Emerging Markets Radar (August 20, 2012)

Sunday, August 19th, 2012

Emerging Markets Radar (August 20, 2012)

Strengths

• Malaysia’s second quarter GDP accelerated to 5.4 percent year-over-year, higher than the consensus 4.6 percent. CPI for July fell to 1.4 percent from 1.6 percent in June, lower than the consensus 1.6 percent.
• Chinese premier Wen Jiabao said China has more room for stimulus policies since inflation has come down. He also told local business people and government officials in Zhejiang province that the economy is stabilizing.
• China railway investment for the next five months is expected to be about 50 percent higher than the amount invested in the same period last year.

Weaknesses

• Indonesia’s current account deficit widened sharply to $6.9 billion or 3.1 percent of GDP in the second quarter. The Bank of Indonesia (BI), therefore, tightened monetary policy by raising the deposit facility rate by 25 basis points to 4 percent which will push up the interbank borrowing rate. BI also strengthened the loan-to-value ratio to 70 percent for housing and vehicle loans.
• China’s July power demand grew 4.5 percent, lower than the 5.4 percent total demand growth year-to-date. Industrial power demand continued slowing.
• Taiwan’s second quarter GDP contracted 18 basis points, more than the estimate of 16 basis points.

Opportunities

• According to research from ING, the dividend effect on stock outperformance is healthy in emerging Europe and is most prominent among Turkish stocks, some of which pay close to a 10-percent dividend.
• Prior to ex-date, the dividend effect is driven by interest from high-yield equity funds. Post the ex-date, the dividend effect exists due to: 1) cheapness on a P/E basis; and 2) a dividend reinvestment effect into the stock and sector.

• Recovery in Property Transaction Should Improve Cash Flow for Chinese Developers

  The chart below shows July’s housing transactions have picked up on a yearly basis. This will help cash flow for developers, and also reduce inventories. The housing market needs further inventory reduction before new starts can go up.

Threats

• The much hoped for bank reserve ratio reduction by the People’s Bank of China has not arrived. Liquidity tightness in the banking system has affected new loan growth, which will slow the growth recovery of the economy.
• As European policy-makers return from their usual long holiday, the German constitutional court may rule against current transfers.
• Republican and Democratic conventions in the U.S. may reduce the opportunity for compromise on the fiscal cliff.

Tags: Bank Of Indonesia, Basis Points, China Railway, Chinese Premier Wen Jiabao, Current Account Deficit, Dividend Reinvestment, Emerging Europe, Emerging Markets, Equity Funds, Five Months, Housing Market, Interbank, Outperformance, Premier Wen Jiabao, Property Transaction, Quarter Gdp, Value Ratio, Vehicle Loans, Wen Jiabao, Zhejiang Province
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Global Manufacturing PMI (Sept 2011): U.S. Shines in Suffering Global Manufacturing Sector

Wednesday, October 5th, 2011

Growth in the global manufacturing sector is on the brink of contraction. The global manufacturing PMI that I calculate on a GDP-weighted basis for the major economic regions fell to 50.1 in September from 50.4 in August, while the JP Morgan Global Manufacturing PMI fell to 49.9 from 50.1. The U.S. ISM Manufacturing PMI masks the state of the manufacturing sector elsewhere around the globe, though. The gauge jumped to 51.6 in September, indicating acceleration in growth from a paltry 50.6 in August.

While Germany is still showing signs of growth the recession in the rest of the Eurozone’s manufacturing sector is deepening. However, it seems as if the contraction in Italy is easing somewhat, but France, the second largest economy in the Eurozone, is sliding fast. In contrast, the manufacturing sector in the U.K. has managed to grow again after contracting in August. The cold spell has spread to emerging Europe as well, with Poland leading the way as growth in its manufacturing sector is close to stalling. Turkey was the exception as its manufacturing sector is growing again.

Asian countries are also suffering. China was the major disappointment as the CFLP Manufacturing PMI only managed to rise by an abysmal 0.3 percentage points to 51.2 in a month that is normally a very strong month from a seasonal perspective. The result was that my seasonally adjusted CFLP PMI fell 2.1 percentage points to 50.1 and therefore indicates that growth in China’s manufacturing sector has stagnated. It had a severe ripple effect on the rest of Asia. Growth in India’s manufacturing sector slowed sharply, while the contraction in Taiwan, South Korea and Australia deepened.

Russia and South Africa held up reasonably well in the other BRICS countries but the contraction in Brazil’s manufacturing sector quickened.

Sources: Markit*; Li & Fung**; Plexus Asset Management****; ISM*****.

Sources: Markit*; Li & Fung**; Plexus Asset Management****; ISM*****.

Tags: Acceleration, Asian Countries, Brazil, BRICs, Brink, Cold Spell, Contraction, Disappointment, Economic Regions, Emerging Europe, Eurozone, India, Ism Manufacturing, Jp Morgan, Leading The Way, Manufacturing Sector, Percentage Points, Plexus Asset Management, Recession, Ripple Effect, Sector Growth, South Korea
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Are Emerging Markets Ready to Lead the Global Economy?

Friday, July 29th, 2011

by Lupin Rahman, PIMCO

• We forecast emerging economies will expand at a faster pace than advanced economies over the secular horizon.
• The challenge for emerging market central bankers is to remain ahead of inflation expectations and retain credibility on inflation targeting. We feel they are well positioned for this.
• We believe global investors remain significantly underweight emerging market assets. We expect this underallocation to decrease, providing multiyear support for the asset class.

Emerging markets are increasingly important drivers of growth for the global economy, though they face challenges to reaching parity with, or even surpassing, today’s developed nations.

In the final of a series of Q&A articles accompanying the recent release of PIMCO’s Secular Outlook, portfolio manager Lupin Rahman discusses growth dynamics, inflation and structural change in emerging markets (EM) as well as what all of this means for the global economy.

Q. Could you discuss growth dynamics in emerging markets and their share of the global economy?

Rahman: We forecast emerging markets to outperform advanced economies over the secular horizon (next three to five years) with growth averaging 6% vs. 2% in advanced economies. Significant transitions already underway in the global economy underpin this trend. Essentially we are seeing a shift from a unipolar world anchored by advanced economies toward a multipolar world with large emerging economies playing an increasingly larger role in the global economy.

Within EM we expect to see differentiation across economies. In Latin America and emerging Asia we forecast growth in the 6% to 7% range to be anchored by low leverage, strong structural demand for commodities and a soft landing in China. Meanwhile, countries in emerging Europe, and in particular those economies with high levels of leverage, are likely to experience a period of modest growth in the 4% range.

The relevance of this increasing importance of EM for investors lies in the remarkable divergence between current investor positioning and the economic realities of the postcrisis world. Specifically, we believe global investors remain significantly underweight emerging market assets in relation to both their current and future share of the world economy, as well as in relation to the trends in their relative credit fundamentals. We believe that as markets reorient to our New Normal view of the world this underallocation to EM will decrease, providing multiyear support for the asset class.

Q. How does the middle class in emerging markets compare to the developed world? And what are
current and anticipated domestic consumption patterns in EM?

Rahman: The growth of the emerging middle class is an important aspect of the EM growth story, particularly in the context of a deleveraging consumer base in advanced economies. If we take the World Bank’s definition, the global middle class is forecast to triple from 400 million in 2000 to 1.2 billion in 2030, with China and India accounting for most of this expansion, according to a December 2006 report. To put this into perspective, this means that by 2030 a significant majority of the global middle class will be from EM.

In addition to important strides in po verty reduction, this shift represents tremendous opportunities in new global consumer markets as EM consumption expands beyond food and shelter and towards consumer durables and services. In fact we are already seeing this trend with spending on automobiles, refrigerators and entertainment showing robust growth. We expect this to continue in the next decade and be underpinned by gains in real EM consumption growth which we estimate will increase by 50% in real terms.

Q. Shifting gears, could inflation cloud the outlook for emerging markets?

Rahman: There have been two important shifts in EM inflation dynamics over the past decade underpinned by more independent central banks, a reduction of fiscal dominance and a reduction in wage indexation. First, the levels of inflation in emerging markets have dropped from double-digit increases being the norm to headline inflation decreasing to the mid-single digits. Second, inflation volatility has decreased as a result of more anchored inflation expectations.

Looking ahead, the current 2 to 3 percentage point differential between emerging market and advanced
economy inflation will likely persist given our forecast of robust EM growth and debt deleveraging in advanced
economies. But importantly, we do not see a sharp secular increase in this differential. Of course there are risks to this baseline view from potential spikes in commodity prices and asset-market bubbles, but the fundamental shifts in inflation expectations mentioned before provide EM policymakers room to maneuver in tackling these shocks.

Q. What are central bankers in those countries doing to contain inflation, and what are the implications of
their policies?

Tags: asset class, Brazil, Commodities, Credibility, Differentiation, Emerging Asia, Emerging Economies, Emerging Europe, Emerging Market, Emerging Markets, Global Economy, Global Investors, Growth Dynamics, India, Inflation Expectations, Latin America, Leverage, Market Assets, Multipolar World, Parity, Portfolio Manager, Unipolar World
Posted in Brazil, Commodities, India, Markets | Comments Off

Emerging Markets Cheat Sheet (June 20, 2011)

Saturday, June 18th, 2011

Emerging Markets Cheat Sheet (June 20, 2011)

Strengths

• Chinese Vice Premier Li Keqiang said the central government will increase funding for affordable housing projects.
• The National Development and Reform Commission says China will approve more coal-fired power projects to ease power shortages in the country.
• China’s industry value-added production went up 13.3 percent in May, showing steady growth during a monetary-tightening macro environment. Consumer spending also showed resilient growth at 16.9 percent, slightly lower than 17.1 percent in April. Real estate investment was up 34.6 percent, mostly from affordable housing projects. After showing strong growth for the first four months of the year, fixed asset investments increased 25.8 percent for the year-to-date period.
• Turkish deposit and credit penetration caught up with average emerging Europe levels over 2008-2010, while it maintained a self-funded system similar to Czech Republic. This was in contrast to other countries with funding gaps.

Weaknesses

• China saw the lowest new loan and money supply growth in May since 2008. New bank loans totaled Rmb 551.6 billion, while M2 growth was 15.1 percent.
• Hong Kong has raised the minimum down payment for home buyers to cool housing prices.
• China’s inflation in May hit a 34-month high, reaching 5.5 percent year-over-year, but lower than the market’s estimate. The producer price index stayed flat at 6.8 percent, but the industry input price was up 10.2 percent year-over-year, clearly showing downside pressure on industrial gross margins.
• Food prices increased 11.9 percent in May, mostly due to the drought across China during the spring season this year.
• The People’s Bank of China (PBOC) raised the reserve requirement ratio by 50 basis points (to 21.5 percent) for the sixth time this year.
• China’s M2 growth was at 15.1 percent in May, 0.2 percent lower than April, showing a downtrend of money supply as intended by the central bank. A recently published PBOC survey has shown that industries are hoping for a reversal of the monetary tightening policy.
• The Beijing-Shanghai high speed train will officially start operations by the end of June, which is seen as a negative to airline passenger flows.
• Emerging Europe PMIs in May confirm that the region’s manufacturing industry is losing the tailwind provided by the global economic recovery. The slackening comes amid monetary and fiscal tightening in China and Europe.

Opportunities

• HSCI financials decreased 5.4 percent year-to-date, and are down more than 8 percent in June. China’s major banks are currently trading below their historical average, with a price-to-book of 1.77 times or lower, a level which we believe shows great value for investors.

  

• Natural gas from reserve-rich Turkmenistan, Kazakhstan and Uzbekistan could be the best match for China’s gas needs. Turkmenistan alone could probably deliver much more than the currently contracted 30 billion cubic meters of gas from the giant 1.8 trillion cubic meter South Yoloten field, which is currently under a $10 billion development – financed by CNPC loans. A newly constructed 40 billion cubic meter Central Asia–China pipeline fits snugly into existing Chinese gas infrastructure and could probably be expanded to take extra gas volumes if the deals with Russia fail.

Threats

• The PBOC may raise interest rates soon to help curb inflation. In China, the one-year deposit rate is currently at 3.31 percent. At a 5.5 percent inflation rate, the real rate is 2.29 percent, adding pressure for further rate hike.
• Prolonged uncertainty on the political front in Greece translates into instability of the deposit base in Greece and other periphery economies. The Balkan countries are most at risk, with Bulgaria most vulnerable. Greek banks have lent more than 31 percent of Bulgarian GDP to Bulgarian entities.

Tags: Asset Investments, Bank Loans, Bank Of China, Chinese Vice, Coal Fired Power, Country China, Emerging Europe, Food prices, Gross Margins, Industry Input, Infrastructure, Input Price, Macro Environment, Money Supply Growth, Pboc, Power Projects, Power Shortages, Producer Price Index, Real Estate Investment, Recen, Sixth Time
Posted in Infrastructure, Markets | Comments Off

Emerging Markets Cheat Sheet (May 16, 2011)

Saturday, May 14th, 2011

Emerging Markets Cheat Sheet (May 16, 2011)

Strengths

• In spite of political uncertainty in Peru, Credicorp reported solid first quarter results with net income rising 40 percent year-over-year, well ahead of consensus estimates. However, the bank cautioned that its future performance will be linked to economic stability in the country that, in a large measure, will depend on the outcome of the forthcoming election on June 5.
• Mexican-listed airport groups have reported satisfactory traffic data for April: ASUR led with a 4.8 percent increase, while GAP/OMA registered a 1 percent rise in the number of passengers.
• The 2009 combined middle and affluent (MA) class population of Emerging Europe was equal that of China. Russia has the second largest MA emerging market population, and Poland’s rivals that of India. At $17,856, Turkey has the second highest MA class GDP per capita in emerging markets.

• Taiwan’s April exports rose 24.6 percent, driven by information and communication products, minerals, and machineries.
• National Bureau of Statistics of China shows real estate investments reached RMB 1.3 trillion for the first four months of this year, up 34.3 percent from the same period last year. New project starts were up 24.4 percent year-over-year; sales were up 13.3 percent to RMB 1.4 trillion.
• Korean central bank freezes benchmark interest rate at 3 percent, after inflation in April declines to 4.2 percent from 4.7 percent in March, indicating a direction that inflation might start to peak. Also, Indonesia froze its benchmark rate at 6.75 percent in the week after its inflation was stabilizing at around 6.5 percent. If this is a trend, emerging Asia countries might be successful at curbing inflation.
• China International Capital Corp (CICC) says China’s Internet revenue will grow to RMB 1.5 trillion by 2013, which equates to a compound annual growth rate of 40 percent and 6.5 percent of total retail in the country. Sina, in its first quarter earning release, said its Weibo membership has grown to 140 million registered users, adding 40 million since February. CICC also believes the growth in Internet users will drive Internet infrastructure investment. It is estimated that China has 450 million active internet users, the largest in the world.
• In April, China has achieved its targeted money growth rate of 15 percent, i.e., M2 money supply is at 15.2 percent. If maintained, China might be able to manage a soft landing for its high flying GDP growth.
• China’s macroeconomic numbers also show robust consumer spending with retail sales growing 17.1 percent in April.
• Investment momentum remains high in China. Urban fixed-asset investment growth surprised the market on the upside by strengthening to 25.4 percent.
• China’s April exports grew 29.9 percent, which is a desirable growth given the RMB appreciation pressure and cost increases for Chinese manufacturers.
• Power generation in China was up 11.7 percent in April, but it still faces power shortage across the country.

Weaknesses

• Since 2004, public sector wages grew faster than wages in the private sector in Poland. Higher wages, combined with better social benefits and stable employment, lead many Poles to cast a wary eye toward privatization plans. Powerful unions were recently able to block initial public offering (IPO) plans.
• China’s consumer price index was 5.3 percent in April, slightly lower than 5.4 percent in March. Although the number is still above the government’s desired target of 5 percent for the year, a key component of the index, food, has declined 0.4 percent from March, indicating the government measures on price control have worked.
• Industrial production growth in China slowed to 13.4 percent year-over-year in April, compared to 14.8 percent in March, caused by government tightening of the housing market and inflation control.
• Auto sales in April fell 0.25 percent year-over-year in China, indicating a spillover effect from the government’s tightening on the housing market.
• China has just increased the reserve replacement ratio (RRR) another 50 basis points, reaching 21 percent for the large banks. Considering the fact that deposit growth year-to-date in China was 17 percent, the impact on the banks’ loan book is minimal.
• Chinese high speed rails are having a negative impact on airline traffic, particularly in the mid-to-short distance travel. According to the China Ministry of Railways, it takes four hours by high speed train from Wuhan to Guangzhou, while it takes three hours by airplane, including time spent traveling to the airport or train station and check-in.

Opportunities

• The number of listed airlines in Latin America increased this week with a successful IPO of Avianca from Colombia – the stock gained 18 percent on the first day of trading.
• There are indications that Mexico and Panama might be considering joining a combined equities platform (MILA) that will also include Chile, Colombia and Peru.
• Falabella, the Chilean retailer, has received a license to start banking services in Colombia.
• According to Metal Bulletin, Russian producers are looking for a $10 to 20 per ton increase in hot rolled coil export prices in June, which could signal some improvement in demand on the export markets. This could help maintain stable prices on the domestic market, while any signs of recovery in construction demand in Russia would be quite supportive for Russian steel companies.
• Deutsch Bank China Economist Ma Jun recently boosted his forecast of RMB deposits in Hong Kong to 2 trillion by the end of 2012, driven by rapidly rising trade settlement between China mainland and Hong Kong. RMB deposits soared to 407 billion in February 2011, six times the amount in the same period last year. Among the many opportunities arising from this growth is that Macau casino business will be the low hanging fruit for investors since it benefits directly from the RMB out-flows. The chart shows the correlation between RMB deposit in Hong Kong and Macau gaming revenue.

Threats

• A recent correction in commodities prices may be a headwind for resource dependent countries in Latin America, notably Brazil, Chile and Peru.
• A company press release by Magyar Telekom announced that the regulator in Hungary has obliged the operator to provide access to its passive network infrastructures, including ducts, poles, dark fiber, copper and optical local loops. It remains to be seen who will take advantage of this regulation to take share away from Magyar.
• April’s macro economic numbers show that the growth of the Chinese economy is slowing due to China’s monetary tightening. The market believes China will have one more interest rate hike in second quarter, and several RRR increases until inflation concerns subside. While the market is broadly predicting a soft landing in China, investors have yet to commit their money in the market, as shown by Hong Kong lower daily trading volume.

Tags: Asia Countries, Asur, Benchmark Interest Rate, Benchmark Rate, Brazil, Bureau Of Statistics, China International, China Russia, Cicc, Compound Annual Growth Rate, Credicorp, Emerging Asia, Emerging Europe, Forthcoming Election, Gdp Per Capita, India, Infrastructure, Internet Revenue, Market Population, National Bureau Of Statistics, National Bureau Of Statistics Of China, Political Uncertainty, Real Estate Investments
Posted in Brazil, India, Infrastructure, Markets | Comments Off

Emerging Markets Diary (November 22, 2010)

Sunday, November 21st, 2010

Emerging Markets Diary (November 22, 2010)

Strengths

• Hong Kong’s unemployment rate remained at a 20-month low of 4.2 percent in October, as total employment rose for a fifth straight month to a three-year high, exceeding the level before the Lehman crisis.
• Taiwan’s GDP expanded by a faster than expected 9.8 percent year-over-year in the third quarter, thanks to stronger than estimated private consumption and investment.
• Chile’s GDP in the third quarter grew 7 percent, the fastest growth in six years with internal demand (private consumption and fixed investment) being the main contributors.
• Peru’s GDP in September grew by 10.4 percent, above the consensus estimate of 9 percent. Construction, up 23 percent, followed by manufacturing, up 17 percent, and the financial sector, up 17 percent, were the main drivers of growth. Peru’s economy is expected to grow by 8.6 percent for the full year, the fastest in Latin America.
• Despite headline risk, Mexico’s tourism industry is coping quite well. During nine months this year ending September, the number of tourists to the country reached 16.6 million, up 6.9 percent year-over-year, bringing revenue of $9 billion, up 7.7 percent year-over-year.
• While higher sugar prices (up nearly 90 percent in the last six months) can be a headwind for consumers, they benefit producers – Sao Martinho of Brazil reported third quarter results that beat estimates by nearly 80 percent.
• The results of OTP of Hungary for third quarter were much better than expected (net income of HUF30.9 bln vs. HUF22 bln median estimate) due to lower provisions and a low effective tax rate (just 4 percent). Special banking tax was included in these results shaving off HUF14.7 bln from net income on an after tax basis.
• Economic activity in Turkey bounced back aggressively, with first half 2010 GDP up 11 percent year-over-year, well ahead of any other country in Emerging Europe. Credit growth is up by 25 percent year-over-year, showing both willingness of the private sector to borrow and the ability of Turkish banks to lend. Similarly, the labor market in Turkey has shown good improvement, with unemployment (now at 10.6 percent) 2.6 percent lower than a year ago.

Weaknesses

• Singapore’s total retail sales increased by a less than expected 0.3 percent year- over-year in September and declined by a seasonally adjusted 2.4 percent from August, as car sales continued to be affected by government quotas to control pollution and congestion and stronger Singapore dollar encouraged residents to spend abroad and discouraged tourist spending domestically.
• China raised the required reserve ratio for banks again by 50 basis points effective November 29, a second hike in two weeks, bringing the ratio to 18 percent for large banks and 16 percent for smaller ones. This is an effort to drain excess liquidity in the system induced by foreign inflows and manage inflation expectations.
• Hong Kong introduced additional measures to rein in property speculation by imposing a 15 percent stamp duty on the notional amount, in addition to capital gains tax, of homes sold within six months and raising the down payment ratio to 50 percent from 40 percent for homes worth $1.5 million or more.
• Argentina’s inflation expectations (non-government) for this year rose to 30 percent from mid-20 percent, three months ago.
• The National Housing Commission in Mexico reported an 11 percent rise in inventory of housing units at the end of September with most units below the MXP 250,000 threshold (low income).
• Polish inflation rose in October above the central bank 2.5 percent target of 2.8 percent, but the central bank seems reluctant to act for fear of zloty appreciation.

Opportunities

• Historically, it is the real interest rate, or nominal interest rate adjusted by inflation, that tends to negatively correlate with the equity market. China is not an exception. Despite its central bank raising interest rates lately, China’s real rate has been going increasingly negative, because so far the nominal rate has failed to catch up with inflation as policymakers have opted to remain accommodative amid external uncertainty and domestic restraint including property crackdown and energy conservation. This scenario is likely to continue, which should make equities more attractive to investors.

• There are indicators that Mr. Guido Mantega, the Finance Minister under outgoing President Lula of Brazil, will remain in his post in the new government of Ms. Dilma Rousseff. Will it mean continuation of a loose fiscal policy?
• During an investor day at America Movil (AMX), the company provided guidance for revenue growth for 2009-14 (CAGR of 6-8 percent) and EBITDA growth (CAGR of 7-9 percent). AMX also expressed interest in paid-TV, which, with penetration of just 17 percent, offers sizeable growth opportunity in Latin America.
• Retail funding (traditionally a source of strength) has been a curse of Russian banking this year, according to J.P. Morgan. Amid falling inflation, growth in the retail deposits put pressure on net interest margins. With social spending ratcheting up into the end of the year, an opposite trend is likely to unfold.

Threats

• CPI expectations in Brazil are rising with higher food prices. The data from November showed a rise of 1.16 percent vs. median estimate of 1.06 percent, the highest level since December 08.
• Rzeczpospolita reported that Poland might follow Hungary, moving from the private fully-funded system to the public pay-as-you-go pension system, to facilitate deficit reduction by 1.7 percent of GDP. This would be a threat to Polish equities, trading at a premium to other emerging markets due to a local pension funds’ participation.
• 2011 is likely to be difficult for Russian electric utilities due to political pressure on the segment, according to J.P. Morgan. It is a pre-election year, which is likely to result in the regulators paying more attention to tariff growth.

Tags: Bln, Brazil, China, Consensus Estimate, Economic Activity, Effective Tax Rate, Emerging Europe, Emerging Markets, Financial Sector, Headwind, Latin America, Lehman, Median Estimate, Otp, Private Consumption, Quarter Thanks, Russia, Sao Martinho, Sugar Prices, Tax Basis, Third Quarter Results, Tourism Industry, Unemployment Rate
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Emerging Europe: Lessons from the boom-bust cycle

Wednesday, November 17th, 2010

Emerging Europe: Lessons from the boom-bust cycle

by Bas Bakker and Ajai Chopra via VoxEU.org

The crisis in Europe is more commonly used to refer to debt crises in southern Europe than elsewhere. This column focuses on central and eastern Europe, arguing that while the crisis there was triggered by external shocks, it is clear that domestic imbalances and policies also played a key role.

Almost unnoticed amidst the difficulties in Western Europe, the other half of the continent has begun to recover from the deepest slump in its post-transition period. The emerging economies in central and eastern Europe will grow by 3.75% this year and next – a relief after the 6% decline in 2009.

Why was the crisis so severe – and how do we avoid a repeat? This question has been posed with particular focus on Central and Eastern Europe several times on this site (see for example Berglöf 2009 and Darvas 2010). In recent research for the IMF Regional Economic Outlook (IMF 2010), we argue that while the crisis was triggered by external shocks, it is clear that domestic imbalances and policies also played a key role.

After Lehman Brothers defaulted in September 2008, global trade collapsed, capital inflows into the region plummeted, credit growth suddenly stopped, and domestic demand plunged. But pre-crisis domestic imbalances and policies made a difference in how these shocks affected each country’s economy. Some countries saw declines in gross domestic product similar to those in the Great Depression (Estonia, Latvia, Lithuania, Ukraine), while others avoided declines altogether (Albania, Poland).

Origins of the crisis

The seeds of the crisis were sown, in large part, in the five years before the crisis. Between 2003 and 2008, much of the region experienced a boom in bank credit, asset prices and domestic demand. This boom was fuelled and financed by large capital inflows.

With low interest rates in advanced countries, banks in Western Europe expanded aggressively into emerging Europe – where returns were higher. And, while the influx of capital boosted growth, it also led to rising imbalances and vulnerabilities.

• Current-account deficits increased to unprecedented levels in some countries, and asset prices and inflation accelerated.
• Substantial vulnerabilities emerged in bank and household balance sheets, particularly as much of the borrowing was in foreign currency.

The boom years had left much of the region addicted to foreign-financed credit growth, making it very vulnerable to a disruption in capital inflows (see figure 1)

Figure 1.

High cost experience

The first lesson of the crisis is one that is unfortunately not new. Boom-bust credit cycles can be very costly, so it essential to prevent credit booms from getting out of hand.

Indeed, countries that experienced the fastest credit growth during the boom years saw the deepest recessions. And it now appears that average GDP growth over the full business cycle in this group was no higher, and in some cases was lower, than in countries with more modest credit growth.

Tags: Asset Prices, Bakker, Bust Cycle, Capital Inflows, Central And Eastern Europe, Chopra, Darvas, Emerging Economies, Emerging Europe, Estonia Latvia, External Shocks, Great Depression, Gross Domestic Product, Key Role, Lehman Brothers, Low Interest Rates, Regional Economic Outlook, Southern Europe, Transition Period, Western Europe
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Turkey: A Country on the Rise

Friday, October 22nd, 2010

Turkey has been a bright spot for emerging markets this year, nearly tripling the performance of other Emerging European countries. Tim Steinle, co-manager of the Eastern European Fund (EUROX), has just returned from a research trip to Turkey and reports the Turkish story is gaining momentum.

Industrial Production (IP) grew 11 percent during September compared with the same time period a year ago, reflecting the economy is getting stronger. Global investors are starting to take notice. Roughly $40 billion has flowed into emerging markets so far this year and just over 5 percent of those inflows ($2.3 billion) have landed in Turkey.

Some Central Emerging Europe-Middle East-Africa funds already allocate half of their assets in Turkey and recently some “go-anywhere” global funds have upped their allocations.

Some fear the strong recovery could trigger whiplash inflation but the Turkish central bank prefers to sterilize liquidity instead of raising interest rates in order to keep Turkey’s currency, the lira, from appreciating against its peers. One former central bank governor says that he hopes Turkey can follow in the fiscal footsteps of Brazil, which has been able to keep its own currency valuation under control despite rapid growth in the country’s economy.

The future looks bright for Turkey but there are some potential hurdles the country must overcome. Rising consumption, especially for energy, puts a strain on Turkey’s current account (i.e., the country’s balance sheet) and tilts the country’s trade balance toward imports.

However, Turkey envisions itself as the region’s energy transportation hub. Roughly 1.5 percent of the world’s oil goes through Turkish pipelines and several projects already under construction should ease the country’s energy dependence on foreign sources. In addition, tariffs on the oil and natural gas passing through the pipeline should offset some of the import costs.

Another hurdle is that Turkish Islamists and secularists hold extreme and opposing views, and the rift is deepened by the class divide of poor versus the elite. Will the wider masses take advantage of the new opportunities to better their lives or will the country swing toward theocracy like Saudi Arabia or Iran?

The entrepreneurial predisposition and the failed social experiment of the latter ought to keep that from happening.

Foreign and emerging market investing involves special risks such as currency fluctuation and less public disclosure, as well as economic and political risk.  By investing in a specific geographic region, a regional fund’s returns and share price may be more volatile than those of a less concentrated portfolio.

Tags: Brazil, Central Bank Governor, Currency Valuation, Current Account, East Africa, Emerging Europe, Emerging Markets, Energy Dependence, Energy Transportation, Eurox, Foreign Sources, Gaining Momentum, Global Funds, Global Investors, Islamists, Natural Gas, oil, Research Trip, Rsquo, Same Time Period, Steinle, Trade Balance, Transportation Hub, Whiplash
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The Top Performing Markets in Emerging Europe

Saturday, October 16th, 2010

By Frank Holmes, CEO and Chief Investment Officer, U.S. Global Investors

Well-known author and investment consultant Roger Gibson recently hosted a webcast where he educated investors on the importance of diversifying into international markets and we believe it is an opportune time to explore new areas with your portfolio.

Global investment guru Nicholas Vardy says “there’s always a bull market somewhere” and it’s up to investors to find it. We think there’s a bull market emerging in Eastern Europe.

Russia may be the first country that comes to mind when you think of Eastern Europe, but it’s the other countries of Emerging Europe, countries such as Poland, the Czech Republic and Turkey, that have outperformed.

While the S&P 500 Index was only up 3.89 percent as of September 30, Turkey had risen nearly 31 percent, extending a large lead on other Emerging Europe countries. The Czech Republic (up 8.19 percent) and Poland (up 11.16 percent) have also outperformed most emerging markets. Meanwhile, Russian markets have only gained 4.39 percent.

Even with the good performance of these markets so far this year, Emerging Europe markets still have attractive valuations. Emerging markets generally trade at a higher—many times in the double digits—price-to-earnings ratio than the developed markets, but Forbes reports that five of the six cheapest emerging equity markets in terms of price-to-earnings ratio are from Emerging Europe. Russia, Hungary, Czech Republic and Turkey are all currently trading at or below 10 times earnings and Poland comes in at 11 times earnings.

Historically, the German economy has held high importance for Emerging Europe economies because its relatively wealthy population consumed large amounts of goods such as cars, dishwashers and refrigerators imported from the region.

That’s not the case in today’s world. A report out this week showed that German exports into the Eastern Europe region were up 20 percent during the first half of the year from the same time last year. In addition, total trade between Germany, Europe’s largest economy, and Emerging Europe totaled $143.6 billion.

This chart from the International Monetary Fund (IMF) shows the strong rebound in both private consumption and fixed asset investment that Emerging Europe is currently seeing. Private consumption includes retail sales and orders of durable goods while fixed investment represents productive assets like power plants, factories and other infrastructure.

During the depths of the economic crisis, Emerging Europe experienced substantial contractions in both. This year, private consumption and fixed investment will contribute to nearly half of the region’s GDP and it is expected to contribute to nearly all of it next year.

The IMF estimates Emerging Europe will see 3.7 percent GDP growth this year and then dip slightly to 3.1 percent in 2011. But that doesn’t tell the full story.

Poland, which is the only country in the region that avoided recession, grew by 3.4 percent this year and is forecast for higher GDP growth next year. This growth is Poland’s opportunity to close the gap with other members of the European Union.

After contracting nearly 5 percent in 2009, Turkey has notched the highest level of growth for any country in Europe this year—up almost 8 percent. Turkey’s strength is in its robust banking sector and strong domestic demand.

Things are also looking up for Russia. BCA Research upgraded Russian stocks this week, based on increases in household income and spending, improved employment figures and a decrease in household savings rates. Russia also plans to expand oil production in the near term which should be a positive driver for energy stocks that are trading 30 percent below global peers.

We’re positive on Russia because recent weakness in the U.S. dollar bodes well for the country’s energy and commodity exports.

Recognizing these changes and identifying catalysts for outperformance is something our experience investing in the region brings us. We were able to recognize the softness in Russian markets early, allowing us to move larger portions of the portfolio into the better-performing countries. This week, Zack’s named Eastern European Fund (EUROX) in the Top 5 for European Mutual Funds

Tim Steinle, co-manager of the U.S. Global Investors Eastern European Fund (EUROX), contributed to this commentary. Tim and Evan Smith have just returned from Russia and Turkey, obtaining that tacit knowledge you can only gain from being on-the-ground.

Tags: Attractive Valuations, Chief Investment Officer, Double Digits, Eastern Europe Region, Emerging Europe, Europe Countries, Forbes Reports, Frank Holmes, German Economy, German Exports, Global Investment, International Markets, Investment Consultant, Investment Guru, oil, Opportune Time, Price To Earnings Ratio, Roger Gibson, Russia, Russian Markets, U S Global Investors, Wealthy Population
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Chart of the Week: Emerging Europe

Wednesday, July 14th, 2010

Weakness in the euro is a strength for Emerging Europe.

A strong currency tends to make exports more expensive, but Germany (the world’s #2 exporter behind China) remained globally competitive even as the euro’s value climbed to record highs against the U.S. dollar.

One of the key reasons: German manufacturers cut costs by shifting some production to Emerging Europe, where skilled workers are readily available at a far lower wage. The Czech Republic, Poland and other Emerging Europe countries send semi-finished goods to Germany, where they become finished products for export, primarily to Asia and North America.

According to some estimates, this strategy has raised the productivity of the German parent companies by 20 percent.

The euro has depreciated in recent months due to worries about the massive sovereign debt loads in Greece, Spain and other countries. Emerging Europe, by contrast, has much lower debt-to-GDP ratios, which enables higher growth rates.

The weaker euro has helped German exporters by making their products less expensive abroad, and as we pointed out in our latest Weekly Investor Alert, Emerging Europe has also gotten a lift.

The chart above shows the industrial production growth trend (rolling six months) for several Emerging Europe countries, along with Germany’s export growth outside the European Union.

Germany’s overall exports rose 9 percent in May to $98 billion, and were up 29 percent through the first five months of 2010. The government in Berlin now envisions GDP growth of 2 percent this year, higher than the official estimate of 1.4 percent – this would further benefit Emerging Europe.

Tags: Czech Republic, Debt Loads, Emerging Europe, Estimates, Europe Countries, European Union, Five Months, GDP, GDP Growth, German Manufacturers, German Parent, Growth Trend, Investor Alert, Key Reasons, Productivity, Ratios, Rsquo, Six Months, Skilled Workers, Sovereign Debt, Worries
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