The current optimism is not only benefiting the equity market but also emerging debt markets and in particular "pre-emerging" markets. But are they really all booming? Catherine Reichlin, head of financial research, tells us more about this subject in her Bond Moment.
Hello everyone, today let’s look at a specific part of emerging markets.
The current optimism is not only benefiting the equity market but also emerging debt markets, and in particular "frontier" or "pre-emerging" countries, i.e. the riskiest ones. This is the case, for example, with El Salvador and Argentina, which have enabled specialized investors to make gains of over 20% this year.
The optimism is such that credit default swaps (CDS), instruments used to estimate the risk of default, have fallen back to pre-invasion levels in Ukraine. Does this mean we should invest with our eyes closed? Far from it. The recent example of Ecuador is a perfect illustration: in one week, the country went from the top spot to the bottom following a disappointing vote result.
Egypt is also in trouble. The country is benefiting from an IMF program and had been on the road to recovery for several years. Its financial successes had enabled it to diversify its investor base significantly : local and foreign markets, bank syndications, Islamic debt, Green market.
But the downturn in the bond markets and the rise in yields, combined with the plummeting currency, which underwent three devaluations in 2022, have caused debt costs to skyrocket. These costs are not the only ones rising. In January, food prices saw their biggest monthly increase since the statistic was first calculated and led overall inflation to nearly... 26%!
Caught in the squeeze of an economic slowdown, soaring inflation and unsustainable debt service, Egypt chose to disappoint the market by leaving its benchmark rate unchanged for the first time since September. Moody's downgraded the country's rating to B3 because despite IMF support, Egypt will need time to reduce its external risks of financing costs and inflationary pressures.
Local yields are soaring and the credit curve is now inverted, a sign of increased default risk. Since the beginning of the year:
- the 2-year yield has climbed 264 basis points to 22% while
- the 10-year yield has risen 190 basis points to 21.5%.
Foreign debt has not been spared. The green bond issued in 2020 saw its risk premium rise to almost 1'000 basis points in November… It then performed in concert with other emerging countries in the enthusiasm of the beginning of the year and fell back to 420 basis points at the end of January. By mid-February it was well over 600bp for a maturity of ... 2025.
The government continues to implement the IMF reforms, notably to give more space to the private sector. In this context, it has announced the privatization of more than 20 companies, including the Banque du Caïre and the Port Said containers. President El Sisi has begun a charm trip to Dubai to promote his program, as he will need all the support he can get to turn things around. Optimism may be contagious, but it does have its limits.