‘Nearly there’ events dominating the EM investment environment

Jan Dehn, head of Research at Ashmore, suggests that there are a bunch of ‘nearly there’ events currently dominating the EM investment environment, including Brazil’s new fiscal framework nearly ready for approval and the rate cutting cycle is nearly about to begin. In China, MSCI is nearly ready to admit A-shares into the EM indices and in Venezuela, a new poll shows that Maduro’s reign may now nearly be over.


A new poll from Datanalisis, showed that 94.6% of the Venezuelan population now deems the economic situation in the country to be bad. The poll also showed that more than three quarters of voters favour a referendum to recall President Maduro, whose personal approval rating dropped 3.5% to 23.3%. The process of verifying signatures collected in favour of a recall referendum is progressing, and puts Venezuela on track for a change of president within the next 12 months, in our view.

Meanwhile, Oil Minister Eulogio Del Pino said that Venezuela is able to service debts falling due this year, and confirmed that the government is in talks with China over possible easing of its refinancing conditions. This is important. China is Venezuela’s most important source of external financing. China takes a long-term view on Venezuela, one that transcends governments. Venezuela’s sovereign bonds returned more than 17% in Dollar terms last year and have returned more than 11% in Dollar terms year to date in 2016.


In line with dramatic improvements in external balances elsewhere in Emerging Markets (EM), India’s current account deficit shrank to just USD 300m (0.1% of GDP) in Q1 2016. By contrast, as recently as early 2013 India’s current account deficit exceeded USD 30bn (5% of GDP). As a result of the stronger current account balance plus capital inflows, India’s FX reserves reached a new all-time high of USD 363bn in early June, the highest ever level of FX reserves. In other good news, the government has now published a draft version of the Goods & Services Tax (GST) bill. This suggests that the government will seek to obtain approval for the bill in the next parliamentary session that begins in July. India also recently passed reforms of the solvency and bankruptcy laws.

On the other hand, some uncertainty had been created by the announcement at the weekend that the term of Raghuram Rajan, governor of the Reserve Bank of India (RBI), is nearly over. Rajan is stepping down in September. There will be a period of uncertainty until the government announces his replacement, but we are not too concerned about his departure. Rajan was formidable, but he is not indispensable. India is a huge country with many highly qualified professionals who can replace him. Besides, Rajan was brought in to help restore confidence at a very difficult point in India’s recent macroeconomic history, a job executed extremely well and today India’s economy is far stronger.

The key going forward is going to be the RBI’s policies, not personalities. This is not least because the government looks set to preserve the new CPI target (1.5%-2% range for real rates) and the same policy tool (the repo rate) as well as the same committee structure that Rajan designed. This committee structure becomes effective in September and involves a six-member MPC, including three representatives from the RBI. Even so, the market will want to see a technically competent and credible replacement for Rajan, who is in good standing with Modi, and also someone who can hold his own vis-a-vis Jaitley.


Brazil’s upcoming fiscal reform promises to be a game changer. In a note published last week, the Finance Ministry led by Henrique Meirelles explained that the fiscal reforms will be enshrined into Brazil’s Constitution. Under the proposal, a cap will be applied to total spending that prohibits primary spending from growing from 2017 onwards (except for expenditures to recapitalise state-owned enterprises, but including arrears) with penalties for non-compliance. The Constitutional Amendment will remain on the books for 20 years.

The challenge will be getting the reform approved and some dilution of the original bill should be expected, in our view. Constitutional Amendments required passage in both houses of congress twice with majorities of three-fifths of the votes of the respective members of each house. The current political climate is therefore very important. Last week, yet another minister in the government of acting President Michel Temer had to resign over allegations of financial impropriety. Tourism Minister Henrique Eduardo Alves was the third minister to fall on his sword. Temer has maintained a tough line with respect to corruption allegations, sacking or encouraging resignation of ministers who become tainted by a widening campaign by lawyers to punish illegal campaign financing and bribery. Meanwhile, Temer himself sought illegal campaign contributions, according to a key witness for the prosecutors. Illegal campaign financing was widespread in Brazil, not just confined to the PT party of suspended President Dilma Rousseff. The main risk to our bullish view on Brazil is that governance becomes impossible should the Temer administration also be forced to relinquish power over impropriety. Meanwhile, two inflation indicators published last week came lower than expected in a boost to the expectations that the central bank will commence the rate cutting cycle in the second half of 2016.

Index news

China’s A-share market has moved several steps closer to qualifying for inclusion in the MSCI EM benchmark equity index. The two remaining constraints pertain to trading suspension policies and limits on monthly repatriation of funds. We think China will continue to liberalise the capital account and that these outstanding issues will be addressed, paving the way for China’s formal inclusion in the MSCI EM index by next year with the main risk being an earlier inclusion. The market reacted positively to the news suggesting that there was no expectation that inclusion would take place at this time. Besides, China’s index inclusion is clearly not critical for creating liquidity. Between them, the Shanghai and Shenzhen exchanges trade USD 43bn of A-shares every single day compared to just USD 29bn of average daily trading on the New York Stock Exchange (NYSE). In addition, the Hong Kong exchange averages USD 71bn in daily trading, so between Hong Kong and the onshore exchanges China’s market is nearly four times as large as the NYSE.

As for bonds, our view is that the Chinese bond market will achieve index inclusion over the next 18 months, though this remains up to JP Morgan, the index provider. China’s bond market has broader institutional involvement and behaves in a more orderly fashion as a result. In addition to the progress report on the inclusion of A-shares into the MSCI EM index, MSCI announced that South Korea will remain within the MSCI EM index. Other index providers, including FTSE and S&P, already classify South Korea as a developed market, but MSCI deems that restrictions on convertibility of the KRW preclude South Korea from qualifying as a developed market.

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