Schroders Economic and Strategy Viewpoint Pt.2

For professional investors only
Schroders
Economic and Strategy Viewpoint Pt.2
Craig Botham
Emerging Markets
Economist
Will emerging markets elect to grow?
• Emerging markets have a busy election calendar this year. The Fragile Five
all have elections, adding volatility to already febrile markets. The elections
could be a catalyst for change in some, particularly India and Indonesia, but
we see little cause for optimism elsewhere.
Views at a glance (page 8)
• A short summary of our main macro views and where we see the risks to the
world economy.
Major elections in 2014
Country
Election type
Election date
Change of
government
expected?
Brazil
Local, general,
presidential
October
No
India
Indonesia
South Africa
Local, general
General, presidential
General
April/May
April, July
April (expected)
Yes
Yes
No
Turkey
Local, presidential
March, June
No
Source: Barclays, Schroders. 22 January 2014
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For professional investors only
Will emerging markets elect to grow?
2014 has a busy
EM election
calendar…
2014 sees a busy political calendar in emerging markets. In particular, large
emerging market economies exposed to higher US yields – the Fragile Five of
Brazil, India, Indonesia, South Africa and Turkey – all have important elections this
year. Polls do not suggest a change of government in all cases (table 2), but
elections could still prove a trigger for positive reform efforts. Democracy does not
lend itself to painful decisions in the run up to elections, but the immediate post
election period is often when governments feel they have the strongest mandate to
effect change.
Table 2: Major elections in 2014
Country
Election type
Election date
Change of
government
expected?
Brazil
Local, general,
presidential
October
No
India
Indonesia
South Africa
Local, general
General, presidential
General
April/May
April, July
April (expected)
Yes
Yes
No
Turkey
Local, presidential
March, June
No
Source: Barclays, Schroders. 22 January 2014
…and uncertainty
is likely to hinder
investment
Election years often engender uncertainty, and as chart 11 shows, markets have
been pricing in more risk to some of the Fragile Five in recent months. It is of course
difficult to say how much of this reflects concerns over elections, and how much
reflects other developments in those countries, or the decision by the US Federal
Reserve to initiate tapering. But the macro fundamentals of the Fragile Five have
been publicized for some time, so it seems likely that political risk has helped drive
some of the moves. Divergence between members of the Fragile Five – Turkey in
particular has seen its credit default swap (CDS, insurance against default on a
bond) spread widen dramatically – also suggests idiosyncratic factors, rather than
just a common impulse, are at work.
Chart 11: EM CDS: Market perceptions of risk have been on the rise
300
280
260
240
220
200
180
160
140
120
100
Jan
13
Feb Mar
13 13
Apr May
13
13
Brazil
Jun
13
Indonesia
Jul
13
Aug Sep
13
13
Oct
13
South Africa
Nov Dec
13
13
Jan
14
Turkey
Source: Bloomberg, Schroders. 22 January 2014. Comparable data for India is not available.
2
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Empirically, the uncertainty engendered by elections tends to hit investment. An
academic study1 found that corporate investment expenditures are on average 4.8%
lower in election years, with political uncertainty the main driver. This decrease is
higher when the elections are close, public expenditure accounts for a large share of
GDP, and when the current government is regarded as market friendly. There is
some overlap between these criteria and certain members of the Fragile Five, and in
general this effect is bad news for a set of countries that, for the most part, need to
increase investment. However, we do also typically see a pick up in investment
once the election is done. It is the uncertainty that presents the main hurdle.
The rest of this Viewpoint looks quickly at the elections in each of the Fragile Five
and what they might mean for the economy.
Brazil
Polls say no
change in Brazil,
but there is a long
way to go
The most recent polls, conducted in November, give incumbent Dilma Rousseff 47%
of the vote, implying a first round win. However, there is a long way to go until
October’s elections. Rousseff must successfully navigate lower growth and higher
inflation, the World Cup, and the election campaign itself, which will not really kick
off until July. The preferred outcome for the market would be a win by either of the
more market friendly opposition candidates; Aecio Neves and Eduardo Campos.
However, at 19% and 11% respectively, neither is challenging at present. One
possibility is that Campos’ more popular and well known running mate, Marina Silva,
heads the ticket in October instead.
Chart 12: Inflation remains sticky despite rate hikes
%
8
%
14
12
7
10
8
6
6
4
5
2
4
0
2010
2011
CPI, y/y
2012
Inflation expectations
2013
SELIC rate (rhs)
Source: Thomson Datastream, Schroders 24 January 2014
Whoever wins,
fiscal policy will
need to tighten
1
3
Whoever wins will need to tackle Brazil’s fiscal deficit, soft growth, and high inflation.
Clearly, the policies needed for this are something of an impossible trinity. The fiscal
deficit and high inflation can be tackled through tighter fiscal and monetary policy,
but this will crush growth already heavily dependent on credit backed consumer
spending and government largesse. Tighter fiscal policy could be paired with more
accommodative monetary policy to keep growth ticking over while getting the deficit
under control, but then inflation will likely burst out of the 4.5% +/- 2 target band. We
should also note that central bank governor Tombini believes higher rates are
needed to support the exchange rate in an era of higher US yields.
Julio, B., and Yook, Y. (2012) “Political Uncertainty and Corporate Investment Cycles”, The Journal of Finance
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Finally, there is the option of business as usual: loose fiscal policy, tight monetary
policy, and a cap on regulated prices, but as well pumping up the deficit, this seems
to be having limited impact on inflation (chart 12). The government may not even
have much choice on fiscal policy, with ratings agencies threatening to downgrade
the sovereign’s credit rating if fiscal numbers do not pick up. The extra policy tool
needed is structural reform aimed at tackling supply bottlenecks, the root cause of
much of Brazil’s inflation. This requires investment too though, and investors seem
not to trust Rousseff. This may be connected to her tendency towards populism,
short termism and price restrictions. An opposition win might help restore investor
confidence in the government, and give Brazil the investment it badly needs.
India
Change is likely,
and needed, in
India
In comparison with Brazil, polls are pointing to a probable change of government in
India’s elections, to be held in either April or May. Narendra Modi is the current
frontrunner for Prime Minister, at the head of the opposition Bharatiya Janata Party
(BJP). The ruling, Congress Party-led “United Progressive Alliance” is taking the
blame for weak growth, high inflation, governance issues and lack of action on
reform.
While Modi’s candidacy has galvanized his party and cheered investors due to his
reputation, built as chief minister of the state of Gujarat, of an effective and probusiness administrator, there are concerns over his management of deadly
communal riots in the state in 2002. Uncertainty is also generated by the large
number of first time voters (approximately 20-30% of the electorate) and the rise of
regional parties, which could make national level reforms more difficult.
Chart 13: Rupee weakness has boosted exports
%, y/y
35
45
47
49
51
53
55
57
59
61
63
65
30
25
20
15
10
5
0
-5
Jan
12
Mar May
12
12
Jul Sep Nov Jan Mar May Jul Sep Nov
12
12
12
13
13
13
13
13
13
Exports
Rupee:dollar exchange rate (rhs)
Jan
14
Source: Thomson Datastream, Schroders. 24 January 2014.
Additional reform
momentum will
bolster the
economy
4
There is little doubt that reforms are needed. Much like Brazil, India suffers from
fragile public finances, high inflation, and weak growth. Unlike Brazil, some reform is
already underway and should be completed under a fresh government. One is a
much delayed Goods and Services Tax (GST) which will unite the central and state
government tax systems, broaden the tax base and raise compliance, bolstering
revenues. Another is the Dedicated Freight Corridor rail project (DFC), which will
entail $40bn investment over the next five years. Other investment projects, such as
opening the economy to FDI, will require strong leadership to overcome state
objections. Investment will help tackle both inflation and growth, providing scope for
monetary policy to ease, or at least cease tightening. Meanwhile, the weakening of
the rupee has provided a boost to export growth (chart 13) that should help reduce
the current account deficit and vulnerability to Fed tapering. 2014 has the potential
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to be a good year for India.
Indonesia
New president in
Indonesia, but the
inbox will be
crowded
Having reached his term limit, incumbent president Yudhoyono must step down this
year, ensuring a change of regime. Current opinion polls highlight Jakarta mayor
Joko Widodo (Jokowi) as the most likely replacement. However, he has yet to be
nominated as a candidate by his party. In any event, at the moment a second round
of voting seems likely, which will push the election back to September. Jokowi
appears a pragmatic and reform minded candidate, and should provide a positive
impulse to sentiment about the economy.
Indonesia faces considerable challenges in an environment of weaker commodity
prices and lower Chinese growth; non-food commodities account for over 60% of
Indonesia’s exports. There has been some recent improvement in macro
fundamentals, with the trade balance improving in response to currency
depreciation, but this is largely from import compression rather than significant
export growth (chart below). For an improvement in growth, Indonesia needs to
develop its manufacturing sector and pivot away from reliance on raw materials.
Though this may sound familiar by now, the answer is to boost investment. It has
been suggested that a new, more flexible labour law could help on this score, but in
truth it is difficult for a government to quickly reshape an economy’s structure.
Chart 14: Import compression, but little export growth in Indonesia
%, y/y
30
Index, Jan 2013 = 100
90
95
20
100
10
105
0
110
115
-10
120
-20
125
-30
130
Jan Mar May
12 12
12
Jul
12
Exports
Sep Nov Jan Mar May
12
12
13 13
13
Imports
Jul
13
Sep Nov Jan
13
13
14
Rupiah:dollar exchange rate
Source: Thomson Datastream, Schroders. 24 January 2014
Some problems
have no obvious
solution
A new government might be able to tackle the country’s twin deficits (for example by
further reducing the fuel subsidy) but there seems little hope of a quick turnaround in
the trade balance coupled with a boost to growth. A more likely scenario postelection is a boost to investment as uncertainty is reduced, continued tightness of
policy from the Indonesian central bank to address the trade balance despite the hit
to growth, and improvement on the fiscal side. Moving away from reliance on
primary goods will take time and will be difficult to rush.
South Africa
No change in
government,
minor policy
improvement
5
At 53% in the polls, it seems likely the ruling ANC party will retain a majority in
April’s elections. Consequently there appears little chance of a change in policy post
election. However, the 53% poll result represents a decline in support from 2009
when the ANC won 66% of the vote, and this erosion in support could, in an
optimistic scenario, spur the government to speed up reform efforts. We could, in a
best case scenario, see a fast-tracking of labour and structural reforms, along with
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shale gas exploitation, all of which will help the economy and begin to close the
current account deficit, though reliance on commodities will continue to exert
headwinds.
Consequently, more rand weakness seems likely, despite the considerable move in
the currency last year, which will exert inflationary pressure. The rand’s weakness
so far has not done much to reduce the current account deficit but the economy
should receive external supports this year as the US (8% of exports) and Europe
(21% of exports) recover, though with China slowing and account for around 12% of
exports, this effect will likely be muted.
Turkey
Political crisis and
currency crisis,
hand in hand
Of the Fragile Five, by far the most precarious political situation can be found in
Turkey, and this is reflected in its CDS spread (chart 1) and currency (chart 15). The
political crisis escalated in December when a corruption probe led to the detainment
of 52 people, some with close ties to the government. In the fallout, the government
removed the prosecutor and a number of police chiefs and has also made moves to
transfer the powers of the judiciary to the Ministry of Justice. Prime Minister
Erdogan’s Justice and Development Party (AKP) is riven by internecine strife. Trust
in Turkish institutions is eroding rapidly. From a currency perspective, it should be
particularly concerning that the central bank appears to have caved in to
government pressure not to hike rates at its latest meeting despite the obvious
need; the exchange rate has weakened and inflation jumped since concerns over
Fed tapering began last May (chart 15).
Chart 15: Turkey badly needs a rate hike
%, y/y
9.0
2.4
2.3
8.5
2.2
8.0
2.1
2.0
7.5
1.9
7.0
1.8
6.5
1.7
1.6
6.0
Jan
13
Feb Mar
13 13
Apr May Jun Jul Aug
13
13
13
13
13
Lira:dollar exchange rate
Sep Oct Nov Dec
13
13
13
13
Inflation (rhs)
Jan
14
Source: Thomson Datastream, Schroders. 24 January 2014
No change in
government
seems likely, bad
news for
institutional
strength
6
The latest opinion polls suggest the AKP remains firmly in the lead despite recent
developments. Municipal elections in March will influence Erdogan’s next steps. A
strong result for the AKP is likely to see Erdogan run for president and push for
executive power, as he is unable to serve another term as an MP. The most “market
friendly” scenario would probably be a swap between current President Gul and
Prime Minister Erdogan, but it is questionable whether Gul would agree to this
Putin-esque arrangement. However, while Gul may not want to be seen as
Erdogan’s pawn, he is also unlikely to confront Erdogan. Gul is a popular candidate
with the public and markets precisely because he is a conciliator. Yet this means we
could see the least market friendly scenario evolve – a junior MP becomes Prime
Minister, Erdogan becomes President, and the AKP push for constitutional changes
granting greater executive power to the President. Even if a Gul/Erdogan swap
were to occur, it is unclear that Gul would provide much of a check on Erdogan,
perhaps just providing a legitimate face for his continued exercise of power.
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Continued executive power for Erdogan, unchecked by his party or the country’s
declawed institutions could be extremely negative for Turkey given his increasingly
erratic behaviour. Unfortunately, this is looking to be the most likely outcome.
7
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Schroder Economics Group: Views at a glance
Macro summary – January 2014
Key points
Baseline
World economy on track for modest recovery as monetary stimulus feeds through and fiscal
headwinds fade in 2014. Inflation to remain well contained.
Recent upswing driven by manufacturing inventory cycle and, in the US and UK, reviving housing
markets.
US economy still faces fiscal headwind, but gradually normalising as banks return to health and
private sector de-leverages. Fed to complete tapering of asset purchases by October 2014, possibly
earlier, with the first rate rise expected late 2015.
UK recovery risks skewed to upside as government stimulates housing demand, but significant
economic slack should limit any tightening of monetary policy. No rate rises 2014 or 2015.
Eurozone out of recession, but banks continue to de-leverage thus preventing sustained recovery.
Asset Quality Review and stress tests will be macro headwinds in 2014. No rate rises 2014 or 2015.
More LTRO’s likely in early 2014.
"Abenomics" achieving good results so far, but Japan faces significant challenges to eliminate
deflation and repair its fiscal position. Bank of Japan to step up asset purchases to offset consumption
tax hikes, risk of significantly weaker JPY in 2014.
US leading Japan and Europe. De-synchronised cycle implies divergence in monetary policy with the
Fed eventually tightening ahead of others and a stronger USD.
EM fading as a growth engine. Region to benefit from current cyclical upswing, but China growth
downshifting as past tailwinds (strong external demand, weak USD and falling global rates) go into
reverse. Deflationary for world economy, especially commodity producers (e.g. Latin America).
Plenum reforms in China to depress output in the near term before supporting medium term activity.
•
•
•
•
•
•
•
•
•
Risks
Tail risks have reduced compared to a year ago with the US avoiding the fiscal cliff and the Euro
holding together. However, some risks remain, such as "China financial crisis" and in the Eurozone, a
restructuring of Spanish sovereign debt.
Despite upside risk of stronger than expected growth in the US and UK, balance of risks are skewed
toward lower rather than higher inflation.
•
•
Chart: World GDP forecast
Contributions to World GDP growth (y/y)
6
4.8
4.8
4.4
5
5.0
Forecast
4.1
3.6
4
3
4.9
2.4
3.1
2.8
2.2
2.6
3.0
3.1
2.3
2
1
0
-1
-0.9
-2
-3
00
01
02
03
04
05
06
07
08
09
10
11
12
13
14
US
Eurozone
UK
Japan
Rest of advanced
BRICS
Rest of emerging
Source: Thomson Datastream, Schroders. November 2013 forecast
8
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15
World
For professional investors only
Schroders Baseline Forecast
Real GDP
y/y%
World
Advanced*
US
Eurozone
Germany
UK
Japan
Total Emerging**
BRICs
China
Wt (%)
100
64.0
24.0
18.7
5.2
3.7
9.1
36.0
22.2
12.8
2012
2.6
1.4
2.8
-0.6
0.9
0.1
1.9
4.8
5.7
7.8
2013
2.3
1.1
1.7
-0.4
0.6
1.4
1.8
4.5
5.6
7.6
Wt (%)
100
64.0
24.0
18.7
5.2
3.7
9.1
36.0
22.2
12.8
2012
2.9
1.8
2.1
2.5
2.1
2.8
-0.5
4.8
4.0
2.6
2013
2.6
1.3
1.6
1.4
1.6
2.6
0.1
4.8
4.3
2.7
Current
0.25
0.50
0.25
0.10
6.00
2012
0.25
0.50
0.75
0.10
6.00
2013
Prev.
0.25
(0.25)
0.50
(0.50)
0.25 â (0.50)
0.10
(0.10)
6.00
(6.00)
Current
4033
325
NO
20.00
2012
2907
375
YES
20.00
2013
4033
375
YES
20.00
Current
1.66
1.37
102.4
0.83
6.05
2012
1.60
1.25
82.0
0.78
6.20
2013
1.61
1.34
100.0
0.83
6.10
107.9
112
á
á
á
á
â
â
á
á
á
á
Prev.
(2.2)
(1.0)
(1.6)
(-0.5)
(0.7)
(1.5)
(1.6)
(4.4)
(5.3)
(7.4)
Consensus 2014
2.4
3.0 á
1.1
2.1 á
1.7
3.0 á
-0.4
1.1 á
0.5
2.1 â
1.4
2.4 á
1.8
1.3
4.6
4.7 â
5.6
5.5 â
7.7
7.3 â
Prev.
(2.9)
(1.9)
(2.7)
(1.0)
(2.2)
(2.1)
(1.3)
(4.9)
(5.6)
(7.6)
Consensus 2015
3.0
3.1
2.0
2.1
2.8
3.0
1.0
1.4
1.8
2.3
2.6
1.9
1.7
0.9
4.7
5.0
5.6
5.9
7.5
7.5
Prev.
(2.5)
(1.3)
(1.6)
(1.5)
(1.7)
(2.7)
(-0.1)
(4.6)
(4.2)
(2.7)
Consensus 2014
2.7
2.6
1.3
1.5 â
1.5
1.5
1.4
1.0 â
1.5
1.5 â
2.6
2.9
0.3
1.9 á
5.1
4.5 â
4.5
4.0 â
2.7
2.6 â
Prev.
(2.6)
(1.6)
(1.5)
(1.3)
(1.8)
(2.9)
(1.7)
(4.6)
(4.3)
(3.0)
Consensus 2015
2.9
2.7
1.7
1.6
1.7
1.5
1.1
1.5
1.7
1.9
2.4
3.0
2.3
1.4
5.1
4.5
4.5
4.1
3.1
3.0
Inflation CPI
y/y%
World
Advanced*
US
Eurozone
Germany
UK
Japan
Total Emerging**
BRICs
China
á
â
â
â
á
á
á
Interest rates
% (Month of Dec)
US
UK
Eurozone
Japan
China
Market
-
2014
Prev.
0.25
(0.25)
0.50
(0.50)
0.25 â (0.50)
0.10
(0.10)
6.00
(6.00)
Market
0.41
0.84
0.33
0.21
-
2015
0.50
0.50
0.25
0.10
6.00
Market
1.10
1.67
0.57
0.23
-
Other monetary policy
(Over year or by Dec)
US QE ($Bn)
UK QE (£Bn)
Eurozone LTRO
China RRR (%)
Key variables
FX
USD/GBP
USD/EUR
JPY/USD
GBP/EUR
RMB/USD
Commodities
Brent Crude
Prev.
(375)
YES
20.00
á
á
â
â
108.2 á
2014
4443
375
YES
20.00
Prev.
(1.53)
(1.30)
(105.0)
(0.85)
(6.10)
Y/Y(%)
0.6
7.2
22.0
6.5
-1.6
(108)
-3.0
2014
1.58
1.32
110.0
0.84
6.00
Prev.
(375)
YES
20.00
á
á
â
â
á
103.8 á
2015
4443
375
YES
20.00
Prev.
(1.48)
(1.25)
(115.0)
(0.84)
(5.95)
Y/Y(%)
-1.9
-1.5
10.0
0.4
-1.6
2015
1.50
1.27
110.0
0.85
6.05
Y/Y(%)
1.5
1.3
110.0
0.8
6.1
(100)
-4.1
98.8
-4.8
Source: Schroders, Thomson Datastream, Consensus Economics, January 2014
Consensus inflation numbers for Emerging Markets is for end of period, and is not directly comparable.
Market data as at 27/01/2014
Current forecast refers to November 2013. Previous forecast refers to August 2013
* Advanced m arkets: Australia, Canada, Denmark, Euro area, Israel, Japan, New Zealand, Singapore, Sw eden, Sw itzerland,
Sw eden, Sw itzerland, United Kingdom, United States.
** Em erging m arkets : Argentina, Brazil, Chile, Colombia, Mexico, Peru, Venezuela, China, India, Indonesia, Malaysia, Philippines,
South Korea, Taiw an, Thailand, South Africa, Russia, Czech Rep., Hungary, Poland, Romania, Turkey, Ukraine, Bulgaria,
Croatia, Latvia, Lithuania.
9
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28 January 2014
For professional investors only
I. Updated forecast charts - Consensus Economics
For the EM, EM Asia and Pacific ex Japan, growth and inflation forecasts are GDP weighted and
calculated using Consensus Economics forecasts of individual countries.
Chart A: GDP consensus forecasts
2014
2015
%
%
8
8
7
7
EM Asia
6
EM Asia
6
EM
5
EM
5
4
4
Pac ex JP
Pac ex JP
3
2
3
UK
US
Japan
1
Eurozone
0
US
UK
2
Eurozone
Japan
1
0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan
Jan
Month of forecast
Month of forecast
Chart B: Inflation consensus forecasts
2014
2015
%
%
8
8
7
7
EM Asia
EM Asia
6
6
EM
4
4
Pac ex JP
Pac ex JP
3
3
2
EM
5
5
UK
US
Japan
US
UK
2
Eurozone
Japan
1
1
Eurozone
0
0
Jan
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan
Month of forecast
Month of forecast
Source: Consensus Economics (January 2014), Schroders
Pacific ex. Japan: Australia, Hong Kong, New Zealand, Singapore
Emerging Asia: China, India, Indonesia, Malaysia, Philippines, South Korea, Taiwan, Thailand
Emerging markets: China, India, Indonesia, Malaysia, Philippines, South Korea, Taiwan, Thailand, Argentina, Brazil,
Colombia, Chile, Mexico, Peru, Venezuela, South Africa, Czech Republic, Hungary, Poland, Romania, Russia, Turkey,
Ukraine, Bulgaria, Croatia, Estonia, Latvia, Lithuania
The views and opinions contained herein are those of Schroder Investments Management's Economics team, and may not
necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This document
does not constitute an offer to sell or any solicitation of any offer to buy securities or any other instrument described in this
document. The information and opinions contained in this document have been obtained from sources we consider to be
reliable. No responsibility can be accepted for errors of fact or opinion. This does not exclude or restrict any duty or liability
that Schroders has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or
any other regulatory system. Reliance should not be placed on the views and information in the document when taking
individual investment and/or strategic decisions. For your security, communications may be taped or monitored.
10
Issued in January 2014 Schroder Investment Management Limited.
31 Gresham Street, London EC2V 7QA. Registered No. 1893220 England.
Authorised and regulated by the Financial Conduct Authority

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