Investors can discount IMF’s EM gloom
Investors can discount IMF’s EM gloom


Early April in Washington is famous for two time-honoured rituals. The US capital’s Tidal Basin hosts the National Cherry Blossom Festival. A few blocks further north you can hear the International Monetary Fund (IMF) tell visiting finance ministers, central bankers and financiers about the dire economic outlook for emerging markets.

This year, the cherry blossom was spectacular. The IMF didn’t disappoint either. Its flagship Global Financial Stability Report noted that 12 emerging-market governments are already in financial trouble, and the foreign currency bonds of 20 more are trading at levels which have historically endangered countries’ ability to borrow.

IMF Managing Director Kristalina Georgieva went further, warning that no fewer than 60 countries are at risk of debt distress.

The reason for the seasonal gloom is that the IMF and World Bank regularly raise capital from their shareholders to fund concessional lending. This year, the IMF is asking donors to stump up more than $6 billion of additional contributions before the multilateral lenders’ annual meeting in October.

IMF bosses also remember the wilderness years of the early 2000s, when business dwindled to such an extent that the fund had to cut 15% of its staff and was nicknamed the TMF, or Turkish Monetary Fund, after its only sizable remaining client.

All in all, it never pays to paint too rosy a picture of emerging-market prospects. This is why investors should beware of paying too much attention to the dismal mood music.

The reality is that after many years of lacklustre returns, emerging-market sovereign debt has proved one of the best-performing asset classes over the past year. There are good reasons to think there is more to come.

Emerging-market currencies have been remarkably resilient over the past 12 months. The median major currency has weakened only around 2% against the US dollar; the Mexican peso is up 10% against the greenback.

Bonds have done even better. The yield on benchmark 10-year US Treasury notes has risen by 160 basis points (bps) since the Fed started hiking, inflicting hefty losses on bondholders.

But the average yield on local-currency government bonds issued by major developing economies has increased by only half as much. In several markets, bond yields have fallen.

One reason for this resilience is that investors never cut these governments much policy slack in the first place.

Unlike their counterparts in the developed world, less wealthy countries have not benefited from a decade and a half of near-zero interest rates. They could not rely on central bank bond buying to help fund pandemic spending.

Most important of all, many emerging-market central banks learned the lesson of previous cycles and raised rates early.

Emerging economies also appear to have avoided recent stress in the banking sector. Unlike their US peers, emerging-market banks did not load up on long-dated assets which tumbled when policy rates rose.

The IMF estimates that mark-to-market losses on securities currently held at par would shave 2.5 percentage points off the median US bank’s core equity ratio if realised. For the median emerging-market bank, the same number is zero.

The main reason emerging-market governments were so vulnerable to financial crises in the 1990s was their inability to develop local currency debt markets and their resulting reliance on dollar-denominated borrowing. This, coupled with chronic current account deficits and high levels of government indebtedness, invited periodic disaster.

By last year, average emerging-market government debt was 65% of GDP, half the average of the Group of Seven leading economies, and most of it funded at home.

Emerging markets ran a collective current account surplus of nearly 1.5% of GDP, compared to a 2% deficit for the G7.

With cheap valuations, much improved fundamentals and institutions which have earned their spurs over the past 12 months, the reality is that emerging-market sovereign assets don’t look too shabby when compared to their G7 counterparts.

It is no surprise that Georgieva painted the usual gloomy picture earlier this month. But when it comes to considering the investment case for the majority of emerging-market sovereigns, investors should not be swayed.

Published in The Express Tribune, April 22nd, 2023.

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