Emerging Markets: What has Changed

(from my colleague, Dr Win Thin)

1) Tensions in Ukraine have risen again

2) The Ukrainian central bank hiked rates for the first time during the current crisis

3) Moody’s revised the outlook on Turkey’s Baa3 rating from stable to negative

4) S&P upgraded Lithuania from BBB to A- with a stable outlook

5) China announced a cut in required reserves for "qualified" rural banks

Over the last week, Indonesia (+2.8%), Egypt (+2.6%), and Singapore (+1.6) have outperformed in the EM equity space in local currency terms, while Russia (-3.5%), Hungary (-3.2%), and China (-2.2%) have underperformed.

In the EM local currency bond space, Vietnam (10-year yield -15 bp), India (-15 bp), and Sri Lanka (-14 bp) have outperformed over the last week, while Ukraine (10-year yield +54 bp), Russia (+26 bp), and South Africa (+14 bp) have underperformed. To put this in better context, the 10-year UST yield was flat over the past week.

In the EM FX space, PKR (+0.7% vs. USD), PEN (+0.3%), and THB (+0.3% vs. USD) have outperformed over the last week, while CLP (-2.4%), BRL (-1.8%), and TRY (-0.7%) have underperformed.

1) Tensions in Ukraine have risen again. After pro-Russian groups seized control of government buildings in several eastern Ukrainian cities, the government responded militarily and this has resulted in some deaths. Despite Russia’s warnings that it would defend its citizens, it is still unclear how Putin will ultimately respond. Envoys from Ukraine, Russia, the US, and the EU met today in Geneva in an attempt to defuse tensions. Elsewhere, US officials said that another round of sanctions are being prepared and will be imposed if Russia continues to foment unrest in Ukraine.

2) The Ukrainian central bank hiked rates for the first time during the current crisis. The central bank also “temporarily” removed 14 institutions from the interbank FX market, citing currency moves that had a “destabilizing effect” and fed into “negative expectations.” The hryvnia has firmed after the 300 bp hike to 9.5% on Monday. Last move was a 50 bp cut back in August 2013, while the last hike was a 200 bp move back in April 2008. Inflation has started to spike higher, with CPI rising 2.2% m/m in March. However, the economy remains at risk and higher interest rates will simply be an even greater headwind.

3) Moody’s revised its outlook on Turkey’s Baa3 rating from stable to negative. The agency said the change was due to increased pressure on Turkey’s external financing position as well as weakened prospects for structural reforms due to ongoing domestic political uncertainty. We agree, and feel that the move to investment grade by both Moody’s and Fitch were premature. Even S&P with its BB+ rating has moved its outlook from stable to negative back in February. Our own sovereign ratings model views Turkey as a BB/Ba2/BB credit, underscoring the fact that downgrades risks are high.

4) S&P upgraded Lithuania from BBB to A- with a stable outlook. We concur, as our own model has had Lithuania at A- for several quarters now. The agency said the country’s external and fiscal positions exceeded its expectations, adding that Lithuania now meets all quantitative requirements needed to adopt the euro and that it will likely be invited to join the euro zone in 2015. If so, Lithuania would join the other Baltic nations Estonia and Latvia in the euro zone.

5) China announced a cut in required reserves for "qualified" rural banks. The government said that the move was meant to boost lending to agriculture-related industries. Some banks are looking for a cut in the required reserves for large banks later in the quarter (May or June). We remain skeptical, and view this cut as a targeted move that does not presage wider-ranging monetary stimulus ahead. As it stands, the key 7-day repo rate pushed below 3% earlier this week from over 4% on April 11 and near 5% on March 27.