With yields revolving at significantly lower levels, investors in search of higher yields, and thus seeking a higher return on their investment, are left without an alternative, but to apportion a substantial amount of their income-generating portfolios to riskier segments within the debt market, predominantly in emerging markets (EM).
To clarify thoughts, EM comprise of economies that are increasingly becoming more engaged with global markets, this being shown through their:
* increased liquidity in both local debt and equity markets
* increased trade volume and foreign direct investment, and
* the domestic development of modern financial and regulatory institutions.
In addition, EM countries are nowadays high contributors to global growth, with their weighting continuing to experience further increase.
Due to increased economic and political risks, emerging-market countries are generally given a lower credit rating, despite reporting healthy credit metrics and margins. Consequent to the assigned lower credit rating, corporates seeking to finance do so at higher interest rate levels, this being solely due to the risk associated to their geographic position.
An economy which falls under the category of EM, and thus might penalise companies due to its geographic positioning and its sovereign rating, is Brazil, an emerging market economy which is undeniably progressing following torrid years way back in 2014-2016.
Bolsonaro’s impact on the economy
As previously stated, in contrast to developed economies, EM are generally characterised by deepened political risks, risks referring to uncertainty regarding adverse government actions and decisions, in addition to corruption scandals.
Brazil is undoubtedly no exception to the above - an economy which has been mired in political turmoil over the years, this being mainly attributable to the severe level of corruption, even at the highest levels of government. In a bid to rescue Brazil’s troubled country from virulent corruption, rising violent crime, and economic doldrums, the electorate voted Jair Bolsonaro into office.
Under Bolsonaro’s ruling, Brazil, which once was considered as less open to the global markets, has now opened up its economy to business, and is enacting social reform, neglected by the corrupt elite focused more on personal gain, rather than social good.
The measures being taken by Bolsonaro are reaping the fruits, with his economic policies being right on the money. This was why Bolsanaro was considered a market-friendly candidate, with foreign investors cheering poles which saw him leading for months in the pre-electoral run.
Brazil’s economy on the mend
Bolsonaro’s reforms are certainly a step in the right direction. In the second quarter, Latin America’s largest economy reported a growth of 0.4% over the previous quarter, and 1% over the same quarter last year - a better than expected performance, confirming that the extremely weak activity recorded earlier in the year was indeed a blip, rather than the start of a renewed downturn.
Growth predominantly boosted by industrial and services activities.
In numbers, on the production side, the industrial sector grew by 0.7%, rebounding from a 0.5% contraction in the first quarter of the year, this being mainly driven by manufacturing and construction. Meanwhile, the services sector advanced by 0.3%, the growth principally boosted by trade, information and communications, and real estate activities.
An electoral promise which supported Bolsanaro’s Presidential victory was the much-needed pension reform which to date has already surpassed important parliamentary hurdles. A crucial reform which will positively impact the government’s expenditure going forward.
With market illustrates forecasting further growth and increased political stability, Brazil’s attractiveness in the high yield space is set to increase.
Albeit the opportunities posed by this EM, a bottom-up approach is imperative to ensure that the selected investment is capable of servicing its debt, even when economic trends point to a downside.
Ultimately, it’s a fact that in today’s markets, namely in Europe, EM are the place to be for an investor to generate the desired premium returns.
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.