UBS Sees Turkey Credit Risk Rising as HSBC Says Rupee to Drop on $120 Oil
The biggest losers from oil’s rise above $120 a barrel are Turkey, South Korea, India and Sri Lanka as higher energy costs widen trade deficits and boost inflation, according to strategists at the largest banks.
UBS AG is advising clients to buy credit default swaps on Turkey and bet South Korea’s won will weaken against the dollar. Morgan Stanley has “underweight” recommendations on Turkish and Indian stocks, while HSBC Holdings Plc says the rupee will depreciate. Sri Lanka’s currency, the world’s second-worst performer in 2012, may fall further, according to Citigroup Inc.
Crude’s 16 percent advance in London trading this year is increasing costs for oil-importing nations just as their exports slow because of Europe’s economic contraction and the weakest Chinese expansion in more than two years. While China’s leaders signaled last month they may loosen monetary policy and Brazil cut its benchmark interest rate yesterday, traders are raising estimates for borrowing costs in India, Turkey and South Korea (KWSWO1) on speculation inflation will accelerate.
“The markets are beginning to get concerned,” Bhanu Baweja, the global head of emerging-market fixed-income and currency strategy at UBS in London, said in a phone interview yesterday. “The last thing they need is negative news on oil.”
Brent oil futures rose to a 3 1/2-year high this month on concern the dispute between Western nations and Iran over the Persian Gulf country’s nuclear program will lead to military conflict, cutting production from a region that holds more than half the world’s crude. Brent oil for April settlement increased 1.8 percent yesterday to $124.12 a barrel on the London-based ICE Futures Europe exchange, while futures traded in New York settled at $106.16 a barrel.
Oil in London is still trading 20 percent below its inflation-adjusted peak in July 2008 and 5.8 percent less than the level in April 2011, data compiled by Bloomberg show. The surge in crude during those periods buffeted the global economy as Brazil, Russia, India and China, the four-biggest emerging markets, tightened monetary policy to combat inflation.
The countries haven’t raised borrowing costs this year. Brazil cut its benchmark Selic rate by 75 basis points, or 0.75 percentage point, to 9.75 percent yesterday, while China reduced banks’ reserve requirements last month and Premier Wen Jiabao said the country needs to start “fine-tuning” economic policies to support growth. India and Russia have kept benchmark interest rates unchanged in 2012.
“It’s too early to assess the impact” of this year’s rally in crude, Arjun Divecha, chairman and head of emerging markets at GMO LLC, which oversees about $97 billion, said in a March 1 interview in New York. “It depends on how long the oil spike will last.”
Oil climbed 0.9 percent to $125.17 a barrel at 1:03 p.m. in London while global stocks and emerging-market currencies advanced after Germany’s industrial output increased more than forecast and Greece moved closer to completing its debt swap. Turkey’s benchmark equity index rose 1.6 percent, while the South Korean won strengthened 0.6 percent against the dollar and the Sri Lankan rupee appreciated 0.1 percent. India’s financial markets were closed for a public holiday.
Turkey, the seventh-biggest emerging economy, is vulnerable to higher oil because of the country’s current-account deficit, UBS’s Baweja said. The gap was probably 10.3 percent of gross domestic product in 2011, the biggest in emerging markets and up from 5.7 percent in 2008, according to the International Monetary Fund.
Every $10-a-barrel increase in oil adds $4 billion to the cost of imports, or about 0.5 percentage point of GDP, Turkey’s Energy Minister Taner Yildiz said on Feb. 28.
Rising energy prices also pose a risk to inflation, Central bank Governor Erdem Basci said the same day. Turkey’s consumer prices increased 10.4 percent in February, within almost 20 basis points of the fastest pace in three years.
Yields (IESM2Y) on the government’s benchmark two-year notes have climbed 32 basis points this month to 9.25 percent. The lira retreated 1.8 percent versus the dollar, while the ISE National 100 Index (XU100) of shares slid 2 percent. Arcelik AS, Turkey’s biggest producer of household appliances, and Ford Otomotiv Sanayi AS, the Turkish unit of Ford Motor Co., fell on concern higher energy costs will reduce consumer demand.
‘Begin to Worry’
“If oil pushes higher, the market will begin to worry about stock market stability, inflation and the currency, which will all also have an impact on the CDS market,” UBS’s Baweja wrote in a Feb. 28 research report.
The strategist advised clients to buy five-year credit default swaps on Turkey, which cost 235 basis points yesterday, after falling to a four-month low of 229.5 basis points on March 2, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. The contracts increase in value as perceptions of creditworthiness deteriorate.
India’s rupee weakened 2.5 percent against the dollar this month while the BSE India Sensitive Index (SENSEX) of stocks retreated 3.4 percent, the second-biggest decline among equity gauges in 21 emerging markets tracked by Bloomberg after Hungary’s BUX Index. One-year interest-rate swaps, a gauge of expectations for future borrowing costs, are up 42 basis points this year to 8.17 percent, according to data compiled by Bloomberg.
Seven of nine economists surveyed by Bloomberg predict India’s central bank will leave its benchmark interest rate unchanged at a three-year high of 8.5 percent on March 15, even after the government said economic growth slowed to 6.1 percent in the fourth quarter, the weakest pace since 2009.
For every $10-a-barrel increase in oil, India’s inflation rate may rise by 0.9 percentage point and government subsidy costs may climb by 0.3 percent of GDP, according to Morgan Stanley.
“The market has started to discriminate a lot more on the oil factor,” Jonathan Garner, the chief Asia and emerging- market strategist at Morgan Stanley in Hong Kong, said in a phone interview yesterday. For corporate profits, “there’s a potential problem particularly for the oil-importing countries,” Garner said.
Forward contracts show traders are betting India’s rupee will weaken 5.6 percent against the dollar over the next 12 months, according to data compiled by Bloomberg. Daragh Maher and David Bloom, currency strategists at HSBC in London, recommend selling the rupee against Malaysia’s currency because the smaller country is a net oil exporter, according to a March 2 research report.
Inflationary pressures are building in South Korea after gasoline prices in the sixth-biggest emerging economy increased to a record high, Sharon Lam, an economist at New York-based Morgan Stanley, wrote in a March 2 note. The nation’s net crude imports amount to 7.3 percent of GDP, Goldman Sachs Group Inc. said in a Feb. 29 report.
Two-year interest rate swaps in South Korea have increased 13 basis points this year to 3.51 percent, according to data compiled by Bloomberg. The central bank will probably keep benchmark borrowing costs unchanged at 3.25 percent today, according to the median estimate of 16 economists surveyed by Bloomberg.
The Kospi Index of Korean shares has retreated 2.4 percent this month, while the won has slipped 0.5 percent. The currency may extend declines as the surge in oil hurts the outlook for corporate earnings, prompting overseas equity fund managers to cut holdings, according to UBS’s Baweja. He recommends selling a basket of won, Thai baht and Chilean pesos against the dollar.
Sri Lankan Slump
Sri Lanka’s Colombo All-Share Index (CSEALL) has tumbled 9.8 percent this year while the rupee weakened 6.3 percent against the dollar. The government let the currency depreciate to a record low last month while boosting fuel prices and raising benchmark interest rates in an attempt to narrow the island’s trade deficit. Sri Lanka depends on Iran for more than 90 percent of its oil needs, according to Oil Minister Susil Premajayantha.
Further increases in fuel prices may spur the rupee to weaken further, Johanna Chua, an economist at Citigroup in Hong Kong, wrote in a Feb. 20 report. Investors should wait until April to consider buying local-currency debt, she said.
Should oil prices keep rising, the won, lira and rupee may also underperform, according to Alessio De Longis, a portfolio manager at OppenheimerFunds Inc. in New York.
“These countries are very vulnerable to higher oil prices,” said De Longis.
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