Unlocking Opportunities: 3 Potential Reasons to Invest in Emerging Market Bonds?

The tumultuous year of 2022 posed significant challenges for emerging market debt investors. Global inflation surged, interest rates skyrocketed, the US Dollar appreciated, geopolitical tensions flared with the war in Ukraine, and strict lockdowns in China further complicated matters.

Despite these hurdles, the absence of a systemic emerging market (EM) debt crisis underscores the growing resilience of this maturing asset class. Furthermore, 2023 has seen promising returns for EM debt investors, buoyed by the surprising strength of global economic growth and potential indications of a pause in the US Federal Reserve’s rate hikes.

In light of these developments, we maintain a positive outlook on EM bonds, anchored by three compelling reasons:

1. Economic growth momentum favours emerging markets

EM economies have consistently outpaced their developed counterparts in terms of growth, owing to their youthful demographics and robust capital investments. As recession clouds gather over the US and Europe, this growth differential is poised to widen further, and is expected over the next few months to be at the highest level since 2013 Many emerging economies, especially in Central Asia, the Middle East and Africa, display remarkable resilience. As emerging markets increasingly becoming the growth engine of the world, we believe investors could allocate more to this asset class and further support currency valuations and bond prices. 

The emerging markets growth differential is projected higher in 2023 & 2024

GDP growth in advanced economies is forecast to slip in 2023, while EMs are expected to expand faster

Source: IMF World Economic Outlook April 2023

2. Inflation is ebbing in emerging markets

Declining inflation rates present another supportive factor for EM debt . Several Latin American countries initiated rate hikes as much as nine to 12 months ahead of the US. Unlike developed markets, EM countries swiftly took action when inflation started to rise, not dwelling on whether it was transitory or driven by supply or demand dynamics. Immediate action was imperative. Colombia raised rates by 11.5%, Chile by 9.5%, Brazil by 9% and Poland by 7%. In stark contrast, select Asian countries, such as the Philippines, Thailand, and Malaysia, raised rates over the same period by 4.25%, 2.25% and 1.25%, respectively. Consequently, Latin America currencies have outperformed Asian counterparts this year, primarily due to the substantial interest rate differentials. 

Most EM Central Banks hiked aggressively ahead of DMs

Central Banks - rate change over 2 years

Source: Bloomberg, 31 August 2023.
Information is subject to change and is not a guarantee of future results.

In most cases, these prompt actions achieved their desired outcomes, effectively curbing inflation. As a result, several Latin American central banks have initiated interest rate cuts. The Dominican Republic and Uruguay have already reduced rates by 1% and 0.75%, respectively, with Brazil and Chile implementing cuts in August. Peru, Mexico and Colombia are also expected to follow suit later this year. Such rate reductions have bolstered the value of local currency bonds in Latin America and led them to perform strongly on average so far this year.

3. Value in select high-yield hard currency government bonds

In our opinion, despite volatility, some high yield hard currency government bonds also present opportunities. Several nations with credit ratings of B or below have grappled with limited access to the hard currency bond markets, making refinancing of existing debt a formidable challenge. Nevertheless, some sovereigns have successfully met maturities on a case by case basis. Survival strategies have ranged from opportune refinancing (Rwanda) to drawing down foreign exchange reserves for debt repayment (Pakistan), or even offering substantial premiums to issue bonds (Turkey and Egypt). Notably, many frontier economies remain robust and stand to gain from improving fundamentals or lower global interest rates in the future, and therefore could represent attractive investment opportunities for discerning investors going forwards

In conclusion, EM bonds continue to hold promise. However, in the face of prevailing uncertainties, diligent country selection remains paramount when navigating the EM investment landscape. An active approach can mitigate potential drawdowns and capitalize on opportunities as they arise.

*This article was first published, in Chinese, in the Hong Kong Economic Journal.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. The views expressed in this document should not be taken as a recommendation, advice or forecast. Past performance is not a guide to future performance. The information provided should not be considered a recommendation to purchase or sell any particular security.