CEE:Holding its own against some gusty headwinds Hugo Neuhold, Head - - PowerPoint PPT Presentation

CEE:Holding its own against some gusty headwinds

Hugo Neuhold, Head of Money Markets & Repos, Unicredit Bank Austria

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Summary

n 2011 should show growth across the board n 2011 Inflation targets are at risk, though core inflation is contained n Commodities pose a dilemma for central banks n But risk of second round effect is much more limited than in 2008 n External accounts: A global comparison – a significant improvement already occurred n Improving fiscal backdrop – but more work to do in some countries n CEE: capital started flowing back to the region but mostly in the form of portfolio inflows

3

CEE: 2011 should show growth across the board (1)

2011 is the first year in 4 when all 17 countries in our coverage are expected to show positive growth

Source: IMF, UniCredit Research

CEE holds its own once again (real GDP, % YoY)

• 8
• 6
• 4
• 2

2 4 6 8 10 12 14 2007 2008 2009 2010 2011 2012 Advanced economies CEE CIS Developing Asia LATAM/Caribbean Middle East/North Africa Sub-Saharan Africa

Positive GDP gains for every country this year (%)

• 20
• 15
• 10
• 5

5 10 Bulgaria Czech Estonia Hungary Latvia Lithuania Poland Romania Slovakia Slovenia

• Bos. & Herz.

Croatia Kazakhstan Russia Serbia Turkey Ukraine 2009 2010 2011

4

CEE: 2011 should show growth across the board (2)

Manufacturing in the region is doing well, supported by strong external demand

Source: Eurostat, National statistical agencies, UniCredit Research

PMIs point to strong Q1, following up on decent Q4-10

36 41 46 51 56 2003 2004 2005 2006 2007 2008 2009 2010 2011

• 4.0
• 3.0
• 2.0
• 1.0

0.0 1.0 2.0 CEE manufacturing PMI CEE GDP (rhs, % QoQ SA)

Reflecting a high degree of trade integration, industrial production moves in CE4 moves in line with Germany and EMU

• 25
• 20
• 15
• 10
• 5

5 10 15 20 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 % YoY EMU Germany CE4

5

CEE: 2011 should show growth across the board (2)

Technicals for GDP more positive this year

Source: National statistical agencies, UniCredit Research

Most countries enjoy positive carryover into 2011, even if Q4 shows no further gains

• 4.0
• 3.0
• 2.0
• 1.0

0.0 1.0 2.0 3.0 4.0 5.0 6.0 Bulgaria Croatia Czech Estonia Hungary Latvia Lithuania Poland Romania Russia Serbia Slovakia Slovenia Turkey Ukraine pp 2009 into 2010 2010 in 2011

Some easy gains in GDP still ahead in Russia and Hungary

• 8.0
• 7.0
• 6.0
• 5.0
• 4.0
• 3.0
• 2.0
• 1.0

0.0 1.0 2.0 Czech Croatia Estonia Hungary Latvia Lithuania Poland Russia Slovakia Slovenia Turkey Contributi on from inventories to GDP since peak in GDP (pp)

6

CEE: Inflation targets are at risk, though core inflation is contained

Higher oil and food prices mean that inflation targets for many central banks in the region currently are out of reach. At this stage Czech Republic and Turkey are the only countries in the region to post inflation below target.

7

CEE: commodities pose a dilemma for central banks

For many central banks food and energy inflation soak up all of their inflation allowance, leaving no room for inflation elsewhere

8

CEE: Growth vs. inflation risks = risk of spike is more limited

• 2.0
• 1.0

0.0 1.0 2.0 3.0 4.0 2000 2002 2004 2006 2008 2010 2012 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 Output gap (LHS) Inflation (RHS) EM output gap versus inflation

Source: IMF, UniCredit Research

9

CEE external accounts: A global comparison (1)

CEE does not stack up well relative to the rest of the world, though they have adjusted significantly

Source: IMF, national central banks, UniCredit Research

C/A balances in the EM world

• 10
• 8
• 6
• 4
• 2

2 4 6 8 10 CEE CIS Developing Asia Latam % of GDP 2006 2007 2008 2009 2010 2011

C/A balances have adjusted significantly

• 20
• 15
• 10
• 5

5 10 2007 2008 2009 2010 % of GDP

• 20
• 15
• 10
• 5

5 10 CE3 Balkans CIS Turkey Baltics

10

CEE external accounts: A global comparison (2)

With higher external debt comes higher external debt service costs which has the potential to weigh on currencies.

Source: IMF, UniCredit Research Total external debt service

5 10 15 20 25 30 CEE CIS Developing Asia Latam % of GDP 2006 2007 2008 2009 2010 2011

Total external debt service - interest

0.5 1 1.5 2 2.5 CEE CIS Developing Asia Latam % of GDP 2006 2007 2008 2009 2010 2011

Total external debt service - amortisation

0.0 5.0 10.0 15.0 20.0 25.0 CEE CIS Developing Asia Latam % of GDP 2006 2007 2008 2009 2010 2011

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CEE: Improving fiscal backdrop (1)

Budget deficits in the region continue to consolidate but on the whole remain wider than in other emerging market regions and pre-crisis ratios. From an average budget deficit of 7% of GDP in 2009, this year budget deficits in the region should average 5.4% of GDP before narrowing to 4.7% of GDP next year. Public debt will continue to rise but remains broadly in line with other emerging market regions globally.

Source: IMF, UniCredit Research

More work to be done on budget deficits in CEE than elsewhere

• 6
• 5
• 4
• 3
• 2
• 1

1 2 CEE LATAM EM Asia % of GDP 2007 2010 2011 Public debt to GDP has caught up with other EM regions 5 10 15 20 25 30 35 40 45 CEE LATAM EM Asia % of GDP 2007 2010 2011

12

CEE: Improving fiscal backdrop (2)

n In Romania, Serbia and Latvia the IMF continues to impose discipline. Hungary’s commitment to its deficit target is questionable but seems to have improved of late. n Amongst the larger countries, Turkey outperforms while Poland continues to disappoint.

Adjustment in primary balance required to stabilise public debt to GDP at 2010 ratios

• 2
• 1

1 2 3 4 5 6 7 TRY HUF EEK UAH RSD BGN KZH BOS SKK SIT CZK EMU RUB HRK PLN LVL RON LTL pp of GDP

Source: Eurostat, UniCredit Research Deterioration in Poland is a concern (monthly budget deficit performance)

• 50.0
• 40.0
• 30.0
• 20.0
• 10.0

0.0 10.0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec PLNbn 2007 2008 2009 2010

CEE shapes up much better than elsewhere

20 40 60 80 100 120 140 RUB KZT BGN RON SIT BOS LIT UAH HRK RSD CZK SKK LVL TRY PLN Spain HUF Portugal EMU Ireland Greece % of GDP

13

CEE: Improving fiscal backdrop (3)

While deficits are headed in the right direction, there is still plenty of work to do. Eurostat estimates structural budget deficits next year in excess of the EMU periphery average (5.9% of GDP) in Poland, Latvia and Lithuania.

Source: Eurostat, UniCredit Research

2004 2005 2006 2007 2008 2009 2010 Bulgaria 1.6 1.9 3 0.1 1.8

• 3.9
• 4.5

Czech

• 3
• 3.6
• 2.6
• 0.7
• 2.7
• 5.9
• 5.3

Estonia 1.6 1.6 2.5 2.6

• 2.7
• 1.7
• 1.3

Hungary

• 6.4

7.9

• 9.3
• 5
• 3.8
• 4
• 3.8

Latvia

• 1
• 0.4
• 0.5
• 0.3
• 4.1
• 9
• 8.6

Lithuania

• 1.5
• 0.5
• 0.4
• 1
• 3.3
• 8.9
• 8.1

Poland

• 5.4
• 4.1
• 3.6
• 1.9
• 3.7
• 7.1
• 7.9

Romania

• 1.2
• 1.2
• 2.2
• 2.5
• 5.4
• 8.3
• 6.8

Slovakia

• 2.4
• 2.8
• 3.5
• 1.9
• 2.3
• 6.8
• 7.8

Slovenia

• 2.2
• 1.4
• 1.3
• 1.7
• 5.5
• 6

Watch out for excessive deficit procedure

Structural budget balances in the new EU countries

• 10
• 8
• 6
• 4
• 2

2 4

• 10
• 8
• 6
• 4
• 2

2 4 2011 Structural budget balance (%

• f GDP)

2007 Structural budget balance (%

• f GDP)

towards surplus towards deficit BGN Spain EEK Ireland Germany LVL HUF Greece RON LIT PLN SKK Portugal SIT CZK

14

CEE: Capital inflows are largely portfolio in nature (1)

CEE, as with the rest of EM, is benefitting from a return of capital inflows, though there is strong differentiation across the region. Unlike in LATAM and Asia, most central banks in the region have taken little if any action to limit these inflows. The CBT is the exception.

Source: IMF, UniCredit Research Emerging market equities market capitalisation & investor allocations

2 4 6 8 10 12 14 16 18 2004 2009 Share of emerging market equities in total U.S. holdings (%) Share of emerging market equities in world market capitalization (%)

Portfolio Flows to Emerging Markets and Developing Countries (USDbn)

• 100

100 200 300 400 500 600 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 USDbn Potential portfolio flows resutling from 1% reallocation of global equity and debt security holdings

15

CEE: Capital inflows are largely portfolio in nature (2)

Over Q1-Q3 10 CEE saw capital inflows of EUR67.2bn, compared with inflows of only EUR14.8bn for the entirety of 2009. Of concern is the make up of capital inflows. Over Q1-Q3 2010 the region saw portfolio inflows of EUR46.7bn – higher than any full year performance on record. Inflows into the capital account also accelerated, reflecting EU

• payments. Meanwhile FDI remains well below

pre-crisis levels while there is little sign that foreign banks have begun to invest in the region once again.

Source: National central banks, UniCredit Research

Portfolio flows dominate inflows

• 100
• 50

50 100 150 200 250 2004 2005 2006 2007 2008 2009 Q1-Q3 '10 EURbn E&O Other invest non-govt Other invest govt Portfolio FDI Capital A/C Total FDI to the region has not shown signs of recovery yet

0.0 5.0 10.0 15.0 20.0 25.0 30.0 35.0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 EURbn CEE

16

CEE: Differentiation across countries in terms of capital inflows (1)

Foreign banks have been unwilling to commit new funds to entities to CEE since the crisis, unlike in other EM regions

• globally. Within the region, Turkey leads but CIS lags.

Source: BIS, UniCredit Research

Emerging Europe now shows some signs of catch up relative to other emerging market regions

• 600
• 500
• 400
• 300
• 200
• 100

100 200 300 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 2009 2010 USDbn LATAM Developing Europe Asia & Pacific Africa & Middle East Bank inflows into entities in EM

With CEE there was differentiation but now all regions benefit from renewed inflows

• 80.0
• 60.0
• 40.0
• 20.0

0.0 20.0 40.0 60.0 80.0 2008 2009 2010 USDbn Turkey CIS Balkans CE3

17

CEE: fund flow backdrop looks more challenging than in 2011

Significant EM equity outflows vs. DM inflows… This pattern is now gradually appearing in bond funds

• 100.0
• 80.0
• 60.0
• 40.0
• 20.0

0.0 20.0 40.0 60.0 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 DM equity funds EM equity funds 8week rolling, USDbn

• 40.0
• 30.0
• 20.0
• 10.0

0.0 10.0 20.0 30.0 40.0 50.0 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 DM bond funds EM bond funds 8week rolling, USDbn

YTD most hard currency funds saw outflows but LC is also following As weekly data shows big outflows from LC EM bond funds

• 6.00
• 4.00
• 2.00

0.00 2.00 4.00 6.00 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 Local currency bond funds Hard curreny bond funds Blend currency bond funds 8week rolling, USDbn

• 1.00
• 0.80
• 0.60
• 0.40
• 0.20

0.00 0.20 0.40 0.60 0.80 1.00 1.20 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 Local currency EM bond funds (weekly data) USDbn

SOURCE: EPFR, BLOOMBERG, JPM, UNICREDIT RESEARCH

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FI/FX implications

n Fund flows now less supportive for EM assets n Less inflows and higher G3 yields do not bode well for EM local markets but positioning could support some n Sovereign credit market remains an unattractive asset class as a whole but residual opportunities remain n FX should deliver positive returns in 2011 n Prefered FX plays: CZK, PLN, KZT, UAH, RON - evolving: TRY n Preferred rates plays: Turkey, South Africa, Czech Republic – evolving: Poland n Preferred credit plays: Hungary, Romania, Lithuania, Ukraine

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