Last year was a mixed one for emerging market investors. While some countries underperformed due to a political and currency crisis, others despite bearing the brunt of an escalating trade war between the world’s two largest economies – flourished.
As emerging markets expected to benefit further and enjoy further inflows from investors seeking to generate higher returns by apportioning their income-generating portfolios to riskier segments within the debt market, the COVID-19 outbreak along with the unexpected breaking up of the OPEC+ agreement, that sent global oil prices into a tailspin, struck.
Initially, when the outbreak was first reported in Asia, emerging market debt held steady. Now, that the pandemic is global and the outlook for global growth is worsening, things are looking grim.
In a bid to protect investment portfolios against the severe economic downturn, investors shunned riskier assets, notably; names within the emerging market space and sought the relative safety of treasuries and the US Dollar – widely perceived as a safe-haven.
Albeit the idea behind the widespread sell-off and the decline in bond prices is at this stage justified, the default risk being priced-in (currently at higher levels to that of the most recent financial crisis) may indeed be overdone. While we understand that the impact is indeed considerable, the global response has so far been bold. In addition to the recent multi-billion-dollar initiatives announced by the IMF and World Bank, emerging market central banks and governments, in-line with the more advanced economies, have announced substantial monetary and fiscal stimulus.
Notably, notwithstanding Brazil’s fiscal limitations, to soften the economic blow from COVID-19, Jair Bolsonaro’s government unveiled a near $30 billion support package, which would bring forward social assistance payments and deferrals in tax collections.
From a monetary perspective, Central Bank of Brazil followed other peers around the world and cut its benchmark interest rate – known as the ‘Selic rate’ – by 50bps, bringing borrowing costs to its lowest on record, at 3.75 per cent.
Given that the extent of contagion and duration of the COVID-19 phenomenon is, at this juncture impossible to forecast, it is still unclear whether the employed fiscal and monetary policies are sufficient to offset the severe economic impact.
As conferred, with the default risk priced-in possibly being overdone, opportunities within emerging market debt have been created and may be realized when global financial conditions do improve. Valuations of emerging market bonds may suddenly look attractive, especially in countries that have seen an impact beyond which their fundamentals would suggest.
Notwithstanding these opportunities, we reiterate the importance of a bottom-up approach, to ensure that the selected investment is capable of servicing its debt, even when the economic climate isn’t favourable.
Disclaimer: This article was issued by Christopher Cutajar, credit analyst at Calamatta Cuschieri. For more information visit https://cc.com.mt/. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.