Brace for more volatility in 1Q14, more confidence needed — MIDF Research

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KUCHING: While the world ushered the new year with a bang, emerging markets (EM) started the year on a lower note as currencies got battered again but on multitude concerns – signs of China’s slowdown as well as deepening political crisis in Thailand and Turkey.

The research arm of MIDF Amanah Investment Bank Bhd (MIDF Research) highlighted that while developed markets’ (DM) recovery are expected to pick up pace, led by US, the EM countries may instead face a tougher year ahead.

It added, the taper environment may penalise those that put on hold reforms or tightening to support growth and most EM countries would face tough balancing act amidst heightened political risks.

“Political risks would likely escalate, judging from the growing intensity in China-Japan frictions and the deepening crisis in Thailand and Turkey amidst a busy election calendars for the EM – all of the ‘fragile five’, which are Turkey, Indonesia, India, Brazil and South Africa, would hold elections in 2014.

“Also, with a busy US calendar this quarter – Janet Yellen to fill in Bernanke’s post; quantitative easing (QE) taper and the upcoming US debt limit deadline on February 7 – all of which signals that volatility could stay high for another few months,” the research firm pointed out.

It explained, after the first QE taper to be announced in January 17 to 18 during the Federal Open Market Committee (FOMC) meeting and the upcoming US debt limit deadline on February 7, fiscal gridlock issues are expected as the Republicans promised to put up a new fight.

Meanwhile, on China’s economy, MIDF Research noted that the HSBC’s Purchasing Managers’ Index (PMI) for China slowed to a three-month low in December, raising concern that the economy is already entering the phase of slowdown in response to the government’s measures of enforcing fiscal discipline on local government borrowers.

“Chinese officials and analysts have long worried about the amount of debt at local governments, which are not allowed to tap banks directly but establish special purpose vehicles to borrow money for investment projects.

“China’s National Audit Office (NAO) revealed recently that local government debts had increased almost 70 per cent from end-2010 to 17.9 trillion renminbi (US$2.95 trillionn) by the end of June 2013,” it said.

The research firm further noted that the risk is that, the tightening measures would hit China banks hard – although official numbers suggested that NPL at China banks is very low at about one per cent, these off-balance-sheet loans to high risk borrowers which are the highly leveraged real-estate developers and local-government financing vehicles face increasing chances of turning sour.

“While there is still much momentum in the rest of the economy to ensure growth to be sustained at seven to 7.5 per cent level, we believe that the China’s bank lending to decline further and that would take its toll on the economy.

“Nonetheless, we still rule out the possibility of a hard landing (growth below six per cent), given the fact that China has all the resources to stimulate the economy to avert such event,” the research firm opined.

While there will be no repeat of 1997/1998, the taper environment might penalise those that put on hold reforms or tightening to support growth. Those EM countries which saw their currencies badly battered are those with twin deficits, high dependence on short-term foreign funds to finance external funding requirement and are also facing rising inflation.

“These ‘ugliness’ were masked by the huge influx of hot money when they were the darlings of investors seeking higher yields in QE- environment in the last five years or so.

“Now, that QE is ending, it is time for these countries to put their house in order or see their currencies got whacked further as foreign fund outflows may lead to a wider capital flight,” it said.

Aside from that, there is rising chance of most EM resorting to populist measures as elections loom in ‘fragile five’, while delay in elections in Thailand and the deepening crisis amidst dictatorship-like administration in Turkey would all cast negative outlook on the EM world, MIDF Research said.

In Thailand, the heightened anti-government protests raises concern of a possible delay in the general election slated to be held on February 2 while in Turkey, while the political crisis has yet to die down, the government has hiked up taxes on on cars, cigarettes, alcoholic drinks and mobile phones came into effect January 1, which may lead to huge protests and rising calls for Prime Minister Erdogan to step down.

With that, the research firm projected that volatility could stay high for another few months.