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Emerging market economies continue to deploy fiscal and monetary easing to cope with the ongoing crisis but caution is still warranted. In this week’s publication, we share our thoughts on rate cuts in Turkey, Russia, Mexico, and Ukraine and broader effects of loose monetary policy on EM currencies. In addition, we comment on credit headwinds in Mexico and South Africa’s unaffordable stimulus plan.

Central banks across EM continue to deploy countercyclical monetary easing to backstop growth, but space is severely limited except in a handful of cases and EM currencies are bearing the brunt of risk-off market sentiment

Market Event: The central banks in Turkey, Russia, Mexico and Ukraine were among the EM monetary authorities that cut their policy rates this week. While Russia, Mexico and Ukraine are among the very few major emerging markets that entered the crisis with the advantage of having positive real interest rate buffers, Turkey is a perfect example of a jurisdiction where the authorities are willing to push real interest rates further into negative territory (-3.1% ex-ante) with all the associated FX and macro stability risks.

Gramercy View: Since the sudden stop in global economic activity due to the spread of COVID-19, the revealed policy preference by monetary authorities across EM has been to continue aggressive interest rate cuts in an attempt to cushion collapsing growth dynamics in their domestic economies. Aggressive use of the monetary channel has come even at the cost of pushing real interest rates in many economies to historically low (e.g. Brazil, South Africa) or, in some cases, deeply negative levels (e.g. Poland, Turkey, Chile, Hungary, etc.). Given the material carry erosion and the flight to quality by global investors seeking the safety of USD-denominated assets, EMFX has borne the brunt of the risk-off sentiment toward EM as well as within the asset class. Despite material underperformance, our view on EMFX remains cautious, but we see selective idiosyncratic opportunities in local currency duration. We believe a sustainable rebound in EMFX will require compelling signs that EM economies have turned the corner on the economic/social pain caused by COVID-19 before investors get comfortable with returning to otherwise deeply undervalued EM currencies. In addition, EM central banks will also need to support the process by partially reversing recent easing in order to restore some level of real interest rate buffers vis-à-vis DM counterparts. We believe that both conditions are highly unlikely to materialize in the near-term amid the confirmation of a broad and deep economic fallout across EM in the coming months.

Mexico credit pressures continue to mount despite fiscal space; emergency rate cut and other stimulus measures likely to have marginal effect on real economy 

Market Event: After much anticipation, Moody’s downgraded Mexico’s sovereign rating last week to Baa1 with a negative outlook, a move which prompted a subsequent downgrade of PEMEX to sub-investment grade. Now with two sub-investment grade ratings, PEMEX will be removed from major global indices in May, which is likely to result in some forced selling of the company’s bonds. Meanwhile, Banxico implemented a 50bps emergency rate cut and announced efforts to ease pressure in domestic markets via increasing liquidity and credit to SMEs totaling roughly 3% of GDP. On the fiscal side, the government plans to implement austerity measures worth MXN662bn to increase social spending. This is all in the backdrop of continued acceleration in COVID-19 cases, now exceeding 10,500. The mortality rate remains fairly elevated at around 9% and is likely skewed due to testing inadequacy, although pre-existing health conditions are relatively high. Lastly, the sovereign successfully issued $6bn in new debt this week with a modest 25-50bps new issue concession, despite the aforementioned challenges.

Gramercy View: While both Mexico and PEMEX will continue to face credit headwinds, we believe that the sovereign’s commitment to PEMEX will remain intact given its 100% ownership and the company’s strategic importance to the sovereign. We therefore see the deterioration as largely a United Mexican States story resulting in compression of the PEMEX vs. Mex spread mostly driven by widening of the sovereign, particularly over the medium-term. While not imminent, the prospects for a downgrade of the sovereign to HY will grow as the crisis deepens. In the near-term, price volatility could ensue which will result in limited compression or widening of the relative spread due to the fact that the government’s response to PEMEX needs will likely be disjointed, slow, and unclear as it has been in the past. At the same time, the government’s fiscal space is relatively robust complimented by an additional reserve buffer from its ~$65bn Flexible Credit Line with the IMF, despite anticipated meaningful deterioration of fiscal metrics over time. The authorities have indicated that they do not intend to use the IMF facility, but nevertheless is a last resort option available until November 2021. We anticipate growth will disappoint to the downside (contraction of ~7-8%) and AMLO’s policy approach will be increasingly tested if his popularity wanes as the crisis deepens and next year’s mid-term elections move into focus.

South Africa stimulus plan further threatens debt sustainability

Market Event: The Treasury announced a large stimulus package worth ZAR500bn or 10% of GDP this week which entails a credit guarantee scheme, job protection, household transfers, tax initiatives, and food and health support. The authorities confirmed that they are exploring financial assistance from International Financial Institutions (IFI’s), including emergency assistance from the IMF, to help finance the additional spending.

Gramercy View: While the measures announced should help partially offset the significant hit to growth, they will not improve the structural challenges that the South African economy faces. The new plan will likely result in a fiscal deficit of over 15% of GDP, challenging what was already a bleak outlook for debt sustainability. Support from the IMF and other multilateral institutions will be a marginal credit positive but political willingness for a broader IMF program, which entails conditionality and reforms that would more materially improve the outlook for South Africa, remains limited at this juncture. We do not anticipate the entirety of the higher fiscal spending and lower revenues to be covered by IFI support and therefore, expect greater local bond supply as the year progresses. While SARB purchases and additional rate cuts should help to partially offset the impact on local bonds, we believe that a reversal in the recent rates rally is likely as risks remain tilted to the downside from a growth and fiscal perspective, absent clarity or improved confidence on plans for a broader criteria backed IMF program.

Please contact our Co-Heads of Sovereign Research with any questions:

Kathryn Exum, Senior Vice President, Sovereign Research Analyst
[email protected]

Petar Atanasov, Senior Vice President, Sovereign Research Analyst
[email protected]

This document is for informational purposes only. The information presented is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. Gramercy may have current investment positions in the securities or sovereigns mentioned above. The information and opinions contained in this paper are as of the date of initial publication, derived from proprietary and nonproprietary sources deemed by Gramercy to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. This paper may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this paper is at the sole discretion of the reader. You should not rely on this presentation as the basis upon which to make an investment decision. Investment involves risk. There can be no assurance that investment objectives will be achieved. Investors must be prepared to bear the risk of a total loss of their investment. These risks are often heightened for investments in emerging/developing markets or smaller capital markets. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. The information provided herein is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation.