Conclusion: Given the current state of emerging market external debt levels and maturities, King Dollar puts many emerging market corporations at risk of earnings erosion, balance sheet deterioration, and, at worse – bankruptcy.
Asian equity markets had another soft week, closing down -1.2% wk/wk on a median basis. Losses were led by China (-4.7%) and Thailand (-4.1%), as both struggled with heightening domestic risks. Asian currencies had a slightly negative week as well, closing down -0.3% wk/wk on a median basis vs. the USD. India’s rupee led the way to the downside (-2%), while gains were led to the upside be the Japanese yen – a clear sign of regional stress based upon our analysis of the mechanics driving JPY appreciation.
Asian sovereign debt markets were fairly mixed; perhaps the most notable divergence came on the short end of India’s and Indonesia’s maturity curve. Indian 2yr yields increased +12bps wk/wk after the government affirmed that it will buck the developing trend of monetary easing across the emerging market space and maintain its hawkish bias until inflation is under control. Their commentary was taken literally in the swaps market, as India’s 1yr on-shore interest rate swaps widened +15bps wk/wk. As it relates to Indonesia, expectations of further monetary easing drove 2yr yields down -27bps wk/wk.
Sovereign credit default swaps throughout the region were fairly flat on the week. A notable decliner to the downside was Hong Kong, which saw its swaps trade -7bps (-7.4%) tighter wk/wk.
***price tables can be found below***
The Least You Need to Know
- One of the themes we’ve been writing about of late is the risk of a financial crisis to sweep across the EM space driven by movements in the currency markets. Simplistically, as a country’s currency depreciates vs. the USD, both its dollar-denominated borrowing costs and its cost of servicing dollar-denominated debt increase. Corporations in certain Asian countries, like India (INR/USD down -11% over the last 3mo), who’ve loaded up on external debt over past three years amid FX appreciation and low dollar-funding costs are at risk of severe erosion in earnings growth. Moreover, they risk deterioration of their balance sheets as they are potentially forced to take on greater amounts to local currency debt to meet rising foreign obligations. Bankruptcy also remains a possibly for the weakest borrowers.
- To the latter point, Bloomberg data shows that corporations in the ten largest emerging market economies have $54 billion of foreign currency bonds coming due in the NTM – the largest sum on record (dating back to 1999). This is coming at a time where the market for issuing foreign currency corporate debt has gone completely dry ($2.6 billion in Sept. vs. a record $108 billion in 1H11). Furthermore, non-investment grade issuers were completely shut out of the market in September.
- From a borrowing costs perspective, the trend of widening credit spreads and rising interest rates continues. According JPMorgan EM bond indexes, investors now demand a 444bps premium to holding the dollar denominated EM corporate bonds over similar maturity U.S. Treasuries – up from 256bps wide in April. And at 6.36%, rates on dollar denominated EM corporate bonds are the levels last seen since June 2010 (absent a brief stint above 7% in early October).
Net-net, we continue to flag FX risk as a reason to remain cautious on both emerging market equities and credit broadly. We are of the view that a great many EM issuers are likely un-hedged, given consensus forecasts for broad-based EM currency appreciation as recently as 2Q. We’ve done a fair amount of work on this topic in recent months and we’re happy to follow up should you like to dig in further. Simply email us for more details.
- The key data point to flag out of China this week is the central government’s decision to allow some local governments to issue bonds independently. The move ends a 17-year ban, which forced China’s municipal governments to seek financing via arms-length entities (amassing $1.7 trillion in debt in the process). The program is rather small in both size (CNY22.9 billion) and scope (two cities; two provinces), but we would expect to see it expanded upon in the coming months as LGFV debt maturities mount.
While by no means a cure-all (the property market is still showing signs of cracking), allowing the local governments to issue bonds directly to investors will: a) diversify financial risk away from the banking system and b) smooth the systemic balance sheet mismatch that stems from issuing short-term paper to fund longer-term infrastructure initiatives.
- The key data point to flag out of Japan this week is/are the government’s latest fiscal stimulus measures. First, it was announced that the Japan will bolster by +25% funds allocated for the recently-announced Japan Bank for International Cooperation fund to ¥10 trillion. The initiative was set up to help Japanese corporations cope with an elevated yen by aiding in overseas M&A. Secondly, Prime Minister Yoshihiko Noda approved a ¥12.1 trillion third supplementary budget to help fund both quake rebuilding and domestic capex (with the intent of preserving jobs).
As we have seen for the latter part of the past twenty years, the Japanese government continues to be the only source of incremental demand in the ailing Japanese economy. Our secular debt and demographic work on Japan suggests that this phenomenon is likely to continue as growth remains structurally depressed over the long term.
- The key data point to flag out of India this week is the pervasive hawkishness sweeping across various levels of Indian government. This week, Chakravarthy Rangarajan, chairman of the Prime Minister’s Economic Advisory Council, affirmed the country’s need for higher interest rates, in spite of his view that inflation is being largely triggered by elevated food prices and/or supply-side constraints. His comments were supported by additional commentary out of Finance Minster Pranab Mukherjee, who said that India’s inflation “may be under pressure until December”, and that the RBI “need not follow the policy of reducing interest rates being pursued by some of its counterparts abroad.”
These comments echo RBI Governor Duvvuri Subbarao’s statement last week which read: “As much as we look at what other central banks are doing, we take into account our own domestic circumstances and the domestic context in formulating policy,” – suggesting that India is unlikely to follow suit and join the rate cutting cycle anytime soon, given that, while slowing, WPI is likely to remain elevated on an absolute basis over the intermediate term.
- A key data point we wanted to flag out of Thailand this week was the progression of the current nation-wide flooding. Since July, these floods have spread across 61 of the country’s 77 provinces, claimed 300 lives, and forced work stoppages at over 14,000 businesses – including 930 production facilities across 28 provinces. As of the latest estimate, the flooding is anticipated to cost $3.9-$5.1 billion in damages and lost economic growth (subtracting 100-170bps from GDP) .
These floods, particularly if they breach the capital of Bangkok (Oct 29-31 projection) could have a lasting impact on Thai economic growth. As it stands currently, they are already having an impact on global supply chains. Thailand is the world’s largest producer of hard-disk drives, the largest exporter of rice and rubber, and the second-largest exporter of sugar. Companies like Apple, Toyota, Tohsiba, and Hitachi have all been forced to suspend production of key parts and/or move the assembly elsewhere.