EM CENTRAL BANKS ADJUSTING TO A WORSENING EXTERNAL ENVIRONMENT

From April 15 to 19, we were in Washington to meet with central bankers and finance ministers during the International Monetary Fund (IMF) and the World Bank (WB) Group spring meetings.

It was an opportunity to take stock of global macroeconomic issues and policy mix in many countries in our investment universe. The reactivity of emerging market central banks in adjusting their forward guidance to the recent tightening of USD financial conditions again illustrates the professionalism of EM monetary authorities and, more broadly, the improvement in the institutional framework of the asset class. We also noted the growing interest shown by international investors in so-called special situations. In this travel diary, we take a closer look at three of these “risky” countries, which we consider attractive investment cases: Argentina, Turkey, and Egypt.   

Argentina (Presidential republic, population of 46.6M, GDP (ppp) of $1Trn)

Three equal horizontal bands of sky blue (top), white, and sky blue; centered in the white band is a radiant yellow sun with a human face (delineated in brown) known as the Sun of May. The colors represent the clear skies and snow of the Andes; the sun symbol commemorates the appearance of the sun through cloudy skies on 25 May 1810 during the first mass demonstration in favor of independence. The sun features are those of Inti, the Inca god of the sun.

High commitment from the government powering high market expectations

Political authorities have shown determination in meeting their commitment to a balanced budget. Despite a worse-than-expected economic and financial legacy, no country credibility, and the absence of a majority in Congress, the policy mix deployed by the Milei administration enabled an historic fiscal adjustment while avoiding hyperinflation. The parallel exchange rate has fallen, and the central bank has been able to increase its foreign exchange reserves. Monthly inflation is trending down and should reach single digits in April (month-on-month). While expectations for a successful stabilization in the country's macroeconomic situation have increased in recent weeks, key challenges remain, mainly related to President Milei's ability to carry through his economic reform program. The Omnibus bill and revenue-raising measures are being discussed again in Congress following their 1st rejection in early February. An income tax reform, a moratorium on the return of foreign assets, and the privatization of state-owned enterprises are part of the agenda. The government has revised the content of its reform after negotiating with governors and congress members, which increases the likelihood of the bill's adoption. But fiscal balance is not contingent on its approval. New appointments to the Supreme Court are also an issue to monitor as some deregulation laws or revenue conflicts with provinces could be challenged in the judiciary and end up before the top court. A key challenge will be to normalize the current monetary and exchange rate frameworks (2% monthly crawling peg, negative real rates, and extensive capital controls). Capital controls should be lifted as soon as possible, but without taking any risks. The central bank's balance sheet, which is in the process of being cleaned up, is not yet sufficiently robust to ensure currency stability in the event of adverse developments. However, the government relies less on a large stock of foreign exchange reserves than on sound macroeconomic policies to migrate when the time comes to a managed float regime. A balanced budget, supported by the people of Argentina, is the central element of the government's plan. It should enable economic recovery to generate a budget surplus (4 points of GDP generating 1 point of additional revenue) and, in the end, reduce the tax burden on the private sector. The government expects growth between 5 to 6% in 2025, with revenues increasing by 1.5% of GDP. The IMF is impressed by the results achieved by Argentinian authorities in terms of fiscal consolidation and reserves accumulation. The Fund is not ruling out the possibility of a new program with new financing. We maintain a constructive view of the Argentina investment case despite less attractive valuations and still significant political and execution risks.

Türkiye (Presidential republic, population of 83.6M, GDP (ppp) of $2.8Trn)

Red with a vertical white crescent moon (the closed portion is toward the hoist side) and white five-pointed star centered just outside the crescent opening. The flag colors and designs closely resemble those on the banner of the Ottoman Empire, which preceded modern-day Turkey. The crescent moon and star serve as insignia for Turkic peoples. According 

The AKP's failure in the last March municipal elections has not called Turkey's macroeconomic adjustment into question. It's been quite the opposite. As far as the government is concerned, high inflation is at the root of this electoral setback. As a result, the executive doubled down on its fight against inflation, reinforcing the mandate of Finance Minister Simsek. Thus, the fiscal authorities are committed to strengthening the medium-term economic program engineered to reduce inflation. Additional fiscal measures are underway. The government plans to review public spending, gradually reduce energy subsidies, strengthen social safety nets, and combat the informal economy and tax evasion. The government's top priority is disinflation. The next priority is to improve public finances. It should result in an improvement in the country's current account balance and external position. With a budget deficit of -3.6%, excluding earthquake-related expenditures, and a debt level of 29% of GDP, the sustainability of government debt is not an issue. The budget deficit is expected below 5% in 2024. In line with the objectives of disinflation and sound management, an interim increase in the minimum wage is not on the agenda for the rest of 2024. The economic program, built around appropriate policies and structural reforms, should lead to a re-balancing of the Turkish growth model. The results are beginning to show. The contribution of domestic demand to growth has decreased, with external demand making less of a negative contribution. As a result, the current account balance has improved by $28.3Bn since May 2023, from a deficit of $60.1Bn to $31.8Bn at the end of February. One of the challenges in terms of structural reform is to move up the international value chain. In this respect, the ongoing fragmentation of global trade is an opportunity for the country, which is well-positioned to benefit from near-shoring and friend-shoring. The monetary authority's policy aims to bring inflation down to single-digit growth (year-on-year) by the end of 2026. On March 21, the Turkish Central Bank (CBRT) surprised investors by raising its policy rate by 500bp to 50%. Its program now focuses on simplifying macroprudential policies and increasing foreign exchange reserves. However, it remains determined to raise its rate further if necessary. Inflation, at 68.5% year-on-year at the end of March, is expected to cross the 70% threshold by May before starting to fall. Underlying goods inflation dynamics are improving, but services inflation remains problematic. In front of slightly higher-than-expected inflation prints, the central bank took additional macroprudential tightening measures (raising credit card interest rates, encouraging banks to increase commercial deposits in Turkish lira, and introducing reserve requirements in the event of excessive loan growth). Inflation forecasts, which are also targets for the CBRT, are 36%, 14%, and 9% for 2024, 2025 and 2026 respectively. In addition, excess liquidity has been sterilized to make the interest rate policy effective. The monetary policy transmission has been restored, and financial conditions better reflect the desired monetary stance. For now, the CBRT is giving priority to disinflation rather than the accumulation of foreign exchange reserves. But FX reserves will increase if market conditions allow (portfolio inflows, reduction in the current account deficit, de-dollarization of residents). In our view, the Turkish authorities' commitment to restoring orthodox economic policies makes the Turkish investment case more attractive for local-currency debt than hard-currency debt, the latter having already priced in the government's orthodox shift. The success of this positioning depends on the return of non-resident investors to the local market.

Egypte (Presidential republic, population of 111.2M, GDP (ppp) of $1.4Trn)

Three equal horizontal bands of red (top), white, and black; the national emblem (a gold Eagle of Saladin facing the hoist side with a shield superimposed on its chest above a scroll bearing the name of the country in Arabic) centered in the white band. The band colors derive from the Arab Liberation flag and represent oppression (black), overcome through bloody struggle (red), to be replaced by a bright future (white).

Decisive international financial support

The last few months have been decisive for Egypt, with the signing of a $35Bn real estate investment project by the United Arab Emirates, an upgraded IMF program, increased support from the European Union, as well as complimentary fiscal and monetary reforms, all of which have positively changed the outlook for the country. International financial support has made it possible to switch to a floating exchange rate and significantly tighten monetary policy, enabling the return of much-needed non-resident portfolio flows to finance Egypt's local market needs. The fiscal and external situations should continue to normalize. Arrears have been closed in the past weeks. The $24Bn new foreign currency inflows expected from the Ras El-Hikma real estate project with the United Arab Emirates will bolster the central bank's foreign exchange reserves. Half of the funds will be transferred to the Ministry of Finance and accounted as revenues, helping to lower the budget deficit and reduce debt ($12Bn or 3.5% of GDP). The primary surplus is now expected at 5.75% of GDP in fiscal year 2023/2024, with an overall budget deficit of 3.9%. The primary surplus target for next year is 3.5% of GDP. Expected to reach 84% at the end of June, the debt-to-GDP ratio should thus return to its pre-crisis level and remain stable next fiscal year. The overall budget balance will be consolidated by including 59 economic entities along with that of the central government. It should provide a more transparent and accurate picture of the country's overall fiscal picture. An annual cap of £1000Bn in public investments will be introduced alongside a net government debt ceiling. Recent disruptions in the Red Sea have negatively impacted Suez Canal revenues, which have already decreased by 45% in 2024. However, the external accounts should stay resilient, as the drop in revenues should be more than offset by the return of remittances from abroad, with positive signals observed by the government in high-frequency data. While some macroeconomic imbalances are being fixed, challenges remain, particularly from the global geopolitical backdrop. However, the Egyptian authorities seem determined to pursue the reforms agreed with the IMF under the new support program to ensure macroeconomic stability and debt sustainability. A strong commitment supported by multilateral creditors that justifies renewed investor interest in Egyptian debt.