Strategy Note / Global

China devaluation another US-China friction and a risk for rival exporters

  • China's fixed Renminbi rate has depreciated 0.7% in the last month, 2.6% ytd, 3.3% in last year, 8% in last 5 years
  • Currency one of many frictions with the US, eg capital flow, trade, territory, technology, multilaterals, Hong Kong
  • Versus most Asians, China has devalued less ytd but more on 5-year view (more than Bangla and Vietnam over both periods)

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Geopolitics after Covid-19: US-China cold war, fragmented EU and GCC

China and Hong Kong: 'One country, two systems' becoming 'one world, two camps'

Trump's tougher election makes China friction (and EM risks) worse

Biden's US foreign policy would be positive for Emerging Markets

US Dollar as reserve currency after Covid-19? A moot point for EM ex-China


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Strategy Note / Global

Trump's tougher election makes China friction worse

  • Covid-19 policy error has punctured the economic basis for Trump's re-election; hence the deflection of blame to China
  • Cold war creep was inevitable but the coincidence of Covid-19 and the US election hasten it, with more risk for EM as...
  • ...Economic policy (tariffs, currency, overseas investment, debt relief) and multilateral institutions are weaponised
Hasnain Malik @
Tellimer Research
4 May 2020

US-China relations worsen due to US Covid-19 policy and deflection of blame 

The creep towards a cold war between the US and China is inevitable, given that both are of a size that brings them into competition across trade, technology and territory, and neither has the will or resources to settle the rivalry decisively. The recent frostiness seen on multiple fronts is in line with our expectations. 

For investors in emerging markets, some of the negatives (eg increased China territorial friction with ASEAN rivals in the South China Sea, weaker China FX rate) might be offset by positives (eg another bout of US tariffs on China that accelerates both the transition of low-end manufacturing away from China to other, more geopolitically onside, low-cost locations like Vietnam, and reinvigorated implementation, from the Chinese side, of BRI projects in countries like Pakistan). 

But one area where the lack of coordination between the US and China has already played out is the global policy response to Covid-19 and the credibility of an international organisation tasked with that coordination, the WHO, that has been weakened (by both sides, arguably).

Another global policy challenge where this friction may act as an outright negative is on coordinated debt relief for poorer countries in EM (eg Ghana, Kenya, Nigeria, Tanzania, Zimbabwe in Africa or Pakistan in South Asia). 

China is a signatory of the 15 April G20 communique on the debt service suspension initiative for poorer countries; an unprecedented bilateral agreement that promises coordinated action. But the agreement is subject to well-worn implementation and compliance risks, which are more acute when two of the largest providers of bilateral debt are increasingly distrustful of each other:

1) China's lack of transparency over the full extent of its debt exposure via state-affiliated entities (an issue for Europe as much as the US) one team of academics estimate that 50% of China's lending to emerging markets is not reported to the IMF or World Bank; 

2) The lens of the Belt and Road Initiative through which China may view debt relief (which may conflict with US priorities); and

3) China's willingness to participate in a multilateral approach over which it does not exert dominance.

Context of the US election in 2020, China party congress/presidential election in 2022/23

In the context of US President Trump's re-election bid (November 2020), which has unexpectedly been imperiled by a deficient response to Covid-19, rhetoric may be matched by more more meaningful action (eg new tariffs or sanctions). The rhetoric from the Trump administration has recently included blaming China for covering up Covid-19 (both its origin and its threat), compromising global organisations like the WHO (and therefore freezing its funding, where the US provides 22% and China 12%) and engaging in predatory lending and investment practices (eg in a warning repeated most recently to Israel on the need for more thorough scrutiny of Chinese inward investment). 

China President Xi has the benefit of a longer-term mandate (courtesy of the removal of term limits and an authoritarian political apparatus) and a sooner return to domestic social and economic normalcy after Covid-19 (regardless of the credibility of official data on infections). This likely makes for at least as much action as rhetoric; since the start of the year there has been friction between China and territorial rivals around the Nine-Dash Line in the South China Sea (Indonesia, Malaysia, Philippines, Vietnam) as well naval brushes with Japan and Taiwan. 

This is not to say that President Xi is impervious to unfavourable rhetoric from the US: to the degree that it infects either domestic opinion (the renewal of Xi's terms as party leader and president are due in October 2022 and March 2023, respectively) or international relations (eg with recipients of Chinese finance currently hoping for global debt relief and assistance), we expect at least a reciprocal rhetorical response.

Related reading

G20 endorses debt service suspension initiative for poorest countries, 16 April 2020

Geopolitics after Covid-19: US-China cold war, fragmented EU and GCC, 20 April 2020

Trump impeachment or election loss: what would it mean for emerging markets, 14 October 2019

Philippines: US to China rebalance continues, not cause for alarm, 12 February 2020

China's BRI: 2nd forum to stir an old debate, 22 April 2019


 
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Strategy Note / Global

MSCI as expected: Argentina, Turkey may exit EM, Iceland in FM, Kuwait in EM

  • Argentina (capital controls), Turkey (short selling and stock lending bans) potential downgrade candidates from EM
  • Nigeria (FX liquidity), Lebanon (capital controls), Bangladesh (floor limit prices) potential downgrades from FM
  • Iceland (removal of capital controls) upgraded to FM and Kuwait (sufficiently developed stock market) upgraded to EM
Hasnain Malik @
Tellimer Research
24 June 2020

MSCI has spoken. The highlight is the potential ejection of Argentina and Turkey from the emerging market index.

While there are no shocks, the tyranny of benchmarks for active and passive institutional equity funds means we are all forced to pay attention; regardless of whether MSCI's criteria match the objectives of funds in the emerging or frontier market asset class its benchmarks are the most widely used.

The review reinforces our long-standing view that the emerging markets equity universe is split between the big 5 (China-HK, Taiwan, S Korea, India, and Brazil, which collectively account for over 75% of the index) and the very long tail of countries which makes up the rest. In other words, the boundary in this long tail between small emerging markets and frontier is arbitrary.

The details of the review

In its 2020 annual review of which countries are included in its emerging markets (EM), frontier markets (FM), and standalone indices, MSCI has made the following remarks:

The evolution of EM and FM indices

[Note that these are estimates and may not accurately reflect the most recent daily update of weights, and the chart for frontier is for FM100, not FM.]


 
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Macro Analysis / Global

Euroclear: A possible turning point for Turkey

ING Think
18 June 2020

The government’s motives for the deal

With significant improvement in financial infrastructure and adjustments in legal framework, Russia, Peru, Chile, Malaysia and Poland have achieved to have Euroclearability status in recent years, though there are a number of countries in emerging markets space including Brazil, Indonesia, India, and Philippines etc that do not sufficiently meet all the requirements to be Euroclearable. Strong client interest with the reform driven EM stories have been one of the major drivers for them to join Clearstream.

In Turkish case, key drivers according to the Treasury and Finance Minister Berat Albayrak are:

1) Further align capital market framework with the globally recognised standards: The government has always had an objective of deepening capital markets via diversification of financial instruments and raising more funds through alternative and less costly methods. In this regards, we have seen some efforts to improve capital markets including new capital markets law, new products like issuance of Islamic bonds, establishment of ETFs etc. So, the agreement is seen another step in this direction.

2) Support to the Istanbul Financial Center objective: It is widely acknowledged that an international financial centre should offer deep liquid and sophisticated capital markets and competitive regulator regimes with foreign investment and offshore business flow. So, Minister Albayrak expects contribution from the deal in this regard.

3) Wider foreign access to the local market: For the government, being able to tap into the liquidity provided by international investors through Euroclear is important for the continued development of our local debt markets. The move should also contribute to the local market outlook, as a safe place for bond investments in times of risk aversion.


 
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Macro Analysis / Turkey

Euroclear: A possible turning point for Turkey

ING Think
19 June 2020

The Government’s motives for the deal

With significant improvement in financial infrastructure and adjustments in the legal framework, Russia, Peru, Chile, Malaysia and Poland have achieved Euroclearability status in recent years, though there are a number of countries in emerging markets, including Brazil, Indonesia, India, and Philippines etc., that do not sufficiently meet all the requirements to be Euroclearable. Strong client interest with reform-driven EM stories has been one of the major drivers for them to join Clearstream.

In the Turkish case, key drivers according to the Treasury and Finance Minister, Berat Albayrak, are:

1) To further align the capital market framework with globally recognised standards: The government has always had an objective of deepening capital markets via diversification of financial instruments and raising more funds through alternative and less costly methods. In this regard, we have seen some efforts to improve capital markets including a new capital markets law, new products such as the issuance of Islamic bonds, the establishment of ETFs etc. So, the agreement is seen as another step in this direction.

2) Support to the Istanbul Financial Center objective: It is widely acknowledged that an international financial centre should offer deep liquid and sophisticated capital markets and competitive regulator regimes with foreign investment and offshore business flow. So, Minister Albayrak expects contribution from the deal here.

3) Wider foreign access to the local market: For the government, being able to tap into the liquidity provided by international investors through Euroclear is important for the continued development of our local debt markets. The move should also contribute to the local market outlook, as a safe place for bond investments in times of risk aversion.


 
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Macro Analysis / Global

Banks face headwinds from shaky emerging market government finances

  • Covid-19 lockdowns have put pressure on EM sovereign finances; banks could be asked to take some of the strain
  • GCC banks appear susceptible to higher taxes (Saudi Arabia recently hiked VAT); Bangladesh banks already heavily taxed
  • Banks in Oman and Sri Lanka appear to have capacity to hold more sovereign debt; Nigeria and Pakistan banks less so
Rahul Shah @
Tellimer Research
19 June 2020

Recent budget announcements (Kenya and Mauritius in Africa, Bangladesh and Pakistan in Asia) highlight the strain caused by Covid-19 lockdowns on emerging market finances. While government spending is increasing to lessen the economic hardship, income is falling as economic activity declines. In this context, we think bank shareholders could once again find themselves in the firing line.

Banks are already exposed to the economic downturn through lower revenues, higher risk costs and tighter liquidity. In addition, regulators have adjusted loan contract terms in most markets so that borrowers may enjoy payment holidays or even lower interest rates.

Banks could face higher taxes and/or be asked to hold more sovereign debt

Tighter sovereign finances could result in two additional claims to which bank shareholders would be exposed. The first is that governments may raise taxes on the banking sector in order to plug fiscal gaps. While governments so far seem content with raising taxes on consumer staples such as telcos, tobacco and alcohol, past experience (such as the super taxes in Pakistan, or the debt repayment levy in Sri Lanka) suggest banks could also find themselves in the firing line.

Which banks could be most exposed to higher tax rates?

Comparing 2020f projected fiscal deficits with last year’s effective tax rates for our banking coverage highlights GCC markets along with Egypt as being potentially most at risk (ie names in the lower left quadrant of Figure 1 below).

Saudi Arabia recently hiked its VAT rate to 15% (from 5%), which could bring in additional revenues equivalent to 4% of GDP. Looking outside the GCC region, we note that Nigeria has already put in place measures to increase the tax burden on its banks via higher VAT (5% from 0% for online transactions, and 7.5% from 5% for other service fee income) and revocation of the tax-exempt status of government securities from 2022. Kenya in 2018 increased the excise duty charged on bank fees from 10% to 20%, which brought in KES8.3bn in receipts that year, equivalent to around 5% of the banking industry’s pre-tax profits. Another example is Egypt, which has introduced a less favourable tax regime for banks’ T-bill holdings. The chart below suggests that other tax-raising measures in these markets cannot be fully discounted.

Which banks will be asked to fund sovereign deficits?

A longer-term impact comes from increased reliance of bank funding by EM sovereigns. As well as crowding out private sector lending, banks carrying more government debt on their balance sheets make their risk profiles more closely intertwined. Even if such instruments carry zero risk-weights, particularly for the most indebted sovereigns, they are anything but, as the recent example of Lebanon spectacularly highlights.

We think banks in Oman and Sri Lanka could be increasingly called upon to carry more sovereign debt assets, particularly given that the likely increase in global sovereign issuance could lead international investors to become more discerning. We note that Sri Lanka banks are currently barred from holding USD sovereign debt, but they continue to invest in LKR-denominated government bonds.


 
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