Default fears crystallising - Capital Economics
Emerging Markets Economics

Default fears crystallising

Frontier Markets Monthly Wrap
Written by Quinn Markwith

The spotlight has shifted back onto weak sovereign debt positions in Frontier Markets this month after the election of a left-wing president in Argentina and growing political instability in Lebanon. As we see it, debt write-downs are the only way out for both economies. And there’s a growing risk in Lebanon that this happens in a disorderly way, leading to problems in the banking sector.

  • The spotlight has shifted back onto weak sovereign debt positions in Frontier Markets this month after the election of a left-wing president in Argentina and growing political instability in Lebanon. As we see it, debt write-downs are the only way out for both economies. And there’s a growing risk in Lebanon that this happens in a disorderly way, leading to problems in the banking sector.
  • We’ve argued for some time that public debt positions in both countries look unsustainable. Argentina’s president-elect, Alberto Fernández, has talked of maturity extensions, rather than imposing haircuts on private bondholders. But it seems that this would only delay a necessary write-down to resolve to the country’s fiscal problems. The IMF, too, is likely to insist on write-downs on the face value of sovereign debt. (See here.)
  • Elsewhere, protests in Lebanon highlighted the political difficulty of pushing through austerity to stabilise the debt ratio, which currently stands at 150% of GDP. Bond spreads have widened, but the experience of Argentina’s primary election in August – when Mr. Fernández emerged as the front-runner and default fears spiked – suggest that Lebanese dollar bond spreads could widen by a further 400-500bp. (See Chart 1.)
  • This Month in Frontier Markets – Nigeria’s government continued its unorthodox policy shift by closing the doors to all trade across land borders with neighbouring countries. Meanwhile, the new government in Romania faces an uphill task in forming a majority coalition. As a result, efforts to curb the widening budget and current account deficits are likely to stall.
  • This Month in Frontier Financial markets – The MSCI Frontier Index underperformed the MSCI EM Equity Index this month. Frontier Market currencies generally appreciated against the dollar. With the important exceptions of Lebanon and Argentina, dollar bond spreads narrowed this month.
  • The Month Ahead in Frontier Markets – A raft of GDP figures due next month are generally likely to show a slowdown in economic growth. And while the Ukrainian central bank is likely to hold rates, we think that the Serbian, Nigerian and Ghanaian central banks are all likely to cut their policy rates.
  • Background Data can be found at the end of this publication.

Chart 1: Spread of JP Morgan EMBI Argentina & Lebanon Indices over US Treasuries (bp)

Sources: Refinitiv, Capital Economics


This Month in Frontier Markets

  • In Emerging Europe, the collapse of Romania’s government following a no-confidence vote led to Ludovic Orban, leader of the opposition party, being appointed prime minister. Forming a coalition will prove to be difficult and there is a good chance of early elections in 2020. This would push much-needed fiscal consolidation into the future, causing the budget deficit to widen (see Chart 2) and bond yields to rise.
  • Meanwhile, Ukraine’s negotiations with the IMF have stalled as the ownership of PrivatBank – Ukraine’s largest lender – is creating difficulties given President Zelensky’s close ties to its former owner. Even so, spreads on the government’s dollar-denominated bonds remain low. (See Chart 3.)
  • In Latin America, Peronist Alberto Fernández won Argentina’s presidential election. The central bank tightened capital controls after the vote to protect its shrinking reserves after significant FX intervention in the past month. Although the new stringent restrictions will only last until Mr. Fernández takes office on December 10th, we are sceptical that the new government will remove all capital controls. (See here.) While Mr Fernandez’s and the IMF’s stance remains unclear for now, we think that a large debt write-down will ultimately be required to resolve Argentina’s crisis. (See here.)
  • In the Middle East and North Africa, mass protests in Lebanon, which were initially sparked by fresh austerity measures turned into a show of antipathy towards the regime, culminating in the resignation of PM Saad Hariri. Whoever is appointed will face the tough political challenge of implementing the austerity necessary to stabilise the public finances. Given the confines of the dollar peg and weak economic growth, we think that a debt restructuring is inevitable. (See here.) If the experience of Argentina is anything to go by, dollar bond spreads could widen to well over 2000bp.
  • In Sub-Saharan Africa, Nigerian policymakers continued their crackdown on cross border trade this month by banning all imports and exports from crossing their country’s land borders. (See here.) Elsewhere, Q2 GDP figures showed that Kenya’s economy held up better than we’d thought during the recent drought. (See here.)  While our latest quarterly Outlook argued that growth across the region will remain weaker than most expect, we do expect that smaller frontier markets in Sub-Saharan Africa will do better. (See here.) We’ve highlighted Ethiopia, Rwanda, and Côte d’Ivoire (see here) as key outperformers.
  • In Emerging Asia, preparations for Sri Lanka’s presidential election next month are well underway. 35 candidates have registered to stand – President Maithripala Sirisena not being one of them. Only two of those, Sajith Premadasa and Gotabaya Rajapaksa have a realistic chance of winning. The main economic focus in the run-up the vote is Mr. Rajapaksa’s plans to “restore relations” with China. During his brother’s presidency, booming Chinese investment saddled the country with lots of debt.

Chart 2: Romania General Budget Balance
(12m Sum, % of GDP)

Chart 3: Spread of JP Morgan EMBI Ukraine Index
over US Treasuries (bp)

Sources: Refinitiv, Capital Economics

Sources: Refinitiv, Capital Economics


This Month in Frontier Financial Markets

  • In Frontier market equity markets, the MSCI Frontier Markets Index is no longer outperforming the MSCI EM Index this year. (See Chart 4.) Over the past month the former edged up by just 0.4%, while the latter has risen by 3%. The performance was mixed across countries; Jamaica’s benchmark equity index fell by over 4% m/m. By contrast, the Kenyan stock exchange made gains of more than 6% over the same period.
  • The story for frontier currencies has been a bit more positive. Of the 31 frontier currencies that we cover, only four weakened against the dollar and, of those, only the moves in the Argentine peso and Ukrainian hryvnia were notable. (See Chart 5.) The Ukrainian hryvnia has been caught up in the recent uncertainty about whether Ukraine and the IMF will reach a new financing agreement.
  • Sovereign dollar bond spreads generally narrowed in the past month, with only a handful widening. (See Chart 6.) Tunisian dollar bond spreads narrowed the furthest, as the jump in spreads prior to this month’s presidential election receded. Meanwhile, at the other (far) end of the spectrum, spreads in Lebanon have jumped following political instability the rising chance of a debt restructuring.
  • Finally, the monetary policy loosening cycle in the frontier world continued in October. (See Chart 7.) Ukraine’s central bank cut its key policy rate this month by 100bp, from 16.50% to 15.50%. Elsewhere, the decision by the US Federal Reserve to cut its target range by 25bp prompted central banks in the Middle East and North Africa with dollar pegs to follow suit. Elsewhere, rates were left on hold.

Chart 4: MSCI Equity Indices (Local Currency Terms)
(1st January 2019 = 100)

Chart 5: Exchange Rates vs. US$
(% Change, 30th Sep. – 30th Oct.)

Chart 6: EMBI Sovereign Dollar Bond Spreads
(bp Change, 30th Sep. – 30th Oct.)

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. In Ukraine, monthly activity data suggest that growth slowed to 3.5% y/y in Q3, following an impressive 4.6% y/y recorded in Q2. We think that the economy will grow by 3.5% over 2019 as a whole before easing to 2.8% in 2020. In Bulgaria, we think that GDP growth probably softened a bit to 3.3% y/y in Q3. But the economy appears to have held up well as robust domestic demand partially offset weakness in key export sectors.
  • Elsewhere, growth in Nigeria probably remained weak at around 2.0% y/y in Q3. While oil production rose to a joint four-and-a-half year high in August and September, tight fiscal policy has continued to drag on overall activity. And the recent move to close trade over land borders add to the impression that unorthodox policymaking will continue to weigh on activity.
  • Meanwhile, several frontier central banks will make interest rate announcements next month. In Romania, easing inflation means that the central bank is likely to leaves rates on hold next week. However, inflation is likely to rise back above target next year, which we think will prompt 50bp of rate hikes in the second half of 2020. Elsewhere, we expect Serbia’s central bank to cut its key policy rate by 25bp next month.
  • With inflation falling, Kenya’s central bank is likely to keep interest rates unchanged. Further out, we expect that the next move in interest rates is likely to be down. In Nigeria, inflation picked up in September, but we still think that the central bank will cut by 50bp at its meeting this month. And in Ghana, we expect a 50bp interest rate cut as well.

Table 1: Upcoming Events and Data Releases

Date

Country

Release/Indicator/Event

Time (GMT)

Previous*

Median*

CE Forecasts*

November

Wed 6th

Rom

Interest Rate Announcement

2.50%

2.50%

Thu 7th

Ser

Interest Rate Announcement

2.50%

2.25%

Thu 14th

Ukr

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

+1.6% (+4.6%)

0.5%(+3.5%)

Bul

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

(09.00)

+0.8% (+3.5%)

+0.4%(+3.3%)

Fri 15th

Sri

Standing Deposit Rate

(02.00)

7.00%

7.00%

Sri

Standing Lending Rate

(02.00)

8.00%

8.00%

Tue 19th

Jam

Interest Rate Announcement

0.50%

Mon 25th

Ken

Interest Rate Announcement

9.00%

9.00%

Nga

GDP (Q3)

(1.94%)

(+2.0%)

Gha

Interest Rate Announcement

16.00%

15.50%

Tue 26th

Nga

Interest Rate Announcement

13.50%

13.00%

Wed 27th

Cro

GDP (Q3)

(10.00)

(2.4%)

(+2.5%)

Fri 29th

Est

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

(06.00)

+0.4%(+3.6%)

+0.4%(+3.0%)

Slv

GDP (Q3)

(09.30)

(+2.5%)

(+1.7%)

*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


Quinn Markwith, Latin America Economist, +44 20 7808 4072, quinn.markwith@capitaleconomics.com
James Swanston, Middle East and North Africa Economist, +44 20 7808 4991, james.swanston@capitaleconomics.com