EMs passive observers of printing frenzies

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Jan Dehn, head of Research, at Ashmore, discusses recent activity in emerging markets and why EM countries are passive observers of the printing frenzies orchestrated by the central banks of the developed world.

Last week was a big one for central banks:

  • Brazil surprised the markets by hiking rates 25bps despite serious economic weakness
  • Russia jacked up rates by 150bps in a bid to keep inflation under control amidst continuing RUB weakness as attention now shifts to currency intervention measures.
  • The Fed ended QE, which means that the Fed is no longer pro-actively easing policy, though tightening is not on the cards anytime soon
  • The biggest event of the week was Bank of Japan’s big QE bazooka, which fired in dramatic fashion in one of the most obvious manifestations to date that what developed market governments cannot fix by reform they aim to fix by devaluing their currencies and inflating away their debt

The rest of Emerging Markets (EM), are largely passive observers of the printing frenzies orchestrated by the central banks in developed economies. The first order impact of easier monetary policies in Japan ought to be positive for asset prices, but markets are obsessed with zero-sum trades in the currency space.

Thus expectations of ECB QE and Japan’s latest monetary splurge could well set in motion another temporary surge in the USD versus both EUR and JPY that ultimately could also leave EM FX in its wake. Less myopic investors should look to such a development with relish for the opportunity it provides to protect the purchasing power of capital at more attractive entry points by adding to positions in EM local markets.

Brazil: The monetary policy rate setting committee of the Brazilian central bank (COPOM) raised rates by 25bps to 11.25% in a move that goes a long way towards restoring the credibility of monetary policy. Few things create as much respect for central banks as hiking into economic weakness. The move also supports the insight that inflation is ‘worse than death’ for most EM governments.

This is the first major policy change since the re-election of President Dilma Rousseff. Attention is now turning to the question of who will become Brazil’s next finance minister and what the government will do to remedy a growing fiscal problem. September’s fiscal numbers were very poor with the deficit twice as wide as expected.

The primary surplus on a 12 month basis is now just 0.61% of GDP versus the 1.9% primary surplus target defined in the Budget Law. Having acknowledged the impossibility of fulfilling the target, the government will now have to get a new budget approved in Congress for the 2013 budget (failures to meet targets have to be approved by Congress).

President Dilma Rousseff will have few options but to change due to deep divisions in Congress after the recent election campaign, a large Petrobras scandal and very low poll ratings. Opposition party PSDB has sent a petition to the Electoral Court requesting an audit of the voting system, though the party is not questioning the final result or asking for a full recount of votes.

Russia: The central bank hiked 150bps, taking the policy rate to 9.5%. The FX market was not hugely impressed, because USD/RUB briefly fell, but then rose to higher levels than before the rate hike.

This is telling price action. It suggests that Russian households may be getting concerned with the pace of RUB weakness and are converting their savings to Dollars. So far the Russian government has been happy to let the RUB weaken in line with oil prices – the chart below shows that the fall in oil has almost perfectly been offset by the fall in RUB.

But when households begin to panic about the RUB then it matters very little that the Russian central bank offers 1.5% more in interest on an annual basis. Hence, FX policy may soon have to change. In fact, the only way to break the momentum of a budding currency crisis is to slam the market down with huge force. That moment may be drawing nearer. The good news is that Russia has a frightening monetary arsenal at its disposal. Russia’s FX reserves stand at USD 439bn.

China: The big transformation of China from the world’s leading exporter to a domestic demand-led economy received another boost this week, when the government introduced further measures specifically aimed to boost consumption. The measures include improved access to social security.

This is critical in order to bring down China’s high precautionary saving rates. There will also be measures aimed at improving income distribution and consumer protection. We think one of the most powerful drivers of consumption will be the development of the domestic bond market; wider access to government bonds for savers will stabilise savings and thus contribute to lower precautionary savings rates.

Meanwhile, official PMI numbers declined marginally in October to 50.8 from 51.1 in September, while HSBC’s PMI number was unchanged mom at 50.4. Services PMI declined marginally from 54 to 53.8. This suggests that parts of the supply-side in the Chinese economy are moderately slowing. We expect China’s economy to continue to gradually slow, but we note that growth and PMI are two entirely different things.


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