What goes in, can come out. And the more that goes in, the more than can come out. That’s what emerging economies have been finding out in recent weeks as capital flees their stock and bond markets.

Take the case of Russia. It’s decision last year to allow foreigners to access its domestic bonds more easily led to a boom in its OFZ or rouble debt, market, with many analysts reckoning OFZs could receive inflows of almost $50 billion in 2013-2014.

Analysts at RBS calculate some $24 billion was received in the past 18 months by OFZs but in the words of outgoing central bank Governor  Sergei Ignatyev, recent outflows have been “very heavy”. Yields on Russia’s 10-year bond have jumped 120 bps since early June.RBS analysts write

This is the shape of things to come: with investors getting better access to local bonds via the international clearing systems, local bond prices and rouble as a consequence will become increasingly prone to fluctuations at the times of sharp global market moves.

But these are hard times, and competition for capital is actually inducing more and more emerging markets to open up capital markets to foreigners. Brazil for instance scrapped the taxes that have kept foreign participation in its bond markets well below the emerging market average. India and China both have strict curbs in place but have been loosening them.

India in particular, worried about financing its current account deficit, has been rapidly expanding bond investment quotas available to foreigners, hoping to attract more capital. This week it raised investment limits for long term foreign investors six-fold. This policy is not without dangers  — India’s relative isolation so far has protected its bond markets from excessive volatility, says Steve O’Hanlon, head of fixed income at ACPI Investment Managers.

In 2008, India did not see a huge outflow of capital that upset the local yield curve. Ultimately allocation to foreigners is still small, nowhere like Indonesia for example. And the current account deficit won‘t disappear if you get more fixed income investment. They need to make  structural changes to the economy otherwise they will just be hiding the problem.

There’s probably a lesson there for all emerging markets.

Central banks from India to Turkey have acted this week to
stem currency losses and on Thursday the Indonesian rupiah was
buoyed by a surprise central bank rate rise.

Investors were unwinding short bets on the yen – which
surged 1 percent on the dollar – and long positions on equities,
pushing the Nikkei down more than 6 percent.

Markets are being rattled by uncertainty over the next moves
of central banks in Japan and well as the United States.

The latest asset shifts bring year-to-date losses on MSCI’s
emerging equity index to more than 11 percent while
sovereign dollar bond yield spreads widened 4 basis points to
348 basis points over Treasuries, around the widest in a year
.

Emerging assets are likely to stay under pressure at least
until the Federal Reserve’s meeting next week when the bank
could provide clarity about scaling back its bond-buying plan.

“We are seeing an unwinding of carry trades in the FX space
and that is impacting most emerging markets and especially
high-yield currencies,” said Murat Toprak, emerging markets
strategist at HSBC in London.

Carry trades involve borrowing in low-yielding currencies to
by assets in higher-yielding ones.

“The expectation had been of outflows from Japan towards the
emerging markets space but we are seeing the opposite,” Toprak
said.

DUMPING ASIA

Foreign investors were dumping Asian stocks, pushing the
Seoul market to seven month lows while Shanghai fell
almost 4 percent and the Bangkok market lost 5.5
percent.

Emerging currencies too saw big losses, forcing several
central banks to wade in. The Indian rupee hit fresh record lows
despite central bank action in the previous session while
Indonesia raised interest rates in a move seen motivated by the
need to defend rupiah which is 3-1/2 year lows

South Korea held interest rates steady and analysts expect
India to keep policy stable on Monday to support the rupee.

“The key point is U.S. yields. If they keep going up, EM
currencies cannot hold up. Central banks are responding in a
conventional way.. trying to ease volatility,” Toprak said.

The currency losses are also linked to selling of local
currency debt, where yields on the main GBI-EM index are at 6.18
percent, a percentage point higher than early May levels
indicating selling.

Emerging European assets were less hard hit however though
the Russian rouble fell half a percent along with a 1
percent equity fall that took the market to new one-year lows
. The Polish zloty fell 0.4 percent.

Turkish stocks however rose 1 percent and the lira
firmed slightly on the back of a slightly calmer political
situation. The forint rose 0.2 percent
as markets priced out further interest rate cuts.

As the U.S. Federal Reserve considers when to turn off its printing presses, emerging currencies have crashed to multi-year lows against the dollar. That rout is a big risk for corporate debt, which has gone from being a sideshow of the sovereign bond market to an asset class that surpasses U.S. junk debt in size.

As past decades show, a surging dollar can make trouble for emerging markets, rapidly pushing up debt service costs.

And implications go far beyond the companies themselves. Corporate defaults can lead to bankruptcy, share price falls, job losses and even sovereign stress, if governments are forced to step in as was the case in Asia during the 1997 crisis.

Corporate vulnerability was one of the motivations behind Russia’s costly $200 billion defense of the rouble in 2008.

In Mexico, several real estate firms are currently struggling. As investors flee such firms, a chain reaction raises borrowing costs across the sector, making it harder for others to refinance debt.

“Corporates are like popcorn – once one starts to pop the others are going to join,” said Sergio Trigo Paz, head of emerging debt at BlackRock. “This is happening, as we speak, with Mexican homebuilders.”

“Should the dollar get stronger, revenues in local currency will not match the coupon payments,” Trigo Paz added.

The bond boom was of course a response to paralysis in bank loan markets, once a common borrowing avenue for emerging companies. But the numbers are still astounding.

Emerging corporate bond sales have doubled since 2005 to a record $200 billion last year but that figure was already surpassed this year by end-May. Companies account for 80 percent of all hard currency debt sold in 2013, ING Bank data shows.

Many such companies will have hedged dollar exposure. But given that expectations have been for emerging currencies to strengthen, such protection is by no means universal, says Colm McDonagh, head of emerging debt at Insight Investments.

“If your revenues are in, say peso, and you have debt in dollars, do you hedge the whole time? The cost could be very high,” says McDonagh who has gone overweight cash in his funds.

He also notes that much recent borrowing has come from junk-rated credits. ING data shows almost 40 percent of issuance this year is speculative and nearly a quarter had no rating at all.

Corporate yields have blown out almost a half percentage point since early May to 374 basis points over U.S. Treasuries. Demand to hedge risk via credit default swaps has also risen: spreads on corporate CDS indices run by Markit in emerging Europe and Latin America have risen 80-100 bps since mid-May.

WORRIES BUT NOT 1997

For emerging market watchers, the scenario is familiar. In 1997, the crash in currencies such as the Korean won and Thai baht plunged over-leveraged companies into default, their spiraling debt repayments almost causing sovereign insolvency.

Back then, around a third of outstanding emerging corporate debt went into default. Even as recently as 2008, defaults rose to 10 percent, with delinquents as diverse as Brazilian meat packer Independencia Alimentos to Kazakh bank BTA.

But only the gloomiest foresee a reprise of 1997 in 2013.

First, junk-rated companies owe $33.6 billion in principal and interest this year, or a third of the total corporate payments due, ING says, describing the amounts as “manageable”.

Second, the biggest debt increases have come from energy firms, and banks, often state-run, research by JPMorgan shows. The former have a natural hedge via dollar-based revenues and banks are usually regulated to limit foreign exposures.

Russian banks Sberbank and VTB both told Reuters they hedge exposure or utilize bond proceeds for foreign currency loans.

“The situation today compared with 2008 is different,” central bank governor Sergei Ignatyev said last week. “Back then, net foreign assets of the banking system were minus $100 billion. But now, as of June 1, it is plus $72 billion – see the difference?”

As in prior crises, some sectors, countries and companies are more vulnerable. Analysts say the most pain could be felt by utilities, retailers, consumer goods and real estate firms whose cash flows tend to be in domestic currencies.

In Turkey, where corporate borrowing has rocketed, gross hard currency liabilities in the coming year are estimated around $155 billion, mostly corporate. While Turkish banks, like most peers, use cross currency swaps to hedge part of their risk, short-term liabilities well exceed central bank reserves.

Other possible hot spots, JPMorgan says, are Chinese property firms – which account for most of the $68 billion Asian real estate debt outstanding – and Indonesia where the currency could fall past levels at which hedges are capped.

Ukraine or Kazakhstan with little access to hedging are also at risk if firms lack natural hedges. Kazakh BTA and Ukraine’s Naftogaz were among defaulters after the 2008 crisis.

JPMorgan compares Ukrainian metals conglomerate Ferrexpo, which exports 100 percent of its output, with poultry farm MHP which exports less than a tenth. Yields on the latter’s dollar bond are up over 100 bps since end-April, more than double the move in Ferrexpo.

(Additional reporting by Carolyn Cohn in London; Oksana Kobzeva and Ekaterina Golubkova in Moscow; Graphic by Natsuko Waki; Editing by Ruth Pitchford)

As the U.S. Federal Reserve considers when to turn off its
printing presses, emerging currencies have crashed to multi-year
lows against the dollar. That rout is a big risk for corporate
debt, which has gone from being a sideshow of the sovereign bond
market to an asset class that surpasses U.S. junk debt in size.

As past decades show, a surging dollar can make trouble for
emerging markets, rapidly pushing up debt service costs.

And implications go far beyond the companies themselves.
Corporate defaults can lead to bankruptcy, share price falls,
job losses and even sovereign stress, if governments are forced
to step in as was the case in Asia during the 1997 crisis.

Corporate vulnerability was one of the motivations behind
Russia’s costly $200 billion defence of the rouble in 2008.

In Mexico, several real estate firms are currently
struggling. As investors flee such firms, a chain reaction
raises borrowing costs across the sector, making it harder for
others to refinance debt.

“Corporates are like popcorn – once one starts to pop the
others are going to join,” said Sergio Trigo Paz, head of
emerging debt at BlackRock. “This is happening, as we speak,
with Mexican homebuilders.”

“Should the dollar get stronger, revenues in local currency
will not match the coupon payments,” Trigo Paz added.

The bond boom was of course a response to paralysis in bank
loan markets, once a common borrowing avenue for emerging
companies. But the numbers are still astounding.

Emerging corporate bond sales have doubled since 2005 to a
record $200 billion last year but that figure was already
surpassed this year by end-May. Companies account for 80 percent
of all hard currency debt sold in 2013, ING Bank data shows.

Many such companies will have hedged dollar exposure. But
given that expectations have been for emerging currencies to
strengthen, such protection is by no means universal, says Colm
McDonagh, head of emerging debt at Insight Investments.

“If your revenues are in, say peso, and you have debt in
dollars, do you hedge the whole time? The cost could be very
high,” says McDonagh who has gone overweight cash in his funds.

He also notes that much recent borrowing has come from
junk-rated credits. ING data shows almost 40 percent of issuance
this year is speculative and nearly a quarter had no rating at
all.

Corporate yields have blown out almost a half percentage
point since early May to 374 basis points over U.S. Treasuries.
Demand to hedge risk via credit default swaps has also risen:
spreads on corporate CDS indices run by Markit in emerging
Europe and Latin America have risen 80-100 bps since mid-May.

WORRIES BUT NOT 1997

For emerging market watchers, the scenario is familiar. In
1997, the crash in currencies such as the Korean won and Thai
baht plunged over-leveraged companies into default, their
spiralling debt repayments almost causing sovereign insolvency.

Back then, around a third of outstanding emerging corporate
debt went into default. Even as recently as 2008, defaults rose
to 10 percent, with delinquents as diverse as Brazilian meat
packer Independencia Alimentos to Kazakh bank BTA.

But only the gloomiest foresee a reprise of 1997 in 2013.

First, junk-rated companies owe $33.6 billion in principal
and interest this year, or a third of the total corporate
payments due, ING says, describing the amounts as “manageable”.

Second, the biggest debt increases have come from energy
firms, and banks, often state-run, research by JPMorgan shows.
The former have a natural hedge via dollar-based revenues and
banks are usually regulated to limit foreign exposures.

Russian banks Sberbank and VTB both told Reuters they hedge
exposure or utilise bond proceeds for foreign currency loans.

“The situation today compared with 2008 is different,”
central bank governor Sergei Ignatyev said last week. “Back
then, net foreign assets of the banking system were minus $100
billion. But now, as of June 1, it is plus $72 billion – see the
difference?”

As in prior crises, some sectors, countries and companies
are more vulnerable. Analysts say the most pain could be felt by
utilities, retailers, consumer goods and real estate firms whose
cash flows tend to be in domestic currencies.

In Turkey, where corporate borrowing has rocketed, gross
hard currency liabilities in the coming year are estimated
around $155 billion, mostly corporate. While Turkish banks, like
most peers, use cross currency swaps to hedge part of their
risk, short-term liabilities well exceed central bank reserves.

Other possible hot spots, JPMorgan says, are Chinese
property firms – which account for most of the $68 billion Asian
real estate debt outstanding – and Indonesia where the currency
could fall past levels at which hedges are capped.

Ukraine or Kazakhstan with little access to hedging are also
at risk if firms lack natural hedges. Kazakh BTA and Ukraine’s
Naftogaz were among defaulters after the 2008 crisis.

JPMorgan compares Ukrainian metals conglomerate Ferrexpo,
which exports 100 percent of its output, with poultry farm MHP
which exports less than a tenth. Yields on the latter’s dollar
bond are up over 100 bps since end-April, more than double the
move in Ferrexpo.

(Additional reporting by Carolyn Cohn in London; Oksana Kobzeva
and Ekaterina Golubkova in Moscow; Graphic by Natsuko Waki;
Editing by Ruth Pitchford)

MSCI redesignated Greece an emerging market late on Tuesday,
12 years after its promotion from the category, assigning it a
tiny 0.3 percent weighting – far less than it had when last in
the emerging index.

In a follow-up conference call on Wednesday, an MSCI
official then triggered worries about Egypt when he said the
firm had had reports of investors having difficulties with
currency when repatriating money out of Egypt.

Greek stocks fell sharply and the bond yield curve inverted
further, meaning longer term debt returned less than shorter
term, a sign of investor fear about Athens’ ability to pay.

Egypt’s stock market fell more than 2.5 percent.

The Greek move, which means pension funds and more cautious
investors will have to move out of the Athens stock index
, left Greece with less weight in MSCI’s emerging market
index than the 0.4 percent index weight assigned to
Qatar and the United Arab Emirates.

Those two are former frontier markets that MSCI will include
in the emerging markets index from mid-2014.

It is also far smaller than the 5 percent share Greece had
held before its 2001 promotion, making it one of the smallest
constituents of the emerging markets index

MSCI, whose indices are tracked by $7 trillion worldwide and
$1.3 trillion in emerging markets alone, nonetheless said less
stringent entry criteria for the emerging index meant that a
number of Greek companies would be eligible to join, as opposed
to just two that are in the developed index.

“We would at the time of change, which would be November,
apply the new threshold for inclusion.. It will become a
broader, more representative index,” MSCI managing director Remy
Briand told reporters.

“Whether it benefits the equity market or not…it’s hard to
gauge whether there will be more interest,” he said.

Greece at present has a tiny 0.01 percent weight in the $29
trillion market cap developed index but the
relatively small size assigned to it effectively dash any hopes
the country would benefit from being a big fish in a small pond.

Earlier this year Russell Indexes which is tracked by $3.9
trillion, also downgraded Greece. A third major provider, FTSE,
has it on review for switch to emerging markets.

The Athens stock market fell 1 percent on the day and
10-year Greek bond prices fell more than the 30-year issue,
continuing a recent sell off.

“There are some pension funds whose mandates are to invest
in developed markets only. They will be forced sellers. That
will more than offset buyers because there is so much more money
tracking the developed index,” said Patrick Armstrong, a fund
manager at Distinction Asset Management in London.

MIDDLE EAST

MSCI’s Briand said his firm was being told by clients about
problems with currency when repatriating money out of Egypt,
where political turmoil has deterred foreign investors.

“We have no proposal to change anything in the index but we
have investors giving us (this) feedback,” he said. “We have
highlighted that the situation in Egypt regarding the currency
is being monitored very carefully.”

The firm said in a statement that it may be forced to launch
a public consultation with the investment community on a
potential exclusion of the MSCI Egypt Index from the MSCI
Emerging Markets Index were the situation to worsen.

Qatari and UAE stocks meanwhile were celebrating their
upgrade to emerging markets from the less liquid and smaller
frontier index, with the Doha bourse rising to its highest since
September 2008.

Despite carrying large weightings of 15 and 12 percent
respectively in the frontier index, joining the more liquid
emerging index is expected to bring more inflows

Morocco on the other hand was designated a frontier market.

While an upgrade for UAE was widely expected, fuelling a
blistering 50-percent rally since the start of 2013, Qatar had
been seen as less likely because of limits on foreign ownership
and relatively small free floats of shares.

Growth forecasts for the Andean country are likely to be
downgraded, with 4.4-4.5 percent a likely rate for 2013,
Mauricio Cardenas told Reuters editors and Reuters Television.

Future growth however could see an annual boost of two
percentage points, thanks to planned increases to infrastructure
spending and if peace talks with Marxist-led FARC rebels – due
to restart on Tuesday – succeed in ending half a century of
insurgency.

“We are going to make an announcement by the end of this
week of between 4.4 and 4.5 percent, we are revising our
projections a little downward,” he said of the growth forecast
which is currently at 4.8 percent.

The exact revision is dependent on economic data coming
through this week.

Falling commodity prices are an issue for Colombia, whose
main exports include oil, coal and coffee. The other worry is
Venezuela, which is facing shortages of basic goods from toilet
paper to wheat flour, raising fears of instability.

“Developments in Venezuela are very important to us – a
stable growing economy in Venezuela is very important from
Colombia’s perspective,” Cardenas said.

He added Colombia has been talking with Venezuelan ministers
about the possibility of offering food for oil, or food for
future oil reserves.

“We are very dependent on commodity prices, and whatever
happens to future oil prices,” Cardenas said.

The government was likely to keep a Brent crude oil
reference rate of around $100 a a barrel for budget purposes, he
said, not far below the current $104 level.

The U.S. shale gas revolution has also cut the United States
as an export destination for Colombia’s coal, he added.

INFRASTRUCTURE, PEACE

Colombia has a potential growth rate of between 4.5 and 4.8
percent, but ambitious infrastructure spending plans could add
around a percentage point to those estimates, Cardenas said.

The government plans to spend $20 billion on infrastructure
over the next 10 years, with most focus on roads, and is looking
for around $30 billion from the private sector, he said.

“Better infrastructure will add one percentage point to
growth, and the peace process another percentage point,”
Cardenas said, adding that the impact of the peace programme
could be felt quickly.

President Juan Manuel Santos has said he wants the talks
with FARC ended this year. The two sides last month reached
agreement on the critical issue of agrarian reform.

More than 100,000 people have died in the war which has
diverted billions of dollars from the economy.

Cardenas said that if peace with FARC were agreed: “There
will be more investment, there will be more projects, the
sectors that will benefit the most are agriculture and energy.”

(Additional reporting by Axel Threlfall; editing by Ron Askew)

Emerging economies such as South Africa, Indonesia, India,
Turkey and Poland are on the front line as investors reconsider
exposure to markets which have attracted trillions of dollars of
cheap money printed by developed world central banks.

Waves of stimulus cash have barrelled into emerging bonds
rather than equities, leaving countries with heavy financing
needs – especially in local currency debt – vulnerable to any
abrupt withdrawal.

Yields on JPMorgan’s benchmark domestic bond index have
risen almost 80 basis points since early May, dragging returns
deep into the red. Currencies have meanwhile crashed to
multi-year lows against the dollar, while emerging equities
are down 7 percent on the year. (link.reuters.com/sab78t)

“Countries with large current account deficits certainly are
vulnerable,” said Michael Gomez, head of emerging debt at PIMCO.
“Twin deficits on the fiscal side and the current account side,
those are natural places to look” for dangers.

In Turkey, whose Prime Minister Tayyip Erdogan responded to
anti-government protests on Friday by rounding on an “interest
rate lobby” of speculative investors, local stocks have
had all this year’s gains wiped out in just two weeks.

Yields on Turkey’s lira bonds have risen almost 200 bps
while South African yields have jumped 150 bps, portending a
steep rise in borrowing costs for governments and companies.

Currencies in countries heavily dependent on foreign cash
flows have also depreciated more than elsewhere.

Recent moves may have been exaggerated because bumper gains
have attracted investors who – unlike traditional emerging funds
- are not used to the sector’s periodic bouts of volatility.

Around a third of emerging domestic debt is now in foreign
hands, but in some countries the ratio is close to half.

What’s more, many economies’ financing gaps have widened as
tax revenues slow and bricks-and-mortar direct investment dries
up. That has left countries such as Turkey and India almost
fully reliant on foreigners’ stock and bond buying.

To put that into perspective, Turkey has a balance of
payments deficit of over 6 percent of its economy, or around $50
billion. India’s deficit is around 5 percent, meaning it will
have to find almost $100 billion of foreign financing this year.

Other countries which have received hefty overseas flows
also look vulnerable. Poland, with a current account deficit of
3.2 percent of GDP, has seen portfolios snap up domestic debt
equivalent to nearly 13 percent of GDP since the second quarter
of 2009 – second only to Mexico, according to Morgan Stanley.

Indonesia has attracted equity portfolio inflows of over 4
percent of GDP in the same period, and Poland over 3 percent.

“The foundations are shifting and in any sell-off when
people are reducing risk in emerging markets, there’s no logic,”
said Insight Investment’s head of emerging debt Colm McDonagh.

“Just imagine if these flows dry up. You could easily get a
balance of payments crisis.”

WHEN THE MUSIC STOPS

Behind the sell-off are the first signs of an end to easy
money with the Federal Reserve beginning to talk of phasing out
its stimulus programme as the U.S. economy improves.

With growth looking up in the United States and Japan, so
are investment opportunities. U.S. real yields now have the edge
on many emerging markets where inflation is running far higher,
while Japanese 2013 equity returns top 24 percent.

Recent flow data shows the magnitude of the moves. Fund
tracker EPFR reports outflows of $1.5 billion from emerging bond
funds in the week to June 5. Equity funds lost $5.5 billion,
their biggest outflow since mid 2011.

Given emerging markets’ smaller size – the market value of
developed equity markets is seven times bigger at $29 trillion -
a slight shift in investor attitude can create havoc.

That’s what Turkey has experienced over the past week, as
intensifying political risk has added to financing concerns.

“We’re going to see more and more of this. A lot of
imbalances that have been accumulated in the past years may
ultimately explode,” said Stephen Jen, managing partner of hedge
fund SLJ Macro Partners.

“A lot of money has been chased away by developed central
banks … Money has been pushed, not pulled in by emerging
markets. If conditions change… the underlying process that has
propelled capital into emerging markets can suddenly stop.”

In Japan, where retail investors have been keen buyers of
emerging debt – especially Turkey and South Africa – recent yen
volatility could dampen enthusiasm. Assets managed by Japanese
emerging market-oriented investment trusts stand around $61
billion, JPMorgan data shows.

Some recent moves also stem from increased hedging of
emerging currency exposure, which creates demand for dollars.

There may also be a snowball effect of falling local
currencies eating into foreign investors’ returns, prompting
them to sell securities and so amplifying refinancing concerns.

“A spark – such as the Fed’s prospective tapering – could
ignite crisis-like price action in some EM currencies,” Jen
said. “(A move of) 20-25 percent in a few weeks – that’s what I
call crisis-like price action without a crisis.”

(Additional reporting by Carolyn Cohn in London and Krista
Hughes in Mexico City; Editing by Catherine Evans and Ruth
Pitchford)

Nick Shearn, a portfolio manager at BlueBay Asset Management, sees the rise in inflation as not an if but a when, which makes inflation-linked bonds (linkers in common parlance) a good idea. These would hedge not only against EM but also G7 inflation — he calculates the correlation between the two at around 0.8 percent. He says linkers outperform as inflation uncertainty increases, hence:

As a result of the loose monetary policies of recent years that have been implemented to promote growth within emerging market economies, we believe rising as well as persistent inflation should become a trend….. Currently we are seeing the early signs of an inflation dynamic in isolated countries such as in Brazil. But, as inflation begins to rise across the region, inflation uncertainty will also begin to rise and consequently inflation-linked bonds should perform well.

The way linkers work is that the principal of the bond is indexed to inflation and the coupon is calculated using the nominal rate and the inflation index. A rise in inflation expectations would lead to a higher coupon.

There has indeed been some investor interest in EM linkers of late. State Street Global Advisors’ ETF arm, SPDR Europe, in April launched the first exchange-traded fund for EM inflation-linked bonds. It said at the time that three-quarters of the investors it surveyed expected global inflation to rise in the next 1-3 years, with developing countries especially hard hit.

One problems for investors though has been that emerging market linkers are relatively few. State Street puts the value of this market at a trifling $600 billion (total local currency emerging debt in comparison amounts to over $7 trillion). Issuance is concentrated in a few countries — Brazil, South Africa, South Korea and Poland have issued most of the EM linkers that are out there.  But the market is growing. Shearn notes a growing linker curve in Thailand, while Indonesia and Philippines are also considering issuance.

The latest entrant to the market is India, which saw good demand at its first ever linker auction this week and plans to sell up to $2.7 billion worth of bonds in the fiscal year to March 2014.   But the Indian linker plan is likely to share the problems faced by many other EM linker markets — thin liquidity as a result of dominance by local banks and pension funds who are usually buy-and-hold investors.  says Steve O’Hanlon, head of fixed income at ACPI Investment Managers. But he is not yet buying the Indian linker. O’Hanlon says:

(Issung inflation-linked bonds) sends a message the authorities are not massively concerned about inflation going forward and that’s a positive. But we don’t know how the liquidity will be and how much they will roll out ultimately. Most importantly, how effective will it be in determining what inflation expectation will be if the market becomes illiquid very quickly. 

Analysts at Barclays are not too keen on the Indian linker either. India’s motivation in issuing an inflation-hedged instrument is to wean locals off their addiction to gold, and given expectations of 5.3 percent inflation this year, Barclays reckon the bond needs a real yield of at least 1.75 percent to be attractive. But huge local demand could drive real yields to around 1.25 percent, they reckon.

The removal of the 6 percent IOF tax, imposed in 2010 to
fend off so-called hot money flows, could bring up to $30
billion into the local bond market, according to some estimates.

The real, which had hit four-year lows amid a widespread
selloff in emerging assets, rose 2 percent at one point on
Wednesday after Brazil announced it was removing the tax.

JPMorgan, whose bond indices are used by 80 percent of
emerging market investors, said in a note to clients that 11
Brazilian bonds would now become eligible to enter its GBI-EM
Narrow and GBI-EM Narrow Diversified indices.

“Potential flows for passive investors total approximately
$2.8 billion,” the bank said.

Entry will be staggered over a 10-month period starting Aug.
1, the bank said.

These two indices exclude countries and bonds that impose
any form of tax or capital controls for international investors.
As a result of inclusion, Brazil’s weight in the GBI-EM Narrow
will rise to 26 percent, up from 1.13 percent, to become the
biggest component of the index.

Its share in the GBI-EM Narrow Diversified will rise to 10
percent from 4.7 percent, JPM said, adding that index-eligible
Brazilian bonds would have a market value of $217.7 billion.

The imposition of the IOF in late 2010 has been a
significant deterrent to foreign flows, keeping the share of
foreigners in Brazilian local bonds to around 15 percent
compared to the 30 percent average in emerging domestic debt.

Bank of America/Merrill Lynch put flows to Brazilian local
bonds last year at $11.3 billion, almost a third of 2010 levels.

“This shows the possible magnitude of the increase in
inflows,” the bank said in a note to clients

But JPMorgan says the tax move will have no impact on the
composition of its most widely used domestic debt index, the
GBI-EM Global Diversified, which has less stringent entry
criteria. This index assigns Brazil a 10 percent weight.

JPMorgan says assets managed against the GBI-EM indices
total over $231 billion but the narrow versions make up only $16
billion or less than 7 percent.

(Reporting by Sujata Rao; Editing by Susan Fenton)

The removal of the 6 percent IOF tax, imposed in 2010 to fend off so-called hot money flows, could bring up to $30 billion into the local bond market, according to some estimates.

The real, which had hit four-year lows amid a widespread selloff in emerging assets, rose 2 percent at one point on Wednesday after Brazil announced it was removing the tax.

JPMorgan, whose bond indices are used by 80 percent of emerging market investors, said in a note to clients that 11 Brazilian bonds would now become eligible to enter its GBI-EM Narrow and GBI-EM Narrow Diversified indices.

“Potential flows for passive investors total approximately $2.8 billion,” the bank said.

Entry will be staggered over a 10-month period starting August 1, the bank said.

These two indices exclude countries and bonds that impose any form of tax or capital controls for international investors. As a result of inclusion, Brazil’s weight in the GBI-EM Narrow will rise to 26 percent, up from 1.13 percent, to become the biggest component of the index.

Its share in the GBI-EM Narrow Diversified will rise to 10 percent from 4.7 percent, JPM said, adding that index-eligible Brazilian bonds would have a market value of $217.7 billion.

But the tax move will have no impact on the composition of the most widely used domestic debt index, the GBI-EM Global Diversified, which has less stringent entry criteria. This index assigns Brazil a 10 percent weight.

JPMorgan says assets managed against the GBI-EM indices total over $231 billion but the narrow versions make up only $16 billion or less than 7 percent.

(Reporting by Sujata Rao; Editing by Susan Fenton)