G-20 Split Over Rates Signaled by Rupee, Real Swaps

Sept. 18 (Bloomberg) -- Investors are buying Indian rupees, South Korean won and Brazilian reais, betting developing nations will raise interest rates even after the Group of 20 said it’s too early to end central bank support for the global economy.

Swap contracts, in which traders exchange a fixed rate for a floating one, indicate the market is pricing in the fastest increases in borrowing costs in the G-20 in India and South Korea. The cost of a one-year agreement in India has risen to 1.61 percentage points over the central bank’s benchmark, up from 0.95 point on June 30. Spreads in Indonesia and Brazil have also grown and are wider than the U.S., Germany and Japan.

Threadneedle Asset Management Ltd., Schroders Plc and Ashmore Investment Management Ltd. say they are buying emerging- market currencies as policy makers in New Delhi, Seoul and Brasilia become more focused on avoiding inflation and stock- market bubbles than on supporting the global recovery. The won and the rupee will be the world’s best-performing currencies in the year ahead, each gaining about 7 percent, median estimates in Bloomberg strategist surveys show.

“It’s going to be the emerging-market world that sees rate hikes first, and that should support currencies,” said Richard House, who manages $2 billion in developing-nation fixed income at Threadneedle in London and started buying the rupee and the real in the past month. “India will be among countries that will be first.”

The International Monetary Fund forecasts developing nations will expand 4.7 percent next year, almost eight times faster than the 0.6 percent growth in advanced economies. Consumer prices will rise 4.6 percent, dwarfing developed countries’ 0.9 percent inflation rate, the IMF predicts.

‘Imbalances’

Brazilian central bank President Henrique Meirelles, a Harvard Business School graduate, told reporters in Brasilia on Sept. 15 there was a danger accelerating growth could cause “imbalances” in demand and supply. Latin America’s largest economy created jobs in August at the fastest pace in 11 months, the Labor Ministry said Sept. 16. The real is the second-best performing emerging-market currency against the dollar this year with a gain of 29 percent to 1.8055 per dollar.

Bank of Korea Governor Lee Seong Tae told reporters in Seoul on Sept. 10 he would “consider a revision to our policy direction.” Spending at the nation’s three biggest department- store chains climbed 7.6 percent from a year earlier in August, government data released yesterday showed. The won climbed 4.2 percent this year to 1,208.7 per dollar.

Challenge

Reserve Bank of India Governor Duvvuri Subbarao, a former fellow at the Massachusetts Institute of Technology, said at a conference in New Delhi on Sept. 15 that balancing growth and inflation has become a challenge for India. The Sensex stock index has rallied 73 percent this year. The rupee has gained 1.4 percent this year to 48.1525, after plunging to a record low of 52.18 on March 3.

By contrast, Federal Reserve Chairman Ben S. Bernanke, who studied at both Harvard University and MIT in Cambridge, Massachusetts, said on Sept. 15 the U.S. economy isn’t strong enough to reduce the 9.7 percent unemployment rate quickly. European Central Bank President Jean-Claude Trichet said on Sept. 4 that it’s “premature to declare the financial crisis over,” while Bank of Japan Governor Masaaki Shirakawa said on Aug. 31 he’s not yet confident in his nation’s recovery.

‘Exit Strategies’

President Barack Obama and other G-20 leaders will pledge in Pittsburgh next week to keep stimulus policies in place until a recovery is certain, Michael Froman, a deputy assistant to Obama, said in a Sept. 16 interview. Finance officials from the group said after talks in London Sept. 5 that they would engage in “coordinated exit strategies” when growth returned. The collection of industrial and emerging economies includes Brazil, China, India, Indonesia, Mexico, Russia, Saudi Arabia, South Africa and Turkey.

Rate increases would boost the appeal of selling currencies from nations with lower borrowing costs to buy assets where they are higher, a tactic known as the carry trade. The three-month London interbank offered rate, or Libor, for dollar loans has fallen to 0.29 percent from 1.43 percent at the end of 2008 after the Fed reduced its key rate to 0.25 percent. Brazil’s benchmark rate is 8.75 percent, a record low.

The Israeli shekel has gained 5 percent this quarter to 3.7389 per dollar as the Bank of Israel became the first central bank to tighten monetary policy in the past year, increasing its benchmark rate by a quarter of a percentage point to 0.75 percent on Aug. 24.

Won, Rupee

Developing nation currencies will continue to outperform, with the won forecast to climb 7.2 percent by Sept. 30, 2010, the rupee estimated to rise 6.4 percent and the Israeli shekel 5.8 percent, according to the median estimates by strategists in Bloomberg surveys. The Brazilian real will advance to 1.79 per dollar from 1.80, according to the forecasts.

Emerging-market central banks may try to limit appreciation and protect exports by selling their own legal tender, according to Allianz SE, Europe’s biggest insurer.

Global foreign-exchange reserves have climbed by $441 billion in the past five months to a record $7.088 trillion, reflecting increased dollar purchases by China, South Korea, India and Brazil, data compiled by Bloomberg show. They declined by $340 billion in the eight months ended March as the global credit crisis forced investors to dump emerging-market assets and hoard dollars.

Stability

“Gains in currencies won’t be huge because there is a desire for stability among central banks,” said Nikhil Srinivasan, who oversees $20 billion of assets as chief investment officer for Asia and the Middle East at Munich-based Allianz.

The Asian Development Bank warned in a Sept. 15 report that premature interest-rate increases could disrupt financial markets. Merrill Lynch & Co. and Banco Votorantim SA predict Brazil will keep rates on hold next year, Bloomberg data show.

The search for higher yields helped emerging-market bond funds take in a net $3.6 billion in a 21-week stretch that ended Sept. 2, the longest streak of weekly inflows in two years, according to EPFR Global in Cambridge, Massachusetts.

Foreign holdings of Indian bonds climbed 28 percent since March 31 to $6.4 billion, stock exchange data show. Japanese investors bought a net 1.66 trillion yen ($18.2 billion) in overseas debt in the week ended Sept. 12, the most since June 2005, the Ministry of Finance said yesterday.

‘Value’

“We do see value in both emerging-market debt and emerging-market currencies,” said Nicholas Gartside, head of global fixed income at Schroders in London, who oversees $31 billion. “Asia could be the first region to raise rates.”

The spread between the benchmark monetary-policy rate and the one-year swap rate, a measure of expectations for rate changes, has increased by 38 basis points in South Korea this quarter to 1.42 percentage points, 53 basis points to 1.48 percentage points in Indonesia and 55 basis points to 0.57 percentage point in Brazil. In Germany, the U.S. and Japan, the spreads are 0.18 percentage point, 0.36 point and 0.42 point.

Goldman Sachs Group Inc. forecasts India, Indonesia and South Korea will raise interest rates in the first quarter of 2010. The Reserve Bank of India may increase 300 basis points to 6.25 percent and Bank of Korea by 75 basis points in 2010 to 2.75 percent, Goldman Sachs chief Asia-Pacific economist Michael Buchanan wrote in a Sept. 8 note.

Doug Smith, chief economist for the Americas at Standard Chartered Plc in New York, predicts Brazil will add 50 basis points by March 31.

Inflation will accelerate to 4.4 percent in Brazil in 2010, from 4.3 percent in 2009, according to a Bloomberg survey of 13 economists. For the U.S., the median prediction of 66 analysts is for 0.5 percent deflation this year and 1.9 percent inflation in 2010.

“The interest-rate turn will come first in emerging markets for the simple reason they don’t have a credit crunch,” said Jerome Booth, head of research at Ashmore Investment Management in London, which manages $25 billion of developing- nation assets.