EM Local Debt and Politics

Policy agendas can separate winners from losers in financial markets – and not just in emerging markets (EM) (August-September mini-crisis in the U.K. is a good example). Investors’ perceptions about the shifting policy direction played a big role in LATAM’s Fixed Income space this year – including Chile’s rebound after the benign referendum outcome, Brazil’s pause after the presidential runoff, and Colombia’s failure to recover after the elections and massive underperformance vs. the rest of the region (see chart below). And the latest news flow raises a lot of questions about the 2023 outlook. In Brazil, President-elect’s spending plans and cabinet appointments led to a significant widening of the 2023 consensus budget deficit forecast (to 8.3% of GDP), which can lead to higher bond issuance and less room for central banks’ rate cuts. Peru’s never-ending government reshuffles distract from key structural reforms, putting more pressure on the central bank to act as the only adult in the room.

EM Debt Sustainability

Not all “policy mandate” stories are glum. The South African rand staged a nice rally in the morning trade, following President Cyril Ramaphosa’s re-election as the African National Congress (ANC) leader. The fact that Ramaphosa’s victory margin was broader than expected led to suggestions about a stronger reform mandate going forward. This would be a much-needed development, as the market is still uncertain about the pace of fiscal adjustment and debt sustainability – the consensus sees very limited improvement in the 2023 budget deficit, and this can weigh on South Africa’s local debt performance, despite its high yield.

China Reopening, Policy Stimulus

China’s zero-COVID/real estate policy U-turn also did not go unnoticed by the market – J.P. Morgan’s CEMBI High Yield+ China Index returned 66% since November 3. The key message from the Central Economic Work Conference was encouraging, especially as regards regulations (pro-growth) and on-going policy support. We also keep an eye on efforts to prop up domestic demand and consumption – these were mentioned, but a sustained turnaround would be condition on successful reopening. China’s activity gauges for December should give us the first “taste” of the economy’s response to lifting the COVID restrictions. Stay tuned!

Chart at a Glance: LATAM Fixed Income - Diverging Performance

Source: Bloomberg LP