The recent Annual Meeting of the IMF reinforced that EM debt investors should pay extra attention to countries’ individual circumstances, write Aaron Grehan and Carmen Altenkirch.
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The Annual Meetings of the International Monetary Fund (IMF) and World Bank on October 8 to 14 to discuss issues of global concern began on shaky ground; quite literally, as a 6.0-magnitude earthquake rocked the Indonesian island of Bali, the location of this year’s event. The choice of destination was particularly apt given so much of the world’s attention has been on the challenges facing emerging countries.
The IMF cut its global economic growth forecasts for this year and next – the first reductions in more than two years – citing the worsening trade war between the US and China and a sharper-than-expected rise in US interest rates. The fund projected global output will expand 3.7 percent this year and next, down from the 3.9 per cent growth it projected just three months ago. The risks remain tilted to the downside.
However, while the overall message was glummer, with more emphasis on the downside risks, it was acknowledged that global growth remains healthy. That is especially true of emerging economies, with growth in the main group of nations seen holding steady at 4.7 per cent next year while low-income countries, such as those in Sub-Saharan Africa, should see growth accelerate. In comparison, the outlook for the wealthiest nations is less impressive, with the IMF expecting growth to slow to 2.1 per cent in 2019 from 2.4 per cent this year. US growth is set to slow to 2.5 per cent from 2.9 per cent as the impact of fiscal expansion fades; growth in the euro zone is set to slow to 1.9 per cent from 2.0 per cent and in Japan to 0.9 per cent from 1.1 per cent.
The IMF urged countries to protect against the risks they faced, suggesting some had become too complacent thanks to more accommodative financial market conditions since the global financial crisis. It argued “the time to repair the roof is when the sun is shining”. However, several countries were at pains to differentiate their position from those of Argentina and Turkey, and highlight where policies had been proactive. For instance, current Mexican Finance Minister Jose Antonio Gonzalez Anaya highlighted the improvement in credit metrics delivered by the outgoing administration. “When the Fed hikes something always happens and we don’t want to be that something,” he said.
In truth, many of the risks outlined by the IMF have been apparent to markets for some time, and help explain the underperformance of EM assets as the mood of optimism at the start of the year disappeared. As such, it felt as if the messages from the meeting were aligned with investors’ concerns. We expect the EM debt universe will be scrutinised ever more closely, meaning investors will need to be extremely careful when selecting countries.
The focus for much of this year, has been on identifying and limiting exposure to countries with weak fiscal positions and a heavy reliance on external funding. Following the IMF meetings, we believe it is important to distinguish between countries that understand financial market conditions are increasingly challenged and are willing to react, and those which are not. We were struck by just how blasé policymakers from many of the most vulnerable emerging countries were, with the focus too often on what had been achieved and neglecting what more needed to be done.
The haves versus the have-nots
One of the biggest questions likely to emerge over the coming months, and a focus of many of the Q&A sessions, was market access: the ‘haves’, the ‘have-nots’, and ‘those that would pay dearly for it’. Unchallenged market access for much of the past five years, along with readily available Chinese financing, has resulted in a rapid rise in debt and an increase in the number of countries at risk of distress as the cost of servicing that debt rises. Just how adaptable governments are to their changed circumstances, and their ability to unearth alternative financing options, will become areas of greatest scrutiny. In some cases, plugging these large financing gaps and dealing with potential restructurings will involve co-ordination between traditional multilateral lenders and new creditors, like China; adding a layer of complexity.
Nonetheless, the widening of spreads in higher-yielding segments since the start of the year has created pockets of value. The most interesting opportunities are likely to be found in countries that are in the early stages of taking the necessary steps to deal with the new reality and where consequently there is most room for outperformance.
Perhaps the best example is Angola, which received rare praise from the IMF during the meeting after it approached the organisation for assistance. While Ecuador did not make the journey to Bali, it is among the most interesting of the high-yield stories. Even if the authorities don’t succeed in convincing the market of their commitment to fiscal consolidation, and are unable to close the financing gap by issuing debt, they will have the option of approaching the IMF for support early next year.
Pakistan, which has seen a sharp drawdown in international reserves over the past year, ducked out of its meeting with investors as it sought much-needed IMF support. Assistance from China and possibly Saudi Arabia, along with the IMF, could help the country close its funding gap. Argentina could be in a similar position, which could leave its debt beginning to look more interesting. However, Treasury Minister Nicolás Dujovne’s presentation demonstrated the country faces a monumental task to get its fiscal position back under control. Overlay election-related risks next year and its debt remains unattractive, at least for now.
We are also cautious of countries exiting IMF-reform programmes, particularly those with large issuance and roll-over requirements. Perhaps the best examples are Egypt and Sri Lanka, whose IMF programmes end next year. Egypt, which needs to fund a near double-digit budget deficit, will find it hard to tighten fiscal policy rapidly, given rising interest costs and the ever-present risk of social unrest. As for Sri Lanka, it needs to refinance a sizeable amount of eurobonds at the same time as its reformist government is facing a credible threat of being defeated by a populist opposition in elections in 2020.
Sitting somewhere in the middle of these two groups is Ghana. Its credit metrics are decent, and during the meetings the Ghanaians stressed they were quite capable of managing public finances without IMF support. However, history casts serious doubt on that claim, and new issuance will have to come at a premium. Signing up to a new programme would be enough to ensure Ghana retains easy market access.