March 2016 >BRIC Fundamental Commentary

BRAZIL — A high-inflation recessionary environment amidst a profound institutional crisis continues to shape investor sentiment towards Brazil with a myriad of downside risks to both growth and inflation. The double-notch downgrade by Moody’s at the end of February sealed the newly achieved “speculative-grade” status by Brazil as a government borrower. We are of the belief that multiple downgrade revisions were fully priced in Brazilian debt securities. The Brazilian real (BRL) was fairly muted to the rating actions (which tend to follow market prices, not pre-empt them). In this context, we do not anticipate a large-scale depreciation of the BRL in the year ahead similar to the 33% accumulated in 2015 as a whole. In fact, the BRL has been immersed in a relatively well defined trading range over the past six months despite a highly volatile financial market environment (courtesy of erratic policy shifts in China and ambiguous monetary policy decisions in the USA). We have revised our economic projections anticipating a real GDP contraction of 3.6%, a consumer price inflation rate of 7.5% (measured by the IPCA index), a nominal exchange rate depreciation of 8.5% and a current account deficit equivalent to 2.1% of GDP by the end of 2016. We anticipate that political stress associated with potential impeachment proceedings against President Rouseff will continue to escalate, deterring the fiscal adjustment under way; indeed, the consolidated public sector deficit already reached 10.8% of GDP.
RUSSIA — Preliminary estimates of Russian real GDP indicate that the economy contracted by 3.7% in 2015, underpinned by the sharp drop in household spending and investment. Business investment is expected to remain weak given the subdued oil price outlook, extension of EU sanctions through at least July 2016, depressed corporate profitability and banking sector challenges. Meanwhile, Russian manufacturing and export orders data continue to prove very fragile at a time when the Ministry of Labour believes that unemployment could rise by an additional 500,000 people this year. This suggests that the Russian economy is far from a turning point and supports our view that real GDP will contract by -1% in 2016. Nevertheless, conditions appear to be improving for the Russian consumer, with inflationary pressures easing – the headline CPI print edged down to 9.8% y/y in January from 12.9% in the prior month – and retail sales volumes picking up. The tentative signs of a recovery in household income and consumption could be further reinforced by an improvement in consumer sentiment, which could take place amid stabilization in oil prices and the ruble exchange rate. The Russian Central Bank (RCB) will likely maintain a cautious monetary policy stance in the near-term given still elevated consumer price inflation as well as concerns regarding banking sector instability and global capital shifts in favour of the US dollar amid Fed monetary tightening.
INDIA — India’s Union Budget for fiscal year 2016/17 (April-March), presented at the end of February, maintained the promise for further fiscal consolidation. The administration kept previous fiscal targets in place and aims to narrow the central government deficit to 3.5% of GDP in FY2016/17 from 3.9% in 2015/16. Nevertheless, the shortfall remains larger at the general government level, averaging 6¾% of GDP through 2017, according to the International Monetary Fund. The budget focuses on rural development and infrastructure. The fiscally cautious budget supports our view that the Reserve Bank of India will likely lower the benchmark interest rate in the near future by 25 basis points to 6.50%. The most recent cut took place at the end of September. While India’s inflation environment remains generally favourable, consumer price gains have accelerated somewhat in recent months and reached 5.7% y/y in January, driven by higher food prices, particularly those of pulses. We expect a further but modest pick-up over the course of 2016 before inflation stabilizes around 6% y/y by the end of the year. The Indian economy expanded by 7.3% y/y in the final quarter of 2015, taking the increase in the nation’s output to 7.3% in 2015 as a whole. We expect real GDP expansion to average around 7½% in 2016-17, below India’s potential growth of 8-10% due to rather slow progress on improving the ease of doing business.
CHINA — Monetary conditions continue to ease in China. The People’s Bank of China lowered the Reserve Requirement Ratio (RRR) by 50 basis points for all financial institutions on February 29th. The cut — the fifth since February 2015 — brings the ratio for most large banks to 17% of deposits. The RRR reduction is aimed at supporting adequate liquidity in the banking system and boosting money supply and credit growth, thereby offsetting the strong decelerating forces the Chinese economy is facing. The country’s authorities are operating in a challenging context: while the economy is in need of a boost, it would simultaneously benefit from relatively tight monetary conditions to limit ongoing capital outflow pressure, which is placing the Chinese yuan on the defensive. The potential for further bouts of financial market volatility over the coming months remains high, forcing the government to keep its interventionist approach in place. We expect additional cautious monetary easing over the coming months, together with sizable fiscal injections. Nevertheless, in our view, monetary and fiscal stimulus will not be enough to prevent China’s real GDP growth from slowing to 6.4% this year from 6.9% in 2015. The inflation outlook is favourable as persistent producer price deflation is helping keep costs in check. Consumer prices increased by 1.8% y/y in January; we expect only a modest pick-up over the coming quarters, with inflation at slightly over 2.0% y/y at the end of 2016.
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