Will the emerging market rout get even worse? Watch corporate bonds

Will the emerging market rout get even worse? Watch corporate bonds

By Matt Phillips @MatthewPhillips 7 hours ago

Global investors have suddenly remembered that emerging markets have a rich, recent history of florid financial crises.

The cracks are starting to emerge everywhere: wobbly “wealth management products” in China, the Turkish lira’s tumble, the selloff in Brazilian bond markets and last summer’s mini-rupee crisis.

So are we about to see a replay of the Brazil 1999Turkey 2001Russia 1998, theThai baht bust of 1997Mexico 1982 or Mexico 1994?

Not exactly. Yes, emerging markets have absorbed a tsunami of investor cash in recent years. And yes, historically, when inflows of investor cash start reversing course, problems tend to present themselves.

But by and large, the big problems this time around will differ from what we saw in the late 1990s.

For one thing, many EM countries moved to flexible exchange rates after the unpleasantness of the late-1990s experience, which at least in theory is supposed to insulate these economies from major shocks. (Although it doesn’t help themavoid distress altogether.) And for another thing, instead of government bonds, the immediate carnage will likely show up in corporate debt. Check out this chart, from global banking group the Institute of International Finance. It shows that the vast majority of bonds issued by emerging markets have been borrowings by private entities, rather than governments.

image001-9

​Let’s talk Turkey, for example.

ver the last few years, Turkish corporations did a lot of borrowing in foreign currencies. Why? Because it was cheaper. As a result, the structure of Turkish corporate liabilities looks something like this, according to Moody’s.

image003-3

Borrowing cheaply in foreign currencies may have seemed a good idea at the time. But a weakening Turkish lira–and it’s been weakening a lot—makes those debts much more difficult to pay back. (The currency is down about 4.4% against the US dollar this year alone. Over the last three months it’s down by about 11%.)

Here’s another look at the same trend, from Morgan Stanley analysts. The takeaway: The emerging market private sector owes a lot of dollar-denominated payments to investors.

image002-5

​Emerging market central banks have been trying to prop up their currencies by raising interest rates, which could work. But those higher interest rates will also make it tough for emerging market corporates, for instance, by acting as a drag on economic growth. (And economic growth in a lot of these countries is already arriving somewhat below overly enthusiastic expectations.)

Problems in the corporate bond market could also scare investors away from government debt purchases in emerging markets. That’s because slowing growth would hurt tax revenues and potentially demand more fiscal spending, both of which would hurt the national balance sheet.

Governments might even be on the hook for the bad debts of certain corporate entities. (Example: The US government nationalized Fannie Mae and Freddie Mac during the US financial crisis.)

Add those to the pile of worries investors have about the fate of the global econom

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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