Emerging Markets: What Has Changed?

(from my colleague Ilan Solot)

This is what has changed in the EM space, in our view:

1) Brazil is hiking, but reluctantly

2) Turkey is cutting, and resolutely

3) China will further relax the FX trading band

4) Philippines will further relax FX trading limits

5) Korea announces a big stimulus package

6) Colombia announces a medium stimulus package

7) Political change in Venezuela is happening too fast

8) Political change in India is happening too slowly

1) Brazil is hiking, but reluctantly. The Brazilian central bank decided to hike rates by 25 bp last night after days (if not weeks) of shifting markets expectations. Yesterday’s move is just the first one of many hikes in a cycle that will total between 100-150bp, in our view, though early dovish signals suggest the lower end is more likely. The statement was not convincing about the bank’s commitment to hike, and two members voted for no change. As a result, yields came crashing down across the local swap curve in a strong bull steepening move.

2) Turkey is cutting, and resolutely. We were surprised to see the 50 bp cut to the benchmark repo rate on Tuesday. We thought the bank would stick with lowering the bottom end of the corridor for now, which it reduces the lira’s carry. Instead, they cut 50 bp off all three rates. The bank is counting on weak global demand and lower commodity prices to "contain the upward pressures on inflation." We hope they are right, but with CPI still running at about 7.5% y/y and a more active policy to weaken the lira, we are not totally convinced. We would hate to see the central bank’s hard earned credibility eroded by a precocious move towards easing. For now, we still give them the benefit of the doubt. 

3) Korea announces a big stimulus package. At about $15.4 bln, the supplementary fiscal stimulus package surprised on the upside, mostly because it included plans to raise more debt. Beyond that, the announcement was as expected. The package is estimated to boost growth by 0.3 percentage points and create 40,000 jobs. 

4) Colombia announces a medium stimulus package. The $2.7 bln package includes subsidized mortgage credit and an expansion of housing programs for low income families. The plan also included changes in rules on pension funds to encourage more investments abroad and ostensibly weaken the peso. There was little noticeable reaction in USD/COP, and we doubt there will be. 

5) China will further relax the FX trading band. Let’s recap: When the strict yuan peg ended in July 2005, the +/- 0.3% trading band was put in place for USD and +/- 1.5% for non-dollar foreign currencies. Then in September 2005, the non-dollar trading band was widened from +/- 1.5% to +/- 3.0%, but USD band maintained. The USD trading band was then widened from +/- 0.3% to +/- 0.5% back in May 2007. In April 2012, the USD band was widened from +/- 0.5% to +/- 1.0%, which is where it stands now. Looking at past patterns, a move to widen the USD band from +/- 1.0% to +/- 1.5% would seem the more natural course. 

6) Philippines will further relax FX trading limits. This means that the government will allow for more investments abroad. It will also double the limit for over-the-counter FX transactions. The idea is to prevent further appreciation of the peso, but we doubt it will have a noticeable impact in the short term. Still, the move helps consolidate the idea that Philippines is becoming far more active in the currency markets. We think the continuous cutting of the SDA rate, for example, helped send the signal that stemmed the decline in USD/PHP since March. We are neutral on PHP in the short term, but doubt the currency will participate in any broad EM currency rally – should one come along. 

7) Political change in Venezuela is happening too fast. Rather than provide a sense of closure after the death of Chavez, the close election shows just how divided the country remains and how difficult it will be to govern, no matter who is president. Maduro seems to be doubling down on his predecessor’s inflammatory rhetoric, accusing the US of being behind the violence. The situation remains fluid, but it’s hard to see the silver lining for a new era in Venezuela.

8) Political change in India is happening too slowly. Something is definitely happening, but it's not convincing enough yet for us to change our neutral stance towards the INR. Indian Finance Minister Chidambaram promised that diesel prices will be subject to increase every month until losses at state oil companies are wiped out. The minister also commented that the government plans to ease limits on FDI and make other reforms, including opening the insurance and pension industry further. Something is happening, but not convincingly or fast enough yet for us to change our neutral stance towards the INR.