Featuring: Argentina | ECUADOR | BRAZIL | SERBIA | INDONESIA |

This week we discuss Argentina and Ecuador’s debt restructuring offers and comment on Brazil’s credit outlook amid the worsening COVID-19 outbreak that has now reached President Bolsonaro, street riots in Serbia against measures to curb the spread of the virus, monetization of the fiscal response to the crisis in Indonesia, the Trump-AMLO meeting in DC, and Peru’s general and presidential elections scheduled for April 2021.

Market Overview

The week began with China’s endorsement for domestic equities. This seemed to subside as Chinese pension funds reduced exposure only days later, which leaves us questioning whether this credit bubble has similar traits to the 2014/15 hard landing or whether this is merely an event that will soon be forgotten. The catalogue of risks is increasing and U.S. election risk is becoming more prevalent, indeed Biden’s statement calling time on the “era of shareholder capitalism” is just one example. The statement itself may have been misconstrued by markets, yet it offers a reminder of what’s ahead in four months. Needless to say, U.S. IG yields remain on track to break 2% if the momentum persists. Momentum of course is the theme. The S&P’s golden cross came as the 50dma crossed the 200dma, however the key is whether it can break through 3,180 as a technical ceiling. The Nasdaq also pushed higher but breadth is increasingly weak as the move was predominantly driven by Amazon. Perhaps U.S. bank stocks are more troubling as the BKX continues to decline, so much so that the correlation with SPX reached all-time lows this week. Meanwhile, U.S. treasuries bull flattened after the auction, which saw the 30-year tighten 9bps, however high demand comes with uncertain sentiment while positioning is still in favor of bear steepening. This now puts 10s30s inside of 70bps for the first time since mid-May, and with the 10-year at 57bps, it is only 3bps off the all-time lows from March 9. Speaking of uncertain sentiment, gold rallied above $1,800/oz, which put it on par with December 2012 levels and brings the all-time highs from September 2011 ($1,921/oz) into question. EM credit markets were mixed this week with the EMBI 3bps wider and CEMBI 2bps tighter. Argentina was one of the outperformers and some 172bps tighter as bonds rallied 4-5pts on the improved restructuring proposal. Elsewhere, Ecuador and Suriname stole the spot-light after putting forward friendly terms, or at least with Suriname, as creditors agreed to delay the amortization associated with the 2023 bond. Weekly inflows into the asset class added a savory note to EMD-dedicated investors which amounted to $1.5 billion, as the new issuance floodgates continued to remain open. Near-term events focus on re-imposing lockdown measures and the challenges that brings, especially after protests in Serbia, followed by political risk after the passing of Ivory Coast’s PM and elections in Singapore and Poland.

Argentina’s government made a new offer to creditors to restructure its $65 billion of debt

Market Relevance: The Argentinian authorities have made a new offer to bondholders that represents a substantial improvement from their initial proposal in April. Under the new agreement, the government would begin making semi-annual coupon payments in 2021 with a step-up schedule that starts from 0.125% annually and moves gradually towards 5%. Principal repayments would be delayed until 2025. Creditors have until August 4 to decide whether to take the offer.

Gramercy View: Gramercy sees the new offer as a serious effort by the government to come to an agreement with bondholders. Compared to the first offer, this new proposal provides an additional $13 billion of value and by Gramercy calculations, will bring average recoveries up to 53.5 at an exit yield of 10%, compared to just 40 under the original terms. This offer has backing from the IMF, who believes it is fair to bondholders while still providing the room to restore debt sustainability. The agreement would also provide breathing room for Argentina’s economy, which has been battered by the coronavirus and is now expected to shrink by at least 12% in 2020. Bonds have risen through the week in response to the news. The government has set the minimum threshold for moving forward at 66.6% of total bondholders across the 2005 and 2016 notes. This would allow a deal to progress even if there are holdouts and Economy Minister Guzman has said that officials are open to such an arrangement.  At this point, however, the Ad Hoc and Exchange Groups, which represent approximately 35% of the bonds in the restructuring, have rejected the offer while stating that they are open to additional negotiations. After a lengthy debt restructuring process, we see such approach as risky due to the significant macroeconomic deterioration from COVID-19, lingering macro imbalances, and limited upside in the context of a hard default alternative.

Ecuador reaches an agreement in principle on sovereign debt restructuring terms 

Market Relevance: The government of Ecuador unveiled the terms of its debt restructuring offer to bondholders and announced that it has reached an agreement in principle with a large group of creditors. The agreement paves the way to finalizing a debt restructuring deal and a new IMF program by the mid-August deadline.

Gramercy View: The restructuring process lasted only a few weeks and was characterized by strong goodwill and mutual understanding, highlighting the excellent relationship between Ecuador and the global investor community under the current administration. The Ecuador complex reacted very positively to the news, reflecting a benign (from bondholders’ perspective) nominal haircut of around 9% on the existing Eurobonds principal. At the same time, the deal provides material liquidity relief to Ecuador over the medium-term with private sector debt service not exceeding $1 billion (~1% of GDP) until 2026 and no principal due until 2030. As such, the government and economy will get substantial breathing space to recover from the twin shocks of COVID-19 and the collapse of oil prices. Importantly, in our view, the framework of the deal materially decreases the risk that a potential populist administration in 2021 will have the political will and motivation to “revisit” the agreement with bondholders, given the light repayment profile in 2021-25. As part of the deal, Ecuador will get a 42% reduction of average contractual coupon rate to 5.3% and a doubling of the length of the yield curve from 10 to 20 years. Going forward, our focus shifts to the upcoming general and presidential elections in early 2021 (the new president will take office in May 2021). Ecuador’s ability to grow the economy, stabilize its fiscal framework and service external debt obligations hinges directly on the macroeconomic policy framework and direction under the next administration and its willingness (or lack thereof) to continue cooperation with the IMF and the excellent relationship with global capital markets.

Brazil’s President Bolsonaro tests positive for COVID-19

Market Relevance: Brazil’s President, Jair Bolsonaro, tested positive for COVID-19, joining the ranks of other world leaders such as UK Prime Minister, Boris Johnson, Russia’s Prime Minister, Mikhail Mishustin, and Honduras’ President, Juan Orlando Hernandez, who were infected, but have since recovered.

Gramercy View: The infection of Bolsonaro, who has consistently ignored and opposed COVID-19 containment measures, further highlights Brazil’s plight as one of the main global hotspots of the pandemic, with more than 1.7 million confirmed cases and close to 70,000 deaths (~300 per 1m population, which is among the highest in EM). Bolsonaro issued a public statement indicating that so far he is feeling only minor symptoms and remains in charge of the government, albeit from isolation. We note that in the event the President becomes incapable to serve, the Brazilian constitution stipulates that the Vice President (i.e. retired army general Hamilton Mourão) would take over. Short of a dramatic deterioration in Bolsonaro’s health condition, we do not expect to see any material impact on Brazil’s policy environment and economic outlook. The IMF’s latest projection see real GDP contracting by more than 9% YoY in 2020 and the budget deficit ballooning to the 13-16% of GDP range (from an already elevated 6% of GDP in 2019), reflecting the collapse in revenues amid large fiscal spending to offset the economic and social fallout from COVID-19. We are growing increasingly concerned about the ability of the government to roll some of this stimulus back in 2021-22 as the 2022 general and presidential elections get closer and the trajectory of public debt that is projected to surpass 90% of GDP in 2020, from around 75% in 2019.

Street unrest in Serbia as government attempts to reintroduce virus containment measures 

Market Relevance: Violent clashes with security forces erupted in Serbia’s capital Belgrade that culminated in some protestors storming and occupying the national parliament building in an attempt to prevent authorities from tightening previously relaxed virus containment measures.

Gramercy View: Protests in Serbia against measures to curb the spread of COVID-19 clearly highlight the very delicate balance between lives and livelihoods that national authorities across the globe are trying to navigate amid the COVID-19 crisis. Countries in the Balkans and Central and Eastern Europe (CEE) generally implemented timely and forceful containment measures during the initial wave of the pandemic, which has helped to keep infections and mortality at much lower levels relative to those in Western Europe. However, due in part to the successful initial public health response, but mostly because of the devastating economic consequences, many containment measures have been dramatically relaxed across the region, leading to a sharp increase in infections in recent weeks. We expect the precarious balancing act for EM governments to become increasingly challenging, however,  given the dire economic consequences of lockdowns and the growing risks to social stability, we think a return to government-mandated full lockdowns is unlikely for the time being unless the outbreak/mortality worsen materially. However, as the spread of the virus accelerates across previously relatively unscathed parts of Europe and EM in general, self-imposed social distancing and isolation, as well as the likely complete failure of the summer season in many tourism-dependent jurisdictions, will weigh heavily on economic recoveries in the region.

Bank Indonesia (BI) and the Ministry of Finance (MoF) reached a “burden sharing” agreement to fund the budget deficit 

Market Relevance: BI has announced it will purchase up to $40 billion (3.5% of GDP) worth of bonds directly from the government at the benchmark 7-day reverse repurchase rate. The funds will go towards the financing gap that the government is facing as it seeks to ramp up spending to counter the pandemic and will only be spent on public goods, such as healthcare and social protection, according to the official statement.

Gramercy View: Indonesia is facing significantly higher financing needs than previously expected as the budget deficit is projected to reach 6.5% of GDP due to the COVID-19 fiscal response. This agreement with the Central Bank will provide substantial relief in filling that gap, leaving the government with the task of financing $23 billion while the rest will be covered by the Central Bank through the aforementioned direct bond purchases and a previously agreed to stimulus package for SMEs. Although Indonesia has one of the lowest debt levels within EM, at around 30% of GDP in 2019, and a strong culture of fiscal prudence, a shallow domestic market and high foreign ownership of its debt have created a challenging environment for the government to fund its spending needs. Indonesian bond prices reacted positively to the news as it reduces additional market supply risks, but going forward, avoiding the monetization of fiscal deficits will be a critically important issue not only for Indonesia, but for EM in general. We worry that the post-pandemic economic reality will create serious challenges to the monetary-fiscal divides across EM and expect to see an increasing number of EM authorities following Indonesia’s experiment. For the time being, some obvious risks such as inflation pressures, remain contained, but it will be important for EM central bank credibility that direct financing of fiscal spending does not happen outside of truly extraordinary situations such as the ongoing COVID-19 crisis.

Presidents AMLO and Trump met in Washington D.C.

Market Relevance: Mexican President, Lopez Obrador (“AMLO”), made his first international trip to meet with President Donald Trump in Washington D.C. from July 8-9 in celebration of the U.S.-Mexico-Canada trade agreement (USMCA), which went into effect on July 1.

Gramercy View: The meeting marks a step forward for the U.S.-Mexico relationship as AMLO and Trump have struck up an unlikely partnership. President Trump remains highly unpopular in Mexico due to his using of inflammatory anti-Mexico rhetoric during his election campaign in 2016. However, despite this and the significant ideological differences between the two leaders, AMLO stroke a very conciliatory tone in his speech at the White House this week, thanking Trump for his “kindness and respect.” While the concrete outcomes of the meeting between the two heads of state remain to be seen, the tone of cooperation and focus on North American trade relations as an important factor of economic recovery from the COVID-19 shock for the U.S., Canada, and Mexico are generally positive. Canada’s Prime Minister, Justin Trudeau, did not participate in the meeting, despite having been invited. For Mexico, facing the worst economic contraction in a century (IMF projects real GDP of -10.5% YoY this year), good economic and political relations with the U.S., its powerful neighbor and largest trade partner, are of vital importance.

General elections in Peru scheduled for April 2021 

Market Relevance: On Wednesday, Peruvian President, Martin Vizcarra, signed a bill calling for a general election on April 11, 2021.

Gramercy View: President Vizcarra’s term ends on July 28, 2021 and he cannot be re-elected per Peru’s constitution that limits presidents to one term in office. He came to power after his predecessor Pedro Pablo Kuczynski was impeached amidst a corruption scandal. Vizcarra led Peru through one of its most significant political crises in the fall of 2019 when he legally dissolved Congress after a vote of no confidence and Congress appointed an interim president in response, so the upcoming election will be a chance for a “restart” in the relationship between the executive and legislative branches. However, from an investment standpoint, the key risk stemming from the elections will be the emergence of non-establishment candidate(s) with extreme social and economic views who, if elected, could challenge Peru’s track record of economic policy prudence. COVID-19 has hit Peru especially hard within Latin America, which additionally increases political risks for next year as the economic and social impact of the pandemic will likely boost the electoral appeal of fringe candidates.

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.