Emerging Markets: What has Changed

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

1) Optimism about Petrobras and BRL was dented as Friday’s key event was postponed

2) RBI Governor Rajan continues to push with his aggressive reforms

3) Turkey gave more hawkish-than-expected guidance on rates

4) Czech central bank hints at further action

Over the last week, China (+5%), Hong Kong (+4%), Poland (+3%), and Mexico (+3%) have outperformed in the EM equity space in local currency terms, while Peru (-3.5%), Thailand (-3%), and Hungary (-1%) have underperformed. 

In the EM local currency bond space, Brazil (10-year yield up 30 bp), China (up 23 bp), Indonesia (up 22 bp), and Thailand (up 17 bp) have underperformed over the last week, while Colombia (10-year yield down 10 bp), Turkey (down 7 bp), and South Africa (flat) have outperformed.

In the EM FX space, TRY (+0.5% vs. USD), KRW (+0.5%), and ZAR (+0.3%) have outperformed over the last week vs. USD, while IDR (-1.4%), RUB (-1.1%), MXN (-1%), and THB (-1%) have underperformed.

1) Optimism about Petrobras and BRL was dented as Friday’s key event was postponed. The markets were supposed to hear about a new methodology for setting fuel prices in Brazil, but it has been delayed a week as discussions likely remain contentious. Highly regulated and subsidized fuel prices are one of the main factors behind the troubles Petrobras is facing. Meanwhile, the BRL outlook remains in flux. Friday will still hold some suspense as the government auctions off two airports, and the minimum bid is set at $2.6 bln. Some of the real’s recent firmness was supported by speculation of inflows from these auctions. Many observers are taking these auctions as a key test of the government’s ability to attract investment, as major international operators will likely take part. Last auction was not very well-received so tomorrow will be a litmus test. Moreover, a successful auction could help allay lingering fiscal concerns as part of Rouseff’s privatization drive. 

2) RBI Governor Rajan continues to push with his aggressive reforms. In an interview with the FT, the governor sees “a dramatic remaking of the banking landscape.” This includes greater freedom for foreign banks to expand and more licenses for domestic private sector institutions. At the same time, the central bank is providing extra liquidity in the form of an $800 mln refinancing line for small businesses. All in all, we continue to commend Rajan’s continued efforts to boost India’s financial system and we think they are positive for local assets. He has also delivered hawkish surprises on the rate front. We just hope that the government follows suit on the fiscal side and pushes ahead with more reforms there as well. The twin deficits remain key concerns for India.

3) Turkey gave more hawkish-than-expected guidance on rates. The bank announced at its policy meeting that “One month repo auctions will be terminated, as a result of which interbank money market rates will materialize around 7.75%. The Committee decided to strengthen the cautious stance and reduce the volatility of short term money market rates." Interbank rates (as well as the weighted average cost of funding) have moved higher during recent bouts of TRY weakness, only to come off after the currency firmed. For instance, the weighted average cost of funding spiked to 6.8% early last week, edged back to 6.34% later in the week, then has moved back to near 6.5% since then. This 6.5% rate is what the central bank signaled is consistent with an interbank rate of 7.75%. The central bank has signaled higher rates will remain in place for now, which is a bit more hawkish than expected. We now have seen Brazil, India, Indonesia, and Turkey tightening to support FX and limit inflation. 

4) Czech central bank hints at further action. MPC member Lizal said he can imagine moving the EUR/CZK target to 28.00, adding that this is not an "unrealistic scenario." We don't think Lizal's view is shared yet by a majority of the board, but we suspect he is not alone and may get more on board if data remain weak in 2014. For his part, Governor Singer later said that the bank is not planning any new intervention and that the EUR/CZK 27.00 level is sufficient. In any case, EUR/CZK has moved even more above 27.00 since the November 7 decision and further gains seem likely as the economic data remain weak. We have yet to see any actual foreign reserve numbers reflecting official FX intervention since the program just began this month.