EM investors to shift attention to growth

Principal Asset Management’s emerging markets debt (EMD) investment team, Principal Finisterre, has released its 2024 outlook, expecting investors to pivot away from inflation and interest rate concerns to focus on growth.

The report said that if global inflation continues on its “receding path”, the team expects EM investors to reconsider their approach away from the past two years obsessing over the interest rate cycle to a “traditional blend of growth and fiscal dynamics”.

“The latter will matter most to select EM sovereigns in USD, with the risk of further external debt issuance or sporadic fiscal deterioration ahead of key elections potentially weighing on sovereign spreads,” it said.

“Local interest rates curves could also be liable to steepening risks on the back of possible rising issuance, although they should ultimately remain anchored by continuing disinflation and the prospect of interest rates cuts.

“All in, current expectations as per the IMF World Economic Outlook look relatively benign with some moderate 0-1% of GDP primary deficit reduction between 2023 and 2024, but we remain conscious that higher refinancing costs should also weigh on headline deficit numbers, while elections are often the excuse for extra spending.”

Principal Finisterre indicated its preference for a “resilient basket of high-carry EM corporates” for investors looking to generate strong returns this year.

“We like the quality of AT1 and T2 bank papers in Asia and Mexico, which are callable within a few years, and MREL (EU senior non-preferred) bank papers issued by Eastern European banks. Pan-African and Caribbean telecom or towers operators offer the blend of dollarised revenues and visible cashflows in currencies often linked to the USD (Caribbean Dollar) or the EUR (CFA franc).

“Oil and commodity exposure should find an expression through select African corporate oil producers or Middle-Eastern oil and gas quasi-sovereign issuers. We think that the Asia credit space remains quite poor in terms of attractive value opportunities although we continue to like the Macau gaming sector as a China normalisation trade continuing to benefit from the lack of overseas travel by Chinese nationals.

“A couple of opportunities may also exist in the Indian renewable space. Finally, Brazil remains a fertile ground for diversified cyclical exposure, from steel to infrastructure or protein sectors, as a play on a growth rebound in both scope and quality, especially if administrative reform is passed in congress in early 2024.”

The report also emphasised the effects of political elections occurring this year in several EM territories, warning investors to be prepared in case of a shakeup in fiscal policy and economic conditions.

“The most globally significant should be the Taiwanese election in January, which may or may not help preserve the status quo of the island vis-à-vis China without triggering an escalation of tensions.

“We believe that none of China nor Taiwan would see any upside in a short-term rise in tensions. February will see Indonesia choose a successor to long-term incumbent Jokowi Widodo. His appointed heir and current minister of defence Prabowo Subianto leads the polls but seems to be a bit more polarising and less fiscally rigorous, hence the degree to which he retains Jokowi’s legacy will be an important factor.

“The Mexican election will also see Andres Manuel Lopez Obrador leave his seat in April in what will be a key focus for EM investors, where his appointed successor is a pragmatist but possibly lacks his charisma and is not yet ensured of a victory.

“South Africa’s general and presidential contest in May will likely be the first one since the end of Apartheid where the African National Congress (ANC) party loses its absolute majority and needs to govern with a coalition partner. Whether they end up aligned with the ultra-left Economic Freedom Fighters (EFF) party or the center-right Democratic Alliance (DA) will bear a lot of significance as to the country’s outlook, while they are still mired in an acute energy crisis creating fiscal strains and sub-par growth potential.

“Other key elections in Senegal, El Salvador, Pakistan, Ghana, Sri Lanka, and Tunisia later in the year will be closely watched and quite defining for those countries with still fragile debt dynamics.”