The 5 Frontier Market Countries to Worry About with Rates Rising
US rates have been rising steadily with 5 rate hikes since the end of 2016. The US Yield curve is getting flatter putting tremendous pressure on Frontier Market economies that rely on borrowing in USD for both public and private initiatives. Frontier Markets are hit harder because they tend to be unable to issue long duration bonds due to their risk profile, so they are more exposed to short and medium-term rates than more developed economies that choose to issue in USD.
There are a number of countries for whom the USD interest payments are becoming increasingly burdensome, particularly when coupled with a local currency that is under stress. At the same time, rate hikes do indicate a thriving local US economy which generates demand for good from Frontier Market countries. This offset though is not complete, and the countries below are where we would advise extreme caution, with respect to investment opportunities.
Lebanon
Lebanon is surrounded by chaos, though this is nothing new. Israel-Palestine tensions have escalated while the Syria situation is far from abating. Domestically, the year started off with madness as Saad Hariri had been imprisoned in Saudi Arabia in late 2017 and was going around the carousel with respect to resigning and not resigning. In the end, we have a Lebanon that is very clearly a pawn within the Middle East hegemony of Saudi Arabia and Iran. On top of all this, we have high domestic inflation, tepid growth, and ever-growing USD-denominated debt that is becoming increasingly challenging for the government to service. Lebanon’s external debt of over $30bn equates to almost 2/3 of Lebanon’s GDP. This exposure makes Lebanon vulnerable to manipulation by wealthier groups such as Saudi Arabia.
Lebanon has always been addicted to debt and presently debt is growing 5x the growth of the economy[1]. The budget deficit is expected to be 10% of GDP and interest payments constitute half of the government’s revenues[2]. Increases in interest rates will make the budget situation of Lebanon untenable requiring either a bailout or some sort of arrangement with a country such as Iran or Saudi Arabia.
Amidst this macroeconomic backdrop, the stock exchange is up 5% over the last year, almost all of that coming since November. This is a great time to sell anything in Lebanon that you do not have a strong conviction in. Lebanon is certainly one of those countries where entrepreneurs have figured out how to thrive in the chaos. The country has a GDP per capita of 19,128 on PPP basis which is the equivalent of Mexico, Iran, and Argentina.
Serbia
Serbia has had a tough time of late. The country has an external debt that is now 70% of GDP. Serbia has lagged many of its economic peers which were shown in 2017 when the economy grew 1.9%.[3] Serbia has repeatedly hoped that exports would pick up, and they have not since the GFC.
The IMF is convinced, however, that Serbia will grow, expecting 3% growth this year and over 4% for 2019 and 2020[4]. This degree of growth is expected solely by spending, and therein we have concerns. S&P, however, is not phased at all by Serbia’s failure to deliver and has upgraded its debt to BB from BB-, this is largely driven by the government expecting to enjoy a surplus in 2018. We do not think this will be possible if the US does 2 rate hikes this year. This alone will cause a few downgrades in the debt ratings and is likely to drive the economy lower.
The Belgrade Stock Exchange is 2% over the last year and the country is enjoying a wider Balkan recovery. The population continues to shrink by 0.5% with no desire or openness towards immigration. Labor participation is abysmal and the government needs material changes and improvements before the economy is structured in a way to enjoy growth. Unlike the other countries on our list, we actually think there are opportunities to invest in the economy but we would stay far away from government bonds or fixed income investments in general.
El Salvador
El Salvador’s anemic growth finally started to turn a corner in 2017 with increased remittances and a variety of economic initiatives. However, as is usually the case, the country is overextending itself on the back of 2% growth. The government expects to spend a material amount of money on economic growth, in addition to 20% of the budget being devoted to debt repayment. This is, of course, good, but the country has a 61% external debt to GDP ratio with almost $17bn in external debt.
The country continues to be plagued by poverty (over 40% of the population) and shockingly high crime, El Salvador had over 6,500 murders last year[5]. This is the equivalent of Ethiopia, a country with 15x as many people, or 60% of China’s total murders (10,083), despite China having more than 200x the population. It is obscene, with a murder rate per capita that is 15x that of Afghanistan and 12x that of Iraq.
El Salvador will be squeezed with rising rates and making the payments will be possible but it will be at the expense of local economic growth. There is not a compelling reason to be in the country from a macro perspective. We will always concede, however, that there are excellent business opportunities in every country, under any regime at all times.
Ukraine
Ukraine is going to be very challenged in 2018 to grow despite a flurry of reports that suggest that economic growth could accelerate to 3%. Ukraine has an election coming up and the country is still unclear what its eastern border will look like. Amidst political uncertainty, the country expects inflation of almost 14% in 2018 which will produce a material drag on investment and spending. This is despite the doubling of minimum wages in 2017[6].
Ukraine has external debt of $116bn despite having a GDP of only $93bn. This has been largely accommodated by Western institutions keen on enabling Ukraine to succeed and highly interested in maintaining Ukraine as a middle ground between Western Europe and Russia. Ukraine spends a lot of money repaying interest and the country is likely to need $8bn in new issuance this year[7] to pay for its increase in pension payments.
Ukraine will continue to be challenged by Russia and given the environment there is both a net emigration and a population growth (births – deaths) of less than zero, indicating that the country continues to decline in population. This will not help with interest payments in the near future or further along. Interest payments from Ukraine are unlikely to cease due to a wide swatch of western institutions wanting to protect Ukraine, but largesse around spending needs to be contained for the economy to truly begin its recovery.
Belize
Belize has external debt that amounts to 67% of its GDP and a growth rate of 1.5% which is almost entirely driven by capital-intensive infrastructure projects. In fact, consumer spending is declining but is not an area of focus for the government because they lack the analytics to focus on the right areas.
The government has an explicit objective of reducing total debt-to-GDP to 80% by the end of 2020, but they have no idea how to actualize this objective. The government was expecting a 3% surplus at the end of 2017 and got a surplus of 1.8% only. While a surplus is good, in Belize’s case its largely driven by a lack of good ideas for how to invest in the economy such that there is material growth in wages and income, in the country.
GST has been implemented in the country and will enhance the government’s revenue without having a material impact on spending from locals or tourists. The country is coming out of a debt restructuring in early 2017 that was largely effective. However, there is no indication that the country as a whole has learned from its previous experience.
Belize Bank was recently given the authority to seize government property in order to satisfy the $90mm UHS debt. This ruling was done by a US court and allows Belize Bank to seize assets even outside of the country. The bank has been told by the government that there are no assets to take, which suggests a high sensitivity to any changes in interest payments that would occur from an interest rate hike.
Conclusion
The majority of countries are sensitive to changes in US interest rates, however, the degree of sensitivity varies tremendously. There are many other countries that are impacted by the rapid rise in interest rates in the US, but we do believe that within the Frontier Markets Universe, these countries are amongst the most sensitive and should be closely monitored.
