Three Thoughts From London – FX Intervention, Populism and Market Liberalization

1. After Mexico and Russia, it was the turn of the Brazilian central bank (BCB) to take action against currency depreciation.
2. There were a few developments in Poland that may have gone unnoticed, but are important.
3. India may soon become a more attractive prospect for bond investors.

1/ After Mexico and Russia, it was the turn of the Brazilian central bank (BCB) to take action against currency depreciation. The BCB decided to increase the rollover rate of its FX intervention program (via swaps) from 60% to 100%. These swaps function as sales of dollars in the futures market and the adjustment of the rollover rate should be interpreted as a proxy of the BCB’s attitude towards FX moves. We believe that the trigger for the change was as much levels as context. USD/BRL reached an intra-session high of just under 3.57 yesterday. In addition, the currency has been weakening much faster its EM peers, falling 3.2% over the last 5 sessions, for example, only comparable with the RUB. Over the same period, MXN was down only 1.3%, TRY was down 0.3% and the INR and KRW were up around 0.5%. The move by the BCB is unlikely to cause a sustained reversal of the trend, but it should help, especially after the more hawkish minutes earlier this week.

2/ There were a few developments in Poland that may have gone unnoticed, but are important. First, the WSE equity index fell 2.4% yesterday (and flat today) with the country’s largest bank, PKO, falling 7.3% (and up 0.8% today). The reason for yesterday’s large moves was that the lower house voted on a new legislation that would increase the burden of FX-linked mortgages losses to banks (from sharing 50% of losses to 90%). A vote is expected in the upper house on September 2-3, then it needs to be signed by the president. Judging by the market reaction, there is a considerable chance this gets done. Second, yesterday was also the day President Andrzej Duda from the Law and Justice party (PiS) was sworn into office. As we discussed in our report Politics to Weigh on Poland But Fundamentals Sound, the PiS is seen as more populist, more euro-skeptic than the ruling Civic Platform (PO).  President-elect Duda ran on promises to spend, and that has dragged PO into taking more populist stances as well to boost its rating. The risk is that with Poland heading into parliamentary elections in October, the two parties will be trying to outbid each other with populist proposals, which will only undermine the country’s relatively good prospects.

3/ India may soon become a more attractive prospect for bond investors. Comments by RBI Governor Rajan raised hopes of softer limits on foreign portfolio investment in local debt. This led to a pickup in inflows this week equivalent to $145 mln, according to Bloomberg data. So far this year, inflows have been well below the average seen over the last few years (see graph below), despite the country’s comparatively high carry. The current cap on foreign holdings of sovereign debt is set at $30 bln. Local debt yields were down a few basis points and INR has outperformed on the week.