Russia's 'Grain Diplomacy' and EU - Mercusor Historical Breakthrough

Hi all,

Rift between OPEC members over new production cuts, investors express confidence in U.S. debt, ECB stopped hiking, Russia tries to win over African countries with free grain, and the EU nears a historic deal with Latin America.

Let’s dissect.

Markets Snapshot

Oil Prices and OPEC+ Meeting

• OPEC+ extended voluntary oil production cuts in 2024 for market stability last Thursday. Saudi Arabia pledged a 1 million b/d cut extension, Russia increased export reduction to 500,000 b/d, and Angola was instructed to reduce by 170,000 b/d.

• Angola has refused to accept a new output quota and expressed intentions to breach it, marking a rare challenge within the cartel and signaling potential for continuation of the increased internal discord. For Angola, a surge in oil production is crucial to fund its expanding interest obligations and uplift its depreciating national currency. For Saudis, oil price of $100 per barrel is crucial to fulfill the financial demands of its capital investment projects and economic reform programme. A noticeable rift has emerged within OPEC+, as members' objectives no longer align.

• After Angola opposed OPEC's decision, President Biden promptly hosted Angolan President Joao Lourenco at the White House, and, expectedly for some, here's what happened😅

  

  Source: X

• Market confidence in OPEC’s ability to maintain price stability is waning, attributed to expectations of modest demand growth from countries like China and increased alternative supplies. Evidently, crude prices failed to rally after OPEC+ decision to cut oil supplies: Brent crude went down by as much as 5% after the OPEC+ meeting, as of the market close on Friday. Although, considering the increases earlier in the week, the price has barely changed for the last week.

US Treasury

• US 10Y treasury yields declined to approximately 4.2%, driven by robust demand in recent treasury auctions and the anticipation of imminent interest rate cuts. Significant participation from foreign investors in the latest auctions signals a shift in market sentiments.

• Christopher Waller, who is one of the Fed’s most hawkish policymakers, expressed confidence last week that monetary policy was in the right place, and if inflation continue to fall, “you could then start lowering the policy rate just because inflation’s lower”.

Global Finance

Pause in Hikes from the ECB

• European Central Bank President Lagarde announced a pause in the bank's tightening measures, allowing for an assessment of their impact on the economy.

• The effects of the aggressive tightening campaign since mid-2022 are evident, with a slight contraction in the euro area GDP in Q3 2023. Factors contributing to the economic stagnation include higher interest rates, decreased foreign demand, and diminishing impact of economic reopening.

• The ECB remains focused on its price stability mandate: Inflation, at 2.9% YoY in October, is anticipated to furhter decelerate, although overall price growth may accelerate in the coming months with the "considerable uncertainty" surrounding the medium-term outlook.

• The EUR hit USD 1.1, its highest since August, driven by the ECB statements. Investors now turn attention to upcoming November inflation data.

Should MDBs take a hit in sovereign debt restructuring?

• Sovereign debt restructurings have significantly risen in recent years, involving countries such as Argentina, Sri Lanka, Ghana, and Zambia defaulting on its debt. Moreover, the International Monetary Fund (IMF) has seen the number of countries classified as in debt distress or at high risk more than double since 2015.

  Sovereign debt restructuring involves changing the terms to make debt service payments more manageable (changing maturities, adding grace periods, reducing the principal amount of the debt, reducing the interest rate, debt service suspension, etc.)

• In response, global institutions like IMF and World Bank as well as members of the Paris Club created framework to expedite the debt restructuring process. The Debt Service Suspension Initiative (DSSI) resulted in a $12.9 billion payment suspension for 48 participating countries. The Common Framework, succeeding the DSSI, also allows limited write-downs. However, participation has been limited to Chad, Ethiopia, Zambia in 2021, and Ghana in 2022.

• While bilateral creditors advocated for both initiatives, they also encouraged the private sector and MDBs to engage in debt relief efforts. However, despite calls for MDBs to suspend debt service payments for borrowers, no MDB has been participated in a debt restructuring due to its status as a preferred creditor, essentially safeguarding them from losses. In other words:

  

  Preferred Creditor Status (PCS) is a widely accepted principle under which MDBs are given priority for repayment of debt in the event of a borrower experiencing financial stress.

• Some analysts believe that resolving the sovereign-debt crisis necessitates the involvement of MDBs in restructurings alongside bilateral and private creditors. However, to ensure fair burden sharing, losses should be determined through equitable rules for treatment comparability, taking into account the cost of lending.

Our thoughts:

• The debate over whether multilateral development banks (MDBs) should bear losses alongside other creditors is highly contentious. Countries such as China, with significant commercial creditors extending capital to sovereigns, and having recently incurred losses, advocate for MDBs to accept losses equally.

• There is no international bankruptcy mechanism for countries that default on their external obligations. However, the involvement of all external creditors, including MDBs, in debt restructuring would eliminate notions of unfairness or free riding. This, in turn, could enhance the willingness of bilateral and private creditors to engage in negotiations.

• Another aspect to consider is that MDBs' participation in debt restructurings on equal terms with other creditors could significantly impact their business models. This might necessitate substantial increases in loan pricing and more frequent capital raises for MDBs.

Feel free to let us know your thoughts on this isssue by replying to this post/email.

Geopolitics

In pursuit of African Geopolitical Validation, Russia Acts

• Russia is poised to start delivering free grain to African countries within a couple of days, following President Vladimir Putin’s pledge in July according to Bloomberg.

• As reported by the Russian Ministry of Agriculture, the shipments of 200,000 tons of grain by year-end will go to Somalia and Burkina Faso first. Other recipients, including Zimbabwe, Mali, Eritrea, and the Central African Republic, are expected to receive between 25,000 and 50,000 tons each, a small portion of their overall consumption.

• The Ministry also monitors grain stockpiles to safeguard local supplies. An export ban is recommended if domestic stocks dip below 10 million tons, with monthly inventory checks initiated by the government.

Our thoughts:

• Through grain donations, Russia aims to bolster its influence in Africa and address criticism regarding its major role in global food price hikes and disrupted supply chains due to the war in Ukraine. After halting the Grain deal in July, Putin swiftly pledged grain shipments to African nations as an alternative in a strategic move to gain favor on the continent. As reckless as it may sound, this tactic partially works in winning back some countries in the region, given the shortage of food commodities.

Two Decades into Making: EU and Mercosur Nearing a Deal

• The EU and Mercosur countries are on the brink of concluding a historic trade agreement, marking the culmination of over two decades of negotiations. EC President Ursula von der Leyen and Brazilian President Lula da Silva intend to finalize the deal, pending approval of other Mercosur members, especially Argentina.

  Mercosur is an economic and political bloc consisting of Argentina, Brazil, Paraguay, and Uruguay established by the Treaty of Asunción in 1991.The main objective of Mercosur is to bring about the free movement of goods, capital, services, and people among its member states.

• The agreement would establish an integrated market comprising over 780 million consumers and accounting for a quarter of the world's Gross Domestic Product (GDP). It is projected Mercosur will reduce tariffs on 90% of its imports from the EU in the next 15 years, while the EU will be able to eliminate tariffs on 93% of its imports from Mercosur within a 10-year timeframe.

• The European Commission projects potential savings exceeding $4.4 billion in tariffs enhancing Europe's access to minerals vital for renewable energy applications. Simultaneously, farmers in Mercosur countries anticipate significant benefits in the export of beef, coffee, and soybeans to the EU.

Our thoughts:

• Despite the optimism four years ago when the deal was "agreed in principle," finalizing and ratifying the EU-Mercosur agrement has always faced political and economic hurdles. EU interest groups emphasize sustainability, labor rights, and animal welfare standards. For instance, some of the member states advocated for more rigorous external monitoring and protections against Amazon deforestation than the Brazilian government was willing to accept.

• While it's premature to definitively conclude the successful finalization of the agreement, both parties are more motivated than ever before. Lula, committed to end Amazon deforestation and new improved climate targets, is reversing his predecessor's cuts. EU politicians, having recently failed to sign deals with India and Australia, are eager to secure economic trade agreements before the upcoming EU parliamentary elections, bringing the puzzle closer to completion.