Emerging Markets: What has Changed

(From my colleague Dr. Win Thin)

1) The Russian central bank hiked its key policy rate 150 bp to 7.0%

2) The US announced sanctions on Russia

3) Tensions on the Crimean Peninsula have eased, but the situation in Ukraine remains very fluid

4) Europe is in the process of cobbling together an aid package for Ukraine

5) The Polish central bank has moved a bit more dovish

6) The Czech central bank also hinted at a more dovish approach

7) The yuan has stabilized after the large moves last month; possible corporate default should not be seen as systemic risk

Over the last week, Pakistan (+5.4%), Colombia (+4.5%), and Turkey (+3.7%) have outperformed in the EM equity space in local currency terms, while Russia (-7.6%), Egypt (-2.2%), and Brazil (-1.2%) have underperformed. 

In the EM local currency bond space, Chile (10-year yield -37 bp), Indonesia (-35 bp), and Hungary (-28 bp) have outperformed over the last week, while Russia (10-year yield +33 bp), Ukraine (+11 bp), and Korea (+7 bp) have underperformed.

In the EM FX space, IDR (+1.6% vs. USD), TRY (+1.3%) and COP (+1.2%) have outperformed over the last week, while PLN (-0.5% vs. EUR), ARS (-0.2% vs. USD), and RUB (-0.2%) have underperformed.

1) The Russian ruble weakened sharply, and led the Russian central bank to hike its key policy rate 150 bp to 7.0% in response. The bank was also forced to intervene heavily ($11.3 bln sold on Monday alone) as the ruble basket moved outside of the daily corridor, which it then reset by a record 35 kopecks to 35.75-42.75. Furthermore, shifts in the daily corridor will now only take place after $1.5 bln of cumulative FX intervention vs. $350 mln previously. These moves, along with lessened tensions, have helped the ruble stabilize. However, Russian assets remain highly vulnerable to negative headline risk.

2) The US announced sanctions on Russia. The State Department has imposed a ban on visas for anyone deemed “responsible for or complicit in threatening the sovereignty and territorial integrity of Ukraine.” President Obama also issued an executive order that provides the legal basis for additional penalties (such as a freeze on assets) on “individuals and entities” that have undermined Ukraine’s territorial integrity, misappropriated Ukrainian assets, or asserted authority over parts of Ukraine (Crimea) without the approval of the Ukrainian government. The Europeans appear less inclined to hit Russia with sanctions. EU leaders are currently meeting in Brussels to discuss a possible response.

3) Tensions on the Crimean Peninsula have eased, but the situation remains very fluid. The Crimean parliament voted unanimously 78-0 (with 8 abstentions) to secede from Ukraine and join Russia. This will be put to a popular referendum March 16, but officials in Kiev have already called any such vote illegitimate. Russian parliament is trying to make it easier, with one lawmaker introducing a bill to simplify the procedure for joining Russia.

4) Europe is in the process of cobbling together an aid package for Ukraine. EU official said as much as $15 bln will be offered to Ukraine, which includes EU grants as well as loans from EBRD and EIB, while the US has offered $1 bln in loan guarantees. The IMF is in Ukraine this week for preliminary talks, so we wouldn't expect any concrete numbers on a standby program for a couple of weeks yet. The IMF has had to freeze its past two programs for Ukraine due to non-compliance, but it will face a tricky balancing act now regarding how tough its conditionality should be. Ukrainian euro bonds took a hit this week after Finance Ministry warned of potential debt restructuring. 

5) Poland central bank has moved a bit more dovish. It kept rates steady at 2.5% this week, as expected. However, it cut its CPI forecasts for 2014 and 2015 and, more importantly, said rates to stay unchanged to at least end-Q3. Before this meeting, many officials had said steady rates until mid-year. We had always thought mid-year was too soon. Indeed, the Polish Finance Minister warned this week about headwinds from Ukrainian and regional turmoil, which would argue for tightening later, not sooner. We may see rates steady until year-end, but let's see how data come in.

6) The Czech central bank also hinted at a more dovish approach. Governor Singer said that the CZK floor could be extended as inflation remains subdued. In the past, officials have said the floor would likely remain in place through 2014. Singer added that the bank would rather extend the duration of the floor in response to unfavorable developments, rather than change the level of the floor.

7) The yuan has stabilized after the large moves last month. After 10 straight down days, CNY has risen for 3 straight. As we have consistently said, we did not view recent weakness as any sort of regime change. Yes, greater two-way risk appears desirable for Chinese policymakers, but we did not think CNY weakness would persist long enough to be destabilizing to global markets. A possible corporate default should not be seen as posing systemic risk. Solar company announced this week that it may not be able to make CNY89.8 mln interest payment on its debt. This would be the first bond default in China, but will likely be allowed as a warning to both companies and investors that there is moral hazard in the debt market as well as in the FX market.