Charles Robertson of Renaissance Capital -
--We've been arguing for a while now that emerging markets (EM) would attract a flood of cash as investors despaired of developed markets (DM), and we expect some of you will have seen a graph of Eurobond issuance by region and type of issuer that confirms this. We present a simplified version of that graph in Figure 1. It shows that international securities issued by EM banks, corporates and sovereigns have been running at a total of around $80bn per quarter since the third quarter in 2009. We have never seen such huge ability to borrow by the EM world via Eurobonds.
--Our concern is that this borrowing may have replaced syndicated lending. Perhaps commercial banks were getting anxious and EM debt funds stepped up to replace them.
Having spent hours trawling through the Bank of International Settlements (BIS) website, we can see that while syndicated lending slumped in 2008-2009, it recovered well in 2010/2011 and there was EM borrowing of over $163bn in the second quarter. This is not as high as the borrowing peak of $212bn in the third quarter of 2008, but is evidently very strong. Clearly, the third quarter of this year will be weaker and European banks in deleveraging mode are likely to scale back their lending. For example, Germany's second-largest bank, Commerzbank, recently announced that it will cut lending in all of the countries in which it is present, except Germany and Poland. Nonetheless, we can be fairly confident that while flows to EMs in 2011-2012 may not exceed the peak of 2007-2008, we are very unlikely to see a return to the EM world's pre-2005 levels of borrowing. By 2013, it would be no surprise to us if lending to EMs hit record highs.
We have focused on two EM countries in this report: Turkey and Russia.
For Turkey, it's surprising to us that borrowing has been so very high in the past year - roughly as much as in 2005-2006. Yet the lira has been weaker than ever. In our view, a key reason for this was because the current account deficit reached record levels in dollar terms, and was on course to roughly double in 2011 vs the annual current account deficit of $38bn seen in 2007. In our view, borrowing has played a role, and high oil prices too.
Investment implication: Turkey has evidently retained a good name with syndicated lenders. Nonetheless, with falling demand for loans in Turkey, we assume there will be reduced demand from Turkish borrowers internationally, at a time when global banks will be keen to cut back. This would be negative for the lira, but we note that lower borrowing should mean a smaller current account. Renaissance Capital economist Mert Yildiz's base case is that the Central Bank of the Republic of Turkey is (just about) in the driving seat, and he expects the lira to remain around TRY1.80/$1 in the coming months.
In our view, the biggest surprise of all is Russia. While Turkey and South Africa have been borrowing at near-record levels in 2011, Russia has not. Quarterly borrowing remains very low when compared with peak levels, presumably because investment plans remain smaller than in 2006-2008. This may be the single biggest reason why the ruble has remained weaker than other commodity currencies since 2009. The ruble now depends to a greater extent than before on the current account and capital flight issues, as foreign capital is no longer flooding into the country, as it did in 2006-2008.
Investment implication: We expect the ruble to remain weak vs other commodity currencies until borrowing by Russian companies picks up, via either syndicated loans or new bond issuance. This may begin in 2012 if the global environment improves, and because political risk should be much reduced, encouraging investment. As it stands, we expect continued ruble weakness relative to the other commodity currencies, unless borrowing increase to the point that it is able offset the effects of a deteriorating current account. Strong capital inflows to Russia represent the major risk to Renaissance Capital economist Ivan Tchakarov's base case.
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