The Korean economy has slowed. Q4 2017 GDP decreased 0.2% q/q, the first such decrease in 9 years. Gross fixed capital formation and net exports dragged on growth while private consumption remained steady. Despite this, the economy is expected to continue to grow. Exports are firm thanks to the steady global economy. Private consumption should continue to expand under solid employment conditions. The Bank of Korea (BOK) forecasts the economy to grow at around 3.0% this year, followed by another 3.0% in 2019.
The current account surplus peaked but has been steady despite a strong won and rising oil prices. The current account surplus of GDP is expected to continue dropping to 5.6% in 2017 and 5.2% in 2018. The foreign reserves continue to be at record highs.
Inflation pressures have been capped under the strong won and modest growth. South Korean headline CPI is expected to accelerate to 1.9% from 1.5% in 2017, while core is likely to move at 1.0-1.5% y/y.
Modest inflation pressure is likely to make BOK cautious with respect to additional rate hikes. BOK has kept rates at 1.5% since November 2017. BOK believes the current monetary policy stance is accommodative and emphasized that inflationary pressures on the demand side will not be elevated for the time being. BOK’s stance should make won appreciation gradual.
South Korean President Moon will meet with North Korean leader Kim Jong-un in late April. Kim also invited US President Trump to meet for negotiations over his country’s nuclear program. The meetings might serve as a catalyst for easing tensions, but it is likely that North Korea will continue to put pressure on both countries to get more concessions. Persistent regional tensions will continue to weigh on the won.
The won was strong in Q4 2017 and steady in Q1 2018. Strong Korean fundamentals should continue to support the won. BBH’s sovereign ratings model showed Korea’s implied rating steady at AA-/Aa3/AA-. Korea still faces very modest downgrade risks to S&P’s AA and Moody’s Aa2 ratings, while Fitch’s AA- appears to be on target.
The Indonesian economy continues to improve modestly. Its Q4 2017 GDP rose 5.19% y/y from 5.06% y/y in Q3 2017. Fixed investment and exports have been the main growth drivers. Building investments and infrastructure development have stayed firm, and non-building investments are expected to increase on improved business sentiment. The steady global economy combined with rising international commodity prices stimulated export growth. Accelerated government spending and stable household consumption backed by controlled inflation have also supported growth. The Bank of Indonesia (BI) expects the economy to grow in the range of 5.1-5.5% in 2018.
Indonesian external accounts have been deteriorating since mid-2017. The current account deficit was 1.7% of GDP in Q4 2017, the largest such deficit in 3 years. The capital and financial account surplus offset the current account deficit, but the balance of payments surplus shrunk last year to $0.974 billion in Q4 from $5.359 billion in Q3. BI sees a mix of monetary and macroprudential policies improving the performance of the balance of payments. BI projects the current account deficit in 2018 to widen due to higher imports on the back of the recovering economy and rising oil prices, but remain within 2.0-2.5% of GDP.
Inflation remains within the target range as Indonesian headline CPI has been below 4% since July 2017. A stabilized rupiah and anchored inflation expectations help curb inflation pressures. Higher oil prices may lift inflation close to 5% but modest growth should limit inflation expectations. BI expects inflation in 2018 to be within the target corridor of 2.5-4.5%.
BI has been cautious around US monetary policy normalization and inflation expectations. BI is likely to keep policy rates unchanged while growth is modest. BI sees the current policy rate as adequate to control inflation within the target corridor and maintain the current account deficit. It also says its monetary policy stance remains neutral.
The rupiah continued to rise in January but has been weakening since February. BI has expressed concern about recent rupiah weakness, and could take action if the moves become disruptive. In fact, BI has intervened in the market to support the rupiah. Widened current account deficits and modest growth would weigh on the rupiah, while stable inflation, positive real yields, and intervention by BI would continue to support it.
Brazil’s economy continues to recover. GDP continues to accelerate, and grew at 2.1% y/y in Q4 2017, the most growth since Q1 2014. Private consumption should consolidate with continued low inflation and improved labor conditions. Business confidence continues to improve and industrial capacity utilities have gradually risen on the back of the steady Chinese economy.
The external account has been in good shape. Last year, Brazil’s current deficit slightly declined to 0.5% of GDP in Q4 from 0.6% in Q3, representing the lowest level since Q1 2008. The deficit will expand to 1.4% in 2018. The inflow of foreign direct investments (FDI) has decreased with the 12-month total near $6.5 billion, the lowest amount since December 2013. Yet it could easily offset the current account deficits.
Brazil’s inflation pressures have been low and stable. Brazil IPCA has been below 3.0% y/y for 8 months. The Monetary Policy Committee's (Copom's) inflation projections, assuming interest and exchange rate paths extracted from its Focus Survey, stand around 4.2% for both 2018 and 2019.
The Brazilian central bank – Banco Central do Brasil (BCB) – cut rates by 25bp in February as expected, and suggested that the monetary easing process would be terminated. Yet low inflation and stagnant growth could cause monetary easing to continue. The BCB is expected to lower rates by 25bp in its March meeting, and to signal the end of its easing cycle at the next meeting in May.
The political situation remains unclear. After months of escalating violence in Rio de Janeiro, the Brazilian federal government placed the military in control of public security until the end of December. As the country’s constitution cannot be amended during the military’s operation, the pension reform bill, which requires revision of the constitution, will be postponed until the next government takes office. Primary fiscal deficits should reach 2.4% of GDP in 2018, and the next administration may kick the can on passing pension reform. The fragile fiscal stance is the main variable that should halt the cutting rate.
Brazil’s presidential and national elections will be held in October. The former President Lula has been leading but an appeals court upheld his conviction for corruption and money laundering and extended his sentence to 12 years. It seems increasingly unlikely that Lula will be able to run again for president. Excluding Lula, rightist lawmaker Jair Bolsonaro is leading, with Leftist candidates Marina Silva and Ciro Gomes behind him. They are closely followed by Centrist candidates Gerardo Alckmin and Luciano Huck.
Whoever wins the election, it will be hard to keep the fiscal and pension reform going. All candidates fully understand that the lack of support for current President Temer comes from his reform policies. If pension reform is not passed, the government needs to find further austerity measures for improving fiscal conditions. Without them, fiscal deterioration could lead to a weaker real, which would boost inflation and require monetary tightening. Externally, the threat of a tariff war and uncertainty around the number of hikes in the US should increase the real’s volatility.
The Mexican economy has slowed due to monetary and fiscal tightening. Its GDP has been below 2.0% y/y for three straight quarters. Monthly data in Q1 suggests that the economy has been stagnant mainly due to manufacturing. The average IMEF index level in January and February was lower than the Q4 2017 average, while the non-manufacturing index continues to rise gradually.
Inflation has started to ease finally. February Mexico CPI slowed to 5.34% y/y, which is the lowest reading in one year, in spite of high oil prices. Previously implemented monetary tightening and appreciation of the Mexican peso has lowered inflation pressures, while medium- and long-term inflation expectations stay around 3.5%.
The Mexico central bank, Banxico, has continued to hike rates since December 2015. The policy rate reached 7.5% in February 2018, with a total increase of 450bp since December 2015. Banxico mentioned that the higher target rate hinged on expectations of tighter monetary conditions in the US economy. Another rate hike cannot be ruled out if the peso comes under pressure.
The Mexican government has kept the fiscal policy prudent. The fiscal deficit has continued to shrink and will be 1.1% of GDP in 2017, down from 2.5% in 2016. Yet it could worsen to 2.3% of GDP in 2018. High oil prices should improve fiscal conditions, while fiscal austerity may be eased ahead of the national and presidential elections in July 2018.
The political situation remains unclear. Andres Manuel Lopez Obrador (AMLO), who leads the left-wing party, Morena, is still leading with around 30% support. PAN leader Anaya is following AMLO with around 20% support. Former Finance Minister Meade, who is the PRI presidential nominee, has slipped to the third position with 16% support. The next government is likely to push fiscal stimulus as fiscal austerity has been unpopular under current Mexican President Peña Nieto. If AMLO is expected to win, markets would react negatively.
NAFTA renegotiations with the US have been delayed without significant progress on contentious issues, and could continue to weigh on the peso. The seventh negotiating round will be held in April in Washington, DC.
The improving South African economy will be hampered in 2018. Its GDP rose 1.5% y/y in Q4 2017, and is expected to accelerate at around 2.0% y/y in Q1 2018. But capital investment remains weak despite improved business sentiment following the change in South Africa’s president from Zuma to Ramaphosa. Private consumption continues to grow but hiking VAT and rising inflation could impede household expenditures. The South Africa Reserve Bank (SARB) raised the growth outlook to 1.4% from 1.2% in 2018, and to 1.6% from 1.5% the following year, but these are still low levels. Weak growth would enhance the downside risk of government revenue, and make it more difficult to cut expenditures.
South African inflation continues to ease as core CPI slowed to 4.1% y/y, which is the lowest level since December 2011. SARB remains vigilant and sees CPI rising 4.9% in 2018 and 5.4% in 2019. A strong rand and limited increase in the electricity tariff would stem inflation, while high oil prices and hiking VAT and the sugar tax would boost inflation pressures. The survey by the South African government indicates its inflation expectations in 2018 marginally declined to 5.7% from 5.8% in 2017, remaining close to the upper end of the target range.
S&P and Fitch continue to rate South Africa’s long-term local currency as sub-investment grade. Moody's has kept South African debt on negative watch, which implies that it may downgrade the debt to junk if the Ramaphosa administration fails to improve the country’s fiscal position and commit itself to credible growth-enhancing policies.
The South African government’s proposed FY2018 budget includes hiking VAT from 14% to 15%. The fiscal deficit would narrow to 3.6% of GDP from 4.3% in FY2018 based on the proposal. Fiscal consolidation and improvement in the debt trajectory would support the rand, but the entire fiscal trajectory depends on the improved growth.
The rand is expected to remain vulnerable to the prospect of a credit rating downgrade and possible risk-off sentiments generated by political developments.
The Turkish economy has been strong. Its Q3 2017 GDP grew significantly at 11.1% y/y and Q4 2017 is expected to expand by 6.0% y/y. Industrial production rose over 7% in Q4 2017 and 12.0% in January 2018. Services and trade remain moderate while the tourism rebound bolsters economic growth. Domestic demand continues to expand. Private consumption growth is expected to slow in Q4 2017 following the expired tax incentives for home appliances and furniture. Machinery equipment investments have been improving since Q3 2017.
External demand has been supported by the EU, but the Turkish external account has started to deteriorate. Slowed exports, strong import demands, and high oil prices should expand the current account deficits. The 12-month total of current account deficits increased to $51.4 billion in January 2018, which is the highest level since April 2014. The current account deficit is expected to be 4.9% of GDP in Q4 2017, and 5.4% in Q1 2018, the highest it has been since Q2 2014.
Inflation pressures remain high in Turkey. Headline CPI shows two-digit growth since July 2017. Underlying trend indicators suggest core inflation remains elevated. The current elevated levels of inflation and inflation expectations continue to pose risks to the pricing behavior. Headline CPI rose 11.1% in 2017 and is expected to slow slightly to 10.0% in 2018.
Responding to high inflation, the Turkish central bank hiked the late liquidity window rate, which is a new policy rate, to 12.75% in December 2017. It suggests, however, that further monetary tightening is not needed as the current monetary policy has been tightened.
Relations between the US and Turkey remain strained. The US government could consider Turkey’s offensive stance against the Kurdish YPG as an obstacle to their anti-ISIS operations. The Turkish government might face further sanctions by US, which would block money inflow from the US to Turkey. The country’s foreign reserves have been low to protect against a credit crunch due to US sanctions. Its usable reserve for currency defense is only expected to be around $23 billion.
Moody’s downgraded Turkey a notch to Ba2 with a stable outlook. It mentioned an erosion of checks and balances under President Erdogan, the growing risk of an external economic shock, and Turkey’s large external financing needs. We see the potential for further downgrades by the agencies to actual ratings of BB/Ba2/BB+. BBH’s sovereign ratings model showed Turkey’s implied rating falling a notch to B/B2/B in Q1 2018.
The lira continues to underperform. It declined by 7.2% against the US dollar in 2017 and has been down 3.1% YTD in 2018. Turkey’s weak fundamentals should continue to weigh on the lira.
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