Emerging Markets: What has Changed

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

1) China stimulus continues

2) India reform efforts are being stymied

3) Brazil’s fiscal outlook has worsened after the lower house passed an amendment to boost pension payments

4) Polish political risk is rising

5) The Russian central bank bought USD for the first time since last June

6) Ukraine default risk appears to be rising

Over the last week, Peru (+1.8%), Philippines (+1.3%), and Indonesia (+1.3%) have outperformed in the EM equity space as measured by MSCI, while Egypt (-3.2%), Hungary (-1.9%), and Brazil (-1.4%) have underperformed. To put this in better context, MSCI EM rose 0.4% over the past week while MSCI DM rose 0.5%.

In the EM local currency bond space, Turkey (10-year yield -33 bp), Brazil (-32 bp), and Indonesia (-21 bp) have outperformed over the last week, while Czech Republic (10-year yield +17 bp), Israel (+17 bp), and Poland (+16 bp) have underperformed. To put this in better context, the 10-year UST yield rose 4 bp over the past week.

In the EM FX space, TRY (+4.0% vs. USD), RUB (+1.8% vs. USD), and CLP (+1.1% vs. USD) have outperformed over the last week, while COP (-1.5% vs. USD), HUF (-1.3% vs. EUR), and BRL (-1.2% vs. USD) have underperformed.

1) China stimulus continues. Last weekend, PBOC cut rates after earlier reporting soft April CPI and PPI data. This Wednesday, China reported soft April money and loan growth, retail sales and IP. Even after the weekend cut, markets are pricing in further PBOC easing, and we agree. PBOC fixed USD/CNY at another new cycle low this week (and the lowest since February 2014), supporting our view that the authorities aren’t pushing a weak yuan policy.

2) India reform efforts are being stymied. Lawmakers have delayed votes on bills that would create a goods and services tax (GST) and to make it easier to buy land. The bills will now be sent to committees for further scrutiny before they are taken up again in the next parliamentary session in July. The delay will make it harder for Prime Minister Modi to meet his April 2016 goal for implementing the GST. This is a big reform, and along with subsidy cuts would go a long way in reducing India’s structural budget deficits. We think that stalling fiscal reforms and a weak INR will likely keep the RBI on hold for now.

3) Brazil’s fiscal outlook has worsened after the lower house passed an amendment to boost pension payments. This will clearly hurt Finance Minister Levy’s efforts to rein in spending. As it is, it will be a struggle given rising interest rates and slowing growth. Press is reporting that President Rousseff will veto the pension amendment, but whatever compromises that may come in the coming days, the initial vote is a clear signal that fiscal reforms won’t come easy.

4) Polish political risk is rising. Last weekend’s presidential election saw the opposition Law and Justice party candidate win more votes than the ruling Civic Platform candidate. This points to rising discontent with the Civic Platform after 8 years in power. These two candidates were the top vote-getters, so they now go into a second round runoff on May 24. Incumbent President Komorowski has been endorsed by his predecessor Kwasniewski.

5) The Russian central bank bought USD for the first time since last June. Before, there was only verbal intervention from officials. Now, actual direct FX intervention signals discomfort with USD/RUB below 50. The central bank suggested that the purchases are meant to manage foreign reserves, rather than signaling a desired exchange rate or contradicting a free float. We believe both are playing a role in the decision to intervene.

6) Ukraine default risk appears to be rising. Talks between the main creditor group and the Ukraine government have stalled, with both sides taking a less conciliatory tone in the media. The key area of disagreement is write-down on principal. Ukraine believes a combination of cuts to both interest and principal as well as maturity extensions are needed, while the creditors believe the principal amounts should be left intact. The IMF has said that a debt deal was “vital” before it completes its next review in mid-June.