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Asia Bonds’ Narrow Escape Hatch

2019 April 21 by

Posted in: Asia   

The Asian Development Bank’s March local bond monitor, for the first quarter through mid-February, traced yield decline in six of nine East Asia countries as “improved investor sentiment” equally buoyed equity markets. The region outperformed the Morgan Stanley Capital International index with an 11% gain for the full quarter to beat Europe and Latin America.  All components led by China rose in the core universe except Malaysia, and the three frontier index members were also positive, topped by Vietnam’s almost 15% uptick. The rate fall reflected the US Federal Reserve’s pause, Chinese monetary easing, and Washington-Beijing trade talk progress. Currencies, particularly the Thai baht and Indonesian rupiah, in turn firmed against the dollar, but they are not “out of the woods” with lingering economic growth and private debt drags. Foreign ownership stabilized in the last quarter of 2018 and jumped in the Philippines, but internal and external strains, including the ripple effects of choppy Brexit, continue to haunt the $13 trillion combined bond market, the ADB warned.

In last year’s final quarter volume was up only 2% from the previous one, with China’s size almost three-quarters of the regional total. The government and corporate bond shares are two-thirds and one-third respectively, and Thailand is the largest ASEAN market. As a fraction of gross domestic product, the average approaches 75%, with Korea’s the highest at 125% as the number two overall with $2 trillion outstanding. Foreign fund inflows moderated at the end of 2018, as ownership in the Philippines and Thailand rose several points and in Indonesia came to 37.5%. The ADB growth forecast this year is unchanged near 6%, with healthy domestic demand cushioning trade expansion at a subdued 4% global clip. Hong Kong and Korea are the laggards in the 2-3% range, on regional inflation at the same level. However predictions could be upended again by sudden emerging market risk aversion that prompts fiscal and monetary tightening, the Bank cautions.

Credit default swap spreads narrowed from December-February, with the benchmark Volatility Index (VIX) down “sharply” with Chinese trade negotiation extension and the US government budget resolution. At the margin, the brighter outlook also aids “green” bond issuance for clean energy projects. In Asia, China was the most active with $55 billion placed between 2016-18, followed by India ($5.5 billion) and Korea ($2.5 billion), according to the Climate Bonds Initiative. Over the period ten emerging economies floated thirty instruments, and almost half were renimbi-denominated. Most are investment-grade rated and above $200 million, and pricing depends on underlying bond market depth as they are bought both by sustainable and conventional investors. China’s central bank has clear guidelines, and  Bank of China and China Development Bank are regular sponsors. Another study by the United Nations Environment Program points out that climate-vulnerable developing countries face an estimated 125 basis points borrowing cost premium from that risk, so asset class development should be a priority. The private sector yield demanded is steeper still, as economies “pay twice” with physical damage and higher debt service. On the positive side project and social preparedness investment show good returns, but greater international concessional funding is needed to create a “virtuous cycle,” the report suggests.

Cross-border local currency bond deals totaled $5.5 billion in the fourth quarter last year, with the biggest a Hong Kong dollar Chinese property company issue. Names from Korea, Malaysia and Singapore each represented around 5% of activity, and Laos’ government managed four Thai baht-denominated bonds worth $200 million. The longest maturity was twelve years with a 6.5% coupon. In hard currency markets 2018’s amount was down 15% annually to $295 billion, with China’s share at 60%, followed by Korea’s $30 billion led by the Export-Import Bank. Cambodia and Vietnam were on the radar with hospitality firm transactions in US dollars amid tourism pushes in both places.

Policy rates stayed intact across the nine countries tracked over the review period on lower inflation, while the yield spread between top rated corporate and government bonds dropped in Korea and increased in Malaysia. As regional commercial allocation deepens, central banks have rolled out local currency-denominated swap facilities. A recent $10 billion arrangement between Indonesia and Singapore includes repos, and is designed for the next time bond markets are in peril despite the ADB’s temporary reassurance.

The World Exchange Federation’s Universal Lessons

2019 April 21 by

Posted in: General Emerging Markets   

The Madrid-based World Federation of Exchanges and EBRD’s Capital Markets Development team unveiled an update on last year’s investor emerging and frontier market survey which found that operational and practical aspects were greater determinants than headline economic and share performance trends. Account opening and management costs, corporate governance in the broader ESG context, infrastructure beyond standard custody and settlement systems, and the local institutional base were core criteria according to the structured interviews with big foreign holders. The World Bank estimates almost $1 trillion in inflows from 2000-2017, and across the 25-country universe covered overseas direct ownership is $100 billion with their slice swamping not as deep domestic fund managers. The US and UK are the dominant sources accounting for 60% combined, followed by Western Europe, North America and Asia. Other emerging markets in Central Europe and the Middle East also actively allocate, and the biggest depository receipt target is Russian companies that received over $35 billion as of mid-2017. The original classifications date back decades, but index providers have created subsets such as advanced and secondary emerging using their own taxonomy beyond per capita income and general access and liquidity. Higher returns remain a prevailing attraction, but cheap valuations and price inefficiencies also contribute to long-term outperformance as an exposure rationale. EM is embedded in global mandates, and passive ETFs are increasingly available for the diversification range. Frontier exchanges “struggle for attention” with their limited research and risk premium, but big houses are forming dedicated teams. Share free float is smaller than developed markets, with the weighted portion halved to 10% of the MSCI All World Index adjusted for this factor. The EBRD is looking to introduce new benchmarks like an EU-wide one that can break these strangleholds and channel smaller company interest, with the possible eventual goal of a Capital Markets Union asset class.

Economic and political conditions were monitored as they affect company earnings and currency stability, but overall policy predictability was a more important consideration. So-called “red lines” varied without consensus, from capital controls and industries such as fossil fuels and tobacco to minimum investment size and trading. Other roadblocks included state and family control undermining minority rights, poor disclosure, steep transaction costs and lack of market data and information. Dual class shareholding with weighted voting was a flag, and management otherwise needed to communicate and interact regularly. Volatility was not a concern for long-term managers, with foreign portfolio swings often a mixed trigger since underlying conditions set the tone. More research on second-tier listings is desirable, and the EBRD is sponsoring a support program to address the gap. Global custodians and delivery versus payment practice are prerequisites, and international financial reporting rules should be followed. WFE and IOSCO membership is welcome, alongside strong insolvency codes.  A competitive brokerage industry and anti-corruption bodies and norms are also in the frame, and greater local investor diversification especially where retail buyers are prominent is a frequent prescription. The review concludes that “friction removal” in the form of taxes and balance sheet and top executive access should be a guiding principle, with stated law and regulation within the same frontier as actual enforcement and experience.

Algeria’s Layered Liberation Lament

2019 April 14 by

Posted in: MENA   

Thirty years after a popular revolt against one-party military-guided rule that may have been an Arab spring precursor, Algerians took to the streets to demand the 80-year old stricken President not seek another term and that competitive elections be held against the backdrop of long-promised political and economic reform. The late 1980s uprising led to civil war, resulting in tens of thousands of deaths and a harsh army crackdown after an Islamic party election victory was annulled. A state of emergency lasted the next two decades, until the 2011 regional protests, when the authorities also boosted social spending to quell double-digit youth unemployment with vital oil export prices still high. The state hydrocarbons monopoly Sonatrach by then had diversified with Asian partners beyond traditional European ones, with almost all foreign direct investment at less than 1% of GDP in the sector with post-independence access and ownership restrictions in local banks and industries lingering. Foreign exchange in turn has always been strictly controlled despite an active parallel market, while domestic capital market plans dating from the 1990s stalled despite a legal stock exchange launched with World Bank technical advice. President Bouteflika’s brother is also a member of the ruling clique, and business cronies benefiting from import curbs and government contracts have resisted breakaway from the National Liberation Front’s mercantilist and protectionist policies. The regime has suggested a compromise with technocrats in place until a legitimate fresh poll can be organized, but this capability has often been on display at the central bank and finance ministry while influential generals and politicians pull the strings behind the scenes.

Since the 2014 oil price decline, the economy has grown only 2-3% annually and foreign reserves halved to $95 billion, as the IMF’s 2018 Article IV report cited urgent fiscal, monetary and structural overhauls still on the back burner. The current account and budget deficits approach 10% of GDP, and inflation is projected in the 7.5% range this year, aggravated by liquidity injection from central bank borrowing. State banks are sufficiently capitalized and profitable, but the bad loan ratio is in double digits and the government is in arrears to client suppliers. Originally it was to embark on fiscal consolidation through raising fuel and electricity taxes and introduce business climate and currency hedging changes in 2019, but the agenda is off the table with the popular unrest. With public debt at 40% of GDP and constrained domestic bond markets, the Fund proposes external issuance along with modest exchange rate depreciation to address overvaluation. Interest rate subsidies should be phased out, and bankruptcy and creditor rights modernization could aid small business financing.  Allowing overseas majority control in joint ventures, and more flexible and inclusive labor markets are other overdue steps. Increased Treasury bill issuance and maturity extension, and bid-ask spread introduction on the official currency market to shrink the estimated 50% parallel premium should be priorities following the central bank’s recent clarification of non-energy earnings surrender mandates. Bank supervisors are behind in beginning to implement the old Basel II rules, and lack crisis preparation and intervention blueprints. Adjustment strategy before the mass demonstrations predicted budget balance early in the next decade, but political accommodation is now the undefined feature of the larger liberation formula, the report intimates.

China’s Bright Bond Future Squint

2019 April 14 by

Posted in: Asia   

As Chinese local bonds prepare to enter the Bloomberg Barclays aggregate index in April unleashing an estimated $5 billion monthly in foreign investor inflows, with the renimbi currency forecast also strengthened from the previous 7/dollar, the International Monetary Fund and government counterparts in Beijing released a several hundred page study on the market’s “bright” future despite opening and building challenges ahead. It coincides with the 40th anniversary of economic liberalization first concentrating on trade with World Trade Organization admission in 2001, and subsequently on capital market development, with the signature Stock and Bond Connects through Hong Kong aiding direct international access.  The promotional hype around the publication, including an event at Washington’s Center for Strategic and International Studies, was in contrast to China’s reported delay of a World Bank report on “new growth sources” that has been ready for a year.

 The Trump Administration did not weigh in formally on the bond roadmap but counts US inroads into the market as a victory even if underwriting and ownership totals remain paltry. The People’s Bank revealed RMB 3 trillion in January issuance with RMB 85 trillion outstanding overall, with the monthly government segment heavily provincial placement. State banks and enterprises remain a huge component, as the Paris-based Organization for Economic Cooperation and Development warned that corporate borrowing was up 400% the past decade to almost $3 trillion at the end of 2018. The Fund guide urges improved liquidity and risk pricing, implicit guarantee removal and further domestic and overseas investor outreach to balance allocation and stability on the way to maturity and global mainstream acceptance.

The research notes that cross-border financial lags trade and product integration, with the exception of bank lending to African and Asian countries under the Belt and Road and other aid-infrastructure programs. The push for a greater capital markets slice in the bank-dominated system was underscored in Premier Li Keqiang’s proclamation last year for “multi-tier bond and futures development.” In the corporate segment in particular after debt/gross domestic product hit 150% in 2016, the authorities demanded more efficient allocation and deleveraging, as 2018’s over 4% private company default ratio far outpaced the almost nonexistent state-owned one.  As portfolio inflows increase domestic monetary policy will more closely mirror global trends, but better bank supervision and more exchange rate room than under the current band can act as buffers.

 Sovereign paper was first introduced in the 1950s, but the corporate market is only 35 years old, and over the counter interbank dealing still is 90% of activity as stock exchanges slowly diversify into debt listings. The public sector including policy banks and local governments accounts for 60% of bonds, and corporates feature novel asset-backed and “green” structures. A quota regime was first introduced fifteen years ago for foreign institutional investors, and central banks and sovereign wealth funds gained full access in 2010. With the 2017 Hong Kong Bond Connect so-called northbound exposure “surged,” but international holdings are only 2% in comparison with the big emerging market average ten times that figure.  With the addition of China’s currency to the IMF’s special drawing rights basket, foreign central banks boosted their share to the same 2%, with $200 billion in renimbi reserves as of mid-2018. With expected index insertion in the Financial Times and JP Morgan gauges beyond Bloomberg in April, with the weighting there rising in phases to 5%, passive investors will direct another $150 billion to local bonds, the analysis calculates.

Near term practical steps can be taken to smooth entry pending broader policy and regulatory decisions, the Fund team recommends. Tax treatment is uncertain despite a declared three-year exemption, and hedging tools are limited for onshore cash positions. Domestic banks and mutual funds overwhelmingly follow buy and hold strategies that could be altered with more market making and repo lending capacity, and the central bank and securities supervisors should harmonize rules and communicate common development objectives. Mandatory credit ratings involve a dozen approved agencies after a fragmented screening process, and grading is 95% “skewed” toward the top AA category. Standard & Poor’s was recently granted its own license within the Washington-Beijing trade dialogue, but alone cannot tip the ratings scale to emerging market norms without larger cultural and methodology changes, the report suggests.

Ukraine’s Comedy Candidate Cringe

2019 April 7 by

Posted in: Europe   

Ukraine shares struggled to stay positive on the MSCI frontier before the first round of presidential elections, where a well-known comedian leads 40 rivals in surveys ahead of incumbent Poroshenko and previous occupant Tymoshenko. The frontrunner Zelensky has no detailed campaign platform beyond establishment mocking, but reminds voters that television personalities without political experience triumphed in the US and elsewhere, although he has been accused of close association with oligarchs who dominate the media. The incumbent has highlighted a mixed reform track record, as the latest IMF program is due to expire later this year, and his willingness to confront Russia on the fifth anniversary of Crimea’s seizure as the east of the country continues in civil war. Tymoshenko, after emerging with a burnished reputation for opposing the Yakunovych regime landing her in prison, has been haunted by old state oil company corruption allegations as she assumes a populist economic policy stance. Her anti-Fund position and spending promises come as the constitutional court threw out the anti-corruption law passed to satisfy international donors and energy subsidy reductions were further delayed. Pre-election budget strains led the government to re-open a 2028 external bond but sell it directly to JP Morgan’s trading desk given larger investor doubts about growth and servicing. Prospects for GDP warrants paying off are mixed with 3% expansion forecast this year on flat EU exports and domestic consumption. Inflation is just below double digits and the currency rebound against the dollar is expected to stall after the polls. The current account deficit is stuck at 10% of GDP with remittances and international aid the main bridges as foreign direct and portfolio investment falter. External financing needs are 40% of output annually, with gross reserves only $20 billion, and another banking system rescue may be in order with the bad loan ratio still 50%. Nationalization and fraud charges against the biggest private competitor Privatbank controlled by the oligarch Kolomonsky have entered campaign debate as he owns the comedian’s TV channel and rumors fly that he is pulling the strings. Average citizens are angry at frozen living standards and the Russia conflict but have also reportedly been targeted by Moscow disinformation to sway their preferences toward the neophyte who may be inclined to friendlier relations than other chief candidates in the mix as sworn enemies. The split widened early in the election cycle with Ukraine’s Orthodox Church formally severing ties, and a consensus that the US and Europe should stiffen trade and financial sanctions after five years of battle claiming tens of thousands of lives and displacing even more.

Russian shares were up 10% on the MSCI Index through February following a sovereign ratings downgrade, but growth is only in the 1% range on a precipitous FDI drop in anticipation of further cross-border commercial curbs. 5% inflation, pension retirement age delay and higher value added tax have slashed President Putin’s popularity rating to 60%. With the balanced budget, he unveiled new social spending to regain momentum, while dismissing international investor criticism over the detention of veteran private equity executive Calvey, caught in a bank dispute with a Kremlin ally. Over three decades he managed to avoid controversy while maintaining a top reputation for performance and integrity, and colleagues invited to the summer St. Petersburg economic forum have chosen their own boycott to convey a message.

ASEAN’s Sleepy Stock-Taking Exercise

2019 April 7 by

Posted in: Asia   

Among ASEAN stock markets, only frontier component Vietnam was up double-digits through February, as Indonesia, Malaysia, the Philippines and Thailand could not excite investors to beat the core 9% MSCI Index advance. A Moody’s Ratings report captured economic “slower momentum” angst, and the International Monetary Fund weighed in with a Malaysia Article IV report almost a year after the Mahathir administration retook power citing fiscal and financial stability risks. The analyses addressed potential softness from commodity and tech trade and investment ties with China, as well as uncompleted infrastructure projects and commercial and capital market integration within the region.

 The current lethargy overshadowed a Price Waterhouse longer-term fund management study predicting Asia-Pacific assets to double by 2025 to $30 trillion. ASEAN’s cross-border collective investment scheme is modeled on Europe’s UCITS, and rapid urbanization has promoted “impact” investing such as green bonds. Singapore as the area venture capital hub helped generate a record $13 billion in deals in 2017, as governments consider additional small business tax breaks. This future vision also came with a stark warning that retirement savings into the next generation remain inadequate, even as countries strengthen private pension pillars to relieve pressure on official social security systems.

Moody’s projects gross domestic product growth after two years over 5% to fall to the 4.5% range through next year. While the US-China trade spat is a drag, monetary tightening fears faded with the Federal Reserve’s possible pause. The Philippines and Vietnam will lead the pack with 6% expansion as manufacturing exports slow for the rest, although Indonesia’s election spending will partially offset the trend. Thailand faces protectionism abroad and weaker public investment at home, and was hurt by Malaysia’s delay of the East Coast Rail Link connected to the Port Klang container center. Prime Minister Mahathir Mohamed is renegotiating debt terms, and while Thailand’s domestic demand is “relatively healthy,” intermediate tech and auto exports have increased only single digits in recent months.

Malaysia’s new government scuttled other ventures, as natural gas and palm oil earnings slip despite solid private consumption for below 4.5% growth this year according to Moody’s, while the IMF sees it just above that level. The rater expects the fiscal deficit to repeat at 3.5% of GDP, with the narrower goods and services tax pledged during the election campaign. The Article IV survey projects rising inflation around 3% on programmed fuel subsidy cuts, and urges the budget to incorporate contingent liabilities, with end-2018 public debt estimated at 52%, 3% below the agreed cap The current account surplus was 2% last year, and capital outflows reversed with local institutional investors hiking their share of Treasury bonds to three-quarters of the total. Monetary policy is neutral, but the central bank continues ringgit intervention with $100 billion in gross foreign reserves, while mainly private external debt is 65% of GDP. Officials clamped down on currency speculation through mandatory export conversion requirements and an offshore non-deliverable forward ban, and these curbs should be lifted in the near term, the report urges. Commercial bank bad loan ratios are under 2%, but household debt is close to 85% of output, with variable mortgages subject to interest rate risk. House price gains halved to 3% according to the latest figures and macro-prudential controls serve as a cushion, but are directed more to non-residents, the Fund cautions.

Indonesia growth will be 5% as it is less exposed to global trade cycles, but runs a persistent current account deficit forcing rate hikes to steady the rupiah, Moody’s notes. Inflation is at the low end of the 2.5%-4.5% target and could aid private fixed investment post-election. Singapore will lag at under 2.5% growth with export and house price decline. The Philippines’ pace is triple that figure under President Rodrigo Duterte’s original near 7% goal, but he will fall short at 6.2% this year. Over half of 75 major infrastructure projects have been launched to enable a 7.5% of GDP contribution by 2022, but the tax package to pay for it ratcheted headline inflation toward 7% and put the central bank on notice. Equipment imports in turn widened the current account gap, and rice costs have spiked with bad weather. May midterm elections will likely witness backlash despite President Duterte’s still high opinion approval, as voters spot faulty aspects of the signature “Build” program.

Bretton Woods’ Golden Age Grasping

2019 April 1 by

Posted in: IFIs   

In the 75 year Bretton Woods institution history, both the Committee and emerging market investment field have also been in existence roughly half that period. As a late 1980s pioneer analyst, I began to appreciate the basic economic, banking and securities information and guidance available through the IMF, World Bank and regional development lenders. They encouraged dialogue with the few private sector financial institutions and fund managers interested in considering a new investment landscape after major debt crisis, and would later help lay the foundation for asset class definition and acceptance through innovative data and launch with the IFC capital markets arm.

 The Fund and Bank more broadly recommended financial sector opening policies and reforms, and extended crisis management facilities and support under the fiscal and balance of payments emergencies that have been standard features since the earliest days. In the three decades since, the proliferation of public and private institutions, bank/non-bank and securities markets, and economic and financial performance elements have far outpaced Bretton Woods creators, as they have struggled to define relevance beyond longstanding building, monitoring and rescue functions. After the initial generational burst, many emerging markets are in turn caught in a stagnation phase as both sides look to recapture previous glory for a next historical cycle. The milestone BW75 rethink can offer a platform for reflection on this signature relationship and detailed action agenda for another boom period ahead.

Average GDP growth is now half the original pace, in the 4%-plus range, as the export-led model has been supplemented by a domestic-demand based one. Productivity has often languished after an initial wave of labor, capital and technology gains, as education and skills training lag. Inflation is low and rarely in double-digits, but credit continues to outpace output expansion and fiscal policy is also loose. On the balance of payments, current account surpluses are flat, and $1 trillion annually sloshes around in cross-border direct and portfolio investment to swing currencies. Government debt is under control, but private local and external borrowing is at a multiple of economic size. In all developing market regions, structural reform is blocked with heavy state ownership in contrast with previous efficiency and privatization pushes.

The IMF-World Bank Financial Sector Assessments are important references for gauging commercial health and Basel Standard regulatory adherence, but complications have arisen. Macro-prudential/ investment flow measures can have equal impact with traditional capital, liquidity and leverage ratios. Shadow banking through unsupervised products, intermediaries and fintech platforms can overlap and approaches the scale of conventional systems. Institutional investor creation was once a priority with private pensions spreading throughout Europe, Asia and Latin America, but they have since been diluted or scrapped entirely. In the Middle East and Africa informal payments and savings networks maintain an outsize presence and pose financial and security risks.

Stock market tracking began with the IFC’s proprietary database, and it also introduced the emerging-frontier distinction between middle-low income and access and sophistication levels. The MSCI Index as the main benchmark remains heavily weighted toward Asia on a regional basis, while by industry consumer goods and technology are now as important as commodities and financials. Global listings on local as well as developed markets have faded from popularity, and small company tiers have yet to gain traction despite their employment contribution. While developing economies now account for over half of global GDP, their equity market share has been stuck at the same 20%.

Bond markets took off with the 1990s Brady restructurings ushering in dollar sovereign instruments, the JP Morgan index, and the Emerging Markets Traders Association to promote awareness and rules. In the following decades external corporate issuance joined as a multi-trillion dollar market, and local currency bonds came to dominate the government segment with the Bretton Woods Institutions, including the Asian Development Bank after the crisis there, working with central banks and finance ministries on building blocks such as yield curves, primary dealers and foreign investor participation. They have also collaborated with private counterparts like the Institute for International Finance on establishing debt restructuring principles and after large preliminary strides on these issues, progress has typically been incremental.

Thirty years ago marked the launch of a new era incorporating emerging economies and financial markets into the global investment mainstream, and that mission has lost momentum even as the subsequent BRICS discovery and institutional creations of their own highlighted common objectives. Recommitment from the broader Bretton Woods partner base on the vast unfinished agenda can produce another peak cycle of policy and performance breakthroughs.  

Foreign Banks’ Credit Share Carousel

2019 April 1 by

Posted in: Global Banking   

The BIS quarterly review continued a theme of global financial crisis retrospectives with an examination of foreign bank control of overall lending in major emerging economies, which aggravated Europe’s plight in particular amid cascading upsets the past decade. The current 12% -15% share may be half the previous average, but country concentration among a handful of institutions is higher at 75% with private borrowing prominent, as official access is mainly through bond markets. Such non-bank lines increased 5% annually, while traditional cross-border loans are flat, and trends vary by location, sector and over time. Mexico, Poland and Chile have the most reliance since foreign groups also have big local operations, with business in the first getting half of credit from the common source. At the opposite extreme is China, as well as households as a class, and funding techniques as risk measures are not explored as a further layer, with domestic deposits the safest alternative. Concentration declined before the 2009 collapse, but now Indonesia and Turkey depend heavily on respective Asian and European bank facilities. Private sector claims in a geographic cross-section are lodged three-quarters in the top three international banks, according to the analysis. Units from Belgium, Germany, the Netherlands and Switzerland retreated while ones in Australia, Canada, Japan and Spain became more active. The US and UK have the most outstanding, and official outweighs private sector dominance in places like South Africa. Stability concerns have transformed over the period but remain pressing with these patterns, and bond dependence is a separate issue for consideration.

A recent US-German academic study shows emerging market bonds outperformed rival classes over history despite frequent default periods with their underlying return premium. The authors trace the record from the 1800s through the Argentina “century sale” and IMF rescue last year, which narrowly avoided another interruption after seven previously. Sovereign hard currency performance was 5% above the US and UK over 125 years, and the controversial century instrument could retrace its secondary issue price in the coming months as the category recovers strongly so far with US Federal Reserve tightening caution. Corporate bonds drew an alarm over “fallen angels” with the next downturn, as BBB-rated ones now are 30% of the investment-grade space that could tip into junk. Developing market issuance quadrupled the past decade, with China’s alone over half a trillion dollars, the Paris-based OECD reported. Over the medium term $4 trillion must be refinanced globally, as economists predict end-decade recession, but for now investors are enjoying solid fixed-income gains after 2018’s negative results on JP Morgan’s hard and local currency benchmarks. According to its investor survey at the Americas corporate conference, the relative good times should last with steady GDP growth and commodity prices, and minimal drag from trade confrontation and incremental rate hikes. In Latin America, Brazil was a favorite under the new business-friendly administration followed by Argentina, while Mexico was the laggard with expected downgrades under the populist AMLO regime. State oil behemoth Pemex received budget help but is set for a downgrade, and the sovereign outlook went negative with fiscal policy unreliability a credit blemish.

Asia’s Ineluctable Election Whirl

2019 March 24 by

Posted in: Asia   

The three stock markets in election mode were on average behind the MSCI EM Asia’s index 9% jump through February, with only Thailand around that mark while India lost 2% and Indonesia was ahead 3%. Incumbents, including Prayuth Chan-ocha as the military ruler vying to head a civilian government, are favored, although Indian Prime Minister Narendra Modi and Indonesian President Joko Widodo find themselves in unexpectedly close races with their economic growth and reform platforms offering mixed records. Both promised 7% gross domestic product expansion, and the former has been accused of fudging that figure while the latter consistently fell 2% short of his campaign target. Foreign investors are largely on the sidelines pending the outcome, as they plough money into index heavyweight China on the rebound with a new “A” share wave scheduled to join. They prefer also to add positions in Pakistan, up 10% with Gulf Arab money offering a rescue as International Monetary Fund talks continue. A  Kashmir border skirmish after early fright was cast mainly as another Indian poll risk. Even with solid second term victories, the trio will  remain outside immediate embrace so long as banking, debt and competitiveness woes persist, especially since they are glossed over in otherwise rousing candidate rhetoric.

India media surveys show 80% expectation that Prime Minister Modi and his National Democratic Alliance will keep a lower house majority in April, with the Rahul Gandhi-led United Progressive Alliance the chief rival. The contest is estimated to cost $8.5 billion, double the amount five years ago, and the ruling government following longstanding tradition has primed the fiscal and monetary pumps to secure voter support. Negative consequences will be overlooked until later this year, when state and federal budget deficits and   bank double-digit bad loan ratios will again be in the headlines. The last official quarterly GDP report had growth slipping half a point to 6.5% at the end of 2018, with the leaked unemployment rate at a multi-decade peak of 6%. Public statistics, attempting to mix formal and informal economic measures, otherwise underscore the current coalition’s outperformance on national account indicators despite several agency resignations in protest over methodology. A main exception   the politically-sensitive farm sector, is “under stress” according to analysts as food prices stay low to restrain inflation. To pre-empt criticism, the Prime Minister was ready with a transfer package of $10 billion to strengthen rural incomes, supplemented by middle class tax breaks to appeal to that constituency.

The central bank cut the benchmark rate 25 basis points in early February, and also agreed to increase the direct budget dividend to $4 billion to retain the 3.5% deficit goal as feasible in principle. The moves smacked of an election ploy and continued acquiescence by the nominally independent body to outside pressure under new governor Shaktikanka Das, a close Modi ally. In February more money was injected into public banks, but Moody’s Ratings warns the system needs further cleanup and acts as a restraint on future growth likely to top out at 7%. Following the default of investment-grade infrastructure lender IL&FS the non-bank “shadow” segment, where balance sheets ballooned 20% annually in recent years, is also in crisis with wholesale borrowing frozen and resolution postponed until after the elections.

In Indonesia a March reading has President Jokowi with a 20% margin over opponent Prabowo Subianto, with a clear urban-rural divide. The challenger has attacked over the current account deficit at 3% of GDP, and rising external public and private debt levels which cramp the currency, and predicts an upset as with Malaysian President Mahathir’s surprise triumph. Jokowi in turn touts anti-poverty programs and hundreds of billions of dollars in infrastructure spending, low 2% inflation and his hands-on decision-making style. However away from the political battle fund managers are heavily focused on a court fight over unpaid debt between Austria’s Raiffeissen Bank and a unit of the Lippo conglomerate controlled by the wealthy Riady family, and that outcome which will help dictate future allocation. In Thailand after the Royal Princess was disqualified as a contender General Prayuth and his party appear to have the fix in, but even if successful an economy policy correction is overdue with lackluster 3% growth. He may be the frontrunner for end-March voting, but large contingent fiscal liabilities after numerous army-directed outlays have yet to be tested commercially and democratically.

Poland’s Flourishing Family Feuds

2019 March 24 by

Posted in: Europe   

Polish financial assets continued to lag double-digit index bumps elsewhere, as the ruling Law and Justice Party with 40% opinion approval bid to solidify re-election support with an estimated 2% of GDP fiscal package including the “Family 500-plus” child subsidy promised in its original winning campaign. The giveaways sparked worry that the fiscal deficit could hit the Brussels warning 3% threshold after officials there have already suggested government punishment for alleged media and judiciary tampering. A lackluster result in the May European elections could prompt further spending, and under best case scenarios another victory would maintain only a thin majority, with current parliamentary control just over half of seats. Prime Minister Morawiecki and his team have been regularly embroiled in diplomatic tiffs and political scandals since the beginning of the year, including a dispute with Israel over World War II history, a generous severance bonus paid to his predecessor, and alleged bribery of the financial services regulation head. State pension increases were another component of the recent stimulus, as a private successor to the defunct post-independence system is due to roll out with compulsory large company participation but an uncertain timetable for creating new managers, and recordkeeping requirements, and portfolio guidelines, although the debt-equity balance will be more even as a possible Warsaw Stock Exchange catalyst.

The IMF’s February Article IV report underscored ambivalence as it noted the economic cycle likely peaked late in 2018 when growth was 5% on strong private consumption and public investment in contrast with persistent private weakness. The labor-intensive model is badly in need of productivity improvement with demographic and migration trends, as the job market remains tight. Inflation is on target, but capacity utilization is high and a new financial services tax will raise sector costs. Expansion this year will fall to the historical 3% range, and the 1% current account gap should slightly worsen. Credit growth overall is manageable, but is in double digits for local currency mortgages and small business lines through bank leasing affiliates. Unsecured bad consumer loans are 10% of the total, and while capital, liquidity and other ratios are sound the strategy of replacing foreign to ensure domestic majority ownership, so-called “re-Polonization,” is an overarching risk that may deter future cross-border business. Public debt should reduce to around 45% of GDP by end-decade with better tax compliance to offset social transfers.

 The financial system has “pockets of vulnerability eves as previous foreign-currency mortgage exposure has faded. The supervision authority is resource-constrained and self-regulation poses conflict when assets are 40% under government direction. On the stock market it cannot fully protect minority shareholder rights, and pension fund oversight will also be tested under the new private regime.  Banks stress testing under a separate assessment revealed limited adverse scenarios despite slipping profitability with across the board observance of Basel core principles. However  clearer resolution powers and steps are in order, and the sizeable cooperative and credit union sector escaped detailed monitoring especially in relation to commercial bank overlap. Over 500 cooperatives is a large number, and credit unions often lack due capital. The government bond market stood at 625 billion zloty in 2017, but the corporate one is undeveloped with more trading, tax and placement modifications urges to join the fixed-income family.