Global Investing

In Brazil, rate cuts but no economic recovery

Brazil’s central bank meets today and almost certainly will announce another half point cut in interest rates, the eighth consecutive reduction since last August. But so far there is little sign that its rate-cutting spree – the longest and most aggressive  in the developing world – is having much success in resuscitating the economy.

HSBC’s closely watched emerging markets index (EMI), released this week, shows Brazil as one of the weak links in the EM growth picture,  with sharp declines in manufacturing and export orders in the second quarter.

The government is expected to soon revise down its 4.5 percent growth projection for 2012; the central bank has already done so.  Industrial output is down, and automobile production has slumped 9 percent in the first half of 2012. Nor  it seems are record low interest rates encouraging the middle classes to take on more debt — the number of Brazilians seeking new credit fell 7.4 percent in the first half of this year, the biggest fall on record, according to credit research firm Seresa Experian.

And investors aren’t too happy with Brazil either. Despite the steep rate cuts, Brazil’s stocks are among the worst performing in emerging markets this year. (See here for what I wrote on Brazilian stocks a few weeks back)

Grappling with the slowdown in China and other export markets, Brazil, understandably, is trying to stimulate domestic demand. But its problem (and indeed that of many others such as India) is that it is trying to repeat the strategy it pursued in 2009 when countries resorted to huge stimulus to kickstart growth after the Lehman Brothers disaster.  It worked back then but may not be quite so successful again, says Karen Ward, senior global economist at HSBC who worked on the EMI report. Ward notes that China, in contrast to Brazil, has been measured in its monetary easing this year, even though its growth too is slowing.

Argentine CDS spiral on “peso-fication” fear

Investors with exposure to Argentina will have been dismayed in recent weeks by the surging cost of insuring that investment — Argentine 5-year credit default swaps have risen more than 300 basis points since mid-May to the highest levels since 2009. That means one must stump up close to $1.5 million to insure $10 million worth of Argentine debt against default for a five year period, data from Markit shows.

The rise coincides with growing fears that President Cristina Fernandez Kirchner is getting ready to crack down on people’s dollar holdings. Fears of forcible de-dollarisation have sent Argentine savers scurrying to the banks to withdraw their hard currency and stash it under mattresses. That has widened the gap between the official and the “black market” exchange rate. (see the graphic below from Capital Economics)

While government officials have denied there is such a move afoot, Fernandez has not helped matters by exhorting people to “think in pesos”.  That will be hard for Argentines, most of whom have vivid memories of hyperinflation, default and devaluation. Unsurprisingly, most prefer to save in dollars. 

India rate cut clamour misses rupee’s fall-JPM

Indian markets are rallying this week as they price in an interest rate cut at the Reserve Bank’s June 18 meeting.  With the country still in shock after last week’s 5.3 percent first quarter GDP growth print, it is easy to understand the clamour for rate cuts. After all, first quarter growth just a year ago was 9.2 percent.

Yet,  there may be little the RBI can do to kickstart growth and investment.  Many would argue the growth slowdown is not caused by tight monetary conditions but is down to supply constraints and macroeconomic risks –the government’s inability to lift a raft of crippling subsidies has swollen the fiscal deficit to almost 6 percent while inhibitions on foreign investment in food processing and retail keep food prices volatile.  

The other side of the problem is of course the rupee which has plunged to record lows amid the global turmoil. Lower interest rates could  leave the currency vulnerable to further losses.

Lower rates give no respite to Brazil stocks

In normal times, an aggressive central bank campaign to cut interest rates would provide fodder for stock market bulls. That’s not happening in Brazil. Its interest rate, the Selic, has fallen 350 basis points since last August and is likely to fall further at this week’s meeting to a record low of 8.5 percent. Yet the Sao Paulo stock market is among the world’s worst performers this year, with losses of around 4 percent. That’s better than fellow BRIC Russia but far worse than India and China.

Brazil’s central bank and government are understandably worried about a Chinese growth slowdown that would eat into Brazilian commodity exports. They are therefore hoping that rate cuts will prepare the domestic economy to take up the slack.

But the haste to cut interest rates appears to have spooked some foreign investors, with many seeing the moves as evidence of political pressure on the central bank. A closely-watched survey from Bank of America/Merill Lynch showed that fund managers had swung into a net 14 percent underweight on Brazil in May from a net overweight of over 20 percent in April (See graphic). This is the first time investors have turned negative on Brazil since February 2011, BofA/ML said.

Battered India rupee lacks a warchest

The Indian rupee’s plunge this week to record lows will have surprised no one. After all, the currency has been inching towards this for weeks, propelled by the government’s paralysis on vital reforms and tax wrangles with big foreign investors. These are leading to a drying up of FDI and accelerating the exodus from stock markets. Industrial production and exports have been falling.  High oil prices have added a nasty twist to that cocktail. If the euro zone noise gets louder, a balance of payments crisis may loom. The rupee could fall further to 56 per dollar, most analysts predict.

True, the rupee is not the only emerging currency that is taking a hit. But the Reserve Bank of India looks especially powerless to stem the decline. (See here for an article by my colleagues in Mumbai) .  One reason  the RBI’s hands are  effectively tied is that  India is one of the few emerging economies that has failed to build up its hard currency reserves since the 2008 crisis and so is unable to spend in the currency’s defence. Usable FX reserves stand now around $260 bilion, down from $300 billion just before the 2008 crisis.  See the following graphic from UBS which shows that relative to GDP, India’s reserve loss has been the greatest in emerging markets.

But there is worse. The relative decline in reserves since 2008 coincides with a ballooning in India’s external debt, both private and public. Comprising mostly of corporate borrowing and trade credit, the debt stands at $350  billion, up from $225 billion four years back.

Three snapshots for Thursday

The Bundesbank is preparing to stomach higher German inflation than it likes, above the European Central Bank’s target level, because of the euro zone crisis, a source at the central bank said on Thursday.

Although the Bundesbank still wants stable prices across the euro zone, its latest comments show the bank recognises that upward pressure on German wage costs and property prices suggest its inflation is likely to rise above the bloc’s average.

As this chart shows, historically the Bundesbank was quick to react to any signs of inflation:

Poland, the lonely inflation targeter

Is the National Bank of Poland (NBP) the last inflation-targeting central bank still standing?

The bank shocked many today with a quarter point rate rise, naming stubbornly high inflation as the reason, and signalling that more tightening is on its way. The NBP has sounded hawkish in recent weeks but few had actually expected it to carry through its threat to raise rates. Economic indicators of late have been far from cheerful – just hours after the rate rise, data showed Polish car production slumped 30 percent in April from year-ago levels. PMI numbers last week pointed to further deterioration ahead for manufacturing. And sitting as it does on the euro zone’s doorstep, Poland will be far more vulnerable than Brazil or Russia to any new setback in Greece. Its action therefore deserves praise, says Benoit Anne, head of emerging markets strategy at Societe Generale.

(Poland’s central bank) is one of the last orthodox inflation-targeting central banks in the global emerging market central bank universe. They are taking action because they are seeing inflation creeping up and have decided to be proactive.

Hungary can seek IMF aid now. But can it cut rates?

The European Union has given Budapest the green light to seek aid from the IMF. (see here)  In fact, the breakthrough after five months of dispute does not let Hungary completely off the hook  — to get its hands on the money, Viktor Orban’s government will have to backtack on some controversial recent legislation, starting with its efforts to curb the central bank’s independence.  It remains to be seen if Orban will actually cave in.

But markets are reacting as if the IMF money is in Hungary’s pocket already. There have been sharp rallies in Hungarian dollar bonds,  CDS and currency markets (see graphic below from Capital Economics). The Budapest stock market has posted its best one-day gain since last November while the yield on local 10-year bonds have collapsed almost 100 bps. Hungarian officials are (a bit prematurely)  talking of issuing bonds on world markets.

What investors are hoping for now is a cut to the 7 percent interest rate. Hungary’s central bank jacked up rates by 100 bps in recent months to defend the forint as cash fled the country. Now there is a chance those rate rises can be reeled back in. After all, the moribund economy could really use a dash of monetary easing. Thanasis Petronikolos, head of emerging debt at Baring Asset Management has been overweight Hungary and  recalls that after 2008 crisis, the central bank was able to quickly take back its 300 bps of currency-defensive rate hikes.

No hard landing for Chinese real estate

The desperate days when Chinese property developers offered free cars as an inducement to homebuyers look to be over.

Sales and earnings figures indicate some of the gloom is lifting as developers have enjoyed a second straight month of rising sales. Vanke, China’s biggest developer by sales, said last week that March sales had risen 24 percent year on year, while  2011 profits rose 30 percent. Another firm, China Overseas Land, posted a 21.5 percent profit rise last year.

The mood is reflected in stock prices. While the Shanghai shares index has risen less than 5  percent this year,  a sub-index of Chinese property companies has risen 13 percent. Shares in Vanke and COL are up 13 percent and 22 percent respectively. A Reuters poll of fund  managers showed that investors had upped their weighting for property stocks to 10.9 percent at the end of March, the highest level in two years.

How Turkey cut interest rates but didn’t really

How do you cut interest rates without actually loosening monetary policy? Turkey’s central bank effectively did that today.

I wrote this morning that the bank and its boss Erdem Basci were gearing for rate cuts, thanks to the lira’s steady rise (see the graphic)  that should help tame inflation later this year (provided the global investment feel remains positive). But I also said a rate cut was unlikely to happen today. I was wrong — and right too. The central bank cut its overnight lending rate by 100 basis points to 11.5 percent while keeping the one-week repo rate  — the main policy rate — steady at 5.75 percent.

So why is this not a real cut? Note that the former overnight rate hasn’t been used for over a month. Instead the central bank has been using the “corridor” between the lending and borrowing rates to adjust policy on an almost daily basis. The upper end of the corridor is in fact used more to tighten policy when there is a need to defend the lira, analysts point out. And most importantly, the central bank has already been providing funds at the cheaper 5.75 percent rate.