Emerging Markets: What has Changed

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

1) The Brazilian central bank seems to be re-weighting its policy tools

2) The yuan continued to depreciate and the PBOC conducted its first liquidity draining operation since mid-2013

3) In Kiev, hopes for the truce announced yesterday were quickly shattered by new deadly clashes

4) Political tensions in Venezuela have ratcheted up

5) The Russian Finance Ministry announced plans this week to buy USD for its Reserve Fund

Over the last week, the Philippines (+4.1%), Egypt (+4.0%), and Indonesia (+2.4%) have outperformed in the EM equity space in local currency terms, while Pakistan (-3.9%), Brazil (-1.6%), and Mexico (-1.1%) have underperformed.  

In the EM local currency bond space, Indonesia (10-year yield down 42 bp), Brazil (down 19 bp), and South Africa (down 10 bp) have outperformed over the last week, while Ukraine (10-year yield up 92 bp), Turkey (up 34 bp), and Russia (up 23 bp) have underperformed.

In the EM FX space, IDR (+1.3% vs. USD), CZK (+0.5% vs. EUR) and MYR (+0.4%) have outperformed over the last week, while RUB (-1.7% vs. USD), CLP (-1.7%), and COP (-1.3%) have underperformed.

With all the pressure that’s been brought to bear on EM in recent months, it’s worth noting that Frontier Markets appear to be at even greater risk.  Ukraine, Argentina, Kazakhstan, Ghana, Serbia, and others have all been forced recently to take measures to address these currency pressures.  These actions range from intervention to capital controls to outright devaluation.  

We believe the process is still in the early stages, and that other Frontier countries are likely to come under pressure.  EM also appears likely to remain out of favor.  As in the case of EM, we hesitate to use the term “contagion” in the Frontier space since so many of these countries have homegrown problems.  As such, we look for more differentiation amongst credits as global capital outflows from EM/Frontier are likely to continue for much of this year.  With financial markets that are much less developed than in EM, even small amounts of capital outflow have the potential to be destabilizing for many Frontier countries. 

1) The Brazilian central bank seems to be re-weighting its policy tools. In our interpretation of Tombini’s last speech, he is signaling a smaller tolerance for further FX depreciation and a desire to manage expectations towards a smaller interest rate increase.  Indeed, his comments were decidedly dovish.  Sound bites included, “monetary policy operates with a lag,” and stating that all the tools are on the table to stabilize the BRL.  Also, net FX inflows continue to increase, reaching $1.93 bln year to date.

2) The yuan continued to depreciate and the PBOC conducted its first liquidity draining operation since mid-2013.In fact, the PBOC conducted two 7-day repos this week.  The repo came after the release of a large than expected January rise in yuan loans and aggregate financing.  USD/CNY is up 0.7% since its low in mid-January, as the PBOC has been continuously setting the fixing higher. Lastly, we note that Chinese equities continue to outperform most major equity indices.  Towards the end of the week, stocks were also supported by news that Sinopec (+11% this week) is proposing to sell 30% of its retail assets to private investors.

3) In Kiev, hopes for the truce announced yesterday were quickly shattered by new deadly clashes.  Nearly 20 people have reportedly been killed while protesters wounded and captured dozens of police.  Recall that yesterday there were headlines about Ukraine army being given the power to detain and/or fire on Ukrainian citizens.  Meanwhile, the EU and the US are threatening sanctions against the Ukrainian government.  The US has already imposed visa travel bans on 20 senior members of the Ukrainian government.  

4) Political tensions in Venezuela have ratcheted up.  Protests have spread and turned more violent, leading to numerous deaths.  Furthermore, President Maduro has detained opposition leader Lopez for as many as 45 days for inciting the violence.  Also this week, Maduro signed a new currency law that he said would boost the supply of dollars in the economy, allowing importers to purchase more goods and alleviate shortages of food and medicine under the new so-called Sicad 2 system.  With inflation running at 56% y/y in January, we believe another devaluation is likely this year.  However, this would do little to help the fundamentals, which should continue to deteriorate.

5) The Russian Finance Ministry announced plans this week to buy USD for its Reserve Fund.  The plan is supposed to be RUB-neutral, with the central bank decreasing its daily USD interventions to exactly offset the planned amount of Fin Min USD purchases. The amounts involved are small ($98 mln daily), so we do not put a lot of weight on this as a factor behind recent RUB weakness.  Still, many have interpreted it as a negative development for the RUB, along with the collateral sentiment damage from the worsening story in Ukraine.