Schroders
Outlook 2015: Emerging Markets
Debt (Relative)
By James Barrineau, Co-head of Emerging Markets Debt Relative
November 2014

Divergence among the countries that make up the emerging markets sector is
set to continue.

Currency depreciation is likely to be a major theme, particularly in countries linked to
the euro and those impacted by lower commodity prices

Reform-minded politicians could significantly improve the outlook for a number of
countries
“Despite all of its problems, emerging market debt could still produce satisfactory returns when looked at relative to the global fixed income universe.” “Relative to history, currencies are inexpensive and local rates are very attractive relative to developed markets.” Though the asset management industry treats emerging markets as a single entity, those countries that
comprise the grouping continue to go in different directions, a trend that is almost sure to define 2015. The
main drivers of this development—lower commodity prices, divergent monetary policy from major central
banks, and differing responses to their regional impacts—show no signs of abating.
Growing divergence to continue
The universe is almost evenly split between countries with positive and negative trends in the terms of trade,
current account deficits of more than 3%, and real exchange rates above or below their ten year-averages.
So, lower commodity prices will benefit primarily emerging Asia, and hit the rest of the asset class. Even
countries normally viewed as being pillars of policy rectitude like Colombia are facing growing current account
deficits amidst declining terms of trade. More directly-affected oil producers like Nigeria, Venezuela, and
Russia will be under increasing pressure should oil prices stabilize in a low $80 price range. An extended
period of triple-digit oil prices led to a ratcheting up of spending that is now under pressure. On the other
hand, some countries like Chile and Indonesia which are commonly viewed as major commodity exporters, are
actually feeling the benefits of lower oil prices that more than offset the hit from lower prices in commodities
which they primarily export.
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Currency depreciation likely
European emerging markets directly linked to the euro like Poland, Hungary, and Romania will likely endure
an extended period of currency depreciation as the European Central Bank continues its campaign to soften
the euro. Asian countries may decide that they need to follow suit, given the sharp depreciation in the yen. In
Latin America, lower commodities and the stronger dollar will continue to drive currency depreciation there. In
2014 many EM central banks were able to lower interest rates in response to softer global growth. However,
the pressure of lower currency levels will curtail that ability, and should that intensify central banks may be
forced to respond with higher rates even with lower growth prospects.
Grounds for optimism
All is not gloomy, however. A big slate of elections in 2014 have given Indonesia and India reform-minded
leaders who could turn sentiment more positive if political systems can be bent to their agenda. Even in Brazil,
the return of a disappointing incumbent may lead to reforms simply on the back of sheer necessity, as poor
fiscal policy led to a complete reliance on monetary policy that has only exacerbated recessionary growth
prospects. Argentina will almost certainly see a more market-friendly leader in elections in late 2015.
Despite its problems, emerging market debt could still produce satisfactory returns when looked at relative to
the global fixed income universe. Most of emerging market debt is investment gradei and is trading at
average spreads relative to US Treasuries. Yet in a world where German ten-year bunds yield below 1%,
European high yield is at about 4%, and US high yield is at about 5% (with a large component at risk in energy
issuers), the yields on emerging market debt look attractive.
Non-investment grade dollar bonds are likely to struggle, however. The sovereign universe here is stressed oil
producers like Venezuela and Nigeria which are likely to be forced to adjust currency regimes and fiscal
policies or face potential crises. Corporate non-investment gradeis also heavily exposed to commodities.
Corporate issuers with dollar liabilities and local currency revenues are likely to face continued pressure.
Local currency investing will continue to be out of favour as the strong dollar story steams along. However,
relative to history, currencies are inexpensive and local rates are very attractive relative to developed markets.
There will certainly come a time when this combination attracts investors, but this likely requires stabilization in
commodities and more clarity on developed market monetary policy endgames.
Important Information:
The views and opinions contained herein are those of James Barrineau, Co‐head of Emerging Markets Debt Relative and may not necessarily represent views expressed or reflected in other Schroders
communications, strategies or funds.
This document is intended to be for information purposes only and it is not intended as promotional material in any respect.
The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is
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Information herein is believed to be reliable but Schroder Investment Management Ltd (Schroders) does not warrant its
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from time to time) or any other regulatory system. Schroders has expressed its own views and opinions in this document
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i highest quality bonds as assessed by a credit ratings agency, rated at least BBB by Standard& Poor's or Baa3 by
Moody's’
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