What Has Changed in EM

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1) Turkey kept rates on hold but the statement had an unexpected hawkish twist
2) The budget deficit for South Africa looks to be larger than previously expected
3) The Brazilian central bank made an important change of the statement in its last monetary policy meeting
4) The PBOC sold its first offshore note and cut interest rates and reserve requirements
5) The Indonesian government has proposed a tax break
6) Malaysia’s 2016 budget looks to be more populist

In the EM equity space, Indonesia (+2.9%), Brazil (+2.8%), and the Philippines (+2.6%) have outperformed over the last week, while UAE (-3.2%), Malaysia (-0.3%), and Colombia (-0.2%) have underperformed.  To put this in better context, MSCI EM rose 0.2% over the past week while MSCI DM rose 0.7%.

In the EM local currency bond space, Turkey (10-year yield -33 bp), Brazil (-16 bp), and Russia (-7 bp) have outperformed over the last week, while South Africa (10-year yield +22 bp), Thailand (+9 bp), and Hungary (+7 bp) have underperformed.  To put this in better context, the 10-year UST yield rose 4 bp over the past week.

In the EM FX space, KRW (+0.4% vs. USD), TRY (+0.2% vs. USD), and CNY (+0.1% vs. USD) have outperformed over the last week, while ZAR (-3.5% vs. USD), CLP (-1.9% vs. USD), and ILS (-1.5% vs. USD) have underperformed.

1) Turkey kept rates on hold but the statement had an unexpected hawkish twist.  The central bank removed a phrase about maintaining a flat yield curve from today’s statement: “A cautious monetary policy stance will be maintained by keeping a flat yield curve, until there is a significant improvement in the inflation outlook.”  That phrase has appeared in its previous statements this year and was seen as a sign of rates on hold.

2) The budget deficit for South Africa looks to be larger than previously expected. According to the projections by Finance Minister Nene, tax revenue in the next three years will be ZAR 35 bln less than projected in February. The deficit for the fiscal year ending March 2016 was reduced slightly to 3.8% of GDP from 3.9%. But with the expected tax revenue shortfall, the deficit is projected to increase to 3.3% for next year from 2.65% targeted in February, and 3.2% in the following fiscal year, up from 2.5%. Nene also cut this year’s growth forecast to 1.5% from 2% previously, and cut next year’s growth forecast to 1.7% from 2.4% previously.  Nene pledged to stick to the spending ceiling and to keep gross debt under 50% of GDP, but this seems too optimistic.

3) The Brazilian central bank made an important change of statement in its last monetary policy meeting. After keeping rates on hold at 14.25% as expected, it replaced the language on inflation convergence to the target that said, “by year-end 2016” with “within the relevant forecast horizon for monetary policy.” We think this is a signal that they have no intentions of hiking rates – unless we get a material shock to inflation or FX, of course, but even then the bar is high. We think that any unwanted currency weakness will still be dealt with by using FX-related tool, including spot intervention if needed.

4) The PBOC sold its first offshore note and cut interest rates and reserve requirements.  CNH5 bln in 1-year senior unsecured notes was met with strong demand and was priced to yield 3.1%. This compares with indications of 3.30% on Tuesday and final guidance at 3.15% on Wednesday morning.  Then on Friday, the PBOC cut the 1-year lending rate by 25 bp and the reserve requirement ratio by 50 bp.  Further easing seems likely.

5) The Indonesian government has proposed a tax break.  The Finance Minister is proposing a reduction of the tax on corporations from 10% to 3% if they agree to revalue their assets before year-end.  The measure is part of the fifth stage of reforms and the idea is to encourage investment.  In addition, the government intends to reduce the double taxation on REITS to improve functioning in that market.

6) Malaysia’s 2016 budget looks to be more populist.  Those earning MYR600k-1 mln annually will now be taxed at a rate of 26% vs. 25%  currently, while those earning more than MYR1 mln annually will pay a rate of 28%.  The added revenue is earmarked for rural roads, increases in civil servant wages as well as minimum wages, and other categories.  The government forecasts GDP growth of 4-5% next year vs. 4.5-5.5% this year, both of which may be too optimistic in light of slowing growth.