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China: What happens when the free greenbacks dry up? Alicia García-Herrero Chief Economist Emerging Markets BBVA Research Foreign Correspondents’ Club of China, Beijing May 2014 China: What happens when the free greenbacks dry up? Outline Section 1 Global economic outlook Section 2 The FED exit Section 3 Impact on Emerging Markets: What is it for China Section 4 Conclusions for China Page 2 China: What happens when the free greenbacks dry up? Global Economic Outlook 1 Global expansion moderating with China growing less than previously expected and without immediate risks of a sudden adjustment Global GDP growth (%) Source: BBVA Research 6 5.2 5 4 4.0 3.8 3.2 2.8 3.0 3.4 3 2 The combination of the Fed tightening and (further) adjustments of China’s growth will be the dominant factors in the coming months (absent an ECB’s QE) with an heterogeneous impact on EM 2 1 0 -0.4 -1 -2 2008 2009 2010 Developed Mkts 2011 2012 2013 (e) 2014 (f) 2015 (f) Emerging Mkts Baseline Jan14 Page 3 China: What happens when the free greenbacks dry up? Monetary Policy & Capital Flows Emerging Asia: Cumulative Net Capital Flows (Cumulative since 2005, US$ bn) 5 In any case, EM Portfolio Capital Flows are still below equilibrium and should start to navigate to their long run trend Source: BBVA Research, IMF and EPFR 500 450 400 350 Forecasts 300 Tapering 2013 150 QE3+Dragui 200 Actual: -17% (undershooting) 100 50 2016 2015 2014 2011 2010 2009 2008 2007 0 2006 6 After being particularly penalized by the US tapering Emerging Asia will follow this path too 2012 250 Page 4 China: What happens when the free greenbacks dry up? China: Updating our baseline scenario due to poor incoming data and new assumptions on economic policy China: GDP Growth (%, y-o-y) Source: BBVA Research 8.0 7.7 The government will press ahead with reforms and implement measures to curtail financial risks 7.7 7.5 7.2 7.0 7.0 We expect a higher adjustment in investment than in consumption 6.5 6.0 Policy supports from public expenditure (infrastructure investment, tax reliefs) would be implemented if domestic economy loses momentum below the bottom line of 7.0% 5.5 5.0 2012 2013 Baseline Apr-2014 2014 2015 Baseline Jan-2014 Page 5 China: What happens when the free greenbacks dry up? Outline Section 1 Global economic outlook Section 2 The FED exit Section 3 Impact on Emerging Markets: What is it for China Section 4 Conclusions for China Page 6 China: What happens when the free greenbacks dry up? The US Tapering is already here and signs of economic improvement are materializing… US: GDP Forecast, QoQ SAAR % change Source: BBVA Research The rebound after the winter months is more evident, particularly in consumption. 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 However, weaker global demand and some housing sector pressures are limiting the pace of expansion. Job growth is not expected to accelerate significantly in 2014 and inflation is expected to increase slowly. We maintain our baseline scenario mostly unchanged (2.5% GDP growth for 2014 and 2015), slightly elevated upside risk to GDP growth Source: BBVA Research Page 7 China: What happens when the free greenbacks dry up? US monetary policy: Fed funds scenario unchanged, risk tilted towards an earlier rate hike Latest What do we expect? FOMC Statement: April 29-30, 2014 Monthly pace of asset purchases tapered to $45bn – spread to $20bn in MBS and $25bn of Treasury securities Forward guidance left untouched bringing back unanimous FOMC vote Fed Expected Timeline for Exit Strategy Changes to FOMC voting members by June 17-18 meeting. Two incoming Governors, vice-chair Fischer and Brainard, will likely be in place to vote, one Governor, Stein, leaving Centrist voter, Pianalto, Cleveland FRB, will be succeeded, by likely hawkish Mester Measured steps reduction of QE3 of Policy pause until $10bn Course of policy firming remains data dependent Anticipated changes to June projections on “pace of policy firming” due to new, incoming FOMC members Mid – 2015 Maintaining the 3Q15 baseline but with lower likelihood as the probability of early rate hike increased FOMC likely to introduce further modifications to the forward guidance throughout the policy normalization process 4Q14 3Q15 1H16 Expected End QE3 First FFR Hike Policy Normalization Balance sheet: let securities mature/sales Page 8 China: What happens when the free greenbacks dry up? Outline Section 1 Global economic outlook Section 2 The FED exit Section 3 Impact on Emerging Markets compared with China Section 4 Conclusions for China Page 9 China: What happens when the free greenbacks dry up? QE tapering at first dramatic for EMs but improving Net Portfolio Inflows : Developed vs Emerging (Country Flows over Total Assets, moving average 3 months) Source: EPFR and BBVA Research Net Portfolio Inflows : Regional Emerging Mkts (Country Flows over Total Assets, moving average 3 months) Source: EPFR and BBVA Research Page 10 China: What happens when the free greenbacks dry up? Path of recovery strong but should moderate Emerging Markets: Cumulative Net Capital Flows Emerging Asia*: Cumulative Net Capital Flows Source: BBVA Research, IMF and EPFR Source: BBVA Research, IMF and EPFR (Cumulative since 2005, US$ bn) (Cumulative since 2005, US$ bn) 500 900 Eq. reached by Dec 2014 (model forecasted pace) 800 700 450 400 350 2016 Actual: -17% (undershooting) 2015 Tapering Eq. reached by May 2015 (model forecasted pace) 2014 2011 2016 2015 2014 2013 2012 2011 0 2010 -200 2009 50 2008 -100 2007 100 2006 0 2010 150 2013 200 2009 100 250 2008 200 Tapering QE3+Dragui 300 2007 400 300 2012 Actual: -14% (undershooting) 2006 500 QE3+Dragui 600 (*) Includes: China, India, Indonesia, Philippines, Thailand, Korea, Taiwan, Hong-Kong and Singapore Page 11 China: What happens when the free greenbacks dry up? Asymmetry in capital flows adjustment remains… Russia: Cumulative Net Capital Flows Turkey: Cumulative Net Capital Flows (Cumulative since 2005, US$ bn) (Cumulative since 2005, US$ bn) Source: BBVA Research, IMF and EPFR Source: BBVA Research, IMF and EPFR 70 +2% 60 50 140 120 100 80 30 -24% 2013 2012 2011 2010 2009 2006 2014 2013 2012 2011 0 2010 -10 2009 20 2008 0 2007 40 2006 10 2008 20 2007 60 2014 40 Brazil: Cumulative Net Capital Flows Mexico: Cumulative Net Capital Flows (Cumulative since 2005, US$ bn) (Cumulative since 2005, US$ bn) Source: BBVA Research, IMF and EPFR Source: BBVA Research, IMF and EPFR 250 140 120 +6% 100 200 150 80 60 100 -45% 40 50 20 2014 2013 2012 2011 2010 2009 2008 2007 2014 2013 2012 2011 2010 2009 2008 2007 2006 2006 0 0 Page 12 China: What happens when the free greenbacks dry up? … with a some particular “damage” to Asia… China: Cumulative Net Capital Flows Indonesia: Cumulative Net Capital Flows (Cumulative since 2005, US$ bn) (Cumulative since 2005, US$ bn) Source: BBVA Research, IMF and EPFR Source: BBVA Research, IMF and EPFR 160 50 140 40 120 30 100 -13% 80 -31% 20 60 Thailand: Cumulative Net Capital Flows Philippines: Cumulative Net Capital Flows Source: BBVA Research, IMF and EPFR 50 45 40 35 30 25 20 15 10 5 0 Source: BBVA Research, IMF and EPFR (Cumulative since 2005, US$ bn) 50 45 40 35 30 25 -14% 20 15 -10% 10 2014 2013 2012 2011 2010 2009 2008 2007 0 2006 2014 2013 2012 5 2011 2010 2009 2008 2007 (Cumulative since 2005, US$ bn) 2006 2014 2013 2012 2011 2010 2009 2008 2006 2014 2013 2012 2011 2010 2009 -10 2008 0 2007 0 2006 20 2007 10 40 Page 13 China: What happens when the free greenbacks dry up? Global Factors dominant when tapering started… increasing role of domestic factors thereafter Emerging Markets: Total Net Portfolio Flows Drivers China: Total Net Portfolio Flows Drivers Source: BBVA Research Source: BBVA Research (External (Global and Regional) + idiosyncratic) Tapering QE3 + Dragui (External (Global and Regional) + idiosyncratic) 35% 60% 40% 35% 65% 40% 25% 40% 75% 60% Page 14 China: What happens when the free greenbacks dry up? In China institutional flows recovering China: Institutional Net Portfolio Flows Drivers China: Retail Net Portfolio Flows Drivers ( External(Global and Regional) + idiosyncratic) ( External(Global and Regional) + idiosyncratic) Source: BBVA Research 6 8 6 2 0 0 -2 -2 -4 -4 -6 -6 -8 -8 -10 -10 Local Global/Regional Flows Apr-14 Feb-14 Dec-13 Oct-13 Aug-13 Jun-13 Apr-13 Feb-13 Dec-12 Oct-12 Aug-12 Jun-12 Apr-12 Apr-14 Feb-14 Dec-13 Oct-13 Aug-13 Jun-13 Apr-13 Feb-13 Dec-12 Aug-12 Oct-12 2 Jun-12 4 Apr-12 4 Tapering 8 10 Local Global/Regional Flows QE3 & Draghi 10 Tapering QE3 & Draghi Source: BBVA Research Page 15 China: What happens when the free greenbacks dry up? Impact of QE tapering seems bigger in China than in rest of EM (especially for bonds) China Net Bond Inflows: Response of 40 bp reduction in US 10yr & Bund ( in % over baseline, Total Assets Under Management) Source: BBVA Research Capital Flows DLM-FAVAR Model EM Net Bond Inflows: Response of 40 bp reduction in US 10yr & Bund ( in % over baseline, Total Assets Under Management) Source: BBVA Research Capital Flows DLM-FAVAR Model 1.00 Shock to Bund 0.80 Shock to 10y Bill 0.60 0.40 0.20 0.00 0 1 2 3 4 5 6 China Net Equity Inflows: Response of 40 bp reduction in US 10yr & Bund ( in % over baseline, Total Assets Under Management) Source: BBVA Research Capital Flows DLM-FAVAR Model EM Net Equity Inflows: Response of 40 bp reduction in US 10yr & Bund ( in % over baseline, Total Assets Under Management) Source: BBVA Research Capital Flows DLM-FAVAR Model 1.00 0.80 0.60 Shock to Bund 0.40 Shock to 10y Bill 0.20 0.00 -0.20 -0.40 0 1 2 3 4 5 6 Page 16 China: What happens when the free greenbacks dry up? EMs have introduce a wealth of measures to contain capital outflows Policy options to cope with a sudden deceleration in capital inflows Source: World Bank Macroeconomic Policy Allow FX Rate Depreciation Prudential Measures Exchange Rate Interventions Stricter Capital Requirements Market Absorption Tighter Macroprudential Rules FX Reserve Buffers Increase in Interest Rates Tighter monetary policy Tight Decrease in Capital Inflows Targeted Prudential Measures Limit on Banks FX Open Positions Easing Capital Inflow Regulation Neutral Loose Fiscal Stabilization Counter Cyclical Fiscal Policy Capital Controls Structural and Financial Mkts Reforms Temporary restrictions on Capital Ouflow Regulation Page 17 China: What happens when the free greenbacks dry up? Outline Section 1 Global economic outlook Section 2 The FED exit Section 3 Impact on Emerging Markets compared with China Section 4 Conclusions for China Page 18 China: What happens when the free greenbacks dry up? China: BOP’s situation China: Balance of payments Source: BBVA Research USD bn The fluctuation of reserve increase is mainly driven by capital flows 250 200 150 Net error and omission reflect somewhat growing amount of outflows 100 50 0 -50 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 -100 Current account Capital account Reserve increase Capital controls partially insulate China from external shocks bit it might change with the deepening of liberalization Financial account Net error and omission Page 19 China: What happens when the free greenbacks dry up? How should China react? • Domestic factors increasingly important at explaining China’s reaction to QE tapering – Capital outflows very influenced by political/business uncertainty – Bond flows from institutional investors leading specially relevant • The latest data points to new capital inflows as in the rest of EMs but situation can worsen – The key is no longer the speed of tapering – But rather earlier increase in hikes in the US • Other things given, QE tapering, implies a more restrictive monetary policy in China as sources of liquidity are reduced. – PBoC can, of course, counterbalance this impact but might not be the right time (trade-off with reforms) Page 20 China: What happens when the free greenbacks dry up? Thank you! Comments welcome [email protected] Page 21