The Paradise Junked

Spoiler alert -- This post is not about the Yen carry trade, AI mania, soft vs hard landing or central banks' monetary policies and puts. The roller coaster ride of the last few days allowed me to once again go back and look at one of my favourite segment of EM Sovereign credit, which is the Distress debt. And here I am with my analysis and a BOLD idea. Please note this one is not for the faint hearted.

The Shrinking Sovereign Distress Debt Universe

At the start of the year, there were 10 High Yield EM sovereigns from Asia, Africa and Eastern Europe whose Eurobonds were trading at or near distress levels i.e. at a credit spread of at least 1,000 bps over the US treasuries. That list included sovereigns that had already defaulted and were negotiating a debt restructuring with the support of the IMF with their official bilateral and private creditors, namely Sri Lanka, Ukraine, Ghana, Zambia and Ethiopia. The remaining were Pakistan, Egypt, Kenya, Tunisia and Maldives, and the first four of these were facing maturing debt obligations and dwindling FX reserves without access to external private financing, and hence were dependent on multilateral and bilateral support to avert a default. In our credit outlook for the year, we took the view that (i) Sovereign defaults will be avoided even for distressed issuers with the help of multilateral and bilateral creditor support, and (ii) Lower-rated EM credits will also face lesser refinancing pressure as Eurobond issuance opens up allowing tapping the debt markets.?

The improvement in distressed debt started from the first quarter with Kenya managing to tap the Eurobond market in February and raised USD 1.5 billion through a new 7 year bond and repaid the maturing bond in June. The country also signed a new IMF program in June, although the implementation of fiscal measures has hit a roadblock due to public protests and led to the reversal of the controversial finance bill. As a result, in July Moody’s lowered Kenya’s rating to Caa1 from B3 and on 3rd August, Fitch also downgraded the rating to B-,? citing rising fiscal risks.

Tunisia also managed to avert a default and repaid EUR 850 million bond in February, and since then the country has managed to secure funding from World Bank (project related), ITFC (Oil imports) and a couple of other multilateral institutions. However, talks with the IMF have stalled as the President is opting for populist measures and using monetary financing to fund the fiscal deficit and debt payments. Without clarity over an IMF deal, country’s Eurobonds maturing in 2025 and 2026 are trading at distress levels.

In March we witnessed Egypt getting a generous bilateral package from the UAE, followed by financing agreements with the IMF, the World Bank and the EU. The external support measures coupled with the Central Bank of Egypt’s actions to raise interest rates and adjust the currency value, helped the country in repaying the maturing Eurobonds and attract significant foreign inflows into the local currency debt market. As per conservative estimates, the inflows in LCY treasury bills were around ~ USD 15-20 billion from March to July, although the pace has slowed sharply due to rising geo-political risks in the Middle East and Egypt’s proximity to the conflict zone.

Pakistan, that got a lifeline in June last year through a 9-monht IMF facility, managed to finish the program successfully and repaid the maturing USD 1 billion Eurobond in April 2024 and also cleared out a significant backlog of external profit repayments (dividend repatriation). The performance was rewarded in July with the signing of a 3- year USD 7 billion EFF with the IMF, that is likely to get approved in the coming month. Pakistan’s Eurobonds were one of the top performers in the HY EM credit universe during the first half of the year.

Defaulted sovereigns are also getting a reprieve as they reach restructuring agreements with their private creditors (including Eurobond holders). Zambia singed a restructuring deal for USD 3 billion of Eurobonds in March. Ghana reached restructuring deal for USD 13 billion of Eurobonds in June and Sri Lanka followed soon with a deal for USD 12.6 billion in July. Ukraine also finalized a restructuring deal with Eurobond holders in July for a total size of USD 23.4 billion. Ethiopia finalized a USD 3.4 billion deal with the IMF and secured additional funding commitments from the World Bank and will start debt restructuring negotiations with the private creditors under the Common Framework. For a couple of weeks, it looked like there will be no member left in the Distressed Debt club for my bold (call it crazy) trade idea. However, there is one name to look at and recommend as a Buy to the brave souls who dabble with default risk and do not mind price moves that resemble a Ferrari World roller coaster ride.

The Paradise Junked

The credit I am referring to is Maldives, which was recently downgraded to Caa1 by Moody’s and CCC+ by Fitch. Maldives sovereign sukuk was issued at a profit rate of 9.875% in 2021 and matures in April 2026. The sukuk is currently trading at a price of around 87, which yields ~ 19.3% and translates into a credit spread of roughly 1550 bps. What’s happening with Maldives, and why the tourist paradise is facing a debt distress. The IMF warned in May that the country is facing fiscal pressure and high risk of external and overall debt distress due to the policies of the current government. Ratings agencies have also raised red flags over rising public debt, higher financing needs over the next three years and wide CAD. The fiscal deficit widened to 13.4% of GDP and public debt rose to 119% of GDP in 2023. Current account deficit also widened due to rising imports of capital goods and higher costs of food/fuel. Gross FX reserves have declined to USD 509 million as of June 2024. Foreign exchange reserves continue to face pressure from still-elevated fuel import prices that drive wide current account deficits. IMF projects FX reserves to stay around USD 550 million until 2026, after taking into account the debt repayments.

According to IMF, GDP growth is projected at 5.2% for 2024, supported by rising tourism. Planned removal of subsidies will help in narrowing the fiscal ?deficit to 12.2% but public debt will stay above 110% of GDP. CAD is also expected to remain wide at ~ 20% of GDP. Fitch projects economic growth to accelerate to 5.0% in 2024 and 6.3% in 2025, from an estimated 4.0% in 2023 with tourism being the main driver. Overall tourism receipts were up by 27% YoY in Q124. The joint IMF-World Bank Debt Sustainability Analysis (DSA) indicates that Maldives remains at high risk of external and overall debt distress and gross external financing needs are expected to rise in the coming years due to large fiscal deficits and repayments and rollovers of debt. Fitch projects the fiscal deficit to fall to 12.7% of GDP in 2024 and 11.0% in 2025 from an estimated 14.5% in 2023. This reflects stronger revenue collection on robust tourism growth, a measured capex rationalisation, and gradual subsidy and healthcare reforms. Subsidy reforms are postponed to late 4Q24, and are expected to yield about 3% of GDP on average over 2024-2026.

External refinancing pressures are expected to peak in 2026, with the sukuk maturity in April. Fitch has estimated external debt servicing of USD 409 million in 2024, USD 557 million in 2025 and over USD 1 billion in 2026. According to the IMF, reforms such as increase in the GST rate, removal of subsidies and reduction in capital expenditure will support the target of lowering deficit and public debt. The government also outlined a liability management plan in this year’s budget to buy back USD 200 million of the sukuk through a new bond/sukuk of USD 250 million in 2025 and then refinance the maturing sukuk in 2026 though a new sukuk/bond issue of USD 400 million. This is subject to the ability of the sovereign to tap the debt markets, which at current rating and spread levels is very limited. Maldives will need to get financing from bilateral (China being the major lender) and multilateral (IMF and the WB) creditors to meet its debt servicing obligations as economic projections show that the country will not be able to generate sufficient cash to repay the debt. As per Moody’s twin fiscal and current account deficits and a ramp-up in external borrowing with the implementation of large public-sector infrastructure projects drive government liquidity and external vulnerability risks. Fitch downgraded Maldives to reflect increased risks associated with the country's worsening external financing and liquidity metrics. Although Fitch expects the government to reduce the external financing requirement over the medium term through fiscal consolidation, it will still have large external refinancing needs in 2025 and 2026. There are a lot of negatives and that’s why the credit is trading at these levels. However, improvement in fiscal position and increase in tourism are also envisaged that will help the country in 2025, as highlighted by the IMF and ?the rating agencies. On the plus side, Maldives can get support from bilateral and multilateral partners facilitated by both the country's geopolitical strategic importance and the reforms agenda of the new government. The government had set up a Sovereign Development Fund (SDF) for US dollar bond amortisation, and the total size is over USD 500 million but as per Fitch the SDF currently holds only USD54.4 million in hard currency whereas the rest is in local currency.

Latest economic performance can be accessed here - https://www.mma.gov.mv/documents/Economic%20Update/2024/EU-Jul-2024.pdf

IMF Article IV consultation can be accessed here - https://www.imf.org/-/media/Files/Publications/CR/2024/English/1MDVEA2024004.ashx

Maldives and Peers

Source: Bloomberg ????????????? Prices, Yields and Spreads are as of 6th August