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Emerging markets at crossroads
Dr Murat Ulgen, Global Head of Emerging Markets Research
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Alternatives needed to conventional monetary policy.
Emerging economies and their financial markets have started to recover from the initial losses that followed the coronavirus crisis, thanks partly to record global liquidity as the world’s central banks implemented aggressive bond-purchase programmes and other measures that have improved confidence in emerging economies.
Manufacturing has recovered quicker than in developing countries as factories resumed production, led by Asia, following the easing of restrictive measures. Domestic demand has also been strong, with new orders at their highest since January 2013, and there are preliminary signs that the worst might be over for exports, thanks to strong demand for electronics and medical equipment.
Yet the road ahead is bumpy for emerging economies. Having cut interest rates aggressively – rates have fallen between 2.5 and 3.5 percentage points in Brazil, Mexico, South Africa and Egypt for instance – the scope for conventional monetary policies has narrowed significantly.
We expect rates to remain broadly on hold for most of 2021: the exceptions could be half-point cuts in Egypt, Indonesia and Romania with quarter-point reductions in India and the Philippines, while mainland China trims by another 20 basis points.
Central banks may thus switch further into unconventional monetary policies, mirroring developed countries with more quantitative-easing type measures.
However, these are likely to have some unintended consequences, including continued pressure on currencies and escalating inflationary pressures. Additionally, despite the widening output gaps, supply-chain disruptions – particularly in the food sector – could also push up prices given food comprises a high share of consumer spending in emerging markets compared with developed countries.
The lack of conventional monetary easing will likely mean tighter financial conditions. Government borrowing has remained high because the fiscal stimulus – including support for households and companies hit by the pandemic – led to a sharp deterioration in public accounts. Total public-sector borrowing could be around 9 per cent of emerging-market GDP, or $2.7 trillion, for the final nine months of 2020 and a return to more sustainable levels seems unlikely in 2021.
Egypt’s gross borrowing requirement could exceed 28 per cent of GDP next year with Brazil and South Africa also big borrowers.
Meanwhile fiscal gaps will be particularly large in Central and Eastern Europe, Middle East and Africa, led by South Africa, where the budget deficit is expected to reach 11.7 per cent of GDP, and Saudi Arabia at 8.7 per cent next year. Brazil could also see an 8.8 per cent deficit and Argentina 6.0 per cent.
The deterioration in emerging-market fiscal accounts is likely to continue, with deficits remaining large for years to come. Ample liquidity will buy some time, but developed markets are also borrowing aggressively and there is probably only so much excess savings globally. Emerging nations need to improve their risk premium to attract capital.
Emerging markets are thus at a cross-roads and policymakers face hard choices. One option is fiscal consolidation (like in Saudi Arabia) and/or monetary tightening (following Turkey and Hungary) to help with capital flows and prevent currencies from weakening further. Another is continuing the loose fiscal policies and unconventional monetary policy, hoping for a growth rebound and benign inflation. Alternatively, fiscal reforms could improve investor confidence.
HSBC’s flagship GEMs Forum – virtual this year – runs from 6 to 30 October with over 40 macro, thematic and sector panels and discussions plus meetings with about 100 global emerging market companies.
First published 4 October 2020.
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Analyst Certification
The following analyst(s), economist(s), or strategist(s) who is(are) primarily responsible for this report, including any analyst(s) whose name(s) appear(s) as author of an individual section or sections of the report and any analyst(s) named as the covering analyst(s) of a subsidiary company in a sum-of-the-parts valuation certifies(y) that the opinion(s) on the subject security(ies) or issuer(s), any views or forecasts expressed in the section(s) of which such individual(s) is(are) named as author(s), and any other views or forecasts expressed herein, including any views expressed on the back page of the research report, accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Dr. Murat Ulgen
Important disclosures
Foreign exchange: Basis for financial analysis
This document has been prepared and is being distributed by the Research Department of HSBC and is intended solely for the clients of HSBC and is not for publication to other persons, whether through the press or by other means.
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HSBC believes that investors utilise various disciplines and investment horizons when making investment decisions, which depend largely on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations.
HSBC’s currency trade ideas on deliverable FX forwards (DF) or non-deliverable FX forwards (NDF) are usually identified on a time horizon of up to three months, although HSBC reserves the right to extend this time horizon on a discretionary, trade-bytrade basis.
HSBC believes an investor's decision to buy or sell an instrument should depend on individual circumstances such as the investor's existing holdings and other considerations. Different securities firms use a variety of terms as well as different systems to describe their recommendations. Investors should carefully read the definitions of the recommendations used in each research report. In addition, because research reports contain more complete information concerning the analysts' views, investors should carefully read the entire research report and should not infer its contents from the recommendation. In any case, recommendations should not be used or relied on in isolation as investment advice.
Definitions for currency trades on DFs and NDFs
Buy: refers to buying the first currency in the named pair in exchange for the second currency in the named pair.
Sell: refers to selling the first currency in the named pair in exchange for the second currency in the named pair.
The tenor of the instrument will be denoted and will refer to a settlement date relative to the opening date of the trade idea e.g. 1m refers to a settlement date 1 month forward from the open date of the trade idea. NDF trades normally fix two working days prior to the settlement date.
Distribution of currency trades
The nature of foreign exchange forward trade ideas is such that there will always be an equal number of buy and sell trades (buying one currency in exchange for selling another), both outstanding and historically.
Equities: Stock ratings and basis for financial analysis
HSBC and its affiliates, including the issuer of this report (“HSBC”) believes an investor's decision to buy or sell a stock should depend on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations and that investors utilise various disciplines and investment horizons when making investment decisions. Ratings should not be used or relied on in isolation as investment advice. Different securities firms use a variety of ratings terms as well as different rating systems to describe their recommendations and therefore investors should carefully read the definitions of the ratings used in each research report. Further, investors should carefully read the entire research report and not infer its contents from the rating because research reports contain more complete information concerning the analysts' views and the basis for the rating.
From 23rd March 2015 HSBC has assigned ratings on the following basis:
The target price is based on the analyst’s assessment of the stock’s actual current value, although we expect it to take six to 12 months for the market price to reflect this. When the target price is more than 20% above the current share price, the stock will be classified as a Buy; when it is between 5% and 20% above the current share price, the stock may be classified as a Buy or a Hold; when it is between 5% below and 5% above the current share price, the stock will be classified as a Hold; when it is between 5% and 20% below the current share price, the stock may be classified as a Hold or a Reduce; and when it is more than 20% below the current share price, the stock will be classified as a Reduce.
Our ratings are re-calibrated against these bands at the time of any 'material change' (initiation or resumption of coverage, change in target price or estimates).
Upside/Downside is the percentage difference between the target price and the share price. Prior to this date, HSBC’s rating structure was applied on the following basis: For each stock we set a required rate of return calculated from the cost of equity for that stock’s domestic or, as appropriate, regional market established by our strategy team. The target price for a stock represented the value the analyst expected the stock to reach over our performance horizon. The performance horizon was 12 months. For a stock to be classified as Overweight, the potential return, which equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated, had to exceed the required return by at least 5 percentage points over the succeeding 12 months (or 10 percentage points for a stock classified as Volatile*). For a stock to be classified as Underweight, the stock was expected to underperform its required return by at least 5 percentage points over the succeeding 12 months (or 10 percentage points for a stock classified as Volatile*). Stocks between these bands were classified as Neutral. *A stock was classified as volatile if its historical volatility had exceeded 40%, if the stock had been listed for less than 12 months (unless it was in an industry or sector where volatility is low) or if the analyst expected significant volatility. However, stocks which we did not consider volatile may in fact also have behaved in such a way. Historical volatility was defined as the past month's average of the daily 365-day moving average volatilities. In order to avoid misleadingly frequent changes in rating, however, volatility had to move 2.5 percentage points past the 40% benchmark in either direction for a stock's status to change.Rating distribution for long-term investment opportunities
As of 02 October 2020, the distribution of all independent ratings published by HSBC is as follows:
Buy 56% ( 32% of these provided with Investment Banking Services )
Hold 35% ( 32% of these provided with Investment Banking Services )
Sell 9% ( 25% of these provided with Investment Banking Services )
For the purposes of the distribution above the following mapping structure is used during the transition from the previous to current rating models: under our previous model, Overweight = Buy, Neutral = Hold and Underweight = Sell; under our current model Buy = Buy, Hold = Hold and Reduce = Sell. For rating definitions under both models, please see “Stock ratings and basis for financial analysis” above.
Fixed income: Basis for financial analysis
This report is designed for, and should only be utilised by, institutional investors. Furthermore, HSBC believes an investor's decision to make an investment should depend on individual circumstances such as the investor's existing holdings and other considerations.
HSBC believes that investors utilise various disciplines and investment horizons when making investment decisions, which depend largely on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations. Given these differences, HSBC has two principal aims in its fixed income research: 1) to identify long-term investment opportunities based on particular themes or ideas that may affect the future earnings or cash flows of companies in corporate credit and based on country-specific ideas or themes that may affect the performance of these bonds in the case of covered bonds, in both cases on a six-month time horizon; 2) to identify trade ideas on a time horizon of up to four months, relating to specific instruments, which are predominantly derived from relative value considerations or driven by events and which, in the case of credit research, may differ from our long-term opinion on an issuer. Buy or Sell refer to a trade call to buy or sell that given instrument; HSBC has assigned a fundamental recommendation structure, as described below, only for its longer-term investment opportunities.
HSBC believes an investor's decision to buy or sell a bond should depend on individual circumstances such as the investor's existing holdings and other considerations. Different securities firms use a variety of terms as well as different systems to describe their recommendations. Investors should carefully read the definitions of the recommendations used in each research report. In addition, because research reports contain more complete information concerning the analysts' views, investors should carefully read the entire research report and should not infer its contents from the recommendation. In any case, recommendations should not be used or relied on in isolation as investment advice.
HSBC Global Research is not and does not hold itself out to be a Credit Rating Agency as defined under the Hong Kong Securities and Futures Ordinance.
Definitions for fundamental credit and covered bond recommendations
Overweight: For corporate credit, the issuer’s fundamental credit profile is expected to improve within the next six months. For covered bonds, the bonds issued in this country are expected to outperform those of the other countries in our coverage over the next six months.
Neutral: For corporate credit, the issuer’s fundamental credit profile is expected to remain stable for up to six months. For covered bonds, the bonds issued in this country are expected to perform in line with those of the other countries in our coverage over the next six months.
Underweight: For corporate credit, the issuer’s fundamental credit profile is expected to deteriorate within the next six months.
For covered bonds, the bonds issued in this country are expected to underperform those of other countries in our coverage over the next six months.
Definitions for trades (Rates & Credit)
Buy and Sell refer to a trade call to buy or sell a bond, option on an interest rate swap ("swaption"), interest rate cap or floor, inflation cap or floor, or Total Return Swap ("TRS"). The buyer/seller of a TRS receives/pays the total return of the underlying instrument or index at the end of the period and pays/receives the funding leg.
Buy protection and Sell protection refer to a credit default swap (CDS): the protection buyer/seller is effectively selling/buying the reference entity's credit risk.
Pay and receive refer to a trade call to pay or receive the fixed leg of an interest rate swap (IRS), a non-deliverable IRS, the first-named leg of a basis swap, the realised inflation leg of an inflation swap, or a forward rate agreement (FRA). An investor that executes a pay or receive trade is said to be "paid" or "received".
Payer and receiver refer to inflation caps or floors and to swaptions: a payer is an option giving the right but not the obligation to enter a paid position in an interest rate or inflation swap, and a receiver is an option giving the right but not the obligation to enter a received position in an interest rate or inflation swap.
ASW (also asset-swap, Buy on asset swap, Buy on an asset-swapped basis): Buy a bond packaged with a swap that is tailored to eliminate the bond’s interest rate risk, effectively transforming the bond to a floating rate instrument whilst preserving the credit exposure to the bond issuer.
RASW (also reverse asset-swap, Sell on asset swap, Sell on an asset swapped basis): Sell a bond packaged with a swap that is tailored to eliminate the bond’s interest rate risk, effectively transforming the bond to a floating rate instrument whilst preserving the credit exposure to the bond issuer.
Distribution of fundamental credit and covered bond recommendationsAs of 01 October 2020, the distribution of all independent fundamental credit recommendations published by HSBC is as follows:
All Covered issuers Issuers to whom HSBC has provided Investment Banking in the past 12 months
Count Percentage Count Percentage
Overweight 123 26 79 64
Neutral 212 45 102 48
Underweight 134 29 56 42
Source: HSBC
For the purposes of the distribution above the following mapping structure is used: Overweight = Buy, Neutral = Hold and Underweight = Sell. For rating definitions under both models, please see "Definitions for fundamental credit and covered bond recommendations" above.
Distribution of trades
As of 30 June 2020, the distribution of all trades published by HSBC is as follows:
All Covered instruments Issuers to whom HSBC has provided Investment Banking in the past 12 months
Count Percentage Count Percentage
Buy 139 67 97 70
Sell 67 33 28 42
Source: HSBC
For the purposes of the distribution above the following mapping structure is used: Buy/Sell protection/Receive/Buy Receiver/Sell
Payer = Buy; and Sell/Buy protection/Pay/Buy Payer/Sell Receiver = Sell. ASW is counted as a buy of the bond and a paid swap, and RASW as a sell of the bond and a received swap. For rating definitions under both models, please see "Definitions for trades (Rates and Credit)" above.
For the distribution of non-independent ratings published by HSBC, please see the disclosure page available at http://www.hsbcnet.com/gbm/financial-regulation/investment-recommendations-disclosures.
Recommendation changes for long-term investment opportunities
To view a list of all the independent fundamental ratings/recommendations disseminated by HSBC during the preceding 12-month period, and the location where we publish our quarterly distribution of non-fundamental recommendations (applicable to Fixed Income and Currencies research only), please use the following links to access the disclosure page:
Clients of Global Research and Global Banking and Markets: www.research.hsbc.com/A/Disclosures
Clients of HSBC Private Banking: www.research.privatebank.hsbc.com/Disclosures
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