Emerging Markets Diary (October 25, 2010)

Emerging Markets Diary (October 25, 2010)

Strengths

• China has been supportive of small and medium-sized private companies engaged in equity financing this year, as the Shenzhen Stock Exchange, where most of these smaller deals occur, has raised a record $33.6 billion via initial public offerings this year. This volume is triple last year’s total and higher than the $24.1 billon raised in Shanghai, where mega state-owned companies typically list.
• Thanks to robust external demand for electronics and auto parts, Thailand’s exports rose more than expected to 21.2 percent in September from a year earlier, despite an appreciating local currency.
• China’s GDP expanded by a slightly faster-than-expected 9.6 percent year-over- year in the third quarter, despite policy tightening on real estate and local financing vehicles, as well as power cuts to meet carbon reduction targets.
• Sales of steel billets, long products, and metalware in Russia soared by 47 percent in the third quarter on the back of the seasonal uplift in construction works. Housing volumes approved for construction in 2011-15 exceed those of the previous 2006-10 program by one third.
• ASUR’s passenger traffic in the third quarter rose 10 percent year-over-year. However, the reported EBITDA (earnings before interest, taxes, depreciation and amortization) margin declined to 43 percent from 61 percent, due to changes in accounting standards.
• Brazil’s unemployment rate in September declined to 6.2 percent from 6.7 percent in August, well below market expectations. While the trend is a positive development from an economic recovery point of view, we will monitor whether falling unemployment translates into higher wage claims, which would be worrisome for inflation expectations.

Weaknesses

• China unexpectedly raised both one-year lending and deposit rates by 25 basis points to 5.56 percent and 2.5 percent, respectively, to better anchor inflation expectations and prevent economic overheating in anticipation of further hot money inflows as a result of additional quantitative easing in developed countries.
• The Philippines posted a fiscal deficit of $31.7 billion pesos in September, from a surplus of $1.3 billion pesos in August, driven by an 8.7 percent year-over-year decline in revenue and a slower 3.6 percent decline in expenditure.
• Poland’s Central Bank is expected to raise interest rates next week after inflation accelerated faster than expected in September, reaching its 2.5 percent policy threshold. Since 1998, each of the three tightening cycles began at the Central Bank meeting immediately after the inflation target was met.
• The outcome of the Brazilian presidential election (the second round will be held on October 31) may have an impact on the fortunes of the country’s utilities players. While some, such as Cemig and Copel, are operated and governed at a regional level, where the current governments are supportive of higher tariffs, others such as Eletrobras are governed by federal authorities. The expectations are that the government of Dilma Rousseff would be more consumer-friendly while a government of Jose Serra would be more pro-business.

Opportunities

• Does Fed easing always lead to an emerging markets rally? Examining the historical relationship, BCA indentified two regimes:

1) In the early 1990s, emerging market share prices were negatively correlated with the Fed funds rate. Low interest rates in America drove capital to emerging markets, where growth was robust;

2) Whereas from 1995 until very recently, emerging market equities were positively correlated with U.S. interest rates. Global growth conditions were improving and U.S. interest rates rose in recognition of a firmer economic environment.

Ultimately, if global growth disappoints, emerging markets will likely be hurt regardless of the Fed’s liquidity boost. But if global growth is firm, emerging market prices should resume their uptrend even when U.S. interest rates rise.

• Even though emerging market equities have rallied around 30 percent from the low reached in late May, the ongoing trend has the potential to continue now that industrial production in these developing countries, a critical driver for market returns, has superseded its 2007 peak whereas equities have not responded in the same magnitude.
• China’s total subway length may more than double in the next five years according to construction plans from major cities because of the government’s role in promoting urbanization and consumption. Although 1,014 kilometers of subway lines were already in operation in 11 cities in China as of 2009, subway capacity either per capita or per unit area is still well below the global average, with Shanghai and Beijing representing 62 percent of increased subway length since 2006. Railroad construction and equipment companies should benefit going forward.
• Indonesia has received $52.9 billion of investment commitments from Japan over the next 15 years to fund the country's 44 infrastructure projects ranging from construction of ports to power plants.
• Although India’s sugar production this year is expected to increase to 24.5 million tons (up 30 percent year-over-year), tighter supplies from Brazil (due to adverse weather conditions and poor infrastructure) have been supportive of sugar prices that are up 16 percent month-over-month in September.
• Brazil’s federal tax revenue in September reached R63.4 billion vs. R62.7 billion in August and compared with R51.5 billion in September 2009 – a sign of better tax discipline and economic recovery that should lead to improvement in the country’s finances.
• Grupo Banorte of Mexico announced its intention to acquire Bank Ixe, with a stronghold in Mexico City. Banorte has long been rumored to be an acquisition target by a number of foreign players eager to expand in Mexico, but the bank had communicated its desire to remain independent. The acquisition of Ixe provides a stronger platform for growth in the country despite Ixe’s relatively small size (around 1.5 percent market share in loans).
• Cencosud (a retail group from Chile) is to acquire Brazilian supermarket chain Bretas, which currently operates 62 stores and three distribution centers in Brazil. This is a further sign of the Chilean retailer’s expansion on the continent. Following this acquisition, Cencosud will derive nearly 20 percent of consolidated sales from Brazil.

Threats

• The Czech government proposed to implement a 25 percent tax on free carbon dioxide credits allocated to power generation companies. The new tax will be effective in 2011 and 2012. The proceeds from this tax will be used to offset the negative impact of higher solar energy generation volume.
• Just two weeks after raising a tax on foreigner’s investments into Brazilian fixed income securities (from 2.5 to 4 percent), the authorities raised the tax again, this time to 6 percent in order to stem the appreciation of the real. It remains to be seen if this measure will prove effective in light of Brazil’s highest real interest rates in the world. Concurrently, the authorities in Colombia and Chile indicated that they will not follow Brazil’s example in discouraging inflows into their countries, both of which are also struggling with appreciating currencies.