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What’s new this month

The EM ‘yield grab’ has dominated this year as conviction in ‘lower for longer’ global rates has increased.

But with the market overly complacent about the near-term risk of a second Fed rate hike and…

…fresh concerns bubbling up over policy exhaustion in Japan and Europe, a rougher ride is likely in the near term.

Looking through any Fed-induced market ‘squall’, the big picture is likely to remain intact heading into 2017.

The hunt for yield in EM should therefore resume with opportunities the greatest where inflation can fall sharply…

…thanks to falling food inflation and wide output gaps, so opening up space for substantial rate-cutting cycles.

In LatAm, Brazil remains in the vanguard. Colombia and Argentina should also see investor-friendly inflation drops.

Elsewhere, political and downgrade uncertainties are masking a decisive shift in inflation risks in South Africa.

Russian inflation, already down sharply, can also fall further, spurring rate cuts by the CBR.

In Asia, the space for rate cuts is fading. The Philippines’ epic domestic boom leaves it a genuine outlier in EM.

Chart of the month

Food for thought

Source: Macrobond, BNP Paribas

EM Economics 14 September 2016

EM Matters 2 www.GlobalMarkets.bnpparibas.com

What’s inside

Emerging views

The EM ‘big picture’ ........................................................................................................................... 3-4

Top macro convictions:

CEEMEA .......................................................................................................................................... 5

LatAm ................................................................................................................................................ 6

Asia ................................................................................................................................................... 7

Conviction colour:

Russia and Poland: Divergent ............................................................................................................. 8

South Africa: Food, glorious food ......................................................................................................... 9

Brazil: Flying back to target ............................................................................................................... 10

Argentina: Inflation likely to collapse in early 2017 ............................................................................. 11

Philippines: Boom! ............................................................................................................................ 12

Taiwan: Look beyond the ‘tech-nical’ rebound ................................................................................... 13

Where are we different?

How we compare to consensus on growth and inflation ............................................................... 14-15

Arrested development

EM potential growth ........................................................................................................................... 16

Reserve judgement

Trends and country details on EM reserves ....................................................................................... 17

REER-view mirror

EM real exchange rates ..................................................................................................................... 18

Taking the temperature

Heat-map analysis of EM vulnerabilities ....................................................................................... 19-20

Would you credit it?

Sovereign CDS and ‘implied ratings’ ................................................................................................. 21

Pressure points

What to watch in EM over the next month ......................................................................................... 22

Key forecasts

GDP and CPI inflation ....................................................................................................................... 23

Recently published research ................................................................................................................ 24

Market coverage ................................................................................................................................... 25

Research disclaimers ...................................................................................................................... 26-27

Richard Iley 14 September 2016


Emerging views

After the severe volatility initially seen at the start of the year, markets’ increased confidence in lower-

for-longer global yields and the associated hunt for yield have been THE story of 2016. Inevitably a

shift in expectations around the US Federal Reserve was the key circuit breaker as the drip-feed of

rate hikes expected around the turn of the year largely was priced out.

A constellation of factors drove the shift. The disappointing performance of the US economy itself has

inevitably been front and centre: consensus estimates for 2016 have now slid to 1.5%, leaving the US

on course for its worst annual average performance since the global financial crisis. Estimates of

longer-run growth and equilibrium interest rates have also continued to slide in the background,

reducing the perceived amount of accommodation embedded in current policy settings. This dynamic,

alongside a greater appreciation of blow-back from tighter US monetary policy on the global economy,

has shifted the FOMC’s collective reaction function in a dovish direction relative to the start of the year.

Equally, mounting evidence of policy exhaustion in both the euro-zone and especially Japan has

further helped break the sense of progressive policy divergence that was driving USD strength. While

the zero bound is necessarily not a binding constraint, it has become increasingly apparent that

moving too far below zero becomes counter-productive as banks’ profitability comes under pressure.

Combined with a dwindling supply of safe assets to suck up via QE, the impression that both the BoJ

and ECB are increasingly hamstrung is building. The announcement of ‘reviews’ by both central banks

adds to the sense of policy makers are running low on both ammunition and ideas.

The JPY in particular has strengthened as the sense of relative policy impotence has mounted. As we

have stressed in numerous articles, the strong JPY has been key to helping break the depreciation

fever around the CNY and so damp capital account vulnerability. A more stable China has been the

third piece of the jigsaw pieced together over the last six months. Alongside the stronger JPY that has

spurred the biggest trend depreciation in China’s REER in over twenty years (Asia: State of Play),

mainland activity has also been therefore bolstered by substantial credit easing behind the scenes by

the PBoC. Loans to ‘other depository corporations’ (aka the ‘policy banks’) jumped by 4% of GDP in

H1, helping support infrastructure and property capex. While risks to Chinese activity still look skewed

to the downside, there is little sense that these will crystallise any time soon given actual and

prospective policy support.

This backdrop of sluggish global growth and lower-for-longer global interest rates has been a fertile

environment for EM bonds allowing nominal yield compression in EM. Returns have accordingly been

impressive. While EM bond returns have lagged the strong performance of precious metals and

German bunds, their c.15% YTD return leaves them one of the strongest performing global assets.

After such a strong run, the asset class is necessarily looking a bit toppy. Indonesia provides a prime

example. As we argued as far back as Q1, the Fed’s likely inability to decisively lift off from the zero

bound leaves capital account vulnerabilities permanently reduced. In turn, Indonesian bond yields

north of 7.5% are structurally attractive (EM: Remember the Fragile Five?). South of 7%, they are

necessarily much less so. Add in the near-term prospect of a Fed rate hike as soon as this month’s

FOMC meeting (which the market continues to largely discountenance) then, in the short term at least,

much of the juice from the EM yield grab has probably been squeezed.

Whilst acknowledging the risk of a short-run, Fed-induced market ‘squall’ given the market’s serial

under-pricing of the potential for a US rate hike on 22 September, it is nonetheless hard to see a

fundamental change in the weather for EM. With Europe and Japan seemingly mired in the liquidity

trap for the foreseeable future, the US remains also partially trapped, with at least one ‘leg’ in.

In essence, there would seem three key candidates that could provide a truly decisive jolt to the

forward structure of the US yield curve and so generate a meaningful and lasting global interest rate

shock that would roil EM. The first is a US inflation scare that threatens that the FOMC is genuinely

behind the curve so reigniting market pricing of a steady string of rate hikes. Although a range of

indicators suggest that the US labour market is tight, data continue to show quiescent wage trends

with headline average earnings advancing by a nugatory 0.1% m/m in the August labour market report.

One concern is that apparent breakdown of the Phillips curve in the US is simply a case of inflation

illusion with depressed rates of headline inflation in turn depressing nominal wage growth. A

normalisation in headline CPI from c.1% y/y currently to 2-2½% could therefore spur a significant

acceleration in nominal wage inflation. While our base case is that headline CPI inflation will pick up

by c.1pp heading into 2017, much depends on oil and food prices. Oil continues to oscillate in a rough

USD40-50 per barrel range with the ebb and flow of supply-side developments determining short-run

price action. Critically, global food prices are soft with the CRB foodstuff index pulling back towards its

January low. Prospective food disinflation is a key development to watch for in both DM and EM.

Lower-for-longer global

yields key global theme

Shift in expectations about

the Fed inevitably pivotal

Fading policy space in

Europe & Japan also key

Stronger JPY key circuit-

breaker for CNY

EM bonds have performed

strongly in this climate…

… but much of the juice

has now been squeezed…

… for now given near-term

risk of a US rate hike

US inflation shock the key

risk to ‘lower-for-longer’

US wage inflation damped

for the time being



The second push factor that could jolt global markets away from the prevailing lower-for-longer mind

set would be a decisive shift in the policy mix in the G3 spurred by looser fiscal policy. For the time

being, prospects for this look remote. The Japanese authorities’ fiscal boost, announced last month,

underwhelmed while a big fiscal boost in Europe is unlikely with discretionary fiscal policy anathema

to Germany; the one economy with genuine fiscal space. In the US, much depends on the outcome of

the presidential race with more Congressional gridlock the most likely outcome whoever wins.

A third factor is policy risk emanating from the BoJ and ECB. Both central banks have tacitly kicked for

touch in the near term by announcing ‘reviews’ of their policy programmes. Both central banks in turn

have tight-ropes to walk, looking to convince markets that they have sufficient flexibility left to stay the

course to meet inflation objectives without compromising the fundamental health of the financial

system. As with fiscal policy, the safest forecast is probably more of the same with QE programmes

extended, but not radically altered. Given the importance of the JPY in relieving pressure on

USD/CNY, the BoJ’s meeting on 21 September, just before the FOMC meeting, is a key risk event.

The hunt for yield and associated carry trade dynamics should therefore resume with the greatest

opportunities still to be found inevitably where nominal yields are highest, spreads to USTs still wide

and where inflation has the potential to fall sharply, opening up space for rate-cutting cycles. In other

words, those EMs where spread compression can happen for both structural and cyclical factors over

the next year. Critically, cyclically elevated food inflation rates in a number of EMs should fall sharply

over the next 6-9 months, increasing policy space and so bolstering the cyclical case for further

spread compression (EM: Food for thought).

Brazil has been the poster child for 2016’s yield grab and should continue to be in the spot-light.

Headline inflation of 9% y/y is being propped up by c.17% y/y food inflation and masking the steady

retreat of underlying inflationary pressure. Helped by global factors, food inflation should decay rapidly

in the coming months; a development that underpins our optimism that inflation will fall much faster

than the consensus expects next year, opening up space for 525bp of rate cuts by BCB (Brazil: Flying

back to target). Despite the huge gains it has already enjoyed this year, Brazil looks likely to remain

an EM carry trade darling heading into 2017.

Food inflation is also in double-digit territory in Colombia but already appears to be heading down; a

key source of comfort for one of the few remaining central banks in EM threatening rate hikes. With

base effects strongly favourable heading into 2017, the risk is that inflation will fall further and faster

than markets expect, opening up space for a substantial rate-cutting cycle next year. Expected rapid

disinflation is also key to our continued optimism on Argentina; a long-held conviction view. A

combination of tight policy mix and, as in Brazil and Colombia, falling food inflation should see inflation

collapse in 2017H1, increasing both political and macro-economic room for manoeuvre.

Turning to CEEMEA, South Africa and Russia stand out as the two economies most likely to benefit

from any renewed garb for yield. In the near term, a recrudescence of political risk and the simmering

threat of a downgrade to junk by year-end have predictably put the ZAR on the back foot and pushed

bond yields back up towards an appetising 9%.

The looming risk events of G3 central bank meetings, the October medium-term Budget review and

S&P’s rating review in early December should ensure that the hawkish SARB retains a tightening bias

through year-end even as inflation risks begin to tilt decisively south. Once again led by food prices,

inflation should fall sharply in 2017H1, pulling towards the middle of the SARB’s 3-6% inflation band

(South African monetary policy: Food, glorious food). Our well-below consensus CPI forecast supports

our view that, looking through the inevitable political noise of the next few months, the SARB should

be cutting rates, albeit slowly in 2017H2.

In Russia, food inflation has already collapsed, helping produce the sharpest disinflation in EM (c.8pp)

over the last year. The combination of a firmer RUB, a bountiful harvest and a sizeable output gap

suggest more disinflation to come, however, and should give the CBR confidence to cut rates by 50bp

as soon as 16 September. All told, we see inflation slipping a further 2pp to the 5% area, allowing

scope for policy rates to fall 350bp to 7% by mid-2017.

Scope for further yield compression in Asia is more limited. Space for rate cuts is fading in both the

low yielders (Korea, Thailand and Taiwan) and the high yielders (India and Indonesia) although we do

expect at least one rate cut, as soon as this month in the case of Taiwan, by all five central banks.

The Philippines, by contrast, is a genuine outlier (Philippines: Boom!). Bar India, it is the only major

EM where trend growth estimates are moving up and seemingly unique in enjoying a cyclical boom on

top of rising potential. Even though tilted towards productive capex, the Philippines’ domestic demand

boom will eventually lead to overheating if sustained at the current breakneck clip. A widening of the

current account (the worst in EM) is taking the strain for now but ultimately tighter policy settings will

need to accommodate what looks like a move to a structurally higher investment share. Tighter fiscal

policy is the ideal but the risk is that monetary policy, as elsewhere, will have to carry the burden.

(Unlikely) shift in G3 policy

mix another threat…

… alongside policy risk

from BoJ and ECB

Grab for yield likely to

resume after air pocket

Likely collapse in food

inflation key dynamic…

… in Brazil, Colombia and

also Argentina

Political risks have

rekindled in South Africa…

… but behind the scenes

inflation risk turning down

Disinflation to spur hefty

rate-cut cycle in Russia

In a world of low growth,

the Philippines an outlier

Michal Dybula / Jeffrey Schultz 14 September 2016


Macro convictions: CEEMEA

Russia and Poland: Divergent

Source: Macrobond, BGZ BNP Paribas

The stabilisation of the oil price is likely to lead to higher inflation in Poland, while it will improve Russia’s terms of trade, support the

rouble and spur Russian disinflation in the coming months. While the scope for monetary easing in Poland is pretty much

exhausted, we expect substantial interest-rate cuts, totally 350bp, by the Central Bank of Russia over the coming 6-9 months.

Want to read more? Russia and Poland: Divergent

IMPORTANT DISCLOSURE: This analysis has been produced by Bank BGZ BNP Paribas and has been reviewed, but not amended, by BNP Paribas. BNP Paribas is a majority shareholder in

Bank BGZ BNP Paribas. This analysis does not contain investment research recommendations.

South Africa: Food, glorious food

0

2

4

6

8

10

12

14

-20

-10

0

10

20

30

40

2010 2011 2012 2013 2014 2015 2016

CRB foodstuffs index (ZAR terms, % y/y, 3M lag, LHS)

SA CPI food prices (% y/y, RHS)

Source: SARB, BNP Paribas Securities

Global and domestic factors suggest South African food-price inflation will slow sharply in 2017 and, in turn, spur lower-than-

expected inflation next year. We see CPI slowing to a well-below-consensus 5.3% average rate in 2017 from an estimated 6.2% in

2016. Falling headline inflation should also feed into lower inflation expectations, affording the still hawkish SARB sufficient comfort

to first pivot to an easing bias and then, eventually, embark on a modest easing cycle, probably beginning in H2 next year.

Want to read more? South Africa: Food, glorious food

IMPORTANT DISCLOSURE:

This analysis has been produced by BNP Paribas Securities (Pty) Ltd and has been reviewed, but not amended, by BNP Paribas. BNP Paribas is an indirect shareholder of BNP Paribas Securities (Pty) Ltd with a 60% stake. This analysis does not contain investment research recommendations.

Gustavo Arruda / Florencia Vazquez 14 September 2016


Macro convictions: LatAm

Brazil: Flying back to target

Source: IBGE, BCB, Macrobond, BNP Paribas

The massive supply shock in food prices has caused the recent inflation surprise. Year-on-year, headline inflation is now running at

9.0% y/y, as food inflation sits at 16.8% y/y. While shocks, by definition, are impossible to anticipate, we believe the current one will not

last long. For 2017, we see evidence pointing to inflation finally converging to the 4.5% y/y target centre.

Want to read more?? Brazil: Flying back to target

Argentina: Inflation likely to collapse in early 2017

Source: BCB, Macrobond, BNP Paribas

Following the initial spike driven by tariff hikes and pass-through from the peso devaluation, inflation has now embarked on a steady

downward trend thanks to a tighter policy mix. We expect the monthly inflation rate to settle in the 1.5-2% m/m range in Q4.

However, the y/y inflation rate will likely remain high, lifted by base effects. Base effects, though, will change dramatically as we

enter 2017 and the annual inflation rate is likely to collapse from 41% by year-end to 22% in May 2017 (according to the Buenos

Aires city index).

Want to read more?? Argentina: Inflation likely to collapse in early 2017

7.5

9.0

16.8

-5

0

5

10

15

20

25

30

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

IPCA X-Food at home

IPCA y/y

Food at home

Richard Iley / Mole Hau 14 September 2016


Macro convictions: Asia

Philippines: Boom!

Source: Macrobond, BNP Paribas

In a world of scarce growth, the Philippines stands out as unique in enjoying booming final domestic demand growth of 12%+ y/y.

Strength is broad based but capex is the real star. Despite the favourable tilt towards plant and equipment capex, no economy can

realistically maintain this rate of torrid domestic demand growth without eventually overheating. Tighter policy will be needed to rein

in demand. The Philippines thus could be the only major EM where policy rates may be hiked in 2017 for the ‘right’ reasons.

Want to read more?? Philippines: Boom!

Taiwan: Look beyond the ‘tech-nical’ rebound

Source: CEIC, Macrobond, BNP Paribas

Demand for electronic components and China’s latest stimulatory drive are now fuelling an industrial upswing in Taiwan. With both

drivers likely to be short-lived and a number of structural headwinds prevailing, however, additional stimulus is needed to wear away

excess capacity and disinflationary pressure. As the CBC’s hopes of fiscal easing will likely remain wishful thinking, a weaker TWD

via a further discount rate cut at its late September meeting remains a likely option to lift imported inflation and growth.

Want to read more?? Taiwan: Look beyond the ‘tech-nical’ rebound

Michal Dybula 14 September 2016


Conviction colour: Russia and Poland

Divergent

Improving terms of trade suggest continued disinflation and rate cuts to come in Russia.

In contrast, higher oil prices will add to inflation in Poland, where interest rates are low.

Portfolio inflows to Poland could be at risk if the US Fed hikes more than expected.

The rebound in the oil prices from lows early this year is the key reason for the RUB’s

stabilisation in recent months. With the impact of last year’s RUB depreciation set to be entirely

gone by the end of Q3 2016, we expect Russian inflation to continue to decline over the

remainder of the year and into 2017. Russia’s large negative output gap and a plentiful harvest

should lower food prices, underpinning the disinflationary outlook. Moreover, stronger terms of

trade and lower inflation suggest that Russian growth will start to recover soon.

Lower inflation and a stronger exchange rate should, in turn, start to scale back inflation

expectations, creating scope for monetary easing by the Central Bank of Russia (CBR) over the

coming months (Chart 1). We expect the CBR to cut rates by 50bp on 16 September, taking the

policy rate to 10%. We expect it to continue easing over the following 6-9 months. With inflation

slowing to the 5% area next year, we see the policy rate falling to 7.00% by mid-2017.

In Poland, the stabilisation of oil prices signals the end of a long and deep disinflationary cycle,

especially against a backdrop of major fiscal loosening, rising consumer demand and likely

hikes in administered prices (electricity and water) next year. The uptick in inflation will, in our

view, prevent any further monetary easing, despite slowing economic growth. Although a

number of Polish policymakers have sounded more dovish recently, they, too, are not convinced

that further interest-rate cuts could actually help boost GDP growth.

Polish interest rates are already extremely low and any tightening of Fed policy is likely to trigger

a further decrease in short-term interest differentials between Poland and the US. This may

create a more challenging environment for portfolio inflows to Poland over the coming months,

especially if the Fed were to turn more hawkish than markets expect (Chart 2). Moreover, in light

of the substantial fiscal relaxation already in place, Poland’s budget deficit and public debt will

be on the rise next year, increasing the risk of further sovereign rating downgrades and raising

the risk premium on Polish assets.

Chart 1: Disinflation and rate cuts ahead in Russia

Chart 2: Portfolio inflows to Poland at risk

Source: Rosstat, CBR, Macrobond, BGZ BNP Paribas Source: NBP, Federal Reserve, Macrobond, BGZ BNP Paribas


This analysis has been produced by Bank BGZ BNP Paribas and has been reviewed, but not amended, by BNP Paribas. BNP Paribas is a majority shareholder in Bank BGZ BNP Paribas. This analysis does not contain investment research recommendations.

Things are starting to look

better in Russia…

… creating more scope for

substantial CBR easing

In contrast, disinflation

will soon end in Poland

Risks to porfolio inflows to

Poland are on the rise

Jeffrey Schultz 14 September 2016


Conviction colour: South Africa

Food, glorious food

Food prices are likely to be a key driver of lower-than-expected inflation in 2017.

Softer inflation and a stronger ZAR should pave the way for rate cuts in H2 2017.

Heightened political risk is the wildcard, though, and it will keep the SARB cautious for now.

There is growing evidence that the worst of the food-inflation headache faced by many emerging

markets, particularly South Africa, may be over (see EM: Food for thought). These disinflationary

pressures are already being felt in domestic agricultural and manufactured-food prices at a

producer level: both global and domestic grain prices have plummetted since mid-January.

Consequently, we see scope for CPI food inflation to slow to an average 5.6% next year, well

down from 2016’s expected average of 10.5%. With food having a relatively high weighting in

South Africa’s inflation basket (14.2%), we expect food-price disinflation to be one of the largest

contributors to lower-than-expected inflation over the next 12 months. We estimate that food

prices, alone, should shave 1.0-1.2pp off South African headline inflation by the end of next year.

Weak domestic demand, crimped corporate profitability and the persistence of a negative output

gap until 2018 also indicate to us that core and services inflation could be dragged down next

year. As such, we think that South African headline inflation could slow markedly from next year,

averaging a well-below-consensus 5.3%, from our 6.2% average estimate for this year. At

current policy-rate levels, our inflation estimates suggest that real policy rates could climb to just

over 2.0% by end 2017.

Consequently, we are pencilling in two 25bp rate cuts from the South African Reserve Bank in

September and November 2017, which, we believe, will still leave the country with one of the

highest real policy rates in its peer group. The risk of a sovereign ratings downgrade to ‘junk’

status in December, the high degree of political upheaval currently being felt and a likely US

Federal Reserve hike this year, however, are likely to keep the ZAR trading haphazardously into

year end. This will also keep the SARB cautious about calling the peak of the current interest-

rate cycle and relaxing its tightening bias.

Food price momentum is

falling fast…

… and should shave a pp

or more off 2017 inflation

SA’s real rates are high in

a peer-group comparison

We now expect two 25bp

rate hikes from H2 2017

Chart 1: Food prices to shave 1pp-plus off 2017 inflation

Chart 2: A sharp decline in inflation likely in 2017

Source: Statistics South Africa, BNP Paribas Securities South Africa Source: Statistics South Africa, BNP Paribas Securities South Africa


This analysis has been produced by BNP Paribas Securities (Pty) Ltd and has been reviewed, but not amended, by BNP Paribas. BNP Paribas is an indirect shareholder of BNP Paribas Securities (Pty) Ltd with a 60% stake. This analysis does not contain investment research recommendations.

0.0

0.5

1.0

1.5

2.0

2.5

2009 2010 2011 2012 2013 2014 2015 2016 2017

Contribution of food inflation to y/y CPI inflation (pp) Our forecast

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

2014 2015 2016 2017

Our forecastHeadline CPI (% y/y)

Core CPI

Gustavo Arruda 14 September 2016


Conviction colour: Brazil

Flying back to target

Food inflation keeps surprising upwards and has been a main driver of inflation recently.

Underlying inflation, however, has been showing a more benign trend, in our opinion.

We remain confident that inflation will move back to the target of 4.5% y/y by year-end 2017.

Despite Brazil experiencing the greatest recession on record, the country’s inflation remains

high (9.0% y/y). Inertia is part of the problem, but supply shocks are also culprits and this very

high annual reading is largely explained by a massive food price shock. Even though shocks

may prevent inflation from a faster deceleration in the short term, we remain confident of our call

that inflation will converge on the target centre of 4.5% y/y at the end of 2017.

Thanks to the massive supply shock in food prices, year-on-year headline inflation is now

running at 9.0%, as food inflation sits at 16.8% y/y. This upset is comparable to the two latest

food shocks in 2008 and 2013. While shocks, by definition, are impossible to anticipate, we

believe the effects of the current one will not last long. According to the wholesale prices index,

agricultural prices are now accommodative and even moving to negative terrain, and this should

start to be reflected in consumer prices in coming months.

As shocks do happen, the underlying trend is key to assessing possible second-round effects.

Right now, inflation excluding food prices is slowing faster and is running at about 7.5% y/y

compared to the 9.0% y/y headline rate. We believe this underlying inflation measure will end

the year at about 6.0% y/y, whereas headline inflation should be about 7.0% at end-2016.

For 2017, we are seeing evidence that points to inflation finally converging to the 4.5% y/y target

centre. A combination of re-anchored inflation expectations, a stronger currency, lagged effects

of this year’s recession and the likely tightening in fiscal policy should reduce actual inflation.

Within the components (Chart 1), we project a further deceleration in service inflation, more

contained regulated prices and food price inflation coming back to a more reasonable level.

Our forecast is below the consensus view (Chart 2), which we believe will continue to head our

way in coming months. The latest central bank (BCB) survey signalled the bank expects 2017

inflation at 5.1%, compared to 5.7% back in May, when we revised our call to 4.5%.

We expect falling inflation to create a path for the BCB to cut rates. We expect to see a total of

525bp of rate cuts in the coming easing cycle, bringing the policy rate from 14.25% all the way

down to single digits by the end of 2017. For now, we assume an inaugural rate cut of 50bp in

October (please see: Brazil: The big easing).

Chart 1: BNPP inflation forecast (%)

Chart 2: 2017 inflation forecast (%)

Source: IBGE, BNP Paribas. * BNPP forecasts Source: IBGE, BNP Paribas.

7.0 6.1

13.0

6.7

1.9

5.94.5 4.8 4.9 5.1

2.4 3.6

IPCA Regulated

items

Food Services Durable

goods

Non-

durables

2014 2015 2016* 2017*

Supply shocks explain

part of this year’s inflation

Annual food inflation is

now running at 16.8%

Inflation, ex-food prices, is

now running at 7.5%

We project inflation flying

back to 4.5%

Lower inflation should

allow the BCB to slash

rates

Florencia Vazquez 14 September 2016


Conviction colour: Argentina

Inflation likely to collapse in early 2017

Following an initial spike, the inflation downtrend is here to stay thanks to a tighter policy mix.

Inflation is expected to collapse in early 2017, then slide gradually thereafter.

Central bank likely to launch a formal inflation-targeting regime sometime in September.

Following an expected, initial spike driven by tariff hikes and pass-through from the peso

devaluation, inflation has now embarked on a steady downward trend, we believe. Moderation in

H2 2016 was expected as a result of the implementation of a tighter policy mix. For a change,

the pace of primary spending stood visibly below revenue growth in the first seven months of the

year (18% versus 27% y/y, respectively) and the primary deficit shrank 1.8% in real terms.

Moreover, growth of monetary aggregates has slowed markedly as real interest rates have been

guided back towards positive terrain after many years of negative readings (Chart 1).

We expect the monthly inflation rate to settle in the 1.5-2% m/m range in the remainder of the

year, on average. There will be some volatility, though, linked to court rulings that have

suspended tariff hikes. August’s CPI print was depressed by the suspension of the natural gas

tariff hike announced in April 2016 effective that month. In turn, we foresee a likely spike in

October, when natural gas tariff hikes will probably be implemented for good.

The year-on-year inflation rate will remain high in the near term – despite the moderation in the

monthly pace of consumer prices – lifted by base comparison effects. These base effects,

though, will change dramatically as we enter 2017, as the high prints of early 2016 will come into

play. We thus expect the CPI inflation rate to collapse from 41% at the end of 2016 to 22% in

May 2017 (according to the Buenos Aires city index). The decline in the inflation rate is expected

to be much more modest after that, as base effects will shift again and become less favourable

(Chart 2).

The central bank (BCRA) is expected to launch a formal inflation-targeting regime sometime in

September. Unlike currently, where the 35-day Lebac rate (the policy rate) is set at weekly

auctions, the BCRA is expected to shift to monthly rate-setting meetings. It still remains unclear

which rate will become the policy rate. Most likely, the central bank will replace the liquidity

paper rate with the repo rate. According to press reports, financial assistance to the treasury

from the central bank would fall by 25% in 2017.

Chart 1: Interest rate on peso CDs (Badlar, % pa)

Chart 2: CPI inflation and expectations (% y/y)

Source: BCRA, BNP Paribas Source: Ministry of Finance, BA City, UTDT, Macrobond, BNP Paribas

-15

-12

-9

-6

-3

0

3

6

Jan 06 Jan 08 Jan 10 Jan 12 Jan 14 Jan 16

0

10

20

30

40

50

2006 2008 2010 2012 2014 2016

BA City CPI index

Average inflation expectations

BNPPforecast

Tighter policy mix has

resulted in lower inflation

Low average inflation with

some volatility expected

Annual inflation rate likely

to collapse in early 2017

BCRA to launch inflation-

targeting regime soon



Conviction colour: Philippines

Boom!

The Philippines is unique in enjoying a domestic demand boom, with capex the real star.

But no one can sustain this rate of torrid domestic demand growth without finally overheating.

It thus could be the only major EM where rates may be hiked in 2017 for the ‘right’ reason.

In a world of increasingly scarce growth, the Philippines stand outs as unique in enjoying a domestic

demand boom. Real final domestic demand is surging at 12%+ y/y. This is more than 5pp faster than

China and more than double India and Indonesia’s. Strength of the Philippines’ domestic demand is

across the board. Private consumption is growing steadily at a China-like 7-7½% while government

consumption is booming. Capex, up a stunning 27% y/y, is the real star, however.

Importantly, the surge in capex is skewed towards productive durables i.e. plant and equipment

rather than construction. Spending on durables was up an eye-watering c.43% y/y in Q2 2016

compared to construction investment’s ‘relatively’ sluggish 14% y/y rate over the same period. Given

the Philippines’ Achilles Heel has been its historically low investment share of sub-21%, the surge in

spending on durables is a sorely needed and ultimately strongly bullish development.

Despite the favourable tilt towards productive capital spending, however, no economy can sustain

12%+ domestic demand growth without eventually overheating. GDP growth of 7% over the last year

has likely eroded any remaining margin of spare capacity with our estimate of its output gap starting

to edge into positive territory. After China, the Philippines also has the loosest aggregate financial

conditions, suggesting that there is little restraint on booming domestic demand.

In the short-term, however, there is scant evidence of overheating. CPI inflation of sub-2% is just

below the BSP’s 2-4% inflation target range. The GDP deflator, up just 1.6% y/y in Q2, also suggests

little inflationary pressure. Muffling inflationary pressure for the time being is the rapid erosion of the

trade balance; a dynamic that has left the Philippines with the worst current account momentum in

major EM. The trade accounts can likely continue to take the strain for some time but ultimately policy

settings will need to be tightened to rein in red-hot domestic demand growth and boost national

saving to make space for the structurally higher investment share that is emerging.

The Duterte administration is encouragingly looking to introduce four tax reform packages that seek

to lift government revenues by up to 3% of GDP by 2019, but execution risk is necessarily high. This

risks the burden of tightening falling more heavily on monetary policy. In a world of scarce growth and

falling interest rates, the Philippines thus seems a genuine outlier; one in danger of finally cyclically

overheating and so ultimately requiring a dose of old-fashioned monetary tightening next year.

Chart 1: Capex the real star

Chart 2: Slacking off

-2.0

-1.5

-1.0

-0.5

0.0

0.5 Output gap, % (Q2 2016)

Source: Macrobond, BNP Paribas Source: Macrobond, BNP Paribas

Final domestic demand

booming at over 12% y/y

Strength across the board;

plant capex the real star

Tighter policy settings

ultimately needed

Price pressure muffled by

trade balance erosion

Output gap likely positive

despite higher trend GDP

Mole Hau 14 September 2016


Conviction colour: Taiwan

Look beyond the ‘tech-nical’ rebound

Demand for electronics and China’s latest stimulus are fuelling an industrial upturn in Taiwan.

But both drivers are likely short-lived, structural headwinds prevail and deflation risks loom.

A weaker TWD via CBC easing in late September remains a likely reflationary option.

Taiwan’s economy barely advanced in Q2, but macro-momentum looks to have perked up in Q3.

Industrial production, export volumes and orders have all trended higher, with momentum

gauges at multi-year highs. Viewed in terms of export sales by destination, the improvement is

most evident in demand from China and Hong Kong although exports to the rest of Asia and the

US have also improved. By commodity, electronics are predictably providing the biggest thrust.

Chemicals, metals and minerals are also adding to the revival (Chart 1).

Demand for electronic components and China’s latest stimulus provide a ray of hope for

Taiwanese manufacturers with de-stocking over much of the past year putting the level of

inventories more in line with demand. Momentum of tech shipments however may not last

beyond the cyclical smartphone-driven recovery. More generally, China’s structural industrial

slowdown and rebalancing drive remain significant headwinds to the island’s manufacturing.

Unless it is sustained, the current cyclical upswing will do little to eliminate the excess capacity

accumulated from quarters of sub-par GDP growth; closing the output gap, estimated at close to

2% of potential, requires a string of quarters of above-trend growth. Excess spare capacity was

evident in August’s CPI data, which sprang a downside surprise as core momentum faded and

food prices slipped, highlighting the risk of renewed deflation.

The CBC’s hopes of fiscal easing to boost demand will likely remain wishful thinking, with a

narrow tax base and an ageing society meaning fiscal space is limited without a rise in debt

limits (see Taiwan: Time to get fiscal?). A modest rise in spending proposed in the 2017 budget

signals the new government continues to prioritise fiscal prudence. The lack of punch from fiscal

policy and near-term reform leaves the onus firmly on the CBC to do the reflationary heavy lifting.

Given already-abundant domestic liquidity, another cut to the discount rate is unlikely to make a

material difference to onshore borrowing conditions. But the signalling impact to the market

could boost confidence while weakening the TWD. The CBC appears to have slowed reserve

accumulation under the US Treasury Department’s watch (Chart 2). A weaker TWD via CBC

easing at its late September meeting therefore remains a likely option to lift inflation and growth.

Chart 1: ‘Tech-nical’ rebound

Chart 2: Appreciate that!

-10

-8

-6

-4

-2

0

2

4

6

8

12 13 14 15 16

Contributions to 3m/3m export growth (USD terms), pp

Minerals Chemicals Plastics & rubber

Prec. stone & jewellery Basic metals Machinery & electrical eq

Transportation & eq Precision instruments Others

Total

Source: CEIC, Macrobond, BNP Paribas Source: Bloomberg, Macrobond, BNP Paribas

An industrial upswing now

underway in Taiwan

But durability doubtful and

deflationary risks looming

More stimulus needed to

erode excess capacity

A weaker TWD via CBC

easing a likely option

Tech demand and Chinese

stimulus the key drivers



Where are we different? EM growth

2016: GDP growth (%)

-8

-4

0

4

8

12

16

Arg

en

tin

a

Bra

zil

Ch

ile

Ch

ina

Co

lom

bia

Hun

gary

India

*

Ind

onesia

Mala

ysia

Me

xic

o

Peru

Phili

pp

ines

Pola

nd

Russia

Saudi A

rabia

South

Afr

ica

South

Ko

rea

Tha

ilan

d

Turk

ey

Vie

tna

m

2016 GDP growth forecasts

10-year historical range Consensus BNPP

Source: Bloomberg, national statistics offices, BNP Paribas; * FY2017 for India

We remain typically more downbeat on emerging markets’ 2016 growth prospects than the consensus. Saudi Arabia (−0.6%) is

where we are the most pessimistic relative to current market estimates according to Bloomberg. We are also some way below

consensus on Vietnam (5.5%), Hungary (1.4%), Turkey (2.7%) and Poland (2.8%). In contrast, we are somewhat above consensus

when it comes to Russia (0.0%), Brazil (−3.0%) and India (8.2%).

2017: GDP growth (%)

-8

-4

0

4

8

12

16

Arg

entina

Bra

zil

Chile

Chin

a

Colo

mbia

Hung

ary

India

*

Indon

esia

Mala

ysia

Mexic

o

Peru

Phili

ppin

es

Pola

nd

Russia

Saudi A

rabia

South

Afr

ica

South

Ko

rea

Thaila

nd

Turk

ey

Vie

tna

m

2017 GDP growth forecasts


Source: Bloomberg, national statistics offices, BNP Paribas; * FY2018 for India

The distribution of our current growth forecasts compared with consensus for 2017 is more balanced. Brazil (2.0%) and Argentina

(4.0%) are where we are most optimistic relative to consensus. We are also above consensus for Russia (2.2%) and the Philippines

(7.0%). We remain the most pessimistic on Saudi Arabia, forecasting just 0.3% growth. Our 1.2% Hungarian forecast is also well

below the current consensus. Poland (2.5%) and Colombia (2.4%) are not far behind.

Link to key forecasts (GDP and CPI inflation)



Where are we different? EM inflation

2016: CPI inflation (%)

-5

0

5

10

15

20

25

30

35

40

45

Arg

entina

Bra

zil

Chile

Chin

a

Co

lom

bia

Hungary

India

*

Ind

onesia

Mala

ysia

Mexic

o

Peru

Phili

pp

ines

Pola

nd

Russia

Saudi A

rabia

South

Afr

ica

South

Kore

a

Thaila

nd

Turk

ey

Vie

tnam

2016 CPI inflation forecasts


Source: Bloomberg, national statistics offices and central banks, BNP Paribas; * FY2017 for India

In 2016, Argentina (43%) is where our inflation forecast is the highest relative to market estimates. Thanks in part to currency

weakness, Brazil (8.8%), Poland (-0.4), Saudi Arabia (4.1%) and Colombia (7.6%) are also among the economies where our

forecasts are (just) above consensus. Malaysia (2.0%), South Africa (6.2%), Russia (7.1%), Indonesia (3.7%) and Peru (3.4%) are

where our forecasts are lowest relative to market estimates. We are also below consensus for Korea (0.9%) and Turkey (7.9%).

2017: CPI inflation (%)

-5

0

5

10

15

20

25

30

Arg

entina

Bra

zil

Chile

Chin

a

Colo

mbia

Hung

ary

India

*

Indon

esia

Mala

ysia

Mexic

o

Peru

Phili

ppin

es

Pola

nd

Russia

Saudi A

rabia

South

Afr

ica

South

Ko

rea

Thaila

nd

Turk

ey

Vie

tna

m

2017 CPI inflation forecasts


Source: Bloomberg, national statistics offices and central banks, BNP Paribas; * FY2018 for India

Our 2017 inflation forecasts are generally below consensus. Indonesia is the standout, with our 3.9% inflation forecast 0.8pp below

the current consensus. Our recently revised 5.3% forecast (versus 6.5% previously) also leaves South Africa among the economies

where our forecasts are some way below market estimates. Argentina is the clear exception, with our 25% forecast 3.5pp above the

current consensus. We are also (just) above consensus for Turkey (8.5%), Hungary (2.7%) and Chile (3.6%).

Link to key forecasts (GDP and CPI inflation)



Arrested development: EM potential growth

EM potential growth 2017 – IMF April 2016 WEO

-1

0

1

2

3

4

5

6

7

8 Potential GDP growth 2017 (IMF April 2016 WEO)

Source: IMF, BNP Paribas

We have worked out estimates of potential growth for a range of EM countries using IMF World Economic Outlook (WEO) data.

According to the latest, April 2016, India, with a 7.5% potential growth rate, stands out as the fastest-growing EM. The Philippines

and China, both around 6%, follow. With rates of close to 5%, Indonesia and Malaysia are not too far behind. At the other end of the

spectrum are Brazil and Russia, whose potential growth estimates, are near zero. South Africa and Argentina are next at about 2%.

EM potential growth 2017 – IMF April 2016 versus October 2012 WEO

-5

-4

-3

-2

-1

0

1

2 Potential GDP growth 2017 (IMF April 2016 vs. Oct 2012 WEO), pp

Source: IMF, BNP Paribas

Comparing estimates from different IMF WEO publications helps us gauge how growth potential has evolved in recent years.

Potential growth is estimated to have skidded over the last four years ago almost all EM countries. Russia and Brazil, where

estimates has slipped over 4pp, are clearly the worst in class. South Africa, Thailand and most other net commodity exporters

(excluding Malaysia) have also seen estimates of short-run potential suffer significant reversals. India (up +0.6%) and the

Philippines (up 1.2%) are the sole exceptions where supply-side developments have improved rather than soured.



Reserve judgement: EM FX reserves

EM FX reserves – aggregate

-300

-200

-100

0

100

200

300

400

500

99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

Quarterly change in EM FX reserves*, USD billions

Adjusted forvaluation effects

Gross change

* BNPP constructed

Source: Bloomberg, BNP Paribas

Our emerging-market FX reserve aggregate, which we construct from national data, captures around 92% of the IMF’s discontinued

COFER emerging-market measure. By our estimates, emerging-market reserves look to have been little changed in Q2 2016, a

stark improvement on Q1’s USD 106bn decline, bringing the past year’s decline to USD 609bn. Adjusted for valuation effects,

emerging-market reserves in fact increased for the first time in a year in Q2, by USD 38bn.

middle of last year.

EM FX reserves – country comparisons

Source: Bloomberg, BNP Paribas, IMF

In the year to Q2, emerging-market (gross) FX reserves fell an estimated USD 609bn. China dominated, accounting for USD 489bn,

or 80%, of the drop. Saudi Arabia, whose reserves have fallen USD 103bn over the past year, followed at a distance. With

increases of USD 16-19bn in their FX reserves, Thailand and Russia were the clear outliers. Data for August show China’s gross

reserves were down USD 20bn from end-Q2. The near-term prospect of US Fed rate hikes may have increased outflow pressures.



REER-view mirror: EM real exchange rates

EM REERs (% y/y)

Source: BIS, BNP Paribas

In the year to July 2016, real effective exchange rates (REERs), according to data from the Bank for International Settlements (BIS),

depreciated in most emerging markets. The ARS, which fell 17%, led the downward move, followed by the MXN, which dropped

12%. The ZAR, CNY and PLN, with declines ranging from about 5¼% to 7¾%, also saw significant weakness. With gains of 3¾%

to 9¼%, the BRL, IDR, SAR and CLP were the clear outliers.

EM REERs: Standard deviations from mean

Source: BIS, BNP Paribas

Normalising REERs relative to their long-run mean is a useful gauge of the extent of over- or under-valuation of a currency. The

CNY, INR, SAR and PHP, at 1.3-1.8 standard deviations (SD) above their mean, stand out as the most overvalued. REERs of net

commodity exporters are typically cheap. The MXN and the ZAR, at 1.9 and 1.5 standard deviations below mean, respectively, look

the most undervalued, followed by the MYR, ARS and COP, at 0.8-1.2 standard deviations below mean.



Taking the temperature - I

Mapping emerging markets' external vulnerabilities

Argentina Brazil Chile China Colombia Hungary India Indonesia Malaysia Mexico

GDP growth change (2016 vs. 2014) 15 20 10 12 17 14 6 8 16 7

Current account/GDP (2016) 10 12 13 6 19 3 9 15 7 14

Current account/GDP change (2016 vs. 2014) 13 3 16 9 15 2 12 8 18 14

Inflation pp deviation from target (Q2 2016) 18 19 13 7 20 2 11 9 8 10

Real policy rate (Q2 2016) 1 3 18 6 19 11 13 7 8 9

Net exports of commodities/GDP (2014) 15 12 17 2 19 7 3 13 18 9

Basic balance/GDP (year to Q1 2016) 14 9 10 7 18 4 11 13 5 15

Gross external financing needs/FX reserves (end-Q1 2016) 20 8 15 6 16 9 10 14 17 12

REER % deviation from 20-year average (July 2016) 1 13 8 19 4 9 15 16 5 2

Net sovereign external debt/current external receipts (end-Q1 2016) 20 2 10 3 13 17 6 19 11 15

External vulnerability scores (out of 200) 127 101 130 77 160 78 96 122 113 107

Peru Philippines Poland Russia Saudi Arabia South Africa South Korea Thailand Turkey Vietnam

GDP growth change (2016 vs. 2014) 2 9 5 19 18 13 11 1 3 4

Current account/GDP (2016) 17 5 11 4 20 18 1 2 16 8

Current account/GDP change (2016 vs. 2014) 11 17 10 6 20 7 4 1 5 19

Inflation pp deviation from target (Q2 2016) 14 5 1 17 12 15 6 4 16 3

Real policy rate (Q2 2016) 15 12 5 4 20 14 16 10 17 2

Net exports of commodities/GDP (2014) 14 4 8 20 15 10 1 6 5 11

Basic balance/GDP (year to Q1 2016) 16 6 12 8 20 19 3 2 17 1

Gross external financing needs/FX reserves (end-Q1 2016) 7 3 13 2 4 18 1 5 19 11

REER % deviation from 20-year average (July 2016) 12 18 6 7 17 3 11 14 10 20

Net sovereign external debt/current external receipts (end-Q1 2016) 4 8 18 5 1 14 9 7 12 16

External vulnerability scores (out of 200) 112 87 89 92 147 131 63 52 120 95

Source: BNP Paribas

To scrutinise the vulnerability of emerging markets to external shocks, we adopt a relative-ranking approach, which can be used to

generate a heat map. We have recently expanded our analysis to cover 20 major emerging economies, which we then compare

and rank based on 10 key indicators, spanning macro momentum, policy space, external liquidity and solvency. The resulting 20-

by-10 matrix means that each economy is scored out of 200. The higher the score, the more vulnerable the economy.

Incorporating the latest data and forecasts from the IMF, Colombia remains the most vulnerable emerging market, with a score of

160. Saudi Arabia is in the silver-medal position, at 147, followed by South Africa (131), Chile (130) and Argentina (127). Indonesia

(122) and Turkey (120) are relatively ‘high risk’, but are moving out of the danger zone. Brazil scores terribly on a couple of

indicators, but is saved by its high real policy rates, improving current account and ample FX reserves.

Healthy external surpluses, combined with policy space, ensure that many Asian economies, such as Thailand, South Korea,

China and the Philippines, stand out as safe havens. Hungary is also relatively ‘low risk’. The gradual restoration of policy controls

and the much improved balance-of-payments have helped India’s external vulnerability to fall dramatically since 2013.



Taking the temperature - II

Mapping emerging markets’ fiscal fragility

Argentina Brazil Chile China Colombia India Indonesia Malaysia Mexico

Cyclically-adj. primary bal./potential GDP (2016) 17 8 13 14 5 15 10 12 7

Cyclically-adj. primary bal./potential GDP change (2016 vs. 2014) 11 2 10 16 5 7 9 14 1

Gross debt/GDP (2016) 15 17 2 9 10 16 4 14 13

Gross debt/revenue (2016) 7 14 2 6 11 17 13 16 15

Expenditure/GDP change (2016 vs. 2014) 17 12 16 15 4 11 3 1 2

Interest rate-growth differential (5yr avg) 1 17 8 3 14 5 7 6 12

Total fertility rate (2015) 6 11 12 14 10 4 2 9 7

Old-age dependency rate (30yrs ahead) 8 12 13 14 10 3 4 5 7

Government external debt/total (end-Q1 2016) 7 2 8 1 12 3 17 10 13

Government external debt/FX reserves (end-Q1 2016) 17 5 7 1 12 6 15 10 13

Fiscal fragility scores (out of 170) 106 100 91 93 93 87 84 97 90

Peru Philippines Poland Russia South Africa South Korea Thailand Turkey

Cyclically-adj. primary bal./potential GDP (2016) 9 1 11 16 4 3 2 6

Cyclically-adj. primary bal./potential GDP change (2016 vs. 2014) 13 15 8 17 3 4 6 12

Gross debt/GDP (2016) 3 6 12 1 11 7 8 5

Gross debt/revenue (2016) 4 10 5 1 8 9 12 3

Expenditure/GDP change (2016 vs. 2014) 9 13 8 5 14 6 10 7

Interest rate-growth differential (5yr avg) 10 2 13 16 15 11 9 4

Total fertility rate (2015) 3 1 16 13 5 17 15 8

Old-age dependency rate (30yrs ahead) 6 2 15 11 1 17 16 9

Government external debt/total (end-Q1 2016) 15 9 16 6 11 5 4 14

Government external debt/FX reserves (end-Q1 2016) 8 9 16 2 14 4 3 11

Fiscal fragility scores (out of 170) 80 68 120 88 86 83 85 79

Source: BNP Paribas

We have also refreshed our fiscal-fragility heat-map analysis. Data limitations mean we have used a universe of 17 major

emerging-market economies. We rank them according to 10 fiscal indicators, ranging from debt dynamics to fiscal space and long-

run solvency risk. The resulting 17-by-10 matrix means each economy is scored out of 170; the higher the score, the more fiscally

fragile the economy. Our latest analysis draws heavily on the IMF’s fiscal estimates in its April 2016 Fiscal Monitor.

Poland stands out as the most fiscally fragile emerging market, with a score of 120 out of 170. Strongly negative demographic

trends, high external borrowing, slowing nominal GDP growth and souring debt dynamics are its key weaknesses. Argentina, Brazil

and Malaysia are also among the most fiscally fragile. Fiscal momentum and high debt levels are among the key areas of

vulnerability for Argentina and Malaysia, while both high debt levels and souring debt dynamics are key worries for Brazil.

In the chasing pack are Colombia, which is struggling with negative debt dynamics and high(ish) external borrowings, China, which

is wrestling with a shift to a structural primary deficit and negative demographic trends, and Chile, which is running a large structural

primary deficit and seeing souring demographic trends. The Philippines, Turkey and Peru are the least fragile.



Would you credit it?

CDS spreads vs credit ratings

Source: Bloomberg, Moody’s, S&P, Fitch, BNP Paribas; *Data and ratings as of 12 September 2016

In an attempt to identify countries for which the current market pricing of sovereign credit risk is most at odds with average

sovereign ratings, we best-fit an exponential line through five-year sovereign credit-default swap (CDS) spreads against the average

credit ratings of the three main ratings agencies (Moody’s, S&P and Fitch). Interestingly, with a sample of 38 countries and

‘goodness of fit’ of more than 80%, our model suggests that the investment-grade threshold equates to about 150bp.

Market pressure on ratings

Source: Macrobond, BNP Paribas. * Data and ratings are as of 12 September

Deviations from the ‘best-fit’ line show where the market currently perceives pressure on ratings to be greatest. Among the emerging

markets, Vietnam and Argentina are trading ‘tightest’. The CDS of Saudi Arabia and South Africa, with spreads about 100-120bp

above their implied values, are the widest relative to the value implied by their current ratings. Turkey’s CDS spread, at about 70bp

more than its implied value, follows remotely. Notably, Brazil’s CDS spread is now only 25bp or so above its implied value.



Pressure points: What to watch for

CEEMEA

26 October 2016 Medium-term budget (South Africa)

Treasury is likely to present a weaker growth and revenue forecast profile to what it estimated in February. Nevertheless, we expect it to maintain broadly similar debt and deficit trajectories as it attempts to stave off a sovereign downgrade.

16 September 2016 Central bank rate decision (Russia)

We expect the Central Bank of Russia (CBR) to cut rates by 50bp on the upcoming meeting. The case for disinflation in Russia is broad-based which bolsters the case for a rate-cutting cycle in the months ahead.

4 November 2016 Moody’s ratings review (Hungary)

We expect Moody’s to upgrade Hungary’s rating to BBB- from BB+. Moody’s put the country on a positive outlook back in November 2015 and substantial reduction of fiscal and external risks should incline the agency to cut the rating now

2 December 2016 Standard & Poor’s ratings review (South Africa)

We expect S&P to downgrade the country’s long-term foreign currency rating to BB+ (sub-investment grade) in December on the back of a lack of structural reform progress and increased political risks to some of the country’s institutions (Treasury).

LatAm

15 September 2016 Monetary policy decision (Chile)

Chile’s central bank is widely expected to remain on hold. The adoption of a neutral bias in August confirmed the view of no rate changes near term. Comments included in the last monetary policy report downplayed the probability of rate cuts.

30 September 2016 Q3 Inflation report (Brazil)

Central bank is schedule to release the quarterly inflation report up to last day of September. Central bank is paving the way to cut rates and the report should be an important channel for the central to communicate. We project the first cut in October.

30 September 2016 Pensions reform bill (Brazil)

The government confirmed that it will send to congress a broad proposal for pension reform bill until end of September. This needed but unpopular reform is key for fiscal sustainability and will likely require long negotiation in congress.

Asia

1 October 2016 RMB’s SDR Inclusion (China)

In November 2015, the IMF decided that, effective 1 October 2016, China’s RMB will be included in the SDR basket as a 5th

currency, along with the USD, EUR, JPY and GBP. The RMB will receive a weight of 10.92%.

1 October 2016 Tax amnesty rates increase (Indonesia)

Penalty rates under Indonesia’s tax amnesty programme rise to 3% for onshore and repatriated offshore asset declarations (up from 2% previously). Assets that are declared but will remain offshore will attract a penalty of 6% (up from 4%).

4 October 2016 RBI Policy Review (India)

The October Policy Review will be new governor Urjit Patel’s debut at the helm. August CPI’s downward surprise should keep the door ajar for a final 25bp rate cut this cycle. An October rate cut cannot be ruled out, but December looks more likely.

Market Economics 14 September 2016


Key forecasts (GDP and CPI inflation)

Table 1: GDP growth forecasts (% y/y)

2014 2015 2016 (1) 2017 (1)

World (2) 3.4 3.1 3.0 3.3

Advanced (2) 1.8 1.9 1.4 1.3

Emerging & developing (2) 4.6 4.1 4.2 4.9

G7 (2) 1.7 1.9 1.3 1.2

Asia ex Japan (2) 6.4 6.1 6.0 6.1

CEE and Russia (2) 1.6 -0.3 1.3 2.3

Latam (2) 0.7 -0.4 -0.9 2.3

US 2.4 2.6 1.5 1.6

Eurozone 0.9 1.6 1.5 1.0

Japan 0.0 0.5 0.4 0.1

China 7.3 6.9 6.6 6.3

CEEMEA

Russia 0.7 -3.7 0.0 2.2

Ukraine -6.8 -11.1 1.2 2.5

Poland 3.3 3.6 2.8 2.5

Hungary 3.7 3.0 1.4 1.2

Czech Republic 2.0 4.3 2.5 1.5

Romania 2.8 3.8 4.1 2.2

Turkey 3.0 4.0 2.7 3.0

South Africa 1.6 1.3 0.4 1.3

Saudi Arabia 3.6 3.4 -0.6 0.3

United Arab Emirates 4.6 3.7 2.0 2.4

Qatar 4.0 3.8 4.8 4.2

Asia Pacific

Australia 2.6 2.2 2.5 2.8

India 7.0 7.2 7.9 8.3

South Korea 3.3 2.6 2.4 2.4

Indonesia 5.0 4.8 4.9 5.0

Taiw an 3.9 0.6 0.9 1.6

Thailand 0.8 2.8 3.0 3.0

Malaysia 6.0 5.0 4.0 4.5

Hong Kong 2.7 2.4 1.0 1.3

Singapore 3.3 2.0 2.0 2.5

Philippines 6.2 5.9 6.5 7.0

Vietnam 6.0 6.7 5.5 6.0

Americas

Brazil 0.1 -3.8 -3.0 2.0

Mexico 2.2 2.5 2.0 2.9

Colombia 4.4 3.1 2.2 2.4

Chile 1.9 2.0 1.5 2.0

Argentina -2.6 2.4 -1.2 4.0

Peru 2.4 3.3 3.8 4.3

Venezuela -4.0 -6.2 -9.7 -4.0

(1) Forecast; (2) BNPP estimates based on weights calculated using PPP

valuation of GDP in IM F WEO April 2016

Source: BNP Paribas, national statistics offices, national central banks

Table 2: CPI inflation forecasts (% y/y) (1)

2014 2015 2016 (1) 2017 (1)

World (3) 3.7 3.5 4.0 3.8

Advanced (3) 1.3 0.3 0.7 1.5

Emerging & developing (3) 5.6 5.9 6.5 5.5

G7 (3) 1.5 0.2 0.7 1.6

Asia ex Japan (3) 3.3 2.4 2.7 2.8

CEE and Russia (3) 7.6 9.4 5.4 5.9

Latam ex-Venezuela (3) 7.1 7.3 10.7 6.7

US 1.6 0.1 1.2 2.2

Eurozone 0.4 0.0 0.2 1.1

Japan 2.6 0.5 -0.3 0.3

China 2.0 1.4 2.0 2.2

CEEMEA

Russia 7.8 15.6 7.1 5.4

Ukraine 12.1 48.7 17.5 10.2

Poland 0.0 -0.9 -0.4 1.9

Hungary -0.2 -0.1 0.6 2.7

Czech Republic 0.3 0.4 0.6 2.0

Romania 1.1 -0.6 -0.6 3.4

Turkey 8.9 7.7 7.9 8.5

South Africa 6.1 4.6 6.2 5.3

Saudi Arabia 2.7 2.2 4.1 3.5

United Arab Emirates 2.3 4.1 3.5 3.0

Qatar 3.3 1.7 2.8 3.0

Asia Pacific

Australia 2.5 1.5 2.0 2.4

India 6.6 4.9 5.4 5.0

South Korea 1.3 0.7 0.9 1.1

Indonesia 6.4 6.4 3.7 3.9

Taiw an 1.2 -0.3 1.1 0.5

Thailand 1.9 -0.9 0.5 1.7

Malaysia 3.1 2.1 2.0 3.0

Hong Kong 4.4 3.0 2.2 1.1

Singapore 1.0 -0.5 -0.5 1.6

Philippines 4.2 1.4 1.9 2.7

Vietnam 4.1 0.6 2.5 4.0

Americas

Brazil 6.3 9.0 8.8 5.0

Mexico 4.0 2.7 2.8 3.1

Colombia 2.9 5.0 7.6 3.9

Chile 4.4 4.3 4.0 3.6

Argentina 22.3 16.0 43.0 25.0

Peru 3.2 3.7 3.4 3.0

Venezuela 62.2 128.6 385.8 366.0

(1) HICP where available; (2) forecast; (3) BNPP estimates based on weights

calculated using PPP valuation of GDP in IM F WEO April 2016

Source: BNP Paribas, national statistics offices, national central banks



Recently published EM research

Philippines: Boom! Richard Iley 9 September 2016

India: Back in the black Mole Hau 9 September 2016

Mexico: Oil change Marcelo Carvalho 7 September 2016

South African monetary policy: Food, glorious food Jeffrey Schultz 7 September 2016

EM: Food for thought Richard Iley 6 September 2016

China: 2016 G20 – China’s solution Xingdong (XD) Chen, Jacqueline Rong 6 September 2016

Polish monetary policy: Diminishing returns Marcin Kujawski, Michal Dybula 5 September 2016

Argentina: Onwards and upwards Florencia Vazquez 2 September 2016

Poland: Heavy-hearted industry Rafal Staroscik 2 September 2016

Russia: More disinflation ahead Michal Dybula 2 September 2016

Australia: Speed wobble? Mark Walton 2 September 2016

Brazil: Paving the way for cuts Gustavo Arruda, Marcelo Carvalho 1 September 2016

Brazil: Guide to the COPOM statement Gustavo Arruda 30 August 2016

China: Public-(and hopefully) private partnerships Jacqueline Rong 26 August 2016

South Korea: Top 10 (August 2016) Mark Walton 26 August 2016

Taiwan: Top 10 (August 2016) Mole Hau 26 August 2016

Brazilian central bank: Brave new world Marcelo Carvalho 25 August 2016

Hong Kong: The spectre of deflation Mole Hau 24 August 2016

Indonesia: Top 10 (August 2016) Philip McNicholas 22 August 2016

India: Credibility and continuity ensured Mole Hau 22 August 2016

South Africa: Fundamental failings Jeffrey Schultz 19 August 2016

Latam: Olympic-sized interest rates Marcelo Carvalho 18 August 2016

China: July’s statistics tell growth reality Xingdong (XD) Chen 18 August 2016

Asia: State of play Richard Iley 17 August 2016

Brazil inflation: Aiming for the target Gustavo Arruda 12 August 2016

China: Expanding its fiscal horizons Jacqueline Rong 12 August 2016

Australia: Top 10 (August 2016) Mark Walton 12 August 2016

China: The anniversary of August 11 RMB reform Xingdong (XD) Chen 11 August 2016

Thailand: Something’s gotta give Philip McNicholas 11 August 2016

China: When monetary policy becomes less effective… Xingdong (XD) Chen 09 August 2016

For further research, please see:

Economic research Global rates plus Global Strategy outlook: Brexit – the path ahead

Global outlook Q4 2016: Clearing the Brexit hurdle

FX weekly Gilt complex EM strategy plus What Struck Us



Market coverage

Market Economics

Location Phone Email address

Richard Iley Head of Emerging Market Economics, Asia, India Hong Kong 852 2108 5104 [email protected]

Mole Hau Asia, Hong Kong, India, Taiwan Hong Kong 852 2108 5620 [email protected]

Mark Walton Australia, South Korea Hong Kong 852 2108 5105 [email protected]

Philip McNicholas Southeast Asia Singapore 65 6210 3429 [email protected]

Xingdong (XD) Chen Chief Economist, China Beijing 86 10 6535 3327 [email protected]

Jacqueline Rong China Beijing 86 10 6535 3363 [email protected]

Michal Dybula Chief Economist Central & Eastern Europe, Russia Warsaw 48 22 697 2354 [email protected]

Marcin Kujawski CEE, Romania Warsaw 48 22 697 2355 [email protected]

Rafal Staroscik Poland Warsaw 48 22 566 9567 [email protected]

Serhiy Yahnych Ukraine Kiev 380 44 537 50 82 [email protected]

Emre Tekmen Turkey, GCC Istanbul 90 216 635 2975 [email protected]

Tugba Talınlı Turkey, GCC Istanbul 90 216 635 2973 [email protected]

Jeffrey Schultz South Africa Johannesburg 27 11 088 2171 [email protected]

Marcelo Carvalho Head of Economics, Latin America São Paulo 55 11 3841 3418 [email protected]

Florencia Vazquez Argentina, Chile, Colombia Buenos Aires 54 11 4875 4363 [email protected]

Gustavo Arruda Brazil, Mexico São Paulo 55 11 3841 3466 [email protected]

BNP Paribas Global Website

www.globalmarkets.bnpparibas.com BNP Paribas Market Economics Website

Bloomberg

Market Economics BPEC



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