Emerging Markets Weekly Economic Briefing The risks of renewed capital flight from emerging markets Recent episodes of capital flight from emerging markets have highlighted the vulnerability of a number of countries. Although conditions have become calmer in recent weeks, the threat of a further sell-off remains significant. As part of our Global Scenarios Service, we have simulated the likely effects on emerging markets. The most vulnerable countries (with current account and fiscal deficits, falling international reserves and an uncertain political environment) would be hit particularly hard as investors shift out of assets in these countries. Latin American GDP growth falls to just 1% in 1, with Brazil and Argentina experiencing particularly sharp currency depreciations, inflationary pressures and interest rate hikes. Turkey and South Africa would both fall into recession, and Chinese GDP would grow at its slowest rate since 199. Another round of capital flight Recent episodes of capital flight from emerging markets have highlighted the vulnerability of a number of countries. A combination of QE tapering by the US Fed and poor domestic fundamentals in some countries (current account and fiscal deficits, falling international reserves and uncertain political environment) has prompted investors to shift out of assets in these countries, leading to stock market sell-offs, exchange rate depreciations and forced interest rate hikes. Although conditions have become calmer in recent weeks, the threat of a further sell-off remains significant, as financial markets are still quite volatile. This would lead to changes in portfolio allocations away from emerging market assets and towards safe havens. We have used our Global Economic Model to simulate the effects of another wave of risk aversion on emerging economies. would damage emerging market growth Another round of sudden outflows of foreign capital would particularly affect the fragile five countries, which run large current account deficits. An abrupt halt in external financing would force their central banks to raise interest rates to prevent a balance of payments crisis, and confidence would be eroded by increased volatility in bond, stock and currency markets. Sharp currency depreciations would also raise inflationary pressures, reinforcing the need for higher interest rates and amplifying the downturn. In Latin America, GDP growth plunges to just 1% in 1 in these circumstances. In addition, further macroeconomic dislocations arise (e.g. government deficits and debt increase due to higher interest GDP growth: Emerging Markets 9 7 3 1 Forecast Baseline Capital outflows 7 9 11 13 1 17 Source : Oxford Economics/Haver Analytics 1
payments) and episodes of social unrest become more likely as unemployment escalates. GDP growth in India and Indonesia also slows sharply, to around % and 3% respectively next year. Turkey, South Africa and Argentina would fall into recession. Fragile five most at risk Turkey s exchange rate would fall by more than a third, and Brazil, India, Indonesia and South Africa would experience falls of around a quarter. We have assumed that India and Indonesia, which have made progress in recent months in narrowing their imbalances, would still be affected by market concerns. Hardest hit emergers: GDP Growth: 1 South Africa Turkey Argentina Thailand Mexico Indonesia India Hong Kong China Brazil cap outflows baseline -3 - -1 1 3 7 Source : Oxford Economics/Haver Analytics The currency depreciation would boost import prices and raise inflationary pressures. Interest rates rises would be most notable in India and Indonesia. In India, inflation would stay above 1% this year and next, with short-term interest rates exceeding 13% in early 1 (from around 9.% now). Nevertheless, inflation would still accelerate to almost 1% by late. In Indonesia rates would rise to over 1% next year from around %, and inflation would remain close to % into 1. High inflation and interest rates would hit activity hard. Investment would fall in India and Indonesia, and consumer spending would slow sharply. Headline growth would be just % in India and 3% in Indonesia in 1. Turkey, with a very large current account deficit of % of GDP at the end of last year, would be even harder hit. GDP would contract by more than 1% this year and next, with investment falling by more than % and import volumes down around %. The onset of recession, combined with lower commodity prices, would narrow the current account deficit faster than we expect in the baseline forecast, but FDI inflows would also fall sharply. Current Account Balance 13, % GDP Turkey South Africa India Brazil Indonesia Chile Thailand Czech Republic Mexico Poland Argentina Russia Hong Kong China Hungary Malaysia Philippines Korea Taiwan Singapore - - - - 1 1 1 1 1 South Africa would also fall into recession next year. Its FDI inflows and investment would decline in and 1. Short-term interest rates would be raised to more than 1% to tackle inflation, which would reach.3% in Q. Argentina would be hit hard Source: Oxford Economics Within Latin America, the hardest hit country in this scenario is Argentina, where in the past few years a rapid deterioration of public finances accompanied by escalating inflation has prompted Argentines to seek protection in the US dollar. As a result, the central bank has lost nearly half of its international reserves since 11, leaving the country very vulnerable to such episodes of capital flight. Under this simulation, the Argentine peso would depreciate by 7% in (far further than the % depreciation assumed in the baseline), leading to higher inflation and tighter credit conditions. As a result, domestic demand contracts for two consecutive years in -1. Moreover, a slowdown in Argentina s trade partners means reduced demand for its exports, further detracting from GDP growth. In this scenario, Argentina s economy enters in a prolonged recession, with GDP falling by.% in and by.% in 1, causing the unemployment rate to approach the 1% mark.
followed by Brazil As one of the fragile five economies, Brazil is hit hard in a scenario of intensified capital outflows from emerging markets. Although the country has US$3bn of international reserves, some of its domestic fundamentals do not look very encouraging. In particular, Brazil experienced a surge in credit growth in the last five years, which led to percentage point increase in the credit-to-gdp ratio in this period most of it accounted for by subsidised credit. This led to a rapid increase in both consumer price and asset price inflation, as well as deterioration in public finances. Moreover, a combination of poor economic growth with widening current account deficits also helped to place the country in the list of most vulnerable emerging economies. Given Brazil s fragile domestic situation, another wave of risk aversion would prompt an intensification of capital outflows. In this scenario, the Brazilian real (BRL) weakens by % in (compared with a depreciation of 13% assumed in our baseline). This would force the central bank to further hike interest rates to defend the BRL and curb the effects of the depreciation on consumer price inflation. As a result, domestic demand the key engine of Brazil s economy would slow sharply in and even contract in 1. Moreover, weaker growth in global trade would not only affect Brazil s export volumes, but would also cause commodity prices to fall below baseline for a prolonged period. Brazil s GDP growth would slow sharply to just.9% in before contracting by.1% in 1. With growth remaining well below baseline until 1, labour market conditions deteriorate significantly, pushing the unemployment rate to.% by 1 far higher than the.9% level assumed in the baseline. Chile and Mexico far less affected Argentina and Brazil s poor macroeconomic fundamentals mean they would be hit hardest by renewed capital flight from emerging markets. By contrast, Chile and Mexico would be significantly less affected. Chile, in particular, has reduced its reliance on copper exports, and pursued prudent macroeconomic policies. Its exchange rate depreciation (1% in ) would be much less pronounced than in Brazil and Argentina. Chile s GDP growth slows but remains relatively robust, at.9% in and.% in 1 (compared with 3.% and.% in the baseline). as they implemented the correct policies Mexico s economy is even less affected. Recent structural reforms have led to a sovereign ratings upgrade. Mexico s dependency on global capital is significantly lower than its regional peers. Moreover, the Mexican business cycle is more closely correlated with developments in its northern neighbour, the US, which is not severely affected in this scenario. Lastly, Mexico encompasses a prudent fiscal framework and pragmatic monetary policy management that has helped to anchor Mexican financial assets and investor sentiment. In this scenario its GDP growth slows to 3.% in and.3% in 1 (compared with 3.% and 3.9% in the baseline), but activity quickly bounces back and growth actually exceeds the pace assumed in the baseline in 17 and 1. China somewhat insulated too China would grow by around.% next year in this scenario, down from.% in the baseline. It is insulated from stronger effects by its closed capital account and managed exchange rate, but this is still the slowest rate of growth seen since 199. Not all economies would face rising inflation pressures. Those with current account surpluses would be less affected by capital flight, so would not see the same downward pressure on their exchange rates. In Korea FDI would fall modestly in 1 and 1 but FDI inflows to Hong Kong, Singapore and Taiwan would be little affected, as these economies are seen as providing safer investment opportunities. In addition, Imported commodity prices would fall as demand from commodityintensive economies slows. Korea, Hong Kong, Taiwan and China would actually experience slightly lower inflation in the scenario than in our baseline forecast. 3
Latest data Recent Data Releases Previous month Latest Comment China Official Manufacturing PMI (Feb) HSBC Manufacturing PMI (Feb) HSBC Services PMI (Feb). 9..7.. 1. Manufacturing export orders contracted again according to both PMIs. The HSBC PMI showed that new domestic orders and output fell for the first time since July 13. Services new orders continued to improve. Brazil HSBC Manufacturing PMI HSBC Services PMI (Feb) Exports (Feb). (Jan) 9..% y/y. (Feb)..% y/y The manufacturing sector remains fragile but the services PMI edged up on stronger new orders. Import growth outpaced export growth in February, suggesting improving domestic activity. India HSBC Manufacturing PMI HSBC Services PMI (Feb) 1. (Jan).3. (Feb). The manufacturing sector showed signs of strengthening but services remain weak. Korea Exports (Feb) Imports (Feb) Trade balance (1m total) HSBC Manufacturing PMI (Feb) -.% y/y -.9% y/y $.bn (Jan).9 1.% y/y.% y/y $3.bn (Feb) 9. The manufacturing PMI fell below for the first time since September, driven by weaker domestic orders. The outlook for manufacturing exports should improve, however. Global demand is expected to pick up and upward pressure on the KRW has eased this year. Russia CPI (Feb) HSBC Manufacturing PMI (Feb).% y/y..% y/y. The manufacturing sector contracted for the fourth successive month. New orders fell by the most since May 9. Turkey Exports (Jan) (s.adj) Imports (Jan) (s.adj) Trade balance (1m total) CPI (Feb) Core CPI (Feb).% y/y 1.%y/y -$1.7bn 7.% y/y 7.% y/y.% y/y.% y/y -$1.3bn 7.9% y/y.% y/y The weaker lira pushed core inflation to the highest rate for two years, raising likelihood that the central bank will tighten policy further. Imports slowed sharply in January but the trade deficit is still very high. Taiwan Exports (Feb) Manufacturing PMI (Feb) -.3% y/y. 7.9% y/y.7 Exports rose just.% y/y in January and February combined, as exports to the Mainland fell by 3.% y/y. But new year timings suggest caution is needed in interpreting these figures. Czech GDP (Q, s.adj).3% q/q -1.% y/y 1.9% q/q 1.3% y/y Investment rose by.1% q/q in Q. Exports and consumer spending improved at a more sustainable pace. Hungary GDP (Q, s.adj).% q/q.% q/q Private spending and exports picked up in Q. 1.7% y/y.7% y/y Thailand Current Account (1m total) Private Investment (Jan) (s.adj) Private Spending (Jan) (s.adj) -$.bn (Dec) -.% y/y -.3% y/y $.bn (Jan) -.% y/y -1.% y/y Goods imports fell by almost 13% y/y, boosting the current account balance despite a 1.% y/y drop in exports. Domestic activity remains very weak, constrained by the political uncertainty.
Events Monetary policy meetings in past week Key rate (now) Outcome Comment Mar th Malaysia 3.% (Overnight policy rate) Unchanged As expected, the central bank kept the interest rate on hold for a seventeenth month to support economic activity. Inflation has edged up in recent months to 3.% in January but this was boosted by an increase in subsidised fuel prices and electricity tariffs. Core inflation was.% in January. Mar 3 rd Poland.% (Reference rate) Unchanged The National Bank of Poland has left its main interest rate unchanged since July 13, satisfied that record low rates are supporting stronger activity. We expect the bank to start raising rates to more normal levels in Q, provided the recovery is still on track. For further information contact Sarah Fowler (sfowler@oxfordeconomics.com)
Asia China: Manufacturing PMI = expansion / contraction line Official PMI India: HSBC Manufacturing PMI = expansion/contraction breakeven point HSBC PMI 3 7 9 1 11 1 13 Source: China Federation of Logistics and Purchasing / Markit 7 9 1 11 1 13 Source: Markit Korea: Exports US$bn (seasonally adjusted) Taiwan: Exports (3 month moving average) 1 3 3 1 - - Total China & Hong Kong 1 1 1 Source: Korea Customs Service / Oxford Economics - 1997 1999 1 3 7 9 11 13 Korea: CPI Headline CPI Taiwan: Inflation Headline 3 3 1 Core CPI (CPI ex agricultural products & oil) 7 9 1 11 1 13 Source: Oxford Economics / Bank of Korea -3 199 1997 1999 1 3 7 9 11 13 Source: DGBAS 1-1 - Core
Asia Emerging Asia: Short-term interest rates % 1 9 India 7 China 3 Malaysia Thailand 1 1 3 7 9 11 13 Emerging Asia: Bank lending Indonesia Singapore 3 1 Thailand Malaysia -1 1 1 / IMF Emergers: Exchange rates v US$ Index (Dec 3, 1 = 1) 11 1 China 1 Korea 9 9 Indonesia appreciation India 7 7 Jan 11 Jul 11 Jan 1 Jul 1 Jan 13 Jul 13 Jan 1 Emergers: Exchange rates v US$ Index (Dec 3, 1 = 1) 11 1 appreciation Malaysia 1 Singapore Philippines 1 1 1 9 9 9 Thailand 9 9 Jan 11 Jul 11 Jan 1 Jul 1 Jan 13 Jul 13 Jan 1 Emerging Asia: Trade balance India: 3-month interbank rate US$ bn % 3 1 3 China 11 1 1 "Rest of Asia" 1 9 - -1 India -1 1 month moving average - 7 1997 1999 1 3 7 9 11 13 Jan 11 Jul 11 Jan 1 Jul 1 Jan 13 Jul 13 Jan 1 7
Latin America Brazil: Exports and imports 7 3 month moving average (US$) Exports 3 1-1 - -3 Imports - 199 199 1 1 Chile: Monthly indicator of economic activity =1 (IMACEC, seasonally adjusted) 13 1 11 1 9 7 3 7 9 1 11 1 13 Mexico: PMIs Index (IMEF) Non-manufacturing Manufacturing 7 9 1 11 1 13 Argentina: Inflation expectations & wages 3 3 1 1 average 1 month inflation expectations 7 9 1 11 1 13 Source : Oxford Economics/Haver Salary Index Latin America: Short-term interest rates % Brazil Emergers: Exchange rates v US$ Index (Dec 3,1 = 1) 11 Chile 1 9 Mexico 1 Brazil 1 Colombia Mexico 7 Argentina Chile depreciation 1 1 Jan 11 Jul 11 Jan 1 Jul 1 Jan 13 Jul 13 Jan 1
Emerging Europe Poland: GDP Czech: GDP 1 1 Exports GDP Exports 1 GDP 1 - -1 Investment Consumer spending - -1-1 Consumer spending Investment -1 1 1-1 1 Central & Eastern Europe: Consumer prices 1 1 Russia 1 1 Hungary Poland Czech - 3 7 9 1 11 1 13 Central & Eastern Europe: Bank lending Russia Poland 3 Hungary Czech 1-1 - 3 7 9 1 11 1 13 Emergers: Exchange rates v Euro Index (Dec 3, 1 = 1) 19 Hungary 1 Czech 13 1 Russia & Ukraine: Exchange rate v US$ Index (Dec 3, 1 = 1) 11 11 Hryvnia per US$ 1 1 97 9 Poland 9 9 Ruble per US$ 91 depreciation depreciation 7 Jan 11 Jul 11 Jan 1 Jul 1 Jan 13 Jul 13 Jan 1 Jan 11 Jul 11 Jan 1 Jul 1 Jan 13 Jul 13 Jan 1 9
Rest of World Turkey: Inflation % 1 1 Headline CPI Turkey: Bank lending % 13-week annualised change 1 CPI ex food, energy, alcohol, tobacco & gold 3 1-1 7 9 1 11 1 13-7 9 1 11 1 13 Turkey: Manufacturing capacity utilisation % (seasonally adjusted) Turkey: Interest rates % 1 3-month interbank rate 7 7 11 1 9 7 1-year bond yield 7 9 1 11 1 13 Jan 11 Jul 11 Jan 1 Jul 1 Jan 13 Jul 13 Jan 1 Emergers: Equity markets Index (Dec 3, 1 = 1) 1 1 World: Commodity prices 7=1 (rebased) 1 Oil 13 1 11 1 9 US S&P Emergers (MSCI, US$) 1 1 1 1 CRB raw industrial materials CRB foodstuffs Copper 7 Jan 11 Jul 11 Jan 1 Jul 1 Jan 13 Jul 13 Jan 1 1 1 1
Industrial Production Percentage changes on a year earlier unless otherwise stated China Brazil Korea India Mexico Russia Turkey Taiwan Poland 13 Jan 9.9.3 1.. -.3 -..1 1. -1.7 Feb 9.9 -.3 -.9.. -3.1 3..9-1.3 Mar.9 1.3 -. 3.. -.1 1. -. -. Apr 9.3 3. -.7 1. -1. 1.1 3. -1..7 May 9. 1.9-1. -. -1. -..7-1.1.3 Jun.9 3.9 -.3-1. -1. 1.7.3 1.3.7 Jul 9.7. -.. -.9... 3. Aug 1. -.7 3.3. -.1 -..9 -.1.3 Sep 1..9 -..7-1. 1.3.1 -. 3.9 Oct 1.3. 1. -1..3 1. 1... Nov 1. 1. -. -1.3-1.1..7. 7. Dec 9.7-3. 1. -. -.. 7...7 Jan - - 1. - - -. - 1..3 Consumer prices Percentage changes on a year earlier unless otherwise stated China Brazil Korea India Mexico Russia Turkey Taiwa n Poland 13 Feb 3..3 1. 1.9 3. 7.3 7. 3. 1.3 Mar.1. 1. 1..3 7. 7.3 1. 1. Apr.. 1.3 9.. 7..1 1.. Ma y.1. 1.1 9.3. 7...7. Jun.7.7 1. 9.9.1.9.3.. Jul.7.3 1. 9. 3...9.1 1.1 Aug..1 1. 9. 3... -. 1.1 Sep 3.1.9 1. 9. 3..1 7.9. 1. Oct 3...9 1. 3..3 7.7.. Nov 3.. 1. 11. 3.. 7.3.7. Dec..9 1.1 9.9.. 7..3.7 Jan.. 1.1...1 7...7 Feb - - 1. - -. 7.9. - 11
Exports (US dollars) Percentage changes on a year earlier unless otherwise stated China Brazil Korea India Mexico Russia Turkey Taiwan Poland 13 Feb 1.7-13. -..3. -.9 7. -1.. Mar 1. -7...9 1. -.. 3. -.9 Apr 1.7...1 -. -1. -3. -1.9 9.7 May 1. -. 3.1 -.3 1. -9...7 1. Jun -3.1 9. -1. -.7.. -3..7 11. Jul.1 -.9. 1.7 3.7.3-1. 1. 13. Aug 7. -.3 7. 13.. 3. -9. 3. 9. Sep -.3. -1.7 11.9.3.. -7. 1.3 Oct..9 7. 13.. -. -.3.7. Nov 1.7 1.9... 3.. 3. 7.1 Dec.1. 7. 1.9 1.3 1.9. 1. 1. Jan 1.. -. 3.. -. -.3 - Feb -. 1. - - - - 7.9 - Imports (US dollars) Percentage changes on a year earlier unless otherwise stated China Brazil Korea India Mexico Russia Turkey Taiwan Poland 13 Feb -1. 3.1-1... 7. 1. -. -. Mar 1. 1. -.3-3..1 1. 3.. -3.1 Apr 1. 1.7 -.7 1. 1. 1.9 13. -.3. May -.3. -.7.1.3 -..9 -.1 -. Jun -.7 1. -3. -... 7.. 3.3 Jul 1.9. 3.3 -.3..7. -7.7 9.3 Aug 7.1. 1.1-1. 3. -. 1. -1.3. Sep 7..1-3. -1..7.7 -. -.7 7.1 Oct 7. 1..1-1. -.1 -.1 1. -.9. Nov.3-7. -. -1. -.3-1.3. -.. Dec. 3.9 3. -1.3-1..7 1. 1.. Jan 1.. -.9-1.1 3.1 -. -1. - Feb - 7.3. - - - -.9-1