Emerging Markets Credit Overview: Decoupled Or Deteriorating? by Jamie Nicholson-Leener, Managing Director, Emerging Markets Credit Research, Credit Suisse
Discussion Points
- Investment Thesis for EM – an Historical Perspective
- Current EM Vulnerability to Global Credit Crisis
- Outlook for EM – Risks and Opportunities
- Relative Value in EM Markets
EM Investment Thesis – Historical Perspective
- From 2003 until the current credit crisis began, EM markets generally outperformed developed market benchmarks reflecting:
– High growth rates of underlying EM economies
– Sovereign upgrades as EM economies recovered from the late 1990’s (Asia crisis and Russia default) and 2001 (Argentina default) market turmoil
– Low starting base, reflecting late 1990’s / early 2000’s EM market turmoil
– Emergence as a dedicated asset class, attracting increased fund flows
– Greater appetite for risk
EM equity markets best performer until mid-2008
EM debt markets performed strongly through mid-2008
“Riskier” asset classes performed well in this period
- Higher yields and spreads over benchmarks
- Low default rates due to favorable access to liquidity
- Greater risk appetite increased fund flows into risky assets
- Improving credit quality due to strong economic fundamentals and better balance sheets from diversified funding sources
- But strong market environment also allowed “junkier” credits to issue debt with increasingly loose structures
EM corporates often outperformed US benchmarks
EM distressed debt was outperformer as credits restructured
EM credit quality improved (but “junkier” credits also issued)
Strong new issuance trend in EM through 2007
Many EM economies significantly improved since 2000
- Implementation of orthodox economic reforms
- Recapitalization of banking systems post 1990s crises
- Strong increase in FX reserves
- Reduction in inflation, providing flexibility for current rate cuts
- Favorable credit markets allowed for longer term issuance
What happened to EM decoupling?
When the crisis began, EM markets were hit hard
Although crisis started elsewhere, EM economies are hard hit by three types of shocks:
- A sharp and sudden drop in credit flows from G3 to EM countries (hitting countries with current account deficits and countries with banks that rely on wholesale funding)
- An abrupt fall in commodity prices during 2H08 – typically with 50%-60% declines in dollar terms
- A sudden collapse in G3 imports (badly affecting those EM countries that rely heavily on exports of industrial goods)
Sharp drop in credit flows affecting EMEA countries most
- Many countries in the region generated large current account deficits
- EMEA banks borrowed significantly in foreign currencies to fund a domestic credit boom
– Kazakhstan, Russia, Ukraine, Latvia domestic credit growth was 50% + annually up to 2007
– Real estate was often the asset class receiving the most credit flows - Political challenges often exacerbated the economic instability in these countries
Sharp drop in commodity prices affecting Latam and oil exporters
- In Latam, fall in oil prices most affected Venezuela and Ecuador
– 30% of Venezuela GDP is exports and 90% of exports is oil
– 40% of Ecuador GDP is exports and 60% of exports is oil - Chile’s economy is most vulnerable to fall in copper prices
– 45% of GDP is exports and more than 50% of exports is copper
– Chile’s economic stabilization fund has helped mitigate this shock - In EMEA, Russia and Kazakhstan are most vulnerable to oil price decline
- Brazil’s GDP is less affected by commodity exports as only 14% of GDP is exports (and largest exports are food commodities at @ 20% share)
Collapse in G3 imports affecting EM exporters
- China’s export driven growth (nearly 40% of China’s 2007 GDP was exports) contracted sharply in 4Q08
– Exports fell 19% yoy in 1Q09
– Strong fiscal stimulus (5% of GDP) and bank lending are cushioning the downturn - Mexico’s economy is highly correlated to trade with the US
– Nearly 30% of GDP is exports, with 80% destined for the US
– More than 20% of Mexican exports are cars, trucks and auto parts
– Swine flu impact is exacerbating the current economic downturn
EM markets also affected by trading technicals
- Reduced trading liquidity increased EM volatility
- Significant selling pressure from HY and hedge fund investors, which sold EM positions first
- Currency volatility (and speculation) caused derivative losses (particularly in Latam)
- But strong recovery in risk orientation is currently benefiting EM market performance
See full PDF below.
