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Sustainability of selected EM
Overall debt positions and currency risk
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EM public debt is significantly lower…
Gross government debt
120
(in % of GDP)
100
Advanced world
80
60
40
Developing and emerging world
20
0
2000
2003
2006
2009
2012
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…and EM deficits are substantially smaller
Gross government net lending
4
(in % of GDP)
2
0
Developing and emerging world
-2
-4
-6
Advanced world
-8
-10
2000
2003
2006
2009
2012
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EM overall debt levels are significantly lower…
Gross debt position
500
(in % of GDP)
Private debt (domestic)
Public debt
400
300
200
100
Indonesia
Russia
Mexico
Turkey
Bulgaria
Poland
India
Brazil
S.Korea
Hungary
China
S.Africa
Eurozone
US
Japan
0
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…but therefore not necessarily better
Net international investment position (NIIP)
NIIP
100
(in % of GDP)
Most vulnerable
50
0
-50
-100
NIIP = difference between external assets and liabilities
Hungary
Bulgaria
Turkey
Poland
Brazil
Indonesia
Mexico
S.Africa
S.Korea
India
Russia
China
US
Eurozone
Japan
-150
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EM have a CA surplus as a whole….
Current account balance
800
(in bn USD)
600
400
Developing and emerging world
200
0
-200
Advanced world
-400
-600
1992
1995
1998
2001
2004
2007
2010
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….but some countries have large funding needs
Current account
6
(in % of GDP)
4
2
0
-2
-4
-6
Most vulnerable
-8
Turkey
South Africa
Poland
India
Brazil
Mexico
Indonesia
South Korea
Bulgaria
China
Hungary
Russia
US
Eurozone
Japan
-10
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Some countries look vulnerable in this respective
S. Africa, Poland and Turkey in particular
Current account balance
(in % of GDP)
4
2
0
-2
-4
-6
-8
Turkey
-10
1992
Poland
1995
S.Africa
1998
2001
2004
2007
2010
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Turkey and Poland look particularly vulnerable
Combining a large NIIP deficit with large funding needs (CA deficit)
Turkey
40
(composition of NIIP, in % of GDP)
Turkey
 Current account deficit of almost 9% of GDP in 2012
 IMF projects CA deficits of around 8% of GDP until 2017
 NIIP stands at 50% of GDP in 2010
 But ongoing large CA deficits will lead to higher NIIP deficit
 Other and portfolio investment liabilities (~ hot money) account
20
0
-20
-40
-60
-80
2000
2002
2004
2006
FDI
Other investments
NIIP
2008
2010
Portfolio investments
Reserves
for almost 40% of GDP in 2010
More volatile by nature
Poland
40
(composition of NIIP, in % of GDP)
Poland
 Current account deficit of almost 5% of GDP in 2012
 IMF projects CA deficits of around 4% of GDP until 2017
 NIIP stands at 55% of GDP in 2011
 But ongoing CA deficits will lead to higher NIIP deficit
 Other and portfolio investment liabilities account for 45% of GDP
20
0
-20
-40
-60
-80
in 2011
-100
2000
2002
2004
2006
2008
2010
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(1) What happens when investors’ risk appetite dries up?
The example of Turkey
Turkey
(composition of capital account, in % of GDP)
15
16000
A1: Investors’ appetite dries up!
A2: Primarily via other investment account!
Q1: What happens here?
Q2: How does it happen?
10
12000
5
8000
0
4000
-5
0
-10
-4000
Reserves
Other investments
FDI
-15
2000
2002
2004
Portfolio investments
errors and omissions
Capital account
2006
2008
2010
Other investments: liabilities (4Q moving avg)
-8000
Q1 1998
Q4 2000
Q3 2003
Q2 2006
Q1 2009
Q4 2011
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(2) What happens when investors’ risk appetite dries up?
The example of Turkey
…This is reflected in the exchange rate
1.9
USD/TKL
1.7
1.5
1.3
1.1
0.9
0.7
↑ Currency depreciation
0.5
Jan-00
Oct-01
Jul-03
Apr-05
Jan-07
Oct-08
Jul-10
Apr-12
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(3) What happens when investors’ risk appetite dries up?
The example of Poland and Hungary
Poland
12000
3
3.2
Other investment liabilities (lhs)
EUR/PLZ (rhs, inv)
3.4
Hungary
8000
6000
220
230
Other investment liabilities (lhs)
EUR/HNF (rhs, inv)
240
8000
3.6
4000
250
3.8
260
4000
4
2000
270
4.2
4.4
0
280
0
↓ Currency depreciation
4.6
290
-2000
4.8
-4000
Q1 2001
5
Q2 2003
Q3 2005
Q4 2007
Q1 2010
↓ Currency depreciation
-4000
Q1 2001
300
310
Q2 2003
Q3 2005
Q4 2007
Q1 2010
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How do EM currencies react when risk aversion sets in?
Correlation with market volatility
Correlation with Vix
80
(against EUR, since begin 2008)
60
Currencies (very) sensitive to market volatity
40
20
0
-20
USD benefits from high market volatity
-40
BRL
ZAR
KRW
IDR
MXP
PLZ
HUF
INR
TKL
RUB
USD
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Recent performance of EM currencies
EM currencies have already lost significant ground
Currency performance
10
(since begin March)
5
0
-5
-10
-15
Against EUR
Against USD
-20
JPY
CNY
IDR
GBP
CAD
KRW
SWF
SKK
BGN
TKL
NOK
RUB
CZK
SEK
MXP
HNF
AUD
NZD
PLZ
ZAR
INR
BRL
-25
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How much is already priced in?
TKL, PLZ, HUF and INR look cheap against their own postlehman history: from current valuations the downward
potential in a lehman style scenario is relatively limited.
Also, their upward potential in the most optimistic senario
is high (around 30%).
Currency performance since lehman
40
30
Current vs peak
Current vs trough
↑Downward potential in
lehman style scenario
20
From the previous, however, it is clear that there seems to
be a reason for this: Turkey, Poland, Hungary and India were
indeed identified as the countries with the highest funding
needs (current account deficits) and therefore more
vulnerable.
10
0
-10
Against EUR
-20
-30
↓Upward potential in
most optimistic scenario
CNY
KRW
IDR
RUB
MXP
BRL
ZAR
INR
HNF
PLZ
TKL
-40
To a large extent, a negative scenario is already priced in for
the ZAR, BRL, MXP and RUB. However, the downward
potential is also (very) significant when economic
conditions take a turn for the worse.
The IDR and KRW exchange rates have fallen back
significantly less and actually strengthened against the eur
in recent months. Not surprisingly, these countries have
relative stronger fundamentals. The downward potential is
obviously high when economic conditions would
deteriorate.
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The valuation of (selected) EM currencies
EM currencies remain (significantly) undervalued in a LT-perspective
Currency undervaluation
(based on PPP against EUR)
BRL
IDR
ZAR
RUB
CNY
INR
KRW
MXP
TKL
HNF
PLZ
Theory of PPP states that exchange rates between countries
are balanced when their purchasing power (of a fixed basket
of goods and services) is equal in both countries.
Theory of PPP states that all EM currencies (apart from the
BRL) are heavily undervalued. The undervaluation ranges
from 64% for the INR to 23% for the RUB.
-70
-60
-50
-40
-30
-20
-10
0
Currency undervaluation
(based on PPP corrected for productivity differences, against EUR)
BRL
IDR
ZAR
RUB
CNY
INR
KRW
MXP
TKL
HNF
PLZ
However, the undervaluation of EM currencies is unlikely to
be that large. One important reason is that not all goods and
services are tradable and therefore not subject to arbitrage.
Wages make up a substantial part of the final cost of any
product (tradable or not). Wage differences, in turn, reflect
differences in productivity so that the overvaluation of DM
currencies tends to be overstated.
Corrected for productivity differences, the undervaluation of
EM currencies is much smaller, ranging from only 6% for the
IDR to 23% for the PLZ
-25
-20
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-5
0
16
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Conclusion (1)
EM currencies remain a (very) risky asset class in times of high uncertainty
EM overall debt is significantly lower compared to DM. However, that does not mean that
debt levels are more sustainable.
Some countries have large funding needs including India, S. Africa, Poland and Turkey. Poland
and Turkey combine this with a large NIIP deficit (= net debtors to the rest of the world)
When risk aversion sets in and investors’ confidence dries up, this is reflected via weakness
in the exchange rate.
The BRL, ZAR, KRW, IDR show the highest correlation with market uncertainty and volatility
(VIX) while the USD benefits from financial distress and economic turmoil.
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Conclusion (2)
EM currencies remain a (very) risky asset class in times of high uncertainty
It seems that already a great deal of this is reflected in most EM currencies as exchange rates
have already lost significant ground in recent months. Some currencies have hardly
recovered from their pre-Lehman troughs and therefore look cheap. However, there seems
to be a reason for this. Indeed, these countries also have (large) funding needs and weak net
international investment positions.
In a LT-perspective, corrected for productivity differences, the undervaluation of EM ranges
from 6% for the IDR to 23% for the PLZ (according to the theory of PPP). The BRL is the most
expensive EM currency from this perspective.
Despite the undervalution of most EM currencies in a LT-perspective, playing EM currencies
remains obviously very risky in times when risk aversion is high and likely to rise even further
against the back of mounting uncertainty related to the eurozone crisis.
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