Bond outlook pieces often mention developed market monetary policy as a driver of returns, and rightly so. However, for EMs in 2024, a different theme has emerged: elections.
A look back at the polls
To date, voters have gone to the polls in Bangladesh, Taiwan, El Salvador, Pakistan, Senegal, India, Mexico, Turkey, and South Africa. We don’t have time to analyze the individual country outcomes, but a few elections warrant a closer look.
Pakistan
In January, a civilian government came to power, pledging fiscal consolidation and promising to build foreign exchange (FX) reserves. Sound familiar? That’s because it is. Pakistan is now looking to enter a record 24th International Monetary Fund (IMF) program.
Will the outcome [for Pakistan] differ this time? The early signs are promising.
The question remains: Will the outcome differ this time? The early signs are promising. Ongoing disinflation has allowed the central bank to loosen monetary policy, and the balance of payments recently turned positive. But let’s not get carried away. This story is still unfolding, and we’ll keep a close eye on developments over the coming months.
Mexico
The election of Claudia Sheinbaum, a protégé of the current president Andrés Manuel López Obrador, is expected to maintain the political status quo. Sheinbaum will need to focus on reducing the deficit from 6% of GDP to a manageable level. The fiscal deficit blew out in the run-up to the election, as López Obrador increased unfunded social security payments – among other social transfers – in a bid to shore up support. It certainly did the trick.
It's hard to see how Sheinbaum will address these issues in the near future.
Sheinbaum will also have to reckon with Mexico’s state-owned energy company groaning under heavy debt and declining crude production. López Obrador's decision to include the energy company’s amortization payments in the national budget for the first time also increased the deficit. It's hard to see how Sheinbaum will address these issues in the near future.
India
Liberal democracy has come under pressure over the last few years. Therefore, it was encouraging to see the world’s largest democracy, India, go to the polls in a general election that was generally seen as free and fair.
President Modi has walked away wounded but victorious.
Such is the scale of proceedings that voting took place over six weeks. President Modi has walked away wounded but victorious. His Bharatiya Janata Party remains the largest in Congress, and coalition partners are unlikely to block his planned economic initiatives.
South Africa
The loss of the African National Congress party’s majority for the first time since the dawn of democracy shocked the party. For the moment, things are likely to remain the same. Yet, looking ahead, there's an increased chance of the government collapsing, leading to either parliament choosing a new president or calling for new elections. Stay tuned.
What does it mean for investors?
Why are we focusing on country-specific events? Because it’s in idiosyncratic stories where we see the most compelling investment opportunities. This plays to our strength in EM debt: fundamental bottom-up research to generate alpha.
At an index level, spreads across bond markets, including EM debt, are tight compared with historical levels. Meanwhile, investment-grade spreads have been unattractive for several quarters. We remain underweight here.
Over a year ago, we identified value in the distressed and CCC segments. The near completion of several debt restructurings has validated this view, leading to outperformance. Recently, investors accepted Zambia’s debt restructuring deal, which official creditors, the IMF, and the private sector crafted.
These deals should lead to renewed inflows into Zambia and bodes well for Ghana and Sri Lanka, which are negotiating similar deals. While we haven't seen credit-rating upgrades for CCC-rated issuers – where the most significant spread changes have occurred – further narrowing of spreads is likely should such upgrades occur.
Final thoughts
The US Federal Reserve’s decision to delay rate cuts has notably affected EM local bond markets, particularly sensitive to shifts in interest rate cut expectations. At the end of May, the EM Index was down -2.7% year-to-date.
Despite the current challenges, rate cuts in EMs are coming. Monetary policy remains tight, growth is lagging long-term averages, and base effects mean inflation should continue to fall. Despite the macro backdrop, local bond markets continue to price in tight monetary policy.
On frontier local markets, we believe a lot will be changing. And for the better. Policymakers are building external buffers, inflows into the local market are contributing to rebuilding FX reserves, and financing from commercial and official sources is on the rise. Meanwhile, fiscal consolidation and tightening monetary policy are helping to establish policy anchors.
Finally, high nominal yields and attractive carry in countries like Pakistan, Nigeria, Kenya, and Egypt mean that these markets are now garnering investors’ attention and may be worth considering for investment.
Important information
Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).
Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.
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Standard & Poor’s credit ratings are expressed as letter grades that range from “AAA” to “D” to communicate the agency’s opinion of relative level of credit risk. Ratings from ‘AA’ to ‘CCC’ may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the major rating categories. The investment grade category is a rating from AAA to BBB-.
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