After Lebanon, where next? Emerging markets look for weak links

LONDON, March 18 (Reuters) – In the aftermath of Lebanon’s sovereign debt default and with the global economy reeling from its biggest shock in more than a decade, emerging market investors are honing in on other potential weak links from Oman to Zambia.

Record amounts of cash have been pulled out of emerging markets in recent weeks as investors shied away from risks, with the exodus hastened by a plummet in oil prices that has taken a particular toll on oil exporters.

“You have the potential for a lot of dominoes to fall,” said Sonja Gibbs, managing director, Institute of International Finance (IIF). “We have been saying as long as rates are low and government debt is low and there’s an ability to refinance debt then that’s alright. As long as nobody rocks the boat. But this is definitely rocking the boat.”

Many of those now vulnerable are frontier markets, like Lebanon, typically sought out by investors during prosperous times as a way to tap into higher returns than those offered by larger emerging markets.

Selling pressure by exchange traded funds, which have built up a large portion of the market share of hard currency credit in recent years, could exacerbate the challenge for some frontier markets, which tend to have a higher exchange traded fund ownership, such as Jordan, Angola, Kenya, Nigeria, Ivory Coast and Iraq, Pakistan and Azerbaijan, said Trieu Pham, EM Sovereign Debt Strategist at ING.

Oman, a small oil producer which has had its credit ratings trimmed further into junk territory in recent days, has seen its bonds slump by more than a quarter in less than a month.

Investors are particularly worried about Oman’s looming debt obligations, with $1.7 billion of debt due in 2020 and a further $1.8 billion due next year, said an emerging markets fund manager who offloaded exposure to the sovereign last week.

“Oman, with the upcoming maturity and its already high debt, deficit and less likely scope to garner regional support,” said Rachel Ziemba, founder of Ziemba Insights. “It has little foreign currency liquidity and has little room to cut spending. Default is not the only option but it will put the peg under strain.”

Algeria, Nigeria, Libya and Iraq were other oil producers at risk, Ziemba said. Another oil exporter, Ecuador has seen its bonds collapse by around half this year.

Energy importers are also wobbling.

Some of Zambia’s bonds are trading as low as 40 cents in the dollar, having shed around 40% of their value in recent days after doubts arose about the government’s ability to close a fiscal deficit of 7% of GDP with tepid economic growth.

S&P Global last month lowered Zambia’s long-term rating to ‘CCC’, pushing it deeper into speculative territory. It cited increasing risks of likely nonpayment of commercial debt this year.

Fresh from a completed debt exchange with creditors, Mozambique is vulnerable because of its large twin deficits and its junk bond rating, fund managers say.

A broader concern is the ramping up of debt levels across emerging markets in recent years, which has made them more vulnerable to the so-called sudden stop in investment flows.

Although government debt accounts for 52% of GDP in emerging markets, less than half the level in developed markets, on average, 60% of the non-financial corporate debt is from state-owned firms, with levels even higher for China and South Africa, according to IIF. That puts government on the hook for much larger financial burdens, known as contingent liabilities.

The burden is a growing headache for countries facing coronavirus-induced economic slowdowns and capital markets closed to refinancing or new issues.

“Turkey stands out for having a large short-term debt burden relative to reserves and company financials that look more risky,” Renaissance Capital said in a note this week.

Turkey’s lira tumbled on Tuesday to its weakest level since its 2018 currency crisis, extending losses after the central bank cut its key interest rate by 100 basis points to offset the negative impact of the coronavirus.

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