Emerging markets debt: from the margins to the mainstream
This global financial crisis was a landmark role reversal for the developing world, which proved a source of relative stability amid the turmoil in developed economies, and a leader in recovery. That phenomenon will be no surprise for those who have witnessed the rise of emerging markets (EM) as powerhouses of global growth over the past decade. The more surprising phenomenon is that EM economies account for almost half of global GDP.
Global markets are still heavily underweight emerging markets debt, thanks to a common perception of EM as a “niche” sector. But this traditional view is ready for an overhaul. The rebound in EM from this latest crisis shows how local strengths, including growing economies, credible monetary policy, and deepening capital markets, are providing better buffers against global shocks. These strengths add to the appeal of EM debt returns, which we estimate to be in the 5-7 per cent range for external debt and 9-12 per cent for local-currency bonds in 2010.
The case for emerging markets investment today is backed by strong numbers: growth across the developing world is expected to top 5 per cent in 2010, almost quadrupling the rate of advanced economies. But even more compelling for investors than the numbers are the economic trends generating them.
Developed countries’ debt-to-GDP percentages were high and rising before 2007, and an estimated $20,000bn in public sector borrowing over the coming years, according to the IMF, will push those percentages well above 100 per cent. Emerging economies’ debt-to-GDP levels have scarcely breached a third of that, and relatively strict controls on government spending have kept deficits in the low single-digits. Governments of the world’s leading industrialised nations, by contrast, are struggling with budgets blown on stimulus to jolt their economies out of recession.
As a result of this phenomenon the structure of global bond markets will likely change: advanced countries might be forced to lean heavily on bond issuance to finance more sizeable fiscal deficits. We could then see developed country sovereign issues become a larger overall share of all government bonds outstanding; the public sector in external surplus countries (generally EM) may sterilise any current market intervention by issuing stabilisation bonds, and this will contribute to their sovereign debt outstanding; emerging corporates might rely on more diversified sources of financing away from bank finance in future and their growth might be a key driver of increasing debt issuance in the emerging world.
Of course, emerging market bonds still entail risks despite their fundamental improvements. In particular, our positive view hinges on the critical assumption that EM countries can continue their multi-year transformation toward greater economic stability. Local currency bonds also entail currency risk, which can result in greater volatility.
Nonetheless the trends are already in place that might help emerging economies transcend a volatile history in financial markets. Foremost among those trends are strengthening national balance sheets, improving financial policies, and advances in capital markets depth and infrastructure, all of which have helped inflows to EM debt strengthen substantially over the past decade.
Their durability over that time suggests these trends are sustainable in the long-term, and in many cases they are the envy of the developed world. An important legacy of the 2008 financial crisis is the challenge to long-held distinctions between EM and developed markets, and investors alert to the evolution of international capital markets are quickly realising that, in globally diversified portfolios, emerging markets no longer belong at the margins.
Lloyd Reynolds, Head of Sub-advisory in Asia, for Goldman Sachs Asset Management.
In association with Goldman Sachs Asset Management.
