- Macro Strategist
Asia ex-Japan, Institutional
Change
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Recent years have been a test of emerging markets resilience. COVID generated the largest decline in global GDP in decades. It was followed by the US Federal Reserve (Fed)’s most rapid hiking cycle in many years and quantitative tightening across most developed economies. Persistently slow growth from China also served as another headwind for emerging markets countries over the last several years.
Emerging markets have proven to be resilient in the face of this adversity. This robustness has been most evident in emerging bond markets, with investment-grade sovereign spreads demonstrating stability in recent years, and BB-rated spreads posting a healthy rally. Many currencies represented in the J.P. Morgan GBI-EM (Government Bond Index-Emerging Markets) have delivered positive returns since the Fed started raising interest rates in early 2022, with some delivering double-digit returns at time of writing. A variety of factors contributed to this outcome:
- Policy making in emerging markets has matured. Over the past two to three decades, many have moved towards flexible currencies and inflation targeting. Currency mismatches across public and private sector balance sheets have fallen. This, combined with improved inflation-targeting credibility, means that currencies are now effective adjustment mechanisms to help absorb shocks rather than amplify shocks.
- Improved policy making has allowed many emerging markets to develop large and liquid local markets to help fund governments. Reliance on external sources of funding is much smaller than in the past.
- Management of the inflation shock over 2021–23 bolstered credibility. Central banks in emerging markets began hiking rates much sooner than their developed economies’ counterparts, with many bringing rates well above neutral. Emerging market central banks signalled a clear preference for stable-to-strong currencies to help contain inflation during this period.
- A weaker US-China relationship generates positives (as well as negatives) for emerging markets. Some are benefitting from near-shoring, while robust commodity prices represent a terms-of-trade boost for several other emerging economies. Moreover, many countries benefit from a good relationship with both the US and China – they do not have to choose between one or the other.
There are parts of emerging markets where a series of shocks and poor domestic policymaking have significantly weakened debt sustainability and, in some cases, forced a debt restructuring. These countries tend to be some of the smaller, more fragile economies that struggled in the face of the twin shocks of the global pandemic and the ensuing inflation shock. However, these countries constitute a relatively modest portion of the emerging markets bond universe, and in some cases will present a new opportunity as they work through debt restructuring negotiations.
A positive outlook
Broadly, we expect emerging markets growth to slow moderately in 2024, but we are not expecting a hard growth shock as lower inflation and lower interest rates boost consumer and corporate purchasing power. There is still some work to do on fiscal consolidation, but for most emerging market economies there is much less effort required than in the US to stabilize public debt. Governance will be a key focus given elections across several emerging markets— Indonesia, India, Mexico and South Africa to name but a few — and in the US.
