Battered economies need to expedite efforts to tap loan and bond markets

The US Federal Reserve, on the verge of increasing their interest rates, is causing further urgency for battered economies to expedite their efforts to tap loan and bond markets. Liquidity, the centrepiece of global finance, is the key theme that needs to be monitored and is quickly disappearing across the globe due to unique reasons in various geographies.
Global finance has rocked fundamentals that practitioners of economics had taken for granted since the end of World War 2. With implementation of economic reforms, commodity super cycle testing new and sustained lows, global currencies testing their quest for weakness and consumption anaemic; every economy today is battling to attract funding to stay afloat.
In the meantime, as the world anxiously awaits the verdict of the US presidential elections in November, there are doubts across the globe whether the American voters will favour political correctness or get trumped by public rhetoric now synonymous with Brexit. Just like the global economies today, this election is not going to reflect strength of candidates; rather it will be a contest of who is weaker.

Money Market Funds — small change, large shadow
The 2008 financial crisis exposed a fundamental flaw in Money Market Funds, an asset class considered as robust as bank deposits, with better returns. The protocol of a floor of $1 per share as fixed price gave investors the perception of stability, which needed an amendment. The US Securities and Exchange Commission introduced a reform for regulating these funds effective October 14 where they will require publishing their net asset value. This change means that unlike government only funds, investors can now lose money if the market value of such funds falls below $1 per share. In addition the funds will also need to be transparent with their weekly liquidity disclosed to their investors, facilitating fund managers to impose redemption fees if liquidity for their fund falls.
The changes have resulted in multiple industries and households pulling out up to $1tn from this anchor asset class and moving it to government funds. Banks as a result are suffering from resultant contracted liquidity and scrambling to get access to liquidity from corporate and institutional markets thereby raising cost of funds which in turn is raising LIBOR rates on every tenor. The 3-month US dollar LIBOR, a benchmark for global borrowing, as a result has increased by three and a half times, since January this year, increasing cost of borrowing and putting immense downward pressure on corporate profitability as well as investment yields.

China — passing the sentence and swinging the sword
China had identified resource rich Africa and South America as its next frontier and advanced to make inroads by funding critical projects for these high-risk and resource countries. In a quest to secure these
reserves of oil, iron ore and copper; China’s policy banks with an investment of $700B took immense economic and political risks to structure transactions that would promise infrastructure projects in return for commodities. China’s funding diplomacy will now test not just the political resolve but also the financial commitment the country is willing to put behind these projects. Cracks have started to appear in Africa’s balance of trade deficit with China is expected to grow to $60B on the basis of 40% contraction of commodity value.
With low commodity price sustaining, LIBOR and cost of funds rising, it will be a struggle to keep Africa afloat as there will be restructuring of debt in the continent where countries like Angola, Ghana, Niger and Zimbabwe will find it difficult to service their debts. China will have to fund its political commitment to this continent by finding the liquidity for mass rescheduling which will raise costs and require further capital injections in the policy banks to keep them afloat. There is limited capital market availability for Africa today and it will be critical for them to reschedule the funding with China at increased cost and hope that the commodity prices recover.

Oil – winter is coming
Opec and Saudi Arabia have finally abandoned the pump and dump strategy to realise the resilience of the market and lack of options other players have in the larger hydrocarbon space. Opec cut is too little too late, the spike we will see in the oil price in the coming days will be more related to winter provisioning than a 700,000 barrels cut.
These years of high production, however, have caused a significant drain on reserves and national exchequers of most of the hydrocarbon countries. Across the GCC, there has been a spike in domestic borrowing and with low oil prices, a drain on availability of domestic funds that has raised cost of liquidity in the region. This upward trend is similar to LIBOR but completely unassociated with it and may have camouflaged the reason for hike. Austerity measures have become mandatory and are being pursued aggressively, however, structural reforms on availability of local liquidity are critical. Banks will need increased local currency liquidity and in the days to come the pegs will be tested. Saudi will need to tap the bond markets this year to ease liquidity pressures at home and the likely $15B bond issuance may not be the optimal number. The remaining GCC is also evaluating timing for the Bond issuance as are some of the government owned corporate entities before demand for emerging markets wanes and the mid rate swaps hike from 5 across to 30 years.

GCC holding the door
We have clearly come to the end of low cost of funds run and it will be a challenge for the global economies to re-embrace leverage that will cost them significantly more than what they have become accustomed to in the last decade. These costs are real and their fundamentals are beyond policy decisions of the Federal Reserve. Meltdown of African debt will put further pressure on funding costs and the yield differential caused by African vacuum will have the potential to bring the other sovereign debt yields higher up as well. Closer to home, while the sovereign bond markets have appetite for now, GCC will need to rein in fiscal prudence and develop a sustainable local debt proposition as a priority else these bond issuances will be band aid solutions. Corporate entities will need to bring discipline in not only term but also in working capital indebtedness. Managing liquidity and funding will need to be top priority not just for growth but also for sustenance. While debt will be available at a price, the famous quip, ‘In battle, discipline beats numbers, nine times of every ten’ is more pertinent today than it ever was before.