Editorial p.2 BRAZIL RUSSIA INDIA CHINA PHILIPPINES TURKEY POLAND UKRAINE ALGERIA ...

28 Pages·2017·2.77 MB·English

ECONOMIC RESEARCH DEPARTMENT

Editorial
Favourable winds, but residual risks
In emerging countries, the economic recovery is firming thanks to China’s growth stabilisation, the p.2
upturn in foreign trade and the normalisation of financial conditions after the turmoil that followed
Donald Trump’s election. The main two global risks – the threat of protectionism and the risk of an
accelerated tightening of the Fed’s monetary policy – do not seem to be as menacing as in late 2016.
But the international financial institutions keep drawing our attention to other specific risks, which call
for caution.
BRAZIL RUSSIA INDIA
An endless saga Macroeconomic consolidation Feeble investment strains growth
p.3 p.5 p.7
CHINA PHILIPPINES TURKEY
Less credit should mean slower economic Getting nervous about politics? Anaphora of threes
growth
p.9 p.11 p.13
POLAND UKRAINE ALGERIA
Cyclical upswing Economic growth picks up, but not Striking the right balance
employment
p.15 p.17 p.19
NIGERIA EGYPT QATAR
A sluggish recovery ahead Inflation: EGP depreciation does not Political crisis highlights economics
explain everything vulnerability
p.21 p.23 p.25

economic-research.bnpparibas.com Eco Emerging 3rd quarter 2017
Editorial
Favourable winds, but residual risks
In emerging countries, the economic recovery is firming thanks to China’s growth stabilisation, the upturn in foreign trade and the
normalisation of financial conditions after the turmoil that followed Donald Trump’s election. The main two global risks – the threat
of protectionism and the risk of an accelerated tightening of the Fed’s monetary policy – do not seem to be as menacing as in late
2016. But the international financial institutions keep drawing our attention to other specific risks, which call for caution.

For emerging countries, the economic environment is more buoyant. levelled off and the gaps have narrowed. Moreover, under a
Since the beginning of the year, external trade in goods has simulation of higher interest rates, debt servicing ratios do not
accelerated, portfolio investments are flowing in again, and USD- deteriorate to the point of exceeding critical thresholds.
denominated financing conditions are still very favourable: for the
Bank risk: in its Global Financial Stability report released in April,
moment, the easing of risk premiums has offset the mild increase in
the IMF warns that in some countries, the ratios of non-performing
US bond yields. In our selection of 26 of the main emerging market
loans and problem loans (restructured loans, loans with late
countries, year-on-year growth could surpass 5% in Q2 2017, up
payments but not classified as non-performing, and loans under
from 4.7% in Q1 and 4.5% in H2 2016. The EM Growth Tracker of
surveillance) increased between year-end 2013 and mid-2016, due
the Institute of International Finance (IIF) was already up 5.2% year-
either to general recessions (Brazil, Russia, Nigeria, Ukraine) or to
on-year in May. At the same time, the rebound in oil and metal
heavily indebted companies operating in ailing sectors (China, India,
prices came to a halt and agricultural commodity prices remained
and to a lesser extent Indonesia). Of a selection of 300 banks from
flat. Of course, this is bad news for oil-exporting countries; the most
14 countries, the ratio of non-performing and problem loans in 2016
fragile oil producers still have to rebuild their foreign reserves again
did not exceed 10% with the exception of India (11%) and Russia
(see Editorial of April 2017). For oil-importing countries, in contrast,
(15.6%). However, they accounted for nearly half of equity capital
the slight upturn in inflation between mid-2016 and early 2017 will
and provisions (both specific and general) in Columbia, South Africa
probably disappear, especially since most of their currencies have
and Brazil, and for almost 80% in India and Russia.
regained ground against the US dollar. Central European countries
are the main exceptions: inflation was negative until mid-2016 but Sovereign risk: In the June issue of Global Economic Prospects,
has now swung back into positive territory, as job market pressures the World Bank points out that a high proportion of commodity
are building and wage growth is accelerating. If there is any region exporting developing countries has a primary balance (i.e. total
where monetary policy should be tightened, this is probably it, fiscal balance excluding interest charges) that is not large enough to
although only mildly. Lastly, the main two global risks for emerging stabilise the country’s public-debt ratio. This proportion is currently
countries – the threat of protectionist measures announced by 80%, up from only 30% before the 2008-2009 financial crisis. The
Donald Trump after taking power, and the risk of an accelerated difference between the primary balance and the debt-stabilising
tightening of the Fed’s monetary policy – do not seem to be as primary balance (so called sustainability gap) was on average -5%
menacing as in late 2016. of GDP in 2016, whereas it was clearly positive before the crisis
(+5% of GDP). Moreover, despite fiscal consolidation efforts, the
But the international financial institutions have warned of other
sustainability gap still has not started to narrow whereas, in past
specific risks in their recently published first-half reports:
episodes of sharp oil price corrections, this indicator had returned to
Financial risk: The Bank of International Settlements (BIS), in its pre-shock levels in two years’ time. Yet with higher debt ratios and a
annual report released in June, notes that, historically, peaks in the narrowing gap between the GDP growth and the average interest
financial cycle are generally followed by periods of financial or rate on the debt, interest charges have increased sharply for low
banking stress. BIS assesses the position of an economy in the income developing countries, meaning that they will need to make
financial cycle based on two early-warning indicators: the credit-to- even bigger fiscal consolidation efforts.
GDP gap (i.e. the deviation of the private non-financial sector credit-
François Faure
to-GDP ratio from its long-term trend) and the debt service ratios for
[email protected]
private agents (household and corporate debt combined) relative to
the historical average. The second indicator provides a better
measure of near-term risks. The use of gaps signifies that the
dynamics are more important than the level.
Looking at a selection of the 15 largest emerging countries, only
China and Hong Kong have high or very high credit-to-GDP or debt
service gaps. Next comes Turkey, with moderately high gaps.
According to BIS, the credit-to-GDP gaps are moderately high for
several other countries (Thailand, Indonesia, Malaysia, and Mexico).
Moreover, the Asian countries face an aggravating factor: housing
prices are significantly higher than their long-term trend. Over the
course of 2016, however, private sector credit-to-GDP ratios have

economic-research.bnpparibas.com Editorial 3rd quarter 2017 2
Brazil
An endless saga
The political and legal saga that has shaken the country over the past three years is perpetually postponing the normalisation of the
institutional environment. Accusations against the President are unlikely to prevent him from finishing his mandate, and the financial
markets have reacted less virulently than during previous episodes. But the smooth implementation of structural reforms and the
confidence of economic agents and investors are critical for fostering a solid, sustainable economic recovery. Faced with another
bout of uncertainty, the central bank continues to support monetary easing in a persistently disinflationary environment.

■ Carnival marks summer’s end and the revival of the
1- Forecasts
political and legal saga, which is detrimental to
2015 2016 2017e 2018e
investor morale and the Brazilian real, …
Real GDP growth (%) -3.8 -3.6 0.5 3.0
In Brazil, the month of March signals the end of summer vacation.
Inflation (CPI, year average, %) 9.0 8.8 3.6 4.0
After the traditional Carnival festivities, the usual “back-to-business”
Fiscal balance / GDP (%) -10.3 -8.9 -8.8 -7.7
period has been transformed in recent years into “back to court” as
Gross public debt / GDP (%) 66.2 69.5 79.3 80.1
the political and legal saga resumes. Fall 2013 was marked by
fierce protest movements against the rising cost of living, the Current account balance / GDP (%) -3.4 -1.3 -1.3 -2.5
exorbitant price tag of the 2014 Football World Cup, and corruption. External debt / GDP (%) 30.5 34.2 29.2 28.2
March 2014 will be remembered as the start-up of Operation Car Forex reserves (USD bn) 349 354 358 365
Wash (Lava Jato), the corruption probe into Petrobras, followed a
Forex reserves, in months of imports 20.7 23.9 22.0 19.5
year later by the first accusations against elected officials, which
Exchange rate USD/BRL (year end) 3.9 3.3 3.0 3.3
ensnared the presidents of both houses of Parliament. Fall 2016
e: BNP Paribas Group Economic Research estimates and forecasts
marked a major turning point in the political crisis as President

Dilma Rousseff was suspended from her functions (and impeached
2- FX rate and confidence indices
in August) and replaced by Vice-President Michel Temer.
Convinced by fiscal austerity and the structural reform programme, — Business confidence — Consumer confidence
— Nominal foreign exchange rate USD/BRL (rhs, inverted)
investors regained confidence in the midst of a more buoyant
international environment (fewer worries about China, rebound in 120 1.5
commodity prices, and abundant liquidity in the international
markets). The Brazilian currency (BRL) appreciated 28% against the 110 2.0
dollar (USD) between early 2016 and mid-May 2017.
100 2.5
Unfortunately, fall 2017 was not spared this new tradition, and the
political saga continues. In April, the Supreme Court opened a new 90 3.0
case against a hundred politicians, including several government
members. Although the Electoral Court acquitted Dilma Roussef 80 3.5
and Michel Temer of charges of soliciting illegal campaign donations
during the 2014 presidential election, since mid-May, the President 70 4.0
has been caught up in the Lava Jato investigation for “passive
60 4.5
corruption”, “obstruction of justice” and “participating in a criminal
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
organisation”. The opposition party is calling for his resignation, but
Sources : BCB, Fundação Getulio Vargas
it seems unlikely that impeachment procedures will win the support

of two thirds of Parliament, as stipulated in the constitution. The
According to the Finance Ministry, non-resident investors divested
coalition may have been weakened, but it still enjoys an
USD 1.8 bn from the local bond market in May. Their share of
overwhelming majority, with 75% of the Assembly’s seats. The most
Treasury bonds declined from 19% at year-end 2015 to a little over
probable scenario is that President Temer will complete his
13%, and their portfolio valuation declined from BRL 498 bn to BRL
mandate in December 2018, after general elections in October.
420 bn.
This new episode in a never ending political maelstrom shook the
■ …may hamper the smooth implementation of fiscal
Brazilian markets, which have since recovered somewhat. The
and social security reforms, …
USD/BRL exchange rate depreciated 5% between mid-May and the
end of June, the Sao Paulo Ibovespa equity index lost 10% in the The major risk associated with this weakened government is that it
local currency, while the yield on 5-year Treasuries rose 50 basis could slow down the reform agenda launched a year ago. The 20-
points (bp) to 10.25%, and the premium on 5-year CDS on year freeze on public spending in real terms was approved in
sovereign bonds in hard currencies rose to 240 bp. December. The Senate might still vote on the labour law reform in
July, and other microeconomic and sector reforms still seem to be

economic-research.bnpparibas.com Brazil 3rd quarter 2017 3
on track, since their voting procedures are not very restrictive, and
3- Real GDP growth (%)
there is a relatively broad consensus. Yet pension reform, which is
currently being debated in Parliament, requires a three-fifths █ q/q, sa — y/y
majority in both houses, and could be postponed and/or watered
10
down. The same applies to fiscal reform, which is still under review.
8
■ …the keystone of fiscal consolidation, …
6
Though very unpopular, pension reform is nonetheless a key pillar
4
for the credibility of the fiscal consolidation plan. Under this plan, the
minimum retirement age would be raised to 65, about 10 years 2
more than the current average age of retirement. The public and
0
private pension systems would be aligned, and pensions for high-
wage earners would be capped. -2
The country’s demographic transition, marked by a declining birth -4
rate and longer life expectancy, makes the current pension system -6
unsustainable. The private social security regime (INSS) reported a 2010 2011 2012 2013 2014 2015 2016 2017

deficit of BRL 150 bn in 2016 (2.4% of GDP), accounting for 96% of Source : IBGE
the overall public sector primary deficit according to the Finance
Ministry. According to the National Statistics Institute (IBGE), the d own by corporate loans (-8.4% year-on-year), while household
over-65 age group as a share of the total population will rise from loans increased 3.6% year-on-year.
11.5% in 2010 to 21.5% in 2030, and 29% in 2040. The number of
Against this backdrop, we have lowered our average growth outlook
active workers per retiree will be halved (from 8 to 4). Without
for the year 2017 from 1% to 0.5%. Activity should regain some
reforms, pension-related spending would increase from 11% to 13%
vigour in H2, bolstered by the gradual acceleration of investment
of GDP in ten years, including nearly three-quarters for the private
and consumption as well as decent export performance, whereas
sector. According to the government, its reform project would
the increase in imports is likely to strain growth.
stabilise this ratio and generate savings of BRL 604 bn, or an
average of about 0.7% of GDP a year. ■ …without jeopardising the easing of the central
bank’s monetary policy
■ …and be fatal to the economic recovery in Q2, …
Disinflation continues, and the IPCA-15 slipped to 3.5% year-on-
Awaited for the past eight quarters, real GDP finally rebounded
year in June. The persistently negative output gap favours the
vigorously in Q1 2017, to a seasonally-adjusted 1% q/q.
convergence of core inflation (+4.7%) towards the mid-point of the
Unsurprisingly, the main growth engine was the agricultural sector,
target range (4.5% +/- 2 percentage points). The very strong farm
which made a positive contribution of 0.9 percentage points, thanks
harvest held down food prices (+0.7% year-on-year). The Selic rate
to double-digit growth compared to the previous quarter (+13.4%).
was trimmed from 14.25% in September 2016 to 10.25% in June
The contraction in industrial activity and services came to a halt. In
2017, and the pace of key rate cuts was amplified to 100bp in recent
terms of demand, private consumption stagnated (-0.1%), while
months.
investment continued to decline (-1.6%). This means that exports
were the only driving force for GDP (+4.8%), in an environment Despite renewed financial volatility, the real’s depreciation and
marked by a slight improvement in the terms of trade and an upturn greater uncertainty over the implementation of reforms, the fragility
in world trade, which contributed to the trade surplus. of the economic recovery in the short term should encourage the
central bank (BCB) to continue easing its monetary policy. In the
Unfortunately, the new bout of political turmoil could jeopardise the
latest inflation report released in June, Brazil’s monetary policy
economic recovery in Q2. Monthly and leading indicators are mixed.
committee (Copom) announced that the size of the next rate cuts
On the positive side, since April, manufacturing PMI has been
would be determined by cyclical trends, the balance of risks and
higher than 50, the threshold separating expansion from contraction,
inflation expectations. The later seem to be well anchored at 3.8%
for the first time since January 2015. Industrial output and retail
at year-end 2017, 4.5% at year-end 2018 and 4.3% at mid-2019. In
sales increased slightly between March and April (the most recently
early July, the National Monetary Council (CMN) is expected to
available statistics), prior to the new political-legal revelations. The
approve the downward revision of the 2019 inflation target, bringing
labour market created 193,300 net jobs between February and May,
it more in line with emerging market standards.
after destroying nearly 3.6 million jobs since year-end 2014. The
unemployment rate slipped from a seasonally adjusted 13.1% in Sylvain Bellefontaine
April to 13% in May. Real wages increased 1.8% year-on-year, [email protected]
bolstered by disinflation, which boosts household purchasing power.
On the negative side, business and household confidence indicators
(available through June) have begun to decline again. Bank lending
still has not picked up, despite lower interest rates. Total loans
outstanding declined again in May (-2.6% year-on-year), pulled

economic-research.bnpparibas.com Brazil 3rd quarter 2017 4
Russia
Macroeconomic consolidation
Russia’s macroeconomic situation has consolidated significantly in recent months. Real GDP growth accelerated to 0.5% year-on-
year in Q1 2017, and the latest indicators point to an upturn in household consumption in early Q2 2017. The banking sector situation
has stabilised since the end of last year, which should help support the recovery in H2 2017. Moreover, in the first five months of
fiscal year 2017, the deficit narrowed sharply, thanks to higher oil and natural gas revenues and cutbacks in spending. The Russian
authorities have also begun to rebuild the reserve fund, using surplus fiscal revenues, without placing a strain on the rouble.

■ Private consumption picks up 1- Forecasts
2015 2016 2017e 2018e
In first-quarter 2017, Russian economic activity rebounded to 0.5%
year-on-year. The main support factor was the upturn in investment, Real GDP growth (%) -2.8 -0.2 1.4 1.6
while household consumption continued to contract. Yet retail sales Inflation (CPI, year average, %) 15.5 7.1 4.5 4.5
stopped declining in March, and even increased 0.9% year-on-year General Gov. balance / GDP (%) -3.4 -3.7 -2.7 -2.1
in April, while automobile sales rebounded by 5.1% year-on-year.
Public debt / GDP (%) 17.7 18.4 19.0 19.3
The upturn in private consumption was fuelled by the increase in Current account balance / GDP (%) 5.0 1.9 3.4 3.2
real wages resulting from the net slowdown in inflation and the External debt / GDP (%) 38.9 38.1 32.2 30.6
decline in the unemployment rate. In May, consumer prices rose
Foreign exchange reserves (USD bn) 320 318 349 395
only 4.1% year-on-year, compared with 7.3% in the year-earlier
Foreign exchange reserves, in months of impor1ts0.8 11.2 10.9 11.2
period. Yet the central bank esteems that inflation is close to a low
Exchange rate RUB/USD (year end) 72.5 60.3 60.0 62.0
point, and that it could reach around 4% at the end of the year.
e: BNP Paribas Group Economic Research estimates and forecasts
At the same time, industrial output accelerated to 5.6% year-on-year
in May, and business confidence indexes are looking upbeat in both 2- Industrial output and PMI in manufacturing industry
manufacturing and services.

Non-financial corporates also consolidated their position over the ▬ Industrial output (yoy, %, LHS) ▬ PMI (RHS)
course of 2016. On the whole, earnings increased nearly 38%. The
4 56
strongest earnings growth was in manufacturing industry, notably in
textiles and the production of machines and equipment. The number 55
3
of corporate bankruptcies also levelled off at 9.9 per 1000 in
54
February and March 2017, down from 19.1 per 1000 in December
2 53
2016. The easing of monetary policy enabled interest rates on
rouble-denominated corporate loans to decline by 200 basis points 52
1
over the past year, which should further consolidate the position of 51
companies and support renewed investment.
0 50
■ The situation levels off in the banking sector 49
-1
In a much more favourable economic environment, the banking 48
sector situation stabilised in late 2016. The quality of bank assets -2 47
stopped deteriorating. In the first four months, the non-performing 2014 2015 2016 2017
loan ratio declined by 0.6 points to 8% in April 2017, and the share Source: Rosstat

of total risky assets1 stabilised at 18.8%.
In the span of a year, Russian banks have increased their earnings
Capital adequacy ratios (CAR and Tier 1 CAR) stopped
five-fold to RUB 930 bn, returning to the pre-crisis level. This
deteriorating as of late H1 2016 and increased to 13.3% and 9.2%,
improvement was confirmed by the statistics available for Q1 2017.
respectively, in April 2017.
Yet despite the stabilisation of the banking sector situation, credit
The liquidity deficit has totally disappeared and Russian banks have
growth is still weak. Adjusted for currency fluctuations, the stock of
reported a liquidity surplus since the beginning of the year. Under
private-sector loans contracted by 2.1% in full-year 2016, and this
these conditions, the central bank managed to introduce new
trend does not seem to have reversed itself in the first three months
monetary policy instruments to maintain money market rates close
of 2017.
to key rates.

1 Defined as the sum of non-performing loans, overdue and loss loans.

economic-research.bnpparibas.com Russia 3rd quarter 2017 5
■ Fiscal consolidation early in the year
3- Exchange rate and foreign exchange reserves
In the first 5 months of 2017, the federal government’s fiscal deficit ▬ Exchange rate RUB/USD (LHS, inverted scale)
is estimated at 1.7% of GDP, a 2.9 point decline from the previous
▬ Foreign exchange reserves (USD bn, RHS)
year. Over the same period, the primary deficit narrowed to only 30 500
0.8% of GDP.
40
This consolidation can be attributed in part to higher oil and natural 450
gas revenues (+0.9 points of GDP), which offset the decline in non-
50
oil and gas revenues, and in part to cutbacks in government
400
expenditure2, which declined by nearly 3 points of GDP. As a result,
60
in the first five months of the year, the non-oil and gas fiscal deficit
350
declined by 4.6% y-o-y to a total of 7.9% of GDP.
70
In the first three months of the year, 70% of the deficit was financed
300
by dipping into the reserve fund, and the remainder was financed by 80
issuing debt instruments in the domestic market. A new fiscal rule
90 250
was introduced in February to allow surplus oil and natural gas
2014 2015 2016 2017
revenues3 to be used to acquire hard currencies in the foreign Source: Central Bank of Russia (CBR)
exchange market, in order to rebuild the reserve fund, which has
held steady since the beginning of the year at USD 16 bn. Despite
At the same time, the European Union extended its sanctions
the risk of tighter US sanctions, the Russian finance ministry
against Russia for another six months.
managed to issue USD 3 bn in bonds last June.
■ Consolidation of external accounts
■ Towards tighter US sanctions?
On 15 June, the US Senate approved a bill to tighten the sanctions In the first five months of 2017, Russia’s external accounts
strengthened significantly, thanks notably to the improvement in the
against Russia and to prevent President Trump from easing its
terms of trade. The rouble has stabilised at RUB 57 to the USD
sanctions policy without prior congressional approval.
(+6% year-on-year) despite central bank interventions to purchase
Adopted by a vote of 98 to 2, the bill calls for existing sanctions to dollars as part of its programme to rebuild the reserve fund. Foreign
be expanded to cover state-owned companies in mining, iron & reserves have increased by nearly USD 19 bn to USD 326 bn,
steel, rail & maritime transport and pipelines. It also calls for which is equivalent to nearly 16 months of imports of goods and
reducing the duration of financing for Russian banks and oil services.
companies to 14 days and 30 days, respectively, down from 90
days currently. It also prohibits taking any equity stakes of more In Q1 2017, the balance of payments surplus (excluding fluctuations
in foreign reserves) amounted to more than 4.1% of GDP, nearly 2
than USD 10 m in Russian companies “close to the government”,
points of GDP higher than in Q1 2016. The current account balance
and all purchases of treasury notes might ultimately be forbidden4.
increased by 1.6 points of GDP compared to Q1 2016 to reach 6.7%
Easing these sanctions would require prior approval by two thirds of of GDP, bolstered by the increase in the trade surplus, thanks to the
the members of the House of Representatives and the Senate, rise in oil and natural gas prices.
whereas currently, the president alone has the authority to ease
At the same time, despite major debt repayments by the banks, the
sanctions.
financial account deficit narrowed slightly by 0.4 points of GDP to
The bill must still be adopted by the House of Representatives 2.6% of GDP.
before it is sent to the US president for ratification. The House is
Johanna Melka
unlikely to vote in favour of tighter sanctions against Russia, unless
[email protected]
the scope of the initial bill is modified somewhat, under pressure
from Germany and Austria. Both countries have companies that are
involved in numerous energy projects in Russia, and have
expressed their disapproval of the US Senate’s vote on this
proposal, which imposes financial sanctions on companies that
contribute in one manner or another to the construction of Russian
pipelines.

2 In Q1 2017, nearly 60% of spending was allocated to pensions and
defence.
3 Whenever international oil prices exceed those set in the 2017 budget, i.e.
USD 40 per barrel.
4 The US Treasury reserves the right to prohibit the purchase of Russian
sovereign securities in the six months that follow the law’s adoption.

economic-research.bnpparibas.com Russia 3rd quarter 2017 6
India
Feeble investment strains growth
Economic growth slowed in the fourth quarter of fiscal year 2016/2017. This slowdown is only partly due to the demonetisation
process. As of September, investment began to slow and the production of capital goods to decline. Looking beyond the difficulties
of some corporates, the deterioration in the quality of bank assets has placed a heavy strain on loan distribution. Faced with this
situation, the government adopted a new measure to increase the central bank’s role in managing non-performing loans. Although
this measure should accelerate the debt resolution process, it will not offset the major capital needs of the state-owned banks.

■ Activity slows
1- Forecasts
Real GDP growth slowed to 6.1% year-on-year in the fourth quarter 2015 2016 2017e 2018e
of fiscal year 2016/2017, which ended on 31 March 2017. This Real GDP growth(1) (%) 7.9 7.1 7.5 7.9
slowdown is partly due to the demonetisation process introduced in Inflation (1) (CPI, year average, %) 4.9 4.5 4.6 4.9
November 2016. By late May 2017, money supply in circulation was Central Gov. Balance(1) / GDP (%) -3.9 -3.5 -3.4 -3.4
still 16% below the October 2016 level. The withdrawal of INR 500 Central Gov. Debt(1)/ GDP (%) 46.6 47.2 47.0 46.5
and INR 1000 notes triggered a slowdown in household
Current account balance(1) / GDP (%) -1.1 -0.9 -1.2 -1.4
consumption. At the same time, investment contracted (down 2.1%
External debt(1)/ GDP (%) 23.2 21.2 20.4 19.8
y/y excluding inventory in Q1 2017) and net exports made a
Forex reserves(1) (USD bn) 336 346 369 390
negative contribution to growth, despite a buoyant increase in
Forex reserves(1), in months of imports 7.8 7.7 7.9 8.1
exports.
Exchange rate INR/USD (year end) 66.2 67.9 66.0 68.0
The slowdown in household consumption is likely to be temporary. (1): Fiscal year from April 1st of year n to March 31st of year n+1

In contrast, the contraction in investment (down 1.7% y/y in Q1 e: estimation and forecast Group Economic Research BNP Paribas
2017) is more troublesome because it dampens the country’s
medium-term growth prospects. It cannot be blamed solely on 2- GDP and its components
demonetisation. The decline in investment confirms the contraction
Real GDP growth (y/y) and its components (percentage points)
in industrial production of capital goods reported as of September
▬ GDP (y/y) █ Government expenditure (pp) █ Net exports (pp)
2016. Until now, higher public investment has offset the decline in
█ Private consumption (pp) █ Investment █ Change in inventory (pp)
private investment. Yet in the fourth quarter of fiscal year 2016/2017,
█ Statistical errors (pp)
the government cutback spending in order to limit the fiscal deficit to
15
3.5% of GDP.
The decline in private investment is due to the deleveraging of 10
Indian companies, a strategy justified by persistently high surplus
production capacity, notably in the steel sector. The financial
5
situation of state-owned banks is also straining their lending policy.
In the first four months of 2017, the growth of bank lending
0
remained weak (+4.3% y/y), even though it accelerated slightly,
buoyed by increased lending in the services sector. Yet lending to
industry continued to contract (-1% y/y). Moreover, interest rates on -5
1-year loans granted by state-owned banks have declined only 86
basis points over the past two years, even though key rates have -10
been lowered by 125 basis points (bp). The increase in non- 2013 2014 2015 2016 2017
performing loans and the provisions they require have sharply Source: Central Bank (RBI)
curtailed the credit supply of state-owned banks. As a result, over
the past two years, the market share of state-owned banks has authorities to clean up their balance sheets. Risky assets 1
declined by 5 percentage points in favour of private banks. Even accounted for 16.1% of total loans outstanding for the state-owned
though private banks are more active and have reduced their banks at the end of December 2016, two points more than the
lending rates more sharply than the state-owned banks, the overall previous year, and the equivalent of 5.6% of GDP. Risky debts
credit supply continues to hamper the recovery of investment. continue to be concentrated in the iron and steel sector, energy and
infrastructure. In these sectors, corporate situations continued to
■ The burden of non-performing loans
deteriorate in fourth-quarter 2016, which means that non-performing
Last May, the government adopted a new rule to increase the loans are likely to continue rising in the months ahead.
central bank’s role in the resolution of non-performing loans. For
nearly the past three years, NPL remain a burden for the state-
owned banks despite numerous measures taken by the Indian 1 The sum of non-performing loans and restructured assets, according to
the central bank’s definition.

economic-research.bnpparibas.com India 3rd quarter 2017 7
At year-end 2016, the IMF estimated the non-performing loan ratio
3- Loans
(net of provisions) at 38.7% as a share of bank equity, compared to
Year-on-year (%)
only 24% the previous year.
Corporates loans Loans in industry Total loans
Cleaning up bank balance sheets is still problematic because the
banks are reticent to sell their non-performing loans to the Asset 25
Reconstruction Companies, private defeasance structures created
20
in August 2014. The banks esteem that the ARC are demanding
excessively high discounts on asset value. Moreover, the banks are 15
finding it difficult to reach an agreement on debt resolution terms.
Until now, they have had to obtain an agreement with 60% of their 10
debtors holding at least 75% of the debt. The regulation adopted in
5
May should help ease the NPL resolution terms. The central bank
notably decided to lower the threshold for obtaining an agreement 0
between lenders2. Moreover, it can intervene directly in the loan
restructuring process in order to advise ailing banks. Even so, -5
although the measure aims to accelerate the NPL resolution
-10
process, it will not offset the banking sector’s major recapitalisation 2012 2013 2014 2015 2016 2017
needs, estimated at INR 1.8 trillion (the equivalent of 3.4% of 2016 Source: RBI
GDP), 83% of which is for the state-owned banks alone. Until now,
the Indian authorities have planned to inject only INR 0.7 trillion in p oints) should reduce inflation by about 33 bp. But the increase in
the state-owned banks. Although capital adequacy ratios improved the average rate for services (from 15% to 18%) should generate
slightly for the Indian banking sector as a whole at the end of 2016 higher inflation excluding food products. In the short term, the
(CAR and Tier 1 CAR of 13% and 10.7%, respectively, according to introduction of GST will trigger a temporary slowdown in economic
the IMF), the situation remains extremely heterogeneous depending growth due to the difficulties for small and mid-sized companies to
on the bank. Moreover, most of the state-owned banks will not meet set up the new tax system, and the informal sector’s heavy
their Basel III regulatory requirements in 2019. weighting within the Indian economy.
■ Application of GST as of 1 July 2017 In the medium term, implementation of a single tax applicable to all
states should generate competitiveness gains and revitalise trade
A year after it was adopted by the upper house of Parliament, the within the country, because the reform will considerably reduce
goods and services tax (GST) was officially launched across the costs and red tape for companies. This should strengthen their profit
country on 1 July 2017, and will be applicable in all states. Fresh margins and competitiveness, and in turn encourage further
produce, alcohol, drugs and electricity will be tax exempt. As for the investment.
rest, there are four tax rates: 5% for basic goods, 12% for small
The IMF esteems that the introduction of a single tax could boost
appliances and frozen foods, 18% for the vast majority of goods and
India’s growth potential by 8%. According to Leemput and Wiencek
services, and 28% for luxury goods and services. There will be a
supplementary tax on certain goods like automobiles to provide (2017)3, the increase in real GDP is estimated at between 3.1 and
4.2 percentage points.
financial compensation for states due to the revenue loss arising
from the elimination of certain taxes. The tax rates were revised Johanna Melka
downwards from the initial figures presented in December 2016. By [email protected]
setting up a highly progressive tax system, the government’s goal is
to spare the poorest segments of the population.
To take into account the country’s federal structure, the tax will be
levied at the government (central GST) and state levels (State GST).
For operations between states, a single tax will be levied (integrated
GST), the sum of the central and state GST.
In the short term, the introduction of a single VAT tax applicable to
all states should have a neutral impact on fiscal revenues, and
possibly even a disinflationary effect of 2 percentage points
according to Finance Ministry projections. In the longer term, the
reform should generate additional fiscal revenues thanks to higher
investment and accelerated economic growth.
In the short term, the disinflationary effect is likely to be mild.
According to a Nomura study, the decline in food prices (60 basis

2 It now suffices to reach an agreement with 50% of creditors holding 60% 3 “Financial frictions, underinvestment and investment composition:
of the debt. evidence from Indian corporates”, IMF working paper 17/134.

economic-research.bnpparibas.com India 3rd quarter 2017 8
China
Less credit should mean slower economic growth
Monetary tightening and a stricter prudential and regulatory framework for the financial sector should curb domestic credit growth
in 2017. For the time being, the main consequences are a slowdown in interbank financing, a bond market correction and the slower
expansion of certain shadow banking activities. Commercial bank loan growth has not really decelerated yet. The slower growth in
the real estate sector in recent months could spread to other sectors that are credit-dependent, and economic growth is likely to
slow again in the quarters ahead.

■ Tighter monetary conditions…
1- Forecasts
China’s monetary policy stance has changed since the last quarter 2015 2016e 2017e 2018e
of 2016. The authorities have adjusted their priorities at a time when Real GDP growth (%) 6.9 6.7 6.6 6.4
economic growth was stabilising, industrial activity was improving,
Inflation (CPI, year average, %) 1.4 2.0 1.8 2.3
inflation was accelerating, asset market bubbles were forming and
Official budget balance / GDP (%) -3.4 -3.8 -3.2 -3.0
capital outflows were surging. After bolstering support for economic
Central Gov. debt / GDP (%) 15.5 16.1 18.0 19.5
growth, they have focused more on reining in risks of financial
Current account balance / GDP (%) 3.0 1.8 1.4 1.1
instability since last fall1.
Total external debt / GDP (%) 12.6 12.7 12.7 13.0
Firstly, the People’s Bank of China (PBOC) has adjusted its open
Forex reserves (USD bn) 3 330 3 011 3 024 3 072
market operations in order to guide money market rates higher.
Forex reserves, in months of imports 19.5 17.8 17.1 17.0
Repo rates have been gradually increased since October 2016, then
the central bank increased the rates on its “liquidity facilities” (which Exchange rate CNY/USD (year end) 6.5 6.9 7.0 6.9
e: BNP Paribas Group Economic Research estimates and forecasts
enable it to provide liquidity to certain well-targeted institutions) in

Q1 2017. These measures are mainly designed to discourage the
2- Tensions in the money and bond markets
use of interbank financing (which has increased rapidly in recent
years), thereby reducing the leverage levels of financial institutions Interest rates, %
and curbing the expansion of their lending and investment activities. ▬ 7-day repo rate ▬ Benchmark rate on 1-year loans
▬ 5-year AAA+ note yield
Although benchmark rates for loans and deposits have remained
%
unchanged for more than two years, the cost of borrowing for 7
corporates has begun to rise as a result of the tightening of liquidity
6
conditions in the interbank market. The weighted average rate on
bank loans, which had mirrored the benchmark rates between late
5
2014 and Q4 2016, started to rise in early 2017. It increased to
5.5% in January 2017 from 5.3% in December. Bond yields have 4
also increased rapidly since October 2016: this has been the
3
consequence of monetary tightening measures, but also of a
confidence crisis in the bond market that led to the reassessment of
2
risk premia. See chart 2.
1
The authorities have accompanied the tightening of monetary
2014 2015 2016 2017
conditions: 1) by tightening the prudential rules governing house
Sources: PBOC, CEIC
purchases and property loans in most of the big cities, and 2) by

taking new measures to strengthen the financial sector’s regulatory
framework. PBOC set up a Macro-Prudential Assessment (MPA)
Products (WMPs), which are off-balance-sheet items, into the MPA
last year. As part of this MPA framework, Chinese banks should be
framework. Their inclusion means that WMP activities must be fully
rated according to a series of financial soundness ratios. The ratings
accounted for in the banks’ risk management systems (with the
then could change the remuneration on reserve requirements paid
same capital buffer requirements as its balance-sheet activities, the
to the banks (premiums and penalties are determined on the basis
same reporting rules, etc.).
of financial soundness ratios), as well as access conditions for the
PBOC’s liquidity facilities. The MPA framework also makes it easier Moreover, the various financial-sector supervisory authorities are
for the regulators to supervise growth in a broad array of assets. also trying to better coordinate their actions in order to close
Moreover, since Q1 2017, the PBOC has increased its control over persistent regulatory loopholes, to make it harder for financial
shadow banking activities by integrating Wealth Management institutions to resort to regulatory arbitrage and engage in complex
and opaque structuring of financial products, and to better control all

the existing ties between banks and non-banking institutions.
1 For more information on China’s excessive debt and financial risks, see:
“Danger in China’s financial nebula”, Conjoncture, BNP Paribas, June 2017.

economic-research.bnpparibas.com China 3rd quarter 2017 9
■ … will weigh on credit and economic growth
3- Financing of the economy
Monetary tightening, stricter prudential regulations and a more Total social financing components, year-on-year % change
systemic and better coordinated approach to supervision should ▬ Bank loans ▬ Bonds Entrusted loans
logically slow domestic credit growth. For the moment, the ▬ Trust loans ▬ Banks’ acceptance bills ▬ Equity
consequences can be seen mainly in the interbank and bond 60
markets. Interbank financing has slowed sharply since Q4 2016, 50
affecting shadow banking institutions in particular and thereby 40
limiting their lending capacity. Combined with a more restrictive
30
prudential framework, this has helped trigger a drop in WMP activity.
20
Moreover, bond issuance stopped increasing in December 2016,
10
bringing an end to several years of steady expansion. In the
0
meantime, overall growth in “total social financing” (TSF)2 has not
-10
shown any real signs of deceleration over the past six months. The
-20
increase in “traditional” bank loans dipped slightly in late 2016 and
-30
in Q1 2017, but picked up again in April and May. Over the same
-40
period, creditors and borrowers also took greater advantage of trust
2014 2015 2016 2017
loans. See chart 3.
Source : PBOC
We should see a slight easing in total social financing growth in the
short term (to 12% year-on-year at the end of 2017, from 12.8% at and the expected economic growth slowdown in the short term3.
the end of 2016). Shadow bank lending (particularly activities not Consequently, commercial banks could see another surge in non-
reported in TSF data) could slow somewhat more sharply. performing loans (the NPL ratio has levelled off for the past year),
Consequently, we should also see slower activity in the sectors that while the deterioration in the average quality of shadow bank assets
are the most heavily dependent on credit, particularly real estate is likely to persist and default risks in the bond market should
and construction. Signs of a slowdown have emerged: growth in continue to rise.
volumes of property transactions has weakened since last spring (it
Under this environment (deleveraging of financial institutions, credit
reached 14% year-on-year in the first 5 months of 2017); average
boom, ongoing rise in credit risks, deterioration in bank profitability,
house price inflation peaked at 10.5% in December 2016 and has
slightly slower domestic credit growth, and downward correction in
eased slightly ever since (to 9.5% year-on-year in May 2017); and
asset markets), the risks of financial-sector instability increase.
investment in both real estate and infrastructure has lost momentum
Faced with a new bout of financial instability and slowing economic
for the past three months. Real GDP growth, which stood at 6.9%
growth, the authorities must not back down again by easing
year-on-year in Q1 2017, is projected to slow gradually to 6.5% in
monetary policy and scaling back the implementation of new
Q4 2017.
prudential regulations. To the contrary, the solution to the debt
The authorities will undoubtedly continue to strike a balance excess and high credit risks is to maintain a very cautious monetary
between containing financial-instability risks and at the same time policy, to accept more moderate real GDP growth rates, and to
maintaining generally adequate credit conditions to contain the continue pushing through structural reforms, notably aimed at
slowdown in economic growth. In this context, the big state-owned strengthening the governance of financial and non-financial
commercial banks, which benefit from large customer deposits, may institutions, and restructuring state-owned companies.
be encouraged to increase their credit supply to partially offset the
Christine Peltier
decline in bond issuance and loans from institutions hit harder by
[email protected]
the effects of tighter liquidity conditions in the interbank market.
Certain financial institutions (small banks, shadow banking
institutions) could face some difficulties in the months ahead. Their
earnings growth prospects will continue to deteriorate due to their
higher financing costs and smaller asset expansion. Moreover, after
a period of reprieve last year, the debt servicing capacity of
corporates is likely to deteriorate again, due to higher interest rates

2 Total Social Financing comprises the main, but not all, domestic sources
of financing provided by banks and nonbanks to Chinese corporates, local
government financing vehicles and households. In May 2017, bank loans
accounted for 69% of TSF; bonds, 11%; the main shadow banking credits,
16% (entrusted loans, 8%; trust loans, 4%; and banks’ acceptance bills,
3%); and equities, 4%. Financing of the economy also includes other
shadow banking activities (such as WMPs) that are excluded from official 3 For more information on corporates’ financial health, see: "Credit risks still
statistics on social financing flows. rising”, EcoEmerging BNP Paribas, 4th quarter 2016.

economic-research.bnpparibas.com China 3rd quarter 2017 10