Emerging market rebounds after China interest rate scare; funds lose $99 million

By Reshmi Basu and Paul A. Harris

New York, Oct. 28 - Emerging market debt bounced back after an initial downturn on news that China would lift its interest rates.

In a surprise move, the People's Republic of China increased its core interest rate for the first time in nine years in attempt to cool off its economy.

Initially, the emerging markets were unhappy with this move but they bounced back towards the end of the day.

Overall, the JP Morgan EMBI+ Index widened one point to 413 basis points in trading Thursday.

China's central bank increased its benchmark rate on one-year yuan loans to 5.58% from 5.31% and the rate on one-year deposits to 2¼% from 1.98%.

"That was done with the objective of controlling inflation first and also slowing down the economy," said a Latin America debt strategist for Refco EM.

"That took the market by surprise and that made emerging markets lower during the morning hours, specifically export countries such as Brazil.

"So that gave a negative tone to the market, but it has come back a little from this morning's trading range," he said.

Overall Thursday's session was mixed, according to the debt strategist.

"Brazil is down a quarter of point. Mexico is up by a 1/8 of a point. Colombia is mixed. Venezuela is lower. There's a little bit of lack of direction today [Thursday] with some markets closing up and some of them just weaker from yesterday [Wednesday," he said.

EM outflow at $99 million

Emerging market bond mutual funds had outflows of $99 million in the week ending Oct. 20, according to EmergingPortfolio.com Fund Research.

The report extended the current losing streak to four straight weeks. In that time the funds have lost a total of $319 million.

Inflows are $285 million year-to-date, which is 1.78% of their beginning of year total assets.

Global bond funds had inflows of $139 million in the week, extending the winning streak to three weeks. These funds have had $5.7 billion of inflows year to date.

Argentina deal likely?

A local newspaper reported that the Argentine government was close to resolving the restructuring of bonds with certain groups, including insurance companies, according to the Refco EM strategist. Argentina is in negotiation with disgruntled bondholders over $100 billion of defaulted debt.

"That overall has mixed reactions. The fact that the government is dealing individually according to bondholders is not a positive sign," he said.

But this strategy has proven to be successful in the past, much to the chagrin of foreign bondholders who have been left in the dark, he noted.

"It seems like everyone else but them are getting to okay an agreement with the government.

"The feeling is that maybe at the end of the day, you're going to have to deal with the burden," he observed.

But the market remains divided over when the parties will reach a resolution.

"There are analysts that say that the deal won't happen till well over next year. Others say the negotiations could end by year's end," he commented.

"The feeling is a lot more positive, in my opinion, than it was six months ago.

"Some of the corporates have been able to reschedule their debt," such as Argentine natural gas transport company Transportadora de Gas del Sur, he said.

"There has been a slow improvement in restructuring level.

"At the sovereign level, we are expecting a proposal according to rumors and comments in the market, it will be a little bit better than before," the strategist observed.

The consensus is that the Argentine government will sweeten the deal to 35 cents on the dollar from 25 cents.

And the debt strategist believes that tired investors will agree to almost any improvement rather than going back and forth, especially given that now the market needs more investment opportunities.

"I'm a little more positive than I was six months ago, so I think there is deal that is going to happen. And it is going to happen within the next six months," he concluded.

Philippines lower house OKs diluted tax bill

In a unanimous decision, the Philippines' lower house passed a weaker version of the sin tax bill, a tax levied on products such as tobacco.

Although the measure passed swiftly, it was with some disappointment. It removed an automatic indexation calling for a 20% increase in 2005 and 3% increase in 2006 and 2007. It also decreased the initial tax increase to 20% from 30%.

Congressmen say their measure would raise Ps. 7.6 billion a year.

Other analysts say that figure is not even close. They estimate revenue gains at Ps. 5.7 to Ps. 6.6 billion.

Even with the passing of the new taxes, Standard & Poor's is seen likely to downgrade the county's rating.

"It's good to see at least minor progress in Congress, but clearly this one tax increase will not be enough to satisfy S&P," said an emerging market analyst.

"The Lower House is only giving [president Gloria] Arroyo a little less than half of the sin tax increase she wanted, and the sin tax measure was only one part of her larger proposal to raise taxes.

"This new poll showing Arroyo with only an 8% approval rating makes you wonder whether she'll be able to get the rest of her tax package through Congress," he added.

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