economic update: bric by bric - cme group · economic update: bric by bric blu putnam samantha...

Economic Update: BRIC by BRIC Brought to you by CME Group and Profit & Loss

1

http://www.cmegroup.com

© 2013 CME Group. All rights reserved. © 2013 CME Group. All rights reserved. 2

Bluford Putnam

Chief Economist, CME Group

Samantha Azzarello

Economist, CME Group

Moderator:

Nicola Tavendale

eChannels Editor, Profit & Loss

Presenters


Economic Update: BRIC by BRIC

Blu Putnam Samantha Azzarello

Chief Economist Economist

November, 2013

The research views expressed herein are those of the author and do not

necessarily represent the views of the CME Group or its affiliates.

All examples in this presentation are hypothetical interpretations of

situations and are used for explanation purposes only.

This report and the information herein should not be considered investment

advice or the results of actual market experience.


© 2013 CME Group. All rights reserved. © 2013 CME Group. All rights reserved.

Disclaimer

4

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options on futures.

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within the meaning of section 1(a)12 of the Commodity Exchange Act. Swaps are a leveraged investment, and because only a

percentage of a contract’s value is required to trade, it is possible to lose more than the amount of money deposited for a swaps

position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of

those funds should be devoted to any one trade because they cannot expect to profit on every trade.

Any research views expressed are those of the individual author and do not necessarily represent the views of the CME Group or its

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responsibility for any errors or omissions. Additionally, all examples in this presentation are hypothetical situations, used for

explanation purposes only, and should not be considered investment advice or the results of actual market experience.

All matters pertaining to rules and specifications herein are made subject to and are superseded by official Exchange rules. Current

rules should be consulted in all cases concerning contract specifications.

Copyright © 2013 CME Group. All rights reserved.




5

• BRIC – Country Overviews

• Global Issues challenging Emerging Markets

• FX and Equity Contagion



Country Reviews

6



Brazil

7

• Brazil has sustained an increased standard of living for its citizens.

• This has been partly fueled by economic growth and partly financed by

an increase in credit.

• Demographic Shifts – with the rise of the “C” class ( a lower-middle

class)

• The “C” class is defined by individuals who earn between $1800-6000 USD/year

• 2005 this demographic represented 21% of the population

• This demographic has increased to 54% of the population in 2013

• “C” class presents a great opportunity for companies in Brazil with a

new range of products and services being made available.

• Lower priced versions of traditionally higher end goods and services

• Examples include hairstyling, chocolate



Brazil

8

-4%

-2%

%

2%

4%

6%

8%

10%

Pe

rce

nt

Ch

ange

Ye

ar o

ver

Year

Brazilian Real GDP Growth

Source: Data from Bloomberg Professional (BZGDYOY)



Brazil

9

• Slowing economic growth comes at a time when a large class of people

who’s economic status had been improving steadily – and are now

expecting and demanding more from their government.

• The government provision of basic services against the backdrop of

massive spending for World Cup/Olympics has led to protests.

• Quality of life issues are at the core of the protests – health care,

education, transport and education. All these issues are longer-term

structural issues which cannot be affected immediately.



Brazil Social Services

10

• Examples of lacking social services include:

• A healthcare system with a shortage of doctors, there has

been recent efforts by the government to attract doctors from

other Latin American countries.

• The Justice system and police force are considered by some

as a system which favors the wealthier classes.

• Education in Brazil had quality and quantity issues. Education

reform is cited as being highly needed.



Brazilian real depreciation set-off by Fed taper

talk and Geopolitical events

11

1.90

2.00

2.10

2.20

2.30

2.40

2.50

Bra

zilia

n R

eal

pe

r U

SD

Brazilian Real Exchange Rate

Source: Brazilian Real (BRL) from Bloomberg Professional.

Fed announces plans to taper QE



Brazil FX

12

• Brazilian government announced a FX intervention program in

August 2013.

• The program is in place and ready to be utilized in order to halt

the decline in the Real.

• The 60 Billion Real program is intended to provided liquidity.

• The technical details are that the Central Bank of Brazil we be

able to provide liquidity through selling currency swaps and

repos, with the aim of decreasing volatility in the FX market.

• Brazil wants to avoid the inflationary pressures associated with a

weakening Real.



Brazil

13

1.25

1.45

1.65

1.85

2.05

2.25

2.45

2.65B

razi

lian

Re

al p

er

USD

Brazilian Real Exchange Rate

Source: Brazilian Real (BRL) from Bloomberg Professional.

Real depreciating



Russia - WTO

14

• Entry into the World Trade Organization (WTO) has been disappointing– not a

driver of growth as hoped.

• Entry was confirmed after 18 years of negotiations.

• Russia is the EU’s third largest trade partner, entry into the WTO would make

trade between the two countries more standardized.

• Russia has to reduce import tariffs

• Especially hard-hit Russian sectors include agriculture

• Entry into WTO was meant to be a catalyst to diversify and modernize the

Russian economy.

• Proposed benefits had been to attract foreign investment more easily, and move

towards a more diverse economy less reliant on Energy exports over the long

term.

• Issue of timing – where increase competition will be beneficial over the long term,

shorter term adjustments will not support GDP and export numbers.



Russia - Energy

15

• Energy exports are 70% of Russia’s total exports

• Tax on export duties of oil and gas is the largest source of tax

income for the Russian government.

• Russian government is highly dependent on increasing oil output

and increasing Brent prices to finance government receipts.

• Flat lining of energy exports in dollars suggests government

revenues will not grow.

• Government revenue stagnating will be exacerbated if a structural

change occurs where Russian gas prices are no longer tied to oil

prices as they are currently.



Russian Commodity Exports

16

$0

$20

$40

$60

$80

$100

$120

$140

$160

in B

illio

n U

SDRussian Commodity Exports in US Dollars

Source: Central Bank of Russia, Key Economic Indicators 2006-2013

Export revenues are flat lining



Russia - Energy

17

• Russia dominance in world energy markets has been challenged

by the US energy boom, which is having a large impact on prices

and increasing total supply.

• The tie of Russian gas prices to Brent oil also is

unsustainable as gas prices worldwide fall.

• Gazprom recently lost a case against German energy company,

RWE over oil-indexing the gas price on its contract. A court

tribunal in Vienna ruled against the formerly accepted practice of

oil-indexing gas prices.

• Gazprom is being forces to adjust its gas price contract with RWE.



Russia

18

20

25

30

35

40

9/2007 9/2008 9/2009 9/2010 9/2011 9/2012 9/2013

Ru

ssia

n R

ub

le p

er

USD

Russian Ruble Exchange Rate

Source: Russian Ruble (RUB) from Bloomberg Professional.

Ruble depreciating



India – Oil Subsidies

19

• The magnitude and continued growth of government subsidies in India are

concerning for government fiscal health.

• Oil Subsidies

• Oil subsidies are deemed as unsustainable in the longer term

• India imports 80% of its oil which is then subsidized for consumers

• At the end of India’s 2013 fiscal year in March the total fuel subsidy cost was

$23.5 Billion (1.6 trillion rupees).

• Oil refining and marketing companies import crude oil at market rates. They are

then required to sell the 3 key products: kerosene, diesel and LPG at subsidized

rates.

• Gas or oil bought by the refining companies from Indian oil producers is

purchased at a significant discount.

• Approx. 40% of the subsidy burden is borne by the Indian oil producers. The

remaining 60% is by the oil refiners and government.



India – Oil Subsidies

20

• The issue of oil subsidies is being exacerbated by the decline in

the Rupee. Global oil contracts are priced in US dollars.

• In something of an FX intervention plan, the Reserve Bank of

India announced it would be selling US dollars to the largest

state run oil companies.

• A few oil subsidy reforms are slowly occurring:

• A small increase in the price of subsidized diesel, and a limit on the

supply of subsidized cooking gas to households.



India – Current Account Deficit Worsening

21

-6%

-4%

-2%

0%

2%

4%

As

pe

rce

nt

of

GD

PIndian Government Current Account

(as percent of GDP)

Source: Data from Bloomberg Professional (EHCAIN).



India

22

Food Subsidies

• New Program, the Food Security Bill has an estimated cost of 21 B.

• Program will subsidize rice, wheat and grains for 2/3 of the population

• Pregnant women, and certain categories of mothers and children will be eligible for

free daily meals

• Subsidy programs shake investor confidence on India’s ability to

manage the growing budget deficit.

• A growing current account deficit works to depreciate the rupee, this

in turn leads to inflation pressures.

• India is highly dependent on FDI to fill the gap left by the deficit –

furthermore the FDI flow is temperamental with regards to markets’

appetite for risk.



India

23

-2%

%

2%

4%

6%

8%

10%

12%

Year

-ove

r-Ye

ar P

erc

en

t C

han

geIndia Wholesale Price Inflation

Source: India Wholesale Price Index (INFINFY) from Bloomberg Professional.



India

24

30

40

50

60

70

9/2007 9/2008 9/2009 9/2010 9/2011 9/2012 9/2013

Ind

ian

Ru

pe

e p

er

USD

Indian Rupee Exchange Rate

Source: Indian Rupee (INR) from Bloomberg Professional.

Sharp depreciation:India implements capital controls



India – Gold

25

• Contributing to India’s growing current account deficit is gold

imports which stand at $16.5 billon/quarter.

• India is the world’s top importer of gold, followed closely by

China.

• The Indian government acknowledges the imbalance with the

implementation of tight new rules to decrease gold imports.

• A tax on gold imports was raised from 2% to 15% since

beginning of 2012.



Gold

26

• Lack of inflationary pressures in the US diminishes gold’s appeal as

a safe-haven asset.

• Investment demand for gold has fallen in 2013 as investors look to

return to high-yield investments in equities.

• This has inter-played with expectations of Fed tapering and a move

to higher interest rates.

• Markets also took notice of the slowdown in EM countries, leading

to expectations that gold demand at current levels will not be

sustainable from countries such as India and China.

• Gold still has appeal as a balancing asset in portfolios.



Commodities

27

• Weaker economic growth in EMs equates with less demand

growth for commodities and raw resources.

• Also slower demand will not put upward pressure on prices.

• Another factor at play is EMs weaker currencies, which increase

the price domestically of raw materials which are quoted in USD.

• An exception to this is China, who’s currency has strengthened.

• Advanced economies growth is less raw material intensive but

much more energy-use intensive.



China

28

• China’s aim to transition to a more consumption-based economy

from a infrastructure and investment based economy is

occurring at a time of lackluster global economic growth.

• Steady, if not lower growth in the US

• Stagnant growth in Europe

• Emerging Market countries no longer pulling up global growth

• These less than ideal global growth conditions condition’s are

slowing Chinas export growth.



China

29

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

Pe

rce

nt

Ch

ange

Chinese Exports in Billion USDPercent Change Year over Year

Source: Data from Bloomberg Professional (CNFREXP$).

Stagnant or slow growth in many of China's major export partners



European Imports on the Decline

Not a source of export capacity for BRICs

30

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

Pe

rce

nt

Ch

ange

Source: Data from Bloomberg Professional (XTTIEZ).

European Union Imports in Million euros Percent Change Year over Year



China

31

• China is moving towards financial market modernization

and integration with world markets. However the pace is

slow.

• China wants to utilize financial innovation to spur growth.

• Use asset securitization as a method to make better use of bank credit

• Loosening control of interest rates occurred in Summer 2013

• Residential Mortgage rates still have restrictions and caps

• Liberation of deposit rates – currently there exists a ceiling on the rate banks can pay

depositors, this has effectively guaranteed profits for Chinese banks.



US Financial Modernization

32

• A parallel can be made to conditions in the US in the

1970’s:

• Low growth and high inflation - stagflation, very high interest rates

• High unemployment, oil price shocks of 1973 and 1979

• Less than ideal economic conditions at the time were a

catalyst to see the beginnings of financial innovations and

modernization

• USD moved from fixed peg to full floating currency.

• Change from fixed to completely competitive brokerage commissions on the NYSE

• Increased use and research on options

• Interest rate ceilings on deposit accounts phased out completely



China

33

5

6

7

8

9/2007 9/2008 9/2009 9/2010 9/2011 9/2012 9/2013

Ch

ine

se R

en

min

bi p

er

USD

Chinese Renminbi Exchange Rate

Source: Chinese Renminbi (CNY) from Bloomberg Professional.

Loosening of the Renminbi rate in the managed float

system



China Financial Market Modernization

34

• China is moving towards financial market modernization

and integration with world markets. However the pace is

slow.

• Example of the slow place is the re-introduction of Chinese

Government 5-year bond futures. • Closed trading in 1995, re-introduced 18 years later

• Restrictions on who can trade – major players including banks and insurers are not allowed

currently. Certain firms , including mutual funds, can trade only for hedging purposes

• Margin requirements are being set higher than the legal minimum

• Limit of holdings was also revised downwards by 20% from draft regulations



China

35

0

200

400

600

800

1000

1200

1400

1600

1800

2000in

Bill

ion

s o

f R

en

min

bi

China New Loans in Renminbi

Source: Data from Bloomberg Professional (CNLNNEW)

New Governmentstimulates economy



China

36

1000

1500

2000

2500

3000

3500

4000

1/2009 9/2009 5/2010 1/2011 9/2011 5/2012 1/2013 9/2013

in B

illio

n U

SDChina Central Bank International Reserves

(Billion USD less gold)

Source: Data from Bloomberg Professional IMF Database (924.064)



Global Issues challenging

Emerging Markets

37



Global Challenges to EM

38

• US Federal Reserve monetary policy has had severe implications

for EMs.

• The initial EM FX sell-off in 2013 started as the Fed hinted that

the beginning of tapering QE would be soon.

• The switch or change in investor sentiment characterized by

risk-on vs. risk-off means that EM are still heavily influenced by

geopolitical worries.



Contagion: Risk Off

39

-11.1%

1.9%

-6.4%

-12.0%

-14%

-12%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

Brazil India Russia China

Pe

rce

nt

Ch

ange

in In

dex

Lev

el

Emerging Market EquitiesChange in Index from January 2013 to September 2013

Source: Data from Bloomberg Professional (IBOV, SHCOMP, SENSEX and RTS).Calculations by CME Economics.



Contagion: Risk Off Rebound

40

-3.1% 2.3% 1.6%

49.1%

-10%

0%

10%

20%

30%

40%

50%

60%

Brazil India Russia China

Pe

rce

nt

Ch

ange

in In

dex

Lev

el

Emerging Market EquitiesChange in Index May 2013 to September 2013

Source: Data from Bloomberg Professional (IBOV, SHCOMP, SENSEX and RTS).Calculations by CME Economics.



US Equities, Bull Run in 2013

41

0%

4%

8%

12%

16%

20%

24%

28%

Pe

rce

nt

Ch

ange

in In

dex

Lev

el

S&P 500 EquitiesPercent Change in Index Year over Year

Source: Data from Bloomberg Professional (SPX).Calculations by CME Economics.



Contagion: EM Policymaker Options

42

Increase

Rates Defend

FX

Do

nothing

Slow

Growth

Currency

Falls

Deplete

Reserves

Markets Grow wary, affects confidence and

selling cycle continues



India

43

-$12000

-$10000

-$8000

-$6000

-$4000

-$2000

$0

$2000

$4000

$6000

$8000

Ch

ange

in R

ese

rve

s in

mill

ion

s


Declining Reserves as Rupee depreciated

Indian Central Bank International Reserves Year over Year Change(USD less gold)



Brazil Reserves

44

-$15000

-$10000

-$5000

$0

$5000

$10000

$15000

$20000

Ch

ange

in R

ese

rve

s in

mill

ion

s


Brazilian Central Bank International Reserves Year over Year Change(USD less gold)



Russian Reserves

45

-$15000

-$10000

-$5000

$0

$5000

$10000

$15000

$20000

$25000C

han

ge in

Re

serv

es

in m

illio

ns


Russian Central Bank International Reserves Year over Year Change(USD less gold)



Trading Opportunities cmegroup.com/fx

46

• Averaging $123 billion in daily notional liquidity, CME is the world’s largest

regulated FX marketplace.

• The leading FX platform of choice for a global and increasingly diverse

customer base, with growth rates that continue to outperform the broader over-

the-counter (OTC) market.

• 61 futures: standard- and E-micro (1/10th standard) contract sizes, including 20 non-

U.S. dollar cross-rate pairs

• 31 options contracts: more than $8 billion in daily turnover (+50% year over year)

and increasingly electronic (85%) markets

• 21 global currencies: spanning the majors and a full suite of emerging markets

currency pairs, including the entire BRICS offering with the following new additions:

• Indian rupee (INR) futures

• Off-shore Chinese renminbi (CNH) futures

• U.S. dollar-denominated South African rand (ZAR) futures



Blu Putnam Samantha Azzarello

Chief Economist Economist

November, 2013

The research views expressed herein are those of the author and do not

necessarily represent the views of the CME Group or its affiliates.

All examples in this presentation are hypothetical interpretations of

situations and are used for explanation purposes only.

This report and the information herein should not be considered investment

advice or the results of actual market experience.


economic update: bric by bric - cme group · economic update: bric by bric blu putnam samantha...

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