Emerging Market Macro Insights - February 2023

Emerging market local debt poised for a positive 2023
With COVID in the rearview mirror, hiking cycles and yield curve adjustments near their ends and many of last year’s macroeconomic headwinds diminished, we expect robust performance in most emerging market countries this year. In our view, emerging market currencies will likely be the outperformer in the first half of the year relative to interest rates, while interest rate curve steepening will most likely dominate the second half of the year, as we gain more certainty on US and European policy paths. We are positive on the direction of interest rates toward the end of the year. With that said, we expect elevated dispersion across regions and countries when individual central banks begin their easing cycles. We expect Latin America to start easing first, followed by the Central and Eastern European, Middle East and African (CEEMEA) countries, while Asia will likely be on pause for some time. China’s full reopening will likely benefit the Association of Southeast Asian Nations (ASEAN) countries most, while the impact on commodity exporters in Latin America will likely be muted compared to past periods of Chinese growth recovery.
Market pulse
From a central bank policy perspective, we are nearing the end of the hiking cycle in most countries. It doesn’t mean that rate cuts are around the corner, although there may be some opportunities for a few central banks to ease monetary policy in the second half of this year. In Latin America, Peru raised rates by 25 basis points in January and may raise once more, while Colombia reduced their tightening pace to 75bps to bring its policy rate to 12.75%. The rest of Latin America and most of CEE remained on hold in January. Romania and South Africa hiked by 25 basis points in January, as did Indonesia, South Korea, and Thailand. With policy rates at or above, and in many cases, significantly above, pre-pandemic levels, we expect central banks to be at, or close, to their terminal rates. With a clearer path now on developed market central bank monetary policy and with emerging market inflation on the decline, we expect emerging market central banks to be more comfortable with current market risk scenarios, although a few countries on pause may have to resume stricter policy actions. Nevertheless, we believe tighter policy action in developing countries will be limited.
Regional Spotlight: Southeast Asia | Notes from the ground
In January, we visited with government officials at central banks, debt management offices and treasuries, as well as with IMF representatives, investors, journalists and political consultants in Indonesia, Malaysia, and Thailand. We have since become more cautious on the Thai baht and constructive on Thai long-term interest rates. We are also more cautious on Malaysian interest rates and prefer the five to 10-year part of the curve versus the long end.
If Erdogan wins, more orthodox policies would likely be needed, as funding becomes increasingly critical. A sudden disruption in economic activity ahead of the election is not out of the question if rollovers of local government debt drop below 50%. Some economic pressures have eased due to a significant uptick in tourism and Russian immigration that have net increased the country’s errors and omissions account in the balance of payments by USD25 billion from January through August this year. These economic contributors could wane soon, however. Regardless, interest rates in Turkey must increase significantly for inflation to subside and allow a transition to a new policy framework. We believe the currency would have to depreciate as well. From an investment perspective, Turkey is only a small percentage of the benchmark, and, in our view, there is no reason be constructive at this point on Turkish interest rates and the currency.
Thailand
Thailand surpassed our expectations in terms of its stability and economic fundamentals. Its solid fundamentals are underpinned by ongoing economic reopening and growing tourism and business activity. Fiscal performance and inflation are expected to return to pre-pandemic levels sooner than anticipated. Structural issues remain and competition with Indonesia for foreign direct investment in electrical vehicle production may not turn out in their favor. However, elections are expected to result in continued stability with respect to policymaking. Currency and short-term interest rate valuations reflect these positive headwinds for the sovereign, and we are most constructive on long-term interest rates.
Indonesia
Indonesia was in line to slightly above our expectations. The strong recovery of 2022 has normalized but remains brisk, with expected growth around 5% and continued disinflation. Given its already sound macroeconomic framework (primarily fiscal but also monetary), the central question is how the country can unlock its growth potential of 7-8%.1 Structural reforms related to taxes, unemployment and trade are moving slowly, while leakage in the balance of payments are continued drags. Foreign direct investment, however, has been picking up, especially in electric vehicle production, and Indonesia seems better positioned than peers in the “China plus one race” that aims to diversify supply chains in response to pandemic-driven disruption. The February 2024 presidential elections are too far in the future to be a concern, in our view. However, a new central bank governor will likely be appointed in March, and there is a small probability that an unknown candidate could be named.
Malaysia
Malaysia disappointed versus our expectations, though to be fair, the new government has only recently taken office, so our takeaways may be premature. Malaysia’s task at hand has been to reverse the talent drain to Singapore but this could be challenging. Additionally, the sovereign will likely struggle relative to Thailand and Indonesia for benefits of the China plus one strategy, given the lukewarm relationship between President Xi and Prime Minister Anwar. Needed, though unpopular, measures will not likely be taken until the state elections this summer.
With contributions from Mohit Patel, Associate Product Manager, Invesco Fixed Income.
Investment risks
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.
Footnotes
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1
Source: Bloomberg L.P. Data as of Dec. 31, 2022.