William Gamble
The long and short of emerging market debt

At this point in the business cycle, emerging market debt looks very attractive, but the lesson of the recent crash is that no investment is free from risk

Emerging market debt. Quite recently the idea seemed to involve quite a bit of risk. After all, investments in debt or fixed income investments are supposed to be conservative investments without either the risk or the volatility of equities. Emerging markets are supposed to involve a great deal of volatility, currency, and political risk. How could they become so respectable? One word: Greece.

  In contrast to Greece, the balance sheets of many emerging markets look quite strong. While both Italy and Japan have debt to GDP ratios above 100%, almost 200% in the case of Japan, the debt of Brazil, Turkey, Mexico, Poland and even South Africa are below 50%. Tony Crescenzi of PIMCO put it very simply, “investors are asking themselves, ‘Would I rather lend money to nations whose debt burden is worsening, or to nations where it is improving?’ ”

  Not only are the balance sheets often stronger, the yields are as well. For 10-year bonds, the bid price for Mexico is 3.95%, for Brazil it is 4.19%. Ten-year bonds in the US are yielding only 2.43% and Japan’s 10-year JGB yield is only 0.62%.

  But what are the risks? First there is the currency risk. In the past unstable emerging market economies produced high inflation and volatile currencies. Often they would borrow in dollars, which caused a crisis if their currencies fell. Today the situation may be reversed. The credit ratings of many emerging markets are good enough to allow them to borrow in their own currencies.

  The currency risks have also changed. Much has been written about the undervalued renminbi, it is not alone. The Economist’s most recent Big Mac index, a measure of currency valuations according to purchasing power parity, showed that several emerging markets including Mexico and Indonesia have substantially undervalued currencies. So if anything there is the potential for currency appreciation.

  Inflation has always been a headache for emerging markets. Governments would often follow unsustainable development and social programs financed by international borrowing and printing money. Again it appears that the situation is reversed, as central banks in developed countries follow extraordinary loose monetary policies to avoid a nasty recession. Emerging market central banks have looked positively responsible in contrast although inflation numbers in China, Brazil and India are causing concern.

  But there are other risks including trying to determine the risk. The Greek crisis was certainly exacerbated by dodgy accounting. According to Pierre Cailleteau of Moody’s, a rating agency, “The state of public-finance accounting is extremely rudimentary relative to private-sector accounting.” Greece is subject to EU rules, has a democratic government and a free press. Legal institutions that allow for access to accurate information simply do not exist in many emerging markets, so the optimistic numbers may only give the illusion of solvency. The reality may be quite different.

  It is not only information about governments that creates risk in emerging markets. It is the governments themselves. In developed markets, according to a recent study, increased government interference in the economy resulted in less efficient use of resources. For each percentage-point increase in the share of GDP devoted to government spending, growth was reduced by 0.12%-0.13% a year.

Emerging markets like India, China and Russia are dominated by the government. In all of these countries the government sector is over 50% of the economy. So the present fiscal situation could change rapidly.

  In fact it is already changing. Due to the demand, emerging market corporate and sovereign bonds have been issued at a record pace. They are 10% above 2009, itself a record year. This new debt may cause problems because of the nature of debt itself.

  In game theory a debtor’s best move is to not pay back the creditor. Debtors do so for only two reasons: the law and reputation. An enforced law can require a debtor to repay. Without law, creditors must rely on reputation. If debtors get a bad reputation then they cannot borrow in the future.

  The problem with sovereign debt is that governments make the law, so collecting from defaulters like Argentina has been exceptionally difficult. Usually some sort of structured settlement is necessary similar to what is taking place with Dubai World.

  Private companies are worse. The Guangdong International Trust and Investment Corp (GITIC) in China returned probably less than 2% to its creditors. More recently, the creditors of Asia Aluminum also in China may have to wait a long time to see anything. Despite these risks, emerging market corporate borrowing now makes up about three-quarters of emerging market bond issuance, up from just over half before the financial crisis. Ominously the issuers are led by Chinese companies.

  Investors want a return on their investments, but it is more important that they get their investments returned. At this point in the business cycle, emerging market debt looks very attractive, but the lesson of the recent crash is that no investment is free from risk. 

 (The writer is president of Emerging Market Strategies and can be contacted at [email protected] or [email protected]).


Hindustan Times: Nice idea, same product

The TV commercials for the newspaper are a classic case of good advertising for a not-so deserving product

I actually quite like the Hindustan Times TV commercials. The newspaper has allegedly revamped itself, and is increasingly trying to raise social, local issues, and therefore its new ad line is: 'It is time for change'. In all the short TVCs, a rolled-up HT edition is used as an assault weapon. A cool brand memory device, and the point of 'change' made without being preachy and serious. And because the idea is so simple and extendable, a thousand TVCs can be made at very little cost. Good stuff. Young viewers will get hooked on to this campaign.

Some commercials were released late last year, and now they have come up with two more. Though I think they need to create a lot many, and up the frequency if they desire big impact. One deals with a typical traffic jam caused by drivers of two vehicles that crash into each other (a regular occurrence in Mumbai). And as the two gents fight and seek each other's blood, an onlooking feisty lady arrives on the scene and whacks the two with an HT.

 Another commercial deals with the issue of wastage of power and water. So when the daughter leaves the air-conditioner running, she gets thwacked by the dad. And when the dad leaves the tap water running, she strikes him with an HT. So, good show. Nothing extraordinary about the ads (the lady intervening with the road-rage ridden dudes is predictable), but the point of change and involvement gets made. Some would say a better brand connect might have been ideal (like 'The Economist' ads attempt to do), but I disagree. HT is a mass newspaper, and a serious, rational approach would kill the idea. And alienate youngsters.

However, the proof of the pudding is in the eating, as the cliché goes. On that score, the newspaper leaves you a tad disappointed. The content is pretty much the same. Okay, so they have a new section or two, but nothing that's not been done before, I don't smell freshness. In fact, I read the Times of India first, followed by the HT, each morning. And I find 90% of the content to be the same. It's much too me-too.

The HT editors, especially for their Mumbai edition, where the newspaper has made a late entry, need to think seriously off-beat. If they hope for a sustained connect with the impatient Gen X. Right now, it's a classic case of good advertising for a not-so deserving product.


Riding High

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