IFR IMF/World Bank 2015

The IMF’s decision to provide a third of the funds required to finance Greece when it could no longer access the market in 2010 backfired in spectacular fashion this July, when the recipient defaulted on a payment to its overly generous creditor. Breaking the taboo, that no one defaults on the IMF, was Greece’s last act before accepting a humiliating deal with its European partners to release funds to repair the hole. That also ensured that further financial totems – the European Central Bank was next in line – were not questioned. However, the wound had been administered. And although quickly patched up, the full implications of the IMF’s over-extension to Greece – achieved by changing its exceptional access rules at the peak of the crisis – remain unexamined. Systemic? To emerging market countries the debacle confirmed their long-held suspicion that the Fund had been hijacked by its major shareholders, the developed countries, who had amended the institution’s rules to support their own, on grounds of preventing a global systemic collapse. The figures starkly bear out this accusation. European countries, which account for a third of the votes on the IMF’s board, are in receipt of two-thirds of the Fund’s outstanding credit (see chart). “Many policy-makers, in particular those outside Europe, see the IMF’s exceptional access criteria and policies as having been fundamentally compromised by the fudges and exceptions made to allow approval of the IMF-supported program in Greece,” wrote Richard Gitlin and Brett House in a Centre for International Governance Innovation paper. A first step to rectify the policy errors so that the balance between developed and emerging countries is more even could be to revoke these “systemic exemption” criteria, which allowed it to make such a disastrous loan to Greece in the first place, under the exceptional access policies. An overhaul is already under consideration by the IMF but House, now chief economist at Alignvest, does not think the systemic exemption will be removed any time soon. “The US Treasury, which has a de facto veto on major deisions at the IMF board, has been opposed to the removal of the systemic exemption. It wants to retain the option for the IMF to lend at massive scale so long as there is the possibility of an existential crisis in the eurozone,” he said. Gabriel Sterne, head of macro at Oxford Economics, agrees. “The IMF board would be reluctant to let go of armoury once it is created in case it might need to use it in the future,” he said. Signs of distrust A more lingering sign of distrust between the two blocs is the stalled reforms to the Fund’s quota system that would give faster-growing emerging market countries, such as Brazil, China and India, a greater say in board decisions. These proposals, which would also reduce the US’s votes so they no longer held a blocking stake at board level, were first set out in 2010. However, they remain on ice since the US Congress has refused to ratify the proposals to reduce its influence. The suspicions that the IMF continues to be a trans-Atlantic cabal were heightened when yet another European, French finance minister Christine Lagarde, was appointed managing director in June 2011, succeeding the disgraced Dominique Strauss-Kahn, another French citizen. At the time Lagarde’s main rival for the post, Mexico’s central bank governor Agustin Carstens, hinted of the problems that might lie ahead regarding the Greek package (relating to the 2010 loan), whose exact structure was being debated. “If the problem is driven by high liquidity constraints, the Fund should lend, including in large amounts. If, on the other hand, the debt position is unsustainable, Fund lending would only overburden the member, and would lead to the postponement of other, more effective, decisions,” he said. Several non-European members of the Fund’s board, such as Brazil, apparently expressed unease, behind closed doors, at the prospect of giving Greece such

With the wisdom of the ancients, an old Chinese proverb suggests that prosperity and calamity are different sides of the same coin – an insight that captures well China’s current condition. Just as it was standing confidently poised to convince the IMF that the renminbi should be included in its basket of global reserve currencies, chaos on the equity markets cast a shadow over Beijing’s global pretensions. It is small wonder then that the IMF has extended until September 2016 its existing Special Drawing Rights basket of reserve currencies – the US dollar, euro, Japanese yen and pound sterling – offering China a window in which to tie up loose ends. The Fund is likely to make a final decision on the renminbi’s inclusion in November, but deferring implementation until next year would enable it to time this to coincide with the Chinese presidency of the G20 while securing the support of US President Barack Obama in the dying days of his term. If patience were a virtue, the government in Beijing might be considered one of the world’s most virtuous for refusing to abandon its ambition for SDR inclusion after the IMF snubbed the renminbi at its last five-yearly review of the basket in 2010. But this patience merely reflects confidence that there has until recently been little doubt that the IMF will incorporate the Chinese currency. As managing director Christine Lagarde has stated unequivocally, it is not a matter of “if” but “when”. Karine Hirn, head of East Capital’s Asia team based in Hong Kong, said: “They do this review only every fifth year and that’s a bit of an issue because it’s a bit too early today but at the same time it will be too late by 2020. If I would have to bet on it that would be my bet: they will consider that it is too early now but we don’t want to have to wait until 2020 so we might look into it again before that, outside of the regular schedule of the SDR review.” According to the IMF, the world’s central banks had allocated more than US$6trn of foreign-exchange reserves by the end of last year, more than 60% in US dollars. But use of the renminbi as a reserve currency is growing and in June, Standard Chartered said CNY assets now accounted for US$70bn–$120bn (0.6%–1.0%) of global FX reserves. Nonetheless, potholes have appeared along the path to SDR inclusion during a turbulent summer that will, inevitably, focus minds at the IMF. On August 11, China surprised the world’s financial markets with a 1.9 percentage point cut to the daily fixing rate against which it allows the renminbi to trade against the dollar, and in just three days, the currency weakened by 3.8% to its lowest level since 2011. Then, China’s equity markets plummeted, culminating on August 24 in the 8.5% plunge now known as “Black Monday” and triggering a global shares rout. In apparent response, the central bank (PBoC) cut the one-year lending rate by 25bp, bringing it down to 4.6%, reduced the savings rate, and lowered the reserve requirement ratio. The Chinese government said it would close the gap between the fixing and market-based valuations of the renminbi and then let markets determine the FX going rate. While it is not allowing the renminbi to float freely, the regime it has adopted represents calculated intervention characterised by more flexibility. The IMF has welcomed the PBoC’s new FX mechanism – closing the gap between the fixing and market-based valuations is a requirement for SDR inclusion. “A significant portion of investors are trading on headline risk rather than actually knowing the facts” But the moves were widely interpreted as a response to slowing growth – Chinese exports tumbled by 8.3% in July – an interpretation dismissed by Danny Tenengauzer, RBC’s head of emerging markets research and global FX strategy. He said: “China is adjusting to different things. One, it is transitioning from an investment-led model to a consumer-led model, which basically means it will become less productive by definition. There is a

Malaysia’s national day at the end of August is normally a time for celebration as large crowds wave flags in Independence Square and watch the air-force stage a fly-past. But this year had a different tone. The weekend before the holiday was marked by protesters in yellow shirts throughout Kuala Lumpur. The popularity of Prime Minister Najib Razak is at an all-time low after it was alleged that about US$700m had been deposited in his personal bank account over the past two years by troubled strategic state fund 1Malaysia Development Bhd. Although Razak has denied the charges, people are all too ready to believe them. His personal credibility had declined after the implementation of a hated 6% goods and services tax earlier this year and a blatant clampdown on critical media. All this has happened against a backdrop of a continuously falling Malaysian ringgit. At the time of writing the currency sits at a 17-year low against the US dollar; indeed, it has so far dropped by 18% this year and more than 10% in the last month (August) alone. As the worst performer among 24 emerging market exchange rates, it is even trailing the Russian rouble. Gloom upon gloom has hit the markets hard; especially debt issuance. As the world’s largest and deepest Islamic bond issuance centre, accounting for a sizeable 42.3% of the global sukuk market according to Reuters, Pollyannas at the start of the year were expecting to see US$115bn of global sukuk debt this year. But in July, after the Central Bank of Malaysia – one of the largest issuers of sukuk worldwide – stopped issuance, ratings agency Standard & Poor’s halved its forecast for global sukuk issuance to a maximum of US$60bn. “In the first half of 2015, the Central Bank of Malaysia’s [BNM] pull-back saw total sukuk issuance drop by 42.5% compared with the same period a year earlier,” said Mohamed Damak, Standard & Poor’s global head of Islamic finance. “In 2014, BNM alone issued about US$45bn of sukuk out of total issuance of US$116.4bn.” Several months on, the outlook for issuance from Malaysia is not great. Most bankers reckon that volumes will be 15%–20% down on last year. “If you take out government-owned issuances, I am expecting around M$40bn–$45bn [US$9.5bn–$10.7bn] of corporate sukuk deals to be completed for the year, accounting for approximately 75% of total Malaysian ringgit corporate issuances for 2015. These are obviously dependent upon, among others, specific funding requirements and market conditions,” said Safri Shahul Hamid, senior managing director and deputy CEO of CIMB Islamic. This is where the weakness of the ringgit comes into play. It is no surprise that the figure of a decline of 15%–20% more or less corresponds with the percentage of sukuk issuance that comes from foreign issuers. “There is absolutely no point in a Turkish bank, for example, doing a sukuk issue at the moment. The volatility is too high,” said one foreign banker. “There is some merit in sitting on dry powder at the moment.” And that is exactly what is happening. Although bankers say they are not seeing foreigners exit on the fixed-income side just yet, nor, with everything going on, are foreign issuers prepared to commit themselves. Where demand remains is from domestic issuers, especially where refinancing is needed, but few believe that any new entrants to the market are going to stick their heads above the parapet this side of the new year. All of this is, of course, bad news but there are silver linings to every cloud. In this case it emerged in the form of Malaysia’s US$1.5bn in Islamic 144A/Reg S bonds in April. US$500m of the two-tranche paper, sold through CIMB, HSBC and Standard Chartered, had a 30-year tenor, the world’s first such sukuk paper. Not only was there significant demand for the paper (the books reached US$9bn) but enthusiasm was such that the sovereign did not pay the typical Islamic premium. Flying slightly below the radar, there has been a natural evolution within the

A new dawn for India’s capital markets beckoned when Prime Minister Narendra Modi took office in May last year. The hope was that Modi would instigate an infrastructure boom in the country as well as tackle balance sheet problems at the banks and consolidate the industry. Debt markets were set to boom as a result but frustration has set in. The offshore funding route has been taken by the large Indian corporate with international name recognition as well as the state-owned and large private banks. But the fact remains that given Reserve Bank of India regulations demand that such issuance be hedged, the costs on a post-swap basis are high and it is cheaper for most Indian entities to look to raise capital onshore on a term-funding basis. “There was a degree of euphoria in terms of issuance but that has abated due to external stress factors such as the China and commodities sell-off and perhaps expectations got too heady,” said Rakesh Garg, head of global finance, for Barclays in India. “The key problem is that a lot of the companies in the traditional sectors of the Indian economy, such as steel, power, cement and textiles, are over-leveraged and not generating sufficient Ebitda to cover interest payments on debt.” Still, India’s blue-chip corporates are willing to take the offshore route in the interests of investor diversification, and those in the investment-grade silo can tap tenor and size in the US Reg S and 144A markets, where Indian paper still commands a rarity value premium. Much of this paper has emerged from the oil and gas sector, but in June telecoms company Bharti Airtel was able to price a US$1bn 10-year inside its implied curve for two times book cover. The demand is there, but supply remains sorely lacking from the India corporate complex. “The domestic market is very liquid and presents a more compelling case for Indian borrowers than taking the offshore route, where hedging costs are high. There have been various phenomena such as the use of standby letters of credit, but there is a concern that the creation of contingent liabilities could become excessive. The issuance of offshore rupee bonds is waiting in the wings and we are bullish about the future of the asset class,” said Garg. Offshore rupee bonds – dubbed Masala bonds – have been long in gestation and, after a long wait, in June the RBI released draft guidelines on the product. Far from exciting market players, the guidelines were widely savaged as being too restrictive. Issuance in Masala bonds would be made according to the external commercial borrowing guidelines, under which most Indian companies are prohibited from borrowing more than US$750m-equivalent in any one year. Further removing any buzz from the proposals was the imposition of pricing, volume and use of proceeds strictures on Masala issuance, as well as the prohibition of banks from issuing in the asset class. Potential high-yield issuance in Masala bonds was headed off at the pass by the requirement that issuance in the format could not come more than 500bp wide of like tenor Indian sovereign issuance. It seems therefore that only top rated Indian issuers with name recognition will be Masala bond issuers. Initial forays in the product came from the Asian Development Bank and the International Finance Corporation, which have typically issued in offshore domestic currency for benchmarking purposes. The prohibition of Indian banks from entering the Masala bond space has shone a spotlight on the capital needs of the Indian banking system, where it is estimated that there is a Rs400bn (US$6.2bn) Additional Tier 1 funding requirement between now and the end of the fiscal year in March 2016. In addition, the system requires as much as Rs2trn in Basel III-compliant funding over the next three years, according to Icra estimates. “There is a huge need to raise capital among the top 10 Indian banks. Still, there is a tremendous need for consolidation in the Indian banking sector and a need to cle

China has the world’s largest corporate debt market and huge levels of local government debt, but default has been a rarity. Many believe recent defaults herald the beginning of a trend, although the government’s commitment to rate liberalisation and debt restructuring will allow this to proceed at a measured pace. The beginning of what many China market observers believe will be a long tale of default in what is the world’s largest domestic corporate debt market began last March when Shanghai Chaori Solar Energy Science and Technology defaulted on the Rmb89.9m coupon on a domestic bond. This came at the point where China’s corporate debt had risen to US$16.1trn, or roughly twice the size of the US corporate debt market, a surge from 120% of GDP to 160% in little over a year. Standard & Poor’s predicted in a report last month that this tally could balloon to US$28.5trn by 2019 and potentially unleash instability in China’s financial markets. For China watchers searching for more telling signs of distress in the country’s heavily indebted corporate sector, the default last April by Baoding Tianwei Group, a manufacturer of power equipment, hit the spot. The company became the first state-owned enterprise in China to default on domestic debt when it failed to pay a Rmb85.5m (US$13.5m) coupon on a Rmb1.5bn bond. “Rapid debt growth, opacity of risk and pricing (partly due to bank loans dominating funding), very high debt to GDP, and the moral hazard risk of the Chinese market make it a high risk to credit,” Standard & Poor’s wrote in the report. Shanghai Chaori’s default underlined the somewhat remarkable fact that since China established its domestic bond market in the early 1990s there had been not one instance of an outright coupon or principal default – and although there had been cases of technical default in the early to mid-1990s, local governments had stepped in at the last minute with the necessary funds. The Chinese financial authorities introduced restrictions in 1997 to limit the contingent liabilities of local governments, but these did not prevent the Shanghai government from stepping in to provide financial support to Chaori in 2013 when it first had trouble servicing its debts. Markets shrugged off the Chaori default even though many observers suggested it would become the “Bear Stearns” moment for Chinese corporate debt and lead to a chain reaction of selling in the asset class. That did not happen because investors had been preparing for such an eventuality, although tellingly, spreads between low-rated corporate paper and that at the upper reaches of the China domestic corporate credit curve began a steady widening following Chaori’s default. At the time of that default it was felt that the authorities’ unwillingness to bail out the company – coming as it did during the China communist party’s annual political plenum – was a sign that it was signalling the concept of letting market forces prevail rather than allowing command style economics, which has been the norm in the country, to prevail. But perhaps in the light of the recent equity market turmoil, which has seen leading Chinese equity indices plummet by more than 30% from their highs amid an atmosphere of crisis that has spread to global stock markets, that thinking has changed. Major rethink Certainly, the authorities’ direct intervention via the purchase of stocks following the collapse of the indices in an attempt to staunch the bleeding suggests a major rethink of what had appeared to be a new laissez faire mindset. Despite an economic growth slowdown in China, where in the first half of the year, GDP came in at 7% – a 25-year low – credit growth in the country has remained robust. A heady Rmb1.28trn (US$206.1bn) of new loans was provided by banks in June and the recent 50bp reduction in reserve requirements as well as a 25bp reduction in the one-year lending rate in response to the equity market crisis are likely simply to keep the lending cont

Brazil is hosting the 2016 Olympics but it won’t be winning any medals for the performance of its economy, which has tumbled into recession while the country fights to retain its investment-grade status. It’s a battle it seems destined to lose, after S&P downgraded it to junk on September 9. Should Moody’s or Fitch follow suit, then Brazil will have officially lost the investment-grade status it has held since 2008. The S&P downgrade to BB+ from BBB – came after Brazil posted its worst fiscal results in 18 years on August 28, when official figures confirmed that the country had entered recession after its economy contracted by 1.9% between April and June, compared with the previous three months. Days later, Brazilian credits took a beating after President Dilma Rousseff submitted a bill to Congress on August 31 that predicted a fiscal deficit for the first time, after repeatedly saying previously that the economy would preserve its surplus. Rousseff proposed a 2016 budget bill that forecast a primary deficit of the non-financial public sector of 0.34% of GDP, compared with an earlier forecast that predicted a surplus of 0.7% in 2016. After failing to manage expectations about the state of its finances, this latest move suggests Rousseff’s regime has finally got a dose of reality. “It keeps making assumptions that are not realistic and fails to have a worse-than-priced in growth outlook,” said Danny Tenengauzer, RBC’s head of emerging markets research and global FX strategy. The country’s fall from the grace, from BRIC darling to brink of collapse, has been swift and deeply damaging. Under Rousseff, Brazil has racked up a deficit where debt stands at 70% of GDP. Rousseff still has three years of her term to run, but her approval rating of 8% is the lowest of any leader. The country has been racked by the scandal at state-run Petrobras, which Rousseff used to run, raising the spectre of her being impeached. The currency has plummeted, bond yields are rising, and the local stock market has given up its 2015 gains. “Brazilian assets will continue to underperform until the downgrade is announced, which I expect to be during the first or second quarter of 2016,” said Tenengauzer. The county’s five-year CDS has spiked to 350bp as price dynamics have deteriorated to reflect a more significant chance of Brazil going sub-investment grade. Jan Dehn, head of research at Ashmore, said: “Brazil has a major political scandal rooted in corruption taking place at the exact time when the country needs to take austerity measures. Add in the prospect of US rate hikes and falling commodity prices, and the country is in dire straits.” A matter of time The country’s descent to junk appears only to be a matter of time. The question now is how long it will be before other agencies follow suit, as a second downgrade to junk would force foreign pension funds and other large investors to unload bonds. JP Morgan research said that in the event of a second downgrade, passive investors would be forced to sell US$1.5bn of foreign debt issued by Brazilian companies and US$800m of sovereign debt. Tenengauzer says that the main implication from S&Ps’ action will “likely be additional downgrades in the private sector”. Petrobras CDS is now 766bp against 232bp a year ago, while mining company Vale CDS is 526bp against 215bp, according to Tenengauzer. On August 11, Moody’s lowered Brazil’s government bond rating to Baa3 from Baa2, citing weak economic growth and rising government spending. In July, Joaquim Levy, Rousseff’s new finance minister, cut his projection of the size of the country’s fiscal surplus, slashing it to 0.15% of GDP from 1.1% in 2015, while for 2016 it was revised downward to 0.7% from 2%. The country has suffered capital outflows while the Real has weakened by 23% this year, placing it among the worst performing currencies. Soumyanshu Bhattacharya, an institutional portfolio manager for the emerging markets sovereign team at BlueBay

All summer long, Russia-focused debt capital market bankers waited, fruitlessly watching the parched skies and waiting for the levees to break. “Through June and July, there was a lot of chatter about who would be the first Russian borrower to return to the international bond markets,” said one senior debt banker. “But nothing happened.” The drought persisted, bemusing even seasoned practitioners. “It’s surprising that it has taken Russian firms so long to return to the market, given that corporate spreads performed very strongly through the first half of the year,” said Nicholas Hardingham, a portfolio manager at Franklin Templeton. Then the skies opened. And when it rained, it poured. On September 1, Gazprom, the world’s biggest supplier of natural gas, announced plans to issue €1bn (US$1.13bn) of Eurobonds in October – its first international print since raising US$700m last November, and its first sale of euro-denominated notes since February 2014. Intesa Sanpaolo, Deutsche Bank, JP Morgan and UniCredit were mandated to organise the sale on behalf of the company, which is being buffeted by low oil and commodity prices, fears of a hard landing in China, and US and European Union sanctions on key Russian corporates and interests, all of which have driven up borrowing costs. Norilsk Nickel is also hopeful of tapping the international debt markets in soon, with the aim of raising about US$500m. The nickel and palladium miner, rated BBB– by Standard & Poor’s and Fitch, will meet investors in early October in Europe, Asia and the US, accompanied by five banks: Barclays, Citigroup, ING, Societe Generale, and UniCredit. The transaction, if it goes ahead, would be a relatively small print for the miner, suggesting that Russian corporates, as well as their financial advisers, remain wary of the strength of their reception by the international investor community. Hell-on-wheels The past 18 months has been hell-on-wheels for the world’s 10th-largest economy, and the pain is not over yet. Problems mounted in December when the rouble crumpled, briefly falling to 80 against the US dollar, as sanctions bit and oil prices tumbled. For a few days, another full-scale financial meltdown, akin to the rouble crisis of 1998, seemed on the cards. In the end, despite seeing net capital outflows surge to a record high of US$151.5bn in 2014, a country accustomed to feeling the pinch and ignoring it simply muddled through. Yet nine months on, not much has changed. Capital continues to flee the country almost as soon as it’s formed – the economy ministry conservatively tips outflows to reach US$93bn in 2015 and US$70bn in 2016. Economic output is set to contract by 3.4% this year, according to projections from the IMF, and to shrink again next year. In the last week of August, the rouble tumbled to 71 against the dollar for the first time since January, hit by the price of oil, one of the country’s most profitable exports, which continued to languish below US$50 a barrel. Consumer prices rose by an annualised rate of 8% in the second quarter, according to central bank data, while purchasing power, in the form of real wages, plummeted 9.2% year-on-year in July 2015. Again the Kremlin reacted predictably, slipping last year’s patriotic playbook from the drawer, and begging major exporters to sell foreign currency and bolster the value of the national currency. Yet in other ways, the latest crisis to play out in Moscow is different from those that came before. Last December, Russia was the focal point of its own simple story: a stagnant economy battered by military misadventures of its own making, and desperate to shore up a flagging currency. This time round, the rouble is just one of a clutch of currencies caught in a far wider emerging market sell-off. The currencies of Colombia, Mexico, Brazil and Turkey have tumbled in recent months against the dollar, while the last time the Malaysian ringgit and Indonesian rupiah were trading at their current

And so Turkey faces yet another election. Like Wagner’s Ring Cycle or an Escher drawing, the process never seems to end. Over the past year, this country of 75 million people has laboured through three wearying polling cycles, balloting once for local and once for national-level parliamentarians, while in between elevating a familiar face – ex-premier Recep Tayyip Erdogan – to the position of president. Vote, rinse, repeat. Yet despite all this democratic fervour, voters face yet another trek to the polls on November 1, after Erdogan, in the last week of August, formally called for the second general election in a year – the first time that has happened in the country’s modern history. The president appointed Ahmet Davutoglu, his successor as prime minister, to head an interim government while polling takes place. For weary domestic voters and frustrated global investors, a sense of deja vu will shroud the run-up to the November poll. No single group won enough votes at the June general election to form a working government. The Justice and Development Party (AKP), still the country’s leading political group, logged a little more than 40% of the vote, down from nearly 50% in the 2011 election – a long way short of the two-thirds majority that Erdogan needed to rewrite the constitution and grant the presidency genuine powers of state. In the weeks following the June election Ankara was full of coalition chatter. Hopes of a patched-together government were high. But then Erdogan fell out with the third-largest Nationalist Movement Party, and any prospect of a working relationship vanished. The other parties had too little clout or too few votes to form a majority government. And so the electorate resigned itself to another round of political grandstanding and backstabbing. Some analysts believe this was the aim of Erdogan and the AKP all along. “It feels that the AKP is willing to have the country undergo repeated bouts of re-election pain, because the party believes that voters will ultimately choose the stability of AKP rule over the current purgatory,” said Phoenix Kalen, director of emerging markets strategy at Societe Generale. Yet if this genuinely is their aim, they may be sorely disappointed. Jonathan Friedman, an analyst in London at risk management specialist Stroz Friedberg, said early polling for November’s election “almost precisely mirrors the results in June”, making an AKP majority look increasingly less likely. That adds to the likelihood of Turkey entering a nightmarish cycle of election after election, with no end in sight until, presumably, a coalition is grudgingly formed. The only other immediately visible option, suggests Friedman, is that Erdogan finds a new way to undermine his political opponents, and to make the AKP the only viable political option for a disgruntled populace. This might include fomenting friction within the loose coalition that holds together the pro-Kurdish People’s Democratic Party, or perhaps siphoning votes from the far-right MHP. Even this may prove beyond the president. Erdogan has dominated the domestic political scene since the turn of the century. Yet his presidential approval ratings have slipped below 35%, while the AKP, the party he once led with an iron fist, is overwhelmingly blamed by voters for the post-June political malaise. To many, Erdogan, a self-styled strongman who was once viewed as the country’s greatest weapon, is now seen as its Achilles’ heel. “If Erdogan exerted less influence on political dynamics, some of Turkey’s problems would abate, and you’d probably see more political stability and moves to form a working coalition, which would attract more investment, and get consumption rising again,” said SG’s Kalen. Guillaume Tresca, senior emerging market strategist at Credit Agricole, fears that another ambiguous election result might even encourage the president to rewrite the constitution without first seeking approval through a national referendum. “He may t

In July, the Greek government finally agreed to a bailout deal that mobilised up to €86bn in financial assistance between 2015 and 2018. The deal will see funds released in increments, as and when Greece meets certain targets on implementing structural reforms, which past governments had struggled to deliver. Although the details of the latest bailout deal are yet to be formally finalised, a provisional memorandum of understanding recognises some of the mistakes made in former deals. Past agreements had demanded too much, in terms of budget savings that were too front-loaded, weighing too heavily on the Greek economy, said Peter Schaffrik, head of UK and European rates and economics research at RBC. The savings demanded in the new package are therefore lower than last time. But the MoU is unrelenting in its calls for structural reforms, such as securing the independence of the statistical authority, and labour market reforms. Unsurprisingly, in the aftermath of the bailout agreement being announced, the Greek government tore itself apart and the left wing of Syriza split off to form a new party, Popular Unity. Greece has endured seemingly endless political turmoil that has seen the electorate called to the polling booths three times in eight months, with the latest election still to be held at the time of writing. But Dimitris Paraskevas, managing partner of Paraskevas Law in Athens, is less concerned about political risk than the economic hardship being thrust on the country. Paraskevas said: “Tsipras has shown himself to be a pragmatic prime minister. The big risk is the economy and the currency. Companies are seeing their revenues drop by 70% or 90%; many could disappear. Greek banks could fail unless recapitalised.” The state of the banking sector remains a particular concern. Besides high NPLs, Greek banks appear to own a lot of assets linked to the government, so the suspicion is that if the state does go bankrupt, it will take the banks down with it, adding to the chaos. Deposits have drifted away and it will take time for trust to be restored sufficiently for all those assets to come back. “Low coupons and extended maturities are the most likely options for debt relief, while a haircut is unlikely. In our view, this last option will not be acceptable for most of the parties involved in the negotiations” Everything therefore hinges on Greece’s ability to push through the kind of reforms it has struggled to implement in the past, and to collect more taxes. “It is hard to see it,” said Schaffrik, even the IMF now argues that some level of debt forgiveness is necessary for the Greek economy to begin healing. “Concerns remain regarding the deteriorating economic conditions and the ballooning public debt, which may prevent the IMF from joining the bailout absent some form of relief,” said Monica Defend, head of global asset allocation research at Pioneer Investments. Yet the deal is not expected to include any haircut to the debt. What it will do is ease the repayment schedule, making it easier for Greece to service the debt, although, given that Greeks are not currently repaying any debt, the restructuring is mostly about lengthening maturities, said Schaffrik. “There could be a plan where the ESM buys the ECB bonds and transfers them into longer maturities,” he added. Most likely options Defend said: “Low coupons and extended maturities are the most likely options for debt relief, while a haircut is unlikely. In our view, this last option will not be acceptable for most of the parties involved in the negotiations.” However, even without a haircut, some remain convinced that Greece can turn itself around. Japan has been running a higher debt-to-GDP ratio than Greece has, and has no problem servicing the debt, said Paraskevas. But Schaffrik believes this comparison is misleading. “Much of [Japan’s] debt is held by the central bank itself, the net holding is much lower than the headline figure. And Japan has savings. Its pens

There is, for Ukraine’s war-ravaged economy, and for the wobbly, embattled government that emerged last February to replace ousted president Viktor Yanukovych, finally some blessed relief. In the last week of August, after five months of intense and often bitter negotiations with its chief commercial creditors, Kiev emerged with some good news, having hammered out a deal to restructure US$18bn worth of its foreign debt. The announcement was in many ways a pleasant surprise, catching seasoned observers on the hop. Many had expected talks to drag on, up to and beyond September 23, the due date for repayment on a US$500m bond. A few had taken an even more pessimistic tone, tipping discussions to stretch through the autumn months, and perhaps right up to December 15, when a landmark US$3bn sovereign bond repayment to Russia comes due. “There was a widespread expectation that the brinkmanship would continue for months, with Western creditors blinking first,” said Katya Kocourek, a senior associate specialising in intelligence and due diligence at Stroz Friedberg in London. Yet in the end, all were quick to applaud the outcome. An elite group of the country’s largest private sector creditors, led by US asset manager Franklin Templeton, and including the likes of BTG Pactual, TCW and T Rowe Price, agreed to an immediate 20% write-off on US$18bn of the country’s bonds. The deal (which includes a freeze on debt repayments for four years) would enable Ukraine, the group said in a statement, to “maintain its access to capital markets and provide the stable economic platform that will help the country to restore growth”. Ukraine finance minister Natalie Jaresko said: “It’s not one side winning, it’s a win-win situation.” All heads will now turn to the IMF, which has lent US$11bn to the country since conflict began there last year. The IMF wanted a firm deal in place before pressing ahead with an expected US$40bn financial support programme. The Fund released a statement praising the deal for having “met its requirement” that Ukraine cut its total debt to commercial creditors by US$15.3bn over four years. The agreement will “provide the targeted external debt service relief, reduce annual gross financing needs essentially as envisaged under the programme, and place public debt on a clearly downward path”, it said. A few obstacles remain. The agreement needs to be tabled to, and agreed by, Ukraine’s parliament, though that – most agree – is a formality. Beyond that, in mid-September, a larger set of minority bondholders were set to vote on the deal. That too seemed a shoo-in, given that smaller creditors have been furnished with a reasonably juicy carrot. If Ukraine’s economy regains full strength sooner rather than later, creditors are guaranteed a “value recovery instrument” – essentially a bonus that will pay out if the economy expands by more than 3% a year from 2021. Prices for Ukraine’s outstanding bonds jumped in the wake of the deal, with the sovereign’s US$2.6bn dollar bond, due July 2017, rising from 57 cents to 66 cents. Traps and blind alleys Yet August’s surprise deal merely marks the first footfalls on a long and arduous road lined with traps and blind alleys. Ukraine’s economic tailspin has been at least partially arrested in recent months. Inflation, which topped out at 60% earlier this year, has moderated, as has the formerly steep decline of Ukraine’s currency, the hryvna. These though are mere grains of good news. Ukraine’s economy shrank by 17.6% on an annualised basis in the first three months, and is on track to contract by 5.5% in 2015, according to IMF projections. Corruption remains endemic, while vast portions of the economy are hidden from enfeebled tax officials and governed by powerful oligarchs. Russian-backed troops and mercenaries remain embedded in the country’s eastern provinces, home to its prime industrial and mining facilities, now shattered and destroyed. Euphoria over the debt restructuring, moreover,

Asia’s offshore G3 markets have seen record issuance volumes in the years since the financial crisis, with each year surpassing the last. Despite recent global financial market volatility and the closure of primary markets as a result, regional DCM bankers remain confident that issuance is set to pick up and another record-breaking year seems unlikely. Demand for fixed-income paper issued in 144A or Reg S format has remained stubbornly high in the years since the global financial crisis and the region has been a veritable printing press – with deals emanating from across the credit spectrum, from sovereigns, to corporate investment grade, to bank capital and to the very lowest of low grade. The offshore dollar market for Asian names has appealed versus the competition that presents itself in the form of onshore bond issuance or bank funding in either local currencies or G3 debt. It is not difficult to see why. The offshore bond markets are deep and liquid, there are fully formed yield curves to use for benchmarking purposes and the opportunity to tap a wide investor base in Asia and Europe (for Reg S deals) with the addition of the US (for 144A deals) is something issuers find hard to resist. Invariably, for the better rated names there are savings versus the term funding costs in the offshore loan or domestic bond markets and the opportunity to build a fully formed yield curve that reduces all-in funding and pushes the debt service burden out to long tenors. In the years since the crisis there have been grumbles that Asia’s offshore debt markets have become expensive. This is despite the fact that they offer the infamous “Asia premium” in which issuers in Asian industries offer a yield pickup to their peers in the developed Western markets. “Asian issuers have got used to an environment in which they can seek razor-thin pricing terms thanks to high liquidity, the global quest for yield in the context of historically low US interest rates and a willingness among global real money investors to diversify. Whether or not the normalisation of US interest rates will change all that is open to debate,” said a Hong Kong-based syndicate head. Despite a backdrop that has this year for the most part remained auspicious, there have been areas where issuance has stumbled, most notably in the beaten up oil and gas, commodity and China property sectors. And the backdrop of market volatility in June and July, based on uncertainty surrounding Greece’s membership of the euro together with the recent equity market turbulence in China, has led to widened spreads across much of the offshore Asian bond complex. “Asian issuers have got used to an environment in which they can seek razor-thin pricing terms thanks to high liquidity, the global quest for yield in the context of historically low US interest rates and a willingness among global real money investors to diversify” “We feel constructive about primary issuance from Asia-Pacific going into September and October, investment-grade credit, including in Asia, has been one of the most stable asset classes during the general market volatility. Investors have strong cash balances and many issuers have the flexibility to access a range of funding markets,” said Alexi Chan, HSBC’s global co-head of DCM, based in Hong Kong. The Asia IG index widened by around 20bp after the precipitous collapse in the Shanghai main board at the start of the last week of August, but had begun to grind in as the week progressed as Chinese and global equity markets staged a recovery. “Asian high-yield has felt the impact of the recent market volatility. But Chinese property issuers have been able to access the onshore renminbi market instead, in good size and at competitive levels, and this has been a game-changer for a number of companies. Nevertheless, I would expect to see China property offshore supply coming back in the months ahead, as the yield gap between onshore and offshore markets narrows,” said Chan. The ongo

Of all the varied consequences of the post-crisis financial reform programme for financing and trading, from rising costs to increasing complexity of market structure, it is the changing nature of liquidity that most often tops the agenda. Increasingly frequent instances of gaps in liquidity have spooked some policymakers, highlighting the impact of the constraints that have been placed on traditional market-making. This decline in liquidity has become evident across a number of financial markets, but it has been particularly noticeable in emerging markets, where the structural effects of regulation have combined with macroeconomic uncertainty. As banks have scaled back the provision of liquidity, there has been increased selling pressure on many EM assets, creating a challenging environment for investors. “We have seen times over the past year when liquidity has been particularly poor, driven mainly by negative investor sentiment and one-sided selling pressure. It does create a somewhat dysfunctional market when there are no market-makers willing to absorb short-term volatility,” said Soumyanshu Bhattacharya, institutional portfolio manager in the emerging markets sovereign team at BlueBay Asset Management. Illiquidity can mean different things to different participants, but simply put it refers to a situation where it becomes harder, or even impossible, to buy or sell an asset at a reasonable price. A liquid market therefore depends not just on consistently high trading volume, but also on tight and reliable pricing. And just because a market has high turnover, it does not necessarily have deep liquidity. Ironically, EM bond issuance has grown significantly since the financial crisis. The total EM debt universe surpassed US$13.5trn in 2014, up from just US$6.5trn in 2007, according to a recent report by the Institute of International Finance. However, secondary market liquidity has failed to keep pace with bond issuance since the “taper tantrum” in 2013, when the US Federal Reserve’s decision to cease quantitative easing fuelled a dramatic sell-off in emerging markets. Fast-forward to 2015, and the expectation of an imminent rate rise in the US could have a similar effect. “Emerging markets are particularly susceptible to illiquidity because everyone is sensitive to the Fed hiking interest rates and the knock-on effect that may have in shifting money back to the US market, especially in the sovereign space,” said Lee Sanders, head of FX and money markets execution and UK and Asia fixed-income trading at AXA Investment Managers. Available data on EM liquidity already show some cause for concern. In hard currency sovereign bonds, turnover ratios – represented as quarterly trading volumes over outstanding bonds – have more than halved since the crisis, according to the IIF. Brazil and Hong Kong have been among the worst hit markets for sovereign bonds, while corporate bonds have suffered badly in China, Brazil and Mexico. A drop in liquidity may not always be obvious to all participants, particularly when transaction volume remains robust. But it is felt acutely at the level of the buyside trading desk, where orders coming in from portfolio managers often cannot be executed with the same level of efficiency and speed as in the past. AXA, for example, keeps constant tabs on the proportion of orders that are completed on an intraday basis, and has found that EM now performs significantly worse than rates and credit. “For the nearly 10% of EM orders that we can’t complete intraday, that is invariably due to poor liquidity and having to work part of the order over a longer period of time. We see illiquidity in both wider bid-ask spreads, as banks have to charge more to take down risk, and also, in some cases, a complete lack of market-making,” said Sanders. It’s the regulation… Of the many factors that can influence liquidity, it is the capacity of banks to provide pricing and make markets that appears to have changed most signific