The EM Default Picture: More Nuanced Than Headlines Imply
In some ways, the challenges confronting EMs in the short to medium term are similar to those faced by their developed market (DM) counterparts. Health and wellness are front and center in this regard, as COVID-19 shows no preference for the population of Germany over that of Algeria. And no matter how you slice it, both EMs and DMs are facing financial distress in the vast majority of sectors. With locked-down businesses and stay-at-home orders still largely in effect, virtually every economy globally is feeling the pain.
But EMs are also grappling with a unique set of obstacles. For one, many rely heavily on tourism—as opposed to it being an ancillary industry in most developed market economies—for which revenue streams have all but dried up. Many also rely on remittances from their migrant populations living in foreign countries, which may be threatened by rising unemployment. Some countries also depend greatly on oil—and the decline in prices has created a tough reality for a number of EM exporters in particular. EMs are further disadvantaged by the fact that they do not have reserve currency status (i.e. their currencies, unlike the USD or EUR, are not held in significant quantities by central banks or other monetary authorities as part of foreign exchange reserves), and therefore are on the other side of ‘flight to safety’ trades. And finally, the financial firepower of EM central banks is quite limited relative to their DM counterparts, meaning they have less capacity to conduct ‘shock and awe’ monetary stimulus programs.
However, contrary to what some headlines may suggest, these challenges do not necessarily translate into an inevitable and widespread spike in defaults. EM economies are slowing as a result of the crisis, certainly, and we will unquestionably see defaults increase as a result. But not all countries and companies will be impacted to the same extent—and understanding the complex factors driving the default picture will be key to identifying the issuers that are best-positioned to withstand the current shock.