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) Brazil is stepping up its defences against market volatility.

2) Signs that China is looking for more (and better) sources of external funding sources is mounting.

3) Turkish central bank governor Basci seems ready to take action to stabilize markets.

1) Brazil is stepping up its defences against market volatility. Finance Minister Mantega announced Wednesday the lowering of IOF tax on foreign investments in local fixed income markets from 6% to 0%. The tax was introduced in 2011 when the real was under pressure to appreciate. 

Now both the Finance Ministry and the central bank (via swaps) are together trying to (A) slow down further BRL depreciation and/or (B) cap the move at 2.15. Their intention is not yet clear, and we may never know. Still, we think their commitment (and capability) is strong enough to help BRL outperform other EM currencies in periods of broad dollar strength.

2) Signs that China is looking for more (and better) sources of external funding sources is mounting. This week, the media suggest that plans are moving ahead to cut red tape to boost foreign investment by easing application and approval procedures for foreign investors. Separately, we are hearing more talk about the development of local bond futures markets to give investors better hedging tools. 

These developments are in line with the view that there may be growing urgency to attract more stable funding capital to make up for the diminished capacity of local lenders. In fact, reports suggest that China’s big four banks issued only RMB208 bln loans in May (down from RMB245 bln in April). This will surely lead to a downward revision of expectations for the May new yuan loans data release next week, where consensus is currently at RMB850 bln.

3) Turkish central bank governor Basci seems ready to take action to stabilize markets. Expectations have now rightfully shifted from easing to tightening of monetary conditions. We could see the bank return to the policy framework of using “special” days and “normal” days for liquidity management and guiding the interbank rate higher. 

The interbank rate has risen from around 4.0% in mid-May to 5.6% now. At this point, the upper end of the corridor set at 6.50% represents the upper limit for the interbank rate. Raising the top end of the corridor would be a drastic measure, and we don’t think it will happen unless the situation gets a lot worse. We do note that rising political concerns go hand in hand with steadily deteriorating economic fundamentals in Turkey.