Important disclosures are found at the Disclosures Appendix. This research material is released by Renaissance Securities (Cyprus) Limited. Regulated by the Cyprus Securities & Exchange Commission (License No: KEPEY 053/04).
27 January 2011 Global economics outlook Renaissance Capital
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Summary 3 Market outlook 5 Developed markets in crisis 6
Many attributed this to excessive debt levels 7 What about inflation? 11 What about the EMs? 12 China as Japan – the outlook for the renminbi 13 Which markets to buy? 17 Our currencies outlook 20 Inflation and interest rate outlook 22
Global GDP 23 Oil scenarios 25
Summary of top picks for EEMEA 28 Russian equities in 2011 29
Our top-five ideas for Russia 31 Russia 35 Kazakhstan 37 Ukraine 39 Ghana 41 Kenya 43 Nigeria 45 South Africa 47 Zambia 49 Zimbabwe 51 Turkey 53 Selected EM markets
China 55 South Korea 56 Indonesia 57 India 58 Hungary 59 Poland 60 Egypt 61 Argentina 62 Brazil 63 Mexico 64 Venezuela 65
Eurozone 66 US 67 Disclosures appendix 68
Contents
Renaissance Capital Global economics outlook 27 January 2011
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Fighting one’s destiny can be a great storyline, as fans of Star Wars’ Anakin Skywalker to Shakespeare’s Macbeth will tell you. But in a captivating story, it just can’t be done. Such is the situation for developed nations. When crises such as those witnessed in 1973-1974 or 2008-2009 hit after a generation of rising indebtedness, the consequent problems of economic mayhem and collapsing confidence require highly stimulative policies to counter them, policies that themselves store up new problems for the future. The Fed could no more resist QE2 in late 2010 than it could resist loosening policy in late 1975. The short-term results are clear: markets are up and the US economy should grow by 3-4% in 2011. If the Fed tightens policy in late 2011 as it did in late 1976, it might be too late to stop inflation’s gradual rise through 2012 and its more significant rise in 2013.
Equally irresistible is the attraction of fast-growing low-debt emerging market (EM) economies relative to slow-growth highly indebted developed market (DM) economies. From 1975 EMs boomed and unsurprisingly the same thing is happening again. To meet global demand for EM assets we can assume currencies will strengthen alongside more issuances of external debt, local bonds and equities, with only grievous policy errors or surprisingly successful macro-prudential measures likely to stand in the way of these developments.
This is not to say that every EM asset will outperform the S&P 500 in 2011 – global investors have arguably priced in a good chunk of this story already, particularly in Asia and Latin America, while the S&P 500 was priced for a possible double-dip – but we do believe there is a good case for EEMEA and the frontier markets to be the best EM performers this year. Largely unloved in 2010, they are cheaper than their EM peers and, as our country sections show, with growth of 5-11% good opportunities abound. We favour countries with low private-sector debt that have the appetite to borrow, and preferably have the funds to self-finance a rise in lending, which leads us to favour a number of countries in EEMEA and Sub-Saharan Africa (SSA).
What could alter the plot in 2011? Evidently, a continued rise in EM inflation is a threat. But assuming we have a good harvest in August, the inflation risk associated with soft commodities should dissipate. For other commodities, the likelihood that growth fears will occasionally resurface, or that OPEC might pump more oil, could prevent excessive price rises for these assets.
A second threat is China slamming the brakes on its economy, although if new loans are ‘only’ an additional trillion dollars this year it would still look fairly positive for Chinese demand. China could instead choose to significantly revalue its currency as Japan did in 1976-1978 – the yen appreciation then would be the equivalent of China moving to around CNY3.8/$1 in 2013. Not only would this sharply cut inflationary pressure in China, but other countries in the region could then follow suit. It is too contrarian even for us to seriously forecast CNY3.8/$1 in 2013, but CNY5.4/$1 in 2012 is the base case of this report.
We doubt Europe will be a more significant target for the occasional risk-off trade in 2011 than in 2010, as we share the consensus view on Portugal (IMF soon) and Spain (maybe IMF later), with restructuring of some peripheral eurozone debt likely to occur when it is affordable, presumably not before 2012.
What else lies out there? Oil much above $90/bbl would be a problem, particularly for countries like Turkey and perhaps Kenya, and within the EEMEA space, but this is not our base case for 2011. But that’s enough of the risks. Today we have a new hope, to quote Star Wars: Episode IV, and we should enjoy it.
Summary
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Figure 1: Country summaries Country Comments
Russia
After the global crash of 2008-2009 and the drought of 2010, it’s remarkable that Russia may become a $2trn economy as early as 2012. The prospect of a return to more prudent fiscal policies, some rouble appreciation, of course a helpful oil price, the likelihood of a sharp rise in agricultural production in 2011 and a renewed rise in bank lending are all encouraging factors. Sentiment is further supported by the possibility of WTO accession and the biggest privatisation drive since the 1990s. All in all, it is a rather good time to be facing the electorate, in our view. Among the key stocks we favour are Sberbank, Gazprom, Transneft, Magnitogorsk and OGK-5, and overall we believe there is 30% upside potential in the market this year.
South Africa Our assumption of 4% growth in 2011-2012 is not quite at the 5-6% peak reached over 2005-2007, but we believe it is more sustainable, coming as it does without the wide current account deficits of previous years. The current strong rand might weaken towards the year-end in the event of Fed tightening, but until then a rate of ZAR7/$1 (our forecast) or stronger should help cap inflation, therefore we assume there will be no rate hike this year. We like Anglo-American, Aquarius and Foschini, among others.
Nigeria
Political uncertainty and banking problems should be put behind us in the second quarter, and we feel it is likely that investors will be more confident about re-investing here given the oil price rise of recent months. The Central Bank of Nigeria seems committed to a stable exchange rate over the medium term, removing one potential risk, and we expect banks to become increasingly confident in lending later this year. With frontier markets looking like good value and with our forecast for growth at a high 7-8%, we believe there is upside potential for a range of stocks from Oando to PZ Cussons.
Kenya and Turkey
A curious pairing at first glance, but both are energy importers running noticeable current account deficits with growth expected by us of around 5% over 2011-2012. Also, interest rates of around 6% seem low given the rate of inflation, good GDP growth and a rise in bank lending. Both have approved constitutional referenda changes, with politics as a more dominant issue in both countries compared with many others. Interest in these two countries could prove an interesting bellwether of global sentiment towards EMs. While benign, their deficits can be covered with ease, which is our base case, but any fall in confidence might provoke interest rate hikes in both countries, or at least in Turkey.
Zimbabwe Politics is a big issue here too, with talk of possible early elections in 2012, but in the meantime we expect very strong 9-10% growth and low inflation at just 3-5%, which should foster a return of deposits into the banking system, in addition to fuelling self-financed growth into 2012.
Ghana Africa’s newest oil producer, and the most recent to reach middle-income status, is set to grow by 10-11% this year, in our view. With a gradual revival of credit growth and a current account deficit of just 4-5% of GDP; we believe there is little not to like. The main constraint for investors will be getting access to suitable amounts of stock.
Zambia Another SSA boom story with our projection of 6-7% growth over 2010-2012, as well as a decent fiscal picture and a current account deficit more than covered by FDI over the same period. A key factor here is of course the price of copper remaining high.
Kazakhstan Ever-closer connections to China mean that Central Asia should continue to attract investor attention. New pipelines and roads into China and a shift in trade flows, against a backdrop of high energy prices, seem set to deliver good growth in Kazakhstan, especially as the country moves closer to increased oil output from the Kashagan field, which we expect to start having an impact after 2015. Our top picks for 2011 include: Tethys Petroleum, KMG EP and Halyk Bank.
Ukraine For once the outlook for Ukraine seems fairly stable. Rising metal prices are positive for the export sector. While there is talk of a move to inflation targeting, for now a stable currency is our base case.
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The graph in Figure 3 showing the Dow Jones stock market history in five of the biggest crashes of the past 100 years has proven surprisingly useful in guiding us on the ups and downs of global sentiment in recent years. Each line begins with the Dow at its peak in 1929, 1937 (just before the Great Depression’s double-dip), 1973, 2001 (the tech bubble) and in 2007 when it reached 14,165. Note how many working days each crash took to reach its bottom – usually about 12-18 months after the peak. The Great Depression was a horrendous exception.
Figure 3: Five big stock market crashes 1929-2011
Source: Bloomberg
What is important is what this tells about 2011. Of all of the crashes above, the Great Depression is the least relevant as Chairman of the Federal Reserve Ben Bernanke read his history and avoided the mistakes made then. The 2001 tech bubble was the mildest of these five crashes and by an equivalent date in the cycle, the Fed had already started hiking rates, so again this is not so useful. The 1937-1940 double-dip has been a useful crash to consider, but it has lost its validity as it was this point in the cycle which saw the May 1940 invasion of France (an unexpected geopolitical event that rather upset the markets).
Which leaves us with the mid-1970s, when commodity shocks were followed by a financial crisis and a collapse in confidence. A significant rally after this stalled in 1975 as the IMF began bailing out weak economies like Greece, and the Fed felt it necessary to offer more fiscal stimulus to an economy that many feared would double-dip. This easing by the Fed occurred in what would be the equivalent of the fourth quarter of 2010, bizarrely similar to what we saw with the recent QE programme.
The fiscal stimulus by the Fed worked. Despite the challenges it faced, the US stock market in 1976 rose to within 3% of its former 1973 peak. Yet later in 1976, when the Fed felt it should tighten monetary policy (the equivalent of 4Q11 this time around), the market fell back to about 11% below the 1973 peak.
This implies the Dow will rise as high as 13,700 in 2011, equivalent to 1,400 on the S&P 500, but it won’t rise above the 2007 peak and we forecast pull-backs to below 13,000 later this year. The most obvious parallel would be if the Fed began withdrawing QE in late 2011 or even hiked rates, which could provoke that kind of market weakness. For now though, this suggests that we have much better prospects than in January 2010, when the New Year rally lost momentum after two weeks.
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The Dow will rise to 13,700, equivalent to 1,400 on S&P 500, but will pull back to
below 13,000 later this year
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To paraphrase Crane Brinton1, those who do not know their history are bound to repeat it, but those who do know it are bound to repeat it too.
The similarities between the 1973-1974 and 2007-2008 crashes are too striking to ignore. What is so interesting about the former episode, other than the guidance about our near future that it provides, is that we can see the same pressures at roughly the same points forcing us to make the same decisions as were made then. The Fed needed to loosen policy in late 1975 because a double-dip recession was feared, and it could not tighten policy until a full year later, as seems likely in late 2011. Peripheral Europe was bailed out by the IMF while the EM world boomed.
Both crashes began with a surge in commodity prices. The failure of the Soviet wheat harvest in 1972 resulted in global wheat stocks falling to levels that we only saw again in 2006-2007.
Figure 4: Global wheat stocks (mn tonnes lhs, and weeks of supply rhs) Figure 5: Global foodstuffs and livestock prices % change YoY
Source: USDA Source: Bloomberg
This was followed by oil prices shooting up when US dependence on the Middle East left it vulnerable to the 1973 oil embargo. The oil bill shot up to approximately 4.5% of global GDP, similar to the 5.0% reached in 2008. Based on our assumption that real oil prices will be $90/bbl in 2011-2012, we expect the global oil bill to remain around 4.5% of global GDP.
Figure 6: The oil bill as % of global GDP (lhs) and oil prices in constant 2009 prices (rhs)
Source: BP
1 American historian and author of The Anatomy of Revolution
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Developed markets in crisis
We forecast real oil prices of $90/bbl for 2011-2012, equivalent to 4.5% of global GDP
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Next came a financial crisis, which prompted the economist Hyman Minsky to write his seminal book that was referred to so often in 2008-2009. In 1975, US banks failed at 10 times the average rate since the 1930s, with some of the largest bank failures since the 1930s, including Herstadt in Germany and Franklin National and the US National Bank of San Diego in the US.
Many attributed this to excessive debt levels The financial crisis of the time was attributed by many to the excess borrowing that had taken place. BusinessWeek in October 1974 carried a piece on “the debt economy”, highlighting that there was $8 of debt to every $1 of money supply, double that of 20 years before, while household debt had risen to 93% of disposable income, compared with 65% in 1955. There were worries about loan/deposit ratios that were way out of line, and a huge real estate market that was in desperate trouble, despite all the authorities did to attempt to save it. Meanwhile President Gerald Ford mourned “the longest and most severe housing recession since the end of World War II“.
Figure 7: The stock of household and corporate debt in the US, 1952-2009
Source: IMF
Businesses shed labour at a pace not seen repeated until 2008. US unemployment did not reach pre-crisis levels until over a generation later, which tells us we will next experience the low levels of unemployment witnessed in 2007 only in 2031. There was criticism at the time that official unemployment figures did not truly reflect the scale of joblessness in the economy. We are hearing something similar now from those focusing on the U6 measure of unemployment.
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Unemployment rose more quickly than in any other crisis up to then, until now
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Figure 8: US unemployment and the Fed funds rate, 1971-2011
Source: Bloomberg
With the economy in crisis, public finances lurched deeply into deficit. By late 1975, US municipal and state debt had become so unsustainable that the federal government had to step in to bail-out New York City. For 2011, Meredith Whitney sees municipal debt as a key threat to financial market stability, while Illinois appears one of the vulnerable states.
The crisis swept across the Atlantic. By 1975, the IMF was bailing out Greece, and in 1976, both the UK and Italy were in IMF negotiations. The subsequent deal with the UK in 1977 was at that point the largest in the IMF’s history. It was followed by Spain in 1978. The IMF had little choice but to bail-out these countries. As BusinessWeek had written in 1974 “should a colossal borrower such as Italy default – and the threat is very real – it could possibly send big banks toppling faster than central banks could respond.”
The European crisis led the European Union to the brink of the abyss, with its perceived father, Jean Monnet, saying as late as 1979 “we may yet experience the ultimate crisis of a break-up of the European community, and we may see it happen within the next 12 months” as its institutions are “irrelevant to Europe’s real needs.”
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New York City in 1975; US municipal debt or Illinois in 2011?
Greece, Spain, Italy and the UK bailed out by the IMF
The collapse of the European Community (the EU) was threatened
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Figure 9: Budget balance (lhs) vs public debt (horizontal) as % of GDP in 2010
Source: Eurostat, IIF, Renaissance Capital estimates
Today we must assume that Portugal in 1Q11, and possibly Spain in around 2Q-3Q11, will seek IMF help, as Greece and Ireland did in 2010, because Europe cannot afford the alternative of a banking sector collapse. Even a restructuring of eurozone sovereign debt may be more than the eurozone banks can afford – in this regard, European banks look similar to US banks in the early 1980s when their exposure to LatAm was twice that of their capital. They could not afford to negotiate a restructuring of LatAm debt until 1986, four years after Mexico stopped meeting its debt obligations.
You can guess what the US response to the 1970s crisis was. Aggressive loosening of policy by the Fed and a big rise in the budget deficit. This was initially welcomed, but the US found it nearly impossible to reduce its budget deficit, particularly as the new Democratic US president, Jimmy Carter, felt it necessary to push through an expensive national healthcare programme ahead of mid-term elections. By 1978, equivalent to 2013 in this cycle, the IMF was preparing contingency plans to bail-out the US itself. The recent US decision to extend the Bush tax cuts for two more years has done wonders for 2011 GDP forecasts, but also sends the message that the US budget deficit may remain extremely large until after the presidential elections in late 2012.
Whether foreigners would continue to fund such a large budget deficit became a topic of popular fiction. The novel The Crash of 79 began with the suggestion that Arab oil money would leave New York. Today, of course, the fear is China’s withdrawal from the US treasury market.
The US was fully aware of this risk, but felt it could not tighten policy appreciably unless others did more to drive the global economy. In particular, the US singled out Europe’s largest economy, Germany, and Asia’s largest economy, then Japan (c.f. China today) and demanded that they become the locomotives of the world economy. An increase in their domestic demand and a rebalancing of the world
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By 1978 the IMF was preparing contingency plans to bail out the US
Would foreigners fund the US deficit? A question for the late 1970s, and for the
coming years
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economy was seen as essential. The Italian central bank governor said, “the basic cause of current monetary and other economic problems is the mercantilist approach adopted by most countries over the past decade or more. Other countries have allowed exports to lead their economic growth and enjoyed the US deficit while complaining about it”. A new body formed in 1976, the G-7, was one conduit of this pressure. Today the G-20 is its natural replacement.
Both Germany and Japan initially stood firm against this US pressure for them to adopt more reflationary policies. In 1977, a Japanese official warned that Japan was forced into a corner 40 years before (pre-WWII) and spoke of “dangerous pressures placed on us again” with regards to US trade restrictions on Japanese exports of manufactured goods. In 1978, the German chancellor Helmut Schmidt criticised America’s “vulgar Keynesian economics” claiming “economies ... are not suffering from the effects of deflationary fiscal and monetary policies … [but] are suffering from the medium-term effects of inflationary policies.”
Yet, a combination of increasingly belligerent protectionist talk from the US and a willingness on the part of the US to effectively abandon support for the dollar did finally have an impact.
So, the key lessons to learn from the 1970s are as follows:
1) The monetary and fiscal stimuli will produce US growth in 2011-2012.
2) The fiscal nightmare in Europe and the US will continue for years.
3) We should expect more talk of protectionism in 2011-2012 and even less willingness on the part of the US to support its currency if trading partners don’t adjust their policies.
4) The biggest Asian and European economies will be reluctant to adjust their policies.
Figure 10: US consumer confidence 1973-1977 and 2007-2013
Source: Bloomberg
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The biggest economies in Europe and Asia initially rejected US pressure in 2010, as they did the 1970s
Rebalancing of the global economy demanded by the US
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Figure 11: US industrial confidence - ISM survey
Source: Oct 1973-77, 2007-2011
What about inflation?
While most have a vague sense of the 1970s as a period of high inflation, at this point in the cycle in 1976 it was still disinflationary trends that were predominant. The US authorities were not stupid. There was concern that higher inflation might result from their policies. But they were still late to react to inflation when it did occur, because they feared for their growth outlook. They had to loosen policy in late 1975 because a double-dip recession was a threat, just as it was a threat in late 2010. Equally, they could no more tighten policy in early 1976 than the Fed could hike rates in early 2011. The 1970s tells us that the Fed will only tighten in 4Q11, either through rolling back QE or hiking Fed funds.
Figure 12: US CPI and Fed Funds 1973-1977 and 2007-2011
Source: EcoWin, Bloomberg
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The key difference between 1976 and 2011 is the position of inflation. It fell to 5% by the end of 1976, while in 2011 it may yet hover close to 0-1%. When inflation rose in 1977-1978, it increased to 9%, an increase of 4 ppts. A similar pattern would result in US inflation at roughly 4-5% by the end of 2013. The real surge in inflation only came in 1979-1980 when a second oil price shock pushed US CPI to 15% – and now, a second Iranian revolution disrupting global oil supplies would be too coincidental for any analyst to forecast.
What about the EMs?
While the DMs were in crisis in the 1970s, many EMs were booming. Global capital was faced with the choice of lending to nearly bankrupt Western countries or investing in EMs with their low external debt and high growth. Unsurprisingly, the latter were favoured. External debt in the EM world boomed, along with growth rates. If the current part of our cycle corresponds with 1976, we can foresee at least another five years of this kind of behaviour from 2011.
Figure 13: Brazilian and Mexican GDP growth 1971-2010
Source: IIF
Figure 14: External debt, $bn during the boom of 1975-1983
Source: IIF, National sources
Figure 15: External debt ratios in 2009-2010, GDP % change
Source: National sources, Renaissance Capital estimates
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EMs were booming in this period
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Figure 16: If external debt was to double or rise threefold from here ...
Source: IIF, National sources, Renaissance Capital estimates
There are three differences between the state of EMs and DMs now compared with the 1970s. First, EMs now demonstrate even better ratios than in the 1970s, while Western nations demonstrate worse, so the choice of EMs over DMs looks even more irresistible at the moment.
Second, in the 1970s it was autocratic governments that borrowed from EM countries, from Brazil to Romania, whereas this time it is more likely to be private sector borrowing.
Third, EM governments, having experienced the 1980s debt crash and much volatility since then, may be more cautious about accepting inflows of foreign capital. Macro-prudential policies could slow foreign inflows, hopefully avoiding or minimising the crash that might otherwise follow in the equivalent of 2016 (1982 in the last cycle).
Was there any differentiation between EMs during the 1970s? Yes. Those exporting commodities and energy did best of all, but a number of energy and commodity importers faced problems. There are already signs of current account deterioration from Turkey to Kenya and India, which we believe should be easily financed given the demand for EM assets, but will require our attention in the coming years.
China as Japan – the outlook for the renminbi
The Japanese yen surged from JPY307/$1 in early 1976, roughly where we are in the equivalent-cycle today, to JPY177/$1 by October 1978. This was an incredible move. From the end of World War II to 1971, the yen had been pegged at JPY303/$1. This was a cornerstone of a national development policy, supported by a high domestic savings rate, and we saw the Japanese population move from the countryside to the cities in huge numbers. The economy grew by 9.5% a year from 1947 to 1973, and by an even more impressive 10.5% annually in the last decade of this period (1963-1973). Along the way, Japan joined the General Agreement on Tariffs and Trade (GATT), the forerunner of the WTO, in 1963, hosted the Olympics in 1964 and became the world’s second-largest economy in 1965. It did not actually run significant external surpluses until the mid-1960s, but the cheap yen enabled it to avoid a balance of payments crisis as it imported the investment goods needed to develop its economy.
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Figure 17: JPY/$ 1971-1980 (lhs) and CNY/$ 2005-2011 (rhs)
Source: Bloomberg
Figure 18: JPY/$ 1971-1980 and CNY/$ 2005-2011 – index
Source: Bloomberg, Renaissance Capital estimates
The similarities between Japan’s situation at the time and China’s now are obvious, from the high savings rate to the undervalued currency. While the world was shocked when Japan ran a current account surplus of some 3-4% of GDP in the 1970s, it is even more shocking to note that China’s surplus was 11% of GDP in 2007. Yet, curiously, as recently as 2001 China’s surplus was a minimal 1% of GDP, similar to Japan’s rough balance in the early 1960s. China joined the WTO in 2001, hosted the Olympics in 2008 and became the world’s second largest economy in 2010.
A crucial question for us in 2011 is whether China will allow its currency to substantially strengthen in 2011-2013, akin to what Japan reluctantly accepted to do in 1976-1978. It would be the equivalent of the renminbi strengthening, temporarily at least, to CNY3.8/$1, or to CNY4.2/$1 if we take 1971/2005 as the starting point. By contrast, the Bloomberg consensus for the renminbi is for it to strengthen to just CNY6.3/$1 in 2011 and CNY6.05/$1 in 2012.
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China has trod the same development path as Japan
Will China let the renminbi appreciate from CNY6.6/$1 to CNY3.8/$1 during 2011-2013?
Renaissance Capital Global economics outlook 27 January 2011
15
The primary advantage of faster currency appreciation would be reduced inflation, most importantly by making the import of commodities cheaper. The alternative is to slow bank lending more quickly than the authorities would like. China has already begun to slow its lending, far earlier than it did in the wake of the Asian crisis or the tech-crash. But so far this is having a very limited effect. In addition, the strengthening currency would boost consumption and domestic demand and so improve relations with key trading partners. It would reduce upward pressure on forex reserves, help with sterilisation costs, and stop the accumulation of Western debt. Eurozone bonds and US treasuries would not be our first, second or third choice of investment.
Figure 19: China's GDP % change and injection of credit by banks as % of GDP
Source: IMF
China is evidently reluctant to appreciate its currency so fast. One conspiracy theory is that the US wants the renminbi to strengthen in the same way that the yen did after the Plaza Accord of 1985, which pushed the yen to extremely strong levels, and arguably contributed to the stock market crash of 1990, ending Japan’s bid to rival the US in the world economy. A recent IMF paper comparing China now with Japan in the 1980s only adds fuel to this fire.
But it is quite wrong to compare 1980s Japan with today’s China. If we look at per capita GDP, budget balance data, trade and current account history, the level of savings, the dominance of the ruling party, the record-high savings rates, the percentage of the population that is rural vs urban, or GDP growth rates, or even the timing of social security reform (Japan 1977, China 2011), then China is evidently experiencing something akin to Japan’s 1970s, not its 1980s.
Will the experience that Japan had in the late 1970s put China off revaluation? Perhaps. Growth slumped from 10% annually and the budget deficit began to widen. But inflation was kept under control, the Liberal Democrats did not lose power for another generation, despite the rise of the yen, the external balance remained very healthy and within a decade few could imagine anything that might derail Japan’s rise. What China now has to decide upon is whether this model is attractive, or whether they would prefer to take risks with inflation.
The graphs below (Figures 20 and 21) help show why inflation is dangerous for Japan and China. Both nations are massive savers at the household level. Economists have tried to explain this for generations. In the 1950s it was assumed that Japan saved because it was a young country, but in the 2000s it is said that Japan saves because it is an old country. It was said in the 1970s that the Japanese
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While Japan’s growth slowed, yen appreciation did not hurt the ruling party
If the alternative is inflation, a stronger Chinese currency is preferable
27 January 2011 Global economics outlook Renaissance Capital
16
saved because there was inadequate social security provision, but reforms in 1977 did little to change behaviour. We assume the same will be true in China with its social security reforms due to be enacted this year. What economists hate is having to attribute saving habits to national stereotypes, yet the graphs below do highlight a difference between Anglo-Saxon countries, like the US and the UK, and Japan or China.
Figure 20: Household cash and bond savings, and debt as % of GDP in 2007-2009
Source: BIS, National sources
Figure 21: Net cash position of households (cash and bonds minus debt) as % of GDP
Source: BIS, National sources
The data show that household debt is roughly equivalent to household cash savings or bond savings in the US, the UK, Spain, Turkey and so on, while household cash savings are way in excess of household debts in Japan, China, Italy and others. The US and the UK primarily save through housing and equities, which are inflation hedges, because the authorities in those countries deliver inflation to nearly every generation. Countries on the left of the chart should be terrified of inflation – indeed, it was inflation that led Japan to hike rates in 1990, even as the stock market crashed, while in China the events of 1989 have been attributed to the high rate of inflation then. Efforts in China to hedge-out inflation risk by buying property, gold or equities tend to meet resistance from the authorities, who presumably see significant advantage in China’s banks having access to huge reserves of cheap deposits.
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Inflation should be politically popular in these countries
Deflation should be politically popular in these countries
High-cash savers hate inflation
Renaissance Capital Global economics outlook 27 January 2011
17
Overall, we believe Japan’s experience in the 1970s and China’s fear of inflation today suggest that the renminbi will appreciate far faster than the market consensus assumes. Instead of around CNY6.0/$1 for the end of 2012, we assume at least a move to CNY5.4/$1 with a still stronger figure for 2013.
Which markets to buy?
In the chart above showing the US private sector debt ratio, it is clear that asset prices, such as those of housing or equities, are strongly linked to the level of private sector debt compared to GDP. When debt is rising faster than GDP, it will usually result in higher prices for domestic assets. Why then has the Japanese stock market been such a disaster for the past 20 years? Because the private sector debt ratio has generally fallen over the same period.
Figure 22: Japanese GDP growth and the injection of credit by banks as a % of GDP since 1980
Source: IMF
We believe investors need to identify those countries where the debt/GDP ratio can rise. To do this, the following three questions must be asked:
1) Is there room for the ratio to rise?
2) Does the country like to borrow?
3) Can the country finance the rise?
The answers are not as straightforward as one might think. In the mid-1970s it was said that US private sector debt levels were too high at around 100% of GDP, but it was able to double these to 200% of GDP in the 1990s. When interest rates more than halved in the 2000s, debt became more affordable. Another issue to consider is that broader, high-debt countries tend to be wealthy long-standing democracies where the rule of law makes borrowers and lenders more comfortable with debt. However, China’s private sector debt level, far higher than many Western European countries, is in stark contrast to this.
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Japanese stocks and/or real estate worth buying until 1990
Then again mid-1990s and lastly in2005
Credit growth is often the major driver of asset price growth
27 January 2011 Global economics outlook Renaissance Capital
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Figure 23: Household and corporate debt as % of GDP, 2009
Source: IMF - 32d series or 42d series
Generally, our view is that developed markets with debt at around 200% of GDP are unlikely to experience any significant rise in this ratio in the coming few years. We prefer markets with far less debt, such as Russia, SSA, Turkey, Brazil and Poland.
When answering the question – does a country like to borrow? – we find a number of countries are reluctant to do so. Within this camp, we can identify the Czech Republic, Mexico and Indonesia. In all of these countries, data to 2010 have shown little or no rise in the debt/GDP ratio since the crises of the 1990s. This means that their asset prices, e.g. equities or real estate, have not been prone to the massive rises seen elsewhere, unless foreign money has been involved. These countries may be more suited to debt investors.
Figure 24: Indonesia – rise in GDP and injection of credit to households and corporates as % of GDP
Source: IMF, Bloomberg
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High debt in Asian and rich countries
Emerging European debt was heading towards euro zone levels
Latam, African and CIS countrieshave low debt levels
We like Russia, SSA, Turkey, Brazil and Poland from the debt perspective
Not every country with low debt wants to borrow more, e.g. Mexico, Indonesia and the Czech Republic
Renaissance Capital Global economics outlook 27 January 2011
19
Figure 25: Mexico – change in GDP and in bank credit to households and corporates as % of GDP
Source: IMF, Bloomberg, IIF, Renaissance Capital estimates
At the other end of the scale we have Russia, Nigeria and Turkey, which like to borrow and where we foresee multi-year rises in asset prices. These are the markets more attractive for equity investors while the debt/GDP ratio is increasing.
Figure 26: Russia – GDP % change and credit change as % of GDP
Source: IMF, Renaissance Capital estimates.
The ideal for equity investors is find those countries which have begun to borrow when previously they did not. Brazil did not borrow until 2004-2005 and, until that point, the equity market did not offer much more than volatility. But from 2005-2009, and onwards, the market has risen 400%. Poland changed in 2006. Also, given that private sector debt/GDP ratios remain around 50% of GDP for both Brazil and Poland, they may both have a long way yet to run.
The third question refers to the country’s ability to finance this credit growth. The Eastern European boom in credit in the 2000s was largely financed from abroad, either by the financial markets or by parent banks in Western Europe. When that financing disappeared, so did the credit boom and stock markets plunged. By contrast, China’s very good loan/deposit ratio meant it could inject trillions of dollars into its economy in 2009-2010.
Among the countries we have examined here, Brazil is beginning to exhaust the deposit base used to fuel lending growth. Much like Kazakhstan in 2003-2004, foreign investors are, however, keen to lend to the Brazilian financial sector, and we assume this will run for a few years in Brazil as it did in Kazakhstan. For Russia, the
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rose 400% in five years
Having a good loan/deposit ratio (below 110%) means credit growth can be self-
funded
27 January 2011 Global economics outlook Renaissance Capital
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considerable improvement in the loan/deposit ratio since 2008 means it is closer to being able to sustain its own lending story. Kazakhstan’s access to financing should also improve, as we get closer to the oil export boom we expect to occur in around 2015. Even Ukraine, which suffered so much in 2009, should find that as its rate of nominal GDP growth accelerates, its debt ratios will return to levels that begin to encourage banks to lend again.
SSA looks particularly attractive, like Turkey and most Asian countries, with their banking systems that have large cash deposits. In Ghana and Nigeria, banks have been lending to the government, as Turkish banks did in 2009, and profiting from this. Now their economies are back on their feet, we have scope for a lending boom that can be financed domestically.
To conclude, we are encouraged by the low level of credit relative to GDP in a number of EEMEA and SSA countries, as well as Brazil. Investors should also appreciate that the desire to borrow exhibited by Brazil, Russia, India, Poland, Turkey, and much of SSA suggests these countries could produce strong equity market performances in coming years. Finally, we believe there is room for most of these countries to fund lending growth without excessive dependence on foreign capital, a dependence that led to serious problems for other countries in 2007-2008.
Our currencies outlook
EM currencies have generally been strengthening since at least 2004, based on Big Mac Index-type measures and, in general, they are no longer cheap. In particular, commodity currencies, from Brazil to Argentina to Canada, look expensive. Among the best value countries would appear to be Mexico in Latin America, Poland in emerging Europe, and Russia among the commodity currencies. In our view, long-term fair value for Mexico is around MXN10-11/$1 and for Poland is around PLN3.5/EUR1, while the rouble is now roughly 30% cheaper than the basket of commodity currencies.
Figure 27: The Big Mac Index – prices paid for a Big Mac in dollar equivalents
Source: The Economist, Bloomberg
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SSA countries are surprisingly attractive, as are Turkey and many Asian countries
EM currencies are getting expensive, but Mexico, Poland and Russia are cheap compared with commodity currencies, and of course China is cheap too
Renaissance Capital Global economics outlook 27 January 2011
21
Within SSA we created our own Big Mac-style index by visiting Western-style retail supermarkets in Kenya, Nigeria and Ghana. In each case the local currency appeared to be expensive. Prices in Ghana and Kenya were roughly comparable to the UK, while Lagos was more expensive than either New York or London, and was similar to Istanbul. However, buying a basket of Western middle-class goods in countries where transportation costs can be high and retail competition for such goods is low, tells us little about true currency competitiveness and more about the profit margins of high-end retailers.
In our opinion, the EUR/$ rate is the hardest variable in the world to forecast. Yet we have to use a number in our forecasts. We have gone down the cautious route, assuming, like in 1976, that there will be little change in 2011 with an average rate of $1.30/EUR1, which is line with market forecasts. But for 2012, we have pencilled in a rate of $1.35/EUR1. We have also pencilled in dollar appreciation to $1.25/EUR1 for the end of 2011, on the assumption that US tightening around that time will support the dollar, but this strength will be wiped out by a sell-off to $1.38/EUR1 by the end of 2012, as investors act on the fear that the US is behind the curve in terms of inflation.
Figure 28: Dollar vs euro since 1974
Source: Bloomberg
More importantly, we have assumed that pressure on EM currencies will be maintained over the coming years, and that they will tend to appreciate against both the euro and the dollar in 2011, with particular appreciation against the dollar in 2012. This appreciation will be led by China. Even if the dollar is stronger against the euro in 2012, we have assumed it will not strengthen against EM currencies. Our only caveat here is that the dollar is already very weak on a trade-weighted basis, which reflects the dollar’s weakness vs the currencies of large trading partners, like Canada.
SSA currencies are expensive based on a Big Mac Index comparison, because
retail competition is limited to high-end retailers
We assume a $/EUR average rate of 1.30 in 2011 and 1.35 in 2012, with end-year
rates of 1.25 and 1.38
We assume EM currencies will remain strong or strengthen against a $/EUR
basket
27 January 2011 Global economics outlook Renaissance Capital
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Figure 29: US trade weighted dollar exchange rate (1973 = 100)
Source: Bloomberg
Inflation and interest rate outlook
Strong or stronger EM currencies should help limit inflation, but we believe the key variable that will impact inflation during 2011-2012 will be the northern hemisphere’s cereal harvests of August 2011. If these are good, stocks of wheat, rice and corn should rise, and food price pressures should dissipate. If, however, the harvests are poor, we face a severe risk of much higher food prices, with central banks being forced to respond with rate hikes.
Figure 30: Component weights in the CPI baskets of various countries
Source: National sources Limited interest rate rises are possible in the EEMEA region, but it is in Asia, which has experienced two strong years of growth while avoiding currency appreciation, where we expect there to be the most tightening.
Figure 31: Interest rate outlook, December 2008 and January 2011
Source: Renaissance Capital estimates
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A good northern-hemisphere harvest in August should ease inflationary pressures
Interest rates are on the way up, but less so in EEMEA as it was hit the hardest by the 2008-2009 crisis
Renaissance Capital Global economics outlook 27 January 2011
23
The tables below show the actual size of economies based on GDP estimates in cash for 2010, using exchange rates provided to the IMF by national authorities and the actual $/EUR rate for the eurozone countries. In 2010, China soared past Japan, the eurozone shrank in dollar terms, Brazil took eighth place in the global economy while Russia took 10th, and Africa grew 15% in dollar terms. As its economies are among the fastest-growing in the world, we expect Africa to climb further up the rankings in the coming years.
We also include some data on US state GDP, partly to help us understand the global macro-economic impact of housing problems in California and Florida, but also to highlight that, in terms of GDP, Illinois is larger than Greece and Ireland put together.
Figure 32: The five largest economies in 2009 and 2010, $bn
Source: IMF, Renaissance Capital estimates
Figure 33: US state GDP in 2009-2010, $bn
Source: BEA Figure 34: The 6th to 20th biggest economies ranked by 2010 GDP, $bn
Source: IMF, Renaissance Capital estimates
14,624
5,745 5,3913,363 2,599
2,0004,0006,0008,000
10,00012,00014,000
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China
Japa
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P, $
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Euro zone = $12.5trn in 2009, $12.3trn in 2010
1,891
1,145 1,093737 630 555 483 471 408 398
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1,564 1,477 1,430 1,3981,220
1,004 986784 729 695
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Global GDP
27 January 2011 Global economics outlook Renaissance Capital
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Figure 35: The 21st to 40th biggest economies ranked by 2010 GDP, $bn
Source: IMF, Renaissance Capital estimates
Figure 36: The 41st to 60th biggest economies ranked by 2010 GDP, $bn
Source: IMF, Renaissance Capital estimates
Figure 37: The 61st to 80th biggest economies ranked by 2010 GDP, $bn
Source: IMF, Renaissance Capital estimates
Economic size may bear little relation to market size. The table below shows the size of the equity market in various EMs compared with the sizes of their domestic debt market, external debt market and forex market.
445 439 434 427 414
377354 351 338
314 313 305285 283
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159 158 154138 137 132 130 127 117
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2009 2010
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P, $
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Renaissance Capital Global economics outlook 27 January 2011
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Figure 38: Various EM market sizes, $bn
Equity MktCap (as of 20-Jan-11)
Domestic debt securities (Jun-10)
External debt (bonds and notes), (Sep-10)
FX market, (daily turnover Apr-10)
Total MktCap (Factset database)
MSCI, MktCap MSCI, free float Government Corporate/FI Sovereign Corporate/FI In local
Source: Factset, MSCI, BIS, national sources * is early 2008 data for domestic debt, March 2009 for external debt
Oil scenarios
Below we outline two scenarios for Russia, Kazakhstan and Nigeria in 2011 and 2012, based on flat real oil prices of $70/bbl and $110/bbl in each year.
Figure 39: Key economic indicators under different oil price scenarios
Average oil price, $/bbl 2011E 2012E 70 110 70 110
Russia Real GDP (YoY), % 1.0 5.5 2.0 7.0 Nominal GDP, RUBbn 48,166 50,312 52,421 57,440 Nominal GDP $bn 1,542 1,692 1,720 2,188 Budget deficit, % GDP -4.1 0.4 -3.8 0.7 Exchange rate, RUB/$ 31.96 27.5 30.44 25 Current account, % GDP 3.4 6.4 2.2 4.2 Kazakhstan Real GDP (YoY), % 4.1 6.0 4.0 7.0 Nominal GDP, KZTbn 21,655 23,066 24,833 26,265 Nominal GDP $bn 142.0 164.8 165.0 194.6 Budget deficit, % GDP -2.8 0.5 -2.4 1.0 Exchange rate, KZT/$ 152.5 140.0 150.5 135.0 Current account, % GDP 1.0 3.5 1.2 4.0 Nigeria Real GDP (YoY), % 6.1 9.6 6.3 9.5 Nominal GDP, NGNbn 37,789 39,517 44,895 46,949 Nominal GDP $bn 228 294 280 362 Budget deficit, % GDP -5.8 0.7 -5.2 1.3 Exchange rate, NGN/$ 155 145 147 142 Current account, % GDP 14.5 22.8 13.7 20.5
Source: Renaissance Capital estimates For Russian GDP, we note the greatest sensitivity is on the downside: confidence would be hit hard and the rouble would weaken. Naturally, the budget would look far messier.
We note the reduced sensitivity in Nigerian output. For GDP, this is because the oil sector has actually done very little to support growth in recent years. Even the oil price fall in 2008-2009 did not stop the economy from growing 7% in 2009. We note
27 January 2011 Global economics outlook Renaissance Capital
26
that the currency has the least sensitivity to oil price. The authorities will be very reluctant to allow another unpopular devaluation, but would presumably like the opportunity to build forex reserves if oil prices remain high.
For Kazakhstan, the current account surplus would nearly disappear with oil at $70/bbl, but the economy would fare better than Russia’s and still show an estimated 4% YoY rise in real GDP in both years.
Renaissance Capital Global economics outlook 27 January 2011
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Figure 40: Trade ties (2009 data unless otherwise stated)
Exports/GDP, % $, % EUR,
% Other significant Main exports
Argentina (2008) 17* 8 19 Brazil 19%, Chile 7%, Uruguay 3%, Mexico 2%, Vene 2%
Hong Kong 151 (incl re-exp) 12 13 China 51%, Japan 4%, Australia 2% Apparel & clothes 39%, electrical machinery 10%, jewellery 6%, textile
yarn 2% (2006) India (2008/09) 13* 11 21 UAE 14%, China 5%, Singapore 4% Engineering goods 25%, gems/jewellery 15%, petrol products 15% Indonesia (2008) 22* 10 11 Japan 20%, China 10% (est), Singapore 9% Gas 13%, crude petrol 12%, palm oil 12%, rubber 8% Malaysia (2006) 72* 19 13 Singapore 15%, Japan 9%, China 7%, Hong
Kong 5% Electronic equipment 24%, semi-conductors 18%, electrical products
7%, chemicals 6% Pakistan (2007) 17 22 28 UAE 7%, Afghanistan 5%, Hong Kong 5%,
Saudi Arabia 2%, Turkey 2%, India 2% (2006) Clothing/apparel 34%, cotton 21%, rice 7%, leather 4%, petroleum
products 2% (2006) Philippines (2008) 23* 18 17 Japan 16%, China 11%, HK 10%,
Pair trades: long Anglo American/short AngloPlats; long Foschini/short Massmart, Shoprite or Pick n Pay; long Barloworld/short Imperial
SSA:
BUY: Oando, African Petroleum
SELL: Tullow
Ukraine:
BUY: MCB Agricole
Pair trade: long Raiffeisen Bank Aval/short Ukrsotsbank
Zambia:
BUY: Zanaco Bank, Stanchart Bank Zambia, CEC, Natbrew, Zambeef
Zimbabwe:
BUY: Delta, Innscor, AICO
Summary of top picks for EEMEA
Renaissance Capital Global economics outlook 27 January 2011
29
The economic recovery is under way and we expect this recovery cycle to be stronger and longer than the previous two. Russians learned quite a lot from the busts of 1998 and 2008, and Russia is moving to establish more protection against external shocks for its domestic economy, through a freer rouble, diversification, the creation of a deeper financial system and increased investment.
Russian political life is not as exciting as that in Ukraine, but 2011 is likely to be an exception with Duma elections at the end of the year and the presidential election due in March 2012. However, we expect things to quiet down in 2012 as the next president-elect may be in power for two terms and may spend 12 years in office.
Russian stocks are cheap. The oil price is high. Rates are low. The risk trade is on. The state is prepared to invest. The Russian market is posed for around a 30% rise in 2011 in our view, lifting the RTS Index to at least the 2,200 mark.
Russia is cheap, cheap, cheap!
Russia has been one of the world’s worst-performing markets relative to its GDP recovery (Figure 41) and Russian stocks are cheap relative to earnings growth levels (Figure 42). The 44% discount Russian stocks trade at compared with the global emerging market (GEM) average has never been wider (Figures 43 and 44), while at the same time Russia’s debt trades at a premium to the EM average (Figure 45). On a sector-by-sector basis, Russian stocks are cheaper than EM stocks in most sectors (Figure 46) and not only for oil and gas stocks, which are usually discounted due to heavy taxes on Russian oil and gas companies.
Russian stocks are at the bottom of the 2011 GEM P/E ranking. The top-20 cheapest GEM stocks have a 50% MSCI Russia weight. Transneft’s preferred shares, the cheapest GEM stock, trade on a 2011E P/E multiple of 2.3x. Gazprom, the fifth-cheapest GEM stock, trades on a 2011E P/E multiple of 4.7x. Surgutneftegas’s preferred shares hold the number eight place with a 5.4x 2011E P/E multiple, followed by Lukoil in the number nine spot with 5.6x. Sberbank’s preferred shares trade at 5.9x, putting it in 14th place, while Tatneft’s 6.2x 2011E P/E multiple puts it in the number 18 spot (All the above multiples are based on consensus estimates and are relevant as at mid-January 2011.)
Russia’s discount case has long been known to investors. Russia is discounted due to the ‘boom-bust’ nature of its economy, which expands well when the oil price is high and credit rates are low, but suffers otherwise. The discount is partly a function of Russia’s huge oil and gas taxes, and partly because the dividend yield for Russian stocks is so low (Figure 47). Another reason for the discount, in our view, is the corporate governance practices of some state companies, which keep ignoring the shareholder rights of minorities (a good example is Transneft – the cheapest of the GEM stocks). The discount is also partly as a result of the treatment of Russian ex-oligarch Mikhail Khodorkovsky, who was arrested in 2003 and sentenced in 2005 to eight years in prison on charges of fraud and tax evasion, and then sentenced to a further six years in prison on embezzlement charges at the end of 2010. Another contributing factor to the discount is the level of corruption in Russia.
We think the pipeline of privatisation and M&A deals could stimulate an improvement in corporate governance in the short-to-medium term.
Russian equities in 2011
27 January 2011 Global economics outlook Renaissance Capital
30
There has been no shortage of reform attempts in Russia. A reform of the army is currently taking place and police reform is on the calendar for 2011. In addition, there has been an ongoing fight against corruption and modernisation attempts are taking centre stage.
There is little hope that taxation in the oil and gas sector will dramatically change this year, but Russia’s possible WTO accession in 2011 could catalyse the beginning of change. We can hope that oil taxes will be partly redistributed to other commodity sectors or could be replaced by higher dividends from state-held companies. We note that Gazprom avoided a gas mineral extraction tax (MET) hike by increasing its dividend.
Portfolio investors are not the only ones affecting the price of Russian equities. Recent M&A deals have put slightly different valuations on Russian stocks: the Rosneft/BP deal values the Russian oil and gas company at a P/E multiple of 8x for 2011E vs 2011E sector average P/E multiples of 6x and 9x for Russia and GEMs, respectively. While the PepsiCo/WBD deal assigns a value to Russian consumer names of 30x 2011E earning, vs the GEM average of 15x. In our view, Western corporates believe Russian oil stocks should trade on a 2011E P/E multiple of 8x, and Russian consumer stocks should trade on a 2011E P/E multiple of 30x.
The price of oil is close to an all-time high (in terms of average annual prices) and global interest rates are at an all-time low, yet the average discount of Russian stocks to GEM stocks has never been so wide. Russia is certainly cheap relative to oil price levels, and relative to current dollar LIBOR, as investors apply a discount to reflect the ‘boom-bust’ nature of Russian equities. However, the Central Bank of Russia (CBR) is prepared to back a less restricted rouble exchange rate policy during this new cycle, focusing on inflation. We believe attempts will be made to bolster the Russian financial system to sustain speculative inflows and outflows of capital. We feel this could be the beginning of Russia’s immunity to swings in the external environment, which will act as a catalyst to decrease risk.
This year the Duma elections will be held, and in November 2011 we are likely to see the final list of candidates for the 2012 presidential elections in Russia. The next president-elect will hold office for six years. Without going into too much detail, investors tend to invest in pre-election years and take profits the year after. This trade strategy worked well in Russia in 1996, 1999 and 2003, while 2007 and 2008 witnessed an exaggerated example of this trade. The trade also worked well in Ukraine last year and in 2005. In our view, we can expect more of the same from investors in Russia this year.
Meanwhile, we foresee the consumer goods and banking sectors as benefiting from expanding credit and consumer demand in 2011. In our view, the way to play the rising price of oil on the Russian market is by gaining exposure to infrastructure names in the real estate, construction and steel sectors, especially as Russia has to prepare for the APEC Russia 2012 summit in Vladivostok, the 2014 Winter Olympics in Sochi and the 2018 FIFA World Cup. In addition, we estimate that infrastructure underinvestment during the transition period has led to a shortfall in investment spending of $1trn, a shortfall which can no longer be ignored.
Of the abovementioned three events, the APEC Russia 2012 summit in Vladivostok will come first and is the smallest in scale. Even for this relatively small-scale event, the investment pipeline is impressive and includes the construction of two huge Hyatt hotels, a further six other hotels, a university, an airport, a hospital, over 100 km of road, two bridges, a ballet theatre and sewage facilities.
Renaissance Capital Global economics outlook 27 January 2011
31
In addition, the benefits of infrastructure spending will spill over into the travel and entertainment, and consumer goods sectors
The global market has experienced a number of shocks, such as the European sovereign crisis, the negative effect of Chinese tightening and increasing EM inflation, and there are still concerns about the recovery of developed economies and the strength of the dollar. We expect the Russian market to be periodically reminded of the existence of such risks and, as Russian stocks have high beta, there will the customary reactions to these risks, causing corrections, but we assume these will be nothing more than just corrections.
Our top-five ideas for Russia
Gazprom (BUY; TP $11.8, upside potential 86%)
An obvious top pick for a pre-election year in Russia
Fifth-cheapest EM stock on 2011E P/E multiple of 4.7x
27 January 2011 Global economics outlook Renaissance Capital
34
Figure 47: 2010 estimated dividend yield (payable in 2011)
Source: Bloomberg
6.76.2
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Renaissance Capital Global economics outlook 27 January 2011
35
Figure 48: The rouble is the cheapest EM currency The rouble is the cheapest commodity currency
The rouble is undervalued relative to other EM currencies. The rouble appreciated only 2.3% against the dual currency basket (45% euro, 55% dollar) in 2010. Having depreciated 2.1% in 2010, the rouble may be the cheapest commodity currency against the dollar. The rouble managed to ignore the increase in oil price from $75/bbl to $85/bbl in September-November 2010 due to one-off capital outflows because of the departure of the mayor of Moscow. The low interest rate environment restrains speculative capital inflow into Russia, despite the CBR indicating possible rate hikes in 1Q11. An oil price around $90/bbl supports rouble appreciation from the foreign trade channel. A current account of $63bn is projected for 2011 and the CBR will invest $30-40bn in international reserves, in a conservative scenario. Long rouble vs the dual-currency basket is our top trade idea in 2011, with a target of RUB33.25 by mid-2011.
Source: Bloomberg, Renaissance Capital estimates
Figure 49: CBR heading for small rate hikes CBR heading for small rate hikes Consumer inflation may reach 10% as soon as April 2011, as food price pressure is unlikely to weaken until the next harvest. Assuming a good harvest, inflation is likely to come down to 8.2% YoY by the end of 2011. In response to rising inflation, the CBR increased the deposit rate by 25 bpts to 2.75%, which is an extremely loose decision, in our view. However, when inflation reaches close to 10%, we expect the CBR to be pushed to increase refinancing rates and will try to not deviate from its upper inflation forecast of 7%. At the same time, we do not believe that the CBR will seriously fight inflation at the cost of lower economic growth and higher lending rates, especially during the pre-election period. In our view, the likely outcomes are a more significant increases in deposit rates in 1H11 (to 4%) and slight refinancing rate hikes until inflation decelerates (to 8.75%).
Source: CBR, Renaissance Capital estimates
Figure 50: Higher oil = better budget Higher oil = better budget Russia will run an expansionary fiscal policy in 2011-2013, but only on paper. The approved federal budget anticipates a deficit of 3.6% of GDP in 2011, falling to 2.6% in 2013. Real growth in government spending will not exceed 1.0% YoY. A much tighter fiscal policy will start in 2011. The pension tax rate will be 34% and is likely to subdue household consumption. We believe the budget deficit will be below official estimates, nearer to 1.8% of GDP in 2011 at an oil price of $90/bbl. Due to CBR interventions in the forex market, we expect liquidity in the banking system to remain abundant. Therefore, the Ministry of Finance could decide to follow counter-cyclical fiscal policy by borrowing in the domestic market and saving excess revenues in the Reserve Fund: this will reduce inflationary risks without increasing monetary policy rates, side stepping currency wars.
Source: Renaissance Capital estimate
Figure 51: Recovery will accelerate Recovery will accelerate Economic growth will accelerate in 2011 to 4.9% (vs the government forecast of 3.1% and market consensus of 4.2%), but will remain below the 2000-2008 pre-crisis average of 6.9%. Consumption may remain weak due to the pension tax rate increase and low wage growth. Mild consumption growth will be unlocked via a decline in the rate of savings and a 20% pick-up in consumer lending in 2011. Investment will drive economic growth in 2011, as the construction sector recovers and the government launches the Olympic and World Cup developments. Net exports are a deadweight on economic growth in Russia, due to the more flexible exchange rate. The current account surplus is shrinking and, in our view, this will continue. The bad harvest and grain export ban reduced economic growth by 0.5-1.0 ppt in 2010. A good harvest in 2011 could contribute to the ongoing recovery.
Source: Rosstat, Renaissance Capital estimates
0.60.70.80.9
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-7.5-5.0-2.50.02.55.07.5
10.0
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2002
2003
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2005
2006
2007
2008
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2011
E20
12E
Budget deficit, % GDP Urals price (right), $/bbl
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30
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2012
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27 January 2011 Global economics outlook Renaissance Capital
Source: National sources, Renaissance Capital estimates
Russia: Key economic forecasts
37
Renaissance Capital Global economics outlook 27 January 2011
Figure 53: Industrial production drove GDP in 2008-2010 GDP real growth at ca. 7% in 2010; we forecast 4.5% in 2011 FY growth is expected at 7% according to preliminary data from the government, ahead of our 6.2% forecast. We forecast 4.5% real growth in 2011. Strong global demand for oil and metals was behind the strongeconomic growth in 2010. Metallurgy and uranium production contributed the most to economic growth, with the energy sector showing steady growth as the oil price hit two-year highs. In 2011, two major factors will support the country’s economic growth: China, a major consumer of Kazakh mineral resources, is projected to grow 9-10%, and oil prices are expected to surpass 2010 levels. The Kazakh economy will continue to enjoy favourable market conditions for its major exporting goods. Exports will remain the major driver, though imports are expected to catch up as more public funds are spent on industrialisation and as domestic consumption revives. Investments that declined by close to 10% in 2010 will most likely turn positive, while banking will remain a relative drag
Consumer price inflation in Kazakhstan in 2010 was in line with our 7.7% forecast and was mostly driven by growing global commodity and food prices. The major driver was food prices that grew 10.1% and contributed half of the price increase, while services and non-food products grew 6.8% and 5.5%, respectively, with roughly equal contribution. The government established price caps on “important dailynecessities” to contain inflation as it started creeping up towards year-end. Real wages in 2010 increased 7.5%, while productivity grew 2.9% in 9M10. Monetary problems remain at bay on the back of weak bank lending that decreased 5.9%. We expect lending to return, but to remain sluggish. Money supply growth has increased from last year, however, at a much lower rate than in the pre-crisis years. We expect the rate of inflation in 2011 to stay within the 6-8% range projected by the government, with risk to the upside and the most important trigger being global food prices.
Note: * Jan-07=100 Source: FAO, Statistics Agency of Kazakhstan
Figure 55: Tenge to appreciate smoothly Tenge to appreciate gradually to KZT142/$1
The exchange rate was stable throughout 2010 and we expect gradual appreciation in 2011. The tenge showed real appreciation against the dollar of 7% in 2010 (0.6% nominal). The current account had a $4.2bn surplus in 9M10 and is expected to close 2010 with 3.5% surplus of GDP. The economy's improving external position increased monetary reserves by $4.7bn and National Fund assets by $5.8bn; combined reserves amounted to over $58bn, or almost half of GDP. The National Bank of Kazakhstan (NBK) saw no big pressure on the tenge after 1Q and announced it was considering a shift towards a more flexible currency regime after March 2011, targeting smooth tenge appreciation. In our view, in 2011 NBK will focus on inflation targeting and trade facilitation with Russia, which has its currency floating against the currency basket. We expect a stronger tenge to promote domestic demand in 2011.
Note: *Dec-00=100 Source: National Bank of Kazakhstan
Figure 56: Fiscal tightening expected in 2011, % of GDP
Source: Ministry of Finance of Kazakhstan
Budget deficit of 2.8% at an oil price of $65/bbl in 2011 The government’s revenues (including an increase in the National Fund assets) totalled $30bn in 2010, up 46.5% from 2009 and 6.5% above 2010 government projections. The 2010 budget deficit was approved at $5.5bn (4.1% of GDP). A robust recovery is expected to lead to an improvement in the government’s fiscal position. The state budget for 2011-2013 has been adopted with a much lower deficit of 2.8% in 2011, based on additional revenues of $2.8bn from a doubling of the oil export duty in 2011 to $40/tonne. We expect the government to generate extra revenues (that will eventually go to the National Fund) as the budget was drafted based on an oil price of $65/bbl. Fitch raised its sovereign rating on Kazakhstan to positive, while S&P raised its sovereign rating on the country one notch to BBB. As global financial markets open up to Kazakh companies and banks, we expect state funding to be redirected from supporting the economy to financing development programmes.
Source: National sources, Renaissance Capital estimates, exchange rate (KZT/EUR) annual average
Kazakhstan: Key economic forecasts
39
Renaissance Capital Global economics outlook 27 January 2011
Figure 61: Administrative factors to drive inflation Inflation drops to 9.4% in 2010, but risks still exist An untypically low CPI in 4Q10 meant that the annual average inflation rate dropped to 9.4% in 2010 (vs the initial government forecast of 13.1% and our estimate of 12%). The slowdown was as a result of unexpected declines in theprices of some food products, despite the growth of global food commodity prices. We have not ruled out the possibility of administrative measures taken by the government as a cause for the food price drops (or even ‘creative accounting’) in4Q10. In addition, the central bank prevented an increase in liquidity in the banking system whilst keeping the currency stable. The government expects 2011 inflation to fall to 8.9%, which we doubt can be achieved given the planned notable hike in gas and utility tariffs and the recovery in domestic consumption. These factors,together with possible growth in global commodity prices (at least in 1H10), suggest to us inflation of 11.3% in 2011 (consensus is 10.8%). We expect the regulator to continue to implement inflation control measures during 1H11, and possibly afterwards.
Source: Ukrainian Statistic Committee, Renaissance Capital estimates
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Figure 58: Key components of GDP GDP growth to be driven by domestic consumption and capex After a huge slide in 2009, real GDP increased by over 4% YoY in 2010 driven by the recovery in global steel prices and the low base. Since the high rate of growth in the metals sector has already come to a halt (we forecast only 4.4% growth in steel prices in 2011), we expect the main drivers of economic growth will be a recovery in internal demand and higher capital investments. Internal demand will be driven by 10% growth in real wages and the return of consumer lending. Growth in capital investments should be fuelled by increased government spending and FDI in infrastructure projects. Overall, our 2011 GDP forecast of 4.2% YoY growth is slightly cautious vs the government’s forecast of 4.5% and consensus forecast of 4.6%.
Source: Ukrainian Statistic Committee, Renaissance Capital estimates
Figure 59: C/A gap increases but FDI growing Capital account deficit grows on the back of imports’ recovery
A negative implication of the rebound in domestic demand is the likely widening of the capital account deficit to 3% of GDP in 2011. Moreover, in 4Q10 we saw notable growth in retail demand for foreign currency (net cash purchasing of dollars reached about $1.5bn/month) that we relate to an increase in imports by small business. This demand is likely to be visible in 2011 as well. The capital account gap should be covered by an increase in FDI and new external borrowings (we expect net inflows to be $3bn) and tranches from the IMF ($6bn). We estimate a capital account surplus of $2bn in 2011. We believe the National Bank of Ukraine will have enough reserves to prevent the hryvnia from any sharp depreciation this year, but we have not ruled out higher exchange-rate volatility during the gradual move to inflation targeting.
Source: The National bank of Ukraine, Renaissance Capital estimates
Figure 60: Budget deficit is declining
2010 2010E 2011E 2011E/ 2010E
Total revenue 252.7 245.2 281.5 1.15 % of GDP 23.7% 23.0% 22.5% VAT 104.7 96.8 108.3 1.12 % of GDP 9.8% 9.1% 8.6% Corporate profit taxes 40 37.9 37.5 0.99 % of GDP 3.8% 3.6% 3.0% Excises 25.3 22.8 34.9 1.53 % of GDP 2.4% 2.1% 2.8% Non-tax revenues 55.4 58.2 42.7 0.73 % of GDP 5.2% 5.5% 3.4% Total expenditure 306.8 303.8 321.9 1.06 % of GDP 28.8% 28.5% 25.7% Deficit 54.1 58.6 38.8 0.66 % of GDP 5.1% 5.5% 3.1%
Source: Ukrainian Ministry of Finance, Renaissance Capital estimates
2011 budget seems fairly realistic
Budget revenues were below the 2010 target as there was additional pressure on the government to pay off notable VAT rebate arrears accumulated during the financial crisis. However, the government kept the budget deficit (5.5% of GDP) in line with IMF requirements by cutting budget spend by UAH3-5bn and delaying VAT repayments. The 2011 budget law is based on the newly adopted budget code, which targets a 1% drop in the VAT rate to 19%, and a 2% decline in the corporate income tax rate to 23%. Corporate tax revenues are expected to be flat in nominal terms, while VAT revenues and VAT cash rebates are expected to grow in line with GDP. Overall budget revenues are planned to grow 15% to 22.5% of GDP, while expenditure is targeted to grow 6% YoY, nominally. The 2011 budget deficit is to be reduced to a viable, in our view, UAH38.8bn (3% of GDP), but will require growth in external and local borrowings ($5bn and UAH48.6bn, respectively) given the UAH62.2bn refinancing needs; planned proceeds from privatisation are expected at UAH10bn.
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27 January 2011 Global economics outlook Renaissance Capital
Source: Ukrstat, NBU, Ministry of Finance, Renaissance Capital estimates
Ukraine: Key economic forecasts
41
Renaissance Capital Global economics outlook 27 January 2011
Figure 63: Oil growth Oil debut to spur double-digit growth in 2011 2011 will be the first full year of oil production in Ghana following the commencement of production on 15 December 2010. Production is expected to reach 120k bpd in 2011. Ghana’s oil production may be low compared with Nigeria’s 2.5mn bpd, but it promises to be a significant source of tax revenue (1% of GDP) and an important export (8-10% of GDP) for Ghana. The IMF’s projections put oil production at 17% of non-oil GDP. Moreover, the sector will boost demand for services. Ahead of the commencement of oil production, the business services sector, including ICT, financial services and commerce, and the hospitality sector exhibited strong growth in 2010. We expect this to continue in 2011. The striking of first oil is expected to propel real GDP growth to 10.5% in 2011, from 6.6% in 2010, before moderating to 7.1% in 2012.
Source: Renaissance Capital estimates
Figure 64: Oil export earnings to be countered by higher income payments Repatriated income to mute impact of exports
Oil is expected to boost Ghana’s export earnings by 50% in 2011, which should bring down the trade deficit/GDP ratio to single digits. For a country that is often troubled by large current account deficits, this projection is a boon. However, as oil production in developing countries, such as Ghana, is dominated by foreign companies and imported skills, repatriation of income is expected to surge from 2011 onwards. Moreover, service receipts are likely to increase on the back of an increase in imported services, such as consultancy services. As such, the negative balance in the services and income account is expected to increase in 2011, muting the positive impact of oil on the merchandise trade balance. We expect the current account deficit to narrow to 4-5% of GDP in 2011 from 9% in 2010, mainly due to a significant reduction in the import bill that was inflated by oil-related imports. A smaller current account deficit implies a stable cedi.
Source: Renaissance Capital estimates
Figure 65: Clearance of arrears spurs lending , YoY% Credit growth to strengthen The recovery of credit growth is expected to continue in 2011 on the back of lower interest rates, a decrease in the NPL ratio and strengthening economic activity. The average lending rate decreased to 27.6% in November 2010 from 32.8% a year earlier, easing the cost of capital. Moreover, the government has cleared some of its arrears, which partly helped lower NPLs to 18.1% in September 2010 from 20% in February 2010. The improvement in credit growth that began in mid-2010 stemmed from the recovery of international trade and industrial production. In particular, credit extended to exporters and importers grew by 77% YoY and 30% YoY, respectively. We expect the construction sector, which was the worst hit by unpaid government contracts, to stage a recovery in 2011. This is positive for lenders because almost 10% of pre-crisis credit went to construction.
Source: Bank of Ghana
Figure 66: Nowhere else for inflation to go but up
Source: Ghana Statistical Service
The return of double-digit inflation
Inflation has been on an almost two-year decline on the back of good rains, tighter fiscal policy, softer commodity prices and a stable cedi. However, it has hit bottom and is set to increase in 2011 after coming down to a two-decade low of 8.6% YoY in December 2010. Inflationary pressures will mainly stem from non-food inflation, particularly energy prices. In early January 2011, the government announced a 30% increase in the fuel price, in accordance with the higher international oil price. A stronger oil price will translate into higher transport and distribution costs. Moreover, the surge in global food prices will feed into local food inflation; up to 80% of the rice consumed in Ghana is imported. We expect inflation to return to the double-digit realm and end 2011 at 11.5-12.0% YoY. If inflation proves stronger than our projection, monetary policy will be tightened.
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27 January 2011 Global economics outlook Renaissance Capital
Kenya’s agriculture sector produces 25% of its GDP and at least 50% of its exports, including tea and horticulture. Therefore, the economy’s health is intrinsically linked to the rain-fed agriculture sector’s performance. This link was highlighted during the 2009 drought. The return of good rains in 2010 explains the 5.7% and 12.4% YoY expansion of the agriculture, and electricity and water sectors respectively in 9M10, following the contraction of both sectors a year earlier. An improved power supply boosted manufacturing’s growth to 7.8% YoY from 1.3% over the same period. An early end to the February-June 2010 rainy season and poor rains in 4Q10, due to the La Nina weather phenomenon, implies the growth momentum of the agriculture sector will be subdued in 2010. We thus expect real GDP growth to slow to 4.9% in 2011 from 5.3% in 2010.
Strengthening internal demand and expansionary fiscal policy will put upwards pressure on the current account and fiscal deficits over the next couple of years. Higher real incomes, on the back of a lower inflationary environment, will push up domestic expenditure, including the demand for imports. Moreover, an increase in commodity prices, particularly oil and food prices, will put upward pressure on the value of imports in 2011. Fuel and food make up 20% and 12%, respectively, of merchandise imports. On the fiscal front, the government’s capital expenditure programme and recurrent expenditure pressures imply there will be a wide fiscal deficit over the medium term. The capex spend also implies imports of high-value machinery and equipment. Both deficits are thus expected to remain north of 5% of GDP over the medium term.
Figure 70: Pressure on reserves from higher imports to weigh on shilling Shilling to exhibit a weakening bias
Kenya’s perennial current account deficit explains the propensity for the shilling to depreciate. Rising imports, on the back of strengtheninginternal demand, and increasing capital expenditure by the government imply a widening of the current account deficit over the next couple of years. Kenya’s foreign reserve position improved to about four months of import cover in 1H10 since its dip to just under the critical floor of three months, at which an economy is considered vulnerable to an exogenous shock, during the 2008/2009 drought. As the oil price is expected to trend higher in 2011 and as food prices are shooting up, Kenya’s import cover is expected to move to three to three-and-a-half months, and the shilling will come under pressure to depreciate. We expect the shilling to end the year at KES81.7/$1 from KES81.2/$1 a year earlier.
Source: Kenya’s National Bureau of Statistics, Bloomberg
Figure 71: Strengthening food price growth to pull up inflation
Source: Kenya’s National Bureau of Statistics
Inflation can only go up from here
Inflation slowed to a low of 3.1% YoY in October 2010, after peaking at 19.5% YoY in November 2008 during the 2008/2009 drought. A good harvest in 2010 supported the softening of food inflation from late 2008 into 1H10. However, deteriorating weather conditions, including an early end to the 1H10 rains, threaten to undermine food production. Strengthening food price pressures are thus expected to pull up inflation in 2011. A surge in global food prices and a fair probability of poor rains in 1H11 will translate into double-digit food inflation in 2011. A stronger oil price also implies higher fuel and transport costs in 2011, however, the low base of non-food inflation implies that it is likely to remain contained in the single-digit region. Alongside these price pressures is Kenya’s loose fiscal policy. Thus, we project inflation will average at 5.9% in 2011, up from 3.8% in 2010.
0
2
4
6
8
-15-10
-505
1015202530354045
2007 2008 2009 Jan-Aug2010
Real GDP growth, YoY% (rhs) Tea, mt (YoY%)Horticulture, mt (YoY%)
-10-9-8-7-6-5-4-3-2-10
2010 2011E 2012E
Government balance Current account balance
% o
f GDP
2
2.5
3
3.5
4
4.52006 2007 2008 2009 2010
60
65
70
75
80
85
KES/USD (rhs) months of import (G&S) cover
02468
101214161820
2007 2008 2009 2010 2011
Overall Food
% o
f YoY
Kenya Ratings (S&P/F): B+/B+
44
27 January 2011 Global economics outlook Renaissance Capital
Sources: Bloomberg, Central Bank of Kenya, IMF, Kenya’s National Bureau of Statistics, World Bank, Renaissance Capital estimates
Kenya: Key economic forecasts
45
Renaissance Capital Global economics outlook 27 January 2011
Figure 73: Exports growth soars on the back of higher prices and output
Source: Central Bank of Nigeria
Export-led growth on the back of higher oil price
A 24% YoY increase in the oil price combined with a 25% YoY increase in crude oil exports boosted Nigeria’s oil export earnings by 55% YoY in 2010. The strong recovery of exports, which constitute 40% of GDP, contributed to the acceleration of real GDP growth to 7.8% in 2010. Moreover, a 20% YoY increase in domestic oil production to 2.45mn bpd at the end of 2010 resulted in 4.0% YoY growth in the oil and gas sector in 1H10, compared with a contraction of 1.7% YoY a year earlier. Nigeria can potentially produce up to 3.0mn bpd. That, combined with our projection of an average oil price of $90/bbl in 2011, up from $80/bbl in 2010, implies that there is significant upside for oil production and consequently export earnings in 2011. This favourable outlook for oil combined with strong growth in trade and telecommunications, and solid growth in agriculture, has led us to forecast real GDP growth of 7.6% in 2011.
Figure 74: Private sector credit growth on the brink of recovery, YoY%
Source: Central Bank of Nigeria
Credit growth to stage a recovery
Credit growth began its modest recovery in 4Q10 after bottoming at 4.5% YoY in August, following the establishment of Asset Management Company of Nigeria (AMCON). The commencement of AMCON’s operations in November 2010, coupled with the revelation of the valuation methodology of banks’ bad debt, imply the removal of the margin loan overhang from the banking sector’s books, which was inhibiting lending, is imminent. Moreover, the government’s real economy reforms, including the establishment of funds that will provide single-digit interest loans to the power and manufacturing sector, and small and medium enterprises, are expected to support an increase in lending in 2011. We expect credit growth to accelerate to a sustainable 20-30% over the next couple of years.
Figure 75: Rebound of forex reserves to support stable naira
Source: Central Bank of Nigeria
No devaluation in 2011
In November 2010, we projected that the exchange rate will remain at NGN150/$1 in 2011. This was affirmed by the budget exchange rate of NGN150/$1 set in the 2011 Budget read by President Goodluck Jonathan in December 2010. We disagree with those that anticipate a devaluation of the naira around the April 2011 elections. Our view is that if the authorities did not bend under the pressure to devalue the naira in 2010, when forex reserves dropped by $11bn to $33bn at year-end, then they are unlikely to do so in 2011, when reserves are expected to recover. Forex reserves are already on an upturn and at mid-January 2011 they were higher than at the end of November 2010. Higher export earnings and stronger capital inflows are expected to support the reserves position and stabilise the naira. Moreover, import cover remains strong at above 10 months, compared with the recommended floor of three.
Figure 76: Sustained high food price pressures in 2011, % YoY
Source: Nigeria’s National Bureau of Statistics
Inflation to remain stubbornly high
Food prices are by far the largest source of inflation. They are responsible for about 60% of inflation, although food only constitutes one half of CPI. Strong food inflation is attributed to high distribution costs and imported inflation. Imported food constitutes 13% of CPI, which is higher than both transport, and clothing and footwear’s shares of the consumer basket. As global food prices are expected to exhibit their strongest increase since 2008 in 2011, food price pressures, particularly from imports, are set to escalate in 2011. Moreover, a higher international oil price implies upward pressure on fuel and transport costs, which has implications for distribution costs. Looser fiscal spending than expected by the government and significant fiscal injections related to AMCON are expected to add to the inflationary pressures in 2011. Therefore, we expect inflation to continue to elude the single-digit level and remain in the 11-12% region in 2011.
405060708090100110120130140150
-75-50-25
0255075
100125150175200
1Q06
2Q06
3Q06
4Q06
1Q07
2Q07
3Q07
4Q07
1Q08
2Q08
3Q08
4Q08
1Q09
2Q09
3Q09
4Q09
1Q10
2Q10
3Q10
4Q10
Exports, YoY% Bonny Light crude oil, $/bbl, QE (rhs)
0102030405060708090
100110
2006 2007 2008 2009 2010
115120125130135140145150155160
12131415161718192021
2007 2008 2009 2010 2011E
Months of import cover, 12M MA NGN/$ (rhs)
0 1 2 3 4 5 6 7 8
Food & non-alcoholic beveragesTransport
Clothing and footwearHealth
Restaurants & hotelsRecreation & culture
2009 2010
Nigeria Ratings (S&P/F): B+/BB-
46
27 January 2011 Global economics outlook Renaissance Capital
Sources: Bloomberg, Central Bank of Nigeria, IMF, Nigeria’s National Bureau of Statistics, World Bank, Renaissance Capital estimates
Nigeria: Key economic forecasts
47
Renaissance Capital Global economics outlook 27 January 2011
Figure 78: Rand mimicking comparable currencies Strong rand pivotal for economic outlook Despite the unprecedented ZAR99bn ($13.5bn) of bond and equity inflows into SA last year, we expect foreigners’ appetite for the currency to endure as long as the current global economic setting prevails. Rand strength is the key reason why SA inflation remains very subdued despite strong increases in commodity prices (food in particular) that have, since last year, forced some EMs to start hiking interest rates. The most likely catalyst for a turnaround in the rand and other high-yielding assets is US interest rate hikes, which the market expects only in 2012 (the assets will likely price this in pre-emptively). Until then, and in the absence of any global shocks, these assets should generally remain strong. This is a key underpin to the expectation that SA rates will not rise before 2012.
Source: I-Net Bridge, Renaissance BJM estimates
Figure 79: Broad-based robust growth Economic recovery accelerates In contrast with the softer economic growth expected in most regions, we expect SA growth to accelerate to 3.7% in 2011 (from an estimated 2.8% in 2010). The authorities assume growth of 3.4% (SARB) and 3.5% (government) with the market consensus at 3.4-3.5%. Household consumption should make a similar contribution to last year, but fixed investment’s role should improve hugely These themes should intensify into 2012, with growth of 4.2% pencilled in. While the market is sceptical about the support from credit growth in light of a historically high household debt/income ratio, we maintain our long-standing optimism in this regard given the supportive environment and low debt-repayment/income ratio. The recovery in corporate credit take-up will be delayed somewhat by corporates’ high cash balances.
Source: SARB, Renaissance BJM estimates
Figure 80: Low post-crisis debt Prudent and predictable monetary and fiscal policy
The market’s concern about a left-ward shift in policy was allayed last year with the tabling of a very prudent medium-term budget policy statement in October, in which revenue overruns were used to reduce the fiscal deficit and debt. But the government did not reduce its (foreign) borrowing accordingly, and instead used the opportunity to build forex reserves and created scope for the parastatals’ foreign borrowing in due course. The increased forex reserves, combined with exchange control relaxation, were the government’s key currency policy interventions. We maintain our view that market-unfriendly policies such as capital inflow taxes are not very likely. In contrast with some market participants’ fears, government recommitted to the inflation targeting regime. We do not attach a high probability to a departure from the prudent policy approach, despite political noise.
Source: Treasury, Renaissance BJM estimates
Figure 81: Relatively safe economy
Source: OECD, The Economist, IMF, National Treasury , Renaissance BJM estimates
Outlook risks mainly foreign
Figure 81 shows the comparative health of the SA economy using two key economic measures in a global context. The risks to SA’s benign macroeconomic outlook mainly emanate from abroad, including: a disruption to the global economic recovery, which will adversely affect domestic growth; a meaningful positive or negative global growth shock or marked increase in global risk aversion, which will likely weaken the rand and derail the benign inflation and interest rate projections; and a meaningful exogenous global inflation shock (such as bad grain crops that boost prices further), which might have stagflationary consequences for the global and SA economies. While the risk of another electricity shortfall in SA is non-negligible, our analysis suggests that it would only occur after a huge and unexpected supply disruption and we attach a reasonably low probability to this outcome.
020406080
100120140160180
31-Dec-06 31-Dec-07 31-Dec-08 31-Dec-09 31-Dec-10
Inde
x 200
7=10
0
ZAR HUF PLN TRYNZD BRL AUD
-4
-2
0
2
4
6
2008 2009 2010 2011E
%
Households Government GFCF Inventories Net exports
0102030405060
0123456
1990
/91
1992
/93
1994
/95
1996
/97
1998
/99
2000
/01
2002
/03
2004
/05
2006
/07
2008
/09
2010
/11
2012
/13
%%
Debt servicing costs (% of GDP) Debt (% of GDP, RHS)
Australia
Austria Belgium
CanCzech R.
Denmark
SAFrance
Germany
Greece
HUN Ireland
Israel
Italy
JapanKorea
Netherlands
NZ
Norway
Poland
PortugalTurkey
SwedenSwitzerland
UKUS
EU
ChinaRussia
Turkey
IndiaArgentina
BrazilChile Mexico
-15
-10
-5
0
5
10
15
0 70 140 210
Curre
nt ac
coun
t / G
DP
Fiscal debt / GDP
South Africa Ratings (M/S&P/F): A3/BBB+/BBB+
48
27 January 2011 Global economics outlook Renaissance Capital
Source: National sources, Renaissance Capital estimates
South Africa: Key economic forecasts
49
Renaissance Capital Global economics outlook 27 January 2011
Figure 83: Favourable agricultural harvest underpins strong GDP growth Another strong agricultural harvest in 2011 Zambia appears to be set for a third year of good harvests, following the bumper harvests of 2009 and 2010, owing to good rains in the first half of the 4Q10-1Q11 rainy season. Solid growth in the rain-fed agriculture sector is intrinsic to the rest of the economy because it is the livelihood of about 50% of the workforce, it determines food security, and it produces a sizeable share of national output (12% of GDP). Favourable harvests imply lower food prices and softer inflation, which in turn also means higher real household incomes. Manufacturing activity is also projected to strengthen in 2011 on the back of sound growth in agriculture, because half of the secondary sector comprises enterprises that add value to agricultural commodities; the other half adds value to minerals.
Source: Bank of Zambia
Figure 84: Copper price is on an incline Mining industry rides wave of strong copper price
Export earnings and the performance of the mining sector are expected to exhibit strong growth in 2011, on the back of a high copper price. Copper constitutes about 60% of total exports, while the mining sector generates 10% of GDP. The copper price increased by 25% in 2010 and surged beyond its previous high of $8,900/tonne in December 2010. Accelerating economic activity in the EM economies is expected to support high commodity prices in 2011. The cumulative volume of copper exports increased by 1.2% YoY in 2010, which is its strongest expansion in six years. The combined effect of a strong price and higher production was a 33% YoY increase in export earnings in 3Q10. The weak kwacha/copper correlation implies that the kwacha will not exhibit a sharp appreciation in tandem with a rising copper price in 2011.
Sources: Bank of Zambia, IMF
Figure 85: FDI boosts fixed investment Industry reels in FDI Zambia is among the top recipients of FDI in SSA largely due to its lucrative copper industry, but increasingly due to manufacturing. China alone is estimated to have invested $1bn in Zambia in 2010. Moreover, the southern African country is one of the few SSA countries that China has identified as a destination for special economic zones (SEZs). China has invested in two SEZs in Zambia; one serving the mining industry in the Copperbelt and the other being developed into a manufacturing-for-export hub near the capital, Lusaka. It is noteworthy that the manufacturing industry attracted the greatest share (40%) of the FDI pledged in 1H10, implying that FDI is diversifying away from mining. The entry of a Malaysian cellphone manufacturer into the manufacturing SEZ signals diversification away from the processing of agricultural and mining commodities within manufacturing.
Sources: Renaissance Capital estimates, UNCTAD, Zambian authorities
Figure 86: Low inflation owing to favourable outlook for agricultural output
Source: Zambia’s Central Statistical Office
Food inflation to subdue non-inflationary pressures
A two-year slowdown in food inflation to a low of 2.5% YoY in November 2010 explains the softening of headline inflation to within the government’s end-2010 target of 8% YoY. Good rains in the first half of the 4Q10-1Q11 rainy season suggest that food security will be sustained in 2011 and, as such, prices will remain benign. However, strengthening oil prices are projected to manifest as higher inflation. Zambia’s landlocked position results in higher energy prices pushing up distribution costs. Non-food inflation, which moved sideways in 2010, is thus projected to increase in 2011 on the back of higher fuel, transport and distribution costs. However, we expect low food inflation to subdue non-food inflation and contain headline inflation in the single-digits region. The downside risk is poor rains. Monetary policy is expected to remain accommodative owing to weak credit growth.
Sources: Bloomberg, Bank of Zambia, IMF, Zambia’s Central Statistical Office, World Bank, Renaissance Capital estimates
Zambia: Key economic forecasts
51
Renaissance Capital Global economics outlook 27 January 2011
Figure 88: Mining output elevated by strong commodity prices and increasing volume
Source: Robertson Economic Information Services
Mining – the engine of the economy
We project the mining sector will be the fastest growing economic sector in Zimbabwe. Mining output presently constitutes 7% of GDP, however, double-digit growth over the medium term is expected to boost its output to 12-13% of GDP by 2015. Strong commodity prices and increasing fixed investment in the industry are set to propel the sector’s growth to new heights. This is significant because minerals make up two-thirds of Zimbabwe’s exports, equivalent to one-third of GDP. The recovery of existing gold mines, recent diamond discoveries and increasing output from platinum group metals have all contributed to the increase in the sector’s activity. Going forward, new gold mines are to be opened and a significant coal-bed methane discovery is to be developed. Increased earnings from mining will improve the forex available for producers to import capital equipment and raw materials, as well as augment liquidity.
Figure 89: Distribution of loans and advances, September 2010
Source: Ministry of Finance
Higher export earnings = higher liquidity
Higher export earnings in 2011 will help ease liquidity in Zimbabwe’s credit-squeezed economy. Deposits in the banking system increased by $1bn between January and September 2010, reaching $2.3bn. The increase in deposits, which was equivalent to the improvement in forex earnings over the same period, enabled banks to increase their lending by $0.66bn to $1.42bn. The critical productive sectors of agriculture, manufacturing and distribution were the largest recipients of credit at the end of September 2010. Improving liquidity implies that the access productive sectors have to working capital is increasing. However, long-term capital remains scarce and, in most instances, has to be sourced from abroad. The underperformance of the construction sector is largely attributed to the dearth of long-term capital.
Figure 90: SA is Zimbabwe’s biggest source of imports
Source: IMF
Strong rand to subdue demand for SA imports
A stronger rand on average in 2011 compared with that of 2010 is expected to inflate the cost of importing goods and services from SA. Local producers are expected to use this opportunity to increase their shelf space in local retailers’ shops. This should further boost the performance of the manufacturing sector, which grew by an estimated 20% in 2010. While the dampening effect of a strong rand on consumer goods is positive for the current account, its impact on inputs and capital goods will have negative implications for manufacturers that depend on significant amounts of imported inputs. The decline in raw material supplies in recent years has compelled producers to import inputs from SA. An increase in manufacturing’s procurement costs may undermine the sector’s growth momentum.
Figure 91: Non-food inflation to strengthen in 2011
Source: Robertson Economic Information Services
Benign inflation outlook
Non-food inflation will rise in 2011 on the back of a higher oil price, which will push up fuel prices and transport costs. Food inflation is expected to peak during the lean harvest of 1H11, slowing thereafter as harvesting begins. Nevertheless, the inflation outlook remains benign owing to the low base effect. The downside risks to inflation include a surge in global food prices and higher labour costs. As Zimbabwe is now a net food importer, an increase in global food prices will put upward pressure on inflation. Wage increases may compel some manufacturers to pass on increased costs of production to consumers, which is likely to translate into higher inflation. As consumers have the option of substituting local produce with imported goods, retailers may choose to stock their shelves with imports instead of local produce, depending on the cost implications of a stronger rand.
0123456789
1011
2010 2011 2012 2013
% o
fGDP
Distribution21%
Agriculture 21%
Manufacturing21%Services
10%
Households8%
Mining7%
Construction2%
Other10%
South Africa62%China
6%Botswana
4%
US3%
Zambia3%
Malawi3%
Kuwait2%
India2%
DRC1%
UK1%
Germany1%
Other12%
-20
-15
-10
-5
0
5
10
15
Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10
Food Non-food Overall
%Yo
Y
Zimbabwe Ratings: Not rated
52
27 January 2011 Global economics outlook Renaissance Capital
Source: National sources, Renaissance Capital estimates
Zimbabwe: Key economic forecasts
53
Renaissance Capital Global economics outlook 27 January 2011
Figure 93: Turkey's bust and boom cycle Bust and boom The economy's ‘bust and boom’ was typical of the experience throughout the 1990s and 2000s. From around 7-8% growth in 2010, a slowdown in 2011 is very likely, with the range of market forecasts running from 3.9-5.5%. We sit at the top end of these forecasts because 1) elections in 2011 suggest the government will not be very restrictive until later in the year; 2) interest rates are very low and, despite restrictions on credit growth to households, lending may remain fairly high; 3) investment could perform strongly, as banks still have good loan/deposit ratios; and 4) exports have the potential to improve in 2011 given eurozone demand and a somewhat weaker lira. Consensus assumes 4-5% growth in 2011 and 2012, and for 2012 we broadly agree but foresee risks from higher interest rates, less government spending and current account limitations.
Source: Turkish statistical office, Renaissance Capital estimates (2010-2012)
Figure 94: Exports slow, energy bill rises Current account deficit is the key long-term problem The widening of the current account deficit is surprising even by Turkish standards. As of October 2009, the rolling 12-month deficit was $12bn. By November 2010, it had nearly quadrupled to $45bn. Two factors suggest we should be relaxed about this: 1) Turkey always runs a deficit, and 2) at 6% of GDP in 2010, the deficit is in line with the 2006-2008 average. In part this reflects Turkey's near-total dependence on energy imports and, given the rise in energy prices in 2010 relative to the year before, a wide deficit was to be expected. The reason we should be concerned by the deficit is that export growth has slumped from around 20% YoY export growth in 2Q10 to around 6% over July to November. This does not fit with the stronger numbers from central Europe, which benefited from Germany's strong industrial performance. Unlike consensus forecasts of a $50bn deficit in 2011, we assume at least $53bn.
Source: Turkish statistical office, Renaissance Capital estimates (2010-2012)
Figure 95: Covering the current account deficit Covering the current account deficit The widening current account deficit is not just a Turkish issue. Other energy importers from India to Thailand or Kenya will be facing similar challenges. Our base assumption is that the demand for EM assets should see an inflow of capital into local bonds or equity that will cover this deficit, while external debt might also rise. Portfolio inflows were the theme of 2010 for Turkey. But investor disquiet at the unorthodox Turkish policies at present could result in an outflow, keeping the currency under pressure, which does seem to be the authorities’ intention, and today a weakening currency is a key risk to our current forecasts. Over the medium term, an AKP election victory could pave the way for more FDI, an inherently more secure form of external financing.
Source: Central Bank of Turkey
Figure 96: Opinion polls point to another AKP victory
Source: Metropoll via CEE MarketNews
AKP re-election expected in 2011
The AKP has been one of the most reform- and market-oriented governments in the EEMEA region since winning power in 2002. Its re-election victory in 2007 is expected to be repeated again this year. This is likely to be taken more positively by the markets as long as it is not dependent on a junior coalition partner; historically coalitions in Turkey have not produced good government.
The challenge for the AKP will be in sustaining its reform and market drive for another term in office. This is nearly always a challenge for governments that have been in power for so long. But still, the economic experience of the team in place suggests markets will welcome the AKP's re-election.
Note that, in terms of EU membership, few now believe Turkey could join the Union before 2020 (if ever). We see the process as having minimal importance.
-40-30-20-10
010203040
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
E20
12E
GDP % change YoY Investment % change YoY
-100-50
050
100150200250
Jan-
07Ap
r-07
Jul-0
7Oc
t-07
Jan-
08Ap
r-08
Jul-0
8Oc
t-08
Jan-
09Ap
r-09
Jul-0
9Oc
t-09
Jan-
10Ap
r-10
Jul-1
0Oc
t-10
Exports, 12M Imports, 12M C/A balance, 12M$bn
-60
-40
-20
0
20
40
Jan-
07Ap
r-07
Jul-0
7Oc
t-07
Jan-
08Ap
r-08
Jul-0
8Oc
t-08
Jan-
09Ap
r-09
Jul-0
9Oc
t-09
Jan-
10Ap
r-10
Jul-1
0Oc
t-10
C/A balance, 12M Net FDI, 12MNet equity flows, 12M Net local debt flows, 12M
27 January 2011 Global economics outlook Renaissance Capital
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Disclosures appendix
69
Renaissance Capital Global economics outlook 27 January 2011
Renaissance Capital equity research distribution ratings Investment Rating Distribution Investment Banking Relationships* Renaissance Capital Research Renaissance Capital Research Buy 163 40% Buy 4 57% Hold 60 15% Hold 3 43% Sell 17 4% Sell 0 0% Under Review 12 3% Under Review 0 0% Suspended 0 0% Suspended 0 0% Restricted 0 0% Restricted 0 0% Unrated 151 37% Unrated 0 0% 403 7 *Companies from which RenCap has received compensation within the past 12 months. NR – Not Rated UR – Under Review
Renaissance Capital research team
Head of Equity Research David Nangle +7 (495) 258-7748 [email protected]
Name Telephone number Coverage Name Telephone number Coverage Equity Strategy Oil and gas Charles Robertson +44 (207) 367-8235 Global Ildar Davletshin +7 (495) 258-7770x4971 Russia/CIS Ovanes Oganisian +7 (495) 258-7906 Russia Irina Elinevskaya +7 (495) 258-7770x5662 Russia/CIS Vitaliy Shushkovsky +38 (044) 492-7385x7145 Ukraine Dragan Trajkov +44 (207) 367-7941x8941 Africa, MENA Herman van Papendorp +27 (11) 750-1465 South Africa Gerhard Engelbrecht +27 (11) 750-1454 South Africa Leye Adekeye +234 (1) 448-5300x5386 Sub-Saharan Africa Media/Technology/Real estate Macro and Fixed income research David Ferguson +7 (495) 641-4189 Russia/CIS, Africa Charles Robertson +44 (207) 367-8235 Global Anastasia Demidova +7 (495) 258-7770x4040 Russia/CIS, Africa Anton Nikitin +7 (495) 258-7770x7560 Russia/CIS Johan Snyman +27 (11) 750-1432 South Africa Ilya Zhila +7 (495) 258-7770x4582 Russia/CIS Anastasiya Golovach +38 (044) 492-7382 Ukraine Telecoms/Transportation Kassymkhan Kapparov +7 (727) 244-1570 Central Asia Alexander Kazbegi +7 (495) 258-7902 Global Lyubov Nikitina +7 (495) 725-5229 Russia/CIS Ivan Kim +7(495) 258-7770x5620 Russia/CIS, Africa Mikhail Nikitin +7 (495) 258-7789 Russia/CIS Alexandra Serova +7 (495) 258-7770x4073 Russia/CIS Rita Tsovyan +7 (495) 258-7770x4516 Russia/CIS Johan Snyman +27 (11) 750-1432 South Africa Elna Moolman +27 (11) 750-1462 South Africa Busi Radebe +27 (11) 750-1473 South Africa Utilities Mamokete Lijane +27 (11) 750-1471 South Africa Derek Weaving +44 (207) 367-7793x8793 Russia/CIS Yvonne Mhango +27 (11) 750-1488 x1488 Sub-Saharan Africa Vladimir Sklyar +7 (495) 258-7770x4624 Russia/CIS Banking Luxury goods and tobacco David Nangle +7 (495) 258-7748 EMEA Rey Wium +27 (11) 750-1478 Africa Milena Ivanova-Venturini +7 (727) 244-1584 Central Asia Svetlana Kovalskaya +7 (495) 258-7752 Russia Quantitative analysis Armen Gasparyan +7 (495) 258-7770x4964 Russia Renda Rundle +44 (207) 367-8240 South Africa Kirill Rogachev +7 (495) 258-7770x4015 Russia Ilan Stermer +27 (11) 750-1482 South Africa Small and medium cap Naeem Badat +27 (11) 750-1431 South Africa Jeanine Womersley +27 (11) 750-1458 South Africa Adesoji Solanke +234 (1) 448-5300x5384 Sub-Saharan Africa Medium cap/Transport/Construction/Building materials Chemicals/Engineering/Building materials John Arron +27 (11) 750-1466 Africa Mikhail Safin +7 (495) 258-7770x7550 Russia/CIS Carmen Gribble +27 (11) 750-1474x1474 South Africa Paper Adriana Benedetti +27 (11) 750-1452 South Africa Consumer/Retail/Agriculture Natasha Zagvozdina +7 (495) 258-7753 Eastern Europe, Russia/CIS Diversified industrials/Support services/Packaging Ulyana Lenvalskaya +7 (495) 258-7770x7265 Eastern Europe, Russia/CIS Ceri Moodie +27 (11) 750-1459 South Africa Konstantin Fastovets +38 (044) 492-7385x7125 Ukraine Robyn Collins +27 (11) 750-1480x1480 South Africa Regional research Rohan Dyer +27 (11) 750-1481x1481 South Africa Mbithe Muema +254 (20) 368-2316 East Africa Anthea Alexander +263 (772) 421-845 Southern Africa Metals and mining Ruvimbo Kuzviwanza +263 (7) 88-317x8795 Southern Africa Rob Edwards +44 (207) 367-7781x8781 Global Akinbamidele Akintola +234 (1) 448-5300x5385 West Africa Boris Krasnojenov +7 (495) 258-7770x4219 Russia/CIS Gbadebo Bammeke +234 (1) 448-5300x5367 West Africa Andrew Jones +44 (207) 367-7734x8734 Russia/CIS Ekaterina Gazadze +7 (727) 244-1581 Central Asia Jim Taylor +44 (207) 367-7736x8736 Africa Vasiliy Kuligin +7 (495) 258-7770x4065 Russia/CIS Ian Woodley +27 (11) 750-1447 South Africa Christina Claassens +27 (11) 750-1460 South Africa Emma Townshend +27 (11) 750-1463 South Africa
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