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EM Matters Summary - April 18, 2016

Core Content

The document provides an analysis of emerging market (EM) economic and monetary conditions in April 2016, focusing on growth prospects, inflation trends, central bank policies, and capital inflows. It highlights the impact of the US Federal Reserve's dovish stance on EM economies and outlines the diverging monetary policy paths across different regions.

Main Views

• Global Interest Rates Remain Low: The Fed's prolonged pause in raising interest rates supports EMs, especially those with sound policies, stronger growth, and less debt.
• EM Winners: Countries like India, the Philippines, and Indonesia are likely to benefit more from the low-interest-rate environment due to improving macroeconomic fundamentals.
• Indonesia's Progress: Indonesia is showing signs of exiting the "Fragile Five" group, with inflation and growth fundamentals improving, supporting further rate cuts by BI.
• Mexico and Argentina: Mexico and Argentina are expected to benefit from the Fed's pause, with Banxico maintaining a policy rate differential with the US and Argentina poised to return to international capital markets.
• South Africa's Tightening Cycle: The South African Reserve Bank (SARB) is in a tightening cycle, with further rate hikes expected in September and November to ensure financial stability.
• Turkey's Easing Cycle: The Turkish Central Bank (CBRT) has initiated an easing cycle, but the analysis suggests this may be a policy mistake due to high core inflation and external imbalances.
• Russia's Policy Stance: The Central Bank of Russia (CBR) is expected to keep rates on hold in Q2, with inflation risks remaining significant despite recent declines.
• Colombia's Deficit Reduction: Colombia has a large current account deficit and will benefit from delayed Fed tightening to reduce external imbalances.
• Central Europe's Policy Divergence: Central European countries are expected to follow ECB easing, but with divergence due to varying domestic and external conditions.

Key Information

• US Fed Outlook: The Fed is expected to keep rates on hold in 2016 and 2017 due to dimmer growth prospects, reducing the risk of a global interest-rate shock.
• Indonesia's BI Easing: BI is expected to cut rates by another 25bp in Q2 and an additional 25bp in Q3, taking the policy rate to 6.25%.
• Argentina's Debt Resolution: Argentina has reached an agreement with holdout creditors and is expected to issue bonds on April 19, with a settlement on April 22.
• Mexico's Banxico Policy: Banxico will maintain a policy rate differential with the Fed and is likely to hike rates in response to volatility or FX pressure.
• South Korea's Rate Cut Pressure: The Bank of Korea is under pressure to cut rates, with a rate cut expected on April 19.
• Czech and Hungarian Central Banks: The Czech National Bank (CNB) may consider negative rates if the koruna cap is abandoned, while the National Bank of Hungary (NBH) is expected to cut rates further.
• Poland and Romania: These countries are expected to keep rates on hold in 2016 due to inflationary pressures and policy stability.
• Turkey's Inflation Concerns: Despite recent rate cuts, core inflation remains above 9%, and the CBRT's easing cycle is considered premature.
• EM Vulnerabilities: The heat-map analysis indicates that some EMs remain vulnerable to capital outflows, especially those with high inflation and external deficits.

Key Forecasts

• Indonesia: BI to cut rates by 25bp in Q2 and another 25bp in Q3.
• South Africa: Two more rate hikes expected in September and November 2016.
• South Korea: Rate cut on 19 April 2016.
• Hungary: NBH to cut rates further, possibly bringing the policy rate to 0.70% by end-Q3.
• Czech Republic: CNB may introduce a below-zero deposit rate if pressure on the CZK intensifies.
• Mexico: Banxico likely to follow the Fed's tightening path, with potential hikes if volatility increases.
• Russia: CBR to keep rates on hold in Q2, with rate cuts expected only in late 2016 if inflation continues to decline.

Pressure Points

• Fed's Policy Delay: Continued Fed pause is crucial for EMs like Indonesia, Mexico, and Argentina.
• Inflation Trends: Inflation remains a key concern for EMs, especially in Turkey and South Africa.
• Debt Resolution: Argentina's successful debt negotiations and legal hurdles removal are significant progress.
• Capital Flows: EMs with strong fundamentals are expected to attract more capital inflows, while those with high vulnerabilities may face outflows.
• Political and Economic Stability: South Africa's focus on financial stability and Colombia's need to reduce external imbalances are key considerations.

Summary of EM Winners and Losers

Conclusion

The analysis suggests that while the prolonged Fed pause provides support to EMs, the effectiveness of this support varies by country. EMs with strong macroeconomic management and low debt are expected to thrive, while those with high inflation and external imbalances face continued risks. Central banks in the region are responding to these dynamics with diverging monetary policies, emphasizing the need for careful calibration to avoid financial instability.