All good comes to those who wait in India
In a very meaningful policy announcement the government said it will recapitalise public sector banks to the tune of 1.4% of GDP, or $32bn. According to the government this will be sufficient to cover losses from all remaining problem loans in the public sector banks. The recapitalisation of public sector banks will have to be followed up by material changes in the management of these institutions to avoid a repeat of the NPL issue when public sector banks were abused by the former Congress-led government resulting in a major quasifiscal deterioration. The Modi Administration has undertaken bold reforms and has now finally decided to tackle the banking sector problem. This is extremely good news for India. Firstly, bank recapitalisation was the single largest urgent reform still outstanding in India. Stronger banks will enable corporate and household credit conditions to improve, which should lead to stronger domestic demand-led growth in the coming years.
Secondly, once the banking sector is healthy there is no real reason (other than lobbying from interest groups) for India not to grant foreign investors greater access to its bond domestic bond market. This will in turn lead to lower interest rates over the cycle, in our view. The news of bank recapitalisation comes against a backdrop of slowing growth due to GST implementation. The government is working to deal with the teething problems associated with GST and the system should start to function as intended within the next couple of quarters.
Meanwhile, Indian inflation is under control as monsoons have been decent, but the Reserve Bank of India is still cautious as the fiscal deficit looks set to widen. This is partly due to bank recapitalisation and partly due to the announcement that the government will spend INR 6trn on infrastructure (mainly roads) over the next five years. In reality, spending will be far less, because India implements infrastructure spending extremely slowly.
Still, this is also positive news because the government is clearly acknowledging the need to deal with the country’s enormous infrastructure deficit. The bottom-line is that India’s medium-term outlook is improving very sharply on the back of Modi’s reforms. As GST drags fade, banks get healthier and infrastructure issues are addressed India will be able to realise its enormous potential. The flipside is that the markets tend to take a much more myopic view. Markets may push bond yields and weaken the currency a bit until the upside actually materialises. Stock markets in India are also expensive with many of these developments priced in, so failure on the part of the government to deliver would pose some risk given rich valuations.
South African Medium Term Budget Policy Statement – unambiguously negative
The South African Medium Term Budget Policy Statement – a key document setting out the government’s fiscal projections – pointed to a material deterioration in fiscal policy with major increases in borrowing requirements for the next couple of years, which will push up the government’s debt burden. Revenue projections are also poor as the economy remains sluggish and the Zuma administration seems more concerned with sustaining its support within the ANC by corrupt means than sustaining the South African economy as a whole. The immediate implication of the deteriorating fiscal outlook is that the risk of ratings downgrades is now materially higher. A downgrade could have material implications for South African bonds and the currency, since South Africa would lose investment grade. Moody’s and S&P are due to review South Africa on 24 November. There are some silver-linings, however. South Africa is not about to default nor will South Africa have a major balance of payments crisis. South Africa’s gross debt to GDP was 51.7% at the end of 2016 compared to, say, 107.5% for the United States.
Also, a change in ANC leadership in December could usher in better policies. Hence, the loss of a fiscal anchor may reprice markets, but if markets reprice too far South Africa will be a buy on value grounds. A more material improvement in the economic outlook will require deep reforms. This will probably only happen if fresh blood is injected into South African politics in the shape of a new ruling party. However, this still looks unlikely under the very long and dark shadow still cast by South Africa’s apartheid past.
China issues first Dollar-denominated sovereign bonds since 2004
The two bonds, a 5-year and 10-year benchmark bond sized at $1bn each were priced at 15bps and 25bps over the US Treasury curve. Markets are therefore pricing China as an AAA credit, underlining the biases that are embedded in ratings agencies due to the perverse incentives they face (the biggest debtors are their biggest clients). Despite the narrowness of spreads the bonds look cheap relative to most developed market bonds, in our view. China has far less debt, undertakes reforms instead of stimulus, grows faster, has stronger political leadership and, besides, issues far fewer bonds. Demand for the two bonds exceeded $21bn. We understand that the unrated bonds will enter the JP Morgan EMBI GD index, which already harbours 67 sovereign names. The Chinese bonds augment the already very broad suite of risk profiles on offer within the diverse EM external debt universe. They also improve the efficiency of the $-denominated corporate bond market within China, because corporates can now price bonds off the government curve.
Brazil – corruption dismissed
The Brazilian parliament dismissed charges of corruption against President Michel Temer, who now has a brief window of opportunity to present a pension reform to parliament for approval before year end. However, it is unclear if the bill will pass. There is very little time and many other bills compete for space in the legislative agenda. Temer is also very unpopular and the charges against him were dismissed with a reduced majority relative to the last time he faced a similar vote. On the other hand, failure to reform now only means that the reform will have to be passed under the next administration, which will pay a high price to do so. Many parliamentarians will therefore understand the logic of passing the reform now and letting Temer take the blame.
The next administration will take office after elections scheduled for late 2018. The importance of reforming the pension system is illustrated richly by the dynamics of fiscal deficit. The government has slashed discretionary spending by more than 14% in real terms this year, but social security spending has increased 10.3% over the same period. Hence, statutory social security payments are almost entirely nullifying what is a very serious spending adjustment in the rest of the public sector. Meanwhile, the current account declined to the lowest level since March 2008 (0.6% of GDP in rolling 12-month terms). The current account was in outright surplus to the tune of $0.4bn in September versus a consensus expectation of $0.3bn).
Jan Dehn, head of research at Ashmore Group
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