This week, we go over the key structural drivers of the Turkish Lira (TRY) and explain why we remain cautious despite recent weakness; review Mexico’s 2021 draft budget that unlike most other EMs prioritizes fiscal prudence over economic stimulus; comment on Angola’s rating downgrades and prospects of increased multilateral and bilateral support; and highlight risks to India’s IG rating amid a still deteriorating COVID-19 outbreak. In our Global Emerging Market Corporates series, we comment on primary market issuance trends by EM corporates this year.

Market Overview

“There is no room for complacency” seemed to be the quote of the week from the ECB’s Philip Lane. Investors were left feeling fatigued with ECB miscommunication and indeed whether the Central Bank could have been: (1) more clear on inflation after discussing the August HICP print; (2) clearly flagging the implications of EUR appreciation; and (3) addressing measures to tackle muted core inflation, while also leaving the door ajar for a policy twist in December. Meanwhile, Brexit tensions notched higher as the UK government seeks to introduce the Internal Markets Bill, which may violate the Withdrawal Agreement and in turn trigger legal action by the EU. Separately, the AstraZeneca/Oxford University vaccine trial was paused after an unexplained illness, which comes as the tech-led weakness began to subside. This in turn saw VIX futures trade down even if the volatility hump into October remains elevated. Crude markets traded poorly in view of second lockdown concerns, which dragged U.S. Treasuries 3-4.5bp tighter as European equities outperformed US, mainly on French stimulus and weak GBP lifting the FTSE. Indeed, Israel is set to follow Indonesia in re-imposing national lockdown measures, which comes as Hungary and Ukraine reported record high case growth. Over the course of the week, the EM Sovereign index was down 0.5% but 9bp tighter while the EM Corporate index was flat on the week. The newly restructured Argentina and Ecuador benchmark bonds entered EM indices this week, where Suriname, Croatia and Brazil outperformed, as Lebanon, Sri Lanka and Angola lagged. Primary markets continued to pick-up through the shortened week and showed few signs of easing up as Korea became the first negative yielding EM bond at the point of issuance (5yr in EUR). Into next week, South Africa is likely to cut rates by 25bp and take the repo rate to 3.25%, although Brazil, Indonesia, Poland and Russia should keep rates unchanged. Chile will also be publishing minutes from its September meeting. Focus will be on Israel’s deflationary pressures with Tuesday’s release, although the prospect of a two-week lockdown may overshadow this. Elsewhere, we expect inflation to be more elevated out of India and Argentina, with releases due on Monday and Wednesday.

Turkish Lira (TRY) trajectory depends on the interaction of several key structural factors, outlook remains challenging despite record weakness 

Event: This week TRY approached the psychologically important 7.50 level against the USD, despite overall dollar weakness and the absence of major idiosyncratic negative headlines.

Gramercy Commentary: Amid renewed pressure on the TRY throughout August and the beginning of September, there are several important trends and variables that we are watching closely for signals on the currency’s outlook. On the top of our list are real yields. Due to sticky high inflation, ex-post real yields remain negative, despite close to 300bps of “hidden tightening” delivered by Central Bank of the Republic of Turkey (CBRT) since mid-July through increasing its effective funding rate that currently stands at around 10.15%, almost 200bps higher than the headline policy rate of 8.25%. However, with on-the-run inflation of around 12% YoY, the CBRT needs to push the effective funding rate further up in order to bring real yields back to positive territory. Given that the effective funding rate plays an important role in pricing TRY deposits at local banks, it has a direct link to deposit dollarization, which is another factor we are watching closely. Dollarization of bank deposits has eased during August, but FX deposits stand at around 53% of total deposits in the banking system and positive real yields are necessary for the trend to reverse more meaningfully. Meanwhile, CBRT’s gross FX reserves are under significant pressure; they rebounded in the first week of September to $44.9 billion from $41.5 billion in the prior week, but remain around 45% lower YTD. On the money creation front, despite recent moderation in credit growth, it is still at historically high levels owing to the authorities’ attempts to support economic activity in the face of the pandemic. Strong credit growth has pressured the current account balance, a perennial structural weakness, that has consistently deteriorated in 2020 (despite lower global energy prices), after improving materially throughout 2019. Last but not least, we are watching geopolitical developments, a factor that can always introduce additional event risk premium to Turkish assets. Tensions with Greece and Cyprus over hydrocarbon exploration in disputed areas of the Eastern Mediterranean have been gradually escalating in recent weeks and the market is expecting the EU Council’s decisions on September 24-25 in terms of Europe’s reaction to the brewing crisis. Separately, Turkey has a number of unresolved diplomatic and political issues with the U.S. (e.g. potential sanctions over the acquiring of Russian S-400 air defense systems), which are likely to resurface promptly in the event that former Vice President Joseph Biden wins the U.S. presidency in November. Putting all these factors together, the near-term outlook for the currency remains challenging, in our view. The critical conditions to reverse some of the recent TRY weakness are further tightening of monetary policy and easing of domestic credit creation, which could produce a tactical short-term investment opportunity, but our structural view remains cautious.

Mexico’s 2021 draft budget signals fiscal prudence, but appears to rely on optimistic macro assumptions   

Event: Mexico’s Ministry of Finance (MoF) submitted to Congress a tight draft budget for 2021 that prioritizes fiscal discipline and protecting the sovereign ratings over offering robust fiscal stimulus to the economy badly hit by the pandemic.

Gramercy Commentary: The administration of President Andrés Manuel López Obrador (AMLO) is among the very few globally that appear to remain firmly committed to maintaining fiscal discipline amid the economic and social fallout due to the pandemic. Planning to keep government spending tight even as the economy has been severely battered by COVID-19 (-18.7% YoY in 2Q, among the top 3 worst affected major emerging markets together with India and Peru) is in stark contrast to Brazil’s approach thus far for example. It is also in line with AMLO’s promise to control spending and debt, and not increase taxes or introduce new taxes in 2020. On the other side, the austere fiscal approach will create headwinds for Mexico’s economic recovery, which will likely trail that of peers in 2021. The budget assumes a contraction of 8% YoY in 2020 and a recovery of 4.6% YoY in 2021, but in reality, the contraction will likely be worse this year. The MoF’s assumptions are significantly more optimistic than current market consensus of -10% YoY for 2020 and a very mediocre recovery of +3.4% YoY in 2021. Furthermore, the latest GDP projections by Mexico’s Central Bank see a “best case scenario” of -8.8% YoY in 2020 and +5.6% YoY in 2021 and a “worst case” scenario of -12.8% YoY in 2020 and +1.3% YoY in 2021. As such, the budget’s macro projections seem optimistic. The medium-term (2022-2026) framework incorporated in the budget also appear to be on the optimistic side. The government assumes average annual real GDP growth of 2.5% over the medium-term vs 1.9% YoY median forecast for annual growth in the next 10 years in the CB’s survey. Against a backdrop of projected sharp increases in sovereign Debt/GDP burdens across the majority of both emerging market and developed market economies in 2020-21, Mexico’s budget is targeting lowering debt/GDP by 1% of GDP to 53.7% in 2021, from a projected 54.7% in 2020. In regards to PEMEX, 2021 oil production projections were scaled back by 8.4% to 1.857 million barrels per day, down from 2.027 million barrels per day in an earlier forecast and the budgeted price for the Mexican basket is $42.1bbl (in the mid-$30s currently). Overall, PEMEX/the hydrocarbon sector is projected to contribute around 17% of the government’s total revenues in 2021, which mainly comes from duties levied at the crude oil production level and not income taxes. While PEMEX clearly still represents an important share of the government’s overall income, the relative weight of other sources has grown significantly over the last few years, most notably taxes, because of former President Peña Nieto’s aggressive tax reform and enforcement as well as lower oil production/prices.

Moody’s downgrades Angola, discussions with the IMF appear to be progressing 

Event: This week Moody’s downgraded Angola’s sovereign rating to Caa1 from B3 and assigned a stable outlook. In Moody’s assessment, the shocks resulting from the sharp drop in oil prices, the coronavirus outbreak, and the related further depreciation of the currency, all contribute to a significant weakening in Angola’s already weak public finances and fragile external position, despite tangible and continuing reform efforts. Angolan bond yields widened by about 1ppt to around 12% on the news.

Gramercy Commentary:  As we wrote recently, Angola faced a sudden triple economic shock from COVID-19: a precipitous drop in oil prices, a reduction in crude production, and a global pandemic. Moody’s rating decision, which follows a similar one by Fitch last week, reflects the profound challenges this credit faces over the medium-term. However, the near-term outlook appears more constructive. Angolan officials are scheduled to meet with the IMF next week to discuss a potential increase to the Government’s existing program with the Fund to $4.5 billion, from $3.7 billion. A larger IMF program could also help Angola secure up to $1 billion in additional support from the World Bank and the African Development Bank. In addition, we continue to watch closely Angola’s negotiations on deferring bilateral debt owed to China, by far the country’s largest creditor holding around a quarter of total government debt, that could result in a material $2.3 billion in debt service deferment this year. As a reminder, the G20 members, including China and the Paris Club have been working since April on implementing a freeze on debt service payments by the world’s poorest countries through the end of 2020 in order to free up funds to fight COVID-19 and mitigate its economic impact. While temporary deferment of debt service certainly helps governments in their attempts to manage the fallout from the pandemic, we are of the opinion that such measures are unlikely to be sufficient to avoid debt distress by the most vulnerable issuers. Less resilient sovereigns that entered the crisis with already challenged credit profiles and inadequate buffers are likely to require more material forms of debt relief, involving both official and private sector creditors, in our view.

India surpasses Brazil in total confirmed COVID-19 cases

Event: With close to 4.5 million confirmed COVID-19 cases as of September 10, India has now overtaken Brazil (4.2 million cases) as the COVID-19 hotspot in emerging markets. India, similar to the U.S., went into lockdown when the pandemic emerged in March, but has since reopened many parts of its economy despite continued growth in the virus. The most recent phase of reopening began at the end of August, with the Delhi metro starting to operate last Monday.

Gramercy Commentary: August was the worst month in India since the start of the pandemic with close to two million new confirmed cases and almost 29K confirmed deaths. The surge of the virus in India follows abysmal 2Q GDP results caused largely by the lockdown (-23.9% GDP growth YoY). Analysts now estimate the full-year GDP decline in the 10-15% YoY range. India’s preemptive opening underscores the challenge for emerging markets economies. While lockdowns slow the spread of the virus, they also impose harsh economic costs, disproportionately affecting the most vulnerable sections of the population. This is especially true for countries like India, which have large informal economies and a significant portion of workers rely on daily wages. We are watching India closely to see how it will stimulate its economy in the near-term, and if it will need to borrow additional funds to do so. Given that India entered the pandemic with limited fiscal space, additional borrowing will likely inhibit its ability to maintain an investment grade rating (currently: Moody’s – Baa3 Neg, S&P – BBB- Sta, Fitch – BBB- Neg). A potential sovereign downgrade will likely increase the borrowing costs and create additional pressure on Indian investment grade corporates, most of which are constrained by the sovereign rating.

Global emerging market corporates in focus: Open the (supply) floodgates

While it may not seem like it after a busy week in the primary market, global emerging market corporate Eurobond issuance is still down year over year. This largely reflects a decline in non-investment grade new issues. In two of the three emerging market regions – Asia Pacific and Latin America – investment grade issuance is up this year. We are likely to see the catching up there is to be done in the primary market completed in the very near-term. This may lead to concerns about performance and valuations. We think two things are worth highlighting on this. First, data available to us suggests inflows into the asset class remain strong. Secondly, more issues from non-investment grade issuers may help address lingering concerns about liquidity at these issuers, possibly leading to a reassessment of default risks.

There may be more for all issuers – not just those rated below triple-B – to do. For banks in particular, prolonged payment deferral programs may impact liquidity metrics. Incremental (and in some cases, cheaper) liquidity from central banks may have helped. Regulatory forbearance on liquidity requirements can be another offset. However, those may not be ideal, long-term (or even medium term) solutions. Funding in Eurobond format may be needed. For non-financial companies, stimulus packages from governments in the form of direct payments or grants and state-guaranteed loans may have helped address the impact the COVID-19 pandemic has had on customer volumes, and therefore on cash flows. However, these measures may be limited in size, scope and/or tenor. Bond issues can help bridge the gaps there may be in government-sponsored programs.

Subordinated securities may also continue to feature in primary markets. There are at least three reasons for this. First, capital ratios at some banks have come under pressure as some emerging market currencies have weakened. This is because capital, the numerator in these ratios, is usually predominantly in the local currency while a significant portion of risk-weighted assets, the denominator, may be foreign currency-denominated. Issuance of Tier 1 and/or Tier 2 securities in hard currency can help offset the impact of weaker local currencies on capital ratios. Secondly, issuing subordinated securities in the Eurobond market may be preferred where stock market multiples such as price-to-book remain depressed (restrictions on dividend payments in some countries have contributed to this). Thirdly, while regulatory intervention in some jurisdictions may have helped by lowering capital requirements or altering the way capital ratios are computed, such intervention is only intended to be temporary. Any capital shortfalls there may be will eventually need to be addressed. The Eurobond market is one way of doing so. Accordingly, financial institutions may issue more subordinated securities where new regulations or approvals permit such issuance. Two recent subordinated notes – from the Philippines and from Hong Kong – are examples of this.

More issuance from supranationals, multinational development banks (MDB) and similar entities appears almost inevitable. Demand from these lenders’ member states is likely to have increased as a result of the pandemic – MDB loans may be needed more than ever. In addition, existing loans may need to be renegotiated. The requirement to provide funding in or to member states may mean MDBs and lenders like them also contribute to increased primary market activity.

Raising funds in the Eurobond market may now be seen as an option by corporates that had not previously issued such securities. These potential first-time issuers may have seen funding from other sources decline, or dry up completely. As examples, the ability of some banks to extend loans may be constrained, lower business volumes may mean operations are no longer self-funding and for banks, large depositors may need to withdraw funds to meet their own day-to-day needs. It is possible that the COVID-19 pandemic may have led to a reassessment of the merits of Eurobond issuance even where funding from elsewhere remains available. The diversification this market can provide may have increased in importance. Thus, bonds from first-time issuers may also contribute to increased primary market activity.

Local market issuance is possible in some jurisdictions. This may be an alternative to Eurobonds. However, size and tenor limitations in some markets can mean that the Eurobond market is preferred. It may not have seemed like it in March and April but it now seems 2020 may turn out to be a record year for Eurobond issuance from emerging market corporates.


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.