26th April 2016
Jan Dehn, head of research at Ashmore, gives his assessment of what is going on in two key emerging markets, Brazil and China and considers Argentina’s return to the fold.
Brazil pleases fixed income investors
The news from Brazil is awesome, if you are a fixed income investor, that is. Firstly, disinflation is intense. The mid-month IPCA-15 inflation index decelerated sharply from 9.95% yoy in March to 9.34% yoy in April, while core inflation fell to 7.96% yoy in April from 8.39% yoy in March. Secondly, the current account deficit narrowed further to just USD 0.9bn in March, lower than anticipated (USD 1.2bn). FDI flows over the past twelve months have remained solid and now stand at USD 78.9bn, which is equivalent to 4.6% of GDP, or more than twice the twelve-months rolling current account deficit. Thirdly, without in any way qualifying as strong, some of the indicators of economic activity are beating very negative expectations. For example, the monthly indicator of economic activity – known as IBC-Br – declined by less than expected in February (-0.3% mom versus -0.5% mom expected), while activity was revised marginally higher in January. The fiscal outturn, though weak, was also better than expected in March (BRL 95.8bn vs BRL 93.6bn expected). The downturn in inflation, the improving external balances and the process of impeachment of President Dilma Rousseff, now underway, have strongly supported the fixed income market in Brazil this year.
Judge Griesa of the Second District Court of New York on Friday lifted all injunctions against Argentina following an extremely successful bond issue last week. The holders of the discount and par bonds that were pushed into default last year when the court forbade the payment agent from processing coupon payments in order to put pressure on the government at the time are now likely to be paid in full, in our view. The government raised USD 16.5bn in last week’s bond issue. This money will be used to pay holdout investors and to finance the fiscal deficit. The new bonds were large and liquid benchmarks, which are likely to become attractive trading vehicles. Specifically, Argentina issued USD 2.75bn, USD 4.5bn, USD 6.5bn and USD 2.75bn of three, five, ten and thirty year bonds respectively, with coupons of 6.25%, 6.875%, 7.5% and 7.625%. The total combined demand for the new bonds exceeded USD 68bn, which is the largest ever demand ever recorded for an EM bond issue (for context, the demand was twice as great as the combined issuance of all Latin American sovereigns in the whole of 2015). The government has indicated that it will not issue any more bonds in external markets this year, although we expect more supply from provincial governments and corporates as well as from the central government under local law, either in USD or local currency. Griesa can now retire in peace.
Sustainable debt levels in China
It seems that China cannot get any peace. If the country is not experiencing a hard landing it must be collapsing under excessive levels of debt. Fortunately, not all the analysis on China is superficial. China’s debt levels are in fact sustainable. When looking at outstanding credit – debt – it is important also to look at the source of funding – savings. Taking into account differences in savings rates across countries, China’s debt stock is entirely in line with the debt stocks of other EM countries, which, of course, are much lower than those in developed economies. The mistake many make is to look at the absolute level of debt in China without taking into account China’s extra-ordinarily high savings rates. High savings means high levels of deposits in the banking system, which in turn leads to high levels of lending (but not excessive banking sector leverage). China is a high saving – high investment – high growth economy. Investors are right to always ask questions about debt, but they should be more concerned about debt levels in the Western world, which are as high or in some cases higher than those in China and not supported by high levels of savings. We would also argue that the gradual slowdown in China over the last few years has very little to do with the level of debt. Rather, the slowdown is a consequence of China’s rapid pace of reforms, including interest rate liberalisation, price liberalisation, deep financial reforms at local government level, capital account liberalisation, changes to the FX regime and reforms of state-owned enterprises. These deeply intrusive but necessary reforms cause consumers and investors to temporarily delay their spending decisions, thus slowing the economy. However, the reforms will place the country on a much better footing to sustain healthy growth rates over the longer-term. Do not bet against China.