Emerging Markets: What has Changed

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

1) The Indonesian central bank unexpectedly hiked rates 25 bp to 7.50%

2) India reported higher than expected October CPI and WPI, and should tip the RBI into hiking again next month 

3) Hungary reported much lower than expected October CPI and we now expect the central bank to cut the policy rate below 3%

4) The Third Plenary session of the Chinese Communist Party has ended

Over the last week, Israel (+0.3%) and Brazil (+0.7%) have outperformed in the EM equity space in local currency terms, while Chile (-4.5%), Colombia (-4.25%), and Czech (-4%) have underperformed. 

In the EM local currency bond space, Indonesia (10-year yield up 52.5 bp), Russia (up 28 bp), Turkey (up 27 bp), Malaysia (up 19 bp), and South Africa (up 15 bp) have underperformed over the last week, while Czech (10-year yield down 9 bp), Brazil (down 10 bp), and Israel (down 4 bp) have outperformed.

In the EM FX space, MXN (+1% v. USD), PLN (+0.1% vs. EUR), and CNY (flat) have outperformed over the last week vs. USD, while IDR (-1.5%), BRL (-1%), INR (-1%), and RUB (-1%) have underperformed.

1) The Indonesian central bank unexpectedly hiked rates 25 bp to 7.50%. No move was expected but we suspect this latest bout of EM selling pressures convinced Bank Indonesia that it was needed to help stabilize the rupiah. After spending months behind the curve, we think the Indonesian authorities are acting aggressively to get back ahead of it, as this was the fifth hawkish surprise since June. BI stated that this latest rate hike was aimed at easing the current account deficit and meeting the inflation target. To us, it seems they are willing to tolerate slower growth in order to lower the country’s vulnerabilities. Further hikes are possible, but will depend in part on external factors.

2) India reported higher than expected October CPI and WPI, and should tip the RBI into hiking again next month. October CPI rose 10.1% y/y vs. 9.9% consensus and 9.8% in September. Next RBI policy meeting is December 18. Governor Rajan has delivered two straight rate hikes since taking the helm in September, and another one is likely next month as price pressures remain strong and the rupee continues to weaken. Like Bank Indonesia, the RBI may be pushed into hiking more in the months ahead due to the same factors that are hurting the weak links in EM, which also include Brazil, South Africa, and Turkey. 

3) Hungary reported much lower than expected October CPI and we now expect the central bank to cut the policy rate below 3%. On Wednesday, the central bank released minutes from its October policy meeting when it cut 20 bp to 3.4%, noting there was scope for continued easing. Next central bank policy meetings are November 26 and December 17. With growth slow and inflation low, we see 20 bp cuts at both of those meetings, which would take the policy rate down to 3.0%, followed by more rate cuts to sub-3% in 2014.

4) The Third Plenary session of the Chinese Communist Party has ended. It will take some time for its true significance to be appreciated, but the initial official coverage seemed to emphasize the upgrading of market forces. Since the early 1990s, the official slogan was that market should play a "basic" role in the allocation of resources. Now the Chinese Communist Party says markets will play a "decisive" role. What it really means in practice has yet to be determined, but it does represent an upgrading of the role of markets in what China calls the "socialist market economic system." We expect further liberalization of interest rates and exchange rates, albeit at a very modest pace.