General Emerging Markets

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Contingent Sovereign Debt’s Emergency Appeal

2017 June 3 by

After months of public and private sector consultations the IMF completed a policy paper at the request of the G-20 on promoting use of state contingent debt instruments (SCDIs) adjusted to continuous economic indicators like GDP or singular events such as natural disasters. They are recognized for countercyclical and risk-sharing features, and recent development institution focus has been on commodity hedging for low-income countries. Recently in Argentina’s and Ukraine’s restructurings growth-linked warrants were offered, but the concept has yet to gain widespread acceptance even in current global low-yield conditions inviting alternatives. As an automatic stabilizer they “preserve space” in bad times , but other tools are available to serve this purpose including foreign reserve accumulation, fiscal rules, commercial insurance, and central bank swap lines. However these backstops all have downsides and are not as accessible as well-designed long-term SCDIs in principle, which also increase securities diversification and the global financial system “safety net,” according to the Fund. Previous simulations show that introduction of GDP-tied bonds can raise the national debt limit before crisis by dozens of points as a fraction of output. The natural investor base would not be commercial banks or other mark-to-market buyers, but so called real money participants that can balance country welfare with asset returns. They nonetheless demand high novelty yields to compensate for liquidity and performance doubts, which would be magnified with data frequency and reporting gaps. For troubled countries the advance cost could spike, and until a track record develops moral hazard could argue that officials will not be as motivated to tackle macro and structural economic weakness. For issuers the operation must be the responsibility of independent debt managers to avoid political considerations and short-term time horizons, and to prepare in the context of asset class trends and sentiment swings. These combined factors argue for gradual testing within strictly-defined gain and loss boundaries, with ratings agencies brought in at an early stage, the study believes.

Official lenders like France’s development agency already provide counter-cyclical facilities to poor countries, and both advanced and emerging economies have adopted inflation-adjusted obligations and contingency features have entered sovereign debt rescheduling since the 1990s Brady Plan. Value recovery rights were in a dozen transactions, with half in detachable form, but the experience has often been indexation lags and undue complexity impeding further adaptation. Nonetheless investors surveyed were open to fresh pilots, on the assumption that pricing may be up to 50 basis points over conventional offerings at the outset. Legal and regulatory treatment should be equal to other instruments, and standard contracts and benchmark issues are preferred, with jurisdiction choices London and New York. Commodity exporters, small states, and emerging markets with shallow local bond activity are potential priority initial borrowers. Pension funds controlling $40 trillion are natural takers but may be confined to hard currency investment-grade exposure. The Islamic finance sector, currently with over $150 billion in sovereign and quasi-sovereign sukuks outstanding, would also be a likely target along with insurers and reinsurers. The document proposes three design versions, one with an automatic maturity extension trigger upon adverse statistics or events. It suggests that official creditors could add guarantees or otherwise work to galvanize multiple attempts through balance sheet and technical support, but concludes urgency is lacking.

Institutional Investors’ Sweeping Sustainability Suspicions

2017 May 26 by

Ahead of consecutive UN conferences on Financing for Development and the Sustainable Development Goals (SDG) a blue-ribbon panel of investment managers and international lending agency officials released a long-term action plan to mobilize global banking and capital markets participants around environment, social and governance (ESG) returns. Infrastructure alone will need $2.5 trillion over the next dozen years for low-carbon energy and education-health purposes, and current financial assets at $300 trillion and increasing 5 percent annually are an untapped pool ready to look elsewhere with the large negative-yield industrial country sovereign debt category. However a wholesale commercial, regulatory, technology  and long-term “reorientation” is needed for outcomes that will only be clear over decades , according to the study under the auspices of the Business Commission on Sustainable Development. New international standards like Basel III do not incorporate SDG criteria, even if the UN Environment Program and related efforts try to transmit practices and principles. The report recommends that banks, rating agencies, stock exchange listed companies and institutional investors with $100 trillion under management apply yardsticks to be created by global accounting and rulemaking bodies. Central banks in Bangladesh, Brazil, China and Indonesia already impose requirements around “green” projects so that lenders duly disclose and monitor benefits and risks. On reporting, following a series of initiatives since the 1990s, over 90 percent of the word’s 250 leading corporations detail ESG performance. Almost 1500 fund houses have signed the UN responsible investment code, but the lack of common universal metrics remains and prevents company comparisons, with 80 percent of managers expressing discontent in a Price Waterhouse survey. Regardless of the gap thousands of empirical studies show a positive correlation between compliance and profitability. Small and midsize enterprises, which have not participated due to cost and information disadvantages, could be specifically targeted in future outreach and standard-setting.

Infrastructure has a $2-3 trillion yearly hole through the SDGs 2030 deadline, two-thirds in emerging and frontier economies, in sectors including energy, transport, telecoms, water and sanitation. The goal is to limit global warming to a two degree temperature rise, as the urban population will roughly double by midcentury to 6.5 billion. Public financing falls short even in the US and Europe, where it is under 2 percent of GDP, one-third the rate to meet developing world demand. The eight major development banks in turn provide just $40 billion annually and they could leverage up to $1 trillion without jeopardizing credit ratings. In seventy five low income countries, mainly in Africa private investment has been only $75 billion the past five years. Insurers are also missing as asset and risk managers for climate change, following a pattern of minimal natural disaster coverage that came to $100 billion in the latest estimate. Regional initiatives like China’s $1 trillion One Belt One Road are in a startup phase and the two big policy banks, each with over $300 billion in assets, charged with credit support are struggling with previous portfolio cleanup in that geographic nexus and elsewhere, particularly Latin America. Private pension fund expansion must go further and sovereign wealth pools should increase infrastructure project exposure with governments acting as the ultimate market maker for sustaining long-term trading products, the group suggests.

Global Reserves’ Restocked Shelf Space

2017 May 21 by

Global foreign exchange reserves, after slumping $1 trillion from mid-2014 through the end of last year mainly due to dollar fluctuations, have stabilized in recent months with restored emerging market capital inflows, according to IMF and central bank figures. The global total is now almost $11 trillion and $8.5 trillion for developing economies after a double-digit annual fall from China and Gulf country drawdowns in particular. Fund tracking data shows $50 billion in foreign investor debt and equity allocation in the first quarter, with leaps in IIF monthly high-frequency numbers. Currency manipulation through deliberate depreciation is no longer the case, although many countries have excess reserves as defined by international yardsticks of four months import and short-term debt coverage, with Hungary and Turkey exceptions with shortfalls on the respective measures. The emerging market 15 percent savings rate now tops the developed nation one, and the spurt outstrips the reserve accumulation pace. The US and UK on the flip side run the highest current account deficits as a portion of world output, although the dollar accounts for two-thirds of foreign exchange holdings, with the euro a distant second at 20 percent, and the RMB only 1 percent. In fixed income both external sovereign and corporate issuance at $75 billion and $170 billion through April are at records. In the former half the supply has been from the Middle East, with Argentina also contributing $7.5 billion. These new entrants have spurred the asset class, along with a $100 billion annual refinancing hump toward end-decade. Big houses like JP Morgan predict $50 billion in retail and institutional inflows this year, and 5 percent cash positions built up during the initial Trump confrontation scare can help accommodate heavy hard currency-denominated pipelines.

The CEMBI spread at 250 basis points over US Treasuries is at an unprecedented low with a 4 percent index return so far, and projected high-yield defaults have halved to 2 percent with commodity price recovery. Final issuance in 2017 should approach $400 billion, with one-quarter from Asia, almost all China. One third of advanced economy bonds still carry negative yields, and Latin America has been the best performing region, as Brazil and Russia bounced off bottoms. The difference between speculative and investment-grade paper has narrowed to 300 basis points and scarcer euro-denominated have returned more than dollar bonds through April. Commodities remain mixed, and dollar strength has faded, but the main risk is with unhedged domestic-oriented consumer and utility names. Daily trading volume by the US TRACE system is $3.5 billion, half in quasi-sovereigns. Dedicated assets under management are $80 billion, and so-called crossover investor interest has increased although US high-yield exposure is still below 3 percent. Recovery values were dismal last year at 35 cents, and 20 instruments in Brazil and Venezuela currently trade at 50 percent of par or under in deep distress. Net debt and ratings downgrade ratios have improved with better earnings estimates. Of the $2 trillion tracked half is quasi-sovereign with Asia and the Gulf having majorities in the category, and leverage indicators have stabilized although state support is the credit bulwark increasingly offset by policy wobbles, analysts caution.

Merger Fever’s Testy Temperature Reading

2017 May 5 by

The latest edition of auditing and consulting firm Ernst and Young’s global capital confidence barometer, surveying thousands of senior executives in forty countries across fifteen industries, was upbeat on global economy and M&A prospects despite geopolitical jitters. It found that digital and supply chain evolution, aided by private equity again on the hunt, continue to propel deals. The worldwide rise in purchasing manager indices has translated into “stretched” earnings expectations that drive buying interest beyond internal growth. Short-term credit and securities markets are stable and improving to support higher valuations, although currency and commodity volatility lingers, according to the poll. Policy uncertainty by geography—US, EU and China—and issues including cyber war, trade protectionism and immigration affect the business model but Eurozone breakup and Chinese debt crisis are low-risk probabilities. Technology disruption may be the leading factor in strategy and tactics, with traditional complications like tax rates and government intervention losing sway. It has resulted in global outsourcing of information and finance functions so companies focus on “core competence,” itself a moving target with increased automation and innovation. Acquisition pace may not return to 2015’s record and will spike this year but not overheat, with over half of respondents on the trail. They are following customers and trying to retain competitive edge, and also looking to simpler relationships like alliances and joint ventures. Methods range from full asset purchase to investment through corporate venture capital units, and high-profile bids will attract scrutiny from activist shareholders. In the US and Europe sentiment is split as the business-friendly Trump administration has triggered optimism, while UK-EU negotiations over Brexit prompt a wait and see stance. China is the number two M&A destination, and this year’s trend toward domestic combinations and inward allocation is opposite 2016’s. State enterprise consolidation in excess capacity sectors like aluminum and steel, along with consumer play shifts in the economic model, will be major themes, the study believes. Brazil and India are also in the top ten countries, and autos, energy, mining and telecoms are the main categories on the radar.

Brazil’s FDI is on solid course as portfolio inflows lift stocks and bonds and chase a raft of initial public offerings such as airline Azul after a long pause. Recession is over and inflation is heading toward 5 percent as the central bank may slide the benchmark rate to single digits. According to regulators banks are in decent shape to tackle corporate bad loan damage, while consumer borrowing appetite is frozen as reflected in flat to negative retail sales. The interim government has proposed aggressive pension reform to accompany long-term spending restraint, but Congress may dilute the package to modest changes phased in over time extending fiscal deficit positions. In the House 60 percent of lawmakers must approve before the bill goes to the Senate, and party discipline has fractured with President Temer’s popularity at a nadir under the weight of overlapping scandals. Top officials at the IMF-World Bank spring meetings assured investors that this social security overhaul attempt would not meet the fate of the previous two decades ago which failed by one vote, but political drama could again doom it if early presidential elections are called due to resignation or popular demand which in limited quarters has repositioned disgraced former President Lula on the stage.

The Opportunity in Refugee Finance (Financial Times)

2017 March 13 by

As the World Bank and other official lenders promote financial inclusion strategies in development programs, specific payment and borrowing needs around refugee communities, particularly in the Middle East and Africa, have started to come into focus. The newly-formed Tent Partnership for Refugees, hosted by yogurt maker Chobani as the successor to President Obama’s private sector call to action last year on the global migrant crisis, organized a working group, together with government and international organization partners, on banking and capital market access that met in January to consider policy input and pilot projects. Big names like Citigroup, Mastercard and Soros Fund Management are members of the panel, along with smaller specialist firms interested in micro-credit and crowdsourcing as well as traditional commercial bank and bond and stock market linkages. The group explored a range of promising business and technology fixes where tens of millions of dollars could be initially deployed, such as a vehicle to invest in major locally-listed financial institutions in exchange for their commitments to grow and adapt refugee finance solutions. This emphasis could help alter the savings and investment landscape for host migrant populations along with doubts about ailing mainstream banks struggling with difficult economic conditions, which have soured fund managers on major frontline state exposure.

Turkey’s sophisticated state-owned, private, and Islamic lenders have been caught in a political and economic morass since 2016’s failed coup attempt. The lira extended its losing streak into January as emerging markets’ worst performer, with the central bank refraining from raising headline interest rates in part for fear of further damaging bank portfolios, which have not yet incorporated the fallout from widespread forced and involuntary company closures. However even with a 10 percent MSCI equity decline last year many analysts continue to recommend Akbank and other sector stalwarts as good value with their franchises. They could potentially deepen footprints among millions of Syrian refugees in border camps and surrounding cities, and

diversify consumer and business outreach to offset existing deterioration. With the sovereign’s ratings downgrade to the BB speculative category, and delays and possible unraveling n the EU’s multi-billion euro aid plan, these intermediaries could also devise and underwrite new influx-specific infrastructure and education bonds if charged with the task and offered regulatory leeway.

 

Jordan and Lebanon likewise have world-class financial heavyweights on the stock exchange already engaged with refugee products and services and able to expand the delivery and innovation range. Starting with the “Jordan Compact” reached at a Syrian aid conference a year ago, international allies have stressed expanded free trade preferences in exchange for Amman’s relaxation of labor restrictions. The EU recently struck a garment import deal and supported further technical work and special tax-free zone local relocation for European multinationals, while the US Commerce Department led a trade mission there in December with financial services firm representation. Arab Bank could be a channel for greater banking and securities market development there and in neighboring countries, including the West Bank and Gaza, with a refugee presence. Lebanese counterparts in turn, have an historic reputation for functioning in a high-debt extreme conflict environment, and many have continued operating in Syria during the civil war while also serving the fleeing millions at home and abroad. They have created private placement sovereign bonds when external capital markets were relatively closed, and despite fresh access to the World Bank’s concessional borrowing facility, the government announced at last September’s UN Refugee Summit a pressing need for alternative long-term refugee funding sources that its banks could explore under a broad inclusion rationale.

 

Kenya has hosted one of the oldest and biggest camps for Somalis escaping their decades-long state destruction, and it is considered Africa’s digital payments pioneer with the M-Pesa network which has penetrated a full range of rural and marginalized communities. Almost all listed banks like Equity and Kenya Commercial have joined this revolution, and they were heavily switching from corporate to consumer business, including small traders as omnipresent in the refugee space, before a regulatory crackdown and the introduction of interest rate caps in a pre-election move by the President’s party. The government has threatened to close the camp but many security and economic analysts warn of chaos without a transition period and advise stepped-up financial sector coverage.

 

Asia would be an additional overlooked region where banks could be further tapped to tackle the

crisis response in their own interest. The Rohingya in Myanmar have escaped to Malaysia by boat, where Maybank and CIMB are among regional giants in both conventional and Islamic lines. A dedicated global refugee finance fund could be originated with Tent Foundation or other sponsorship, and would appeal to both standard emerging market and impact investors recognizing refugee waves as both business and development imperatives.

Islamic Finance’s Higher Calling Calibration

2017 March 5 by

The World Bank  and Islamic Development Bank (IDB) issued their first joint Islamic finance report underscoring its potential contributions to reducing global income disparity and achieving sustainability goals, while advocating specific policy and banking and capital market changes for “shared prosperity.” Mutual risk and asset-backed redistribution principles undergird the concept, with priority small business and infrastructure purposes. Industry assets are almost $2 trillion spread across 50 countries, as a dedicated Malaysia-based financial services board tries to promote best practice and common rules. The sukuk bond market has grown “considerably” the past decade, but equity is often hampered by “perverse” tax treatment, and corporate access has lagged sovereigns in the absence of a long-term yield curve. Non-bank institutions like takaful insurers are not as prominent, and adaptation for public social spending on education and housing has been slow. The IDB prepared a 10-year strategy and the G-20 presented recommendations for greater sharia-compliant application in government development plans, but major gaps remain, according to the study. Poverty rates in Islamic Conference countries in Asia and Africa exceed non-members, and financial inclusion indicators are also low with borrowing frequently confined to informal channels. No stock exchange yet operates in full observance, although index providers offer screens and performance data. Sukuk issuance peaked in 2012 and has leveled off recently, but  Gulf external sovereign entry could boost the hybrid asset class, and investors may turn more to share alternatives as tax-deductability becomes more even. Accounting and auditing standards are increasingly similar through the technical work of a specialist body, but liquidity is still constrained by the lack of secondary trading, price discovery and rapid settlement. Islamic fund managers controlled $60 billion as of 2014 on annual double-digit expansion and have attracted socially-responsible mandates. For smaller firms crowd funding techniques could be adapted, and ijarah houses could increase leasing coverage. In religious and practical guidance a divide lingers between the leading national authorities in Malaysia and Saudi Arabia, and clarity is urgent on allowable participation in hedge funds and derivatives which should not automatically be considered “speculative.” Malaysia’s regime dates back decades, and has the most comprehensive and sophisticated regulation and products, while Pakistan has a strategic plan that extends to Islamic micro-finance.

The Banks’ vision was unveiled as S&P Ratings warned of “continued hurdles” for Middle East banks this year with political and economic risks. They have ample retail deposits, but with thin fixed income markets government securities and direct lending dominate balance sheets. Debt-GDP ratios range from 80-135 percent in Egypt, Jordan and Lebanon, and Moroccan and Tunisian banks have less sovereign exposure but asset quality is in doubt. Foreign currency liabilities are a looming problem as longstanding exchange rate pegs are modified, and private sector creditworthiness is a “drag” with emphasis on “cyclical and vulnerable” tourism, real estate and commodities sectors. Construction and mortgages are 40 percent of the total for the region, but Egypt is “subdued” as an exception. Tunisia has low loan loss coverage generally as write-offs are rare, and residential property softness has spilled over to the commercial segment. Lebanon’s housing loans have surged under a central bank subsidy program, as Syrian refugees continue to seek shelter with scant conventional or Islamic finance recourse.

Trump Tremors’ Makeover Mobilization

2017 January 29 by

Last year’s rally in emerging bond and stock markets skidded in the final quarter, with expected and surprise US shifts as the Federal Reserve began hiking interest rates and President-elect Trump’s tough campaign currency and trade positions came into initial view. Assets sold off immediately after his upset win, with Mexico’s peso and the Chinese renimbi especially under fire from immigration and tariff threats, but recovered into the New Year as panic gave way to lingering anxiety over Washington’s new direction and developing economies’ growth and reform agendas. The main JP Morgan local and external bond indices ended 2016 up 10 percent, and the MSCI equity gauge was close behind at 8 percent. Fund tracker EPFR registered over $50 billion in combined foreign retail and institutional inflows, with a record $40 billion into fixed-income spurred by industrial world negative yield aversion. Despite recession, Brazil and Russia bouncing off 2015 crisis bottoms were standouts, while Turkey portfolios were slashed in the coup attempt aftermath and frontier share markets were also big disappointments with a flat composite index. For years investors have tended to look at relative global asset class and valuation rationales rather than emerging market merits themselves for inspiration. With the looming Trump test and quantitative easing fade, 2017 could continue the pattern of indirect judgment but governments and companies may finally be motivated to seize upon underlying policy and performance supports missing for the last decade.

On the macro-economic front, the IMF recently changed its forecast but both GDP growth and inflation remain stuck at 4 percent, double the advanced economy average. Monetary policy must contend with higher world interest rates and another likely depreciation bout against the dollar after mixed results in 2016. Fiscal positions may be equally constrained with prevailing deficits, as both state and private banks curtail double-digit credit expansion with rising bad loan ratios and recapitalization needs. In external accounts, trade could plummet in the short-term with “war” outbreaks but is in secular decline anyway in measurable goods and services, according to the WTO. Cross-border remittances from the Gulf in particular are also slowing, while FDI should be steady as many recipients like China become even larger source countries. Agricultural, energy and industrial commodities have rebounded but are far from former peaks, and infrastructure projects may face more competition as the US, Europe and Japan ramp up spending after relative austerity. Asian and Middle Eastern economies continue to hold trillions of dollars in reserves but increasingly must turn to foreign borrowing as backstops against persistent capital outflows. Standard and Poor’s sovereign ratings picture for twenty large emerging markets, with the exception of Indonesia, is universally for downgrades, with South Africa soon due to lose its top-quality ranking.

By asset class trends have also been uneven, with China “A” shares left out of the MSCI index still at a major discount to the S&P 500; sovereign bond issuance doubling with Argentina’s return and Saudi Arabia’s entry; and corporate debt activity again hitting $300 billion last year despite a 5 percent high-yield default rate focused on Latin American names. By region, favorites stumbled like India in Asia after its seizure of large denomination banknotes and national tax delays. In the Middle East/Africa, Egypt drew fresh interest after ending its currency peg and receiving $12 billion in IMF support, while Nigeria was removed from the local bond GBI-EM index for foreign exchange access limits. Even before Mexican and Chinese securities were battered by President Trump’s rhetoric their state enterprise reform and presidential leadership stories flagged, and they will be among the key destinations in the spotlight for potential debt and productivity turnarounds to restore positive momentum. Emerging markets as a whole, a decade after escaping financial crisis, face a credibility crunch that can best be addressed by their own structural and systemic leaps, including in next generation liberalization and privatization, regardless of outside circumstances. This year’s winners, likely in small and mid-tier markets as the more unwieldy BRICS continue to struggle, can make the category great again.

Intelligence Networks’ Gauzy Future Gaze

2017 January 23 by

The National Intelligence Council issued its latest global trends medium and long-range scenarios prepared every presidential term, and described a “paradox of progress” based on thousands of interviews in dozens of countries where power shifts create new international stress. It posits that “promise or peril” may result from the information and connectivity revolution, as recent experience has slashed poverty but also spawned the global financial crisis and populist politics. In the next five years world GDP growth will slow as American post-Cold War dominance fades with the associated rule-based international order, which is regularly subject to challenge by state and non-state actors, with an “emboldened China and Russia. ” Decades of trade and technology integration has hurt Western middle classes and drained budgets with the highest immigration flows in seventy years. A “dreary” near-term future is likely but will be colored by alternative organizational paths into “islands, orbits or communities” depending on the degree of cross-border cooperation on economic stability as well as transnational issues like climate change. Overarching themes through 2035 include population aging in the industrial world, identity-based governance threatening liberalism and tolerance, cyber and robotic systems altering conflict, and common environment and health challenges. Unconventional energy sources and biopharmaceutical products have become readily available and affordable but lack shared regulatory standards requiring a combination of technical expertise and multi-stakeholder diplomacy, the report argues. Pollution and water quality rank as developing country priorities alongside economic growth and natural disaster and emigration costs are rising with continued deterioration. ICT evolution has yielded a fragmented marketplace of contradictory news realities which frustrate consensus and also invite authoritarian attempts to shape messages. Commercial interdependence has historically been a check on war but both major and middle powers also seek to reduce vulnerabilities to potential sanctions and terror attacks.  Europe faces additional shocks with undercapitalized banks and EU separatist movements like Brexit, and the US has low public trust in leaders and institutions.

Central and South America has endemic economic mismanagement and corruption, and gangs and organized crime have filled the breach. China lags on state enterprise reform and the working age cohort is shrinking rapidly, while Russia has been unsuccessful in diversifying from oil, and male life expectancy is the shortest in the G-8. In East Asia, North Korean provocation will continue with missiles able to reach across the region, and MENA governments still inhibit markets, employment and human capital, according to the analysis. In Sub-Sahara Africa breakneck urbanization overwhelms infrastructure and it will experience chronic water shortages destroying agriculture and fostering violence. India will be the growth champion but its development track remains hobbled by poor education, health and sanitation and rivalry with next-door Pakistan. In the coming decade, countries under the “island” scenario will prevail only by redressing income inequality with better job training and lifetime learning. In “orbit” adversaries can selectively work toward joint conflict resolution and public good objectives, while with “communities” governments will join with business and civil society on “soft power” transnational policy and technology partnerships. They could promote underlying state “resilience” in financial and safety networks as an ultimate paradox in ceding official control, the study suggests.

Corporate Debt’s Dangling Default Dominoes

2017 January 16 by

Last year’s corporate bond high-yield 5 percent default rate was the highest in the post-crisis period, with Latin America’s at double that damage, while the average 27 percent recovery was the lowest in five years, according to JP Morgan’s annual asset class roundup. It came despite moderation in overall distressed credit below under 70 cents/dollar, where the portion improved to 6.5 percent from 9.5 percent at mid-year, as the EMBI spread stands at 450 basis points over US Treasuries. Near $30 billion was unpaid, with Brazil’s Oi accounting for one-third and three Latin American names together 60 percent of the total. Missed interest owed and restructuring-bankruptcy was the main cause, along with discount and forced exchanges. China’s onshore market experienced dozens of cases but offshore was spared despite “close calls” like Glorious Properties, which needed a grace period. Europe’s 3.5 percent level came mostly from Ukraine, followed by Russia and Turkey. Africa had a big Nigerian oil firm default, but the headline bare miss was Venezuela’s $7 billion PDVSA quasi-sovereign swap with participation short of the 50 percent threshold. Coupon and amortization obligations are $8.5 billion over 2017 with residual credit event risk, the analysis cautions. In the last quarter commodity price recovery, capital spending retrenchment and liability management offered a rating downgrade respite, but demotions at almost 350 were triple upgrades for a 2016 “negative bias.” Value recovery approached half 2015’s 49% norm, with Latin America and Europe lagging and Asia largely in line with the above 50 percent historical trend. One of the top results was Ukraine Railway over 80 percent while Colombia’s Pacific Rubiales and Brazilian corporates were at bottom. China property firm Kaisa was an initial casualty but the outcome a “pleasant surprise,” while Mongolian Mining prices jumped from the teens to the 50s after negotiations. From this year 100 percent-owned quasi-sovereigns will be excluded from the company default tally, with PDVSA still on the watch list after the recent distressed transaction. Issuer removal after non-payment enabled 25 basis point shrinkage on the CEMBI benchmark, and the under 50 cents/dollar most impaired category remains dominated by Brazilian and neighboring and energy industry bonds.

The 2017 forecast is for a drop to 2 percent after the peak default cycle, with maturity pickup “benign” and economic fundamentals “stabilizing,” according to JP Morgan. However in specific countries, including Brazil where a corruption saga lingers, it warns of continuing risk aversion. Repayments from speculative and unrated issuers will be $60 billion, up from $35 billion last year but should be manageable, aided by ongoing buyback operations and insolvency code overhauls. On the latter, the IMF released an update on sovereign bond collective action clause incorporation to facilitate the workout process, with 75 percent of the $260 billion nominal amount containing them the past two years. New York law has a 90 percent incorporation rate, 10 percent above English jurisdiction. Modified pari passu provisions are routinely added, and the undertakings have “no observable” pricing effect, the Fund believes. The outstanding stock without these inserts is $850 billion, and trusts are increasingly replacing fiscal agent structures for contractual implementation responsibility. Future outreach will target Africa, Asia and non-euro Europe with less participation as sponsors try to assert their collective will, the document adds.

Capital Flow Management’s View Vagaries

2017 January 3 by

The IMF published an updated paper on issues and trends informing its “institutional view” on capital controls since 2012, a period of greater openness and volatility addressed mainly with macro-economic and prudential policies as opposed to strict movement limits. The G-20 and OECD continue to debate revised frameworks and multilateral consistency as direct and portfolio flows recover while still lagging pre-crisis levels, particularly on bank loans and derivative transactions. In recent quarters they have swung several points as fraction of GDP often due to global shifts such as during the 2013 Federal Reserve “taper tantrum.” Both push and pull factors contribute and domestic emerging market risks increasingly focus on both corporate and sovereign balance sheet weakness. Funding costs dropped this year aided by better current account performance, but the reduction may not last, according to the analysis. Two dozen countries such as Brazil, India, Russia, South Africa and Turkey resorted chiefly to fiscal and monetary responses, including currency depreciation intervention, to handle reversals. China and Peru loosened policy while imposing outflow curbs, while broader emergency restrictions applied in Cyprus, Iceland, Greece and Ukraine to prevent bank deposit flight and exchange rate collapse in the context of Fund adjustment programs. They typically followed previous recommendations as to scope and timing with unwinding linked to general financial sector stabilization, but also added costs in terms of administrative burden, risk premium, and market distortion. In the latest 2013-16 timeframe economies like Colombia and Thailand relied on macroeconomic tools almost entirely to counter surges as a wider range of countries adapted bank rules on loan-to-value and debt-to-income ratios as well as capital and liquidity standards. Frontier market experience in Africa and elsewhere has been different as they only began accessing global bond markets in recent years and exchange rate changes have been slower. Ghana and Nigeria introduced controls both in law and practice that were subsequently relaxed, although the latter remains suspended from JP Morgan’s local debt index for lack of access. The paper acknowledges that easy advanced economy monetary policy magnified direction but argues that improved regulation across-the-board on Basel III norms, insurance, accounting and derivatives mitigated pressure.

China will continue the capital account liberalization pattern according to its next 5-year Plan, as neighbors like Korea also relax repatriation conditions. Sequencing reflects the Fund’s preference to begin with direct investment and delay short-term portfolio opening until last. Beijing in 2015 started to tighten outflow flexibility, first with suspension of the Qualified Domestic Institutional Investor scheme, but it insists such moves are temporary and the yuan’s inclusion in the SDR basket should reinforce freer securities participation. The OECD is now reviewing its 25-year old Capital Movement code with attention to macro-prudential treatment, and the proposed Trans-Pacific Partnership, although scrapped with US failure to ratify, nonetheless detailed disruptive flow provisions. In Europe the Vienna Initiative and new Single Supervisor have developed formal and informal regimes for cross-border bank credit, and cross-regional bodies have collaborated on joint supervision. The Fund has strengthened technical assistance on the issue on missions to poorer members like Bangladesh and Myanmar, but global data gaps persist despite improvement in the Coordinated Portfolio Investment Survey. As the IIF tracks for a half dozen developing economies, a questionnaire completed by 40 members recommended more frequent even daily numbers for a worldwide cross-section matching information flow.