Global Outlook 2016 TRAVERSING TURBULENT …...Key global themes...as commodity prices surged in the...

...as commodity prices surged in the second half of 2010

1

Global Outlook 2016

TRAVERSING TURBULENT TIMES

Analysing global growth and inflation


2

Looking back on the state of the world economy as

a backdrop for 2016

Low growth low inflation conditions prevailing globally


3

GDP growth (%)

2014 2015 (f) 2016 (f)

World 3.4 3.1 3.4

Advanced 1.8 1.9 2.1

US 2.4 2.5 2.6

Eurozone 0.9 1.5 1.7

EM economies 4.6 4.0 4.3

China 7.3 6.9 6.3

India* 7.3 7.3 7.5

Brazil 0.1 -3.8 -3.5

Russia 0.6 -3.7 -1.0

* - Fiscal Year, Gross value added

Inflation (%)

2014 2015 (f) 2016 (f)

World 3.5 3.3 3.4

Advanced 1.4 0.3 1.2

US 1.6 0.1 1.1

Eurozone 0.4 0.2 1.0

EM economies 5.1 5.6 5.1

China 2.0 1.5 1.8

India* 5.9 5.4 5.5

Brazil 6.3 8.9 6.3

Russia 7.8 15.8 8.6

* - Fiscal Year

Slowdown in world growth; pockets of recovery witnessed

Divergence in emerging and advanced regions’ growth rates… …with EM contribution to global growth slowing

Source: Bloomberg, ICICI Bank Research

Source: Bloomberg , ICICI Bank Research

China witnessing deceleration while US growth remains robust ...as commodity prices surged in the second half of 2010US to lead global growth and China to continue slowing


-4

-3

-2

-1

0

1

2

3

4

5

5

6

7

8

9

10

11

12

13

14

15

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

China GDP US GDP(% YoY) • Global growth is expected to recover only marginally

over the course of 2016.

• The incremental contribution of emerging markets to

world growth has been reducing of late. The differential

in EM and DM growth is now the lowest since 2001.

• As far as growth engines are concerned, Chinese growth

is likely to be in a secular downtrend going ahead and has

already slipped below 7%.

• US growth is showing robust recovery but will take a few

quarters to be well cemented on account of increased

global volatility.

4

0

1

2

3

4

5

6

7

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

Emerging and developing regions growth

Aggregate emerging EM-DM growth differential (RHS)

(% YoY)(pps)

-6

-4

-2

0

2

4

6

8

10

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

World growth rates

Emerging World Advanced(% YoY)

Emerging markets witness slowdown for 5th year in a row

All emerging markets showing slowdown in growth The importance of investment demand for growth is reducing

Source: IMF, ICICI Bank Research


...as commodity prices surged in the second half of 2010Fall in commodity prices have helped (Asian) external balances Challenges to EM economies continue to persist

Source: Economist, ICICI Bank Research

5

0.0

2.0

4.0

6.0

8.0

10.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

Emerging and developing regions growth

Aggregate emerging (RHS) EM Asia (RHS)

Emerging Europe Latin America(% YoY) (% YoY)

36.0

36.5

37.0

37.5

38.0

38.5

15

16

17

18

19

20

21

22

23

24

200

9

201

0

201

1

201

2

201

3

201

4

201

5E

201

6F

Fixed investment % of GDP

Latam EEMEA Emerging Asia(RHS)

(%)

-4

-3

-2

-1

0

1

2

3

4

5

20

09

20

10

20

11

20

12

20

13

20

14

20

15E

20

16F

Current account % of GDP

Latam EEMEA Emerging Asia Aggregate emerging

(%) • The emerging market region has entered a protracted

slowdown territory.

• Most major EM regions are witnessing sharp deceleration

in growth.

• Chinese growth is likely to continue to slow going ahead.

• Economies such as Brazil and Russia which are large

commodity exporters are facing recession.

• Within EM Asia countries such as India still stand out but

are facing some stress.

• Emerging Europe also seems to be better placed as

compared to Latam economies.

Activity indicators showing muted outturn

Output gap improving only for advanced economies led by US Industrial production trending down globally





Sentiment indicators globally remain muted… …manufacturing and services sentiment both trending downward


6

51

51.5

52

52.5

53

53.5

54

54.5

55

55.5

56

Ap

r-13

Ju

n-1

3

Aug

-13

Oct-13

Dec-1

3

Fe

b-14

Ap

r-14

Ju

n-1

4

Aug

-14

Oct-14

Dec-1

4

Fe

b-15

Ap

r-15

Ju

n-1

5

Aug

-15

Oct-15

Dec-1

5

Global composite PMI(3m MA)

51

52

53

54

55

56

50

51

52

53

Ap

r-13

Ju

n-1

3

Aug

-13

Oct-13

Dec-1

3

Fe

b-14

Ap

r-14

Ju

n-1

4

Aug

-14

Oct-14

Dec-1

4

Fe

b-15

Ap

r-15

Ju

n-1

5

Aug

-15

Oct-15

Dec-1

5

Manufacturing PMI Services PMI

(3m MA)

-6

-5

-4

-3

-2

-1

0

1

2

3

4

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

Output gap

Advanced Asia Latam World

(pp)

-3

-2

-1

0

1

2

3

4

5

-12

-10

-8

-6

-4

-2

0

2

4

6

8

10

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

Global IP Global growth rate (RHS)(% YoY)

Consumption demand showing a mixed picture

Consumption demand shows strong uptick in DMs… …but retail sales trends not robust yet



...as commodity prices surged in the second half of 2010Confidence indicators also paint a mixed picture DM consumption likely to improve while EM remains muted


7

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07

20

08

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09

20

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11

20

12

20

13

20

14

20

15, Q

3

EM DM

Retail sales(% YoY)

0.00

0.50

1.00

1.50

2.00

2.50

0

1

2

3

4

5

6

7

8

9

201

1

201

2

201

3

201

4

Q3

, 20

15

Emerging Market Developed Market (RHS)

(% YoY)Private consumption demand

• The world economy is also going through a low inflation

scenario, which in itself should be beneficial for

consumption demand.

• However, a sustained increase in consumption will also

have to be bolstered with an increase in income levels.

• In a world where fixed investment growth is increasingly

trending lower, the driver of global growth is likely to be

consumption.

• From an overall growth perspective global trade remains

at record lows and the space for Government spending

support is also limited.

90

95

100

105

110

Q1

2014

Q2

2014

Q3

2014

Q4

2014

Q1

2015

Q2

2015

Q3

2015

Q4

2015

Consumer confidence index

EM DM

Sharp disinflation/deflation conditions prevailing globally

Most of the world economy is witnessing either deflation or sharp disinflationary pressures barring a few outliers



Source: Bloomberg, IMF, ICICI Bank Research

Deflationary pressures on developed markets continue to intensify Dwindling commodity prices are weighing on inflation

Source: Bloomberg, CEIC, ICICI Bank Research

8

0

100

200

300

400

500

600

0

1

2

3

4

5

6

7

20

00

20

01

20

02

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04

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05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

Global Inflation Commodity Price Index (RHS)(% YoY)

0

10

20

30

40

50

60

70

80

90

200

0

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

201

0

201

1

201

2

201

3

201

4

201

5

Countries with inflation below 1%

Developed economies Emerging markets(% share of countries in group)

0

5

10

15

20

25

30

35

40

-2 0 2 4 6 8 10 12 14 16 18 20

Sh

are in

wo

rld

GD

P (%

)

Inflation rate (2015, % YoY)

US

CH

EZ

JN

UK

CA

AU MEX

IN

SA

IND TUR

BR

RUARG

Bulk of developed economies

are embroiled in a situation of

low inflation even as labour

market shows signs of

recovery

Disinflation is the theme

for emerging markets too

as global commodity

prices witness a slump

While some continue to face elevated

levels of inflation as domestic

idiosyncratic factors outweigh global ones

US

Commodity prices to keep inflation subdued for a while

Chinese growth deceleration will also have an adverse impact on global commodity prices


...as commodity prices surged in the second half of 2010Producer prices are also spiralling downward Commodity price trajectory is likely to keep inflation subdued

Source: UNCTAD, ICICI Bank Research

9

-6

-4

-2

0

2

4

6

8

Dec-1

0

Ju

n-1

1

Dec-1

1

Ju

n-1

2

Dec-1

2

Ju

n-1

3

Dec-1

3

Ju

n-1

4

Dec-1

4

Ju

n-1

5

Dec-1

5

Producer prices Index

EU US UK Japan(% YoY)

• Most of the developed economies are now facing very

low inflation levels and most levels are far below their

central bank targets.

• Emerging markets are also facing disinflationary situation

with the sharp fall in oil price leading to correction in fuel

indices.

• Some outliers still remain such as Argentina and Russia,

which are usually high inflation countries, wherein price

pressures are driven by country specific factors.

0.0 10.0 20.0 30.0 40.0 50.0

Primary

energy

Oil

Metals

Grains

Edible oils

1990-94 2010-14

China's share in global consumption of commodities

(%)

Key global themes and their consequences


10

Low commodity

prices

US lift off

Impact of crude

prices

Pressure on global capital flows, currencies and

corporate debt

Divergence in

global monetary

policy

Yuan devaluation

China slowdown

Key global themes


11

Analysing low oil prices

US Federal Reserve initiates policy normalisation

China slowdown to impact global growth

Global themes Consequences Impact


12

US Federal Reserve initiates policy normalisation


US embarks on policy normalization after 10 years

Overall GDP growth remains promising… …and labour market recovery continues




Source: US Federal Reserve documents, ICICI Bank Research

Inflation however remains lower than target Policy normalisation process to be gradual

Source: CEIC, ICICI Bank Research

13Global themes Consequences Impact

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

0

50

100

150

200

250

300

350

400

Feb

-12

Jun

-12

Oct-12

Feb

-13

Jun

-13

Oct-13

Feb

-14

Jun

-14

Oct-14

Feb

-15

Jun

-15

Oct-15

Feb

-16

Change in NFP Unemployment rate (RHS)

('000) (%)

-3

0

3

6

-3

0

3

6

Mar-14

Ju

n-1

4

Sep

-14

Dec-1

4

Mar-15

Ju

n-1

5

Sep

-15

Dec-1

5

Private consumption Investment

Net exports Government

GDP growth (RHS) (% QoQ,saar)(pp)

US GDP growth (contribution)

-1

0

1

2

3

4

Jan

-1

4

Mar-14

May-14

Ju

l-14

Sep

-14

No

v-1

4

Jan

-1

5

Mar-15

May-15

Ju

l-15

Sep

-15

No

v-1

5

Jan

-1

6

CPI-inflation PCE-based inflation

Fed's 2% inflation

target

% YoY

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

2016 2017 2018 Long term

FOMC median Fed Funds rate projection

December March(%)


14

China slowdown to impact global growth


China: The economy is moving to a new normal

China’s economic growth is slowing down… …as the focus shifts from investment toward domestic consumption


Source: CEIC , ICICI Bank Research

...as commodity prices surged in the second half of 2010Investment slowdown broad-based The structural slowdown likely to persist in 2016


15

-2

0

2

4

6

8

10

12

14

16

20

10

20

11

20

12

20

13

20

14

20

15

20

16

Consumption Investment

Net exports Real GDP(% YoY)

30

35

40

45

50

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

Private consumption GFCF

China GDP break-up

(% of GDP)

• Chinese economy transitioning from an investment led high

growth to a more sustainable growth fuelled by private

consumption

• Consumption has been playing a more important role in

driving growth in recent years.

• The slowdown in fixed asset investment clearly indicates

the rebalancing efforts of the establishment

• The structural slowdown is likely to continue going forward

and headline growth is likely to decelerate further


10

15

20

25

30

35

40

45

Fe

b-05

Fe

b-06

Fe

b-07

Fe

b-08

Fe

b-09

Fe

b-10

Fe

b-11

Fe

b-12

Fe

b-13

Fe

b-14

Fe

b-15

Fe

b-16

FAI (headline) Manufacturing Infrastructure

(% YoY YTD)

China urban fixed assets investment (FAI)

Services sector emerging as a “new” driver of growth

China’s services sector share lowest among major economies Sustained growth in services sector crucial to support growth…

Source:CEIC, ICICI Bank Research




..and support employment generation Greater share of investment is also going into tertiary sector


16

40.0%

42.0%

44.0%

46.0%

48.0%

50.0%

52.0%

54.0%

Mar-06

Dec-0

6

Sep

-07

Ju

n-0

8

Mar-09

Dec-0

9

Sep

-10

Ju

n-1

1

Mar-12

Dec-1

2

Sep

-13

Ju

n-1

4

Mar-15

Dec-1

5

China GDP composition

Secondary Tertiary

0

10

20

30

40

50

60

70

80

US Brazil Korea India China World

Service sector's share (2014)(% of GDP)

0

10

20

30

40

50

60

2000 2002 2004 2006 2008 2010 2012 2014

Employment by sectors

Agriculture Manufacturing Services

(% of total employment)

0

5000

10000

15000

20000

25000

30000

35000

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Fixed asset investment

Secondary Tertiary(RMB bn)


China’s private sector debt overhang could pose risks

Total debt in China has accelerated significantly Liquidity conditions have tightened on fall in aggregate financing …



...as commodity prices surged in the second half of 2010…with non-bank credit leading the declines Chinese financial sector poses a challenge


17

0

50

100

150

200

250

2007 2008 2009 2010 2011 2012 2013 2014 2015

Total debt as % of GDP

Corporate debt Household debt Government debt

• The rising trend in total debt poses challenge even as the

Chinese economy transitions to a slower growth path

• The country’s total social financing, a broad measure of

overall liquidity in the economy, is witnessing a slowdown

led by non bank credit (primarily trust loans)

• Even the bank loans segment has started to slow down in

recent months


0

6

12

18

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

Total bank credit Total social financing(RMB trn)

(annual flow)

10

12

14

16

18

20

22

24

26

Jan

-1

2

Ap

r-12

Ju

l-12

Oct-12

Jan

-1

3

Ap

r-13

Ju

l-13

Oct-13

Jan

-1

4

Ap

r-14

Ju

l-14

Oct-14

Jan

-1

5

Ap

r-15

Ju

l-15

Oct-15

Jan

-1

6

Total Social Financing(%YoY)


18

Analysing slowdown in oil prices


Sharp slowdown in commodity prices has been seen since 2014

Commodity prices have fallen to multiyear lows Crude oil prices have fallen ~ 70% since their peak in June 2014....



Saudi Arabia continues to keep output elevated to gain share ...as commodity prices surged in the second half of 2010


…and is unlikely to cut production in the near term


19Global themes Consequences Impact

20

30

40

50

60

70

80

90

100

110

120

Mar-14

Ju

n-1

4

Sep

-14

Dec-1

4

Mar-15

Ju

n-1

5

Sep

-15

Dec-1

5

Mar-16

Brent WTI(USD/bbl)

50

150

250

350

450

550

650

750

Mar-11

Ju

n-1

1

Sep

-11

Dec-1

1

Mar-12

Ju

n-1

2

Sep

-12

Dec-1

2

Mar-13

Ju

n-1

3

Sep

-13

Dec-1

3

Mar-14

Ju

n-1

4

Sep

-14

Dec-1

4

Mar-15

Ju

n-1

5

Sep

-15

Dec-1

5

Mar-16

S&P GSCI Commodity Index Energy

Agri commodities Industrial metals

0

2

4

6

8

10

12

65

70

75

80

85

90

95

Jan

-0

0

Jan

-0

1

Jan

-0

2

Jan

-0

3

Jan

-0

4

Jan

-0

5

Jan

-0

6

Jan

-0

7

Jan

-0

8

Jan

-0

9

Jan

-1

0

Jan

-1

1

Jan

-1

2

Jan

-1

3

Jan

-1

4

Jan

-1

5

Jan

-1

6

Total world Saudi Arabia (RHS)

USA (RHS) Russia (RHS)(mbpd)(mbpd)

Crude oil output

26

28

30

32

34

Fe

b-08

Aug

-08

Fe

b-09

Aug

-09

Fe

b-10

Aug

-10

Fe

b-11

Aug

-11

Fe

b-12

Aug

-12

Fe

b-13

Aug

-13

Fe

b-14

Aug

-14

Fe

b-15

Aug

-15

Fe

b-16

OPEC oil prodution quota Actual oil output(mbpd)

Increase in Iranian oil exports to weigh on oil prices

Iran-Saudi Arabia rivalry hampers OPEC unity Iran is set to increase exports by 0.5-1.0 mbpd…

Source: OPEC, ICICI Bank Research

Source: US Energy Information Administration (EIA), ICICI Bank Research

...as commodity prices surged in the second half of 2010…thereby weighing on oil market balance Crude prices are likely to remain muted in near term

Source:ICICI Bank Research

20

Syria:

Iran supports Bashar

Hafez al-Assad

(Ba’ath party) led

government.

Saudi Arabia

currently backs

Syrian opposition

(rebels).

Yemen:

Iran reportedly

supports Houthi

rebels.

Saudi Arabia

currently backs

President Abd

Rabbuh Mansur

Hadi.

0.0

0.5

1.0

1.5

2.0

2.5

2008 2009 2010 2011 2012 2013 2014 2015

Iranian oil exports

Impact of US-EU sanctions

(mbpd)

sanctions tightened

• Saudi Arabia (current top producer in OPEC) and Iran (the

second largest OPEC producer a couple of years back) are

major geopolitical rivals.

• Given the discord between the OPEC members and aim

to maintain market share, OPEC is expected to continue

producing above its 31.5 mbpd collective target.

• Post the removal of sanctions, Iran is slated to increase its

exports and add to supply pressures.

• However oil prices have seen volatility recently and there

are risks that key oil producers may negotiate some sort

of production changes going ahead in light of growing

stress in their domestic economies.


0.00

1.00

2.00

3.00

4.00

Excess supply Excess supply (with

increased Iran exports)

Global oil market: Excess supply (mbpd)

Lower crude prices to have adverse impact on oil exporters

Saudi Arabia and Iran continue to see low production break evens… …however fiscal and current account break evens have worsened





Saudi Arabia and Iraq have posted double digit fiscal deficits Current account balances are also steadily shrinking


21

-30

-20

-10

0

10

20

30

Saudi Arabia UAE Kuwait Qatar Iraq

Fiscal Balance (% of GDP)

2014 2015 2016F

-15

-10

-5

0

5

10

15

20

25

30

35

Saudi Arabia UAE Kuwait Qatar Iraq

Current Account Balance (% of GDP)

2014 2015 2016F


0 20 40 60 80 100 120

Kuwait

Qatar

UAE

Saudi Arabia

Oman

Iraq

Algeria

Bahrain

Iran

Breakeven prices (2016F)

External Breakeven Fiscal Breakeven

(USD/bbl)

Current Brent oil price

0 20 40 60 80

Kuwait

Saudi Arabia

Iraq

Iran

Norway

Qatar

Russia

Venezuela

Britain

US

Canada

Nigeria

Production break-even (2015)

(USD/bbl)

Current Brent oil price

Meanwhile, importers have received limited benefits

Most countries have witnessed an increase in consumption Trends in consumption can be attributed to declining inflation..

Source: CEIC, Bloomberg, ICICI Bank Research

Source: CEIC, Bloomberg , ICICI Bank Research

.. and stable policy rates ...as commodity prices surged in the second half of 2010Oil plunge: where is the oil surplus going?


22

• Oil prices have plummeted over 60% since September

2014

• Net oil importers have gained at the expense of net oil

exporters on account of this crude price slump

• The net benefits can be observed by gauging the trends in

consumption and investment for various countries

• Considering a sample of major EM Asian economies we

find some fillip in consumption and investment demand

between Q3 2014-Q3 2015, however the experience has

been varied

0.00

2.00

4.00

6.00

8.00

10.00

12.00

PH

SG

IN ID

HK

MY

KR

TH

TW

Consumption

Q3 2014 Q3 2015

(% YoY)

-2.00

0.00

2.00

4.00

6.00

8.00

10.00

ID IN

MY

HK

KR

PH

TW

SG

TH

Inflation

Q3 2014 Q3 2015

(% YoY)

0

1

2

3

4

5

6

7

8

9

ID

IN

PH

MY

TW

TH

KR

HK

SG

Policy Rates

Q3 2014 Q3 2015(% YoY)

Tempered gains in consumption and investment

But falling nominal GDP growth arrested further rise in consumption Consumption patterns are mixed but investment uptick is widespread




Falling PPI across the board can explain improved investment levels Increased levels of investment also seen in majority of the countries

Source: Bloomberg, CEIC, ICICI Bank Research

23

• Theoretically, net oil exporters (like Malaysia) should have

witnessed a fall in both consumption and investment

• On the other hand, net oil importers (like India and

Singapore) should see a rise in consumption and

investment.

• While most countries seem to follow the above trend, a few

outliers exist, most noticeably India and Taiwan, which saw

a major decline in consumption.

• These patterns persist, perhaps, because oil prices of most

of EM Asia economies are administered by their

governments which prevents a full pass through to retail

consumers.

0.00

2.00

4.00

6.00

8.00

10.00

12.00

PH

SG

IN ID

HK

MY

KR

TH

TW

Nominal GDP Growth

Q3 2014 Q3 2015(% YoY)

-10.00

-5.00

0.00

5.00

10.00

15.00

PH

KR

IN

MY

ID

TW

SG

TH

HK

Investment

Q3 2014 Q3 2015

(% YoY)

-20.00

-15.00

-10.00

-5.00

0.00

5.00

10.00

15.00

IN

HK

TW ID

TH

SG

PH

MY

KR

WPI

Q3 2014 Q3 2015

(% YoY)

Oil prices to pick up towards end 2016

US crude oil production to continue to fall as energy companies

reduce their capex plans

US oil rig count has been declining, thereby likely to weigh on future

output


Source: US EIA, ICICI Bank Research

...as commodity prices surged in the second half of 2010Oil prices are expected to gradually rise as oil surplus shrinks Brent oil prices to trade in the range of USD 40-45/bbl by end 2016


24

• We expect supply pressures to dominate in the near term

in light of OPEC’s stance (i.e. lack of willingness to cut oil

output), OPEC’s disunity (due to geopolitical tensions) and

increase in exports from Iran.

• However, a gradual shrinking in oil market surplus with an

expected fall in output from US and Canada; as well as

gradual rising demand (from US , China, etc) providing

support.

• We expect Brent prices to remain subdued in the near

term and pick up towards end 2016. Consequently, we

expect Brent to trade in the range of USD 40-45/bbl by

end 2016


8.7

8.8

8.9

9.0

9.1

9.2

9.3

9.4

9.5

9.6

9.7

Jan

-1

5

Fe

b-15

Mar-15

Ap

r-15

May-15

Ju

n-1

5

Ju

l-15

Aug

-15

Sep

-15

Oct-15

No

v-1

5

Dec-1

5

Jan

-1

6

US crude oil production(mbpd)

0

500

1000

1500

2000

2500

Sep

-11

Dec-1

1

Mar-12

Ju

n-1

2

Sep

-12

Dec-1

2

Mar-13

Ju

n-1

3

Sep

-13

Dec-1

3

Mar-14

Ju

n-1

4

Sep

-14

Dec-1

4

Mar-15

Ju

n-1

5

Sep

-15

Dec-1

5

Mar-16

Oil rigs Gas rigs Misc

US oil & gas rig count

US oil rig count

US gas rig count

Geopolitical dynamics to pose risks

Geopolitical concerns in the Middle East remains critical… …given the vast reserves it controls


Source: ICICI Bank Research

...as commodity prices surged in the second half of 2010Geopolitical tensions: A black swan event

25

North

America

Latin

America

Western

Europe

Eastern Europe and Eurasia

Africa Asia and Pacific

53.8%

22.9%

8.5% 8%

3.2%2.7%

0.8%

Geographical distribution of world oil reserves (proven)

Middle

East

• Geopolitical events have taken a back seat in the recent

months given their muted impact on oil prices of late.

• This is largely due to the fact that reports of possible talks

between key oil players has taken precedence over

geopolitics.

• However, going ahead geopolitical events may contribute

to volatility in oil prices.


Key consequences


26

Slowdown in global capital flows and impact on petrodollars

Divergence in global monetary policy

Yuan devaluation and its impact on currencies

Impact on global trade flows and consequent currency wars


Global monetary policy remains mostly accommodative



...as commodity prices surged in the second half of 2010Accommodative stance to stay; US to temper its rationalisation

27

Divergence in policy rates within DM Central Banks

• The Federal Reserve has embarked on policy normalization

but the pace of hikes is likely to be very gradual.

• Meanwhile most other Central Banks across DMs and EMs

have an accommodative stance and DM majors have also

adopted negative interest rates.

• Some outliers such as Brazil and other Latin American

countries remain where inflation is a concern.

• Broadly over the course of the year to counteract a tepid

growth expectation we believe this accommodative

monetary policy stance will continue.


Jan-15 (latest)

Poland 2.0 1.5

Russia 17.0 11.0

Turkey 8.25 7.5

Hungary 2.1 1.35

Brazil 11.75 14.25

Chile 3.0 3.5

Peru 3.5 4.25

India 8.0 6.75

China 5.6 4.35

Indonesia 7.75 6.75

Malaysia 3.25 3.25 --

Philippines 4.0 4.0 --

South Korea 2.0 1.5

Thailand 2.0 1.5

US 0.25 0.5

Canada 1.0 0.5

Australia 2.5 2.0

Japan 0.01 -0.01

ECB -0.2 -0.4

Asia

Developed

Country

Policy rate Direction of

change

EEMEA

Latam

-0.5

0.0

0.5

1.0

1.5

2.0

Mar-09

Sep

-09

Mar-10

Sep

-10

Mar-11

Sep

-11

Mar-12

Sep

-12

Mar-13

Sep

-13

Mar-14

Sep

-14

Mar-15

Sep

-15

Mar-16

Fed funds rate ECB main refinancing rate

ECB deposit rate(%)


28

Yuan trajectory to impact global currencies


China has stepped up fx intervention to stabilise the Yuan

China caught between the impossible trinity conundrum Steep interventions have been undertaken to stabilise the Yuan





Reserve adequacy ratio has fallen sharply and hovers close to the

prescribed 100-150% limit for EMs

29

110

120

130

140

150

160

170

180

190

200

2011 2012 2013 2014 2015

Reserve adequacy ratio

The policy trilemma illustrated by the Mundell Fleming

model states that an open economy can have at most two of

the following- free capital movement, a stable exchange rate

and an independent monetary policy- at the same time.

1. Stable exchange rate and free capital outflows (No

independent monetary policy as setting an interest

rate would undermine the stable currency by exerting

a depreciation/ appreciation pressure).

2. Independent monetary policy and free capital

outflows (No stable exchange rate possible as (say)

addressing a devaluation pressure will require curbing

capital flows).

3. Stable exchange rate and independent monetary

policy (Capital controls are required under this

regime).


6.0

6.4

6.8

7.2

7.6

8.0-120

-100

-80

-60

-40

-20

0

20

40

60

80

100

Fe

b-07

Fe

b-08

Fe

b-09

Fe

b-10

Fe

b-11

Fe

b-12

Fe

b-13

Fe

b-14

Fe

b-15

Fe

b-16

China

Change in fx reserves USDCNY(RHS)

(USD bn)

China likely to see more depreciation in Yuan

Policymakers allowed gradual depreciation in Yuan…. …to correct for the overvaluation in Yuan


...as commodity prices surged in the second half of 2010Persistent capital outflows are likely to weigh… …thereby paving the way for further gradual depreciation


30

40

60

80

100

120

140

Dec-9

4

Dec-9

5

Dec-9

6

Dec-9

7

Dec-9

8

Dec-9

9

Dec-0

0

Dec-0

1

Dec-0

2

Dec-0

3

Dec-0

4

Dec-0

5

Dec-0

6

Dec-0

7

Dec-0

8

Dec-0

9

Dec-1

0

Dec-1

1

Dec-1

2

Dec-1

3

Dec-1

4

Dec-1

5

REER Long term average(Index; 2010=100)

-40

-20

0

20

40

60

80

-160

-80

0

80

160

No

v-10

May

-11

No

v-11

May

-12

No

v-12

May

-13

No

v-13

May

-14

No

v-14

May

-15

No

v-15

Residual (hot money) Change in FX reserves

FDI + trade surplus (RHS)

(USD bn) (USD bn)

2

4

6

8

10

19

85

19

87

19

89

19

91

19

93

19

95

19

97

19

99

20

01

20

03

20

05

20

07

20

09

20

11

20

13

20

15

USD/CNY

Phase 1:

(1980s and

early 1990s)

CNY

devaluation

Phase 2: (1990s to 2005)

CNY maintained weak

Phase 3: (post-

2005) CNY

appreciation

• Against the backdrop of capital outflows, maintaining a

fixed exchange rate led to restrictions on monetary easing

by the Central Bank to boost growth. (Impossible Trinity)

• This is because rate cuts aggravated capital outflows,

thereby forcing the PBoC to sell Dollars in order to maintain

a stable Yuan.

• However, the liquidity impact of FX intervention caused

upward pressure on rates, thereby limiting the impact of

monetary policy easing.

• Consequently, continued pressure on the currency (from

capital outflows) and steep drawdowns in FX reserves are

likely to pave the way for further depreciation in the Yuan.




31

Global capital flows to face pressure


Global capital flows to remain under pressure


32 Global themes Consequences Impact

Monetary policy

divergence

Capital outflows from EMs

and pressure on currencies

Chinese

slowdown

Low commodity

prices

Rising rate differentials

will impact currencies

Shrinking petrodollars

and SWF withdrawals

Slowdown in

capital flows

Traditional bastions of capital providers are under stress

China continues to bleed reserves in a bid to defend currency… …as do major oil exporters such as Saudi Arabia





Accretion to EM reserves has become negative after two decades Capital outflows continue unabated from EM economies


33

-400

-200

0

200

400

600

800

1000

1200

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

EM economies' annual accretion to fx reserves(USD bn)

-30

-20

-10

0

10

20

30

40

50

Ju

n 0

5

Dec 0

5

Ju

n 0

6

Dec 0

6

Ju

n 0

7

Dec 0

7

Ju

n 0

8

Dec 0

8

Ju

n 0

9

Dec 0

9

Ju

n 1

0

Dec 1

0

Ju

n 1

1

Dec 1

1

Ju

n 1

2

Dec 1

2

Ju

n 1

3

Dec 1

3

Ju

n 1

4

Dec 1

4

Ju

n 1

5

Dec 1

5

EM Portfolio flows(USD bn, 6mma)


-150

-100

-50

0

50

100

150

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16 (E

')

Saudi FX Reserve accretion(USD bn)

1000

1500

2000

2500

3000

3500

4000

Fe

b-07

Fe

b-08

Fe

b-09

Fe

b-10

Fe

b-11

Fe

b-12

Fe

b-13

Fe

b-14

Fe

b-15

Fe

b-16

FX reserves(USD bn)

SWF withdrawals would impact capital flows as well

SWFs have significant amount of funds under management… …most of which is funded by oil revenues

Source: FT, ICICI Bank Research

Source: Moody’s, ICICI Bank Research



Returns on investments have started to shrink recently

34

73.3

20.55.8

0.4

SWF funding sources

Oil & gas related Trade surplus

Government linked and others Other commodities

SWF (USD bn) end 2014

Total Assets under

management 4,500

of which

Norway 865

Saudi Arabia 762

China 653

UAE 589

Kuwait 548


-10

-5

0

5

10

Q3 2014 Q4 2014 Q1 2015 Q2 2015 Q3 2015

Equity Fixed Income Real-estate Fund

Return on Norway's SWF*

*in international currency terms

(%)

Significant policy shifts for commodity exporters


35

FX reserves:

Saudi alone has seen depletion of ~USD 100 bn to

defend its peg

Growing possibility of Saudi sale of parts of Aramco

Policy rates:

Saudi Arab, Kuwait and Bahrain have raised rates

despite adverse economic conditions

Currency:

Kazakhstan/ Azerbaijan have abandoned their

currency pegs

Venezuela and Ecuador are facing challenges

and the former has devalued its currency



36

Global trade flows and currency wars


Global trade conundrum: Depreciating currencies and muted exports

Global trade volumes have been subdued since last quarter of 2012 Meanwhile, most currencies have depreciated against USD


...as commodity prices surged in the second half of 2010Export values have been plummeting across the board Global trade slowdown: Depreciating currencies and muted exports


37

• Global trade volumes have witnessed a considerable

decline since 2012

• WTO has revised down its merchandise trade growth

forecast to 2.8% in 2015 from its prior estimate of 3.3%.

• Economic recovery in the US has led to large

depreciation in most currencies

• While traditionally, these exchange rate depreciations

would have led to increased trade volumes, this time

around the link between exchange rates and exports is

not as clear

*For the period Q4 2014-Q3 2015


-25.0

-20.0

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

25.0

Dec-9

6

Dec-9

7

Dec-9

8

Dec-9

9

Dec-0

0

Dec-0

1

Dec-0

2

Dec-0

3

Dec-0

4

Dec-0

5

Dec-0

6

Dec-0

7

Dec-0

8

Dec-0

9

Dec-1

0

Dec-1

1

Dec-1

2

Dec-1

3

Dec-1

4

Dec-1

5

World Trade Volume(%YoY)

Asian financial

turmoilUS tech-bubble

burst

Lehman collapse

IN

BR

CH

MEX

RU

SA

TUR

UK

EZ

JN

CAAU

0

5

10

15

20

25

30

35

40

45

-35 -30 -25 -20 -15 -10 -5 0

No

min

al exch

an

ge rate d

ep

recia

tio

n (%

)

Change in export value (%)

Impact of exchange rate depreciation on export value

-10

-5

0

5

10

15

20

25

JP

Y

EU

R

ID

R

HK

D

SG

D

AU

D

CH

F

GB

P

TW

D

PH

P

CN

Y

CA

D

IN

R

KR

W

TH

B

MY

R

TR

Y

BR

L

RU

B

Currrency return (FYTD)(%)

Source: BIS, UNCTAD, Bloomberg, ICICI Bank Research

Incremental gains from currency wars seem limited

Experience with export volumes has not been so uniform Movements in REER can explain some of these differences

Source: CEIC, BIS, ICICI Bank Research


Source: UNCTAD, ICICI Bank Research

Plummeting import demand by major importers Global trade slowdown: Impact of weakening import demand

Source: UNCTAD, CEIC, BIS, ICICI Bank Research

38

IN

BZ

CN

MX

RU

SA

TUR

UK

EZJN

CA AU

-20

-15

-10

-5

0

5

10

-15 -10 -5 0 5 10 15 20 25

Ch

an

ge in

RE

ER

(%

)

Change in export volume (%)

Impact of change in REER on export volumes*

IN

BZ

CN

MX

RU

SA

TUR

UK

EZ

JN

CA

AU

0

5

10

15

20

25

30

35

40

45

-15 -10 -5 0 5 10 15 20 25

No

min

al exch

an

ge rate d

ep

recia

tio

n (%

)

Change in export volume (%)

Impact of exchange rate depreciation on export volumes*

• Instead of gaining from large exchange rate depreciations

countries have seen declines in trade values

• The experience with underlying export volumes is less

uniform but the quantum of volume spurts for most

countries remain too modest to compensate for value

declines (Brazil being the only nation where volume

growth has outstripped value decline)

• Exports in nominal terms have taken a major hit from the

on-going slump in commodity prices and weakness in

currencies vs. the USD. Broadly there does not seem to

be significant real gains from competitive devaluation

• Plunging import demand from major economies, on the

other hand, has put a drag on export volumes.

*For the period Q4 2014-Q3 2015 *For the period Q4 2014-Q3 2015

*For the period Q4 2014-Q3 2015


-30

-25

-20

-15

-10

-5

0

5

10

RU BR TUR EZ CH CA UK SA JN IN US AU MEX

Change in import volumes*(%)

Trans Pacific Partnership: A structural change in trade flows


39

Trans-Pacific Partnership agreement (TPP) was recently signed in Auckland.

It is a major trade deal encompassing 12 nations whose current share in global trade

stands at 40%.

Countries included are:

US, Japan, Malaysia, Vietnam, Singapore, Brunei, Australia, New Zealand, Canada,

Mexico, Chile and Peru.

Amid an environment of dwindling global trade volumes, the TPP strives to foster

trade between the participating nations by

• Bringing down barriers to trade and investment

• Streamlining the ground rules on intellectual property rights

• Other trade related issues

However, civilians in the US fear loss of jobs, others criticize the TPP for giving

major corporations the right to sue sovereigns for their vested interests in the event

the terms of the deal are not met with.

Bottom Line

This very ambitious deal is thus likely to see a rocky path ahead but long term

implications of the deal would be extremely significant


Impact on key asset classes


40

DM fixed income will continue to find favour

US policy stance will lead to Dollar strength

Currencies and Dollar debt would be under pressure

Negative interest rate regime will impact currencies as well

Yuan devaluation and slowdown in oil prices will impact assets

Global risk aversion to remain high and cause asset volatility

Shift from EMs to DMs to continue



41

Global risk aversion and portfolio shifts


Risk aversion tendencies have increased sharply globally

Our risk appetite index shows significant risk aversion in the system and significant changes in global portfolio allocation patterns

...as commodity prices surged in the second half of 2010Allocation has been shifting from EM to DM in bond markets… …as well as in equity markets


42

-0.4

-0.35

-0.3

-0.25

-0.2

-0.15

-0.1

Ja

n-15

Feb

-1

5

Mar-15

Ap

r-1

5

May

-15

Ju

n-1

5

Ju

l-1

5

Ju

l-1

5

Au

g-15

Sep

-15

Oct-1

5

No

v-15

Dec-1

5

Ja

n-16

Global Risk Appetite Index

Greece related

uncertainty

China

related

uncertainty

Generic global

uncertainty

mainly on

crude

80

80.5

81

81.5

82

82.5

83

18

18.2

18.4

18.6

18.8

19

19.2

19.4

19.6

19.8

20

No

v-11

Feb

-1

2

May

-12

Au

g-12

No

v-12

Feb

-1

3

May

-13

Au

g-13

No

v-13

Feb

-1

4

May

-14

Au

g-14

No

v-14

Feb

-1

5

May

-15

Au

g-15

No

v-15

Developed markets (RHS) Emerging markets(%) (%)

Portfolio allocation to equity markets



87

87.5

88

88.5

89

89.5

10.5

11

11.5

12

12.5

13

No

v-1

0

Mar-11

Ju

l-11

No

v-1

1

Mar-12

Ju

l-12

No

v-1

2

Mar-13

Ju

l-13

No

v-1

3

Mar-14

Ju

l-14

No

v-1

4

Mar-15

Ju

l-15

No

v-1

5

Developed markets (RHS) Emerging markets(%) (%)

Portfolio allocation to bond markets

13.0

14.0

15.0

16.0

17.0

18.0

81.0

82.0

83.0

84.0

85.0

86.0

2008 2009 2010 2011 2012 2013 2014 2015

Portfolio allocation

Developed markets Emerging markets (rhs)

(% to total

equity/debt)




43

Dollar strength and impact of policy divergence


44

Monetary policy

divergence

Capital outflows from EMs and

pressure on Dollar debt

Dollar strength

Depreciation bias for most currencies

and worsening of credit spreads

Rising rate differentials

will impact currencies

Impact of Dollar strength and policy divergence

Dollar to continue to strengthen on policy stance

Dollar index has almost always strengthened during hiking cycles Most currencies have depreciated against the Dollar over last year

...as commodity prices surged in the second half of 2010Stronger Dollar will impact major risk assets negatively Dollar to impinge on currencies, capital flows and Dollar debt

45

0

2

4

6

8

10

12

60

70

80

90

100

110

120

130

19

85

19

87

19

89

19

91

19

93

19

95

19

97

19

99

20

01

20

03

20

05

20

07

20

09

20

11

20

13

20

15

DXY index Fed funds rate (RHS)

(%)

• Three key themes will impact currencies throughout the

world this year viz. China, oil and US tightening.

• On a broader basis, most currencies are likely to depreciate

in nominal terms against the Dollar as the US monetary

policy diverges from the rest of the world.

• Strength in Dollar will also impact Dollar denominated

corporate debt especially in emerging markets.

• The adoption of negative interest rates recently by major

Banks such as BoJ and ECB will also play a role.

• However global risk aversion will remain high and safe

haven assets will continue to find support

Source: Bloomberg, ICICI Bank Research Source: Bloomberg, ICICI Bank Research


-1.2

-1.0

-0.8

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

MS

CI E

M

CN

Y

SP

X

LM

EX

In

dex

Nik

ke

i

Yen

Eu

r

Bre

nt

US

AA

A c

orp

US

hig

h y

ield

Eu

ro

sto

xx

EM

FX

2003-2015 2016YTD

Correlation with Dollar index


-10

-5

0

5

10

15

20

25

JP

Y

EU

R

ID

R

HK

D

SG

D

AU

D

CH

F

GB

P

TW

D

PH

P

CN

Y

CA

D

IN

R

KR

W

TH

B

MY

R

TR

Y

BR

L

RU

B

Currrency return (FYTD)(%)

Corporate debt to face pressures in 2016

Corporate Dollar issuances have started falling as Dollar strengthens Ratio of upgrade/downgrade has worsened in the EM region

Source: FT, Rencap, ICICI Bank Research


...as commodity prices surged in the second half of 2010Dollar debt has risen to unsustainable levels in some EM economies Credit conditions have deteriorated across EM economies

Source: IMF, Bloomberg, ICICI Bank Research

46

0

50

100

150

200

250

300

350

400

20

11

20

12

20

13

20

14

20

15 E

EM corporate hard currency issuance

Latam EEMEA Asia

0

5

10

15

20

2008 2009 2010 2011 2012 2013 2014 2015 2016F

EM credit rating changes

upgrades downgrades

A rating scale from 15 (for AAA rating) to 6 (for a Baa3 or BBB-); 5 for the highest non-

investment grade (Ba1 or BB+), 0 for lowest rating at which a country is able to manage

debt (B3 or B-), -1 for Caa1 or CCC+ and -7 for actual default is used. For each country,

the scores from all rating agencies is averaged.

• According to Standard and Poor’s 2015 would have

finished with the highest number of worldwide defaults

since 2009.

• Against the backdrop of Federal Reserve policy

tightening, EM corporates will continue to face stress and

accordingly the quantum of hard currency issuances have

also been reducing over the past year.

• According to industry estimates the number of

downgrades vs. upgrades for most EM regions is likely to

increase sharply in 2016.


0

2

4

6

8

10

12

14

16

18

20

Arg

en

tin

a

Cze

ch

Po

lan

d

Isra

el

Me

xic

o

Ch

ina

Sau

di A

rab

ia

Ind

on

esia

So

uth

Afric

a

Ind

ia

Th

ailan

d

Bra

zil

Tu

rkey

Ru

ssia

Hu

ng

ary

Mala

ysia

Ko

re

a

Dollar denominated debt (end - 2015)(% of GDP)

Corporate debt to face pressures in 2016 (contd.)

Corporate debt issuances remain elevated AAA rated corporates are dwindling in the US

Source: FT, ICICI Bank ResearchSource: Bloomberg, ICICI Bank Research

...as commodity prices surged in the second half of 2010Lending standards have tightened across DMs as well Estimates suggest that downgrades are likely to accelerate this year

47

40

43

46

49

52

55

58

Q3

-20

10

Q3

-20

11

Q3

-20

12

Q3

-20

13

Q3

-20

14

Q3

-20

15

US Eurozone Japan

Lending Survey

0

20

40

60

80

100

120

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

Number of US companies rates 'AAA' by Standard & Poor's

Currently there are only

three AAA US companies

• Corporates in the US are also facing pressure as

estimates suggest that over USD 1 tn worth of corporate

debt has been downgraded over the course of 2015.

• As per the S&P only 3 companies have a AAA rating in

the US and credit as an asset class is likely to come under

pressure across most regions globally over the course of

the year.

• Most ratings agencies have forecasted that downgrades

are likely to go up especially in the commodity segment.

• Bank lending conditions are tightening across regions.

0.0

20.0

40.0

60.0

80.0

100.0

120.0

US Eurozone Japan UK

Corporate debt outstanding

2013 2014 2015(% of GDP)



Indebtedness to remain source of vulnerability for EMs

Fiscal deficits rising across regions although public debt not a worry High levels of Dollar debt is a concern for EM-ex-Asia economies

Source: IIF, ICICI Bank Research

Source: IIF , ICICI Bank Research



Private credit has risen across EM economies Credit standards are tightening across the board

Change over 2009 to 2015


48

0

20

40

60

80

100

120

20

10

20

11

20

12

20

13

20

14

20

15 E

EM sovereign hard currency issuance

Latam EEMEA Asia

38

42

46

50

54

58

Q1

2011

Q2

2011

Q3

2011

Q4

2011

Q1

2012

Q2

2012

Q3

2012

Q4

2012

Q1

2013

Q2

2013

Q3

2013

Q4

2013

Q1

2014

Q2

2014

Q3

2014

Q4

2014

Q1

2015

Q2

2015

Q3

2015

EM bank lending standards

Emerging markets Latam Emerging Europe Asia

Easing standards

Tightening standards


0

20

40

60

80

100

120

140

160

200

9

201

0

201

1

201

2

201

3

201

4

201

5E

201

6F

Private credit % of GDP

Latam EEMEA Emerging Asia Aggregate emerging

(%)

-4

-2

0

2

4

6

8

10

12

Latam EEMEA Asia Aggregate

Change in public debt Change in fiscal deficit(% of GDP)

Credit as an asset class to face pressures this year as well

The US HY corporate spreads have witnessed recent increases …as the energy companies bear the brunt of falling oil prices

Spreads across the Atlantic have risen sharply as well Credit spreads to remain volatile over the course of 2016

49

• According to market estimates trading volume in European

CDS markets were at a 3 year high recently and spreads all

across the board have been tightening for HY and IG alike.

• The fall in oil along with the rising threat of growing

downgrades and defaults all across the developed and

emerging world are also aggravating credit spreads.




40

50

60

70

80

90

100

200

250

300

350

400

450

500

Fe

b-15

Mar-15

Ap

r-15

May-15

Ju

n-1

5

Ju

l-15

Aug

-15

Sep

-15

Oct-15

No

v-1

5

Dec-1

5

Jan

-1

6

Fe

b-16

CDS for Corporate sector (EUR)

High Yield Investment grade (RHS)

0

20

40

60

80

100

120

140

80

90

100

110

120

130

140

150

160

Fe

b-10

Ju

n-1

0

Oct-10

Fe

b-11

Ju

n-1

1

Oct-11

Fe

b-12

Ju

n-1

2

Oct-12

Fe

b-13

Ju

n-1

3

Oct-13

Fe

b-14

Ju

n-1

4

Oct-14

Fe

b-15

Ju

n-1

5

Oct-15

Fe

b-16

USD HY Energy bond index Brent Crude (RHS)

(USD/bbl)

200

300

400

500

600

700

800

Mar-10

Ju

l-1

0

No

v-10

Mar-11

Ju

l-1

1

No

v-11

Mar-12

Ju

l-1

2

No

v-12

Mar-13

Ju

l-1

3

No

v-13

Mar-14

Ju

l-1

4

No

v-14

Mar-15

Ju

l-1

5

No

v-15

Mar-16

US HY CDS Index


50

Yuan devaluation and falling oil prices to impact assets


Asset classes have been affected by China and oil as well

Changes in Yuan policy to impact EM fx significantly Correlation of assets with China has spiked recently

...as commodity prices surged in the second half of 2010Falling crude prices will affect portfolio flows and in turn currencies Oil prices are now impacting assets more sharply than before

51

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

KR

W

AU

D

ID

R

SG

D

PH

P

TH

B

IN

R

TW

D

TR

Y

CA

D

MY

R

BR

L

RU

B

Sensitivity to Yuan movement(%)



-1.0

-0.8

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

MS

CI E

M

CN

Y

SP

X

LM

EX

In

dex

Nik

kei

Do

llar

Yen

Eu

r

Bre

nt

US

AA

A c

orp

US

hig

h y

ield

Eu

ro

sto

xx

EM

FX

2003-2015 2016YTD

Correlation with Chinese A shares

-0.8

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

MS

CI E

M

CN

Y

SP

X

LM

EX

In

dex

Nik

ke

i

Do

llar

Yen

Eu

r

US

A

AA

co

rp

US

h

igh

yie

ld

Eu

ro

sto

xx

EM

FX

Sh

an

gh

ai c

om

p

2003-2015 2016YTD

Correlation with Brent



-20

0

20

40

60

80

100

120

140

60

65

70

75

80

85

90

95

100

105

110

Aug

-10

Fe

b-11

Aug

-11

Fe

b-12

Aug

-12

Fe

b-13

Aug

-13

Fe

b-14

Aug

-14

Fe

b-15

Aug

-15

Fe

b-16

JP EM FX index EM portfolio flows (RHS) Brent prices

(USD bn) (Index, USD/bbl)


52

DM fixed income to continue to find favour


Fixed income in DMs continue to fare well on risk aversion

DM sovereign bonds have seen sharp declines in bond yields Nearly 80% of global fixed income yields are 3% or lower

...as commodity prices surged in the second half of 2010Yields have hardly moved over the year except in high stress

countries such as Brazil

Over the course of 2016, DM bond yields are likely to stay low and

outflows from EM bonds would be expected

53

0

5

10

15

20

25

30

35

40

>=5% 3-5% 1-3% 0-1% -1-0% <-1%

Proportion of bonds outstanding by yield brackets(%)

• Bond yields in developed markets have declined

significantly and recently the JGB 10Y yield has turned

negative for the first time for G7.

• Going ahead, ultra accommodative monetary policy in

major CBs except US and an increase in global volatility will

keep DM bonds supported.

• Pricing for incremental Fed rate hikes have been scaled

down and US Treasury yields are unlikely to increase

sharply.

• On the other hand, there are likely to be capital outflows

from EMs, which will adversely impact EM yields.




2Y 5Y 10Y

Switzerland -1.02 -0.82 -0.34

Denmark -0.37 -0.04 0.48

Sweden -0.65 -0.12 0.54

Germany -0.48 -0.30 0.21

Finland -0.40 -0.17 0.51

Netherlands -0.48 -0.32 0.31

Austria -0.43 -0.28 0.42

France -0.43 -0.17 0.55

Belgium -0.43 -0.24 0.59

Japan -0.24 -0.23 -0.10

UK 0.47 0.87 1.45

US 0.86 1.37 1.90

Snapshot: sovereign bond yields (%)

-300

-250

-200

-150

-100

-50

0

50

100

150

Gree

ce

Jap

an

Ind

ia

UK

Italy

US

1

0 Y

r

Ire

lan

d

Germ

an

y

Fran

ce

Sp

ain

Ind

on

esia

US

3

M

US

2

Yr

Bra

zil

Po

rtu

gal

Movement in bond yield (March-2016 over March 2017)(bps)

US 5YR IRS are an attractive buy at current levels

5YR IRS have fallen steeply while the 3M month LIBOR has edged up Cost of hedging is below historical average





Gap between the average Fed funds rate over the next five year and

5YR IRSs caps the downside risk to IRS

3M LIBOR, following the Fed Funds rate trajectory, is expected to

reach ~3.89% levels by 2019

54



1.0

1.2

1.4

1.6

1.8

2.0

2.2

0.21

0.26

0.31

0.36

0.41

0.46

0.51

0.56

0.61

0.66

Jan

-15

Feb

-15

Mar-15

Ap

r-15

May-15

Jun

-15

Jul-1

5

Aug

-15

Sep

-15

Oct-15

No

v-15

Dec-15

Jan

-16

Feb

-16

Mar-16

3-m USD Libor 5-yr IRS (RHS)(%)

(%)

-4

-3

-2

-1

0

1

2

Mar-01

Mar-02

Mar-03

Mar-04

Mar-05

Mar-06

Mar-07

Mar-08

Mar-09

Mar-10

Mar-11

Mar-12

Mar-13

Mar-14

Mar-15

Mar-16

Spread(3M Libor-5Yr IRS) Average(%)

Calender

year

Projected

3M Libor

(basis

points)

2016 1.14

2017 2.14

2018 3.14

2019 3.39

Overall Libor

increase 3.89

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Ap

r-15

Ju

l-15

Oct-15

Jan

-1

6

Ap

r-16

Ju

l-16

Oct-16

Jan

-1

7

Ap

r-17

Ju

l-17

Oct-17

Jan

-1

8

Ap

r-18

Ju

l-18

Oct-18

Jan

-1

9

Ap

r-19

Ju

l-19

Oct-19

Jan

-2

0

Ap

r-20

Fed funds rate Average

Asset market summary

55 Global themes Consequences Impact

Key themes for asset markets:

• Dollar strength

• Volatile risk sentiment

• Yuan depreciation

• Negative policy rates

• Changes in capital flows

Currencies

• EM currencies will be vulnerable

• Safe haven currencies to get support

Fixed income

• DM fixed income markets to find favour

relative to EM bonds

Equities

• To remain volatile

• To be driven by global growth, risk

sentiment and flows

56

Treasury Research Group

Economics Research

Sunandan

Chaudhuri

Senior

Economist

(+91-22) 2653-

1414 (ext 7525) [email protected]

Kamalika Das Economist

(+91-22) 2653-


Samir Tripathi Economist

(+91-22) 2653-


Niharika Tripathi Economist

(+91-22) 2653-


Sagrika Gogia Economist

(+91-22) 2653-


Sonal Surana Economist

(+91-22) 2653-


Radhika Wadhwa Economist

(+91-22) 2653-


57

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