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Emerging markets: What lies ahead?

ToM09.09

Demand for emerging market debt has over the past 20 years boomed.

Against the backdrop of; investors not being duly compensated for the risk being undertaken and years of low, and even negative interest rates, credit investors, in search for yield, sought juicer returns outside the major economies.

While enjoying increased interest and thus inflows from investors seeking to generate higher returns, by apportioning their income-generating portfolios to the riskier segments within the debt market, governments and corporates domiciled within these geographical regions, seized the day, increasing their debt issuance, which in turn boosted economic growth. Regions such as Brazil, India, China, and other EM’s alike benefited.

Notably, following a severe economic crisis from mid-2014 to 2016, during which Brazil registered a contraction in economic activity, Latin America’s largest economy showed signs of improvement. Albeit, after his tenure, he will be predominantly be known for stirring political controversy during the Covid-19 pandemic, Jair Bolsonaro’s social and pro-business reforms, while further increasing investor optimism, prompted economic growth.

India, after slowly opening up its market through economic liberalisation and implementing a string of fundamental reforms, has in the past 25 years, continuously, registered economic growth. In fact, before being severely impacted by the Covid-19 pandemic, India’s economy, in the first quarter of 2020 expanded 3.1 per cent year-on-year.

Similarly, after opening up and reforming its economy, China’s economy, in the face of structural constraints, including; declining labour force growth, diminishing returns to investment, and slowing productivity, became the world’s fastest-growing major economy following the much needed adjustments.

Despite the said improvements, investors have witnessed over recent years, risks within the asset class do exist.

When Covid-19 began to spread uncontrollably, the number of confirmed cases primarily increased the most in economies across; China, Europe, and then the US. Although other developing economies, took longer to feel the pinch, when it did, the impact was severe and presumed to be longer-lasting.

To-date, economies first to feel the pinch witnessed improvements in economic activity amid the re-opening of communities and businesses. Notwithstanding the risks that lie ahead, possibly due to fears of the possibility for the need to re-introduce measures to mitigate contagion, economic activity has shown drastic improvements. The same cannot be said for EM economies. Despite witnessing improvements in manufacturing, this being mainly due to the demand from economies whose battle with the pandemic seems to be easing, or at least, is less severe, the fight against the pandemic appears to be far from over. Contagion figures, are yet or may have just possibly reached the peak.

Apart from the risks posed by the relentless Covid-19 pandemic, the US election, set for 3rd November and which may have significant implications for emerging markets, both pre and post-election, lies ahead.

Although the latest opinion polls are currently suggesting a possible Biden victory, which at this stage, seem to bode well for EMs, the possibility of Trump being once again elected as president of the US, looms. Should Trump be re-elected for a second term, emerging markets, recovering from the ensuing impact of the Covid-19 pandemic, may once again bear the brunt of an escalating trade war between the world’s two largest economies.

Although many US policies impacting EM’s are at this stage, not yet formulated and thus not definite, trends currently being foreseen under a Biden administration may indeed augur well.

Notably, even though more regulation and a reversal of tax cuts may initially hurt risky assets, a return to multilateralism may reduce uncertainty in global affairs. Support for multilateral organisations such as the IMF and World Bank may well aid debt-ridden EM economies in need of financial support.

Meanwhile, for Latam economies, implications may vary. Should the former vice-president be re-elected, Mexico – the nation most reliant on US trade, may well indeed benefit from less uncertainty over trade policy. Meanwhile, given that a Democrat administration will undoubtedly be more watchful of both environmental and social policies, India and Brazil may indeed see the progress on long-awaited trade deals slow down.

In part funded by tax hikes, a Biden administration is also expected to boost spending on infrastructure and energy to support US growth. Should this be the case, Latin America’s largest economy shall indeed benefit, this, being mainly due to the increased demand for Iron Ore and other metals, the economy is renowned for exporting.

Lastly, should currency developments pan out as expected, meaning: the USD continues to weaken, EM economies are set to benefit, particularly, due to lower borrowing costs and increased trade flows.

That said, from a credit perspective, we recommend corporates with excellent fundamentals and robust liquidity, allowing them to deal with both this unprecedented scenario and any hiccups that may indeed crop up in the coming months.

Disclaimer: This article was issued by Christopher Cutajar, Credit Analyst at Calamatta Cuschieri. For more information, visit, https://cc.com.mt/. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.

The Calamatta Cuschieri Traders Blog is available daily on CC WebTrader. Other market coverage including coverage of the International Bond Markets is also available.

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