Sri Lanka’s Second Wave Wallop

2019 June 16 by

While Pakistan’s stock market losses and risk of return to the MSCI frontier index occupy specialist investor thoughts with announcement of another $6 billion International Monetary Fund fiscal and balance of payments rescue, Sri Lanka’s quieter year-long extension of its program after drawing $1 billion also raises eyebrows. The request was not as abrupt a departure as with Prime Minister Imran Khan’s initial spurning of a deal, and then replacing his finance minister and central bank head with former officials of the maligned Bretton Woods institutions.

It was sealed after “setbacks” including a delayed budget from last year’s political standoff between the president and prime minister over dismissal and possible new elections, and the April multiple church and hotel terrorist bombings killing and injuring hundreds. The authorities declared a state of emergency in the aftermath, as retaliation attacks targeted Muslims and leading foreign visitor sources issued travel warnings. Fresh parliamentary and presidential polls are scheduled over the coming year, but both bond and equity buyers continue to closely track erratic debt refinancing and economic reform signals amid the security contingency and additional donor lifeline.

In March the government tapped external bond markets through a $2.5 billion dual issue at 7% yield to shore up dwindling reserves, below $7 billion at the end of last year. The exercise helped steady the exchange rate, which tumbled almost 15% in 2018 against the dollar on a 3% of gross domestic product current account gap from a combination of lagging agricultural exports and high oil imports. In the latest IMF review not yet incorporating the terror incidents’ fallout, that deficit is projected to improve slightly on 3.5% commodities and manufacturing-driven growth. Despite food price stabilization with normal weather, inflation will be 4.5%, and global financial and trade “adverse shocks” threaten tourism, capital flows, and foreign direct investment.

 Public debt is 90% of GDP, with “lumpy” near term repayments increasing rollover risk, and the fiscal deficit 3.5% target will stay out of reach without state enterprise restructuring and sale. The electricity, petroleum and airline companies had 1.5% of GDP in losses in 2018, and governance and subsidy overhauls are long overdue, according to the document. Divestiture through stock exchange listings could boost foreign investor sentiment after temporary currency controls ended in March, it suggests. While debt owed to China is in the headlines with the $1 billion takeover of the Hambantota port, it accounts for less than 10% of the external total compared with heavier loads due the Asian Development Bank and Japan.

A new central bank law aims to phase out government lending, limit currency intervention and boost independence. It steadied the rupee in the aftermath of the April carnage, but net purchases in the $150 million range have been minor compared with $1 billion last year. A cap on foreign buying of local government bonds remains in place at 5% of the outstanding amount, following large fund outflows during the early 2019 skirmish between the President and Prime Minister. Annual credit growth will approach 15% this year, with bank and non-bank bad loan ratios at 3.5% and 7.5%, respectively. Non-banks need fresh capital to meet Basel III standards, and comprehensive deposit insurance for the entire system will soon be introduced as anti-money laundering procedures are also upgraded to Financial Action Task Force compliance levels, the IMF commented.


Korean stocks that were positive through April on the other hand also got an excess credit non-bank warning in a May Article IV report. It forecast lackluster 2.5% growth on China-related semiconductor export drag that will only be partially offset by fiscal stimulus. Unfavorable demographic and productivity trends, rising income inequality, and rigid labor and product markets stifling small firm competition against the chaebol conglomerates are longer-term structural obstacles, joining the geopolitical uncertainty on the peninsula with Northern  diplomatic negotiations in limbo. Household credit expansion is still above 5% with the ratio to disposable income at a dangerous 160%, and two-thirds of the total at variable rates. Macro-prudential debt service limits will be extended to non-banks in the coming months, as they shift client emphasis from personal to corporate borrowers in a possible preemptive strategy. Their business real estate lending is up 30%, as aggregate company leverage tops GDP and property defaults raise the specter of a non-nuclear chain reaction.

Central Asia’s Skidding Transition Tread

2019 June 10 by

The International Monetary Fund’s April update on the Caucasus/Central Asia (CCA) region quelled investor excitement about political and economic transition in Morgan Stanley Capital International frontier-listed market Kazakhstan and elsewhere, as it cited incomplete banking system and structural reforms among other legacies throttling competitiveness and growth. Kazakhstan’s 9% gain through end-April lagged the core emerging market index, despite President Nursultan Nazarbaev’s decision to turn over power to a successor after decades in office, and the prospect of large-scale state enterprise privatizations through the stock exchange following years of preparation. State governance is unlikely to improve should family members or political allies assume the post as expected, and the corporate version will also be stymied by public sector continued ownership control with asset divestiture. The Fund review points out that such ingredients threaten to repeat currency and financial system disaster patterns in the region amid low productivity, as main trading and investment partners China and Russia struggle with their own performance and stabilization challenges.

CCA forecast gross domestic product growth through next year is 4%, with oil exporters relying increasingly on the non-oil pillar. Kazakhstan can look to manufacturing and Azerbaijan to construction and services alongside new gas pipeline operation. Armenia, Georgia and Tajikistan will suffer from falling Russian remittances, offset by infrastructure projects within fiscal consolidation programs. Inflation through 2019 is estimated at 8%, before a drop to 6.5% at end-decade which could allow monetary easing. Medium-term growth will stay constant at 4%, half the clip in the post-independence 2000s, and insufficient to hike incomes to peer economy levels. Bank bad loan ratios in double-digits plague half a dozen countries; Uzbekistan has a long history of government-directed lending; and Armenia and Azerbaijan foreign currency borrowing is unhedged. Kazakhstan and the Kyrgyz Republic provided emergency liquidity, and insolvency is a “lingering risk” with bank resolution and supervision gaps, according to the outlook.

 Interest and exchange rate regimes have been in flux since the 2014-16 Russian ruble depreciation, with widespread shifts toward inflation-targeting and floating currencies. However Tajikistan and Turkmenistan still manage overvalued units, which can raise bank balance sheet pressure in highly-dollarized systems, and foreign exchange trading is typically shallow. Fiscal rules and stricter tax codes were adopted throughout the region, but expansionary policy elevated public debt to 50% of GDP for oil importers. Geopolitics is a drag with the prospect of additional commercial sanctions against Moscow and US military and aid withdrawal from Afghanistan. The export range outside commodities is narrow, and concentrates disproportionately on China and Russia. Capital market development lags such as creation of local government bond yield curves, and better private business climates would foster global supply chain integration. While Bank cleanup is in limbo associated money laundering and corruption can persist, the review warns.

The Fund’s Middle East/North Africa take released at the same time also sounded the alarm by first noting that a new Reported Social Unrest index was at a multi-year peak. It calculates the share of media coverage devoted to conflict, protests and civil strife in recent flashpoint countries including Algeria and Sudan. The gauge has an inverse relationship to per-capita income growth, where Jordan and Lebanon score poorly, as well as investor-friendly rule of law. Gulf oil exporters will grow only 2% this year, but inclusion in the benchmark emerging market external sovereign bond index could spur $40 billion in inflows to counter credit deterioration from energy price swings and spillover from the Syria and Yemen civil wars. Domestic credit expansion is barely positive, and despite healthy bank capitalization real estate exposure will dent earnings and franchise value. Fiscal balance is remote and tax mobilization and spending restraint has slowed, and the state company-led loss-making model is unable to generate the million new jobs annually needed for Gulf Cooperation Council (GCC) members. Small business can be a major employer, but funding access is a chronic impediment demanding deeper securities markets. The Fund urges the GCC to construct a common financial and monetary conditions indicator to equally guide the real economy, but components are either absent or reported with serious lag. In oil importers Egypt, Jordan and Lebanon public debt is above 80% of GDP posing a next-generation burden, the review cautions for more investor pessimism.


Asia Financial Inclusion’s Selective Reach

2019 May 19 by

An IMF working paper, in view of inclusive growth’s place on the Sustainable Development Goals ahead of a UN conference, sets out to measure credit and insurance access progress across Asia, where many countries promote dedicated strategies. Economic and savings benefits are “well documented “and measured by indicators such as citizens with an account and the number of ATMs. Of the 40% unbanked in low and middle-income regions as of 2017, half were in Asia and only one-tenth of the population in these places formally borrows. Despite numerous demand and supply barriers, it outperforms peers amid wide disparities between developed Japan and Korea and poorer members like Myanmar. China, Malaysia and Thailand score well in traditional/ digital banking, while Cambodia and Nepal rely 60% on informal sources despite mobile money strides. Over half of Indians have a bank account following a push early in Prime Minister Modi’s first term, but only one-fifth use it. Gender differences are stark in South Asia, where only 30% of women versus 45% of men are banked. Poverty and rural location is even more exclusionary, with only 10% of poor Indonesians in the system. Higher income levels equate with inclusion, but governments can take specific steps to remedy gaps, such as Cambodia’s mobile public-private partnership, and the Maldives’ fishing boat outreach. Small Pacific island states like Samoa and Tonga have lagging infrastructure and wide interest spreads and are remittance-dependent, with correspondent relationships often in jeopardy from money laundering rules compliance. With their natural disaster threat, fintech is now promoted as preferred safer alternative. Asian companies have less concern about account ease compared with other geographies, but ones in Mongolia, Nepal and Sri Lanka cite both debt and equity constraints. The regulatory climate can be an overriding factor, and the Global Microscope survey based on a dozen metrics has India, Indonesia and the Philippines as leaders and Bangladesh and Myanmar at the bottom. However, consumer and privacy protections, and enforcement and supervision capacity are missing, according to the Fund document.

Public bank ownership can boost penetration at the cost of lower efficiency and earnings, and on the subcontinent usage is compromised by distance and collateral demands. Fintech is a major driver in China and elsewhere, with artificial intelligence reinforcing basic approaches, Chinese consumers have skipped a generation bypassing credit and debit cards, and ASEAN is far along with Thailand’s physical bank branches falling. Despite the region’s pace, it is behind Africa in mobile technology, where the East African Community is particularly active. The paper concludes that inclusion and broader development are not always correlated, with securities market building typically a distinct category. A separate Price Waterhouse-Economist study on major emerging markets projects trends into 2030, when China and India companies and stock exchanges are expected to dominate globally. Outside Asia, Brazil, South Africa and Russia will be top players, as the Chinese retail investor base of 300 million already will be a “huge pot.” The research notes that rivalry with New York and London is stiffer with domestic institutional assets and tighter corporate governance, while geopolitics remains a “drag,” with trade conflict and populism spread defying inclusion.

Asia’s Refashioned Frontier Frame

2019 May 11 by

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.

Asia’s Stock Sprint Wheeze

2019 April 28 by

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.

Asia Bonds’ Narrow Escape Hatch

2019 April 21 by

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.

China’s Bright Bond Future Squint

2019 April 14 by

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.

ASEAN’s Sleepy Stock-Taking Exercise

2019 April 7 by

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.

Asia’s Ineluctable Election Whirl

2019 March 24 by

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.

China’s Latin America Litter Litany

2019 March 17 by

China’s MSCI Index comeback, with double-digit gains through February, continues on strong foreign investor inflows. Morgan Stanley and Citigroup predict over $100 billion in allocation this year, even if “A” share weightings only increase incrementally. According to data trackers, around $10 billion went into equities in January, and the Shanghai exchange this week notched the biggest daily rise since 2015 and is up almost 20% for the first two months. Lunar New Year retail sales climbed only 8.5% on an annual basis, the worst performance since coverage began in 2005, and with US trade tensions the current account surplus was barely positive in 2018. However gross domestic product growth is expected to continue in the 6.5% range as the government again opened the fiscal and monetary spigots short of “flood-like” stimulus. It will likely widen last year’s 4% of GDP declared budget deficit, and total social financing hit a record RMB 4.5 trillion in January with a raft of new state bank facilities directed at small business in particular.

The enthusiasm sloughs off research such as respective Morgan Stanley and China Beige Book criticism that the economy is in “long-term decline “ and published national account numbers are “garbage.” It ignores the first offshore state company bond default in 20 years when Qinghai  Provincial Investment Group failed to pay $10 million due in Hong Kong, and stock exchange price-earnings ratios tipping again into double-digits toward recent averages. Retail investor margin loans have resurfaced as a catalyst, and any Beijing- Washington trade truce may prove short lived as President Trump extended the March negotiating deadline. With Venezuela’s eruption spilling over into neighbors, emerging market investors increasingly are wary about China’s large Latin American footprint as a new risk. Bilateral policy bank loans to Caracas totaled almost $70 billion the past fifteen years, according to a database compiled by the Washington-based Inter-American Dialogue. Internationally-recognized President and opposition head Juan Guaido pledged to honor outstanding obligations estimated at $20 billion for principal alone, and Ecuador as another major recipient just agreed on an International Monetary Fund program to be able to settle its own oil for credit ledger, but both contingencies could further erode Chinese financial system and fiscal discipline commitments.

In 2018, the China Development and Export-Import Banks lent over $7.5 billion to Latin American and Caribbean governments and state-owned firms, outstripping activity through the World Bank and Inter-American Development Bank. Venezuela took $5 billion, around two-thirds the sum, and Ecuador and Argentina, which received a record $50 billion IMF rescue last year, each got $1 billion. The Dominican Republic’s electric utility borrowed $600 million, with the regional sector focus as in the past on energy and infrastructure. The arrangements do not attach policy conditions but require Chinese contractors and equipment, as in Argentina’s railway and Ecuador’s earthquake reconstruction. In Venezuela its stake increased in oil output, as the Maduro administration announced the drilling of several hundred wells and a joint venture between the state monopolies CNPC and PDVSA.

Chinese facilities are on commercial terms, but in Ecuador’s case the interest rate was half the 11% through standard global bond issuance. With Venezuela’s additional funding last year, Beijing stipulated an end to a previous principal payment grace period, implying a country exposure limit even before the confrontation between National Assembly leader Guaido and incumbent Nicholas Maduro over presidential legitimacy. Elsewhere dams in Argentina were caught in corruption allegations, and a Bolivian one was halted after lack of local community consultation, the Inter-American Dialogue finds. These projects are under pressure to improve risk assessment and preparation, especially since they were rejected on environmental and social grounds by other development lenders. Latin America’s relationship to the multi-trillion dollar Belt and Road Initiative is also an open question, as Beijing emphasizes closer strategic areas geographically. Argentina and Ecuador reportedly wish to renegotiate loan terms, and Brazil’s new President Jair Bolsonaro campaigned on a platform of reducing oil company Petrobras’ Chinese bank ties. The big four state commercial banks at the same time have been more active in co-financing transactions and specialist funds, as the Asian International Infrastructure Bank also considers regional participation. The review suggests Chinese finance will turn more cautious, and investor sentiment as well, under near-term mounting losses.