On Is there an EM Crisis?; Global Liquidity; Poor Diet and Early Death!

From: aditya rana
Date: Sat, Sep 19, 2015 at 2:02 PM
Subject: On Is there an EM Crisis?; Global Liquidity; Poor Diet and Early Death!


Emerging markets have been in the spotlight over the last two months, with widespread concerns about an impending crisis. Is this a likely event? To shed further clarity on this question, recent research from Jonathan Anderson (Emerging Advisors Group) provides some interesting insights as summarized below:

-The last two months have been brutal for EM, driven by a worsening external environment – weak export demand, falling commodity prices, a strong dollar and the China Renminbi devaluation combined with a fall in real domestic demand in the commodity exporting bloc.

-However, even during the depths of the recent downturn, there was no meaningful capital outflows in the EM ex-China region, no stress in the local (and dollar) debt and interest rate markets and a much milder drop in the local currency equity markets when compared to EM indices in US$.

-Looking at the valuation-adjusted FX reserves as a % of GDP of the 29 EM economies (ex-China) at end-August (see graph below) we can see that they have not been out of line when compared to the last two years.

-Similarly, there has been no substantial change in the trend of foreign holdings of local sovereign debt of the largest 10 EM economies (see chart below) – they have been trending down since 2013 with the strong dollar, but there was no panic selling during the last two months.

-In addition, local interest rates (nominal and real) have remained in a steady declining trend since the sharp rise in late 2014, driven by Russia and other commodity exports in the aftermath of the collapse in oil prices (see chart below). Normally in a crisis situation, one would expect to see a drying up of local liquidity and a sharp rise in rates.

-Finally, when comparing the US$ MSCI EM index (ex-China) to the local market index one can see a significant divergence between the US$ index which has fallen almost halfway to the 2009 lows, and the local currency index which has remained roughly flat over the last 12-18 months (despite the recent fall)-see chart below.

-Turning to China, the big story has been the record drop in FX reserves during the month of August ($94 BN). Does this signal more capital flight ahead? Not likely, and outflows should taper down in the coming months and FX reserves are likely to remain flat or even rise gradually by year-end for the reasons outlined below.

-Looking first at the “micro-devaluation” of the Renminbi on August 11, despite widespread talk about a floating Renminbi, China continues to broadly run a de facto peg against the dollar (see chart below) over the last four weeks. While the PBOC might allow a gradual depreciation against a stronger dollar, there has not been a meaningful change in its FX policy as evidenced by the Renminbi’s continued appreciation on a trade weighted basis (see second graph below).

-While China maybe experiencing the largest historical loss in its FX reserves, its capital outflows as a percent of GDP are in line with what it experienced in 2009 and China routinely sees outflows equal to 6-7% of GDP (see chart below). A point to note here is that in 2009 China had a much bigger current account surplus relative to GDP which more than offset capital outflows equal to 10% of GDP, causing no decline in FX reserves. In addition, China’s reserve loss and capital outflows are meager when compared to peak loss which other EM countries (in particular countries with pegged currencies) have experienced historically (see second chart below).

– The reason why China has not experienced the type of capital outflows associated with EM crises, is that it has a very closed capital account. This is reflected clearly by comparing the difference between the 3-month onshore interest rate versus the 3-month offshore rate as implied by the offshore FX market (see charts below) between EM countries with relatively open capital accounts and China. While the former move together with minimal divergence, the latter move in totally uncorrelated fashion with no converging trend whatsoever. This feature, plus other metrics tracked by them show China to have the most closed capital account amongst the 40 other major EM countries.

-Next, looking at the banking system it is clear that net claims of international banks against China have declined significantly following the surge in 2013-2014 (see first chart below) due to the large capital inflows into China (loans, Renminbi carry trades), leaving limited scope for unwind of these positions and hence further outflows.

In addition, there are no signs of stress on the domestic banking system with net deposits reaching a record high in July (a regular pattern when capital outflows increase – see first chart below). It is important to note that capital outflows and inflows in the context of China primarily implies a shift from FX reserves of the PBOC to the banking system – there is no significant amount of capital fleeing the country per se. This is clearly evidenced by the second chart below which compares changes in the PBOC’s FX reserve position versus changes in foreign assets of the banking system – while the PBOC has been selling dollars since the beginning of the year, domestic banks have been accumulating even bigger FX assets.

-Lastly, and perhaps most importantly, China remains very much a significant external surplus country of about 5% of GDP (reflecting its excess of savings over investment) which translates into $450-500 billion per year (see chart below). So once capital outflows subside, China should start building its FX reserves again at a pace of roughly $40 million per month.

In conclusion, so while EM currencies are coming under pressure to due weak exports, falling commodities and a stronger dollar, this remains primarily an external environment driven issue rather than a “balance sheet” crisis driven by unwind of local financial positions, massive capital outflows, collapsing confidence and asset prices. An early indicator of a rebound will be a recovery in EM FX.

-Fascinating analysis and data which clears the air surrounding the recent media focus on an impending EM crisis. It has primarily been an EM FX issue – partly driven by global investors shorting EM currencies (the most liquid EM asset) as a hedge against the deterioration in the external environment.

-Regarding the concern of a decline in global liquidity due to a decline in global FX reserves, as JP Morgan points out in a recent research note, it is the excess in global broad money supply (M2) over money demand which really matters which have underpinned the strength in global assets over the last three years (the previous dip below zero was in 2011 until mid 2012). While this measure has declined from its peak in mid-2014 following a stronger dollar, it has bounced back this year following dollar weakness and is well into positive territory (an excess of $3 trillion-see chart below). Since EM account for more than two thirds of the $4 trillion of global M2 which is created every year, credit creation in EM (and in particular China as illustrated by the second chart below) will be a key determinant going forward (in addition to the direction of the dollar and policy uncertainty).

-With stabilising China growth (the recent increase in money supply (13%), credit (15%), and fiscal spending together with a housing recovery are early indicators) and a pick-up in demand from the developed world (after a three year slump) should provide impetus to EM assets. Though, as noted in last week’s newsletter, given the uncertainty surrounding the Fed’s lift-off (despite the recent delay) will cause continued volatility in markets and the strategy of “raising cash during rallies and buying on dips” should remain a core investing strategy going forward.

Poor Diet among Leading Causes for Early Death:

PRCM, Sept 14, 2015:

-A diet low in fruits, vegetables, whole grains, and fiber but high in red meat, salt, and processed sugar is now a key contributor to early death worldwide, according to a study published in The Lancet. Researchers from the Institute for Health Metrics and Evaluation (IHME) examined life expectancy for 79 different risk factors in 188 countries from 1990 to 2013. Dietary risk factors, including low intakes of fruits, vegetables, whole grains, nuts, and seeds, had the most impact on early death.

Forouzanfar MH, Alexander L, Anderson HR, et al. Global, regional, and national comparative risk assessment of 79 behavioural, environmental and occupational, and metabolic risks or clusters of risks in 188 countries, 1990–2013: a systematic analysis for the Global Burden of Disease Study 2013. Lancet. Published online September 10, 2015.

Here’s to eating a diet rich in whole grains, vegetables, fruits, legumes and nuts!




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