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Featuring: ARGENTINA | ECUADOR | TURKEY | LEBANON | PERU | EUROPE | EM Corporate CREDIT MARKETS

In this edition, we comment on Argentina and Ecuador’s successful sovereign debt restructuring deals, renewed market volatility in Turkey, the latest element in Lebanon’s worsening crisis, Peru’s increasingly polarized political environment in the lead up to the April 2021 election, and stronger signals that COVID-19 is resurging in Europe. We also discuss the role rating agencies continue to play in EM corporate credit markets.

Market Overview

This week was extremely busy and in some cases, tragic in terms of news flow, particularly in the EM space. Overall, markets continue to rally around optimism for a recovery and excessive liquidity. The S&P is up by 258 bps this week and is only 40 points away from its all-time high of February 19th, 2020. Similar trends follow across the Dow and the Nasdaq. In the EMD world, the EMBIG is up 1.25% (22 bps tighter), largely lifted by Argentina’s outperformance, and the CEMBI was up 0.69% (21 bps tighter) with IG barely outperforming HY. Gold is continuing its historic rally and is settled well above the 2000 mark, current at around 2050. The big news of the week is of course Beirut’s terrible explosion. The total costs of the damages could exceed over $5 billion according to initial estimates. (please see our Lebanon comment below). Colombia’s  former President Uribe was placed under house arrest for accusations of witness tampering. On a more positive note, Argentina and Ecuador reached historic and speedy restructuring agreement with bondholders (see comments below). In Argentina’s case, the deal covers $65 billion of international debt, for a value of 54.8 cents on the dollar. We see this outcome as a win- win-win: for the government, the local population, and the creditors. Argentina also suspended its nationalization of soy trader Vicentin by annulling Fernandez’ decree from last week, therefore sending another positive message to the markets. In the US, there was some positive economic data stemming from the July jobs report, with a total of 1.8 million jobs created over the month as many states were in the process of re-opening, beating analyst expectations of 1.5 million and bringing unemployment down to 10.2%. However, there is growing uncertainty around the next stimulus package in light of stalling discussions in Congress. Additionally, President Trump unleashed his latest weapon in the new Cold War on China by attacking Chinese tech giants. Two executive decrees ban US citizens from doing any business with WeWork and TikTok: make sure you get your TikTok choreographies in before the decree takes effect in 45 days…

Argentina and Ecuador complete sovereign debt restructuring deals 

Event: The governments of Argentina and Ecuador reached agreements this week with a critical mass of private sector creditors in order to trigger the restructuring of their sovereign debt obligations with aggregate principal amounts of around $65 and $17.5 billion, respectively.

Relevance: Both restructurings will deliver significant liquidity relief to the respective governments over the decade ahead, while producing recovery values that we estimate to be in the mid-50s to low-60s range, making the outcomes constructive for all stakeholders. As such, we believe deal risk to be low. The agreements reached this week area successful resolution for two of the most prominent EM sovereign debt restructurings precipitated by legacy credit vulnerabilities accumulated in the pre-COVID era. The liquidity relief will be to the tune of around $40 billion in the case of Argentina and $16 billion in the case of Ecuador over the next 10 years, combined with no principal repayments until the middle of the 2020 decade. This debt relief will provide material support to the authorities as they tackle the negative economic and social impact of the pandemic over the coming years. Using the resources efficiently and the policy space freed up by their respective debt restructurings will be critical for both governments as they try to steer their economies back toward a sustainable and more inclusive growth path. With the restructuring negotiations behind them, the two administrations will focus on new agreements with the IMF, which will be important for reform momentum and market confidence going forward. There are signals that Argentina will try to reach a deal on a new IMF program by the spring of 2021. Ecuador, for its part, is in advanced negotiations over a successor IMF program, although a few details remain to be ironed out with the Fund, especially in the context of a highly uncertain economic outlook and a challenging fiscal path ahead. In addition, in Ecuador’s case, investors will also have to digest uncertainty around policy continuity stemming from general and presidential elections in February 2021. This being said, we believe that the IMF strongly endorsing both restructuring deals is a good sign. The Fund’s Managing Director, Kristalina Georgieva, congratulated Argentina and Ecuador on reaching agreements with their creditors and said that the IMF looks forward to deepening the dialogue with the authorities. Last but not least, we believe that the example set by Argentina, Ecuador, and their creditors in 2020 sends a strong signal to markets that pre-emptive sovereign debt restructurings based on mutual respect and cooperation can produce win-win outcomes. Importantly, such an approach in the future can help avoid prolonged hostile restructurings that lock countries out of global capital markets at significant opportunity costs in terms of lost economic development.

Renewed FX volatility in Turkey as unorthodox measures fail to keep the currency stable   

Event: After a period of recovery and relative stability since early May, supported by state-banks’ interventions in the currency markets, the Turkish Lira (TRY) has come under renewed pressure, breaking above the psychological level of 7.25 against the USD this week. Prompted by the TRY weakness amid relative EMFX strength, the Central Bank of the Republic of Turkey (CBRT) announced that its targeted additional liquidity facilities will be phased out and it will use all available instruments to reduce the excessive volatility in the markets.

Relevance: Absent an abrupt policy shift toward politically highly unpopular interest rate hikes by the CBRT, fundamental factors are pointing to further currency weakness, despite the authorities’ imposing a de-facto “managed currency” regime at the expense of burning through FX reserves. With inflation on the rise again following a massive rate-cutting cycle by the CBRT, real interest rates are trending deeper into negative territory. At the same time, the current account is again on a deteriorating path, driven by a failed summer tourism season and economic weakness in key export markets in Europe, the Middle East and Asia. These factors create incentives for local savers to switch their TRY deposits into hard currency ones and we have seen deposit dollarization accelerating over the last few weeks. This local demand for USD seems to be one of the key drivers behind renewed volatility/weakness in Turkish assets over the last couple of weeks against a backdrop of general risk-on sentiment in EM. However, local confidence in the banking system remains strong, which confirms our view that Turkey is not at the verge of a banking and/or balance of payments crisis, at least in the near-term. Furthermore, local banks rollover ratios of external debt remain stable at around 90%, having recovered from around 75% in the aftermath of the 2018 crisis episode. We believe that the authorities policy choices will remain consistent with a “muddle-through” strategy and supporting growth as much as possible, but will likely start to pivot to a slightly more orthodox toolbox forced by renewed market pressure. Market and policy dynamics in Turkey will also continue to hinge largely on the pace of global recovery from the COVID-19 shock. If the domestic and external economic situation deteriorates materially, an IMF program could become an option for securing external financing, but only as a last resort given that IMF conditionality will be politically highly toxic. Deposit outflows from the banking system and/or inability by the local banks to roll over external debt are the key signposts to watch on whether a material crisis is forthcoming. In the absence of an immediate acute crisis on the horizon and given the muddle-through scenario that we expect in 2020, risk-off episodes like the current one present opportunities for tactical trades in select assets and idiosyncratic stories within the Turkish economy, in our view.

Port blast in Beirut leaves already vulnerable Lebanon reeling and IMF talks challenged

Event: A large explosion occurred Tuesday in the port of Beirut, close to shopping and nightlife districts. The blast killed at least 135 people, wounded thousands, and displaced hundreds of thousands whose homes were shattered. It also caused significant damage to the infrastructure at the country’s main port and the surrounding area. Though the cause of the incident is still under investigation, the explosion was allegedly fueled by 2,750 tons of highly explosive ammonium nitrate that was stored at the port since 2014, despite safety concerns.

Relevance: This tragedy could not have come at a worse time for Lebanon, which is in the midst of its most acute political and financial crisis since the 15-year civil war ended in 1990. We see three key challenges for Lebanon in the wake of the explosion. First, given the already inflammable social and political environment in the country, the large-scale loss of life and property will likely add fuel to public discontent with the authorities and can re-ignite mass protests, further undermining political stability. We note that just a day prior to the explosion, Lebanon’s foreign affairs minister resigned, blaming his departure on lack of political will for comprehensive structural reforms and saying that Lebanon was at risk of becoming a “failed state”. Second, the costs of mitigation and reconstruction will be significant and will take a toll on already dire government finances, as well as a hospital system overwhelmed by the COVID-19 pandemic. Finally, the incident is likely to further complicate Prime Minister Diab’s efforts to negotiate a bailout with the IMF. Even without the explosion, Diab’s government was already struggling to advance IMF negotiations due to opposition from Hezbollah, whose support is important for the administration’s political survival. Anti-Hezbollah sentiment has been building in the country with the upcoming verdict of the UN Special Tribunal investigating former PM Hariri’s assassination, which is widely expected to incriminate Hezbollah members. For now, there is no evidence of any Hezbollah involvement in the explosion, but the deadly calamity is adding fuel to the political fire in an already divided country.

Peruvian President Vizcarra’s newly assembled cabinet lost a vote of confidence, prompting an immediate reshuffle

Event: Peru’s cabinet led by now former Prime Minister (PM) Pedro Cateriano lost a vote of confidence in Congress, forcing another reshuffle after more than half of the members, including the Prime Minister, were replaced in mid-July. Congress reportedly opposed mining and education policies proposed by PM Cateriano. This is occurring as the Vizcarra Administration has come under heavy criticism of its management of the coronavirus pandemic and represents the first time Congress has refused to support a newly appointed Prime Minister.

Relevance: Peru’s political environment is becoming increasingly polarized as the country is facing one of the most severe coronavirus outbreaks globally, with close to 450,000 confirmed cases and over 20,000 deaths. The high case count is despite the government’s very strict containment measures since March and reflect Peru’s large informal economy that is not subject to lockdowns. Because of the pandemic, Peru’s central bank expects growth to contract by 12.5% in 2020. President Vizcarra, who is an independent politician without any representation in Congress, came into office in 2018 when the opposition party forced former President Kuczynski to resign over corruption allegations. Vizcarra’s relationship with the legislature has also been tense, reflected in his decision to dissolve Congress last year over the Administration’s anti-corruption campaign. These divides have only grown in the last few months, with President Vizcarra criticizing Congress’s vote of no confidence and accusing politicians of putting their interests ahead of the nation’s. We think that yet another cabinet reshuffle will further delay and undermine the government’s ability to execute on both health and economic measures to combat the pandemic, which include an ambitious $26 billion stimulus plan. The increasingly difficult relationship between the Administration and Congress is also eroding one of Peru’s key strengths, its strong institutions, hindering the country’s ability to recover. Our main concern, however, is that the increasingly volatile political and economic environment and mistrust in the political class will likely increase the electoral appeal of non-establishment candidates in the upcoming general elections in April 2021. The key risk from a market perspective would be the emergence of a competitive candidate, who runs on a platform that could challenge Peru’s orthodox policy environment, a key credit strength.

A number of European countries have experienced an increase in COVID-19 cases in recent weeks, reinforcing concerns over a material second wave of the pandemic 

Event: A number of European countries, including Spain, Belgium, Greece, France and Germany among others, have seen an uptick in coronavirus cases in the last few weeks. Many experts attribute this to the easing of lockdowns and relaxing of social distancing over the summer months. Both German and UK officials have warned that a second wave of cases could be building in parts of Europe.

Relevance: Europe was the first region outside of China to be hit forcefully by the coronavirus pandemic, experiencing a death toll of over 200,000 over the last six months. With strict lockdown measures, the region was largely able to flatten the curve by May, when much of the rest of the world was still seeing a rising case count. Since then, European countries have gradually eased restrictions, including allowing businesses to reopen and permitting certain levels of international tourism, while emphasizing the importance of social distancing and wearing masks. For a few months, this seemed to be progressing well, with cases continuing to decline. Yet the last few weeks have seen an uptick in infections, with new confirmed cases in a number of countries rising back to levels previously seen in May. Politicians and health officials in Germany and the UK have begun to raise concerns over a second wave that could undo some of the region’s hard won progress. As much about COVID-19 remains unknown, the rest of the world is looking to Europe to gain insight into how the virus develops and whether reopening is possible without serious public health repercussions. The most recent developments in Europe support our view that governments across the globe will continue to face a “lives vs livelihoods” dilemma for the foreseeable future. Markets, in turn, will have to digest that the path to global recovery will likely be bumpier than currently anticipated as countries attempt to find a delicate balance between human and economic costs.

Global Emerging Markets Corporates in Focus: Much ado About Ratings

In the aftermath of the Global Financial Crisis, more than a few questions were asked about the role of rating agencies. Ratings assigned to structured finance deals in particular came under scrutiny, but so did other assessments from leading global agencies. There was even talk of scrapping these agencies altogether. Clearly, that has not happened. There are many reasons why. Here are just a few:

  • Ratings remain a quick way of ‘benchmarking’ issuers: When a new issue is announced, one of the first questions that may still get asked is ‘what is it rated?’ The rating can determine what funds can invest in the new issue and what investors expect to be paid. These assessments may determine when a bond needs to be sold (or bought – though that happens somewhat less often). Ratings may also play a part in bond index inclusion. There are clearly many unrated securities which have been placed. However, it is clear that these assessments still contribute to how new securities are evaluated relative to existing ones. Internal ratings using similar scales may even be applied where no public rating exists. It is important to stress, however, that ratings are just one of many inputs in the investment process.
  • Central banks can use ratings in quantitative easing decisions: In the US, the EU and elsewhere, ratings have sometimes determined if bonds qualify for inclusion in central bank buying programs. This is not a new phenomenon, but it has been a focus this year. We have seen that even vague speculation about such purchases can have a significant impact on valuations, and can skew how bonds which are included trade, versus those which are not.
  • Ratings can impact banks funding and liquidity: Local or international ratings have been used by authorities in determining where some deposits may be placed. In at least one country, these assessments have been used to decide what banks can hold certain state funds. Thus, ratings, even at the local level, can affect banks access to liquidity.
  • Local and global rating agency assessments do not have to be mutually exclusive: We now have even more ratings, global and local. Sanctions-related concerns and questions about objectivity at global rating agencies have led to more local rating agencies being established. The rise of local ratings has not necessarily led to a fall in global assessments. These assessments can be complementary, and can enhance investors understanding of issuers. Local ratings can play a role in intra-country comparisons, for example, and can be used to assess in-country credit factors where issuers’ peers are only rated locally.
  • Capital and other bank requirements may use ratings as an input: During the results season, at least one global bank noted that rating downgrades had resulted in higher risk weights on certain exposures. While lenders tend to have their internal models and assessments, public ratings can be an input into this. There may be higher return on investment hurdles when an issuer is downgraded, and therefore higher fees or other costs. This means that even where issuers chose loans rather than bonds, maintaining certain ratings may be important.
  • Bond documentation can require issuers to maintain certain ratings: Issuers can ill afford to ignore rating assessments, especially where changes can impact how much is paid on existing bonds. Downgrades can lead to coupon hikes and vice versa. Further, some change of control language requires that such ownership updates impact ratings before holders can put bonds back to the issuer.
  • Rating changes can still move markets: Rating agencies are sometimes perceived as having access to more in-depth information than most others do. Thus, the withdrawal of ratings can still cause consternation as such actions may suggest that issuers are less willing to provide information to market participants (though this is certainly not always the case). Considering rating changes, it is not as simple as ‘upgrades are good’ and ‘downgrades are bad’. We have seen bonds sell off after anticipated upgrades. However, rating changes, even when driven by criteria updates, can still impact valuations.

There have been changes in workings of rating agencies including sovereign rating calendars, even more regular periodic reviews and, of course, more disclaimers. Crucially, ratings remain deeply imbedded in credit industry structures and processes. Rumors of the demise of rating agencies may have been greatly exaggerated.

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.