Emerging market GDP figures have surprised to the upside this year, and this, in turn, means good news for emerging market currencies. Emerging Market Views is taking a closer look at country-specific developments and what they mean for global investors.
Argentina: Fiscal Reforms A Game Changer
Argentina is preparing to pass a fiscal responsibility law governing the finances of provincial governments. Under the proposal, the current spending of provinces would not be allowed to rise faster than inflation and government employment would not be allowed to rise faster than the pace of population growth.
The proposal is due to be submitted as part of the 2018 budget proposal, but will not be voted on until after the midterm legislative election scheduled for October 22nd. If passed, this would be a big deal. “Argentina is one of the world’s great defaulters, not because of character flaws or cultural peculiarities, but because the Constitution grants provinces excessive powers compared to the central government,” Jan Dehn, head of research with Ashmore Investment Management explains. “This flaw in the constitution has enabled provinces to borrow too much money time and time again in the knowledge that they will eventually be bailed out by the central government, which eventually defaults under this arrangement.”
In short, Dehn says, the upcoming midterm elections have suddenly taken on much more importance from an investor perspective.
Brazil: Public Finances On A Downward Trend
Ratings agency SP Global has adopted what Dehn says is a “longer-term perspective” in its assessment of the public finances in Brazil when earlier this month it removed Brazil from credit watch negative, yet maintained the current sovereign credit rating of BB with a negative outlook. The decision followed an announcement by the government that the fiscal deficit will increase by a total of 2.6 percent of GDP for the period 2017-2020. The decision “seems sensible to us.”
Brazil’s public finances are deteriorating and for two significant reasons. First, it is mainly cyclical due to the country’s long and deep recession, which has undermined fiscal revenues and pushed spending higher than would otherwise be the case. However, there are now some signs of “green shoots” within the Brazilian economy, so the fiscal numbers should gradually begin to improve. Secondly, a reason for the weak state of the public finances is structural, particularly the irresponsible commitments to pensions made by the Lula and Dilma administrations.
The current Temer administration is committed to reforming public finances and has already made great strides. It is clear, however, that the Temer and his party do not have sufficient political capital to pass any full pension reforms, which would solve the fiscal problems. There is good reason to expect the next administration, which takes office after the 2018 election, to pick up the baton of reform. “We think a partial pension reform under Temer followed by a second pension reform under a future PSDB-led government would be sufficient to avoid a downgrade,” explains Dehn. “By then the cyclical upswing in Brazil will be much stronger, so rating upgrades rather than downgrades could be quite conceivable.”
China: Tussle With US Won’t End Well
China has now set in place rules governing foreign direct investment (FDI). Going forward, FDI is to be categorized with regulations that will govern each category. This move on new rules increases transparency, but also increases the scope for the Chinese government to use FDI for policy purposes.
For example, should the US go ahead with reported plans to hinder Chinese exports to the US, China then can scale back FDI into the US using its new framework. Capital inflows, including those from China, finance a big part of America’s current account deficit. “If less financing comes to America from abroad then either the dollar will fall or Americans will have to tighten their belts (or both) in order to spend less on imports.”
That is how the current and capital account balances are linked and why the whole notion that somehow America can ‘punish’ China’s exporters without inflicting a big cost onto Americas consumers and businesses is “idiotic,” according to Dehn.