Emerging Markets Diary (November 29, 2010)
Strengths
- After taking measures in selling its food reserve and providing free or reduced transportation fares on November 11, China’s National Development and Reform Commission (NDRC) has seen soft commodity and vegetable prices drop 10 percent.
- Profits of sizable industrial companies in China have increased 51.6 percent on a year-over-year basis to 2.84 trillion RMB during the first 10 months of this year, according to the China National Bureau of Statistics. Sales increased 32 percent to 45.3 trillion RMB during the same period.
- In October, China’s current account surplus increased 103 percent on a year-over-year basis to $102 billion, according to the China State Administration of Foreign Exchange.
- Fitch upgraded Turkey’s credit outlook to positive from stable, reflecting the country’s strong economic recovery, increasing confidence of its macroeconomic transformation, and improving public finances. Fitch rates Turkey just one notch below investment grade. Fitch foresees Turkey’s budget deficit-to-GDP ratio at 4.0 percent in 2010 and 3.2 percent in 2011.
Weaknesses
- An artillery exchange between North and South Korea happened along the border between the two countries this week. The situation is still tense and could possibly escalate quickly.
- China is still in the process of figuring out price control measures to curb further inflation.
- China saw huge capital inflows during October. The country’s money supply growth during the month includes 519 billion RMB coming from purchases of foreign currency inflow.
- The Customs Union established by Russia, Kazakhstan and Belarus envisions duty-free trade in oil and related products within the Union’s borders. The Russian government plans to compensate for the missing budget revenue by charging higher product duties. Unicredit sees product duties reaching 60-90 percent of the crude duty, up from the 38 percent on dark and 71 percent on light products charged currently.
Opportunities
- China money supply is the largest in the world at $10.5 trillion, according to Bloomberg. This huge reservoir of money has to find its way into investments. China, at this moment, still restricts its domestic individual investors from free access to international capital markets so the only markets left for them are domestic property and equity markets—the two free markets in China. After the government limited the household ownership to one house in order to prevent a property bubble, investors are left with only the equity market in which to invest. The thought of money flowing into equity markets has been talked about since April of this year but has yet to make a substantial difference. However, we believe it will eventually become a significant factor in driving the market after the current market gyration is complete.
- In the twelfth Five Year Plan, China has identified industries on which to focus and provide favorable policy assistance, such as renewable energy, environment protection, agriculture, medicine, biotechnology and precision automation. China is in the process of changing its GDP growth model from fixed asset investment (FAI) and exports to being driven by consumer spending. Meanwhile, there is still huge FAI to be made in Western China and on the railways and highways needed to connect China with the rest of Asia. These connections include China to Pakistan through Afghanistan and China with Central Asia. Eventually, China plans to connect with Europe by highway and railway both through Southwest Asia and Russia. These are growth opportunities in which companies inside and outside China can participate.
- Residential real estate in Russia and Turkey stands to benefit from historically low interest rates, recovering unemployment, and improving consumer confidence, according to Merrill Lynch. However, affordability is currently better in Turkey than in Russia. The ratio of income-to-price per square meter in Istanbul is twice as high as in Moscow. Turkey also has the added benefit of a young and growing population.
Threats
- According to our calculations, China’s current monetary tightening is only enough to absorb new money created from trade surplus, foreign direct investment (FDI), and hot money. In October alone, China’s new money from purchasing capital inflow accounted for 519 billion RMB ($77.6 billion U.S. dollars). Hot money accounted for 286 billion RMB while 234 billion RMB is from trade surplus and FDI. To counter this hot money effect, the People’s Bank of China needs to raise the required reserve requirements (RRR) another 50 basis points. The market expects China to raise RRR a few times before all is stable. China also needs to withdraw excessive liquidity by raising interest rates and limiting new loans next year to below this year’s levels. If China’s money supply reverts to its mean, it should result in sustainable economic growth.
- The chart from Bloomberg shows the short interest as a percentage of shares outstanding for the MSCI Emerging Market Index touching the lowest level since January 2006. This bullish sentiment may foreshadow a nascent bubble forming in emerging markets.
