Debt and denial in emerging markets

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Ahead of US rate hikes, Jan Dehn, Head of Research at Ashmore, reminds everyone that per capita debts have risen by USD 50,000 in developed countries and fallen by USD 3,500 per person in Emerging Markets (EM) since 2000.

He also covers the latest developments in China’s financial liberalisation, Ethiopia’s entry to the global capital markets and changes in the Indian banking sector.

Between 2000 and the end of 2013, developed economies increased the volume of outstanding government and corporate debt by an astonishing USD 66,027,859,420,489.1 Over the same period, their GDP only increased by USD 16,679,400,000,000 (in current PPP adjusted international USD terms).

Debt rose by the equivalent of USD 60,942 for every man, woman and child. After netting out the per capita income gains over the same period the debt burden rose by USD 46,967 per person.

In EM, outstanding EM government and corporate bond debt increased by USD 12,047,005,781,161, while GDP increased three times more (USD 36,683,352,000,000), equivalent to each man, woman and child in EM getting USD 3,513 less indebted over the period. Developed economies have wallowed for years in the pleasant fiction that the debt does not cost anything. We suggest this dream ends when the Fed begins to raise rates.

China: China is actively engaging government and private sector institutions around the world in a bid to internationalise the Renminbi and turning it into a global reserve currency. The Sri Lankan government is the latest government to consider issuing bonds in Renminbi, according to Sri Lankan central bank sources.

China’s drive will be successful, in our view. China is also opening its domestic market to foreign investors in both equities and fixed income. We think China will diversify its foreign exchange holdings, particularly when inflation re-emerges in the US. These three drivers will provide strong structural support for the Renminbi, which, in our view, will be among the strongest currencies in the world over the next decade. As China’s currency appreciates it will have to rely more on domestic demand-led growth.

In turn, this requires new macroeconomic tools, notably bond markets. China’s financial liberalisation is now embracing securitisation. A senior official in China’s Banking Regulatory Commission this week said that credit securitisation will be elevated to priority status. This is very positive both for banks and the emerging mutual fund industry.

Chinese savings rates are about 50% of income and savers have few ways to invest their money outside stocks, property and low paying deposit accounts (trust products are also available, but they are mainly used by wealthier investors China’s services PMI rose to 53 in November slightly up from 52.9 in October, while the trade surplus for November was much larger than expected. At USD 54.47bn, the trade surplus was the largest ever.

To place the number in context, the latest US trade deficit was USD 43.4bn. China’s trade surplus is rising in large part due to weaker imports, but the larger trade surplus will be a positive contributor to GDP growth.

Ethiopia: Ethiopia is set soon to become the 62nd member of the JP Morgan Global Diversified Emerging Markets Bond Index (EMBI GD). The government issued USD 1bn of an inaugural index-eligible 10-year dollar denominated sovereign bonds at a yield of 6.625%. Sub-Saharan Africa is the fastest region for external debt markets in EM. Africa is also the fastest growing continent in the world.

The end of the Cold War and access to global capital markets instead of dependence on aid has been critical to raising Africa’s growth rates. African countries are useful diversifiers in global fixed income portfolios; the sovereign risk profiles of African countries are not only diverse, but also distinct from those of other regions of EM.

India: The Reserve Bank of India signalled rate cuts early in 2015, but kept the policy repo rate unchanged at 8%. Other policy rates were also left unchanged. Inflation is on a declining trend in India and will receive further momentum from lower oil prices.

Equally important, greater fiscal discipline is allowing rates to be reduced, which should be beneficial for investment spending and therefore increase economic growth. India is experiencing a cyclical upswing evident in stronger PMI numbers, higher auto sales, a pick-up in corporate investor sentiment and aided further by the expectations of rate cuts next year. Coal mining licences are due to be auctioned in March 2015, which should be supportive for power plants. In the financial sector some 85 million people are about to be given bank accounts as the government seeks to convert in-kind subsidies into cash payments.

This is good economic policy, but the benefits to the banking sector and India are broader and the boost from including so many more people into the financial sector should not be underestimated. Efforts are also underway to improve the efficiency of India’s banks, which should help to bring down borrowing costs for businesses and households over the longer term. More efficient banks are also important for the efficiency of the bond market as a pre-cursor for a possible opening of the domestic bond market to foreign investors.

One of the measures under consideration is a change to rules governing conversion of debt into equity, which could help public banks in capturing some upside from restructuring loan books. The government has proposed a new bankruptcy law, which should also help lenders. Finally, Parliament passed two labour reform bills that cut red tape for hiring new workers and promotes training and apprenticeships.

 

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