Asia’s Delayed Debt Exits

2020 October 4 by

On the MSCI EM Index through the first eight months of the year, the only three markets in positive territory in dollar terms are in Asia: China, South Korea, and Taiwan.  Their “first in, first out” of the Covid-19 crisis pandemic amid unprecedented low interest rates and expansionary fiscal policies have attracted local and foreign investor interest in both stocks and bonds. Inflows have also been driven by majority weighting on the MSCI EM Index, 65% of the total, and China is half the local bond markets universe, $trillion w Korea another size leader. On the equity index, eight of the ten largest companies are from these three markets, accounting for 27.5%, dominated by Alibaba Group, Tencent Holding, and Taiwan Semiconductor.

All three economies show signs of recovery, spurred by export rebound. The IMF is projecting that China will be one of the few countries to grow this year and Taiwan’s government is similarly expecting expansion, both around 1%. The wealthy nation OECD expects that Korea will outperform its peers and contract only 0.8%.  China and Taiwan have benefited from relatively stable currencies, while South Korea’s won has recovered 8% from its March low and is only down over 2% against the USD this year.

However, not classic sovereign but company/personal debt levels could derail continued early recovery progress.  In all three loan repayment standstills due to expire at end-September are likely to be extended, only to “kick the can” down the road.  As of mid-August, loan repayments worth USD 33 billion were on hold in South Korea, with Fitch Ratings estimating banks had made an additional USD 150 billion in corporate relief loans. Pre-pandemic debt levels in all three markets were worrisome.  Traditionally EM investors assess government debt/GDP as a key factor in investment decision-making, with a 60% level the danger zone.  China, Taiwan, and South Korea all have official, on-balance sheet debt at less than 50% of GDP. 

 Corporate and/or household debt levels are already elevated, threatening the bank and non-bank financial sectors.  According to the Bank for International Settlements most recent data, credit to the non-financial sector as a percentage of GDP is 258% in China and 237% in South Korea.  In Taiwan, household debt/GDP has topped 90% and in South Korea the level is at a record high of over 97%, according to the Institute for International Finance. While in China it is just below 60% of GDP, lending for consumer debt and mortgages has surged in recent year from only 18% in 2008, while outstanding credit card debt doubled the past five years. 

 In South Korea, corporate debt was 104.6% of GDP in Q1, up from 97.2% a year earlier. With record low interest rates, it has surged since them.  In July, corporate bond issuance totaled USD 17.5 billion, up 74% from a month earlier and dominated by low grade issuers more likely to be unable to meet obligations. In China, corporate debt/GDP surged 13%-points in the first half to reach 164.4% according to the National Institution for Finance and Development. In contrast, Taiwan’s local corporate debt remains manageable for now with a large life insurer buying base.  As in China and South Korea, issuance has surged ,through the first five months, doubling from the same period a year ago with risk expected to rise as lower rated, pandemic-hit companies come to market.

 Bond default risk and bank and consumer lender stress are growing. Already this year the banking regulator in China estimated bad loans will reach near USD 500 billion, while it reported that the official level – which does not include debt repayments on  hold – stood at a 10-year high of 1.94% in June.  While onshore local bond delinquencies fell 17% in the first half of the year, the drop came as the government encouraged bond holders to accept payment delays and issuers to find solutions such as extending maturities.   Some USD 500 billion in local bonds are due to mature by year-end, and defaults will be a double-hit to domestic banks, the largest holders of corporate bonds. They   will also derail the massive foreign inflows which have topped USD 66 billion so far this year chasing positive real yields. Last year local corporate bond defaults reached a record high at more than USD 20 billion.

A Special Purpose Vehicle was established in South Korea by the government, central bank, and Korea Development Bank to purchase select corporate bonds and commercial paper to prevent defaults and stabilize the market.  The program is largely focused on A-rated debt but can also buy fallen angels that were downgraded to junk due to the pandemic.  The USD 8 billion SPV, which can be expanded, was established in May and is due to expire in November, although like bank loan standstills, this too will likely to be extended.  While default prospects in Taiwan remain less likely, there is growing worry about pressure on banks from SME sp loans which have grown rapidly in recent years, with loan growth averaging over 6% the past two years against 5.2% for other corporate loans.

While China, South Korea, and Taiwan have attracted interest in recent months on signs of recovery, a second wave of Covid-19 could easily derail investor appetite. Behind the rosier macro-economic data on exports, PMI, low rates, and contained inflation, the already high pre-pandemic debt levels are still rising. Loan repayment standstills will eventually end.  Access to the bond markets for junk-rated, highly leveraged corporates will halt as inability to pay becomes clearer.  The potential debt crisis in the three East Asian economies will be vastly different than the traditional EM sovereign debt crises of recent decades, w a departure from blanket fiscal support during pandemic peak. Household and corporate debt levels of near or over 100% of GDP restrict another wholesale bailout round, as they are first in to attempt cleanup of a long-ignored mess. #KleimanIntCon

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Central Asia-Caucuses’ Seared Stargazing

2020 July 29 by

The World Bank’s Central Asia/Caucasus review depicted “dark skies” for the region with a recession worse than the global financial and subsequent 2015 currency crises. Output will contract almost 2% in contrast with the original 4% pre-virus forecast, with oil and gas exporters Azerbaijan, Kazakhstan and Turkmenistan suffering from the price crash in the commodity accounting for one-third of GDP.  Importers in turn like the Kyrgyz Republic, Tajikistan and Uzbekistan face reduced Russia remittances and supply chain disruptions in Asia and Europe. Armenia and Georgia will absorb tourism blows, and exchange rate impact ranges from the flexible Kazakh tenge hitting new lows to the more stable managed Kyrgyz and Tajik units. In 2019 growth was “resilient” at near 5% in 2019, on wider current account deficits reflecting both import and export squeezes. Fiscal balances will also deteriorate on health and social outlays, and increased retail and mortgage credit has combined with slacker standards under subsidized programs in Azerbaijan and Kazakhstan. Bad loans and liquidity pressures will accumulate as forbearance and central bank support are planned for households and small business. Most countries in the area have banned travel and imposed lockdowns, and Kazakhstan’s central bank hiked rates almost 300 basis points. It rolled out the biggest stimulus at 9% of GDP, and Armenia’s was one-third that size, and the bank urges steps to facilitate medical supplies and treatment. Fiscal space is limited, and deficit widening should be temporary, while monetary tightening may be needed to defend currencies and capital inflows. Outright controls should be a last resort, and macro-prudential policies the immediate resort if outflow tension persists. The region is in line for IMF Rapid facility access to reinforce these approaches, with the Kyrgyz Republic the first recipient of a $120 million line.

The publication also covered the MENA group with “drastic economic decline” in store with the Gulf GDP tumbling 3%., and Algeria, Iran and Iraq are off even further at 5%. Libya’s civil war will produce another 50% plunge, while Yemen’s contraction could tail off at 3% amid cease-fire rumors. Saudi Arabia, where reserves shrank the most to date in March, still has ample fiscal buffers, but Bahrain and Oman are hard-pressed. Regional current account balances will hit a 6% deficit, double the previous surplus. Public wage bills and pensions remain too high Iraq and Kuwait, and tourism declines will exacerbate strains in the UAE and elsewhere. Supply and demand and remittance shocks will batter Egypt, Jordan, Morocco, Pakistan and Tunisia, on steeper budget and trade deficits. Tax relief and subsidies, and rate cuts and direct credit help will drive virus response, but countries already with mixed records under IMF arrangements will struggle to maintain sound macro and structural performance. In Jordan and Lebanon the Syrian refugee crisis compounding their predicament is now a decade old with no end in sight and almost two million in camps and informal jobs between them. The pandemic brings “another vulnerability layer” but ultimately these communities should be integrated into mainstream livelihoods and medical care as emergency phases pass, the document directs.

China’s Dialed Back Decade Dominance

2020 March 11 by

With Chinese “A” shares’ 40% gain at the top of the core MSCI Index last year amid past decade retrospectives charting the mainland’s across the board asset class hold, investors expect economic and financial market growth momentum to flag over the medium term as they look for other geographic and thematic anchors. The disconnect between emerging market share of global GDP and stock market capitalization, at 60% and 20% respectively remains as wide as ever despite the latter near doubling to over $6 trillion since 2010 with China accounting for 30% of the figure. In daily currency trading the EM portion is now one quarter, with the renimbi and Hong Kong dollar the runaway favorites at over $500 billion combined annually. Local and external debt sales tell the same story at $2.5 trillion in 2019, triple the amount during the 2009 crisis. Chinese companies are almost one-third the Bank of America gauge in that category, with Mexican ones a distant second at less than one-tenth. The two most popular Vanguard and iShares ETFs listed in New York, with $60 billion each under management, have similar mainland weighting roughly mirroring the current MSCI formula. It will increase in 2020 as more “A” listings are added, and more market-friendly IPO rules go into effect for foreign investor access outside long-running bilateral trade and financial services negotiations that will continue to affect sentiment around the US presidential election.

Asia with its closer ties was again the top performing region as the MSCI main index rose 15% last year, with the so-called BRICS up 20% with Russia’s equal 40% spurt. Taiwan was in second place with 30%, and Korea was the only other double-digit winner. India, Indonesia and Thailand were ahead single digits, while Malaysia lost 5% but was behind Bangladesh (-18%) on the frontier index as the biggest area drop. In Latin America Brazil and Colombia jumped over 20%, but Chile declined in comparable magnitude and Mexico’s advance was just half the benchmark one. In Europe Greece’s climb equaled Russia’s, Hungary matched the MSCI, and Turkey (+7%) ended positive after early year carnage, but Poland and the Czech Republic slid. In the Middle East complex Egypt (+38%) triumphed by far, with Saudi Arabia (+5% barely helped from the gigantic Aramco offering designed for domestic and Gulf buyers. The UAE and Qatar were in the negative column, as frontier Bahrain and Kuwait otherwise paced the GCC pack with 30-40% upticks.

That universe lagged 2% behind the core, with Lebanon’s 50% crash amid political gridlock and protests and possible debt default and exchange rate realignment dragging the region. Africa was up just 5% as Kenya’s 40% jump was offset by double-digit setbacks in Nigeria, Botswana and Zimbabwe, in contrast with South Africa’s +7% close. Europe’s ten markets were mixed, with 20-30% rises in Lithuania, Romania and Slovenia, and Bulgaria and Ukraine the biggest losers as the former is due to formally enter the euro. In Central America/ Caribbean Jamaica and Trinidad went opposite ways and Panama (+35%) was a standout in a triangle hobbled by bad migration and security trends as exotic markets reconfigure their own geometry.

US-China Trade’s Diversion Divination

2020 January 10 by

Amid continued speculation over a “Phase 1” US-China trade deal while mutual tariff increases are on hold, an IMF working paper points to likely distortions under a “managed “ outcome assuming agreement on higher American imports. In this way global benefits in terms of commercial efficiency and policy certainty are diluted in an effort to remedy bilateral imbalances. The research looks at the top ten products, and assumes that commodities are more substitutable than manufactured items. It finds that big economies like the EU, Japan and Korea will be hit from car, machinery, and electronics exposure, as well as small emerging markets implicated directly or in supply chains. On agriculture, China’s decision to purchase more US soybeans would affect Argentina, Brazil and Canada. Correcting the roughly $350 billion trade gap would entail 2-3% export diversion of ASEAN economies and South Africa, as well as tinier partners Angola and Oman. In a final “cascading” tally of specific categories for US and China sale the study reveals that “intensive” raw materials producers such as Mongolia and the Congo would lose the most, while Indonesia and Russia would suffer 0.5% contractions. With these risks the document urges that an eventual pact also take into consideration spillover into the multilateral trading system, where WTO and other bodies may propose safeguards.

China “A” shares still lead the MSCI index with an over 30% advance, along with Greece which was the subject of a simultaneous Article IV review predicting 2% growth through next year on “lackluster” public and private investment. Despite the Conservative party government’s economic reform agenda, demographic and productivity trends are “adverse” with structural unemployment keeping the formal rate above 15%. Bank balance sheets a decade after the crisis and a series of EU-guided rescues have near 50% bad loan ratios, as net credit provision falls. Fiscal relaxation and foreign capital inflows offer short-term impetus, but privatization and labor market changes lag and imperil long-range debt sustainability despite official breaks. Recovery is “disappointing” with income levels below the euro adoption era, although consumption and tourism are up with inflation less than 1%. The current account deficit is 3.5% of GDP under estimated 10% currency overvaluation, while the primary budget surplus exceeds the 3% target. After bilateral debt relief, sovereign bond issuance at record low 150 basis point spreads has been oversubscribed, and banks repaid emergency liquidity assistance with nonperforming assets only half provisioned. Germany and the UK are the biggest trading partners and face slowdowns and Brexit shocks reinforcing the odds for 2-3% best case medium-term growth. The new administration pledges personal and corporate tax reductions that may halve the primary balance, and pension spending must still be curbed as actuarial and solvency studies are conducted.  Worker retraining should accompany the double-digit minimum wage rise, and bank cleanup awaits new out of court restructuring options and a proposed centrally-guaranteed securitization scheme to tackle euro 80 billion in distressed assets. The legacy state lenders in turn must improve governance and profitability to be internationally-competitive. Business licensing will be streamlined further despite better World Bank rankings, and data transparency remains a serious issue with the sad saga of a prosecuted former IMF statistician lingering, the report implies.

The Asia Subcontinent’s Subpar Sweep

2019 November 15 by

Pakistan on the main Morgan Stanley Capital International Index with a 15% loss and Bangladesh and Sri Lanka, down 5% on the frontier rung, were at the bottom of regional ranks through the third quarter.  Foreign investors shunned bonds as well on uncertain standing with the International Monetary Fund, and political and geopolitical complications. Subcontinent giant India struggling with financial sector crisis reinforced negative neighbor views likely to persist into year-end in the absence of economic policy breakthroughs.

The IMF’s September Article IV report on Bangladesh captured “downside risks” despite strong 7.5% gross domestic product growth predicted again this fiscal year. Private consumption, garment exports, worker remittances and infrastructure projects will be drivers, against the background of rising trade protectionism and natural and humanitarian disasters. Monsoon flooding and climate change erosion could lift food prices beyond the 5.5% inflation target, and the 700,000 Rohingya refugees from next door Myanmar remain in place with a $1 billion donor appeal subject to “fatigue” and fiscal fallout. Reserve money growth as of mid-year was double the 8% central bank goal, and it recently shifted course on lowering banks’ mandatory loan/deposit ratio to 83.5%. Higher electricity charges and value added tax could be inflationary, but disciplined monetary and fiscal policies, with the deficit to be kept under 5% of GDP, are official commitments. Tax collection at 10% of GDP lags behind peers, and without a broader base and exemption elimination revenue mobilization will also stymie progress toward the anti-poverty Sustainable Development Goals, the Fund warned.

Banking system cleanup is pressing with the stated bad loan ratio above 10%, and 30% for state-owned lenders. Under a wider definition stressed assets exceed one-fifth the total, despite a “growing trend” of rescheduling and restructuring. Due diligence and risk management are poor and “comprehensive reforms” are overdue to reverse regulatory leniency. Loan classification and corporate governance criteria should be stricter, and fraud and defaults require court action. The overall historical role of government-run intermediaries must meet a commercial test, especially as national savings certificates sold through them crowd out private capital markets.. As investors in this paper they also come under pressure to breach allocation limits to help relieve short-term budget squeezes, the Article IV commented.

Securities market weakness is in turn an obstacle to economic diversification beyond ready-made garments, as new businesses seek venture funding. South Asian stock exchanges trade at a discount to the region with single digit price-earnings ratios, but the Dhaka heavyweight Grameenphone is in a fight with the telecoms regulator over outstanding fees. Until a settlement and further bad loan purges at banks otherwise prominent among listings, possibly through a central disposal agency as in Vietnam, lethargy is the presumed near-term sentiment.

Sri Lanka’s second quarter GDP growth halved to 1.5% with the Easter terror bombings, but the PMI manufacturing gauge was again over 50 in August signaling recovery. The central bank cut the benchmark rate 50 basis points then on 3.5% inflation, and in October imposed loan cost caps on banks to ensure relief was transferred to borrowers. Investors have taken positions on private sector retail-oriented competitors most likely to benefit, and they could further rally after the November presidential election with the two party contenders are in a close race. The winner may offer additional fiscal and monetary stimulus after the IMF program allowed such temporary moves in the wake of the bloody attacks still denting tourism and consumer confidence. A silver lining in the latter is lower import demand set to narrow the current account gap to 2.5% of GDP.

Pakistan is a contrarian play as the Fund’s mid-September review called for “decisive implementation” of far reaching reforms never achieved under previous arrangements. The central bank is on hold, and fiscal retrenchment is to shrink the coming year’s deficit to 7% of GDP.  Growth is estimated in the 2-3% range, and inflation should fall to single digits. The 5%-plus current account hole has started to improve with the 30% real exchange rate depreciation the past two years, although foreign direct and portfolio investment have yet to rouse. The Kashmir confrontation with India has again raised the nuclear alarm, at a time when prospective share buyers prefer to monitor that reaction within the economic sphere.

Asian Stocks’ Staid Strictures

2019 November 8 by

Emerging Asia stock markets mirrored the almost 4% Morgan Stanley Capital International core index gain through September, and equaled Latin America and beat Europe performance, with China “A” shares up 28% the runaway leader. The main China component rose 5% and the Philippines, Taiwan and Thailand increased in the 5-10% range. India was barely positive (+1%) and Indonesia was fractionally negative, while Korea (-2%), Malaysia (-7.5%) and Pakistan (-17%) were losers. On the frontier rung, the regional advance was double at 9%, as big weighting Vietnam (+12%) offset 5% drops in Bangladesh and Sri Lanka.

 The Asian Development Bank noted that the first two of these members experienced double-digit export jumps with the US-China trade war, as it cut this year’s economic growth forecast to below 5.5% with underlying electronics cycle “sharp contraction.” The ADB expects weaker trade and investment into 2020, as the International Monetary Fund predicted a 1% global growth setback and new head Kristalina Georgieva pledged to tackle the slump to “minimize crisis risk.” Global fund trackers reinforced gloom with a $25 billion emerging market equity outflow total, as surveys pointed to Hong Kong’s and non-banks’ respective drags in China and India as asset class overhangs.

Chinese August data showed slack in industrial production, retail sales and fixed investment, with producer prices deeper into near 1% deflation. The Bank for International Settlements’ triennial foreign exchange study had the Yuan share of global trading unchanged at 4%. Formal foreign institutional investment quotas were lifted but remain one-third unused, with international reserves frozen at $3.1 trillion. Fitch Ratings projects gross domestic product growth below 6% next year, despite record total social financing from January-August over RMB 15 trillion. The central bank reported one-tenth of 4500 lenders at high distress risk comprising 5% of system value.

 Standard & Poor’s again sounded the alarm on local government debt, with almost RMB 4 trillion to be repaid by 2021. Dealogic, monitoring cross-border mergers and acquisitions, revealed that Chinese companies had already divested $40 billion in overseas assets through August, versus $32 billion for all of 2018. New home prices were up in only 55 of 70 cities, a six-month low, with widespread property developer layoffs. After one hundred days of protests, Moody’s downgraded Hong Kong’s outlook to negative as reserves fell $15 billion to $430 billion, the most in two decades.

Foreign direct investment for the year was $9 billion, a 3% rise, and the official manufacturing PMI gauge was under 50 in September. In the balance of payments the combined current and capital account surpluses were matched in the $130 billion “errors and omissions” outflow, signaling strong underground money flight. The private sector-oriented Beige Book described the third quarter as particularly hard for retail and services, as “shadow banking” like bond issuance registered a period peak as the chief funding channel. The Finance Ministry relaxed commercial bank bad loan provisioning requirements, as the central bank warned that regional players were “overstretched” and shareholders would face the consequences. Researcher FT/Wind estimated a capital shortage in most stock-exchange listed banks, as rumors circulated in Washington that the Trump Administration was considering US investor portfolio investor curbs as a negotiating lever.

Indian growth similarly disappointed in the April-June quarter at 5%, as ratings agencies cited “precipitous private consumption decline” that will not be overcome by a surprise 10% corporate income tax reduction. They argue structural reforms are still missing to improve competitiveness and business sentiment, and that the break will hike the fiscal deficit above target to 4% of GDP. Fitch puts the combined state and central government gap at 7% at year-end, even after the central bank was forced to transfer record reserves. It has been in easing mode with another recent 25 basis point move to just over 5% in the benchmark rate, but household confidence remains soft amid overlapping real estate and financial sector crises following the collapse of non-bank giant ILFS. According to local consultants stalled residential projects now total $65 billion, and analysts believe the banking system bad loan ratio is again heading toward 15% on damage from housing specialist ties. Listed Yes Bank was caught in the vortex, as share value was almost wiped out with its affirmation of a speculative shadow franchise under harsh investor glare.

Asia Bonds’ Serial Signal Clashes

2019 October 25 by

The Asian Development Bank’s quarterly local currency bond survey of mid-year and through end-August trends noted lower yields with slower economies, amid still positive “risk off” foreign investor sentiment raising future flags. The US-China trade standoff continued to loom over regional markets cutting interest rates in line with developed world central banks. The Japan-Korea diplomatic and export clash added to aversion, as equity markets also slid and currencies weakened against the dollar. Annualized growth was almost 15% in the latest period for combined size of the nine Emerging East Asian destinations over $15 trillion, three-quarters from mainland China, and close to another 15% from Korea. A Cambodian bank bond as the third such listing on the stock exchange was a highlight as broader Indochina coverage may soon join Vietnam in the publication.

In most places the 10-year government bond yield drop surpassed the 2-year, with curve flattening suggesting economic “gloom,” the ADB commented. Korea, Malaysia and Thailand reduced benchmark rates 25 basis points, and Indonesia got a sovereign ratings upgrade to slash cost. Hong Kong’s fall was less than the rest with “political uncertainties” from months of anti-Beijing street riots. The International Monetary Fund in its July outlook predicted 2.5% trade growth this year will be half the pace of 2017. Emerging market gross domestic product expansion will be just 4%, with inflation almost a point higher. Asia’s clip is a “rock solid” 5.7%, despite Hong Kong and Korea at half that figure. Vietnam was an exception to the stock market spin in part due to possible MSCI index elevation from the frontier to core rung in 2020.

 Credit default swap spreads “rose sharply” in July, even as overseas ownership of domestic bonds was “stable,” according to the report. However Malaysia and the Philippines had 1.5% declines, with net outflows in the former on oil export price softness and potential removal from an FTSE global bond index. A new World Bank policy paper points out that East Asia is ahead of other regions in developing capital markets for a state and corporate borrowing “spare tire” since the late 1990s financial crisis, although the private sector can be “crowded out” and small and midsize company access lags. The update warns that Chinese growth “moderation” is a bigger risk than US recession, while multiple trade conflicts rage. While the Federal Reserve reversed course toward lower interest rates, major emerging market upsets elsewhere, such as in Argentina and Turkey, can still readily translate into asset class selloffs, it added.

The government-corporate bond divide is 60%-40%, and overall growth was 3.5% in the second quarter, roughly the same increase as in mainland China. In contrast Hong Kong’s outstanding amount slipped slightly to $250 billion, while ASEAN’s combined was up 2% to $1.5 trillion. Thailand leads there at $425 billion, followed by Malaysia’s $350 billion and Indonesia’s $220 billion. In Malaysia 60% of volume is Islamic-style sukuk, and Singapore’s $320 billion market is also moving into this niche. The Philippines and Vietnam are minnows at $125 billion and $50 billion respectively, although Manila stands out with a retail investor program. As a fraction of regional GDP the total is near 85%, with Korea the outlier with a 125% proportion. The foreign investor share ranges from 5% in China to almost 40% in Indonesia, with net buying over the April-July timeframe.

 Cross-border Asian placement was $3.5 billion, with China names accounting for half. Bank of China had the single biggest $750 million issue in Hong Kong dollars, and denominations in Singapore dollars, Korean won and Malaysian ringgit were 5% of activity. Hard currency East Asia offerings climbed 20% from January-July to over $200 billion, 90% in the greenback. Indonesia was responsible for $12 billion; Thailand $1.5 billion; and Vietnam Prosperity Bank completed a $300 million bond. Cambodia’s Advanced Bank local listing had a 7.75% coupon above bank term deposits, with the proceeds going to more speculative rural business. It got a “B” Standard & Poor’s rating to facilitate institutional and individual sale, with over 20,000 investors now registered on the $150 million exchange. The small bourse is on the radar screen especially of Indochina specialists already in Vietnam, and eying fresh spots with the announced merger of the Hanoi and Ho Chi Minh markets, under the caveat that “rock solid” may also describe boulder dangers.

Central Asia’s Currency Steppe Changes

2019 October 25 by

Central Asian currencies entangled in Russian ruble and Chinese Yuan slides dipped to new lows against the dollar in August, as external bond investors took the signal to trim positions. The Kazakh tenge, Uzbek som and Tajik somoni fell 2-12% due to outsize Russian trade and remittance dependence. Kazakhstan is a member of the Moscow-led Eurasian Economic Union, and gets one-third of imports from its historic ally and neighbor. Tajik worker proceeds from there account for one-third of gross domestic product; for Uzbekistan the fraction is only 10%, but the central bank ended the foreign exchange fluctuation band during the month in another liberalization move drawing frontier market investor interest. China’s currency weakened amid the prolonged US tariff and technology restriction battle for additional sub-regional pressure, as foreign direct investment in natural resources and infrastructure gathers pace under the Belt and Road push.

In Kazakhstan, with new President Kasym-Zhomart Tokayev in office, panic buying prompted a documentation crackdown on customer and dealers as the tenge veered toward 400/dollar. It had stayed in a 375-385 range despite oil price weakness on presumed sovereign wealth fund intervention. Since the dollar peg’s collapse 5 years ago, a half dozen devaluations have hurt the population, which erupted in nationwide protest when snap elections were called in June. With double-digit unemployment and state banks still reeling from troubles originating a decade ago, a recent poll showed just 60% of citizens satisfied with living standards. To shake up the banking system the government intends to boost Islamic finance’s share, which now barely registers, to 3% over the medium term and may allow conventional lenders to open sharia-compliant arms. Next door Kyrgystan has a 5% goal, and Tajikistan and Uzbekistan are designing legal and regulatory frameworks with support from the Islamic Development Bank. According to Moody’s Ratings growth in this segment will strengthen and diversify funding sources, including from Asian hubs like Indonesia and Malaysia, but must link to existing deposit insurance and liquidity schemes to be competitive and sustainable.

Against the background of renewed currency jitters, Mongolia’s recent predicament of 25% depreciation and exhausted reserves before turning again to an International Monetary Fund rescue haunted portfolio managers, as bonds were dumped ahead of a heavy repayment schedule next year. Its August Article IV report predicts 5% plus growth over the next five years, but warns of the “narrow economic base” with mining 80% of exports and almost entirely destined for China. The OT copper project is half of foreign investment, with continued delays in coming fully on line. A $500 million swap line with a domestic bank and the bilateral Chinese central bank facility tapped for $1.8 billion expire in 2020, and large Eurobond amortizations start in 2021.The reserve position is projected to plateau then at $4 billion, but under a stress scenario could plummet to $1 billion as public debt hits 95% of GDP.

Years of double-digit household loan expansion have hurt bank capital and profitability and an asset quality review is not yet complete as the 2020 parliamentary election cycle approaches to further postpone action. Inflation is still high at 8%, amid chronic fiscal and current account deficits and worsening environmental damage to the key livestock industry. A budget rule was adopted but not enforced as the Development Bank runs up contingent liabilities, and retail borrowers circumvent macro-prudential debt service/income limits through resort to unregulated non-banks charging 40% interest, the review adds.

Investor qualms also touched hydrocarbon exporter Azerbaijan recovering from bank collapse and recession, despite selective appetite for its illiquid “exotic” bonds. The exchange rate is a de facto peg at 1.7 manat/dollar, after the SOFAZ sovereign wealth pool transferred billions of dollars in holdings for stabilization. Growth is expected at 2.5% and inflation 3.5% this year, as the fiscal stance moves from stimulus to consolidation, the IMF comments in a September Article IV survey. Monetary policy moved to inflation targeting, and structural reform strides are evident with a leap in the World Bank’s Doing Business rankings. However banking sector cleanup remains a work in progress after fraud and failure at leading state institution IBA, and corruption and transparency scores are poor. Local government bond development is also lacking until a durable shift in currency and capital markets confidence, the report cautions even high-risk speculative investors.  

China Bonds’ Zero Intolerance

2019 October 19 by

Global fixed income portfolio managers contending with a near $15 trillion universe of low and negative yielding developed world government bonds, with euro-denominated emerging market issues also in the fold, have hailed the entry of positive return Chinese local instruments into benchmark indices. Together inclusion in major Bloomberg, Financial Times and JP Morgan gauges will trigger estimated hundreds of billions of dollars in allocation to raise foreign investor ownership beyond the current 2% share, as compared with an average ten times greater for big developing markets in Asia and elsewhere.  In the region China accounts for three-quarters of the $13 trillion local bond total, as the number two market worldwide in nominal terms behind the US. Starting in February next year, it will get a full 10% individual weighting in JP Morgan’s GBI-EM gauge embedding Asian dominance there, just as in equities where  China’s “A” share addition boosts the already 30% portion on the core Morgan Stanley Capital International Index. This step caps a three-year opening process luring thousands of participants in domestic interbank bond dealing, as Beijing declares a path toward automatic foreign institutional access joining the emerging market mainstream. Its long-awaited arrival on the scene as a top-rated credit is an upbeat asset class story despite growth, trade and banking system concerns continuing into 2020.

Amid the anti-export tariff, currency and national security imbroglio with the US likely to last through next year’s presidential election, an expanded bond channel can support domestic demand through infrastructure projects, and reduce disproportionate bank reliance in total social financing. It will enable China’s global gross domestic product contribution to increase to 20% over time despite a probable shift to current account deficit status, and demographics-driven economic slowdown from decades of the one-child policy. Diversified financial intermediation can offset falling total factor productivity, with recent annual gains in the 1-2% range. However while overseas investors may be sanguine in the near term about the reported government debt level at 50% of GDP, they will insist that the 150% state enterprise load, due to leap another 10 trillion Yuan this year, be reined in for overall sustainability.

On the index launch mechanics, JP Morgan will incorporate a half dozen liquid government bonds, and projects an early $20 billion infusion with the 10% weighting since it is tracked by $200 billion in assets. The Finance Ministry puts the amount outstanding at $2 trillion on a defined yield curve, with 1-10 year maturities auctioned monthly. Banks and insurers are the main buyers with the former taking two-thirds of issuance, and secondary trading is minimal. Policy bank offerings from the Agricultural, Development and Export-Import Banks are also part of the sovereign mix but so far eligible only for Bloomberg’s separate yardstick. With integration Hong Kong’s Bond Connect scheme for onshore entry in effect since 2017 is expected to improve, especially in addressing remittance and settlement complications. The currency convertibility timetable, with a vague next decade target, could also be spelled out concretely to harness fresh inflows, in the wake of recent annual drops in Standard Chartered’s Renimbi Globalization measure. Trade settlement and international payments rankings have declined despite acceptance in the International Monetary Fund’s Special Drawing Right (SDR), and official no-devaluation assurances.

Chinese local corporate bond participation should pick up at the same time despite the absence of a dedicated index, as 80% of borrowing is still through banks and Standard &Poor’s has begun competitive credit ratings. Surveys of central bank reserve managers also reveal an appetite for higher safe asset exposure with only 2% of holdings Yuan-denominated, below the 10% stake in the SDR, amid the search for dollar and euro alternatives on commercial and geopolitical grounds. On an historical view, emerging market analysts predict a similar trajectory for local bonds as external ones the past decade, as half a trillion dollars in corporate issuance now leads as a stalwart in JP Morgan’s benchmark for that field. Offshore investors continue to snap up risky property developer placements this year, with double digit yields rarely available elsewhere. They may default and leave holders at the mercy of uncertain legal recourse, while Chinese central government paper is considered a solid bet for now on the basic balance sheet.   

China/Hong Kong’s Stubborn Standoff Stripe

2019 September 27 by

China’s MSCI components were pressed to keep double digit gains and Hong Kong to stay positive as months of pitched trade and political battles promoted foreign investor outflows and IPO delays, after the renimbi settled below 7/dollar. The US extended the bilateral tariff and investment restriction fight into currencies with a “manipulation” declaration at odds with the IMF’s conclusion that value reflected economic fundamentals. The finding did not meet legislative criteria for current account surplus and intervention size, and since retaliation is already in effect with another duty round the practical effect is limited beyond a negotiating tactic. Ratings agencies pointed out that weakening may have been a tariff rejoinder, but that a combination of flexibility and stability was likely in the future to forestall capital flight and permit Chinese company repayment of $800 billion in dollar debt. Reserves fell $15 billion in July but still exceed $3 trillion, with the manufacturing PMI under 50 with exports and fixed investment only ahead 5%. Retail sales were negative during the month, and producer prices show deflation. The IMF’s Article IV report predicted ‘moderate slowdown” and raised the alarm on debt approaching 275% of GDP this year. The current account balance will be just 0.5%, while the errors and omissions tally is negative with the Fund advising floating exchange rate transition. In the financial sector, the central bank embraced previous recommendations with scrutiny of property borrowing and holding companies, and launch of a benchmark “prime rate” structure reflecting market competition. It has also overseen takeovers of second-tier banks and steered credit toward small business under dedicated facilities. The shakeup contributed to a lower RMB one trillion monthly loan total and single-digit monetary expansion. Real estate developers in particular have turned to onshore and offshore bond issuance and “shadow” commercial acceptance bills, now at $200 billion outstanding for a 30% annual jump. Chinese credit abroad is also under pressure, with BIS Q1 statistics reflecting Japanese lines at four times the $45 billion extended.

The overseas development and Belt and Road portfolios have entered the mix with a Rhodium Group study of 40 restructurings calling sustainability into question, and Johns Hopkins University research tracking $150 billion in African lending the past two decades as the number one creditor. While mainland growth will still be 6% plus, Hong Kong faces recession with a paltry half a percent output improvement in the end-June quarter before the summer street battles between marchers and police. Protesters demand less control from Beijing and the resignation of its allied chief executive Carrie Lam. Officials announced a 0.3% of GDP stimulus package with the political and economic squeeze, as monthly home prices also fell signaling softness in that critical sector. Retails sales and tourism suffered and the PMI index is at a decade bottom. Foreign reserves around $400 billion remain ample to back the dollar peg and ten months imports, but the CNY is half the currency basket and a military crackdown could suspend the arrangement under emergency law. Yuan deposits and equity Connect flows are down, and the Hang Seng index could be the regional laggard with typhoons unleashed in all forms.