Long-Ignored Balkan Bonds Find Converts From IMF Accolade

(Bloomberg) -- The one Balkan nation that was largely overlooked in the hunt for yield this year may be on the cusp of a bond-market turnaround as the International Monetary Fund throws its support behind the country’s economy.

Serbian debt is set to outperform Croatia and Bulgaria as the government pushes through policy changes requested by the IMF and seeks to expedite membership to the European Union, according to Italian money manager Euromobiliare Asset Management and Nomura Holdings Inc. The nation’s bonds returned almost 6 percent this year, lagging peers and less than half the gains for emerging markets worldwide in a Bloomberg Barclays index. 

While political turmoil and failure to overhaul the economy has repelled investors in the past, Premier Aleksandar Vucic, who won a new four-year mandate in April elections, has cut the budget deficit in half and pledged to modernize the tax code and sell state-owned assets. Those efforts won praise from the IMF in August, which raised its growth forecast for 2016 to 2.5 percent, double last year’s pace.

"They could finally outperform," said Giuliano Palumbo, a senior portfolio strategist at Euromobiliare who helps manage 20 billion euros ($22.5 billion) of assets, including Serbia’s five-year dollar bond. Yields could fall as much as 30 basis points as the government in Belgrade does its “homework in terms of what the IMF is requiring," he said.

‘Exceeded Expectations’

The government’s efforts to win IMF support have centered on curbing the budget deficit toward a target of 2.5 percent of gross domestic product this year and 2 percent in 2017. The shortfall is poised to narrow to 3.2 percent this year, according to the median estimate of 11 analysts polled by Bloomberg, the narrowest since 2005. The IMF said in August the country’s economic recovery has “exceeded expectations.”

The sovereign’s bonds due September 2021 have gained this year, pushing the yield down 91 basis points to 3.67 percent on Thursday, lagging the 148 basis-point decline in Croatian notes due the same year.

“Serbia is rapidly becoming the IMF’s poster child,” said Tim Ash, an emerging-market strategist at Nomura. “It’s an improving credit story, and should begin to catch up with its peers.”

After Serbia endured civil wars and hyperinflation in the 1990s and more recently three governments since 2012, investors are looking favorably on Vucic’s goal to attain an investment-grade rating by 2019 and complete EU membership talks a year later.

The government holds a rating of BB-, three steps below investment grade, at Fitch Ratings and S&P Global Ratings. Moody’s Investors Service ranks the Balkan country one grade lower, at B1, with a positive outlook.

Not all analysts are predicting a recovery in the nation’s bonds. Richard Segal, a senior analyst at Manulife Asset Management in London, said a lack of supply may deter investment, while Regis Chatellier of Societe Generale SA in London, said bonds have lagged because they are “very short-dated.”

“Fundamentals would have to be more bullish, whereas they are mostly neutral for the time being,” Segal said.

Economic growth is forecast to double this year to 2.4 percent, and stay at a similar level next year, according to estimates compiled by Bloomberg. That’s higher than the average for emerging Europe and compares with projections of 1.8 percent expansion in Croatia.

The yield on the country’s callable Eurobond due in November 2024, has increased 10 basis points to 6.66 percent this month. Rates on Serbian debt have to potential to drop 25 to 30 basis points, said Lutz Roehmeyer, a money manager at Landesbank Berlin Investment, who owns the callable notes.

“I expect some financial discipline and a positive reform drive,” said Roehmeyer, who helps oversee about $12 billion of assets. “That should lead to outperformance against other eastern European countries.”

--With assistance from Lyubov Pronina To contact the reporters on this story: Gordana Filipovic in Belgrade at gfilipovic@bloomberg.net, Marton Eder in Budapest at meder4@bloomberg.net. To contact the editors responsible for this story: Daliah Merzaban at dmerzaban@bloomberg.net, Douglas Lytle