Lower borrowing rates traditionally have been positive for most emerging markets, including Southeast Asia. Despite the rapid decline of interbank rates in several of these markets, rates in some economies are now so low that the negative effect of margins is more than offsetting any benefit from loan growth.
In 2013, emerging markets were in the early stages of currency weakness and expectations were for localized rate hikes to protect the currency and capital. This is no longer the case as the charts below illustrate. To some degree, the ongoing weakness in domestic demand has mitigated the pass-through effect of FX on inflation in a number of developing nations. As such, rate hikes are not as essential as in past circumstances despite the ongoing weakness in EM currencies. This partly reflects the realities of a “QE world,” in which countries are comfortable devaluing their currencies for competitive purposes.
Exhibit 1: EM 5y Rates Weighted Yield* (Red) vs. 10y UST Yield
Sources: Citi Research and Bloomberg *Weighted average BRL, MXN, PLN, MYR, ZAR, TRY
Exhibit 2: EM 5y Rates (Red) vs. Weighted Index EM FX vs. USD*
Sources: Citi Research and Bloomberg *Weighted average BRL, MXN, PLN, MYR, ZAR, TRY, Higher=Strong USD
Historically, many EM banks have been asset sensitive with higher rates driving higher net interest margin (NIM) and ROE. Given the post-global financial crisis increase in credit leverage (and carry trades), there should be a greater divergence in performance in tandem with this round of rate hikes. Because most lending is priced off of the short-end of the curve, steeper yield curves alone are unlikely to boost NIMs. Instead, steeper yield curves should benefit banks that can redeploy excess liquidity into longer-dated securities for higher asset yields (e.g., insurance, etc.). Hence in this cycle, a steeper yield curve is likely to prove negative for the ASEAN region and countries like Turkey, whereas fee-based financial systems or current account surplus nations—like Taiwan or Hungary—stand to deliver relative outperformance.
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