Emerging-market debt during and after the crisis
What is the outlook for emerging-market debt amid the global economic shutdown?
Monetary and fiscal policy has come to the rescue of many developed markets in this unprecedented global crisis. Several are expected to spend 5-10% of their gross domestic product (GDP) in government stimulus packages, to say nothing of the accommodation provided by their central banks.
Few emerging markets, however, have the ability to bestow such largesse upon themselves despite the grave challenges they face. Yet it is important not to paint all emerging markets with the same brush. In our view, the countries that are most vulnerable to the current crisis can be grouped into three broad categories.
1. Commodity producers, which face a difficult outlook with global demand destruction depressing the prices of natural resources. Even within this category, some have significantly larger policy and fiscal buffers than others.
2. Countries with large financing needs, significant need for rollovers, and those for which foreign portfolio flows are a significant part of their financing mix.
3. Countries that have deep economic and trading relationships with developed markets, including those that receive a large share of their remittances, tourism or foreign direct investment flows from developed markets, or countries where associated flows are a significant form of financing and/or keeping the current account balance in check.
As a result of all these vulnerabilities and their potential impact, many emerging-market issuers have seen their credit ratings downgraded or placed on negative watches.
But while the challenges are formidable, several more positive considerations for emerging markets are often missed.
First, the International Monetary Fund (IMF) has stepped up support to the most vulnerable countries. Since the start of the COVID-19 pandemic, the IMF has provided emergency lending to over 35 countries (a list is available here).
The World Bank and sister agencies like the African Development Bank along with other multilateral agencies are also providing significant funding. Beyond the international financial institutions, the US Federal Reserve has also provided swap lines to central banks in large emerging markets, in addition to repo facilities.
Second, emerging markets as a whole have lower debt levels than advanced economies (53% of GDP at the end of 2019 versus over 100% of GDP for developed markets, according to the IMF). They will also see fiscal deficits widen less than in advanced economies: although subject to unusual uncertainties, based on IMF numbers, advanced economies are expected to see a net borrowing requirement of 10.6% of GDP in 2020 compared with 8.8% in emerging markets. Therefore, domestic financing options are available for many of them to meet additional COVID-19 related spending.
Third, emerging markets are underpinned by favourable demographics, with the age cohorts more vulnerable to COVID-19 representing a smaller proportion of their population. Many emerging markets may have weaker health systems and weaker income support than in developed markets, but we should note that their social support networks are considerable as is the provision of assistance via the non-profit sector.
Fourth, the latest IMF projections suggest that emerging markets will not only contract by less than advanced economies this year (-1% versus -6%), but that they will also rebound to higher growth in 2021 (6.6% versus 4.5%). This has also been evident during past downturns.
And fifth, benchmark interest rates in developed countries have headed even lower since the start of the COVID-19 outbreak. In contrast, yields on emerging-market assets have widened as risk appetite has weakened. Thus, the relative value case for emerging markets is now even stronger – despite relatively attractive growth and debt profiles. As was clear post the global financial crisis, expanding developed market central-bank balance sheets do eventually lead to greater capital flows to emerging markets.
Our argument is not to overstate the opportunity in emerging markets, but to recognise the progress made since the last crisis in 2008. Many are now fundamentally more resilient to exogenous shocks and are less reliant on international capital markets.
Finally, we must stress that despite the temptation to discuss emerging markets as one homogenous asset class, they represent a broad and diverse range of issuers. That should be clear from the fact that, whereas most sovereign issuers in developed markets are rated investment grade, the credit range in emerging markets is very wide.
That is why, almost irrespective of the macro picture, choosing the right credit remains imperative.