Argentina's humiliating resort to the International Monetary Fund bodes ill for other emerging markets like Turkey, which are heavily dependent on foreign funding, but many developing nations are well-placed to withstand a stronger dollar and the rise in U.S. interest rates, analysts said.
The turn in the U.S. rate cycle claimed its first sovereign casualty May 8, when Argentina said it would seek a credit line from the Fund. It was the economic hardship of a previous IMF program that precipitated the collapse of Argentina's currency peg in what was then the largest default in history in 2001. This was a politically risky step for market-friendly President Mauricio Macri, and one that came only after 12.75 percentage points in central bank interest rate hikes failed to halt a slide in the peso.
Less than 12 months had passed since investors jostled to bid for Argentina's heavily oversubscribed 100-year bond, but current account and government borrowing requirements both running at close to 5% of gross domestic product in 2017 made the country’s financing arrangements unsustainable. The government is asking for about $30 billion, officials told local media.
The peso, which had slid 5% before the announcement, immediately stabilized. The yield on the 100-year bond, which had jumped to 8.39% from a low under 6.9% in October 2017, eased to 8.28% the next day.
Argentina's dash for emergency funding came amid selling pressure on emerging-market, or EM, assets which has gathered force as U.S. Treasury yields have risen above 3%. But not all EMs are in the firing line.
"While dollar strength is causing strain, some countries have been hit worse than others as the stronger dollar has dampened sentiment and highlighted deeper problems in some emerging markets," CreditSights' Richard Briggs wrote in a research note, adding that EM economies reliant on volatile flows of foreign portfolio investment, loans and deposits, rather than on direct investment, are most exposed.
"On that basis, the likes of Turkey, South Africa, Indonesia, Argentina and Sri Lanka look vulnerable," he said.
All of these countries run current account deficits, and of them only Sri Lanka managed to balance its government’s books in 2017. While South Africa and Indonesia are likely to allow their currencies to slide in the face of financial outflows, Turkey, Argentina and Sri Lanka may be tempted to fight back by selling foreign reserves, eating into stocks of sovereign assets already low relative to their external financing needs, Briggs said.
Turkey's currency has been on a downward trend since 2010 and has depreciated by 12% against the dollar since the beginning of February, when the U.S. Treasury yield began to approach 3%. Unlike some emerging markets, including Argentina, it is a commodity importer rather than an exporter, and the recent rise in the price of oil has added to its woes. An increasingly authoritarian government and its proximity to Middle Eastern strife have added to investors' nerves.
The lira fell 1.5% on May 8, and started the next day sharply lower before rebounding 1% amid as the government vowed to protect currency stability. S&P Global Ratings downgraded Turkey one notch to BB-, its third-highest noninvestment grade, on May 1, warning that lira weakness and high inflation were raising the risk it would struggle to cope with its high external debts.
"What we'd be worried about in Turkey is currency collapse," said Paul McNamara, a fund manager at GAM Investments, "That leads to an activity collapse, which leads to problems for the banks, which in turn, makes foreigners much less likely to provide funding."
Turkey's exposure is made more acute by the extent to which its corporate sector has joined in the credit binge. Total credit to nonfinancial Turkish corporations shot up to 67.4% of GDP by the third quarter of 2017, up from 44.8% of GDP in 2012, according to the Bank for International Settlements, or BIS. Such trends are reminiscent of those seen in Asia leading up to that region's 1997 financial crisis, McNamara said.
"Turkey is the exception," he said. "EM more broadly, that credit growth kind of topped out in about 2011 and '12, and even in places like Brazil or India or Indonesia where we saw a lot of credit growth, that story's a few years old. The story of 2013, '14, '15 was really that the credit balancing across most of EM is pretty much complete now."
Nonfinancial emerging market firms quadrupled their debt from roughly US$4 trillion to over US$18 trillion in 2014. But of the more than 400,000 firms the IMF examined, nearly 50% were from China, a country with a current account surplus and only a partially open capital account. In many other locations, like Brazil, Indonesia, and even in Argentina, growth in corporate debt as a percentage of GDP has been more constrained, the BIS data shows.
After years cut off from international markets following their country's last default, Argentine nonfinancial companies' debt is only worth 14.2% of GDP, the lowest in the BIS' list. This should better enable them to withstand the pain of the attempts to support the peso by Macri and the central bank, which has pushed its benchmark interest rate to 40%.
"You hike interest rates, and you're not affecting a big part of the economy," said Edgardo Sternberg, an emerging-market debt portfolio manager at Loomis Sayles, noting that dangers could arise if Macri’s program of economic reforms further erodes his popularity. The president, a wealthy industrialist who has said he entered politics after being kidnapped by corrupt policemen by 1991, has also struggled to lower inflation, running at an annual 25.4%, well above the central bank's 15% target for 2018.
Other emerging-market countries have so far escaped little scathed from this spike in turbulence. While spreads between yields on BB-rated junk bonds issued by emerging-market companies and their developed market peers have jumped above 80 basis points, these are only a fraction of levels reached in November 2014, according to CreditSights. High-yield EM sovereign spreads have risen in line with DM corporate spreads, and, at about 370 basis points, are far from levels near 900 at the beginning of 2016.
Both Turkey and Argentina have large shares of short-term debt denominated in foreign currency, equivalent to almost 100% of foreign reserves and 140%, respectively. But other countries are less exposed, with short-dated debt in Brazil and Russia running at less than 20% of reserves, South Africa at about 60% and Indonesia 40%.
Dollar strength, always problematic for emerging markets, may prove short-lived, according to Jim Barrineau, a portfolio manager for the Hartford Schroders emerging markets multisector bond fund. The disruptive effect of U.S. rate rises will also be minimized by their being so well telegraphed, said Mauro Roca, emerging markets managing director at TCW.
"Fundamentals in EM have improved a lot. We are in a completely different position than we have been in similar situations in the past," Roca said.
This S&P Global Market Intelligence news article may contain information about credit ratings issued by S&P Global Ratings, a separately managed division of S&P Global. Descriptions in this news article were not prepared by S&P Global Ratings. The original S&P Global Ratings documents referred to in this news brief can be found here.