Emerging Markets: What has Changed

(from my colleague Dr. Win Thin)

1) Tensions in Ukraine have moved up a notch

2) Moldova’s Transnistria region is now seeking to join Russia

3) The dispute with between China and the Philippines has escalated and is, arguably, surpassing the dispute with Japan

 4) Indonesian election results warn of need of coalition government

5) South Korea central bank stands pat, but turns more optimistic

1) Tensions in Ukraine have moved up a notch. Ukraine sent security forces into the city of Kharkiv to clear it of pro-Russian separatists which had seized some buildings. This led Russia to warn that such actions risk civil war. The US at the same time warned Russia not to foment unrest as a pretext for further incursions into Ukraine. The situation remains fluid, but such cat-and-mouse actions are to be expected. We maintain our base case that despite the likelihood of periodic flare-ups in Ukraine, Russia will not risk antagonizing the West with further military actions. Instead, the battle seems likely to shift further to financial channels (sanctions and counter-sanctions) and away from the battleground itself in eastern Ukraine.

2) It’s worth noting that Moldova’s Transnistria region is now seeking to join Russia, according to Transnistria President Shevchuk. Last week, Russian Foreign Minister Lavrov met with his Moldovan counterpart in an effort to cool tensions a bit. Pro-Russian Transnistria is a strip of land in Moldova that lies along its eastern border with Ukraine. NATO’s top commander recently warned that Russia could make a similar move into Transnistria, as it did in Crimea. Transnistria split away from Moldova as the Soviet Union collapsed, and is one of several “gray areas” that sprang up after that collapse. Others include Abkhazia and South Ossetia, in Georgia. Like Crimea, Transnistria is a semi-autonomous part of Moldova with strong ties to Russia, but it remains to be seen if Russia is willing to take it on. In a 2006 referendum, 96% in Transnistria voted to secede but Russia turned them down.

3) The dispute with between China and the Philippines has escalated and is, arguably, surpassing the dispute with Japan. There have been two developments that have escaped the notice of many observers. First, China tried in vain to stop the Philippines from re-provisioning a garrison it created on the disputed Second Thomas Shoal in 1999. Second, the Philippines also pressed its legal case, filing a 4000-page opening argument with the International Permanent Court Arbitration at The Hague. China is not happy about either development. The Philippines are flaunting their security pact with the US to embarrass China. Make no mistake about it. Although Russia's threat in Europe is real and will not go away as long as Putin rules, the geopolitical problems in Asia are even more vexing. 

4) Many investors hoped that this week's election would point to a clear victor in the July presidential race.  However,  the front runner Joko Widodo garnered what appears to be a little less than 20% of the vote.  This is about half of the level that was projected last month.  The official results will not be declared until next month.   Indonesian shares have been among the best performers this year, rising around 17% over the past three months, in part due to the anticipated favorable political backdrop.  As the preliminary results were reported, stocks shed more than 3% and the rupiah posted its biggest drop in three weeks. 

5) South Korea's central bank met for the first time under the leadership of Lee Ju Yeol.  As widely expected the 7-day repo rate was left unchanged for the 11th month.  However, the central bank edged up its GDP forecasts for this year and next, and warns that by the end of the year inflation will be back into the 2.5%-3.5% target range.  This raises the prospect that the next move will be a hike and a consensus expects it to be in Q1 2015.  Korean shares have rallied foreign investors have been consistent buyers over the past three weeks.    The dollar has fallen about 4.75% against the won since March 21 to KRW1031.55, but the central bank is thought to have mounted a spirited defense, pushing the greenback above KRW1040 earlier today.    Additional near-term corrective dollar gains are likely with potential toward KRW1050.