We are optimistic about Emerging Markets (EM) going into 2021, but our near-term preference is for commodity-linked assets. This means we prefer Latin America over EM Asia. This does not mean we are negative on EM Asia, but we think that much of the positive news is already priced in, especially a better outcome from the pandemic. The positive factors supporting Asian assets will remain in play but are likely to play out over a longer period and depend on the speed and intensity of the change in China's policy direction.
China will continue benefiting from economic outperformance and sustained inflows. We expect the yuan to continue appreciating and relatively high-interest rates for its local bond market to remain advantageous, making it one of the best carry trades out there, especially adjusted for volatility. From a fundamental perspective, the "dual circulation" strategy will accelerate the rebalancing from external to domestic demand, and a stronger currency would help the process. But, as always, it’s important to remember that the yuan is both an economic instrument and a political one.
We think the U.S.-China conflict will continue; it's just a question of how severe and disruptive it will be. Markets may be somewhat complacent here. Biden will be under pressure from the far left of the Democratic party to act on China's perceived human rights violations. But in general, we expect Biden’s policy towards China to be a stabilizing force because (1) it will be slower moving, seeking consensus, (2) it will be less focused on bi-lateral trade in comparison with Trump, and (3) less erratic than under Trump.
Foreign investor inflows into Indonesia’s bond markets are starting to pick up again after dropping off sharply last year, which should help support the currency. The good news is that the issue of central bank independence seems to have moved off the radar (at least for now), with Bank Indonesia (BI) ending its direct bond purchases from the government this year. BI kept the 7-day target rate steady at 3.75% at its last meeting. Governor Warjiyo noted that inflation estimates are still low and expects the economy to grow between 4.8-5.8% this year. Recall that the Indonesian government was forced to step up mobility restrictions as the pandemic worsened. CPI rose 1.68% y/y in December, the highest since June but still below the 2-4% target range. The outlook suggests a considerable chance of further easing by the BI, but it will depend on external factors, the rupiah's trajectory, and how the mass vaccination program goes.
The country is well position to outperform across a longer time frame. Korea combines a favourable Covid outcome, solid fundamentals, and is well placed to face global supply chain changes. From a geopolitical angle, Korea has a strong political alliance with the U.S. and deep trade ties with China. Its tech export industry will likely play a major role in China’s drive to diversify away from U.S. components. Domestically, it seems like another supplementary budget is on the way, which might be worth between $18-27 bln. On the equity markets, authorities are partially reducing the short-selling restrictions, which will no longer affect large-cap shares.
India unexpectedly boosted fiscal stimulus, raising fears of fiscal populism. The government expanded the target deficit from -3.5% to -9.5% of GDP for FY2021, which will result in a considerable increase in borrowing. The trade-offs are clear: spending will accelerate the recovery but will put India on the radar for a re-rating of its fundamentals and institutional credibility. The Reserve Bank of India (RBI) recently kept rates on hold at 4.00% as most expected, which makes sense after the upside budget surprise. The forward guidance indicated that officials will continue to rely on liquidity support measures. The RBI also increased the cash reserve ratio by 50 bp, which had been temporarily lower to 3%, allowing it to lean on other liquidity measures. We will be keeping a close eye on how foreign investor inflows behave, especially in the fixed income market as insurance increases.
The government recently extended mobility restrictions for two weeks, from February 5 until February 18. These restrictions began on January 22 and cover all Malaysian states and federal territories except one. This will lead to a significant hit to the economy in Q1. The government just unveiled a stimulus package last month. The MYR15 bln aid package aims to help households and businesses weather the ongoing lockdowns.
Bank Negara Malaysia kept rates steady at 1.75% in its last meeting, as expected. However, the bank left the door open for further easing by noting that policy going forward “will be determined by new data and information, and their implications on the overall outlook for inflation and domestic growth.” While the central bank does not have an explicit inflation target, ongoing deflation risks as well as widening lockdowns warn of an eventual rate cut this year, perhaps as early as the next meeting March 4.
Political risk remains elevated after the king called a nationwide state of emergency and suspended parliament last month for the first time since 1969. Many viewed this as an attempt to maintain the status quo by preventing the opposition from calling a vote of confidence and possibly triggering early elections, which aren’t due until 2023.
Political risk is low for the time being. President Duterte’s term ends in 2022 and he cannot run again. His daughter is widely expected to take up the leadership of Duterte’s ruling coalition. The central bank delivered a 25 bp cut to 2.0% at the November meeting. Since then, CPI rose 4.2% y/y in January, the highest in two years and above the 2-4% target range. The bank sees inflation staying above the mid-point of this range in H1 before falling below 3%. As such, Governor Diokno said there will be a "long pause" in the easing cycle and its current monetary stance will likely stay in place for two quarters or more. Next policy meeting is February 11 and rates are expected to be kept steady at 2.0%. The recovery continues but policymakers are likely to remain accommodative this year. Bloomberg consensus sees a tightening cycle starting by year-end, but we are not convinced. The current account is expected to move back into deficit this year after a rare surplus was posted in 2020. The deficit may act as a headwind for the peso.