In this week’s edition, we comment on credit-relevant developments in Latin America’s three largest economies – Brazil, Mexico, and Argentina. We also discuss the latest in the U.S.-China relationship and shine a spotlight on India’s banking sector.

Market Overview

Jackson Hole limited some of the market consternation and strengthened what is often codified as the “Fed put”. The first development is a more flexible approach to average inflation targeting, while the second is an asymmetric approach to unemployment. The Framework Review is akin with what is considered to be an opportunistic reflation strategy, as discussed in our previous publication, although is admittedly vague and not a panacea. The likely reaction is 5y5y inflation swaps edge well above 2% as 10yr breakevens have already shown few signs of deviating from the upward trend, which then risks real yields moving deeper into negative territory. Needless to say, the Fed is allowing for overshooting before the picture normalizes. There is now a higher likelihood of forward guidance and a review of the asset purchase program at the next FOMC in September, rather than in November. Meanwhile the MSCI Equity Index surpassed February 12th levels to post all-time highs, the S&P broke 3,500 and the Nasdaq similarly made fresh ground. This comes as the U.S. added 24 additional Chinese entities to its blacklist after celebrating Phase 1 trade developments and watering down its approach to Tencent’s WeChat. This at least paved the way for Tencent’s online music subsidiary to issue 5yr and 10yr debt in $800 million below 2.1%. The week was also dominated with headline noise from the Republican National Convention as the election campaign shifts into a higher gear as we enter the final 10-week countdown. That said, developments in EM were relatively benign. Returns were again unchanged across the EMBI and CEMBI as spreads tightened 2bp. Aside from the month-end buying technical, the winners on the week were with Lebanon, Sri Lanka and Angola, while Zambia, Suriname and Mozambique materially underperformed. Into next week, we anticipate some focus on Chinese and Mexican PMIs, followed by GDP out of Brazil, India and Turkey, then inflation prints out of Peru, Indonesia and the Philippines. Beyond that, Ukraine made headlines for all the wrong reasons after the NBU’s fourth MPC resignation in eight weeks, which comes prior to the next rate decision on Thursday (also watch out for Colombia’s rate decision). Primary markets remain largely muted although are beginning to open up. The first benchmark issuance was from Abu Dhabi with a multi-tranche 3yr/10yr/50yr transaction, which is only the second sovereign to issue in August after Bermuda a fortnight ago.

Argentina formally requests a new IMF program; COVID-19 spread continues to accelerate  

Event: In a letter to IMF’s Managing Director, Kristalina Georgieva, signed by Finance Minister, Martin Guzman and Central Bank Governor, Miguel Pesce, Argentina formally requested the initiation of consultations toward a new Fund supported program. Meanwhile, the spread of COVID-19 continues to increase at a rapid pace as Argentina set daily records for both new cases and deaths this week.

Gramercy Commentary: The tone of Argentina’s letter is constructive, refers to “more than nine months of fruitful collaboration” with the IMF and signals the authorities’ commitment to “put forward consistent policies to achieve the macroeconomic and financial stability objectives of the program”. We think that the market will like the tone and commitment of Guzman and Pesce’s letter, but will also be looking for “proof” over the coming months that such commitments are backed by real policy intentions and political will. The letter marks the start of a new Argentina-IMF negotiation cycle that will likely take until 1Q 2021 and in which Argentina will seek to defer the repayment of around $45 billion it owes to the IMF from the previous program. Fernandez’s Administration has made clear its intention not to repeat what they consider “the flawed assumptions of the 2018 program” under Macri, which signals that negotiations will be challenging, but we expect both sides to work hard and constructively in the initial phases. We think that the process will get more difficult as they go down the road to formal approval (likely in early 2021), but we believe strong incentives to reaching an agreement exists on both sides. In the meantime, we note that Argentina is one of the major EM jurisdictions where the spread of COVID-19 has accelerated lately. This week, Argentina set daily records since the start of the pandemic in terms of both new confirmed cases (10,550) and deaths (381). However, despite the acceleration of infections in August, thus far Argentina remains considerably less affected in terms of deaths and confirmed cases per million people relative to some of its Latin American neighbors such as Peru, Chile and Brazil. Argentina’s mortality rate of around 2% also compares favorably; for context, with 1.7% Russia fares best among major EMs, while Mexico is worst with close to 11%.

Bolsonaro’s public criticism unlikely to cause Guedes’ exit, but highlights Brazil’s tough fiscal trade-offs 

Event: President Bolsonaro openly criticized and rejected Economy Minister Paulo Guedes’ initial proposal for “Renda Brasil”, a new large social spending program included in the Bolsonaro Administration’s economic policy plans dubbed the “Big Bang”. Bolsonaro sees “taking away funds from the poor to give to the very poor” as unacceptable, so when formulating a revised proposal, Guedes’ team will need to find creative ways to satisfy the President within Brazil’s very tight fiscal space.

Gramercy Commentary: The first question that likely comes to mind in the context of Bolsonaro’s public criticism for Guedes is whether it could foreshadow the Minister’s departure from his role as Brazil’s economy tzar. Such a development will be seen as a material credit negative event, but we think it is unlikely and expect Guedes to retain the reigns of Brazil’s economic policy for the foreseeable future. This being said, the developments this week very clearly illustrate our key concern regarding Brazil’s sovereign credit trajectory: severely limited fiscal space that is being stretched even further by the ongoing crisis and is forcing policymakers into very difficult and potentially politically costly trade-offs. We think the administration is facing a classic impossible trilemma: (1) trying to respect the constitutionally mandated fiscal spending cap for 2021, (2) protect the economy and vulnerable populations in the context of the COVID-19 shock, and (3) deliver on points (1) and (2) without jeopardizing too much the chances of Bolsonaro and the political elite in Congress in the upcoming 2022 elections. It is not possible to have all three outcomes at the same time, which highlights the very significant fiscal and political challenges the government will certainly continue to face in 2021 as it attempts to support an economic recovery from the record-breaking recession this year. As such, growth is likely to face headwinds while the market will remain skeptical about the political will/ability to roll back some of the large fiscal easing that the government is in the process of delivering due to COVID-19. As we discussed in a recent publication, market consensus expects a GDP contraction of 6.0% YoY in 2020, while the IMF is considerably more pessimistic and projects (as of June) a 9.1% GDP decline this year. The currently projected recovery in 2021 is 3.4% (market) and 3.6% (IMF). As the fiscal deficit balloons to 12-15% this year, the sovereign debt burden is projected to surpass 90% of GDP and continue to edge higher. In order to reverse the negative fiscal/debt dynamics, Brazil’s authorities will need to implement forceful fiscal consolidation after the COVID-19 emergency gets under control. However, we are not optimistic about the political will and ability to do so in the near term, given that 2022 is an election year.

Mexico confirms a record GDP slump in 2Q, setting the stage for its worst recession in nearly a century

Event: Mexico reported a YoY GDP drop of 18.7% for the second quarter (from -1.3 YoY in 1Q), in line with consensus expectations. This is a historic contraction, but it likely reflects the trough of the Mexican economic slump given the nationwide quarantine that began in March, but is now slowly easing.

Gramercy Commentary:  Mexico’s 2Q GDP decline is larger than that in most developed economies and one of the worst thus far in emerging markets, a testament of the severe disruption that COVID-19 shutdowns are causing to economies across Latin America. The GDP slump was mainly driven by the industrial sector, including mining, construction, and manufacturing, which contracted more than 23% relative to the prior period. Services, including transportation and media fell by 15%. The second quarter results are much more severe than the impact of the Great Recession or the Tequila Crisis (both were declines of around 10% YoY). The recovery in the second half of 2020 and into 2021 will be only gradual and subject to avoiding new material economic shutdowns domestically as well as in the Southern and South-Western U.S. states that account for a large share of Mexico’s trade and economic activity.

Phase One of the U.S.-China trade deal is reaffirmed despite an increasingly tense relationship

Event: Secretary Mnuchin met with Chinese officials earlier this week to reaffirm both parties’ commitment to the Phase One trade deal in a previously postponed biannual review. Both sides demonstrated willingness to adhere to the terms of the deal, even as tensions continue to rise over a variety of issues, including the Tik Tok ban, the Hong Kong national security law, and, most recently, the South China Sea.

Gramercy Commentary: Attempting to resolve the “trade war” has emerged as an area of relative cooperation while the two largest global powers continue to confront one another over a number of other bilateral issues. We think China’s cooperative attitude could be construed as preference of a “wait-and-see” approach by the ruling elite given perception in some circles that a Biden presidency could bring some relief to the increasingly tense relationship. Despite the cooperative tone, China remains behind on its agreed-upon quota of purchasing American goods; it would need to purchase about $130 billion worth of U.S. imports in the second half of 2020 to comply with the original terms of the agreement. Any discussion of changes to the deal will likely come after the U.S. election in November, when there is clarity on the next four years and, if re-elected, President Trump may have more flexibility to adjust the terms without appearing “weak on China”.

Global Emerging Market Corporates in Focus: Spotlight on India’s Banking Sector

The banking sector in India has been through its fair share of changes. One significant development occurred almost a year ago. On August 30, 2019 the government announced four sets of mergers involving state lenders: (1) Corporation Bank and Andhra Bank with Union Bank, (2) Indian Bank and Allahabad Bank, (3) Syndicate Bank and Canara Bank, and (4) Orient Bank of Commerce and United Bank of India with Punjab National Bank. The government also announced capital injections into some of these banks.

There may be other changes in ownership in the future. In July this year, it was reported that India plans to sell more than half of the state-owned lenders, reducing ownership to just five banks from the current twelve, but no further mergers of state-owned lenders are planned. Disposals may only occur after the current financial year, according to reports, which is expected to be challenging for the sector.

As in other markets, a moratorium on loan repayments was put in place in India. This applied from March 1, for 90 days initially, but was extended to 180 days. The moratorium comes to an end on August 31, 2020. The Reserve Bank of India “RBI” disclosed that loans subject to the scheme accounted for 15% of total loans in June, down from 50% in April. The figures declined as customers became increasingly aware of the costs attached to payment deferrals, including increased monthly installments and charges. The RBI will now allow banks to restructure MSME loans up to INR250 million if borrowers were not in default at March 1, 2020 or adopt resolution plans for personal loans not in default at the start of March. Such resolution plans may include a payment moratorium. The RBI has also constituted an expert committee, headed by a former CEO of ICICI bank, to make recommendations on resolution plans, assess sector-specific parameters and vet resolution plans where lenders’ exposure exceeds INR15bn (US$200 million). At least one rating agency has noted that this may not address oversight issues in most retail and MSME lending, which may account for a significant part of banks’ restructuring programs. This may reflect experiences with debt restructuring in the 2010-2016 period. There is also uncertainty about how the new framework will be applied vis-à-vis the insolvency and bankruptcy code passed in 2016.

Asset quality and capital are two of the key focus areas for India’s banks. The RBI expects the sector’s gross non-performing assets ratio to rise by 4 percentage points in its baseline scenario, and banks may need more capital. Some rating agencies agree – one estimates that state banks may need INR1.9-2.1 trillion over the next two years. Various lenders have already announced plans to raise capital. A number of these lenders have completed these plans. More capital increases are on the way.

Turning to the bond market, the Indian bank USD-denominated Eurobond universe is overwhelmingly short-term and mostly senior-ranking. Of the 34 bonds with at least USD100 million outstanding, just two securities are subordinated. All others are senior unsecured. Eight of the bonds mature or are callable this year (three bonds) or next year (five bonds). Another 11 bonds are due to be repaid in 2022. As part of capital raising plans, some lenders have issued subordinated bonds in the local market. Others may consider international markets. If many lenders do this, it could change the mostly-short-and-senior nature of the Indian bank Eurobond market.

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.