Bond Market Insights - Sun, 10 July 2022
During the 1970s, two large oil price shocks created current account deficits in many Latin American countries. The US government encouraged large US banks to lend to Latin America. Near-zero real rates at the short end along with world economic expansion created an ideal environment to borrow. But in the late 70’s the focus was controlling inflation and global rates rose aggressively as did the value of the US$.
Bloomberg: Dollar Index (DXY) 1978 to now, Reached 151.7
In 1982 Mexican Finance Minister Jesús Silva Herzog announced that Mexico would no longer be able to service its $80 billion of debt. Contagion set in and ultimately 16 LATAM countries had rescheduled their debts. The abrupt exclusion from international markets resulted in deep recessions.
The US took up the mantle of lender of last resort, partly due to US banks being deeply involved. By 1989, it was clear to US Secretary of the Treasury, Nicholas Brady, that these loans could not be repaid and in the years to 1994 private lenders forgave about a third of the debt, $61 billion in loans.
In exchange, the eighteen countries that signed on to the Brady plan agreed to domestic economic reforms that would enable them to service their remaining debt.
Fast forward to now. Sovereign debt ballooned since 2008 and a few crises have been averted subsequently, more in the developed arena, resulting a prolonged period of artificially low rates. A desire for debt to finance economic development followed by a rush to sell overseas bonds during the Covid pandemic has been met with global central banks in developed countries tightening financial conditions and, once more the US$ has appreciated strongly, leaving emerging borrowers in quite a predicament.
In Asia Sri Lanka has already gone, Pakistan just resumed talks with the IMF as it runs thin on dollars for at least $41 billion of debt repayments in the next 12 months and to fund imports. Reminiscent of events in Sri Lanka, protesters have taken to the streets against power cuts of as long as 14 hours that authorities have imposed to conserve fuel.
In LATAM El Salvador’s ratings have been slashed to CCC and ELSALV 5 ⅞ 01/30/25 its dollar bonds yield over 50%, not helped by the adoption of Bitcoin as legal tender. The $800mm ELSALV 7 ¾ 01/24/23 is due in January and yields around 90%, with a widespread believe that it will not be redeemed. In Argentina inflation is expected to top 70% by year-end, adding to pressure on authorities to limit the flight of dollars out of the economy to control the exchange rate. The political situation is unstable as VP CFK gains ground.
Africa: African sovereigns have relatively low amounts of foreign reserves on hand to cover bond payments coming due through 2026. That could become an issue if they are unable to roll over their maturing notes due to the increased cost of tapping foreign debt markets. Ghana is seeking as much as $1.5 billion from the IMF.
Investors have pulled $50bn from emerging bond funds this year, according to the FT. The net outflows from EM fixed income funds are the most severe in at least 17 years.
Who is going to stem this tide? IMF is being asked for assistance across the globe and is setting guidance on how recipients should mold their economies, such as placing taxes on oil petrol etc. If this is too austere, history may repeat itself and another "Lost Decade" could ensue.