EM Debt Outlook: Growth Drivers Persist

1. Last year, you felt EM inflation had peaked. Today, inflation has drifted lower in line with your expectations. Will inflation remain a key factor for emerging markets in 2024?

Yes, inflation will continue to be a factor, but we would add that maintaining growth will also be important—both points cut across developed markets (DM) and emerging markets (EM). In the US, it appears that the Federal Reserve (Fed) has engineered a soft landing. This should result in lower policy rates and yields. A no-recession environment would be very positive for EM, especially now that starting yields in EM are higher than in any of the recent rate easing cycles.

In EM, you have countries that are accustomed to dealing with inflation. Some have dealt with double-digit inflation over long periods. Broadly, EM central banks were much earlier and more aggressive in dealing with the post-COVID-19 inflation challenge than those of DM. This was underappreciated in the global market and underpinned the strong performance in many EM local markets in 2023.

As we enter 2024, many EM central banks are looking at cooling their inflation fighting efforts. In fact, many have already entered easing cycles. For example, Poland, Hungary, Brazil, Chile and Peru cut rates in the latter half of 2023. Expectations are for others to follow suit. Lower inflation provides the flexibility to reduce rates and prioritize growth.

2. What’s your view of corporate fundamentals in EM, and how do they inform your default expectations? Are there industries where you are finding more compelling opportunities than others?

Despite a decelerating global growth backdrop, EM corporate credit fundamentals remained resilient in 2023. From a net leverage perspective, we see EM corporate credit tracking to a modest 20 basis points uptick to 2.4 in 2023.[i] The move was largely driven by cyclical pockets of weakness in the high yield segment, with EM investment grade corporate leverage remaining largely stable. Post-pandemic, EM corporate issuers were active in rebuilding balance sheet buffers. Disciplined financial policy has provided an offset to softer earnings growth. As a result, aggregate EM corporate net leverage is at the lower end of its historical range and is entering 2024 from a position of relative strength.

From a default perspective, we believe 2024 should see marked improvement from the default levels of recent years. Two discrete pockets of pressure elevated EM corporate high yield (HY) defaults in 2022 and 2023. They were in Russian corporates—many entered technical default following the Russia/Ukraine war—and Chinese property developers. With many of these Russian and Chinese issuers out of the market, our EM corporate HY default expectations for 2024 are fairly benign at 4%. Our expectations are for idiosyncratic credit stories to drive the default backdrop in 2024 versus sector or country specific factors.

In terms of opportunities, we continue to favor countries with strong domestic growth drivers—with buffers against slowing external demand—and those with long-term structural tailwinds. India appears to be a standout in this space. Mexico is poised to benefit from investments into nearshoring. We are also looking for opportunities in countries with continued positive policy reforms, including Turkey and Nigeria.

Across sectors, we remain constructive on the consumer, technology, media, telecommunications and utilities sectors. In our view, each stands to benefit from positive internal demand drivers and long-term government policy objectives.

3. What do you see as potential risks to your outlook?

There are several risks to our sanguine EM outlook for 2024. They include, election cycles, geopolitical conflicts, the potential for a US economic growth downturn and unevenness in China’s economic growth recovery.

In the emerging world, the market will be watching the upcoming presidential elections in Taiwan, Indonesia and Mexico. General elections in India, Panama, South Africa, Sri Lanka and Pakistan are also taking place. Collectively, these elections could have an impact, especially if results are contrary to expectations. We also expect the US presidential election to drive swings in risk sentiment. The primary season and subsequent general election campaign are likely to produce market volatility, in our view.

On the geopolitical front, the conflict in the Middle East and the Russia/Ukraine war loom large. An escalation of tensions in either region may have meaningful consequences for global risk appetites.

As it relates to the global growth backdrop, the risk for a US recession or a significant downturn has not disappeared. We believe that a reversal in inflation trends and/or slump in demand due to the escalation of the conflicts mentioned above could result in a US slowdown. Likewise, while we believe that China’s growth will be close to potential and likely be in the 4.5% range for 2024, recent growth unevenness could persist. Conversely, China’s GDP could surprise to the upside if authorities stimulate more broadly than what has been done so far. This would have a positive impact similar to the one we experienced toward the end of 2022 and beginning of 2023.

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[i] Source: JP Morgan, LTM, as of 30 November 2023.

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