Emerging Markets: What has Changed

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

1)        India’s equity index continues to outperform following Prime Minister Modi’s decision to end fuel subsidies on diesel 

2)        On Friday, Moody's cut Russia by a notch to Baa2 and kept the outlook at negative 

3)        Russian state oil company Rosneft is reportedly seeking over RUB2 trln from the Wellbeing fund 

4)        South Africa's mid-term budget review was positive 

5)        Petrobras had its credit rating cut by Moody’s 

Over the last week, Indonesia (+5.1%), UAE (+3.4%), and India (+3.4%) have outperformed in the EM equity space as measured by MSCI, while Brazil (-7.1%), Egypt (-0.9%), and Russia (-0.7%) have underperformed.  To put this in better context, MSCI EM rose 1.2% over the past week while MSCI DM rose 3.3%.

In the EM local currency bond space, Turkey (10-year yield -36 bp), Indonesia (-30 bp), and South Africa (-22 bp) have outperformed over the last week, while Brazil (10-year yield +57 bp), Mexico (+12 bp), and Hong Kong (+10 bp) have underperformed.  To put this in better context, the 10-year UST yield was up 10 bp over the past week.

In the EM FX space, IDR (+1.6% vs. USD), ZAR (+1.5%), and COP (+1.1%) have outperformed over the last week, while ILS (-2.0% vs. USD), RUB (-2.0%), and BRL (-1.2%) have underperformed.

1) Prime Minister Modi is reducing India’s expensive fuel subsidies on diesel.  This helped the equity index outperform its regional peers this week.  After another electoral victory (in the regional elections) last weekend, Modi seized the opportunity from lower oil prices to make the regulatory change.  In the short run, Indians may even get a small reduction in prices at the pump, but the real questions will be asked if international oil prices start rising again.  Last weekend, Modi also announced the increase in gas prices.  USD/INR has drifted higher since the May lows, but nowhere near as much as against other major EM currencies.  This is partially thanks to an increasingly pro-active central bank in the currency markets.  We remain confident about Indian assets and still think INR will outperform.  

2) On Friday, Moody's cut Russia by a notch to Baa2 and kept the outlook at negative.  This was no surprise, as Moody's was the clear outlier with its generous Baa1 rating.  Our model has Russia at BBB-, which lines up with S&P's rating.  Still, we think both Moody's and Fitch (at BBB) will eventually cut again.  Right now, Russia should hang on to investment grade status, but if the sanctions remain in place and oil prices head lower, we can't rule out eventual junk status.  Russia escaped junk status in 2003 (Moody's) and 2004 (S&P, Fitch).  It's worth a reminder that Russia was at junk when it defaulted in 1998.  USD/RUB and the RUB basket are making new all-time highs again.  

3) Russian state oil company Rosneft is reportedly seeking over RUB2 trln from the Wellbeing fund.  That's a very big amount.  The Wellbeing fund is supposed to help cover shortfalls in pension funds, but there have been a few stories in recent months about the government raiding it to cover infrastructure projects and other spending.  To put it bluntly, it's a pretty bad sign but not surprising given the stresses being seen on the economy right now.

4) South Africa's mid-term budget review was positive.  It saw the government cut expenditures and raise taxes, with Finance Minister Nene warning that "Fiscal consolidation can no longer be postponed."  We think ZAR remains vulnerable, as fiscal tightening will weigh on growth even more.  However, the moves may help the country ward off a ratings downgrade near-term.  Elsewhere, CPI inflation moved back into the 3-6% target range in September, for the first time since February and much earlier than expected.  So at least monetary tightening is over, as we think disinflation will keep SARB on hold now.

5) Petrobras had its credit rating cut by Moody’s.  The agency attributed the decision to a worsening in the financial indicators, which have been affected by the real’s drop and by the "inability" to pass on the costs and accumulated losses from the gap in fuel prices over the last few years.  Petrobras is currently at the center of the political debate with a myriad of corruption allegations.  Its stock (US ADRs) is trading at their lowest levels since March, down 37% since its recent peak just under two months ago.