Emerging markets watch: Argentinean debt and Russian sanctions
August 8, 2014
The following notes address two recent headline events related to emerging markets: (1) the Argentine debt default, and (2) the European Union's (EU's) sanctions against Russian banks. Portfolio managers Steven Landis and Wen-Dar Chen put these developments in perspective.
In Argentina, the media noise is overdone
We believe the recent news coverage regarding Argentina's debt litigation and eventual default has been disproportionate to the amount of debt outstanding. Media coverage has also been heavy handed relative to the default's actual effect on emerging markets as an asset class. (Consider, for instance, that Argentine debt only represents between 0.5% and 1.9% of the various emerging market debt indices we monitor. Analysts widely believe that Argentina's circumstances will not have negative ramifications for emerging markets as a whole.) Other notes to keep in mind:
- Argentina has clearly expressed its desire to service its debt (albeit selectively), and the country's ability to do so is not in question. However, having enjoyed the benefit of the U.S. judicial system during years of litigation and appeals, the administration has made political choices to simply reject court decisions it has not liked; such is the legacy of Peronist populism.
- Argentina is a country with enormous natural resources and a well-educated population. After our visit to Buenos Aires in the fall of 2013, we concluded that the impending end of the Kirchner presidential regime (expected to wind down in 2015) has the potential to reverse years of economic mismanagement and anticommercial policies. Argentine debt and equity prices have performed in a manner consistent with that outlook since that time. (However, we remind investors that Argentina will not achieve its potential unless it regains access to international capital markets — something that will not happen until issues dating back to the 2001 default are fully resolved.)
- To satisfy pending court judgments, Argentina will have to spend approximately 3% of its gross domestic product, a relatively small sum for a country whose debt-to-GDP ratio is a modest 45%. (Data: Bloomberg.) Poorly drafted offering documentation in the indentures for the 2005 and 2010 restructurings are a material impediment to resolving so-called “holdout claims,” but the language self-extinguishes at the end of 2014.
- An “inter-creditor” solution promoted by the private sector may also result in a more prompt and market-friendly outcome. (In this scenario, the country's various lenders — the bond holders — would work out an arrangement specifying their relative rights and establishing how the debt repayments will be allocated.)
In light of the circumstances noted above, we remain optimistic that the current default (more accurately described as a “technical” default) will be resolved, and under no circumstances do we expect it to have an economic effect as severe as Argentina's prior default in 2001.
Russian banks will likely hold their own
When it comes to the EU's sanctions against the major state-owned Russian banks, we view them as having limited economic effects (and we remind investors that we began the year with low expectations for Russian economic growth to begin with). Furthermore, it's important to note that Russia has $472.5 billion in reserves as of July 2014 and $111 billion in U.S. Treasurys as of May 2014 — a cache that can fund the banks for at least two years. (Data: Bloomberg.) So far, at least two of the banks have issued statements indicating their commitment to continuing normal operations. Overall, there appears to be no concern about the banks' abilities to fulfill their liabilities, and Russia's central bank has promised it will provide support if needed.
Longer term, EU president Herman Van Rompuy has indicated that the union remains ready to re-engage with Russia if it starts contributing actively (and without ambiguities) toward a solution to the Ukraine crisis. This is a fragile set of circumstances, and the chances of fallout may remain high until Ukraine's government finds a balance between its economic integration into the E.U. and continued political influence from Russia. Moreover, an escalation of Russian aggression cannot be ruled out, perhaps resulting in more aggressive sanctions.
For now, the conflict has not resulted in material “contagion” to other emerging market assets, a reflection of the maturation process that has taken place in the asset class thus far in 2014.
Investing involves risk, including the possible loss of principal.
The views expressed represent the Manager's assessment of the market environment as of August 2014, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager's views.
Fixed income securities can lose value, and investors can lose principal, as interest rates rise. They may also be affected by economic conditions that hinder an issuer's ability to make interest and principal payments on its debt.
International investments entail risks not ordinarily associated with U.S. investments including fluctuation in currency values, differences in accounting principles, or economic or political instability in other nations.
Investing in emerging markets can be riskier than investing in established foreign markets due to increased volatility and lower trading volume.
A country's debt-to-GDP ratio measures its total national debt as a percentage of its GDP, or gross domestic product. A country's gross domestic product is the monetary value of all the goods and services it produces during a given time period (usually one year).