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Capital Markets Weekly: Risk of multiple emerging-market defaults increasing

26 March 2020

Amidst acute pressure on energy-oriented emerging market economies and against the background of deeper economic recession stemming from COVID-19, Ecuador has announced its intention to defer interest payments. This week, Argentina and the IMF both renewed their push for private sector write-downs on Argentine debt, and African states are pushing for temporary debt relief. This aligns positively with IMF and World Bank calls for immediate relief on the official debt of poorer countries.

Ecuador

On 23 March, Ecuador's EMBI+ spread surged by 2415 basis points to 6063 basis points. The trigger was a statement by the Minister of Finance Richard Martínez that Ecuador planned to defer some USD200 million of interest payments on its 2022 and 2030 bonds due this week, although it paid USD324 million of principal on 24 March.

Martínez stated that the funds retained will be used towards containing COVID-19. He stated that Ecuador will "begin dialogue with commercial, bilateral and multilateral creditors", with the goal of reaching "a good, sensible arrangement".

Ecuador has sought IMF help through a Rapid Financing Instrument (RFI) to address "urgent balance of payments needs" and support critical sectors such as healthcare. The IMF's Managing Director Kristalina Georgieva stated that the IMF was "working expeditiously" to address the request. She also stated that the IMF was working on a successor facility to Ecuador's current Extended Fund Facility, "to provide immediate support" to help Ecuador face the impacts of COVID-19 on economic conditions while continuing to back "the authorities' unwavering commitment to implement much-needed economic and structural reforms".

Subsequently, on 24 March, President Lenín Moreno stated that the IMF would grant Ecuador USD2.5 billion of RFI support to address its COVID-19 related health crisis.

Argentina

On 23 March, Argentina's EMBI+ spread widened 347 basis points to 4362 basis points, amidst concerns that COVID-19 driven economic slowdown would push it towards hard default.

On 20 March, Argentine Finance Minister Martín Guzmán stated that Argentina is "in the midst of a major economic crisis", while reiterating the country's desire to proceed with debt restructuring. Argentina claims it cannot service its foreign currency liabilities for at least the next four years, with Argentine sources claiming that the IMF - which previously has suggested the need for haircuts on its public debt - shares its perspectives.

This view was reinforced this week. On 20 March the IMF published a technical note reiterating that Argentina's public debt stock of close to 90% of GDP at end-2019 is "unsustainable". The note stated it would not be "economically or politically feasible" to reduce this sufficiently through running primary surpluses. Instead, the technical document calls for a "decisive debt operation, with a meaningful contribution from private creditors". The analysis states clearly that there is "virtually no scope" for debt service payments "to private creditors over the near to medium term".

Additionally, Kristalina Georgieva, Managing Director of the IMF, issued a parallel statement stating that "substantial debt relief from Argentina's private creditors will be needed to restore debt sustainability" and calling for "a collaborative process of engagement between Argentina and its private creditors".

Even official debt faces non-payment: in a radio interview on Radio Rivadavia, Argentine President Alberto Fernández announced he had "told the IMF that in the next five years we cannot pay them a peso", highlighting that with COVID-19 "I have a thousand more reasons" to delay debt service.

Africa

A recent release by UNECA (UN Economic Commission for Africa) states that the region will require emergency assistance estimated at USD100 billion during 2020. African governments are also planning to request from the G20 the waiver of interest rate payments on public debt and sovereign bonds, estimated at USD44 billion, falling due in 2020 to free resources for COVID19.

Official debt relief initiatives

On 25 March, the World Bank Group and International Monetary Fund issued a joint statement warning of the "severe economic and social consequences" of COVID-19 on International Development Association countries, the world's poorest states and home to a quarter of the world population.

The two bodies called on "all official bilateral creditors" to suspend debt payments from IDA countries "with immediate effect" to assist them fund COVID-19 related measures and permit adequate assessment of their needs.

It further asked G20 leaders to mandate the two bodies to identify countries with "unsustainable debt positions" and prepare proposals for "comprehensive action" by official lenders for "both the financing and debt relief needs of IDA countries": it sought approval for this at the G20 meetings on 16-17 April.

High grade debt

Market activity has been encouraged by the Federal Reserve offering to make unlimited purchases of US Treasury Bonds and extending its support to corporate debt and ETF corporate bond funds, combined with passage of extraordinary US fiscal measures. European markets similarly have been helped by ECB quantitative easing and fiscal moves, not least in Germany.

The consistent theme this week has been of large-scale supply in high-grade markets, with companies paying up to obtain this. In the week to 20 March, some USD60 billion of investment grade corporate debt was sold in the US. However, this came at a heavy price: The Financial Times noted that the average yield on investment grade corporate debt has risen from the 2020 low of 2.26% in early March to around 4.5%, according to Ice Data Services.

On 23 March sentiment was further boosted by the Federal Reserve's decision to extend its purchases. Bond supply remained active with seven US high-grade deals worth almost USD20 billion, including transactions by Wells Fargo, with USD6 billion in a two-tranche deal, and corporate offerings from General Dynamics, Humana, Proctor and Gamble and Thermo Fisher among others.

On 24 March, Kingdom of Spain placed a EUR10 billion syndicated seven-year deal, which gained final demand of EUR36 billion at pricing of 0.84%, 18 basis points over the Spanish government's outstanding debt. Slovenia sold a EUR850 million three-year deal with a 0.2% coupon, priced at 50 basis points over mid-swaps. It also tapped its EUR1.85 billion 1.1875% 2029 issue with a further EUR250 million.

Dollar supply also was active. Kingdom of Sweden sold USD2 billion of two-year debt with a 0.75% coupon, at a 40-basis point spread over US Treasuries. Other issuance included a USD4 billion three-tranche package for Mastercard including seven, 10 and 30-year bonds, and a 10-year deal for Kimberly Clark.

The market remained active on 25 March, with new Euro-denominated supply including a four, 6.5 and 10-year package for US conglomerate Danaher, a seven-year benchmark for Carrefour, and issuance by Lloyds Bank and Goldman Sachs.

Lloyds Bank attracted an impressive EUR8.25 billion of demand for its EUR1.5 billion six-year deal, while Goldman Sachs raised EUR3 billion, howbeit at a 355 basis point margin, described by Bloomberg as equivalent to four times the spread it had paid for 10-year Euro-denominated debt earlier this year. Credit Suisse and NatWest Markets then entered the markets, with the latter rapidly gaining EUR4.5 billion in demand for a five-year issue.

Dollar supply also was impressive, with ten borrowers seeking USD23.5 billion: these included Archer Daniels Midland, Deere, and 3M.

Outlook and implications

During this week, IHS Markit has moved to adjust GDP projected trajectories further downwards. In turn, the spread of COVID-19 and wider lockdowns increase the need for extraordinary fiscal measures, combined with large scale quantitative easing.

Against this background, there are two key implications:

  • Companies face sharp declines in revenues, in some cases with an almost total temporary cessation of revenues. While some of the damage to their cash flow and capital position should be offset by government intervention measures, companies are likely to borrow in heavy volume during periods of market receptivity, while drawing down standby lines from the banking sector, pressurizing financial sector liquidity. This indicates clear likelihood of the continuation of the recent heavy issuance whenever market conditions permit, involving both bank and corporate issuers.
  • Riskier credits face acute challenges: this was already indicated last week when the average spread on US junk bonds moved into double digits, a traditional indicator of debt distress. This week's events suggest that emerging market default risk now also is substantially worsening. This risk applies very clearly in Argentina, with the IMF's continuing calls for heavy private sector write-offs likely to meet private investor push-back against the goal of achieving full payment for official creditors. A long and potentially stand-off is a clear risk, which would be damaging for Argentina's economic prospects and its goal of attracting fresh investment capital, particularly for its Vaca Muerta energy development.
  • African debt stress is also severe, illustrated by the collective moves to achieve relief on near-term debt service burdens. If these apply to only official creditors and concessional lenders, this would require the agreement of relatively few bodies and would avoid triggering technical default on public debt. In this regard, the World bank/IMF statement is clearly positive, indicating a strong likelihood of debt relief on official debt for poorer states and potentially others facing severe debt stresses.
  • Lastly, despite the unprecedented surge in borrowing needs, quantitative easing appears to be succeeding in preserving market stability. In this regard, Spain's successful issuance this week, is a clearly-encouraging indicator that QE will help states heavily affected by COVID-19 to preserve market access.

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