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GMO: It’s Times Like This That Offer the Best Opportunities in Emerging Market Debt
“There’s value in the asset class,” said Carl Ross, partner and sovereign credit analyst at GMO.
Despite macroeconomic turmoil and mounting sovereign debt, GMO believes that emerging markets remain ripe with value.
In a recent paper from the asset management firm’s emerging country debt team, authors Carl Ross and Eamon Aghdasi argue that despite a spike in sovereign defaults in emerging countries over the last few years, these markets aren’t on the brink of a debt crisis like many assume. Instead, they found that the majority of countries with sovereign debt have the “fiscal space and flexibility” to steer clear of an economic disaster.
“It’s generally times like this — when there’s so much doom and gloom in the market — that are the best buying opportunities,” Ross told Institutional Investor.
The current market “bogeyman” that is spooking investors is a lethal combination of rising inflation, increasing interest rates, and murmurings of a recession, Ross said. But, he noted, that there are always risks in the market — and GMO believes that emerging markets still have room to grow and avoid a crash.
Ross and Aghdasi screened the 70 countries included in the J.P. Morgan EMBI Global Diversified Index, which GMO uses as a benchmark for its external debt strategies. For each country, the authors determined the debt-to-GDP ratio, which is a combination of its current debt-to-GDP ratio, the interest rate on the debt, the growth rate of the economy, and the budget balance.
The concern among the “doom and gloom” crowd, Ross and Aghdasi wrote, is that if interest rates are rising, global growth is declining, and today’s debt-to-GDP ratios are higher than before the Covid-19 pandemic, then emerging markets will have a high debt-to-GDP ratio, a number that indicates inevitable financial ruin.
Instead, the GMO analysis found that the majority of emerging countries are actually in decent shape: Fifty percent of J.P. Morgan’s index is made up of investment grade sovereigns. These countries, including Mexico, Indonesia, China, Saudi Arabia, Kuwait, India, and Peru, had some combination of “sound debt dynamics” and diversified sources of funding that will help them steer clear of a crisis.
Among the countries categorized as sub-investment grade, 25 percent were placed into the “low debt” group, meaning they had a low enough current debt-to-GDP ratio to avoid a crisis if they took on higher debt.
In addition, 11 percent of the countries on the index had high existing debt but had fiscal balances that will result in them lowering their debt ratios over time.
A smaller percentage — about 5 percent of sovereigns on the index — had a high risk of debt distress, meaning they had a high existing debt-to-GDP ratio that their fiscal trajectory isn’t likely to correct. These countries include Bolivia, Brazil, El Salvador, Ghana, Morocco, Namibia, and Tunisia.
And only six countries — Sri Lanka, Zambia, Ethiopia, Suriname, Lebanon, and Ukraine — were in the “default category,” meaning they were either in default, in debt negotiations, or likely to default in the next year.
The results are promising for investors, Ross said. While the current macroeconomic environment poses challenges for emerging markets, the majority of the countries included in the analysis aren’t on the verge of a debt crisis and, in fact, have room to grow.
“There’s value in the asset class,” Ross said. “The level of credit spreads that are being paid in the asset class right now are high relative to historical context and relative to likely losses from debt defaults.”
The debt defaults that are likely to occur have largely already been priced into the market, Ross added.
“So if you’re an institutional investor investing in this asset class now, you’re investing in this asset class at a time of attractive spreads but also at a time of attractive price levels of countries that are vulnerable to default because their bonds are already trading at very very low prices,” Ross said.