Brazil: Rising political risk in persistent recession
Brazil president Temer’s top congressional liaison was implicated in an influence peddling scandal. Government Secretary Lima resigned after former Culture Minister Calero claimed that he was pressured into authorizing a construction project that Lima had financial interest in. Temer himself was found guilty of violating campaign finance limits. Some opponents filed a request to open impeachment proceedings against Temer for committing an administrative crime by getting involved in a matter related to the private interests of Lima.
The lower house passed a watered-down package of anti-corruption measures and a constitutional amendment to cap fiscal spending, but it still needs to be passed by the Senate. The recent political developments could slow or even halt the government’s progress in passing reforms.
October municipal elections saw gains by the opposition PSDB. The ruling PMDB did not fare well, though not as badly as the PT, which was roundly punished for the same poor economic record and corruption that cost Rousseff the presidency. A lot can happen between now and the scheduled national elections in October 2018, but a poor economic outlook is likely to weigh on the ruling PMDB. Temer is not expected to run then, but his still-low popularity could weigh on his party’s candidate.
The economy remains in recession. GDP is forecast to contract by 3.4% in 2016 before recovering modestly to grow around 0.8% in 2017. Brazil’s central bank cut rates by 25 bp in October and another 25 bp in November. The bank will continue easing if inflation slows. Its easing cycle could be accelerated, but it will depend on both internal and external developments. The slower than expected pace of easing means that the recovery will most likely be delayed and perhaps shallower as a result.
Fiscal policy has been tightened, but recession continues to hurt revenues. October budget data was boosted by the one-off impact from the tax amnesty program, and the November and December data should revert to the worsening trend. Consensus forecasts see the budget deficit coming in around -9% of GDP in both 2016 and 2017, up (down?) from -8.2% in 2015.
The real has outperformed in EM, up 18% YTD in 2016 after -33% in 2015. The central bank should continue to adjust its FX swaps program as needed to help manage the currency. Our EM FX model shows the real to have WEAK fundamentals, so this year’s outperformance can be viewed as unwarranted.
Mexico: Tighter fiscal and monetary policies weigh on the growth outlook
Inflation pressures in Mexico are picking up due in large part to the weak peso. Headline CPI accelerated to 3.31% y/y in November, which is the highest since December 2014 and above the 3% target for the second straight month. PPI excluding oil rose 7.87% y/y while headline PPI rose 8.45% y/y in November. The weak peso is likely to boost price pressures and will require the Banco de Mexico to tighten in 2017. The bank has already hiked rates 50 bp at meetings in February, June, September, and November, followed by a December move.
The Mexican economy has been sluggish as Q3 GDP slowed to 2.0% y/y, the lowest growth since Q2 2014. Weak manufacturing continues to depress the growth, even as the service sector has also softened. Both fiscal and monetary policies have remained tight and will further weigh on the growth outlook. The budget deficit came in around -3.5% of GDP in 2015. It is expected to narrow slightly to around -3% this year and -2.5% in 2017, but this may be too optimistic in light of the weak growth trajectory.
The external accounts bear watching. Oil prices insufficiently rose to boost exports, but slow growth has helped reduce imports. The current account gap was around -3% of GDP in 2015, and is expected to remain around there in 2016 and 2017.
US President-elect Trump may pursue measures that threaten substantial disruption between US and Mexico. Though not our base case, the US could withdraw unilaterally from NAFTA, but it is still unclear whether US laws will require some sort of congressional approval. NAFTA needed to be passed by both houses of Congress. The Republican establishment wing typically favors free trade. Rather than exit NAFTA, Trump could simply try to renegotiate the terms. Either way, the risk of tariffs going up in both countries would be significant. Immigration was an important issue in Trump’s platform. The potential impact of immigration curbs may be limited since the size of the Mexican immigrant population in the US has stabilized in recent years. The peso remains fragile due not only to potential US policy changes under the Trump administration, but also from the risks to EM of rising US interest rates.
South Africa: Political uncertainty heightens downgrade risk
South Africa continues to face a period of political uncertainty. The opposition party Democratic Alliance raised a no-confidence motion for President Zuma in the parliament after the state corruption watchdog issued a report alleging that he may have abused his position to win state contracts for his friends, the wealthy Gupta family. Most members in the ruling party ANC have also blamed Zuma’s corruption scandals for the party’s poor performance in local elections in August. The recent ANC executive meeting reportedly discussed dismissing Zuma, but he could still escape both moves to oust him as the president.
The ANC under Zuma will likely try to boost fiscal expenditures in an effort to recover support, which would worsen fiscal condition and raise the risk that South Africa would be downgraded to sub-investment grade. S&P maintained its BBB- rating with negative outlook in December, but we still expect an eventual cut to sub-investment grade by at least one of the agencies in the coming months. All the agencies have cited the lack of economic growth as a major factor behind potential downgrades.
The South African economy (?) has been sluggish. Q3 GDP rose 0.7% y/y, which is the fifth straight quarter of below 1% growth. The South Africa Reserve Bank (SARB) expects growth of 0.4% in 2016 and 1.2% in 2017. Weak growth should enhance downside risk of government revenue and make it more difficult to cut expenditures.
Inflation pressures remain strong as October CPI rose 6.4% y/y, which is above the inflation target range of 3-6%. SARB has kept rates at 7.0% since March 2016 to stem inflation pressures. While the weak economy will likely preclude further rate hikes, we see no easing until well into 2017, if at all. The rand remains vulnerable to possible risk off sentiment, changes in US monetary policy, and concerns over rating downgrades, while it has been supported by high yields.
Turkey: The lira remains vulnerable to external conditions and political risk
The outflow from Turkey continues as $3.4 bln of Turkish government bonds have been sold by foreign investors since October. The central bank unexpectedly hiked rates 50 bp in November to curb these outflows and to help support the weakening lira. However, negative external conditions such as a rise in US treasury yields and higher oil price should continue to weigh on the lira.
The Turkish government under Erdogan has put much emphasis on growth, while the central bank tries to lower inflation pressures. Turkey’s banking regulator eased rules on non-performing loans after the government agreed to help commercial banks boost lending in an effort to revive the economy, which could lead to a weaker lira via an expanding money supply.
Improvement of Turkey external accounts has stopped due to rise in oil price and weak exports. Tensions with the EU, its largest trading partner, have ratcheted up as accession talks have stalled. The European Parliament voted to suspend talks with Turkey, while President Erdogan threatened to reopen its borders to allow refugees into Europe.
The Turkish economy faces recession risks as Q3 GDP contracted -1.8% y/y, the first contraction since Q3 2009. The coup attempt in July appears to have hurt the economy more than expected. Higher rates should continue to subdue private consumption and business investment.
Inflation pressures have come down as both headline and core CPI in November slowed to 7.0% y/y, at the top of the 3-7% target range. However, the weak lira is likely to continue feeding into higher inflation. The central bank will clearly be under pressure not to hike again while the government continues to pressure the central bank to cut rates.
China: Continued weak yuan with stable economy
The Chinese economy has stabilized in 2016, thanks to fiscal stimulus. GDP has grown by 6.7% y/y for three straight quarters. Q4 growth is likely to keep stabilizing as November manufacturing PMI rose to 51.7, which is the highest since July 2014. Exports, IP and retail sales remained steady in October and November.
However, the economy is likely to resume slowing in 2017. China’s president Xi has pursued economic reforms (so-called new normal), which moves to a consumption-led economy from one led by investments and exports. Consumption could slow due to weak income growth and strengthening inflation pressures. China’s PPI has accelerated, with November rising 3.3% y/y, the highest since October 2011. The government will need to keep up its fiscal stimulus to help struggling businesses in traditional industries, but it should also pursue supply side reforms, which could curb growth in the short-run.
The US election itself is a mixed blessing for China. Trade and currency issues will likely prove more contentious. However, to the extent that a Trump administration pulls back from global engagement and leadership, there may be less confrontation over human rights and freedom of the press, as well as China’s efforts to boost its regional hegemony.
The yuan has weakened against the dollar all year, but this has intensified since October. USD/CNY has traded above 6.90, the highest since June 2008. The currency is likely to be a flashpoint for the incoming Trump administration. As a candidate, Trump has claimed China is a currency market manipulator and could make this an official assessment early in his term. The Treasury Department, following Congressional legislation, has devised a framework with quantitative measures to better define manipulation. We have shied away from claims of a currency war, but this too can change. We do not expect a one-off devaluation in the foreseeable future, but continued weakness (though likely in line with wider EM FX) could keep US-China tensions high.