Emerging markets are becoming an increasingly important part of the global landscape. For example, emerging economies now account for considerably more than half of the global economic output1. In comparison with the developed world, emerging nations are posting substantially more robust growth, while their gross debt ratios as a proportion of GDP – at an average of 53% – are significantly lower than those of their developed world counterparts, which average some 103%. This positive trend on the macroeconomic front looks set to be maintained, creating a fertile environment for corporate bonds in these nations. This should continue to open up exciting opportunities for investors.
Positive rating trend continues
Looking back, it is evident that emerging markets have exhibited a positive rating trend in the global context. While positive macroeconomic factors have helped in this regard, so too has the general willingness to implement reforms. Emerging markets have already undergone various economic cycles and know what it means to withstand a crisis. Numerous emerging economies have implemented key reforms to strengthen their systems and are likely to continue to do so going forward. As a result, the positive rating trend should remain intact in future.
Focus on hard-currency corporate bonds
The fundamental factors outlined above provide the essential bedrock for the respective countries’ corporate bonds. Rating upgrades at the country level also benefit fundamentally strong companies that are strategically relevant and have close links to the state. Owing to the methodology used by the rating agencies and the country ceiling, corporates cannot generally be awarded a rating higher than the respective sovereign. However, in the case of businesses with global operations or large firms with very strong fundamentals, the rating agencies exercise a certain degree of discretion and may award the company in question a higher – by a limited number of notches – rating than the respective country. This in itself is especially likely to pique investors’ interest. If certain companies were headquartered in a developed nation with a higher credit rating than that of their own developing market, they would be given a correspondingly better rating. As a result, investors can benefit from the higher spreads of emerging market corporates with strong fundamentals. Demand has indeed picked up in recent years, while on the supply side the market has posted strong growth and the diversification in the number of issuers, sectors and maturities has continually increased. In the past, many emerging market companies refinanced their bank loans on the international capital market and have since been active on the primary market. The market in hard-currency corporate bonds from emerging nations is now bigger than that of European or US high-yield issuers. If we include emerging market hard-currency government bonds as well as corporate paper, the volume runs to half that of the US investment-grade market and actually exceeds the European investment-grade universe.