Featuring: UKRAINE | PAKISTAN | ETHIOPIA | OPEC+ | OECD PROJECTIONS
This week we highlight Ukraine’s new formal agreement with the IMF and how it reduces government financing risk and anchors investor confidence, Pakistan and Ethiopia join the list of low income economies requesting debt standstills by G20 official lenders, OPEC+ one-month extension of output cuts sends an encouraging message to oil markets, and the OECD projects deeper than consensus economic contraction across the global economy in 2020 and slow recovery from 2021 onward.
The race to retrace or a turning point for the bears?
Market Relevance: Anticipation into the FOMC stole most of the limelight this week. An unsurprisingly dovish twist triggered further weakness as Powell downplayed the prior NFP print and signaled more caution. However, the news-flow coincided with second wave fears in the U.S., Poland and Brazil as Azerbaijan re-imposed lockdown measures. On the Fed, specifically there are three takeaways: (1) YCC and forward guidance are expected to remain discussion points for September; (2) monthly purchases are expected to continue at least at the current pace; and (3) median dots remain unchanged for the next two years which puts zero interest rate policy on the backburner (for now). The USD weakness that has ensued over this week briefly reversed, though the sell-side remains long EUR, meanwhile the DXY caps the rally in EMFX. Market participants are now recalibrating their views on U.S. Treasuries as we shift from a bear steepening to a flattening environment, although this is triggering further fragility across emerging markets. Moreover, oil remains largely flat on the week but disguises the near 7% move on Thursday. Credit spreads through June are almost on par with May, with CEMBI Investment Grade 25bps tighter and CEMBI High Yield 74bps tighter. In the Race to Retrace the CEMBI High Yield has recouped 68% of its widening, while CEMBI Investment Grade has only recovered 55%. Despite brimming with excesses, the market finds itself once again seeking more.
Ukraine’s new IMF program unlocks much needed external financing and anchors investor confidence
Market Relevance: The IMF’s Executive Board approved an 18-month, $5bn Stand-By Arrangement for Ukraine. The approval enables the immediate disbursement of $2.1bn in balance of payments and budget support funds, while the remaining $2.9bn will be disbursed over four reviews with relatively light structural reform conditionality attached. The IMF’s program will also unlock up to $3.2bn of additional external funding from the European Union and the World Bank. Meanwhile, with the IMF anchor secured and having one of the highest real policy interest rates across EM, the National Bank of Ukraine (NBU) delivered a 200bps cut to 6% on June 11, signaling this will likely mark the end of its easing cycle that started in March 2019 and saw 1200bps of monetary policy easing.
Gramercy View: Securing a new program with the IMF and unlocking sizable multilateral financing was of critical importance for Ukraine’s government and economy as the country copes with COVID-19 challenges while also facing significant external debt service payments in the near-term. Importantly, as it has consistently been the case throughout this most recent phase of Ukraine’s cooperation with the IMF that began in 2015, we expect the Stand-By Arrangement to anchor investor confidence and help source additional financing as the authorities are navigating the likely challenging domestic and global economic environment in 2020-21. According to our estimates, Ukraine’s total gross financing needs (budget deficit and debt amortizations) amount to around $22bn this year and the incoming budget support from multilateral sources will go a long way toward bridging the gap. However, we estimate that around $10bn still remains to be financed in the domestic market or from bilateral creditors. Given the material improvement in global financing conditions for HY EM sovereign issuers such as Ukraine that has taken place in May and June, we are of the view that the government is likely to also consider tapping the global capital markets in 2H20 should the benign external environment persist.
The Paris Club grants debt relief through the end of 2020 to Pakistan and Ethiopia
Market Relevance: Pakistan and Ethiopia are the latest countries to receive debt relief from the Paris Club, along with Chad and the Republic of the Congo. This brings the total number of countries that have been granted waivers to 12. The Paris Club’s chairwoman also said in a press conference that governments are losing their fear of asking for debt repayment holidays.
Gramercy View: Pakistan is by far the largest country to have been approved for the G20’s Debt Service Suspension Initiative (DSSI) thus far, owing over $20bn to G20 members, with the largest debtholder being China. Ethiopia is also one of the 26 countries that qualifies for the program with outstanding sovereign bonds. At this point, the initiative is still small, with the 12 approved countries together accounting for $1.1bn of the $36bn total eligible debt. Yet with these new additions, the Paris Club’s chairwoman stated that she expects relief efforts to continue accelerating as the waters are tested and countries are less fearful of losing market access. However, we note that in addition to serious concerns about market access implications, another major issue for national governments is the potential impact on sovereign credit ratings that still remain subject to significant uncertainty. As discussed in our May publication, “Emerging Market Debt Relief and The Paradigm of Non-Payment”, we continue to take a cautious approach to countries that came into the crisis with “pre-existing conditions,” or low fiscal, monetary and external buffers. While talks regarding private investor participation have stalled with improving market conditions in recent weeks, we remain wary that greater country participation in the G20’s DSSI along with tighter financial conditions and/or acceleration of COVID-19 in low income economies (mainly in Africa) could reignite the issue.
OPEC+ announced a one-month extension of its historic output cuts
Market Relevance: The announcement keeps OPEC+ supply cuts at 9.6 mb/d (vs. 9.7 mb/d previously due to Mexico’s refusal to roll its cuts). Additionally, the agreement includes language that will force those countries that failed/fail to comply with their quota to compensate with additional cuts in the coming months.
Gramercy View: The tone of this meeting was very encouraging for market participants. In particular, all members (except Mexico) agreed that the current context required coordinated action. Further, the language that was added to pressure ‘cheaters’ into compensating for missed quotas (now including monthly Joint Ministerial Monitoring Committee (JMMC) monitoring meetings) is also encouraging and was not part of our base case. Combined with the sharp decline in U.S. production, the OPEC+ extension adds further clarity to near-term unknowns. Our focus now turns on how non-OPEC+ players will react to the announcement. Principally, we expect shut-in production, especially U.S. production, which is down ~2.0 – 3.0 mb/d, to react to higher oil prices. The next immediate risk is how OPEC+ will react in a scenario where U.S. production starts coming back online. We think that the large global inventory balance combined with the return of Libya to the global stage is likely to cap a move closer to $50/bbl Brent in the near-term.
OECD’s mid-year Economic Outlook projects sharper contractions across the global economy and soaring unemployment in the wake of COVID-19
Market Relevance: The OECD released the first volume of its 2020 Economic Outlook Report, a bi-annual analysis of economic trends and outlook for the next two years. The report outlines two possible scenarios for the global economy: 1) a single-hit scenario, where no second wave of the COVID-19 outbreak occurs and 2) a double-hit scenario, where a second wave of COVID-19 hits before the end of 2020.
Gramercy View: In the single-hit scenario, global economic activity falls 6% in 2020, unemployment climbs to 9.2% (from 5.4% in 2019), and living standards fall globally, with about five years of income growth lost by 2021. In the double-hit scenario, a second wave outbreak triggers renewed lockdown measures, world economic output plummets 7.6% in 2020 before climbing 2.8% in 2021, and the OECD unemployment rate almost doubles to 10%, with little recovery in 2021. While we cannot predict the potential for a second outbreak, our view is that the outlook for countries in emerging markets will largely depend on the fiscal and economic space with which they entered the crisis. For example, among the most impacted emerging markets by COVID-19, countries like Russia, Chile and Mexico that entered 2020 with relatively stronger fiscal frameworks are better positioned to cope with the social challenges and the pandemic-induced economic downturn than peers such as Brazil, South Africa, and Turkey that are struggling with weaker fiscal and/or policy frameworks.
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]
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