CitiFX | Corporate Solutions Group

Market commentary | October 2013

Emerging Markets: Is The Crisis Over?

Stephen Leach [email protected] +1 212-723-9332 Contents

 Summary  Themes  The (misnamed) ‘Fragile 5’  Central response  Outlook?  Non-tradable currencies

1 Summary

Tradable currencies: is the crisis over?  Yes – for most currencies in both the short- and medium-term  This does not mean that currencies cannot depreciate further – some will in the normal turn of events  But a few are still at risk – most obviously the Turkish lira  Appreciation for the Chinese renminbi & a number of other Asian currencies Why did currencies rebound?  Global factors – the Fed, China etc.  Central bank signals – rather than intervention or tighter monetary policy per se

2 Summary

Non-tradable currencies: more problems ahead?  The obvious candidates: Argentine peso, Egyptian pound, Pakistani rupee, Ukrainian hryvnia, Venezuelan bolivar  A number of smaller currencies?

3 Summary

 Two buckets……..

ARS The main Those tradable impacted EGP currencies primarily by PKR affected by domestic UAH global trends factors alone VEF …et al

4 Summary

DEPRECIATION vs. base currency: April 30 to October 18 0% -3% -6% -9% -12% -15% -18%

-21% -24% INR BRL MNT IDR UYU ZAR TRY ARS GHS MXN PYG THB CLP MYR PHP Maximum depreciation 18-Oct

Source: Reuters, own database

5 Summary

APPRECIATION vs. base currency: April 30 to October 18 12%

10%

8%

6%

4%

2%

0% EURHUF KRW UGX MAD ILS MUR TZS CNY TWD KWD Maximum appreciation 18-Oct

Source: Reuters, own database

6 Themes

Chinese rebalancing & commodity EMFX ‘Tapering’ of QE3 demand

Softer GDP growth as a constraint

7 Themes

FOREIGN HOLDINGS OF GOVERNMENT DEBT

Per cent of outstanding debt 50%  Malaysia: not a risk of a ‘sudden stop’; 40% rather the risk of outflows 30%

20%

10%

0% | '08 | '09 | '10 | '11 | '12 | '13 | Korea Thailand Malaysia Indonesia

Source: Citi Asia Macro View, June 14, 2013

8 Themes

Appreciation? Countries with Higher current account surpluses or deficits funded with long-term yields Greater capital (direct investment?) difficulty in attracting portfolio capital or in raising Re-pricing external loans of EM risk Depreciation? Countries with current account deficits funded previously with portfolio capital or loans

The (supposedly) longer-term issue…………….

9 Themes

ASIA: Current Account Balances

Vietnam ? Thailand Taiwan Singapore Philippines Malaysia Korea 2014 Indonesia 2013 India Hong Kong China -6% -3% 0% 3% 6% 9% 12% 15% 18% Per cent of GDP

Source: Citi Global Economic Outlook & Strategy, September 2013

10 Themes

CEEMEA: Current Account Balances

Ukraine Turkey South Africa Serbia Russia Romania Poland Nigeria Israel 2014 Hungary 2013 Czech Rep. -10% -8% -6% -4% -2% 0% 2% 4% Per cent of GDP

Source: Citi Global Economic Outlook & Strategy, September 2013

11 Themes

Slower Chinese GDP Rebalancing of growth + Chinese economy

Slower growth in demand for Could demand actually industrial commodities decline?

Division between price & Flat-to-lower commodity prices volume?

Weaker balance of payments Trade & investment for commodity producers

12 Themes

CHINA:GDP growth

Per cent

12%  Official target = 7.5%.... 11%  ….or is it really 10% 7.0%?

9%  Caveat: 7.5% growth adds as 8% much GDP as 11.5% just five 7% years ago 6% '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15

Source: Bloomberg for history, Citi Global Economic Outlook & Strategy September 2013

13 Themes

EXPORT COMPOSITION IN 2012

Per cent 100%  Mexico is the standout in terms of 80% a low exposure to commodity exports 60% and thus to China 40%

20%

0% A Bra C Co Ecuador M Pe U Venezuela rge h exi ru zi ile lo ru gu n mbia c t l o a in y a

Agriculture Fuel/mining Industrial

Source: IIF, Latin America, Call of the Yield, March 2013; own calculations

14 Themes

BRAZIL: Exports to China & the U.S.

US$ bn, 12-mos rolling total 50  Not as exposed to commodities as 45 some, but China is To China 40 by far its largest single export market 35

30

25

20 To the United States 15

10 | 2009 | 2010 | 2011 | 2012 | 2013 |

Source: Bloomberg, own calculations

15 Themes

Current a/c deficit about US$24 bn

‘Tapering’ of QE3 FDI less than US$1.3 bn Large unfunded Dependence on commodity exports current a/c deficits Continuing labor unrest + Extremely large real wage increases China Sluggish growth = no rate increases + Longer-term political concerns

Local factors SOUTH AFRICASOUTH AFRICA + Large depreciation of the rand Economic ‘soft patch’ Extreme volatility

16 The ‘Fragile 5’

THE ‘FRAGILE 5’

Index, Apr 30 = 1.00  Starting point: May 1 1.30 when U.S. 10-year yields reached their 1.25 low 1.20 1.15 1.10 1.05 1.00 0.95 |M |J| J |A|S|O | BRL INR IDR TRY ZAR

Source: Reuters, own database

17 The ‘Fragile 5’

CURRENT A/C vs. DIRECT INVESTMENT

Per cent of GDP  Based on the most 7% recent data 6%  India, South Africa & Turkey have large 5% financing gaps = 4% risk of sustained FX 3% pressure 2%  Brazil has a small 1% gap that can easily be filled by reserves 0% – if necessary Brazil India Indonesia S. Africa Turkey

Current a/c deficit Direct investment inflows

Source: various central

18 The ‘Fragile 5’

Risk factors Large financing Over- or under- Political gap? valued? constraints on policy Brazil No Over- Yes India Yes Under- Yes Indonesia Yes? OK Yes South Africa Yes OK ? Turkey Yes Over- ?

19 The ‘Fragile 5’

TURKEY: Current a/c vs. Capital a/c

US$ billion, rolling 12-month total 80  The Turkish government Current a/c 60 (sign reversed) forecasts a current a/c deficit of 7.1% of 40 GDP in 2013, falling to 5.5% by 2016

20 Portfolio capital  Too slow & not enough 0 Net FDI

-20 | 2009 | 2010 | 2011 | 2012 | 2013 |

Source: Central Bank of Turkey

20 The ‘Fragile 5’

BRAZIL: Current a/c vs. Capital a/c

US$ bn, rolling 12-month total  Current account 140 Portfolio capital deficit still being 120 covered 100  Can FDI be 80 sustained in a period of slower 60 commodity 40 Current a/c (sign reversed) demand?

20  Can Petrobras Net direct investment continue to 0 attract -20 financing? | 2009 | 2010 | 2011 | 2012 | 2013 |

Source: Banco Central do Brasil

21 The ‘Fragile 5’

GDP GROWTH: Current vs. Previous Trend 10% Almost a common 8% theme:  Less resistance 6% to depreciation at a time of 4% disappointing GDP growth 2%

0% Brazil India Indonesia S. Africa Turkey 2012 2013 2014

Average 2005-2011

Source: Citi Global Economic Outlook & Strategy, September 2013

22 Central bank response

Signaling can be critical  Brazil: . Depreciation stopped only with an intervention package, not with intervention  India: . Depreciation stopped only when the new RBI governor outlined his policy approach, not with higher interest rates  Indonesia: . The central bank pulled back from distorting the market

23 Central bank response

Signaling can be critical  South Africa: . Is the best signal no signal at all -- a laissez-faire approach to the exchange rate  Turkey: . Unorthodox policies have worked so far but signals have been confused if not confusing

24 Central bank response

BRAZILIAN REAL: 2012-2013

Reais per U.S. dollar 2.5  Intervention package announced August 2.4  22 2.3  Represented a signal 2.2 that the central bank 2.1 would resist further 2.0  depreciation 1.9  Previous intervention 1.8 Intervention package announced had been focused on ‘smoothing’ the 1.7 depreciation, not 1.6 stopping it | 2012 | 2013 |

Source: Reuters, own database

25 Central bank response

BRAZIL:  An extremely convoluted foreign exchange market – with a larger role played by domestic futures than anywhere else  Two types of intervention: . ‘Currency swaps’ – transactions in the domestic futures market, with the central bank selling a dollar-real hedge with net settlement at maturity – no net drain on liquidity, the equivalent of sterilized intervention . ‘FX repos’ – sales of U.S. dollars in the spot market, with a simultaneous purchase at some specified future date -- both pre-announced, through an auction mechanism

26 Central bank response

INDIAN RUPEE

Rupees per U.S. dollar  Trend reversed only 70 with RBI’s Rajan announcing policy of 67 “transparency & 64 predictability”

61

58

55

52 |M |J| J |A|S|O |

Source: Reuters, own database

27 Central bank response

BRAZIL & INDIA:  But the problem they both face is “how to reverse course” . Neither central bank favors a further appreciation in light of the current weak economic performance . Central Bank of Brazil is continuing to raise interest rates to fight inflation

28 Central bank response

BRAZIL: Interest Rates vs. Inflation

Per cent . No but to 14% respond to inflationary 12% pressures 10% Selic overnight rate 8%

6% Inflation 4% 2% Inflation target band 0% | '09 | '10 | '11 | '12 | '13 | '14 | '15 |

. Financial repression an Source: Bloomberg, own database ongoing problem

29 Central bank response

INDONESIAN RUPEE

Rupiah per U.S. dollar  Local banks were not 12,000 able to quote accurate transaction 11,500 rates

11,000  Unconfirmed reports that actual spot rates 10,500 hit 12,000

10,000

9,500 |M |J| J |A|S|O | Domestic close Singapore NDF fix

Source: Reuters, Bloomberg, own database

30 Central bank response

INDONESIA:  The whole range of measures: . Higher interest rates, . Intervention, . New BI facilities to attract hard currency deposits & . Interference in the market mechanism  Recovery? . Clear sense that it was only when BI allowed the market to function

31 Central bank response

SOUTH AFRICA: None  No scope for higher rates due to economic weakness  No scope for intervention due to low level of reserves  Trend depreciation due to (wage) inflation

32 Central bank response

TURKISH LIRA

Basket value  No significant 2.40 recovery 2.35 2.30 2.25 2.20 2.15 2.10 2.05 |M |J| J |A|S|O |

Source: Reuters, own database

33 Central bank response

TURKEY: Weighted average cost of central bank funding

Per cent  An unorthodox 9 & erratic policy 8  Refuse to raise 7 interest rates to defend currency 6 5 4 3 2 |M |J| J |A|S|O | Avg. funding cost Borrowing rate Lending rate Repo rate

Source: Central Bank of Turkey

34 Central bank response

TURKEY:

Goals Higher interest rates Stronger currency

Fight inflation Higher reserve Reduced credit requirements growth

Reduce current a/c deficit Lower interest rates Weaker currency

(More recently) Intervention Willing to spend Prevent excessive US$40 bn depreciation Reserve option mechanism

Variable liquidity injections

35 Outlook

U.S. fiscal crisis

Time for emerging markets to adjust Less robust U.S. economy Changes risk attitudes toward emerging markets

Delay in tapering

36 Outlook

INDIA: The key issue: reform under a new government

Strong coalition Weak coalition government government

Committed to reform Limited reforms

Upswing in growth Weak growth

Upswing in investment Anemic investment inflows inflows

Exchange rate stability Further depreciation

37 Outlook

TURKEY:

A resumption of No effective strategy for downward pressure on reducing current account the lira deficit + and/or Poor outlook for increasing foreign direct The adoption of more investment conventional macro- economic policies

38 Non-global currencies

Risk of large discrete devaluations ….. A lack of FX reserves ARS Or currencies being EGP FX markets not working/ allowed to ‘float’ being allowed to work PKR Black markets UAH Dysfunctional institutional/political Payment arrears VEF structure Debt restructurings

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