- After the first wave of the Covid-19 outbreak in China and East Asia, and the second wave in Western Europe and North America, a third wave now looks to be building in several EM and frontier countries. EM and frontier countries may be able to benefit from the experiences and best practices then put in place in countries affected by the pandemic earlier. However, most of them do not have well-equipped health systems and lack the resources to deal with a health emergency vs developed countries. Covid-19 will have very significant negative effects on the economic outlooks for EM, mostly leading to recessions.
- International authorities, such as the IMF and the World Bank, have stepped in to support emerging economies. In the current context, the issue is more about an increase in lending capacity rather than the availability of different instruments. The IMF is trying to revamp its instruments to increase the resources it can allocate. One point in the assessment of the impact of debt relief/cancellation is the role of China. In the past years, China has become a more relevant creditor for small economies (resources-rich) around the world.
- In order to assess the risks that EM are experiencing, we need to evaluate their fiscal fragility and their external vulnerabilities. Looking at all the variables, we came up with a stress ranking that notes countries like South Africa, Colombia, Hungary or Malaysia as being more exposed regarding both issues. In addition to this, the coronavirus is impacting oil demand and, consequently, hitting EM oil producers and exporting countries. However, the current environment may favour net oil importer countries, such as India, Turkey or even China, by improving their external positions.
- On the investment side, sentiment has already started to improve in emerging markets, in terms of asset prices as well as fund flows. We think the key factors to watch going forward will be how long lockdown measures will have to remain in place and whether the risk of a second wave of virus spread materialises once measures are gradually lifted. We are still cautious, looking at what is priced into the market in terms of bad news (earnings deterioration or risk of debt restructuring), and which segments can be more resilient during the downturn or rebound strongly after it.
- We see value in EM external debt, particularly in high yield, where spreads have already widened to global financial crisis levels. We see ample value in Bahrain and Indonesia. We think quasi-sovereign debt in Latin America offers attractive risk/reward scenarios across Brazil, Mexico and Peru. Within local debt, our preference is for EM rates, where we see value in Russian assets across both FX and rates. In Mexico and South Africa, we see value in rates, but not in FX. Regarding the latter, we remain bearish, especially on growth-sensitive currencies such as China and South Korea. Regarding equity, we have been relatively defensive: we prefer countries with fiscal buffers (such as China) and with strong domestic bases. On the other hand, we are very defensive on export-, commodity- and tourism-related stories. We believe that Covid-19 will favour countries that are close to autonomous regarding internal demand and less dependent on global supply chains and trade. Internal demand is also negatively affected by lockdowns, but this is where resilience and rebound should take place as soon as situations normalise.
- On a longer-term perspective, we see Covid-19 as a driver that will reinforce moves towards de-globalisation, a trend already in place even before the crisis, and strengthen the “regionalization” theme. This will lead to a focus on new investment opportunities within ‘specific regions’ beyond the traditional geographical perspective. The new Silk Road is one important example of this concept, based on the growing influence of China in the geopolitical landscape and beyond Asia.