ECONOMIC RESEARCH DEPARTMENT - Cash management€¦ · economic-research.bnpparibas.com Brazil 2nd quarter 2016 3 Brazil Jeitinho Brasileiro – the Brazilian way Jeitinho Brasileiro

economic-research.bnpparibas.com Eco Emerging 2nd quarter 2016

Editorial

Lull

Rebounding oil prices, strengthening fx rates and decreasing risk premia: financial markets’ mistrust towards emerging economies has receded over the recent weeks. Yet news from the Chinese economy has not really improved and political, social and security risks are up...

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BRAZIL

Jeitinho Brasileiro – the Brazilian way

RUSSIA

Growing risks

INDIA

Consolidation of macroeconomic fundamentals

CHINA

Fiscal policy in the spotlight

TURKEY

Still standing

CYPRUS

The worst is over

BULGARIA

Exit of convalescence

PHILIPPINES

Success story

MEXICO

Stability first, growth second

EGYPT

Devaluation has mixed effects

MOROCCO

Difficult rebound

ANGOLA

“In shock”

ECONOMIC RESEARCH DEPARTMENT

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economic-research.bnpparibas.com Edito 2nd quarter 2016 2

Edito

Lull Rebounding oil prices, strengthening fx rates and decreasing risk premia: financial markets’ mistrust towards emerging economies has receded over the recent weeks. Yet news from the Chinese economy has not really improved and political, social and security risks are up. Thanks to its recent agreement with activist funds, Argentina should tap international markets heavily to settle its debt arrears. It is the right time to do it but the price to pay will be high anyway.

A wind of optimism has been sweeping the emerging markets since March: portfolio investment, bond issues and exchange rates have all picked up, while risk premiums have declined (see chart). The international environment has certainly evolved somewhat more favourably in recent weeks (rebound in commodity prices, coordination of monetary policies to avoid a currency war).

From a fundamental perspective, however, nothing has changed radically since the end of 2015. Growth continues to slow in China despite fiscal and monetary stimulus, the Brazilian political crisis is worsening (the positive reaction of financial markets to the impeachment procedure against Dilma Roussef is premature) and Russia remains mired in recession.

Country risk is rising. First to come to mind is security risk with the increasing number of terrorist attacks. Next is sovereign risk, with the growing financing needs of the oil-producing countries, even though sovereign funds should serve as shock absorbers (Saudi Arabia, Russia). Lastly, there is credit risk: dollar-denominated private debt has increased sharply in recent years, and foreign currencies have depreciated massively against the dollar. In 2015, according to S&P, corporate defaults in the emerging countries reached a 6-year high, and they are bound to multiply, at least in the commodity producing countries. According to BIS data, the debt of non-financial companies in the emerging countries continued to swell to 100% of GDP at year-end 2015, and they will face very high repayments for bonds and syndicated loans through 2018.

Argentina: the price to pay for the debt agreement

In March, the Chamber of Deputies and the Senate endorsed the agreement reached by the government of the new President M. Macri and activist funds that have suited Argentina since 2011.

The government will need to raise USD 12.5 bn on international bond markets to settle its debts to all holdouts. These issues will come on top of the USD 6 bn to USD 7.5 bn required to finance the 2016 budget deficit. Assuming that the Argentine government has enough credibility to raise nearly USD 20 bn on the international markets, what will be the scale of deterioration in its solvency ratios?

In December 2015 public sector debt (not consolidated) reached USD 222 bn, equivalent to around 40% of GDP or 200% of fiscal receipts. Two-thirds of this debt are denominated in foreign currencies (the vast majority in dollars), and an additional USD 20 bn or so would take the ratio to 70%. In other words, all other things being equal, a real depreciation of 10% of the peso against the dollar would automatically raise the debt ratio by around 3 points of GDP.

Thanks to the agreement with holdouts, Argentina’s sovereign debt rating is likely to be lifted out of the “default” category. But the very high level of the budget deficit (nearly 7% of GDP for all public authorities in 2015, including 5.2% for central government and 1.5% for the provinces) and the extreme vulnerability of the debt ratio to currency risk remain as major constraints on any upgrading of the rating, and hence on a reduction in the risk premium.

In the immediate future Argentina will have to pay interest rates of at least 8% per year on future issuance of dollar bonds (currently the yield on a 10-year US bond is 1.8% and the risk premium on dollar-denominated domestic bonds with a similar maturity is 620 basis points). Interest costs will therefore rise by at least USD 1.6 bn per year, and the total interest cost will account for around 10% of government receipts. This is the price of drawing a line under the past and coming out of the financial isolation of the country.

François Faure [email protected]

Lull in emerging financial markets

— Equity price (MSCI Index 01/01/2012 = 100 - LHS) ▬ FX rate against USD (01/01/2012=100 - LHS) — Risk premium (spread EMBI+, RHS, inverted scale)

Sources : Datastream , BNP Paribas

mailto:[email protected]

economic-research.bnpparibas.com Brazil 2nd quarter 2016 3

Brazil

Jeitinho Brasileiro – the Brazilian way Jeitinho Brasileiro – the Brazilian way of doing things – is a deeply anchored social and cultural mechanism. Although it flirts with corruption, which lies at the heart of the current political crisis, it can also be interpreted in a more positive light, reflecting the capacity of Brazilians to adapt to a tough, constraining environment, which is vital in the midst of the country’s worst economic recession in modern history. Resolving the crisis lies first in political change, which should usher in the first positive signs that the economy is levelling off. Thereafter, structural reforms will be needed to lend credibility to economic policy, and fiscal policy in particular, and to consolidate confidence and the country’s medium-term growth potential.

■ Coming soon: the final episode of Brazil’s political telenovela?

The political crisis that has swept Brazil since late 2014 reached a climax in March 2016. Through the revelations of legal investigations, the country’s ex-president Lula has been directly implicated in Operation Car Wash (Lava-Jato). On Sunday, 13 March, about 3.5 million protestors marched in Brazil, the largest popular protest in the country’s history. At the same time, Lula was appointed chief of staff (equivalent to Prime Minister), officially to solidify the ruling coalition, reassure the markets and improve the country’s governance, but above all, to grant him immunity and to avoid the impeachment of President Dilma Rousseff (Workers’ Party, PT). On 17 March, a judge annulled the appointment, which is now pending approval by the Supreme Court. On 28 March, judge Moro, who is head of the Lava-Jato, submitted documents to the Supreme Court that were found at the headquarters of Odebrecht, which raises questions about more than 200 political figures. Accused of irregularities in the financial statements of her 2014 presidential campaign and poor management of public finances (Pedaladas), impeachment proceedings seem to be tightening the noose around President Rousseff. PMDB, PT’s main ally, has just walked out of the coalition. Exasperated, 68% of Brazilians now favour impeachment. Official procedures have been launched in the Lower House of congress, which should last at least until June, and potentially through October’s municipal elections.

If the Lower House validates the impeachment proceedings in May, under the constitution, Vice-President Temer (PMDB) would be asked to ensure the presidency temporarily until elections can be held in 2018. Negotiations are currently underway to forge a new alliance with PSDB, the main opposition party, and to agree on a reform agenda based on the PMDB’s “Bridge to the Future” programme. Given the segmentation of the political landscape (23 parties in parliament, including 12 in the current coalition), however, there are no guarantees that the country’s governability can be restored in the short term.

■ Economic policy dilemma: halting fiscal erosion before tackling inflation

Brazil’s central bank, Banco Central do Brasil (BCB), has seen its credibility shaken by soaring inflation, due not only to the real’s depreciation, but also to the government’s decision to sharply raise certain administered prices (25% of the CPI basket). Consumer price inflation (IPCA) reached 10.4% y/y and core inflation, 7.4% y/y in February 2016. Some BCB board members are calling for another selic rate increase (14.25%) to anchor inflation expectations

at a lower level. Yet the monetary status quo seems more probable, given the large output gap, the slow pace expected for the normalisation of US monetary policy, and the sharp rise in public debt interest burden (more than 8% of GDP). In the quarters ahead, inflation will converge very slowly on the BCB’s target (4.5% +/-2pp since 2006 and 4.5% +/-1.5pp in 2017).

Although the central bank is not independent, its monetary policy has been relatively autonomous in recent years (with the exception of 2012). Yet the alarming deterioration of Brazil’s public finances de facto restricts the BCB’s scope of action. Its inflation target could endanger fiscal solvency (debate over fiscal dominance), which is facilitated by mild interest rates and high inflation. With Congress blocking reforms and with structural and cyclical constraints straining the public accounts, the primary deficit rose to 1.9% of

1- Summary of forecasts

f: BNP Paribas Group Economic Research estimates and forecasts

2- Impeachment scenario is gaining ground

Will the Lower House approve/reject the impeachment of Dilma Rousseff? █ February 2016 █ March 2016

Source: Arko Advice (poll with 100 deputies of 23 parties)

2014 2015 2016f 2017f

Real GDP grow th (%) 0.1 -3.8 -4.0 0.0

Inflation (CPI, y ear av erage, %) 6.3 9.0 9.1 7.3

Fiscal balance / GDP (%) -6.2 -10.3 -8.4 -8.2

Gross public debt / GDP (%) 58.9 66.2 73.8 78.9

Current account balance / GDP (%) -4.4 -3.3 -1.0 -1.1

Ex ternal debt / GDP (%) 23.3 29.3 35.2 34.1

Forex reserv es (USD bn) 354 349 350 355

Forex reserv es, in months of imports 15.5 15.1 14.8 14.7

Ex change rate USD/BRL (y ear end) 2.7 4.0 4.4 4.6

0 10 20 30 40 50 60 70 80

Approve

Reject

No answer

economic-research.bnpparibas.com Brazil 2nd quarter 2016 4

GDP in 2015, the overall deficit was 10.3% of GDP, and public debt increased by more than 7 points of GDP in one year. Faced with rumours about a new stimulus package to boost demand, the replacement of the BCB board, and attempts to use part of Brazil’s hefty foreign reserves to pay down the public debt, Mr. Barbosa, the new finance minister, has struggled to reassure the markets. Several measures were announced in late March (limits on primary spending, rescheduling of local government debt with the federal government, creation of a special regime for unexpected spending, and the possibility for commercial banks to voluntarily deposit liquidity with the BCB to reduce repo operations, which de facto increase the public debt ratio), but they do not seem sufficient and some are even dubious.

■ Economic recovery: a 2-stage rocket stuck on the launch pad

The year 2015 ended with real GDP down 3.8% (vs. +0.1% in 2014). The Petrobras scandal and the political crisis are largely to blame, along with structural constraints and the international environment. Hit by a 14% decline in investment (70% of which can be attributed to the Lava-Jato scandal alone, according to Bradesco) and a 4% decline in household consumption, domestic demand made a very negative contribution to growth. Net foreign trade’s contribution was lifted by the 14% decline in imports and a strong export performance (+6%), bolstered by the sharp depreciation in the real (-33% against the US dollar). As to supply, industrial output contracted by another 6% in 2015. The automobile sector reported surplus production capacity of 70% and the resilience of the services sector finally eroded (-3%). The agriculture output increased by 1.5%.

Acquired growth was a negative 2.2% in 2016. Consequently, we are maintaining our growth forecast of -4% in 2016 and 0% in 2017. Since the start of the 20th century, Brazil has experienced two periods of contraction over two consecutive years, once during the Great Depression of the 1930s and again during the Second World War. Yet the size of the current recession is unprecedented, and the cumulated decline in GDP is estimated at about 10% between mid-2014 and early 2017. In addition to the negative factors pointed out previously (see the January 2016 issue of EcoPerspectives), there is also the public health crisis caused by the Zika virus. Even though we see no signs of a return to growth in the short term, our growth forecasts would have a slightly positive bias if there were any favourable developments on the political front. The government’s recent misfortunes sparked a positive reaction from the markets. Even though political uncertainty is likely to weigh on household and investor confidence in the short term, a change in leadership could end the political stalemate and obstructions, as well as the wait-and-see attitude of economic agents in recent months. Positive political developments would trigger the first stage of a 2-stage rocket: consumption and investment would finally level off before slowly beginning to recover thereafter.

The second stage can only be fired by large-scale structural reforms, which would restore the credibility of economic policy, especially fiscal policy, and consolidate confidence and medium-term growth potential. The potential growth rate plunged from about 2.5% in 2014 to less than 1% henceforth, notably due to the impact of the drop-off in the structurally weak investment rate, to 18% of GDP.

Note that in the early 1990s, it took three years to implement the Real plan. Several vital measures are needed, notably an inter-temporal and structural ceiling on public spending increases and a strict target for the primary balance in order to restore the credibility of fiscal policy. They must be accompanied by an overhaul and simplification of the tax code (overhauling the 66 different taxes would require the approval of 27 states) and the creation of an equalisation fund to reduce the tax war between states. It is also essential to end indexation: social spending and wages are indexed to prices (since Lula 1), triggering a wage/price spiral and contributing to the rigidity of inflation (notably in the services sector). In industry, structural wage pressures are also caused by the shortage of skilled labour, which requires substantial investment in education and training as well as greater job market flexibility. The pension system also needs to be reformed by raising the legal retirement age, especially since the over-60 age group is increasing 4.2% a year. Opening the economy is also ineluctable (deregulate the energy sector, privatisations, infrastructure concessions) to attract investors capable of stepping in for the government, and to foster competition with local companies in order to optimise the country’s economic potential. Lastly, institutional reforms are also needed to improve governability, notably by consolidating the political landscape (introduction of election thresholds requiring a minimum share of the vote to secure any representation).

Brazil has major strengths that should serve as the foundation for future development: a large domestic market, abundant natural resources, immense agricultural potential, a firmly anchored though relatively young democracy, and stable, albeit perfectible, institutions (separation of powers, independent judicial branch).

Sylvain Bellefontaine [email protected]

3- Nominal exchange rates (indices: May 2013 = 100)

▬ USD/BRL — USD/basket of EM currencies

Sources: Datastream, BNP Paribas

40

50

60

70

80

90

100

110

120

2012 2013 2014 2015 2016


economic-research.bnpparibas.com Russia 2nd quarter 2016 5

Russia

Growing risks Weak oil prices threaten any hope of a recovery in 2016. The economy is likely to see a recession for the second year running. Against this background, risks to the public finances, hitherto considered to be solid, have increased significantly. The government is unlikely to be able to contain the increase in its deficit. In 2016 this could be funded from the reserve fund. In 2017, the government will have no choice but to issue debt. It will therefore absolutely need to have access to international financial markets. The only good news comes from the balance of payments, which has improved thanks to a rising current account surplus and a reduction in net capital outflows.

■ A second year in recession

The IMF and the World Bank have downgraded their oil price forecasts for 2016 and also for the following five years. The IMF does not expect Brent Crude to return to USD 50/barrel before 2021. Under these circumstances, growth forecasts for Russia have also been scaled back. According to the estimate produced by Standard and Poor’s, the oil and gas sectors account for some 20% to 25% of Russian GDP. However, the recession in 2016 is likely to be less severe than that in 2015, before a return to growth in 2017.

Initial statistics for the beginning of 2016 have confirmed that the economy is shrinking more slowly than it did in 2015. In February retail sales were down just 5.9% y/y, compared to a 7% y/y fall in February 2015. Inflation slowed significantly to 8.1% y/y from 16.7% a year earlier. Alongside this, the fall in real wages was only 2.6% y/y, compared to 7.4% in February 2015. Nevertheless, without a significant acceleration in nominal wage growth, household consumption is likely to continue to fall in 2016.

Manufacturing production fell by only 1% in February (year-on-year), compared to a fall of 2.8% a year earlier. Indeed, production of machine tools, water, gas and electricity increased. At the same time, mining output remained strong, as did agricultural production. However, without a real turnaround in company investment (down 6.7% y/y in December) growth will struggle to return. Despite rising profits, lending to companies continues to fall. Monetary policy is not sufficiently accommodating to encourage companies to invest. Under the current conditions of pressure on oil prices and thus on the rouble, any cut in key interest rates looks unlikely. Thus there is not much room for monetary policy to come to the aid of economic activity, despite an easing of inflationary pressure.

■ Growing threat to public finances

The government also lacks scope to boost growth. Falling oil prices (from USD 53/barrel to USD 37/barrel) are likely to reduce revenues from hydrocarbons by nearly 22%, assuming that the fall in the rouble (estimated at 15%) offsets some of the reduction in revenues in dollar terms. To contain the fiscal pressure, the Ministry of Finance has already indicated that several measures could be introduced (increases in extraction taxes, a privatisation programme, increases in the dividends paid by state-owned companies, etc.). However, despite these measures, federal government receipts could fall from 17.1% of GDP in 2015 to 13.8% in 2016, resulting in the deficit growing from 2.4% of GDP in 2015 to 4.1% in 2016. So far, the government has planned to finance virtually its entire deficit and that of other public sector bodies from the reserve fund, which stood at USD 49 billion in February. Although the fall in the dollar

will increase the government’s room for manoeuvre (in terms of both receipts and the valuation of the fund, which is 40% invested in euros and 44% in dollars), the situation could quickly become critical. The fund will be exhausted by 2017. The wealth fund (the other sovereign fund) is likely to have only USD 40 billion to USD 46 billion (after the recapitalisation of the banks and Vnesheconombank). The government will then have no choice but to issue debt. At present, liquidity in the domestic market is inadequate.



2- Economic activity indicators

Year-on-year, %

— CPI — Retail sales — Investment

Source : Rosstat

2014 2015 2016f 2017f

Real GDP grow th (%) 0.6 -3.7 -1.8 0.6


General Gov . balance / GDP (%) -1.2 -3.7 -5.3 -4.7

Public debt / GDP (%) 17.8 18.5 19.4 22.4

Current account balance / GDP (%) 3.2 5.4 2.8 7.4




Ex change rate RUB/USD (y ear end) 60.0 73.0 89.4 97.8

-30

-20

-10

0

10

20

30

2008 2009 2010 2011 2012 2013 2014 2015 2016

economic-research.bnpparibas.com Russia 2nd quarter 2016 6

■ Significant need to recapitalise the banking sector

The financial position of the banks worsened significantly in 2015. Profits declined by more than 67% due in particular to the sharp rise in provisions to cover the increase in non-performing loans and those considered at risk (which according to ratings agency Standard & Poors account for more than 17% of loans). The overall solvency ratio of the whole banking sector was only 8.5% in December 2015, whereas it was 13.2% five years ago. S&P estimate that the banks require recapitalisation of between 850 billion and 1,300 billion roubles, whilst the recapitalisation of Vnesheconombank could require an additional 1,000 billion roubles.

■ Improvement in external accounts in 2015

Despite the sharp fall in oil prices (-49%), Russia’s external accounts improved in 2015. The balance of payments showed a small surplus that led to an increase in currency reserves of USD 1.3 billion, following a fall of USD 107.5 billion in 2014. This improvement came from the increase in the current account surplus, which reached 5% of GDP, having been limited to 3.1% of GDP in 2014.

The increase in the current account surplus (USD 7.3 billion) was due to the fall in the trade deficit coupled with a slight fall in the balance of payments (due particularly to a reduction in interest payments on debt). The trade deficit was USD 44.1 billion lower, despite the sharp contraction in exports of oil and gas (-42.1%), as well as other exports (-18%). These effects were counteracted by the reduction in imports of more than 37% (due to the economic contraction on the one hand and the embargo on food products on the other).

Russian companies were unable to take advantage of the weakness of the rouble to increase their market share, due to a lack of competitiveness. At the same time, the deficit in the financial account was only 4.7% of GDP in 2015, from 7% in 2014. Net outflows of private capital slowed to USD 56.9 billion, from USD 153 billion in 2014. This reflected the repayment of private sector debt. It did not relate to the sale of Russian assets or the purchase of foreign assets.

The fall in the country’s net foreign currency commitments enabled it to consolidate the net external position, which had a credit balance of more than USD 300 billion at end-2015. The risk of a balance-of-payments crisis in Russia is therefore very low. But what is the risk of a default on external private debt?

■ External debt remains manageable

At the end of 2015, total external debt was USD 515 billion (USD 385 billion excluding commitments to foreign direct investors), from USD 599 billion at and 2014. The federal government and the banks reduced their debt by 26% and 33% respectively, whilst company debt fell more modestly (9%). Thus external debt for banks and companies was USD 473 billion at end-2015, and private debt USD 260 billion at end-September 2015. For private banks, nearly 86% of their external debt consists of currency deposits, but outflows were extremely limited over 2015 as a whole. For companies, if one excludes commitments to foreign direct investors, debt is only USD 129.5 billion.

The central bank estimates that external debt servicing costs will be some USD 100 billion in 2016 (from USD 155 billion in 2015). Debt servicing costs for banks and companies are estimated at USD 24 billion and USD 71 billion respectively. However, these amounts remain manageable and tensions have been reduced significantly, as judged by foreign currency liquidity injections from the central bank. The levels of currency repo operations have fallen substantially over the last year. This has taken them from around USD 35 billion per day a year ago to some USD 18 billion at the end of March. Johanna Melka [email protected]

3- Sovereign funds (USD bn)

▬ National Wealth Fund ▬ Reserve Fund

Source : Central bank of Russia

20

40

60

80

100

120

140

160

2008 2009 2010 2011 2012 2013 2014 2015 2016


economic-research.bnpparibas.com India 2nd quarter 2016 7

India

Consolidation of macroeconomic fundamentals India’s macroeconomic fundamentals improved in 2015/16: growth accelerated, inflationary pressures eased, public finances strengthened and the external position improved. Yet there are still several grey areas. The government failed to pass the tax on goods and services which it had promised to set up by April 2016. The reform process is being obstructed by the lack of a majority in the upper house of Parliament. This explains why the Finance Minister gave priority to rural development in the 2016/17 budget presentation: he hopes to influence the vote in parliamentary elections to be held in six States next May.

■ Strong growth

The Indian government estimates that growth accelerated to 7.6% in 2015/16, an increase of 0.4 points compared to the previous year. In the first three quarters of 2015/16, GDP was already up 7.5%, bolstered by dynamic household consumption (+6.1%) and an upturn in investment (+5.2%), notably government investment. In Q3, however, growth slowed to 7.3% (from 7.7% in the previous quarter) due to less buoyant public investment. India still boasts favourable growth prospects. The economy will continue to be supported by household consumption (thanks to public sector wage increases and limited inflationary pressures) and a rebound in private investment (sustained by the consolidation of the corporate financial situation in Q4 2015).

■ Consolidation of central government finances

With its 2016-17 budget presentation, the Finance Minister published the preliminary estimates for the fiscal year ended 31 March 2016. The results are satisfactory. The government is pursuing investment efforts even though the tax base is still very insufficient. The biggest risk of budget overruns is at the state level. Meeting its initial target, the central government deficit was reduced to 3.9% of GDP in 2015-16, from 4.1% in 2014-15. The primary deficit (i.e. before interest payments) was limited to 0.7% of GDP, 0.2 points less than the previous year.

Fiscal revenues (excluding proceeds from privatisation) increased slightly to 8.9% of GDP, 0.1 point more than the previous year, despite the increase in central government transfers to the states. Between 2014-15 and 2016-17, the transfer of tax revenues to local governments is expected to increase to 35% of all central government revenues, up from 27% in 2014-15. For the government, the shortfall is estimated at 3.7% of GDP in 2015/16, an increase of 1 point of GDP compared to the previous year. India still has a very weak tax base. All fiscal revenues (including privatisation proceeds) amount to only 9.2% of GDP, the lowest ratio in the Asian countries.

At the same time, the government managed to limit spending to 13.2% of GDP. By lowering fuel subsidies, current spending was reduced to 11.4% of GDP, from 11.7% of GDP in 2014/15. Although part of the savings from lower fuel subsidies was offset by higher food subsidies, the overall cost of subsidies slipped to 0.8% of GDP in 2015/16 from 1% of GDP in 2014/15. The government also managed to increase investment spending by 0.2 points of GDP, bringing it in line with its target of 1 point of GDP. Most of this investment was devoted to the public works sector to develop roadway infrastructure.

Whereas the government clearly managed to shore up its finances, unfortunately, the same cannot be said about the states. Their total deficit amounted to 2.5% of GDP in 2015/16, the same level as in 2014/15, despite the increase in central government transfers. Next year, the state deficit will swell to 3% of GDP. The situation has become alarming in certain states. This is notably the case in Rajasthan, where according to preliminary estimates the deficit could reach 3.5% of GDP this year before swelling to 5.6% next year. Consequently, the general government deficit amounted to



2- GDP

Year-on-year GDP growth (%) and contribution to growth (percentage points)

█ Households consumption (p.p) █ Government expenditure (p.p)

█ Investment (p.p) █ Statistical disc. (p.p)

█ Net exports (p.p) ▬ GDP

Source: Reserve Bank of India

2014 2015 2016f 2017f

Real GDP grow th(1)

(%) 6.6 7.2 7.5 8.0

Real GDP grow th(2)

(%) 7.0 7.3 7.9 8.1


Central Gov . Balance(1)

/ GDP (%) -4.5 -4.1 -3.9 -3.5

Central Gov . Debt(1)

/ GDP (%) 47.1 46.4 46.5 45.3

Current account balance(1)

/ GDP (%) -1.7 -1.3 -0.6 -0.6

Ex ternal debt(1)

/ GDP (%) 23.6 23.0 23.4 22.4

Forex reserv es(1)

(USD bn) 283 321 339 365

Forex reserv es(1)

, in months of imports 5.9 6.7 7.9 8.2

Ex change rate INR/USD (y ear end) 63.1 66.2 68.8 70.0

(1): fiscal y ear from 1 April of y ear n-1 to 31 March of y ear n

(2): Calendar y ear

-8

-5

-3

0

3

5

8

10

2012 2013 2014 2015

economic-research.bnpparibas.com India 2nd quarter 2016 8

6.4% of GDP in 2015/16. With public debt of about 65% of GDP, it would take nominal growth of 10% to stabilise the public debt ratio.

As to the year 2016/17, the government intends to pursue public finance consolidation. Its target is to reduce the deficit to 3.5% of GDP by increasing privatisation proceeds and by reducing spending by 0.1 points of GDP. It has yet to spell out several elements of its spending programme. The government has clearly stated its determination to support the rural sector. This decision is undoubtedly linked to its defeat in Bihar’s parliamentary elections last November.

The government also plans to inject more capital into the banking sector, estimated at 0.2% of GDP (USD 3.7 bn), the same amount that was injected in 2015/16. The IMF estimates the recapitalisation needs of India’s state-owned banks at 1.8% of GDP by 2018/19 (or even 3% of GDP if the situation were to deteriorate further).

The Finance Minister also decided to spread out public sector wage increases over time, as recommended by the 7th Pay Commission, the cost of which is estimated at 0.5% of GDP over two years (70% of the increase would fall in 2016/17). Lastly, the government announced that it would maintain investment spending at 1% of GDP in 2016/17. Spending will not be increased until 2018/19.

■ Balance of payments is still solid

In the light of macroeconomic fundamentals, investment flows seem to be going against the current. Net capital outflows have accelerated since May 2015 despite the improvement in macroeconomic fundamentals. Thanks to the sharp decline in the oil bill, the current deficit narrowed to 0.9% of GDP in 2015, the lowest level since 2007.

Foreign direct investment rose to 1.4% of GDP, 0.4 points higher than in 2014, reflecting a healthier business climate and strong growth. In contrast, net portfolio investment began contracting in Q2 2015, and accounted for only 0.3% of GDP, compared to 1.9% of GDP in 2014. In the last three quarters of the year, the balance swung into negative territory with a net outflow of USD 3.7 bn, the equivalent of 0.2% of GDP.

These capital outflows reflect investors’ disappointment over the pace of reforms, even though it was never going to be very easy for the Modi’s government to implement such reforms without a majority in the upper house of Parliament. In this respect, May’s upcoming elections will be key.

In the first two months of 2016, investors have continued to express their mistrust. Even so, capital outflows have been mild and foreign reserves are largely sufficient to cover financing needs. At year-end 2015, short-term financing needs amounted to only 63% of foreign reserves.

■ The next elections will be tense

When his government took power two years ago, Mr. Modi knew that it would be hard to implement reforms without a majority in the upper house of Parliament. He had hoped to build up a majority during partial elections. So far, however, his party has failed to make sufficient gains. In elections in Bihar last November, he suffered a bruising defeat. In May, five states will hold legislative elections, and 17 upper house seats will be up for grab by August 2017. Even if Modi were to win all these seats, which is unlikely, he would still have only 81 seats, compared to 64 today. Nonetheless this would give him more clout against the opposition to drive through reforms that are vital for the country’s development.

Johanna Melka [email protected]

3- Balance of payments (4-quarter moving average, % of GDP)

█ FDI █ Portfolio investment █ Other investment — Current account balance

Source: Reserve Bank of India

-6

-4

-2

0

2

4

2008 2009 2010 2011 2012 2013 2014 2015 2016


economic-research.bnpparibas.com China 2nd quarter 2016 9

China

Fiscal policy in the spotlight Faced with a severe economic growth slowdown and given the increasingly narrow manoeuvring room for monetary policy, the authorities have broadened their scope of action on the fiscal policy front. Growth in public infrastructure investment is expected to strengthen in the short term, and a series of tax cuts is being planned to stimulate corporate and household demand. Public finances are deteriorating slowly due to slower growth in fiscal revenues, higher spending and the excessive debt of local governments and state-owned enterprises. Moreover, contingent liabilities associated with credit risks in the financial sector are also increasing.

Economic growth has continued to slow down in early 2016 and real GDP growth could be close to 6.5% year-on-year in Q1, down from 6.8% in Q4 2015. This is at the lower end of the official target range of 6.5% to 7% set up for 2016. By announcing this target at the National People’s Congress (NPC) in early March, Beijing clearly expressed its intention to stabilise (and therefore boost) economic growth this year. Structural reforms aiming to improve the quality of supply, to rebalance China’s growth engines and to promote more harmonious economic development are still medium-term priorities. In the short term, however, the authorities intend to foster demand through a “cautious” monetary policy easing and a more “proactive” fiscal policy1.

■ A resolutely accommodating fiscal policy

When defining countercyclical policies, the Chinese authorities have most often placed emphasis on changes in the monetary and credit policy stance, as well as on public infrastructure spending. Fiscal policy is now being given a bigger role in response not only to the severe, sustained slowdown in activity, but also to the growing risks associated with monetary easing. Corporates and local governments are already excessively indebted, and banks have had to cope with an increasingly rapid rise in non-performing loans since 2012. Consequently, the monetary authorities have to pursue a very cautious stimulus policy. They are likely to continue to prefer targeted measures aimed at directing credit towards certain sectors. Yet even a mild growth acceleration in total social financing will lead to further increase in the total domestic debt-to-GDP ratio (already above 200% at year-end 2015). This will prevent any clean-up efforts in the corporate sector (especially by state-owned enterprises) and any reduction in credit risks in the financial system, especially if the monetary policy stimulus is accompanied by another deterioration in credit efficiency (see graph 1).

Faced with this situation, the government broadened its scope of action on the fiscal policy front. Growth in investment in infrastructure projects, which has long played a macroeconomic stabilising role in China, is likely to accelerate in 2016. In 2015, the financial difficulties of local governments contributed to the slowdown in infrastructure investment (+17% in nominal terms, down from 20% in 2014). This year, local governments should benefit from a rebound in revenues from land sales (following their collapse in 2015), from lower debt servicing charges (thanks to programmes to swap bank loans for less costly bond issues), and from a better access to financing sources (after the period of tightening that followed the adoption of the new budget law in late

1 See « China: Priority on stabilising growth », EcoWeek, 18 March 2016.

2014). The government also intends to promote financing of infrastructure projects via public policy banks as well as via public-private partnerships.

In addition, some tax cuts have already been introduced and other measures are planned in the short term, in order to stimulate household consumption and reduce corporate costs. The government is also continuing a reform to gradually introduce VAT in all sectors. By replacing the current sales-based tax system with one based on value-added, the reform should encourage the search for profits, and at the same time reduce the tax burden on corporates.



2- Deterioration in the efficiency of credit* and monetary policy

▬ Credit efficiency (change in the stock of total social financing / change in nominal GDP)

* Amount of credit (social financing) needed to generate one point of GDP. Sources: NBS, BNP Paribas

2014 2015 2016f 2017f

Real GDP grow th (%) 7.3 6.9 6.4 6.1


General Gov . balance / GDP (%) -2.1 -2.4 -3.0 -3.3

Central Gov . debt / GDP (%) 16.8 18.1 20.0 21.8



Forex reserv es (USD bn) 3 843 3 330 2 988 3 121


Ex change rate CNY/USD (y ear end) 6.2 6.49 6.78 6.65

0

1

2

3

4

5

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Deterioration

economic-research.bnpparibas.com China 2nd quarter 2016 10

■ Higher fiscal deficits

During the NPC, the authorities unveiled a series of economic policy objectives for 2016. On the fiscal front, they are calling for an increase in the “target” fiscal deficit to CNY 560 bn, or 3% of GDP. By announcing the largest fiscal deficit ever targeted in China, the government is clearly signalling its determination to make greater use of its fiscal manoeuvring room. Actually, the new tax measures combined with the strengthening in infrastructure spending will further strengthen the easing of the fiscal policy stance, which has already been in expansionary mode since 2012 (fiscal policy was tightened in 2010-2011 after a huge stimulus package was implemented in response to the late 2008 global shock). As a result, the fiscal deficit target, which is announced at the beginning of each year and signals the policy stance, has been gradually increased, from 1.5% of GDP for 2012 to 3% for 2016.

An “actual” fiscal deficit is also reported (its definition is not exactly identical to the “target” deficit, which limits comparisons between the two). The actual fiscal deficit rose from 1.6% of GDP in 2012 to 3.5% in 2015. Growth in fiscal revenues has continuously slowed down since 2012 and reached 8.4% in 2015. This figure includes certain special state funds, previously considered off budget and now integrated in government accounts, and without which it would have been lower. Fiscal revenues (over 80% of which come from taxes) remained close to 22% of GDP in 2015 (which is very moderate compared to advanced economies). Growth in total government expenditure also slowed down in 2012-2014, but to a lesser extent than revenues. Growth in infrastructure investment (which is largely off budget) picked up at the same time. In 2015, growth in government expenditure included in the official budget rebounded (+15.8%, vs. 8.3% in 2014), as the government partially compensated for the financial troubles of local governments (traditionally responsible for infrastructure projects) in order to support continued public investment growth (which yet decelerated last year).

Official budget statements published by the authorities in fact report only part of local governments’ activities. The IMF publishes its estimate of China’s “augmented” fiscal deficit, which probably provides a better picture of the country’s actual fiscal performance. The IMF revises the official targeted fiscal balance by adding state and social security funds, and then “off-budget” revenues and expenditures of local governments (land sales, infrastructure investment). In the end, the total augmented deficit, i.e. the net financing needs of the entire general government, was estimated at 7.3% of GDP in 2014, compared to 6.5% in 2012. It is likely to near 8% in 2015 (see graph 2). This highlights China’s rather poor fiscal performance of local governments on the whole.

■ Public finances under pressure

Public finances have been hit by the economic slowdown and the countercyclical fiscal policy implemented over the past four years. Deficits have risen and the total general government debt has swelled. However, a distinction must be made between the central government and local governments. Central government debt is still very moderate at about 20% of GDP, and debt dynamics are not worrying. Local government debt, in contrast, is much more alarming. It has increased rapidly in recent years, first in 2009 due

to the post-crisis stimulus package, and then since 2012 due to the strong rise in infrastructure investment (largely debt financed). Local government debt rose from less than 20% of GDP in 2007-2008 to an estimated 38% in 2015. At the same time, the debt servicing capacity of local governments has eroded, as the projects that have been financed proved to be either not profitable enough or not profitable early enough. Local governments’ revenues have also eroded due to the economic slowdown and to the downturn in the real estate market from late 2013 to 2015.

China’s sovereign risk is seen as very low, notably thanks to the moderate levels of central government deficits and debt, easy access to financing (mostly domestic) and the government’s large asset holdings (including foreign exchange reserves). Yet sovereign risk is coming under increasing pressure due to the economic slowdown and to the rise in contingent risks. These contingent risks can be attributed to the excessive debt of local governments and state-owned enterprises, which the central government may have to support if necessary, and to high credit risks in the financial sector. Moreover, the authorities are giving short-term priority to stabilising growth, at the risk of delaying needed structural reforms aiming to restructure state-owned enterprises, improve the finances of local governments and clean up the financial system. In this context, two main credit rating agencies have recently revised their outlook on China’s long-term foreign-currency sovereign ratings (of Aa3 for Moody’s’ and AA- for Standards & Poor’s) to negative from stable.

Christine Peltier [email protected]

3- A rather mediocre fiscal performance

% of GDP ▬ Official “target” deficit ▬ Actual deficit

▬ “Augmented” deficit (IMF estimate)

Sources: NBS, CEIC, IMF, BNP Paribas

-10

-9

-8

-7

-6

-5

-4

-3

-2

-1

0

2009 2010 2011 2012 2013 2014 2015e 2016e


economic-research.bnpparibas.com Turkey 2nd quarter 2016 11

Turkey

Still standing Despite a series of negative shocks, GDP growth has been fairly resilient so far notably thanks to a relatively supportive policy mix. As long as the narrowing of the current account deficit does not reverse dramatically and domestic demand growth remains alive, one can be reasonably optimistic about the country’s macroeconomic trajectory in the coming two years. In that respect, two X factors concern us as they might crush the Turkish economy: 1/ geopolitical tensions and isolation of Turkey, and 2/ the interdependence of geopolitics and internal politics on the crucial Kurd issue.

■ (Geo)politics is still tight

In power since 2002 AKP lost its absolute majority in the June 2015 legislative elections due to the breakthrough of the pro-Kurdish party (HDP). As no coalition government emerged from political bargaining, President Erdogan called for new elections on November 1. By presenting itself as the sole guarantor of stability and rampart against terrorism (i.e. PKK and Daesh), AKP succeeded in securing an absolute majority (57.6% of the seats) in the unicameral parliament. But President Erdogan lacks the votes of 15 deputies to pass a referendum resolution in the parliament to consolidate his power via the implementation of a presidential regime. It may prompt him to call early elections before the end of the year.

Despite the truce agreement in Syria signed under the umbrella of the US and Russia at end-February 2016, Turkey is still encircled by the Russia/Assad’s Syria/Shia alliance. The Turkish authorities also view with a jaundiced eye the potential creation of a Kurdish proto-state in Syria along its southern border. Turkey’s more resolute opposition to Daesh and renewed conflict against PKK (since July 2015) has triggered a campaign of retaliation on its territory with a series of bloody bomb attacks, notably in Ankara and Istanbul, over the past few months.

Turkey is still protected by its NATO membership. Nevertheless, the transatlantic alliance is shaken by Russia’s strategy. This highlights the Western countries’ divisions and indecisiveness on the regional conflict, which has turned into a global geo-strategic issue. In the meantime, Turkey must deal with the problem of about 2.7 million refugees. However, the EU migrant crisis has revived the bargaining power of Turkey. The country has just secured a EUR 3bn grant from the EU and put the adhesion process back on track.

■ The economy is still alive

The Turkish economy has been struggling with severe financial instability since mid-2013 due to a series of negative shocks. However, it has been fairly resilient so far. After 2.9% in 2014, real GDP growth held at 4% in 2015 and could reach just below 3% this year. Even though the policy mix has been relatively supportive in recent quarters, the resilience of domestic demand has been surprising given the drop in household confidence in the run-up to the November elections and the slowdown in consumer credit. In 2015 private consumption was the main growth driver (+4.5% y/y). Real wages continued to increase, job creations reaccelerated throughout the year (+3.1% in 2015) and the contribution from refugees cannot be neglected. Meanwhile, overall investment

(+3.6% y/y in 2015) has been very volatile. It expanded strongly in Q2 and to a lower extent in Q4 but stalled in Q1 and Q3 on the back of bouts of (geo)political and financial tensions. On the external trade front, export volume gained some traction in Q3 but fell again in Q4 while import volume accelerated markedly, making the contribution from net exports to GDP growth slightly negative in 2015 as a whole.

Tumbling oil prices are a blessing for a large importer of energy products such as Turkey. In 2015 both the trade deficit and the current account deficit (CAD) narrowed though to still high levels (7.1% and 4.8% of GDP, respectively). The surplus in the invisibles balance declined, undermined by the 13% fall in the travel balance



2- GDP growth and contributions

Contribution to growth (point of GDP)

█ Domestic demand █ Net exports ▬ GDP

Sources: Turkstat, BNP Paribas

2014 2015 2016f 2017f

Real GDP grow th (%) 2.9 4.0 2.8 3.5


Gov ernment balance / GDP (%) -1.3 -1.2 -2.9 -2.7

Public debt / GDP (%) 35.0 33.8 32.7 31.5



Forex reserv es (USD bn, gross) 106 96 93 91

Forex reserv es, in months of imports 5,0 5,2 5,6 5,2

Ex change rate USD/TRY (y ear end) 2.33 2.92 3.08 3.46

-20

-16

-12

-8

-4

0

4

8

12

16

20

07 08 09 10 11 12 13 14 15

economic-research.bnpparibas.com Turkey 2nd quarter 2016 12

(tourism revenue down). The surplus of the financial account almost halved to USD 22 bn in 2015. Net foreign portfolio investment outflows (-USD 15 bn) were not offset by the increase in other types of financing. Finally, gross FX reserves (excl. gold) fell by USD 11 bn in 2015, and the TRY depreciated by 20% vs. the USD and 11% vs. the EUR. A positive point is that short-term external credit has declined markedly as local banks have favoured long-term external financing.

Over the past three years the Central bank (CBRT) has intervened massively in the FX market to limit exchange rate volatility. Altogether, it has sold USD 42 bn via daily FX auctions since June 2013. At end-February 2016 it revised its daily auction amount downward to USD 30 m from USD 50 m. Banks have maintained large amounts of foreign currency reserves at the CBRT, but at the expense of the CBRT’s free reserves, which have been cut in half to only USD 29 bn.

Looking forward, the Russian embargo on Turkey (exports, major projects, tourism) and the difficult regional environment should not derail the decline in the CAD this year thanks to higher demand from Europe, low energy prices and slowing domestic demand. But the basic balance (current account balance plus net FDI) will remain broadly negative, which will leave Turkey highly dependent on volatile foreign portfolio investments. The TRY should maintain its depreciating trend this year and next.

■ Rather accommodative policy mix to monitor

Turkey has had an accommodative monetary policy since 2010. Despite inflationary pressures (both headline and core inflation reached around 9% y/y in 2015) driven by the depreciation of the Turkish lira, the CBRT has not drastically tightened monetary conditions over the past year. For several months the CBRT has been working to overhaul its intervention framework, which would send the markets a positive signal. In the meantime, faced with a tough political and financial environment, it has maintained a wait-and-see approach, and like many other central banks, it has been hanging on to the US Fed’s words and actions. The appointment of the new CBRT governor on April 19 will be crucial to demonstrate whether the executive branch is determined to take control of monetary policy. The 25 basis points (bp) cut in the o/n lending rate to 10.50% in March might suggest it. In all, inflation is likely to remain largely above target in 2016-17, notably owing to hikes in wages and utility prices.

On the fiscal front, the central government deficit was broadly stable in 2013-15 at slightly above 1% of GDP and the positive primary balance allowed public debt/GDP to stay on its declining trend. In 2015 the good fiscal performance was underpinned by one-off revenue collections from licencing sales of 4.5G mobile technology and tax amnesty scheme. Those sources contributed to a 13% increase in total revenue in nominal terms, compensating for the equally strong growth in total expenditure.

But these one-off revenues are likely to decline this year. Moreover, the implementation of the government’s generous pre-election promises will push up fiscal spending. Indeed, the government will bear 40% of the 30% increase in the minimum wage, amounting to an additional spending of roughly TRY 10 bn. In addition, the TRY 1,200/year increase in old-age pensions could cost up to TRY 13 bn.

As a result, the overall impact on fiscal accounts could be as high as 1.5% of GDP. Therefore, the budget deficit could widen substantially to nearly 3% of GDP in 2016, higher than the medium-term programme target of 1.3% of GDP.

Despite the expected fiscal slippage, tightening domestic and foreign financing conditions and weakening FX rate, the public debt/GDP trajectory is likely to remain positive in the coming years assuming resilient nominal economic growth and primary balance close to equilibrium. The local bond market is liquid and should still cover 90% of the government’s financing needs for 2016, which are estimated at roughly TRY 113 bn (equivalent to about USD 36 bn). Interest rates and spreads have trended upwards since mid-2013 but have slightly eased since early 2015. Yields on 5-year Treasury bonds have risen by 450 bp to 10% since mid-2013. In the meantime, the spread between 10-year sovereign bonds in foreign currency and their US counterparts and the 5-year CDS spread increased by only 130 bp, at 300 bp and 230 bp, respectively. Turkey’s risk premium seems relatively small compared with the increase in political and geopolitical risks since mid-2013 and is only 60 bp higher than the average spread for “investment grade” sovereign debts.

To conclude, owing to the highly strained (geo)political situation, long-awaited structural reforms (i.e. taxation, long-term savings, energy, the labour market, education and productivity) may be watered down or remain in limbo for some time to come. This would prove to be very detrimental for Turkey’s economic prospects in the medium -to- long term. Nonetheless, Turkey’s economy may still prove its resilience in the coming quarters as the policy mix will be relatively accommodative.


3- Nominal exchange rate and interest rate

▬ CBRT’s average effective rate (%, lhs)

▬ Nominal FX rate 0.5 USD/TRY + 0.5 EUR/TRY (rhs)

Sources: CBRT, Datastream, BNP Paribas

1.6

1.8

2.0

2.2

2.4

2.6

2.8

3.0

3.2

3.4

4

5

6

7

8

9

10

11

12

13

2012 2013 2014 2015 2016


economic-research.bnpparibas.com Cyprus 2nd quarter 2016 13

Cyprus

The worst is over The adjustment programme set up in 2013 has ended on a positive note. Growth has returned and employment is picking up. Public finances have undergone in-depth reforms, paving the way for gradual debt reduction in the medium term. The banking sector’s shock treatment was a success: the Cypriot experience of resolving banking crises became a reference for the EU. Although the worst of the banking crisis is over, several years of convalescence will still be needed. Non-performing loans, especially mortgages, are still a big problem, and resolving it might require further government efforts.

■ Cyprus completes its structural adjustment programme

In mid-March 2016, two months before the official expiration date, the Cyprus government announced that it had completed its adjustment programme with the IMF. Under the triannual programme launched by the Troika (the European Union, the European Central Bank and the International Monetary Fund) in April 2013, this small country in the throes of a severe banking crisis was offered financial assistance totalling EUR 10 bn (55% of the country’s annual GDP) in exchange for a structural adjustment programme, including notably restructuring of the banking sector.

The programme ended on a positive note. Cyprus returned to growth in 2015 after three years of recession during which GDP contracted 11%. The recovery has been mild (+1.6% in 2015), but is nonetheless stronger than expected, surpassing the forecasts of the IMF and the European Commission. Growth accelerated during the second half of the year, buoyed notably by a rebound in tourist flows to the island: tourism revenues increased 4.4% in 2015, offsetting the 2.8% decline in 2014.

The unemployment rate has fallen from a peak of 16.5% at the end of 2014. Adjusted for seasonal fluctuations, it reached 13% of the active population in November 2015. The job market recovery should help shore up household solvency, which in turn should improve the prospects of ending the systemic banking crisis (see below).

Inflation is mired in negative territory for the third consecutive year. Average inflation was -1.5% in 2015 (vs. -0.3% in 2014) and deflationary trends have extended into early 2016 (-1.65% year-on-year in the first 2 months). Cyprus – a small, open Eurozone economy – does not have the means to withstand the region’s deflationary pressures. Persistent deflation also reflects the fragility of Cyprus’s current recovery: in nominal terms, GDP growth only barely levelled off in 2015.

■ Fiscal adjustment

Over the past three years, the country’s fiscal performance has been stronger than expected. After reaching a record high of 9% of GDP in 2014, the budget deficit has narrowed spectacularly to an estimated 1.3% in 2015 (based on European Commission methodology). On a cash basis, the government ended the year with a primary surplus of 1.8% of GDP. Rebalancing public finances required tax increases and spending limitations, notably a freeze on public sector wages. The corporate tax rate was increased to 12.5% and the VAT – to 19%. The tax administration was overhauled as part of far-reaching reforms. Major state-owned companies were

privatised, including CYTA, the national telecom operator, and the Limassol Port Authority.

Yet completion of the adjustment programme does not mean the end of austerity. The bank bailout was extremely costly for the government. Public debt has soared, from 45% of GDP in 2008 to 108% in 2015, which is far above the threshold set by the Maastricht criteria. The Troika will keep the country under post-programme surveillance until three quarters of its loans are paid off.

The Cypriot economy is still exposed to refinancing and interest rate risks. Interest rates are currently at historical lows in the EU, but cannot hold indefinitely at these levels. Since the end of the Troika’s



2- Renewed growth

GDP growth, %

█ EU-28, ----- Cyprus

Source: EU Commission

2014 2015 2016f 2017f

Real GDP grow th (%) -2.3 1.6 1.5 2.0

Inflation (CPI, y ear av erage, %) -0.3 -1.5 -1.0 0.6

Gov ernment balance / GDP (%) -8.9 -1.3 0.1 0.9

Public debt / GDP (%) 108.2 108.4 99.9 95.0




Forex reserv es, in months of imports 0,9 0,8 0,9 0,9

Ex change rate EUR/USD (y ear end) 1.21 1.09 1.14 1.05

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

2007 2008 2009 2010 2011 2012 2013 2014 2015

economic-research.bnpparibas.com Cyprus 2nd quarter 2016 14

assistance programme, Cypriot government securities are no longer eligible for the ECB’s refinancing programme because of their “speculative grade” ratings. To continue to borrow on the markets, the country must convince investors that its fiscal efforts are serious. The road to debt reduction will be long, demanding several years of major fiscal efforts. The IMF’s central scenario envisages primary fiscal surpluses of 3.6% of GDP since 2018. Assuming GDP growth of about 2% a year, this will allow Cyprus to reduce its public debt to about 70% of GDP by 2022.

■ Banking crisis: the worst is over

The Cyprus banking system is still convalescing. On the eve of the 2012-2013 crisis, the country’s banking system was over-dimensioned. At its peak in mid-2010, the banking system’s total aggregated assets amounted to EUR 170 bn, equivalent to nine times GDP. The Cyprus government lacked sufficient financial resources to rescue such a large-scale banking system. The rescue of Cyprus banks – for the first time in the European Union – required the Troika’s support as well as the contribution of the biggest deposit holders (EU deposit guarantees being limited to EUR 100,000). All in all, the big deposit holders, many of whom were non-residents, lost EUR 7.9 bn (47.5% of their assets, on average). After a two-week shutdown, the country’s second largest bank went into bankruptcy, while the first, the Bank of Cyprus, benefited from a EUR 9 bn liquidity injection. This rescue operation was a success: in 2014, the so-called “bail-in” approach was extended to all bank rescue operations in the European Union.

In another first for the euro zone, capital controls were installed within the region’s borders to prevent a liquidity crisis. Transfers out of Cyprus were drastically restricted in April 2013, but were then eased up a year later and definitely lifted in April 2015. Today the situation seems to have stabilised: even with the summer 2015 turmoil in Greece, it was not necessary to restore emergency measures again.

■ Bank balance sheets still need to be cleaned up

Bank assets dwindled by about half compared to their 2010 peak: end-2015 they accounted for only EUR 88 bn, or five times the country’s GDP. Banks have disengaged from government financing and foreign assets. Corporate lending is gradually picking up, rising 4% in 2015. Household lending continued to contract, shedding 6% of its nominal value in 2015.

After racking up heavy losses in 2011-2013, the Cyprus banking sector has swung back into profits. Liquidity has slowly improved: the loan-to-deposit ratio has dropped from 260% in 2010-2011 to 190% in September 2015. The situation is still fragile, however, and future debt reduction efforts will still be needed.

Although the worst of the crisis seems to be behind us, the quality of loan portfolio is still a major problem. In September 2015, the doubtful loan ratio was 46% (chart 2). In absolute value, doubtful loans have levelled off at EUR 28 bn, or 1.6 times GDP. The situation is even more dramatic for household loans, with the NPL ratio of 56%. Provisions are insufficient: net of provisions, non-performing loans still account for 2.5 times the banking sector’s capital.

The IMF welcomed measures adopted in 2015 to facilitate foreclosures of assets in case of non-payment. Together with the measures encouraging banks to restructure their doubtful loan portfolios, they have accelerated the process of cleaning up their balance sheets since Q2 2015. In September 2015, about 17% of total loans had been restructured. As a result, about 4/5ths of these loans have become performing again, thereby avoiding asset seizures.

Once the restructuring process is complete, banks will still have to deal with loan losses. This is a particularly sensitive issue for mortgage loans, which account for 87% of household loans. According to our estimates, the amount of hopeless mortgage loans may reach as high as EUR 2.3 bn to 2.8 bn, or 13-16% of GDP. Such large-scale foreclosures would imply major social risks: therefore a tailor-made solution such as a “bad bank” will probably be necessary to support households and to definitively turn the page on this crisis. A legal framework was adopted in November 2015 that allows the banks to sell loans to third parties.

Anna Dorbec [email protected]

3- Non-performing loan portfolio is still very large

— NPL (% of total loans), lhs

▬ NPL net of provision to capital, rhs

Source: IMF FSI

0

50

100

150

200

250

300

350

400

450

0

5

10

15

20

25

30

35

40

45

50

2010 2011 2012 2013 2014 2015


economic-research.bnpparibas.com Bulgaria 2nd quarter 2016 15

Bulgaria

Exit of convalescence Following two years of political crisis amid sluggish growth, Bulgaria's political environment has stabilized since the legislative elections of late 2014, and economic activity has started to strengthen. In this context, the center-right coalition government led by Boiko Borisov has been able to introduce some structural reforms and pursue a fiscal adjustment program. The budget deficit soared in 2014 as spending increased to respond to social demands and provide liquidity support to local banks; but it then narrowed quickly and stood below 3% of GDP in 2015. In the banking sector, regulation is being improved and an asset quality review is planned for 2016. Banks remain plagued by large non-performing loans, and credit is unlikely to rebound in the short term.

■ Reform action in a stabilized political environment

Bulgaria experienced a period of political and social turbulence following mass protests at the beginning of 2013, but the political environment has finally started to stabilize after the snap elections of October 2014. Since then, a center-right coalition government has been led by Prime Minister Boiko Borisov, the leader of the CEDB (Citizens for European Development of Bulgaria) and former government head from 2009-2013. There are still some risks of political instability going forward, because the ruling coalition may gradually weaken given its complex structure, and parties will soon prepare for the presidential election of October 2016. Moreover, the Bulgarians’ disillusionment with the political establishment remains significant. Nevertheless, in the more stable environment of the last 18 months, the government has succeeded in pursuing fiscal consolidation efforts and accelerating a number of structural reforms, despite the fragility of the coalition.

Reforms that have recently been introduced or are due to be implemented shortly aim to start to improve the work of the Supreme Judicial Council, reorganize the education system, enhance efficiency in the electricity sector, and improve the health and pension systems. The authorities have also taken steps to strengthen the banking sector’s regulatory framework, with the adoption of the Bank Recovery and Resolution Directive (aimed at better handling crises), and plans to conduct an Asset Quality Review (AQR) and banking system stress tests by the end of 2016, with the support of the EU, IMF, and World Bank. Along with the accelerated reform process, relations with the EU have improved. In late 2014, the European Commission (EC) resumed payments to a series of environment-related projects that had been suspended due to problems in the public tendering process, and new investment programs have been approved for the 2014-2020 funding period.

There is a consensus in Bulgaria on the need to enter the euro zone in the long term. In the short and medium terms, the authorities should remain strongly committed to preserving the Currency Board Arrangement (CBA) and thus maintaining policy discipline. Meanwhile, huge progress is still needed on the structural front. Governance and corruption problems, and the poor efficiency of the judiciary and the administration have long prevented Bulgaria’s “institutional convergence” with the EU and contributed to its incapacity to modernize infrastructure, thereby constraining its economic development. Bulgaria remains the poorest country in the EU, with GDP per capita (in PPP terms) at 47% of the EU average. Yet the situation might begin to change if the reform efforts underway since last year continue. A positive sentiment has also recently emerged thanks to economic growth acceleration.

■ Economic growth has gained some momentum

Real GDP growth remained slow in the post-crisis period, averaging only 1.2% per year in 2010-2014. External demand from the main European partners was sluggish and domestic demand remained depressed, severely constrained by weak credit growth, high unemployment (which soared from 5.2% in Q4 2008 to 13.0% in Q2 2013 before starting to decline), political instability, weak confidence (aggravated by the crisis that hit two large local banks in 2014) and, more generally, the poor quality of the doing-business environment. Nonetheless, economic growth started to gain momentum in 2014 and this positive dynamics continued in 2015. Real GDP grew by an estimated 2.8% last year, up from 1.7% in 2014. Domestic demand growth showed small signs of recovery in 2014, but weakened again


f: BNP Paribas Group Economic Research forecasts

2- Real GDP growth acceleration driven by exports Year-on-year change, 4pma, %

— GFCF Government consumption ▬ Private consumption

▬ Exports Imports █ Real GDP (rhs)

Source : National Statistical Institute

2014 2015 2016f 2017f

Real GDP grow th (%) 1.7 2.8 2.6 2.6

Inflation (CPI, y ear av erage, %) -1.6 -1.1 -0.5 1.2

Gen. Gov . balance / GDP (%) -5.8 -2.8 -2.5 -2.3

Gen. Gov . debt / GDP (%) 27.0 30.0 32.0 33.1



Forex reserv es (USD bn) 21.9 22.8 22.9 23.0


Ex change rate BGN/EUR (y ear end) 1.96 1.96 1.96 1.96

-10

-8

-6

-4

-2

0

2

4

6

8

10

-25

-20

-15

-10

-5

0

5

10

15

20

25

2007 2008 2009 2010 2011 2012 2013 2014 2015

economic-research.bnpparibas.com Bulgaria 2nd quarter 2016 16

in 2015, given fiscal austerity measures and the continued process of deleveraging in the private sector. Meanwhile, export growth accelerated thanks to stronger demand from some EU partners and depreciation of the euro and the lev, which helped support sales to some non-euro zone countries (all EU countries represent 62% of Bulgaria’s total exports and euro zone members 46%). Exports to Greece and Russia declined (these countries represent 6.7% and 2.4%, respectively, of total exports). At the same time, Bulgaria’s banking sector has well weathered contagion effects from the Greek crisis. Bulgaria also benefited from the greater use of EU funds, which helped stimulate public domestic demand in H2 2015. In addition to the resumption of EU payments that had been temporarily suspended, Bulgaria received “ordinary” funding from the 2014-2020 period plus “exceptional” funding from the 2007-2013 fiscal period (that had to be fully used before end-2015).

We project real GDP growth at 2.6% in 2016. Negative forces will persist, including a tight fiscal policy, the absence of recovery in credit growth, and the region’s difficulties that will still weigh on export performance. EU-funded projects are expected to remain growth-supportive, but could decline following last year’s exceptional payments. On the positive front, households should start to take advantage of lower energy prices and improving labour market conditions (the unemployment rate fell to 8.8% at end-2015).

■ Fiscal consolidation should continue

Fiscal performance deteriorated significantly in 2014 as the result of: i) revenue underperformance and higher spending given the tense social context and anti-austerity protests of 2013, and ii) the inclusion of additional liabilities due to the need to support the Bulgarian Deposit Insurance Fund (BDIF) following the deposit run that hit two local banks in mid-20141. The 2014 fiscal deficit was finally estimated at 5.8% of GDP by the EC. As the jump in the deficit was primarily due to one-off support to the financial sector and inclusion of BDIF in the general government sector was considered exceptional, Bulgaria has not been placed under any Excessive Deficit Procedure by the EC. Moreover, the government has rapidly taken actions for fiscal consolidation. It plans to reduce the fiscal deficit each year from 2015 to 2018, on the back of stronger revenue growth (including improved tax administration) and a limited rise in expenditure (while still remaining cautious on the social spending front). The fiscal deficit fell to less than 3% of GDP in 2015 and should decline to 2.5% in 2016. In the medium term, effective reforms in the healthcare, pension and energy sectors should also help improve control of public spending and support fiscal consolidation.

Government debt ratios also deteriorated sharply in 2014, rising to 27% of GDP in 2014 from 18% in 2013. This resulted from growing financing needs to cover the larger fiscal deficit and one-off items, as additional debt was issued to support the financial sector (liquidity scheme and payment of guaranteed deposits by the BDIF). The surge in debt was entirely absorbed by the issuance of new debt in foreign currency. At end-2014, 79% of government debt was denominated in foreign currency (almost exclusively euros), up from 66% in 2013. And 55% was held by foreign investors (vs. 44% in 2013). In 2015, in a stronger real GDP growth but deflationary

1 See "Bulgaria: A wave of panic”, EcoEmerging, July 2014.

environment, the government debt-to-GDP ratio increased slightly to 30%. Similar dynamics are expected in 2016.

Compared with two years ago, sovereign risk has slightly deteriorated due to the new contingent liabilities that have emerged in the banking sector and the rise in government debt ratios. However, it remains moderate and public finances still seem strong enough to absorb a shock. Sovereign risk remains supported by: still moderate government debt ratios, large fiscal reserves (about 12% of GDP), and the strong consensus on the need to maintain prudent fiscal policies. Sound public finances are a key requisite for the sustainability of the CBA, which itself is vital for sovereign solvency since government debt is mostly denominated in euros.

■ Domestic credit conditions not yet growth-supportive

Under the CBA, Bulgaria’s monetary policy is tied to that of the ECB. It has been accommodative since 2009 and will remain so in the short term. The main policy rate has been close to 0% for the last three years and the nominal lending rate has decreased gradually. Due to deflation (which has been persistent since August 2013), real lending rates have increased. However, whatever the monetary policy stance, domestic credit has been driven in recent years by the continued deleveraging process in the economy, as corporates have limited their debt growth and banks have reduced their external liabilities. As a result, domestic bank credit to the private sector has barely increased since 2009 (by 0.4% per year on average). It declined as a percentage of GDP from 71% in 2009 to 59% in 2015. Domestic credit growth is projected to be close to 0% in 2016, especially as banks should remain prudent in the preparation for stress tests and the AQR. The high level of non-performing loans (estimated at 20% of total loans in Q3 2015) remains the Achilles’ heel of Bulgarian banks. The sector’s capitalization is adequate, even though it could be dented by potential new credit losses that may arise following the AQR. The sector’s funding profile is also comfortable. While liquidity pressures remain possible, in the event of a confidence shock (like in mid-2014) or as the result of the presence of Greek banks (12% of total domestic assets), the risk is lessening thanks to a strengthening in supervision.

Christine Peltier [email protected]

3- Credit to the private sector still down

█ Credit, % of GDP (lhs) ▬ Loans to corporates, annual change, % (rhs)

Loans to households, annual change, % (rhs)

Source : IMF

-20

0

20

40

60

80

100

120

0

10

20

30

40

50

60

70

2003 2005 2007 2009 2011 2013 2015


economic-research.bnpparibas.com Philippines 2nd quarter 2016 17

Philippines

Success story The economic transformation launched in 2010 is bearing fruit. Economic growth is robust, public finances are being consolidated, external vulnerability has lessened and the institutional framework is improving. Thanks to dynamic domestic demand, reduced exposure to Chinese demand and less dependence on manufactured good exports, the Philippines managed to maintain a much stronger growth rate in 2015 than the other ASEAN countries. If the next government, to be elected in May, pursues the economic reforms implemented over the past several years, the economy’s long-term growth potential could hold at high levels.

■ Positive track record

The Philippine economy continues to boom. Real GDP growth has reached 6.2% per year in average since President Aquino’s election in 2010. Inflation is under control and macroeconomic fundamentals have improved significantly. The Aquino government has a positive track record: domestic political tensions have eased, the institutional framework and business climate have improved (although major shortcomings persist), sparking new inflows of foreign direct investment (FDI), and external and fiscal imbalances have narrowed.

The fiscal deficit shrank to less than 1% of GDP in 2015, leaving room to increase infrastructure expenditure (to 4% of GDP in 2015, compared to only 2% of GDP through 2012) and stimulate growth. Public debt has fallen steadily over the past ten years, to 45% of GDP in 2015 (vs. nearly 70% of GDP in 2005), and the debt profile has improved significantly.

Thanks to robust domestic demand, real GDP growth stood at 5.8% in 2015, and is poised to accelerate to more than 6% in 2016 and 2017.

Domestic demand will remain the main growth engine. Although the investment rate is still low, the Public Private Partnership (PPP) programme launched by the Aquino government is beginning to pay off, and should finance the development of new infrastructure projects. Private consumption (70% of GDP) will get a boost from rapid credit growth and a healthy job market. Although the government has encountered some troubles executing the budget, public spending is likely to increase in H1 2016 in the run up to May’s presidential elections. In January 2016, the public sector already benefited from a 10% wage increase. Low energy and rice prices are also support factors.

■ The slowdown in remittances from migrant workers is not a major risk

Remittances from migrant workers (10% of the population) provide key support for domestic demand; they represented nearly 9% of GDP in 2015. Some fear that the growth slowdown in remittances in 2015 (+4.6% in USD, compared to an average of more than 7% over the past five years) would strain future household spending and the current account surplus. These fears were amplified by the fact that remittances from the Gulf countries account for nearly 25% of the total (vs. 40% from the Americas and about 15% each from Asia and Europe).

Even though remittances will increase at a slower pace (and could even decline under a worst case scenario) in the quarters ahead,

our central scenario still calls for strong growth in household consumption.

First, because several studies indicate that remittances amounts represent more an adjusting variable to consumption needs than a decisive criterion for consumption. Indeed, faced with an expected slowdown in philippinos’ income (following a natural disaster, for example), remittances amounts sent by overseas workers tend to increase rapidly. Inversely, when household income is expected to grow rapidly in the Philippines, remittances amount sent by overseas workers tend to slow. Second, remittances amounts sent by overseas workers are targeted in pesos (and not in USD), which allows more flexibility than in the opposite situation.



2- Real GDP growth GDP growth (%) and contribution to growth (percentage points, p.p.)

█ GDP (y/y), ▬ Net exports (p.p.) Domestic demand (p.p.)

Sources: National accounts

2014 2015 2016f 2017f

Real GDP grow th (%) 6.1 5.8 6.0 6.5



Gen. Gov . debt / GDP (%) 45.4 44.8 43.8 42.7





Ex change rate /USD (y ear end) 44.73 47.06 48.00 49.50

-4

-2

0

2

4

6

8

10

12

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

economic-research.bnpparibas.com Philippines 2nd quarter 2016 18

In the short term, our central scenario calls for a moderate slowdown in remittances (to about 5%), without undermining the increase in household spending. The current account surplus is likely to narrow in the quarters ahead, but this is due more to persistently sluggish exports than to the impact of lower remittances from migrant workers.

■ Relatively resilient to the slowdown in world trade

Whereas the other countries in the region have based their development on exports of manufactured goods, the Philippines have given priority to the export of services. Merchandise exports accounted for only 20% of GDP in 2015, compared to more than 50% in Malaysia and Thailand, for example. Compared to the other ASEAN countries, the economy’s low dependence on the manufacturing industry and its positioning (electronic components and smartphones) have made it more resilient to the slowdown in world trade. All in all, Philippine exports have declined 5% (in USD terms), compared to an average decline of more than 10% in the ASEAN countries.

Compared to the other emerging countries of Asia, the Philippines are also less integrated in the global value added chain and in the regional economy. Consequently, the country seems to be less exposed relative to the region’s other countries to the structural slowdown in world trade and the gains derived from the extension of production chains.

Above all, the Philippines seem less exposed to the transformation of China’s growth model (i.e. the economic transition away from assembly activities for global production chains, in favour of trade based essentially on exports of local inputs and imports mainly to meet domestic demand) than the other ASEAN countries. Although total exports to China are comparable (at around 13% of GDP, see chart), in terms of local value added implicated in the satisfaction of end demand, China accounts for less than 4% of GDP for the Philippines. In comparison, this figure is about 5% of GDP in Thailand and Vietnam and more than 8% of GDP in Malaysia.

■ Strong growth potential

Although numerous shortcomings remain, the Philippines’ solid economic performance stands out from that of the other emerging Asian countries, which have been hit harder by the slowdown in world demand. The Philippines seem to be relatively less exposed to new outbreaks of economic and financial volatility in the very short term.

In the longer term, it is essential to continue recent reforms to improve the economy (the IMF estimates potential growth at nearly 7%). In this respect, not much is at stake in May’s elections. All five candidates in the running to replace B. Aquino (the president can only be elected for a single term) seem to favour continuing economic reforms, without calling into question the dynamics of public finance consolidation. The increase in long-term projects and the rapid growth of FDI in Q4 2015 seem to show that investors are confident that the next government will continue to pursue the same policies.

Hélène Drouot [email protected]

3- Exposure to China % of GDP

X axis: exports to China

Y axis: value added included in Chinese final demand

Sources: IMF, OECD, BNP Paribas HK: Hong Kong, IN: India, ID: Indonesia, JPN: Japan, KO: South Korea, MY: Malaysia, PH: Philippines, SG: Singapore, TH: Thailand, TW: Taiwan, VI: Vietnam

JPN

KO

HK

IN

ID

MY

PH

SG

TW

TH

VI

0

2

4

6

8

10

12

0 5 10 15 20 25 30 35 40 45 50 55


economic-research.bnpparibas.com Mexico 2nd quarter 2016 19

Mexico

Stability first, growth second Economic growth prospects for 2016-2017 remain subdued due to a gloomy global environment (i.e. oil prices and US domestic demand revised downward) and an unsupportive policy mix. The authorities announced in February 2016 a coordinated fiscal and monetary response to adverse global economic conditions by cutting public spending (notably at Pemex, the state-owned oil company), hiking interest rates and revamping the FX intervention programme. Despite even lower oil-related receipts, the twin deficits are likely to remain on the safe side. Thanks to ongoing reforms, the country could still raise its medium-term growth potential by at least 1 percentage point to above 3.5%. But reaching 4% or more appears to be a distant dream.

■ Rather stable but not impressive economic growth

Economic growth has remained broadly stable at around 2.5% y/y over the past seven quarters. This is close to Mexico’s GDP growth trend, which is low for an emerging country. The tertiary sector has performed rather well (+3.3% in 2015), underpinned by rising real wages, accelerating credit growth, better labour market conditions and dynamic remittances from emigrated workers (strong US job market), which have supported consumption (retail sales up 5.1% in 2015). In the meantime, softer external demand (mainly from the US) and Mexican oil production’s new bout of weakness have undermined the expansion of the export-oriented industrial sector (+1% in 2015).

Over the past year we have lowered our economic growth forecasts due to: i/ a less buoyant international environment than expected (i.e. oil prices and US domestic demand); ii/ the weak peso that increases the price of imported inputs, narrows Mexican corporates’ margins, and finally potentially hampers job creations; and iii/ the authorities decision to tighten the fiscal and monetary belt.

■ Current account/FX rate/Inflation: managing a more challenging global environment

The Mexican peso (MXN) is prone to overshoot in periods of global financial stress and often mimics developments in emerging currency, as it is fully convertible, Mexico’s capital account is open with no capital controls and foreign participation in the domestic bond market is significant. As for inflation, the pass-through from FX depreciation to domestic prices was limited last year thanks to the global deflationary trend. In addition, domestic factors such as economic growth near its potential rate and structural reforms (lower energy and telecommunication costs) helped headline inflation to end 2015 at 2.1% y/y (close to the lower band of the 3% +/-1pp target), its lowest level ever.

More fundamentally, the sharp depreciation of the USD/MXN since the summer 2014 (-25%) has been explained by the free-fall in oil prices and the global appreciation of the USD. The trade balance has deteriorated over the past year on tumbling oil exports (-48% y/y in 2015 purely due to a drop in the average price of the Mexican mix from USD 85.5/barrel in 2014 to USD 43.3/barrel in 2015). Meanwhile, manufacturing exports have kept growing (+2.6%), helped by the weak MXN. Oil products now account for only 6% of total exports to the benefit of manufactured products (89% of total exports). Even though foreign direct investments remained dynamic, the strong FX reserve buffer declined by USD 20.7 bn in 2015 on stalling portfolio investments and huge errors & omissions.

Also, Mexico’s Foreign Exchange Commission (FEC) announced on February 17, 2016 the replacement of the USD auction programme with a discretionary FX intervention programme, which should be relatively more sparing in the use of FX reserves ammunitions going forward.

Inflation is expected to accelerate in the coming months (it jumped to 2.9% y/y in February driven by agricultural prices), but it should remain under control. The central bank (Banxico) initiated a monetary tightening cycle in December 2015. This first hike in the policy rate (+25 basis points to 3.25%) since August 2008 was followed by an unexpected intra-meeting 50 basis points (bp) second hike on February 17, 2016 to address the renewed weakening of the USD/MXN (-6.5% from early January to mid-February) and anchor



2- Nominal FX rates (indices : May 2013 = 100)

▬ USD/MXN — USD/basket of EM currencies

Sources: Datastream, BNP Paribas

2014 2015 2016f 2017f

Real GDP grow th (%) 2.3 2.5 2.0 2.4


Budget balance / GDP (%) -3.1 -3.5 -3.0 -2.5

Public debt / GDP (%) 40.1 44.6 45.3 45.8





Ex change rate /USD (y ear-end) 14.7 17.3 17.0 16.5

60

65

70

75

80

85

90

95

100

105

110

115

10 11 12 13 14 15 16

economic-research.bnpparibas.com Mexico 2nd quarter 2016 20

inflation expectations. These measures have so far helped to break the MXN depreciation trend. Banxico’s March policy statement was broadly neutral and all options seem to remain opened. Banxico will be very watchful towards the US Fed policy in order to smooth potential financial volatility.

■ Fiscal policy: belt tightening

Since the global crisis, the government has failed to reach the deficit target of 2% of GDP (including Pemex’s capex) mandated by the fiscal rule. But a prudent fiscal policy has helped the government to manage the deterioration in public accounts despite lacklustre economic growth and a low tax base: primary and overall balances averaged -0.6% and -2.6% of GDP from 2009-2014, respectively. In 2015, the public sector deficit widened slightly to 3.5% of GDP from 3.1% a year before. Both total revenue and total expenditure increased by 6% y/y in nominal terms. On the revenue side, a 35% fall in oil-related revenue was offset by a 31% increase in tax revenue supported by the 2013 fiscal reform. As a result, the share of oil-related revenue in total revenue halved to 17% from 34% on average over the past decade. On the spending side, while current expenditure (wages, pensions, transfers and grants) increased by 6%, total capital expenditure was flat even though Pemex’s capex dropped by 13%.

The Mexican government has implemented an oil price hedging programme (put options at an average annual cost of USD 1 bn) for more than a decade. Last year, the proceeds of this financial hedge amounted to USD 6.3 bn as the price of the Mexican oil mix was USD 31 below the floor price of the hedging programme (USD 76/barrel).

As for public indebtedness, outstanding federal public sector debt expanded by 11% a year from 2009-2015. In a context of tepid growth in nominal GDP, gross public debt/GDP climbed 19 percentage points to 45%, a two-decade high. Public debt is 67% denominated in local currency, of which 36% is owed to foreign investors. They hold 45% of total public debt, which exposes Mexico to swings in investor sentiment.

Interest payments climbed 25% over the past year but are still manageable at 9.6% of total revenue. Financing conditions have tightened but Mexico’s government still enjoys easy access to local and global markets. Five-year local bond yields have inched up from mid-2013 but remained moderate at 5.5% as of March 2016, which compares favourably with most major Emerging Countries. Risk premiums are still moderate: five-year CDS spreads on sovereign Eurobonds reached 190bp in March 2016 (vs. 70bp as of mid-2014), and 10y sovereign bond yield spreads over US Treasury bonds were 270bp (vs. 130bp in mid-2014).

The government’s hedging programme for 2016 will protect its crude oil revenue if prices remain below USD 49/barrel. In tandem with this buffer, the 2016 budget includes a cut in spending (equivalent to 1.3% of GDP), and Finance Minister Luis Videgaray announced in February new spending cuts (0.7% of GDP, mainly at Pemex), which may help to reach the government’s deficit target of 3% of GDP this year. We foresee the overall deficit to be below 3% in 2017 on accelerating economic growth and a very gradual rebound in oil prices. As regards the public debt/GDP dynamics, our central

scenario calls for a continued increase in 2016-2017 to 46% before a very gradual decline.

■ Lifting potential GDP growth to 4%+ is a distant dream

Mexico’s fundamentals are still sound, supported by reasonable macroeconomic imbalances (i.e. inflation, twin deficits, public and external debts), rather prudent economic policy and coordinated policy mix, sound banking system and low direct exposure to China’s slowdown. Nonetheless, the deterioration in the global environment has taken its toll on, and delayed, Mexico’s real GDP “take-off”. Should structural reforms engaged since 2012 (in the labour market, telecommunications, competition, education, social security, politics-elections, the financial sector, taxation and, last but not least, energy) be implemented successfully the country could still raise its medium-term growth potential by at least 1pp to above 3.5%.

But reaching 4% or more appears to be a hard task given the sharp oil counter shock and uncertain global outlook. Severe cutbacks in the investment plans of major oil companies now make the objective of attracting as much as 1pp of GDP in new investments by 2020 unachievable. Mexico’s growth potential is also undermined by a difficult business environment. The administration has henceforth to focus its energy on enforcing the rule of law, notably at the local level.


3- Five-year domestic government bond yields (%, annual)

▬ Mexico — China ▬ India — Russia ▬ Turkey — Brazil (4 years)

Source: Bloomberg

0

2

4

6

8

10

12

14

16

18

05/13 11/13 05/14 11/14 05/15 11/15


economic-research.bnpparibas.com Egypt 2nd quarter 2016 21

Egypt

Devaluation has mixed effects The Central Bank of Egypt (CBE) has devalued the Egyptian pound due to pressures on the FX market that had become unsustainable and were driving the development of a black market. This decision was accompanied by an increase in interest rates in order to attract deposits into the official banking system. This is a first stage in the stabilisation of the FX markets: the rebuilding of the CBE’s foreign exchange reserves and a further depreciation are necessary conditions. In the short term, the rise in interest rates will have relatively little effect. However, despite the devaluation, the current account balance remains under pressure. It is essential that Egypt remains on the path to reform and continues to receive external help.

Despite external financial support, foreign currency liquidity has declined continuously since 2011. Faced with the growing rationing of foreign currencies, the development of a black market and the increase in external debt of the whole banking system, a devaluation of the pound had become necessary.

■ Devaluation of the pound: a first step

The 13% devaluation of the pound against the US dollar on 14 March 2016 was an initial response to the growing shortage of foreign currencies. Given the low level of forex reserves at the central bank and the external debtor position of the banking system as a whole since the beginning of the year, dollar liquidity had become a real problem for economic agents. This resulted in the blockage of imports waiting for payment and caution amongst foreign investors given the difficulty of repatriating funds and the prospects of a depreciation of the pound. The FX black market allowed a certain continuity for business, but at a rate well above the official one (EGP 9.5 per USD against EGP 7.8 prior to devaluation). This market, which may have accounted for 70% of activity on the FX market, deprived the official banking system of a substantial volume of foreign currency liquidity. The aim of the CBE was therefore to introduce to the market a substantial volume of foreign currency at a sufficiently attractive price to encourage a transfer of foreign currencies to the official banking system.

Before the devaluation decision, caps on foreign-currency bank deposits were lifted. Alongside the devaluation, the CBE made a record volume of foreign currency (USD 1.5 bn) available on the market at a rate of 8.85, and significantly raised the interest rate on deposits in Egyptian pounds. The two main public-sector banks increased the rate paid on 3-year deposits by 250 basis points (bp), whilst the CBE increased its main deposit rate by 150bp to 10.75%.

It is still too early to say whether or not the devaluation has achieved its goals. Initial indications are mixed. Having risen slightly, the black market exchange rate continued its depreciation, reaching an estimated level of 10/USD. At the end of March, the central bank’s forex reserves were stable at USD 16.5 bn. Moreover, the bank’s governor announced that non-resident portfolio investment (equities and fixed income securities) increased by USD 0.5 bn following the devaluation. The Cairo stock market gave the devaluation a warm welcome, gaining 14% over 2 weeks, but leading indicators of economic activity remain in negative territory. The PMI index dropped to 44.5 in March (from 48.1 in February), its lowest since August 2013.

This devaluation is the first stage in the process of restoring foreign currency liquidity. The scale of the devaluation so far is still a fair

way short of what would be needed to restore the external competitiveness of the Egyptian economy. Before the devaluation, the trade-weighted real exchange rate of the pound had increased 25% in 18 months against a background of a widespread real-terms depreciation of emerging market currencies. The uptrend in the real exchange rate is likely to continue, given the structurally high level of inflation in Egypt (relative to its main trading partners). Two factors seem necessary before one can conclude that the FX market have normalised (that is to say the black market has been almost suppressed and restrictions on currency movements removed): a further depreciation of the pound and the rebuilding of

1- Summary of forecasts*


2- Real Effective Exchange Rate

Index

▬ Egypt ▬ Emerging countries average

Sources: JP Morgan, BIS

2014 2015 2016f 2017f

Real GDP grow th (%) 2.2 4.1 3.5 4.0



Gen. Gov . debt / GDP (%) 90.0 89.0 85.0 84.0





Ex change rate EGP/USD (y ear end) 7.2 7.6 8.90 9.3

(*) Fiscal y ears T-1/T (July -June)

70

80

90

100

110

120

130

2013 2014 2015 2016

economic-research.bnpparibas.com Egypt 2nd quarter 2016 22

adequate foreign exchange reserves. The CBE’s aim is to build reserves of USD 25 bn, the equivalent of 3.8 months of good and service imports.

■ The expected effects

In the short term, the devaluation of the pound will result in an increase in inflation, even though part of the devaluation had been included in prices for several months. Evidence of this comes from the fact that car importers had increased their prices by more than 5%, and a further 10% rise is likely over the next few months. Average annual inflation is likely to remain above 10% at least until 2016-2017. Part of the political impact of this inflation will be dampened by the maintenance of food subsidies.

Another consequence of the devaluation is that it has been accompanied by a widespread increase in treasury notes and bonds rates across all maturities. Although there has been a slight easing since the end of March, issue yields have risen by between 120bp and 200bp relative to pre-devaluation issues. Given that the bulk of financing of the budget deficit is achieved on the local market, and debt service accounted for 45% of total fiscal receipts in 2014-2015, the negative consequences of the devaluation on the budget deficit will not be negligible. We estimate that the apparent interest rate on government debt is likely to climb by 50bp in 2016-2017 and that debt service is likely to reach nearly 50% of receipts. The consequences of the devaluation for total government debt dynamics will probably be limited, as only 9% is issued in foreign currency. Moreover, despite continuing to run large deficits (10.7% of GDP expected in 2016-2017), government debt is likely to continue to fall as a percentage of GDP, reaching 80% in 2017-2018 (from 89% in 2014-2015), given the relatively strong economic growth and persistently high inflation.

The effects of the devaluation on the current account deficit will probably be fairly limited. The potential gain in price competitiveness generated by the devaluation looks unlikely to be enough to offset the real-terms rise in the exchange rate since 2014. More significantly, the increase in the current account deficit since 2013-2014 (to -3.8% of GDP in 2014-2015) is due mainly to the fall in tourist numbers and the rising deficit on energy. The devaluation will have only a marginal effect on these factors. After rallying in 2014-2015, tourism is likely to decline steeply this year. In the year to February 2016 it had already fallen 41%. Tourism revenues contracted by one third in the first half of 2015-2016. Given the lasting geopolitical tensions in the region, any recovery in tourism will come only very slowly. Meanwhile, oil exports have suffered as a result of lower prices, whilst domestic consumption is driving an increase in imports. In the first half of 2015-2016 the deficit on energy increased by 40%. In all, the current account deficit could hit 5% of GDP in 2015-2016. However, the energy deficit could improve faster than currently expected. According to ENI, production from the Zohr gas field could begin in 2017, thus helping cut the energy deficit. In addition, the agreement with Saudi Arabia for the supply of USD 20 bn in oil products over the next five years (equivalent to around ¼ of the annual energy bill) is also likely to ease pressure on the balance of payments.

The government has high hopes for the return of foreign investors to the local sovereign debt market. In 2010, the stock of treasury notes held by non-residents was USD 6.7 bn. Since 2011 it has been

virtually zero. The increase in the yields on government debt and the ability to hedge against exchange rate risks are likely to encourage a return by foreign investors. However, until the situation is fully stabilised, with a credible level for the pound and a rise in the CBE’s currency reserves, this return will remain slow.

These early stages of a positive trend of reform are a factor in the improvement of Egypt’s economic prospects. However, advances in the fiscal position remain hesitant and the restoration of adequate foreign currency liquidity has not yet been achieved. The country faces another difficult year in 2016-2017, with rising interest rates, continued geopolitical tension in the region and a growing energy deficit. Bilateral and multilateral financial support remains essential to ensuring Egypt’s economic stability.

Pascal Devaux [email protected]

3- Central Bank of Egypt FX reserves

█ USD bn ▬ Months of G&S imports (rhs)

Sources: CBE, BNP Paribas

0

1

2

3

4

5

6

7

8

0

5000

10000

15000

20000

25000

30000

35000

40000

06/2010 06/2012 06/2014 06/2016


economic-research.bnpparibas.com Morocco 2nd quarter 2016 23

Morocco

Difficult rebound Morocco stands out favourably compared to the rest of the region. Macroeconomic fundamentals have improved significantly thanks to the drop in oil prices. The country has never before attracted so much foreign investment, especially industrial investment, and several new high-potential business lines are emerging. Yet there is another reality that must also be taken into account. Non-agricultural growth has decelerated sharply since 2013, and the prospects of a rebound are limited, at least in the short term. The country’s economic development is hampered not only by the weak international environment but also by several structural obstacles.

■ Solid macroeconomic fundamentals

Morocco stands out favourably comparted to the rest of the region. Real GDP growth averaged 4% in 2011-2015 against 2.6% in the oil-importing countries of North Africa and the Middle East, thanks to its relatively stable social-political environment and the implementation of ambitious reforms. The drop in oil prices has also considerably accelerated the macroeconomic consolidation process. The savings enabled it to slash the budget deficit to 4.3% of GDP in 2015, from a peak of 7.4% in 2012, without the gradual deregulation of prices for petroleum-based products triggering renewed inflation. Government debt is still relatively high at 64% of GDP, but it is still supportable. The bulk of outstanding debt is denominated in the local currency. The external position has also improved spectacularly. From nearly 10% of GDP in 2012, the current account deficit narrowed to 2.2% in 2015. It should be closed to balance this year. With the massive inflow of foreign capital, this will further strengthen the country’s external liquidity. Foreign reserves should cover eight months of imports of goods and services by the end of the year. Morocco is thus sheltered from the numerous sources of vulnerability hitting the emerging countries.

■ Yet several factors are hampering growth

Excluding the primary sector, however, Morocco’s performances are much more moderate. Non-agricultural GDP rose only 3.1% on average in 2013-15 compared to 5% in 2011-2012. If we look at the growth of non-farm value added, i.e. without taken into account the contribution to “taxes on income net of subsidies”, the slowdown is even sharper. From 5.6% a year in 2011-2012, the growth rate dropped to 2% over the past three years. Moreover, official forecasts call for only a slight improvement in 2016-2017 as the deteriorated security situation in several countries in the region is straining the tourism sector, and demand from the eurozone, Morocco’s main trading partner, is still sluggish.

Fortunately, the authorities have regained manoeuvring room to revitalise the economy. The 2016 budget calls for an 8% increase in public investment, and the central bank has just lowered its key policy rate by 25 basis points to 2.25%.

Yet it is far from certain that these measures will be all that effective. The government’s determined efforts in terms of capital expenditures did not prevent the investment rate from falling by more than 4 points over the past two years. Bank lending is also sluggish (+2.7% in 2015), despite an initial round of monetary easing in late 2014. Non-performing loans have soared since 2013, making banks more selective. However, the NPLs-to-total loans ratio is high at 7.2%, but it does not threaten the stability of the

financial system. Furthermore, the liquidity squeeze that prevailed in 2012-2013 has eased significantly. As a result, banks difficulties in providing the economy with credit were mainly due to sluggish demand, especially from corporates. The same observation can be made for loans for investment, cash flow or lending to real estate developers: they all contracted in 2015, after three years that were already very tough. Moreover, although household loans are holding up fairly well, momentum is also showing signs of slowing due to persistently high unemployment (9.2%).

In other words, although Morocco’s economic recovery has run up against lacklustre domestic demand, this situation is due less to



2- Economic growth y-o-y change, %

▌GDP ▌Non-agricultural value added

Sources: HCP, BNP Paribas

2014 2015 2016f 2017f

Real GDP grow th (%) 2.4 4.5 1.7 3.8


Central. Gov . balance / GDP (%) -4.9 -4.3 -3.8 -3.5

Central. Gov . debt / GDP (%) 63.4 64.0 65.7 64.7



Forex reserv es (USD bn) 19.7 22.3 26.8 29.5


Ex change rate /USD (y ear end) 9.0 9.9 10.0 9.8

0

1

2

3

4

5

6

7

8

05 06 07 08 09 10 11 12 13 14 15e 16f 17f

economic-research.bnpparibas.com Morocco 2nd quarter 2016 24

financing constraints than to the lack of visibility and structural obstacles.

■ Structural transformation: mixed track record

The slowing momentum of the non-farm sector reflects the country’s troubles in finding new sources of growth in a very unstable external environment.

Yet structural changes are underway, beginning with the development of the automobile industry. Since the launch of the Renault factory in Tanger in 2012, international car sales have increased by more than 20% a year and are now the country’s main source of exports. With the installation of another French carmaker, Peugeot-Citroën, the medium to long-term prospects are promising. Moreover, the economy has never before attracted so much foreign investment. Accounting for more than 3% of GDP since 2013, net FDI inflows have been redirected toward industrial activities to the detriment of real estate and tourism. Lastly, the liberalisation of the exchange rate regime continues to progress with the goal of positioning Morocco as a key regional financial hub. The Moroccan banks’ development in sub-Saharan Africa is also an illustration of the efforts made to diversify trading partners and to be less dependent on Europe.

Yet the economy has accumulated numerous handicaps relative to its main competitors. The first, and not the least, is its shallow industry. Despite the emergence of new sectors, such as the automobile and aerospace industries, manufacturing accounted for only 16% of GDP in 2014. More than half of exports are still comprised of products with low technology content, while certain traditional activities (textiles) are ailing. This explains why the Moroccan economy is having trouble inserting itself within the global value added chain. Another disturbing signal is that the industry is the only sector that has lost jobs since 2009.

Morocco must also cope with major social-economic shortfalls, even though progress has been made since the early 2000s. Per capita GDP amounted to only USD 3,300 in 2014, which is two to three times lower than in Bulgaria, Romania or Turkey. As a result, Morocco’s domestic market is not as deep, hampering potential consumption and savings. The level of education also lags behind. This is a handicap in a very competitive regional environment, even if Morocco has other strengths for attracting foreign companies, starting with the quality of its infrastructure.

We would like to conclude with another observation. Despite a particularly high investment rate, the results are not fully satisfactory. The Turkish economy, for example, obtained virtually the same growth performances in 2005-2015 with an investment rate that was 14 points lower. Against this backdrop, we can see one of the main challenges facing the country in the future: to ensure the up market shift in the production process, especially in industry, to improve productivity and boost the economy’s growth potential. Stéphane Alby [email protected]

3- World market share %

▬ 2010 ▬ 2015

Sources: IIF, BNP Paribas

0,0 0,2 0,4 0,6 0,8 1,0 1,2 1,4

Poland

Turkey

Romania

Bulgaria

Egypt

Morocco

Tunisia


economic-research.bnpparibas.com Angola 2nd quarter 2016 25

Angola

“In shock” Angola’s economy is paying a heavy price for its lack of economic and commercial diversification. Export revenues and public finances have been severely weakened by low oil prices. The economy is facing a shortage of dollar liquidity and the fast depreciation of the kwanza, which is generating significant inflationary pressures and forcing the authorities to tighten monetary policy to the detriment of growth. The lack of foreign currency liquidity and the economic slowdown are also affecting the banking system, and heavily downgrading the political climate with rising public discontent.

■ On the brink of recession

Real GDP growth in Africa’s second biggest oil producer decelerated from 6.8% in 2013 to 3% in 2015, as the result of the slowdown in China and the oil price shock. Against this background, growth could soon turn negative and the country is likely to slip into recession in 2016. Angola is likely to see a de facto fall in GDP/capita for the third consecutive year.

The fall in fiscal receipts has obliged to postpone certain government investment projects. Private investment is held back by high interest rates and measures to restrict the access to foreign currencies. In addition, a law introduced in August 2015 requires foreign investors to form a local partnership for any strategic investment (energy, transport, tourism, construction and technology) with the local partner holding at least 35%.

As a result, the business climate is at its lowest recorded level (the ICE1 fell by 9 points in Q3 2015 and by a further 20 in Q4). The country has rapidly become less attractive, particularly for Portuguese-speaking investors and suppliers, and the unemployment rate is rising (estimated at 25% in 2015).

In addition, household consumption is being held back by increasing inflation as a result of cuts in petrol price subsidies and, more importantly, the depreciation of the kwanza. Inflation has risen sharply since the beginning of the year (20.3% y/y in February), taking it to its highest level for the last 10 years. Given the inability of local industry to substitute for imports, the rapid fall in the kwanza generates imported inflation and leads to shortages of certain goods.

Despite a fairly aggressive tightening of monetary policy, the Central Bank now has very little room for manoeuvre. Moreover, the unexpected departure of its former Governor, at a fairly critical moment, looks like an admission of the monetary policy’s powerless.

■ Deepening fiscal and current account imbalances

Angola is one of Sub-Saharan Africa’s most oil-dependent economies (oil accounts for 40% of GDP, more than 60% of fiscal receipts and 90% of export earnings). The persistent weakness of oil prices has had a heavy impact on external accounts and public

1This indicator of the business climate has been published since 2008 by the National Statistical Institute, and gives the difference between positive and negative responses to a survey of the perception of economic conditions; it covers around 80% of businesses (in mining, manufacturing, construction, tourism, commerce and transport) and 53.5% of employees.

finances. These difficulties have fuelled concerns at the ratings agencies2 and contributed to investor caution.

Because of the sharp fall in export revenues and the rising price of imports due to the devaluation of the national currency, the current account slipped into deficit in 2014, and this deficit could rise to 11% of GDP this year, based on a projected oil price of USD 37/barrel. Despite weak internal demand, the country remains highly dependent on international trade, making part of its imports incompressible.

2On 25 March 2016, Fitch put the sovereign rating on negative outlook. S&P’s downgraded its sovereign rating from B+ to B in February. At the beginning of March Moody’s placed its rating on review for possible downgrade.


f: BNP Paribas Group Economic Research forecasts

2- Powerless monetary tightening against inflation %

█ Inflation (CPI, y/y) ▬ Central Bank policy rate

Sources: IMF, National Statistical Institute

2014 2015 2016f 2017f

Real GDP grow th (%) 4.8 3.0 -1.0 1.0


Cent. Gov . balance / GDP (%) -6.4 -7.5 -5.5 -4.5

Cent. Gov . debt / GDP (%) 39.8 49.7 56.7 57.6





Ex change rate USD/AOA (y ear end) 103 138 165 182

0

2

4

6

8

10

12

14

16

18

20

22

5

10

15

20

25

30

35

2008 2009 2010 2011 2012 2013 2014 2015 2016

economic-research.bnpparibas.com Angola 2nd quarter 2016 26

The deterioration of external accounts has led to dollar liquidity issues and to the substantial downward pressure on the kwanza, which has lost 34% of its value against the dollar over the past year. The gap between the official exchange rate and the rate on the parallel market is widening and becoming difficult to sustain. After the sharp currency devaluations in 2015, the monetary authorities seem to favour a policy of more managed currency depreciation in 2016.

Moreover, to stem the gradual erosion of reserves (to USD 24.3 bn at end-February), the monetary authorities are likely to retain the foreign exchange control measures 3 adopted last year. These measures hit enterprises hard (delayed payments, non-renewal of supply contracts, winding up) and diminish the quality of banking sector assets.

Despite the significant adjustments in the 2015 budget, public finances have deteriorated because non-oil revenues have been limited by the economic slowdown. Given the fairly optimistic assumptions used in the 2016 budget (USD 45/barrel, GDP growth of 3.3% and inflation between 11% and 13%), additional fiscal consolidation measures will be essential to bring the budget deficit to 5.5% of GDP (gradual withdrawal of subsidies, freeze on salaries and recruitment in the public sector, reform of the tax collection system), further depressing domestic demand.

Given the slowdown in economic growth, the exchange rate depreciation and the widening budget deficit, the debt to GDP ratio has risen by more than 20 points over the past three years. It reached 49.7% in 2015 and is likely to be more than 56% in 2016. Given the inadequacy of domestic financing sources, external government debt is likely to rise (largely in the form of concessional loans, given the relatively poor conditions for emerging market debt in the international markets). As a result, the share of debt in foreign currency is likely to reach 60% of the total, whilst the debt-to-GDP ratio will become all the more vulnerable to external financing conditions and exchange rate risks.

■ Growing social discontent

There are several factors that currently threaten Angola’s political stability. Incumbent president José Eduardo dos Santos has long been the “Nation’s Patriarch”, guaranteeing stability after years of civil war. He is now the target of all frustrations, given the lack of change in political leadership since 1979.

The authorities appear increasingly intolerant of any form of opposition (preferring repression to dialogue), with deterioration in fundamental freedoms and the democratic landscape in Angola.

The current economic crisis only serves to heighten socio-economic tensions which have never been resolved (inequality, poverty, corruption). Late payment of civil service wages (and some in the private sector) has further fuelled social unrest. In view of the very difficult economic circumstances, the risk of a political challenge remains very high in the short term.

3Cap on withdrawals from foreign currency accounts, limits on currency for foreigners, import quotas on certain products, priority access list to dollars at the official rate (oil and food goods notably), 10% tax on all services provided by non-residents.

Between now and the legislative elections planned for 2017, the opposition could thus capitalise on growing discontent. In March, the President declared that he wants to retire from the political scene in 2018, after 37 years at the helm. However, in the absence of a succession plan or if the transition were to be poorly managed, there could be political instability (with power struggles in the ruling party).

According to the Constitution, in the case of early retirement of the President, the current Vice President, Manuel Vincente, would step in until the next elections. The President’s children have always denied harbouring any political ambitions, and Mr. Vincente, the former CEO of Sonangol, the main state-owned oil & gas company, looks like the most plausible candidate for Angola’s presidency in the medium term.

Sara Confalonieri [email protected]

3- Reserves maintained at the cost of currency pressures Foreign exchange reserves in USD bn

█ Foreign exchange reserves Parallel exchange rate (rhs) ▬ Official exchange rate (rhs)

Sources: Central bank, IMF, EIU

0

50

100

150

200

250

300

350

4000

5000

10000

15000

20000

25000

30000

35000

40000

2010 2011 2012 2013 2014 2015 2016


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