Emerging Markets Debt Daily
EM Politics – Near-Term Pain, Longer-Term Gain?Natalia Gurushina, Chief Economist, Emerging Markets Fixed Income StrategyJuly 16, 2021
Local bonds are bouncing in the recent political hotspots (South Africa, LATAM), but there is a question whether the risk premium will continue to mean-revert or it will have to move higher in the medium-term as the baseline.
This is the question we’ve been asking ourselves this week as we watched the deadly riots unfolding in South Africa. The situation on the ground seems to be de-escalating, and both the currency and rates retraced some of the week’s losses – albeit South Africa had the worst weekly total return in the J.P. Morgan’s local bond index (GBI-EM, see chart below). What we are struggling to understand is whether the country’s risk premium will mean-revert to the pre-riot levels, or South Africa would require a higher medium-term risk premium as the base line.
The analysis we’ve seen so far suggest that the impact on 2021 GDP growth is likely to be limited, and that the budget can absorb the shock without a material longer-term impact. South Africa’s central bank – widely considered to be among the most credible in emerging markets (EM) (if not in the world) – will provide its updated risk assessment later this month, but is expected not to panic and stay on hold. Suggestions that the crisis can force President Cyril Ramaphosa to seek alliances outside the ANC and that it can strengthen local institutions and NGOs are tantalizing. There is an opportunity, but there is also a risk. South Africa has one of the highest unemployment rates in EM (over 30%), one of the highest inequality ratios in the world and its per capita GDP is way below the rating peers.
South Africa is not the only country/region that saw groundbreaking political developments in the past few months. LATAM is very much on our radar. Local bonds had been bouncing lately (see chart below), as the recent negatives (Peru’s elections, Colombia’s downgrade, Chile’s referendum) are getting increasingly priced in, and there are signs of policy pragmatism on the ground (Colombia still pushing ahead with tax reform, Peru’s president-elect making reasonable personnel calls, etc.). The regional growth outlook has been upgraded the most in EM, as vaccinations are gaining pace, and central banks are responding to higher inflation in an orthodox manner (=rate hikes). Stay tuned!
Charts at a Glance: Local Rates - Political Risks Are Hitting Some EMs, Priced in Others
Source: VanEck Research; Bloomberg LP
PMI – Purchasing Managers’ Index: economic indicators derived from monthly surveys of private sector companies. A reading above 50 indicates expansion, and a reading below 50 indicates contraction; ISM – Institute for Supply Management PMI: ISM releases an index based on more than 400 purchasing and supply managers surveys; both in the manufacturing and non-manufacturing industries; CPI – Consumer Price Index: an index of the variation in prices paid by typical consumers for retail goods and other items; PPI – Producer Price Index: a family of indexes that measures the average change in selling prices received by domestic producers of goods and services over time; PCE inflation – Personal Consumption Expenditures Price Index: one measure of U.S. inflation, tracking the change in prices of goods and services purchased by consumers throughout the economy; MSCI – Morgan Stanley Capital International: an American provider of equity, fixed income, hedge fund stock market indexes, and equity portfolio analysis tools; VIX – CBOE Volatility Index: an index created by the Chicago Board Options Exchange (CBOE), which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities on S&P 500 index options.; GBI-EM – JP Morgan’s Government Bond Index – Emerging Markets: comprehensive emerging market debt benchmarks that track local currency bonds issued by Emerging market governments; EMBI – JP Morgan’s Emerging Market Bond Index: JP Morgan's index of dollar-denominated sovereign bonds issued by a selection of emerging market countries; EMBIG - JP Morgan’s Emerging Market Bond Index Global: tracks total returns for traded external debt instruments in emerging markets.
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