29th August 2018

EM – Not fixing the roof while the sun is shining…?

On Friday (24 Aug), S&P downgraded Zambia to B- from B[1] and kept it on a stable outlook. At time of writing (28 Aug), all its USD bonds are trading at spreads of more than 1000bps[2], over the respective US Treasury Note. This is a huge contrast versus the start of the year, when its 2027 bonds were trading 450bps over³.

Zambia has a heavy reliance on one commodity – Copper, making up 75% of total exports[3]. The Copper price has been strong over the past year averaging around $6700[4], however one year of strong Copper prices is not enough to fix all of Zambia’s economic issues. It does beg the question how the Zambian economy and its bonds would fare if there was a sustained downturn in Copper prices?

This issue is not just limited to Zambia or a single commodity. Many Emerging Market nations are commodity exporters. EM Investors can buy Oil exporters across the whole credit rating spectrum, from Investment Grade issuers like Saudi Arabia and Colombia, right down to single Bs and Cs such as Ecuador and Venezuela respectively.

Ratings are not static, and for nations to be upgraded, there has to be an element of ‘fixing the roof while the sun is shining’. I.e. When commodity prices are higher, exporters of those commodities should act responsibly to shore up their finances. However, the concern is that we are still witnessing exporting nations requiring possible external assistance (e.g. Angola reaching out to IMF in the past week), despite commodity prices above the lows seen in 2015/16.

We note that many Corporates from the Mining and Energy sector de-leveraged their balance sheets and reduced operating costs in the aftermath of the commodity price crash in 2015/16 to weather future commodity price weakness.

The crunch could occur when more speculative grade EM Sovereigns need to raise new debt. With tightening global liquidity, investors appear to be acting rationally in that they are being more selective with where they allocate capital.

With September around the corner, we will be closely observing the investor appetite for EM new issues and stay alert to issuers that might not be able to satisfy their funding needs, as this could have knock on effects for the wider EM market.

For more information please contact Rubrics Asset Management. info@rubricsam.com.

[1] www.spglobal.com [24 August 2018]

[2] www.bloomberg.com [28 August 2018]

[3] www.spglobal.com [24 August 2018]

[4] www.bloomberg.com [28 August 2018]

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