Tougher economic times are making investors more impatient with what they see as monetary policy flaws by some emerging market central banks, driving up borrowing costs for emerging issuers seen to be soft on inflation.
Brazil, Mexico and Poland are among those praised by investors for their handling of economic challenges while central bank credibility in Argentina, Indonesia and Turkey has been dented by charges of unreliable data and institutional weakness.
Ukraine, Vietnam, Sri Lanka and India have come under fire from ratings agencies such as Fitch and Standard & Poor's (S&P) for their inadequate policy response to inflation. "There is higher sensitivity to central bank competence," said Nicolas Schlotthauer, senior portfolio manager for emerging debt at DWS Investments. "This institutional capability is how you separate the wheat from the chaff among emerging markets as the global environment becomes more tricky."
In this climate of risk aversion, emerging markets have seen their sovereign credit ratings hit and their debt yields widen on perceived central bank dithering. "The anchoring of inflation expectations hasn't been strong for some emerging markets which is why we've seen investors shifting to shorter-dated paper and into hard-currency instead of local-currency debt," said Michael Ganske, Commerzbank emerging markets research head.
Unlike their counterparts in the developed West, monetary authorities in the emerging markets have managed only in recent years to keep inflation at bay.
"Investors still remember double-digit inflation in many developing countries. Now that it's shown up again they want central banks to show some mettle," said Brian Coulton, Managing Director of Fitch Sovereign Ratings.
"The concern over macro-economic stability arises less from inflation itself than over how it is being managed." In most cases, wavering policy resolve has been met with swift market retribution.
Turkish assets have been sold down since June 4 when the country's central bank suddenly changed its inflation targets for 2009 and the following two years. The lira fell a further 1 percent against the dollar while the benchmark two-year local currency Turkish bond yield rose as high as 24.0 percent from around 21.0 percent following the inflation target revisions, before recovering to its current level of 21.6 percent.
"The central bank changed the goal posts at the wrong time. It's precisely when inflation is there that the targets matter," said Coulton. Earlier this month, Ukraine had to delay a planned Eurobond issue amid deteriorating appetite for its assets which sent the country's five-year credit default swaps - indicative of the cost of insuring its sovereign debt - soaring above 400 basis points to four-year highs.
Appetite for Ukrainian credit, soured by a ratings downgrade last month by S&P, has been dampened by public squabbling between Ukrainian policymakers over the setting of a new trading band for its hryvnia currency. "Ukrainian fundamentals are actually not too bad. It's got low debt-to-GDP, for instance, but in this market you get penalised for noisy politics," said Simon Treacher, senior emerging debt portfolio manager at BlueBay Asset Management.
Analysts say many developing economies are behind the curve in raising interest rates over the last few months. They also say some central bankers have been overly optimistic, seeing the recent spike in food prices as short-term. Indonesia's central bank governor, for instance, said that the country's inflation may have peaked in June.
"There is a risk that inflation forecasts have become too optimistic given expectations of a large base effect in the second half of this year," said Arend Kapteyn, chief economist for Europe, Middle East and Africa at Deutsche Bank.
"The food and fuel price shock year-to-date is actually larger than the one that gave rise to the dramatic deterioration in inflation late last year, so inflation may come down less than people think." Accustomed to the rapid pace of economic growth of recent years, monetary authorities in many developing economies are loathe to raise interest rates to dampen inflationary pressures.
Those in export-oriented Asia are seen to be particularly resistant to any significant strengthening of their currencies. Meanwhile, investors are also begin to voice concern over the reliability of inflation data from Indonesia, where last month, the government announced it would reduce the weighting of food in the consumer price index (CPI).
"Indonesia's announcement about the changes to its CPI basket surprised investors and seemed rather ad hoc," said DWS' Schlotthauer. "This can affect its reputation in the market." Inflation figures from Argentina - whose five-year CDS trade at above 700 bps - are widely discredited, with private estimates of around 25 percent annual inflation through May, more than double the official 9.1 percent.
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