Emerging Markets: What has Changed

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

1) The Mexican oil auctions, while historic, proved to be a bit of a dud 

2) China revealed more support measures 

3) Brazil is considering an amnesty to undeclared funds held abroad 

4) Political tensions are heating up even more in Brazil 

5) We are a few steps closer to elections in Turkey, and it’s unclear whether markets are prepared for it 

6) Kazakhstan’s central bank widened upper end of its exchange rate corridor 

7) Ukraine’s Finance Minister Natalie Jaresko joined restructuring negotiations with creditors for the first time since the two-month standoff began 

In the EM equity space, Czech Republic (+3.4), UAE (+3.3%), and the Philippines (+3.0%) have outperformed over the last week, while Peru (-0.8%), Thailand (-0.4%), and Turkey (flat) have underperformed.  To put this in better context, MSCI EM rose 0.9% over the past week while MSCI DM rose 2.0%.

In the EM local currency bond space, Russia (10-year yield -49 bp), Ukraine (-23 bp), and South Africa (-17 bp) have outperformed over the last week, while Brazil (10-year yield +8 bp), Singapore (+5 bp), and China (+4 bp) have underperformed.  To put this in better context, the 10-year UST yield fell -4 bp over the past week.

In the EM FX space, PLN (+1.8% vs. EUR), HUF (+0.9% vs. EUR), and ZAR (+0.9% vs. USD) have outperformed over the last week, while COP (-2.9% vs. USD), KRW (-1.6% vs. USD), and ILS (-1.3% vs. USD) have underperformed.

1) The Mexican oil auctions, while historic, proved to be a bit of a dud.  Only 2 of the 14 shallow water oil blocks received qualifying bids, with some of the major oil companies declined to participate.  Still, it was the first oil block sold to a private company since 1938, when the oil industry was nationalized.  However, this is just the first of five auctions.  The government has proven to be open to feedback from the industry, so we think there is a good chance they will make some adjustments and get better results next time around.

2) China revealed more support measures.  Officials said that the government’s margin finance and liquidity facility (China Securities Finance Corp.) has RMB2.5-3 trln available to support stocks via liquidity to brokerages and mutual funds. Meanwhile, China Development Bank and the Export-Import Bank of China will get $32 bln and $30 bln, respectively, from the PBOC’s FX reserves in exchange for equity stakes.  The measures show that the government still has a wide range of tools it can use to support the equities.

3) Brazil is considering an amnesty to undeclared funds held abroad.  The measure is part of the government’s struggle to maintain fiscal credibility against the headwinds of an ailing economy and a difficult political situation.  The idea is to allow Brazilians to bring back money to the country at a cost of 35%, between tax and fines.  According to the senator who authored the project, the measure could lead to $8.0-9.5 bln in tax revenues. This still strikes us as optimistic. A 35% hit is a high price to pay upfront.  Moreover, tax evaders have done quite well keeping their money abroad given the devaluation of the real and so there may not be much appetite to repatriate.

4) Political tensions are heating up even more in Brazil.  Aside from the strengthening calls for an impeachment, discussed in our report Political Risks Rising Again in Turkey and Brazil, ex-president Lula is becoming increasingly embroiled in the corruption investigation.  Recall that Lula is regarded as the most likely PT candidate to succeed Rousseff.  On top of this, the government’s coalition with the PMDB is looking every more acrimonious.  It will be an uphill battle to get anything done in congress now, which could put the government’s fiscal plans in risk.

5) We are a few steps closer to elections in Turkey, and it’s unclear whether markets are prepared for it.  After the first round of coalition building, AKP Prime Minister Davutoglu concluded that the nationalist party MHP won’t be participating in a coalition government. What is more, he also said that the likeliest option was the CHP, the traditional opposition party.  We still think the Kurdish HDP party is the most likely candidate for a coalition, but an agreement still doesn’t seem forthcoming.  The AKP may just be making a token effort at negotiating, while really aiming for new elections. If so, the question is what do the AKP and President Erdogan have up their sleeves to change the results of the electoral stalemate?  

6) Kazakhstan’s central bank widened upper end of its exchange rate corridor.  The band went from USD/KZT 170-187 to 170-198.  By doing this, the central bank recognized the pressure the tenge is under and took another step towards its goal to transition towards a free-float in the next few years.  The currency has weakened about 3% against the dollar from late 2014 until the start of the month, and then it lost another 0.6% since then.  This looks like a gradual easing process, and given external conditions and the economic situation of Russia, we expect it to continue for a while.    

7) Ukraine’s Finance Minister Natalie Jaresko joined restructuring negotiations with creditors for the first time since the two-month standoff began.  While a deal will still be difficult, this is a good sign that a negotiated solution is still possible.  Initial comments were positive, and talks will continue next week.  Ukraine has a $120 mln interest payment due on July 24, as well as a $500 mln eurobond maturing on September 23.  Meanwhile, Ukraine’s parliament passed the final three laws that were needed to unlock the next tranche of IMF money.  However, the IMF also wants to see progress on debt restructuring.  The parliament also gave preliminary approval to constitutional changes that would give more power to separatist regions in the east.  These are part of the February peace accord.

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