EM’s Policy Cushions and Fear of Unknown

Growth in China, U.S.

The U.S. debt ceiling debacle continues to drive some market segments (see chart below), but a big question for emerging markets (EM) folks is which countries might be shielded by a faster recovery in China if U.S. recession concerns stage a comeback (a scenario under which there is no resolution before the debt ceiling is reached). Various sell-side estimates suggest that Indonesia, South Korea, Thailand, Brazil and Poland might be in a stronger position, whereas the Philippines, Mexico, Turkey and Hungary could face more headwinds.

Policy Easing

This configuration sheds a new light on the inaugural rate cuts in EM, including Hungary’s decision to lower the Lombard rate (top range of the interest rate corridor) from 25% to 20.5% this morning. The market’s reaction was much calmer than last week’s currency meltdown, because the key rate remained unchanged at 18%, giving the central bank more time/space to evaluate the disinflation progress (which is expected to accelerate in the summer).

EM External Balances

EMs with less exposure to the U.S. growth downside might also benefit from the fact that their external balances are either already strong (current accounts in Indonesia and Thailand flipped to surplus last year) or started adjusting (Poland). Brazil’s basic balance (current account and foreign direct investments) also looked rock-solid in March, providing fundamental support for the currency and making it easier for the central bank to start rate cuts, once the fiscal path is clear. Stay tuned!

Chart at a Glance: U.S. Debt Ceiling Fear In Two Lines

Source: Bloomberg LP.