Wider yields provide an opening in EM debt
Emerging market debt is gradually becoming a more important home for investors’ assets
Emerging market (EM) debt has experienced something of a revolution during the past 15 years.
The structure of the relevant markets has improved. The bank of investors from which emerging market debt can draw has expanded. Many countries have stopped fixing their currencies’ exchange rates, boosted their foreign currency reserves and introduced more sophisticated monetary policies.
These improving fundamental factors have resulted in agencies upgrading credit ratings in the developing world. More than 57 per cent of emerging markets are now investment grade. As the fundamental factors underpinning emerging markets grow stronger than those of advanced economies, and the risks they present continue to change, emerging market debt is gradually becoming a more important home for investors’ assets.
A long-term story
The long-term case for emerging markets is clear, especially when compared to the weaker growth opportunities presently offered by developed nations. Fundamental factors such as current account balances and ratios of debt to GDP are significantly stronger in developing markets than in the developed world.
Many emerging market countries experienced financial crises in the 1990s and early 2000s because they fixed their exchange rate to the dollar. In response to the crises, emerging market countries implemented new monetary policies that abandoned the currency peg and increased their supply of foreign currency reserves.
By 2008, emerging countries’ international reserves exceeded their foreign debt, turning them into net creditors for the first time ever. Now foreign exchange reserves are eight times larger than a decade ago and are nearly double the foreign exchange reserves of advanced economies.
During the 2008 global financial crisis, emerging market countries were able to stimulate their economies in times of weakness due to their strong external positions. During the past three years, as many areas of the world moved in and out of recession, emerging nations were running a current account surplus averaging 3 per cent of their GDP. For these reasons, emerging market assets are making up an increasingly larger share of the equity and bond instruments available to investors.
Overall expected growth rates for emerging markets are still much higher than for developed markets, at 4.6 per cent compared with only 1 per cent. For example, GDP is expected to expand by 8.3 per cent and 7.7 per cent in China and India respectively this year, which is significantly higher than any developed economy.
Given low interest rates in the developed world, investors continue to increase their strategic allocation to emerging market debt given its attractive yields and improving fundamentals. These improving fundamentals, as well as low financing needs, provide emerging market countries more flexibility in terms of policy than developed markets, therefore increasing their potential to continue growing at a faster rate.