21st October 2011
While developing markets are seeing their sovereign debt subject to downgrade after downgrade, emerging markets are being quietly upgraded. It is one of the clearest signs of a convergence between emerging and developed markets as global economic power shifts.
Financial market analyst Charlie Fell points out in his blog that almost 60 per cent of the debt in the U.S. dollar-denominated J.P. Morgan Emerging Market Bond Index (EMBI) is rated investment-grade today, up from less than 20 per cent a decade ago.
Notable upgrades to investment-grade status in recent years include Mexico in 2002, Russia in 2005, Peru in 2008, Brazil in 2008, and Panama in 2010. This suggests that the term emerging markets is, to some extent, a misnomer in the first place.
The reasons for this convergence are well-flagged, but summarised succinctly in this report by E&Y .
"Emerging markets are amassing huge surpluses while many developed countries plunge further into deficit. And, despite the emergence of the G-20 as a more inclusive "steering committee" for the global economy, the growing assertiveness of emerging economies and a gradual loss of primacy for the US could herald growing geopolitical tensions."
That sinking feeling
Notable developed market downgrades include Italy, Spain, and, of course, the US. There is a second tier of developed market countries who are 'on watch' from the rating agencies.
"The U.S. downgrade is the ultimate symptom of the convergence of creditworthiness between emerging and developed markets; it suggests the old way of thinking about emerging market risk no longer applies," writes HSBC's Global Head of Emerging Market Research Pablo Goldberg in this Reuters article.
This has some important repercussions. First of all, it has created a whole new asset class in local currency emerging market debt. Groups such as Schroders, HSBC, Investec and Pictet all now have funds in this area.
Previously emerging markets had to raise money in foreign currency because investors did not trust in the stability of domestic emerging market currencies. Now those currencies are more secure, emerging markets can issue bonds in their own currency, thereby removing a considerable risk factor for these economies.
This IMF survey highlights the importance of these upgrades for emerging markets . Not only does it ease their path to borrowing in capital markets, it reduces the cost.
"Using a panel framework for 35 emerging markets between 1997 and 2010, this paper finds that investment grade status reduces spreads by 36 percent, above and beyond what is implied by macroeconomic fundamentals.
This compares to a 5-10 percent reduction in spreads following upgrades within the investment grade asset class, and no impact for movements within the speculative grade asset class." The report also highlights that a number of emerging markets are considered investment grade – China, Chile, Poland, Malaysia
"Basic economic theory presumes that capital will flow "downhill" from capital-rich developed economies to capital-scarce emerging ones, as investors in the first seek profits in the second.
Yet over the past 15 years, capital has, on net, flowed "uphill" from emerging economies to developed ones."
There is other evidence that emerging markets are increasingly calling the economic shots. This KPMG survey found that emerging market companies are reducing their M&A activity in developed markets.
Certainly there is evidence that the chief beneficiaries of the consumer boom in, for example, China and Brazil, have been domestic companies. Western companies have often had to acquire local players to get a share of the action.
Perhaps most worryingly for developed market policymakers, is that the politicians in emerging markets have spotted it too …. For a long time economists have been predicted a new economic era. It may finally have arrived.
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