By Natalia Gurushina
Chief Economist, Emerging Markets Fixed Income
Ukraine Debt Restructuring
Ukraine made an official request for a 2-year suspension of coupon/principal payments on foreign-currency denominated bonds. The Paris Club of official creditors also issued a statement this morning, asking Ukraine’s lenders to defer payments until the end of 2023. This twist put emerging markets (EM) sovereign debt back in a spotlight. Granted, Ukraine’s situation is rather unique, but it is not the only frontier EM teetering on the brink of default right now. Sri Lanka is featured prominently in the headlines – in part due to powerful images showing people taking over the presidential palace. The names of several African economies regularly pop up when we talk about various debt relief initiatives.
EM Sovereign Spreads
EM sovereign debt hardship might feel ubiquitous – the U.S. Dollar strength creates such an impression as well – but there is a well-defined “quality” divide here. Sovereign spreads on bonds with strong fundamentals – proxied, for example, by single-A or double-A ratings – are not even remotely close to historic highs, such as the COVID crisis or the global financial crisis of 2008/09 (see chart below). It’s very much “Tantrum? What tantrum?” environment for these bonds. The same can be said about spreads on other Investment Grade sovereign bonds (BBB-rated). Sovereign bonds that are currently under a lot of pressure are primarily lower-rated High Yield instruments (single-B and single-C). Spreads on B-rated bonds are getting close to the COVID levels, while spreads C-rated bonds are now at the 2008/09 crisis highs.
EM Inflation and Rate Hikes
Credible and coherent economic policy is a major factor that keeps EM sovereign spreads in check. And this includes floating exchange rates (=shock-absorbers) and timely policy rate adjustments. This is why EM central banks’ decisions feature so prominently in our daily comments. South Africa’s reserve bank will be meeting tomorrow, and today’s upside inflation surprise should justify a larger 75bps rate hike (especially given that the real policy rate adjusted by expected inflation is still negative). We will also keep an eye on a possible liftoff in Indonesia (the consensus sees no change) and the expected liftoff by the European central bank (ECB) (an honorary EM… just kidding). Stay tuned!
– Read more on inflation
Chart at a Glance: EM Sovereign Spreads – A Lot of Variation by Quality
Source: Bloomberg LP
Originally published by VanEck on July 20, 2022.
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PMI – Purchasing Managers’ Index: economic indicators derived from monthly surveys of private sector companies. A reading above 50 indicates expansion, and a reading below 50 indicates contraction; ISM – Institute for Supply Management PMI: ISM releases an index based on more than 400 purchasing and supply managers surveys; both in the manufacturing and non-manufacturing industries; CPI – Consumer Price Index: an index of the variation in prices paid by typical consumers for retail goods and other items; PPI – Producer Price Index: a family of indexes that measures the average change in selling prices received by domestic producers of goods and services over time; PCE inflation – Personal Consumption Expenditures Price Index: one measure of U.S. inflation, tracking the change in prices of goods and services purchased by consumers throughout the economy; MSCI – Morgan Stanley Capital International: an American provider of equity, fixed income, hedge fund stock market indexes, and equity portfolio analysis tools; VIX – CBOE Volatility Index: an index created by the Chicago Board Options Exchange (CBOE), which shows the market’s expectation of 30-day volatility. It is constructed using the implied volatilities on S&P 500 index options.; GBI-EM – JP Morgan’s Government Bond Index – Emerging Markets: comprehensive emerging market debt benchmarks that track local currency bonds issued by Emerging market governments; EMBI – JP Morgan’s Emerging Market Bond Index: JP Morgan’s index of dollar-denominated sovereign bonds issued by a selection of emerging market countries; EMBIG – JP Morgan’s Emerging Market Bond Index Global: tracks total returns for traded external debt instruments in emerging markets.
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