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The Seamless Rally’s Frayed Fabric

2018 February 4 by

Emerging bond and stock market performance in 2017 exceeded the most optimistic early year scenarios, largely focused on feared global monetary and trade squeezes that proved overwrought and quickly faded to pave the way for uniform rallies. Benchmark indices were up double-digits, led by the MSCI’s 35%, with almost all country constituents in core and frontier and local and external measures along for the ride in a pattern last seen a decade ago right before the global financial crisis. Then a Shanghai Stock Exchange “shock” was originally felt in New York and other centers before the mortgage meltdown.

Combined investment fund flows last year at $200 billion mirrored the previous peak, with ETFs that have since mushroomed accounting for respective 10% and 25% portions of debt and equity allocation. Better than expected corporate earnings and average GDP growth, again approaching the 5% level of boom periods with higher exports and domestic demand, bolstered enthusiasm as a mix of positive underlying story and low-return advanced economy aversion. However the embrace did not distinguish between asset classes and leaders and laggards within them for a longer term winning strategy, and overlooked banking system and geopolitical icebergs lurking beneath the surface. Financial stability may again be a prominent theme after years of post-crisis relief, as private sector leverage rings alarms and the public sector running steeper fiscal deficits has limited rescue space.

In stock markets by region Asia outstripped Latin America and Europe in the core universe, with MSCI’s addition of Chinese “A” shares and buoyant company profits in the global tech cycle were key drivers. These factors neutralized continued worry over China’s banking stress, corporate debt overhang, and capital outflows which were prominent topics at the Central Economic Work Conference going into 2018. Authorities have already announced crackdowns on shadow “entrusted loans,” state enterprise leverage, and bank card holder dollar deposit withdrawals, and signaled further moves with financial stability a Party priority. In contrast with 2008, economic and credit spillovers from potential crisis would now slam emerging market bonds as well, where foreign investor corporate and sovereign exposure ranks near the top globally in volume trading surveys by the industry association EMTA. Asian neighbors Korea, Malaysia and Thailand are grappling with high household as well as business debt levels, regularly drawing warnings from the IMF and the BIS, which will be tested this year as allocation turns more selective, according to the latest Bloomberg fund manager polls. Korea’s central bank stood out last year by hiking interest rates and imposing credit card “macro-prudential” curbs to shrink OECD-leading 150 percent of GDP personal leverage.

In Europe, Russia lagged with a barely positive MSCI result despite low valuations, as it may face more Western sanctions for election interference, with the US Treasury Department considering a government bond buying ban. It took over systemically-important private banks and had to close hundreds of others for prudential violations. Turkey’s 35% rise was at the opposite extreme, but was due to post-coup attempt official loan stimulus overheating the economy and stretching the banking system, which has to rollover heavy foreign exchange obligations. Foreign investors as the largest owners trimmed local bond positions in Hungary and Poland, as they recoil at populist administrations courting EU condemnation and aid suspension, and fear that domestic institutional investors lack backup capacity after private pension fund shutdowns.

Latin America has a nonstop 2018 election calendar with presidential contests in Brazil, Colombia and Mexico, with the main parties and their standard bearers offering scant commodity diversification and productivity raising platforms under scandals and criminal investigations. Brazilian banks, including the development BNDES arm, continue to deal with large corporate borrower restructurings, such as with telecom firm Oi.   Argentina’s economic policy turnaround and world capital market re-entry under President Macri, which resulted in record borrowing and a near 75% MSCI Frontier Index bounce in 2017, is offset by Venezuela’s implosion under a harsher socialist regime bringing hyperinflation, debt default and a singular humanitarian catastrophe.

Frontier market stumbles in the Middle East and Africa left the composite gauge 10% below MSCI’s main roster, as Gulf and Southern African components suffered respectively from the Qatar boycott and South Africa-Zimbabwe political transition jitters, which have also hurt bank liquidity and profitability. A big warning to the overall asset class is the Institute for International Finance’s lending conditions survey stuck around the neutral 50 mark, which fund managers have yet to flag it for future momentum drag.  They will better pick their spots in the coming months, and although stock returns likely will continue long-term catch up with bonds, variation will widen by geography and development stage through the financial sector health filter.





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Corporate Bonds’ Evenly Dispersed Blessings

2018 January 21 by

The CEMBI’s 2017 8% return was slightly lower than the previous year’s 10%, but gains were equally distributed between rating and regional segments, JP Morgan commented in its annual asset class roundup. High yield led results at 45% of issuance, and by industry commodities including hydrocarbon and mining names were the winners. The benchmark spread has dropped the past two years with low volatility reminiscent of the early 2000s period, when the margin was lower than the current 230 basis points over Treasuries. Duration has been steady at 4.5 years, and the CEMBI Broad traded inside the sovereign EMBIG Diversified in 2017 due to a combination of Asia high-grade credits in the former and distressed weighting Venezuela/PDVSA, continuing to miss payments, in the latter. High-yield in turn has been tighter than the US counterpart, likely because of the universe of well-supported quasi-sovereigns. By geography Latin America and Africa were the top performers (+12%), followed by Europe, Asia and the Middle East in declining order although their range was a narrow 5-7%. The external sovereign and local government JP Morgan indices had respective 9% and 15% gains but also fluctuated more widely. The biggest individual issue surge was from Petrobras (+17%) and other Brazilian banking and industrial components also shined. China listings like CNOOC, Bank of China and Evergrande were likewise major contributors, according to the research.

Speculative-grade default rates fell to a six-year low of 2%, with the number halved to sixteen from the preceding year, as “robust” refinancing conditions enabled weak story access. Latina offshore spilled over into 2018, as Noble and Agrokor hurt Asia and Europe, respectively. Venezuela state oil company PDVSA did not enter the total, even though derivatives body ISDA and ratings agencies declared default while the government intends an as yet undefined restructuring. Recovery values almost doubled to 50%, with the bottom levels in the consumer and financial sectors. Leverage was the same as in 2016 at 3 times, with Latin America the most indebted region. The rating upgrade to downgrade ratio was 0.8, with Argentina getting 15 promotions after S&P raised the sovereign to “B.” Turkish companies were slashed an equal number with Fitch’s BB+ cut, while China had the most downgrades at 55 versus 30 upgrades. The Middle East and Africa suffered with South Africa and Qatar actions, which may fade under the prospect of fresh ANC ruling party leadership and lifting of the GCC boycott this year. Primary activity was a record approaching $500 billion, 50% above 2016, with net financing “manageable” under $150 billion. Tenders and buybacks were a hefty $80 billion, and Asia was over half of volume at $300 billion with “sustained” local investor support, the survey notes. China was $200 billion, with Korea next at $25 billion and financials were half of regional supply. In Europe Russia marked its post-sanctions rebound with $20 billion, although new US Treasury Department guidance could again close the window. Regulation S SEC-registered private placements were 55% of the total, beating the previous year peak, and debuts were one-fifth of all transactions, another precedent in value terms although not in issuer number. Asia had 125 maiden offerings, with ASEAN active in particular under longstanding bond market promotion programs.


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GDP Bonds’ Simpler Structure Sanctification

2018 January 15 by

For the past year official and private sector representatives, acting under the G-20’s original direction, have organized informal working groups and events around possible introduction of GDP growth-linked bonds. The idea first gained notice in the aftermath of the 1990s Asian financial crisis, and more recently for Greece, as an automatic stabilizer with countercyclical risk-sharing when recession or natural disaster hit that can also provide upside in boom times. Argentina and Ukraine followed early post-Brady plan restructurings in offering warrants that pay a premium when growth is above 3 percent, but full-fledged instruments have yet to be adopted in standard issuance and workouts despite concerted pushes from the IMF, Institute for International Finance, and other bodies.

Since the middle of 2016, the Fund has published papers on “state-contingent” debt and the Bank of England and International Capital Markets Association in London have taken the lead on global emerging market investor outreach which resulted in a model term sheet. It indexes coupons and amortization to nominal GDP, has both foreign and local currency options, and would be governed under international law with creditors ranking equally. The framework also contains  complex provisions around collective action clauses and statistical calculation which muddy legal and practical understanding. An easier approach would be to incorporate the concept into smaller deals, such as the recent frontier sovereign wave in Africa and elsewhere, to build a credible track record where any dispute from the limited buyer base and transaction size could be handled by independent experts.

The IMF’s May review examined a range of bond alternatives adjusted for economic indicators or weather events and found that other tools can “preserve space” in difficult periods such as international reserve accumulation, fiscal rules, commercial insurance, and central bank swap lines. However, well-designed GDP-formula bonds are more accessible and also promote concrete securities diversification and the more abstract “global safety net,” in the Fund’s view. Its simulations showed that one-fifth of the debt stock in this form would increase emerging economy limits on average 10 percent before debt reached dangerous levels. Real money long-term managers at big institutions are the logical buyers, as they have wider fiduciary scope to balance country welfare with asset returns, the paper argued. However pilot efforts will still demand a novelty premium with liquidity and performance doubts, which could be magnified by data frequency and reporting gaps as in Argentina’s notorious past and in Venezuela’s present case, where related bad governance and economic policies would likely make upfront costs prohibitive. Professional debt agencies and not politicians should be in charge of these operations to plan beyond the next election cycle, and ratings agencies should participate at an early stage, the primer recommended.

Inflation-adjusted instruments offer a foundation and remain popular in Latin America among local and foreign investors, and commodity-tied value recovery rights featured in a dozen decades-old sovereign debt exchanges, but verification lags and other intricacies have impeded mainstream embrace. GDP-linkers will take time to develop benchmarks, and pricing is assumed to be at least 50 basis points over conventional offerings at the outset, according to the literature. Global pension funds controlling $40 trillion may be confined to hard-currency investment-grade exposure to further narrow the structure, while Islamic finance vehicles committed to risk-sharing could be a smooth fit. In discussions on the London term sheet, lawyers have criticized voting and cross-default clauses which seem to prevent aggregation and subordinate “plain vanilla” bonds to GDP-related ones. Analysts in turn are deeply suspicious of government data manipulation in the absence of an established separate mechanism for calculation and publication, and insist in the proposal on possible immediate redemption through a put option for protection.

Instead of mainly relying on these elaborate consultations often with acrimonious debate over motives and principles, GDP-linked bond advocates including the IMF, which has indicated possible balance sheet and technical support, should instead be open to ad hoc insertion in ongoing minor emerging market placements. Leading candidates were the past year’s restructurings in Belize, Mongolia, and Mozambique amid their other outstanding economic policy and statistical disclosure concerns. The three are serial defaulters with fates connected to natural resources, and creditors have been frustrated by continued negotiation and workout impasses which may be more readily overcome with specific data or event-triggered instruments. A standing group of mutually-agreed professional monitors could oversee adapted versions of the template,  as innovation champions bypass lengthy deliberations to forge missing links.




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Investor Surveys’ End-Year Party Indulgence

2018 January 8 by

2017’s impressive debt and equity market streaks are set to continue indefinitely subject to economic growth and inflation adjustments and other caveats focused on global central bank actions and geopolitics, according to early investor pulse-takings. The best year in a decade shrugged off Trump administration and Federal Reserve moves and China and commodity price worries that will remain prominent, and in 2018 EM currencies may not beat G3 ones, according to a limited Bloomberg poll of money managers. Mexico, Brazil, Indonesia and Russia will be outperformers, while China, Argentina, Poland and South Africa should lag. By the main three regions, Asia is favored over Latin America and EMEA, but the often cited “Goldilocks” combination of output, earnings and monetary impetus will be more selective across asset classes and geographies under still buoyant index results, the analysis finds. Turkey is viewed as the riskiest bet as the failed coup repercussions linger, President Erdogan’s allies are implicated in a US money laundering trial, the economy may be overheating with 8 percent growth the past quarter, and interest rates were hoisted only 50 basis points with double digit inflation amid the President’s charge it is on the “wrong path.” EMTA’s Q3 survey also came out to report steady $1.3 trillion in trading, with Asia outpacing Latin America for the first time in its two decades history. Local debt, at 57% of the total was led by India at $130 billion, followed by South Africa, Brazil, Mexico and China in the $75-$95 billion range. Eurobonds, split 53% and 40% percent between sovereign and corporate, had Argentina and Saudi Arabia prominent in the former category.  Brazil and India instrument dealing was almost equal overall, and China and Mexico ones were tied for runner-up status. Warrant and option turnover was $9 billion for the period and without a detailed breakdown were presumably on Venezuela and other oil exporters with value recovery rights from previous restructurings.

China has not yet entered mainstream domestic bond indices, but should be added next year as the stock market weighting also rises marginally on the MSCI. November economic data were mixed, with retail sales and exports up over 10 percent but fixed investment only ahead 7 percent at the slowest clip in two decades. Foreign exchange sales resumed even though the state allocation body cited currency “balance” and the bank regulator will soon end the waiting period for foreign institution yuan trading licenses. The official growth forecast remains 6.7 percent amid reports that the deleveraging push may soften at the December work conference. Tech firms not as indebted as large government enterprises now account for 15 percent of output and 10 percent of employment according to official research. The securities overseer has denied over 100 IPO applications although state company profitability is the best in five years. Moody’s Ratings has a stable banking sector , with the shadow segment under tougher rules as commercial lending continues to jump RMB 1 trillion monthly approaching a 15% annual pace. After signaling opening after a Beijing visit by US President Trump, Beijing insisted the 5 percent ownership reporting mandate will not change, as Washington’s new national security strategy criticized China’s “aggressive, mercantilist” system hardly putting international stakes first.

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FDI’s Ultimate Purpose Posturing

2017 December 5 by

An IMF working paper, responding to gaps in the benchmark coordinated direct investment survey and bilateral reporting generally, has stripped out offshore special purpose structures for the first time in an attempt to chart ultimate investor relationships and totals. It stipulates “asymmetries” in country inward and outward numbers where one is twice the other in half of cases and small economies have disproportionate shares as purely financial conduits. They do not represent physical ownership at the accepted 10 percent threshold and through “complex chains” can mask the business and geographic source. The analysis uses new OECD data and removes the artificial vehicles to chart actual integration and linkages where tiny global hubs in Europe, Asia, the Caribbean and elsewhere fade in importance among the 115 nations tracked. The average discrepancy in pairs is over $5 billion and may derive from conflicting valuation methods for unlisted equities despite Fund guidance. The proliferation of special purpose entities (SPEs) at multinational firms distorts “real” activity, as they are non-resident domiciles without production or presence and often “pass-throughs” for tax and confidentiality advantages. Offshore frameworks can be readily created in major jurisdictions like the US, where they bring in an estimated $100 billion in annual revenue. They encourage questionable transfer pricing for intragroup sales which are to be at “arms- length,” but violated EU rules through Luxembourg and Ireland-based transactions. Tax-shifting to low-cost or exempt locations is another goal and the British Virgin and Cayman Islands are two examples of places that do not report to outside bodies. The final investor with majority voting control may be unknown, but SPE isolation knocks one-third from the IMF survey results even though regional true FDI ties between neighbors, such as with Hong Kong and China are strong. When excluding these arrangements Cyprus and Mauritius are no longer on the top 40 locations and are replaced by “traditional economies” such as the Czech Republic and Saudi Arabia which do not offer financial engineering and round-tripping possibilities. The publication urges permanent statistical revisions around the concept of actual interconnectedness which could feature in the next comprehensive tabulation due in the coming months, at the same time that the US tax code could be changed to reflect productive rather than paper trail direction according to bipartisan advocates.


The fresh methodology will not improve Turkey’s relative position as its aspirations to better balance international portfolio and direct inflows and bridge the chronic current account deficit clash with visa and aid disputes. US commercial relations have frayed since last year’s aborted coup and subsequent crackdown on hundreds of thousands of alleged sympathizers, including a prominent philanthropist and think-tank head the past month. President Erdogan insists that exiled cleric Gulen be extradited and accused embassy personnel of abetting overthrow , as big state lender Halk Bank is under investigation in Washington for illegal gold trading with Iran. Bilateral visa processing has been suspended as the currency again slipped toward 4/dollar on the tensions, aggravated by a threatened EU aid cutoff for anti-democratic practice. Entry talks are already in the deep freeze, and the Turkish President criticized Brussels for “wasting time” and hinted at quitting both the decades-long negotiations and model FDI makeover.



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Sovereign Debt Restructuring’s Loaded Cases

2017 November 22 by

The Institute for International Finance’s annual survey of  its restructuring principles and investor relations trends, prepared under joint public-private sector senior executive direction, covered a half-dozen country cases and forty active communications programs as the joint tracking begun in the early 2000s reflected this year’s sharp capital flow predicted pick up from $750 billion to $1 trillion.  The group noted that a brief July scare around advanced economy central bank liquidity moderation was a minor repeat of the 2013 Federal Reserve taper tantrum and that rising emerging market foreign currency denominated sovereign and quasi-sovereign obligations posed risks, even as systemic crisis was not flagged. The workouts in the report were relatively minor but could be revisited in the near future and also represent troubling precedents. Belize was back for a third round on its $525 million original “super bond” after natural disaster aggravated fiscal and current account deficits. A creditor committee was formed one week after the government sought relief, and 90 percent of holders agreed to lower coupons and an equal installment amortization schedule from 2030-34. Consent solicitation replaced a formal exchange offer due to collective action clause provisions, and negotiations took less than six months, with financial and legal advisers paid for under the previous agreement. Mozambique defaulted on a Eurobond and two loans and proposed to swap state tuna company-owned for sovereign claims in a “compact timeframe” without full consultation. Exit consents applied in the March 2016 operation which got 100 percent acceptance for extended maturities at a 10.5 percent yield. After the deal officials revealed another $1 billion in outstanding credit, prompting IMF program cutoff and an external audit which found that half the proceeds could not be traced. Parliament and the local courts declared the official guarantees illegal, and international banks leading the syndicate are reportedly under US Justice Department investigation. Informal discussions have been held with creditors, who are pressing for a fresh Fund arrangement and debt sustainability analysis with recognition of existing cash flow help in a “cautionary tale,” according to the IIF.

Venezuela is in full-blown crisis with total foreign debt estimated at $150 billion, or 150 percent of GDP, and liquid reserves at $2 billion following a series of state oil company re-profiling and new finance transactions last year. Chinese debt for petroleum exports has already been restructured, and the central bank sold a $3 billion PDVSA bond at a one-third discount to a US asset manager in May in a controversial placement which catalyzed momentum for Treasury Department sanctions against future debt or equity purchase. President Maduro has delayed almost $4 billion in payments due the last quarter and ordered his Vice President, under previous bilateral curbs as an individual for alleged drug trafficking, to lead comprehensive restructuring talks with all commercial and official creditors with a wide disparity in geopolitical and instrument composition. The IMF may be called in to verify statistics, but Caracas with its dueling parliaments and record inflation and violence will remain at the opposite extreme of the IIF’s data and investor outreach winners. Almost half the countries tracked were in the top quartile with  Indonesia, Mexico Turkey with the highest score followed by Brazil, Russia, South Africa and Poland in need mainly of restructuring  information and network links.


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Refugee Bonds’ Millions to Billions Chant

2017 November 17 by

At the annual meetings of the IMF and World Bank, the global refugee crisis, which has spread from the Middle East to Asia with the headline escape of hundreds of thousands of Rohingya from Myanmar into Bangladesh after years of flight into the broader region, was in the spotlight. World Bank President Jim Young Kim emphasized the new development lender mantra of “turning billions into trillions” through innovations and risk management tools to better mobilize private capital, as the Institute for International estimated that foreign inflows into emerging debt and equity markets would again reach $500 billion with this year’s stellar index performance.

The poor country IDA window envisions $2 billion in the future for refugee host needs, as Bangladesh’s Finance Minister submitted an initial request for the Rohingya influx which alone may cost $1 billion, according to a local economist. The Bank may issue additional emergency bonds in its own name for on-lending alongside the Global Concessional Financing Facility (GCFF) – created by the Bank, EBRD and the Islamic Development Bank to allow discount borrowing by middle-income frontline states like Jordan and Lebanon – but conventional emerging and frontier market investors could more easily be directly tapped for larger sums through dedicated “refugee bonds” where the Bank instead should emphasize credit enhancement. Jordan’s government has shown interest in a pilot program which, after modest startup and preparation outlays, could raise hundreds of millions to billions in fresh long-term funding the first year.

Sovereign bonds are a logical starting point for refugee capital markets development, but public and private equity participation through investment funds is also feasible, particularly in view of the number of large listed stock exchange companies already providing goods and services to this population in camps and cities. Jordan is just one possibility in the area’s economies overwhelmed by refugee and displaced person waves, including Turkey, Lebanon, Tunisia and Iraq. It has issued external bonds both cleanly and with US government guarantees, and a $500 million one at 7% yield was oversubscribed recently within the guidelines of its IMF program aiming to prevent increase in the steep 90 percent of GDP debt ratio.

Preliminary discussions with traditional emerging market investors, as well as those focused on “impact” investing drawn to the socially-responsible component, suggest that the government could offer a lower yield for a refugee bond that ties the cost to detailed, independently verified reporting on proceeds allocation. The instrument would be designed to promote “best practice” in relief and to identify revenue streams, such as tax-producing job entry and business creation, that generate repayment cash flow. For collateral backup, buyers could also potentially have limited ownership rights in housing, road, power and sanitation facilities built to handle extended influxes into host countries, now averaging stays of more than a decade, according to UN data.

Bangladesh, which has accessed international markets once, would be a compelling candidate for development bank guarantee and risk support in an inaugural refugee bond. The Asian Development Bank could help arrange a local currency alternative as well, reflecting its mandate to strengthen domestic and intra-regional bond markets since the late 1990s financial crisis. Its work contributed to transforming India, Indonesia, Malaysia, Pakistan and Thailand, also with large Rohingya migrant populations, into mainstream fixed-income emerging market investor destinations. Malaysia has become the global hub for Islamic sukuk activity, and a debut Bangladesh bond with sharia compliant features could be structured through there as the Malaysian government considers a separate one. The World Bank’s South Asia director said that its own form of bonds for the emergency is under review, as it still grapples with the right public-private sector mix in refugee operations. A creative emerging financial market-based solution has been presented to the institution and awaits official, commercial, or philanthropic sponsorship to realize millions to billions in available foreign investment beyond slogans.



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Private Debt’s Hangover Remedy Rumbling

2017 October 22 by

As IMF officials at their annual meeting continued to sound the alarm on private debt buildup as a looming systemic risk, big investment houses have projected calm, with JP Morgan statistics pointing to a slight annual drop to 115 percent or close to 80 percent of GDP excluding China. Government debt in turn increased marginally since 2016 to 50 percent of output, half the level of the US and Europe, with Gulf and frontier countries running up the tab. Egypt, Mongolia, Jamaica and Lebanon have burdens in the 100 percent-plus range, but the external portion for the overall universe has been steady the past decade at around 25 percent. Deleveraging started almost two years ago, including in China where shadow banking-spurred credit growth is down to single digits. Corporate debt spurted 25 percent to almost 85 percent of GDP since the 2008 financial crisis, and the private remainder is household particularly mortgages and credit cards in East Asia and this region has the highest commercial load at 150 percent-plus in China, Taiwan, Korea, Malaysia and Thailand. Since 2014 Mexico and Egypt totals rose 5 percent, and fell comparable amounts in Croatia, Kazakhstan and Ukraine. Domestic borrowing is almost 95 percent of the sum, and 80 percent is through traditional bank lending rather than bonds. As of Q3 credit expansion outside China was 6.5 percent, versus almost triple that pace in 2011. African countries like Nigeria dropped 20 percent on an annual basis, but the cycle has improved in Brazil, Russia and Turkey so that the net effect is no longer negative, according to the JP Morgan research. The trend is reflected in the IIF’s latest survey of banking conditions released before the IMF gathering, with a 48 result approaching the neutral 50 mark. The better outcome is also attributed to developing economy growth pickup across the board highlighted in the Fund’s upgrade to 4.5-5 percent this year.

The corporate benchmark CEMBI was introduced in 2007 and since avoided major selloffs, and local and foreign pension fund investors have jumped in with mandates to follow the 50 country $400 billion gauge. However index allocation misses half the universe in this segment as well as external and domestic sovereigns, and portfolio managers now argue for a blended or unconstrained approach through individual accounts. US public pensions have less than 5 percent of assets in EM debt, and September paper by fund giant Eaton Vance, which recently bought socially responsible specialist Calvert, argues for top-down multi-class exposure. After assessing economic and political risk, bottom-up company and instrument research and market trading and infrastructure capacity should be guides, and institutional investors may lack these dimensions with in house expertise. According to sentiment readings taken during the IMF heavy inflows already near $100 billion and fixed-income overweights should last through 2018, although equities will outperform. Currency and bond enthusiasm will shrug off industrial world central bank planned liquidity tightening, world geopolitical tensions now concentrated on the Korean peninsula, and likely credit rating downgrades which may continue for China, South Africa and other prime destinations caught in their  own subprime borrowing predicaments.


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Exotic Sovereigns’ Pedestrian Sustainability Sense

2017 October 15 by

The dozen countries in JP Morgan’s frontier NEXGEM index continue to outstrip the main external bond gauges as spreads over US Treasuries are at a decade thin 100 basis points, as public debt jumped an average almost 15 percent over the period to 70 percent, resurrecting sustainability fears after large official relief programs. Economic growth and exchange rate stress testing suggests medium term deleveraging could stabilize ratios, and domestic borrowing would increase its relative portion. However levels in Ghana, Jamaica, Mongolia and Ukraine would rise 5-15 percent and translate into higher spreads under normal differentiation, which may not apply currently with sloshing global liquidity and investor positions remaining underweight. Since last year fundamentals have “decoupled,” but the relationship with most specific credits has held up since index introduction, according to the sponsor. In Central America and the Caribbean Moody’s downgraded Costa Rica in February one notch to lower speculative status, a further slip from the previous investment-grade rating. Another blow looms on the horizon with promised fiscal consolidation failing to balance spending and revenue with debt/output already at 65 percent. The government is hamstrung entering next year’s election with control of only one-fifth of legislative seats. Earmarks take up 90 percent of appropriations, and despite announcement of a “budget emergency” and likely wider foreign investment scope for local debt decisive action will await the new administration. The Dominican Republic in contrast was upgraded in September after a well-received $500 million international issue, with debt-to-GDP twenty points less and 5 percent growth on track, with good remittances and tourism before the spate of area hurricanes. Ecuador’s public debt doubled the past five years with oil price collapse and heavy state infrastructure and social outlays. Its main overseas creditor was China until market return in 2014, and President Moreno has yet to signal a break from the loose purse strings of his predecessor and socialist policy champion Correa. The Vice President has been implicated in another Odebrecht bribery scandal around previous construction projects, and dollarization is set to continue with business and financial community support despite populist backlash. Major external bond maturities are not due until end-decade, and relations have resumed with the IMF for possible emergencies beyond a recent earthquake when it was tapped for aid.

El Salvador’s debt stands at 65 percent of GDP and the two main political parties have been at loggerheads over pension reform after missed payments. The opposition recently managed a compromise to hike the contribution rate to 15 percent and extend retirement age over time. The net present value of liabilities is still estimated at 90 percent of national income only expanding at a 2 percent annual pace. Private pension funds must buy the government notes to cover obligations, potentially subjecting them to portfolio and default risks. Jamaica with its world-beating 120% of GDP load has been under IMF supervision for five years, and completed a series of local and foreign debt swaps. A three-year $1.5 billion standby was inked in 2016, and the local dollar continues to depreciate as more flexible currency and inflation-targeting regimes are adopted. A 5 percent-plus budget primary surplus has been regularly achieved but the wage bill has been pared back slowly amid glacial 1% growth.


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Stocks’ Crisis Retrospective Run-Ups

2017 October 9 by

Thirty years after the 1987 New York Stock exchange 25 percent crash and a decade on from the 2008 financial crisis, MSCI core and frontier indices turned in respective 25 percent and 20 percent gains through Q3 for the best performance since 2010. Only Russia and Gulf country indices under trade and financial boycotts were down, alongside refugee emergency-hit Jordan and Lebanon, recent main gauge returnee Pakistan and tiny Botswana. The BRIC component overall was superior with a 30 percent advance, while Poland (+45 percent) led the big roster and Argentina and Ghana on the other one were ahead 60-70 percent. Zimbabwe recorded a stratospheric 250 percent jump through September with the stock exchange the only outlet to preserve savings, with draconian bank deposit withdrawal limits and new borrowing from the African Export-Import Bank to inject emergency dollars. China “A” shares after MSCI’s marginal index addition have surged to almost narrow the gap with the broader mainland 40 percent increase ahead of the Party Congress due to reappoint President Xi and his designated team, which could include well-known economic reformers and technocrats. On the eve monetary policy was loosened through a reserve requirement nudge for dedicated small business credit, as authorities seek otherwise to cap real-estate related personal lending.

Elsewhere in Asia Korea (+30 percent) brushed off border bellicosity, amid harsh rhetoric from Pyongyang against Seoul and the US and a series of test nuclear missile launches. Tech firms were in a sweet spot in the earnings and global manufacturing cycle, helping to overcome Chinese restrictions on consumer goods and Washington’s threat to renegotiate its bilateral trade pact. India (+22.5 percent) faded on demonetization and national sales tax hangovers which have crushed average entrepreneurs and assembly operations, while Indonesia was another 10 percent behind as religion and politics mixed more dangerously with loud calls for more action to protect the Muslim minority Rohingya fleeing Myanmar for makeshift camps in Bangladesh, where the market rose almost 10 percent.

In Latin America Brazil (+25 percent) roared back during the quarter after lagging, as investors were spared a second impeachment even though President Temer remains under criminal investigation  for alleged bribery and his party and allies are unlikely to pass overdue state pension cutbacks to restrain the 10 percent of GDP fiscal deficit. Mexico had the same showing as Pemex private sector exploration auctions proved popular and NAFTA reworking talks appeared to dismiss total breakup with Canada’s views closely aligned. Chile (+30 percent) was at the crest before the first round of presidential elections likely to return free market business magnate Pinera to the post. In Europe behind Poland, Hungary and Turkey each climbed over 25 percent on domestic demand juiced by state lending programs as relations further soured with the EU. Prime Minister Orban has defied Brussels on immigration quotas and President Erdogan accuses it of reneging on visa-free travel promised in exchange for additional Syrian refugee acceptance on transfer from Greece. There after Europe’s biggest run last year improvement is just over 10 percent as banks await another cycle of asset reviews which may reflect crisis respite short of repair to again rouse international community urgency.


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