Brazil is set for full recovery

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Jan Dehn, head of Research at Ashmore, discusses why Brazil is set for a full recovery, China defies the shrill cries of the hard-landing crowd to clock up 7.4% growth in 2014 and highlights some interesting index news.


The central bank raised policy interest rates by 50bps to 12.25% and the government released further details about its fiscal adjustment, including tax hikes on imports, cosmetics, consumer loans and fuel. These changes were announced even as the economic adjustment facing Brazil is beginning to bite.

Labour markets took a substantial hit in December, when job creation fell to the lowest level since 1999. Brazil’s problems strongly resemble that of India a couple of years ago.

Excessive fiscal laxity has created inflation and forced the central bank to raise rates, killing investor confidence and prompting outflows that have also weakened the currency.

Since inflation is not yet dead the weaker currency has not helped the current account – indeed, the December current account deficit was the widest it has been in thirteen years.

The prospect of having to cut spending to fix fiscal issues, while at the same time hiking rates to kill inflation is unappealing, but we think Brazil will undertake the adjustment and restore investor confidence. In order to achieve this, the most critical element is to achieve the fiscal objectives.

Ultimately, the restoration of macroeconomic health is a political imperative.

We think a broader political agreement between the right and left in Brazilian politics lies behind the decision to change direction on fiscal policy. Businesses want the economy to improve.

Dilma wants to deflect for as long as possible the corruption scandals that surround her and the PT party. The centre-right can provide relief from the scandals if Dilma accepts fiscal reform. This truce will eventually crumble when the economy starts to pick up and the next elections draw nearer. But by then Brazil will have stepped back from the brink.


China’s GDP expanded 7.4% in 2014. This means that another year has passed without a so-called hard landing. This has not prevented various punters from predicting that the hard landing will happen in 2015. Why people keep focusing on this is beyond us.

China is slowing because it is changing from a high saving/high investment economy to a consumption led economy. This means greater imports and a smaller current account surplus. To preserve the balance of payments the government is liberalising the capital account.

Between them, China’s domestic bond and equity markets are equivalent in size to 55% of US GDP and foreign investors have almost no exposure.

We expect flows into these markets to dominate outward flows from China’s domestic investors, ultimately ensuring that the CNY will be the strongest currency in the world over the next decade. In the past week, China supported liquidity in the money markets by injecting CNY 50bn of 7-day reverse repos.

We think the PBOC is keen to provide liquidity, but not particularly keen to engage in general easing as the government continues to steer the economy towards interest rate liberalisation as part of the much greater transformation of the economy towards consumption-led growth.

It was also announced that Alibaba is set to purchase a stake in New China Life Insurance Co Ltd, a state insurer. This is also consistent with China’s other important economic objective of reforming its state-owned enterprises.

The president of the Shanghai-Hong Kong Stock Connect says China is considering allowing bonds and ETFs to be traded on the exchange. We think China is targeting global reserve currency status by December 2015 and that the rapid liberalisation of the capital account is in preparation of this.

The HSBC manufacturing index rose to 49.8 in January from 49.6 in December. New home sales jumped 4.2% yoy in December.

Index developments

Barclays Bank, an index provider, has agreed to begin to include Sukuks (Sharia compliant bonds) within its global bond index. This is very good news. Sukuks have been a fast growth area for external bond issuance in EM.

The most commonly used external debt benchmark index, the EMBI Global Diversified Index from JP Morgan does not include Sukuks.

This is one of the reasons why this index only captures about 47% of the EM external debt universe. Recently, Bank of America Merrill Lynch took further initiatives by launching the first EM local currency corporate bond index. These indices are still woefully inadequate, mainly because index providers tend only to include markets in their indices where they trade the bonds.

As global bond yields decline, global investors are becoming more passive. We strongly advocate against benchmark hugging and passive management, which, in effect, boils down to allocating countries purely on the basis of how much debt they issue.

In related news, JP Morgan placed Nigeria on index watch negative on the grounds that the government has taken steps to reduce the liquidity of its bond market. JP Morgan will now evaluate the liquidity situation over the next 3-5 months before taking action, which could involve dropping Nigeria from the GBI EM GD index.

JP Morgan’s allegation of low liquidity may or may not be a good excuse for dropping a country from indices. Ultimately, the liquidity available to investors is subjective and may be a function of many things, including each investor’s investment in local and external counterparties.


The government is preparing to make benchmark revisions to the calculation of GDP in the coming weeks. As in most other EM economies, GDP is seriously underestimated due to the rapid development of new sectors of the economy that are not captured in surveys, which are based on infrequently revised benchmarks.

In 2010, the GDP benchmark was revised higher by 24%. This time GDP could be revised higher by 10% as SMEs in the non-agricultural sector are included. The higher GDP print will improve important ratios such as the deficit to GDP ratio.


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