Emerging market bonds held steady when the coronavirus outbreak was first reported in Asia. Now the pandemic is global, things are getting ugly. But EM debt investors have been here before.
In the week to March 18, investors pulled $18bn out of EM fixed income funds, according to global fund tracker EPFR. That is the most since data began in 2004. It is more than twice the record $7bn in outflows recorded the previous week.
A widespread market sell-off has led to a surge in the dollar. The DXY index, which tracks the buck against global peers, is at a three-year high. That is bad news for indebted emerging market economies reliant on steady inflows from investors overseas.
Fears are growing for the stability of $72.5tn worth of government, corporate, household and financial sector debt. The combined debts of 30 large emerging economies rose to a record 221 per cent of gross domestic product during the third quarter of last year, according to the Institute of International Finance.
Further bond price falls look likely. Yet a focus on blanket EM debt default risk may be misplaced. During the “taper tantrum” of 2013, EM bond prices all fell amid fears that a stronger dollar would make dollar debt harder to repay. Many countries are now better placed to face such shocks. Current account deficits have shrunk and foreign reserves are up. Banking systems are better capitalised and regulated. The $1tn lending facility announced by the IMF this week could also serve as a backstop.
The immediate threat to major EM economies is not default but economic damage caused by the pandemic. JPMorgan expects emerging markets, excluding China, to fall into a recession in the first half of this year. EM corporate earnings will suffer. Equities accounted for the bulk of the $78bn that non-resident investors pulled out of EM assets in the past two months. But EM sovereign bond returns have consistently outperformed Treasuries over the past five years. With rock-bottom interest rates everywhere, expect that trend to continue.
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Source: Economy - ft.com
