Brexit Exodus Skips Serbian Bonds With EU Membership in Limbo

  • Balkan nation's Eurobonds outperform Poland, Hungary, Croatia
  • Commerzbank, Raiffeisen recommend buying Serbian debt

There’s one post-Communist country where investors are finding refuge from the risk of Britain’s exit from the European Union: Serbia.

The nation’s Eurobonds have outperformed those of Poland, Hungary, Croatia and Romania in the past month as concern mounted that those nations may suffer from the loss of billions of euros in EU funding if the U.K. votes to leave the bloc in June. Since Serbia’s application to join the 28-nation group has been in limbo for seven years, the country is more shielded than its neighbors, according to Commerzbank AG and Raiffeisen Bank International AG.

Both banks are recommending clients buy Serbian bonds, which are also benefiting from government plans to overhaul the economy and set the stage for an upgrade to its credit rating. Even if U.K. citizens vote to stay on June 23, Serbian debt will continue to gain after the government was re-elected last month on a mandate to accelerate a push to join the EU by 2020, according to Commerzbank.

"It has less to lose," said Simon Quijano-Evans, Commerzbank’s London-based chief emerging-market strategist, who recommends buying Serbia’s 2021 bonds against selling similar-maturity Polish notes. "Serbia is trading at a higher spread than most central and eastern European peers, which provides investors with more protection in a credit that would be less directly impacted by any EU net payer leaving."

Not Immune

The premium investors demand to own Serbian debt over U.S. Treasuries narrowed 3 basis points in April to 290, according to JPMorgan Chase & Co. indexes. That compares with a decline of one basis point in Hungary’s spread to 209, while the premium for Polish notes was 122 basis points. Bonds of both countries were downgraded to sell by Commerzbank last week and Citigroup Inc. singled out the zloty as among the hardest hit from a potential loss of subsidies.

While Raiffeisen is bullish on Serbian debt, it said the country isn’t completely immune from any spillover of a U.K. exit. Its recommendation to buy Serbian bonds on a three-month horizon is tied more to last month’s election outcome than its relatively smaller exposure to Brexit, according to Gintaras Shlizhyus, a strategist at the Vienna-based bank.

Prime Minster Aleksandar Vucic’s Progressive Party has vowed to rid the public balance sheet of more than 500 money-losing state-owned companies and trim public-sector employment, requirements for maintaining a $1.2 billion credit line with the International Monetary Fund that’s helped shore up state finances.

"In terms of direct volatility Serbia will be less exposed" to Brexit, Shlizhyus said. "But EU integration is of fundamental importance for all eastern European countries, and an exit vote wouldn’t be good for Serbia either."

Rating Outlook

The country’s Eurobonds have handed investors returns of 1.4 percent in the past month, beating gains of 0.5 percent or less for regional peers in the Bloomberg U.S. Dollar Emerging Market Sovereign Index. That lagged returns of 2.2 percent in Russia and 1.6 percent in Brazil.

The yield on Serbia’s $2 billion bond due September 2021 rose one basis point to 4.49 percent by 5:28 p.m. in Belgrade, increasing for a second day from the lowest level in five months on Monday.

Still the outlook for an upgrade to the country’s junk credit rating is improving after Moody’s Investors Service raised its outlook to positive in March, citing progress in EU accession and an improving fiscal picture. The budget deficit will probably narrow to 3.1 percent of economic output in 2016 from as wide as 6.6 percent two years ago, according to European Commission estimates. Gross domestic product rose an annual 3.5 percent in the three months ending March, the fastest clip in 10 quarters, the Statistics Office in Belgrade said Wednesday.

Fitch, which already has a positive outlook on Serbia, is slated to review its B+ rating on June 17, two weeks before S&P Global Ratings’ next announcement.

For Commerzbank, Serbia has less to lose from Brexit than its EU neighbors also because its remittance flows come from countries such as Austria and Germany rather than the U.K. The bank is betting on a decline in the Balkan nation’s credit-default swaps versus Polish and Bulgarian risk.

“Serbia is on the right track in our view on how to deal with the numerous issues at hand, thus keeping its spread over CEE peers looking relatively attractive,” Quijano-Evans said in an April 27 research note. “We see the potential for ratings upgrades.”

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