Global Investing

Russia: a hawk among central bank doves?

This week has the potential to bring an interesting twist to emerging markets monetary policy. Peru, South Korea and Indonesia are likely to leave interest rates unchanged on Thursday but there is a chance of a rate rise in Russia. A rise would stand out at a time when  central banks across the world are easing monetary policy as fast as possible.

First the others. Rate rises in Indonesia and Peru can be ruled out. Peru grew at a solid  5.4 percent pace in the previous quarter and inflation is within target. Indonesian data too shows buoyant growth, with the economy expanding 6.4 percent from a year earlier. And the central bank is likely to be mindful of the rupiah’s weakness this year — it has been one of the worst performing emerging currencies of 2012.

Korea is a tougher call. The Bank of Korea stunned markets with a rate cut last month, its first in three years. Since then, data has shown that the economy is slowing even further after first quarter growth eased to 2008-2009 lows. Exports are falling at the fastest pace in three years. But most analysts expect it to wait it out in August and then cut rates in September. Markets on the other hand are bracing for a rate cut as yields on 3-year Korean bonds have fallen well under the central bank’s main 7-day policy rate.

Russia’s meeting on Friday promises to be the most interesting one. Inflation has risen sharply in the past two months while utility tariff hikes from August were seen adding 1 percent to this year’s headline price growth number.  Year-end inflation could be 6.6 percent, analysts reckon, well above the central bank’s 5-6 percent target range. Deputy Governor Alexei Ulyukayev (who has been making hawkish noises for a while) told reporters last month rates could be “changed” in August.

Analysts at ING suggest the central bank may raise its deposit rate (which would narrow its interest rate corridor) and/or its reserve ratios for banks rather than move its key lending rate, which would have little impact anyway on food price inflation.  “This could be more about signalling than about a real anti-inflation move,” ING analysts write.

India, a hawk among central bank doves

So India has not joined emerging central banks’ rate-cutting spree .  After recent rate cuts in Brazil, South Korea, South Africa, Philippines and Colombia, and others signalling their worries over the state of economic growth,  hawks are in short supply among the world’s increasingly dovish central banks. But the Reserve Bank of India is one.

With GDP growth slowing to  10-year lows, the RBI would dearly love to follow other central banks in cutting rates.  But its pointed warning on inflation on the eve of today’s policy meeting practically sealed the meeting’s outcome. Interest rates have duly been kept on hold, though in a nod to the tough conditions, the RBI did ease banks’ statutory liquidity ratio. The move will free up some more cash for lending.

What is more significant is that the RBI has revised up its inflation forecast for the coming year by half a  percentage point, and in a post-meeting statement said rate cuts at this stage would do little to boost flagging growth. That, to many analysts, is a signal the bank will provide little monetary accommodation in coming months. and may force  markets to pedal back on their expectation of 100 basis points of rate cuts in the next 12 months.  Anubhuti Sahay at Standard Chartered in Mumbai says:

Risks loom for South Africa’s bond rally

Investors are wondering how much longer the rally in South Africa’s local bond markets will last.

The market has received inflows of over $7.5 billion year-to-date, having benefited hugely from Citi’s April announcement that it would include South Africa in its elite World Government Bond Index (WGBI).  But like many other emerging markets, South Africa has also gained from international investors’ hunger for higher-yielding bonds. And the central bank’s surprise rate cut last week was the icing on the cake, sending 5-year yields plunging another 30 basis points.

There are some headwinds however. First positioning. Around a third of government bonds are already estimated to be in foreigners’ hands. Second, markets may be pricing in too much policy easing (Forward rate agreements are assigning a 77  percent probability of another 50 bps rate cut within the next six months).  That’s especially so given local wheat and maize prices have been hitting record highs in recent weeks.

South Africa’s joins the rate cutting spree

Another central bank has caved in and cut interest rates — South Africa lowered its key rate to a record low of 5 percent at Thursday’s meeting. In doing so, the central bank noted growth was slowing further. ”Negative spillover effects (from the global economy)  likely to intensify,” it said.

Very few analysts had predicted this outcome, reckoning the central bank (or SARB as it’s known) would hold fire until its next meeting due to concerns over the currency and inflation.  But in fact, forward markets had guessed a cut was coming, especially after June inflation was lower than expected. And after all, even the conservative Bank of Korea cut rates last week to buck up domestic growth and compensate for slumping exports.  There have also been some policy easing in Taiwan and Philippines in the past week while earlier on Thursday, Turkey’s central bank unleashed more liquidity into the banking system. Kevin Lings, chief economist at Stanlib in Johannesburg says:

(South Africa’s rate cut) would suggest that the Reserve Bank feels they are a little bit behind the curve when they look at interest rate movements in other countries and hence the decision.

More EM central banks join the easing crew

Taiwan and Philippines have joined the easing crew. Taiwan cut interbank lending rates for the first time in 33 months on Friday while Philippines lowered the rate it pays banks on short-term special deposits. Hardly surprising. Given South Koreas’s shock rate cut on Thursday, its first in over three years, and China’s two rate cuts in quick succession, the spread of monetary easing across Asia looks inevitable. Markets are now betting the Reserve Bank of India will also cut rates in July.

And not just in Asia. Brazil last week cut rates for the eighth straight time  and Russia’s central bank, while holding rates steady,  amended its language to signal it was amenable to changing its policy stance if required.

Worries about a growth collapse are clearly gathering pace. So how much room do central banks have to cut rates? Compared with Europe or the United States, certainly a lot.  And with the exception of Indonesia and Philippines, interest rates in most countries are well above 2009 crisis lows.  But Deutsche Bank analysts, who applied a variation of the Taylor rule (a monetary policy parameter stipulating how much nominal interest rates can be changed relative to inflation or output), conclude that in Asia, only Vietnam and Thailand have much room to cut rates. Malaysia and China have less scope to do so and the others not at all (Their model did not work well for India).

Korea shocks with rate cut but will it work?

Emerging market investors may have got used to policy surprises from Turkey’s central bank but they don’t expect them from South Korea. Such are the times, however, that the normally staid Bank of Korea shocked investors this morning with an interest rate cut,  the first in three years.  Most analysts had expected it to stay on hold. But with the global economic outlook showing no sign of lightening, the BoK probably felt the need to try and stimulate sluggish domestic demand. (To read coverage of today’s rate cut see here).

So how much impact is the cut going to have?  I wrote yesterday about Brazil, where eight successive rate cuts have borne little fruit in terms of stimulating economic recovery. Korea’s outcome could be similar but the reasons are different. The rate cut should help Korea’s indebted household sector. But for an economy heavily reliant on exports,  lower interest rates are no panacea,  more a reassurance that, as other central banks from China to the ECB to Brazil  ease policy, the BoK is not sitting on its hands.

Nomura economist Young-Sun Kwon says:

We do not think that rate cuts will be enough to reverse the downturn in the Korean economy which is largely dependent on exports.

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.

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.

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: