Ex-Elliott Manager Jay Newman Sees the Worst Wave of EM Defaults In Decades
“It’s almost the perfect storm for EM.”
Emerging markets are facing the worst crisis since more than two dozen developing countries defaulted on their bonds in the early-1980s era, according to the former Elliott Management Corp. portfolio manager who famously went head-to-head with Argentina over its own defaulted debt.
“It’s almost the perfect storm for EM,” Jay Newman says in an episode of the Odd Lots podcast.
The sovereign debt specialist-turned-novelist helped lead Elliott’s 15-year fight against Argentina following its 2001 default, arguing that the country couldn’t restructure its bonds without continuing to pay holdout lenders. The strategy ultimately helped win more than $2 billion for the hedge fund, and at one point led to Elliott seizing an Argentine naval ship.
With developing nations now facing a toxic mix of both higher inflation and interest rates, Newman sees another bust coming to the world of emerging-market debt after years of booming sales and rampant demand. The cost of servicing debt looks set to rise just as investors might be leery of buying new bonds, setting the the stage for a broader contagion in EM debt on a scale not seen since the Latin American debt crisis of the early 1980s, he says.
Back then, countries including Mexico, Brazil and Venezuela were unable to service their debt thanks to the combined effects of a large energy shock and tighter US monetary policy, resulting in a “lost decade” for many emerging markets.
“What we saw there [in the 1980s] was a period in which something like 25 countries defaulted. They defaulted because markets closed to them. And that’s what typically happens. The initial defaults in Poland and in Mexico made lenders very nervous. And when it came time to roll over the debt, there were no takers. That’s what's happening today. I mean, it’s almost an inevitable process. When things are good and money is easy, people pile in and the underwriters find plenty of buyers. But all of a sudden when one country defaults — let's take Lebanon, let's take Sri Lanka — everyone says, whoa, what about Country X and Country Y, Country Z? And then they become nervous. And then the debt can’t get rolled.”
But the wildcard in the current cycle, Newman adds, is China, which has extended hundreds of billions of dollars worth of credit to emerging markets as it seeks to build relationships with foreign governments and secure valuable natural resources. With China now experiencing its own strains, few investors or policy makers know how the world’s second-biggest economy will behave as a creditor in a default scenario. That could complicate the situation for investors and international institutions seeking to renegotiate debt commitments for troubled EMs.
“You’re the G7 and you know that China is the big dog and you know they’ve invested and lent huge amounts of money. You just want to see the contracts. You just want some transparency,” he said. “So Western governments should be insisting as a condition of any restructuring that involves sovereign debt, whether it’s private sector or public sector, that all the creditors come to the table and put out their cards and show what they've got. And that would seem to be a very easy position to coalesce around, but will it be?”
Meanwhile, weakness in the contracts underpinning many EM bonds more generally could also lead to higher losses for investors this time around. Years of low interest rates sent investors scrambling for the higher yields on offer from emerging market debt, and tipped the balance of power in favor of the companies or countries issuing them.
“What is somewhat different in this cycle?” asks Newman. “We saw it two years ago in the case of Argentina in their most recent restructuring is that the bond contracts are so weak. So creditors realize that they don’t have a lot of leverage and because they don’t have a lot of leverage, they agree to deals that are, you know, much, much better for the debtor and much worse for creditors. And I don’t see that changing.”
Argentina’s bonds fell to a record low last week as higher prices push up the government’s domestic debt burden, some 80% of which consists of inflation-linked bonds. At the same time, prices on Argentina’s dollar-denominated debt have been falling as investors eye the country’s dwindling foreign currency reserves.
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The country has defaulted nine times, including the 2001 incident that set Elliot on its fateful collision course with the Argentine government. A new president — Mauricio Macri — helped push through a settlement deal in 2016. Since then, however, Argentina has a new president and is set to hold elections next year as the economy continues to deteriorate, with inflation expected to end the year above 70% annually.
“Argentina is currently being shunned [by debt markets],” Newman says. “But I think it takes a long time for markets to develop that kind of muscle memory. And in the case of Argentina, it’s taken decades and decades for people to realize that fundamentally Argentina is not a reliable counterparty. I think for most other countries that don't have that kind of history of aggressive defaults and repeated defaults, investors are willing to give new governments a chance. I think the question is going to be whether, in the case of Argentina, when and if there is a change of regime, will markets give that new regime a chance?”
Ultimately says Newman, the existing system of sovereign debt is in his view, “completely flawed, completely rotten.”
If he could wave his magic wand, he says, he would “repeal the Sovereign Act and repeal the State Immunity Act,” both of which made it easier for foreign investors to take governments to court. The upshot of such a move would be, in Newman’s view, a world in which it’s not quite so easy for countries to raise hard currency debt from international borrowers, but also one with far fewer extreme boom and bust cycles.
In such a world, he says, sovereigns would be in a position to say “I'll pay you what I want when I want, and you have to trust me.” Adding “It wouldn't make the underwriting community at all happy about it because it would mean that they couldn't sell as many bonds, but wouldn't that be salutary?”
— With assistance by Carolina Millan
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