The allocation of 650,000 million dollars in Special Drawing Rights (SDR) by the IMF is already a certainty. This will provide a major boost to emerging market high yield bond currency reserves.
In addition to the SDR allocation, the IMF is studying the way of reallocate another $ 100 billion in SDR from rich to low- and middle-income countries.
From a fixed income investing point of view, these policies will provide additional support for the strong performance of emerging market high yield bonds in the second half of 2021.
The most attractive countries include the Ivory Coast, Papua New Guinea, Tajikistan, Maldives, and Seychelles.
The pandemic has made us more aware of the contrast between the haves and the have-nots. Rich countries have been able to deploy massive fiscal and monetary stimulus at historically low interest rates and have been able to gain early access to vaccines.
Meanwhile, many poor countries lost market access in the first half of 2020, forcing them to apply pro-cyclical austerity or, at best, very limited political support, not to mention they tend to be at the end. from the tail in the vaccine race. However, it would be superficial to conclude that low-income countries will do poorly in the post-pandemic world.
Part 1: What We Already Know: The IMF has provided significant support and debt relief to low-income countries since the onset of the pandemic.
The IMF has provided unconditional financing to 78 emerging and developing countries. These IMF loans related to the pandemic amounted to $ 109.6 billion at the end of May, of which 77% were Rapid Financing Instruments (RFI) and Fast Credit Facilities (FCR) without conditions. Low- and middle-income countries only received a third of this amount, but they benefited the most in terms of GDP.
The IMF Board of Governors will approve a new allocation of $ 650 billion from SDRs to all its members. This measure will be approved in August and the central banks of the member countries will receive the funds shortly thereafter.
Rich nations would receive the most in absolute terms, but middle- and low-income countries benefit the most in terms of GDP.
On the whole, low-income countries will receive a boost equivalent to 1.9% of GDP of these SDRs in the form of unrestricted reserves that amount to a subsidy; high-income countries will receive the equivalent of 0.8% of GDP.
The exact amount varies from country to country based on their quotas in the IMF. The following chart shows the 25 countries that benefit most from the allocation of the 650 billion dollars of SDR, in terms of GDP and as a percentage of their foreign exchange reserves.
Chart 1. Top 25 Recipients of $ 650 Billion SDR Allocation (Relative to GDP and Foreign Currency Reserves)
Debt-distressed countries, such as Suriname, Zambia, and Tajikistan, will receive large allocations in terms of GDP and reserves, and thus will benefit the most from the initial allocation of SDRs. This is also the case for island countries such as Jamaica, Seychelles, Trinidad and Tobago, Barbados, Grenada and the Bahamas. Countries with low net reserves, such as Argentina, Turkey and Sri Lanka, will also receive a significant boost to their foreign exchange reserves, even if they are not in the top 25 in terms of GDP.
Part 2: reallocating $ 100 billion of SDR from rich to poor countries
In order to the average of emerging markets, lSDRs will account for less than 2% of GDP and low-income countries will receive a similar amount. This is significant from a macroeconomic point of view, but it is not a game changer.
For this reason, the G7 leaders are now asking the IMF to present a proposal to reallocate 100 billion dollars – of the 437 billion that will be received by high-income countries – to the most vulnerable countries. However, it is not yet clear how that reallocation will take place. The IMF will work on this over the next several months, with the reallocation likely to take place in the fourth quarter of 2021.
The IMF is considering reallocating some of these resources through the Poverty Reduction and Growth Trust Fund (PRGT), which could easily double the SDRs reaching low-income countries.
Low-income countries and small island nations (International Development Association countries) can borrow from the IMF at zero interest through the PRGT fund, which is voluntarily financed through bilateral agreements with high-income countries. or large emerging markets with excess foreign exchange reserves, such as Brazil.
Fourteen countries have pledged a total of SDR 15.4 billion (US $ 22.25 billion) to the PRGT fund since the start of the pandemic. Between March 2020 and May 2021, the IMF loaned US $ 10.1 billion to countries eligible for the PRGT, of which 81% were condition-free through the Rapid Credit Facilities (RCF).
The problem with these condition-free facilities is that they have an access limit of 100% of the country’s quota per year, which was exceeded by most countries in 2020, and 150% of the country’s quota on a basis cumulative. This implies that most emerging markets could receive another 50% of their quota from the IMF in late 2021 or 2022 if requested, which would be interest-free for low-income countries through the PRGT.
The US $ 100 billion would represent more than 10% of the GDP of all PRGT-eligible countries combined. The positive impact on low-income countries could be huge if this materializes. However, it is unrealistic to expect these countries to borrow such a large amount from the IMF.
The $ 100 billion reallocation of SDRs would likely have a strong bias in favor of low- and middle-income countries. In Figure 2, we illustrate a scenario in which one-fifth of these SDRs is reallocated through the PRGT to low-income countries, which is the maximum we consider realistic to reallocate to these relatively small economies.
The remainder is reallocated to middle-income countries through the new Resilience and Sustainability Fund in proportion to the quotas of countries in the IMF. The magenta bubbles (on the right-hand axis) indicate how much each group of countries would benefit in terms of GDP, suggesting a strong bias in favor of low-income countries.
This is just an illustrative scenario because no one knows exactly how it would work. Vontobel AM believes that countries would probably have to request a resilience and sustainability program, which would be more like a World Bank development program than a typical IMF program with strong conditionality. This, in turn, could help improve the IMF’s image, which tends to have a negative political connotation in many emerging markets.
Figure 2. An additional $ 100 billion reallocation of SDRs to emerging markets
(scenario: PRGT + Resilience and Sustainability Fund)
Together, these policies will provide additional support for the continued outperformance of emerging market high-yield bonds in the second half of 2021.
Back in January Vontobel AM explained why 2021 would be the year of emerging market outperformance in this market, and they have been right so far.
These bonds have provided a 1.9% total return so far this year, despite the difficult environment of rising yields in the US, while investment grade yields have lost 3.4% so far this year. The spread between high yield and investment grade has narrowed dramatically over the past year, but is still abnormally above its historical average.
The ongoing normalization of emerging market spreads, coupled with the political support described above, should underpin the outperformance of high-yield bonds in the second half of 2021.