Emerging Markets: What Has Changed

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

1) The RBI is getting ready to adopt a 4% inflation target by 2016

2) China’s Q4 GDP data brings some hope to the rebalancing narrative

3) There was a sharp devaluation yesterday in the Argentine peso, for both the official and unofficial rates

4) Political risks have worsened in both Thailand and the Ukraine

5) Turkey kept policy rates steady and instead introduced more back door tightening

Over the last week, Philippines (+3%), Russia (+2%), and Indonesia (+2%) have outperformed in the EM equity space in local currency terms, while Israel (-2%), Singapore (-1%), Hong Kong (-1%), and Brazil (-1%) have underperformed. 

 In the EM local currency bond space, Ukraine (10-year yield up 56 bp), Indonesia (up 22 bp), and South Africa (up 13 bp) have underperformed over the last week, while China (10-year yield down 9 bp), Czech Republic (down 9 bp), and Turkey (down 7 bp) have outperformed. 

In the EM FX space, ILS (flat vs. USD), CZK (flat vs. EUR) and CNY (flat vs. USD) have outperformed over the last week, while ARS (-3%), TRY (-3%), and CLP (-2%) have underperformed vs. USD.

 1) The RBI is getting ready to adopt a 4% inflation target by 2016. The idea is to bring CPI down from the current 10% to 8% within one year, and 6% by 2016. Then the 4% target would be formally adopted. The report also kept the pressure on the government to do its part by reigning in the budget deficit. Implementation has always been a problem in India, but the relatively new central bank president Rajan has delivered so far. Assuming that the plan moves ahead, the implications for markets are relatively straight forward: (1) positive for the INR and equities in the medium term; (2) the curve should bear flatten as the risks of hikes increase and markets price in lower long term rates; and (3) fiscal performance may matter even more for rates since the RBI will have to make up for any slack via rates to reach the target. Still, the timetable seems way too optimistic, while the fiscal outlook is always open to question.

2) China’s Q4 GDP data brings some hope to the rebalancing narrative. The data also suggests that the external sector is not being overly impacted by the nominal appreciation of the yuan. However, HSBC manufacturing PMI disappointed. Separately, there is much focus in China on the month-end maturity of wealth management products. Previously, reports suggested that China's largest bank may not make good on investors of a particularly troubled trust. This sparked concerns of knock-on effects. However, today a report suggests that ICBC and the China Credit Trust may each assume responsibility for a quarter of the payment (CNY3 bln or ~$500 mln) trust. 

3) There was a sharp devaluation yesterday in the Argentine peso, for both the official and unofficial rates. The official rate fell 3.5% to USD/ARS 7.14, the biggest drop since 2002, while the black market rate is said to be over 12.0. The central bank did not intervene by selling dollars. The depreciation is probably a (misguided) way to try to preserve Argentina’s dwindling FX reserves, which stand at about $30 bln, down from $48 bln in early 2008. The latest desperate measure by the government was to tighten controls on shopping at foreign websites. Negotiations continue with the Paris Club regarding the latest proposal for Argentina, with the organization saying it is too early to respond. Separately, President Cristina Kirchner announced further social benefits for students (as part of the Progresa program), expected to reach 1.5 mln students.

4) Political risks have worsened in both Thailand and the Ukraine. As we have warned for both, things are going to get worse before they get better. The Ukraine protests have already resulted in two deaths and show no sign of abating. In Thailand, Prime Minister Yingluck declared a state of emergency. In both countries, the political turmoil will take a toll on the real economy. The Bank of Thailand unexpectedly kept rates steady, but more easing is likely in the coming months.

5) Turkey kept policy rates steady and instead introduced more back door tightening by saying it would lend at 9% (instead of 7.75%) on “extra tightening” days. What’s worse, it appears that political pressure has been brought to bear on the central bank not to hike rates. Markets did not react well, and the central bank was forced to step up its FX intervention. Today, press reports suggest up to $1.5 bln was sold by the central bank. While this has helped the lira stabilize, it cannot be sustained.

For Turkey, gross reserves vs. net reserves is an important distinction. Gross reserves hit a new high of $114 bln in November but dropped $2 bln in December to $112 bln and dropped to just below $110 bln though January 10. In calculating gross reserves, the central bank counts the foreign currency required reserves by banks as central bank FX reserves, which really doesn't seem kosher. Net reserves are much lower, by our calculations near $36.5 bln thru Jan 10. Obviously, the central bank can't intervene too much on a greater scale.