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Asia’s Refashioned Frontier Frame

2019 May 11 by

Posted in: Asia   

Anticipating index provider Morgan Stanley Capital International’s June review that may hint at future Asia frontier index entrants after Panama and Bosnia were added from other regions, foreign investors have pinpointed a fluid Indochina and Central Asia candidate mix, with no clear immediate prospect. Cambodia and Myanmar are under international trade sanctions threat for political and human rights practice; Mongolia is in limbo under its International Monetary Fund program awaiting bank restructuring; and Uzbekistan after stock market opening and an inaugural sovereign bond is too small and tentative to qualify. Pakistan’s demotion from the core universe may be the first to make the list, as the rupee’s plunge leaves companies under the minimum $1.5 billion capitalization threshold. Sri Lanka’s frontier status in turn could be on notice should trading be suspended in the wake of terror attacks and subsequent security steps, with the blow also calling into question the specific elements of recent IMF agreement extension.

Myanmar has faded with uncertain foreign investor stock market access, and “depressed sentiment” from the Rakhine state refugee crisis highlighted in the IMF’s February Article IV report. Despite a 2018 agreement with Bangladesh over possible repatriation of the over 700,000 Rohingya fleeing, the military has refused to grant freedom of movement and continues to rule out citizenship as it faces United Nations accusations of “war crimes” during the expulsion. Aid partners are “closely watching” the humanitarian and economic aspects of the displaced population emergency, as Myanmar finalized a medium-term Sustainable Development Plan the last six months. It will be implemented through a top-level coordinating body under civilian leader Aung San Suu Kyi, ahead of the next national elections in 2020.

Gross domestic product growth slowed to the 6% range with manufacturing, consumer goods and tourism activity down. Business confidence slipped also with higher inflation and currency depreciation, with the fiscal and current account deficits near 3% and 5% of output, respectively. Central bank financing is still steep to close the former, and foreign direct investment to offset the latter “moderated,” with international reserves below the minimum recommended five months imports level. Annual credit expansion fell 15% to 20% under new prudential rules that strain private and state bank capital and profitability. Directed lending to agricultural borrowers was reduced, and foreign banks stepped in with recent licenses to support exporters, but the eventual cost of system restructuring could surpass natural disasters that historically have claimed several percentage points of GDP, the analysis suggests.

 Exchange rate flexibility and interest rate liberalization timetables could be faster in view of global “downside risks,” including potential European Union cutoff of duty-free garment imports, accounting for half the total and an estimated 500,000 jobs. The Fund reflected foreign fund manager views in urging a second generation reform wave focused on improved governance and infrastructure, privatization and skills training. Banking system fragility in particular must be “addressed quickly” with comprehensive balance sheet overhaul to facilitate capital markets launch, they concur.

Cambodia’s handful of listed stocks drew initial attention against a comparable high-growth and low-budget deficit and inflation background, and infusion of Chinese project and visitor money Resorts and casinos fueled a construction boom, with approvals over $10 billion the past two years, as extreme poverty defined by lees than a dollar a day income fell to around 10%. However the Hun Sen regime in power almost 35 years ranks 160 out of 180 on Transparency International’s corruption register. Political repression with regular arrests of opposition figures may trigger revocation under a one-year deadline of garment trade preferences to Europe, representing two-thirds of the $5 billion market.

Uzbekistan in contrast has been a darling since President Shaviat Mirziyoyev took the post in  2016 and vowed to dismantle his predecessor’s authoritarian legacy. In February its first external sovereign bond with a BB rating was oversubscribed, and in March currency convertibility and capital repatriation restrictions were eased. The $50 billion economy is projected to grow 5% annually over the near term, and single-digit inflation-targeting will begin after widespread food and energy subsidies are phased out. Natural resources including cotton, gold and uranium are lures and the government intends to unload non-strategic state company stakes through the Tashkent Stock Exchange. Current capitalization is $2 billion on price-earnings ratios under five times, with frontier acceptance despite aspirations and hype still on the distant horizon.

Israel’s Blunted Blue and White Whirl

2019 May 11 by

Posted in: MENA   

Israeli stocks and bonds now featuring in developed world indices maintained solid gains with Prime Minister Netanyahu’s surprise coalition re-election victory, after the opposition Blue and White alliance headed by former military chief Ganz first claimed triumph. He becomes the longest-serving in the post following bargaining with small right-wing parties that may shield him from prosecution on corruption charges while in office. The contest was largely run on the force of the two personalities, with US President Trump also throwing his weight behind the incumbent with recognition of Golan Heights control taken from Syria 40 years ago. The challenger’s economic policies were unclear, but income disparity and high housing costs regularly surfaced as issues despite 3.5% GDP growth and unemployment near that number. Consumption, investment and exports have been strong despite the shekel’s 5% rise to 3.5/dollar this year. Inflation is only 1% with the central bank’s benchmark rate barely positive, but the fiscal deficit has doubled to 3.5%, with public debt close to 65% of output. The Prime Minister signaled no major budget changes during the campaign, after previously backing big state enterprise privatizations through the stock exchange. The investment-grade sovereign rating could be further elevated with such steps, while stocks should continue to advance on good bank and technology listing earnings. Investors also await possible business incentives and capital infusions under a promised US proposal for a fresh Palestinian conflict approach. Netanyahu’s new arrangement has ruled out a formal two-state solution, so the search for creative constructs has become urgent especially with half the population in poverty in the West bank and Gaza, according to World Bank analysis.

Across the border Lebanon is at the other end of the ratings scale at a B minus/C with its MSCI component off 3% in the first quarter, and big Eurobonds maturing in April and May. A cabinet was formed finally, with heavy Hezbollah participation slammed by US Secretary of State Pompeo during a visit. The move will allow over $10 billion in international aid pledged at a conference in France to flow, as Iraq and Syria rebuilding plans are also contemplated. The cabinet cobbling may again be short-term on meager 1.5% growth and double-digit fiscal and current account deficits. A tax crackdown and partial privatizations are expected, but major budget reform like electricity price hikes are off the table. Saudi Arabia lifted its travel ban to help revive Gulf tourism, but oil is still not at the break-even level at home curbing discretionary spending. Both Saudi and Qatari sovereign funds have committed to buying Lebanese bonds, with $5 billion in foreign debt service this year. Both foreign reserves and non-resident bank deposits recently dipped $1 billion, as officials reaffirmed the exchange peg. The former pool covers over a year of imports, and the latter is a vital fixed-income investor base largely drawn from wealthy expatriates. Along with the Hezbollah presence, the government risks alienating donor agencies with a harder line against the estimated million Syrian refugees arriving since the civil war. They are barred from formal employment and receive limited education, as authorities have begun to urge a return home despite dire infrastructure and security embrace.

Egypt’s Punctuated Lavish Praise

2019 May 5 by

Posted in: MENA   

Egyptian bonds and stocks, the latter up 15% on the Morgan Stanley Capital International core emerging markets index in the first quarter, continued to draw strong foreign investor inflows around the spring International Monetary Fund-World Bank gathering. Government officials fanned out to promote an economic comeback and political stability narrative to public and private sector counterparts, with President Abdel Fattah El-Sisi showered by US President Donald Trump’s “great job” praise in a White House meeting. The former army chief won a landslide 97% election victory last year, and is on track to secure constitutional extensions that could keep him in the post another 15 years. He agreed to a $12 billion IMF program in 2016, due to expire later this year, which floated the currency and cut fuel subsidies to win sovereign ratings upgrades to “B” and “positive.”

 The stock exchange prepared for another wave of state bank and enterprise partial sales following burst decades ago, and with the pound finally settling at its market level, overseas portfolio managers snapped up local Treasury bills with double-digit yields. Foreign reserves have tripled to $45 billion from their precarious position before the Fund package, with offshore natural gas discovery joining tourism rebound to boost external accounts. However inflation is almost 15% and the fiscal deficit is stuck in high single digits in relation to gross domestic product. Improving indicators otherwise may have come at the cost of runaway public debt, over 90% of GDP, to invite a “great job” rethink on the President’s longer-term performance and reform path.

GDP growth in 2019 is set at 5.5% as a Middle East-North Africa region leader, aided by “megaprojects” such as Suez Canal widening and the $45 billion Cairo relocation to a new administrative capital. The government’s “Vision 2030” charts a diversification strategy for the coming decades that also slashes poverty to meet the United Nations’ Sustainable Development Goals. Banks have been directed to earmark one-fifth of loans over time to small and midsize business to support that sector. A foreign direct investment push is designed to increase the current $7 billion take, equal to 3% of GDP, after new bankruptcy, profit repatriation, and residency laws were passed. In their Washington rounds, officials noted that US company total commitments around $25 billion represented 40% of their Africa total, and that Suez Canal modernization will complement the continent’s nascent sweeping free trade zone.

The fiscal targets in the $12 billion Fund agreement have been met despite the steep headline deficit, with a 2% primary surplus expected this year on higher tax collection. Food prices, and electricity and fuel tariff hikes with subsidy reduction, are the main inflation drivers. The currency is firm at around 17.5/dollar, and the central bank recently cut interest rates 100 basis points. The inflation goal is 9% by year-end with additional 3% leeway, and foreign investment in local government paper may double to $20 billion should it be within reach, but the more likely scenario is position unwinding that in turn weakens the pound. The current account gap will come in around 2% of GDP despite Zohr gas field production and tourism revenue approaching its pre-Arab Spring peak, with slumping Gulf remittances and expanding import appetite. Egyptian representatives conceded these points during the Bretton Woods meetings week, but countered that the domestic consumption could draw on a large 85 million population as reported unemployment fell to a decade low 9%. Standard Chartered Bank echoed these views in a January review predicting Egypt’s ascent to a top 10 global economy in 2030, with $8 trillion in output as Africa’s giant.

Bank balance sheets revived the past five years with Moody’s Ratings assigning a positive outlook, with a 15% increase projected this year. Bad loans at 4.5% of portfolios are one-quarter the amount a decade ago, and capital adequacy is 15% of assets, according to 2018 figures. The loan/deposit ratio is low and local currency deposits are three-quarters of the total. Only 30% of citizens have formal accounts, and greater financial inclusion is to be achieved through digital and technological outreach under a joint industry-regulatory framework. Retail and Islamic lending are promising lines to match trends in neighboring countries, with the youth demographic inviting consumer credit. However one-third of bank assets remain concentrated in government securities, and default or restructuring as widely feared before the IMF program may again be contemplated with exit over the coming months.

Green Finance’s Colorful Garden Variety

2019 May 5 by

Posted in: General Emerging Markets   

The IIF’s first quarterly tracking of green, social and sustainable debt issuance under accepted definitions predicts another record this year after 2018’s $250 billion, up tenfold the past five years. The total outstanding is now $430 billion, but less than half a percent of the global bond market. 2019 volume should reach $150 billion for bonds alone as banks and investors embrace low-carbon energy transition, and policy makers and practitioners promote viable mainstream market instruments. The US, Canada, UK-Europe and China dominate, and dedicated ETFs that have sprouted got $300 million in inflows the first three months. Only one-tenth of bonds are internationally-tradable and mostly in asset manager hands, even as ESG criteria routinely feature in allocation according to surveys. Supranational institutions were the original sponsors, but banks and non-banks currently hold a 40% share as the main players. China, France and Germany account for the same portion by geography, with China’s $95 billion the biggest and two-thirds bank-driven. Other emerging economies include India and Mexico at $5 billion each, and 95% of the universe is investment-grade at average 6.5 year maturity. By currency the leading portion is euro (45%), followed by renimbi (25%) and dollar (15%).

Separately securities regulators through IOSCO, and other bodies such as the Financial Stability Board and European Commission, are working on a company disclosure template for financial and material information. The IIF points out that climate change consequences are cross-border and regulatory fragmentation is a risk unless industrial and developing country supervisors agree on common terminology and guidelines. In China the central bank has its own procedures, while other major emerging markets like Brazil and South Africa enshrine them in standard listing and corporate governance norms. Insurance officials in the IAIS have a proprietary code which can further misalign industry treatment and data and methodology limitations cited by the UN’s environment program must be acknowledged. The organization in view of these discrepancies urges voluntary efforts in an initial phase before considering mandatory practice, under a broader concept than individual company threat. Technical and commercially-sensitive items should be excluded, and a unified “taxonomy” adopted for reporting and investment purposes, the analysis suggests.

South Africa’s energy crunch is a core issue in May elections with state electricity company Eskom’s precarious financial and operational state. Business and consumer rationing could keep GDP growth at 1%, with fixed capital formation in a slump. Voter surveys show the ruling ANC with the same 55% percent support as two years ago before President Ramaphosa assumed the post. He may shake up the cabinet in a symbolic move, and try to mitigate the cost of recently-granted Eskom rate hikes with the budget deficit already at 4.5% of GDP. Moody’s postponed possible ratings cut until the second half, and with 5% inflation in the target zone, the central bank may ease should the power shortage further bite. In Saudi Arabia Aramco’s petrochemical firm acquisition in a landmark oversubscribed global bond was designed partly to prepare for a clean energy future, but lower OPEC production and geopolitical shutoff also raised oil prices to the $70 plus range to aid fiscal deficit sustainability.

Asia’s Stock Sprint Wheeze

2019 April 28 by

Posted in: Asia   

Emerging Asia outperformed both the core Morgan Stanley Capital International gauge and other regions in the first quarter with an 11% jump, mainly due to the 30% surge in China “A” shares, the best result in five years. All other components were in the mid to high-single digit range, with Malaysia the sole loser with a less than 1% decline. India and Indonesia averaged a 5% gain as investors awaited the outcome of April national elections, while Thailand was up 6.5% as party haggling may persist over the next government’s formation, with the military again set to dominate through surprising voter support. Vietnam (+13%) led frontier markets, on actual and perceived trade diversion there from the deep US-China tiff, while Bangladesh (+7%) survived an Islamic bank failure and Sri Lanka was barely positive with its International Monetary Fund program extended another year.

Pakistan (+7.5) may rejoin the frontier list informally as it negotiates another Fund arrangement following Chinese and Gulf credits, with possible temporary capital controls to hoard foreign reserves. The China share bump, including 18% in the basic also Hong Kong-listed category, can be attributed to higher stock and bond index weightings, early year currency and growth stabilization, and a pause in export and foreign direct investment disputes with Western partners, but underpinnings are shaky. The Asian Development Bank before its dashed annual meeting, which underscored the extent of commercial and diplomatic hostilities with Venezuela as a test case as Washington pressed for Guidu opposition participation, slashed regional gross-domestic product expansion to 5.8% this year. It cited global trade policy uncertainty as the World Trade Organization predicted just 3% increased volume, and “sharper slowdown” in China and other major countries as overriding risks.

The National People’s Congress reiterated the 6-6.5% growth target, as the official purchasing manager index topped the neutral 50 mark in March, despite export orders down for the tenth month in a row. In January and February industrial output and retail sales rose 5% and 8% respectively, while mobile phone and car purchases plunged 15%.  Fixed asset investment as the longstanding driver was up just over 5%, and unemployment reached that same level for a 2-year peak. The Yuan strengthened 2% against the dollar over the quarter, as analysts now believe the previous presumed drop to 7 is unlikely, especially if a currency understanding features in an eventual Trump Administration tariff deal. The central bank reported reserves at a six-month $3.1 trillion high in February, and affirmed a “bigger market role” in exchange rate determination. Of the $20 billion in foreign stock market inflows the first two months, $17 billion came through the Hong Kong Connect, and MSCI expects the pace to continue with an $80 billion “A” share allocation by year-end.

However at the party gathering Premier Li revealed that three-quarter of provinces lowered growth goals, as the CASS think tank estimated that broad public debt from the central and local governments and state enterprises approached 150% of GDP. The separate private sector Beige Book found that first quarter corporate borrowing was the steepest since 2013, and called bank deleveraging claims “laughable.” Former central bank head Zhou, who held the post until the 2008 financial crisis, warned that excess debt lessons from Japan’s lost decades have not been absorbed. Total social credit, including from shadow sources is still advancing at a 10% annual clip, as onshore and offshore bond defaults begin to spread to also hurt equity values.

India’s 7% climb lagged the MSCI benchmark’s 9.5% before the mid-April election kickoff, and the ruling BJP party coalition may not win a majority according to early readings. The ADB kept growth above 7% this year, as the central bank downgraded the 1919-20 forecast slightly to 7.2%. Consumer price inflation was 2.5% in February, allowing a 25 basis point interest rate cut before the polls. The rupee mirrored the renimbi with a 2% first quarter uptick versus the dollar, with the current account deficit hovering at 2.5% of GDP. Fitch maintained its lowest investment-grade sovereign rating, but urged fiscal consolidation, bank cleanup and faster structural reform in a presumed second Modi term. That lasting formula is in order for the Asian equity rally to continue, in contrast to the confidence flickers to date.

Central America’s Border Bid Blast

2019 April 28 by

Posted in: Latin America/Caribbean   

As US President Trump threatened to shut the southern border through Mexico to Central American asylum seekers, small bond issuers in the region braced for investor fallout amid otherwise buoyant market conditions with Federal Reserve tightening suspended. After promising immediate shutdown, the President retreated and gave the Mexican government one year to better manage the inflow, as the current policy allows indefinite local humanitarian stay. He brandished tariff re-imposition on car imports with no action, in conflict with the revised USMCA free trade treaty under consideration in Congress. The budget team pared infrastructure and social spending elsewhere to preserve fiscal discipline and a primary surplus, as the ratings outlook is already negative and state oil giant Pemex has been downgraded. El Salvador has been a main “Northern Triangle” exodus source, after former capital city mayor Bukele won a landslide first-round presidential election victory in alliance with a small conservative party. GDP growth is in the 2% range, with a manufacturing slump offset by strong remittances and public debt above 70% of output with the interest bill increasing. A medium term issuance calendar will cover external obligations, but the budget shortfall is stuck at 3% of GDP and despite his market-friendly platform the new President’s specific economic policy and reform agenda is unclear. Looking to neighbors for comparison, after Costa Rica was downgraded to “B” last year, the national assembly debated overdue fiscal changes challenged in the supreme court. They were recently approved, and introduce a value added tax and extend the capital gains charge beyond property. The deficit is still projected above 5% this year, and will be partly bridged by $1.5 billion in global bonds in the pipeline. Unlike El Salvador which uses the dollar, the local currency continues to slip as the central bank keeps a 5% policy rate on inflation half that level.

The Dominican Republic should again be a leader with estimated 6% growth on solid construction and tourism, despite the chronic energy squeeze and a softer peso. The current account is in slight deficit due mainly to oil and equipment imports, and fuel subsidies remain a budget drag after President Medina also hiked public sector wages 10%. He may again attempt re-election in 2020 after an open primary system was agreed, and electricity sector overhaul will be a prominent campaign theme as major areas are still unconnected to the national grid. Panama has congressional and presidential polls in May, with the incumbent party running behind the leftist PRD candidate Cortizo after numerous corruption scandals. Moody’s upgraded the sovereign a notch after fiscal responsibility law refinement, but the stock exchange was a big loser on the MSCI frontier index with a 40% first quarter loss. No party is predicted to secure a legislative majority as the overall business-oriented strategy will continue with likely bribery and tax evasion crackdowns. Growth should be around 5% in 2019 after falling below 4% last year, as the Canal benefits from trade pickup and a new mine begins operation. The debt/GDP ratio has settled at 40%, but the Trump negative Central America effect could further reverberate after his name was stripped from local property over a management dispute.

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.