Update on early 2015 developments in EM

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Jan Dehn, head of Research at Ashmore discusses the main developments over the year-end period, including Prime Minister Yatsenyuk stating he would be willing to leave the question of Crimea to “future generations”.

Ukraine’s parliament revoked the country’s non-aligned status. While the move could be seen as a precursor for closer ties with NATO, we think Prime Minister Arsenyi Yatsenyuk’s statement on Crimea is more telling about the direction of travel in the near-term.

Yatsenyuk, one of the most anti-Russian members of the Ukrainian government, extended an important olive branch to Russia by saying that “future generations” may have to resolve the question of Crimea. His statement in effect removes Crimea from the list of issues that need to be resolved in order to achieve a peace agreement with Russia.

Our view is that the main protagonists in the conflict now have strong economic incentives to seek a peaceful solution. In another important development, Ukraine’s parliament approved the 2015 Budget, which is an important step towards facilitating the completion of the IMF program.

Four important developments took place in Brazil over the year-end period. First, the government published the worst fiscal numbers for nearly two decades. The November fiscal deficit was BRL 7.6bn versus BRL 1.3bn expected. Second, the government announced a significantly more aggressive fiscal adjustment than had been expected. The fiscal savings will be BRL 18bn versus BRL 7bn expected. These savings should put the government on track to meet its 1.2% of GDP primary surplus target for next year.

Thirdly, the central bank extended its FX intervention program until the end of March 2015, but halved the daily auction amount from USD 200m to USD 100m. Finally, in its quarterly inflation report the central bank adopted a distinctly more hawkish stance.

The combination of sharp fiscal savings, less FX intervention and the prospect of further rate hikes show that Brazil’s return to macroeconomic stability will involve adjustment both of the domestic and external accounts. This makes the adjustment credible, in our view. Manufacturing picked up to 50.2 in December from 48.7 in November, but the outlook for manufacturing still looks weak ahead of the likely fiscal correction this year.

SAFE, China’s State Administration of Foreign Exchange, has changed the rules for how banks calculate net open positions on foreign exchange loans. The measure could enable Chinese banks to unwind USD 95bn of FX positions. We expect more and more measures to liberalise the Chinese capital account this year as the government aims to achieve global reserve currency status for the CNY.

Indeed, in the last week of 2014 China extended bilateral CNY swaps with three more countries (New Zealand, Malaysia and Russia). In other policy developments, PBOC, the Chinese central bank, announced that deposits placed by financial institutions with financial institutions will now be included in the formal definition of deposits. Since inter-financial sector deposits are not subject to reserve requirements, the effect will be to ease the loan to deposit limits in China.

In economic developments, manufacturing activity was marginally stronger in December than the market had expected as the official PMI number reached 50.1 versus 50 expected, although manufacturing slowed from November (50.3). HSBC’s PMI number also declined to 49.6 in December from 50 in November; HSBC’s PMI number has greater representation from small and medium sized enterprises than the official PMI.

Saudi Arabia
Following a preliminary announcement in July 2014 that it plans to open its large domestic stock market to foreign investors, unnamed Saudi Arabian officials said that the market could be opened as early as April 2015. The Saudi Arabian stock market is more than USD 500bn in size.

The other notable development in Saudi Arabia was that the 2015 Saudi Arabian budget was published. The Budget does not involve major retrenchment in overall spending as the government intends to use fiscal levers to smooth the effect of the lower oil prices on the economy. Saudi Arabia’s public finances are very strong.

Russia’s PMI fell sharply to 48.9 in December from 51.7 in November. The slowdown in economic activity comes at a time when inflation is rising due to recent RUB depreciation – in December yoy inflation rose to 11.4% compared to 6.5% a year ago. We expect further economic weakness in Russia, but the inflationary effects will prove temporary, not least due to the recent decision by the central bank to raise policy rates to 17%. Russia has the means to manage the transition to weaker oil prices.

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