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Thoughts from a Renaissance Man How Vulnerable Is the Bangladeshi

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Thoughts from a Renaissance Man How Vulnerable Is the Bangladeshi Thoughts from a Renaissance man Economics & Strategy 21 June 2018 Charles Robertson +44 (207) 005-7835 [email protected] Mobile +44 7747 118 756 @RenCapMan Vikram Lopez +44 (207) 005-7974 [email protected] Thoughts from a Renaissance man How vulnerable is the Bangladeshi taka? Four overvalued South Asian currencies in 2015 have now become two, putting growing pressure on Bangladesh. We expect depreciation of the Bangladeshi taka (BDT) to pick up from 4% and approach 10% annually. One-fifth of South Asia’s textile exports have got much more competitive vs Bangladesh First Sri Lanka, starting in 2015, and then Pakistan, in the past six months, have removed most of their overvaluation that we identified in our real effective exchange eate (REER) model in recent years. Together they account for 20% of all South Asian textile exports (vs 50% from Bangladesh), and after 15-20% currency deprecation between them, there is pressure on the BDT to follow suit. The current 4% annualised deprecation in the BDT is probably not enough, especially given two additional factors. First, a possible hike in the minimum wage before elections (expected in 4Q18) threatens further damage to Bangladesh’s regional competitiveness. Second, we see a high risk that US profit repatriation from the EU to the US will strengthen the dollar significantly against the euro. Given that 55.5% of Bangladesh’s exports went to the EU in FY2017, the BDT needs to be depreciating against the euro, not appreciating by 5%, as it has done in the past two months. When Bangladesh’s CA goes into deficit, FX depreciation picks up to 10% or more Looking back over the past 20 years, we can see two periods where after years of only very modest depreciation (2002-2004, 2007- 2010, 2013-2016), BDT depreciation has accelerated to over 10% in a single year. Both the 2005-2006 and 2011 sell-offs appear linked to the current account (CA) slipping into a small 0-1% of GDP deficit range in 2004 and 2011; we saw similar in 2017. One IMF exchange rate model reckons that while a 5% of GDP CA deficit is normal, they adjust this for Bangladesh, arguing that -1% of GDP in Bangladesh is “normal”, presumably because the currency has indeed adjusted when the deficit has reached this level. We think a 10% annualised depreciation is more likely than a bigger 19% move as in 2011-2012 The question for investors is whether a sell-off over the coming year will peak at an 11% move as it did in 2005-2006, or does it risk becoming more extreme? A 9% move in the year to November 2011 accelerated sharply in the subsequent two months and peaked at 19% (before rallying back over the following year, to end up just 10% weaker than two years previously). The argument in favour of the bigger move is that the BDT has never been as expensive in today’s money as it was in 2017. Also the IMF forecasts the CA deficit will reach 2.0% of GDP in 2018 and 2.3% of GDP in 2019, with the latter figure being the biggest deficit since 1990. However, we see a few significant differences from 2011. First, inflation is around 6% while back then it was 12%, driven higher by a poor harvest which sucked in imports too. Second, gross foreign exchange reserves are equivalent to around eight months of import cover now, against just under three months in 2011. Third, key export markets such as Europe looked in deep trouble in 2011, while in 2018 there is a modest recovery under way in Europe. This does not look like 2011. EUR/$, minimum wage hikes, elections, oil and the INR are all variables to watch We expect nominal BDT depreciation to be 10% over a 12-month period, which would still leave the BDT about 15-20% overvalued in REER terms, implying more deprecation in subsequent years. The 4% pace of depreciation may only pick up after 4Q18 elections are out of the way. A stronger dollar and big wage hikes will demand more depreciation and earlier. Falling oil prices might help slow the rate of required depreciation. The Indian rupee (INR) rate vs the dollar and local food production are two other important variables. © 2018 Renaissance Securities (Cyprus) Limited. All rights reserved. Regulated by the Cyprus Securities and Exchange Commission (Licence No: KEPEY 053/04). Hyperlinks to important information accessible at www.rencap.com: Disclosures and Privacy Policy, Terms & Conditions, Disclaimer. Renaissance Capital 21 June 2018 Thoughts from a Renaissance man There is an excellent overview of the Bangladeshi economy and market outlook from Dan Salter, All aboard published on 6 April 2016 – so there is no need to repeat his cool work here. There is further good macro work from the IMF in its last Article IV from June 2017. What we will add is this key table from Electric Power to the People, published on 30 April 2018. It shows in the first column that electricity consumption, at an average 305 kWh per capita, scrapes over the 300 kWh threshold that allows industrialisation. However, adult literacy at 61% is too low to allow manufacturing to rise above 20% of GDP on a sustainable basis1, although as we pointed out last year, this conceals big regional variations within the country (the more highly literate coastal areas probably do meet the 70% literacy threshold for industrialisation). Lastly, it shows that Bangladesh’s strong growth record might well be explained by its excellent investment/GDP ratio, which at 31% is well above the 25% key threshold Dan Salter has written about previously. In brief, when adult literacy reaches 70% – perhaps in 2024, assuming a 1-ppt improvement each year – Bangladesh will be on the path to fast sustained growth and much higher per-capita GDP, via industrialisation, high value added services or both. Figure 1: Key electricity, literacy, investment and manufacturing metrics kWh per Adult Investment to Manufacturing, kWh per Adult Investment to Manufacturing, capita literacy GDP value added % of GDP, capita literacy GDP value added % of GDP, (2015) (2015) (2017) (2016) (2015) (2015) (2017) (2016) Armenia 1,842 100 21 10 Mozambique 498 59 44 10 Jordan 1,835 98 20 18 Zimbabwe 492 87 20 10 Egypt 1,644 76 15 17 Pakistan 465 56 16 13 Namibia 1,562 91 23 12 Papua New Guinea 425 63 na 2*** Tajikistan 1,532 100 21 11* Cambodia 321 78 22 17 Vietnam 1,465 95 27 16 Ghana 316 77 14 6 Tunisia 1,409 81 22 17 Bangladesh 305 61 31 18 Moldova 1,298 99 22 14 Angola 302 71 26 na Colombia 1,188 95 23 13 Sudan 274 59 13 na Iraq 1,180 80 na 2 Cameroon 253 75 26 13** Jamaica 1,030 88 20 9 Ivory Coast 245 43 21 14 Gabon 981 83 32 3** Senegal 217 56 26 14*** Morocco 868 72 34 18 Rep of Congo 180 79 24 8 India 789 72 32 17 Kenya 164 78 17 10 Indonesia 786 95 33 21 Nigeria 139 60 13 9 Zambia 711 85 42 8 Tanzania 92 80 28 6 Philippines 667 97 25 20 Ethiopia 82 49 39 4 Laos 636 80 na 9 Uganda 73 74 25 9 Sri Lanka 558 93 na 17 Rwanda 55 71 23 6 *2013. **2015. ***2014. Source: EIA, IE, UN, IMF Also worth adding are our thoughts on political risk in the country, given forthcoming elections due in 4Q18. Based on 223 countries with Bangladesh’s income level and its political system type of “open anocracy” (democracy, with elements of autocracy), we see a 12% annual chance of a significant regime shift, including a 4.5% chance of a shift to full Gulf/China-style autocracy, a 1.8% chance of a shift towards Egyptian-style closed anocracy, a 0.9% chance of state failure (Somalia, Afghanistan – but we discount even this 0.9% risk though) and a 4.9% chance of a shift to democracy. The base 88% chance is no change in any given year, but the risks are slightly on the side of a shift towards autocracy/failure. This matters because reduced foreign aid was a factor that undermined the BDT in 2011 and foreign aid could be at risk if the political regime changed away from the type that donors tend to favour. 1See Thoughts from a Renaissance Man: Literacy, development and industrialisation, 27 July 2017 2 Renaissance Capital 21 June 2018 Thoughts from a Renaissance man Figure 2: Percentage chance of these "open anocracies" seeing a regime shift at various per-capita GDP levels (constant 2011 PPP $) To closed To full Data Key countries and their To autocracy To democracy To occupation To failure anocracy democracy points per-capita GDP ($ '000) in 2014 0 4.8% 2.4% 9.5% 0.0% 0.0% 1.2% 84 1,000 2.6% 3.9% 5.2% 0.0% 0.0% 2.6% 153 Mozambique 1, Zimbabwe 2 2,000 4.5% 1.8% 4.9% 0.0% 0.0% 0.9% 223 Tanzania 2, Bangladesh 3, Ivory Coast 3 4,000 0.5% 2.2% 8.6% 0.0% 0.0% 0.5% 186 8,000 1.7% 0.9% 8.6% 0.9% 0.0% 0.0% 116 Ukraine 10, Venezuela 14 15,000 0.0% 0.0% 10.0% 0.0% 0.0% 0.0% 20 Turkey 19, Malaysia 23, Russia 24 25,000 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0 Source: Polity IV, Penn, Renaissance Capital Exchange rates – pressure on the BDT For the past few years, we have been showing that South Asia was a region of overvalued currencies.
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