Fixed Income Boutique
As the global vaccination process progresses steadily and restrictions are lifted, many of us will soon be heading to our first proper holidays in a long while. Tourism-dependent countries have been among the worst hit in the pandemic, but they’re also set to rebound as international travel reopens. In this article, we provide an outlook for some of the most tourism-dependent EMs with outstanding eurobonds.
There are a few large EMs with large exposure to tourism, including Thailand, the Philippines, Turkey and Mexico. However, their exposure is quite modest when compared to island nations and other relatively small but popular tourist destinations (see chart 1).
In this context, we think yields on the Philippines’ external debt (~2% on 10y bonds) are too low for comfort, especially when considering the significant ESG-related issues. Moreover, there are many similarly rated sovereigns offering better risk-reward propositions.
The tourism sector is smaller than the Philippines in terms of GDP at just over 11% but it’s larger as a share of exports, accounting for 17% of FX receipts in 2019. And unlike most EMs, where we saw current account balances improve in 2020, Turkey’s external deficit widened in 2020 as imports rose above pre-pandemic levels driven by a strong credit expansion. The Turkish lira’s depreciation has continued unabated amid chronically high inflation, lack of central bank credibility, and low net FX reserves.
Turkey’s tourism recovery had a setback in Q2 when Germany and Russia imposed restrictions preventing their nationals from visiting the country amid coronavirus concerns. Both countries have reopened their borders with Turkey as vaccinations have been advancing at a good pace and cases have fallen dramatically – about 45% of the population has received at least one jab. This is important because Russia and Germany accounted for more than a quarter of all tourists in Turkey before the pandemic. Nevertheless, tourist arrivals will surely remain well below their 2019 level during the summer of 2021.
This unsustainably high current account deficit is now shrinking as tourism recovers and the central bank has maintained interest rates high at 19% to contain excess domestic demand and get inflation back in control. However, it remains an ongoing risk that is unlikely to be resolved in a sustainable fashion.
We’re not tempted by Turkey’s external debt as we consider the 6.2% yield on a 10-year bond to be insufficient to compensate for the risks of this B+-rated sovereign.
Egypt’s macroeconomic fundamentals are slightly worse than Turkey’s on the whole (it’s rated one notch below at B) due to much higher public indebtedness and lower GDP per capita, but its balance of payments position appears to be on a more sustainable footing, not to mention lower policy risk. More importantly, Turkey’s story has been one of deteriorating fundamentals in the last few years, while Egypt’s fundamentals have been consistently improving through successful IMF programs. Egypt’s yields are higher too, especially on the long end of its external debt curve.
Although we don’t have up-to-date data on Egypt’s tourism sector, we know first-hand and through anecdotal evidence that the tourism recovery in the Red Sea is well underway. Egypt has been among the slowest countries in the world in terms of vaccinations, yet, they prioritized vaccinating all tourist-related staff working in the Red Sea resorts, which has allowed the sector to recover at a reasonably good pace. Tourism accounts for over a quarter of Egypt’s FX receipts, so the policy of prioritizing the sector is understandable in this low-middle income country. Finally, Russia has resumed direct flights to Egypt after a long hiatus. Flights from Russia had been suspended since 2015, when a Russian passenger plane crashed in Sinai. At the time, Egypt was one of the most popular destinations for Russians, so this will certainly provide a boost to the ongoing tourism recovery.
This archipelago in the Indian Ocean is the most tourism-dependent EM with outstanding international bonds. More than 85% of its FX receipts came from tourism and travel before the pandemic. Therefore, it’s not surprising that the archipelago’s sovereign external debt was trading at distressed levels in 2020. In other words, the perceived risk of default was perceived as significant. However, a big advantage of small island-nations is that they can be easily bailed out by much larger bilateral and multilateral partners. A relatively small loan – from a global macroeconomic point of view – can be of enormous help for these kinds of countries. Maldives has been benefiting from the G20 Debt Service Suspension Initiative since 2020, saving the sovereign 0.9% of GDP in debt service in 2020 and 2.5% this year. Moreover, in September 2020, India provided a 250 million US dollar soft loan to the Maldives – 4.4% of GDP and enough to cover three months of the country’s external financing needs at a time when the sovereign had lost market access.
This bilateral and multilateral support and the ongoing recovery of tourism allowed the Maldives to recover market access. Maldives got a head start in the global recovery of tourism, which mirrors the K-shaped recovery observed across the world. Being an exclusive luxury destination, it’s not surprising that by December 2020, it had already recovered 56% in terms of tourist arrivals, while mass tourism destination remained mostly closed at the time. By March 2021, tourist arrivals had recovered by 67% compared to March 2019 and Maldives was able to regain market access and issue a new Sukuk international bond at ~10% yield and repurchased three-quarters of their 2022 maturing bond with part of the proceeds. Maldives’ 2026 Sukuk bonds have performed well since then and now trade around 9.2%.
The composition of tourism in the Maldives has changed radically since the pandemic driven by the imposition of travel restrictions. China used to be the top country of origin for Maldives tourism, but it was still down 99% (vs 2019) and ranked 55th in May 2021. Russia, in contrast, climbed from sixth to number one, expanding 162% year-to-date when compared to 2019. This is not the artifact of some statistical base effect, but probably a reflection of lack of choice given the limited number of luxury travel destinations that are currently available for Russian residents. Therefore, we should expect a moderation in the number of Russian tourist but this will be more than compensated by the recovery in tourism from China, Europe, and the US. We expect Maldives bonds to perform well as tourism continues to recover amid good progress in vaccinations in the archipelago and in most of the top countries of origin of this destination.
Another archipelago in the Indian Ocean, but one that is not as dependent on tourism as the Maldives (85%). Tourism represents about 40% of Seychelles’ FX revenues, making it more comparable with more diversified island-nations like the Dominican Republic or Barbados. Seychelles came to the fore in the global news recently because no other country has managed to fully vaccinate 70% of its population against Covid-19 yet. A laudable, yet relatively manageable achievement for their population of less than 100,000. Despite this, new Covid-19 cases remain among the highest in the world on a per capita basis, which probably has deterred some tourist from booking their tickets to this Indian Ocean paradise. Seychelles re-opened to international tourists in late March and received 84% as many tourists in May 2021 as two years before, evidencing holidaymakers pent-up demand. But arrivals dwindled in June to 56% of their June 2019 numbers.
The uncertainty outlook for global tourism probably contributed to the government’s decision to request a 107 million US dollar IMF program, which was approved on July 7. This may not sound like much by international standards, but it’s about 6.3% of GDP, and it’s probably enough to cover the country’s external financing needs for the duration of the 28-month program. Seychelles is a much smaller economy than the Maldives and has no short-term maturities coming due. Thus, we don’t think Seychelles will need to issue new eurobonds in the short-term. With no supply in sight and support from the IMF, we think Seychelles bonds are likely to perform well even if the recovery of global tourism remains gradual.
The Caribbean, in our view, offers a mixed bag, from relatively bright in the Dominican Republic to an ongoing debt restructuring in Belize. Here we'll focus on two relatively bright stories in this region.
Like Seychelles and the Maldives, the Bahamas is a highly tourism-dependent archipelago-nation, which earns more than 70% of its FX revenues from travel and tourism. But the Bahamas has a few things on its favor that differentiate it from most EMs. Its GDP per capita ($33,000) is comparable to that of developed nations like Portugal ($34,000), and higher than that of Greece ($29,000). It’s also one of the least corrupt countries in the world (percentile 84), on par with the US as per Worldwide Governance Indicators. Likewise, political risk appears minimal. Moreover, its financial system represents 10% of its GDP, which is as large as accommodation and food in terms of value added. This is important because countries with a large domestic financial system can finance a large share of their fiscal deficits domestically rather than externally – a key strength when facing sudden stops in capital flows such as in Q2 2020.
Yet, The Bahamas’ international bonds maturing in 2032 yield about 7.3%, which place it squarely among the highest yielding EMs (excluding those in distress) despite its otherwise developed-country characteristics. A key to this puzzle is the fact that the Bahamas is not in the JP Morgan EMIBG diversified index because its GDP per capita is above the maximum threshold allowed to be classified as an EM. This implies that unlike more liquid sovereigns, the Bahamas does not receive inflows from passive investors, which is also the case for the Maldives and Seychelles.
The vaccination process has been rather slow, but tourism has been recovering consistently through the year (see Chart 2) thanks to the rapid progress in vaccinations in the US, the main source of tourists for this destination. The Bahamas managed to pre-finance its fiscal deficit for 2021 through a combination of domestic banks, multilateral loans, and a eurobond issuance in October 2020. We think the Bahamas will probably come to the market again towards the end of 2021, but it will be much better positioned to issue at significantly lower yields than in 2020.
In May 2021, economic activity was already 4.3% above the levels of February 2020 on a seasonally adjusted basis. This is not an artifact of a low base effect, the economy had fully recovered by February 2021 on the back of fiscal and monetary stimuli and record-high remittances from the US. A large Dominican diaspora in the US has made sure that the multiplier effect from the US fiscal stimulus spills over in a timely manner. Tourism is also recovering at a good pace thanks to the good progress in vaccinations both in the US and domestically, with 45% of Dominican having already received at least one jab. By May this year, tourist arrivals had recovered by 75% of their pre-pandemic levels.
But there are risks to this relatively bright outlook. Inflation is currently above 9% and while the central bank argues that most of it will be transitory, the currently fast-paced growth may have to be tamed with some monetary tightening towards the end of the year. The government also needs to narrow its fiscal deficit to make sure debt remains on a sustainable path after the pandemic. The administration is considering a fiscal reform to be implemented in the 2022 budget, but the protests witnessed in Colombia discourage the government from pursuing a relative quick fiscal consolidation despite fast growth. Moreover, spreads on its dollar bonds are basically back to their pre-pandemic level as plenty of investors are aware of the island’s relatively bright outlook.
There are plenty of opportunities to profit from the recovery of global tourism in the EM fixed income space, but also plenty of risks including special situations likes those in Sri Lanka and Belize. Overall, careful selection remains key.