While it is difficult to find region-wide domestic themes for 2017, we see a challenging external environment from the Trump Presidency (and related policy changes) and higher United States rates (and to a lesser degree eurozone and its monetary policy and politics) sharply magnifying domestic issues in EEMEA countries. Politics will be particularly in focus in Turkey with its transition to an executive presidency, the logistics to achieve that and fall-out for the TCMB and currency. Nomura’s Peter Attard Montalto and Inan Demir report
4 January 2016 – In our view Turkey is likely to be the weakest narrative this year played out through the currency, though we are not particularly bearish on growth or fiscal policy with a government focusing on maintaining both.
South Africa too will see an overarching political narrative as the ANC moves to its elective conference in December and shocks within government can occur. All this should keep growth weak, albeit slightly stronger than in 2016. We see this having little impact on the SARB unless the currency weakens, though downgrade risk will be an important secondary narrative. South African asset prices should perform ‘ok’, but mainly because there are more negative peers to compare to – Turkey especially.
Tight labour markets, structural funds flowing freely under the new semester and the implications of these for CPI inflation and rates will be the focus in CEE (Central and Eastern Europe). We expect Hungary to have the most upside risk on inflation, followed by Romania, though Poland is most likely to react with rate hikes earlier than the market expected, while Hungary extends its unorthodoxy in the face of any risks materialising. Romania remains a difficult mix of overheating, fiscal loosening and inflation risk requiring rate hikes in H2 – not to mention ongoing political tensions.
Nomura believes that SA risks will be magnified by external factors
Political tensions are also manifest around Poland’s ongoing rule of law issues, though the emergence of stronger reform-led growth through H2 should put these concerns on the backburner. Czech’s ‘floorxit’ from its currency regime mid-year should be a major global macro event for such a small country.
It could be a year of two halves – Turkey noisy and negative in H1 with South Africa quiet. Vice versa in H2 as Turkey passes the constitutional hurdle and South African politics heats up without much growth. Negative for Poland in H1, but growth emerging in H2 to support it.
Small narratives will remain of interest – especially currency pegs in Nigeria and Saudi Arabia after Egypt’s devaluation in 2016. Mozambique should be the key ‘credit’ or IMF story in the region with other smaller credits in the Balkans latching onto a recovering eurozone.
We view EEMEA (Eastern Europe, Middle East, and Africa) as an asset class likely outperforming LatAm or Asia given lower degrees of connectivity to US rate hikes or Trump policy including protectionism. However, the region and especially its higher beta markets like Turkey and South Africa to a lesser degree, should drive quite differentiated returns within global emerging market (EM) benchmarks – as Fed and European Central Bank quantative easing (ECB QE) flow-related support ceases and reverses. Countries that offer yield and are ‘quiet’ on the narrative front may outperform (including South Africa and Russia in H1, the first half of the year), though shocks and a focus on idiosyncratics can then mean gains are quickly given back.
Overall, it looks like a volatile year to come.
Nomura has drawn up an economic narrative matrix for South Africa and other emerging markets. It notes that the ‘overarching narrative’ is the political war into the African National Congress elective conference in December 2017. The key timelines include the start of the political year with the State of the Nation speech by President Jacob Zuma followed by the national budget at the end of February.
In terms of interest rates, Nomura believes there will be no rate cuts as long as inflation forecast is above 5%. The risks of rate hikes on sharper weakness in the rand remains especially with a deterioration in expectations and wages. Nomura predicts slow recovery to low potential growth, private sector investment being the key.On inflation Nomura predicts dip in the first half of the year then rebound with headline and core inflation remaining “sticky” near the top end of target (3 to 6%) with upside risks. Its fiscal outlook is that it will be ‘ok’ in the short run then it will mount with debt ‘grinding wider’. The current account will slowly ‘widen back’. Nomura believes it is unlikely there will be growth boosting reforms this year. There would be a risk of downgrades mid and end year on slower growth. There would be instant downgrades on an exit of the Finance Minister Pravin Gordhan.
Domestic politics in key countries, greater risks from a Trump presidency
More exciting geopolitics make 2017 a risky year, even if growth broadly holds together. The extent inflation rises in CEE will also be of particular interest. For 2017 we see a wide array of risks in EEMEA and overseas weighing on the region – Trump, geopolitics, domestic politics, G3 monetary policy, and the resulting focus on domestic vulnerability risks will be key drivers on the downside. On the upside will be the new structural fund semester finally supporting CEE GDP, a stabilisation in eurozone demand and upside for demand from the US and its fiscal expansion, plus more limited exposure to a negative demand shock from Asia.
While a year ago we labelled 2016 as a year of diverging paths between countries, we see more common themes and drivers for 2017 – albeit with different reactions between countries. We think this will make for an interesting time for markets and investors.
Trump risk
We think the biggest external risk will be a Trump presidency from January (it is already having an effect). We see seven policy vectors affecting the region: US reflation and changes to the FOMC (coming in 2018) causing a focus on dual deficits and external vulnerability and funding, the infrastructure boom on import demand for the US and energy independence for the US as a policy (pipelines, fracking etc) causing a terms-of-trade focus for EM, corporate cash on shoring having little direct impact on EEMEA, but a strong USD causing a focus on high beta currencies, and an isolationist foreign policy from the US having some risk impact especially via potential Russian aggressive posturing, Middle East tensions and more uncertain diplomatic norms.
Taking all these together we see Turkey likely coming off the worst, alongside the oil dependent Middle East. South Africa and Russia are less badly affected (though on Russia we think the market overestimates the positives from a Trump presidency if there are lower oil prices as a result of his policies), and Poland and Hungary the effects are more neutral. That said, Poland may become a key risk proxy if there is Russian military posturing against the Baltic States especially. This is a ‘grey’ swan risk but one exercising investors.
Given US protectionism (perhaps non-tariff trade barriers more than blunt tariffs) we believe there is a limited impact on real output in EEMEA, with only marginally positive revisions to our US outlook and none to our eurozone outlook, so we have not changed EEMEA GDP growth forecasts and think domestic narratives will be dominant. That said, we would stress limited upside risks in our region with strong downside risks for oil exporters and positive price but not volume effects for others.
The market has moved significantly to price in tightening from the Fed in 2017 which we think provides a backstop for EEMEA (further upside surprises seem unlikely if inflation takes slightly longer to emerge and maybe is more of a 2018 narrative); however, the market is now contemplating some 75bp of hikes for 2017 from the Fed that would still affect spreads and funding costs for EEMEA, especially Turkey even if priced in. We view eurozone tapering as only a 2018 risk (being announced and implemented), so 2017 should remain supportive. We think this monetary policy backdrop means fund flows to the region will remain volatile in 2017, with monetary policy cross currents against divergent terms of trade and markets focusing on domestic risks and politics adding to volatility. The two key political narratives for the market to focus on in the region will be Turkey’s move to an executive presidency and South Africa’s ANC inwardly focusing on its December 2017 elective conference.
Macroeconomic drivers
We believe continued ECB QE will be marginally supportive for CEE FX and spreads, but few flows, and the transmission mechanism while blocked in the eurozone suggests no particular buying of CEE by investors unlike when QE first came in. We think reduced liquidity, domestic policy factors and Trump policy drivers are bigger drivers for CEE. The bigger stimulus for CEE in 2017 will come from the resumption of investment owing to structural funds. The crossover of two seven-year semesters did not go smoothly partly because of front loading of projects and money during 2009-12. Although the new period started in 2014, getting approval for projects, money flowing (happening now) and actual investment into GDP take time. The EUR454bn 2014-20 semester will see Poland getting around EUR86bn and Hungary EUR25bn. We think this will be evident in the GDP numbers and higher investment growth from Q2 2017. This suggests a weak Q1 2017 on a quarterly basis, though in y-o-y terms the base effects should catch up.
Overall, we expect the region’s growth to be relatively low in 2017 with some headwinds outlined above, a sluggish China and little upside from US reflation in real terms. However, this masks some divergence. The largest turnaround in the region is likely to be in Russia in terms of headline growth, moving back to positive growth in Q1 after negative yearly contractions since the start of 2015 on the impact of sanctions and tight fiscal and monetary policies.
As this falls out of the base, positive growth becomes possible albeit remaining at just 1.3%. Downside risks would be strong from lower oil prices, while upside risks are hard to find. Russia’s growth turned out slightly stronger in 2016 than forecast at the end of 2015. We expect South Africa and Poland to be the other countries experiencing higher growth in 2017 than in 2016. In South Africa we expect a slow fading of the political shocks suppressing growth and private sector investment, allowing growth to jump from 0.5% in 2016 to 1.0% in 2017, but this is still negative per capita income growth and the risks are again to the downside on potential political flare-ups.
Pent-up demand and potential animal spirits are upside risks if the private sector had a period of calm, however. South Africa has the largest downward revisions to growth expectations for 2016 and 2017 since our outlook a year ago, thanks to the impact of Nene-gate and political uncertainty (which occurred the week following last year’s outlook publication!).
After an initial large downward revision of South Africa’s forecasts following Nene-gate growth expectations remained fairly steady through the year. Poland has had the second-largest growth expectations downgrades for 2016 and 2017 thanks to concerns on the Morawiecki reform plan turning out to be misplaced and the impact of the structural fund cycle being a stronger negative than expected.
We have not factored in significantly lower oil prices on a Trump energy-independence policy into our inflation or central bank forecasts yet. This would add some downward risks, though the strength of base effects would mean overall inflation would just rise a little more slowly in CEE especially, though would cause a step lower in South Africa and Turkey – possibly offset by currency weakness however. Overall, we expect fiscal policy to loosen in CEE in 2017 with monetary policy tightening – the exception being Hungary. South Africa should see some slight fiscal tightening, but is likely to be neutral on monetary policy. Russia contrasts with most of CEE with meaningful fiscal tightening, but also monetary loosening. Other stories to watch We think geopolitical tensions in the Middle East – the degree of which is dependent on how isolationist a Trump administration becomes vs targeted aggressive interventions possibly against ISIS, combined with the risk of lower oil prices – could severely weigh on the GCC countries and African oil exporters including Nigeria and Angola (both of which have their own domestic political issues).
The ‘internal war’ within the ANC in South Africa
South Africa – The overarching theme of politics in 2017 for South Africa will be the internal ‘war’ within the ANC as factions jostle and campaign for the elective conference in December. Some key events to watch: the ANC’s 8 January anniversary celebrations will be a focal point as will the monthly NEC meetings, then the State of the Nation Address at the start of February and Budget at the end of February.
The ANC’s policy conference and one-day ‘consultative’ conference at the start of July will also be key. But the real action will be below the surface as campaigning occurs at branch level. Investors need to be cautious on public pronouncements of support and be aware that the winner will be the person with the most branch delegates voting for them. As such the restructuring, closure and opening of branches and shifts in membership numbers is a crucial, ‘dirty’, part of the campaign and this is why we ultimately believe the tenderpreneur faction behind Zuma can win with its likely candidate in Nkosazana Dlamini-Zuma.
Deputy President Cyril Ramaphosa. The million dollar question is: Will he become president?
She will represent the status quo for the party, though the coalitions she forms may be able to shift policy either to a better or worse place. Ultimately, her main rival Deputy President Cyril Ramaphosa does not have the grass roots support or the ability to run a dirty campaign in the same way in our view. Therefore, we think a key event in Q2 2018 will be the transition of power from Zuma to his successor as President of the country to allow them to campaign to victory in the 2019 national elections.
We believe a cabinet reshuffle is likely in 2017 as Zuma purges those that stood up to him in the NEC in 2016. He is weakened by that event, but not weak. There is some risk to him from rebel ANC MPs in parliament, and we believe he does not have the political capital to remove Financial Minister Pravin Gordhan because of a pro-patronage anti-Zuma key faction in the NEC that is sticking with him for now. Ultimately, we think Zuma’s fate rests in their hands. Politics will be a big distraction from reforms and policy.