“When written in Chinese, the word crisis is composed of two characters – one represents danger and the other represents opportunity." John F. Kennedy
What is the worst crisis that you have experienced in your life?
For me it was probably the 1998 Russian default during which shortages were severe – store shelves were so empty that I was having to bring loo rolls and toothpaste across from the US. For my mother, it was during the collapse of the Soviet Union when our country went into a food rationing regime. For my grandmother, it was the Stalin-era when salaries were paid through government bonds that were not accepted in most shops. For my great grandmother, it was the Armenian Genocide of 1915.
Everyone has a different experience of crisis, but for all of us, it presents the ultimate test of our coping mechanism. As Winston Churchill is credited with saying, “Never let a good crisis go to waste”.
The perception of the Covid-19 crisis seems to be different amongst some developed and emerging market economies.
My neighbour in a small village in Oxfordshire feels that, for her family, Covid-19 has psychologically been the worst crisis they have ever experienced. She was seeking support and effective coping mechanisms, making some possibly lifelong adjustments.
Yet, for some of my peers in emerging markets, this crisis feels relatively small in comparison to their prior experiences. Are we being too myopic or have some emerging markets developed better coping mechanisms?
Emerging market credit performance has been more robust than most expected this year. Both corporate and sovereign indices have delivered positive returns year-to-date. So far in our portfolios, we have followed a barbell approach on the sovereign side, holding structural overweights in investment-grade credit on one side and countries undergoing debt restructuring on the other.
On the corporate side, our bias has been towards more defensive, domestically oriented names, as well as quasi-sovereign credits. Going forward, we feel that the key differentiating factor for emerging market economies will be the quality of the policy mix and their ability to address the fiscal challenges that lie 12-months ahead.
To-date, in some emerging market economies we have seen a disconnect between the pace of economic recovery and their ability to successfully manage the pandemic. A surprisingly high number of emerging market countries were able to implement QE earlier during the year and provide a variety of measures to support domestic corporates and consumers.
As a result, the recent PMI data prints continue to show a healthy recovery, while the increase in debt stock to-date has been lower than that of many developed market economies. Almost a quarter of EM countries could end this year with positive year-on-year GDP growth.
We have also seen positive developments on the ESG front with a number of countries (e.g. Brazil, Saudi Arabia) increasing their engagement and the volume of green bond financing growing at a fast pace.
On the restructuring front, investors have been positively surprised by the market-friendly approach adopted by both Ecuador and Argentina that resulted in a shorter restructuring period and lower NPV haircuts compared to history. Yet, a month after finalising the restructuring, Argentina's debt is trading at 35 cents on the dollar while Ecuador is trading at close to 70 cents on the dollar. What is the driver of such divergence in performance?
In the Sub-Saharan African (SSA) region, while several countries have broadly similar key economic indicators, recent divergence in performance is equally stark. While Angola’s sovereign debt has recovered from 40 cents on the dollar to 90 cents over the last six months, Zambian sovereign debt has stayed at a similar level to March this year at 45 cents on the dollar. What is the key driver of the different performance?
We believe the answer is the policy framework. Visibility, transparency and prudence are the three criteria that define investors’ support. For example, investors (both IMF and bond creditors) have supported the policies of the current Ecuadorian government that took a cautious fiscal stance and pro-reform agenda on board.
By contrast, in Argentina the government’s priority seems to be focused on its popularity and public support. Yet when a government is facing a double-digit fiscal deficit and inflation against a flat growth backdrop, we believe the focus needs to shift to finding measures to restore local investor confidence and, in particular, a more prudent fiscal stance.
Without action, investors are not willing to add to their exposure, despite the fact that Argentina has no debt to pay for the next four years. Similarly, in the SSA region, Angola has taken a proactive stance with the IMF, introducing measures to gradually reduce its fiscal burden, while the Zambian government has yet to provide clarity on its economic programme or its willingness to engage with the IMF and follow its recommendations.
The country that is trading at the lowest cash price today (mid-teens) is Lebanon, where despite no lack of potential international sponsorship, politicians are failing to address the weak governance issue, which in our view is at the core of Lebanon’s debt reprofiling challenge.
At the end of the day, we believe it is the policy mix that determines the ability of a country to come out of a crisis with several lessons learnt under its belt. While the global macro backdrop is likely to remain supportive in 2021 with US rates on hold, continued Chinese recovery and possibly a pro-global trade stance if Biden were to win the US elections, we believe the key driver of EM performance will remain the policy framework.
In this respect, we are encouraged to see that some countries where we saw challenges earlier in the year are starting to show green shoots. In Turkey, we have seen a move towards a more orthodox policy mix with the central bank increasing rates by 300 basis points. In South Africa, we're seeing more progress on the governance front with the start of the implementation of the long-overdue anticorruption drive.
While investors support these moves, consistency is key. When policymakers’ willingness to engage with creditors is low, the willingness to support will be even lower. Safe carry is investors’ number-one priority and in this environment of uncertainty, there is no room for error.
We're all shaped by our experience of crisis. Today, some countries are facing bigger challenges than Covid-19. The humanitarian crisis as a result of the Nagorno-Karabakh conflict is sending hundreds of social orphans to neighbouring areas in search of shelter. Those families have lost their homes and their loved ones and are likely to remember this (not Covid-19) as the worst crisis in their lives.
Likewise, emerging market economies have been shaped by, and have gone through, many crises. Policymakers have a big role to play in determining the outcome – they must react and not let these crises ‘go to waste’.