Emerging Markets Report - March 2011
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16 Martie 2011 |
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RAIFFEISEN BANK S.A. |
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Regional overview
Rising inflationary pressure is becoming an increasingly significant problem in the Emerging Markets
Along with local issues, financial markets in the Emerging Markets (EM) were dominated by the continued rise in commodity prices and mounting inflationary pressures in February. While the increasingly widespread unrest in North Africa has figured prominently in the headlines, for quite some time it did not have any direct impacts outside of the affected region. The upheaval did, however, have an indirect impact on the global financial markets, in particular through the sharp rise in oil prices towards the end of the month.
Political upheaval in North Africa is spreading, fuelling worries about a domino effect and supply problems on the oil markets
The oil markets are becoming increasingly nervous due to the relatively rapid collapse of the Mubarak regime in Egypt, which was generally considered to be quite stable, the quick contagion of the protests to Bahrain and Libya and the possible spread to other countries in North Africa and the Middle East. Risk sentiment at the global level was hit relatively hard and a mild correction was even seen on the US equity market, which had been practically immune to any bad news in recent months. The US market is still profiting from the enormously abundant liquidity which the US central bank continues to pump into the financial system in massive quantities. Despite the strong increase in money supply (M2), the Fed of course still sees no risk of inflation. But while this may be true in the USA (where the consumer basket features a strong weighting of housing costs, which are currently falling, and a low weighting of food), the situation is totally different in the Emerging Markets. The markets are being hit by some rapid increases in prices, especially for fuel, energy and food, thanks to their own robust economic growth and the ongoing flood of cheap central bank money from the USA, the EU and Japan. In many cases, food costs make up one-quarter to more one-half of the cost of living for households in the Emerging Markets. Another question is how long companies’ currently very high profit margins will be able to withstand the impact of rising commodity prices, as well as the undoubtedly strongly negative effects which will be seen as fiscal stimulus in the developed countries comes to an end.
The economies in Central and Eastern Europe continue to recover. Employment is picking up thanks to an upturn in industrial production driven by strong external demand. In some countries, domestic demand is playing an increasingly significant role as a driver of economic growth. In the Czech Republic in particular, however, almost no growth at all has been seen in domestic demand, and thus the country continues to be very dependent on exports. In general, price levels were rising during the month under review, driven primarily by higher food prices. As the year progresses, this will probably be reflected in rising nominal interest rates, coupled with stronger currencies.
Emerging Market equities once again underperform the established markets
Just like almost all of the Emerging Markets, the equity markets in the CEE countries trended sideways or slightly lower on the whole in February with some ups and down, and thus remained on their trend of underperformance compared to the developed markets. In respect of currencies, the deterioration in investors’ risk appetite had a negative impact on the Czech koruna in particular, but weakening was also registered for the zloty and the forint. By contrast, the Russian rouble appreciated, supported by the sharp rise in oil prices. Yield premiums on CEE Eurobonds widened as risk aversion generally increased.
Country focus
China
Inflation remains a risk. Central bank hikes rates again to counter inflationary pressures
It is still too early to sound the all-clear signal when it comes to inflation in China: although the consumer price index increased by “only 4.9%” in January (versus expectations of 5.3%), inflation still remains well higher than the central bank’s 2011 target of 4.0%. The weighting of the consumer basket was also adjusted by the Chinese authorities, but since no official information is released about the absolute composition of the consumer basket, it is ultimately impossible to check the official data releases. According to government sources, the reason for the adjustment was to reflect changes in consumer habits. Adjustments were also made to producer prices (latest figure for January: +6.6% yoy). One interesting aspect is that the weighting of food in particular, which was responsible for around 70% of the increase in inflation, was lowered. Food prices increased by 10.3% recently. The significantly stronger increases in producer prices compared to consumer prices is bad news for the profit margins of Chinese companies. On the monetary policy front, the central bank continues with its efforts to fight inflation. After the New Year’s festivities, the 1-year base lending rate and the deposit rate were both increased by 25bp each to their current levels of 6.06% and 3.0%, respectively. Another interesting point was that the long-term deposit rate was raised significantly more this time, by 40bp. This could be interpreted as an attempt to steer liquidity from equities or the real estate market into bank deposits.
China’s equity market (Shanghai) was able to move against the general EM trend in February and posted a modest gain, whereas shares in Hong Kong saw more declines. Despite the relatively favourable valuations compared to the other Emerging Markets in the region, Chinese shares remain unable to gather any upward momentum. It is possible that the market has already been anticipating the mounting pressure on Chinese companies’ profit margins, which are very thin anyway. And of course, the central bank’s rate hikes are anything but favourable for share prices. It is likely that the equity markets will remain in wait-and-see mode for the time being, until it becomes clear that a good balance between inflation and growth has been found.
India
Inflationary pressures remain high – another rate hike by the central bank is expected in March
India's equity market suffered from a string of bad news, much of which is home-made (corruption, lack of progress in reforms, crumbling coalition government). On the other hand, the situation is similar to China and most of the other EM: there are worries about inflation. The consumer price index remains stubbornly above the 8% mark, and there is cause for concern as almost all of the sub-indices for prices have increased. This hints at second-round effects, in particular because companies now have more room to pass on price increases due to the tight capacity situation. Consequently, a mild decline in growth would be beneficial as it would ease some of the pressure on prices. Growth in industrial production was rather weak in January, although it should be noted that the basis of comparison (January 2010) was quite high. Production of capital goods contracted by 13% yoy, which can be seen as an indication that companies are currently no longer expanding capacities. On the whole, however, these data are not likely to represent an obstacle to another rate hike in March.
The Indian equity market remains stuck in a strong downward correction, even though it was able to recoup most of the significant January losses in February. The best long-term opportunities are still probably to be found amongst small and medium-sized companies. Share prices of many of these companies are at quite attractive levels again, in conjunction with steadily good earnings growth. Nonetheless, during the weeks ahead the correction on the Indian equity market may continue.
Brazil
In terms of the economy, the main topics are worries about inflation and fears of rising interest rates. The central bank is expected to increase interest rates at the beginning of March. The new President is also working to counter rising prices by cutting spending. In this regard, she recently prevailed in an important conflict in the parliament, as she was able to convince MPs to vote against a significant increase in the minimum wage. Rising minimum wages lead directly to higher government spending, as a string of social benefits are linked directly to the development of the minimum wage.
Not much happened on the Brazilian equity market in February. Most Brazilian stocks are still looking very expensive. Without the shares in Petrobras and Vale, which both feature rather low valuations, the PER for the market as a whole would be much higher. Accordingly, the equity market has already priced in a good deal of positive expectations, and thus the upside potential appears quite limited, at least over the short term.
Russia
Russian currency and bonds profit from rising oil prices
Inflationary pressure continues to mount in Russia, as consumer prices rose at an annual rate of 9.6% in January (8.8% in December). In response, the central bank raised the key rate by 25bp at the end of February. While short-term interest rates had been reflecting expectations of rate hikes for quite a while, the timing of the move came as a surprise. Obviously, the sharp increase in inflation towards 10% prompted the central bank to take immediate action.
Central bank surprisingly moves to increase interest rates
Nonetheless, yields on long-term Russian bonds dropped over the month and booked positive performance on the whole, in conjunction with the stronger rouble. If it proves to be lasting, the higher oil price will result in a significant improvement in the public budget.
Despite higher oil prices, the Russian equity market did not post more gains in February, but merely moved sideways with some volatility. Following the robust price increases from the previous month, this can be seen as a normal phase of consolidation, especially since the positive effect of rising commodity prices is balanced out by the negative price effect of deteriorating international risk appetite. All in all, Russia should remain one of the EM equity markets with the best prospects in the coming months, in large part due to the relatively low valuations and the related potential for this market to catch up.
Turkey
Turkish current account deficit on a disturbing negative trend
In year-on-year terms, the rate of inflation is currently on a strong downward path, but this should not be interpreted as a sustained deflationary trend. Turkey's dependency on commodity imports and the very robust, sustained domestic demand continue to be factors which pose a threat to long-term price stability. In February, the central bank left the key rates unchanged in line with expectations, after having lowered rates twice in the previous months. With these moves, the central bank wished to reduce the level of short-term investment capital in the financial system and alleviate the imbalances in foreign trade by weakening the currency (Turkey's current account balance currently shows the highest deficit ever as a percentage of GDP). The Turkish lira has been the weakest currency in the region since the beginning of the year. January saw sharp increases in yields on Turkish LCY bonds, and not much changed in respect of the yield levels in February. If the current world market trends in oil and food prices continue, the outlook for inflation in Turkey is likely to deteriorate very quickly. In turn, this could require rate hikes and thus create the potential for a stronger currency again. Faced with this situation, the central bank will have tough decisions to make in the months ahead.
Share prices slipped on the Istanbul stock market in February after a positive start to the month, and on the whole the market closed the month with a mild decline. Over the short and medium term, there are hardly any triggers in sight for sustained increases in share prices and thus we do not expect to see any major gains for the time being.
