The big picture
Jacques Perold (Moderator): Should investors be concerned about emerging markets?
John Carlson (Emerging-Market Debt): I would characterize what’s currently happening in emerging markets as more of an adjustment than a crisis. Emerging-market sovereigns are generally in much better shape from a balance sheet/cash flow perspective than they were 30 years ago. Since 1982-83, the wind has been at the backs of these countries. By and large, there has been a massive decline in global interest rates, an increase in commodity prices, a significant rise in global trade, and growth in consumer middle-class populations. In addition, there’s been a decline in foreign currency debt (as a percentage of GDP), and a massive rise in foreign exchange reserves (as a percentage of GDP) (see chart below). Today, fewer countries have fixed exchange rates. These developments illustrate how emerging-market countries are more stable now from a sovereign debt standpoint than during previous crises.
Perold: Are you saying investors shouldn't be alarmed?
Carlson (Emerging-Market Debt): I’m not saying there couldn't be individual countries that may experience a debt crisis—there are still some significant geopolitical risks in certain countries, such as Ukraine, Argentina, Venezuela, and Turkey. A debt crisis, can, in fact, be healthy over the long term. But the overall financial health among many emerging markets is more stable than it was in the past, and I think the likelihood of a local debt problem becoming a systemic problem is diminished.
With the growth of the capital markets over the past several decades, there has been a restructuring of bank loans, the issuance of hard currency, and the increased development of local currency instruments. Emerging-market sovereigns are less indebted today and have moved more of their debt into local currency, mainly because of the rise of the consumer middle class—a population that needed investment/savings vehicles, insurance, and mortgages, all of which required the development of local capital markets.
Perold: Are we a long way from the currency mismatch crises that occurred in the 1990s?
Carlson (Emerging-Market Debt): Yes—a crisis is harder to find today among many sovereigns.
Joseph Desantis (Equities): Given the buildup of local debt-market borrowing, I do think it’s possible there could be a local sovereign crisis due to an internal issue, such as credit deterioration due to slower economic growth and efforts to raise rates to combat inflation.
Bill Bower (International Equities): Yes, I think we are a long way off from a crisis, and I would argue that it’s easier to analyze those local crises today via traditional economics (through current account deficits or surpluses). Many sovereigns are in much better financial shape, so the currency mismatch isn’t as bad as it was in the 1990s, when some countries went bankrupt overnight because they had primarily U.S.-dollar-denominated liabilities (e.g., Asian financial crisis, 1997).
Desantis (Equities): I agree. I think you can analyze a potential crisis situation better if it is more localized—and today it is less likely to have that global effect in which other countries are impacted when their access to capital is pulled by foreign and local investors, which is what happened in the 1990s. There can be a clearer delineation of country fundamentals, which can separate, rather than concentrate, all borrowers in one category.
Matt Torrey (Emerging-Market Debt and Equity): One important point John Carlson is alluding to is that the yield curve in many countries is a lot longer than it used to be. Many countries used to only have the ability to issue very short-term debt (e.g., Mexico in 1994). Those issues still exist to some extent in certain countries, but yield curves in many other countries have gotten longer as local investor pools have become larger.
So sovereigns are less indebted in foreign currencies. Locally, sovereigns generally have much longer yield curves, making the previous debt) rollover problem a much less significant issue. For example, today, Mexico can issue a 100-year bond; that shows the country has come a long way from the 1994 crisis.
Perold: What about the significant presidential and parliamentary election calendar in 2014?
Bob von Rekowsky (Emerging-Market Equity): Emerging markets face an array of election challenges in 2014, with the potential for both optimism and disappointment in regard to necessary structural reforms. The first half of the year is particularly significant, with general elections in South Africa (April), parliamentary and presidential elections in Indonesia (April and July, respectively), parliamentary elections in Hungary (April), presidential elections in Colombia (May), and general elections in India (May). In 2014, presidential elections will be held in Turkey (August) and Brazil (October), two countries whose economic management have been the subject of street protests by unhappy constituents. This could be a catalyst for higher emerging-market volatility as the year progresses. That said, our previous studies of elections suggest that markets tend to underperform during the three to six months prior to an election amid policy uncertainty, and recover thereafter—regardless of the political stripe of the winning party.