Emerging Markets
28 Jun 2016

Emerging market debt to ride out Brexit risks

The havoc wrought by the `Brexit’ vote in the UK last week left no corner of so-called risky assets untouched, as investors rushed to appraise the potential political and economic fallout of such a momentous decision.

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The havoc wrought by the `Brexit’ vote in the UK last week left no corner of so-called risky assets untouched, as investors rushed to appraise the potential political and economic fallout of such a momentous decision. Emerging-market (EM) debt was no exception. 

As we try to put last week’s British vote in context, we must remember that apart from countries in central and eastern Europe, the UK’s departure from the European Union should have minimal direct economic impact on the emerging world. For developing countries that are current or prospective EU members, the ramifications of `Brexit’ are important from a trade and investment perspective. Concerns may also emerge that EU cohesion will suffer and investors are likely to scrutinise the possibility of those countries pushing away from the EU’s integration process as well.

In any case, those woes should be limited to Europe in the broader context of emerging markets. Investors channelled a net US$1.75bn billion into emerging-market exchange-traded funds last week, according to Bloomberg, reaching the highest level in almost three months.  

GOOD PERFORMANCE

In spite of the latest volatility, we remain focused on the promising drivers that have underpinned EM debt in the year-to-date and have allowed the asset class to perform very strongly relative to other investments. Among these factors, economic growth in emerging markets appears to have perked up relative to developed markets, reversing the trend of recent years.  

Also creating a healthier picture in EM is the improvement in current-account deficits, a trend noticeable in most of the economies we track, from India, to Turkey and South Africa, to Latin America. Higher nominal and real yields, and lower debt-to-GDP ratios at the state level are also encouraging trends for investors.

BENIGN MONETARY POLICY

Importantly, these economies benefit from the extraordinarily benign monetary policies in place in the largest industrialized nations, particularly the US. As the Brexit vote rattles markets, economists and traders are already raising bets that the Federal Reserve may delay further interest-rate increases. 

This string of positive fundamentals for EM debt also includes compelling valuations, following three years of relative underperformance to developed markets. Finally, we believe that a recovery in commodity prices, and more favourable domestic policy and reforms, will also provide tailwinds. 

We expect a continued recovery in emerging-market debt as the dust settles on the UK vote. We remain, as always, cognisant that bouts of volatility represent a risk to the asset class. But it is important to focus on the long-term returns expectations of our portfolio and not get distracted by short-term market moves that may end up being a minor chapter in the fundamental story. 

 

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