Emerging Markets: What has Changed

1) China’s central bank announced a 0.5% cut in the required reserve ratio

2) Moody's cut the outlook on China's Aa3 rating to negative from stable
3) Argentina and the main holdouts agreed to a debt restructuring deal
4) Brazilian press reported that a senator implicated both Rousseff and Lula in the corruption probe as part of a plea bargain
5) Chile is cutting back government spending this year in response to low copper prices

In the EM equity space, Brazil (+17.8%), Singapore (+7.1%), and India (+6.4%) have outperformed this week, while Qatar (+0.6%), Poland (+1.1%), and Malaysia (+1.7%) have underperformed.  To put this in better context, MSCI EM rose 6.8% this week while MSCI DM rose 3.1%.

In the EM local currency bond space, Brazil (10-year yield -121 bp), Ukraine (-64 bp), and Russia (-35 bp) have outperformed this week, while Korea (10-year yield +10 bp), Hong Kong (+6 bp), and Mexico (+6 bp) have underperformed.  To put this in better context, the 10-year UST yield was +10 bp this week.

In the EM FX space, BRL (+7.7% vs. USD), COP (+5.7% vs. USD), and RUB (+5.1% vs. USD) have outperformed this week, while PKR (-0.2% vs. USD), EGP (-0.2% vs. USD), and ILS (-0.2% vs. USD) have underperformed.

1) China’s central bank announced a 0.5% cut in the required reserve ratio.  It now stands at 17%.  Further easing seems likely this year.  China hinted last week at scope for monetary and fiscal support, and it wasted no time.  There were also some reports that China intervened to support its stock market, just before policy makers meet to approve the next five-year plan for the economy.

2) Moody's cut the outlook on China's Aa3 rating to negative from stable.  Moody's cited rising government debt, falling foreign currency reserves, and uncertainty about the reform agenda.  The rating agency expressed concern about the weakening of China's fiscal strength and saw a growing risk that some of the government's contingent liabilities materialize, such as aid to local governments, policy banks and/or state-owned enterprises.  Our own sovereign ratings model shows China at AA-/Aa3/AA-, and so we disagree with Moody’s move.

3) Argentina and the main holdouts agreed to a debt restructuring deal.  This is great news, and really completes the complete policy about-face under Macri.  That said, a lot of pent-up pressures remain in play, with ARS the worst EM performer by far this year at -15% YTD.  While the inflation/FX dynamics remain bad, it is simply pay-back for years of bad policies.  We think most investors are prepared for ARS underperformance, as policymaking there has improved significantly.

4) Brazilian press reported that a senator implicated both Rousseff and Lula in the corruption probe as part of a plea bargain.  Police then detained former President Lula for questioning.  Brazilian markets have rallied on the notion that these developments could end Rousseff’s presidency and also would keep the PT out of power for the foreseeable future.  While this should be seen as bullish long-term, the short-term picture seems messy.  We do not think the PT would go down quietly, opening up the possibility of a long and messy impeachment process.  During that time, austerity would likely be either ignored or abandoned, with serious negative economic implications.

5) Chile is cutting back government spending this year in response to low copper prices.  Finance Minister Rodrigo Valdes said spending will rise by 1% less than originally planned, or CLP380 trln ($550 mln). The healthcare ministry will be spared any reductions, he added.  The reduction would have been bigger but tax revenues last year were better than expected due to reforms that reduced evasion.

(from my colleague Dr. Win Thin)

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