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Against the lingering backdrop of an overextended China (and by extension, Brazil et al.) and Friday’s shockingly moribund U.S. NFP report (as Zero Hedge tweeted, ‘less than six weeks until Jackson Hole…’) now is the time for portfolio managers to truly discriminate among emerging and frontier markets and specifically consider reducing exposure to high-beta names that are likely all-too uncomfortably correlated to the kick-the-can, er, ‘risk on’ trade. Per Barclays, Qatar ’20 and ’30 sovereigns, for instance, as well as quasi-sovereign corporate names like Rasgas and Qtel are likely to benefit in the near-term not only from their hitherto underperformance (~20bp spread widening YTD) but from ever-improving macro fundamentals (21.5% y/y GDP, CA surplus 25.3%/GDP in June, a seemingly perpetually subdued, GCC-low 2% annualized headline inflation rate projected for 2011 and GCC-leading annualized export growth) as well as the implementation of the recently announced National Development Strategy 2011-16 ($USD226bn budget) that analysts expect will “boost the non-oil sector activities, particularly on the investment side.” Furthermore fiscal stimulus in Qatar (money supply growth up 29.9% y/y in April versus GCC average of 17.3%) and its corresponding deposit growth (up 18.2% y/y) remains muted and quite manageable in the context of a budget breakeven oil price (now ~$40/b) more than half that of say, Saudi Arabia, while credit trends (bank credit to the private sector in Qatar expanded by 5% y/y in April versus a GCC forecast of 8.6% y/y in 2011 as post Arab-Spring liquidity mean reverts) also look positive.
While back-to-back easing announcements from Ghana left us surprised, nothing compares of late to the State Bank of Vietnam’s (SBV) 100 bp reverse repurchase rate cut (to 14% as of Monday) which came on the heels of June’s inflation reading of 21%–a 31-month high–and the ensuing consensus among analysts for a 100 point hike. At first blush the dovish cuts seem counter to the state’s alleged, newfound resolve away from its hitherto growth fetish and towards a more prudent, macroprudential mantra. Indeed, Barclays reiterated its “underweight” call this week citing heightened risk, though admittedly this comes just one month after it expressed a “constructive view on [the] sovereign” in the belief that “the government is taking appropriate steps to tackle growth, inflation, currency and banking system vulnerabilities.” Yet a more nuanced take tells a different story and suggests that the SBV still may have its eye on the ball despite this latest Jekyll and Hyde routine. Consumer prices actually slowed on a monthly basis in June, for instance, and broad money supply growth remains relatively subdued, up just 2.45 percent YTD versus 7.5 percent during the first five months of 2010, which bodes well for H211 figures and the thesis that this summer marks inflation’s peak. To that end February’s announced policy paradigm shift has effectively reversed the once runaway spread between the unofficial USD/VND rate and spot (a proxy measure for domestic confidence in the currency), meaning that measures to curtail dollar lending and black market trading, as well as to increase the attractiveness of holding dong deposits are becoming entrenched. What has failed to take hold, however, is a healthy borrowing and lending dynamic among domestic banks which explains why growth, at 5.6 percent annualized, still lags the state’s now twice-cut GDP target (6 percent currently for 2011 from 7-7.5 percent initially). While “reasonable lending rates” per one CEO should be 15-18 percent and deposit rates at 13-15 percent, for instance, one report this week stated that banks were offering to pay dong deposits at 20 percent while charging companies roughly 25 percent, well above the central bank’s deposit rate ceiling of 14 percent and the catalyst for a further liquidity squeeze as companies become reluctant to borrow and banks reluctant to lend. The vicious cycle has triggered a liquidity scare of sorts–at least in the country’s ‘productive’ sectors, i.e. agricultural companies, export businesses and SMEs–against the backdrop of further FX reserve development (USD13.5bn at the end of May from USD12bn at the end of 2010, per the IMF), part of the country’s strategy of managing an omnipresent trade deficit made feasible given historical sticky structural flows (FDI, remittances). Macroprudential policy isn’t just about price stability, but also the way in which capital is deployed. There’s no reason the SBV can’t pursue both agendas at once.
Markets hate uncertainty and Tuesday’s price action in EPU, Peru’s index fund, was indicative of such as investors eagerly eye Sunday’s impending Presidential run-off. Interestingly, though Fujimori may be considered “more pro-business than the leftist candidate Humala” other observers point out that in fact “Keiko has few incentives to govern democratically, while Humala faces constraints that may force him to govern democratically.” Meanwhile The Economist somewhat brazenly slags the entire lot off, opining that regardless of who emerges “the single-minded pursuit of foreign investment and economic growth that marked [outgoing President Alan] García’s presidency now seems to be drawing to an end [and] many Peruvian democrats will have nightmares in the coming weeks.” A bit much, no? Peru remains one of the fastest growing countries in the world, up 8.8% annually in 2010 (the BRIC median, for comparison) and projected by Barclays to trail only China for current year domestic output on the back of hitherto both monetary and fiscal stimulus. Moreover the central bank (BCRP) has not overly lagged the curve (per Taylor’s Rule) and prices remain in line with the targeted 3% upper band; the 25bp hike on May 12 (to 4.25%), while below expectations, was more a commentary on the relative slowdown to date and the private sector’s risk averse approach to the election run-up whereby GDP proxies such as electricity consumption and cements sales have visibly dipped. To this end, policy rates should tighten fairly substantially post election to 5.5% by year’s end and, per Barclays analysts, will likely be more front-loaded in the event Fujimori wins. That said, they write, whomever wins will need to navigate the country away from a purely economic and more towards a social agenda: “Peru’s socio-economic conditions and institutional weaknesses explain why, despite impressive growth over the last several years, Mr. Humala’s seemingly radical proposal continues to appeal to a third of the population.” While ominous sounding, it’s hard to completely divorce oneself from a pragmatic central bank in a high growth economy, especially when copper may finally look healthy again. More uncertainty.
The interplay because geopolitics and equity markets–especially when it comes to relatively under capitalized and illiquid developing markets–has been well documented this year against the backdrop of MENA social unrest. But when it comes to trading sovereign debt the importance of insightful political stability and transparency analysis becomes almost as integral a facet to assessing risk premiums as are more conventional fiscal measures. Beyond Brics notes, for instance, the “strong recovery” in Ivory Coast ’32s which fell to 35 cents on the dollar during last month’s nadir and following a missed $29m interest payment at the beginning of the year but have since rallied to 54.6 cents. If only I could have had that crystal ball when a risk consultant back in December emailed me out of the blue asking for my prognosis. That said, while the bounce-back no doubt stems largely from Alassane Ouattara’s official ascent into power, social unrest remains problematic–especially since much of it hinges on the hitherto unresolved issue of land reform that also lies at the center of ensuring cash flows from cocoa–the economy’s lifeblood and thereby a bond holder’s best friend–remain stable. Aid money will help meet debt arrears as will forgiveness of nearly a quarter of debt outstanding, but a fractious constituency may remain fractured longer than expected and shouldn’t be discounted. Meanwhile, in similar fashion analysts with Barclays suggested taking profits on Nigeria’s 2021 Eurobond given its spread narrowing to date vis a vis the benchmark Ghana ’17s despite higher oil prices and improving fundamentals. The call may be prophetical given news of ‘orchestrated’ post-election violence, the country’s history of slumping oil production following elections in 1999, 2003 and 2007, and an uptick in seized, illegal arms shipments to Lagos. To that end, disruption to Nigeria’s light sweet crude output “would come as a double blow for refiners already scrambling to replace the loss from Libya,” per analysts.
The National Bank of Kazakhstan’s (NBK) recent monetary normalization–which upped the refinancing rate for the first time in eighteen months by 50 points to 7.5% in March, a move it will probably repeat in Q2 though when considering Kazakhstan always watch to first see what the Russians do)–along with hawkish comments from chairman Grigoriy Marchenko that “it could raise the full-year inflation forecast” for 2011 from the current 6-8% range, signal a fairly compelling case for further tenge (KZT) appreciation against the dollar (a trade expressed via NDFs) despite some $5.5.bn in intervention designed to offset foreign capital inflows tied to the country’s net oil exports of 1.5 mb/d that have pushed the 12m rolling current account balance well into surplus. While the NBK is mindful of rapid appreciation, said concern lies (rightfully) secondary in our view to inflation which, as myriad EM (like Russia!) bank governors worldwide can attest, may be one reason to let domestic currency purchasing power ascend. Consumer prices in Kazakhstan rose 7.8% last year, compared with 6.2% in 2009, on the back of food prices–which spiked following a poor summer grain harvest–recent fuel price increases, and strengthening consumer demand (retail sales jumped 12.3% last year as gains stemming from robust industrial production numbers–up 10%y/y– passed through to wages) underpinned in part by the state’s social programs. Aggressive intervention would only serve to exacerbate these inflationary trends, undermine the (recently re-elected) President’s mandated budgetary largesse from several months earlier and overall run contrary with the Balassa-Samuelson thesis. Finally, as some observers have noted KZT strength only encourages further de-dollarization, a necessary step in the IMF’s eyes towards achieving domestic capital market maturation.
Herein a few scattered links and stories from the past few days that I feel deserve attention:
- EM debt spreads continue to tighten against treasuries while the percentage of hard currency denominations declines. Trading volumes hit a new peak in 4Q10 and corporates in particular have benefitted, increasing their share of total issuance to $69 billion, “accounting for about three quarters, up from January to March 2010 when they sold $41 billion” in a sure sign of domestic capital market evolution and maturation in said economies. That said, to what degree will developed market monetary tightening mop up liquidity? Per Gramercy’s Robert Rauch from this weekend’s FT, for instance, “in the absence of QE3, QE4 or QE5, many borrowers in emerging markets do not have alternatives to bond markets and we could see another spate of restructurings.”
- As Saudi Arabia’s ever-incrasing social spending bill rises so do OPEC’s revenues (remember the demographics in play: sixty percent of the population (~25m) is under the age of 40 and forty-five percent is under 20; meanwhile analysts estimate that four million jobs will need to be added within the next decade to keep unemployment at ‘acceptable levels’). The growing break-even price needed by the Kingdom to balance its budget is all you need to know about where the price of oil is headed (see chart).
- As Laurent Gbagbo’s days increasingly appear numbered, cocoa prices have in turn tumbled in anticipation of the impending resumption of exports from the world’s largets supplier. That said the turnabout from speculators desparate to liquidiate is likely a bit rash in scope given that it will take time for local farmers to resume activity and in the meantime other producers such as Indonesia need higher prices to incentivize addressing the slack.
- Meanwhile a good ‘political arbitrage’ play to keep an eye on remains Randgold, which operates the Tongon mine in the Ivory Coast and whose shares are still down nearly 10 percent since the start of the year despite a fairly sanguine annual report which forecasts production increases moving forward.
Woe is the EM central banker; as RBI’s Dr. Subir Gokarn pointed out in Wednesday’s FT, for instance, the delicate balance between “keep[ing] inflation in check by containing the potential spillovers from food and energy prices, while minimising deviations from a sustainable growth trend” has rarely been so harrowing. For the Central Bank of Turkey (CBT), the foundations underpinning 8.4% annualized real growth last year have paradoxically also pressured a rapidly ballooning current account deficit (roughly -48.6bn USD in 2010 versus -14.0bn in 2009) as Q4 private sector credit extension surged (41% y/y) and has remained above 40% in the first two months of 2011–well above the government’s 20-25% y/y guidance and despite reserve requirement increases. This ‘monetary normalization lite’ underscores the degree to which lira depreciation remains the Bank’s primary tool (rather than rate hikes which invite capital flows, not to mention political scorn in an election year) to reverse the CA deficit bulge, since the alternative would be to raise real rates and encourage portfolio financing (which saw record flows in 2010) of the very deficit officials purportedly seek to address. The Bank’s policy has also been helped hitherto by falling inflation which slowed to only 4.2% y/y in February, a record low. Yet against the backdrop of the CA breakout and secular lira fall this magic act cannot last forever. Barclays notes, for instance, that low inflation last year “was driven largely by base effects (tax increases early in the year)” while projecting that headline as well as core prices would respond sharply going forward–to 8% by July and then “to about 7.5% by end-year, much of it depending on local harvest dependent developments in unprocessed food prices.” Said occurrence, however, coupled with a CB new governor this month and a further entrenched AKP by summer, may finally create the perfect recipe for bona fide monetary hawks to spread their wings, which in turn would theoretically signal an end to the lira’s nearly four year fall from grace. Payer swaptions, which pay a fixed rate while receiving floating, seem a sensible way to play this envisioned outcome, especially since the market’s current 125bp hike expectations seem low.
Regarding the thesis that “the outlook for [GCC investment banking] is broadly positive” as “the region’s investment and project finance needs are growing enormously,” Global Finance notes this month (“Banking on Stability”) that “after M&A, fees from debt capital markets operations (DCM) constitute the largest portion of investment banking fees in the Middle East.” The piece quotes Mohammed Ali Beyhum, executive general manager at Lebanon’s Bank Med, who opines that the “Islamic bond, or sukuk, markets could hold great promise in 2011.” Analysts in general have been calling for a sukuk ‘convergence’ of sorts ever since Dubai’s debt crisis, which some observers blame for unfairly calling into question the entire premise of Islamic financing structures. “It is important to note that during 2010, the sukuk market lagged the conventional bond market, as the former was hit by the aftermath of Dubai’s debt restructuring and the accompanying series of defaults on high-profile sukuk issuances,” Beyhum said. And recent regional turmoil may have only added further fuel to market discrepancies as well as to upside resurgence: Markaz, a Kuwaiti asset management firm, reported earlier this month that yields on Dubai’s Islamic bonds had dropped to a five-month low, leading a GCC sukuk rally, on speculation that UAE and Qatar would be spared from protests that toppled the governments of Egypt and Tunisia. To that end, a recent New York Times article stated that while uncertainties “may have lowered appetite for sukuk introductions and made issuance more costly by raising premiums,” the long-term trend appears in tact. Per Paul-Henri Pruvost, an analyst with S&P, while Malaysia accounted for nearly 80 percent of last year’s issuances, activity in the Gulf [in Saudi Arabia, Qatar and UAE in particular] is destined to flourish given not only the region’s “huge pipeline of [planned] government projects and infrastructure,” but also the need to “develop a more solid fund-raising market for Islamic banks and insurance companies . . . typically constrained in terms of the asset classes they can invest in.” One U.S.-based law firm, in fact, projected that by next year already GCC-based Shariah-compliant financing will account for nearly one-third of the global market, up from 12.5% five years ago. Said Pruvost: “These institutions in the Gulf and Asia are trying to make their balance sheets very liquid, so they are very hungry for this kind of instrument.” Finally, it will be important for investors to weigh the long-term effects of recent measures taken by Qatar’s Central Bank, which earlier this year banned Islamic banking in conventional institutions, and the possibility of related policies in surrounding countries. At first blush, the move (designed purportedly to squash co-mingling of conventional and Islamic funds) would appear to greatly benefit a handful of domestic Islamic banks such as Qatar International Islamic Bank (QIIB), whose shareholders gave approval earlier this month for a sukuk issuance later this year.
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Robust consumption (global demand has doubled over the past decade) for crude palm oil and its underlying derivative products such as cooking oil, cosmetics, toiletries, and industrial cleaning agents (i.e. all fairly demand sticky goods) led by China and India (5%/annum growth over the past four years, propelled of late by government restocking in the face of inflation-induced reserve releases, in the former and 16% y/y in the past five years for the latter, augmented partially by a lagging domestic peanut oil sector) coupled with La Nina-related, mediocre crop yields in Argentina (the third largest exporter of soybeans and the top exporter of soybean oil) and El-Nino related low yields in Malaysia (which, coupled with Indonesia, supplies roughly 90% of global palm oil production) may help sustain futures prices in the short-term. Analysts point to Singapore-listed Golden Agri-Resources, for one, as a firm that will likely continue to benefit. Barclays projected “global stocks could fall to around 4.5 weeks of consumption–the lowest level in over 30 years” and will rebound only to the degree that governments in Malaysia and Indonesia resist meddling with price controls and export restrictions (to assuage the retail sector they already control prices and subsidize VAT) and weather patterns comply (historically, “yields [should] improve in the second half of 2011 as El Nino’s lagged impact wears off and drier weather allows harvesting and transportation to return to normal operations”). To that end, ECM Libra, an investment bank, notes that an examination of atmospheric indicators such as the Southern Oscillation Index (SOI) and its inverse relationship with the monthly change in Malaysian palm oil production is positive in terms of the probability of near-term yields mean-reverting (“January saw the SOI index trending down to 19.9 from a high of 27.1; to note, the 27.1 reading was the highest La Nina reading since 1973). That said, as with many food commodities a bona fide secular bull market (as in price inflation) in palm oil may be in the making due to notable structural restraints (in addition to the aforementioned Asian demand dynamic): Malaysia’s future yield prospects relative to current ones look dim, while environmental concerns–namely a two-year moratorium on deforestation based in part on Indonesia’s bilateral treaty with Norway–may interminably hamper Indonesian output (though per Greenpeace said edict in reality has far more bark than bite).
JGW
Frontier Markets 