Covid-19 has rapidly become an economic shock for the global economy. Initially rocking China, global economic expectations changed dramatically in early March, and have continued to evolve just about daily since. Against this backdrop of broadening concerns on the spread of the virus, bond markets have been at the epicentre of the recent volatility.
The rapid response of China is starting to pay some dividends for the Chinese economy. They have seen their workers return, interaction is becoming more prevalent and there are encouraging signs that the Chinese economy is recovering. Unfortunately, the same can’t be said for other countries across Asia, as the region shows a very diverse trajectory. Some of the poorer countries, such as India and Indonesia, are struggling with the complexity and size of their economies and the realities of how curfews and shutdowns are impacting them.
In an attempt to counteract the shocks from the pandemic, some countries have deployed aggressive monetary and fiscal policy responses, precisely aimed at preventing a downward spiral into a financial crisis. Central banks have flooded liquidity into markets, prudential regulators have been easing capital requirements, and fiscal authorities are providing sizeable loan guarantee schemes.
Monetary and fiscal stimulus from emerging markets (EM) has generally been more muted so far. EM central banks have been more willing to loosen policy than in the past but are balancing capital flight in this risk off environment which has put pressure on currencies. The recent FED action to provide USD swap lines is easing liquidity pressure in EM where foreign banks can swap treasuries for dollars. Importantly, the financial health of many EM countries, corporates and households are entering this crisis in better shape than in previous times.
Investor’s minds are now turning to credit risks as businesses deal with the reality of dislocation. EM countries with higher credit ratings and more mature economies have seen less dislocation. Larger markets in Latin America, such as Chile and Brazil, have somewhat seen rising interest rates, yet historically are still at low levels. More stress is seen in the lower rated commodity exporters and sovereigns. The recent decline in oil price, as an example, has distressed low rated B credits in the likes of Latin America and Africa.
That said, EM countries are much better financed and governed than before, which better places them fiscally to weather this storm. Countries that have a degree of independence on monetary policy and that have floating exchange rates are in a much stronger position, such as Brazil and Mexico. When the initial shock of the pandemic starts to subside, these countries will be the ones that bounce back quickly. The swift action from central banks where possible has enabled many EM countries to enter into this period with a set of strong policy tools, so that when things do return, these policy actions will have a positive impact on their economies.
Initially when the aggressive lockdowns were rolled out across Asia, we saw outflows in EM debt mutual funds, particularly from wholesale investors and private banks, and market liquidity was challenged. However, we’ve moved through that period now and the market is a lot more balanced with investors looking to move into the asset class.
Taking a step back and a long-term outlook, interest rates in the developed world have lowered even further. Strategic inflows wait in the wings as long-term investors can begin to look at increasing asset allocation. It also makes for interesting entry levels for those looking to invest in EM.
*Written by Brett Diment, Head of Global Emerging Market Debt at Aberdeen Standard Investments