EM Debt Outlook: China Takes Center Stage
1. What is your outlook for growth in emerging markets next year, particularly in light of China’s shift away from its zero-COVID-19 policy? What countries or sectors might benefit most?
While the developed market-led slowdown will likely weigh on global demand, we see China’s reopening providing a strong tailwind to emerging markets, especially within the Asia region. In our view, policymakers’ pivot from zero-COVID policy is a tacit acknowledgment that unshackling the Chinese economy from COVID constraints is key to restoring China’s domestic growth. The massive rollback has led to cuts in quarantine times, reopened borders and the end of testing requirements. This pivot, coupled with the pro-business rhetoric at the December Politburo meeting and increased support to the property sector, has signaled a decisively pro-growth 2023 economic agenda. Increased activity, targeted fiscal stimulus and accommodative monetary policy are likely to provide relief to China’s services sectors, aid the labor market and help restore consumer confidence. Loomis Sayles’ forecast for 2023 Chinese growth is approximately 5.0%; however, a faster reopening may lead to positive revisions in the second half of 2023. Across sectors, we see players in the consumer, real estate, TMT and utility sectors that we believe are well positioned to capitalize on China’s growth recovery. We also see the ASEAN region as a key beneficiary, as Chinese tourism and consumption support its trade partners. More broadly, we expect the normalization of Chinese activity to provide a supportive tailwind to commodity exporters facing weaker US/euro zone demand.
2. EM corporates saw a higher-than-average default rate in 2022, underpinned by Chinese property defaults, defaults stemming from the Russia-Ukraine war and idiosyncratic stories in Mexico. What are you anticipating for defaults in 2023?
While 2022 was a painful year for defaults, we see levels improving in 2023. The EM high yield corporate credit default rate ended 2022 at 14%, dominated by companies related to two pockets of extreme stress—China property and the Russia-Ukraine war. Excluding these pressure points, the default rate was a fairly benign 1.8%. Looking ahead, the full-year 2023 default rate forecast for EM high yield corporate credit is 10.6%. This number is largely comprised of expected defaults stemming from the Russia-Ukraine war and selected Chinese developers, albeit the latter to a lesser extent. Excluding these drivers, default expectations decline to approximately 2.6%, in line with historical averages. Overall, we think default rates in 2023 will be constrained by higher cash buffers, conservative debt levels and access to local capital markets. During the low interest rate regime, EM corporate issuers were actively managing their liabilities, tendering for near-term debt and extending maturity profiles, thus easing refinancing concerns. With net leverage for high yield issuers slightly lower than 2x, we believe issuers are well positioned to weather a macroeconomic adjustment.
3. What are your expectations for EM inflation next year and how does that affect your view on EM rates?
We believe inflation has peaked in many EM countries, and we see potential opportunity in the EM local debt and currency markets. EM central banks are generally further along in the tightening cycle and, where inflation seems to have peaked, may shift their focus to growth. Latin America and central Europe, where inflation has been high, are among those further along in the cycle. Asia, where inflation has been the lowest, may still see more rate hikes.
High-yielding countries such as Brazil and Mexico have flat or inverted yield curveswith positive real yields. Therefore, we find these domestic bond markets attractive. We also like longer-dated South African bonds. South Africa’s yield curve is still quite steep and is likely to flatten from rising yields in the short end, but it commands very high yieldsfor maturities over five years.