Is the recent rebound in emerging and frontier markets sustainable?
Emerging equity funds reported their biggest inflow since 2014 last week and bonds rallied as currencies steadied.
The reasons for the uptick are clear: oil prices hit a three-month high, while interest rate cuts by the European Central Bank and expectations of further reductions in Japan reinforced the idea that near-zero borrowing costs might be here to stay.
However, in the financial storm of the past year, extensive damage has been inflicted on frontier economies.
Take Mozambique. Gas discoveries drove frenzied activity there only three years ago, including a debut $850 million bond to develop the fishing industry. On Friday, amid stalled investment in its Indian Ocean energy projects, the government asked holders to extend the maturity on the so-called tuna bond.
So, what other risks may be lurking out there? Here’s a tour of some of the frontier countries deemed most liable to follow Mozambique to a debt restructuring or default, and an assessment of a couple more risks besides, from Exotix Partners analysts led by Stuart Culverhouse.
Ghana benefits from a more diversified resource base than many of Africa’s commodity producers, with export earnings from oil outweighed by cocoa and gold. Its International Monetary Fund program is pushing on many of the right buttons.
Still, there remains a potential issue with refinancing bonds due next year. At $530 million, the bill is equivalent to a quarter of Ghana’s net international reserves.
While time is on Ghana’s side – it has 18 months to find a solution – the likely answer, of borrowing to solve its debt problem, is a cause for concern.
Because Ghana is in the gray area of debt sustainability and market access, it’s been a long-held worry that the IMF will seek private sector involvement to reduce the burden of repaying the bond.
Yet this concern is fading. There is unlikely to be much official sector appetite to force an African default, risking dominoes and undoing a decade of progress.
There’s also the consideration that if the IMF did seek to force a restructuring of Ghana’s 2017 bonds, this could cause a cross-default on the government’s other bonds – and more specifically, the 2030s that are guaranteed by the World Bank. That suggests a messy conflict of objectives, and something best avoided.
Prompting graver concern than Ghana or Mozambique is Zambia. The slump in sales of copper, its biggest export, and plunging prices have caused Zambia’s current account deficit to surge. Foreign-exchange reserves are running low.
Its bonds have lost 22% in the past year, compared with 14.5% declines for Mozambique and 11% for Ghana, according to JPMorgan’s EMBI Global indexes.
Yet debt servicing is still manageable. The country for now is only paying interest – albeit on $3 billion of bonds. Given this debt profile, a debt restructuring wouldn’t actually save the government much cash flow in the near-term.
For this reason, a Zambian default is unlikely. However, Zambia should approach the IMF for help – and the sooner, the better.
What Other Risks Lurk in Africa?
Despite the disruption from plunging commodity prices, it’s difficult to pinpoint default candidates in Africa. Beyond the challenges for Mozambique, Ghana and Zambia, the debt profile for the region overall is relatively favorable.
The 16 issuers of international bonds in Sub-Saharan Africa outside of South Africa owe a total $26 billion. But the amount payable this year is less than a tenth of that amount, at $2.4 billion. Mozambique’s bond accounts for a quarter, and Tanzania’s floating rate notes due 2020 and Angola’s “Northern Lights” 2019 bonds make up much of the remaining bill.
The really big worries for Africa government debt sustainability won’t come until repayment spikes in 2023 and 2024.
Venezuela – perhaps most people’s single biggest candidate for default – is doing its best to avoid it – see yesterday’s article.
Azerbaijan may call in the IMF for help.
Brazil and to a certain extent Nigeria seem to be heaping more and more difficulties on themselves. But we’re talking re-pricing of bonds rather than any default situations here.
Beyond Mozambique, no other country is talking overtly about a debt restructuring – and in emerging markets broadly, there’s no reason to expect any wave of sovereign defaults.
Nothing to Worry About Then?
But it’s not just governments that investors need to think about when assessing default risk. One consequence of emerging markets becoming a mainstream asset class in the past 15 years is a jump in foreign borrowing by companies in the developing world.
Non-financial companies have quadrupled debt in the past decade across emerging markets, according to IMF data to 2014. Defaults by companies have been climbing and may rise further as a lagging effect from slowing economic growth.
This is a cause for wider concern. Given corporate bond issuance is a relatively new phenomenon, developing-nation policymakers have little experience in handling wide-ranging company defaults. This increases the policy uncertainty and potential for mistakes in the event of corporate debt crises.
Problems for flagship companies could prompt populist responses, including attempts at bailouts, eroding state fiscal and debt burdens further as corporate debt migrates to the public sector balance sheet.
Should companies lose market access, the refinancing risks will only increase and put more pressure on international reserves, sowing the seeds for wider macroeconomic consequences.
Another area of concern is currency risk. Exchange rates generally are still under pressure in an environment of continuing dollar strength.
In the past, the main concern from emerging market currencies was the prevalence of fixed exchange rate regimes, which left countries open to economic shocks. Pegs collapsed and crises developed.
Given the global transition to floating rates, there are fewer fixed currency regimes around now, and therefore fewer pegs at risk of collapse – reducing the chances of a crisis by contagion.
However, large moves in floating exchange rates can still be disruptive, complicating monetary policy decision-making. Depreciation increases debt-servicing costs in local currency terms for governments and creates mismatches between domestic revenue and foreign obligations for companies, leaving them vulnerable to default.
Among the currencies that seem to be the most overvalued and therefore most at risk of depreciation, Venezuela unsurprisingly ranks among the most exposed.
Ironically, the bonds issued by many of these frontier markets are actually less risky than those issued by so-called ‘developed emerging markets’ like Brazil and Venezuela. For those markets that loaded up on cheap dollar-denominated debt in the past, a relentlessly strengthening US dollar now threatens to push them into the abyss.