Feb 17: Emerging markets' funding dilemma
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Emerging Markets

Feb 17: Emerging markets' funding dilemma

Sovereigns turning to sukuk to replace traditional financing is the lead story in our round-up of this week's articles on Emerging Markets Online

Could Egypt become a trend setter for borrowers struggling to fund themselves in the conventional capital markets? Given the country’s political instability and the precariousness of its fiscal position, it’s little surprise that while the government tries to secure help from the IMF and other nations, it’s also mulling every possible way to plug its funding gap. This now includes an attempt to tap the sukuk market with its first issue of Islamic bonds.

Egypt is in an especially desperate position and it’s not even clear it will get the deal done. But the fact that the sukuk market is enjoying near-record liquidity at a time when many traditional lenders are retreating is all of a sudden making a market until now dominated by corporates attractive to sovereigns, as S&P has noted.

Asian and GCC governments are increasingly turning to sukuk to tap local liquidity pools and fund infrastructure projects, while African governments are also starting to express interest. Japan approved a regulatory framework that could accommodate Islamic finance in 2010, while there has been some interest in Europe, although neither has yet seen sovereign sukuk issuance. A sukuk success for Egypt could encourage other prospective borrowers in emerging regions to take a closer look at the market.

One area where Islamic finance seems unlikely to take hold is Central and Eastern Europe. While most sovereigns in this region do not currently face too much trouble funding themselves – Latvia had no difficulting printing its largest ever deal this week, a US$1 billion five year bond – there is a real risk that lending conditions across the region could get much tougher in the next few years.

Critically, the bulk of the region’s banks depend on credit lines from their western European parents. While the European Central Bank’s financing operations may have reduced the risk of a sudden withdrawal of funding, a slow deleveraging looks very plausible as eurozone banks trim their balance sheets and withdraw from non-core operations.

That may well be the best-case scenario. But if there’s a messy Greek default – which this week seemed closer than ever, with reports that the Germany, the Netherlands and Finland were openly talking of cutting Greece off from support – funding problems not just for corporates and banks but also for sovereigns could spread rapidly across Europe and beyond.

In this regard, don’t bet on China coming to the rescue. CIC, the country’s sovereign wealth fund, this week once again rejected the idea that it would contribute to a bailout fund for European governments. The US$410 billion fund said that it is interested in investing in Europe – but in industrial investments and real assets, not debt-burdened sovereigns.

China has its own debt problems, too. One of the week’s big – if long predicted – developments was the news that banks are being instructed to roll over much of the US$1.7 trillion in credit extended to local government financing vehicles.

One region where governments are in no immediate need of alternate sources of funding is Latin America. Government financing needs in the region will fall from 8.2% of GDP in 2011 to 7.6% this year, according to Fitch, and the vast majority of that (90%) is expected to be raised from domestic sources.

Indeed, it’s testament to the relatively benign sentiment in the region thet even Venezuelan bonds have tightened significantly this year, even though that might be partly down to growing hopes President Hugo Chavez will be unseated in the October election. If that happens, the country would probably prove the trade of the year for those brave enough to take it on now.

Elsewhere, there were signs this week that Turkey’s lucky streak is not about to let up: while the full-year trade deficit was an enormous 10% of GDP, the trend appears to be in the right direction – a fact which raises the question of whether the central bank’s unorthodox policies are sounder than they seem. And India’s equally unlucky streak may be turning, with some encouraging hints in the latest inflation data.

Turning to equities, we looked this week at why there might be more value than investors think in Eastern Europe markets – and we discussed the main reason why Korea is never as cheap as it looks.

Lastly this week, Robert Zoellick’s decision to stand down from the World Bank has kicked off the inevitable stampede to succeed him, with calls once again for the next leader to come from an emerging nation. But the media is already placing odds on the most likely candidates: so far, given the speculation, it would seem the chances are that succession will prove business as usual.

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