- Sell-side analysts are considering which EM countries are safe from financial turbulence, following this week’s dramatic sell-off of EM currencies. Danske Bank argues that liquidity hungry countries-those with large current account deficits and large external debt, are the most vulnerable. “We have earlier pointed out Turkey, South Africa, Iceland and Hungary as being particularly in the danger zone. Furthermore, Bulgaria, Romania and the Baltic states also run large current account deficits that make these markets vulnerable to a global liquidity squeeze. Therefore, we recommend reducing exposure to these markets.”
Standard Chartered laments the contagion, pleading that it is vital for investors to “understand the structural underpinnings of strong growth in EM in recent years, and the fact that EM economies are expanding increasingly under their own momentum.” Danske fears risk aversion could spread to those countries that have current account surpluses, such as high-beta markets in Brazil, Indonesia and Philippines.
Commerzbank predicts: “the rising JPY, widening bond and credit spreads, sharply higher volatility and plunging stock markets should keep high leveraged EM currencies in the defensive for the time being”.
Danske Bank’s short to medium-term prediction is that investors will run to countries with large surpluses as well as large FX reserves, in the oil-producing Gulf, CIS and the majority of Asia. “The top picks in terms of currencies would be cousins of the yen and Chinese renminbi – the Taiwan dollar, Korean won, Malaysian ringgit, and Singapore dollar. All of these countries have very strong external balances and have large FX reserves.”
It recommends that investors should prepare themselves for a rally towards commodity exporters with undervalued currencies in CIS and Gulf states. Furthermore, the Czech koruna, unlike most other CEE currencies, will strengthen due to the unwinding of CZK-funded carry trades. With Commerzbank warning: “its days as a cheap funding currency may be numbered as well, as the CNB seems determined to hike interest rates further from 3.0% in the months ahead.”
- Alberto Bernal at Bear Stearns in ‘Venezuela- Still a current account story’, accounts for the terrible performance of Venezuela bonds this year. He then argues how, in light of adverse global conditions, fixed-income investors should position themselves considering the political and economic mismanagement in the country.
“To place the size of the sell-off in perspective, since the beginning of the year, the price of the Venezuela 2027s has fallen materially from 128.5 at the beginning of January to around 105 at this time—yields have widened in tandem,” he explains.
Bernal notes that various political risks such as the nationalization of strategic industries, and the country’s decision to withdraw from the IMF have added to the sovereign risk premium in recent months. However, it underscores a central factor: the current account surplus for Q107 has fallen substantially to $3.77 billion compared with $7.52 billion in the same period last year.
Additionally, the country’s president, Hugo Chavez’s nationalization of oil companies have undermined the fiscal base, he argues. “The widespread nationalization of the oil industry has also resulted in greater dependency of the sovereign on PDVSA’s [the state oil company] present and potential output. This increased dependence has likely been one of the reasons behind the impressive widening seen in sovereign risk.”
Bernal is worried that investments to enhance the productive capacity of the oil industry are instead being directed towards state projects, increasing the sovereign’s vulnerability in the event of a downturn in oil prices.
Nevertheless, he argues “the boom years we have just passed have placed Venezuela’s cash-flow position in a very comfortable state. According to our calculations, it is likely that the government of Venezuela currently has semi-liquid resources in the neighborhood of US$60 billion at hand.” He predicts that foreign-debt obligations, are scheduled to be around US$3.6 billion in 2007, US$4.0 billion in 2008, US$3.4 billion in 2009, and US$4.2 billion in 2010.
But the country’s willingness and ability to pay will be affected by exogenous shocks. “The decline in oil prices and crude demand could possibly cause a decrease in oil and gas export revenue in the third and fourth quarters of this year, and would last through 2009. In response to this decrease in foreign currency receipts, material currency devaluation would appear likely, raising the liquidity threshold necessary to service dollar-denominated debt. In its response, in turn, the market would further increase risk premiums on Venezuelan debt.”
Furthermore, in the event of global oil prices falling, more debt issuance to sustain high social spending is likely, causing local interest rates to increase as well as the sovereign premium. Despite the fact that Venezuela’s debt sustainability path is perilously contingent on high oil prices, Bernal predicts a soft landing for the country given the continuation of relatively high oil prices.
“Petroleum at current prices will be able to sustain Venezuelan deficit spending and financial obligations in the near term. That said, oil prices have been and most likely will remain pro-cyclical. Hence, Venezuela will remain a high beta credit at least until a government comes into power with the agenda of diversifying the structure of Venezuela’s economy. Such an agenda is unlikely to gather steam under a Chavez administration.”