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.

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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.

Driving forces behind EM currencies

Much has been talked about the Malaysian Ringgit downward movement against the US Dollar. As to date MYR is the worst performing currency against USD in the Emerging Market (EM) space, comprising of countries in the regions of LATAM, Asia (Malaysia included) and MENA,

Therefore to understand such currency behaviour, I’d gather few notes hoping that’ll be able to clear the confusion on this

One reason explaining why EM currencies behaving dismally versus the USD is due to not a single EM central bank has engaged in quantitative easing (QE) practices, as done by other developed central banks, like the US, Europe and Japan. Similarly not a single developed central bank has bought EM assets as part of their QE programmes.Thus, EM assets along with their currencies, have in effect suffered in a state of benign neglect. Apart from that sentiment also mirrors the destination of QE flows, where the EM countries have experienced a slowdown in their share of financial flows – even outflows in some cases.

The strong USD has also pushed down commodity prices, which has benefitted the majority of EM countries, sans Malaysia, being an oil exporting country. However, in a market that rarely distinguishes between EM countries and tends to focus on the negative stories, even the lower commodity prices have reinforced the EM scepticism. USD rally was predicted based on the view that the US economy would grow faster and that the Fed would hike sooner than the other developed countries. Market has been expecting the hike since beginning of the year. However now the USD has became so strong that, at the margin, it is impending growth and influencing Fed policy in a dovish direction. When the Fed failed to hike the rate in September, of which citing the reason of slowdown in external markets, the USD has become the victim of its own success.

The reason as to why we haven’t seen a rally in EM currencies is due to no serious outright downward pressure on USD; where there is absent in US inflation and also due to volatility of EM FX.

Some positive news for EM currencies..

Firstly, EM currencies are cheap after four years of unrelenting depreciation. Secondly, if the USD now flat-lines, the expected annual depreciation of EM currencies will also be less, probably closer to zero per year than -10% per year of the past few years. Having said that, 2016 is still expected to be benign for EM currencies and bond market, where it is only forecasted to rebound in the year 2017 onwards.

 

 

 

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.”

 

Stronger dollar and higher rates

Fed rate normalisation

Most analysts are forecasting an increase in fed fund rate and tightening of US monetary conditions, perhaps by second half of 2015. This move will impact  Asian countries, being the large recipients of QE flows and thus vulnerable to sudden stops in the flow.

Further to this, China slower growth and weak imports, as opposed to US’ stronger import would dampen Asia’s export recovery.

Data from Bank of America Merrill Lynch

 Look where Malaysia is?

On the eastern side, Abenomics have failed to achieve the objectives (the three arrows) and Japan is thus likely to be in deflationary state. With the current state of low oil price, Japan as net energy importer would benefit from it, and BOJ has thus lowered its CPI forecast to 1% which has suggested that further monetary easing would be necessary. Subsequent to this yen is expected to go lower to 130 by year end (source: ABN Amro) and putting downward pressure on prices which in turns may delay their inflation target this year.

US is certainly benefiting from potential rate hike and stronger dollar. As we can see in the recent years there is a continuous upbeat in the US economy.

Certainly there are many more areas to look at, Malaysia for example as the exporter of oil impacted by the fell in oil price which has prompted the government to revise its 2015 budget. Greece crisis and Eurozone issues at large are another angle to look at which certainly have impacts on the global growth this year. On the other hand, Indonesia, India and Philippines are enjoying growth and positive outlook, stemming particularly from the policy revision, rebound in government spending and fiscal reduction pledge by their respective governments.

Bleak Market

I am so worried. In fact we are all jumpy in the trading room. Ringgit has fallen so badly in the last few weeks, making it the worst performing currencies in the region. Stock index has also shifted down so quickly (reasons unknown to us. could it possibly just because of oil price?)

More importantly bond market is expected to follow the downward pattern soon. In emerging market we can already see the impact of stronger dollars as opposed to the weakening emerging market currencies. Russia ruble has dropped so badly, its worst condition in 16 years. We have exposures to bonds in Russia and therefore this has hit us in terms of market value quite badly.

Why is this happening at the last stretch of 2014, nobody knows.. This worrying market condition is also the reason why I’m typing this at the office at 9pm tonight. Got to finish up some papers on this tonight. Sigh…