Emerging Markets: What has Changed

(from my colleague Dr. Win Thin)

• Reserve Bank of India surprised markets with the start of the tightening cycle.
• The Czech National Bank (CNB) ended the EUR/CZK floor.
• Israeli central bank said it won’t hike rates until Q2 2018.
• Both S&P and Fitch cut South Africa’s rating one notch to sub-investment grade BB+.
• Moody's put South Africa’s Baa2 rating on review for a downgrade
• S&P upgraded Argentina one notch to B with stable outlook.
• Brazil’s government will water down its pension reform plan
• Brazil’s central bank corrected some errors in its inflation report.

In the EM equity space as measured by MSCI, the Philippines (+3.8%), Chile (+3.5%), and Poland (+3.4%) have outperformed this week, while Korea (-0.7%), Turkey (-0.6%), and Peru (-0.5%) have underperformed.  To put this in better context, MSCI EM rose 0.3% this week while MSCI DM fell -0.5%. 

In the EM local currency bond space, Bulgaria (10-year yield -11 bp), Chile (-6 bp), and South Africa (-6 bp) have outperformed this week, while India (10-year yield +17 bp), Turkey (+12 bp), and Indonesia (+10 bp) have underperformed.  To put this in better context, the 10-year UST yield fell 6 bp to 2.33%. 

In the EM FX space, CZK (+1.7% vs. EUR), INR (+0.9% vs. USD), and EGP (+0.7% vs. USD) have outperformed this week, while ZAR (-3.0% vs. USD), TRY (-2.7% vs. USD), and RUB (-1.6% vs. USD) have underperformed.

Reserve Bank of India surprised markets with the start of the tightening cycle.  It hiked the reverse repo rate 25 bp to 6.0% but left the repo rate steady at 6.25%.  The decision was unanimous, and we expect further tightening as the year progresses.

The Czech National Bank (CNB) ended the EUR/CZK floor.  The timing was a little earlier than expected, but rising inflation and a robust economy warranted it.  While officials warned that rate hikes are now on the table, we see no move near-term.  Upcoming central bank policy meetings are May 4 and June 29.  We see very little risk of a rate hike at either one, despite Governor Rusnok’s warning today that a May hike can’t be rule out.  

Israeli central bank said it won’t hike rates until Q2 2018.  This is six months later than previously forward guidance, due largely to the strong shekel and other factors that the bank said will limit price pressures. The bank also cut its 2017 growth forecast to 2.8% from 3.2% previously.  It also cut its 2017 inflation forecast to 0.7% from 1.2% previously.

Both S&P and Fitch cut South Africa’s rating one notch to sub-investment grade BB+.  This should not come as a big surprise, as the moves have been long overdue.  We also agree with S&P’s decision to keep the outlook at negative, as our own sovereign ratings model shows South Africa’s implied ratings at BB/Ba2/BB.  Fitch moved its outlook to stable.

Moody's put South Africa’s Baa2 rating on review for a downgrade.  We believe a one notch cut to Baa3 is a done deal.  However, there is a growing chance of a two notch cut to Ba1 in light of the moves by the other two agencies.  Note that many investment grade bond indices require an investment grade rating from at least two of the three major agencies, and so Fitch’s cut to sub-investment will lead to forced selling.  

S&P upgraded Argentina one notch to B with stable outlook.  Our model shows Argentina at B/B2/B and so we agree with this move.  This also suggests upgrade potential for Moody's B3 (equivalent to B-) rating, while Fitch seems on target with its B rating.

Brazil’s government will water down its pension reform plan.  Facing growing opposition in Congress, press reports suggest President Temer will present a new proposal on April 18 that cuts the potential savings by up to 20%.  The original plan projected savings of BRL678 bln over the next ten years.  

Brazil’s central bank corrected some errors in its inflation report released March 30.  Inflation is seen at 3.6% (3.9% previously) in 2017 and 3.3% (4.0% previously) in 2018 under the scenario where BRL and the SELIC rate remain unchanged.  Using the scenario of BRL rates as estimated in its market surveys and an unchanged SELIC rate, the 2017 inflation forecast was lowered to 3.7% (3.9% previously) and the 2018 forecast was lowered to 3.5% (4.2% previously).  The central bank said that the wrong estimates were published due to an operational error, adding that other forecasts in report are accurate.

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