Economy

Brad Setser is a senior fellow at the Council on Foreign Relations and a former Treasury Department official. Theo Maret is a research analyst at Global Sovereign Advisory and writes a sovereign debt newsletter.When Zambia announced an agreement with bondholders to restructure its three outstanding Eurobonds, many thought the G20’s Common Framework would finally be able to notch its first major success. Whoops.Alas, the deal was rejected several times by the official sector and the way forward is now unclear. Bondholders are irate. At the heart of the intra-creditor skirmish lies the thorny question of what constitutes comparable treatment for different creditors. Comparability has been the longstanding norm linking the treatments of official and commercial claims. But the assessment is now complicated by a fragmented creditor landscape, limited transparency about the stock of official claims and a lack of trust in existing methodologies, which have grown rusty in the absence of regular use prior to the pandemic. Let’s dive in. Comparability 101Any bond restructuring for Zambia must pass two tests: it must meet the IMF program targets, and it must be judged to be comparable with the complicated deal Zambia reached with its official creditors back in late June.IMF targets include indicators derived from the Fund’s debt sustainability analysis — for Zambia, external-debt-to-exports and external-debt-service-to-revenue ratios — as well as the closing of balance-of-payments financing gaps for each year of the IMF program.Comparability of treatment is the idea that the terms of the private bank and bond restructurings should be “comparable” to the terms of the restructuring of official bilateral creditors, ie loans made by other governments and government-backed export credit agencies.To assess comparability, the Paris Club uses three different formulas: nominal debt service relief over the IMF program period, extension of the duration of the claims, and reduction of the debt stock in present-value terms (see this World Bank note for more details). Official creditors then make a judgment based on the three comparisons.The inclusion of China among official creditors has generated pressure to firm up the comparability requirement. China isn’t keen to subsidise private bondholders which it considers have gotten too sweet deals in the past (private creditors notably did not participate in the 2020 G-20 Debt Service Suspension Initiative). At the same time, traditional bilateral lenders aren’t keen to subsidise Chinese lending that is sometimes perceived as . . . reckless.Making sense of what happened in ZambiaZambia’s debt stock is complex, with a mix of official creditors — the largest being the Export-Import Bank of China with over $4bn owed — another $3.85bn in Eurobond claims, and about $3.5bn owed to commercial banks, including large Chinese state banks. There’s also $2.7bn in non-resident holdings of local currency bonds, excluded from the restructuring but counted as external debt by the IMF.Virtually every substantive issue possible in a restructuring is thus on the agenda (zoomable version).© IMFAll the theoretical considerations about IMF targets and comparability became very real for Zambia when the IMF and official creditors — notably China — in November rejected a bond deal that provided a roughly equal NPV haircut to the official sector deal, but differed on other dimensions.The IMF’s objections, luckily, were narrow — Zambia and bondholders agreed to make the adjustments needed in an updated deal. Yet even with the adjustment, the Official Creditor Committee (OCC) did not bless the deal.Bondholders have provided a table showing how their proposed deal scores on the three comparability criteria. The OCC did not push back on the below numbers, so we’ll take them at face value (pun intended). NB, it’s been reported that a third version of the deal was presented by the country to official creditors, and rejected again, but no details have publicly emerged, and we understand it is close to these last public figures (zoomable version).The table shows that bondholders have a strong preference for short-term cash flows, and thus the debate becomes how much additional present-value reduction is needed to compensate for more upfront cash — the 1 percentage point embedded in the base scenario is apparently not enough for the Paris Club and China.This stalemate illustrates the main issue with the current implementation of comparability: it’s ultimately a subjective judgment, making it impossible to know in advance how concessions on one dimension need to balance with greater effort on others. No one knows for sure how to trade NPV for upfront cash: per Zambia’s statement there is not even consensus among members of the Official Creditor Committee on this critical issue, arguably the result of having new players like China at the table. Bondholders understandably aren’t keen on continuing a FAFO “try and see” back-and-forth with the official sector, arguing that the official sector is intervening in their own negotiations with the country.To add additional intrigue, Bloomberg reported that China obtained approval from the authorities in Beijing to sign off on the June deal based on indicative terms for bondholders that were substantially harsher — 10 percentage points of additional present-value reduction — thinking these terms were final. The bondholders weren’t told about this until later. Other bilateral creditors have suggested a roughly 5 percentage points difference in present-value reduction between the official creditors and bondholders would work.What is the price of a haircut?One argument raised by bondholders is that their principal haircut should be taken into account when assessing comparability, in effect adding a fourth substantive indicator.However, the argument only really gains political merit when the face value of the new debt instruments is being reduced below its level at the time the country first got into trouble. Zambia’s restructuring process has been exceptionally slow. Accumulated past due interest (PDI) has added enough to the bondholders’ legal claim that the face value of the new bonds is set to be higher than that of the old ones, even after the proposed haircut.Bondholders are not alone: official creditors have also accumulated past due interest, yet they have not properly disclosed the size of their claims pre- and post-restructuring — it would help if they were more transparent. To be sure, PDI is a contractual right, and bondholders weren’t responsible for the lag between Zambia’s default and the start of real negotiations — they would rather have had performing bonds than a growing legal claim. Proposals to scrap PDI altogether go too far; a better approach would respect contractual claims without allowing the rise in claims to pull up estimates of what the country actually can pay.The classification of Chinese claims comes back to biteZambia faces another complexity. The contemplated bond treatment would apparently not leave enough cash flows within the IMF envelope if other commercial creditors were to take the same deal. As a Paris Club official told Reuters:If bondholders’ debt relief fell short of expectations, that also raised questions about the effort that would be needed from other private creditors like banks and some Chinese institutions.IMF thresholds indeed are a zero-sum game: commercial creditors standing last in line might be required to do “more” than official creditors or bondholders to fill the restructuring envelope.Historically this was not much of a problem, but in Zambia’s case, China concluded that only China Ex-Im was an official creditor: in June 2023 $1.7bn in claims backed by China’s export credit agency — originally counted as official — were reclassified as commercial.In hindsight this policy choice created a bit of a mess: all the Chinese “commercial” claims are owed to state-owned entities, so it isn’t clear if China’s representatives on the OCC are protecting the interest of all Chinese state creditors or simply these of China’s designated official lenders. China’s decision is even backfiring, as its “commercial” banks cannot extract better terms than the Paris Club since comparability is enforced, while bondholders moving first can obtain better terms than Chinese banks without being subject to comparability with other commercial claims.The obvious fix for this procedural nightmare would be for China to put all the claims of entities controlled by the state in the official bucket and empower a single negotiator to represent the interest of all such entities — or even better, transfer all the distressed loans of its policy banks to a bad bank.What’s next?Bottom line, something will have to give. The official creditors should help sort out the immediate mess by clarifying how much present-value reduction is needed in exchange for bondholders getting the lion’s share of available cash upfront. Then, tweaks in the bond deal potentially could help get something close to the last agreement over the finish line.Creditors are taking advantage of the large amount of dollars that the IMF program leaves available in coming years: it allows Zambia to pay about $1bn a year in external debt service in 2024 and 2025, while net reserves are below $2bn and expected to remain under $2.5bn. This high debt servicing in fact corresponds to a surge in official inflows in 2024 and 2025. This should raise questions about future program design: using an increase in preferred debt (from the IMF and multilateral development banks) to allow private creditors to exit generates additional risks to both the Fund and the borrower down the road.But taking a step back, beyond jerry-rigged fixes for Zambia, the time is ripe for a rethink of how best to define comparability. There’s a trade-off between the need for clarity and simplicity — which a unique mathematical formula would provide — and the inherent political aspect of comparability, which has always reflected the specific constraints faced by major bilateral creditors.Right now though, with a broad sense of distrust across the board, there’s a clear need to shift towards the prioritisation of upfront clarity. In Zambia, official creditors agreed to a deal based on the assumption that other creditor groups would accept a significantly higher present-value reduction, and the bondholder deal would not work if other commercial creditors asked for a similar amount of upfront cash.Clarity should start with transparency about the overall scale of the effort needed and the amount of cash available for all creditor groups that are part of the restructuring.The core data needed for the calculations — NPV of claims, interest and amortisation by creditor group during the program, available foreign exchange for external debt service — should be in the actual financing tables of IMF staff reports (the best data currently comes from an outdated investor presentation). This would make it immediately clear if a creditor group was doing a deal that implied an asymmetric effort by other creditors.Some adjustments to the mathematical formulas might then be appropriate, dropping the duration extension (which is redundant) to focus on present-value reduction and the allocation of short-term cash flows. To limit the distorting effect of PDI and incentivise faster deals, the present-value reduction used for comparability could be calculated using either the original face value or the size of the claim at the time of an IMF staff level agreement as the denominator.Apportioning the available cash on the calculated stock, not claims due in the program period, would also makes sense in cases of deep distress. Trades that offer deeper haircuts for more front-loaded cash are in fact often good all around, but they need to be assessed against a clear baseline. Symmetric treatment of the stock inside the perimeter of the restructuring is an obvious choice.Such an approach would create a safe space for quick deals. Any creditor group that agrees to a deal that passes a basic test for maturity extension and does equiproportional (symmetric) NPV debt reduction for an equal share of the available cash flow would not need to wait for other creditor groups to approve the deal. They would of course want a chance to reopen their deal if the issuer and the IMF subsequently agreed to increase the size of the pie (through updates of program parameters, or with state contingent instruments).Of course, this new norm would also place an even bigger premium on the IMF’s ability to rapidly set out parameters ensuring a reasonable balance of effort between debt relief and fiscal adjustment. Squabbles over who gets the biggest slice of the pie are less important than getting the size or the flavour of the pie right: the real debate should be over the level of debt that the issuer can support, with and without state contingent features, not which creditor can score a better deal than others. More

1. Futures inch lowerU.S. stock futures edged down on Wednesday, as investors looked ahead to the release of minutes from the Federal Reserve’s latest policy meeting.By 05:09 ET (10:09 GMT), the Dow futures contract had dipped by 56 points or 0.2%, S&P 500 futures had shed 11 points or 0.2%, and Nasdaq 100 futures had fallen by 76 points or 0.4%.The benchmark S&P 500 and tech-heavy Nasdaq Composite both lost ground in the first day of trading of 2024, weighed down in part by ebbing hopes that the Fed will roll out interest rate cuts early this year. Meanwhile, the 30-stock Dow Jones Industrial Average gained just under 0.1%.In individual stocks, shares in Apple (NASDAQ:AAPL) sunk by around 4% after analysts at Barclays downgraded their rating of the iPhone maker, citing weak hardware demand and concerns over revenue at its services division. Nvidia (NASDAQ:NVDA), Google-parent Alphabet (NASDAQ:GOOGL) and Microsoft (NASDAQ:MSFT) — who, along with Apple, form part of the so-called Magnificent Seven group of tech firms that helped drive a stellar 2023 for stocks — also declined.”The impressive rally into year[-]end has faded a bit despite the seasonal tailwinds, but we expect the loss of short[-]term momentum to be modest,” analysts at Fairlead Strategies said in a note to clients.2. U.S. Treasury yields climbAlso denting stocks on Tuesday was a rise in U.S. Treasury yields, in a possible sign that markets’ excitement over the prospect of Fed rate cuts early this year may be easing.The yield on the benchmark 10-year note — a key gauge of long-term estimates for borrowing costs — briefly touched an over two-week high, while the yield rate-sensitive 2-year also moved up. Prices typically fall as yields increase.At the end of 2023, the 10-year Treasury yield was under 3.9% following a strong rally to cap off the year that was driven by expectations for early Fed rate cuts and a so-called “soft landing” for the U.S. economy. In this scenario, the Fed’s aggressive rate hiking campaign successfully cools inflation without sparking a meltdown in the broader economy.Bolstered by the jump in Treasury yields, the U.S. dollar index, which tracks the greenback against a basket of its currency pairs, had its best daily performance since March 2023.3. Fed minutes aheadTraders are now turning their attention to the minutes from the Fed’s December gathering, which are due out at 19:00 GMT on Wednesday.How officials see borrowing costs evolving in the coming months could factor into the staying power of recent bets that the U.S. central bank will soon begin to bring down interest rates from a more than two-decade high.In December, the Fed left rates unaltered at a range of 5.25% to 5.50%, but signaled that its unprecedented tightening cycle aimed at corraling elevated inflation may have peaked. New forecasts from policymakers also suggested that they may slash rates by 75 basis points this year, an outlook that was more dovish than prior projections.Speculation over potential rate reductions fueled a late-year surge in stocks, although many officials have since attempted to temper this enthusiasm. The minutes could provide even more insight into the Fed’s thinking.4. Sales of Tesla’s China-made EVs surge in DecemberSales of Tesla’s electric vehicles (EVs) made in China surged by 68.7% on a yearly basis last month, new data from the China Passenger Car Association showed on Wednesday, although the U.S. carmaker still faces intense competition in the country.The December total, which includes exports, brought Tesla’s annual amount of China-made sales up to 947,742 — just over half of the company’s global deliveries.Tesla’s Shanghai plant is its largest production hub, supplying China and other countries like New Zealand and Australia. The group has outlined plans to expand its EV capacity at the factory, but the move has yet to receive regulatory approval from Beijing.The latest CPCA numbers come after China’s BYD (SZ:002594) unseated Tesla as the world’s biggest EV maker earlier this week. BYD, who offers both battery-only and hybrid options, delivered 341,043 passenger cars in December, an increase of 45% year-on-year.5. Oil slipsOil prices retreated Wednesday, ahead of the release of crucial weekly inventories data from the U.S., the world’s largest consumer.By 05:09 ET, the U.S. crude futures traded 0.6% lower at $69.94 a barrel, while the Brent contract dropped 0.5% to $75.53 per barrel.U.S. crude stockpiles from the American Petroleum Institute industry group are due later Wednesday, a day later than usual due to Monday’s New Year’s holiday. Official data will then be published on Thursday.The crude benchmarks had climbed sharply earlier in the week after attacks on vessels in the Red Sea by Houthi rebels raised concerns over potential supply disruptions through this key region. More

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IMF Deputy Managing Director Gita Gopinath in December said that if the world economy and trade fragmented into two blocs – implying predominantly the U.S. and Europe in the West and China and Russia in the East – global gross domestic product could be cut by 2.5% to 7%.”A trade war, a science and technology war, exercises in decoupling or de-risking are, in essence, the politicisation of economic and trade issues,” said Wang Wenbin, a Chinese foreign ministry spokesperson.”This is immoral and unsustainable and ultimately affects the overall interests of the international community.”The world’s two biggest economies used to be each other’s largest trading partners. While both governments publicly oppose decoupling, China is now trading more with Southeast Asia, and the U.S. with neighbouring Canada and Mexico.China has imposed exports curbs on a number of critical minerals, such as graphite – of which it provides 67% of global supply – citing national security concerns. The United States opposes export controls announced by China on gallium and germanium, metals used to produce semiconductors and other electronics. Meanwhile, the U.S. has placed restrictions on the export of semiconductors and the equipment to make them to China, also citing security concerns.”China is willing to work with all parties to advocate inclusive economic globalisation, resolutely oppose anti-globalisation and oppose all forms of unilateralism and protectionism,” Wang said. More

Two of China’s biggest state-owned banks and a leading joint-stock bank have stepped up reviews of smaller lenders over the past couple of months to identify those with poor asset quality and have a high risk of default, the sources said.The two state-owned banks have decided to reduce interbank lending limits and set shorter maturity periods for smaller peers deemed high risk, said two of the sources.All the sources, who spoke on condition of anonymity due to the sensitivity of the issue, have direct knowledge of the matter.The move comes amid growing worries about the health of the smaller banks in the world’s second-largest economy, as a deepening property sector crisis and ballooning local government debt make them the weak link in the financial system.The cautious approach taken by some big banks in dealing with smaller peers could exacerbate capital woes for the latter as they have fewer other fundraising options, which could force Beijing to step in with more supportive measures.While the larger Chinese banks mainly use customer deposits – a stable and long-term funding source – to make loans, in recent years smaller lenders have been aggressively borrowing from local rivals to raise funds.China’s mid-sized and smaller banks account for roughly half of the trading volume in the interbank lending market, data from the China Foreign Exchange Trade System (CFETS), which is overseen by the central bank, showed.One of the sources, a senior official at the leading joint-stock bank which is among those to review credit exposure to smaller peers, said the bank had tightened its criteria for lending to smaller banks.As part of that, it has stopped purchasing bonds issued by smaller banks that have total assets below $40 billion, said the source.The People’s Bank of China (PBOC) and the National Financial Regulatory Administration, the watchdog overseeing all aspects of China’s $63 trillion financial sector, did not respond to Reuters request for comment.LIQUIDITY GAPAs China grappled with the impact of the slowing economy on the financial system, the local authorities have been taking measures to support the banking system, especially the smaller ones to maintain financial stability.As part of those measures to prevent financial risks, some of China’s local governments sold record amounts of so-called special bonds last year to inject capital into troubled small regional lenders.The state media reported last month, citing the Central Economic Work Conference held on Dec. 11-12, during which top leaders set economic targets for 2024, that it was necessary to effectively resolve risks in small and medium-sized banks.Although roughly 4,000 small banks are not by themselves seen as a systemic risk, the concern is that enough of them have largely funded themselves via short-term money market borrowing, posing a collective danger in the event a few of them fail.Greater use of interbank lending for funding purposes makes banks more sensitive to counterparty risk.While the country’s Big Five banks, including the likes of Industrial and Commercial Bank of China and Bank of China, dominate the sector, smaller banks still account for a quarter of assets, according to regulatory data.The second source at one of the big state-owned banks said some of the small lenders his firm had reviewed and deemed risky were in highly indebted areas such as parts of Northeast China, the Inner Mongolia region, and Henan province.Rates for negotiable certificates of deposit (NCDs), usually a routine fundraising tool for small lenders, have risen steadily since August, partly due to a liquidity gap in recent months amid a heavy debt supply.The interest rate on one-year NCDs sold by small and medium-sized rural commercial banks reached 2.84% in mid-December, the highest level since August, according to a research note by Chinese brokerage TF Securities.In a sign of growing stress, 10 small and medium-sized banks have defaulted on commercial paper at least three times over six months last year, according to a statement released on Nov. 30 on the Shanghai Commercial Paper Exchange website.The banks include regional lender Ningxia Helan Rural Commercial Bank Co. Ltd., based in northwest China’s Ningxia region, and Shaanxi Baoji Weibin Rural Commercial Bank Co. Ltd., located in northern Shanxi province, the statement said. More

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The Institute of Directors’ (IoD) confidence index – which maps the gap between business leaders who are optimistic about the economy and those who are pessimistic – fell to -28 in December from -21 in November, having gradually risen since June.Expectations for business investment, costs and wages, and headcount were all little changed.Despite the caution, company leaders were more upbeat about prospects for their own businesses with hopes for revenue and export growth rising.Roger Barker, policy director at the IoD, said sentiment among directors had been largely stuck in the doldrums over the second half of 2023 as the impact of higher interest rates took its toll on the economy.”Although aspects of the business environment have improved in the last couple of months, particularly with regard to inflation, this is not yet exerting a meaningful impact on business decision-making,” Barker said.The IoD called on the Bank of England to start cutting interest rates in early 2024. “With inflationary pressures abating, business is in dire need of a boost if it is to help drive meaningful economic growth in 2024,” Barker said.The BoE raised Bank Rate 14 times in a row between December 2021 and August last year, since when it has held its benchmark rate at a 15-year high of 5.25%. Governor Andrew Bailey and other top officials have signalled they want to keep borrowing costs high to ensure inflation pressures are snuffed out.The IoD survey was based on 703 responses from companies polled between Dec. 14 and Dec. 29. More

LONDON (Reuters) -Argentina and the International Monetary Fund are close to an agreement on a review of its $44 billion loan programme, three sources told Reuters, a key step that would put the country on track to unlock the next tranche of funding.Government officials and IMF staff representatives are in talks over the seventh review of the 2022 loan, the sources familiar with the matter said. The review was originally scheduled to be completed in November but was delayed amid a change of government, as President Javier Milei took office on Dec. 10.”An agreement is close, the country is working to get an approval this month,” said one of the sources, who asked not to be named because the talks are private.A spokesperson for Milei declined to comment. An IMF spokesperson said that staff of the agency will travel to Buenos Aires on Thursday to continue negotiations on the seventh review, and added that Argentina will bundle capital payments due in January into one at the end of the month.Argentina is due to pay some $2 billion to the IMF this month.The seventh review, which revises the programme’s performance criteria until September, is key to putting the deal back on course, as it had gone off track shortly after its latest formal assessment in August due to missed targets. If approved by both the IMF staff and the Fund’s executive board, the review will also unlock disbursements for around $3.3 billion.FROM PRIOR ACTIONS TO WAIVERArgentina’s Milei administration has already initiated a formal request for a waiver for the programme after the previous administration failed to meet the goals agreed in August.”The key is that the country’s recent prior actions could allow a waiver on the programme,” one of the three sources said. The IMF usually approves waivers to missed quantitative performance criteria if it believes that a programme “will still succeed,” according to the Fund’s guidelines. The IMF recently hardened its view on Argentina after the country missed fiscal and reserves accumulation targets.The prior actions are steps that a country takes before completing a review. Milei’s administration has laid out a package of economic measures to tackle a deep fiscal deficit, triple-digit inflation and a dearth of foreign reserves. Argentina devalued its peso by 54%, weakening the official exchange rate from 366 to 800 pesos per dollar in December, narrowing the gap with the black-market peso to a level last seen in 2019, when capital controls were imposed. Milei’s government also said it is working on reducing energy and social subsidies to restore fiscal balance in 2024. The IMF called the economic measures “bold,” adding, “their decisive implementation will help stabilize the economy.” Milei has also sent a reform bill to Congress proposing far-reaching changes to the country’s tax system, electoral law and public debt management.Argentina has to pay $2.8 billion on IMF maturities in January and February. The latest loan payment to the IMF was secured via a $960 million short-term financing bridge from the Development Bank of Latin America and the Caribbean (CAF), as the country’s net reserves are in the red.Wall Street bank Morgan Stanley said it expects a fully revamped IMF programme for the country for the second half of the year, according to a note to clients published on Tuesday. More