Financing conditions are tougher worldwide, but are especially an issue for banks in emerging markets. However, some of these banks are reaping unexpected benefits.
Banks in the Caucasus region, which includes Armenia, Georgia and Azerbaijan, and also those in Uzbekistan, have benefited from the geopolitical turmoil caused by Russia’s invasion of Ukraine.
Since last year, these countries have seen a massive inflow of capital from Russia and Ukraine as well as an increase in the number of professional and skilled migrants.
As a result, Georgia’s gross domestic product expanded by 10.1% in 2022, with Armenia jumping 12.6%, while Uzbekistan’s expansion was more limited at 5.7%, according to World Bank data.
Benefiting from improved macroeconomic conditions, Bank of Georgia recorded a 134% increase in pre-tax profits to $605m, while the National Bank for Foreign Economic Activity of the Republic of Uzbekistan reported pre-tax profits of $391m, growth of 193.17%.
“The war in Ukraine made investors worried about investing in the region,” Natalia Yalovskaya, director of financial institutions at S&P Global Ratings, told a panel at the Global Emerging Markets Conference organised by S&P Global Ratings in London on July 11.
“At the beginning of last year, we were much more concerned about the region because of its close ties with Russia, worried they would have performed poorly, but the reality was absolutely different,” Ms Yalovskaya added. “Except Azerbaijan, which is still struggling with growth, these economies have done well, which was a positive message for the banking sector.”
It is very difficult to predict how many people will try to relocate their capital from Russia to the region, and for how long these countries will keep expanding on the back of a positive external environment.
These markets, which have previously relied on domestic financial sources of funding, traditionally do not have access to external capital markets.
What next for Turkish banks?
Other countries have been facing more turbulent times. A lot of attention is now on Turkey, as president Recep Tayyip Erdoğan names his new cabinet after being sworn in for a third term in office in June.
With newly appointed central bank governor Hafize Gaye Erkan and finance minister Mehmet Simsek, the country seems heading towards economic orthodoxy. While Mr Erdoğan had previously refused calls to raise interest rates to fight double-digit inflation, last month the central bank hiked its main interest rate from 8.5% to 15%.
At the end of June, the country also loosened bank regulations aimed to push consumers and businesses to reduce dollar holdings.
Turkish banks are in a delicate situation: they have around $90bn of external financing to renew in the next 12 months. “They will still be able to tap markets but at higher costs,” says Anais Ozyavuz, associate director, Financial Institutions Ratings at S&P Global Ratings.
“Banks have been accumulating $152bn in liquidity to face any stress scenario, with a large portion of it placed at the central bank. In a stress scenario, the central bank might put restrictions in place to protect the foreign exchange reserves at the country level. I really wonder if banks will be able to roll over a sufficient amount of their short-term debt, without the need to touch that liquidity placed at the central banks.”
“The country needs to reduce the current account deficit, increase their foreign reserves, control inflation without causing a negative impact on the financial sector,” Ms Ozyavuz adds.
Turkey will likely need to increase interest rates quite significantly and no longer use the reserves of the central bank to defend the lira, therefore letting the national currency depreciate. Such a policy reset will hurt the country’s growth and affect financial institutions’ asset quality. The higher cost of funding will also affect their profitability.
“I think the ones that will be most affected will be state-owned banks, which have been really aggressive over the last year in terms of growth at all costs and which are highly exposed to the construction and energy sectors,” says Ms Ozyavuz.
Geopolitical risk
Looking at sovereigns and corporates in emerging markets more broadly, net issuance is actually negative.
“When you actually look underneath the issuance, it’s predominantly investment-grade where the businesses are blue-chip within their country, or have different access to financing,” says John Gray, senior portfolio manager for emerging markets at Legal & General Investment Management.
“The lower investment flow is a common concern for banks in emerging markets but there is still space for high-quality assets,” he adds, mentioning the recent $750m bond issuance by Abu Dhabi Islamic Bank, which was nine times oversubscribed at a time when other financial institutions have struggled in their issuances.
Geopolitical risks will remain a part of the equation for banks in emerging markets, sometimes in a way outside their control. Few in the industry could have predicted the situation in Russia in terms of the strength of sanctions.
“I expected Vnesheconombank to be completely barred. But what about the rest of them? Perfectly good credits being absolutely collapsed by the fact that they couldn’t transmit dollars to bondholders,” says Mr Gray.
Some countries, such as Mexico, are instead set to benefit from more positive geopolitical changes including nearshoring, which is seeing US companies shift production to neighbouring countries rather than relying on Chinese manufacturing and facing supply chain and geopolitical risk.
