We believe weakness in the EM space will remain concentrated in the five problem countries of Argentina, Brazil, Russia, South Africa and Turkey. All have idiosyncratic risks that are likely to persist into 2019. However, India and Indonesia are also likely to remain under pressure, albeit to a lesser extent, due to their high financing needs.
As a result of fiscal and monetary tightening, the economy is likely to experience its second recession in three years. What’s worse, inflation is running close to 35% and is likely to continue accelerating. This outcome is all the more disappointing since President Mauricio Macri has for the most part done all the right things.
This backdrop does not bode well for President Macri as he faces an election in October 2019. The Peronists would like nothing better than to get back in power and reverse Macri’s orthodox policies. Argentina approached the IMF and was able to increase its credit line to $57 bln, a bit less than the rumored $70 bln. It will come with even greater conditionality, but austerity will be difficult to enact in an election year.
Yet price pressures are rising and the central bank’s Monetary Policy Committee (COPOM) appears likely to embark on a tightening cycle as early as October 31. The budget numbers have improved modestly due to the cyclical recovery, but the lack of structural reforms during Temer’s lame duck administration points to more fiscal woes ahead. If the real continues to weaken, there will be significant fiscal costs due to the $68.9 bln stock of outstanding FX swaps.
As of this writing, the October 7 election remains too close to call. It appears that Jair Bolsonaro and Fernando Haddad are likely to be the top two vote-getters in the first round. However, the most recent polls show a toss-up in the second round on October 28. To state the obvious, markets would not like to see Haddad, Lula’s heir apparent, win. Amongst other things, many believe Haddad would be a figurehead, with Lula pulling the strings behind the scenes. On the other hand, there are signs that Bolsonaro’s market-friendly economic advisor, Paulo Guedes, may have limited influence on policies.
These will weigh on an already sluggish economy. Relations with the West and the US remain poor, and the upcoming US elections could be another flashpoint if further Russian interference is detected. The so-called “Sanctions Bill from Hell” will be debated by the Senate, with some believing that US entities may be prohibited from buying Russian government bonds. The Russian Finance Ministry is reportedly looking into alternative means of financing.
The central bank just started a tightening cycle in September, adding to the headwinds. The budget numbers will be boosted by high oil prices, giving the government some leeway to use fiscal stimulus. However, inflation has clearly bottomed and is likely to breach the 4% target in the coming months. With the ruble remaining vulnerable, we think tightening will continue into 2019.
The mid-term budget statement in October will be very important for the nation’s efforts to stave off further rating downgrades. High unemployment remains persistent even as the economy is stuck in a low growth cycle. President Cyril Ramaphosa faces a host of issues as we approach elections next spring, which may push the ANC toward a more populist stance.
The South African Reserve Bank (SARB) delivered a hawkish hold in September. The 4-3 vote with dissents favoring an immediate hike suggests that a consensus to tighten will be seen sooner rather than later. Inflation is drifting toward the top of the 3-6% target band. While the SARB does not forecast a breach of that band, we see upside risks to inflation.
The recently announced New Economic Plan was woefully short on details, suggesting that policymakers still do not have a handle on what needs to be done. Inflation is likely to accelerate to the 25% area, which would make the current policy rate of 24% inadequate.
The longer the adjustment is put off, the greater the economic costs. We believe the economy will undergo a hard landing next year. With no plan yet in place to deal with corporate FX exposure, we think the situation could develop into a much deeper banking and financial crisis.
Markets are increasingly focused on countries that have outsized financing needs (both domestic and external) in this period of tightening global liquidity. India has a growing current account deficit as well as persistent budget deficits.
Price pressures are rising, spurred in part by higher energy costs. The Reserve Bank of India (RBI) started a tightening cycle but has since taken a more neutral stance. We believe pressure on the rupee will force the RBI to tighten further in the coming months. This will come at a cost to growth, and at an uncomfortable time for Prime Minister Modi. General elections are due next year, and polls suggest support for him is already slipping.
USD/IDR rose above 15000 for the first time since 1998. Given the sharp moves seen during the Asian Crisis, there really aren’t any major chart points between current levels and the all-time high near 16950 from June 1998. The next policy meeting is on October 23 and another 25 bp hike appears likely then. Like India, markets are focusing on Indonesia's growing current account and budget deficits. Indonesia's Net International Investment Position (NIIP) of -34% is the biggest in Asia, which represents another vulnerability.
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