In this month’s instalment of our visual series on topical themes, we look at some of the biggest recent trends in EMD.
Read this article to understand:
- The opportunities in this growing market
- How performance varies between commodity importers and exporters
- The implication of food price challenges
Dynamic growth and real returns?
Following a strong rebound in 2021, the global economy is expected to slow materially in 2002 and 2023 as the effects of higher inflation and tighter monetary policy feed through.
However, the outlook varies considerably between emerging, developing and developed markets. Emerging markets are forecasted to report four per cent growth next year compared to a modest 0.6 per cent for developed markets.
Figure 1: Global growth projections
Source: Aviva Investors and Macrobond. Data as of September 27, 2022
In contrast to many developed markets, rate hikes have helped build a real rate cushion in many EM countries (Figure 3).
Higher carry and favourable terms of trade movements have helped Latin America deliver decent returns, and Central and Eastern European sovereigns (with some notable exceptions) are also being aided by hawkish central banks. Nevertheless, surging inflation and G10 rate hikes remain headwinds.
Figure 2: EM real rates, 2-year real yield versus US (per cent)
Source: Aviva Investors, Macrobond. Data as of June 28, 2022
Too big to be ignored
The emerging market debt universe is too big to be ignored. Investible assets have grown considerably in the past twenty years. From a market that was initially driven by hard-currency issuance, local-currency bonds are now the largest component by far.
Issuance of emerging market corporate bonds has risen sharply; the market has grown much faster than developed market equivalents (Figure 3).
Figure 3: Growth of EM corporate bond issuance versus other debt markets
Source: BAML, June 2022
Exporters versus importers: Not all EMs are born equal
While non-energy trade links with Russia were not significant across EM, the indirect spill overs are having a material impact. Even before the war, inflation was running uncomfortably high for many EM countries – since the war started, the pressures on food and energy prices have intensified, necessitating more proactive intervention by central banks.
One dominant theme this year has been the distinction between commodity importers versus exporters (Figure 4). Exporters are benefitting from terms of trade gains, despite offsets, while importers are seeing deficits rise from soaring food and energy prices.
Figure 4: EM – deviations of headline and core inflation from target (per cent)
Source: Aviva Investors. Data as of September 28, 2022
With EM sovereigns, there is differentiation between countries with more fiscal room to alleviate social tensions rising from higher prices. In many cases, they have commodity export revenues coming through which, combined with higher nominal GDP growth, have exceeded projections. They can offset extra costs with less deterioration in their fiscal positions. This is largely the case in Latin America and commodity producers more generally.
EM sovereigns can offset extra costs with less deterioration in their fiscal positions
Then there is a second tier that are having to pay up for food and energy, as well as rising defence costs, without having the commodity revenues to fall back on (CEE countries like Poland, Hungary and the Czech Republic). However, they have more ability to absorb some of these pressures.
Then comes the third tier, large commodity importers with less fiscal space and higher costs to bear; countries like India, Turkey, and Egypt. Particularly at risk are frontier markets that already have limited fiscal room due to large debt-servicing costs.
Figure 5: EM fiscal balances (per cent of GDP)
Source: Aviva Investors, Bloomberg. Data as of September 28, 2022
The resilience of corporate EMD
The JP Morgan CEMB Index, which tracks the performance of hard-currency EM corporate bonds, tends to outperform the broader EMB Index during periods of market stress. Data shows the corporate index is less sensitive to changes in US Treasury yields (see Figure 5).
Credit spreads among CEMBI oil and gas companies are also less sensitive to fluctuations in the oil price than their developed-market peers. This reflects the preponderance of national champions in the index, which can count on government support when prices fall.
Figure 6: Spread between EM corporate and sovereign debt
Source: J.P. Morgan, June 30, 20221
EM companies have also strengthened their balance sheets in recent years. Leverage among emerging market companies is at its lowest level for ten years – far below the average among US firms (Figure 7). During previous episodes of turmoil, overly leveraged emerging market companies had few buffers to absorb a slowdown and an associated decline in earnings; today, the picture is more positive.
Figure 7: Net leverage of EM corporates versus US
Source: BAML, June 2022
Broadly speaking, EM corporates also hold more cash than their US counterparts, an additional source of resilience (Figure 8).
Figure 8: Cash-to debt positions of EM corporates versus US corporates
Source: BAML, June 2022
Food shock: A growing threat
The commodity price shock has been felt acutely across the EM universe (Figure 9).
Figure 9: Contribution of food/energy inflation to EM ex-China
Source: Goldman Sachs, July 20222
Although rising food prices could benefit some countries, such as Uruguay, a major food exporter, they are the exception. According to Goldman Sachs analysis, shown in Figure 9, the food terms of trade – the change in the price of food exports/the change in the price of food imports, weighted according to exports and imports’ respective shares of GDP – have worsened for 80 per cent of EM countries.
Even for the few countries that have experienced an improvement, this does not necessarily cushion consumers from the impact of rising international food costs. Brazil is a case in point. Although the Brazilian agricultural sector stands to benefit from rising soyabean prices, the government may still have in with subsidies or transfer payments. Argentina is in a similar position.