Distressed bonds likely to head in opposite directions - Capital Economics
Emerging Markets Economics

Distressed bonds likely to head in opposite directions

Frontier Markets Monthly Wrap
Written by Edward Glossop
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Ecuador this month joined the handful of frontier economies where sovereign dollar bonds are trading at levels commonly associated with default. But with the IMF likely to stand by the government, we think the recovery in bonds in recent days has further to run. In contrast, we doubt that Argentine and Lebanese bonds are on the cusp of a rebound.

  • Ecuador this month joined the handful of frontier economies where sovereign dollar bonds are trading at levels commonly associated with default. (See Chart 1.) But with the IMF likely to stand by the government, we think that default fears are overdone and that the recovery in bonds in recent days has further to run.
  • In contrast, we doubt that Argentine and Lebanese bonds are on the cusp of a rebound. While markets are clearly pricing in some form of default (see Chart 1 again), spreads are still lower than the peaks reached in past default episodes where bondholders secured low recovery values – which we think are likely in Argentina and Lebanon. As such, if anything, we think that bond spreads have further to rise.
  • This Month in Frontier Markets – Ukraine’s government is close to securing a fresh IMF deal, which should help to ensure that market-friendly reforms continue in the coming quarters. Policymaking in Sri Lanka seems to be going in the opposite direction. The newly elected president has already announced a cut in the rate of VAT and, while looser fiscal policy should boost growth in the near-term, it could mean the government misses the IMF’s fiscal targets.
  • This Month in Frontier Financial Markets – The MSCI Frontier Index underperformed the MSCI EM Index this month. At the same time, dollar bond spreads widened in most countries. The performance of currencies was mixed.
  • The Month Ahead in Frontier Markets – GDP data are likely to show a slowdown in growth in some Emerging European frontiers, but a pick-up in parts of Sub-Saharan Africa. With inflation falling and the currency strengthening, Ukraine’s central bank is likely to cut interest rates. Finally, Alberto Fernández will be sworn in as Argentine President on 10th December and markets are likely to take their cue from his pick for finance minister.
  • Background Data can be found at the end of this publication.

Chart 1: Average Daily EMBI Bond Spreads in 12m Prior to Sovereign Defaults (bp)

Sources: Refinitiv, Capital Economics


This Month in Frontier Markets

  • In Emerging Europe, the Ukrainian authorities are edging closer to securing a fresh deal with the IMF. President Zelensky’s government has overcome most of the hurdles but the ownership of Ukraine’s largest lender, PrivatBank, is proving a key sticking point for the Fund. Optimism about a new deal has boosted the hryvnia in recent months and we think this rally has a bit further to run.
  • Romania’s finance minister announced the newly-formed government’s fiscal consolidation plan to rein in the budget deficit next year. But there doesn’t seem to be much cross-party support to reach an agreement and parliamentary elections next year mean that tightening policy may be politically difficult. Ultimately, we think the budget deficit will widen further (see Chart 2) and this will continue to weigh on the leu.
  • In Latin America, Ecuadorian bond spreads surged in mid-November after Congress rejected President Lenín Moreno’s tax reform bill. (See Chart 3.) Spreads are now at levels typically associated with default risk. However, with the IMF likely to stick with Ecuador, we expect that the recovery in bonds that has begun in recent days will continue.
  • Elsewhere, Argentina’s President-elect Alberto Fernández and the IMF are at loggerheads over the need to pursue fiscal austerity, making it unlikely that the new government will secure additional financing from the Fund. Whether a deal is reached or not, we think that a large debt-write down is on the horizon.
  • In the Middle East and North Africa, the crisis in Lebanon shows no sign of abating. Dollar bond spreads are now up by 1,000bp since protests erupted in mid-October. The government managed to meet a $1.5bn debt payment due this month, but a restructuring seems inevitable. The lack of collective action clauses on its bonds means that this could be a lengthy and arduous process. Moreover, pressure on the dollar peg is mounting and, in the event of a devaluation, the pound could fall by as much as 50%.
  • In Sub-Saharan Africa, having collapsed in October, Angola’s kwanza has stabilised against the US dollar this month. But with inflation heading up and oil production faltering, we think that the economy will contract again in 2020. The latest figures show that growth in Nigeria remained very weak in Q3, and we think that it will also struggle next year. Policymakers held their key interest rate at 13.50%, and we expect that the benchmark rate will be left unchanged in the coming months.
  • In Emerging Asia, Sri Lanka’s newly elected president – Gotabaya Rajapaksa – has wasted no time in announcing a loosening of fiscal policy. The recently-announced VAT rate cut should boost growth but will put further strain on the public finances and is likely to be opposed by the IMF. In addition to loosening fiscal policy, President Rajapaksa’s other key campaign promise was to “restore relations” with China. The policy could increase investment, but there is a risk it will leave Sri Lanka saddled with more debt.

Chart 2: Romania Budget Balance (% of GDP)

Chart 3: Ecuador Spread of JP Morgan EMBI Ecuador Index Over US Treasuries (bp)

Sources: Refinitiv, Capital Economics

Sources: Refinitiv, Capital Economics


This Month in Frontier Financial Markets

  • Currencies in frontier markets have had a mixed month. (See Chart 4.) At one end of the spectrum, the Ghanaian cedi and the Romanian leu are down by over 1% m/m against the dollar. At the other end of the spectrum, the Ukrainian hryvnia strengthened by 4.6% m/m on optimism about a new IMF deal.
  • Frontier equity markets underperformed their emerging market counterparts over the past month. The MSCI EM Index rose by 1.9% m/m, while the MSCI Frontier Index is only up by 0.6% m/m. (See Chart 5.) Stock exchanges in Bangladesh, Bulgaria and Vietnam performed the worst.
  • Most sovereign dollar bond spreads in frontier markets widened. (See Chart 6.) Lebanon’s spreads were up by almost 800bp as devaluation and default fears escalated. And in Ecuador, spreads widened by over 300bp after a failure by the government to pass an important fiscal reform bill. Sovereign bond spreads narrowed in a handful of countries, most notably in Serbia.
  • On the monetary policy front, most central banks that held meetings over the past month kept their interest rates on hold. (See Chart 7.) The notable exception was Kenya, where policymakers cut the key rate from 9.00% to 8.50%. The move came after the removal of a controversial interest rate cap that depressed lending to the private sector. We expect another interest rate cut next year.

Chart 4: Exchange Rates vs. US$
(% Change, 27th Oct. – 27th Nov.)

Chart 5: MSCI Equity Indices (Local Currency Terms)
(1st January 2019 = 100)

Chart 6: EMBI Sovereign Dollar Bond Spreads
(bp Change, 27th Oct. – 27th Nov.)

Chart 7: CE Frontier Market Interest Rate
Diffusion Index*

Sources: Bloomberg, Refinitiv, Capital Economics


The Month Ahead in Frontier Markets

  • A raft of Q3 GDP figures will be released in the coming weeks. Growth probably weakened in Estonia from 3.6% y/y in Q2 to 3.0% y/y in Q3 due to sluggish growth in the country’s key trading partners, the eurozone and Russia, and weaker domestic demand. Domestic demand in Romania has held up better. Even so, the second estimate of Q3 GDP should confirm a sharp slowdown in growth on the back of weakness in exports. Weak exports is one reason why we expect growth in Romania to slow further next year.
  • We think that Kenya’s GDP growth picked up from 5.6% y/y in Q2 to 6.0% y/y in Q3 as the economy gradually recovered from a recent drought. We expect the country to be one of Sub-Saharan Africa’s fastest growing economies in 2020. Growth in Ghana probably accelerated too, from 5.7% y/y in Q2 to 6.3% y/y in Q3, with more support from the private sector in the aftermath of a banking sector clean-up.
  • The Fed is likely to hold interest rates at its meeting on 11th December and continue to suggest that the bar for further easing is high. But we don’t think that this will prevent a number of frontier market central banks from cutting interest rates further in the coming months. In particular, low inflation and a rebound in its currency will give the Ukrainian central bank room to continue its easing cycle.
  • Finally, Alberto Fernández will be sworn in as Argentine President on 10th December and, with his agenda still unclear, markets are likely to react to any concrete policy proposals. His pick for Finance Minister will also be an important clue. For now, we suspect Mr. Fernández’s presidency will be marked by high inflation, looser policy and a write-down on Argentina’s sovereign debt.

Table 1: Upcoming Events and Data Releases

Date

Country

Release/Indicator/Event

Time (GMT)

Previous*

Median*

CE Forecasts*

November

Fri 29th

Est

GDP (Q3, q/q(y/y))

(06.00)

+0.4% (+3.6%)

+0.4% (+3.0%)

December

Mon 2nd

Ser

GDP (Q3)

(11.00)

(+2.9%)

(+2.9%)

Thu 5th

Bot

Interest Rate Announcement

4.75%

4.75%

Rom

GDP (Q3, q/q(y/y))

(07.00)

+0.8% (+4.4%)

+0.6% (+3.0%)

Tue 10th

Arg

Alberto Fernández takes office

Wed 11th

US

Fed Policy Announcement

(19.00)

1.50-1.75%

1.50-1.75%

Thu 12th

Ser

Interest Rate Announcement

(11.00)

2.25%

2.25%

Ukr

Interest Rate Announcement

(12.00)

15.50%

15.00%

EZ

Interest Rate Announcement

(12.45)

-0.50%

-0.50%

Wed 18th

Gha

GDP (Q3)

(+5.7%)

(+6.3%)

Fri 20th

Bot

GDP (Q3)

(+3.1%)

(+3.5%)

Jam

Interest Rate Announcement

0.50%

0.50%

Tue 31st

Jam

GDP (Q3, q/q(y/y))

+0.1% (+1.3%)

+0.1% (1.0%)

Also expected during this period:

9th – 16th

Ken

GDP (Q3)

(+5.6%)

(+6.0%)

*m/m(y/y) unless otherwise stated

Sources: Bloomberg, Capital Economics


Background Data

Table 2: Key Indicators (2018, unless otherwise stated)

 

 

Share of World Output (%)(1)

GDP ($bn)(2)

Population (mn)

GDP per cap. ($ 000s)(2)

GDP per cap. (% of US)

Stock Mkt. Cap. ($bn, Latest)

Emerging Europe

Kazakhstan

Kaz.

0.38

184.2

18.5

9,977

16.0

7.6

Romania

Rom.

0.38

239.4

19.6

12,189

19.5

24.2

Ukraine

Ukr.

0.29

126.4

42.6

2,964

4.7

2.2

Bulgaria

Bul.

0.12

63.7

7.0

9,080

14.5

15.1

Serbia

Ser.

0.08

47.7

7.0

6,814

10.9

Croatia

Cro.

0.08

60.0

4.1

14,637

23.4

21.4

Lithuania

Lit.

0.07

52.5

2.8

18,856

30.2

4.0

Slovenia

Slv.

0.06

55.0

2.1

26,586

42.5

8.0

Bosnia & Herzegovina

B&H

0.04

20.0

3.5

5,703

9.1

Estonia

Est.

0.03

29.5

1.3

22,416

35.9

2.8

Latin America

Argentina

Arg.

0.68

475.4

44.6

10,667

17.1

30.5

Venezuela

Ven.

0.24

96.3

29.2

3,300

5.3

Trinidad & Tobago

T&T

0.03

23.3

1.4

16,930

27.1

12.9

Jamaica

Jam.

0.02

15.4

2.9

5,393

8.6

43.8

Emerging Asia

Vietnam

Vie.

0.52

241.4

94.6

2,552

4.1

194.2

Bangladesh

Ban.

0.56

286.3

164.9

1,736

2.8

Myanmar

Mya.

0.27

71.5

52.8

1,354

2.2

Sri Lanka

Sri.

0.22

92.5

21.7

4,265

6.8

14.2

Mid. East & N. Africa

Morocco

Mor.

0.23

118.2

35.2

3,355

5.4

61.0

Kuwait

Kuw.

0.22

144.5

4.5

31,915

51.1

97.1

Tunisia

Tun.

0.11

41.7

11.7

3,573

5.7

8.0

Oman

Oma.

0.15

81.7

4.3

19,170

30.7

17.4

Lebanon

Leb.

0.07

56.7

4.6

12,453

19.9

6.0

Jordan

Jor.

0.07

41.9

9.9

4,227

6.8

20.8

Bahrain

Bah.

0.06

39.3

1.5

26,531

42.4

23.5

Sub-Saharan Africa

Nigeria

Nga.

0.87

397.5

193.9

2,050

3.3

31.4

Kenya

Ken.

0.13

89.6

48.0

1,865

3.0

21.9

Ghana

Gha.

0.11

51.8

29.0

1,786

2.9

3.6

Cote d’Ivoire

CIV.

0.08

45.9

25.6

1,791

2.9

Botswana

Bot.

0.03

19.1

2.3

8,168

13.1

3.6

Zimbabwe

Zim.

0.03

19.4

15.3

1,268

2.0

1.8

Mauritius

Mau.

0.02

14.0

1.3

11,014

17.6

8.5

Sources: Refintiv, IMF, Bloomberg. 1) Share of World GDP in 2018 PPP terms (IMF estimates). *BVRM 2) At market exchange rates


Edward Glossop, Emerging Markets Economist, +44 20 7808 4053, edward.glossop@capitaleconomics.com
Quinn Markwith, Latin America Economist, +44 20 7808 4072, quinn.markwith@capitaleconomics.com
Virág Fórizs, Emerging Markets Economist, +44 20 7808 4079, virag.forizs@capitaleconomics.com