Jan Dehn, head of research at Ashmore Group, explains that although EM FX reserves have declined in aggregate over recent years, this has been caused by the fall in reserves in a small number of countries – in the vast majority they have continued to rise. He also takes a look at how the situation is developing in Venezuela and the implications for bondholders, as well as at the Kenyan elections as they unfold today.
EM central banks still control 76% of global FX non-gold reserves
The stock of FX reserves controlled by EM countries has declined in aggregate in recent years, but the decline has mainly been due to falling (but now stabilising) reserves in a small number of large countries, including oil producers and China. By contrast the vast majority of EM countries have seen their FX reserve levels rise albeit at a slower pace. This increase has taken place in spite of lower commodity prices, a stronger Dollar, capital flight and Fed hikes.
Reserves are now showing signs of stabilisation in large oil exporting countries and China, where reserves have now reached 3.08trn, an increase from last month and from the low of USD 3.00trn in January 2017. This bodes well for overall EM FX reserve levels going forward. Emerging Markets (EM) central banks today control 76% of global FX non-gold reserves, or USD 8.5trn. This means that EM’s share of global FX reserves has been unchanged from 2007 to this day despite the global financial crisis. Note that in the intervening period, EM’s share of FX reserves briefly reached 80% before rapid accumulation of reserves in Switzerland and Japan due to FX interventions drove the EM share lower.
The sharp decline in EM FX reserves from 2014 onwards was mainly due to lower oil prices hitting some large EM oil producers, including Saudi Arabia and Russia. Chinese reserves also dropped significantly around the time China abandoned the Dollar peg, although a significant part of China’s reserve loss at the time was due to currency effects (since reserves are generally measured in Dollars and China has significant non-Dollar currencies within its reserve basket).
Venezuela: An oil company with a country attached
Local and foreign revulsion at the Maduro regime’s recent power grab has increased, though, so far, without triggering regime change. In fact, events in recent days may have further strengthened Maduro’s position. The government crushed an alleged coup in the city of Valencia and is now likely to exploit this episode as a pretext for further repression. The members of a controversial Constituent Assembly were sworn in and immediately removed Public Prosecutor Louisa Ortega, a major critic of the government, from office. The Constituent Assembly ranks above the National Assembly, Venezuela’s parliament. The Maduro Administration also showed largesse by saying it might not dissolve the National Assembly and by releasing opposition leaders Leopoldo Lopez and Antonio Ledezma from prison and putting them back into house arrest. These moves may be aimed, perhaps, at forestalling further US sanctions.
A muddle-through scenario accompanied by plenty of volatility, but also continuing debt service looks like the most likely outcome. Following last week’s Constituent Assembly election the political dynamics in Venezuela have quickly reverted to a familiar pattern, where the Opposition tries to pressure the Maduro Administration into talks by marching through the streets of Caracas, while the government offers concessions in order to exploit divisions within the Opposition only to renege later and take ever more power. Venezuela is to all intents and purposes an oil company with a country attached. Unless and until the country as a whole gets serious about taking back power from President Nicolás Maduro’s increasingly autocratic government these dynamics are unlikely to change much.
All else even, this should be ok for bond holders, since the one thing that could unseat the Maduro Administration would be a default, which would result in a collapse in oil exports as working capital credit lines to PDVSA, the state oil company, would be cut. The US imposed personal sanctions on President Nicolás Maduro, but has so far shied away from oil and financial sanctions. Personal sanctions on Maduro make a great deal of sense, because they do not hurt an already weakened population. They also do not wrongly target bond holders, who, after all, are merely trading bonds in the secondary market and not providing new financing for the government, since the primary market for Venezuelan debt has been closed for some time.
Further sanctions cannot be ruled out, especially in light of evidence that the government tampered with the referendum result. Oil sector sanctions would be very disruptive, but Venezuela could still re-route oil to Asia. Financial sector sanctions would be even more serious, in our view. Even trading with Asia would be challenging without Dollars and Venezuela would in any case not be able to acquire the Dollars required to meet its debt service obligations. However, broad sanctions on the Venezuelan oil industry would also impact the US oil and gas companies operating in Venezuela and US refiners, which import nearly 800k barrels of Venezuelan crude per day. Some two thirds of Venezuelans, including leaders of the Opposition, currently disapprove of any form of economic pressure against the country. US National Security Adviser H.R. McMaster appears to be sensitive to these arguments: last week he said that the US would not impose sanctions which hurt the Venezuelan population.
Meanwhile, Russian energy giant Rosneft has agreed to help PDVSA by making early payments for oil supplies and says it stands by its investment plans in Venezuela. It is possible that US sanctions against Russia have made the latter keener to support countries, which irritate the US, such as Venezuela.
Political noise is increasing ahead of Kenya’s general election today with the murder of a prominent election official and a public spat between political groups and the Judiciary. Kenyan elections often descend into violence since the two main political groupings are closely aligned with the two main ethnic groups, Luos and Kikuyus. Polls are very close, which suggest a run-off between incumbent President Kenyatta and challenger Raila Odinga.
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