The fact that Argentina was able to sell 100-year USD bond recently shows how desperate some fixed income funds have become in their search for big returns. Argentina requires a ‘root and branch’ overhaul of its institutions and infrastructure before it can genuinely be considered a viable, long-term investment opportunity.
Starting from such a low base, there are always going to be pockets of opportunity, however a change of a president and rhetoric on economic reform aren’t enough to genuinely change economic fundamentals.
Turkey also poses as interesting from an investment perspective, given the structure of its sovereign and private sector balance sheets. The private sector runs a significant short USD position using cheap USD debt to fund local currency assets, the majority of which is unhedged. As a nation of running twin deficit and net oil importer, inflationary spikes are susceptible when oil prices rise, which leads to a sell-off in the currency and higher interest rates. With a populist President and a central bank that appears to have lost independence, Turkey resists tightening in fear of the slowing economy impact on jobs.
By waiting, this creates a vicious circle of a weakening currency, which leads to a worsening of the US dollar mismatches in corporate balance sheets and causes the currency to weaken further. This should continue until Turkey’s central bank is forced to hike rates aggressively to defend the currency, forcing the economy into a painful adjustment.
This is a classic Emerging Market FX crisis that we have seen many times before, which has been made worse under strong grip of the dominant AKP and President Erdogan. While Turkey is in a tough spot, we don’t necessarily see it being a systemic risk for Emerging Markets more broadly, as it is a very small trading partner for the big Emerging Market economies (aside from some smaller central Europe and former Soviet countries).
▶ Asia - A different space
Since the late 1990s / early 2000s Asian currency crisis, corporates and sovereigns have been more mindful of currency mismatches on their balance sheets.
Indonesia is slightly more challenging as it is one of the biggest carry trade markets in Emerging Market debt and has benefited from low dollar rates globally. Given recent improvement of terms of trade, it makes Indonesia’s carry trade attractive as 30-40 per cent of its bond market is owned by overseas investors. Winning populist member from outside the ruling party is not necessarily in the best interests of markets, as this raises the prospect of the Government taking populist measures to shore up support ahead of the forthcoming elections.
South Korea is different to the majority of other global emerging markets as, along with Taiwan, it is the most developed of the economies within this universe. By extension, the investment opportunities presented tend not to coincide with the typical ‘structural penetration’ themes that we find elsewhere within emerging markets.
As a result, much depends on the direction of the US dollar from here. Fundamental demand looks relatively healthy and commodity prices appear to be holding up. We do need to be mindful of the signals that the bond and FX markets are giving about the likely direction of global demand, and thus commodity prices, from here.
The sell-off of BRL has made producing iron ore even more profitable and so we should see a supply response. If this occurs and demand even softens slightly, then we are likely to see another round of commodity price declines, which will be negative for Emerging Market FX across LatAm, much of EMEA and parts of South East Asia.
Much will depend on the direction of demand growth in China, which for now seems reasonable, though probably not accelerating. Internal demand in China is likely to be strong enough to keep the Chinese economy ticking over. The rest of Emerging Markets, however, really do need a strong China and robust global trade to defend FX and drive economic growth in the local economies. That’s why what is bad for China is generally worse for broader Emerging Markets.
▶ What this means for investors
While there are risks to definitely be aware of in Emerging Markets and, at the margin, the market does seem to be telling us something, it appears to be too early to say that the recent problems in Emerging Markets is an FX crisis - unless something bad happens in China.
Emerging market sovereign balance sheets are far more resilient than they were in past cycles, due to many economies having paid down US dollar debt and built up US dollar reserves.
This enables many central banks and Governments to act counter cyclically and proactively when it comes to supporting their domestic economies in times of stress.
To classify the recent problems in Turkey and Argentina as the demise of Emerging Markets as an investment destination is possibly too early right now - but it does require monitoring. 【The contributions from outside analysts are unrelated to the views of the publisher. They have been contributed in English and the wordings have been mildly edited.】
By Country Head for Fidelity International in Korea, Joon Kwun
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