Why Emeging Market Debts Bears Need a Reality Check

Bearish investors on emerging market debt have a lot to worry about, but the risks are often overstated and mistaken, according to Pictet Asset Management head of emerging corporates Alain-Nsiona Defise and Mary-Thérèse Barton, head of emerging market debt.

As the already dim view of developing economies and ongoing predictions of an emerging market crisis have continued to grow, bonds issued by governments and companies based in developing economies have spiralled lower.

The biggest concern for the sceptics is the damage higher US interest rates and a strong dollar could do to the finances of developing countries, Barton and Defise pointed out.

‘Many developing countries are reliant on foreign investment to fund persistently high current account deficits. When US rates and the dollar head north, these economies find it harder to service their debts; they also struggle to prevent international investors from shifting capital elsewhere.’

Alain-Nsiona Defise, Pictet Asset Management head of emerging corporates and Mary-Thérèse Barton, head of emerging market debt, believed that those concerns are often overstated and mistaken.  Like in 2013 during taper tantrum, when the US Federal Reserve signalled its intent to reign back QE. The bears turned out to be wrong then.  This time, they could be wrong again the  on the following aspects:

1. Fed’s Rate Hike Can be Good for EM currencies and bonds – According to Barclays analysis, it found that in every US hiking cycle since the mid-1990s, EM currencies and bonds have tended to outperform their developed world counterparts. ‘As long as the Fed is tightening monetary policy in response to faster growth, the economic spill-over to the developing world should be positive.’
2. Argentinian Peso & Turkish Lira are not representative of EM – The sell-offs seen this year in the Argentinan peso and the Turkish lira speak to the fears of the bears, as they are countries with some of the largest current account deficits in the EM world. The currencies are down 32% and 21% respectively since the start of the year.  They are outliers that have been punished for several missteps.  As a matter of fact, ‘The current account positions of developing economies more generally have in fact improved considerably since 2013. In aggregate, emerging markets’ current account surplus has grown from 0.1% to 0.8% of GDP over that time.’
3. Exclude China, EM’s corporate finance have fallen more than 100% to 48% – Pessimists also raise the fact that corporate finances are barely any healthier, as emerging world firms have taken full advantage of low interest rates since 2009 to increase their borrowing as a percentage of GDP from around 80% in 2013 to 101% at the beginning of 2018.  ‘With the bulk of those loans and bonds denominated in US dollars, the Fed’s tightening of the monetary reins threatens to make it harder for the private sector to pay back its debts, too.’  

   It is true that Chinese firms are big borrowers, but removing them from the analysis, it’s clear that company debt as a proportion of GDP in EMs drops from more than 100% to 48%, they said. ‘That compares with 72% for the US, 100% for the eurozone and 103% for Japan.’  The proportion of risky corporate loans and bonds in the developing world excluding China is lower than it was during the 2008 financial crisis, they said, citing a study from the Fed.  ‘In part, that’s because many of the firms issuing dollar-denominated bonds are exporters whose revenue is predominantly denominated in foreign currency. For these companies, when the greenback rises, the resulting increase in debt costs is offset by the extra revenue earned overseas.’

Reference

CityWireSelector.com, Jessica Beard, 2018-08-09, “Pictet EMD chiefs: why EM debt bears need a reality check”