Emerging Markets: What has Changed

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

1) Political risk is rising in Colombia
2) Petrobras issued debt for the first time in six months
3) The Russian central bank suspended some FX auctions, stepping up measures to counter RUB strength
4) Tensions between Ukraine and Russia are escalating again
5) Hungary’s central bank has changed its policy tools
6) China took another important step towards interest rate liberalization
7) In a highly unusual development, the Thai government started to argue for less central bank easing

Over the last week, UAE (+1.6%), Qatar (+1.6), and Hong Kong (+0.9%) have outperformed in the EM equity space as measured by MSCI, while Russia (-6.6%), Chile (-5.4%), and Taiwan (-4.3%) have underperformed.  To put this in better context, MSCI EM fell -2.6% over the past week while MSCI DM fell -1.4%.

In the EM local currency bond space, Ukraine (10-year yield -121 bp), Chile (-8 bp), and Peru (flat) have outperformed over the last week, while Russia (10-year yield +45 bp), Brazil (+41 bp), and Indonesia (+36 bp) have underperformed.  To put this in better context, the 10-year UST yield rose 29 bp over the past week.
In the EM FX space, PEN (+0.4% vs. USD), PKR (+0.1%), and INR (+0.1) have outperformed over the last week, while RUB (-8.0% vs. USD), COP (-3.7%), and ZAR (-3.5%) have underperformed.

1) Political risk is rising in Colombia.  FARC rebels blew up oil wells and pipelines in southern Colombia last weekend after calling an end to a unilateral cease-fire last month.  Furthermore, about 400,000 people in Colombia's port city of Buenaventura lost power after a key electrical tower was destroyed that was blamed on FARC rebels.

2) Petrobras issued debt for the first time in six months.  The state-owned oil company issued $2.5 bln of 100-year paper to yield 8.45%.  Book size is said to have exceeded $7 bln, suggesting strong demand despite a soured outlook on Brazil. For comparison, Mexico’s 100-year issued last April is trading around at 4.25%, but note that it is denominated in euros and it was a sovereign bond.  Petrobras is coming back to markets in style, hoping to speed the slow healing process after it took a $17 bln write-down and saw several of its executives get arrested or investigated.

3) The Russian central bank suspended some FX auctions, stepping up measures to counter RUB strength.  The Bank of Russia suspended the sale of one-year FX repurchase agreements on Monday, continuing a policy of restricting access to dollars that can be used to reinvest in higher-yielding ruble-denominated assets.  The bank also continues to accumulate FX via direct purchases, about $200 mln daily.

4) Tensions between Ukraine and Russia are escalating again. Ukraine’s President Poroshenko has even warned against a “full-scale invasion” from Russia.  Hyperbole aside, the conflict flared up with several soldiers reportedly killed over the last couple of days, jeopardizing the already fragile Minsk agreement.  Our base case is that the situation will settle to a low intensity conflict again, with frequent but not game-changing flare ups, akin to the Israeli-Palestine or India-Pakistan situation.  Still, the Russia ruble was the worst performing currency this week and surely geopolitical risk premium has contributed to the decline.

5) Hungary’s central bank has changed its policy tools.  Starting in September, the main policy rate will be the 3-month deposit rate, replacing the current 2-week policy rate now at 1.65%.  It will also limit the amount of 2-week deposits allowed, and the central bank predict that HUF5.5 trln now held in 2-week deposits will gradually fall to near HUF1 trln by the end of the year.  Much of that will flow to government debt.  The negative market reaction is warranted.  Hungary's BUX was down marginally on the day of announcement (-0.1%), but financials took a much bigger hit (-2%).

6) China took another important step towards interest rate liberalization. The PBOC issued guidelines for certificates of deposits (CDs).  The instruments will be classified as a form of deposit, hence covered by the deposit insurance system.  The next step is to soften the upper limit for deposit rate.  The move is part of a package of policy measures which, amongst other things, are helping to deflate the shadow banking system by offering an alternative vehicle for funds to go into.

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