Emerging Markets: What Has Changed

(from my colleagues Dr. Win Thin and Ilan Solot)

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

1) In Brazil, government finances are back in focus and sparking calls for faster hikes

2) The Philippines government takes action on FX, more is coming

3) FX measures are also coming in Thailand

4) PBOC resumes CNY appreciation

5) Social-political tensions continue to mount in South Africa

1) In Brazil, government finances are back in focus and sparking calls for faster hikes. Some houses are calling for 50 bp hike at the May 28/29 meeting. We think that the BCB should use stronger language to convey to markets that inflation remains a priority, especially with the fiscal situation deteriorating, but we doubt they will deliver a 50 bp hike. The curve is now pricing about 40 bp of tightening for the May meeting. A new round of fiscal concerns was sparked by news that the PT is up to their usual accounting tricks. The government is selling some $15 bln of debt linked to future revenue from the Itaipu hydro-plant, up to 10 years – i.e. impacting the next 3 presidential terms. 

2) The Philippine government takes action on FX, more is coming. This week, the central bank once again used the special deposit accounts (SDA) to reduce the attractiveness of the PHP to help keep the currency from appreciating. After 200 bp cuts to the SDA this year, Governor Tetangco now resorted to adjusting the limit of use for some accounts. In our view, Philippine policy makers are looking to find ways to keep their currencies from appreciation, but without resorting to stronger measures of capital controls. At this juncture, it seems to us that they have not yet found the best way to go about it, but they are working on it. Given this uncertainty, we remain defensive on the currency, especially in relative terms. 

3) FX measures are also coming in Thailand. Central bank president Prasarn said they are waiting for a response from the finance ministry on measures the bank had suggested to reduce baht volatility. He also said that the bank has the power to bar foreign investors from purchasing some central bank bonds. Again, we doubt they will go this far, but we expect something soon. Direct FX intervention and rate cuts are both on the table. This is especially the case after Thai Q1 GDP came in lower than expected this week, at -2.2% q/q. We note that as measured by OECD, Thailand is the 10th most similar to Japan globally, and behind only Korea, Taiwan, and Czech Republic in the EM space. With THB/JPY trading near 3.40 currently, up from near 2.60 back in November, this would tend to weigh on Thai exports in the months ahead. No wonder Thai policymakers are trying to weaken the baht more. 

4) PBOC resumes CNY appreciation. It seems that last week’s apparent shift in FX policy was a head fake. After several higher fixes that broke the steady trend of lower USD/CNY fixes, the PBOC reversed course this week and set a record low fix near 6.19 on Wednesday. Thus, the near-term outlook for the exchange rate remains unclear. The economic outlook has also gotten worse. After the weaker than expected China HSBC PMI reported at 49.6, markets will be looking for a weak official PMI reading for May too when it is reported June 1. We think signs are pointing for China growth slowing eventually to the low 7s, which is perhaps a worse outcome than markets are pricing in currently. The lack of a significant policy response to this latest slowdown is noteworthy. 

5) Social-political tensions continue to mount in South Africa. The latest round of tension was sparked by security guards firing rubber bullets at a crowd of striking workers at a chrome mine owned by Lanxess, but that’s just one incident. Workers at Lonmin held a two-day strike before that. Meanwhile, Amplats announced that it will cut 6,000 jobs – though is significantly less that the 14,000 from the original announcement. Separately, the power system is being compromised by tensions in Eskom’s coal supplier Exxaro. The problem is that there is no end in sight. In fact, the sense we have by looking from the outside is that the labor problem is getting worse, and more generalized across industries. The risk is that these tensions could pull the more centrist Zuma/ANC further to the left, or eventually open the door for an anti-establishment candidate to rise to power.