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Brexit – Impact on emerging markets
The surprise result of the UK referendum has led to major weakness in global markets.
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Mirza Baig +65 6210 3262
Given the relatively low direct links between EM countries and the UK, we expect a lower impact, although CEE countries have stronger ties.
We emphasise that G4 central banks are likely to remain dovish (if not more so given the implications of the vote), which should support EM assets generally. This may also allow EM central banks to further ease policy.
Wike Groenenberg +44 20 7595 8746
Gabriel Gersztein +55 11 3841 3421 Piotr Chwiejczak +44 2075958715 Andrew MacFarlane, CFA +44 20 7595 8827
The Brexit result has major implications for Europe, but the impact on EM is lower The UK has voted to leave the European Union by a relatively narrow margin of 51.9% – 48.1%, surprising the market (which was expecting a narrow ‘Remain’ victory) and causing dramatic moves in asset prices (see Charts 1 and 2). So far today, for example, sterling dropped over 10% versus the USD at one point, although it has partially rebounded since. In emerging markets (EM), assets have been affected by the broader market weakness, with the PLN and ZAR 4.2 – 4.5% weaker versus the USD at the time of writing, for example. In EM credit, CDX EM is 26bp wider, with CDS in CEE countries such as Croatia and Hungary widening by 35bp. The UK exit vote will have a largely indirect impact on most emerging markets. Aside from Central and Eastern Europe, trade links and fiscal transfers with the UK are small. What matters much more for EM is the availability of global USD funding as well as the health of the Chinese economy.
Chart 1: EM FX 1m implied volatilities 28
USDZAR
USDTRY
USDHUF
USDMXN
EURPLN
EURPLN
Chart 2: EM FX one-day moves vs USD (%) 5.0% 4.5% 4.0%
23
3.5% 3.0%
18
2.5% 2.0%
13
1.5% 1.0%
8
0.5% 0.0%
THB
SGD
INR
IDR
BRL
CLP
MYR
RUB
CZK
TRY
May-16
RON
Jan-16
KRW
Sep-15
COP
Source: Bloomberg, BNP Paribas.
May-15
HUF
Jan-15
MXN
Sep-14
PLN
May-14
ZAR
3 Jan-14
Source: Bloomberg, BNP Paribas.
G4 central bank liquidity should support EM assets We have previously argued that plentiful global financial liquidity is a positive factor for EM – this positive effect will be strengthened if G4 central banks add further liquidity to the global system to calm the financial markets. We expect the Bank of England to cut rates further, the ECB to extend its quantitative easing programme (QE) in September, and the Bank of Japan to add liquidity. Meanwhile, the Fed is less likely to hike rates over the coming year. Indeed, the markets are now pricing in just a 2% chance of a rate hike by December 2016, 25% chance of a rate hikes in August 2017 and no full rate hike until November 2018. And in the very near term, the markets are pricing in a 10% chance of a Fed rate reduction. As recently as last week, a full 25bp rate hike was priced in by May 2017. The plentiful and cheap availability of global USD liquidity is of critical importance to the pricing of EM assets (and those of the rest of the world), given the considerable rise in indebtedness in the past few years in EM (and the rest of the world); see Chart 3. Since January 2007, USD
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lending to EM countries has surged from USD 1.3trn to USD 3.2trn, according to BIS statistics (Chart 4). This is lending to EM corporates, households and sovereigns. Chart 3: A dovish Fed should support EM assets
Chart 4: USD credit to emerging markets 10 9
US Real 2y Rates (RHS)
600 550
7
0.5
6
450
0.0
400
-0.5
350
5 4 3
%
bp
500
8 1.0
USDtrn
EMBI Spread (LHS)
300
-1.0
2
250
-1.5
1
-2.0
0 Mar-00
200 150 100 Jan-10
Jul-02
Nov-04 Mar-07
Jul-09
Nov-11 Mar-14
-2.5 Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
USD credit outside of the US of which, USD credit to emerging markets
Source: BNP Paribas, Bloomberg
Source: BIS, BNP Paribas.
The currencies and EM bonds and credit that have been badly hit today are likely to bounce back and reverse part of their sell-off soon. This is likely in South Africa for example, a country that is very reliant on financial flows due to its large current account deficit (5% of GDP in Q1 2016) and negative FDI balance (1% of GDP), and which requires financial financing of a high 6% of GDP. Chart 5 shows the financing of South Africa’s current account, which is increasingly financed by other flows (which are banking sector flows that are reliant on global USD liquidity). This is in spite of the country’s well known structural problems, including low productivity and high real wage gains. Chart 5: South Africa balance of payments (in USD bn)
Chart 6: Corporate Eurobond gross issuance 600
Asia
CEEMEA
Latam
500 87 83
400
USDbn
85 134
300
112 107
62
200
40 350
62 100
0
Source: Macrobond, BNP Paribas.
65
26
43
65
74
55
35
34
2006
2007
17
8 39 13 2008
72
47
70
2009
2010
183
2011
217
2012
35
252
2013
2014
148
39 23 85
2015
2016
Source: Dealogic, BNP Paribas.
Asian currencies should also see a rebound, given their limited trade links with the UK and their high reliance on debt. Within EM, gross Eurobond issuance over the past 10 years has been the highest in Asia, particularly in corporates (Charts 6 and 7). Separately, Russia may well be a beneficiary, on the basis of the reduced likelihood of EU sanctions being extended during next year. EU sanctions were extended this week for the next 12 months and the country will be reviewed again by the EU in December. CEE countries are more directly linked to the UK The countries likely to underperform going forward are in Central and Eastern Europe. This is to some extent linked to these countries’ stronger trade links with the UK, as well as sizable links through EU fiscal transfers, than the rest of EM (see Table 1). Any downturn in the UK economy 24 June 2016 EM Strategy Plus
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would have a bigger impact on their exporting industries than on those of the rest of EM. Cars are a big export component in the case of the Czech and Slovak Republics and Hungary, and are therefore highly cyclical. Moreover, Central Europe would receive fewer subsidies from the EU at some point in the future if and when the UK reduces its payments to the EU (now at some EUR 7bn a year). We do not wish to overstate this issue, though, not least because the UK is expected to continue to pay into the EU budget for at least another few years, but also because many Central European countries run favourable balance of payments. For example, both Hungary and Poland run primary surpluses, in other words their current accounts plus FDI balances are in surplus. Hence, the pricing of their financial markets are not so reliant on these EU transfers, which to a large extent end up in the reserves of their central banks. More important for Central Europe than the direct link with the UK economy are their very strong trade and investment links with the EU. Heightened uncertainty over European stability and integration going forward is likely to affect investor sentiment towards Central Europe more than the rest of EM. Note that foreign participation in Hungary and Poland local currency debt markets is high at around 10% of GDP (EUR 44bn and EUR 11bn respectively, see Chart 8). These shares are bigger than their trade flows with the UK and their fiscal transfers from the EU. Chart 7: Sovereign Eurobond gross issuance 140
Asia
CEEMEA
Table 1: EM exposure to UK trade and EU budget
Latam GDP
120
EURmn Bulgaria Croatia
30 100 34
15
USDbn
80 20
24
16 61
60 40
46
15 52 6
20 0
27
36
37
58
9
40
30 23 8 2006
4 2007
20 5 2008
24 12
7
2009
2010
Source: Dealogic, BNP Paribas.
2011
34 19
14
2012
2013
18 2014
2015
10
% of GDP
Net payment from EU budget % of GDP
EURmn
Remittances from UK % of GDP
42,751 43,020
5,900 10,200
1.1% 0.4%
4.2% 0.4%
1,795 155
0.1% 0.0%
154,739
14,700
4.3%
1.9%
2,871
0.1%
Hungary
5,624
0.3%
104,239
10,600
2.9%
5.4%
Latvia
23,581
11,800
2.2%
3.4%
792
1.0%
Lithuania
36,444
12,400
2.5%
4.1%
1,501
0.6%
Poland Romania
410,856 150,230
10,700 7,500
2.7% 1.4%
3.3% 3.0%
13,481 4,485
0.2% 0.0%
75,561
13,900
4.4%
1.3%
949
0.2%
2.0%
758
0.0%
Slovenia
58
EUR
Czech Republic
Slovak Republic
63
GDP per capita Exports to UK
37,303
18,100
1.2%
Brazil
1,631,317
7,985
0.2%
India
1,924,081
1,490
0.4%
Indonesia
790,496
3,097
0.2%
1,053,133
8,298
0.2%
Singapore
269,404
48,710
1.1%
South Africa South Korea
288,015 307,700
5,245 25,760
1.2% 2.3%
Turkey
675,172
8,692
1.4%
Mexico
2016
Source: IMF, BNP Paribas, local authorities.
We may see more easing by certain EM central banks In terms of monetary policy in EM, a number of central banks were approaching the end of their easing cycles, but some may now ease more on the back of more dovishness by G4 central banks. Inflation in many EM countries is very low and economic growth is generally subdued. With regards low beta and low inflation currencies, we see the possibility of renewed central banks easing in Korea, Thailand, Singapore, Taiwan as well as in Czech Republic and in Hungary. For the high beta currencies, there is also scope for easing in some places. Examples are in Turkey, Russia and South Africa (in the latter, tightening is likely to be less than thought before). Note that we are in quite a different period than in 2H 2015 when EM currencies weakened following the China mini-devaluation. At that time, EM central banks in the high beta countries were not able to lower rates as USD liquidity was being tightened (on Fed rate hike expectations) and EM break even rates relative to G4 break even rates were widening (see Chart 9).
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In Latam, monetary policy is not likely to be influenced by the immediate fallout of Brexit. This is for various reasons including a very high interest rate differential versus the USD in some places, and hence a lower path of US interest rates and increased QE elsewhere does not matter much for them. The exception is Mexico where the currency has weakened significantly today on top of months of previous weakness and markets now price in almost 50bps in rate hikes next week (30 June). In order to prevent the MXN from depreciating disorderly and contain the second order effects of the potential pass-through, we see Banxico tightening next week. In the case of Brazil, we had anticipated substantial rate reductions over the next two years (by some 500bp, well above market expectations) and we see no reason to change our view given the limited currency move today and relatively smaller importance of global liquidity in the reaction function of the central bank. We think that increased confidence in local policies will keep the currency strong and permit inflation and inflation expectations to fall, and hence the central bank to lower rates substantially. Note also that foreign participation in local debt is low and the current account is close to turning into a surplus. Chart 8: Non-resident bond ownership as % of total bond ownership
Chart 9: 10y bond breakeven spreads over the US (15d moving average, in bp)
50% 45%
900
40%
800
35% 30%
700
25%
600
20%
500
15%
400
10%
300 Jan-15
5% 0% 2007
2008
2009
Hungary
2010
2011
Poland
Source: Macrobond, BNP Paribas.
2012
2013
Romania
2014
2015
Apr-15
Jul-15
Oct-15
South Africa
Turkey
Jan-16
Apr-16 Brazil
Turkey Source: Macrobond, IMF, BNP Paribas.
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Emerging Markets Strategy Contacts Wike Groenenberg
Global Head of EM Strategy
London
44 20 7595 8746
[email protected]
Piotr Chwiejczak
FX & IR CEEMEA Strategist
London
44 20 7595 8715
[email protected]
Erkin Isik, CFA
FX & IR CEEMEA Strategist
Istanbul
90 (216) 635 2987
[email protected]
Muhammet Sevim
CEEMEA Graduate
London
44 20 7595 1581
[email protected]
Stoyan Dogandzhiyski
CEEMEA Graduate
London
44 20 7595 1416
[email protected]
Mahesh Bhimalingam
Global Head of EM Credit Strategy
London
44 20 7595 8439
[email protected]
Andrew MacFarlane, CFA
Credit CEEMEA Strategist
London
44 20 7595 8827
[email protected]
Clara Leonard
Credit CEEMEA Graduate
London
44 20 7595 1424
[email protected]
Mirza Baig
Head of FX & IR Asia Strategy Singapore
65 6210 3262
[email protected]
Jasmine Poh
FX & IR Asia Strategy
Singapore
65 6210 3418
[email protected]
Jennifer Kusuma
FX & IR Asia Strategy
Singapore
65 6210 3263
[email protected]
Altaz Dagha
AU/NZ IR Strategist
Singapore
65 6210 4994
[email protected]
Gabriel Gersztein
Head FX & IR Latam Strategy Sao Paulo
55 11 3841 3421
[email protected]
Samuel Castro
FX & IR Latam Strategist
Sao Paulo
55 11 3841 3492
[email protected]
Gustavo Mendonca
FX & IR Latam Strategist
Sao Paulo
55 11 3841 3445
[email protected]
Production and Distribution Barbara Consuelo, London. Tel: 44 20 7595 8486, Email:
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