viernes, 11 de abril de 2014

viernes, abril 11, 2014

Parsing the top 10 risks for EM investors

Apr 9, 2014 3:00 am 

by James Kynge and Jonathan Wheatley


There is no doubt that emerging market (EM) investors have cheered up considerably of late. Following a torrid January and February, virtually all asset classes in the EM universe appearon aggregate at least – to be gaining in value.

The bellwether stock index, the MSCI EM index, is up 9.6 per cent since the start of the year. EM sovereign bonds are yielding an average of 5.51 per cent, down 0.37 per cent since January 1. Local currency bonds are, in many cases, producing stellar returns sharpened by windfall currency gains. Indeed, some EM currencies are among the world’s best performers, with the Indonesian rupiah rising 7.81 per cent, the Brazilian real gaining 7.3 per cent and the Indian rupee climbing 2.8 per cent so far this year.

Nevertheless, several EM analysts say it would be unwise to extrapolate this performance seamlessly into the future. There are still some big risks that could upset the EM asset cart. We have identified 10 here – the list is not intended to be exhaustive, so do let us know your views.


1) China’s economy doesn’t respond to “stimulus”


“The key risk (to EM) is that the Chinese can’t actually micro manage growth,” said David Hauner, EM Strategist at Bank of America Merrill Lynch.

The consensus view among EM investors is that Beijingthrough a combination of its strong administrative levers and hefty fiscal and monetary resourceswill be able to keep GDP growth at above 7 per cent this year, and may achieve its target of “about 7.5 per cent”.

But what if this rationale is flawed?

What if the latestmini-stimulusannounced by Beijing this month fails to deliver? As Rafael Halpin, Director of Capital Intensive Research at China Confidential, notes, the so-calledmini-stimulus did not contain any infrastructure projects that had not already been planned. In addition, there have been no signs that Beijing is ready to relax its tighter credit policies, without which financing any stimulus could prove tricky.

“The uptick in infrastructure investment in mid-2013 was preceded by a 31 per cent rise in total social financing in the first six months of that year,” Halpin says. Total social financing in the January-February period was down 3 per cent from the period last year. This is the metric that investors should watch for signs of a genuine stimulus.”


2) Defaults ripple through China’s property sector

China’s property sales volumes are down significantly on a year-on-year basis in 2014, deepening investor concerns over the financial health of some highly-leveraged developers. Unsold inventory is soaring (see chart).


        Source: China Confidential

Yerlan Syzdykov, Head of Emerging Markets, Bond and High Yield at Pioneer Investments, says that while larger developers with hefty land banks and good cash flows are likely to weather current adverse market conditions, some smaller developers in second and third tier cities may struggle.

“There may be defaults in this sector,” Syzdykov said.

Distress within the sector can already be seen clearly in the yields on some mainland developer bonds issued in Hong Kongeven though these companies are by definition among the strongest and most international of the thousands of Chinese developers.

Glorious Property and Hopson Development Holdings, which have a combined $1.3bn in bonds, were already trading at distressed levels with yields of 24.5 per cent and 12.4 per cent respectively on Tuesday. The bonds of Wuzhou International Holdings and Modern Land are also distressed.

According to Moody’s, the rating agency, one of the key vulnerabilities of Chinese property developers is their exposure to high interest trust loans absorbed from the mainland’s shadow finance system. Eighteen companies owing $15.2bn to bondholders have “material exposure” to trust financing in excess of 10 per cent of their total debts, Moody’s said.


3) Investors lose faith in Chinese shadow finance products


The opacity of China’s shadow finance system heightens the dangers of miscalculation. An eleventh hour rescue prevented a $500m trust from defaulting in January but things remain perilously poised for a trust sector estimated at Rmb10.9tn ($1.75tn) in size.

Trust defaults could explode in a concentrated period of time,” Zhang Jingfan, president of Cinda Asset Management, a state-owned company, said late last month, adding that such products have proliferated by 50 per cent annually in recent years. UBS estimates that more than 20 trust products worth Rmb23.8bn have encountered payment difficulties since 2012.

One danger is that a series of trust defaults could deter new investors in trust products, thus preventing the “roll over” of non-performing trusts. This dynamic is largely outside authorities’ control because a key investor type in trust products are wealthy individuals; if some get burned by a significant default, others could get spooked and fight shy of further investments.

Analysts estimate that about 30 per cent of maturing trusts require “rolling over” – in other words, they need to be issued again to a new batch of investors in order to pay principal and interest to the product’s first wave of investors. This is necessary because the asset the trust was invested intooften real estate – has failed to yield a return sufficient to repay creditors.


4) Electoral disappointment in India and Indonesia




Indian assets have rallied strongly over the past couple of months, partly on the belief that Narendra Modi, candidate for the opposition BJP, will win the election currently under way and emerge as India’s next prime minister when the results of five weeks of voting are announced on May 16. The CNX Nifty index is up 6 per cent year to date and 11 per cent from its lows in February. The rupee has also rallied, to about 60 to the dollar from 62 at the start of the year and 63.26 at the end of January.

Modi has a strong track record of driving development during 12 years as governor of the state of Gujarat. Indian and foreign investors see him as being friendly to business and likely to push ahead with long-delayed infrastructure projects and other reforms.

Indonesian assets are enjoying even more of an electoral boost, with the Jakarta Composite index up nearly 14 per cent year to date and the rupiah at about 11,300 to the dollar, from more than 12,200 in January. The PDI-P of frontrunner Joko Widodo is expected to emerge victorious from Wednesday’s legislative election, putting him in pole position for the presidential election on July 9.

But betting on the outcome of an election is just that – a bet, and a risky one at that. Apart from the possibility of upsets, there is no guarantee that if the markets’ choices win either or both elections they will deliver on their promises. Both countries, says Luca Paolini of Pictet Investment Management, are being given the benefit of the doubt by investors – but they are too dependent on electoral outcomes, and their assets are no longer even very cheap.


5) Sub-Saharan Africa’s vulnerability to China.


Any ranking of EM vulnerability toward slowing Chinese demand for metals and other commodities would include investor stalwarts such as Chile, Colombia, Russia, Peru, Indonesia and Brazil.

But sub-Saharan Africa, where countries are often classified as “frontierrather thanemergingmarkets, may be doubly vulnerable to a China shock because its economies are smaller and less diversified.

“The risk is to the downside on China, so for those frontier markets dependent on Chinese demand the risk is also to the downside,” said David Hauner, EM Strategist at Bank of America Merrill Lynch.

He added that things could get so serious that some sub-Saharan economies may be forced to seek bailouts from the International Monetary Fund over the next 12 months. Particularly vulnerable are Ghana, Mozambique and Tanzania, analysts said.

Zambia, with its reliance on copper exports to China, has also looked fragile. Nevertheless, it managed to raise $1bn through the issue of an international bond this week. Its yield of 8.625 per cent on the 10-year dollar denominated bond represented a surge in the country’s borrowing costs since it issued a 10-year bond paying 5.63 per cent in 2012.


6) Headwinds for Russia.




If investors are being overly optimistic about India and Indonesia, they seem to be under few such illusions about Russia. The Ukraine crisis has given investor confidence a hammering – the RTS equity index is down 14 per cent year to date, even after recovering from its low point in March. Capital flight in the first quarter was about $60bn, almost as much as the $63bn in the whole of last year.

But Ukraine is far from the only issue facing investors in Russia and Russian assets were cheap before the crisis, for good reason. In a rundown of investor concerns, Chris Weafer of Macro-Advisory lists, in addition to a military escalation of the situation in eastern Ukraine: the impact of sanctions and a general decline in domestic confidence and activity; a scaling back of earnings assumptions in the face of a slower economy and weaker rouble; a slowing of Chinese demand for oil and other Russian commodities; contagion from withdrawal of quantitative easing by the US Federal Reserve

“Because Russia is a high-beta theme with a low domestic investor base, the markets remain a fringe theme within global and GEM portfolios,” Weafer writes. A reported climb down on plans to make state enterprises pay more in dividends adds to a welter of Russia-related fears.

7) Venezuela and Argentina.


At least, for investors, the Ukraine crisis has crystallised. Investors in Venezuela and Argentina are still in the limbo of wondering what on earth is coming next. Take a look at their 5-year CDS spreads, a proxy for insuring against default on their debt during the coming five years. Our charts show Venezuela first, followed by Argentina.


   Source: Thomson Reuters

      Source: Thomson Reuters

You will notice that, even after substantial falls from their peaks, the cost of default insurance in Venezuela is 1,115 basis points (or 11.15 per cent of the debt insured) and in Argentina, 1,756 bpdown from a mind-boggling 4,700+, or 47 per cent, at the end of last year. (In crisis-torn Ukraine, 5-year CDS spreads are about 940 bp, down from a peak of 1,400 bp in mid February.)

In both Venezuela and Argentina, investors’ nerves have been calmed by what look like signs of a willingness to embrace pragmatism. Venezuela’s latest addition to its foreign exchange regime, for example, is a baby step into the real world. Argentina has reached agreement with Repsol, the Spanish oil group, after appropriating its Argentina assets in 2010 and vowing never to pay a penny, and is edging closer to agreements with its creditors in the Paris Club.

But both countries are still wildly dysfunctional. Dozens of people have been killed on the streets of Venezuelan cities in riots fuelled in part by the breakdown of the economy and chronic shortages of basic goods such as milk, flour and toilet roll. Argentina continues to impose price controls in an unsuccessful bid to control raging inflation. Policy makers in both countries are flirting with disaster.

Most investors are able to distinguish between governments and there is little risk of contagion to other markets. But Venezuela and Argentina are reminders that political risk still matters, and of how badly things can still go wrong.


8) A strong DM recovery – risky for EM asset classes.


This one does not need much explanation.

If developed market (DM) economies, especially the US and the EU, return to strong growth rates more quickly than expected, then a much-heralded dynamic could come to pass. DM monetary authorities could accelerate the unwinding of their monetary stimulus policies, thus tapering” the supply of global liquidity. Then, with DM investment assets appearing more attractive amid depleting supplies of liquidity, EM assets could suffer outflowstriggering the familiar chain reaction of EM currency weakness, rising bond yields and slumping stock prices.

Deja vu, in other words.


9) Mexico’s crisis of expectations.


Mexico risks turning into the fallen angel of the EM firmament – and is a reminder of how quickly things can change.

Mexico’s labour became cheaper than China’s about two and a half years ago and it has enjoyed a widening competitive edge in making everything from flat-screen TVs to SUVs. To help things along, Enrique PeƱa Nieto, its can-do new president, has brought in a swathe of reforms that promise to deliver game-changing productivity gains from energy to education.

But productivity gains have long been elusive, a problem that has become more acute as Mexico’s economy stubbornly refuses to take off. Growth has averaged just 2.3 per cent a year since 1981 and was a measly 1.1 per cent last year. Retail sales, formerly one of the economy’s bright spots, have become erratic.
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   Source: Trading Economics


An increase in public spending has done something to revive economic growth in the first quarter but private consumption and investment have failed to recover. There are some positive signs: auto production picked up strongly in March, although it was driven much more by exports than by domestic sales.

It was also a reminder that Mexico remains very much at the mercy of the US economy. When the US recovery appeared to be surging ahead, Mexico’s outlook was rosy. Now that US growth is less assured, Mexico’s outlook looks bleaker. Whatever the outcome, what until recently was borderline euphoria over Mexico has become a crisis of confidence. And Mexican assets are still expensive.


10) State interference.

For most investors, the state’s role is to provide the conditions for healthy development under equal conditions and the rule of law and then get out of the way. But not all governments agree. In Brazil, investors routinely blame the heavy hand of the state for holding back economic growth. Their targets are usually the state’s intrusive role in the energy sector, especially in oil and gas, and in its fixing of “administered prices”, mostly of fuels and public utility charges.

Many argue that the state intrudes far deeper into Brazilian economic life. A fascinating paper by Marcos Lisboa and Zeina Latif, Democracy and Growth in Brazil, identifiesinstitutionalized rent seeking as a unifying theme in the development of political and economic institutions” in the country.




Be that as it may, any suggestion that the state may be forced to rein in its interventionist instincts is welcomed as good news by investors. So it was that recent opinion polls suggesting Dilma Rousseff, Brazil’s leftwing president, may not be the shoo-in previously thought at October’s general election, gave a boost to Brazilian assets. Stocks in SĆ£o Paulo have rebounded 16 per cent from their losses in much of the first quarter and are up 3.6 per cent year to date.

Readers should not confuse this with the danger of electoral disappointment in point 4 above. Few investors are betting that Rousseff will actually lose the presidency in Octoberalthough, were a candidate such as Eduardo Campos, the market-friendly governor of Pernambuco state, to gain a fighting chance once campaigning begins, asset prices would surely soar. Most are simply betting that Rousseff will read the writing on the wall and tone things down a bititself perhaps enough to underpin investment sentiment. The danger, of course, is that once the election is out of the way it will be business as usual.

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