Emerging Markets: What has Changed

(from my colleague Dr. Win Thin)

1) Brazil central bank increased the amount of daily FX swaps offered, signaling discomfort with recent BRL weakness

2) Brazil also announced that the 6% IOF tax that was charged on foreign loans up to 1 year duration will now apply for those up to six months

3) Poland’s central bank has opened up the possibility of further easing

4) The European Commission (EC) has confirmed that Lithuania meets all convergence criteria

5) China cut reserve requirements late last week for selected banks that have rural and small company loans

6) A G8 (G7?) meeting was held without Russia for the first time in seventeen years

Over the last week, India (+3.2%), Thailand (+3.2%), and Egypt (+3.1) have outperformed in the EM equity space in local currency terms, while Korea (-0.8%), Chile (-0.7%), and Singapore (-0.6%) have underperformed. 

In the EM local currency bond space, Russia (10-year yield -19 bp), Turkey (-18 bp), and India (-14 bp) have outperformed over the last week, while Hong Kong (10-year yield +19 bp), Mexico (+18 bp), and Singapore (+17 bp) have underperformed. To put this in better context, the 10-year UST yield was up 13 bp over the past week. 

In the EM FX space, COP (+0.7% vs. USD), THB (+0.5), and PHP (+0.3%) have outperformed over the last week, while ZAR (-3.0%), BRL (-2.2%), and TRY (-0.8%) have underperformed.

1) Brazil’s central bank increased the amount of daily FX swaps offered, signaling discomfort with recent BRL weakness. It doubled the daily amount offered from 5k contracts to 10k contracts. At its previous swaps expiry date, the central bank let $4.6 bln worth of contracts expire rather than rollover. The next expiry date is July 1, and boosting the daily amount to 10k contracts (if sustained) should lead to a much greater rollover. This latest move also supports our belief that the intervention program will be extended to year-end.

2) Brazil also announced that the 6% IOF tax that was charged on foreign loans up to 1 year duration will now apply for those up to six months. This was decided in the form of a presidential decree. The last time the rules were changed was in Dec 2012. The goal appears to be to help companies with short-term credit. However, coming at a time when the real is coming under pressure, the move should be seen as meant to lend the currency some support.

3) Poland’s central bank has opened up the possibility of further easing. Previously, bank officials had spoken only in terms of when the first hike would be within its forward guidance. We thought that the guidance was likely to be pushed back even more at the July meeting, but with Governor Belka saying he wouldn’t exclude a cut and that the chance of further easing “isn’t zero”, the policy outlook is quite muddy. Suffice to say Polish rates won’t be going up until well into 2015.

4) The European Commission (EC) has confirmed that Lithuania meets all convergence criteria, and is expected to adopt the euro on January 1, 2015. It was rejected in its bid for 2007 adoption, but is now poised to become the 19th member of the euro zone and joins the other two Baltic states (Estonia and Latvia). This official recommendation by the EC was made in consultation with the ECB, and still needs a formal decision by the EU’s national ministers after the summit meeting June 26-27.

5) China cut reserve requirements late last week for selected banks that have rural and small company loans. This follows similar cuts for rural banks back in April, and continues the current stance of targeted (vs. large-scale) stimulus efforts. For now, the efforts seem to be working as May PMI readings (both official and HSBC) point to stabilization ahead, albeit at more modest growth rates. 

6) A G8 (G7?) meeting was held without Russia for the first time in seventeen years. The G7 warned of more sanctions. However, tensions seem to have eased as Russia finally started moving its troops back from the Ukraine border. Senior Western officials (UK Prime Minister Cameron, French President Hollande, US Secretary of State Kerry) will meet with their Russian counterparts this week in an effort to resolve the Ukraine crisis, meeting on the sidelines of D-Day commemoration being held in northern France.