23 Aug 2024
Kate Moreton, Emerging Market Sovereign Analyst
Key Takeaways
Growth forecasts trending up
Despite recent challenges, emerging market economies remain robust and are delivering positive growth. India is leading the charge, benefiting from secular demographic trends like a growing working-age population as well as resilient domestic demand. As China’s share of global growth declines, India is stepping in to fill the gap. More broadly, EM growth projections have been revised upward by the IMF’s World Economic Outlook (WEO), benefiting from country-specific factors.
Inflation remains above target
The outlook is less sanguine for inflation. After a period of meaningful disinflation, the average EM inflation outlook was revised up by about half a percentage point in the April WEO. Many EM central banks, having begun their cutting cycles last year ahead of the Federal Reserve, are now slowing the pace or considering. Mexico, for example, held rates in May after starting its cutting cycle only two months prior.
Further fiscal consolidation will be tricky
EM government revenues are under pressure after two years of high interest rates that increased the debt service. Interest costs as a percentage of revenues are expected to rise in 2025 and remain elevated, crowding out the ability to invest in public works and projects.
Figure 1 Interest payments
Source: IMF, World Economic database: and IMF staff calculations
Post pandemic, gross debt levels remain high and are unlikely to come down meaningfully anytime soon. In Latin America, newly elected populist platforms are now grappling with promises of increased social spending. These challenges suggest that further fiscal consolidation will be difficult.
The chart shows the average deficit in EM and by region. A lot of the deterioration in 2020 has reversed, but in many cases, countries are still not back to pre-Covid deficit levels.
Figure 2 Slowing pace of fiscal adjustments in many regions
Source: IMF World Economic Outlook, April 2024
Value remains in distressed credit
Current valuations in EM debt have priced in the positive growth outlook, particularly in investment-grade EM bonds where spreads are at 10-year tights. Despite these challenges, opportunities exist for active investors, with recent outperformance of idiosyncratic high-yield credits. In Turkey, we’re seeing better monetary policy; Egypt has secured big chunks of funding from the Middle East; and in Argentina, there’s a new political regime taking aggressive measures to stabilize the economy. Improvements in these credits, and the ability of several weaker issuers to access debt markets in recent months, have removed some negative tail risks in EM assets.
Figure 3 EM spreads at tights across credit spectrum, particularly in IG
Source: Macrobond and Columbia Threadneedle Invesments
While the easy post-pandemic wins are behind us, the ongoing growth in emerging markets provides a tailwind against fiscal and inflationary headwinds. What happens next will be more challenging, as investors will need to focus on idiosyncratic credits that offer potential for meaningful returns amid the increased complexities of the EM debt landscape.
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