Brazil: Support for the real
The economy has finally come within sight of recovery. Markit Brazil composite PMI rose to 50.4 in April and May, which is the highest since February 2015. Q1 GDP rose 1.0% q/q, the first rise since Q4 2014.

he external accounts remain in good shape. The trade surplus is at the highest level since data started in 1991. The current account deficit will stay around -1% of GDP in 2017, down from -3.3% in 2015. The inflow of foreign direct investment has increased since H2 2016 and fully covers the current account deficit.

Inflation pressures continue to ease under weak growth and past tightening of monetary policy. May IPCA inflation slowed to 3.6% y/y, which is the lowest since May 2007 and well below the 4.5% target. The Brazilian central bank – Banco Central do Brazil (BCB) – has cut rates by 400 bp since October 2016. BCB is likely to keep cutting rates to support the economy in 2017, and the Selic rate is expected to drop to 8.50% by the end of 2017.

The political situation remains confused. Last month, local media reported President Temer approved hush money payments to jailed former House Speaker Eduardo Cunha. Temer’s administration, and Temer himself, denied alleged efforts to keep Cunha from testifying. We believe the Temer administration will have trouble keeping fiscal reforms on track, and so fiscal conditions are likely to keep worsening. The primary budget deficit could reach -3% of GDP this year from -2.4% in 2016. The heightened uncertainty regarding the speed of the process of reforms and adjustments in the Brazilian economy is still the biggest downside risk.
Slower inflation, high yields, and solid external accounts should support the real, but the poor economic outlook and political turmoil could largely depress it.

Mexico: Economic improvement, but weak fundamentals

Inflation pressures in Mexico have been strong as May CPI accelerated to 6.2% y/y, which is the highest since April 2009 and above the 2-4% target range. Mexico’s central bank (Banxico) has been vigilant about heightened inflation pressures. It unexpectedly hiked rates for the sixth straight meeting, by 25bp to 6.75%. The bank is likely to remain hawkish as it said it will pay attention to weak peso pass through and Mexico’s monetary posture relative to the U.S. It also said its monetary policy shifted from accommodative to neutral even after 375 bp of tightening.

The economy has started to improve as Q1 GDP rose 2.8% y/y, the strongest since Q3 2015. The service industry remains steady, boosted by strong remittance inflow, while manufacturing has accelerated, supported by exports. But the economic outlook is still unclear. Sluggish oil prices could encourage the government to keep tightening fiscal policy. Persistent monetary tightening will curb private demand. Uncertainty regarding US polices such as renegotiation of NAFTA, potential implementation of tariffs on Mexican goods, and possible changes to US immigration policy could weigh on the growth in Mexico.

The ruling party (PRI) narrowly won the elections in the State of Mexico, which is the most populous state in the country, and home of President Peña Nieto. The PRI has held the governorship of the State of Mexico for more than 80 years, but only got 34% of the vote, a decrease from 61% in the last state election in 2011. The PRI’s struggles in the gubernatorial election suggest a difficult campaign for PRI in the presidential election in 2018.

The peso has been firm since February under Banxico’s hawkish stance. But political risk and softening oil prices could weigh on the peso. Mexico’s fundamentals remain weak and Mexico’s rating faces downgrade risks. BBH sovereign ratings model showed Mexico’s implied rating fell a notch to BBB/Baa2/BBB compared to actual ratings of BBB+/A3/BBB+.

Philippines: A limit to inflation pressures needed

The Philippine economy has slowed in 2017. Q1 GDP rose 6.4% y/y, marking two straight quarters of slowing and the lowest growth since Q3 2015. Public expenditure has stalled and private consumption has weakened. Overall, the economy should remain robust. Philippine overseas remittances have improved on rebounding Middle East economies. An aggressive infrastructure budget may boost the growth in H2 2017.

The country’s external accounts have worsened. Its exports continue to expand while imports have been boosted by solid domestic demands and worsened net exports. The trade deficit also continues to expand as imports have been spurred by strong domestic demand. The current account is expected to be in deficit this year.
Inflation pressures have risen as CPI accelerated to 3.4% y/y in March and April before falling back to 3.1% in May. Inflation is still within the 2-4% target range, and the Philippine central bank – Bangko Sentral ng Pilipinas (BSP) – foresees it rising 3.4% in 2017 and 3.0% in 2018. President Duterte has named Deputy Governor Espenilla as the new governor of BSP, replacing Tetangco who will retire on July 3. Espenilla has worked at BSP for 35 years and is well respected in the financial community. BSP will continue to be vigilant about inflation pressures under Espenilla.

President Duterte placed the southern island Mindanao under martial law due to attacks by Islamic militants. Duterte warned he may expand martial law nationwide. Duterte’s brash attitude in diplomacy may discourage foreign investors from investing in the Philippines. It is the only emerging Asian country that has seen foreign equity outflows over the last twelve months.

Duterte’s economic policies are orthodox, however, as evidenced by the government expanding infrastructure investment to boost long-term growth. Duterte’s administration successfully obtained $6 billion in official development assistance from the Chinese government after bilateral meetings between Duterte and Chinese President Xi.

The peso has been fragile due to worsening external accounts and stronger inflation pressures. For a peso recovery, Philippine officials need to reassure markets that they will control fiscal loosening and limit inflation pressures.

Indonesia: Stronger export and investment performance, coupled with tenacious consumption

The Indonesian economy has gradually improved. Q1 GDP rose 5.01% y/y and Bank Indonesia (BI) expects the domestic economy to grow in the range of 5.0-5.4% in 2017, underpinned by stronger export and investment performance as well as tenacious consumption. Exports have boosted the economy, mainly caused by the improvement in global commodity prices. Government expenditures have also supported the economy as infrastructure project continue. Indonesia consumer expectations rose to 123.7 in April, which is the highest level since the data started in 2002.

Inflation pressures, while rising, have been kept within the 3-5% target range since November 2015. CPI accelerated to 4.33% y/y in May, the highest level since March 2016. Core CPI, which excludes government-controlled and volatile food prices, remains stable at below 4%. The muted growth has limited inflation expectations.
BI has been vigilant with respect to inflation and structural reform. It has kept rates at 4.75% since March 2016. It also said it will continue to strengthen coordination with the government to keep inflation within the target corridor and accelerate structural reforms to support sustainable economic growth.

Fiscal policy has remained prudent, although infrastructure spending by the government is likely to remain robust. A tax amnesty plan boosted revenues in 2016, but more needs to be done to widen the tax base. The budget deficit came in at an estimated -3% of GDP in 2016, little changed from 2015. It is expected to remain around -2.5% in both 2017 and 2018. S&P raised Indonesia’s rating to investment grade, in line with the other two main rating agencies. Moody’s and Fitch have a positive outlook on their assessments.

Indonesia’s balance of payments remains firm as it stood at $4.5 billion surplus in H1 2017. The capital and financial account surplus was $7.9 billion and in line with increased economic growth momentum and investors’ positive perception of the domestic economic outlook. It fully offset the current account deficit recorded at $2.4 billion.

The rupiah has been stable since this year started. Controlled inflation, relatively high rates, and ratings upgrades should continue to support the rupiah.

South Africa: Political uncertainty weighs on rand

Inflation pressures in South Africa have fallen. CPI inflation returned to the target range in April, slowing to 5.3% y/y, which is the lowest level since December 2015. Steady rand and weak demand have curbed inflation expectations. While the South African Reserve Bank (SARB) revised its inflation outlook favorably over the near-term, it kept the longer-term inflation outlook unchanged as it expects inflation will remain over 5% in 2018 and 2019.

Growth remains sluggish as GDP is expected to rise 1.0% in 2017 and 1.6% in 2018. The credit rating downgrades to sub-investment level have weighed on domestic investment and consumer sentiment.

The SARB has kept rates at 7.00% since March 2016 but one Monetary Policy Committee (MPC) member voted for a 25 bp cut in May and April. The bank has suggested the tightening cycle was over but it is unlikely to cut rates in July. Inflation stays close to the upper limit of the target range and Governor Kgnayago will serve as a barrier to cut rates with his hawkish bias.

The government has kept to fiscal austerity, at least until now. The 2016/17 budget deficit is expected at 3.8% of GDP, which is lower than government’s estimation at 3.9%. But the government might expand fiscal deficits to boost the economy. President Zuma reshuffled his cabinet and named Gigaba to replace Gordhan as finance minister in March. Gigaba said he will use the National Treasury to push for inclusive economic growth.

The political situation remains uncertain. Zuma is due to step down as ANC leader in December and as president in 2019. While some executive members in the ruling party ANC tried to remove Zuma, he has survived. He is also likely to survive the no-confidence motion in parliament but is still facing mounting pressures from not only ANC but also the opposition parties. Deputy President Ramaphosa is favored as the next president by the markets, while Zuma favors ex-wife Dlamini-Zuma. Zuma wants to confirm the next president would not imprison him after his term ends.
The rand has been firm since February 2016 under higher rates. South Africa’s fundamentals remain fragile due to weak growth, high inflation, and political uncertainty. The rating agencies have warned that the budget plan is not credible, citing persistent weak growth. Our own ratings model has South Africa at BB/Ba2/BB. The rand continues to carry a high risk of a sudden fall.

Poland: Inflation pressures may weigh on the zloty

The Polish economy has picked up. GDP rose 4.0% y/y in Q1, the highest since Q4 2015. The growth is driven mainly by increasing consumer demand which has been supported by steady labor conditions and benefits disbursement. The Polish central bank – Narodowy Bank Polski (NBP) – forecasts GDP will rise 3.7% in 2017.

Headline inflation has stabilized near the bottom of the 1.5-3.5% target range and core inflation remains low. Inflation pressures from the demand side have been stalled despite growing employment and wages. NPB expects inflation will remain at 2% in both 2017 and 2018.

NPB has kept rates at 1.50% since the last 50 bp cut in March 2015, and is unlikely to start hiking rates this year. NPB said the risk of inflation running persistently above the target in the medium term is limited. Governor Glapinski said there might not be a need to hike rates until the end of 2018.

Fiscal conditions have marginally worsened with expanding government spending. The fiscal deficit is expected to widen to -2.9% of GDP in both 2017 and 2018 from -2.4% of GDP in 2016. Moody’s up¬graded its credit rating outlook to A2 from negative to stable in May.

The zloty continues to rise against the dollar and the euro. Steady Polish growth under low inflation has supported the zloty. However, a dovish stance by NPB should lead to strengthening inflation pressures and may weigh on the zloty.

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