Emerging market economies have been prudent with their fiscal performance over the last decade.
The average credit rating for emerging market countries is now solid investment grade.
While developed market economies are now being forced to face their own overdue fiscal adjustments, emerging market economies are generally in a position to continue growing economically.
By virtually any dynamic measure, emerging market (EM) economies are on a much better trajectory than their developed market (DM) counterparts. EM economies in aggregate appear to be in a much better place compared with most DM countries, whether we look at growth rates, the size of their economies relative to the global economy, fiscal deficits and government debt, credit ratings and upgrade-to-downgrade ratios. In fact, the average credit rating for EM countries is now solid investment grade.
The future looks bright for these economies, which in most cases already have endured their own trial of macroeconomic adjustment and structural reform in the previous 10 to 15 years. Now that they are in a position to continue growing economically, the DM economies are being forced to face their own overdue fiscal adjustments, which will be a burden on their growth in the years to come.
The signiﬁcance of debt management in EM countries
EM economies have been much more prudent with their fiscal performance over the last decade. Both EM and DM economies had government debt-to-gross domestic product (GDP) ratios of about 48% in 2003 (see chart below). However, the IMF reports that since 2008, they have been on very different trajectories, with EM government debt forecast to be 34% of GDP in 2012 versus 74% for DM governments.
The divergence in fiscal policy is the key driver of these public debt trends. EM economies have run much smaller fiscal deficits each year even as their economies grew much faster relative to the DM economies (further shrinking the relative size of their public debt). In addition, EM economies escaped the financial crisis in 2008 with only a period of slower growth, avoiding most of the financial sector bailout costs seen in DM economies. They also used their strong government balance sheets to cushion the growth shock in their economies without endangering their public debt ratios.
Not only have EM governments run smaller budget deficits (adding less public debt to their debt stock each year) and grown faster (growing out of their debt), but they have also changed the composition of their debt by relying less on international capital markets, and more on their own domestic capital markets.
Over the last decade, EM governments have reduced the size of their external debt from 37% to 25% of GDP. This is important because it reduces their exposure to unstable exchange rates, improves the independence of their central banks, and diminishes their vulnerability to sometimes volatile international capital markets.
It is important to note that not all of the creditworthiness improvements in the emerging markets are due to prudent public policies. Some of the improvement is due to stronger commodity prices and improving terms of trade since 2000.
The ratings agencies have recognized the improvements in EM sovereign creditworthiness with multiple upgrades for most EM sovereigns over the last 10 years. The average credit quality for the EM sovereigns in the JPM Emerging Market Bond Index Global (EMBIG) has moved from BB+ in 2000 to BBB+ in 2012 (according to Standard & Poor’s, March 2012). During this same period, the credit rating for the major DM economies fell from an average of AA+ to AA-.
There is no question that comparing the sovereign debt, fiscal deficits, external balances and credit rating trends does not tell the whole story. The DM economies still have the strength of institutions, rule of law, respect for property rights and underlying accumulated wealth and intellectual property — significant factors that are not as readily quantifiable but still important to a sovereign’s creditworthiness. Nonetheless, the trends are clear and are moving in the right direction in most EM countries.
Many of the more successful EM sovereigns have undertaken the next generation of reforms to address labor market and infrastructure rigidities, which will further enhance their competitiveness and growth potential. And, while much of the DM world will spend 2013 focused again on getting their fiscal house in order and continuing to address the detritus of their 2008 financial sector crisis, most of the EM world will keep growing, becoming a more integral and creditworthy part of the global economy.
The JPMorgan Emerging Markets Bond Index Global (EMBI Global) tracks total returns for traded external debt instruments in the emerging markets and is an expanded version of the JPMorgan EMBI+. As with the EMBI+, the EMBI Global includes U.S. dollar-denominated Brady bonds, loans and Eurobonds with an outstanding face value of at least $500 million. It covers more of the eligible instruments than the EMBI+ by relaxing somewhat the strict EMBI+ limits on secondary market trading liquidity.
There are risks associated with fixed-income investments, including credit risk, interest rate risk, and prepayment and extension risk. In general, bond prices rise when interest rates fall and vice versa. This effect is more pronounced for longer term securities.
Investments in emerging markets present greater risk of loss than a typical foreign security investment. Because of the less developed markets and economics and less mature governments and governmental institutions, the risks of investing in foreign securities can be intensified in the case of investments in issuers organized, domiciled or doing business in emerging markets.