Emerging Markets: What has Changed

1) Argentina eliminated capital controls and allowed the peso to float 2) Argentina also eliminated export taxes on agricultural goods that include beef, wheat, and corn 3) Fitch joined S&P in cutting Brazil to sub-investment grade BB+ with a negative outlook 4) Brazil’s Supreme Court ruled that impeachment proceedings can move forward 5) Banco de Mexico hiked rates for the first time since 2008 6) Under strong pressure from the financial markets, South African President Zuma reinstated former Finance Minister Gordhan 7) The new Polish government increased state spending its 2016 budget revision 8) Vietnam’s central bank cut the USD deposit rate cap to 0% in order to discourage dollar hoardingIn the EM equity space, Poland (+5.6%), Colombia (+5.6%), and China (+4.4%) have outperformed over the last week, while Brazil (-2.1%), Qatar (-0.8%), and Russia (+0.1%) have underperformed.  To put this in better context, MSCI EM rose 2.3% over the past week while MSCI DM rose 0.3%.

In the EM local currency bond space, the South Africa (10-year yield -101 bp), Mexico (-23 bp), and Poland (-20 bp) have outperformed over the last week, while Ukraine (10-year yield +31 bp), Brazil (+27 bp), and Colombia (+12 bp) have underperformed.  To put this in better context, the 10-year UST yield rose 8 bp over the past week.

In the EM FX space, ZAR (+5.9% vs. USD), TRY (+2.5% vs. USD), and MXN (+2.4% vs. USD) have outperformed over the last week, while ARS (-27.2% vs. USD), ILS (-1.2% vs. USD), and BRL (-0.7% vs. USD) have underperformed.1) Argentina eliminated capital controls and allowed the peso to float.  The peso traded close where to the so-called “Blue Chip” parallel rate was trading, but has since firmed a bit.  Officials said that FX intervention would be carried out as needed to prevent a disorderly move, but reserve data suggest no action seen yet.

2) Argentina also eliminated export taxes on agricultural goods that include beef, wheat, and corn.  The tax agency AFIP estimates that as much as $11.4 bln of soy, corn and wheat are being held by farmers waiting to be sold, which has pushed grain prices down this week.  Energy and Mining Minister Juan Jose Aranguren said the government will modify electricity and gas tariffs in the coming weeks too.  These are good signs that orthodox policies are being reinstated.

3) Fitch joined S&P in cutting Brazil to sub-investment grade BB+ with a negative outlook.  Many investors can only invest in countries that have at least 2 out of 3 agencies at investment grade.  Now that only one agency has Brazil at investment grade, there will likely be some forced selling.  Moody's still has Brazil at Baa3, but it's only a matter of time before they cut too.  Our own ratings model has Brazil at BB-/Ba3/BB- so there are still downgrades in the pipeline ahead.

  4) Brazil’s Supreme Court ruled that impeachment proceedings can move forward.  However, then court also agreed to several new procedures that seem to benefit Rousseff and improve her chances of survival.  For instance, the Senate (which has proven to be more supportive of the government than the lower house), has been given the ability to halt the proceeding.  To us, the whole impeachment process is negative for Brazil by being a distraction that will delay fiscal adjustments.

5) Banco de Mexico hiked rates for the first time since 2008.  The 25 bp move was widely expected.  The central bank said that the move was in response to the Fed, adding that it was playing close attention to possible inflation pass-through from the weak peso.  We think this rate hike was a questionable move, as inflation is at all-time lows and the economy appears to be slowing a bit.  Lower oil prices remain a headwind for the economy.

6) Under strong pressure from the financial markets, South African President Zuma reinstated former Finance Minister Gordhan (Finance Minister from 2009 until 2014).  The macroeconomic condition in South Africa is difficult and Zuma's decision to replace Nene with a little-known ANZ lawmaker had rattled investors.  This reversal is a good move, but the damage to investor confidence has been done, and will be hard to regain.  We believe downgrades to sub-investment grade are still likely.

7) The new Polish government increased state spending its 2016 budget revision.  However, it maintained its deficit forecasts by relying on optimistic revenue projections.  The budget gap is still forecast at -2.8% of GDP, unchanged from forecasts by the previous government and still below the EU’s -3% ceiling.  Budgetary spending will increase 4.7% percent from the previous plan to PNL368 bln, while revenue will grow 5.4% to PLN313 bln from new taxes on banks and retailers as well as from efforts to improve actual tax collection.

8) Vietnam’s central bank cut the USD deposit rate cap to 0% in order to discourage dollar hoarding.  The dong fell to the weak end of its trading band this week, which is +/- 3 percentage points around the official reference rate of 21890.  This rate has been kept steady since the third devaluation this year back in August.  This is not a strict peg, and so further adjustments appear likely in 2016 as pressures build.