Featuring: Ukraine | China | malaysia | tunisia

This week, Ukraine’s relationship with the IMF hinges on maintaining central bank policy framework and independence under a newly-appointed governor, the U.S. ramps up pressure on China, near-term policy uncertainty recedes in Malaysia and Tunisia faces fresh political deadlock after the Prime Minister is forced to resign.

Market Overview

Market Commentary: Markets traded higher this week on vaccine developments and navigated through U.S. earnings in an acceptable fashion. China’s 2Q growth beat (3.2%) was marred by weak retail sales, which led to some equity panic, although volatility was contained regionally without a major spill-over. The same followed after Singapore’s weak GDP print. A heavy calendar was dominated by central banks such as BoC, BoJ and ECB, while the EM cutting cycle continues for Indonesia, as we now turn to South Africa, Hungary and Russia next week. Meanwhile, OPEC+ delivered another cut to 7.7m albeit mostly priced-in, as copper traded up on Chilean labor disputes and gold largely held onto $1,800/oz, amid renewed USD weakness that is trending back to March levels. EM credit markets were relatively quiet and received most of their gains via U.S. Treasuries rallying 1-4bp, but the real headline was in UST volatility falling to all-time lows. Spreads on the whole in EM were virtually unchanged, but CEMBI high yield relative to investment grade now stands at six-week highs on a ratio basis. Instead, the theme is back to new issuance with syndicate desks firing on all cylinders, which could become a source of market indigestion. In the same breath, we continue to monitor defaults which stand at 2.3% in 2020, although the figure will rise after Indonesia’s Modernland Realty failed to stay current on local bonds, triggering a cross-default in its USD debt. Into the weekend, the main risk event lies with the EU Council Summit, even if the base case is further gridlock.

Ukraine’s Parliament affirms new Central Bank Head 

Market Event: The Rada (Ukraine’s parliament) approved President Zelenskiy’s nomination of Kyrylo Shevchenko, CEO of state-owned Ukrgasbank, as the new Governor of the National Bank of Ukraine (NBU). Shevchenko replaces Yakiv Smoliy who resigned abruptly on July 3rd citing political pressure.

Gramercy View: Given the very sensitive nature of Smoliy’s departure and accusations in terms of Ukraine’s cooperation with the IMF, the key issue from a market perspective was the perceived acceptability to the Fund of Zelenskiy’s pick for the new Central Bank Head. In our view, Shevchenko’s appointment does not raise any immediate “red flags” for the IMF and as such, is positive from a near-term credit perspective because it removes the uncertainty around who would fill the vacancy at NBU’s helm (for context, NBU was without a permanent governor for almost a year after the previous governor’s resignation). Going forward, the IMF will focus on evaluating NBU’s policies under the new governor as well as on any threats to central bank independence, but this process will play out over a period of time during which we believe Shevchenko will receive the benefit of the doubt from investors. In an unequivocal signal on its stance vis-à-vis NBU, after a phone call between IMF Managing Director, Kristalina Georgieva, and President Zelenskiy preceding Shevchenko’s nomination, the Fund issued a statement that “it is in the interest of Ukraine to preserve the independence of NBU and it is also a requirement under the current IMF-supported program”. As such, in our view, as long as there are no material changes to the policy framework and/or independence of NBU, the IMF will maintain its strong support for Ukraine. From our local interlocutors we understand that Shevchenko has a reputation of being a strong manager and a history of working with external donors such as the International Finance Corporation (IFC), part of the World Bank. With a new NBU Governor in place, investors will be awaiting the potential re-launch of the Ukraine 2033s Eurobond deal that the Ministry of Finance pulled back from the market after Smoliy’s resignation became public on the same day as the bond sale. Refinancing near-term external obligations with longer dated debt amid current benign global financial conditions would be a credit positive development for the sovereign, especially in the context of unprecedented medium-term global economic and market uncertainty due to the pandemic.

The Trump Administration ramps up its response to the Hong Kong National Security Law, escalating U.S.-China tensions 

Market Event: The U.S. State Department issued a statement this week calling China’s actions in the South China Sea “completely unlawful” and broke its previously neutral stance on the issue, outwardly supporting the Philippines and other lesser regional powers on sovereignty disputes with China dating back to 2016. In addition, President Trump signed an executive order curbing Hong Kong’s special trade status with the U.S. Trump also signed legislation passed by Congress that would allow for sanctioning of Chinese officials responsible for cracking down on political dissent.

Gramercy View: With President Trump falling further behind in the latest polls and the worsening pandemic situation in the U.S., the White House has materially ramped up anti-China rhetoric this week. We think U.S.-China tensions are likely to increase between now and November, as it is politically attractive with fewer economic costs given the current state of the global economy. Being tough on China is at the core of Trump’s campaign and is probably the one key issue for the election on which the incumbent retains the advantage over the challenger. For the time being, China’s response has been measured and Beijing continues to work toward meeting the targets agreed upon in Phase 1 of the trade deal, which signals to us that at the moment, there is little appetite on both sides to derail the status quo on trade. This being said, the U.S. actions this week have been accompanied by Trump’s signaling in the media that a Phase 2 trade deal is increasingly uncertain. We also continue to watch whether other countries will follow the U.S.’s tougher stance on China. This week, the UK, having previously engaged Huawei to develop its 5G network, ordered Huawei to remove all equipment from the 5G network by 2027. If other countries follow suit, especially in continental Europe, it could create a more challenging environment for Chinese companies abroad and global trade in general. From a top-down perspective, a material escalation in the U.S.-China decoupling process over the coming months ahead of November is one of the main downside risks for global markets in the second half of the year.

Malaysian Prime Minister Muhyiddin won a show of support in Parliament after successfully replacing the lower house speaker

Market Event: Prime Minister (PM) Muhyiddin narrowly won the vote to remove speaker Mohamad Ariff Yusof, who was appointed by former PM Mahathir. Azhar Azizan Harun, a former election commission chairman, was appointed the new speaker. This is the first piece of legislation supported by the PM that has passed Parliament since he took office in March.

Gramercy View: Malaysia has been struggling with policy uncertainty since the unexpected transition of power from Mahathir to Muhyiddin. A week of political turmoil saw the governing coalition, Pakatan Harapan (PH), break down over political infighting and culminated in the King’s appointment of Muhyiddin as the new PM. His political party, Bersatu, also pulled out of PH to join forces with the former opposition coalition, which includes UMNO, the party that had lost power in the 2018 elections. Yet, what remained unclear for months was whether Muhyiddin possessed sufficient political support in parliament. While this vote is encouraging, Gramercy does not see the narrow two vote margin as sufficient to provide investors with confidence in the current political environment in Malaysia. The other material challenge is economic as the IMF is now expecting growth to contract by 3.8% YoY 2020 with the pandemic impact. In response to the crisis, the government announced a significant stimulus program of close to $70 billion, which is expected to push debt above the self-imposed 55% of GDP ceiling this year. This has been concerning to markets as Malaysia has backtracked from previous commitments to balance the budget in recent years. While its debt is nearly entirely domestic and has performed well due to record rate cuts by Bank Negara Malaysia, the Central Bank, foreign investors have remained cautious, with less than 50% of net outflows from February to April returning as of the end of June. We believe that Malaysian market assets will continue to be anchored by local investors, but there will likely need to be evidence of greater political stability before foreign inflows can recover closer to pre-crisis levels.

Tunisia’s Prime Minister, Elyes Fakhfakh, resigned amidst corruption allegations and losing political support 

Market Event: Tunisia’s Prime Minister, Elyes Fakhfakh, resigned in the face of a vote of no confidence campaign, after accusations that he retained shares in companies that had received state contracts. This follows an escalation of tensions between Fakhfakh and the moderate Islamism Ennahda movement, which is the largest party in parliament and a member of the governing coalition.

Gramercy View: Elyes Fakhfakh was Tunisia’s 8th Prime Minister since the Arab Spring Revolution in 2011 and his resignation reflects the country’s fragmented political environment and will likely lead to fresh political deadlock. While President, Kais Saied, had initially backed Fakhfakh during the scandal, and attempted to restore peace between the two sides, escalation of tensions ultimately resulted in the President’s decision to withdraw support from Fakhfakh. The resignation allows Saied to retain control of the nomination process. The President now has 10 days to nominate a replacement, who will then be tasked with forming a new government that must receive parliamentary approval within two months. While the new nomination is unlikely to come from within Ennahda itself, which has become increasingly at odds with the Administration over issues such as Tunisia’s stance on neighboring Libya, it will be difficult for Saied to form a government without the party’s support. Either way, the process will likely be long with the possibility that negotiations could fall apart, resulting in early elections. Like all tourism-dependent jurisdictions, Tunisia is in a challenging economic position due to the pandemic; growth is projected to contract by 5-6% YoY in 2020, while the government’s debt burden is expected to reach at least 80% of GDP. In this context, a protracted political crisis introduces the risk of a delay in negotiations with the IMF on a new program and securing a vital source of external financing in the current environment. While Tunisia’s geopolitical importance in relation to Libya will likely keep the IMF flexible in it’s engagement with the country, we are concerned about deteriorating fundamentals and the increasingly challenging political picture.

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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