G-20 split over rates signalled by Re, real swaps

LONDON/MUMBAI: Investors are buying the rupee, 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 G-20 in India and South Korea. The cost of a one-year agreement in India has risen to 1.55 percentage points over the central bank���s benchmark, up from 0.95 points on June 30. Spreads in Indonesia and Brazil have also grown and are wider than the US, Germany and Japan.

Threadneedle Asset Management, Schroders and Ashmore Investment Management 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 around 7%, 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.���

IMF forecasts developing nations will expand 4.7% next year, almost eight times faster than the 0.6% growth in advanced economies. Consumer prices will rise 4.6%, dwarfing developed countries��� 0.9% inflation rate, IMF predicts.
RBI governor Duvvuri Subbarao said at a conference in New Delhi on Tuesday that balancing growth and inflation has become a challenge for India. The Sensex has rallied 73% this year. The rupee has gained 1.3% this year to 48.1675, after plunging to a record low of 52.18 on March 3.

By contrast, Fed chairman Ben S Bernanke said on Tuesday the US economy isn���t strong enough to reduce the 9.7% unemployment rate quickly. European Central Bank president Jean-Claude Trichet said on Monday that it���s ���premature to declare the financial crisis over.���

President Barack Obama and other G-20 leaders will pledge in Pitts-burgh next week to keep stimulus policies in place until a recovery is certain, Michael Froman, a deputy assistant to Obama, said in a September 16 interview. 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% from 1.43% at the end of 2008 after the Fed reduced its key rate to 0.25%. Brazil���s benchmark rate is 8.75%, a record low.

The Israeli shekel has gained 4.8% this quarter to 3.745 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% on August 24.

Developing nation currencies will continue to outperform, with the won forecast to climb 7.2% by September 30, 2010, the rupee estimated to rise 6.4% and the Israeli shekel 5.8%, 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, 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.

���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 September 15 report that premature interest rate increases could disrupt financial markets. Merrill Lynch & Co and Banco Votorantim 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 September 2, the longest streak of weekly inflows in two years, according to EPFR Global in Cambridge, Massachusetts.

Foreign holdings of Indian bonds climbed 28% since March 31 to $6.4 billion, stock exchange data show. Japanese investors bought a net Y1.66 trillion ($18.2 billion) in overseas debt in the week ended September 12, the most since June 2005, the ministry of finance said on Thursday.

���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 US and Japan, the spreads are 0.18 percentage point, 0.36 point and 0.42 point.

Goldman Sachs Group forecasts India, Indonesia and South Korea will raise interest rates in the first quarter of 2010. RBI may increase 300 basis points to 6.25% and Bank of Korea by 75 basis points in 2010 to 2.75%, Goldman Sachs chief Asia-Pacific economist Michael Buchanan wrote in 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% in 2009, according to a Bloomberg survey of 13 economists. For the US, the median prediction of 66 analysts is for 0.5% deflation this year and 1.9% 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.