Home When to Invest Economies Emerging countries: Catch a knife in free fall

Economies Emerging countries: Catch a knife in free fall

Economies Emerging countries: Catch a knife in free fall

Although it may offer attractive opportunities, investing in developing markets is a big risk in the short term. And this is due to the economic crisis. Along with many surprises and unusual behaviors, the Covid-19 crisis has caused the largest money outflow from countries with emerging economies, according to the International Institute of Finance.

This brings falls in their markets, especially in bonds, strong depreciation of their currencies, and investment opportunities.

These economies share the same ills of the pandemic with the developed countries: a paralysis of activity and, therefore, falls in GDP. The results are unemployment and the need for liquidity to withstand the confinement. However, these ills are worse in emerging economies, because of their dependence on foreign money to finance themselves. Besides, these countries are generally exporters of raw materials. The sharp fall in oil has dragged down the set of raw materials – only gold is saved this year – while buyers do not consume it.

The recovery of their economies will depend on: 

  • The progress of the pandemic.
  • Aid from international organizations, such as the IMF or the World Bank
  • Political measures that allow the return of foreign capital. 

Stefan Scheurer, a strategist at Allianz Global Investors, points to the fiscal stimulus measures of 3.6% of GDP in Brazil and 4.8% in Chile, or 9% in Poland. These impulses contrast with the EU, where the fiscal packages rise to 21% of GDP, or in the United States (8.3% of its wealth). For now, they have already benefited from the monetary expansion of the Federal Reserve or the ECB. This allows countries like Colombia and Mexico to lower their interest rates by half a point.

One of analysts’ great concerns is the heavy debt these economies have. This money will have to be returned in dollars after a sharp drop in local currencies. The 40% drop in Brazilian real, or 25% in Mexican peso stands out. Turkey has even lost 17% of their liras’ value.

Debt for all emerging countries (including China) is at about four trillion dollars. The ratio of public debt to GDP is at the highest level in decades. Approximately, 730,000 million of emerging debt will have to be financed in 2020. 80% is in dollars, according to the International Institute of Finance.

Pablo Duarte, an analyst at the Flossbach von Storch Institute, explains that 

“debt in dollars explodes, this makes payments more complicated. Besides, it impulses refinancing international financial markets, currently struggling, is almost impossible.”

And he adds: 

“In October 2019, the IMF warned about the increase in public and private debt. This was due to low world interest rates. This could increase the risk of over-indebtedness due to the increasing dependence of countries on external financing.”

Deficits and debt capacity will be key. We will distinguish between the best and worst-positioned emerging markets for recovery. S&P Ratings explains in a recent report that the consequences of Covid-19 have weakened  sovereign credit. Especially in those countries already facing fiscal rigidities or foreign financing.

Pablo Duarte indicates that before the break, current account deficits were financed with foreign capital. Without capital inflows, large deficits become unsustainable. The highest were recorded in sub-Saharan Africa and Latin America. Emerging and developing Asian countries had current account surpluses, mainly driven by Thailand, China and Vietnam. India, Indonesia and Bangladesh posted large deficits.

Daniel Graña, manager of Janus Henderson, has a positive vision of Asian countries. Those who 

“experienced the SARS outbreak in 2003, began a more effective response to covid-19. As a result, some investors are putting those economies on a faster path to recovery. In addition, several countries with large domestic markets have reached a great level of wealth. Consumption is becoming a major contributor to growth” he concludes.

Economies Emerging countries: Catch a knife in free fall

Economies Alternatives

Latin America has been the hardest hit market. For Goldman Sachs, this offers the greatest investment opportunity in both stocks and bonds. But this optimism has its moment. They recommended investors consider emerging economies only when thinking about medium-term horizons. 

“We had a more optimistic outlook for commodities in the second half of the year.  We expect Latin American assets to outperform in 6-12 months. in equities, we prefer Mexico to Turkey and Brazil to South Africa.”

From Allianz Global Investors, they point out capital outflows and risk aversion. They assure it has led emerging stocks to trade below the historical average. This implies that investors should be able to find attractive long-term values.

We have Diego Fernández Elices, the general director of investments at A&G Banca Privada. He explains he likes emerging markets, especially debt in local currency with interest rates of 5% at maturity. 

“The data is better than expected and prices have barely recovered yet.”

Claudia Calich is head of emerging fixed income at M&G. She considers that debt issued in hard currency represents an attractive investment opportunity. It has higher profitability forecasts than would be expected from debt issued in local currencies. The Latin American market and Egyptian bonds stand out.

The S&P Ratings firm ranks the housing construction, real estate, consumer products and public services sectors. Just as the ones with the greatest potential for downgrades in emerging markets. Something to keep in mind when buying bonds: since the high profitability in emerging markets includes the risk of the currency. (It might not be issued in euros). As well as the risk of default of the firm that issues it.


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