When one reads investment banking reports and financial commentary, EM assets are a strong BUY, because of two reasons. First, they are cheaper compare to Developed Market valuations. Secondly, Fed-ECB-BoJ wall of money is spilling over the respective border, filling the cup of many Developing Nations. While these may be valid trading tips, they don’t constitute a case for investment. If the only story of EM is the wall of money and comparative value to Wall Street, it is plausible that when the latter crashes, the entire EM will go down.
It is a pity that the words “reform, democracy and good governance” have become blasphemies in most EM. Bolsanaro, Putin, MN Obrador, and Turkey’s Erdogan come to mind when talking about economic mismanagement and entirely counter-effective response to the Coivd-19 health crisis. With weak fundamentals and a growing addiction to stimulus, EM as a whole has become a value trap.
ING: Emerging Markets have limited fiscal scope with debt sustainability at risk for some
The slump in advanced economies is deeper for 2020 (-8.0% vs -6.1% in the April WEO) but growth has been revised up slightly for 2021 (+4.8% vs +4.5%). We remain concerned about the growth outlook in many emerging market and developing economies. Altogether, they are seen contracting by 3.0% this year (vs -1.0% in April) with a depressed recovery in 2021 (+5.9% vs +6.6%). Notwithstanding, the heterogeneity means that deviations across regions and countries are substantial:
Asia (-0.8% in 2020; +7.4% in 2021) faces a more modest contraction, with China holding up (+1.0% in 2020; +8.2% in 2021) thanks to policy. India is the exception, with growth revised down by 6.4ppt to -4.5% in 2020. Asia remains best positioned for the recovery with growth seen recovering to 7.4% in 2021.
Latin America (-9.4%; +3.7%) has seen the steepest downward growth revision since April (-4.2ppt), with Argentina, Brazil and Mexico facing a contraction of around 10% as those countries have been struggling with containing the virus.
In between those two extremes, we find EM Europe (-5.8%; +5.3%), Middle East & Central Asia (-4.7%; +3.3%) and Sub-Saharan Africa (-5.4%; +2.6%). Among them, commodity exporters and South Africa (-8.0%; +3.5%) are facing steeper declines, writes ING’s Trieu Pham.
Emerging Markets have limited fiscal scope with debt sustainability at risk for some
In response to the Covid-19 outbreak, most economies have followed a combination of containment measures and policy stimulus. Notably fiscal balance sheets are seeing a meaningful deterioration in 2020 due to the weak growth outlook and larger fiscal deficits as we highlighted in a note on the risks of sovereign debt distress on 2 April. In addition to the growth forecasts, the IMF has therefore also provided updated fiscal projections for a small subset of DM and EM economies.
Global gross debt/GDP is expected to rise from 82.8% in 2019 to 101.5% in 2020. Both the high absolute number and the increase over 2020 are skewed upwards by advanced economies (with debt/GDP seen increasing from 105.2% in 2019 to 131.2% in 2020). Emerging markets, on balance, carry a much lower debt burden and see a reasonably modest increase (from 52.4% to 63.1%). Yet, it is here that we are more concerned about debt sustainability, as many advanced economies benefit from reserve currency status and ultra-low interest rates. In turn, EMs are using limited fiscal resources compared to DMs in the fight against Covid-19 (see the IMF’s Covid-19 Fiscal Monitor).
Stimulus addiction grows as risk in emerging markets
Emerging-market (EM) inflation is dormant even as governments and policy makers hurl money into the economy. Investors shouldn’t count on it staying that way.
Once the coronavirus pandemic is over, governments are going to struggle to wean themselves off the loose fiscal and monetary policies that have averted economic collapse, said David Hauner, a London-based strategist at Bank of America Corp. That risks reviving inflation, weakening currencies, and undermining bonds.
“Many EM governments will confront even greater social problems post-COVID-19 than they were facing before,” Mr. Hauner said. “A permanent increase in government spending appears likely”, according to Bloomberg.
For now, the coronavirus pandemic has slashed consumer demand and investment and pushed inflation to a record low in Brazil and a six-year low in Colombia. Across emerging markets inflation is moribund, allowing governments to ramp up spending and central banks to provide the liquidity markets need. The longer it goes on though, the harder it will be for policy makers to turn off the tap.
Still, the gap between breakevens, a measurement of inflation expectations, in riskier, high-beta markets and more stable low-beta peers is widening as traders begin to worry about inflation risks in countries with greater political and fiscal threats, according to Bank of America.
In the next six to 12 months, South Africa’s rand may be among the most at risk given lower policy rates, underlying vulnerabilities, and the central bank’s quantitative-easing program, said Brendan McKenna, a foreign-exchange strategist at Wells Fargo Securities in New York. Brazil’s currency may also come under pressure as policy makers become increasingly likely to embark on a bond-buying program, he said.
While Chile’s central bank forecasts subdued inflation for the rest of the year, the amount of stimulus rolled out has also put the South American nation’s peso on Mr. McKenna’s radar, he said.
The risks are highest for nations that have tapped foreign-currency markets and could run into trouble if their currencies decline sharply, said Damian Sassower, chief emerging-market credit strategist at Bloomberg Intelligence in New York, citing Turkey, South Africa, and Colombia.
Prolonged monetary stimulus measures would be an even deeper issue for nations with less-credible central banks, according to Michael Bolliger, head of emerging-market asset allocation at UBS Switzerland AG in Zurich.
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