15 March 2016
Standard Chartered Reports on One Belt One Road Initiative March (March 2016)
Standard Chartered Reports on One Belt One Road Initiative
Special Report: China’s bond markets – The start of a golden age
China’s onshore bond market is now the world’s third largest, and its credit market has become the second largest. We expect the market to more than double to CNY 100-105tn by end-2020 (from CNY 48tn at end-2015), rising to c.100% from 62% of nominal GDP.
We see strong supply during the 2016-20 period, boosted by local government debt swaps, a likely wider budget deficit, the transition of China’s credit extension model from loans to bonds, and the significant relaxation of regulations on credit bond issuance in 2015.
We expect strong demand. Asset managers could become much larger holders, driven by the centralisation of pension investments and fast growth in the mutual fund and insurance industries amid China’s growing wealth and ageing population. Banks’ holdings are likely to decline. We expect foreign ownership to rise sharply following the interbank bond market liberalisation, to 4-7% by 2020.
We provide a detailed analysis of the supply outlook for each bond type, and the outlook for demand from banks, pension funds, mutual funds, insurers and foreign investors. We summarise key regulatory changes and discuss on- and offshore FX and rates hedging options.
Economic Alert: India – Budget target is a positive; quality could suffer
The positives in India’s FY17 budget were strong: Much to the surprise of the markets, including us, the finance minister announced a tough fiscal deficit target for FY17 (year ending March 2017) of 3.5% of GDP (FY16: 3.9% of GDP). This is in Iine with the original fiscal consolidation plan and comes despite a challenging economic environment. We believe adherence to the original target for FY17 will enhance both policy credibility and macroeconomic stability for India, a big advantage in today’s volatile global environment. With the government adhering to its promise, we expect the Reserve Bank of India (RBI) to reduce the repo rate at its 5 April policy meeting, if not sooner. An inter-meeting cut cannot be ruled out. The ongoing focus on select infrastructure projects, such as roads and railways investment, is another positive.
Aspirations to improve the quality of fiscal consolidation are unlikely to be realised: We expect the government to adhere to the 3.5% of GDP fiscal deficit target irrespective of any adverse developments, much in line with the trend since FY14. However, we think the government will have to reduce its capital expenditure (excluding for roads) in FY17 to meet this target. This is because we think the government has (1) overestimated one-off receipts by 0.35-0.40% of GDP; (2) underestimated recurrent expenditure related to the implementation of the seventh pay commission and food subsidies by 0.10-0.15% of GDP; and (3) provided a lower-than-expected allocation for bank recapitalisation which could increase over FY17.
OTG: Pakistan – Steady as she goes
February marks Pakistan’s entry into the last six months of its three-year IMF Extended Fund Facility (EFF). Staff-level agreement on the 10th review was reached last month, with the programme likely to be concluded by August 2016. The Fund’s mission chief, Harald Finger, has described the prospects of a successful programme as “quite good”. We believe policy makers will continue to focus on meeting programme targets – particularly fiscal consolidation and building FX reserves – as they enter the last few reviews.
Despite tighter fiscal policy, we believe domestic demand requires little stimulus after 350bps of cuts since November 2014 (On the Ground, 9 November 2015, ‘Pakistan – Spotlight on domestic demand’). Credit flows to the private sector in 7M-FY16 were twice the level in FY15, and consumer confidence was at an all-time high. However, we maintain our FY16 GDP growth forecast of 4.4% on supply-side constraints (e.g., energy shortages and a lower cotton crop) and trade weakness, partly on real effective exchange rate (REER) strength.
Rising import demand and declining exports widened the non-oil goods trade deficit (FOB) by c.90% y/y in 7M-FY16. Despite low oil prices, the goods trade deficit was nearly flat (-1.3% y/y). Remittance growth slowed to 6% from 17%; we expect similar growth for the full financial year ending June on weaker GCC growth. We raise our current account (C/A) deficit forecast to 1.3% of GDP from 0.6%. Against this backdrop and stable inflation, we expect the central bank to keep the policy rate steady at 6% in FY16.
OTG: Bahrain – Bear with me
We turn more bearish on Bahrain’s short-term growth on weaker prospects for non-oil-sector growth and the vulnerability of oil-sector growth to swings in oil production, particularly from the Abu Safah shared field.
We cut our 2016 real GDP growth forecast to 2.5%, from 3.5% previously. Real GDP growth dropped to 2.4% y/y in Q3-2015 from 3.7% y/y in Q2. The oil sector – which makes up 21% of real GDP – contracted 1% y/y. The non-oil sectors lost momentum, but continued to post positive growth. Financial services, manufacturing, trade and construction slowed, while tourism, health care and education picked up growth momentum. Growth in government services, which make up 12.6% of real GDP, continued to slow. We believe that this is a sign that public consumption and investment are decelerating.
Indeed, fiscal policy has turned contractionary, which is also likely to affect Bahrain’s growth outlook. We forecast a fiscal deficit of 14% of GDP for 2016. Fiscal adjustment is necessary, as Bahrain has already raised its debt ceiling twice to BHD 10bn (c.80% of GDP). The government has started subsidy reform – subsidies for energy, utilities and meat are gradually being lifted. This reform could cause a one-off impact on inflation, which we forecast will accelerate to 3.5% in 2016. Adhering to a fiscal adjustment path will be crucial for the government to maintain its investment-grade ratings. All three rating agencies rate Bahrain at the lowest investment-grade status, with negative outlooks.
OTG: Saudi Arabia – Deficits, debt and deceleration
A second year of low oil prices is weighing heavily on Saudi Arabia’s economy. Growth momentum should slow significantly under the weight of lower government spending. We reduce our growth forecast to 1.5% this year (from 2.7%).
We expect the fiscal balance to reach a deficit of 12.3% of GDP, versus 15% in 2015. 2016 is set to be a year of fiscal consolidation. The fiscal adjustment effort will likely initially focus on expenditure. To this end, the government appears to be sending a strong message about the need to cut spending – defence and security spending is budgeted 31% lower than in 2015 and energy subsidy reforms have been kick-started. Measures are also underway to bolster the revenue side, but these will probably take longer to come into effect. Contractionary fiscal policy and spending cuts support the fixed exchange rate regime by compressing imports and reducing demand for foreign currency resources.
We expect further tightening in monetary conditions this year as the government continues to finance the budget partly by issuing local-currency (LCY) government bonds. We anticipate that the government will rely more on debt issuance this year than in 2015, including by tapping international capital markets and via loan syndications.
We estimate that the current account (C/A) turned to a deficit of 7.5% of GDP last year for the first time since 1999 on the terms-of-trade shock. We expect the C/A to remain under pressure this year, with a deficit forecast at 6.7% of GDP. For 2016, we estimate the C/A breakeven oil price at c.USD 65/barrel (bbl).
Although financial markets question the sustainability of the Saudi Arabian riyal (SAR) peg to the USD, we expect no change in Saudi Arabia’s currency policy. Reserves, although declining, are adequate. Given that exports are dominated by hydrocarbons, currency devaluation would yield limited competitiveness gains. Furthermore, the SAR peg stands to benefit from fiscal consolidation and tighter monetary conditions, both of which should reduce pressure on reserves.
OTG: ASEAN – Lining up the bulls and the bears
The Standard Chartered Global Research team conducted annual briefings in five ASEAN cities in January. Besides presenting our 2016 outlook, we took the opportunity to poll our clients on their views and sentiment (refer to the Standard Chartered Research website for publications on individual country polling results).
A key takeaway is that growth expectations for ASEAN are mixed. Sanguine growth expectations for ASEAN appear almost out of place compared to global financial market sentiment. Although we believe ASEAN will not be insulated from a global slowdown, we think it will continue to outperform other regions such as Latam (see On the Ground, 14 January 2016, ‘ASEAN – Growing, but below trend’).
Client sentiment appears largely in line with our expectations. We expect ASEAN growth to be slightly better, but still below trend, this year, driven by domestic factors. Optimists outnumber pessimists in three ASEAN countries – Vietnam, Indonesia and the Philippines. Pessimists outnumber optimists in Thailand and Malaysia.
We expect stronger growth in Vietnam (2016: 6.9%; 2015: 6.7%) and Indonesia (2016: 5.2%; 2015: 4.8%), but a slightly worse, albeit still strong, year for the Philippines (2016: 5.7%; 2015: 5.8%). Our forecast for stronger growth in Thailand (4.0%; 2.9%) differs from negative client sentiment. We expect weaker growth in Malaysia (2016: 4.7%; 2015: 4.9%). We believe, however, that our clients are excessively bearish.
OTG: Sri Lanka – Subdued outlook for 2016
We believe Sri Lanka’s economy will need to re-balance in 2016, as macro vulnerabilities have increased on a widening twin deficit, high public debt and low FX reserves. The government will therefore need to increase its monetary defences by raising interest rates gradually in 2016, bolstering FX reserves and lowering the current account deficit. It will also need to sharply cut expenditure (mostly public investment) to rein in the fiscal deficit and rising public debt given that a sharp increase in revenue collection is unlikely. We expect this to have a negative impact on growth.
We therefore lower our GDP growth forecast for 2016 to 5.5% (from 6%) on an expected slowdown in private consumption due to monetary tightening, higher inflation and a slowdown in remittances. We forecast a fiscal deficit of 6% of GDP for 2016. We expect the Central Bank of Sri Lanka (CBSL) to raise policy rates by 50bps in 2016 (two hikes of 25bps each) as it gradually tightens monetary policy.
OTG: Indonesia – Sustaining growth momentum
On 11 February, the Indonesian government revised its investment-negative list, the list of sectors closed to foreign investment or partly open with specific requirements, to attract more foreign investment to the country. 84 industries are now open for foreign investment, even up to 100% ownership. In addition to creating jobs and financing economic development, the government aims to promote more competition in highly concentrated industries that have been keeping the price of goods high. The policy is likely to prepare domestic industries to compete globally by acquiring new technologies and adopting industry best practices. We think the policy will attract more foreign direct investment (FDI) as the government opens foreign access to Indonesia’s lucrative industries, such as health-care, services, and distribution and warehousing, which are the beneficiaries of the country’s growing middle-income class and government infrastructure projects.
The latest data suggests that growth momentum remained upbeat in January. Private consumption and investment performed well, as indicated by improved consumer confidence and strong growth in cement demand. We maintain our 2016 GDP growth forecast of 5.2%, up from 4.8% in 2015, on a strong boost to investment.