COVID-19 devastating for EM prospects

The COVID-19 pandemic will deliver a devastating blow to emerging markets (EMs) prospects as Fitch Ratings has already made 18 downgrades with regards to emerging markets sovereigns in 2020 which was the highest annual total in less than four months. 

EMs would face the most adverse economic conditions due to the twin shocks of the coronavirus  pandemic and plunge in commodity prices, amplified by financial market dislocation, massive capital outflows and a strengthening in the US dollar, the agency said. 

On top of that, the sovereigns most exposed would be those reliant on commodity exports, tourism or remittances; with large external financing requirements, foreign currency debt, hot-money inflows and low reserve buffers; or with generally weak credit fundamentals, such as high debt and weak policy credibility. 

Under the base case the health crisis was expected to eventually pass, with economic recoveries starting in 2H20 and 2021 after an unprecedented drop in activity in 1H20.  

“But we recognise the huge uncertainties and downside risks hanging over the outlook, and oil prices will be persistently lower. Moreover, the crisis will leave a legacy of increased sovereign defaults, higher public debt, diminished central bank firepower and potentially structural changes to global trade, public ownership and social attitudes,” Fitch Ratings’ analyst, Ed Parker, said in a note. 

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Fitch said it would continue to assess sovereign creditworthiness case-by-case as the crisis and policy responses evolve, with negative rating actions focussed on sovereigns where creditworthiness was most vulnerable to particular stress points of the crisis or where prior weaknesses left limited resilience to shocks. 

Since the beginning of March, Fitch also affirmed some EM sovereigns with stable outlooks, which it believed were relatively resilient to the coronavirus shock compared with rating peers; so far this included Kuwait, Peru, Poland, Saudi Arabia, Serbia and Uzbekistan, the firm said. 

According to exchange trade funds (ETF) provider, VanEck, emerging markets winners and losers could surface in the bond market following the coronavirus pandemic, while longer duration government bonds from developed markets could be crushed in an eventual economic recovery. 

Also, the coronavirus hurt global growth prospects and investors flocked to 'safe' or lower risk assets such as US Treasuries, which are trading near all-time high values which forced yields on government bonds to historical low levels below 1% in many developed nations and below 0% in Germany and Switzerland, drastically hurting investors' income streams. 

This could encourage investors to turn to emerging market bonds, with active fund managers best placed to pinpoint winning investments, Eric Fine, VanEck Portfolio Manager for the Emerging Markets Fixed Income Strategy, said. 

“The emerging markets asset class is not a monolith. Some are bad, so don't invest. Some are good, so don't throw them out. Some are really good and have done well in this environment, like Czech, Thailand, and Philippines,” he said. 

“By the same token, some developed markets bond markets have been crushed, like in Australia, Italy, and Greece. A good investment, in other words, depends on country-specific factors. It is not the case that all emerging markets bonds are 'bad', or all emerging markets bonds are 'good'.”