Seismic shifts

IFR 2255 13 October to 19 October 2018
9 min read

An earthquake in the small hours of Thursday morning gave delegates at the IMF’s annual meetings in Bali an uncomfortable reminder that Asia’s emerging economies remain vulnerable to unforeseen shocks. The financial markets have been delivering their share of shocks as well, and another terrible week for risk assets provided a tricky backdrop for the gathering. Rising oil prices, slumping emerging market currencies and the worsening US-China trade war were all high on the agenda.

More important still, however, the global community must reinforce the goal of free and open trade as a means to promoting shared prosperity. And in the near term, it must prevent less-developed markets from being unduly punished as the withdrawal of quantitative easing raises the cost of capital around the world.

The recent shift in global portfolio flows is proving especially painful for countries with a high current account deficit – in other words, emerging markets that are investing in the future.

Calls are growing for the IMF to relax its insistence on fiscal prudence – traditionally a prerequisite for financial assistance – and develop a far larger counter-cyclical fund to help emerging markets continue to invest in growth. Even Singapore ran a large current account deficit until the 1980s.

To do that, however, the IMF will need more capital. And that is hardly a given when the US, the fund’s biggest shareholder, is backing away from multilateral institutions in favour of bilateral “America First” agreements.

As if to encapsulate the challenges ahead, Pakistan formally approached the Fund for assistance last Thursday. Pakistan sits at a crossroads, vulnerable to both global capital flows and geopolitical tensions between the US and China, thanks to its embrace of China’s Belt & Road initiative as a means to finance infrastructure projects.

Another IMF bailout for Islamabad will require some serious manoeuvring to keep all sides happy, while also being an opportunity to restore confidence in multilateral institutions and the long-term potential of a fragile economy. If the IMF manages to achieve those goals, that would be a far more welcome seismic shift.

University challenge

After decades of under-investment, UK universities have been on something of a spending spree in recent years, ploughing hundreds of millions of pounds into projects designed to guarantee their status as world-class institutions into the 21st century and beyond.

The investment spree has its roots in the huge overhaul of rules governing the sector. Since 2012, the government has increased student fees, lifted the cap on student numbers and pushed institutions to compete.

Students, quite rightly, expect more for their money. At the same time, increased competition is making universities fight harder to attract what are now, in effect, customers. The push to upgrade facilities is a natural consequence.

The capital markets have made much of this possible. At a time when banks have been under pressure to reduce lending to the sector because of new capital rules, UK universities have created a new niche in bond markets. A handful of deals have raised more than £2bn since 2012.

But by far the biggest supply of capital has come via the private-placement market, where dozens of deals have been printed, supplying billions of pounds of capital. It is a welcome development: in most cases, this is long-term money being lent at low rates.

Private-placement investors, it seems, see the UK universities sector as a one-way bet. They think the UK would never let an institution go under. To be fair, that is a reasonable assumption – the practicalities, never mind the politics, of allowing a university to go bankrupt almost guarantee that the government would step in.

But if UK plc is expected to eventually pick up the bill on deals that go sour, the government should have more of a say in which deals get done. Allowing almost 170 institutions to take big risks, backed by investors who know they will be bailed out, is a recipe for disaster.

Saudi shambles

Loan syndicators are beginning to doubt Saudi Aramco’s ability to raise a US$50bn–$70bn mega-loan to back its acquisition of a stake of up to 70% in Saudi petrochemical firm Sabic.

Those doubts were evident even before the disappearance of Jamal Khashoggi, the prominent Saudi journalist who has been missing since he visited the Saudi consulate in Istanbul earlier this month. Lenders were becoming increasingly frustrated by the mixed messages from Riyadh about Saudi Arabia’s long-term funding strategy, particularly after Aramco’s proposed IPO was apparently shelved earlier this year in unclear circumstances.

The sale of 5% of Aramco was the centrepiece of Crown Prince Mohammed bin Salman’s plan to diversify the kingdom’s economy beyond oil by raising US$100bn for investment in other sectors.

Saudi Arabia’s heir-apparent now says that Aramco’s stock market debut will take place by early 2021, but banks’ confidence that it will be delivered has taken a big hit.

The mega-loan does not make sense on a stand-alone basis. Many lenders will only take part if they think they have a chance of getting a piece of the IPO, or at least some other ancillary business. And many banks will have to increase their country limits to get approval for the huge sums required.

Before Khashoggi’s disappearance, a solution might have seemed simple. A clear strategy for the IPO and the Aramco/Sabic M&A trade itself, signed off on by the ruling family, would give clarity to banks and enable them to lend in size.

Absent that, a US$50bn loan looks a long shot. And one that has got a lot longer since the mysterious events in Istanbul.

Going through the motions

China’s US$3bn sovereign bond issue on Thursday was only its third in the US dollar market since 2004, but after last year’s triumphant return it was hard to escape a sense of weariness and déjà vu, with all eyes focused instead on Wall Street’s rout.

Not surprisingly, China’s Ministry of Finance made a virtue of this very ability to sail through heavy weather, which it billed as proof of the international financial community’s confidence in the country’s economic strength and long-term prospects.

The deal was also a demonstration that China can do things its own way, as it again declined to seek a rating and refused to budge on guidance – even after US stocks had suffered their worst fall in eight months.

But since none of that was ever really in doubt, it’s hard not to ask, so what?

Aside from its symbolic value, the practical aim of last year’s return to the offshore bond market was to establish a sovereign yield curve that other Chinese issuers could piggy-back on to raise funds at competitive rates. But that part of the plan hasn’t worked out so well.

With the Fed embarking on a still unfinished rate-hiking cycle, and President Trump unleashing a trade war against the Middle Kingdom, emerging markets have swooned – and harsher credit markets have quashed any benefit that the new Chinese sovereign curve might have bestowed on the country’s issuers, especially the weaker ones.

Indeed, it is notable that, as China repeats this now presumably yearly fundraising, the sovereign has become one of the country’s rare names still capable of getting its way on duration and pricing. Others have had their wings clipped, or are stuck in a vicious circle of short-term refinancings at often double-digit rates.

In the syndicated loan market, Chinese borrowers are facing exacting scrutiny for fear that they might fall prey to President Trump’s ever-expanding tariffs or get in trouble should US authorities suspect them of engaging in cyber-espionage or sanctions-busting.

Faced with so many potential minefields, investors seem to have concluded that the only China risk that they are prepared to stomach without demanding a pound of flesh is the most generic one, the sovereign itself. This can hardly be what Beijing had in mind.