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Featuring: G20 DEBT RELIEF | Argentina | BRAZIL | MEXICO | CHILE

This week we comment on the latest around G20 debt relief for the least developed economies, Argentina’s debt restructuring saga, the proposal for the first phase of tax reform in Brazil, Mexico’s pension system overhaul plans, and Chile’s likely approval of early pension fund withdrawals to help savers weather the economic storm due to the pandemic.

Market Overview

U.S.-Sino relations were in focus after consulate closures where retaliatory steps are still being considered. This dampened asset markets toward the end of the weak as Chinese equities weakened and CNH headed back above 7 once again. Meanwhile, the weak USD narrative continues to play-out and is back to January 2019 levels, just as the 5 year U.S. Treasury struck new lows, but the real story was with 10 year real yields declining to all-time lows of -93bps. Elsewhere, the Fed’s SMCCF continues at its current pace of $740 million per week, as some noise over expanding counterparty participation was read as a bullish signal. Coordinated policy is also occurring within Europe as the EU Recovery Fund agreed on €750 billion with €390 billion in grants, which saw BTPS-Bund yields decline below 150bps and Italy’s 10 year eventually traded below 1%. At the same time, risk sentiment traded positively on these developments, but precious metals also marched higher as gold broke $1,900/oz, with silver touching $23/oz. The EM central bank cutting spree remains in play with Russia, South Africa, Kazakhstan, and Hungary, while the PBoC injected more stimulus but some restraint was displayed within Turkey, Nigeria, Ukraine, and Costa Rica. We end the week with the EMBI up 1.5%, with EM duration outperforming as the 30 year U.S. Treasury tightened 11bps. We also note that HY outperformed IG with the spread ratio standing at 10 year wides (4x), where Sri Lanka, Suriname and Angola were key beneficiaries, while Papua New Guinea, Belize and Ecuador did not participate in the momentum. Into next week, we expect more noise associated with U.S.-Sino relations, Phase 4 stimulus discussions, and the House Judiciary Committee on antitrust matters with U.S. tech stocks, which all comes prior to the FOMC on Wednesday.

No extension of G20 debt relief for the world’s poorest economies yet   

Market Relevance: After the July virtual meeting, the G20 finance ministers issued a communiqué indicating that extending the Debt Service Suspension Initiative (DSSI) into 2021 would be considered in the second half of the year after the IMF and World Bank complete a report on the liquidity needs of eligible countries.

Gramercy View: As a reminder, in mid-April the G20 finance ministers approved a standstill on 2020 debt service for 76 of the world’s poorest countries called the Debt Service Suspension Initiative (DSSI). Although a final decision has been delayed to the next G20 finance ministers meeting in October, our understanding is that there is strong support for extending the current debt freeze beyond the end of 2020, given the severity of the economic and social fallout from the pandemic. In addition, there are increasing calls about forgiving, rather than just deferring, the debts of some of the poorest countries. On the issue of private sector participation, the G20 finance ministers said they “strongly encourage” commercial lenders to participate in the DSSI and provide relief on comparable terms to official lenders if requested by eligible countries. In our view, it would be extremely challenging to enforce and/or coordinate a “one size fits all” approach to private sector debt in the context of the DSSI. However, we think the momentum generated by the DSSI might turn over time as the economic and social fallout from the pandemic is increasingly felt across emerging and frontier markets, into a broader, more systemic “paradigm of non-payment” for some EM sovereign and corporate issuers. Furthermore, a parallel proposal for an additional allocation of IMF SDRs, which was also discussed during the G20 finance ministers meeting, appears to have encountered serious roadblocks, which would limit the resources the IMF can make available to EM member-states as they continue to grapple with the pandemic’s economic and social effects in the coming quarters.

Argentina’s three largest creditor groups have submitted a joint debt proposal to the government

Market Relevance: The Ad Hoc Bondholder Group, the Exchange Bondholder Group and the Argentina Creditor Committee have rejected the government’s previous offer and submitted a new proposal. The new offer would start coupon payments at 0.125% and step up over time for an average rate of 3.4%. Amortizations would remain delayed until 2025. This deal is valued around 56.5 cents compared to the government’s offer of 53.5 cents.

Gramercy View: The three bondholder groups coming together now makes it difficult for Argentina to restructure its $65 billion of debt without coming to an agreement with this bloc. Although the group rejected the government’s second offer, their counteroffer includes a number of important concessions. Key components include accepting coupon payments starting at 0.125%, having accrued interest be paid to creditors in a bond that matures in 2030, and allowing new bonds issued in exchange for the existing notes to be governed by legal terms of the 2016 notes. We believe these concessions show that creditors continue to be willing to negotiate and remain hopeful of reaching a deal. Following the bondholders’ announcement, both President Fernandez and Economy Minister Guzman have said that the previous offer the government made was its best one, although they remain open to further discussions. While Gramercy continues to expect that a deal will be reached, we see the risks of a no deal situation as political rather than economic. At this point, the gap between the government’s offer and the bondholders’ counter proposal is only 3 cents, and there is little reason for either side to force a disorderly default over such a margin. Politically, however, there is the danger that the government will reject this new counter proposal.

Economy Minister Guedes submitted a proposal to Congress for the first phase of Brazil’s tax reform 

Market Relevance: The proposed first step would merge two federal consumption taxes, the PIS and Cofins federal consumption tax, into one VAT with a rate of 12%. The government has also announced that more elements of the reform will be revealed in the coming days.

Gramercy View: This week the government finally revealed a portion of its plan to implement tax reform, the Bolsonaro Administration’s economic priority since the successful passage of pension reform nearly a year ago. Brazil’s tax system is incredibly complicated, with a large number of indirect taxes and substantial exemptions. Progress towards reforms would support domestic business activity as well as ease barriers to foreign investment. From the first proposal, it seems that Economy Minister, Paulo Guedes, has chosen to phase in tax adjustments, rather than deliver one comprehensive reform, a path seen as likely to face less resistance in Congress. Feedback from both lawmakers and investors in Brazil have found the proposal to be underwhelming, particularly as there are already two separate bills being discussed in the chamber of deputies and the senate that are perceived to be more ambitious. The proposal has also faced criticism from policymakers that delivering adjustments piecemeal hinders the ability to view the tax reforms in their entirety. The administration has announced it will be sending the next phase of the reforms to Congress within 30 days, with additional ones to come on income, payroll, and digital payments taxes. Guedes’ approach to tax reform suggests that the administration expects opposition to some key elements of the proposal and will attempt to push through what it can without letting certain thorny issues hold up the entire process. In particular, the proposed digital transaction tax is highly unpopular in Congress and will likely be a difficult battle. While the current administration has shown some political savviness in pushing through controversial legislation, tax reform is a highly complex issue and we believe it is unlikely to be completed this year, especially in the current crisis management mode given the enormous impact of COVID-19 on the economy. This being said, completing tax reform in 2021 will be critical for reversing some of Brazil’s material fiscal deterioration that is the key medium-term credit challenge for the sovereign.

AMLO presented a plan to overhaul Mexico’s pension system

Market Relevance: Mexican President, Andres Manuel Lopez Obrador (AMLO), presented proposed reforms to the country’s $266 billion pension industry, with the stated goal of boosting the average private sector worker’s pension by about 40%.

Gramercy View: The initiative proposes three main changes: i) increasing total contributions, ii) reducing the contribution time necessary to receive a pension from 25 to 15 years, and iii) reducing commissions charged by the retirement fund administrators. We view the current proposal as neutral to positive. It eliminates the risk that AMLO might propose more radical pension reform that would increase state control over the pension system or force pension funds to invest in his agenda for large infrastructure projects. However, uncertainty remains, given AMLO’s subsequent comments that the government would look to raise pensions for public sector workers as well. There are no details nor a timeline for public pension reform as of yet, and we continue to monitor this and the potential risks those reforms could pose to the sovereign.

Early pension fund withdrawals approved by Chile’s Senate

Market Relevance: Chile’s Senate passed a bill allowing citizens to withdraw up to 10% of their pensions without penalty amidst the coronavirus pandemic. The Chilean pension funds, known locally as AFPs, are Chile’s largest institutional investor with an estimated $200 billion in assets. They own ~75% of local government debt and ~6% of local equities. If enacted, the pension bill could drive outflows of up to $20 billion in assets under management within 30 days, according to local regulator CMF.

Gramercy View: The CMF’s $20 billion projection assumes that 100% of eligible pensioners will withdraw funds. While we view this as unlikely, it is still hard to say what the actual withdrawal level will be. Potential material outflows could weigh on Chilean equities and corporate bonds in particular. In addition, the bill will have an estimated fiscal cost of around $6 billion, equivalent to 2.5% of GDP, according to the government budget office, an added cost to the government amidst the uncertainty of the pandemic. With the bill now passed by both the House and Senate, President Piñera still has the option to sign or veto it, or send it to the constitutional court for review. He has vocally opposed the changes in the past, but not enacting the bill would be unpopular given high levels of public support and the extraordinary economic situation due to the pandemic. As a reminder, in October, Chile is facing a referendum on rewriting the country’s Pinochet-era constitution, after the country experienced social unrest and widespread street protests in 2019.

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.