Brazil

Private capital flows to developing countries eased in October, but remain close to their highest level in more than a year, led by robust bond issuance by emerging market sovereigns and firms. Business sentiment has strengthened in some countries, including the US and several emerging markets, but remains weak in general amid US “fiscal cliff” and Euro Area risks. In the US, new discoveries and innovations have pushed down domestic prices of natural gas, creating arbitrage opportunities between domestic and international markets.
Private capital flows to developing countries remain high, despite easing in October. Gross international capital flows to developing countries equaled $49 billion in October, the second highest inflow over the past 15 months, but down from the record $71bn of inflows during September. Euro Area debt turmoil in May caused capital flows to slow, but stabilization of financial market tensions and high-income monetary policy prompted the recent uptick in flows. Bond issuance was particularly strong at $32 billion in October, with 44% of the total destined for the financial sector. Notable issues included a $2 billion bond sale by Russia’s Sberbank, a $1.5 billion offering of 10-year sovereign bonds by Chile, and a $500 million sale by Bolivia (its first in nearly a century). New equity issuance and bank lending (especially to Emerging Europe and Latin America) moderated, partly because low bond yields made bonds a more attractive option for some borrowers.
Business sentiment indicators have strengthened in several countries, but remain weak in general amid risks to the global economy. Manufacturing Purchasing Managers’ Indexes (PMIs) for October suggest a strengthening of activity in the US as labor and housing markets continue to improve. PMIs also gained ground and suggest expansion in Brazil, Indonesia, India, Russia, and Turkey. In China, however, both the official and Markit PMI are below or close to the no-growth 50 threshold despite recent accelerations in industrial activity. Similarly, the manufacturing PMI for both core and periphery Euro Area countries points strongly toward further contraction, despite a stabilization and even small gains in industrial activity during recent months. Business pessimism may be reflecting market worries that the U.S. fiscal cliff or Euro Area tensions could flare up dampening demand and prospects—a view seemingly supported by weak sales of capital goods.
The wide gap between U.S. natural gas prices and European natural gas and crude oil prices suggests downside risks on oil prices. The post-2005 increase in crude oil prices induced innovation in both natural gas and oil extraction technologies such as horizontal drilling and hydraulic fracturing. A 28 percent increase in U.S. natural gas production between 2005 and 2011 has depressed domestic prices. Low prices have induced electrical and petro-chemical producers to substitute natural gas for coal, but a similar shift by the transportation industry has yet to take place, in part due to the absence of distribution networks and safety concerns. So far, export licensing requirements have prevented U.S. producers from selling into world markets where natural gas prices are much higher. U.S. natural gas costs only 29 and 20 percent as much as European and Japanese gas. Should licenses become more readily available, the arrival of US gas on international markets could exert significant downward pressures on international prices of both natural gas and crude oil.

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Financial Markets…European stocks slipped on Friday with the benchmark index falling to a three-week low as early optimism on Spain’s new austerity measures was short-lived.

Spanish 10-year bond yield rose back above 6% amid uncertainty over its troubled banks before stress test results, fading optimism on the country’s debt cutting plan, and a looming Moody’s rating review which may cost the country its investment grade rating. 

South Africa's rand weakened against the dollar after Moody's cut the government's bond rating by one notch to Baa1 from A3, but bonds were supported by their imminent accession to Citi's World Government Bond Index (WGBI) on October 1.

High-income Economies…France’s government announced its 2013 budget that includes a package of tax hikes, including a 75% tax rate for people earning more than 1 mn euros, aimed at narrowing the deficit to 3.0% of GDP in 2013 from 4.5% this year.

Euro Area consumer price inflation accelerated to 2.7% (y/y) in September from 2.6% in August according to a Eurostat flash estimate, driven mainly by an increase in Spain’s inflation to 3.5% (y/y) from 2.7% in August after the government increased its value added tax (VAT) from 18% to 21%.

German retail sales edged up by 0.3% (m/m) in real terms in August (-0.8% y/y) after a 1% drop in July (-1.6% y/y), giving rise to hopes that private consumption will prop up the economy.

Canada's GDP rose 0.2%(m/m) in July (+1.9% y/y) compared to 0.1% (m/m) rise in June, as strength in manufacturing and utilities sectors offset weakness in crude oil extraction.

Japan’s industrial production fell 1.3% (m/m) in August as a slowdown in China and Europe weighed on exports, raising risks of a GDPcontraction this quarter.

South Korea’s industrial production fell 0.7% (m/m) percent, from weakness in trade partners and also due to a strike at Hyundai Motor Co.

Developing Economies…The Central Bank of Brazil increased its 2012 inflation forecast to 5.2% from 4.7%, while cutting only marginally its 2013 forecast to 4.9% from 5.0%.

Chile’s manufacturing output rose 6.8% (m/m) in August (3.6% y/y) as copper production rose by 11.3% from July. Retail sales growth accelerated to 11.3% (y/y) in August from 7.9% in July.

Democratic Republic of Congo’s central bank lowered its benchmark interest rate by 1.5 percentage points to 6%, citing macro-economic stability and inflation of close to 6% in August, lower than the targeted 9.9% for 2012.

The Central Bank of the Dominican Republic kept its monetary policy rate unchanged at 5.0% following interest rate cuts in June and August with a total reduction of 125 basis points this year.

Turkey's merchandise trade deficit declined significantly to US$5.86 bn in August from US$8.43 bn in August 2011 as goods export grew 14.5% (y/y) while imports declined 4.8% (y/y).

Thailand's industrial production index fell 11.3% (y/y) in August, declining for three consecutive months.

South African producer price inflation hit two year low level of 5.1% (y/y) in August, down from 5.4% in July.

The looming US “fiscal cliff” is one of the main downside risks to the global economy in 2013, with Latin America and East Asia and Pacific to be among the most affected if it materializes. Several developing country central banks have eased monetary policy in recent months on concerns about the growth outlook, but they may now pause as growth is expected to pick-up and as they assess the impact of the monetary easing in high-income countries. Precious metal prices have risen sharply on supply concerns, related to labor disputes in South Africa’s platinum mining sector, and on higher investment demand, related to uncertainty about the global outlook and the Federal Reserve‘s quantitative easing QE3.
One of the main downside risks to global growth is the looming US “fiscal cliff”. Automatic tax hikes and spending cuts are set to take effect starting in 2013 if the US Congress fails to agree on an alternative debt-reduction plan. The US’s Congressional Budget Office forecasts that the US fiscal deficit will decline 3.3 percentage points to 4% of GDP in 2013. In the event the full “fiscal cliff” materializes we estimate global growth will be 1 percentage point weaker than our revised 2.6% forecast (which assumes that only about 30% of the fiscal cliff will materialize), as US growth would be 2.2 percentage points lower in 2013 at -0.2%. The Euro area would also fall back into recession, as output is expected to decline by 0.4 percentage points relative to the baseline growth of 0.3%. Growth in developing countries would be 0.6 percentage points lower in 2013 with the more open economies and the ones that have strong economic linkages with the US being the hardest hit.
Concerns about growth following disappointing outturns in 2012H1 prompted several developing country central banks to ease monetary policy in July-August. Central banks of several developing countries, including Brazil, Colombia, and the Philippines cut policy rates between late-July and August. Brazil’s easing cycle was one of the most aggressive, (500 bps since August 2011), slashing the policy rate to a record low of 7.5% by late-August. In contrast Russia’s central bank raised its policy rates by 25 bps, the first hike in 16 months, on inflation concerns. We expect developing country central banks to remain on hold over the next months, given the expected pick-up in growth in Q4 and as they pause to assess the impact of monetary easing in the US, the Euro Area, and Japan. In China, concerns about growth deceleration in the context of low inflation may prompt further easing. If investors’ appetite for riskier assets intensifies, bringing hot money back to emerging markets, central banks may cut rates further and/or impose capital controls to stem currency appreciation.
Precious metals have risen sharply on rising investment demand and supply concerns. The precious metals prices are up between 15% and 30% from the lows reached in the May-June period. Gold prices rose 15% to $1,770 by mid-September, matching the year-ago all-time highs, while silver and platinum prices rose 30.6% and 22%, respectively. Demand for precious metals by institutional investors (who are increasingly turning to platinum) has increased recently, following the Federal Reserve‘s QE3. In addition, labor disputes in several South African platinum mines that began a month ago and escalated in early September, have pushed platinum prices to 6-month highs.

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