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Featuring: Ukraine | SOUTH AFRICA | china | dominican republic | india
In addition to a weekly market recap, this week we focus on the Ukrainian Central Bank Governor’s unexpected resignation and potential risks for IMF cooperation, South Africa’s “pre-COVID-19” recession, potential market ramifications of China’s approval of the controversial Hong Kong Security Law, the upcoming general elections in the Dominican Republic, and India’s strong stock market rally in June amid worsening pandemic dynamics.
A week of technical developments

Market Commentary: Key events this week focused on Powell and Mnuchin’s testimony, but also followed individual corporate bond purchases under the Fed’s SMCCF program. Expectations into FOMC minutes were somewhat benign, yet YCC discussions flagged disagreement and an overall lack of enthusiasm, instead the preference now sits with forward guidance. Nevertheless, the market has remained exceptionally strong this week with U.S. investment grade yields hitting all-time lows, which is a similar story for EM local markets while the Nasdaq made fresh highs. Technicals were in vogue as the S&P hovered above the 200dma along with the 76.4% Fibonacci level as the VIX edged below 30. Geopolitical risk also re-entered the equation with the U.S. sanctioning China, and with further measures expected under the Magnitsky Act. Elsewhere, Russia’s extraordinary constitutional vote saw overwhelming support (78%) as Putin paves the way for a two-term extension after 2024, but risk markets adjusted and CDS now sits below 100bps once again. As new issuance continues to pick-up, Ukraine sought to tender 2021/22 bonds and issue 12-year debt. However, between the deal pricing on July 1 and being Free-to-Trade on July 2, the Central Bank Governor resigned creating significant volatility. The sovereign transaction was therefore cancelled. Cancelling Eurobond debt issuance is a rare phenomenon: the most recent cancellations are with (1) Turkey’s Yapi Kredi in July 2016; (2) Bahrain’s sovereign tap in February 2016; and (3) Paraguay’s BCP bond in 2012. In other news, Grupo Posadas missed their coupon payment, Aeromexico filed for Chapter 11 and Suriname sent out a consent solicitation aimed at pushing out the amortization associated with the 2023 Eurobond (following Belize).

Ukraine Central Bank Governor’s abrupt resignation       

Market Event: The governor of the National Bank of Ukraine (NBU), Yakiv Smoliy, submitted his resignation to President Zelenskiy on July 1 citing “a sustained campaign of political pressure” against him and the NBU in general.

Gramercy View: Smoliy’s abrupt resignation came as an unpleasant surprise for investors on a day Ukraine tapped global capital markets for a new $1.75 billion 12-year Eurobond. Following the news, the Ministry of Finance made the decision to cancel the Eurobond offering in order to give investors sufficient time to evaluate the developments. The governor has enjoyed strong market credibility and NBU’s policy framework under his leadership has received consistent strong endorsements by both the IMF and global investors. As such, Smoliy’s likely departure (the resignation needs to be accepted by President Zelenskiy and approved by parliament) is a negative development. Whether it becomes a driver for a change in our constructive structural view on Ukraine depends on two factors: the reformist reputation and credibility of the successor and policy continuity (or lack thereof). If the current policy framework and independence of the NBU is maintained, we have limited concerns about the impact of Smoliy’s resignation on Ukraine’s overall credit story. We recall that when the previous governor and investor favorite, Valeriya Gontareva, resigned in April 2017, NBU’s market-friendly policies remained broadly unchanged, although it took almost a full year until political compromise was achieved to formally appoint Smoliy as the new governor in early 2018. We think a similar benign scenario is likely to materialize again given the vital importance for the government and the economy of IFI funding, especially in the current crisis environment related to COVID-19. However, in the event any signs emerge that Ukraine Central Bank independence could be compromised, we’ll become concerned about the IMF relationship given that the Fund’s support for Ukraine has always hinged on government guarantees of NBU’s independence and continuation of banking sector reforms. As a good signal for investors, the Office of the President issued a statement following Governor Smoliy’s resignation stating that “ensuring the independence of the NBU remains an unconditional priority”.

South Africa’s GDP contracted by 2% quarter-over-quarter (QoQ) in 1Q20, confirming significant economic pain even prior to the COVID-19 shock    

Market event: GDP in South Africa contracted by 2% QoQ in the first three months of 2020, following a contraction of 1.4% QoQ in Q419 and marking a 3rd straight quarter of decline for the economy.

Gramercy View: The negative number in Q120 highlights South Africa’s weak economic position going into the COVID-19 crisis. The national lockdown did not begin until March 23, which means economic prints for 1Q should be largely unscathed by those restrictions. With the impact of the virus and subsequent constraints taking effect in 2Q, expectations are for South Africa’s economy to contract by 7-8% in full year 2020. Although the government has announced credit guarantees, tax incentives and household transfers worth around 10% of GDP to support the economy, a weak base limits the positive effects of the stimulus. The significant economic fallout has also driven the country to begin easing restrictions in May, even as coronavirus cases continued to increase rapidly. This leaves the government in a tough position moving into 2021, as it must balance the need for fiscal consolidation with a weak economy that requires support. As a result, Gramercy continues to have a cautious view of South Africa’s sovereign profile, as deteriorating fiscal metrics, low growth and substantial social tensions create a challenging set of conditions that we believe will be difficult for the authorities to overcome and might force them to consider a full-blown program with the IMF.

China approved the controversial Hong Kong Security Law 

Market Event: On the 23rd anniversary of Hong Kong’s handover from the British to the Chinese, the Mainland Government passed a new national security bill, bypassing Hong Kong’s domestic legislative body entirely. The bill limits free speech, creates the potential for a life prison sentence for those deemed guilty of state subversion, and provides for extradition from Hong Kong to the Mainland. The law has already sparked initial action from the Trump Administration, with the U.S. moving to restrict defense and technology exports to Hong Kong in response.

Gramercy View: We continue to watch three trends, which we think have the potential to have market impact. First, we see growing risk for continued social unrest in Hong Kong, which could extend the current negative overhang on the domestic economy. The past year of unrest and limited tourism due to the pandemic have disrupted the local economy (GDP is -9% YoY), and, in particular, companies in the retail, real estate, and tourism sectors. Second, we are concerned about the U.S. response and potential China retaliation. We expect that U.S. revocation of Hong Kong’s special trade status would affect only a small part of the U.S.-Hong Kong trade relationship, given that Hong Kong’s economy is mostly comprised of services, rather than manufacturing. However, it would certainly complicate the future negotiations of President Trump’s China trade deal, which could create additional uncertainty in markets. Finally, we consider whether the law’s passage might realign European policy with the U.S. The crackdown on Hong Kong could push Europe to cooperate with the U.S. on restricting Chinese companies abroad (for example, Huawei’s 5G efforts) and increasing pressure on China to conform with WTO norms, among other policies.

The Dominican Republic will hold general elections on July 5.

Market event: The Dominican Republic is set to hold general elections on July 5, which will include voting for president and the bi-cameral legislature. Center-left opposition candidate, Luis Abinader, is expected to receive the largest share of votes in the presidential race but there is reasonable probability of a second round later in the month.

Gramercy View: The Dominican Republic is set to move forward with its elections on July 5, following the delay from May 17 due to the pandemic. The two main contenders for the presidency are Gonzalo Castillo from the incumbent Dominican Liberation Party (PLD) Party and Luis Abinader from the Modern Revolutionary Party (PRM). Internal splits within PLD have given Abinader, a businessman and relative outsider to the political system, an advantage. Presidential elections in the Dominican Republic, however, operate on a two-round system and there is a high probability that there will be a run-off round on July 26 if neither candidate can secure more than 50% of the vote. In such a case, Abinader is still likely to hold the upper hand, as polls show the 3rd place candidate’s votes moving towards him rather than Castillo. Yet, under either candidate, economic policy going forward will be constrained by the substantial challenges that the country is facing with the severe declines in tourism and remittances due to the COVID-19 pandemic. The risk, however, is that a tight race could result in greater fragmentation in Congress and lower government effectiveness, which would negatively impact the ability to implement fiscal consolidation reforms in the aftermath of the COVID-19 shock.

COVID-19 concerns remain high in India amid a strong local stock market rally in June

Market Event: Hopes for an economic recovery upon reopening sent the Indian Sensex up 7.7% in June, helping the index recoup almost half the losses from the COVID-19 pandemic-triggered selloff in March. The Sensex outperformed all of the other Asian indices for the month of June.

Gramercy View: Despite excitement for a rebound upon reopening in India, we still view COVID-19 as a considerable negative overhang for the domestic economy. The latest numbers show coronavirus cases increasing by around 20% week-over-week (one of the highest in EM) as the country begins its second phase of reopening. We believe second wave risks in India are high, especially given the underfunded healthcare system, widespread poverty, and significant practical challenges to social distancing policies. In line with such concerns, last week the IMF revised India’s real GDP growth forecast down to -4.5% YoY in 2020, an astonishing 6.4 percentage points lower compared to the its World Economic Outlook (WEO) projection made in April. We continue to watch India’s sovereign rating trajectory (Baa3 Negative by Moody’s and BBB- Negative by Fitch) closely as a fallen angel candidate in the next 12 months. The rating outcome for the sovereign is largely dependent on the government’s ability to contain the virus and the ensuing economic fallout, which, so far, has proven to be a very challenging task.

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.