* Hungary, Russia under pressure to raise rates next
* Current account surpluses no longer offer cast-iron
* Rate shocks needed to stabilise currencies
By Natsuko Waki
LONDON, Feb 3 After abrupt interest rate rises
in India, Turkey and South Africa, investors are now betting
that Hungary and Russia will be the next emerging economies
forced to defend their currencies, even though their finances
look very different.
The three countries that acted last week - including Turkey
which raised its rate by a dramatic 425 basis points - all rely
heavily on foreign capital to power their economies.
Hungary and Russia, by contrast, run large current account
surpluses. However, this has not stopped investors from selling
off their currencies during the present rout, where they are
lumping emerging markets together often regardless of major
differences in the underlying economies.
Markets are pricing in a likelihood that Budapest and Moscow
will also have to raise interest rates as the waves of emerging
market selling - set off by concerns about Chinese economic
growth and the U.S. Federal Reserve's decision to reduce a flood
of cheap money - reach their shores.
The surprise actions by the central banks of India, Turkey
and South Africa have eased some pressure on their markets. But
this has shifted the focus to other countries where investors
are worried about debt levels, inflation or just policymakers'
Investors have dramatically changed their expectations for
Hungary and Russia. According to Societe Generale, interest rate
markets are pricing a 167 basis point rate rise in Hungary over
the next 12 months, contrasting with expectations of no change
just two months ago.
In Russia, markets are pricing rates to rise 58 bps in the
next 9 months, swinging from previous bets for a 33 bps cut,
although many analysts believe the central bank will not act, at
least for the moment.
Nevertheless, both countries may need to act aggressively to
get ahead of market expectations and boost real interest rates -
rates adjusted for inflation - to lure foreign capital and
restore investors' faith in their monetary policy.
"The focus is what the reaction function of central banks
will be. If they are too slow and reluctant, you may see further
weakness of currencies. Then we get into a negative spiral
here," said Luis Costa, head of CEEMEA strategy at Citi.
Hungary was a prime example, he said. The forint hit a
two-year low as concerns grew about the country's debt
levels near 80 percent of annual economic output, its record of
unconventional economic policies, and elections in April.
"If you want to stabilise your currency, the rationale is to
deliver an interest rate shock. Hiking in line with market
expectations doesn't work. You need what the Indonesians did."
Indonesia, part of the so-called Fragile Five economies
which are vulnerable to capital flight, has managed to avoid a
violent sell-off after the rupiah's 20 percent slide against the
dollar last year. This is thanks to rates increases totalling
175 bps since June.
Institutional credibility is also vital. "It's less about
the distinction between current account deficit and surplus
countries, it has more become an issue of who's more credible.
It's all about the credibility of political and monetary
institutions," said Gaurav Saroliya, strategist at UniCredit.
A rate rise would mark a U-turn by the National Bank of
Hungary, which cut interest rates to a record low of 2.85
percent in January to support the economy.
Forward rate agreements - futures contracts on short-term
deposits used by investors to hedge against interest rate
changes - are pricing in a 15 bps rate increase at next week's
Some dealers questioned this market's reliability as a
guide, saying that if the central bank moved at all, it would
have to make a dramatic gesture like in Turkey. One Budapest
bond trader said that 15 bps would be nothing like enough to
calm any panic - which in any case did not currently exist.
"Rates will either stay unchanged or will jump," said the
trader. "There is no panic in Hungarian debt market, but there
is big uncertainty," he added. "Sooner or later the central bank
will have to communicate something."
Panic or no panic, the central bank may have no choice.
"These days the game is about positioning for investor
expectations," said Benoit Anne, head of emerging market
strategy at Societe Generale.
"If the hedge funds managed to score against (Turkey and
South Africa), there is absolutely no reason why they should not
be able to score against the National Bank of Hungary."
Analysts say a further forint fall beyond the 2012 record
low of about 324 to the euro may force a rate rise. However, a
possible rate cut by the European Central Bank this week would
boost the forint's premium over the euro and may give some
Rate rises in Brazil or Turkey have not allowed these
countries to escape the onslaught of investors who think they
are not adequately compensated for risks.
In South Africa for instance, investors have almost doubled
their rate rise bets, despite the Reserve Bank's surprise 50 bps
move last week. Markets now expect a further 245 bps in the next
12 months, compared with 120 bps two months ago.
Currency moves are crucial for foreign investors as exchange
rate losses can easily wipe out any gains in the high-yielding
emerging world. For example, returns on South African government
debt were slightly positive in rand terms in 2013. But in dollar
terms, investors lost more than 18 percent, according to Citi's
The share of foreigners in Hungary's bond markets is among
the highest in emerging markets at over 40 percent while the
share of non residents in Russia stands at over 25 percent, five
times the level of early 2012.
Brazil is set to extend its aggressive rate rises to counter
inflation, with investors boosting their tightening bets to 213
bps over the next 12 months from 141 bps in Dec.
RUSSIA'S INFLATION BATTLE
In Russia, the rouble's fall of more than 6 percent against
the dollar is threatening to breach the central bank's 5-percent
inflation target for the year.
Every one percent fall in the rouble feeds through into an
increase of the headline inflation rate of around one decimal
point, according to calculations by HSBC.
Russia's reserves fell 7 percent in the year to the end of
January to $497 billion, having spent around $10 billion this
year to support the rouble. But this is modest compared with
2008-2009 when it spent $200 billion in a matter of weeks.
An exodus of investors is gathering pace, with Russian
equity funds tracked by EPFR losing $615 million of flows in the
week, the biggest since August 2011.
The central bank was already forced to fire a verbal warning
shot, repeating last week that it would launch unlimited
interventions to keep the rouble stable.
"(The central bank) will likely be forced to deliver some
form of tightening in case of currency weakness starting to
compromise (the) 5 percent inflation target," Bank of America
Merrill Lynch said in a client note.
Emerging market central banks which hold policy meetings
over the next week include, Poland, the Czech Republic, Romania,
Croatia, Serbia, the Philippines, Indonesia and South Korea