Emerging Markets: What has Changed

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

1) Hong Kong indicated it would lift the CNY20k limit for daily currency limit for Hong Kong residents 

2) Moody's upgraded the outlook on Hungary’s Ba1 rating from negative to stable 

3) South African politics are heating up 

4) Moody's downgraded South Africa to Baa2 and the outlook was changed from negative to stable 

5) There are press reports that Brazil’s President Rousseff will pick former central bank head Meirelles as her new Finance Minister, but this is not at all a given 

6) Recent news in Mexico has not been kind to President Pena Nieto 

7) Mexico has instituted a new collective action clause (CAC) into its bond issuance that is aimed at limiting the power of holdouts in the event of a debt restructuring 

Over the last week, UAE (+5.5%), Hungary (+3.3%), and Hong Kong (+2.5%) have outperformed in the EM equity space as measured by MSCI, while Colombia (-2.7%), Mexico (-2.1%), and Egypt (-1.2%) have underperformed.  To put this in better context, MSCI EM rose 0.5% over the past week while MSCI DM rose 0.6%.

In the EM local currency bond space, Hungary (10-year yield -17 bp), Poland (-15 bp), and Turkey (-13 bp) have outperformed over the last week, while Ukraine (10-year yield +79 bp), Korea (+38 bp), and Brazil (+25 bp) have underperformed.  To put this in better context, the 10-year UST yield fell -3 bp over the past week. 

In the EM FX space, HUF (+1.2% vs. EUR), TRY (+0.9% vs. USD), and PKR (+0.8% vs. USD) have outperformed over the last week, while COP (-1.4% vs. USD), KRW (-1.2% vs. USD), and CLP (-0.6% vs. USD) have underperformed.

1) Hong Kong indicated it would lift the CNY20k limit for daily currency limit for Hong Kong residents.  This is likely aimed at ensuring a strong start to the HK-Shanghai equity link that will be launched early next week.  Earlier this week, China unveiled this sooner-than-expected opening of the Shanghai-Hong Kong exchange link.  This will allow around $3.8 bln of daily cross-border purchases and equates to a big step towards opening up China’s capital account.  

2) Moody's upgraded the outlook on Hungary’s Ba1 rating from negative to stable.  The agency cited an improved medium-term outlook, including a strong commitment by the government to keep the budget gap below 3% of GDP.  Our model has had Hungary fluctuating between Ba2 and Ba1 in  recent quarters, and so we cannot quibble with Moody’s decision.  In related news, the government provided more details about FX conversion process.  There doesn’t seem to be any major surprises but the fact that the process is moving ahead is positive.

3) South African politics are heating up.  A split has widened within the Congress of South African Trade Unions (Cosatu, with 2.2 mln members) after it expelled the National Union of Metalworkers of South Africa (Numsa, with 350k members) for not backing the ruling ANC in recent elections.  Seven of Cosatu’s other 20 affiliated unions suspended their involvement in Cosatu and called for Numsa to be reinstated.  Numsa is reportedly thinking about forming a new political party to challenge the ANC in 2016 municipal elections, as it views the ruling party as catering to entrenched business interests and not caring enough about poverty and unemployment.

4) Moody's downgraded South Africa to Baa2 and the outlook was changed from negative to stable.   To us, Moody's didn't go far enough and at the very least should have kept negative outlook in place.  Our model has it in BB territory.  S&P has South Africa the lowest at BBB-, while Fitch has it at BBB.  New Finance Minister Nene did announce some fiscal tightening steps in the mid-term budget review last month.  But we don't think the rating agencies should let them off the hook so easily.  Fundamentals remain awful.  

5) There are press reports that Brazil’s President Rousseff will pick former central bank head Meirelles as her new Finance Minister, but this is not at all a given.  Meirelles would be taken relatively positively by the markets, in the sense that the other options would be worse.  He had a good rapport with the markets during the two Lula administrations.  Still, any feel-good momentum will likely be blunted by the government's efforts to get an accounting change that would allow it to report a larger primary surplus than it could under current rules.  On net, we think markets remain suspicious and doubtful that Rousseff can pull it off and so we see further downward pressure on BRL ahead.

6) Recent news in Mexico has not been kind to President Pena Nieto.  "A protest in Mexico City to demand justice over the disappearance of 43 college students turned violent on Saturday, with a group partially breaking the entrance door of the National Palace. (AP)"  This is on top of news that a construction firm that received contracts from Pena Nieto when he was governor of Mexico State has now built a house for him in Mexico City.  Rising political risk is worth keeping an eye, as it will offset the improving fundamental outlook. 

7) Mexico has instituted a new collective action clause (CAC) into its bond issuance that is aimed at limiting the power of holdouts in the event of a debt restructuring.  The clause would allow restructuring to proceed if at least 75% of the bondholders agree to it.  Kazakhstan made a similar move last month, Mexico is a much bigger issuer and so its decision will likely compel other major EM  issuers to follow suit.  Such clauses should prevent any future Argentina-style vulture fund holdouts.