So this is spring?

Spring is supposed to be the season of renewal and rebirth, from the Prague Spring to the Arab Spring, hope springs eternal. Here in Quebec we have one of the nastiest elections I have ever witnessed, and any green-shoots outside my front door were buried by today’s snowstorm.

I confess I felt a little uneasy suggesting the other day that spring had come to the Emerging Markets. It’s always so much easier to stick to consensus and let someone else tread on the landmines first. As Keynes said, it is better to fail conventionally than to succeed unconventionally…

Still, there is no better feeling than when you do get it right. 

I should also tip my hat here to Adrian Mowat at JP Morgan. He has been consistently counter-consensus on Emerging Markets this year, and I find his positive outlook very appealing.

Markets certainly took heart from the lack of escalation in Ukraine, recognizing that the annexation of Crimea is a done deal. One may not like Realpolitik, but sometimes it is the best we can do. Meanwhile, once it becomes clear that things are not going to get worse, the only sensible thing is to make the best of a bad situation.

I would, however, argue that the rally we have experienced in more than just making the best of it.

As I mentioned in previous weeks, Fed tapering hasn’t had any effect on the ability of countries to fund themselves, and they have already raised materially more than they did during the equivalent period last year.

The biggest of the “unknown unknowns” this year has been Chinese moves to increase uncertainty in trading of the Yuan. By allowing their currency to depreciate against the Dollar, and widening the trading band, the authorities have killed the carry trade – Borrowing USD and converting the proceeds into the Chinese currency to benefit from the ever-increasing currency. Because that borrowed money has to be paid back, it has pushed the dollar up and US interest rates down, countering much of the effects of tapering. The US 10 Year bond yields 2.72% currently, which certainly does NOT represent a huge hurdle for foreign borrowers.

More recently, S&P followed through with the ratings downgrade on Brazil that I discussed in one of my initial posts, and the markets did precisely nothing on the news. In fact they actually rallied. The lack of negative action may have been related to the change of outlook to stable, since everyone knew that the downgrade was inevitable.

It may also have been obscured by the news of a corruption enquiry at Petrobras concerning the purchase of an oil refinery for $1.2BN that was really only worth $40M. Although she is not directly implicated, President Rousseff was head of Petrobras at the time of the purchase, and it has dented her credibility as a technocrat. If she had the wool pulled over her eyes on this, what else has gotten passed her?

It is telling that an event that might derail Dilma’s election prospects should cause the markets to rally. It just goes to show how badly she is deemed to be running the economy.

Yet the fact that a corruption investigation is taking place is an incremental improvement, and people are starting to look for the incremental change, such as Petrobras admitting to analysts that the numbers in its revised 5 year CAPEX plans don’t add up, and they need to look at improved cost controls. They also made it clear that the Government will give them another price increase to close the import parity gap. At the turn of the year, both these pieces of news would have been taken negatively – Brazil continues to be run badly – now they are being interpreted as Brazil recognizing it is run badly and starting to do something about it.

So the focus on Brazil is switching to what happens after the elections. If Dilma stops mismanaging things but actually tries to repair the damage, what can she do without too much shoving and losing too much face?

Elsewhere, the improvements to the current account in Indonesia appear to be solid, and the expected winner of July’s Presidential Elections Joko Widodo appears ready to tackle two of Indonesia biggest structural problems, namely poor infrastructure and the huge amount of money wasted on the fuel subsidies. The first test will be parliamentary elections to be held in April, with early expectations that his party can double their seats to around 35%.

It would be overly optimistic to say that we are now living in the best of all possible worlds.

Thailand, unfortunately, appears to be bogged down in its never-ending psychodrama. The opposition Democrat Party can’t beat the Thaksin Government in the polls, so they are boycotting them and using the courts to tie the Government up in procedural issues in an attempt to discredit them in the eyes of their supporters. As far as I can tell, their policies look more like scorched earth than anything else, and I remain confused by the relative strength of the market.

Sadly the flicker of hope that was the new SICAD2 FX system in Venezuela already appears to be snuffed out, keeping the focus on the here and now.

Just to recap, Venezuela has 4 exchange rates, the official rate decreed by Chavez at 6.3/$, the secondary rate of 11 in SICAD, the new rate in SICAD2 of approximately 57/$, and the unofficial rate in the parallel market which is somewhere around 70.

The misalignments of the exchange rate is a major cause of the shortages of everything from pharmaceuticals to toilet paper; although vital medicines and food are supposed to be imported at VEB6.3, no-one is stupid enough to sell dollars at that price. SICAD was supposed to solve that problem by auctioning off $200M or so every week at a more realistic exchange rate. Unfortunately the market demanded more dollars than that, and the Government failed to deliver even the $200M. When the VEB11 rate was set it was already too strong, and the rampant inflation since then has only served to make the situation worse, hence the third tier.

SICAD2 was supposed to be unconstrained, with rates set by the market unhindered by the Government – a huge ideological shift by the highly doctrinaire administration.

The lower exchange rate would close the budget deficit but it would drive up inflation since so much is imported; a dangerous thing when people are on the streets protesting. Unsurprisingly, the Government appears to be backtracking already, and the rates in the parallel market are falling again as citizens scramble to protect their meager savings.

Meanwhile Air Canada has stopped flying to Caracas because they haven’t been paid; arrears to international airlines are believed to have reached $3.5BN or so at the old exchange rate, whilst the Government is expected to revalue those arrears to the new rate, meaning they will only ever get cents on the dollar.

Despite the blanket of snow outside, the noisy old raccoon that was jumping up and down on my roof last week tells me that spring is really here. The renewed focus on reforms and the possibilities of future Governments suggests the markets are feeling it too.