Market Insights en-gb Sat, 23 Feb 2019 03:47:29 GMT 2070 Viscous Fiscus: In Pursuit of Reform, South Africa Takes One Step Forward, One Step Back Markets have hung their hopes on the upcoming 2019 election and the avoidance of a blowout at troubled state-owned utility Eskom as potential reasons for optimism in South Africa, but without a monumental shift in mindset, or an end to the factionalism that has increasingly defined the executive and the ANC, both reform and growth will remain elusive. Is it time to curtail unafordable policies? 22 Feb 2019 Africa Market Insights 44 Fri, 22 Feb 2019 15:43:35 GMT Cyril Ramaphosa unveiled the African National Congress’s (ANC) election manifesto to much fanfare in Durban January 12, timed appropriately with the party’s 107th anniversary celebration. Analysts believe the 66-year old politician, former businessman and trade union leader who took over following the resignation and trial-by-popular-opinion of former president Jacob Zuma, is likely to secure a mandate at the polls in May.

For keen observers and the market practitioners, the manifesto, expounded over a five-day conference, was as notable for what it contained as that which it lacked. Flagship commitments, such as the government’s bid to attract ZAR2.1tn (approx. USD87bn) in new investment over five years; an acceleration of land reform; increasing transparency and reducing contingent liabilities through reorganisation of state-owned enterprises; and a promise to curbing unemployment – especially youth unemployment – by encouraging the creation of more than 270,000 new jobs per year, double the current job growth rate, are all largely regurgitated from the previous 12 months.

The manifesto also paid homage to real and pressing issues, like boosting promotion of water conservation, a hot topic in the wake of Western Cape’s worst drought in decades, or the need to boost social infrastructure, without articulating a vision of how those objectives would be achieved.

“What’s new? As far as I can tell, nothing,” says Peter Montalto, Head of Capital Markets Research at Intellidex. “Many of the flagship policy proposals are recycled from the past year, and more importantly, lack more clarity around the steps to see implementation through, or a fundamental shift in mindset.”

This was followed by the release of the 2019 budget in February, which among other things finally revealed the government’s turnaround plan for Eskom: a ZAR150bn equity injection over the next decade – rather than a debt transfer. There is purportedly strict conditionality attached to the funding, Montalto says, but those conditions have not been made public as of yet – a blow to investors and the wider market as they search for ways to police the utility’s financial discipline.

“The surprise, a positive one, was that as a result of the choice of form of bailout, and indeed the panic we perceive within Cabinet on Eskom, [the National Treasury] managed to force through major underlying cuts in expenditure to the tune of ZAR50bn over the MTEF (or 0.5pp GDP per year), half of which is from the public sector wage bill. Given other issues, such as higher debt service costs, weaker revenue and pencilling in contingency reserve for other SOE bailouts, so this ZAR50bn only partially covered the Eskom bailout meaning it wasn’t overall deficit neutral and additional debt will be raised and cash drawn down. It also meant the expenditure ceiling had to be broken, a negative, though it can regain some credibility if still stuck to going forwards. SAGB net issuance levels for the coming year moved up by 1.9% vs the MTBPS,” Montalto explains in a note following the budget’s release.

“Going forwards the problem is that there is virtually nothing ‘easy’ left in the revenue policy cupboard but also now in the expenditure cupboard to aid further consolidation. Add in further expenditure pressures on NHI and higher education (both of which saw no mention). The bailout of Eskom is also a ‘minimum’ per year payment in our view whilst growth forecasts are still too high. Put simply the risks are still skewed to the negative side – even if today showed a crisis can generate political space for [the National Treasury] to occupy, from here things will be more challenging given there is no real flexibility left – only Narnia is left at the back of the fiscal cupboard.”

The deficit is forecast to widen to a peak of 4.5% of GDP in the next fiscal year, mostly on lower revenues and despite a tax adjustment that would bring in an extra ZAR10bn; expenditure cuts mostly came in the form of adjustments to the wage bill. Growth will also take a hit, with 2020 figures revised down from 2.1% to 1.7% of GDP; Montalto says growth expectations for this year – 1.5% - are still too optimistic, with 1.2% looking much more realistic. And despite the government’s decision to lean on equity as a solution to Eskom’s funding woes, the government’s funding requirements will still rise in the near term; it also had to revise up its expenditure ceiling by ZAR14bn, which most analysts see as a negative.

“The results of the budget are that most of the Eskom bailout is taken in the expenditure cuts in the medium run, though before these fully bed in, in the coming fiscal year 2019/20, most is not deficit neutral and has to be supported by debt increases.”

Rising Costs Boxing-in the Treasury

The budget retains a number of costly Zuma-era commitments that could weigh heavily on a an already stretched fiscus, including an initiative announced in December 2017 that would see the government scrap tuition fees and subsidise skills retraining and higher education for pupils from lower-income families.

The move, which would see the government switch from a loan to a grant scheme for funding post-school education, could add close to USD13bn to the national budget – equivalent to nearly 3.5% of GDP – by 2022, and may actually serve to aggravate youth unemployment rather than generate an up-skilled economy, according to an analysis carried out by the World Bank.

 “The policy agenda of expanding the Post School Education and Training (PSET) sector clearly illustrates the trade-off between maintaining fiscal restraint and addressing key structural constraints that may be costly to the fiscus,” the World Bank noted in the analysis.

In South Africa, acquiring skills through programmes like PSET is among the best guarantors of escaping poverty according to the institution, as income inequality continues to be mostly driven by labour market developments which create demand for skills many lack.

“Quantitative analysis in this [October 2018] Update based on administrative and household survey data suggests that the financial cost of studies can be a major barrier to enrolling poor students in PSET institutions… it also suggests that the quality of education, in TVET notably, is very poor and is not meeting labour markets’ demand – making private returns from TVET very low, likely discouraging enrolments.”

The policy is just one of a growing number of proposals which sit at the increasingly uncomfortable nexus of fiscal prudence and populism embraced by the ruling party in the run-up to the election in May. Others include a generous expansion of the social security system (though concrete spending and implementation measures are somewhat sparse), and a long-delayed National Health Insurance (NHI) programme, which has stalled in recent months – and a proposed bill rejected in Parliament – in part because the National Treasury raised several concerns about its implementation and cost. 

The reforms could edge public debt as a percentage of GDP up past 60% from its current 57.5% mark, putting its precarious investment-grade rating from Moody’s at risk, and its position in Citi’s World Government Bond Index (WGBI).

The ramifications of it sinking into junk territory, particularly in terms of forced-selling and asset prices, aren’t entirely clear because a downgrade has been priced-in for the past 12 to 18 months.

Some put the dollar value of forced-selling in the country’s bond markets at around USD2-3bn, but that’s probably a very conservative number and largely accounts for Japanese institutional investors, which tend to have a more rigid mandate by comparison with other emerging market investment pools. Conversely, some investment banks have estimated we could see up to USD15bn in forced-selling, which is probably too high and does not take into account the scale of pull-back already seen amongst discretionary funds.

“The real number is probably somewhere in the region of USD5-10bn, but it’s pretty much impossible to forecast,” Montalto concedes.

Eskom and the Fiscus: Bailout is a Foregone Conclusion

Mounting costs don’t include what looks set to become one of the biggest bailouts in the country’s history. Caught between unsustainable tariff levels set by energy market regulator NERSA, inefficient and ageing assets, and a bloated headcount, state-owned utility Eskom in December last year sought a National Treasury bailout of around ZAR100bn, or approximately USD7.2bn – about USD1.5bn of which is needed by March this year to stave off financial collapse.

It managed to secure ZAR150bn over the next ten years through equity injection via existing shareholders and a ZAR69bn loan from the government, and initial plans suggest the company’s generation, transmission and distribution businesses will be restructured into at least three separate entities, laying a path to at least partial privatisation.

Eskom is unique in the scale of the financial and administrative challenges it faces. To begin, it is excessively bulky. There aren’t many utilities that own their own mines, for instance. And a headcount of more than 40,000 makes challenging unions representing its employees nearly impossible from a political standpoint; wage negotiations last year saw Eskom move from a starting position of 0% wage increases to 12%, capitulating after sabotage-induced electricity blackouts caused an outcry from companies and the wider population.

That said, putting the company on the right path means more than just firing a sizeable portion of its workforce, a cash injection or wholesale privatisation, Gondo explains. Critics fairly argue that its clunkiness is one of the factors making it difficult for NERSA, the country’s electricity regulator, to find a tariff that effectively balances consumer demands for a fair price of electricity and producer demands for a tariff ceiling that allows it to generate revenue sustainably.

Rating agencies are consolidating around the view that NERSA’s tariff decisions are structurally inhibiting Eskom’s flexibility in generating sustainable cashflows, but analysts believe this is in large part due to its regulatory mandate – which some say needs to be reformed to help set in motion a turnaround that outlives a short-term cash injection.

“But the reality is, even in a best-case scenario, that still wouldn’t fix the issues facing it or the rest of the country.”

Fork in the Road: Overreliance on SOEs Damaging Over the Long-Term

Eskom is just one a number of state-owned enterprises struggling under the weight of chronic administrative and financial mismanagement, and structural inefficiencies. State-owned broadcaster SABC will need another USD216mn in funding to stave off collapse, while state logistics firm Transnet, national airline South African Airways (SAA), and arms manufacturer Denel are all eagerly positioning themselves for further budgetary support.

 “The ways in which Eskom and most others need to reform is actually fairly clear. Tough decisions need to be made, but those decisions are for the most part clear. For longer-term stability, we need to see a radical change in mindset, one that sees the country move from the old centrally-managed, public ownership model to one that is able at to foster more private sector participation and innovation in critical sectors of the economy,” explains David Makoni, an executive director and fixed income research director within the global emerging markets team at Bank of Singapore.

Many believe that shift in mindset needs to start with an overhaul of the country’s outdated and unnecessarily complex labour and collective bargaining rules, including simplification of the archipelago of minimum wage laws applied in different sectors of the economy.

But this is a politically toxic portfolio that has seen attempts at amendment scuppered in the past. It also requires the deployment of significant political capital needed to stand up to very large and powerful unions, something the country’s political leaders seem increasingly unwilling to do – as Eskom’s own wage negotiation late last year illustrates quite vividly.

“I would be much more optimistic about the country’s long-term prospects were we to see the government standing up to the teacher’s union or the National Union of Metalworkers of SA, for instance, than any specific policy I can think of,” Montalto says, adding that the status quo is unlikely to change until the country reverses its overreliance on SOEs.

Other elements contained in the initial manifesto beyond those related to Eskom and renewable energy point to increased reliance on SOEs – and rising risk. For example, the ANC wants to amend the Banks Act to allow SOEs to obtain banking licenses, the aim of which would be to boost competition among the country’s existing commercial banks and less than a handful of public sector lenders. But the move could increase macroprudential risk because publicly-owned banks currently fall outside the supervisory purview of the South African Reserve Bank.

Ultimately, Cyril Ramaphosa’s ability to carve a viable path forward after an election – an ANC government seems to be the likeliest outcome, according to pollsters – will depend on the extent to which he can bridge bitterly divided factions within his own party, particularly those loyal to ousted leader Jacob Zuma, and the party’s more populist upper strata – including Deputy President David Mabuza, and Secretary General David Mabuza. That Zuma’s name was added to a list of potential lawmakers after the elections, however symbolic, is telling of just how influential the former leader remains, and how important it will be to keep Zuma loyalists in the fold.

But against that backdrop, the ANC looks set to sink its heels further into unaffordable, populist policies that appease key constituencies within the party base in the short-term to the long-term detriment of the economy.

Macro Policy Africa
2069 Malaysia Sukuk Pipeline to Remain Strong as Corporates Seek to Secure Longer Tenors Dato' Lee Kok Kwan, Chairman of BIX Malaysia, the Bond and Sukuk Information Exchange Malaysia, spoke with Bonds & Loans about the sukuk pipeline for the coming year, growing demand for Sharia-compliant instruments, and Malaysia’s innovative approach to Islamic finance. What's in store for Malaysia's Islamic markets in 2019? 22 Feb 2019 Asia Pacific Market Insights 46 Fri, 22 Feb 2019 11:56:13 GMT Bonds & Loans: What are the main drivers behind corporate sukuk issuance at the moment? To what extent is the lack of access to conventional external financing driving this?

Dato' Lee Kok Kwan: Malaysia’s successful sukuk development can be attributed to its innovation-driven attitude when it comes to Islamic finance. We believe the main drivers behind the Ringgit corporate sukuk issuance are, firstly, the large and sustained buyside demand for mid to longer dated fixed-rate assets in conjunction with the high savings rate of the country that is in excess of 28% of GDP and, secondly, strong regulatory and legal framework. Other factors include significant investor confidence in the product as the infrastructure, regulatory and legal framework have proven through many economic cycles that it is protective of RM bond and sukuk investors, and, finally, the fact that corporates are keen to tap the sukuk market to secure longer dated fixed rate financing, so that they can focus on their core business.

Sukuk issuance is not down to a lack of access to conventional external financing. Rather, there is ample access to external non-MYR financing, as there is a scarcity of Malaysian USD and other non-MYR denominated sovereign and corporate bond and sukuk issuances. The pricing is also reflective of the fact that the Malaysian USD sovereign trades at much tighter credit spreads than other A- rated sovereign or corporate credits would imply.

Bonds & Loans: How does pricing tend to differ?

Dato' Lee Kok Kwan: At the moment, we are looking at around 7bp difference in favour of Islamic corporate sukuk over conventional corporate bonds within the same maturity and rating, according to Bond Pricing Agency Malaysia (BPAM). The Ringgit corporate sukuk market also tends to enjoy greater liquidity as both conventional and Islamic funds can invest in Sukuk, while for conventional Ringgit bonds, only conventional funds can.

Bonds & Loans: Are there concerns about sovereign sukuk issuances crowding-out corporate sukuk? How do you expect sukuk supply to evolve over the coming year?

Dato' Lee Kok Kwan: There are few concerns as it is expected that government-guaranteed issuances will decline substantially in the coming years and this will not be sufficiently offset by the increase in sovereign issuances, while corporate issuances will continue apace. Markets remain more concerned about lack of supply as opposed to a crowding-out problem, as the savings rate of the nation is expected to remain elevated at more than 28% of GDP, as it has been for decades.

At the end of November 2018, the overall outstanding amount of sukuk stood at RM839.36bn, while only RM499.89bn of this was corporate sukuk - so only 40.44% of outstanding sukuk was issued by the sovereign. Even though the issuance of sovereign sukuk has demonstrated strong growth since 2015, corporates remain the major issuer of sukuk.

As the Malaysian Securities Commission further develops the Islamic capital market framework, and as the demand for Islamic assets increases, we believe that the sukuk supply will continue to grow.

Bonds & Loans: To what extent is sukuk financing vulnerable to global factors?

Dato' Lee Kok Kwan: We believe the Malaysian Ringgit bond & sukuk market is relatively resilient and that vulnerability will likely be transmitted via global macroeconomic conditions impacting the Malaysian general economic performance. Interest rates, such as the Fed’s Rate, will result in short-term price volatility until yields stabilise and reach a new equilibrium, but it is unlikely to impact the general supply and demand dynamics in the Ringgit corporate bond and sukuk markets. Further Ringgit sukuk issuance will also be driven by general Malaysian economic growth and the growing demand for Islamic assets from investors.

Bonds & Loans: Sukuk has become a popular form of funding in the Middle East, with a growing number of borrowers looking to tap into investment pools that are familiar with the asset class – like Malaysia, and Indonesia, as well as conventional USD-denominated liquidity pools. Could economic reforms in GCC states impact the broader supply dynamic in the sukuk market?

Dato' Lee Kok Kwan: We don’t foresee economic reforms in GCC states impacting the dynamic of Ringgit sukuk issuance in Malaysia as the former is a USD-issuance market, while the Malaysia sukuk issuance is predominately in Ringgit and therefore has a very different investor base. What we have seen in the past is the effect of oil prices on GCC issuances, whereby lower oil prices led to higher deficits and greater funding requirements by the respective GCC sovereigns, resulting in higher USD sukuk issuances. However, this dynamic has no impact on the Malaysian Ringgit sukuk markets in terms of both demand and supply. The graph below shows a stable growth of Malaysia’s sukuk by foreign investors despite the oil price drop and recent political changes in Malaysia.

Notes on BIX Malaysia (

BIX website is a search engine for the entire MYR 1.3 trillion Ringgit bond and sukuk universe and it can search by yield, credit rating, tenor, issuer. BIX has a comprehensive database which includes transacted yields/prices, Offering Circular/Information memorandum, financials, credit rating, credit rating migration, cashflow, total return calculator etc for each Ringgit bond and sukuk. The BIX website can be use as a price discovery engine as one can compare prices and yields by tenor, credit rating of the sukuk or conventional bonds across the entire MYR 1.3 trillion universe. BIX is a free website for all and thus making the Ringgit government and corporate bond & sukuk markets more transparent and accessible to all (current and potential) investors, large and small.

Islamic Finance Asia Pacific
2067 CASE STUDY: Grupo Bimbo Becomes First Mexican Consumer Company to Issue Hybrid Bond Last year, Grupo Bimbo’s debut hybrid transaction marked a milestone not just for the company but the broader Mexican corporate bond market, where primary market activity for hybrid securities has traditionally been dominated by select financial sector issuers. The consumer foods giant sets new milestone 20 Feb 2019 Mexico Market Insights 62 Wed, 20 Feb 2019 15:52:25 GMT Background

Grupo Bimbo is a global consumer food company founded in 1945 and headquartered in Mexico City. With operations in 32 countries, Grupo Bimbo is the world’s largest baking company.

Prolonged periods of steady growth have allowed Grupo Bimbo to successfully complete over 40 strategic acquisitions since 2007, including George Weston Food Ltd in 2009, Sara Lee in 2011, Canada Bread in 2014 and East Balt Bakeries in 2017.

Transaction Breakdown

After announcing the acquisition of Mankattan in China, Grupo Bimbo sought to boost its Capex for 2018. In line with previous funding exercises, the use of proceeds was aimed at investments focused on improving productivity with a long term view on growth, profitability and diversification. Funds were also needed for general corporate purposes, including refinancing existing debt.

At the outset of its fundraising exploration, more traditional structures were considered, such as senior unsecured notes, but the company felt that the use of a hybrid structure better suited its financial aims. With 50% of the perpetual notes receiving equity treatment under the criteria of the Big Three credit rating agencies, the inclusion of optional cumulative interest deferral, and staggered coupon step-ups, a hybrid transaction allowed far greater flexibility than Bimbo’s previous borrowings.

“Our commitment to a strong balance sheet, as well as with investment grade and deleveraging made the hybrid instrument a much more attractive alternative,” Grupo Bimbo’s Treasury Department said in a note.  “The transaction was structured in alignment with our relentless focus on reinvestment while aiming to preserve a sound financial position. In that sense, one of the objectives of this transaction was not only to secure funding for the year, but to maintain flexibility in our capital structure and thus continue to foster our deleveraging commitment and the support of our solid credit rating.”

As the instrument received a 100% equity treatment under IFRS, it does not weigh on the company’s debt profile and is instead listed as an equity component on Bimbo’s balance sheet.

Roadshows and Distribution

The transaction was executed on the back of a successful week-long, two-team roadshow in London, Chicago, Boston, and New York, three days after which IPTs of low to mid 6% was announced. Within 40 minutes, the book was fully subscribed with orders from real money accounts. Oversubscribed 5 times, peaking at nearly USD2.5bn, the orderbook included participation from more than 225 investors.

Due to swelling demand, Grupo Bimbo eventually priced the transaction at 5.950%, representing a tightening of 55 bp from IPTs. Compared to Bimbo’s senior unsecured debt, the final pricing indicates a less than 200 bp subordination premium, in line with comparable corporate hybrid paper.

Investors’ main concerns were regarding the structure of the instrument; the scarcity of corporate hybrid issuances meant that investors were relatively unfamiliar with the instrument.

A number of factors played into the notes’ eventual valuation: secondary levels of Bimbo’s outstanding USD-denominated senior unsecured notes; US Treasury rates; the differential between subordinated and senior notes in Latin America; volatility – as measured through the VIX index; the value of the Mexican peso; and general appetite towards Latin America and the consumer industry.

Due to the paper’s subordination and its discretionary deferral feature, the transaction was rated two levels lower than Bimbo’s senior unsecured debt. This allowed Grupo Bimbo to broaden its investor base, sparking fresh interest from higher-yield investors, who had shied away from Bimbo’s previous high-grade transactions.

By geography, more than half (64%) of the notes were placed with accounts based in North America, 23% were placed with accounts in Europe, 12% to Latin America and 1% Asia. Asset managers accounted for 72% of the final allocation, while banks and private banks accounted for 4% of the overall allocation. Just over 16% went to pension funds, insurers and other long-term institutional investors, and 8% went to hedge funds.

Deals Americas Deal Case Studies Mexico Latin America
2066 The Latin American Political Landscape in 2019: The Good, The Bad and The Ugly Americas Market Intelligence’s John Price takes stock of last year’s hectic election cycle in Latin America and looks more closely at the fortunes of some of the region’s key markets: Brazil, Mexico and Venezuela. Who will be left standing after the latest election cycle? 19 Feb 2019 Latin America Market Insights 73 Tue, 19 Feb 2019 10:57:23 GMT The 2018 elections in Mexico and Brazil turned on its head the investment norm driving Latin America’s two largest economies. After three decades of corporatist politics, some impressive institution building and admirable fiscal and monetary discipline, Mexicans elected a left-wing maverick to los Pinos and gave AMLO’s Morena party and its coalition a majority in both chambers of congress. Meanwhile, Brazil, the country that has failed to realize its enormous potential for decades now finds itself led by a man willing to tear down the coddled trappings of the political class, simplify Brazil’s byzantine tax code and untether the business sector from over-regulation.

Both AMLO and Bolsonaro ran populist campaigns, promising to upend the political status quo after a period of unprecedented corruption revelations and intolerable crime levels. Both leaders tapped into an angry sentiment that helped them stand apart from the mediocre leadership of established parties, the PT in Brazil and the PRI and PAN in Mexico. But there end the similarities between these two populists.

The Good: Brazil

Judging by capital flows, the Latin monied classes endorse Brazil’s Bolsonaro and worry about Mexico’s AMLO. Bolsonaro has a plan and should have the political support to pass pension reform, long considered the third rail of Brazilian politics. In Davos, Bolsonaro reiterated his commitment to simplify Brazil’s tax codes and drastically cut the time it takes to start a business. Paulo Guedes, the former investment banker who now leads the Ministry of Finance, went a step further, promising to lower the nation’s tax burden from 36% of GDP to 20%. Brazil plans to shrink its bloated central government by as much as 25% with the closure and consolidation of several ministries. Brazil will privatize the controlling interest of Eletrobrás as well as up to 20 airports, led by Curitiba’s. New concessions will be issued to build rail lines and ports to facilitate Brazil’s natural resource exports. The national content laws that stymie investor interest in Brazil’s offshore oil resources will also be reformed to help entice more investment.

In short, the Bolsonaro government plans to undertake in the next 24 months the very reforms that political economists have prescribed for the last thirty years and everyone assumed were simply impossible given the dysfunctionality of Brasilia. Together, these reform announcements have attracted waves of new capital to Brazil, driving the Bovespa to new records and strengthening the Real— improving the acquisition power of every Brazilian. Not surprisingly, an IBOPE poll conducted at the time of his inauguration in early January 2019 found that 75% of Brazilians approve of Bolsonaro and 65% believe that he can revive Brazil’s economy in a matter of months.

Paulo Guedes is steering the economic policy ship of Brazil, for now. His priorities are: i) pension reform; ii) tax & labour reform; iii) de-regulation; and then, finally, free trade. He knows that foreign institutional capital will not stick around unless pension reform is prioritized. He also knows that the economic nationalists in cabinet and congress are not ready to lift protectionist walls until the government lowers the custo Brasil through tax reform and de-regulation. Brazil has pending two possible trade agreements, based one on a long-standing negotiation with the EU-Mercosur and the other on a recently started negotiation of a Canada-Mercosur agreement. EU industrial and consumer goods exporters are a far greater threat to Brazil’s inefficient and overtaxed manufacturing base versus Canada’s natural resource exporters. As such, pundits expect the Canadian agreement to pass first, but neither will likely be put to vote before 2021. To convince the protectionist voices inside government that Brazil should sign these free trade agreements, Guedes must first ease the tax and regulation burden on Brazilian business with internal reforms.

The Bad: Mexico

AMLO’s first major policy decision as President was to cancel the USD13 billion airport construction project in Texcoco, east of the overcrowded Benito Juárez Airport. At first glance, this appeared to be a concession to his voter base, which includes students, farmers and green-minded urban voters. But a closer look reveals a more worrisome tendency. Structured as a transparent referendum, the quickly assembled and questionably counted plebiscite included less than 2% of eligible Mexican voters. Santa Lucía, a military base, is favoured by AMLO and lobbied heavily by construction firm Grupo Riobó, which curiously was contracted to produce an analytically dubious feasibility study that favours the base as the best option for airport capacity expansion. The Montreal-based International Air Transport Association has publicly declared that Santa Lucía and Benito Juárez airports cannot technically co-exist because they are too close to one another, contradicting the findings of the Riobó study and questioning the safety of AMLO’s new pet project.

So many bold pronouncements have Brazilian financial markets in a giddy mood. A quick read of Brazil’s new congressional makeup shows that legislators are more open today to reform than in recent memory. But the devil is in the details when passing laws, and Brazilian congressional politics is notoriously laden with pork, with little to no party discipline on votes. Bolsonaro and Guedes are to be applauded for laying out an aggressive but much-needed reform agenda. After Carnival ends and congress begins debating pension reform, we will see how persuasive Bolsonaro can be with his former congressional brethren.

As for placating his electoral base, which includes a large contingent of evangelicals, Bolsonaro regularly emits strong language against political correctness, gays and indigenous land rights. Those remarks are offensive and regressive and tend to alarm the educated classes and the media, but spoon feeding Bolsonaro’s voter base has few economic consequences for Brazil. The exact opposite can be said of AMLO.

In another surprise move, AMLO forced a 60% wage cut on the Central Bank, including its five governors. That prompted one governor to resign ahead of schedule on top of the regularly scheduled rotation of another governor. Later, the Mexican courts overruled the dramatic pay cut at Banixo but the damage was done, the 2nd governor had resigned. In an article that AMI Perspectiva published in May 2018 called Who’s afraid of AMLO?, I identified the Central Bank as of one of the few institutional pillars that would help curtail the populist instincts of AMLO. Such pillars are vital given the Morena party (AMLO’s party) control of the executive and legislative branches in a country with a notoriously weak judiciary. But in two years from now, one third of the way through his mandate, AMLO will replace the third of five governors and thereby take control of Mexico’s most important independent economic institution. The battle lines are already drawn with the Central Bank, whose acting Governor, Alejandro Díaz de León-Carillo, declared: “Loose fiscal policy will have to be met with tighter monetary policy.”

AMLO’s efforts to “drain the swamp” by forcing massive wage cuts promises to drive Mexico’s very capable technocrats into the arms of the private sector. Who might step into their shoes is what has insiders truly worried. If government cannot retain the brightest minds to run its institutions, then it will be run by a motley combination of untested amateurs, rash ideologues and corrupt dinosaurs.

Mexicans have placed their faith in AMLO to fight corruption based upon the singular belief that he is a man of integrity and he will lead by example.  That is a noble thought but a society’s ability to combat corruption requires more than leading by example from the top. It also requires a robust and efficient judiciary system and publicly trusted whistle-blowing institutions that act upon citizen-provided evidence.

AMLO, who cut his political teeth in the 1970s at the zenith of the PRI’s political power and Mexican oil wealth, anchors his economic policy on the rebuilding of PEMEX and wants to commit billions of dollars to build downstream refineries. Mexico’s higher cost of capital means that it can never financially compete with amortized refineries in Texas where most Mexican transport fuels are refined. Betting on hydrocarbons today seems like a fool’s errand for any investor, let alone for a government. Even Saudi Arabia is desperately trying to wean itself off oil.

The rational voices of advice that guided AMLO through his campaign are increasingly sidelined by the man who controls the presidency, the Senate and the House. Mexico’s billionaires—who underwrote so much of Mexico’s industrial expansion over the last two decades—are quietly but quickly moving swaths of their Mexican-based assets offshore. Affluent home pricing in Mexico City has dropped an estimated 20% since October 2018. A sense of gloom is taking hold among the elite in Mexico, even while AMLO’s approval ratings continue to climb.

Divergent Foreign Policies

When it comes to foreign policy, AMLO and Bolsonaro again contrast one another. It has always struck me as hypocritical how Latin American governments can appear so pious when it comes to upholding the international rule of law and human rights abroad while flouting their own laws at home.  But for Mexico to abstain from signing the Lima Group convention letter denouncing Maduro’s farcical re-election and sit on the sideline as the world finally stands up to the ever-hardening dictatorship in Venezuela places AMLO on the wrong side of history. Bolsonaro, on the other hand, was quick to question Maduro’s legitimacy after fraudulent May 2018 elections re-elected him to office. Shifting Brazil from a Venezuela ally to its loudest critic proved crucial in attracting support from the US, Canada, Israel and Western Europe to the idea of making Guaidó, the Venezuelan congressional leader, the country’s de facto interim president.

The Ugly: Venezuela

Twenty years after Hugo Chávez was first elected as President, Latin America’s once shining star of a nation has been plundered by a military-led cabal whose own manipulative interpretation of Venezuela’s revered constitution categorizes the chavistas as dictators operating under a fig leaf of democracy. The political showmanship of Chávez and oil prices above USD120 per barrel permitted the plundering to continue, with only a few critics at home and abroad, generally dismissed by Chávez as spoiled Venezuelan elites slumming it in Miami. But when Chávez died in 2013 and oil prices collapsed in late 2014, the wheels came off one of the most expensive political joy rides the world has ever known.

Since 2015:

  • PDVSA oil production has dropped 2.5M to an estimated 1.2M barrels per day, less than North Dakota. When Chávez first took office, Venezuela produced 3.5M/day.
  • Non-gold foreign reserves dropped 65% from USD23bn to USD8bn.
  • Gold reserves dropped 76% from USD21bn to an estimated USD5bn.
  • Venezuela dramatically reduced its once highly effective Petrocaribe program which had helped buy diplomatic support from 17-member countries.
  • 49% of the U.S.-based Citgo was mortgaged to Russia’s Rosneft.
  • Homicide rates leapt to 60 per 100,000 people, triple the level of Mexico and 10 times the level of homicide rates in the U.S.
  • An additional two million, mostly middle class, fled Venezuela, including many of the nation’s most capable entrepreneurs, scientists, academics, engineers and doctors.

Some estimate that over USD100 billion was stolen from government coffers over the last two decades. Since 2014, Venezuela’s GDP has plummeted 63%, more than double the collapse of the U.S. economy during the Great Depression (-29%). Venezuela today is a skeleton of its former self.

But recent events have injected a sense of hope into the hearts of Venezuelans. The blatantly manipulated elections that re-elected Maduro with 67% of the vote in 2018 finally pushed the opposition into action under the bold leadership of Juan Guaidó and inspired protesters to fill the streets. Except for the most vicious units of the military, soldiers have refrained from exercising physical force on peaceful protestors. Guaidó has proven himself a masterful tactician, employing social media to bring out throngs of protesters, sneaking across the border with Colombia to visit President Duque, and from there flying to Brasilia and Washington to garner support and gaining unprecedented international press coverage of the Venezuelan crisis. Citing the same constitution that the Chavistas so effectively employed, Guaidó, leader of a majority opposition in congress, has knighted himself interim President of Venezuela. To the delight and surprise of many governments in Latin America, Donald Trump has thrown considerable State and Treasury department resources behind Guaidó as a catalyst of change in Venezuela.

The world hopes for a bloodless transfer of power in Venezuela. However, there are plenty of reasons to assume that i) the transition of power may prove more difficult than hoped and ii) rebuilding governance across Venezuela may take years. To begin with, the military brass will not be lulled into submission by the promise of legal impunity, which has been offered by Guaidó. Abandoning Maduro and the sitting Chavista government means walking away from highly lucrative illicit and corrupt business operations that have turned military leaders into millionaires many times over. Today, this group manages PDVSA and its purse strings as well as many of the service companies that transport fuel, import high grade additive fuels, operate the PDVSA maritime vessels, manage Venezuela’s ports that export oil and import staples. The sanctions placed on Venezuelan oil exports by the U.S. directly impact exports to the U.S. (40% of total) but Donald Trump cannot prevent Venezuela from selling its oil to non-compliant countries like China and Russia who may choose to ignore U.S. sanctions.

Beyond the dozens of companies owned and operated by military leaders in Venezuela that rely on the PDVSA teat, there are other businesses that operate in an illicit parallel economy that no amount of international pressure can do much to change. Cocaine production in Colombia today is back to record levels. Most of it is channelled to global markets via Venezuela where, purportedly, gangs who report to the Venezuelan military traffic the product. The gangs and the Venezuelan army live in an uneasy peace after dozens of battles that have reportedly left hundreds dead over the last several years. In the massive state of Bolívar in eastern Venezuela (one-fourth of the nation’s landmass), the world’s greatest gold deposit is exploited today by informal miners, controlled by gangs who then report to factions of the military. The gold that they mine is smuggled into Brazil and sold for dollars that are brought back into Venezuela to buy bolívares at the inflated black-market rate. Both the gold and the cocaine trafficking are multi-billion-dollar criminal enterprises. The next government will have to wage battles across Venezuela to quell these businesses which, at the ground level, are run by well-armed gangs who for the last five years or more have been stockpiling high-calibre weapons that they purchased from underpaid soldiers and officers of Venezuela’s once-proud military.

Once physical security is re-established in Venezuela, the key to reviving Venezuela’s economy will be the reconstruction of PDVSA and the energy sector in general. That is no easy task. Venezuela still has the world’s largest oil reserves (the Orinoco belt contains more oil than the rest of the world has pumped out of the ground in the last 100 years). However, the impressive engineering and managerial talent that once ran PDVSA is now spread across the globe helping run dozens of energy companies on five continents. In a desperate bid to stay afloat, the chavistas auctioned off massive oil fields and concessions to over two dozen countries including: Russia, China, Cuba, Norway, Brazil, Iran, India, France, Spain, Argentina, Ecuador, Uruguay, Chile, Italy, Portugal, Belarus, Vietnam, Malaysia, South Africa and ALBA energy (Bolivia, Cuba, Nicaragua, Ecuador, Dominica, St. Vincent & the Grenadines). The next Venezuelan government may choose not to recognize the legality of some of these concessions or find it challenging to prompt the concessionaires into developing their fields, given the low price of oil.  With its own finances in tatters, PDVSA will find it challenging to boost production using equipment and infrastructure left to rot for two decades and the control of its own reserves possibly entering a legal quagmire.

Lording over such potential oil wealth has enabled the Maduro administration to rack up an estimated at USD157 billion of foreign debt, or about 150% of GDP, more than double what a resource-driven emerging market can normally sustain. Of total debt, probably USD13.5 billion is owed to the Chinese and another USD4 billion to Russia. Neither lender nation is likely to forgive those debts unless they extract lucrative future oil concessions. The problem is that more than half of Orinoco is spoken for by other concessionaires. The chavistas did not only rob Venezuela of its existing wealth and assets, they also mortgaged a good chunk of the country’s resource future. But for now, the hope of a change in Venezuelan leadership has its country and much of the world gripped with excitement and anticipation. Planning for the future can wait.

Macro Americas Mexico Brazil Latin America
2065 Brown Brothers Harriman: Emerging Markets Preview for the Week Ahead Since their post-FOMC peak on January 31, both MSCI EM and MSCI EM FX have fallen. Virtually every EM currency has given up their post-FOMC gains, the lone exception being MYR (+0.2%). The worst performers have been ZAR (-6%), ARS (-3.3%), and TRY (-2.3%). This supports our belief that the liquidity and low US rates story is not enough to sustain the EM rally on its own. What’s still missing is an improved global outlook and we certainly didn’t get that with the US retail sales data. Analysis from Win Thin 18 Feb 2019 Global Market Insights 55 Mon, 18 Feb 2019 13:44:13 GMT Singapore reports January trade Monday. NODX are expected to contract -2.7% y/y vs. -8.5% in December. Data have been coming in weak recently, while inflation remains low at 0.5% y/y in December. The MAS does not have an explicit inflation target, but low price pressures should allow it to keep policy on hold at its semi-annual policy meeting in April. The government will also release its budget statement Monday. We suspect some fiscal stimulus will be included.

Thailand reports Q4 GDP Monday, which is expected to grow 3.6% y/y vs. 3.3% in Q3. The economy has held up well despite ongoing political uncertainty. The Bank of Thailand started a tightening cycle but signaled a cautious pace ahead as inflation remains low at 0.3% y/y. Next policy meeting is March 20, no change is expected then.

South Africa reports January CPI Wednesday, which is expected to rise 4.3% y/y vs. 4.5% in December. If so, this would put inflation below the 4.5% target for the first time since May. Still, the vulnerable rand is likely to prevent the SARB from cutting rates anytime soon. Next policy meeting is March 28 and no change is expected then. Finance Minister Mboweni will make his FY2019/20 budget statement Wednesday.

Poland reports January IP and PPI Wednesday, which are expected to rise 3.6% y/y and 2.1% y/y, respectively.It then reports construction output and real retail sales Thursday, which are expected to rise 8.0% y/y and 5.3% y/y, respectively. Central bank minutes will also be released Thursday. CPI rose only 0.9% y/y in January and so the bank will remain in dovish mode until further notice. Next policy meeting is March 6, no change is expected then.

Korea reports trade data for the first 20 days of February Thursday. Korea offers the earliest and arguably cleanest reads for regional trade and so this report will be closely watched. Headwinds to the economy are building and so we see very little in the way of tightening this year after the Bank of Korea first hiked in November. Next policy meeting is February 28, no change is expected then.

Bank Indonesia meets Thursday and is expected to keep rates steady at 6.0%. CPI rose 2.8% y/y, the lowest since August 2016 and below the 3.5% target. If the rupiah remains relatively firm, we think Bank Indonesia may shift more dovish and perhaps contemplate a rate cut later this year. We know the government has made attempts to reflate the economy ahead of April elections.

Brazil reports mid-February IPCA inflation Thursday, which is expected to remain steady at 3.77% y/y. The new central bank leadership has suggested that further rate cuts will hinge on passage of fiscal reforms. Weak data has pushed out tightening expectations further. Indeed, the CDI market is now pricing in no hikes until early 2020. Next COPOM meeting is March 20, no change is expected then.

Banco de Mexico releases minutes Thursday. The bank delivered a dovish hold this month, suggesting the tightening cycle is over. Mexico reports mid-February CPI Friday, which is expected to rise 4.05% y/y vs. 4.52% in mid-January. If so, this would be the lowest since December 2016 and nearing the top of the 2-4% target range. Yet as long as the peso remains vulnerable, the notion of rate cuts is off the table. Next policy meeting is March 28, no change is expected then.

Malaysia reports January CPI Friday, which is expected to fall -0.4% y/y vs. +0.2% in December. While Bank Negara does not have an explicit inflation target, the lack of any price pressures whatsoever should allow it to remain on hold this year. Next policy meeting is March 5, no change is expected then.

Taiwan reports January export orders and Q4 current account data Friday. Orders are expected to contract -8.5% y/y vs. -10.5% in December. Downside risks to growth are building, while inflation is non-existent at 0.2% y/y. While the central bank does not have an explicit inflation target, this should allow it to keep policy on hold at its next quarterly policy meeting March 21.

Macro Currencies Policy Global