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Liquidity stress across emerging markets

| March 27, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

The International Monetary Fund now reports more than 80 countries seeking access to its $50 billion Rapid-disbursing Emergency Financing Facility formed on March 4.  The ‘B’ credits across EM all now trade near stressed territory with 10% yields or higher while others now trade on price or percentage of par claim. The weakest credits include Angola, Gabon, Zambia, Suriname, Ecuador and Argentina. These first-time issuers had access to the capital markets in the heyday of global liquidity but now all face liquidity stress.  IMF sponsorship will likely depend on geopolitical importance and US diplomatic and multilateral relations.

The case of Ecuador

Taking Ecuador as a case in point, implicit US diplomatic support has helped the country get fast-track access to the IMF Rapid Financing Instrument, a subset of the REFF.   This facility itself does not offer a solution.  Ecuador’s budget stress is too high.  The $500 million RFI loans barely compensate for an estimated direct loss of $2.1 billion in oil fiscal revenues and the estimated secondary shock of $2.1 billion loss in tax income from work stoppage. The IMF facility provides $10 billion in total emergency lending to low income countries and total access for member countries of $50 billion. Countries also have to meet certain requirements:  “county’s debt is sustainable or on track to be sustainable, that it has urgent balance of payments needs, and that it is pursuing appropriate policies to address the crisis.” Venezuela was obviously turned down on their request for $5 billion RFI loan last week.

The unconditional emergency loans like the RFI and Rapid Credit Facility are minimal, with countries allowed to draw only 50% of their membership share of the IMF capital. Conditional, formal IMF funds may trigger domestic resistance on rising social and political pressures. It’s difficult to fix structural macro imbalances with fiscal austerity when countries instead prefer fiscal stimulus to counter negative external shocks. The vulnerability of the ‘B’ countries will depend upon their gross financing needs, domestic funding capacity, domestic savings and the openness of the domestic economy to trade and financial flows.  Ecuador ticks all the boxes for the vulnerability ratio.  It then becomes a function of effective crisis management and potentially a reassessment of creditor relations to seek liquidity relief.

A bright spot in Panama

The bold launch of a new issue in Panama highlights a resilient appetite for the best performing credit year-to-date in Latin America even under current market conditions.  It’s a race to source liquidity and buffer economies and budgets against COVID-19.  The IMF has triggered access to emergency funds while also calling on bilateral lenders to provide cash flow relief to low income nations.

The case of Argentina

Argentina has fewer options with a rigid foreign exchange rate, a low level of net foreign exchange reserves, and financial isolation with no access to external capital markets or conditional funds from multilateral lenders.  The shift towards an unfriendly stance with creditors should delay a resolution with bondholders. And it becomes an increasingly difficult to allocate scarce resources toward the $4 billion in external debt payments due under New York law this year.

The aggressive stance towards creditors now carries high risk of a standoff. There is just no obvious rational economic explanation for why the team would jeopardize a successful transaction and risk exactly what they were trying to avoid: “destabilizing macroeconomic effects.”  Ideological and political interests now dominate rational economic policy management.  The successful debt restructuring was widely viewed as the important first step to restore consumer and business confidence necessary for an economic recovery.  These delays now further compromise cash flow under stress from the commodity shock and work stoppage. Mandatory quarantine compounds downside risks to GDP.  It looks to be another year of economic recession with 2019 posting a decline of 2.2% against market estimates this year of another decline of 3% to 4%.  Despite limited flexibility for counter-cyclical fiscal stimulus, the Fernandez administration announced a 1% of GDP stimulus package.  The initial official estimates of real GDP decline of 1% to 1.5% this year and primary fiscal deficit of 1.1%-1.5% are no longer feasible.

What are the potential financing options? The net foreign exchange reserves continue to decline at $12.7 billion as of March 13 and should quickly decline to $12.2 on depletion of treasury deposits. It’s just not sustainable that the central bank intervenes to defend the official foreign exchange rate while the treasury withdraws US dollars in exchange for adelantos transitorios—non-marketable securities that erode the central bank’s balance sheet.  Meanwhile, the treasury has yet to normalize funding in its domestic markets with a process of compulsory and voluntary re-profiling of securities.  Maturities that are not rolled over convert into a faster pace of monetary expansion that’s only partly absorbed through central bank paper (LELIQ) for a further deterioration in their balance sheet and latent risk to hyperinflation. The budgetary and rollover stress should continue through hefty payments in April and May, including some USD liabilities of BONAR and Paris Club payments.

Argentina will likely have to at least approach the IMF for access to the $2.2 billion of the rapid financing instrument ahead of these US dollar obligations. This precarious balancing act does not seem sustainable, with risk towards worsening growth/inflation tradeoff and further pressure on scarce foreign exchange reserves that may compromise the $4 billion in coupon payments this year. The distressed bond prices may seem low at $24 to $28; however they trade at a higher premium to Ecuador and face much higher challenges on reaching a resolution with bondholders and remaining current on interest payments.

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