Perspectives 2020-2021 Public Sector

Citi Perspectives for the Public Sector 30 31 conditions, with investment grade Panama the first to venture into the market in late March, followed by Mexico and Peru in April, Chile in May, and Uruguay in June. High yield sovereigns Paraguay and Guatemala came to market in April, followed by Brazil and Honduras in June and most recently the Dominican Republic in September. Issuers from other regions were also active, including Egypt, Ukraine, Ghana, Turkey, Bahrain, and Albania. Market recovery was fast but concerns are mounting The IMF disbursed record COVID-19 related emergency funding through its Rapid Financing Instrument (RFI) available to all its member countries. This was followed by Rapid Credit Financing (RCF) and Stand-By Agreements (SBA) to support the capacity of affected countries to implement appropriate response policies. These actions helped to boost market confidence. IMF COVID-19 lending by region from March to September 2020, in $ billion Note: *Excludes Flexible Credit Lines (FCL) to investment grade countries totaling $51.9 billion Source: IMF COVID-19 Lending Tracker Initial worries about the investor appetite for sovereigns’ large borrowing needs and the potential need for multilateral support have dissipated rapidly; over-subscriptions and upsized order books have once again become routine. As the EM market has sequentially opened to weaker credits, the list of countries at risk of being shut out of the market has grown shorter. Nevertheless, the recovery in EM spreads and the renewed ability of EM issuers to come to market has been uneven, and this favorable market environment does not negate changes to underlying fundamentals over the past six months that could still cause problems in the near future. Chief among these is the steep rise in debt-to-GDP ratios across EM countries as economies contracted sharply and governments secured funding to tackle the pandemic. Global debt-to-GDP grew to a new record of 331% in Q1, up from 320% in Q4 2019, with EM debt increasing to over 230% of GDP in Q1 2020 (compared to 220% in 2019). 4 While total EM FX debt was broadly stable at $8.4 trillion in Q1, suggesting sovereigns and corporates could still roll over FX liabilities, risks have clearly increased. More critically, debt affordability metrics (particularly interest expense to government revenues) – which have tended to be more closely correlated with sovereign defaults historically – have deteriorated, reflecting the collapse in tax revenues. The concern is that economies might contract further if there are new waves of COVID-19, leading to renewed lockdowns and a further shock to market confidence. Even if global markets are awash with liquidity, investors could abandon EM debt if they believe that debt is becoming unsustainable. What began as a liquidity crisis could – if investor sentiment changes – become a solvency crisis. With around $3.7 trillion of EM debt due before the end of 2020, and FX-denominated debt accounting for nearly 17% of the total, the scale of the potential problem is significant. 5 Bringing multilaterals and investors together Given the breathing space afforded by central bank liquidity injections and improving investor sentiment – as demonstrated by continuing new issuance, including from non-investment grade borrowers – it makes sense to proactively develop a contingency plan that could support EM borrowers should markets begin to turn against them. Key to this process should be increased dialogue among multilateral development banks (MDBs), private banks and bondholders to develop solutions and tools to avert or mitigate a potential funding crisis and to safeguard the prospects for economic recovery in EM countries. Such ideas have been mooted in the past, but have not come to fruition. One reason for this is that there is often a perception in official circles that helping private bondholders hurts the public sector. However, the bond market is not a zero-sum game: it is in the interest of both borrowers and investors to facilitate an orderly market and avoid bonds trading at distressed levels. Moreover, the unique circumstances of the COVID-19 crisis make the need for dialogue all the more acute. To make progress and to avoid worse-case scenarios, all parties will need to be flexible and creative. Underlying credit fundamentals have weakened significantly over the course of 2020 (percentage average estimate for 2020) Source: Moody's CreditView Fundamental Data & Metrics, accessed September 22, 2020 3 Dealogic as of August 28, 2020 4 https://www.iif.com/Portals/0/Files/content/Research/Global%20Debt%20Monitor_July2020.pdf 5 https://www.iif.com/Portals/0/Files/content/Research/Global%20Debt%20Monitor_July2020.pdf Preparing for a Potential Emerging Markets Debt Crisis: A Response Toolkit