Emerging Markets: What has Changed

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

1) S&P moved the outlook on Turkey’s rating from stable to negative

2) Ukraine’s central bank imposed capital control measures to try and stem outflows and dwindling reserves

3) The Kazakh tenge was devalued by nearly 20%, the biggest move since the 2009 devaluation

4) China e-commerce company Alibaba Group Holding Ltd. is rolling out its first wealth management product

EM is in a consolidative phase right now, with investors left wondering if the February bounce was a correction or a trend change. We still think that currencies of countries that combine the following conditions are best positioned to outperform in the medium term: (1) did undergo a significant re-pricing in this recent sell off; (2) have strong external positions and (3) have low inflation.  

Examples include MYR, PHP, THB (if politics improves), and to a lesser extent, MXN and CLP.

Over the last week, Chile (+4.4%), Hong Kong (+3.5%), and the Philippines (+3.2%) have outperformed in the EM equity space in local currency terms, while Brazil (-1.1%), Turkey (-1.0%), and Hungary (-0.8%) have underperformed. In the EM local currency bond space, Indonesia (10-year yield down 29 bp), Thailand (down 13 bp), and Mexico (down 10 bp) have outperformed over the last week, while India (10-year yield up 15 bp), Brazil (up 13 bp), and South Africa (up 8 bp) have underperformed.In the EM FX space, IDR (+1.8% vs. USD), KRW (+1.2%) and ARS (+0.8%) have outperformed over the last week, while BRL (-1.9% vs. USD), HUF (-1.5% vs. EUR), and RUB (-1.5% vs. USD) have underperformed.

1) S&P moved the outlook on Turkey’s rating from stable to negative. We totally agree but this is not a surprise to us as our model has Turkey at BB/Ba2/BB. S&P's BB+ is the lowest of the three. Fitch and Moody's have Turkey at investment grade (Baa3 and BBB-, respectively), which increasingly looks premature. Recent inflation and current account data have been worse than expected, due in large part to the weak lira. The fundamentals are likely to get worse in the coming months.

2) Ukraine’s central bank imposed capital control measures to try and stem outflows and dwindling reserves. According to Bloomberg, these measures include a waiting period of at least six working days for foreign currency purchases by companies and curbs on individuals’ market access. The central bank also moved the hryvnia’s official exchange rate, used for accounting purposes, to 8.7 per dollar from 7.99, the first change since 2012. Note, however, that the head of monetary policy at the bank said that the controls are temporary. With Russia playing hardball with its loans and FX reserves just over $15 bln, we hope Ukraine has a plan B.

3) The Kazakh tenge was devalued by nearly 20%, the biggest move since the 2009 devaluation. USD/KZT will now trade at 185 plus or minus 3 tenge. Before the devaluation, the rate was largely managed between 145-155 per dollar since 2009. The fundamentals hardly cry out for realignment of the exchange rate. According to the central bank, the reasoning for the devaluation was based in part on weakness in the ruble, but it’s not that clear that a weaker tenge was really needed. Kazakhstan’s Real Effective Exchange Rate (REER) remains well within historical ranges. Despite devaluations and capital controls, we downplay the notion of widespread EM contagion. Instead, we believe most of the countries experiencing the sharpest pressures have many homegrown problems (poor fundamentals, heightened political uncertainty).

4) China e-commerce company Alibaba Group Holding Ltd. is rolling out its first wealth management product. The instrument will be issued by Alipay, the e-payment arm of Alibaba, and follows the widely popular Yu’E Bao, its first Internet finance product which had interest north of RMB250 bln (the largest money market fund in China). The new product will yield 1-year fixed 7.0% return with guaranteed principle, 83 bp more than the Yu’E Bao (which investors can withdraw at any time). It’s hard to imagine that this would be done without the support of the government, and seems like a better alternative (less opaque) than the much discussed wealth management products in China’s shadow banking system. Moreover, these products are likely to come under heavy scrutiny by regulators.