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Directional Economics Emerging and Converging Markets. Analysing the credit crunch. Charles Robertson Head of Research and Chief Economist, EEMEA 2009 charles.robertson@uk.ing.com +44 20 7767 5310. Is this as bad as it gets?.
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Directional EconomicsEmerging and Converging Markets Analysing the credit crunch Charles Robertson Head of Research and Chief Economist, EEMEA 2009 charles.robertson@uk.ing.com +44 20 7767 5310
Is this as bad as it gets? • In every market sell-off, HY spreads reach 1100bp – we hit this level on 3 October 2008. It peaked at over 1,900bp in December – implying .. total default in the US? Or more accurately, a clear out of positions and no bid – the market barely existed. • The real economy only recently began to exhibit real pain. Unemployment may not peak until 2010 with 9-11% looking a plausible range (10.8% in 1982). • EM fundamentals are better than in the 1990s, but relative value trades mean EM spreads have widened and currencies may continue to face pressure. HY spreads over UST
The 5 great crashes 1929-2009 Measured by working days from the peak
ING global forecasts US, Eurozone, Japan – GDP %ch US Fed funds and ECB refi rate US Fed Funds vs Unemployment
The World Economy – Nominal GDP in 2008 (2007 in grey and only 2007 for 21-40th)Political freedom ratings by Freedom House Emerging markets remain small players in the US$52tr 2008 global economy Russia is now a G-8 member, de facto and de jure China is now the 3rd biggest economy in the world G-8 member Canada is 11th between Brazil and India Poland is now in the top 20 All EUR-linked economies may look smaller in USD terms in 2009. In 2007, California was $1.8tr, Africa $1.28tr, Texas or New York at $1.1tr, Florida $0.75tr, Illinois $0.6tr.
Total imports of merchandise goods Total imports of merchandise goods in 2008 – we need US and Eurozone demand
When German confidence collapsed in 3Q08 – so did the world economy Germany in 2007/1H08 – never better but Germany in late 2H08/1H09 – never worse ? • Current conditions fell below the long-term average in Nov-08 (94.8) having been an incredibly strong 108.3 as recently as June. In Dec-08 they were 88.8. • Expectations (76.8, Dec-08) are the lowest since German re-unification. This is negative for global exports, central European investment and isn’t great for Germany either.
Korean and Chinese trade data Korean trade data China's trade data • Korea provides the most recent trade data of a major economy. Nov-Dec data were as terrible as the German IFO or oil prices suggested they would be. Worse still, Dec-09 data were flattered by +3 working days. Jan 09 data could be -40% due to negative working day effects. • China’s exports have now begun their decline. Worse still for the world economy, import value is collapsing, down roughly 20% YoY in Nov-Dec 08. CNY depreciation is plausible to support jobs in China (at the expense of jobs elsewhere in EM).
Exports in 2001 – a rapid decline • US imports fell by roughly 5% in 2001. A fall in US demand and a Eurozone slowdown meant many countries saw exports decline sharply after strong growth in 2000. • Today it is clear that after a strong 1H in 2008, the outlook has dramatically worsened in late 2008 and into 2009. Exports % ch in 2000-01
What happened in the last recession Falling Down Misery and Happiness Deep impact Apocalypse Now
The experience in previous recessions The mid-70s saw a coordinated recession in developed markets with little impact on EM. Slow years saw Turkey at 3%, Mexico at 4% and Brazil at 4% or Korea at 5%. The early 1990s was the most prolonged series of recessions, and came during political crises in China and the former Soviet bloc. It hid Brazil hard at -4%, Mexico 1%, China 4%, Turkey 1%. The early 1980s were the world’s worst recession and came after an EM boom and as oil prices fell significantly. EM was hit hard and dramatically. Brazil went from +9% to -5%, Korea from +7% to -2%, Turkey had two years of recession and China slowed to 5%. Poland had its own crisis.
The credit crunch – private sector debt Lending/GDP – households and corporates (2007) High credit levels in rich and Asian countries Emerging European credit is heading towards Eurozone levels Latam and CIS countries have low credit levels
The credit crunch – total debt in the economy Private and public sector debt/GDP (2007)
The US credit boom – Greenspan 1987-2006 The rise in GDP and the change in credit each year as a % of GDP
Bank lending – credit and GDP growth India lending data China lending data Russia lending data Iceland lending data
Bank lending – credit and GDP growth Poland lending data Hungary lending data Bulgaria lending data Romania lending data
The credit crunch – Asia in the 1990s • Credit rose too fast in south-east Asia in the 1990s. • Credit from 1991-97 jumped by 80pp of GDP in Malaysia and Thailand. • The collapse in 1997 quickly spread to Malaysia and eventually even South Korea and Indonesia where credit growth was just 10-30pp of GDP, vs 80pp in Thailand and Malaysia. • India did not get impacted as credit had not risen, nor did China where credit growth was domestically financed. Change in credit stock 1991-97 in key Asian countries
EMEA credit growth was very high Though some developed markets were higher Credit growth: Developed markets Credit growth: EMEA Ireland even beat Iceland in terms of credit growth, with Spain not far behind and equal to Thailand in the 1990s. Germany, Japan, Italy and Austria seem to have been restrained. Most EMs saw high growth, but the Baltics, Bulgaria, Kazakhstan and Ukraine rose most. Egypt, Czech Republic, Poland and Turkey seem to have been more restrained.
Asia and Latin America were restrained So will be hit mainly by the global slowdown, not directly by a credit crunch Credit growth: Asia 2001-07 Credit growth: Latam 2001-07 In Latin America, credit only began to rise after 2004, and only took off in 2007. This was too late to reach extremely high levels. In Asia, only Vietnam saw very high credit growth in the 1990s. The rest of Asia has learnt lessons from the 1990s.
What happens when credit stops rising so fast • Even when total credit is rising, an economy can go into recession. While new monthly credit extension in Latvia was still around LVL130m each month in 3Q08, GDP was already negative. It is the rate of change in credit that is crucial. Latvia: stock of outstanding credit Latvia: monthly credit and real %ch YoY
What happens when credit stops rising so fast • This graph shows the amount of credit extended each month as a percentage of the peak month, tracked against GDP. Growth disappears when monthly credit is 60% lower than the peak month. When the figure is -100%, it means the debt stock is declining. • Late 2008 saw a dramatic fall in credit growth in every country – the Baltic decline was slow by comparison Latvia and Estonia credit and GDP growth
The sudden collapse in credit growth • The Latvian/Estonian experience was a long drawn out collapse in credit compared to what is happening today. With a few rare exceptions, like Poland, credit has begun contracting and very fast. It has taken just 5 months for Bulgaria to see a collapse in credit growth that took Estonia 17 months over 2007-08. Bulgaria vs Estonia – credit extension Romanian GDP set to fall
What happens when credit stops rising so fast • The Latvian/Estonian experience implies that Kazakhstan could have negative GDP data by early 2009, Lithuania by 2Q09, and even central Europe by 2010 though a global recovery would offset that. Note oil and agriculture may have distorted 3Q08 GDP data. More worrying is that credit growth slowdowns have become more dramatic in recent months so the descent into recession will be quicker. • The caveat is that credit is half as important in Russia or Romania when compared to Latvia/Estonia, so the impact may be less. Big falls in credit growth will hit economies with high stock of debt the most. • Bulgaria, Lithuania and Kazakhstan may suffer more than Romania but less than Latvia. Months since credit peak vs GDP growth Credit to GDP and depth of decline
Emerging markets safer than some developed markets The great EM disasters of the 1990s were usually the consequence of poor policy choices by EM governments, with the crisis occurring when foreign financing for these bad policies disappeared. The triggers came when: 1) Governments could no longer borrow money (Russia 1998, Argentina 2001). 2) Foreign banks would not roll over private sector external debt (Korea 1997, Mexico 1994, Brazil 2002). 3) The current account position made them vulnerable (Turkey 2001, Mexico 1994, Thailand 1997). Now governments do not borrow money – or not much. Short-term external borrowing is low. The current account + FDI picture is much improved. Gross external debt (to BIS banks and for int’l debt securities) due in 12 months + 2008 FDI + C/A, all as % of fx reserves in Jun 2008, with forecasts for 2009 The chart shows the total of the external debt due within 12 months + the C/A + FDI, as a ratio of fx reserves. Ie, it would take Turkey 10 months to run out of reserves if they could not roll over any debt. But it would take Iceland less than 3 weeks (Iceland is off the scale of our chart). Russian reserves would grow!
EM loan-to-deposit ratios Loan-to-deposit ratios (Jun-08 or Sep-08)
(Lack of) foreign ownership helps predict a crisis Foreign bank ownership vs Loan/deposit ratio
Credit crunch – bank ownership vs sovereign risk • While sovereign risk may be low, banks may be more vulnerable if they have borrowed significantly abroad (eg common in the former Soviet Union). • However, if they have borrowed from parent banks abroad (eg the Baltics), then this is less problematic. Then the greater risk is recession rather than devaluation. • The table below also highlights the sovereign risk as seen in short-term external debt figures relative to fx reserves. The data imply the Czech banking system is the most secure, while Ukraine, Latvia, Estonia and Kazakhstan are most at risk, though none are so risky as Iceland. Risk ranking
Conclusions on credit • Since 2000, many Emerging European countries have dramatically increased their borrowing as a percentage of GDP – those that borrowed most are now facing recession. • The greatest concerns have all been connected to locally owned banks, OTP in Hungary (unjustified though that seemed to be), Parex bank in Latvia, Prominvestbank in Ukraine and nearly all the Kazakh banks. And Iceland of course. Only Turkey still looks vulnerable on this measure. • High loan to deposit ratios is a negative for all countries except Poland, Turkey and best of all, the Czech Republic. Others will have to raise deposit rates and cut back on lending. This is an acute need in Russia, but also Romania, Ukraine etc. • Recession can still be very deep even while credit growth is still rising in real terms. • Lastly – connected to apparently low sovereign risk – note that economists can be particularly bad at forecasting an end to currency regimes. Most investment bank reports as late as 4Q1994 predicted Mexico would not be forced to devalue!
The US dollar long-term fair value is 1.10-1.20 based on REER EUR/USD long-term fair value – using the real effective exchange rate
ING PPP (November 2008) ING PPP baskets purchased per EUR100 • This is a long-run indicator and much like The Economist’s Big Mac index. It is not a real effective exchange rate index which is often flawed by its starting point. Our index tells us how much 23 goods cost in these countries.
ING PPP vs per capita GDP 2008 Low per capita income countries NEED a currency that goes a long way • Given that India’s per capita GDP is roughly US$1,000, a hundred euros needs to buy a lot of goods in Mumbai. Given how much richer Mexico is, this is not necessary. When combined with the balance of payments and interest rates, this suggests the rupee may still be expensive at 50/USD while the MXN is extremely undervalued at 13.5/USD. • Sell KZT and RON (to 4.2-4.5), hold HUF at 260/EUR and buy PLN and CZK.
Conclusions • We are seeing the most dramatic worsening of economic data in our working careers. We are faced with a financial crisis at least as bad as 1974-75 and potentially a global recession as bad as 1980-82. A more negative scenario is likely if China implodes in 2009. • Our base case is global monetary and fiscal stimuli will keep the recession centred on 4Q08 and 1H09, with recovery as we head into 2010. There are many risks to this scenario. • Emerging European GDP in 2009 may range from a -5% fall in Latvia to -4.5% in Ukraine, -3.5% in Romania, -2.5% in Hungary, to stagnation or small falls (up to -2%) in Russia, Kazakhstan, Czech Republic and potentially 2% growth in Poland. Recession is plausible in Bulgaria and Lithuania by late 2009 due to slowing credit growth. Political risk is likely to grow across the whole emerging market universe. • Local interest rates on deposits need to rise fastest in countries with poor loan to deposit ratios, particularly in the CIS, Baltics, Romania and to a lesser extent Hungary. • Currencies have sold off and are now at a 2004-08 average relative to the US or Eurozone. Further weakness is possible – and is probable if China implodes. The best value is in the PLN, MXN and the UAH (but only in the long-term). The worst value is in the KZT, with depreciation very justified in Romania and Argentina. We see Russia’s band widening as echoing the fx depreciation in all commodity currencies. Inflation targeting may be well be adopted as a formal policy in 2010, with a full free float. • Yields in developed markets are now so high, that these may benefit first from any market recovery in early 2009, followed by hard currency bonds. Local currency debt is very unlikely to attract the volumes of 2006-07. A poor harvest in 2009 could hurt local debt as we go into 2010. • Equity markets may begin to recover later in 2009, pricing in a recovery well before unemployment has peaked in 2010.
