Emerging Markets: What Has Changed

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

1. China trade data for June was much weaker than expected
2. Turkey’s support of the lira has gotten more aggressive
3. Bank Indonesia delivered a larger than expected 50 bp rate hike
4. India is relying more on regulatory support for the rupee

1. China trade data for June was much weaker than expected. Exports fell 3.1% in May on a y/y basis. It is the first outright decline in over a year and the largest drop since October 2009. The consensus expected a 3.7% increase. Imports slipped 0.7% while the consensus expected a 6.0% rise. The net result was a $27.1 bln surplus after a $20.4 bln surplus in May. The news spurred some speculation that the PBOC may consider a cut in the required reserves, which is a type of monetary easing. China Q2 GDP is due out July 15, and we think there are downside risks to the consensus 7.6% y/y vs. 7.7% y/y in Q1. CNY has traded largely sideways since mid-May, and we believe that will continue in Q3. It’s worth noting the 5th US-China Strategic and Economic Dialogue takes place July 10/11 in Washington DC. It is the first to have Secretary of State Kerry and Secretary of Treasury Lew attending in their new posts.

2. Turkey’s support of the lira has gotten more aggressive. The total intervention Monday was $2.25 bln (5X$250 mln) + (2X$500 mln). The amounts were increased to $500 mln for 5th and 6th auctions so it got more aggressive as the day passed. Turkey then sold $1.3 bln on Wednesday ($50 mln + 4X$150 mln + $650 mln), and has started off Thursday with a $50 mln round. They can't keep up this pace for long. Reserves were around $107 bln at the beginning of July, but they are likely closer to $100 bln after the recent interventions. The central bank is tightening liquidity modestly by injecting money mostly at 6%, near the 6.5% ceiling. We think they will have to hike policy rates in the coming days if TRY weakness continues/intensifies. Some analysts are out there saying TRY would outperform if the central bank were to hike policy rates. We are a bit more skeptical and think TRY would react to higher rates like BRL did. Which is to say not at all. Still, we do think a rate hike is in the cards as FX intervention simply cannot be sustained at this pace. Lastly, Fitch warned that prolonged political turmoil could weigh on its BBB- rating.

3. Bank Indonesia delivered a larger than expected 50 bp rate hike. Markets were looking for a 25 bp hike to 6.25%. Instead, the policy rate now stands at 6.5% after two straight months of tightening. Governor Martowardojo said the bank sees inflation approaching 7.2-7.8% this year, as transportation costs rose “too steeply” after the recent fuel subsidy cuts. We think this was the right move, and expect further tightening ahead. We expect the rupiah to remain stable near the 10,000 area near-term, and believe that IDR outperformance is likely to continue. BI official said the move was pre-emptive one, and added that the central bank is “quite happy” with the current exchange rate.

4. India is relying more on regulatory support for the rupee. Regulators this week lowered position limits and raised margin requirements for currency derivatives overnight. Elsewhere, the RBI restricted “category I” FX dealers from any proprietary trading in FX futures and exchange-traded FX options. The RBI also said later in the week that further trading curbs are being considered. Despite the measures, the rupee remains vulnerable and continues to underperform within EM. To us, speculative activity is not the problem. Rather, India’s poor fundamentals are helping its asset markets underperform as market sentiment sours. After seeing foreign equity inflows peak near $15 bln in early June, India has since seen nearly $2 bln of outflows. Twin deficits, high inflation, and sluggish growth all argue for continued INR weakness. We fully expect more measures designed to help slow the move.