Emerging Markets: What has Changed

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

1) Reports suggest the PBOC will impose a 20% reserve requirement on financial institutions trading FX forwards 

2) The HKMA had to intervene this week at the strong side (7.75) of the HKD peg 

3) Swiss authorities are getting involved in the 1MDB scandal in Malaysia 

4) Brazil’s government will submit budget proposal for 2016 that projects a primary deficit 

5) Brazil’s COPOM kept rates steady at 14.25% this month, as expected 

6) Press reports suggest Obama now has the votes to push the Iran deal through Congress 

7) Israel is injecting some fiscal stimulus to boost the economy 

In the EM equity space, Colombia (+1.7), China (+0.7%), and Qatar (+0.6%) have outperformed over the last week, while India (-4.5%), Hong Kong (-3.6%), and Peru (-3.1%) have underperformed.  To put this in better context, MSCI EM fell -3.7% over the past week while MSCI DM fell -3.5%.

In the EM local currency bond space, Ukraine (10-year yield -37 bp), Malaysia (-19 bp), and the Philippines (-10 bp) have outperformed over the last week, while Brazil (10-year yield +107 bp), Turkey (+30 bp), and South Africa (+19 bp) have underperformed.  To put this in better context, the 10-year UST yield fell -2 bp over the past week.

In the EM FX space, PEN (+0.7% vs. USD), CNY (+0.5% vs. USD), and CLP (+0.2% vs. USD) have outperformed over the last week, while BRL (-5.5% vs. USD), RUB (-3.5% vs. USD), and ZAR (-3.0% vs. USD) have underperformed.

1) In the latest regulatory development in China, reports suggest that the PBOC will impose a 20% reserve requirement on financial institutions trading FX forwards.  The 20% figure refers to the past month’s sales, which will be kept for a year at no interest.  The measure should take effect on October 15.  This macroprudential policy is aimed at reducing systemic risk by making life more difficult for speculators.  Chinese markets were closed Thursday and Friday.

2) The HKMA had to intervene this week at the strong side (7.75) of the HKD peg.  This was the first time it had to do this in more than four months.  Because the HKMA is buying USD and selling HKD, it has unlimited resources to intervene at the strong end of the 7.75-7.85 band.  From what we can gather, the bulk of the inflows reflect outflows from the mainland financial markets that are being parked in Hong Kong.

3) Swiss authorities are getting involved in the 1MDB scandal in Malaysia.  The Attorney General’s office in Switzerland said it was investigating two 1MDB executives for potential offenses that include money laundering, corruption of foreign officials, and suspected misconduct in public office.  This is a positive development in the sense that the investigation should be more thorough and unbiased, as Malaysian investigators have not been seen as very thorough or aggressive.  Indeed, senior Malaysian anti-corruption official has complained of government interference.  

4) Brazil’s government will submit budget proposal for 2016 that projects a primary deficit instead of the previously expected surplus.  The revised primary deficit target of -0.5% of GDP for 2016 already looks impossible.  Why?  1) The government is assuming BRL37.3 bln of revenue from asset sales.  This is highly unlikely in the current environment; 2) GDP growth is forecast at 0.2%, while private sector forecasts (according to weekly central bank survey) are now looking for a -0.4% contraction; and 3) The government is also assuming BRL11.2 of revenue from additional tax hikes.  We do not think Congress will approve further taxes in the current environment.  

5) Brazil’s COPOM kept rates steady at 14.25% this month, as expected.  It was the first time that rates were kept steady since last October.  COPOM said rates would remain at the current 14.25% for a “prolonged period” and stressed that past tightening will be enough to bring inflation down to the 4.5% target by the end of 2016.  With inflation and inflation expectations still rising, we are not convinced that we’ve seen the end of the tightening cycle.  

6) Press reports suggest US President Obama now has the votes to push the Iran deal through Congress.  This is negative for oil prices, as the deal would allow Iran to boost its output.  On top of that, a huge build in DOE crude inventories was reported this week.  Stockpiles rose 4.67 mln instead of the expected 444k, a more than ten-fold miss.  We like to look at the y/y comparisons, and US crude inventories are now 27% higher than they were a year ago, a new cycle high.  We believe the supply-demand dynamics still favor low oil prices.

7) Israel is injecting some fiscal stimulus to boost the economy.  Policymakers said the government will cut corporate and value-added taxes (VAT).  The VAT will drop to 17% 18% while corporate taxes will fall to 25% from 26.5%.  The Bank of Israel called the VAT cut “imprudent.”  However, the central bank is also concerned about the sluggish economy and has started to talk about unconventional monetary policies.  The budget gap is manageable at around -3% of GDP forecast for this year and next.  

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