The Case for Emerging Market Debt
Most of us realize that over the last decade the roles of advanced economies (AEs) and emerging markets (EMs) have been reversed, but few of us have changed the structure of our portfolios to reflect this reversal.
In the past, foreign-currency debt constituted a large part of the external liabilities of EMs. Today, however, foreign direct investment (FDI) and portfolio equity form the largest part.
In the case of AEs, debt and bank loans constitute the major share of their external liabilities.
General Government Gross Debt
As academic research has demonstrated in various papers, government debt levels of over 90 percent of GDP have always resulted in long periods of slow economic growth, high unemployment and, eventually, financial repression.
By 2016, EMs will produce 38% of world output, but will hold only 14% of world debt.
In contrast, the four major reserve currency areas, (US$, €, ¥ and £) will account for 58 percent of global GDP and 81 percent of global debt.
As Eswar Prasad pointed out to the central bankers at their recent meeting in Jackson Hole, “High and rising debt levels among advanced economies pose serious risks to global macroeconomic stability.”
Rising debt levels in advanced economies will result in crowding-out effects which, in turn, will affect productivity growth. The resulting productivity growth gap between AEs and EMs implies that EM currencies will appreciate relative to those of the AEs. Since foreign exchange reserves account for 50 percent of EMs’ total assets, and since 60 percent are in US dollars, EMs will be vulnerable to a likely further devaluation of the US dollar.
I trust these notes confirm the case for emerging market debt, both private and public. Cordiant has been focussing on private EM debt and is proud of the superior results it has achieved over the past 10 years.
As Prasad’s paper and the IMF data suggest, the exchange rates of some leading emerging market countries are likely to appreciate vis-à-vis today’s ‘reserve currencies’. Cordiant, therefore, will likely be looking for select opportunities to invest in EM currency denominated loans.