Emerging Markets: What has Changed

(from my colleague Ilan Solot)

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

1) Thailand:  Officials are stepping up action and rhetoric against THB appreciation

2) India: We are becoming more optimistic that the INR will finally start to recover

3) Mexico: Banxico is sounding dovish again, but caution is needed in interpreting comments

4) Indonesia: The IDR appear to be at an interesting cross road

1)  Thai officials are stepping up action and rhetoric against THB appreciation. We are not sure what is in the pipeline after last week’s approval of the plan to use FX reserves to buy debt from state-owned companies abroad, but more is coming for sure. We have THB firmly in our short side of relative value basket for EM, in our Trading FX Intervention Differentials model. 

On one hand, PM Shinawatra’s administration is pushing hard for interest rate cuts, explicitly to “stop the baht from appreciating further,” because it would, “send a very strong signal psychologically.” On the other hand, the BoT stated that: "The MPC expressed concern over recent volatility and rapid appreciation of the baht, which, at times, have not been justified by economic fundamentals [...] The committee therefore agreed on the need for a timely implementation of appropriate policy mix as warranted by circumstances, in close coordination with the Ministry of Finance and other agencies.” You have been warned. 

2)  We are becoming more optimistic that the INR will finally start to recover. Overnight, Commerce Minister Sharma said that there were discussions of opening FDI in the telecom sector. This follows ratification of new rules to open India’s retail sector to foreign investment which were approved at the end of last year. The minister also added that India should relax FDI limits on many sectors to attract foreign investments, which could be used to bridge the current account deficit. 

Aside from the obvious economic benefits, this is yet another measure that will benefit the INR in the medium term, while also helping to improve sentiment in the short term. USDINR broke below the key 54.0 level after news that India will cut the tax on interest payments for foreign institutional investors from 20% to 5%, both for investment in government and rupee-denominated corporate debt.

3) Banxico is sounding dovish again, but caution is needed in interpreting comments. Central bank president Carsten’s comments have elicited a shift in economists' calls. A rate cut, if it does come, is several months away. At this point, we take this change in tone from the “one and done” 50 bp cut more as a way to gain some optionality rather than a statement of intention. Of course more cuts are possible, but staying dovish and letting the market take yields even lower may be a preferable strategy. 

Recall the Maradona Theory of Monetary Policy, which Banxico is so skilled on. In the margin, we also suspect that the dovish shift is related to the growing discomfort about MXN strength. Suspending the USD auctions was the first alert, and more are coming. Nevertheless, we remain bullish on the peso and fundamentals in Mexico, even if volatility is set to increase in the near term.

4) Indonesia and the IDR appear to be at an interesting cross road. Here is a simplified summary of the state of affairs: (1) The economy is overheated; (2) the currency is relatively weak , looking at 12-month performance; (3) the current account deficit is wide but the trade balance is improving; (4) the imminent hike in subsidized prices could provide an upside shock to inflation of 1.6%, according to the central bank; (5) but this fuel price hike will make a big difference in the fiscal accounts; (6) there has been relatively little active policy making by the central bank or government; (7) strong inflows into local asset with the JCI index making new all time highs. 

With the central bank unlikely to raise rates to counter inflation, their options are limited to liquidity management tools and possibly allowing the currency to do some of the work on inflation. It’s not clear what route they will take, but recent comments suggest that they will lean against further IDR depreciation. In our view, the risk seems to be asymmetrical in favour of a stronger currency.