Brazil: The real still has many downside risks.

Brazil’s inflation pressures have eased as February IPCA slowed to 4.76% y/y, which is the lowest since September 2010. The Brazilian economy is still contracting but is about to touch the bottom. Q4 GDP decreased 2.5% y/y, which is the least negative growth since Q1 2015. The trade account remains firm. The February 12-month trailing trade surplus increased to $51.0 billion, the largest since the data started in 1995. Exports turned upward in H2 2016 with the rise in commodity prices, such as iron ore and bauxite. The current account is still in deficit but foreign direct investment fully covers it.

The Brazilian central bank, Banco Central do Brasil (BCB), continues to cut rates, easing by 200bp since October 2016. BCB is likely to keep cutting rates to support the economy in 2017. COPOM members see the inflation outlook developing favorably, while the economic recovery was delayed more than anticipated. In the most recent weekly economist survey by BCB, Selic rate is expected to drop to 9.00% by the end of 2017.

The outlook for Brazil’s fiscal condition remains uncertain. The Brazilian government has pushed through austerity measures, which include capping public spending and raising the retirement age from 54 years to 65 years as pension system reforms. Despite the reforms, the fiscal condition continues to worsen as primary budget deficit has been high even as January public net debt rose to 46.4% of GDP, the highest since September 2006. Tax revenue has been hurt by persistent recession. President Temer’s government has been unpopular due to the fiscal austerity, with its approval rate below 20%.

The real has been steady to firmer even after Trump’s victory in the US presidential election in November 2016. The real rose 3% YTD against the dollar, following a 22% rise in 2016. High yields, solid trade surplus, and expectation for fiscal reform should continue to support the real.


Mexico: Banco de Mexico lends support to the peso, but risks remain.

The Mexico economy has been sluggish as GDP growth fell to 2.3% in 2016 from 2.6% in 2015. The service industry remains steady, boosted by strong remittance inflow, but has been offset by weak manufacturing and construction. The mining sector continues to decline despite the rebound in oil prices. The economic outlook remains unclear. The likely renegotiation of NAFTA and potential implementation of tariffs on Mexican goods in the US should depress Mexican exports. The possible change in US immigration policy could weigh on remittance inflow to Mexico.

Inflation pressures have risen due to the weak peso. February headline CPI rose to 4.9% y/y, above the upper range of the inflation target (2-4%) and the highest since March 2010. The Mexico central bank has kept a hawkish stance to stem inflation pressures and to help support the peso. It has hiked rates by 325 bp since December 2015. The bank is likely to continue tightening monetary conditions, as it estimates inflation to continue rising until it peaks at 5.0-5.5% in Q2.

The Mexico government continues fiscal austerity in 2017. The public sector fiscal deficit is expected to fall slightly to 2.4% of GDP in 2017 from 2.6% of GDP in 2016. But lower growth and higher inflation could disrupt the government’s commitment to fiscal responsibility. It is likely to cut spending more than budgeted in order to remain in line with the fiscal targets.

The Mexico central bank revealed it would start to auction as much as $20 billion in foreign-exchange hedges to support the peso without decreasing foreign reserves. Some media reported the bank was considering requesting a swap line with the Fed to ensure adequate liquidity, although Governor Carstens denied it. The officials could announce new measures to support the peso if it comes under pressure again.

Weak fundamentals will persist in Mexico with a sluggish economy due to tightened monetary policy and fiscal austerity. Mexico’s trade account is unlikely to improve given uncertainties with respect to the US administration.

South Africa

South Africa: The rand continues to carry downside risks.

The South African economy has suffered from both persistently weak growth and high inflation. Q4 GDP rose 0.7% y/y, which makes 6 straight quarters of growth below 1%. Growth is likely to be restrained in 2017 too. Domestic demand is likely to be restrained by high interest rates, while net exports will continue to squeeze the growth due to high energy prices. The South African Reserve Bank (SARB) cut its growth outlook in 2017 to 1.1% from 1.2% in November last year.

Inflation remains high, though it has slightly softened. In January, South Africa’s core CPI slowed to 5.5% y/y, the lowest rate for the past five months. However, headline CPI rose 6.6%, which is still above the top of the central bank’s target range (3-6%). High inflation pressures should persist in 2017. Energy prices would be boosted by high oil prices, and food prices are likely to rise due to pestilence. A firmer rand could marginally offset these pressures.

The SARB has kept rates at 7.0% since March 2016. Some expect SARB may cut rates in response to weak growth, but others believe it needs to keep rates on hold due to high inflation. The South African government has stuck with fiscal austerity to maintain its investment grade ratings. The government will raise taxes in the 2017-18 financial year, mainly through higher income taxes and fuel levies. The government also plans to reduce expenditures in an attempt to narrow the consolidated budget deficit from an estimated 3.4% of GDP in 2016-17 to 2.6% by 2019-20. It is hard to envision the economy being supported by monetary and fiscal stimulus.

The political situation remains uncertain. South African President Zuma is due to step down as ANC leader in December and as president in 2019. But Zuma’s successor has not been decided and dissent within ANC is growing after it had its worst ever showing in regional elections in 2016. A frontrunner to succeed Zuma is his former wife and soon-to-be ex-African Union Commission chair, Nkosazana Dlamini-Zuma. She steps down from the AU post in January. Dlamini-Zuma has strong support in the party’s largest province of Kwazulu Natal. However, another faction within the ANC wants current Deputy President Cyril Ramaphosa to take the reins. Tensions between Zuma and Finance Minister Gordhan remain high. If Gordhan is forced out, the government could take on more populist, less traditional economic policies thought to be favored by Zuma.

The rand has been firmer, up 5% YTD after rising 13% in 2016. Yet South Africa’s fundamentals remain fragile due to weak growth, high inflation, and political uncertainty. The rating agencies have warned the budget plan is not credible, given persistent weak growth. Our own ratings model has South Africa at BB/Ba2/BB, and we expect downgrades to sub-investment grade this year. The rand continues to carry a high risk of a sudden fall.


Turkey: Fundamentals get worse as Erdogan consolidates power.

Turkey’s fundamentals have started to worsen again. Its inflation pressures have become stronger. In February, Turkey’s headline CPI accelerated to 10.1% y/y, the highest since April 2012.

Yet growth remains low, as GDP is expected to rise 2.2% in 2016 and 2.5% in 2017. Economic sentiments have deteriorated under high inflation, weak growth, and persistently high geopolitical risks. Turkish consumer sentiment has remained close to the global financial crisis low in 2009. Private consumption has been hurt by high inflation and deteriorating consumer sentiment. Turkish tourism continues to contract mainly due to deterioration in the security situation. The external accounts have stopped improving.

The Turkish central bank continues to lose credibility. It should tighten monetary policy but is unlikely to do so under President Erdogan’s pressure. In January, the central bank hiked the overnight lending rate by 75 bp and the late liquidity window rate by 100 bp but left the repo policy rate at 8.00% and overnight borrowing rate at 7.25%. Further tightening will likely be via the rates corridor and not the policy rate.

Turkey will hold a constitutional referendum on April 16, aimed at giving more executive powers to the president. President Erdogan has increased his power since the attempted coup on July 2016. The referendum suggests Erdogan will continue to build his power base. Erdogan could hold a snap election after the referendum in order to further consolidate power. The EU has been concerned about the authoritarian stance of Erdogan, which has led to increased tensions and decreased foreign direct investment. The opposition parties strongly oppose the constitutional reform and polls show the nation is split on the matter. Whatever the outcome, it seems Turkish politics will remain unsettled.

The lira has underperformed in 2017, even as most emerging currencies have risen against the dollar. Weak fundamentals and heightened political risks in Turkey should continue to weigh on the lira.


China: The economy is stabilizing.

The Chinese economy has stabilized since H2 2016. GDP growth slowed to 6.7% in 2016 from 6.9% in 2015, but touched the top of the government goal (6.5-6.7%). Its official manufacturing PMI has been above 50 since August 2016 and reached 51.6 in February, above the Q4 average of 51.4. Q1 2017 GDP is likely to grow by 6.7-6.8% and build a sense of reassurance that growth in 2017 could be over 6.5%, the official goal set at the National People’s Congress held in March. The government will support the economy by fiscal stimulus. It said fiscal deficit would be 2.4 trillion RMB in 2017, larger than the 2.2 trillion RMB in 2016.

Inflation pressures have strengthened mainly due to high oil prices and a weaker yuan. February China PPI accelerated to 7.8% y/y, the highest since September 2008. Its CPI fell to 0.8% y/y in February from 2.5% y/y in January, but it is distorted by the Lunar New Year holiday. Non-food CPI inflation remains over 2%.

The external account has worsened. The current account in Q4 2016 posted a $37.6 billion surplus, down 59.1% compared to Q4 2015. The trade account worsened to a deficit, $9.15 billion, which is the first deficit in the past 3 years. Exports remain weak while imports continue to expand. The capital outflows have persisted as the Q4 non-reserve financial account deficit was $187.2 billion, the biggest since the data started in 1998.

Chinese officials are prepared to come under strong pressures from the Trump administration. Yet Trump's strategy and policy adviser Stephen Schwarzman indicated in a recent interview that the US President is likely to temper his criticism of China. What Schwarzman hints at, and the media reports have expanded upon, is that diverse views are represented in the Trump cabinet and among his advisers. Those that are most rooted in liberal globalism are well represented among the economic advisers and cabinet secretaries. It does not mean they will carry all arguments and win all policy debates, but it does suggest that Trump’s hardline economic stances may be softened. 

The yuan continued to drop in 2016 and it has softened in Q1 2017. Officials have intervened to support the yuan, as foreign reserve decreased below $3 trillion in January before rebounding in February. Heightened tensions between China and the US and persistent capital outflow could weigh on the yuan, however.

South Korea

South Korea: Strong fundamentals continue to support the won.

South Korea’s external account remains strong. The current account surplus stayed over 7% of GDP in 2015 and 2016. January’s current account surplus decreased by 26.5% y/y but the full year surplus is expected to be over 6% of GDP in 2017.

The economy has improved but has downside risks. Q1 GDP is expected to rise 2.5% y/y, higher than the 2.3% y/y rise in Q4 2016. January discount store sales increased by 11.3% y/y, and the March business survey index in manufacturing rose sharply rise to 81, the highest since May 2015. But worsening relations with China and continued political uncertainty may weigh on the economy. Consumer confidence dropped to 93.3 in January, the lowest since March 2009, and stayed at 94.4 in February.

Inflation pressures are rising as CPI in January and February accelerated to around 2% y/y, the highest since October 2012. Inflation is likely to remain high with the improving economy, higher oil prices, and low base effects.

The Bank of Korea (BOK) is likely to take a wait-and-see approach in H1 2017. It said it will maintain its stance of monetary policy accommodation because the inflation pressures on the demand side are not expected to be high given the moderate pace of domestic economic growth.  However, we do think BOK may be forced into a more hawkish stance if inflation persists.

South Korea could remain under pressure from neighboring countries and domestic politics. North Korea launched four missiles in the sea bordering Japan, while South Korea alleges that Kim Jung-Un ordered the assassination of his half-brother in Malaysia. North Korea may intensify its provocative actions toward South Korea and Japan. Chinese officials oppose the US-built missile defense system, THAAD, which arrived at the Osan Air Base in South Korea in March. China told its travel agents to halt sales of holiday packages to South Korea in retaliation, and further measures are possible.

South Korea’s Constitutional Court upheld President Park’s impeachment due to political scandals. A new presidential election will likely be held on May 9, and polls suggest a candidate from the opposition Democratic Party is likely to win. If so, Korea could try to reset relations and take a more constructive approach with China and North Korea.

Strong fundamentals in South Korea and a less dovish stance by the BOK should continue to support the won.