important Information Unless otherwise stated, all information contained in this document is from Pioneer Investments and is as of April 27, The views expressed regarding market and economic trends are those of the author and not necessarily Pioneer Investments, and are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets or sectors will perform as expected. These views should not be relied upon as investment advice, as securities recommendations, or as an indication of trading on behalf of any Pioneer Investments product. There is no guarantee that market forecasts discussed will be realized or that these trends will continue. Investments involve certain risks, including political and currency risks. Investment return and principal value may go down as well as up and could result in the loss of all capital invested. This material does not constitute an offer to buy or a solicitation to sell any units of any investment fund or any services. All investments involve risks. You should consider your financial needs, goals, and risk tolerance before making any investment decisions. Pioneer Investments is a trading name of the Pioneer Global Asset Management S.p.A. group of companies. Date of First Use: May 5, Follow us on: 8 REF-282