Against a backdrop of heightened tension in the Middle East, the World Bank and the International Monetary Fund recently met for their annual spring meetings with a focus on building resilience in the world economy. What was notable, according to NinetyOne’s emerging markets fixed income portfolio managers, Thys Louw, Nicolas Jaquier, Christine Reed, was the shift in sentiment towards emerging markets.
By the time the IMF and World Bank’s Spring meetings began in the third week of April, a resigned acceptance had emerged regarding the probability of developed market rates remaining higher for longer, given sticky inflation and economic resilience in the US. Among the macro and geopolitical concerns discussed by attendees in Washington DC, the perilous fiscal path of the US economy was a recurrent theme. However, any potential repercussions on debt markets are not expected to materialise anytime soon. Additionally, the likelihood of a significant escalation of conflict in the Middle East appeared to have been discounted. But uncertainty around the US election loomed large, with a tougher stance on China the one thing the Democrats and Republicans seem to have in common.
The tone was more upbeat in discussions on emerging markets (EMs). There was no shortage of praise directed towards EM policymakers for their recent actions, encompassing orthodox monetary policy, fiscal discipline, reforms, or a combination thereof. Some EM central bankers flagged concerns about the infamous ‘last mile’ problem, particularly in closing the gap to reach target inflation rates, amid enduring service-sector inflation and ongoing US growth. But the consensus remains that EM economies are much further ahead in their interest rate cycles than their developed market (DM) counterparts, suggesting a solid foundation of support for the EM debt asset class over the coming cycle.
Frontiers back in favour, mostly
One of the most significant developments since last year’s meetings is the positive shift in sentiment towards frontier markets, which had been out of favour for several years, as noted here. The success of several frontier economies in steering clear of dire scenarios and participating in IMF-backed reform programmes appears to have elicited a collective sigh of relief, with the narrative transitioning from fears of an immediate liquidity crunch to a concerted effort towards ensuring long-term solvency and debt sustainability. Notable bright spots include (but are not limited to):
Argentina
There was notable investor interest, and well-attended meetings, focused on this previously unloved market. It was widely recognised that authorities are moving with surprising speed, success, and domestic popular support. We witnessed plenty of optimism around external tailwinds from oil & gas and mining. Upcoming objectives include transitioning beyond the emergency presidential decree (established in December), collaborating with Congress to enact additional reforms, and eventually eliminating capital controls. We have a constructive view on this country’s debt.
Ecuador
Another relatively unloved frontier market that has been delivering positive surprises is Ecuador. The country is widely expected to secure an IMF programme in the coming weeks, which would herald a new chapter for the economy. Since assuming office last year, Ecuador’s administration has exceeded expectations by implementing tax increases, considering reductions in fuel subsidies and demonstrating a commitment to honouring debt payments. We think the country’s debt deserves the increased interest it is attracting.
Egypt
Egypt’s very strong funding position has garnered attention, with its Ministry of Finance indicating that it plans to use the opportunity to reduce fiscal and debt vulnerabilities while enhancing fiscal transparency. While investors have expressed concern that reform momentum will slow due to reduced funding pressure, initial evidence suggests otherwise.
Year-to-date, Egypt’s hard currency debt has performed strongly. However, these assets still retain some premia relative to their rating. This keeps us constructive, and we anticipate favourable returns in local currency debt. See here for reflections on a recent trip to the country.
Senegal
Senegal’s commitment to reforms under its IMF programme, along with intensified efforts to enhance governance and revenue management under this, has earned it significant favour among the investment community. The government does not appear inclined to pursue departure from the CFA franc for the foreseeable future, mitigating concerns regarding potential disruptions macro stability.
We expect that the authorities’ continued commitment to Senegal’s IMF programme will likely support further spread compression in the country’s hard currency debt.
Nigeria
Meetings with the IMF and Nigeria’s central bank underscored the country’s positive reform momentum and willingness to call on broader expertise and embrace best practices. While correcting past missteps will pose challenges, policymakers are moving in right direction. There are indications of further monetary reforms aimed at enhancing pricing mechanisms and market accessibility. On the fiscal side, authorities have stopped all monetary financing, but the fuel subsidy remains an issue.
Nigeria’s hard currency spreads have largely priced in the improvement in fundamentals, and the anticipation of issuance could potentially delay further gains. On the local currency side, we see increased opportunity on the back of the monetary and fiscal reforms.
Ongoing struggles
As expected within this highly diverse investment universe, there were notable exceptions from the prevailing success narrative. Uganda seems to be grappling with challenges in external funding, which if not resolved soon, could put further pressure on reserves. While the central bank has been impressively orthodox in responding to pressure by tightening pre-emptively, there are limitations to what it can do. Similarly, Tunisia, whose government is focused on increasing self-reliance, faces a big external funding gap. With only a moderate level of reserves and very slow fiscal consolidation, its vulnerability to external shocks appears to be growing. EU support could step up, if needed, contingent upon a more expedited release of funds by authorities. Given current valuations, we believe that the risk-reward profile on Tunisian hard currency debt is unattractive.
More broadly, discussions at the meetings revealed that for markets that do find themselves needing to restructure debt, several reforms are being undertaken to increase the pace at which restructurings are completed. Also, the reforms will grant the IMF greater leeway in providing funding in instances where a country faces resistance from official creditors (changes to the lending into arrears programme). These adjustments stem from challenges encountered in countries like Zambia, where disagreements between IMF, China and bondholders resulted in delayed disbursements from the IMF, further exacerbating already strained domestic conditions.
Other sweet spots in EM
The meetings in Washington reaffirmed positive trends in several countries we recently highlighted. India, widely regarded as the poster child of emerging markets, is enjoying strong growth, supported by cleaner corporate balance sheets and increasing lending activity. An example is the country’s firm commitment to expanding its renewable energy sector. While there are already notable Indian renewable energy firms offering compelling investment opportunities, we anticipate further growth in this space, presenting substantial investment potential over time.
Presentations made by the Ministry of Finance and central bank of Turkey were well received, with a clear message of full-fledged support for the programme of orthodox policymaking aimed at fixing this economy’s imbalances.
Meetings concerning Latin American markets, extending beyond Argentina which we have mentioned, garnered considerable attention, with positive dynamics noted across various fronts: Costa Rica’s strong fiscal performance; Paraguay’s progress on reforms, and Peru’s potential for further monetary policy easing. There was also significant optimism regarding the outlook for the Dominican Republic, given the prospect of tax and electricity reforms and increased FDI into various sectors, including renewables. The incumbent, President Abinader, is widely expected to secure a second term in the May election which investors see as positive as it would ensure policy continuity and facilitate the implementation of overdue structural reforms. A recent rally has made the country’s hard currency debt valuations appear relatively expensive, but the fundamental story remains positive.
Election noise
In a historic year for elections, the pre-election ‘noise’ in Mexico ahead of June elections, is keeping many cautious. Investors are weighing whether President Andrés Manuel López Obrador (also known as AMLO) pushes through constitutional reforms (representing further institutional erosion), and the likely policy path of the polls’ leading candidate, Claudia Sheinbaum. She is expected to continue AMLO’s agenda and is backed by his Morena party. At the time of writing, the Mexican debt market reflected a limited risk premium to hedge against the possibility of a Trump victory, given that Capitol Hill is increasingly focused on Chinese investment in the country. Additionally, the front-loaded fiscal spending this year adds to the reasons for caution.
Implications for the asset class
One thing that was clear in Washington is that ongoing competition for capital in a world of sustained higher rates in developed markets, coupled with the lack of a cohesive narrative on emerging markets, is keeping many investors on the sidelines regarding EM debt allocations.
However, a longer-term perspective is gradually regaining prominence, with discussions about EM debt becoming more constructive as perceptions align more closely with reality, particularly in reforming economies with orthodox policymaking. Allocations could shift markedly as the external backdrop improves. In the short-term, selectivity and vigilant monitoring of valuations will be crucial, especially given the heightened uncertainty and market volatility that surround elections this year.
