Emerging Markets: What has Changed?

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

1) The Chinese government continues to press ahead with measures to shore up the country’s economy

2) India is facing two very different types of protests

3) Malaysia was dealt another blow to sentiment with news that 1MDB (a state investment company) failed to pay a MYR2 bln ($563 mln) loan due on December 31

4) CZK is underperforming on the potential for a shift in the EUR/CZK floor

5) Turkey hiked the foreign exchange reserve requirements for local banks

6) Brazilian data gets (even) worse as the new economic team was sworn in

7) Venezuelan President Maduro travels to China for financing help

Over the last week, Russia (+10%), China (+1.7%), and the Philippines (+0.3%) have outperformed in the EM equity space as measured by MSCI, while Colombia (-7.0%), Hungary (-6.7%), and Czech Republic (-5.4%) have underperformed.  To put this in better context, MSCI EM rose 0.2% over the past week while MSCI DM fell -1.4%.

In the EM local currency bond space, Turkey (10-year yield -55 bp), South Africa (-37 bp), and Mexico (-26 bp) have outperformed over the last week, while Ukraine (10-year yield +111 bp), Russia (+71 bp), and Indonesia (+19 bp) have underperformed.  To put this in better context, the 10-year UST yield fell 19 bp over the past week. 

In the EM FX space, TRY (+1.4% vs. USD), RUB (+0.7%), and INR (+1.0%) have outperformed over the last week, while IDR (-2.3% vs. USD), MYR (-1.9%), and ILS (-1.5%) have underperformed.

1) The Chinese government continues to press ahead with measures to shore up the country’s economy.  Some 300 infrastructure projects (worth about $1.1 trln) have been approved to help boost growth.  The industries involved include energy, health, clean energy, and transport.  This move seems to be more about accelerating the projects rather than new projects.  However, it was enough to cheer markets.  Over the last week and the last month, Chinese equities have outperformed significantly within EM. 

2) India is facing two very different types of protests.  First, the coal unions started (but halted after 3 days) a 5-day strike against a move by PM Modi to open up the sector for foreign investment.  The idea is to break the monopoly of the state-owned Coal India, which accounts for 82% of domestic output.  Some have already said it could cause problems for the country’s power supply.  This is just another taste of the challenges Prime Minister Modi will face in trying to modernize the country.  The second protest was against a blockbuster Bollywood film.  Protesters vandalised theatres in the western Indian state of Gujarat (amongst others) for exhibiting the film which many saw as making fun of Hindu Gods.  Dealing with religious tensions will be another challenge for Modi, who was accused of repressing religious communities and minorities in his home state. 

3) Malaysia was dealt another blow to sentiment with news that 1MDB (a state investment company) failed to pay a MYR2 bln ($563 mln) loan due on December 31.  1MDB bond spreads widened to 315 bps from 250 bps, while Malaysia sovereign CDS traded to the widest since Q3 2013 to near 135 bp currently.  USD/MYR shot up to trade near 3.60, the highest since 2009.  While 1MDB bonds have government guarantees, this entity and the resignation of their CEO will be used as a political hot potato by the opposition and former Prime Minister Mahathir, who have accused incumbent PM Najib of economic mismanagement.

4) CZK is underperforming on the potential for a shift in the EUR/CZK floor.  Weakness was attributable in part to dovish comments from central banker Tomsik, who warned of "strong" deflationary pressures.  His comments were most likely touched off by the deflationary EZ CPI print for December, which is seen by many as spilling over into the CEE economies too.  Hungary and Poland are already experiencing deflation, and Czech could tip back into deflation in the months ahead.  We note that right before the holidays, the Czech central bank warned of a possible shift in the EUR/CZK floor.  

5) Turkey hiked the foreign exchange reserve requirements for local banks.  Effective at the middle of next month, the measures are meant to curb local bank reliance on short-term borrowing in foreign exchange.  According to BIS data, Turkey's total foreign borrowing stood at near $400 bln at the end of Q3 14, just below the record high reported for Q2.  Just shy of two-thirds of the debt is from Turkish corporates, with local banks accounting for the remainder.  We have highlighted currency mismatches, especially among corporates, as a major vulnerability for EM in the current strong dollar environment.  

6) Brazilian data gets (even) worse as the new economic team was sworn in.  With the December figures in, we learned that Brazil’s trade deficit for 2014 was the worst since 2000, at just under -$4 bln.  We’ve also learned that the November fiscal numbers showed the worst figures since 1998, with the 12-month accumulated primary deficit falling to -0.2% of GDP vs. +0.6% in October.  The challenges for the new government are mounting, and this week we started to see the first signs of social unrest – albeit small.  The new financial team was just sworn in, and has already made some cuts to discretionary spending to try to improve the outlook for the surplus.  But a lot more will need to be done, and it will be a challenging year for Brazil.

7) Venezuelan President Maduro travels to China for financing help.  Things are clearly getting worse in Venezuela.  Indeed, we think this is one of the major reasons why Cuba moved to normalize relations with the US.  Venezuela had been one of Cuba's lifelines in terms of aid and money.  But with oil prices still falling, Venezuela can barely support itself, much less any of its client states in the region.  Cuba saw the writing on the wall, it seems.  We believe a bolivar devaluation will be seen in early 2015, and markets are increasingly betting on a sovereign default.