Band Natalia Gurushina
Chief Economist, Emerging Markets Fixed Income
Emerging market sovereign debt pressures may seem pervasive, but strong fundamentals and credible policies help control sovereign spreads.
Ukrainian debt restructuring
Ukraine officially requested a 2-year suspension of coupon/principal payments on foreign currency denominated bonds. The Paris Club of Official Creditors also issued a statement this morning asking Ukrainian lenders to defer payments until the end of 2023. This twist has put Emerging Markets (EM) sovereign debt back in the spotlight. Granted, Ukraine situation is quite unique, but it isn’t the only EM border on the brink of failure right now. Sri Lanka is high in the headlines – in part because of powerful images showing people taking over the presidential palace. The names of several African economies come up regularly when we talk about various debt relief initiatives.
Emerging sovereign spreads
Emerging market sovereign debt difficulties may seem pervasive – the strength of the US dollar also creates such an impression – but there are a well-defined “qualitative” divide here. Sovereign spreads on bonds with solid fundamentals – represented, for example, by single A or double A ratings – are not even close to historical highs, such as the COVID crisis or the global financial crisis of 2008/09 (see chart below). It’s a lot “Anger? What tantrum?” environment for these obligations. The same goes for the spreads of other Investment Grade sovereign bonds (rated BBB). Sovereign bonds that are currently under severe pressure are mainly lower-rated high-yield instruments (single-B and single-C). Spreads on B-rated bonds are approaching COVID levels, while spreads on C-rated bonds are now at crisis highs of 2008/09.
Emerging market inflation and rate hikes
Credible and consistent economic policy is a major factor in controlling emerging market sovereign spreads. And this includes floating exchange rates (= buffers) and timely adjustments of policy rates. That is why Emerging market central bank decisions feature prominently in our daily commentary. The South African Reserve Bank will meet tomorrow, and today’s surprise rise in inflation should justify a larger rate hike of 75 basis points (especially given that the real policy rate adjusted by expected inflation is always negative). We’ll also keep an eye out for a possible takeoff in Indonesia (consensus sees no change) and the expected takeoff from the European Central Bank (ECB) (an honorary EM…just kidding). Stay tuned!
– Learn about inflation
Chart at a Glance: Emerging Market Sovereign Spreads – Lots of Variation by Quality
Source: Bloomberg LP
Originally published by VanEck on July 20, 2022.
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PMI – Purchasing Managers Index: economic indicators drawn from monthly surveys of private sector enterprises. A reading above 50 indicates expansion and a reading below 50 indicates contraction; ISM – Institute of Supply Management PMI: ISM publishes an index based on more than 400 surveys of purchasing and supply managers; in both manufacturing and non-manufacturing industries; CPI Consumer Price Index: an index of the change in prices paid by typical consumers for retail goods and other items; PPI – Producer Price Index: a family of indices that measures the average change in selling prices received by domestic producers of goods and services over time; PCE inflation – Personal consumption expenditure price index: a measure of US inflation, tracking changes in the prices of goods and services purchased by consumers across the economy; MSCI-Morgan Stanley Capital International: a US provider of equities, fixed income, hedge fund stock indices and equity portfolio analysis tools; VIX – CBOE Volatility Index: an index created by the Chicago Board Options Exchange (CBOE), which shows market expectations for 30-day volatility. It is constructed using implied volatilities on S&P 500 index options; GBI-EM – JP Morgan Government Bond Index – Emerging Markets: comprehensive emerging market debt benchmarks that track local currency bonds issued by emerging market governments; EMBI – JP Morgan Emerging Markets Bond Index: JP Morgan index of sovereign bonds denominated in dollars issued by a selection of emerging countries; EMBIG – JP Morgan Emerging Markets Global Bond Index: tracks the total returns of external debt instruments traded in emerging markets.
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