Emerging Markets: What has Changed

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

1) New measures by the RBI stop the bleeding in India – for now at least

2) The market is calling Turkey’s CB Governor Basci’s bluff

3) The Polish government announced its quasi-nationalization of the pension system

4) The Malaysian government raised fuel prices for the first time since 2010

1) New measures by the RBI stop the bleeding in India – for now at least. The incoming head of the RBI, Raghuram Rajan, has achieved a lot in his first day, including this great tone-setting quote: “Some of the actions I take will not be popular. The Governorship of the Central Bank is not meant to win one votes or Facebook likes.” More substantially, he announced a set of banking reforms and a dollar funding swap window. The latter will allow banks to swap foreign-currency deposits with the central bank at a rate of 3.5%.

The immediate impact of these actions was a 2.1% rise in the Sensex index, driven by a whopping 7.0% gain for financial sector stocks; a very welcome relief in local yield, with the 5-year swap rate falling 20 bp to 8.3% (a level not seen since the start of August); and a 1.6% gain for the INR, taking the currency back to around 66.0 against the USD. Could this be an inflexion point for India? In some ways it reminds us of the announcement of the big intervention program by the Brazilian central bank last month, which did not reverse the negative sentiment, but was enough to contain further declines for the BRL (at least temporarily). It’s too soon to say, but this does seem like a great time to wait on the sidelines. A break below the USD/INR 65.0 level may signal that a larger pullback may be in store.

2) The market is calling Turkey’s CB Governor Basci’s bluff. Comments from the recent strategy meeting with the central bank left observers frustrated and with the impression that there is nothing in the pipeline beyond liquidity management and changes to reserve requirements. We are not so convinced. Basci has never been afraid to act, and we doubt he is now. There are many rumours about FX swaps (like in Brazil), which would help keep the headline FX reserve figure high – at least cosmetically. We don’t have a view on what is coming, but we doubt they will sit and watch TRY weaken, especially if the likes of BRL and INR start to stabilize. In any case, USD/TRY is making new all-time highs above 2.08.

3) The Polish government announced reforms to the pension system. Amongst other things, the privately managed pension funds have been banned from buying and holding government debt. While the moves are expected to help narrow the budget deficit and to reduce the debt/GDP ratio by about 8 percentage points, the lack of demand for public debt from pension funds is expect to have a negative result for the local fixed income market. In particular, it would make the role of foreign investors even more important in price setting, hence leaving Poland more exposed to global trends – an especially dangerous proposition at this particular point in the cycle. Indeed, the first bond auction this week held after the reforms were announced saw borrowing costs rise sharply for the government.

4) The Malaysian government raised fuel prices for the first time since 2010. This is in line with efforts to curtail some criticism over the deteriorating budget situation. The cut in fuel subsidies is very welcome, of course, and comes after the delay in planned infrastructure measures, which should also alleviate some pressure on the budget. Fiscal stimulus was used in the run-up to the elections, and so countervailing measures are being taken now. Note the central bank just cut its 2013 growth forecast from 5-6% to 4.5-5.0%. If the economy softens further, there may be pressure on the central bank to ease, especially since fiscal stimulus is off limits for now. Indeed, Fitch cut the outlook on Malaysia’s A- rating from stable to negative back on July 30, citing public finances as its key rating weakness.