Market Insights en-gb Fri, 19 Jul 2019 04:46:01 GMT 2177 Borusan EnBW Enerji CFO: Renewables Largely Unscathed by Recent Downturn in Turkey After a slide on the lira in August 2018, followed by creeping inflation, Turkish corporates have had a rough year. One sector that has rode out the storm unscathed however, has been renewable energy developers. Bonds & Loans speaks with Hakan Aras, Chief Financial Officer for Borusan EnBW Enerji about ECA financing, Chinese investment and the company’s expansion plans. Bonds & Loans spoke with Hakan Aras 18 Jul 2019 CEE & Turkey Market Insights 56 Thu, 18 Jul 2019 09:20:37 GMT Bonds & Loans: Can you give us a sense of Borusan EnBW Enerji’s key strategic focus areas over the next 6-12 months?

Hakan Aras: Primarily, we focus on renewables with a particular focus on wind. We currently have two projects in the pipeline with a projected total output of 210MW. Both are wind power projects: one is a capacity extension project with a projected output of 72MW, and the other will be our largest capacity wind project with 138MW. We are currently in the process of finalizing the financing for both of these.

The remaining 400MW are slightly different. These are merchant projects, not feed-in tariff projects, meaning that we will sell the output directly to the market. At the moment we are working on finalizing the permit process, which typically takes longer to close than the financing. As the government is undergoing a restructuring process, permits are no longer being distributed by devolved administrations, but instead by the President’s office. While this process is ongoing, acquiring permit-approval is taking longer than it previously would have.

We have one wind project called Saros which is in the pipeline, awaiting investment. We have another called Kıyıköy which has finalized its financing and is set to roll-out soon.

We are also keeping a close eye on wind and solar tenders in YEKA (Renewable Energy Resource Zones). These Zones offer 15 years off feed-in tariffs, for example, with a 60% local content requirement.

Renewable energy projects are the only projects in Turkey currently capable of producing healthy returns under the current macroeconomic conditions because of the reliable, dollar-denominated revenues provided by the feed-in tariffs.

Bonds & Loans: What are Borusan EnBW Enerji’s funding plans over the coming months? If you are looking to borrow, what format, size and tenors is the company looking at? And what will the use of proceeds be?

Hakan Aras: We are planning to finalize the financing for above mentioned projects (totaling 210 MW). Furthermore, looking for additional funding for our existing portfolio projects which is under development (approximately 400 MW). Our structure is usually going with ECA’s, bank guarantee with local bank and commercial loan local or IFI’s. Tenor for ECA portion is 12 to 14 years plus 2-year grace. Commercial is around 10 years. The use of proceeds usually goes to wind development projects or new tenders such as YEKA.

Typically, we choose an ECA based on the turbine supplier; if we choose a German company, we will use Hermes cover.

Since June 2018, the ongoing macroeconomic situation has meant that even some ECAs are not willing to commit to large transactions in Turkey. For example, we were originally looking to buy turbines from a Danish company and sign an agreement with Export Kredit Fonden (EKF), but they were only willing to fund up to 25MW of power, so we had to turn to another ECA.

Commercial bank funding is also difficult. We find that there is a lot of interest and appetite for our projects, but the issue is pricing. Another issue is tenors – local banks can only offer tenors of up to ten years. Realistically, for a solar project, they can offer tenors more in the range of seven to ten years. ECAs, meanwhile, can lend on tenors up to fourteen years. Previously, ECAs had been able to offer commercial loans; nowadays, they provide the ECA portion, but not the commercial portion, because of the risks involved in Turkish exposure.

Fortunately, given that both our revenues and borrowing is dollar-denominated, we don’t face a currency mismatch, and we haven’t been impacted by the slide in the lira.

Bonds & Loans: Investor diversification has been a growing theme amongst your peers. With Asian investors playing an increasingly active role in the region, is Asian investment an additional source of liquidity you have looked into? What role is Asian investment and lending playing in your funding strategy?

Hakan Aras: We are looking to diversify our funding sources, and Asian lenders play a part in this. All of the Asian dollar-based borrowing we have done so far has been from Chinese institutions. We’re recently been working with China Export-Import Bank, the Industrial and Commercial Bank of China (ICBC), Sinosure, the Agricultural Bank of China, and turbine manufacturers such as Ming Yang, with some institutions even committing to equity. We’ve found that Chinese institutions allow us to incorporate all of our financing into one deal.

The main criteria these institutions require is that revenue should be dollar-denominated – which is no problem for us due to the government’s feed-in tariffs – and should be backed up by a government guarantee.

Bonds & Loans: Are you looking at growing your operations into new markets?

Hakan Aras: We’re currently looking into the Balkan regions alongside Ukraine. We’d previously looked at Bulgaria, but the government has since removed some of their feed-in tariff structures.

Projects CEE & Turkey
2178 As Global Superpowers Question Free Trade, Africa Welcomes it With Open Arms The establishment of the African Continental Free Trade Area (AfCFTA) is both ambitious and impressive, not the least of which because it created a platform for 53 heads of state across a vast and diverse continent to agree on something. But whether or not it’s a game changer for intraregional trade – or the region’s financial markets – depends to a large extent on whether Africa’s leaders knuckle down and finally address far more practical barriers to growth and cross-border commerce. Deal on AfCFTA is close - but will it work? 17 Jul 2019 Africa Market Insights 44 Wed, 17 Jul 2019 13:50:17 GMT In March 2018, after five years of negotiation, African Union (AU) members took a big step towards bolstering intraregional free trade by establishing the African Continental Free Trade Area (AfCFTA), a wide-ranging agreement to eliminate tariffs on nearly 90% of goods, liberalise trade by eliminating red tape, and – eventually – create a continent-wide, 1.2 billion person-strong single market with a combined GDP of more than USD3tn and which includes free movement of capital, services, goods, and eventually, labour.

After securing the minimum 22-country ratification threshold at the end of May 2019, signatories are now in the process of negotiating an operational framework to help hash-out important customs and trade issues like rules of origin, tariff schedules, payments and settlements, with the aim of finalising the framework ahead of an AU summit in July.

Hopes Are High, Expectations Less So

Hopes are high that the deal will lead to material growth in intraregional trade, and for good reason. Some progress is being made on the development of a middle-income segment in countries like South Africa, Nigeria, Botswana and Ghana. But a potentially toxic cocktail prevalent elsewhere on the continent – declining but relatively high fertility rates, poverty, and an inability to move up the value chain in terms of the production of, or demand for, goods and services – risks eroding the demographic dividend many once ascribed to the region.

In terms of intraregional trade specifically, Africa has largely lagged behind her peers across emerging and developed regions, where the prevalence of country-to-country trade is unevenly distributed and largely centred around just four countries: South Africa, Namibia, Zambia and Nigeria. According to Afreximbank, intraregional trade in Africa accounts for just under 15% of overall trade (or approximately USD120bn), compared with 20% for Latin America, 28% for North America, 58% for Asia and 67% for Europe.

But as key details of the AfCFTA are thrashed out, anyone looking for a clear sense of how it will influence trade or economic development should tread carefully.

An oft-cited Economic Commission for Africa (ECA) report suggests the agreement has the potential to boost trade by up to 52.3% by eliminating import duties by 2022; with Nigeria’s recent inclusion in the pact, after initially pulling out last year just days before they were due to join, the AU increased that figure to 60% by 2022. The ECA said that could double if non-tariff barriers are also reduced. But all of these forecasts come with a sizeable list of largely unrealistic caveats – including, notably, full implementation of the AfCFTA by 2017 and tariff harmonisation.

“Laudable though it may be, it seems difficult to imagine how the scale of growth and improvement in intraregional trade being talked about is going to be achieved with this deal in its current form,” explains Robert Besseling, executive director at EXX Africa, a political and economic risk consultancy.

The current approach to tariff removal and exemptions appears problematic from the outset, especially as many African countries pursue moving up the value chain when it comes to domestic production. 

Exports produced by the extractive sectors like oil & gas, coal, minerals and precious metals, which make up a varying but often sizable portion of the economic base of most African countries, appear likely to see tariffs reduced or removed altogether. But these are already largely aimed at export markets in Asia and Europe. Intraregional trade flows are well-diversified, but they tend to contain a much higher proportion of value-added goods than those exported to the rest of the world – clothing, vehicles and white goods, for instance.

Many of those goods, however, may appear under an exemptions list that seems vulnerable to expansion as the practical ins and outs of the operational agreement are developed over the coming months; given the high degree of economic concentration in certain sectors, just two or three exemptions could drastically alter the prospects of some countries.

The (African) Elephant in the Room

Another ideological challenge is that many African nations – whether economic minnows like Togo or Tanzania, or heavyweights like Nigeria – continue to embrace protectionism, whether in the form of import restrictions, prohibitions on local employment, and local content requirements.

But the real elephant in the room is potential foregone revenue. Many African countries – particularly though not exclusively smaller, land-locked states – generate a high proportion of tax revenues from customs and duties; and, many of these countries have yet to articulate a clear strategy for replacing those with more sustainable sources.

In 2017, Botswana generated 44.8% of all tax revenues through customs and duties. Gambia, similarly, generated 45% of its tax revenues from customs, while the DRC, Benin, Togo, Lesotho, the Maldives, and Ethiopia raised 34.5%, 25%, 20%, 19%, 18% and 17% of tax revenues, respectively, from import duties. Those are not insubstantial sums.

“It is encouraging to see such a high volume of signatories for the AFCFTA, but the hard work really only starts now… and given the high proportion of revenues these countries derive from customs and duties, reducing or removing tariffs is going to be a very expensive and politically difficult process, especially for smaller countries like Benin or Togo,” explains John Ashbourne, a senior emerging market economist at Capital Economics.

When it comes to ‘walking the walk’, the conviction amongst some of the region’s largest economic players to abide by the ethos of the agreement may be curtailed by their own domestic macroeconomic challenges.

Nigeria, despite its more recent overtures and intimations around implementing the continental free trade agreement, is more likely than not to face those challenges as it maintains stringent FX controls and import restrictions in a bid to shore up as many US dollars as it can muster – despite the progress made on bolstering its reserves over the past year. With incumbent Central Bank of Nigeria Governor Godwin Emefiele recently appointed for another term, analysts largely expect a continuation of the status quo. 

Around two-thirds of Nigeria’s government revenue, much of which is derived from the export of crude oil and petroleum products, goes towards debt servicing. The government also plans to borrow up to USD2.3bn from external markets over the coming fiscal year (and another USD2.3bn equivalent from local markets), and in the longer term, hopes to increase infrastructure investment to the tune of USD10bn to USD20bn over the next five to ten years.

“The economic situation and the trajectory of its ambitions seems to dictate that it is likely more interested in pursuing dollar revenues, which are largely derived outside the continent.”

Making Multiple Overlapping Communities Work Together

Perhaps more uncertain is the extent to which overlapping regional blocks and communities will dovetail with the proposed structure of the free trade area.

Of the eight economic communities recognised by the African Union, some – like the Common Market for Eastern and Southern Africa, a 21-member free trade area stretching from southern central and north eastern Africa – risk becoming largely redundant. Others, like the increasingly tightly-knit though at times tempestuous East African Community (EAC), will likely need to confront some difficult questions about how they proceed on sub-regional integration in the context of a much wider effort to place countries near and far on level ground.

“There exists a plethora of rules that govern trade between Kenya and Uganda, for instance, but no such framework – until now – exists to regulate trade between Kenya and Ethiopia, so in that sense, something like an AfCFTA is very beneficial,” Ashbourne explains.

Indeed, the agreement could be of most near-term benefit for countries that largely rub up against these existing trade zones and communities – like Zambia, for instance – but that haven’t yet been included in them. Others, like Rwanda for instance, could ably position themselves as thoroughfares to support further trade across these multiple overlapping communities.

But, that a more ambitious free trade agreement could help overcome tensions that already persist against a backdrop of ongoing trade integration seems unlikely.

Both EAC members Kenya and Tanzania only recently began de-escalating from a bilateral trade war which last year saw tit-for-tat imposition of duties on various goods, import bans on certain commodities, and – apparently – intentional delays at the border between the two nations, largely designed to frustrate traders by slowing the movement of people and goods.

“The real question at the end of the day is whether a country like Kenya will – politically and practically speaking – feel comfortable treating goods or labour migrants from Nigeria or Ghana in the same way it would those from Tanzania or Uganda.”

Relieving Non-Tariff Bottlenecks to Trade in Africa is Key

Nobody said free trade would be easy, particularly when it means eroding trade barriers between 53 countries. The initiative should be celebrated and supported both within and outside the continent. But even if legal harmonisation were achieved, payment mechanisms fully fleshed out, or tariffs reduced to nearly zero on all intraregional trade, we are still left with a chronic need for infrastructure to support further intraregional trade.

Estimates by the African Development Bank published at the end of 2018 suggest that the continent’s infrastructure needs across power, water and transportation amount to between USD130bn and USD170bn a year, with a financing gap of up to USD108bn, far higher than previously thought.

Due in part to the nature of demand for goods produced in Africa, much of the continent’s logistics and trade infrastructure being prioritised is primarily outward-facing, designed to carry things like palm oil, cocoa or precious metals to export markets in Europe and the Far East. China accounts for a substantial source of demand for these products, as well as a growing share of the funding used to develop port and rail infrastructure to support their export, raising concerns not only about how the region’s economies will be able to finance that gap (whether through Chinese borrowing or more expensive loans or Eurobonds), but which projects get prioritised first.

Razia Khan, Managing Director and Chief Economist for Africa and Middle East at Standard Chartered Bank, says that while it’s far too early to pass judgement on AfCFTA’s implementation, most of the region’s economies must still overcome the hurdle of the lack of enabling infrastructure to facilitate the physical trade in goods, especially intra-regionally.

“While there is a need for more investment, given the recent rise in public debt ratios, affordability is also a question… the key bottleneck is the lack of enabling infrastructure to facilitate more regional trade. Much of Africa’s trade has traditionally had an external focus, rather than an intraregional focus, and the major infrastructure – ports, road, and rail – largely reflects this.”

Opinions are split between those who believe the AfCFTA will in itself incentivise more inwardly-directed infrastructure that supports transportation and trade, and others who argue that the nature of domestic economic demand in many African countries would have to change before regional leaders see a need to start pumping billions of dollars into new rail or road networks.

“It’s a classic Chicken-and-Egg problem. [African] leaders need to see progress on industrialisation, which will create new and more highly-paid jobs, and stimulate demand for higher-value goods that can be produced within the region – thereby providing a stimulus for trade. But the same leaders are either unwilling or unable to afford the scale of infrastructure investments required that can support further trade of those goods until it’s clear there is demand,” Besseling says.

That Chicken-and-Egg paradigm isn’t just linked to physical infrastructure. Financial services, which are largely absent from the AfCFTA and related discussions, could in fact become one of the leading beneficiaries of the proliferation of free trade on the continent, assuming the benefits of cross-border financial activity can be more widely dispersed. The risk is that regional leaders of nations with smaller, less-developed financial sectors respond negatively to incursions from pan-regional heavyweights like Standard Bank or EcoBank, or international investment banks emboldened by regulatory harmonisation.

“[Financial services] would be difficult to include [with AfCFTA] because the firms, which would benefit from easing of doing business cross-border, would largely be from a handful of countries – South Africa, Kenya, or Mauritius, for instance. For countries that have poorly developed or small financial sectors, their governments would rightly be quite worried about the implications of opening up their banking systems to South African and Kenyan lenders,” Ashbourne explains. “It would be an amazing opportunity, but there would be a lot of opposition.”

But more intraregional trade and labour migration could certainly stimulate greater need for supporting financial services infrastructure in Africa, a longstanding bottleneck for pan-African businesses. Given the scale of economic migration in Africa, which arguably favours less than a handful of economic powerhouses in terms of attracting talent, greater financial integration could make it easier for SMEs and large organisations alike to borrow or establish themselves in other parts of the region. For larger organisations, greater financial integration could also mean finally moving beyond having to choose between borrowing in one’s domestic currency or borrowing in hard currencies.

“Financial services are less constrained than other economic sectors in terms of their cross-border reach, and this is potentially where the impact of an increased intraregional focus is likely to be both the most rapid, and the most profound. While some element of regulatory harmonisation will still be needed, with the adoption of digital banking the benefits of greater scale economies are likely to be significant,” Khan concludes.

Policy Africa Global
2175 Asian Investors Continue to Look to GCC Despite Rising Geopolitical Risk For Asian investors searching for returns across emerging markets, the GCC has long been considered a relatively low-risk, higher-yielding option. But with geopolitical tensions reaching a boiling point, and a number of GCC states fiscally exposed to oil price swings, former safe havens could become a riskier bet. Ultra low rates driving cross-regional deals 16 Jul 2019 Asia Pacific Market Insights 46 Tue, 16 Jul 2019 12:41:18 GMT With ultra-low rates becoming the norm across many parts of Asia, institutional investors are looking further afield for high-yield opportunities, often turning to emerging markets.

Enter the GCC. Large bond and sukuk markets dominated by sovereign and quasi-sovereign names – which account for approximately 80% of issuance – have increasingly drawn the attention of both fund managers and institutional investors across Asia.

That institutional investment base is large and growing. According to a report from Willis Towers Watson, a consultancy, Japanese pension funds held USD3.05tn worth of asset as of 2017, resulting in an assets-to-GDP ratio of 62.5%. South Korea also boasts a sizeable pensions industry, with USD725bn worth of assets, with a 47.4% assets-to-GDP ratio. Hong Kong’s pension system, meanwhile, manages USD164bn worth of assets, which equals a 41.9% assets-to-GDP ratio, and Malaysian funds hold USD227bn with a ratio of 73.4%.

But by comparison with many of their peers, Asian pension funds have typically been more conservative in their investment approach. As of 2017, for example, 56% of total Japanese pension fund assets were invested in bonds, with 30% in equities and the rest in cash and alternative investments such as real estate. Australian pension funds, by comparison, have just 14% of their assets invested in bonds and 49% invested in equities.

“Historically, the GCC has been a natural place for Asian investors to engage with,” argues Todd Schubert, Managing Director and Head of Fixed Income Research at Bank of Singapore. “To a large extent, this is because of the linkages with the sukuk market – there is a large Malaysian buyer base in Asia. Most roadshows from the GCC will come to Singapore and other parts of the region.”

For risk-averse institutional investors in the East, the strong local bid within the GCC – where buy-to-hold strategies remain prevalent – is an additional benefit, insulating GCC credit from the volatility that often thwarts borrowers based in other EM jurisdictions. With around 60-70% of all credit in Asia originating from China, the GCC is a healthy avenue through which life insurers and pension funds can diversify.

According to one senior portfolio analyst, who handles institutional funds for a major Taiwanese life insurer, credit that is inherently tied to the sovereign is particularly appealing because of its implicit or explicit guarantee – hence the preference for the GCC, alongside select Latin American sovereigns and quasi-sovereigns.

Although GCC debt is well-received by Asian investors, there are not enough regular issuers in the GCC to fulfil demand from the east. In part, this is because of local banking sector is easily able to provide cheaper funding. But as sovereigns look to stretch the tenors they seek, they are increasingly being forced to look externally. 

One fixed income analyst at Nippon Life, the largest life insurance company in Japan, explained that GCC sovereigns were appealing, and that over the medium- to long-term they plan to look in greater detail at GCC corporate debt. Currently, their mandate only allows a relatively slim proportion of their portfolio to be invested into the region – though the analyst noted that they are pushing internally to expand this limit

The long-term liabilities borne by Asian institutional investors are also beginning to dovetail with the longer-dated paper issued by GCC sovereigns as they continue to grapple with deficits and wide-reaching reform programmes that require robust external borrowing.

Growing Heterogeneity

Until around 2014, the GCC was often viewed as a relatively homogenous region. But the crash in oil prices exposed the degree to which economies across the region were dangerously yet unevenly unbalanced. Since then, as states have embarked upon ambitious reform programmes (or didn’t, in some cases), the GCC is viewed with far more granularity than it previously had been.

But according to one senior portfolio manager, a number of Asian institutional funds often do not explore the idiosyncrasies of GCC debt; credit ratings remain a lynchpin of the investment process, dictating the portfolio selection process to a large extent.

As geopolitical risks in the Gulf continue to build, it is unclear whether these investors are cognisant of the potential economic damage on the horizon. One London-based fixed income analyst noted with alarm that geopolitical risk was yet to be priced into GCC credit and argued that it is politics, not fiscal issues, that poses the greatest issue to the GCC.

Geopolitics is the main driver that has can potentially derail the region, Schubert argues.

“If geopolitical tensions continue, then we will see outflows, not just in terms of buying but also real investment; this is the wild card. The rhetoric over Iran in recent weeks is something altogether different.”

“From a ratings perspective, the GCC [credit] is cheap; from a geopolitical perspective, it is fairly valued,” noted another analyst.

One senior portfolio manager pointed to a spate of problems that could destabilise the region further. The murder of Jamal Khashoggi, rapidly escalating tensions with Iran, crises of succession in Saudi Arabia and Oman, alongside broader vulnerabilities to oil price fluctuations and a tepid real estate sector in the UAE all have the potential to tip the region into crisis.

Whether Asian investors, who often lean heavily on credit ratings in the investment process, will react early enough to this cocktail of potential threats remains to be seen. In the meantime, the GCC looks set to remain a sweet spot for the Asian investors looking eastwards.

Currencies Middle East Asia Pacific
2173 Brazil: Despite a Challenging Outlook, the Local Market Grows Leaps and Bounds It has not been an easy 12 months for Brazil’s corporate sector, which faces a multitude of challenges, both internal and external. Bolsonaro’s victory in the elections, though divisive, at least provided some reprieve from the political uncertainty that has weighed on Brazil’s markets in the run up to the vote. Still, many questions remain around the direction of policy, and the new government’s ability to push it through congress, as well as broader shifts in the macro-economic environment. What's weighing on CFOs' minds? 15 Jul 2019 Brazil Market Insights 66 Mon, 15 Jul 2019 15:46:51 GMT External pressures persist. Emerging market assets have been battered by US tariffs, prolonged and rarely successful trade negotiations, and geopolitical flare-ups that at various points through the year threatened to upend the global economy. As a result, the Brazilian real, like many EM currencies, experienced significant volatility in the past year; spooked by rising FX risk and the increasing cost of borrowing on the international markets, borrowers and issuers in Brazil (and indeed through much of Latin America) have been retreating to the domestic market, which has boomed since the start of the year.

Corporate CFOs reduced international debt sales almost 40% in 2018, partly to avoid additional expenditure on hedging against a strong US dollar. Locally, sales held steady amid record low interest rates, marginally improved GDP growth expectations and still ample domestic liquidity in Brazil, and Latin America more broadly.

It is in this peculiar, yet promising, environment that many corporate CFOs, Treasurers and finance managers found themselves in as they convened for an exclusive roundtable discussion with Bonds & Loans and HSBC in Sao Paulo in June and ahead of the Bonds, Loans and Derivatives 2019 conference.

Some of the discussions, key themes and learnings drawn therefrom will be summarised in this report, which – we hope – will help other CFOs and Treasurers navigate a challenging economic environment and increasingly complex funding landscape.

Political Landscape: Challenging, but Promising

While the consensus among corporate finance managers was that political uncertainty diminished tangibly with the passing of the elections, few of them have been able to push politics to the back of their minds entirely. Most of their concerns currently revolve around the progress on the reform of Brazil’s pension system. As the revised (and likely watered down) draft of the proposal is about to be unveiled, many questions remain unanswered.

How much of the total savings will be lost to revisions? Will the draft automatically include the states and municipalities? And will this draft glide through all the necessary hoops and be passed by the Lower House before mid-year recess?

Furthermore, as one participant pointed out, much more work will need to be done beyond the pension reform.

“The government has a big task ahead in terms of fiscal targets. The fact that the fiscal gap is being addressed through pension reform is a positive factor. However, the reform – even if passed – will not be a panacea, but only the first step,” said Felipe Bomfim, CFO of Patria Investments.

Most CFOs agreed that the uncertainty over reforms has been weighing on market sentiment in Brazil, negatively impacting issuers’ ability to secure funding. But this is where the banks – especially international ones – can introduce solutions that are tailored to the idiosyncrasies of the local corporate sector.

“In the big scheme of things, the current short-term outlook for the economy is much better than it has been in past decades; there is less pressure on balance accounts, and the country’s long-term prospects are appealing to investors worldwide,” added Bomfim.

Infrastructure in Brazil – Next Steps

According to the World Economic Forum, Brazil ranks 108th out of 137 countries in the “quality of infrastructure” category, well below even some of its smaller regional peers. Yet it is this very gap that holds much of the country’s vast growth and investment potential, particularly as infrastructure investors tend to look for windows of at least 10-15 years for ROI.

“The appalling state of infrastructure in Brazil is actually a huge opportunity, especially now, as historically large-scale infrastructure development programmes formed a big part of any post-recession cyclical recovery in economies world over,” Bomfim pointed out.

The new government, headed by a “strong team of regulation and privatization specialists,” is driving this development; while this is still a tough market, the iterative progress on formulating and reforming regulatory frameworks is seen as encouraging. IPP, the public-private linkup initiated in 2016, has already achieved significant results: of the total of 193 projects picked up by the programme, 136 have been successfully auctioned off and could translate into nearly USD68bn of investments over the next few years.

New regulations in this sector will also have to be part of the government’s toolkit of fiscal solutions, alongside pensions and tax reforms, participants agreed. In the meantime, the BRL20bn (approx. USD5bn) fiscal stimulus package proposed by the government in early June should be sufficient to revive short-term growth and prevent another recession.

While the recent surge of activity in the local markets is facilitating investment in projects, it is also increasingly the case that local lenders are becoming more discerning, willing to put capital towards high quality projects and ventures, but reluctant to gain exposure to riskier ones. But this creates an opening for international banks and multilaterals to provide alternative funding channels.

Innovative structured finance instruments could help plug the gap; over the past year, ECA and IDB-guaranteed wrapped infrastructure debentures have allowed some borrowers to secure longer maturities even in periods of severe volatility or uncertainty. It is still seen as a rather exotic, out-of-the-box solution that is offered by a select few global lenders, but may become more common, particularly in a more accommodating regulatory landscape.

Bright Spots Amid Scarce Deal Flow

The pace of growth in the local capital markets – often at the expense of cross-border borrowing – has taken many participants and observers by surprise, and remains a key theme in Brazil’s – indeed the wider region’s DCM space in recent months. Almost 40% of the USD140bn in corporate bonds issued in the region last year were denominated in local currencies, the highest percentage since 2012, according to Fitch Ratings.

“Now that the cost of funding in BRL – compared to borrowing in dollars and swapping into local currency – has become so appealing, it makes more sense for some issuers to tap the local markets and take advantage of this arbitrage,” said Claudio B Matos, Head of DCM Origination, Brazil at HSBC.

Corporate chiefs participated a spate of bond buybacks and local currency refinancing transactions over the past three quarters, with one participant sharing a positive experience in being able to push sizes and tenors on their transaction to new levels rarely seen in previous years.

“Treasury bonds are now less appealing to local investors compared to four or five years ago, and we are seeing banks being more willing to extend tenors on debentures – from four to six years on average two years ago, to between seven and ten years now. The cost of issuance has also come down quite a bit amid historically low rates, and the country’s investment index relative to the curve has also improved,” they noted.

That said, following the Lava Jato scandal, local banks are really focussing on solid projects and strong names, which has the effect of stratifying the market – with liquidity being channelled towards high-end corporates, making things more difficult for high-yield and mid-sized corporates struggling to source funding.

Top-tier borrowers like Suzano, Ultrapar and Klabin, have tapped the cross-border bond markets without much friction over the past year, but as exporters they have the advantage of sizeable dollar-denominated revenues.

These types of corporates have made a concerted effort to increase both the share of their dollar-denominated debt and the share of bonds in their overall debt composition in recent years. In Suzano’s case, within a span of five years, bonds went from 10% to 40% of overall debt, which means the company is able to access international markets even during downturns or periods of volatility.

“Over the last 9 months we’ve issued USD3.2bn in USD capital markets instruments. But it has taken the company many years to build up the reputation to do so, and it’s a great business case for Brazil’s corporate market. We now have the longest average debt maturity in Suzano’s history, around seven years, and the lowest average costs,” commented Julio Ramundo, Corporate Finance Director, Suzano.

Other corporates are finding new ways of diversifying their investor base; for example, some are looking to tap Asian or European funds, but few have actually sought to access alternative currency funding such as EUR or JPY as yields have been less favourable than in USD markets; instead, Asian and European investors gain exposure to Brazil’s corporate sector via the USD markets.

Still, banks are confident that broader access to international market will return and in the meantime are encouraging CFOs and Treasurers to continue diversifying capital structures and FX exposure given the right conditions.

“The international markets continue provide a much deeper wallet for Brazilian corporates in the long run, and will come back into the picture as the current flurry of “arbitrage-driven deals” fades,” Matos concluded.

Commodity Prices, Rates, and Other Roadblocks

While the current trend towards tapping local markets appears to stretch across the board, challenges and risks preventing some corporates from accessing international capital pools are often sector-specific.

In April, industrial production surprised to the downside, at 0.3% month-on-month. Mining and manufacturing sectors have underperformed, with the latter expanding a mere 1.1% in the last quarter, while core retails sales contracted 0.1% month-on-month.

This slowdown is exacerbated by idiosyncratic challenges in other sectors. Take the sugars and ethanol sector, for example, which has been plagued in recent years by a double-whammy of price instability and poor governance.

Over the past few years, sugar has become extremely cheap, while ethanol, as a commodity with a strong seasonal characteristic, saw severe price volatility. Given the fact that there is no real futures market for this commodity, the resultant lack of hedging options leaves industry giants completely exposed to the vagaries of commodity trade – in an already very volatile macro environment.

Additionally, within the industry there has for the past decade been a huge imbalance between the expansion of sugarcane crushing capacity in Brazil, on the one hand, and stagnant growth in the availability of sugarcane, on the other.

“The tug of war for raw material means that farmers retain an overwhelming portion of the margins at the expense of other production chain participants,” lamented Treasury Director at Biosev Carlos Gradim.

Meanwhile, the expanded capacity has a lot of leverage associated with it, and was hit by price controls and prolonged bear markets, which led to a number of defaults. The four largest sector players have defaulted in recent years, presenting an unfavourable track record to international investors.

All of this means that remaining market participants are starting off from a highly leveraged position, and with investors unable or unwilling to treat the sector in a more discerning way, they are mostly refinancing and rolling over existing debt, with trade finance-related US dollar-denominated products as the only real alternative to the bond markets – which are in turn challenging to roll over unless underlying commodity prices improve.

Many of the smaller sector players have been entirely shut out of the international markets since 2013, and have instead been forced to go to the bank markets, mostly to borrow in US dollars, as local lenders continued to shied away from the industry. Barring a major rebalancing of supply chain margins in the industry, or a prolonged rally in sugar prices, breaking this vicious cycle will remain difficult.

What to Hedge? And by How Much?

These types of bear markets have an unpleasant tendency to spread across interdependent sectors: a struggling agricultural sector tends to undermine fertilizer, farm equipment and trucking industry players. In the trucking sector specifically, which for the past two years has been recovering from a previous crisis, the focus has been on upgrading and renewing existing fleets, rather than investing into additional capacity. But as the policy landscape continues to evolve following the new government’s ascension last year, the market is hopeful that it will see renewed public sector support for the agriculture sector.

Likewise, the ability (or lack thereof) to hedge commodities essential to the business is a cross-sector challenge. In the aviation space, for example, fuel price is a key market variable, yet hedging 100% of that risk is far too expensive for airlines. That is down to two factors: oil price is prone to large and increasingly unexpected swings, which means a full hedge could be as dangerous as no hedge at all; secondly, it is also not always clear which products need to be hedged – crude oil, its refined biproducts or a mix of both?

Some airlines decide against hedging altogether – that trend in particular has been set by US-based carriers. “If no one hedges, then no one will need to start hedging when the market readjusts,” explained one CFO. Some airlines instead choose to do a partial hedge, often around 30% of fuel purchases, mostly via a combination of market derivatives and FX instruments.

In order to minimize those risks – and avoid additional FX exposure – some of Brazil’s airlines have avoided the international markets this year in favour of bilateral debentures with banks. Market access windows, while fleeting, appear more numerous than those found in the international markets. This is applying some pressure on the local banking sector to reduce costs, particularly as investors’ interest in the local markets heats up.

ESG & Sustainability Potential

Amid the shortage of traditional fixed income solutions, more and more corporates are also turning to innovative alternative funding sources. ESG-linked borrowing and other types of sustainable finance is becoming increasingly prevalent; it is a demand-driven market, with demand for these assets far outstripping supply, and with dedicated portfolio allocations to sustainable assets rising every year.

According to a recent study, a total of 71% of investors believe that asset values are – or soon will be – influenced by ESG ratings, while 31% of investors have requirements to report information relating to environmental or social impact and risk of their portfolios.

While there have been few ESG-linked transactions out of Brazil, corporates are increasingly responding to this surge in investor demand by “testing the waters” in this market. One recent green bond issuer, for example, noted that while tapping the local green bond market did not offer them a visible price advantage, the process also was also far less complicated than expected and will be even easier to replicate, thus laying the groundwork for an “ESG story” for the company.

The local ESG markets can offer sufficiently long tenors and attractive pricing – in some cases only 30bp wide of comparable sovereign notes, so there is no urgent need to access alternatives in the international markets.

Other participants observed that, while there is no clear primary market advantage, ESG assets tend to perform better on the secondary markets, which amounts to an incentive for issuers and borrowers to issue “green” (or “social”) if they want to maintain market access. Still, other prospective issuers admitted that while the improved transparency and reputational advantages of sustainable financing are tempting, it remains a difficult proposition to pitch internally without a clear cost benefit.

A Glass Half Full – and Filling Up

It is perhaps a testament to the strength of the Brazilian market and the resolve of her practitioners that, despite an evident lack of clarity and engagement from the new administration, a still fragile macroeconomic environment and a clouded outlook for emerging markets and the global economy – both shaken by tariffs and trade wars, the bulk of the corporate financiers that took part in the CFO roundtable were cautiously optimistic about the economy.

While sector-specific challenges continue to present themselves, policy uncertainty lingers and capital market windows open and shut in a blink of an eye. Top-tier Brazilian corporate names have established such a strong and permanent foothold in the global capital markets that investors will continue to pile into their bonds regardless of the immediate difficulties facing the country.

The small and mid-tier companies, on the other hand, have indeed found it more challenging to source funding when global markets find themselves in the rougher waters, but have found ways of adapting their strategies by either tapping into the domestic capital pools or exploring less orthodox alternatives such as ECA-backed structures or sustainable finance formats.

“Brazil is always a glass half-full, half-empty type of situation; but the longer you wait, the fuller it becomes. After all, look how far we’ve come in the past 15 years!” concluded one of the session participants.

Macro Ratings Policy Americas Brazil Latin America
2172 Brown Brothers Harriman: Emerging Markets Preview for the Week Ahead EM FX was mixed last week despite the dovish signals from the Fed’s Powell. Weak data from emerging Asia support the notion that the ongoing US-China trade war will continue to weigh on global growth and trade, which is negative for EM. We remain cautious on EM, especially given our less dovish take on the Fed. Analysis from Win Thin 15 Jul 2019 Global Market Insights 55 Mon, 15 Jul 2019 07:29:45 GMT China reports June IP, retail sales, and Q2 GDP Monday.IP is expected to pick up to 5.2% y/y, while retail sales are expected to slow to 8.5% y/y. Q2 GDP is also seen slowing to 6.2% y/y. US-China relations continue to fluctuate, with Trump complaining last week that China hasn’t met its promise to buy more US agricultural goods. China officials have declined to confirm that promise and there was no official communique to emerge from the Trump-Xi meeting.

Poland reports May trade and current account data Monday. June industrial output and PPI will be reported Thursday, with both expected to slow significantly from May. June real retail sales will be reported Friday, which are expected to rise 3.8% y/y vs. 5.6% in May. The central bank has maintained its ultra-dovish forward guidance of steady rates through 2021. Next policy meeting is September 11, no change is expected then.

Colombia reports May manufacturing production and retail sales Monday. The former is expected to rise 4.2% y/y and the latter by 5.0% y/y. While inflation remains in the top half of the 2-4% target range, the sluggish economy should keep rates on hold in H2. Next central bank meeting is July 26, no change is expected then.

Israel reports June CPI Monday, which is expected to rise 1.2% y/y vs. 1.5% in May. If so, inflation would move closer to the bottom of the 1-3% target range. Next central bank meeting is August 29, no change is expected then.

Argentina reports June CPI Tuesday, which is expected to rise 2.6% m/m vs. 3.1% in May. If so, the y/y rate would slow to 54.8% y/y. This would be the lowest since March and the first y/y deceleration since December. However, the bank should not risk any sort of premature easing. Lower inflation and a stable peso should be helpful for Marci’s reelection chances this fall.

Singapore reports June trade Wednesday. NODX are expected to contract -9.1% y/y vs. -15.9% in May. After the shock -3.4% SAAR contraction in Q2 GDP reported last week, markets are bracing for weak data ahead for the entire region. MAS is likely to keep policy steady at its semiannual meeting in October, but we think risks of a dovish surprise are building.

South Africa reports May retail sales Wednesday, which are expected to rise 1.7% y/y vs. 2.4% in April. The economy remains weak, while inflation is right at the center of the 3-6% target range. SARB meets Thursday and is expected to start the easing cycle with a 25 bp cut to 6.5%. The last move was a 25 bp hike back in November.

Bank of Korea meets Thursday and the market is split between no move and a 25 bp cut. CPI rose 0.7% y/y in June, well below the 2% target. The economy remains sluggish, leading most to expect the BOK to start an easing cycle soon. If not this week, then a cut at the next meeting August 30 seems very likely. The last move was a 25 bp hike back in November.

Bank Indonesia meets Thursday and is expected to start the easing cycle with a 25 bp cut to 5.75%. CPI rose 3.3% y/y in June, below the 3.5% target but within the 2.5-4.5% target range. The bank hiked rates 175 bp last year and so we believe that a cut this week would be the start of an extended easing cycle.

Chile central bank meets Thursday and is expected to keep rates steady at 2.5%. CPI rose 2.8% y/y in June, below the 3% target but within the 2-4% target range. The surprise 50 bp cut last month took back all of the bank’s previous tightening cycle. We cannot rule out further easing, but this month seems to soon.

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