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MGM Mirage EM Model| United States Update Credit Research

Emerging Markets Research | EEMEA

Recession and overheating probability models


We produce an update of our simple models which look at when economies are at risk of overheating or at risk of recession. These models can therefore provide a useful insight at a time of uncertainty over the growth contagion from Europe into EEMEA. We estimate that the EEMEA region grew at 4.6% y-o-y in 2011, but with growth slowing to just 2.2% this year based on the eurozone contracting by 0.7%.With markets stabilising since the beginning of the year, US and Asian growth outperforming and European growth weakening only modestly, the outlook for global growth looks a touch brighter than at the back end of last year. However, we still expect a mild eurozone recession, which will have a strong weakening effect on output within EEMEA. Linkages between CEE in particular and eurozone domestic demand are unlikely to have changed much since 2009, with declining export demand the largest drag on growth, while any European bank deleveraging will also act as a constraint on output. Recession probabilities for Hungary and the Czech Republic remain significantly raised at levels above 70%, indicating a strong likelihood that the two countries may have entered a period of prolonged sub-par growth. Intuitively, within EEMEA, these two countries with their closer eurozone links and idiosyncratic issues, would seem most likely to suffer from slower global growth. Our models suggest that within EEMEA, South Africa, Turkey and Poland are least likely to enter recession, with limited evidence of any real contagion from last years market turmoil so far. However, we expect the effects of slower global growth to be felt more strongly in the coming months. Our overheating probability indicators suggest there is an extremely high possibility that Turkey and, with a slightly more moderate probability, Russia will overheat at some point over the next 12 months. However, the use of a consistent model for the region means that our indicators continue to portray a picture that is perhaps stronger than reality for both Turkey and Russia, and we still expect a correction in overheating probabilities over the coming months.

0 9 M AR C H 2 0 1 2 Fixed Income Research


Contributing Analysts

Peter Attard Montalto


+44 20 7102 8440 peter.am@nomura.com

Olgay Buyukkayali
+44 20 7102 3242 olgay.buyukkayali@nomura.com

This report can be accessed electronically via: www.nomura.com/research or on Bloomberg (NOMR)

With special thanks to Alastair Matthews for helping devise and build this product.

Notes: Our indicators may technically suggest an economy is both overheating and at risk of recession at the same time, because an overheating bubble can burst very rapidly. A full methodology is available at the back of this report, or please see our introductory report (06 January 2012) for more details.

Summary table: EEMEA Recession Probabilities


10/2011 11/2011 12/2011 01/2012 02/2012 Turkey 1.5% 1.7% 1.1% 1.5% 2.1% South Africa 6.3% 6.6% 7.5% 7.2% 7.0% Israel 28.8% 35.7% 35.7% 42.6% 46.1% Hungary 78.8% 80.3% 75.3% 76.3% 77.7% Czech 50.7% 69.1% 78.8% 87.0% 83.3% Russia 28.6% 24.1% 25.3% 27.1% 34.0% Poland 1.9% 1.6% 2.3% 2.9% 4.1% Note: Poland, Czech and Russia probabilities are for 2 periods of real GDP grow th (% qo-q) of <0.5, due to a lack of recessionary periods w here data is available

Current Recession/Overheating Probabilities


Recession/Overheating Probability 1.0
0.9 0.8 0.7 0.6 Recession 3M ago Overheating 3M ago

0.5
0.4

Summary table: EEMEA Overheating Probabilities


10/2011 97.1% 0.7% 40.6% 17.4% 6.7% 65.6% 0.9% 11/2011 98.0% 0.8% 52.8% 33.2% 8.3% 65.3% 1.6% 12/2011 98.6% 1.3% 47.3% 30.0% 14.6% 72.2% 3.2% 01/2012 98.4% 1.6% 48.4% 28.2% 18.8% 78.4% 3.9% 02/2012 98.3% 2.1% 48.2% 19.0% 22.0% 82.2% 3.8%

0.3

0.2
Turkey South Africa Israel Hungary Czech Russia Poland

0.1

0.0

CZ

HU

IS

RU

SA

PO

TU

All sources: Nomura

Nomura International PLC.

See Disclosure Appendix A1 for the Analyst Certification and Other Important Disclosures

Nomura | EEMEA Recession and Overheating Probability Indicators

09 March 2012

Hungary: Recession is just round the corner


Figure 9. Hungary: recession probability table

Consum er Confidence sa (y-o-y) Equities (% y-o-y) Retail Sales (% y-o-y) Industrial Production sa (% y-o-y) Unem ploym ent (y-o-y) Recession Probability Actual Recession

10/2011 -29.2 -24.0 1.2 3.2 -0.1 78.8% No

11/2011 -28.7 -14.6 1.4 3.1 -0.1 80.3% No

12/2011 -29.2 -20.4 3.0 6.8 -0.1 75.3% No

01/2012 -30.8 -16.8 3.0 -2.7 -0.1 76.3% Yes

02/2012 -23.5 -16.7 3.0 -2.7 -0.1 77.9% Yes

Figure 10. Hungary: overheating probability table

Industrial Production sa M2 Retail Sales CPI (% q-o-q)

10/2011 3.2 -0.8 2.7 0.5

11/2011 6.7 0.6 3.2 1.3

12/2011 -1.1 1.3 3.6 1.6

01/2012 0.9 1.3 3.6 1.0 28.2% No

02/2012 3.0 1.3 3.6 1.0 19.0% No

Overheating Probability 17.4% 33.2% 30.0% Actual Overheating No No No Note: Industrial production, M2 and retail sales refer to the divergence from trend

Figure 11. Hungary: historical recession probability

Figure 12. Hungary: historical overheating probability

Recession 1.0 0.8 40 0.6

Recession Probability
PMI (rhs inverted)

30 35

1.0
0.8

Overheating Overheating Probability Unemployment gap (rhs inverted)

-4
-3

-2
-1

45 50

0.6 0.4

0
1

0.4
0.2

55
60 0.0 Mar-95

0.2 0.0 Jan-95

2
3 Jan-98 Jan-01 Jan-04 Jan-07 Jan-10

Mar-98

Mar-01

Mar-04

Mar-07

Mar-10

65

Summary: Our recession indicator suggests that there is a 77.9% probability that Hungary is in recession, the highest outright score of the seven EEMEA countries. The probability has fluctuated over the past few months as data have been considerably mixed, with industrial production coming out strong in December only to fall back into negative territory in January, while retail sales data have improved over the past five months. However, the probability remains at a level consistent with previous recessionary periods. We expect a sharp slowdown in consumption as unemployment climbs as a result of the economys large exposure to eurozone core consumption. Although net trade should in fact remain supportive as the surplus climbs through 2012. A contraction of private sector investment, accelerated by deleveraging and a lack of FDI stemming from unpredictable policy will both restrain growth, even without further external shocks. Financial stability concerns, especially if risk premia begin to rise again once the market assesses the potential of no IMF deal, mean that further monetary tightening is perhaps more likely than easing (albeit if easing is more likely in the short-run). All this considered, the risk of Hungary entering recession remains relatively high. We currently forecast a 0.8% decline in output (y-o-y) in 2012, including a mild recession. Model notes: Hungarys overheating model is one of the weakest in terms of fit in this suite of models because of the difficulty in finding periods that are overheating. Given how stressed the economy has been over the last 10 years it treats the period of end-2006 to mid-2008 as overheating, even though in reality the economy was still below sub-par. We include it here for consistency across countries.

Nomura | EEMEA Recession and Overheating Probability Indicators

09 March 2012

Poland: No recession, no overheating in sight


Figure 17. Poland: recession probability table

Industrial Production sa (% y-o-y) Consum er Confidence sa Equities (% y-o-y) EURPLN

10/2011 6.8 -23.1 -10.5 4.4

11/2011 8.4 -23.4 -12.4 4.5

12/2011 7.6 -33.0 -21.9 4.5

01/2012 7.6 -28.7 -13.8 4.2 2.9% No

02/2012 7.6 -28.6 -14.7 4.1 4.1% No

Recession Probability 1.9% 1.6% 2.3% Actual Recession No No No Note: Probability is for 2 consecutive quarters of real GDP grow th (q-o-q) <0.5

Figure 18. Poland: overheating probability table

Equities (% y-o-y) Industrial Production sa M2 Private credit (% y-o-y)

10/2011 -10.5 0.9 -0.9 13.9

11/2011 -12.4 4.2 0.7 14.2

12/2011 -21.9 4.5 3.2 13.9 3.2% No

01/2012 -13.8 4.5 1.5 13.1 3.9% No

02/2012 -14.7 4.5 1.5 13.1 3.8% No

Overheating Probability 0.9% 1.6% Actual Overheating No No Note: Industrial production and M2 refer to the divergence from trend

Figure 19. Poland: historical recession probability

Figure 20. Poland: historical overheating probability

Recession
1.0 0.8 0.6 45 Recession Probability PMI (rhs inverted) 30 35 0.8

1.0

Overheating Overheating Probability Unemployment gap (rhs inverted)

-8
-6

-4
-2

40
0.6 0.4

0
2

0.4
50 0.2 0.0 Jul-01

55
60

0.2 0.0 Dec-97

4
6

Jul-03

Jul-05

Jul-07

Jul-09

Jul-11

Dec-00

Dec-03

Dec-06

Dec-09

Summary: Our recession indicator suggests there is only a 3.8% probability that Poland is undergoing a period of sub-par growth in February. We believe Poland should maintain its growth momentum through 2012, outperforming the rest of the region, aided by loose fiscal and monetary policy and strong household and business balance sheets. The FX mortgage pool is small enough not to have a major drag on the economy, and continued investment on next years European Championships should also provide a boost. Deleveraging should affect Poland the least with its profitable foreign banks and strong regulation, willing buyers of assets, limiting fire-sale risk and all remaining a key support for growth. As the most closed economy in CEE, and with some decoupling from the eurozone since 2009, Poland is well placed to deal with an external shock. A contracting trade deficit should actually be slightly supportive to growth through H2, though a stronger currency threatens this. Therefore, we believe Poland will once again, as in 2008-09, survive without recession, with growth falling from 4.3% in 2011 to 2.8% in 2012, although once again, risks are skewed to the downside should the eurozone experience a prolonged downturn. Model notes: Poland has not suffered a recession in recent times, and as such we look here at periods of low y-o-y growth. These are highlighted in the graph above.

Nomura | EEMEA Recession and Overheating Probability Indicators

09 March 2012

Czech Republic: Highest recession probability within EEMEA


Figure 21. Czech Republic: recession probability table

Industrial Production sa (% y-o-y) Retail Sales (% y-o-y) Consum er Confidence sa (% y-o-y) Equities (% y-o-y)

10/2011 2.5 1.5 -8.5 -19.5

11/2011 4.8 0.5 -19.5 -20.6

12/2011 4.5 1.6 -22.6 -25.6

01/2012 4.5 1.6 -17.2 -21.5 87.0% Yes

02/2012 4.5 1.6 -15.8 -18.7 83.3% Yes

Recession Probability 50.7% 69.1% 78.8% Actual Recession No Yes Yes Note: Probability is for 2 consecutive quarters of real GDP grow th (q-o-q) <0.5

Figure 22. Czech Republic: overheating probability table

Private Credit (% y-o-y) M2 CPI (% y-o-y) Im ports

10/2011 5.6 -1.8 2.3 5.9

11/2011 5.7 -1.1 2.5 6.1 8.3% No

12/2011 6.0 1.1 2.4 6.1 14.6% No

01/2012 5.7 0.0 3.5 6.1 18.8% No

02/2012 5.7 0.0 3.5 6.1 22.0% No

Overheating Probability 6.7% Actual Overheating No Note: M2 and imports refer to the divergence from trend

Figure 23. Czech Republic: historical recession probability

Figure 24. Czech Republic: historical overheating probability


Overheating

Recession 1.0 Recession Probability 0.8 0.6 45 PMI (rhs inverted) 30 1.0 0.8 0.6

Overheating Probability Unemployment gap (rhs inverted)

-4

-3
-2 -1 0 1

35
40

0.4
0.2 0.0 Mar-01

50
55 60

0.4
0.2 0.0 Oct-96

2
3 4

5 Oct-99 Oct-02 Oct-05 Oct-08


6 Oct-11

Mar-03

Mar-05

Mar-07

Mar-09

Mar-11

Summary: The probability that the Czech Republic is now experiencing a period of sub-par growth has increased sharply over the past few months, reaching a high of 87.0% in January. This is a level that is consistent with previous periods of subpar growth, and has been led by a decline in consumer confidence and equity performance. However a modest recovery in both of these indicators has seen the score fall back in February to 83.3%. Despite a strong banking system, where deleveraging should only have a limited effect and the fading drag from previous fiscal consolidation, the strong external shock in the eurozone is likely to reduce growth sharply in 2012. The effect of a eurozone recession is likely to be strongly felt here, with the Czech Republic perhaps the most open and exposed economy in Emerging Europe (67% of export demand comes from the eurozone), and with particularly close links to Germany. Recent GDP data suggest the Czech Republic underwent a period of sub-par growth during Q2 and Q3 2011, and this is likely to continue through H1 of this year. Model notes: The Czech Republic has not suffered more than one recession in recent times. As such, here we look for periods of low y-o-y growth.

Nomura | EEMEA Recession and Overheating Probability Indicators

09 March 2012

Methodology
EEMEA Recession Indicator The EEMEA recession probabilities aim to provide an early indication of whether a country has entered recession. With recession defined as two consecutive quarters of negative q-o-q real GDP growth, we are unable to determine when an economy actually entered recession for two quarters and even longer considering data lags. Hence we need a form of leading indicator. To obtain this earlier indication, we create a model for each country from high frequency data using probit regression. With periods of recession denoted by 1, the model provides a probability that the economy in question entered recession in that month. For Poland, the Czech Republic and Russia, which have not experienced more than one recession over the time period dictated by data availability, our model looks at the probability that the economy is entering a period of slow growth (defined as two consecutive periods of q-o-q real GDP growth of less than 0.5%). Where the latest months data have not yet been released, the model uses the latest available figure. In the tables above, this is denoted by the shaded pink areas. For months where we have no GDP data, we have used Nomura forecasts to determine whether the economy is actually in recession, and this is illustrated by the shaded grey values in the tables above. For details on the regression analysis, please see Figure 29 below:

Figure 29: Regression Specifications


Turkey
c USDTRY Business Confidence Industrial Production (% y-o-y) R-Squared: 0.76

Coefficient
1.8932 -3.1188 -0.0680 -0.0647

Standard Error
0.6025 0.6911 0.0148 0.0291

P-value
0.0017 0.0000 0.0000 0.0264 c

Israel
Industrial Production (% y-o-y) PMI (% y-o-y) Equities (% y-o-y) R-Squared: 0.67

Coefficient
-1.9400 -0.0583 -0.0257 -0.0693

Standard Error
0.3945 0.0390 0.0157 0.0225

P-value
0.0000 0.1350 0.1030 0.0021

South Africa
c Manufacturing Sales sa (% y-o-y) Retail Sales sa (% y-o-y) Consumer Confidence sa (% y-o-y) Industrial Production sa (% y-o-y)

Coefficient
-1.1555 -0.0310 -0.1630 -0.1117 -0.0656

Standard Error
0.2228 0.0158 0.0418 0.0600 0.0371

P-value
0.0000 0.0495 0.0001 0.0627 0.0768 c

Hungary
Consumer Confidence sa (y-o-y) Equities (% y-o-y) Retail Sales (% y-o-y) Industrial Production sa (% y-o-y) Unemployment (y-o-y)

Coefficient
-0.9172 -0.0645 -0.0491 -0.1131 -0.1168 0.5602

Standard Error
0.2834 0.0150 0.0130 0.0451 0.0441 0.2479

P-value
0.0012 0.0000 0.0001 0.0122 0.0081 0.0238

R-Squared: 0.47

R-Squared: 0.68

Poland
c Industrial Production sa (% y-o-y) Consumer Confidence sa Equities (% y-o-y) EURPLN R-Squared: 0.66

Coefficient
5.1861 -0.1637 -0.0699 -0.0420 -2.3176

Standard Error
3.0930 0.0708 0.0286 0.0198 0.9164

P-value
0.0936 0.0208 0.0146 0.0338 0.0114 c

Czech Republic
Industrial Production sa (% y-o-y) Retail Sales (% y-o-y) Consumer Confidence sa ( y-o-y) Equities (% y-o-y) R-Squared: 0.72

Coefficient
-3.1000 0.1646 -0.1284 -0.0765 -0.1306

Standard Error
0.9412 0.0883 0.0865 0.0448 0.0427

P-value
0.0010 0.0624 0.1380 0.0881 0.0022

Russia
c Employment (% y-o-y) PMI (% y-o-y) Equities (% y-o-y) USDRUB (% y-o-y) R-Squared: 0.37

Coefficient
-1.2161 -0.1065 -0.0930 -0.0060 -0.0099

Standard Error
0.2319 0.0423 0.0331 0.0044 0.0060

P-value
0.0000 0.0119 0.0049 0.1807 0.0996

Nomura | EEMEA Recession and Overheating Probability Indicators

09 March 2012

EEMEA Overheating Indicator The EEMEA overheating probabilities aim to provide an early indication of whether an economy is growing at an unsustainable rate. We first look at the output gap by calculating the divergence between actual real GDP and trend real GDP (using Hodrick-Prescott filters), expressed as a percentage of trended GDP. We define a period of overheating as one where the output gap exceeds one standard deviation above trend for two consecutive quarters. The standard deviations used in the regression are illustrated in Figure 30 below. Similar to the recession indicator, we used a probit regression with a series of high frequency indicators, such as money and credit growth, hard economic data, inflation and imports (as a demand proxy), assigning values of 1 if the economy was to overheat using the above definition in the next 12 months. For details on this analysis, please see Figure 31 below. Where the latest months data have not yet been released, the model uses the latest available figure. In the tables above, this is denoted by the shaded pink areas. For months where we have no GDP data, we have used Nomura forecasts to determine whether the economy is actually overheating and this is illustrated by the shaded grey values in the tables above.

Figure 30: Standard deviation of output gaps used in regression analysis as percentage points growth
Turkey Israel South Africa Hungary Poland Czech Republic Russia 3.24 1.92 1.28 1.52 1.35 1.88 3.09

Figure 31: Regression Specifications


Turkey
c Imports (% y-o-y) Private Credit Industrial Production Equities R-Squared: 0.70

Coefficient
-3.1730 0.0755 0.2944 0.1620 0.0206

Standard Error
0.8049 0.0245 0.0700 0.0371 0.0084

P-value
0.0001 0.0021 0.0000 0.0000 0.0138 c

Israel
Imports (% y-o-y) Private Credit (% y-o-y) Retail Sales sa Industrial Production R-Squared: 0.73

Coefficient
-5.2965 0.1334 0.2311 0.2646 0.2483

Standard Error
1.3264 0.0380 0.0702 0.0807 0.0951

P-value
0.0001 0.0005 0.0010 0.0010 0.0090

South Africa
c M2 (% y-o-y) Imports (% y-o-y) Retail Sales sa Private Credit R-Squared: 0.75

Coefficient
-9.2609 0.2887 0.1449 0.2008 0.4259

Standard Error
1.7852 0.0676 0.0311 0.0552 0.0860

P-value
0.0000 0.0000 0.0000 0.0003 0.0000 c

Hungary
Industrial Production sa M2 Retail Sales CPI (% q-o-q) R-Squared: 0.53

Coefficient
-2.4605 0.3137 0.0874 0.0724 0.2434

Standard Error
0.4079 0.0501 0.0612 0.0394 0.0866

P-value
0.0001 0.0000 0.1527 0.0661 0.0049

Poland
c Equities (% y-o-y) Industrial Production sa M2 Private Credit (% y-o-y) R-Squared: 0.76

Coefficient
-7.3628 0.0681 0.0838 0.5624 0.2778

Standard Error
1.4459 0.0190 0.0548 0.1340 0.0549

P-value
0.0000 0.0003 0.1262 0.0000 0.0000 c

Czech Republic
Private Credit (% y-o-y) M2 CPI (% y-o-y) Imports R-Squared: 0.68

Coefficient
-4.0343 0.1888 0.4514 0.2517 0.1165

Standard Error
1.0339 0.0449 0.1343 0.1081 0.0578

P-value
0.0001 0.0000 0.0008 0.0199 0.0439

Russia
c M2 Unemployment rate (q-o-q) CPI (% q-o-q) R-Squared: 0.82

Coefficient
11.1580 0.1347 -2.3102 0.1359

Standard Error
2.9525 0.0306 0.5665 0.0626

P-value
0.0002 0.0000 0.0000 0.0300

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