EM Debt – Cover story
An underlying investment theme of concern is centred around a hidden, or not so hidden, crisis in emerging market debt. Is there a case for presenting such a narrative? The International Monetary Fund (IMF) has made a nod in this direction, esti- mating that 30% of emerging market countries and 60% of low-income nations already are in, or nearing, debt distress. Total debt in emerging markets has hit a record high of more than $100trn (£78.4trn) – which amounts to a staggering 250% of GDP – up from $75trn (£58.8trn) in 2019. China, Mexico, Brazil, India and Turkey are the largest upward contributors, according to the Institute of International Finance (IIF). There is no doubt that slowing global growth, high inflation and rising interest rates are squeezing emerging markets harder than more prosperous countries. And several studies of economic crises indicate that low-income countries are often most vulnerable to economic stagnation and financial crisis when global debt levels reach record highs. This is a problem, says Jayati Ghosh, professor of economics at the University of Massachusetts Amherst in the US. “The Covid pandemic destroyed emerging market economies much more significantly than they did in the rich world. These coun- tries were not able to bring about the fiscal response that was required,” she says.
Not systemic
This presents a possibly depressing picture. It implies that investors should not only stay adrift from emerging market debt, but emerging markets in general. But this crisis can be viewed in other ways.
“There is no systemic emerging market debt crisis at present,” says Greg Smith, a fund manager within the emerging market debt team at M&G. Although he adds: “Debt pressures have increased across the board since the pandemic.” Similarly, Amer Bisat, head of emerging markets fixed income at Blackrock, says a new approach to emerging markets is needed, but not necessarily for the reasons emanating from a debt crisis. He suggests the emerging market debt debate should be viewed by looking at emerging markets over a long- er timeframe, given these markets have radically changed dur- ing the past two decades. “A new mindset is needed when investing in emerging markets. The days where one invested in emerging markets as a ‘raw beta’ play are gone.” Importantly, Bisat notes that changes in the emerging market landscape do not mean the asset class is not attractive. “EM 2.0, as we like to call it, still offers significant opportunities for potential durable returns. But investing in it requires a differ- ent investment approach.”
Navigating the markets What is this magical new approach? “To successfully navigate
the world of EM 2.0, investors must focus on differentiation, diversification, income, quality, disciplined risk management and rigorous research,” Bisat says. But, as is often the case with emerging markets, he sounds a note of caution. “We believe it is tough to see an acceleration in capital accumulation in emerging markets, given continued de-globalisation pressures, rising levels of debt – that will make funding these investments harder to come by – and structurally higher global rates.
“Our judgement is that over the next decade we are more likely to see a gradual – though slight – worsening emerging market growth potential than to see a favourable reversal,” he adds. This, along with the debt scenario, suggests that emerging markets may be a less thriving environment. And while Smith rejects the idea of an emerging market debt crisis, he concedes: “Despite the absence of a systemic crisis, several emerging markets are experiencing their own debt crises.” There were six emerging market sovereign defaults in 2020, followed by Sri Lanka a year later and Ghana in 2022. “Which is a lot compared to infrequent sovereign defaults over the prior decade,” Smith says. Added to that is Ukraine, Russia and Belarus defaulting on their debt since Russia’s military aggres- sion increased in February last year.
Emerging market dispersion But given the changing nature of emerging markets, there are number of points to highlight. One is not all emerging markets are the same. “Our analysis shows that dispersion in emerging market asset price changes has already risen. We believe this trend will persist,” Bisat says. His colleague, Tom Donilon, chair of the Blackrock Investment Institute, also expects a divergence in emerging markets, which has an impact from an investor perspective. “Some mid- dle-income emerging markets, like Brazil and Mexico, may be able to ease policies and offset downward growth pressures. Others will engage with the IMF and absorb global shocks.” But, he adds: “Emerging markets with elevated debt levels could be challenged.” Yet there is a further note of concern. “We worry about a lack of global co-operation on debt relief – particularly between the international financial institutions, including the International Monetary Fund, and China,” Donilon says. This is an issue that exacerbates the problem. The main vehi- cles for global co-operation – the group of seven (G7) and G20, along with the IMF – have limited tools to deal with a global debt crisis.
Market lever But for all that, asset allocation within emerging markets is too important a lever for investors not to use. “It is our view that
Issue 125 | July-August 2023 | portfolio institutional | 17
Page 1 |
Page 2 |
Page 3 |
Page 4 |
Page 5 |
Page 6 |
Page 7 |
Page 8 |
Page 9 |
Page 10 |
Page 11 |
Page 12 |
Page 13 |
Page 14 |
Page 15 |
Page 16 |
Page 17 |
Page 18 |
Page 19 |
Page 20 |
Page 21 |
Page 22 |
Page 23 |
Page 24 |
Page 25 |
Page 26 |
Page 27 |
Page 28 |
Page 29 |
Page 30 |
Page 31 |
Page 32 |
Page 33 |
Page 34 |
Page 35 |
Page 36 |
Page 37 |
Page 38 |
Page 39 |
Page 40 |
Page 41 |
Page 42 |
Page 43 |
Page 44 |
Page 45 |
Page 46 |
Page 47 |
Page 48 |
Page 49 |
Page 50 |
Page 51 |
Page 52
