The State of the Economy, Post 2Q2016

Investments, be it bond, equity, multi-assets in foreign countries are exposed to special risks, including currency fluctuations, economic instability and political developments. In certain economies, however, the heightened risks are due to limited number of players in the market, lesser liquidity and lack of business or economic frameworks to support the market. Acknowledging that the investments are susceptible to these risks and uncertainties, therefore it is important to be aware of the happenings in the world.

Brexit

No one has thought that Brexit would actually happened came morning of 23^rd June, but happened it did. Now it’s the time for Britons to wake up and face the consequences.

Post Brexit we could see switching activities happening in the fixed income market, where investors sold their Euro/UK sovereign holdings and went down the credit curve hunting for EM bonds. This activity has indicated investors reaction towards uncertainties in the market and their search for higher yield but relatively safe investments. EM economies have fared better than 2015 due to slight rebound in commodities’ prices, currencies strengthening, and better economics numbers. Post Brexit we could also see that EM had experienced minimal volatility, signalling that the EM economies are sheltered from the downside risks imminent in the Eurozone and have thus far performing more in line with their economic fundamentals.

This is important, especially after disappointing returns since 2013, the investors are pondering the possibilities that the market is set for better EM returns over the next few years.

UK, with its stagnant economics, currently runs the highest current account deficits in the developed world. Now that there’s no turning back for UK, we could anticipate a breakup in the country via Scottish and Irish referenda. Market believes that there is a higher chance for BoE to further cut rates and ECB to extend its QE this year.

Question is, will there be a EU breakup?

Failed coup d’état

There was an attempt of coup in Turkey on 15^th July and it has been thwarted and the Turkish government has had full control of the situation on Saturday. That said coup was not the first to Turkey as there have been multiple coup attempts in the past 60 years

As for sovereign risk, the event has sparked more downside risks to the government bond and credit ratings. The rating agency, Moody’s, will have its Turkish rating review on the 5^th August, in which if they decide on a downgrade, it would then push the sovereign rating to junk, from the current Baa3/Negative. Both S&P and Fitch rated Turkey as BB+/Stable and BBB-/Stable.

Finally, a cut!

On the domestic front, there was an overnight policy rate cut, a first since July 2014. It was during the monetary policy committee meeting held on 13^th July where the new central bank governor has decided to cut benchmark policy rate by 25bps to 3.00%. The cut happened post Brexit, where it was likely that the central bank took advantage from the delay in the Feds interest rate normalization policy.

However, this cut also came as a surprise for many, as economists predicted the cut to materialise in September or later, due to minimal forward guidance to indicate that such a hike was imminent.

Major indicative reasons for the cut; subdued inflation where it gives policy room for loosening, downtrend in consumer and business confidence as well as low and stable inflation in the environment of low global energy and commodity prices. Immediate impact post OPR cut could be seen on sovereign bond where the mid to long tenor had seen the biggest yield drop, resulted in bullish flattening of the yield curve. However the impact was not large per se, as the market has earlier priced in the possibility of rate cut, where yields have fallen by 30-60bps across the curve ytd. Ensuing this, the corporate bond’s behaviour may follow the fall in government bond yields.

Overall, adjustment to the OPR level is intended for the degree of monetary accommodativeness. After all, neighbouring countries in the region are also cutting the interest rates. Interesting thing to note that contrary to textbook theory, MYR has strengthened post cut. The reason could be due to inflows of foreign investments (mainly in the mid tenure of MGS) as the market is anticipating for further cuts in the following months.

 

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Potential amidst slowdown

This is a classic case of a country that gains from another one that’s losing.

India has now become the investor’s emerging market darling, given the slowdown in the country’s closest competitor, China. Both countries form parts of BRIC grouping, that is Brazil, Russia, India and China. Given the slowdown and political risks permeating Brazil and Russia, the investors have shifted their investment focus to the remaining 2 countries. However, China has been experiencing economic slowdown, aided by reduction in demand as well as production growth, India seems likely as the next investment destination. For once, due to the plunge of oil price, India’s inflation has slowed and current account deficit has narrowed. India’s economic growth is outpacing that of all other large nations at around 7.5%. Meanwhile, the other members of BRIC have all lost momentum.

Half of India’s massive 1.25 billion population is 25 and under, implying a robust future workforce. According to IMF, Indian economy expands by 7.5%, beating China since 1999. It is also predicted that by 2030, its labor force may increase to 300 million, equal to countries like Germany, Spain, Italy and French combined.

The growth and development in India are largely dependent on president Narendra Modi’s vision, where he’s paving the way for growth by allowing foreign investment in railways and has also raised the limit for foreign ownership in defense and insurance industries. He’s also fond for telling the investors, “a red carpet, not red tape” awaits them.

demokrasi terpimpin

Soe Hok Gie, karakter dari filem Gie, lakonan Nicholas Saputra ada mengutarakan konsep demokrasi terpimpin, di mana filem itu menyerlahkan Gie, seorang demonstran, sebagai lancang mengkritik ideologi politik ini yang pertama kalinya diperkenalkan oleh bapak Presiden Sukarno. Menurutnya demokrasi terpimpin adalah sebagai topeng untuk menindas golongan bawahan, iaitu berdasarkan elemen autocracy di dalam konsep tersebut. Pada amatannya, sistem ini telah menggagalkan masyarakat, di mana rakyat hidup semakin melarat dengan kenaikan harga barang dan juga bahan api. Perlu diingat zaman Soe Hok Gie ini merupakan zaman parti komunis berleluasa di Indonesia.

He was famously quoted to say this about his teacher who failed him,  “Guru model begituan, yang tidak tahan dikritik boleh masuk keranjang sampah. Guru bukan dewa dan selalu benar. Dan murid bukan kerbau”.

I can resonate this statement with a number of situations. Especially where teachers who think they are right all the time and leave no room for constructive arguments/discussions. I can’t recall how many times I was shunned by the teachers for voicing out, disagreeing and at times even just by asking questions. But more on this in a separate post.

Berbalik kepada konsep demokrasi terpimpin. Coming across this concept has brought my memories back to this one time in Bali in September 2014 where I had the chance to befriend a local Balinese surfer. I asked him about the local projects being developed in Jakarta, including the MRT line. Told him that it’s good that Indonesians will soon be able to commute using rapid trains. His short reply was, korupsi semua itu.

Not that his opinion is profoundly mattered, knowing him, doubt that he reads or understands economic needs and nature of a country. But still, its interesting that he thinks of every development projects in Jakarta is corrupted.

Which brings to my next point, nationalism. Where art thou?

Mahasiswa yang terdahulu, baik dari negara Indonesia mahupun Malaysia, berjuang atas semangat nasionalisme, iaitu sayangkan negara. Masyarakat ketika itu sering berfikiran kritis dan radikal. Tindak tanduk perjuangan sering berlandaskan semangat cintakan negara, yang well at that time Indonesia and Malaysia were infested with communism.

Bagi aku kita perlu punya rasa takut, yakni takut akan hilangnya nilai perjuangan untuk mengangkat masyarakat dan negara kepada keadaan yang lebih baik. Apa yang aku elakkan ialah manusia sekeliling yang berfikiran jumud, for them are lazy dan selalu mengikut sahaja.

Masalahnya sekarang rakyat semakin kritis, sering mempersoalkan dan mengutuk tindak tanduk kerajaan / pemimpin. Namun atas dasar apa? Patriotisme atau sebaliknya? Jika dilihat apa sahaja tindakan kerajaan akan dikritik sepenuhnya oleh rakyat yang pada pengamatan aku tidak faham / malas untuk memahami dasar-dasar, terutamanya dasar ekonomi negara.

Early 2016 Market Update

The time has finally come for certain countries to adopt negative interest rate policy, moving further from zero interest rate policy. Japan has on 29 Jan announced a surprise deposit rate cut to negative, resulting in a benchmark rate of -0.1%. Initially this policy serves as an effort to weaken the yen in order to stimulate an investment shift to other asset classes. The JGB yields have fallen, which was expected as a result from the cut. However instead of weakening the yen, the currency rallied against USD, citing an impact from global slowdown and weak growth in China. BoJ still persistence in further cutting the interest rates as long as it is necessary to achieve an inflation target of 2%.

For central banks in the Eu and Japan, after years of ultra low and even negative rates as of now, its still unclear whether further easing is actually helpful to the economy.

China on the other hand, has eliminated quotas for foreign institutional investors in a bid to encourage local currency bond buying. This is considered as part of major deregulation process by the chinese government. At about USD 6 trillion, China bond market is the third largest in the world, but foreign investors only hold about 2% of the market. Opening of the bond market is also aligned with the PBoC’s effort to encourage Chinese companies to finance themselves in the local corporate bond market, where in turns to be less relying on China shadow banking system.

Besides that, PBoC has cut its reserve requirement by 50bps as to support growth. Malaysia’s central bank has also cut the statutory reserve requirement of 50bps to 3.5%, in an effort to stimulate liquidity in the market.

Rating downgrades for several countries, particularly Brazil, Bahrain, Oman, Saudi and Kazakhstan. Major reason cited by the rating agencies, among others, is the concern over the impact of extended low oil prices on the countries’ finances. Other than that, several commodity-related issuances also faced rating downgrades, particularly due to reason of high gearing level and also deteriorating cash flow debt protection level by the issuers.

From this, we predict for a sub trend global growth as our base case, low global GDP and inflation level, further slowdown in China and weak commodity prices. We havent seen the bottom of crude oil price yet. With the Iranian sanction being lifted-off, oil could depreciate further as supply increases.

sluggish times ahead?

The US Fed had its first rate hike in almost a decade in Dec 2015, which appears to be tightening very late into the economic cycle and amidst declining corporate earnings in the US. With strong Dollar and subdued inflation currently permeating the economy, it seems that now is the year of policy divergence, i.e the US is tightening while the rest of the world easing.

In contrast, ECB continues to enhance its QE program and Japan struggles to grow out of deflation. The regions currently are operating in a negative interest rate environment.

Commodity slump affecting emerging market economies, along with capital outflow, tightening liquidity and weak currencies. These factors ascertaining a challenging 2016 for Asian emerging market economies, particularly the countries that have built the economies to serve China commodities demand.

Asia GDP growth will continue to decelerate in 2016 as a result of high debt, excess industrial capacity and poor external demand. In some Asian countries, the debt levels have reached more than 150% of GDP. Japan for instance, its debt level has now reached near 400% of its GDP. Malaysia’s debt is now over 200% of GDP and surprisingly Indonesia is below 100% level.

Interesting updates have emerged beginning of 2016, where Malaysia’s central bank has cut the statutory reserve requirements (SRR) from 4% to 3.50%, as an effort to increase liquidity in the market and also serves as a credit creation measure. The market now anticipates further cuts throughout 2016, with a probable OPR cut towards the end of 2016. As of December 2015 the foreign holdings of the govt bonds including the t-bills was around 46%..

In an effort to pump money into the market, Japan BoJ has also cut its interest rate. In which it turns out to be a good news for emerging market economies, whereby investors could be seen shifting to EM in searching for higher yields. EM countries, particularly Indonesia, India and Mexico are leading in terms of foreign inflows in their government bonds so far in 2016. In Indonesia, the majority of foreign inflows occurred after Bank Indonesia reduced policy rates by 25bp in January 2016.

2016, as everyone predicts, will be another year of sluggish growth for the global economy as well as volatility in the bond market.

3Q2015 Market Updates

So many things happening in the past 4 months or so.

Here’s the snippets

Market has been crazy volatile in the months of August and September. Lots of bond sell downs in the emerging market space, where and especially malaysia that wasnt spared from it. a combination of global risks, weak inflation and tighter financial conditions encourage the monetary policy heading to year end more dovish that before. on top of that, the emerging market assets have weakened largely due to commodities slump, slowdown in China (growth forecast below 7%?), strength in dollar as well as the possibility of US’ Feds policy tightening

Oil price again plummeted to below $50 level. Coupling that with slowdown in China and devaluation of yuan, have brought ringgit down to 17 years of historical low against dollar. It was crazy.

But as they say, whatever goes up must come down. Now we see market has somewhat less shaky, given that the US’ Feds ‘delaying’ interest rate hike and the market has also managed to price in the rate hike up until 1Q next year. Currently the US dollar position has also calmed a bit that brought ringgit level up a bit.

Brent crude oil hovers at below $50 level which serves as an indicative level for revenue generation forecast for the country. Now analysts are expecting the level will go up to $70 starting only in 2017 onwards. Hence, 2016 continues to be a volatile year.

Expectations from the market:-

• Further targeted stimulus by PBoC on China stability
• Abenomics aint working, sorry Mr. Abe. Japan is viewed to be facing a possible relapse into recession. Given that S&P has cut Japan rating to A+ from AA- in September due to economic support for Japan’s sovereign creditworthiness has continued to weaken in the past three to four years. Plus they are also in view that the govt’s economic revival strategy is not able to reverse the deterioration in the next few years.
• US’ Fed hike by year end, up by 25bps. If not, then by 1Q2016.

Honestly none of analysts and economists I met is positive for 2016, at least for the first half. I’m not seeing any bright spot either.

Weakening Ringgit, Strengthening Dollar

Global and domestic developments are affecting the volatility of Ringgit movement. Global developments would include the investor expectations relating to monetary policies of major central banks and the trends in crude oil and gas prices, where domestic factors include concerns about government linked entities and ratings related issues.

Ringgit has been underperforming against the strengthening US dollar, being Asia’s second worst performer YTD, behind Indonesia, where asian currencies tend to move together against the stronger USD. The pressure on MYR is largely driven by sentiments, rather than fundamentals. The analysts are expecting bad times for the country as well as the whole Asian region, at least until the second quarter is over. For countries under the emerging market space, it seems that only Eastern Europe where the growth has been picking up, but things arent looking that bright in the larger European space, with potential UK and Greece’s exit from Europe. Asia and latin america are both equally been under pressure due to weakening currencies and growth slow down, but on the positive side, most of the Asian countries are benefiting from lower oil price and less inflationary pressure. So yeay to other Asian countries but not Malaysia.

More bad news it seems with Fitch is said to be on track to downgrade the sovereign rating as short term view on Malaysia is not so positive, particularly on the debt ceiling and contingent liabilities. Their next review is due by end of July 2015 and until then, we just hope that the market has priced in the impact. As I talk to few fund managers, they’re currently staying away from our credit papers, due to the foreseeable risk of downgrade and MYR uncertainties.

While external developments are beyond the control of any open economy, every effort needs to be undertaken to bring about resolution to the domestic issues that confront our economy. Once these issues are resolved the performance of the currency is expected to be consistent with our sound economic fundamentals and growth prospects.

 

Emerging Market : Indonesia Growth Target

Not So Fast: Why Indonesia Could Miss Growth Target in 2015

by Andrew Janes

http://www.bloomberg.com/news/articles/2015-02-03/not-so-fast-why-indonesia-could-miss-widodo-s-2015-growth-goal?hootPostID=926458c71835f4370b3156be36c64991

 

(Bloomberg) — Indonesian President Joko Widodo says Southeast Asia’s biggest economy can achieve the official growth target of 5.7 percent this year. That could be a taller order than he anticipates.Widodo, who took office in October, inherited an economy fettered by years of under-investment in infrastructure, plunging commodity prices and the withdrawal of U.S. monetary stimulus. The central bank has kept monetary policy tight to protect a vulnerable rupiah and gross domestic product probably grew 4.9 percent last quarter from a year earlier, the slowest pace since 2009, according to a Bloomberg survey.

The president, known as Jokowi, is promising to rev things up by fast-tracking large road, port and power projects and cutting red tape. He’s seeking to woo investment and boost non-commodity exports, targeting an expansion of as much as 6.3 percent to 6.9 percent next year.

“We are confident to have the target of our economic growth” of 5.7 percent this year, the president said in a Feb. 2 interview in Jakarta. “But we must increase our exports volume and we must reform our bureaucracy. We must invite FDI.”

Yet the World Bank sees Indonesia growing 5.2 percent this year and 5.5 percent in 2016. The economy probably expanded 5.06 percent in 2014, according to a Bloomberg survey ahead of data due Feb. 5 in Jakarta. Here are five things that could stand in the way of Indonesia’s growth goal for this year.

Commodity Prices

The prices of Indonesia’s key commodity exports may not recover anytime soon. Coal has fallen further this year and has now more than halved in price since the end of 2010. Palm oil capped the biggest January decline since 2010 as demand weakens amid a supply glut, after slumping 16 percent in the past year.

While the plummeting price of crude presented Jokowi with an opportunity to scrap gasoline subsidies, it will also sap government revenue.

The state will lose about 158.8 trillion ($13 billion) of revenue because of the drop in oil prices, according to a Nomura Holdings Inc. research note last week by economists including Euben Paracuelles in Singapore. That negates much of the 230 trillion rupiah of budget funds freed up by the fuel subsidy overhaul.

Sticky Deficit

Indonesia was dubbed one of the fragile five emerging-market economies by Morgan Stanley in 2013 because its large external deficit made it vulnerable to capital outflows. While the shortfall in the current account has narrowed from a record 4.4 percent of gross domestic product in the second quarter of that year, Bank Indonesia is forecasting a deficit of 3 percent to 3.5 percent of GDP this year, compared with an estimate for about 3 percent in 2014.

The big infrastructure projects being promised by Jokowi could spur imports, putting pressure on the balance, according to Ndiame Diop, the World Bank’s lead economist for Indonesia. This persistent deficit makes it more difficult for Bank Indonesia to follow global peers in cutting borrowing costs to bolster economic growth.

Standard Chartered Plc said most of its Indonesian clients see the central bank holding or increasing its policy rate in 2015, according to a note released Feb. 3.

Implementation Risks

The stand-off between Indonesia’s police force and its anti-corruption agency, the KPK, has dominated local media in recent weeks. A failure by the president to show strong leadership could undermine his credibility for pushing ahead with economic reforms and cracking down on graft.

“There could be a rippling effect,” the World Bank’s Diop says. He also points out that about 50 percent of the central government budget is actually managed by sub-national governments, raising the possibility that the implementation of infrastructure and social spending will be slower than expected because of the difficulty in transmitting policy from the top.

Global Risk

The global economy is unlikely to provide much support to Indonesia this year, with weaknesses in Japan, Europe and China, Indonesia’s largest export market. Meanwhile, a recovery in the U.S. is forecast to prompt the Federal Reserve to raise interest rates, reducing the appeal of higher-yielding assets in emerging markets like Indonesia.

“This is going to be a very tough year externally,” Mari Pangestu, a former Indonesian trade minister, said in an interview with Bloomberg Television on Wednesday.

A strengthening U.S. economy and slowing growth in China is a “bad combination” for Indonesia as commodity prices will probably keep falling, said Benedict Bingham, the International Monetary Fund’s senior resident representative in Jakarta.

Time Lag

The economic overhaul being promised by Jokowi could take time to benefit the economy. Large infrastructure projects may take a while and the goal of lifting non-commodity exports is dependent on increasing the supply of skilled labor.

“Whether we can actually roll out the infrastructure projects fast enough is really the big question mark,” said Pangestu. “The concern is about implementation.”

The government also needs to review its trade and labor policies, which look more defensive rather than focused on winning global market share, according to Bingham.

“2015 needs to be seen as a year in which the foundations for the medium-term strategy are set,” he said. “It’s not going to be a year where the pay-off from this strategy is going to become immediately apparent.”

 

Strengthening of fiscal policy?

Malaysia’s sovereign risk profile compares poorly to rating peers on the fiscal side. Accelerated by the drop in oil price and weakening ringgit. Being an oil exporting country, it has to absorb a large terms-of-trade shock and face greater fiscal and external vulnerabilities.

Further hike in OPR is expected in 2H2015, probably after the implementation of goods and services tax (GST) in April. Statistically speaking, housing credit has remained pretty stagnant over the last few years, whereas personal loan and vehicle loan are on the rise. I think such unhealthy situation like this wont warrant the central bank to further increase the interest rate this year. Furthermore with the recent implementation of GST, which would normally gives a profound impact to the economy especially within its few months of implementation.

The increase in government’s development expenditure (as announced in the budget 2015) is expected to boost GDP in 2015 due to development expenditure has a higher multiplier impact on the economy relative to government’s operating expenditure.

One thing for sure, 2015 aint going to be a good year for the economy. Say on the currency front, there are analysts who predict that the ringgit might go down to 3.80/dollar level by year end. That is quite a scary possibility. Last week we could see there had been a slight increase for ringgit, 3.62/dollar, but that was expected due to the issuance of the dual tranche $1.5bil sukuk wakalah. By next week the rate could go back down again, we shall see.